The Phoenix Companies, Inc. (NYSE:PNX)
Q2 2014 Earnings Conference Call
August 15, 2014 10:00 a.m. ET
James Wehr – President and Chief Executive Officer
Bonnie Malley – Executive Vice President and Chief Financial Officer
Peter Hofmann - EVP, Strategy & Business Development
Naomi Kleinman – Head of Investor Relations
Welcome to the Phoenix financial and business update conference call. Thank you for standing by. All participants will be in a listen-only mode. This call is being recorded. If you have any objections you may disconnect at this time. I will now turn the call over to the head of Phoenix Investor Relations, Naomi Kleinman. Thank you. You may begin.
Thank you, Jane. Good morning and thank you for joining us. I’m going to start with the required disclosures and then turn it over to Jim Wehr, our President and CEO; and Bonnie Malley, our CFO. The presentation for this call is available on our website at phoenixwm.com, along with our 2013 annual report on Form 10-K and news releases summarizing 2013 results and second quarter 2014 statutory results and operating metrics. Today’s call will be listen-only and we expect to keep this morning until we have current GAAP financial results to discuss.
Slide 2 of the presentation contains 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 August 15, 2014 news earnings release and our latest SEC filings. Our actual results may differ materially from such forward-looking statements. We assume no obligation to update these statements. In addition to Generally Accepted Accounting Principles, we use non-GAAP financial measures such as the statutory financial results of our insurance company subsidiaries to evaluate our performance. Please note that statutory results of our insurance company subsidiaries are not indicative of and are not a replacement for our consolidated GAAP results, and that variances between the statutory financial results of our insurance company subsidiaries and their or our GAAP financial information are likely to be material.
Now I'll turn the call over to Jim.
Good morning everyone and thanks, Naomi. We appreciate your taking the time to join us today. Please turn to Slide 3 and we’ll review the agenda for today’s call. First, I'll address this week’s rating action by S&P. Second, Bonnie will review our revised filing schedules, which put us on track to becoming a current SEC filer in December and she’ll discuss how our remediation plans are progressing. She’ll also take you through our 2013 GAAP and second quarter 2014 statutory results. Finally, I'll come back at the end to take a look at growth in our annuity business and Saybrus.
Let me start with ratings. Earlier this week, S&P lowered our financial strength ratings one notch, citing their updated projections of Phoenix’s capital and earnings. At the same time, they affirmed our senior debt ratings. They have placed our ratings on credit watch with negative implications in May. It’s S&P’s practice to resolve credit watch outlooks within 60 to 90 days, and S&P took action within that time period. As we’ve stated in our news release on Tuesday, we don’t agree with S&P’s opinion of Phoenix’s financial strength. Our statement is available on our website. At the heart of our disagreement is the tangible progress we’ve made since they last changed our financial strengths ratings in 2010. Since then, Phoenix has taken a number of actions to strengthen our balance sheet and grow our business.
Slide 4 provides several key metrics that demonstrate enterprise-wide improvement. Statutory surplus and AVR are up 31% to $752 million. We have enhanced financial flexibility with over $100 million of excess capital at our holding company. Our investment portfolio is stronger with present impairments at record low levels. Our surrender rates are at or better than historic norms with our life insurance surrender rates improving from 9.8% to 3.9% since 2009 and the closed block surrender rate improving from 9.7% to 3.6% during the same period. We’ve built a strong base in the middle market with annuity sales of $371 million for the year through June, up 7% from the first half of 2013. And we established Saybrus in the fourth quarter of 2009 and it is now profitable and growing.
It's worth noting that we’ve accomplished a lot of this while operating in a very difficult environment, including low ratings. The reality is ratings have been a headwind, but we’ve made significant progress despite them. Our financial condition has improved and our repositioned businesses are strong and growing. Our ratings are very important to us and this latest action by S&P will make our jobs more challenging. We can’t control what the rating agencies do, but we know what works in this type of situation, which is to stay focused on our current priorities. These include executing our middle marketing strategy, growing our successful distribution business, becoming a current SEC filer and remediating our control weaknesses.
I'm going to turn the call over to Bonnie to review our filing schedule and financial results. Bonnie?
Thanks Jim. Please turn to Slide 5. After filing our 2012 10-K on April 1, we revisited our overall filing schedule for both Phoenix and PHL Variable, and made some adjustments based on our experience completing 2012. Earlier this month, the SEC approved an amended order containing our revised filing timetable. We met the first of these new dates with the filing of the Phoenix 2013 10-K on August 6. We anticipate staying on track with the filing of our 2013 10-Qs in September, the first and second quarter of 2014 in October and becoming current in December when we file our third quarter 2014 10-Q.
The PHL Variable filings are on a similar track with deadlines that follow those for Phoenix. As you know, we reported a number of material weaknesses and outlined remediation plans when we filed our 2012 10-K. As we previewed on our call in April, we carried these material weaknesses forward into our 2013 10-K filings due to lack of time to do any significant remediation between the two filings.
Remediation is an enterprise wide priority. We’ve made progress in a number of areas and are currently developing a more comprehensive plan. In the meantime, we’ve taken steps to strengthen our finance skills, capabilities and control environments. These include hiring a new Chief Risk Officer and a new Head of Internal Audit while adding new GAAP accounting and actuarial expertise and enhancing our control governance structure. We will keep you updated on our progress on these critical initiatives.
Now let’s turn to 2013 GAAP results on Slide 6. Net income for 2013 was $5.1 million compared with a net loss of $168.5 million for 2012. The most significant driver in 2013 was a positive unlock of $108.1 million resulting from the company’s annual actuarial assumption review. The unlock was based primarily on improved mortality assumptions, partially offset by decreased premium persistency assumptions primarily in the universal life block. We also recorded restatement expenses and audit fees of $88.6 million. This included $62.9 million of restatement expenses incurred during 2013 and $25.7 million of fees related to the 2013 audit. In addition, we converted actuarial models for several blocks of business and as a result of these conversions we increased reserves by approximately $20 million in 2013.
I know many investors want a sense of the future earnings rate of the company. We are not prepared to speak to that today, but I’d like to share several observations. First, the closed block has been and continues to be a stable source of earnings, contributing $25.2 million to earnings in 2013. Second, in the course of restatement, we changed our GAAP accounting model for two blocks of business; Fixed Index Annuities and Universal Life. The models impact the pattern of earnings for these products. Most notably the profits followed by losses model for UL moves out the impact of short term mortality. Although mortality is still an important fundamental of the business, we do not expect to see as much mortality driven volatility in our earnings as we’ve had in the past. Finally, I also want to mention that we expect to have additional expenses as we complete our remediation work, although they will decline over time. At the same time, we will continue to manage overhead expenses going forward.
Our 2013 operating metrics did not change materially from the estimated results we discussed on our last call so we won’t discuss them today. I’ll just note that mortality, policy holder persistency, and investment results were solid for the year and we had about $700 million in annuity sales.
Turning to slide seven, let’s take a look at the balance sheet at year end 2013. Total assets and liabilities did not change significantly during 2013 and the 14% increase in stockholders equity was largely attributable to comprehensive income. The decline in the market value of the securities was more than offset by the decrease in the unfunded pension liability. Our leverage remains stable at 33%.
Slide eight provides information on our investment portfolio. We are primarily a fixed income investor, but have continued to allocate funds to private equity. The company has benefited from the good long term track record of this asset class. From a fixed income perspective, our below investment grade bond exposure has declined since its peak during the financial crisis and as of yearend 2013 was 7.3% of total bonds. Our target range for below investment grade bonds is 6% to 10% and will manage our exposure in a targeted fashion that reflects relative valuation. The level of impairments has been below historic norms for the three years. In 2013 impairments were only $12.3 million versus average expected default experience of about $35 million annually. Although we’ve not closed our GAAP books in 2014, the trend of low impairments has continued and is reflected in our statutory results.
Turning to slide 9, I’ll touch on the Life Company’s statutory results we reported today. Statutory surplus and AVR was up $16.5 million in the first six months of the year, and that’s after paying $26.5 million in dividends to the holding company and recording $31 million in net negative prior period adjustments. Estimated RBC was 333% at June 30, compared with 337% at year-end 2013. The impact of lower interest rates on required capital more than offset the increase in surplus.
We had a $39.2 million net gain from operations for the six months of the year for Phoenix Life, which equates to the current dividend capacity for 2015. Phoenix Life had a statutory net loss from operations of $4.6 million and a statutory net loss of $4.1 million for the second quarter, compared with a $43.8 million statutory net gain from operations and statutory net income of $47.6 million in the first quarter of 2014. The change was driven by less favorable mortality, higher expenses and lower investment income.
As I mentioned we paid dividends of $26.5 million to the holding company year-to-date. Our remaining dividend capacity is $32.2 million for 2014. As a reminder, the Life Company has paid the maximum permitted dividend to the holding company for the last several years to optimize our financial flexibility. The holding company can use these funds for a number of purposes, including returning capital to the Life subsidiary.
As of June 30, holding company liquidity was $154.4 million, more than $100 million in excess of our base line of $50 million, which represents 2 years of holding company expenses. Because we have excess holding company liquidity, we also look at RBC on an adjusted basis to incorporate it. Adjusted RBC was 374% as of June 30, 2014.
Finally I want to touch on our capital management which is an important part of our strategy. As you know, we have been excluded from certain capital management actions due to the reinstatement. Once we catch up on our fillings, we will evaluate our capital management options and share our plans with you.
And with that I will turn it back to Jim to discuss sales trends in our Annuity business and momentum at Saybrus.
Thanks Bonnie. Despite the significant distraction of the reinstatement and catch up, we have remained focused on the business and our results show it. Slide 10 shows growth trends in both Annuities and Saybrus. In terms of the Annuity business, we’re pleased to see the success our wholesalers are having as Phoenix products continue to gain traction in the marketplace. We’ve structured our product portfolio to provide benefits that meets our clients’ retirement planning needs.
Our product portfolio today crosses the spectrum of accumulation, income, critical care and asset transfer planning. Annuity deposits were $201 million in the second quarter of 2014 compared to $174 million in the second quarter of 2013. So we’ve seen healthy sales growth in Annuities this year. However, as everyone knows this is a rate sensitive product and the downward trend in interest rates has put negative pressure on contribution dollars from this segment. As we move forward, we’ll continue to manage the balance between growth and profitability in this business.
Saybrus continues to grow revenue and had record quarterly earnings in our quarter that is typically not one of its strongest quarters. Third party paid premiums and submitted applications are trending up in all channels. We’re very pleased with the continued growth of Saybrus.
In closing, you can see from our 2013 GAAP results and our second quarter metrics that we continue to make real progress, although we still have more to do. We’ll be sharing a lot of additional information as we catch up on SEC filings over the next several months and hold our annual meeting on November 20. In December, we expect to have current GAAP financials out in the marketplace, something I know everyone has been waiting for. We look forward to being able to discuss our results with you on a real time basis and resume our normal conference call format of taking your questions. Thank you for joining us today and for your time and attention.
[There was no Q&A Session for this presentation]
That does conclude today’s conference. Thank you for participating. You may now disconnect at this time.
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