PLC 10Q 3-31-06



 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
 
 
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the quarterly period ended March 31, 2006
 
or
 
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the transition period from ________ to _______
 
 
 
Commission File Number 001-11339
 
Protective Life Corporation
(Exact name of registrant as specified in its charter)
 
Delaware
(State or other jurisdiction of incorporation or organization)
 
95-2492236
(IRS Employer Identification No.)
 
2801 Highway 280 South
Birmingham, Alabama 35223
(Address of principal executive offices and zip code)
 
(205) 268-1000
(Registrant's telephone number, including area code)
 _________________
 
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 [ ]
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer ý     Accelerated Filer o     Non-accelerated filer o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [ X ]
 
Number of shares of Common Stock, $0.50 par value, outstanding as of May 9, 2006: 69,889,419
 




PROTECTIVE LIFE CORPORATION
Quarterly Report on Form 10-Q
For Quarter Ended March 31, 2006
 
INDEX
 
 
 
Part I.
Financial Information:
 
Item 1.
Financial Statements (unaudited):
 
 
Consolidated Condensed Statements of Income for the
 
Three Months ended March 31, 2006 and 2005
 
 
Consolidated Condensed Balance Sheets as of March 31, 2006
 
and December 31, 2005
 
 
Consolidated Condensed Statements of Cash Flows for the
 
Three Months ended March 31, 2006 and 2005
 
 
Notes to Consolidated Condensed Financial Statements
 
 
   
Item 2. 
Management’s Discussion and Analysis of Financial Condition
 
and Results of Operations
 
   
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
 
   
Item 4.
Controls and Procedures
 
   
Part II.
Other Information:
 
Item 1A.
Risk Factors
 
     
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
 
   
Item 6.
Exhibits
 
   
   
Signature 
 
   
   



 


PROTECTIVE LIFE CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
(Dollars in thousands except per share amounts)
(Unaudited)



   
Three Months Ended
   
March 31
     
2006
2005

Revenues
Gross premiums and policy fees
 
$
507,694
 
$
468,514
 
Reinsurance ceded
   
(280,670
)
 
(282,152
)
Net premiums and policy fees
   
227,024
   
186,362
 
Net investment income
   
299,065
   
287,953
 
Realized investment gains (losses):
Derivative financial instruments
   
13,337
   
(6,368
)
All other investments
   
5,153
   
27,878
 
Other income
   
48,536
   
44,284
 
Total revenues
   
593,115
   
540,109
 
Benefits and expenses
Benefits and settlement expenses, net of reinsurance ceded:
(three months: 2006 - $256,558; 2005 - $265,363)
   
349,608
   
300,434
 
Amortization of deferred policy acquisition costs
   
50,031
   
74,251
 
Other operating expenses, net of reinsurance ceded:
(three months: 2006 - $46,291; 2005 - $36,874)
   
82,819
   
73,554
 
Total benefits and expenses
   
482,458
   
448,239
 
Income before income tax
   
110,657
   
91,870
 
Income tax expense
   
38,520
   
31,787
 
Net income
 
$
72,137
 
$
60,083
 
 
Net income per share - basic
 
$
1.02
 
$
0.85
 
Net income per share - diluted
 
$
1.01
 
$
0.84
 
Cash dividends paid per share
 
$
0.195
 
$
0.175
 
Average shares outstanding - basic
   
70,752,202
   
70,474,337
 
 
Average shares outstanding - diluted
   
71,559,255
   
71,273,760
 


See Notes to Consolidated Condensed Financial Statements

 
 


PROTECTIVE LIFE CORPORATION
CONSOLIDATED CONDENSED BALANCE SHEETS
(Dollars in thousands)
(Unaudited)

 
March 31
December 31
 
2006
2005

Assets
Investments:
Fixed maturities, at market (amortized cost: 2006 - $15,008,192; 2005 - $15,172,482)
 
$
14,965,927
 
$
15,472,386
 
Equity securities, at market (cost: 2006 - $117,678; 2005 - $114,994)
   
123,536
   
121,012
 
Mortgage loans on real estate
   
3,411,337
   
3,287,745
 
Investment in real estate, net of accumulated depreciation (2006 - $479; 2005 - $1,009)
   
63,858
   
72,932
 
Policy loans
   
456,147
   
458,825
 
Other long-term investments
   
269,345
   
279,676
 
Short-term investments
   
833,567
   
776,139
 
Total investments
   
20,123,717
   
20,468,715
 
Cash
   
37,118
   
83,670
 
Accrued investment income
   
198,708
   
189,038
 
Accounts and premiums receivable, net of allowance for uncollectible amounts
(2006 - $2,125; 2005 - $2,149)
   
59,236
   
82,080
 
Reinsurance receivables
   
3,146,444
   
3,020,685
 
Deferred policy acquisition costs
   
2,332,639
   
2,171,988
 
Goodwill
   
49,423
   
49,423
 
Property and equipment, net
   
45,941
   
47,010
 
Other assets
   
144,855
   
140,124
 
Income tax receivable
   
96,443
   
85,807
 
Assets related to separate accounts
Variable annuity
   
2,447,968
   
2,377,124
 
Variable universal life
   
269,532
   
251,329
 
   
$
28,952,024
 
$
28,966,993
 
Liabilities
Policy liabilities and accruals
 
$
12,214,590
 
$
11,895,145
 
Stable value product account balances
   
5,873,092
   
6,057,721
 
Annuity account balances
   
3,330,897
   
3,388,005
 
Other policyholders' funds
   
147,470
   
147,921
 
Other liabilities
   
893,828
   
968,403
 
Deferred income taxes
   
280,219
   
317,317
 
Non-recourse funding obligations
   
150,000
   
125,000
 
Liabilities related to variable interest entities
   
442,383
   
448,093
 
Long-term debt
   
473,032
   
482,532
 
Subordinated debt securities
   
324,743
   
324,743
 
Liabilities related to separate accounts
Variable annuity
   
2,447,968
   
2,377,124
 
Variable universal life
   
269,532
   
251,329
 
     
26,847,754
   
26,783,333
 
Commitments and contingent liabilities - Note 2
             
Share-owners' equity
Preferred Stock, $1 par value, shares authorized: 4,000,000; Issued: None
Common Stock, $.50 par value, shares authorized: 2006 and 2005 -160,000,000
shares issued: 2006 and 2005 - 73,251,960
   
36,626
   
36,626
 
Additional paid-in capital
   
441,964
   
440,475
 
Treasury stock, at cost (2006 - 3,366,616 shares; 2005 - 3,557,911 shares)
   
(12,079
)
 
(12,765
)
Unallocated stock in Employee Stock Ownership Plan
(2006 - 377,616 shares; 2005 - 480,356 shares)
   
(1,231
)
 
(1,610
)
Retained earnings
   
1,674,232
   
1,615,714
 
Accumulated other comprehensive income (loss):
Net unrealized gains (losses) on investments, net of income tax:
(2006 - $(21,384); 2005 - $57,649)
   
(40,276
)
 
104,489
 
Accumulated gain - hedging, net of income tax: (2006 - $2,673; 2005 - $394)
   
5,034
   
731
 
     
2,104,270
   
2,183,660
 
   
$
28,952,024
 
$
28,966,993
 


See Notes to Consolidated Condensed Financial Statements

 
 


PROTECTIVE LIFE CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)

 
Three Months Ended
 
March 31
 
2006
2005

Cash flows from operating activities
Net income
 
$
72,137
 
$
60,083
 
Adjustments to reconcile net income to net cash provided by operating activities:
Realized investment (gains) losses
   
(5,153
)
 
(27,878
)
Amortization of deferred policy acquisition costs
   
50,031
   
74,251
 
Capitalization of deferred policy acquisition costs
   
(97,740
)
 
(98,528
)
Depreciation expense
   
3,349
   
4,049
 
Deferred income tax
   
40,278
   
(514
)
Accrued income tax
   
(14,353
)
 
16,818
 
Interest credited to universal life and investment products
   
189,714
   
175,257
 
Policy fees assessed on universal life and investment products
   
(119,662
)
 
(96,921
)
Change in reinsurance receivables
   
(125,759
)
 
(85,719
)
Change in accrued investment income and other receivables
   
13,174
   
(12,123
)
Change in policy liabilities and other policyholders' funds
of traditional life and health products
   
262,294
   
157,719
 
Net change in trading securities
   
7,294
   
477
 
Change in other liabilities
   
(53,336
)
 
344,564
 
Other, net
   
(11,616
)
 
5,529
 
Net cash provided by operating activities
   
210,652
   
517,064
 
Cash flows from investing activities
Investments available for sale:
             
Maturities and principal reductions of investments
             
Fixed maturities
   
265,542
   
422,149
 
Equity securities
   
0
   
94
 
Sale of investments
             
Fixed maturities
   
2,076,761
   
1,026,940
 
Equity securities
   
1,858
   
3,099
 
Cost of investments acquired
             
Fixed maturities
   
(2,180,522
)
 
(2,474,119
)
Equity securities
   
(1,706
)
 
(16,057
)
Mortgage loans:
             
New borrowings
   
(262,617
)
 
(131,113
)
Repayments
   
141,448
   
92,263
 
Change in investment real estate, net
   
15,736
   
1,540
 
Change in policy loans, net
   
2,678
   
10,316
 
Change in other long-term investments, net
   
18,420
   
2,854
 
Change in short-term investments, net
   
(70,500
)
 
275,276
 
Purchase of property and equipment
   
(1,093
)
 
(2,695
)
Net cash provided by (used in) investing activities
   
6,005
   
(789,453
)
Cash flows from financing activities
             
Borrowings under line of credit arrangements and long-term debt
   
13,000
   
0
 
Principal payments on line of credit arrangement and long-term debt
   
(22,500
)
 
(9
)
Payments on liabilities related to variable interest entities
   
(5,710
)
 
(513
)
Issuance of non-recourse funding obligations
   
25,000
   
0
 
Dividends to share owners
   
(13,620
)
 
(12,181
)
Investment product deposits and change in universal life deposits
   
486,646
   
734,458
 
Investment product withdrawals
   
(748,801
)
 
(652,232
)
Excess tax benefits on stock based compensation
   
2,403
   
0
 
Other financing activities, net
   
373
   
125,943
 
Net cash provided by (used in) financing activities
   
(263,209
)
 
195,466
 
Change in cash
   
(46,552
)
 
(76,923
)
Cash at beginning of period
   
83,670
   
130,596
 
Cash at end of period
 
$
37,118
 
$
53,673
 



See Notes to Consolidated Condensed Financial Statements

 
 
 


PROTECTIVE LIFE CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Unaudited)
(Dollar amounts in tables are in thousands, except per share amounts)


1.  Basis of Presentation

The accompanying unaudited consolidated condensed financial statements of Protective Life Corporation and its subsidiaries (the "Company") have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the disclosures required by GAAP for complete financial statements. In the opinion of management, the accompanying financial statements reflect all adjustments (consisting only of normal recurring items) necessary for a fair statement of the results for the interim periods presented. Operating results for the three-month period ended March 31, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. The year-end consolidated condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP. For further information, refer to the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2005.

Certain reclassifications have been made in the previously reported financial statements and accompanying notes to make the prior period amounts comparable to those of the current period. Such reclassifications had no effect on previously reported net income or share-owners' equity.


2. Commitments and Contingent Liabilities

The Company is contingently liable to obtain a $20 million letter of credit under indemnity agreements with its directors. Such agreements provide insurance protection in excess of the directors’ liability insurance in force at the time up to $20 million. Should certain events occur constituting a change in control of the Company, the Company must obtain the letter of credit upon which directors may draw for defense or settlement of any claim relating to performance of their duties as directors. The Company has similar agreements with certain of its officers providing up to $10 million in indemnification that are not secured by the obligation to obtain a letter of credit.

Under insurance guaranty fund laws, in most states insurance companies doing business therein can be assessed up to prescribed limits for policyholder losses incurred by insolvent companies. The Company does not believe such assessments will be materially different from amounts already provided for in the financial statements. Most of these laws provide that an assessment may be excused or deferred if it would threaten an insurer's own financial strength.

A number of civil jury verdicts have been returned against insurers and other providers of financial services involving sales practices, alleged agent misconduct, failure to properly supervise representatives, relationships with agents or persons with whom the insurer does business, and other matters. Increasingly these lawsuits have resulted in the award of substantial judgments that are disproportionate to the actual damages, including material amounts of punitive and non-economic compensatory damages. In some states, juries, judges, and arbitrators have substantial discretion in awarding punitive and non-economic compensatory damages which creates the potential for unpredictable material adverse judgments or awards in any given lawsuit or arbitration. Arbitration awards are subject to very limited appellate review. In addition, in some class action and other lawsuits, companies have made material settlement payments. The Company, like other financial services companies, in the ordinary course of business, is involved in such litigation and in arbitration. Although the outcome of any such litigation or arbitration cannot be predicted, the Company believes that at the present time there are no pending or threatened lawsuits that are reasonably likely to have a material adverse effect on the financial position, results of operations, or liquidity of the Company.


3. Operating Segments

The Company operates several business segments each having a strategic focus. An operating segment is generally distinguished by products and/or channels of distribution. A brief description of each segment follows:

·  
The Life Marketing segment markets level premium term and term-like insurance (collectively “traditional life”), universal life, variable universal life and bank owned life insurance (“BOLI”) products on a national basis primarily through networks of independent insurance agents and brokers, stockbrokers, and independent marketing organizations.

·  
The Acquisitions segment focuses on acquiring, converting, and servicing policies acquired from other companies. The segment's primary focus is on life insurance policies sold to individuals.

·  
The Annuities segment manufactures, sells, and supports fixed and variable annuity products. These products are primarily sold through stockbrokers, but are also sold through financial institutions and independent agents and brokers.

·  
The Stable Value Products segment sells guaranteed funding agreements (“GFAs”) to special purpose entities that in turn issue notes or certificates in smaller, transferable denominations. The segment also markets fixed and floating rate funding agreements directly to the trustees of municipal bond proceeds, institutional investors, bank trust departments, and money market funds. Additionally, the segment markets guaranteed investment contracts (“GICs”) to 401(k) and other qualified retirement savings plans.

·  
The Asset Protection segment primarily markets extended service contracts and credit life and disability insurance to protect consumers’ investments in automobiles and watercraft. In addition, the segment markets an inventory protection product and a guaranteed asset protection (“GAP”) product.

The Company has an additional segment referred to as Corporate and Other. The Corporate and Other segment primarily consists of net investment income and expenses not attributable to the segments above (including net investment income on unallocated capital and interest on debt). This segment also includes earnings from several small non-strategic lines of business (primarily cancer insurance, residual value insurance, surety insurance, and group annuities), various investment-related transactions, and the operations of several small subsidiaries.

The Company uses the same accounting policies and procedures to measure segment operating income and assets as it uses to measure its consolidated net income and assets. Segment operating income is generally income before income tax excluding net realized investment gains and losses (net of the related amortization of deferred policy acquisition costs and participating income from real estate ventures). Periodic settlements of derivatives associated with corporate debt and certain investments and annuity products are included in realized gains and losses but are considered part of operating income because the derivatives are used to mitigate risk in items affecting consolidated and segment operating income. Segment operating income represents the basis on which the performance of the Company’s business is internally assessed by management. Premiums and policy fees, other income, benefits and settlement expenses, and amortization of deferred policy acquisition costs are attributed directly to each operating segment. Net investment income is allocated based on directly related assets required for transacting the business of that segment. Realized investment gains (losses) and other operating expenses are allocated to the segments in a manner that most appropriately reflects the operations of that segment. Investments and other assets are allocated based on statutory policy liabilities, while deferred policy acquisition costs and goodwill are shown in the segments to which they are attributable.

There are no significant intersegment transactions.

 
The following tables summarize financial information for the Company’s segments. Asset adjustments represent the inclusion of assets related to discontinued operations.

   
Three Months Ended
March 31
 
   
2006
 
2005
 
   
(Dollars in thousands)
 
Revenues
         
Life Marketing
 
$
218,925
 
$
163,732
 
Acquisitions
   
101,451
   
102,546
 
Annuities
   
63,796
   
93,178
 
Stable Value Products
   
77,379
   
74,494
 
Asset Protection
   
65,149
   
65,078
 
Corporate and Other
   
66,415
   
41,081
 
Total revenues
 
$
593,115
 
$
540,109
 
               
Segment Operating Income
             
Life Marketing
 
$
40,781
 
$
39,141
 
Acquisitions
   
19,906
   
21,035
 
Annuities
   
4,741
   
4,064
 
Stable Value Products
   
12,344
   
14,399
 
Asset Protection
   
8,738
   
6,172
 
Corporate and Other
   
11,663
   
11,645
 
Total segment operating income
   
98,173
   
96,456
 
               
Realized investment gains (losses) - investments(1)
   
(173
)
 
5,466
 
Realized investment gains (losses) - derivatives(2)
   
12,657
   
(10,052
)
Income tax expense
   
(38,520
)
 
(31,787
)
Net income
 
$
72,137
 
$
60,083
 
               
(1) Realized investment gains (losses) - investments
 
$
5,153
 
$
27,878
 
Less participating income from real estate ventures
   
5,326
   
0
 
Less related amortization of DAC
   
0
   
22,412
 
   
$
(173
)
$
5,466
 
               
(2) Realized investment gains (losses) - derivatives
 
$
13,337
 
$
(6,368
)
Less settlements on certain interest rate swaps
   
1,331
   
3,684
 
Less derivative losses related to certain annuities
   
(651
)
 
0
 
   
$
12,657
 
$
(10,052
)




   
Operating Segment Assets
March 31, 2006
(Dollars in thousands)
 
   
Life
Marketing
 
Acquisitions
 
Annuities
 
Stable Value
Products
 
                   
Investments and other assets
 
$
7,496,142
 
$
3,855,878
 
$
6,140,820
 
$
5,767,416
 
Deferred policy acquisition costs
   
1,714,694
   
359,033
   
122,606
   
18,159
 
Goodwill
   
10,354
   
0
   
0
   
0
 
Total assets
 
$
9,221,190
 
$
4,214,911
 
$
6,263,426
 
$
5,785,575
 
                           
                           
 
   
Asset
Protection 
   
Corporate
and Other
   
Adjustments
   
Total
Consolidated
 
                           
Investments and other assets
 
$
803,949
 
$
2,464,419
 
$
41,338
 
$
26,569,962
 
Deferred policy acquisition costs
   
90,284
   
27,863
   
0
   
2,332,639
 
Goodwill
   
38,986
   
83
   
0
   
49,423
 
Total assets
 
$
933,219
 
$
2,492,365
 
$
41,338
 
$
28,952,024
 
                           


   
Operating Segment Assets
December 31, 2005
(Dollars in thousands)
 
   
Life
Marketing
 
Acquisitions
 
Annuities
 
Stable Value
Products
 
                   
Investments and other assets
 
$
7,219,157
 
$
3,914,853
 
$
6,065,367
 
$
5,959,112
 
Deferred policy acquisition costs
   
1,584,325
   
330,278
   
128,930
   
19,102
 
Goodwill
   
10,354
   
0
   
0
   
0
 
Total assets
 
$
8,813,836
 
$
4,245,131
 
$
6,194,297
 
$
5,978,214
 
                           
                           
 
   
Asset
Protection
   
Corporate
and Other
   
Adjustments
   
Total
Consolidated
 
                           
Investments and other assets
 
$
812,774
 
$
2,732,774
 
$
41,545
 
$
26,745,582
 
Deferred policy acquisition costs
   
101,972
   
7,381
   
0
   
2,171,988
 
Goodwill
   
38,986
   
83
   
0
   
49,423
 
Total assets
 
$
953,732
 
$
2,740,238
 
$
41,545
 
$
28,966,993
 


4. Statutory Reporting Practices

Financial statements prepared in conformity with GAAP differ in some respects from the statutory accounting practices prescribed or permitted by insurance regulatory authorities. In accordance with statutory reporting practices, at March 31, 2006, and for the three months then ended, the Company's insurance subsidiaries had combined capital and surplus of $1.4 billion and net loss of $58.3 million. At March 31, 2006, the combined asset valuation reserve held by the Company’s insurance subsidiaries was $103.1 million.

The statutory net loss for the first quarter of 2006 is the result of an increase in the level of reserves maintained for statutory reporting practices, combined with a loss from separate accounts related primarily to the Company’s market value adjusted annuities. An amendment to Actuarial Guideline 38 increased the level of statutory reserves required for certain universal life with secondary guarantee insurance products issued on or after July 1, 2005. Additionally, during 2005 statutory reserves required by Regulation XXX were reinsured with a special purpose finance captive insurance company wholly owned by Protective Life. A substantial portion of these reserves were previously reinsured with unaffiliated reinsurers.

 
5.  Net Income Per Share

Net income per share - basic is computed by dividing net income by the weighted-average number of common shares outstanding during the period, including shares issuable under various deferred compensation plans. Net income per share - diluted is computed by dividing net income by the weighted-average number of common shares and dilutive potential common shares outstanding during the period, including shares issuable under various stock-based compensation plans and stock purchase contracts.

A reconciliation of the numerators and denominators of the basic and diluted net income per share is presented below:
 

   
Three Months Ended
March 31
     
2006
2005
     
(Dollars in thousands, except per share amounts)

Calculation of basic earnings per share:
         
Net income
 
$
72,137
 
$
60,083
 
               
Average shares issued and outstanding
   
69,793,369
   
69,537,435
 
Issuable under various deferred compensation plans
   
958,833
   
936,902
 
Weighted shares outstanding - Basic
   
70,752,202
   
70,474,337
 
               
Basic earnings per share
 
$
1.02
 
$
0.85
 
               
Calculation of diluted earnings per share:
             
Net income
 
$
72,137
 
$
60,083
 
               
Weighted shares outstanding - Basic
   
70,752,202
   
70,474,337
 
Stock appreciation rights (“SARs”)(a)
   
316,254
   
310,912
 
Issuable under various other stock-back compensation plans
   
490,799
   
488,511
 
Weighted shares outstanding - Diluted
   
71,559,255
   
71,273,760
 
               
Diluted earnings per share
 
$
1.01
 
$
0.84
 
 
(a) Excludes 164,898 and 119,400 SARs as of March 31, 2006 and 2005, respectively, that are antidilutive. In the event the average market price exceeds the issue price of the SARs, such rights would be dilutive to the Company’s earnings per share and will be included in the Company’s calculation of the diluted average shares outstanding.

 
 

6. Recently Issued Accounting Standards

In September 2005, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants (“AcSEC”) issued SOP 05-1, “Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts.” This SOP provides guidance on accounting by insurance enterprises for deferred acquisition costs on internal replacements of insurance and investment contracts other than those specifically described in FAS97. The SOP defines an internal replacement as a modification in product benefits, features, rights, or coverages that occurs by the exchange of a contract for a new contract, or by amendment, endorsement, or rider to a contract, or by the election of a feature or coverage within a contract. The Company is currently evaluating the impact of SOP 05-1, which is effective for internal replacements occurring in fiscal years beginning after December 15, 2006, but does not currently believe that its adoption will have a material impact on its financial position or results of operations.

In February 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 155, “Accounting for Certain Hybrid Financial Instruments” (“FAS155”). FAS155 amends Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“FAS133”) and Statement of Financial Accounting Standards No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities” (“FAS140”) and resolves issues addressed in FAS133 DIG Issue D1, “Application of Statement 133 to Beneficial Interest in Securitized Financial Assets.” FAS155 eliminates the exemption from applying the bifurcation requirements of FAS133 to interests in securitized financial assets, in an effort to ensure that similar instruments are accounted for consistently regardless of the form of the instrument. The Company is currently evaluating the impact FAS155, which is effective January 1, 2007, but does not currently believe that its adoption will have a material impact on its financial position or results of operations.

7.  Comprehensive Income

The following table sets forth the Company's comprehensive income (loss) for the periods presented below:

   
Three Months Ended
March 31
 
   
2006
 
2005
 
   
(Dollars in thousands)
 
           
Net income
 
$
72,137
 
$
60,083
 
Change in net unrealized gains on investments, net of income tax:
(three months: 2006 - $(78,279); 2005 - $(44,552))
   
(147,425
)
 
(82,739
)
Change in accumulated gain-hedging, net of income tax:
(three months: 2006 - $2,285; 2005 - $1,897)
   
4,303
   
3,523
 
Reclassification adjustment for amounts included in
net income, net of income tax:
(three months: 2006 - $1,419; 2005 - $(9,757))
   
2,660
   
(18,121
)
Comprehensive income (loss)
 
$
(68,325
)
$
(37,254
)


8. Retirement Benefit Plans

Components of the net periodic benefit cost of the Company’s defined benefit pension plan and unfunded excess benefits plan are as follows:

   
Three Months Ended
March 31
 
   
2006
 
2005
 
   
(Dollars in thousands)
 
           
Service cost - Benefits earned during the period
 
$
2,576
 
$
2,104
 
Interest cost on projected benefit obligations
   
2,496
   
2,408
 
Expected return on plan assets
   
(3,096
)
 
(2,428
)
Amortization of prior service cost
   
64
   
82
 
Amortization of actuarial losses
   
1,272
   
789
 
Net periodic benefit cost
 
$
3,312
 
$
2,955
 

The Company previously disclosed in its financial statements for the year ended December 31, 2005, that it expected its defined benefit pension plan and unfunded excess benefits plan expenses for 2006 to be $7.0 million and $1.2 million, respectively, and these estimates have not changed. The Company’s estimated expense related to the defined benefit pension plan equals its expected contributions to the plan during 2006. As of March 31, 2006, no contributions have been made to the defined benefit pension plan.

In addition to pension benefits, the Company provides limited healthcare benefits and life insurance benefits to eligible retirees. The cost of these plans for the three months ended March 31, 2006 and 2005 was immaterial.


9. Borrowings

Long Term Debt

At March 31, 2006, the Company had $58.5 million outstanding under its $200 million revolving line of credit due July 30, 2009. The Company was in compliance with all debt covenants at March 31, 2006.

Non-Recourse Funding Obligations

The Company issued $25 million of non-recourse funding obligations during the first quarter of 2006, bringing the total amount outstanding to $150 million at March 31, 2006. The weighted average interest rate as of March 31, 2006, was 6.1%.

10. Stock-Based Compensation

Since 1973, the Company has had stock-based incentive plans to motivate management to focus on the Company’s long-range performance through the awarding of stock-based compensation. Under plans approved by share owners in 1997 and 2003, up to 6,500,000 shares may be issued in payment of awards.

Through December 31, 2005, the Company accounted for its stock-based compensation in accordance with Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation,” (“FAS123”) which was originally issued by the FASB in 1995. As originally issued, FAS123 provided companies with the option to either record expense for share-based payments under a fair value model, or to simply disclose the impact of the expense. Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (Revised 2004), “Share-Based Payment” (“FAS123R”), using the modified prospective method, and accordingly prior periods have not been restated.  FAS123R requires companies to measure the cost of share-based payments to employees using a fair value model and to recognize that cost over the relevant service period. Since the Company elected to recognize the cost of its share-based compensation plans in its financial statements when it originally adopted FAS123, the adoption of FAS123R in the first quarter of 2006 did not have a material impact on the Company’s financial position, results of operations, or earnings per share.

In addition, FAS123R requires that an estimate of future award forfeitures be made at the grant date, while FAS123 permitted recognition of forfeitures on an as incurred basis. Prior to the adoption of FAS123R, the Company accounted for forfeitures as they occurred. This change in method related to forfeitures also did not have a material impact on the Company’s financial position or results of operations.

Prior to adopting FAS123R, the Company presented all tax benefits of deductions resulting from payouts of stock based compensation as operating cash flows. FAS123R requires the cash flows resulting from excess tax benefits (tax deductions realized in excess of the compensation costs recognized for the exercise of the awards) from the date of adoption of FAS123R to be classified as a part of cash flows from financing activities. As a result of adopting FAS123R as of January 1, 2006, $2.4 million of excess tax benefits for the first quarter of 2006 have been classified as financing cash flows.

The criteria for payment of 2006 performance awards is based primarily upon a comparison of the Company’s average return on average equity over a four-year period (earlier upon the death, disability, or retirement of the executive, or in certain circumstances, upon a change in control of the Company) to that of a comparison group of publicly held life and multiline insurance companies. If the Company’s results are below the median of the comparison group (40th percentile for 2006 awards), no portion of the award is earned. If the Company’s results are at or above the 90th percentile, the award maximum is earned. Awards are paid in shares of Company Common Stock.

Performance shares awarded in the first quarter of 2006 and their estimated fair value at grant date are as follows:
Year
Awarded
 
Performance
Shares
 
Estimated
Fair Value
 
   
 (Dollars in thousands)
 
           
2006
   
125,430
 
$
6,100
 

Performance shares are equivalent in value to one share of Company Common Stock times the award earned percentage payout. At March 31, 2006, the total outstanding performance shares related to these performance-based plans (including shares issued prior to January 1, 2006) measured at maximum payouts were 1,080,201.



During the first quarter of 2006, stock appreciation rights (“SARs”) were granted to certain officers of the Company to provide long-term incentive compensation based solely on the performance of the Company’s Common Stock. The SARs are exercisable either in four equal annual installments beginning one year after the date of grant or after five years depending on the terms of the grant (earlier upon the death, disability, or retirement of the officer, or in certain circumstances, of a change in control of the Company) and expire after ten years or upon termination of employment. The SARs activity as well as weighted average base price for the first quarter of 2006 is as follows:

   
Weighted Average
Base Price
 
No. of SARs
 
Balance at December 31, 2005
 
$
26.89
   
1,467,210
 
SARs granted
   
48.60
   
46,900
 
SARs exercised
   
20.30
   
(260,199
)
Balance at March 31, 2006
 
$
29.07
   
1,253,911
 


The outstanding SARs at March 31, 2006, were at the following base prices:

Base Price
SARs
Outstanding
Remaining Life
in Years
Currently
Exercisable
 $22.31
 520,111
3
520,111
  31.26
  50,000
4
 50,000
  31.29
    2,500
4
  2,500
  32.00
435,000
5
        0
  26.49
  80,000
6
        0
  41.05
119,400
8
11,100
 48.60
  46,900
9
        0


The SARs issued in the first quarter of 2006 had estimated fair values at grant date of $0.7 million. The fair value of the 2006 SARs was estimated using a Black-Scholes option pricing model. The assumptions used varied depending on the vesting period of the awards. Assumptions used in the model were as follows: expected volatility ranged from 16.1% to 32.5%, the risk-free interest rate ranged from 4.9% to 5.0%, a dividend rate of 1.6%, a zero forfeiture rate, and the expected exercise date ranged from 2011 to 2014.

The Company will pay an amount in stock equal to the difference between the specified base price of the Company’s Common Stock and the market value at the exercise date for each SAR.

The Company recognizes all stock based compensation expense over the related service period of the award, or earlier for retirement eligible employees. The expense recorded by the Company for its stock-based compensation plans was $1.1 million for the first quarter of 2006.  Additionally, as of March 31, 2006, $16.3 million of unrecognized expense related to the Company's stock-based compensation plans is expected to be recognized in future periods through December 31, 2009.  The Company’s obligations of its stock-based compensation plans that are expected to be settled in shares of the Company’s Common Stock are reported as a component of share-owners’ equity, net of deferred taxes.



ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
(Dollar amounts in tables are in thousands)


This Management’s Discussion and Analysis should be read in its entirety, since it contains detailed information that is important to understanding the Company’s results and financial condition. The Overview below is qualified in its entirety by the full Management’s Discussion and Analysis.

FORWARD-LOOKING STATEMENTS - CAUTIONARY LANGUAGE

This report reviews the Company’s financial condition and results of operations including its liquidity and capital resources. Historical information is presented and discussed. Where appropriate, factors that may affect future financial performance are also identified and discussed. Certain statements made in this report include “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include any statement that may predict, forecast, indicate or imply future results, performance or achievements instead of historical facts and may contain words like “believe,” “expect,” “estimate,” “project,” “budget,” “forecast,” “anticipate,” “plan,” “will,” “shall,” “may,” and other words, phrases, or expressions with similar meaning. Forward-looking statements involve risks and uncertainties, which may cause actual results to differ materially from the results contained in the forward-looking statements, and the Company cannot give assurances that such statements will prove to be correct. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results.

For a more complete understanding of the Company’s business and its current period results, please read the following Management’s Discussion and Analysis of Financial Condition and Results of Operations in conjunction with the Company’s latest Annual Report on Form 10-K and other filings with the SEC.

INTRODUCTION

Protective Life Corporation (the “Company”) is a holding company whose subsidiaries provide financial services through the production, distribution, and administration of insurance and investment products. Founded in 1907, Protective Life Insurance Company is the Company's largest operating subsidiary. Unless the context otherwise requires, the "Company" refers to the consolidated group of Protective Life Corporation and its subsidiaries.

The Company operates several business segments each having a strategic focus. An operating segment is generally distinguished by products and/or channels of distribution. The Company's operating segments are Life Marketing, Acquisitions, Annuities, Stable Value Products, and Asset Protection. The Company has an additional segment referred to as Corporate and Other which consists of net investment income on unallocated capital, interest on debt, earnings from various investment-related transactions, and the operations of several non-strategic lines of business. The Company periodically evaluates its operating segments in light of the segment reporting requirements prescribed by FAS131, “Disclosures about Segments of an Enterprise and Related Information,” and makes adjustments to its segment reporting as needed.

KNOWN TRENDS AND UNCERTAINTIES

The factors which could affect the Company's future results include, but are not limited to, general economic conditions and the following known trends and uncertainties: we are exposed to the risks of natural disasters, pandemics, malicious and terrorist acts that could adversely affect our operations; we operate in a mature, highly competitive industry, which could limit our ability to gain or maintain our position in the industry; a ratings downgrade could adversely affect our ability to compete; our policy claims fluctuate from period to period, and actual results could differ from our expectations; our results may be negatively affected should actual experience differ from management's assumptions and estimates; the use of reinsurance introduces variability in our statements of income; we could be forced to sell investments at a loss to cover policyholder withdrawals; interest rate fluctuations could negatively affect our spread income or otherwise impact our business; equity market volatility could negatively impact our business; insurance companies are highly regulated and subject to numerous legal restrictions and regulations; changes to tax law or interpretations of existing tax law could adversely affect the Company and its ability to compete with non-insurance products or reduce the demand for certain insurance products; financial services companies are frequently the targets of litigation, including class action litigation, which could result in substantial judgments; the financial services industry is sometimes the target of law enforcement investigations and the focus of increased regulatory scrutiny; our ability to maintain low unit costs is dependent upon the level of new sales and persistency of existing business; our investments are subject to market and credit risks; we may not realize our anticipated financial results from our acquisitions strategy; we may not be able to close our pending acquisition, or may not be able to achieve the expected results once it is consummated; we are dependent on the performance of others; our reinsurers could fail to meet assumed obligations, increase rates or be subject to adverse developments that could affect us; computer viruses or network security breaches could affect our data processing systems or those of our business partners; our ability to grow depends in large part upon the continued availability of capital; and new accounting rules or changes to existing accounting rules could negatively impact us. Please refer to Exhibit 99 about these factors that could affect future results.

The Company’s results may fluctuate from period to period due to fluctuations in mortality, persistency, claims, expenses, interest rates, and other factors. Therefore, it is management's opinion that quarterly operating results for an insurance company are not necessarily indicative of results to be achieved in future periods, and that a review of operating results over a longer period is necessary to assess an insurance company's performance.

OVERVIEW

In the following discussion, segment operating income is defined as income before income tax, excluding net realized investment gains and losses (net of the related amortization of deferred policy acquisition costs (“DAC”) and participating income from real estate ventures). Periodic settlements of derivatives associated with corporate debt and certain investments and annuity products are included in realized gains and losses but are considered part of segment operating income because the derivatives are used to mitigate risk in items affecting segment operating income. Management believes that segment operating income provides relevant and useful information to investors, as it represents the basis on which the performance of the Company’s business is internally assessed. Although the items excluded from segment operating income may be significant components in understanding and assessing the Company’s overall financial performance, management believes that segment operating income enhances an investor’s understanding of the Company’s results of operations by highlighting the income (loss) attributable to the normal, recurring operations of the Company’s business. Note that the Company’s segment operating income measures may not be comparable to similarly titled measures reported by other companies.

The following table presents a summary of results and reconciles segment operating income to consolidated net income:
   
Three Months Ended
March 31
     
   
2006
 
2005
 
Change
 
   
(Dollars in thousands)
     
Segment Operating Income
             
Life Marketing
 
$
40,781
 
$
39,141
   
4.2
%
Acquisitions
   
19,906
   
21,035
   
(5.4
)
Annuities
   
4,741
   
4,064
   
16.7
 
Stable Value Products
   
12,344
   
14,399
   
(14.3
)
Asset Protection
   
8,738
   
6,172
   
41.6
 
Corporate and Other
   
11,663
   
11,645
   
0.2
 
Total segment operating income
   
98,173
   
96,456
   
1.8
 
                     
Realized investment gains (losses) - investments(1)
   
(173
)
 
5,466
       
Realized investment gains (losses) - derivatives(2)
   
12,657
   
(10,052
)
     
Income tax expense
   
(38,520
)
 
(31,787
)
     
Net income
 
$
72,137
 
$
60,083
   
20.1
 
                     
(1) Realized investment gains (losses) - investments
 
$
5,153
 
$
27,878
       
Less participating income from real estate ventures
   
5,326
   
0
       
Less related amortization of DAC
   
0
   
22,412
       
   
$
(173
)
$
5,466
       
                     
(2) Realized investment gains (losses) - derivatives
 
$
13,337
 
$
(6,368
)
     
Less settlements on certain interest rate swaps
   
1,331
   
3,684
       
Less derivative losses related to certain annuities
   
(651
)
 
0
       
   
$
12,657
 
$
(10,052
)
     
 
Net income for the first three months of 2006 reflects a 1.8% growth in segment operating income. Additionally, net realized investment gains were $12.5 million for the first three months of 2006, compared to net realized investment losses of $4.6 million for the same period of 2005, a change of $17.1 million. Life Marketing segment operating income was $40.8 million in the current quarter, an increase of $4.2% over the prior year’s quarter. The increase in the quarter was attributable to growth in business in-force due to strong sales in prior periods, partially offset by higher mortality and expenses. The quarterly decline in the Acquisitions segment’s operating income is due to the normal runoff of the segment’s previously acquired blocks of business. Improvement in the equity markets and increasing account balances contributed to the quarterly increase of 16.7% in the Annuities segment’s earnings, while spread compression due to increasing short term interest rates, caused operating income to decline 14.3% for the first quarter of 2006 in the Stable Value Products segment compared to the same period of 2005. The 41.6% increase over the prior year in the Asset Protection segment’s operating income is primarily due to improvements in the segment’s inventory protection product line.

RESULTS BY BUSINESS SEGMENT

In the following segment discussions, various statistics and other key data the Company uses to evaluate its segments are presented. Sales statistics are used by the Company to measure the relative progress in its marketing efforts, but may or may not have an immediate impact on reported segment operating income. Sales data for traditional life insurance are based on annualized premiums, while universal life sales are based on annualized planned (target) premiums plus 6% of amounts received in excess of target premiums. Sales of annuities are measured based on the amount of deposits received. Stable value contract sales are measured at the time that the funding commitment is made based on the amount of deposit to be received. Sales within the Asset Protection segment are generally based on the amount of single premium and fees received.

Sales and life insurance in-force amounts are derived from the Company’s various sales tracking and administrative systems, and are not derived from the Company’s financial reporting systems or financial statements. Mortality variances are derived from actual claims compared to expected claims. These variances do not represent the net impact to earnings due to the interplay of reserves and DAC amortization.

Life Marketing
The Life Marketing segment markets level premium term and term-like insurance (collectively “traditional life”), universal life (“UL”), variable universal life and bank owned life insurance (“BOLI”) products on a national basis primarily through networks of independent insurance agents and brokers, stockbrokers, and independent marketing organizations. Segment results were as follows:

   
Three Months Ended
March 31
     
   
2006
 
2005
 
Change
 
   
(Dollars in thousands)
     
REVENUES
             
Gross premiums and policy fees
 
$
325,364
 
$
273,769
   
18.8
%
Reinsurance ceded
   
(208,631
)
 
(199,746
)
 
4.4
 
Net premiums and policy fees
   
116,733
   
74,023
   
57.7
 
Net investment income
   
72,853
   
61,153
   
19.1
 
Other income
   
29,339
   
28,556
   
2.7
 
Total operating revenues
   
218,925
   
163,732
   
33.7
 
                     
BENEFITS AND EXPENSES
                   
Benefits and settlement expenses
   
135,899
   
89,783
   
51.4
 
Amortization of deferred policy acquisition costs
   
19,466
   
17,827
   
9.2
 
Other operating expenses
   
22,779
   
16,981
   
34.1
 
Total benefits and expenses
   
178,144
   
124,591
   
43.0
 
                     
OPERATING INCOME
   
40,781
   
39,141
   
4.2
 
                     
INCOME BEFORE INCOME TAX
 
$
40,781
 
$
39,141
   
4.2
 




The following table summarizes key data for the Life Marketing segment:

     
 Three Months Ended March 31
     
   
2006
2005
Change
       
(Dollars in thousands)
     
Sales By Product
                 
Traditional
   
$
37,476
 
$
34,508
   
8.6
%
Universal life
     
31,488
   
32,747
   
(3.8
)
Variable universal life
     
1,285
   
1,138
   
12.9
 
     
$
70,249
 
$
68,393
   
2.7
 
                       
Sales By Distribution Channel
                     
Brokerage general agents
   
$
38,179
 
$
36,173
   
5.5
 
Independent agents
     
13,800
   
17,309
   
(20.3
)
Stockbrokers/banks
     
13,567
   
12,670
   
7.1
 
BOLI/other
     
4,703
   
2,241
   
109.9
 
     
$
70,249
 
$
68,393
   
2.7
 
                       
Average Life Insurance In-Force(1)
                     
Traditional
   
$
363,267,522
 
$
328,905,530
   
10.4
 
Universal life
     
49,263,933
   
43,105,270
   
14.3
 
     
$
412,531,455
 
$
372,010,800
   
10.9
 
                       
Average Account Values
                     
Universal life
   
$
4,619,947
 
$
3,876,441
   
19.2
 
Variable universal life
     
260,431
   
217,131
   
19.9
 
     
$
4,880,378
 
$
4,093,572
   
19.2
 
                       
Mortality Experience (2)
   
$
(201
)
$
1,252
       
                       
(1) Amounts are not adjusted for reinsurance ceded.
(2) Represents a favorable (unfavorable) variance as compared to pricing assumptions.

Operating income increased 4.2% from the first quarter of 2005. This increase is the result of a 33.7% increase in total revenues resulting from moderate increases in sales of new business and growth of life insurance in-force and average account values. The increase in revenues was partially offset by 43.0% higher overall benefits and expenses. Additionally, as discussed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, during 2005 the Company reduced its reliance on reinsurance (see additional comments below) and entered into a capital markets solution to fund the additional statutory reserves required as a result of these changes in the Company’s reinsurance arrangements. In addition to the expected fluctuations in premiums and benefits and settlement expenses discussed below, earnings emerge more slowly under a capital markets structure relative to the previous reinsurance structure utilized by the Company.

Net premiums and policy fees grew by 57.7% in the current quarter due in part to the growth in life insurance in-force achieved over the last several quarters. Net premiums and policy fees are also higher than the prior year due to an increase in retention levels on certain newly written traditional life products. Beginning in the second quarter of 2005, the Company reduced its reliance on reinsurance by changing from coinsurance to yearly renewable term reinsurance agreements and increased the maximum amount retained on any one life from $500,000 to $1,000,000 on certain of its newly written traditional life products. In addition to increasing net premiums, this change will result in higher benefits and settlement expenses, and will cause greater variability in financial results due to fluctuations in mortality results.

Net investment income increased 19.1% for the quarter, reflecting the growth of the segment’s assets caused by the increase in life reserves, offset by lower investment yields, while other income increased 2.7% for the quarter primarily due to additional income from the segment’s broker-dealer subsidiary. Due to the nature of this business, the majority of this additional income is offset by an increase in other operating expenses.

Benefits and settlement expenses were 51.4% higher than the first quarter of 2005, due to growth in life insurance in-force, increased retention levels on certain newly written traditional life products, higher credited interest on UL products resulting from increases in account values, and unfavorable fluctuations in mortality experience. Mortality (actual results compared to pricing) for the current quarter was $0.2 million unfavorable, compared to a favorable mortality variance of $1.3 million for the same period of 2005, an unfavorable change of $1.5 million. The estimated mortality negative impact on earnings for the first quarter of 2006 was $0.8 million, which was approximately $0.7 million less favorable than the same period of 2005. Amortization of DAC was 9.2% higher for the first quarter of 2006 compared to the same period of 2005 primarily due to growth of life insurance in-force and the change in the Company’s reinsurance strategy.

Other operating expenses for the segment were as follows:

   
Three Months Ended
March 31
     
   
2006
 
2005
 
Change
 
   
(Dollars in thousands)
     
Insurance Companies:
             
First year commissions
 
$
94,268
 
$
80,048
   
17.8
%
Renewal commissions
   
8,404
   
7,794
   
7.8
 
First year ceding allowances
   
(32,832
)
 
(40,353
)
 
(18.6
)
Renewal ceding allowances
   
(46,332
)
 
(38,126
)
 
21.5
 
General & administrative
   
43,263
   
47,341
   
(8.6
)
Taxes, licenses and fees
   
8,073
   
6,480
   
24.6
 
Other operating expenses incurred
   
74,844
   
63,184
   
18.5
 
                     
Less commissions, allowances & expenses capitalized
   
(81,642
)
 
(73,346
)
 
11.3
 
                     
Other operating expenses
   
(6,798
)
 
(10,162
)
 
(33.1
)
                     
Marketing Companies:
                   
Commissions
   
17,553
   
18,098
   
(3.0
)
Other
   
12,024
   
9,045
   
32.9
 
Other operating expenses
   
29,577
   
27,143
   
9.0
 
                     
Other operating expenses
 
$
22,779
 
$
16,981
   
34.1
 

Currently, the segment reinsures significant amounts of its life insurance in-force. Pursuant to the underlying reinsurance contracts, reinsurers pay allowances to the segment as a percentage of both first year and renewal premiums. A portion of these allowances is deferred as part of DAC while the remainder is recognized immediately as a reduction of other operating expenses. While the recognition of reinsurance allowances is consistent with GAAP, non-deferred allowances often exceed the segment’s non-deferred direct costs, causing net other operating expenses to be negative. Consideration of all components of the segment’s income statement, including amortization of DAC, is required to assess the impact of reinsurance on segment operating income.

Other operating expenses for the insurance companies increased from the prior year as a result of lower DAC capitalization, primarily due to lower UL sales. Amounts capitalized as DAC generally include first year commissions and allowances and other deferrable acquisition expenses. The change in these amounts generally reflects the trend in sales for the quarter. The first quarter of 2006 included a $2.1 million true-up of field compensation expenses related to sales in prior periods.

Other operating expenses for the segment’s marketing companies increased 9.0% for the first quarter of 2006, compared to the same period of 2005, primarily as a result of higher commissions and other expenses in the segment’s broker-dealer subsidiary, resulting from higher revenue.

Sales for the segment increased 2.7% versus the first quarter of 2005 primarily due to an increase in traditional life sales. Traditional life sales were negatively impacted during the first half of 2005 as a result of pricing adjustments on certain traditional life products in response to the rising cost of reinsurance. The Company was able to improve its competitive position with respect to these products in the second quarter of 2005 by reducing its reliance on reinsurance for certain newly written traditional products. As a result, traditional life sales improved during the second half of 2005, and this upward trend in traditional life sales continued in the first quarter of 2006. UL sales declined 3.8% during the current quarter, compared to the first quarter of 2005, as a result of pricing adjustments on certain UL products in response to the higher reserve levels required under Actuarial Guideline 38 (“AG38”.). The Company expects UL sales to continue to decline during the second quarter of 2006 compared to the sales levels achieved in 2005. See additional discussion of AG38 and its impact on certain UL products in the “Recent Developments” section herein. Sales of BOLI business improved from 2005. BOLI sales can vary widely between periods as the segment responds to opportunities for these products only when required returns can be achieved.
Acquisitions

The Acquisitions segment focuses on acquiring, converting, and servicing policies acquired from other companies. The segment's primary focus is on life insurance policies sold to individuals. Segment results were as follows:

   
Three Months Ended
March 31
     
   
2006
 
2005
 
Change
 
   
(Dollars in thousands)
     
REVENUES
             
Gross premiums and policy fees
 
$
62,986
 
$
65,500
   
(3.8
)%
Reinsurance ceded
   
(16,642
)
 
(20,029
)
 
(16.9
)
Net premiums and policy fees
   
46,344
   
45,471
   
1.9
 
Net investment income
   
54,490
   
56,714
   
(3.9
)
Other income
   
617
   
361
   
70.9
 
Total operating revenues
   
101,451
   
102,546
   
(1.1
)
                     
BENEFITS AND EXPENSES
                   
Benefits and settlement expenses
   
67,454
   
66,399
   
1.6
 
Amortization of deferred policy acquisition costs
   
6,335
   
7,071
   
(10.4
)
Other operating expenses
   
7,756
   
8,041
   
(3.5
)
Total benefits and expenses
   
81,545
   
81,511
   
0.0
 
                     
OPERATING INCOME
   
19,906
   
21,035
   
(5.4
)
                     
INCOME BEFORE INCOME TAX
 
$
19,906
 
$
21,035
   
(5.4
)

The following table summarizes key data for the Acquisitions segment:

       
Three Months Ended
March 31
     
   
2006
2005
Change
       
(Dollars in thousands)
     
Average Life Insurance In-Force(1)
                 
Traditional
       
$
10,166,239
 
$
11,190,436
   
(9.2
)%
Universal life
         
16,455,957
   
17,633,906
   
(6.7
)
         
$
26,622,196
 
$
28,824,342
   
(7.6
)
                           
Average Account Values
                         
Universal life
       
$
1,688,627
 
$
1,715,584
   
(1.6
)
Fixed annuity(2)
         
209,049
   
215,707
   
(3.1
)
Variable annuity
         
65,543
   
83,925
   
(21.9
)
         
$
1,963,219
 
$
2,015,216
   
(2.6
)
                           
Interest Spread - UL & Fixed Annuities
                         
Net investment income yield
         
6.87
%
 
7.09
%
     
Interest credited to policyholders
         
5.10
   
5.15
       
Interest spread
         
1.77
%
 
1.94
%
     
                           
Mortality Experience(3)
       
$
267
 
$
447
       
                           
(1) Amounts are not adjusted for reinsurance ceded.
(2) Includes general account balances held within variable annuity products.
(3) Represents a favorable variance as compared to pricing assumptions.

Policies acquired through this segment are typically “closed” blocks of business (no new policies are being marketed). Therefore, earnings and account values are expected to decline as the result of lapses, deaths, and other terminations of coverage.

Net premiums and policy fees increased 1.9% during the current period compared to the first quarter of 2005. Net premiums for the first quarter of 2005 were decreased by payment of amounts due under two reinsurance treaties. While this had no net income impact, the payments decreased net premiums and policy fees by $3.9 million, benefits and settlement expenses by $3.5 million, and other operating expenses by $0.3 million. Excluding the impact of this transaction, net premiums and policy fees decreased $3.0 million (6.0%) during the first quarter of 2006, compared to the same period of 2005. This decline is the result of the runoff of the acquired blocks of business.

Net investment income was lower in the first quarter of 2006 compared to the same period in 2005 due to the runoff of business and lower overall earned rates. The segment continues to review credited rates on UL and annuity business to minimize the impact of lower earned rates on interest spreads. The interest spread declined 17 basis points from the first quarter of 2005.

Benefits and settlement expenses for the first quarter of 2006 are 1.6% higher than the comparable period of 2006 due to the impact of the reinsurance payments in the first quarter of 2005 mentioned above. Excluding the impact of this transaction, benefits and settlement expenses decreased $2.5 million (3.5%) during the first quarter of 2006 compared to the same period of 2005. This decrease is due to the decline in in-force business. Amortization of DAC decreased 10.4% during the current quarter compared to the same period of 2005 due to the overall decline in business. Other operating expenses decreased 3.5% from the first quarter of 2005 due to lower commissions resulting from lower net premiums and reductions in other general expenses.

The segment’s life insurance in-force and UL and annuity account values have declined from 2005 levels as no new acquisitions have been made since 2002. In the ordinary course of business, the segment regularly considers acquisitions of blocks of policies or smaller insurance companies. However, the level of the segment’s acquisition activity is predicated upon many factors, including available capital, operating capacity, and market dynamics. The Company continues to pursue suitable acquisitions as they become available.

On February 7, the Company signed a definitive agreement to acquire from JPMorgan Chase & Co. the stock of five life insurance companies that manufacture and distribute traditional life insurance and annuities (the “Chase Insurance Group”) and the stock of four related non-insurance companies. The transaction is subject to certain regulatory approvals and is currently expected to close during the third quarter of 2006.


Annuities

The Annuities segment manufactures, sells, and supports fixed and variable annuity products. These products are primarily sold through stockbrokers, but are also sold through financial institutions and independent agents and brokers. Segment results were as follows:

   
Three Months Ended
March 31
     
   
2006
 
2005
 
Change
 
   
(Dollars in thousands)
     
REVENUES
             
Gross premiums and policy fees
 
$
8,144
 
$
7,840
   
3.9
%
Reinsurance ceded
   
0
   
0
   
0.0
 
Net premiums and policy fees
   
8,144
   
7,840
   
3.9
 
Net investment income
   
53,494
   
56,150
   
(4.7
)
Realized gains (losses) - derivatives
   
(651
)
 
0
   
n/a
 
Other income
   
2,899
   
1,726
   
68.0
 
Total operating revenues
   
63,886
   
65,716
   
(2.8
)
                     
BENEFITS AND EXPENSES
                   
Benefits and settlement expenses
   
47,313
   
48,080
   
(1.6
)
Amortization of deferred policy acquisition costs
   
5,126
   
7,226
   
(29.1
)
Other operating expenses
   
6,706
   
6,346
   
5.7
 
Total benefits and expenses
   
59,145
   
61,652
   
(4.1
)
                     
OPERATING INCOME
   
4,741
   
4,064
   
16.7
 
                     
Realized gains (losses) - derivatives
   
0
   
(162
)
     
Realized gains (losses) - investments
   
(90
)
 
27,624
       
Related amortization of DAC
   
0
   
(22,412
)
     
                     
INCOME BEFORE INCOME TAX
 
$
4,651
 
$
9,114
   
(49.0
)




The following table summarizes key data for the Annuities segment:

   
Three Months Ended
March
     
   
2006
 
2005
 
Change
 
   
(Dollars in thousands)
     
Sales
             
Fixed annuity
 
$
92,090
 
$
59,568
   
54.6
%
Variable annuity
   
73,731
   
77,003
   
(4.2
)
   
$
165,821
 
$
136,571
   
21.4
 
                     
Average Account Values
                   
Fixed annuity(1)
 
$
3,422,366
 
$
3,442,520
   
(0.6
)
Variable annuity
   
2,358,898
   
2,194,782
   
7.5
 
   
$
5,781,264
 
$
5,637,302
   
2.6
 
                     
Interest Spread - Fixed Annuities(2)
                   
Net investment income yield
   
6.14
%
 
6.60
%
     
Interest credited to policyholders
   
5.39
   
5.60
       
Interest spread
   
0.75
%
 
1.00
%
     
 
 
 
   
As of
March 31
 
   
2006
 
2005
 
           
GMDB - Net amount at risk(3)
 
$
120,269
 
$
198,954
 
GMDB - Reserves
   
2,561
   
4,382
 
S&P 500® Index
   
1,295
   
1,181
 
               
(1) Includes general account balances held within variable annuity products.
(2) Interest spread on average general account values.
(3) Guaranteed death benefit in excess of contract holder account balance.

Segment operating revenues decreased 2.8% compared to the first quarter of 2005, primarily as a result of lower net investment income. Additional income resulting from the modest 2.6% increase in average account balances was reduced by lower interest spreads. Interest spreads on fixed annuities declined 25 basis points compared to the first quarter of 2005, primarily due to the rebalancing of the investment portfolio during the first quarter of 2005 discussed below. The increase in other income is primarily due to an increase in asset-based fees.

During the first quarter of 2005, the investment portfolio was rebalanced to improve the duration match between the segment’s assets and liabilities. Approximately $300 million in securities were sold, causing the large realized investment gains for the three months ended March 31, 2005. These gains were partially offset by $22.4 million in DAC amortization associated with those gains. The resulting funds from this transaction were reinvested in assets with lower rates than the investments that were sold, causing a decline in the investment income yield for the segment’s portfolio beginning in the second quarter of 2005. The segment continually monitors and adjusts credited rates as appropriate in an effort to maintain the interest spread.

Total benefits and expenses decreased 4.1% for the quarter, compared to the same period of 2005. Benefits and settlement expenses for the first three months of 2006 are $0.8 million lower than the same period of the prior year due to reductions in credited interest rates in its market value adjusted annuity line, partially offset by less favorable mortality. Mortality was $1.6 million unfavorable for the first quarter of 2006, compared to a $1.2 million unfavorable mortality variance for the same period of 2005, an unfavorable variance of $0.4 million. These unfavorable mortality variances primarily relate to the nonrecurring sales of $122 million of single premium immediate annuities on approximately 28 lives sold in the fourth quarter of 2004 in a structured transaction. Because this block of annuities is large relative to the total amount of annuities in-force, volatility in mortality results are expected.

The decrease in DAC amortization for the quarter is primarily the result of lower gross profits in the market value adjusted and variable deferred annuity lines resulting from fourth quarter 2005 unlocking. DAC is amortized in proportion to gross profits, so decreased gross profits results in less DAC amortization.

Total sales are 21.4% higher than the prior year. Sales of fixed annuities increased 54.6% as a result of higher interest rates compared to the first quarter of 2005 and strong sales increases in the equity indexed annuity product introduced in 2005. Sales of variable annuities decreased 4.2% from the first quarter of 2005. A general improvement in the equity markets reduced the net amount at risk with respect to guaranteed minimum death benefits by 39.5%.

Stable Value Products

The Stable Value Products segment sells guaranteed funding agreements (“GFAs”) to special purpose entities that in turn issue notes or certificates in smaller, transferable denominations. The segment also markets fixed and floating rate funding agreements directly to the trustees of municipal bond proceeds, institutional investors, bank trust departments, and money market funds. Additionally, the segment markets guaranteed investment contracts (“GICs”) to 401(k) and other qualified retirement savings plans. Segment results were as follows:
   
Three Months Ended
March 31
     
   
2006
 
2005
 
Change
 
   
(Dollars in thousands)
     
REVENUES
             
Net investment income
 
$
82,233
 
$
73,875
   
11.3
%
                     
BENEFITS AND EXPENSES
                   
Benefits and settlement expenses
   
67,463
   
57,169
   
18.0
 
Amortization of deferred policy acquisition costs
   
1,229
   
1,084
   
13.4
 
Other operating expenses
   
1,197
   
1,223
   
(2.1
)
Total benefits and expenses
   
69,889
   
59,476
   
17.5
 
                     
OPERATING INCOME
   
12,344
   
14,399
   
(14.3
)
                     
Realized gains (losses)
   
(4,854
)
 
619
       
INCOME BEFORE INCOME TAX
 
$
7,490
 
$
15,018
   
(50.1
)

The following table summarizes key data for the Stable Value Products segment:

   
Three Months Ended
March 31
     
   
2006
 
2005
 
Change
 
   
(Dollars in thousands)
     
Sales
             
GIC
 
$
46,200
 
$
24,050
   
92.1
%
GFA - Registered Notes - Institutional
   
0
   
350,000
   
n/a
 
GFA - Registered Notes - Retail
   
40,841
   
31,845
   
28.2
 
   
$
87,041
 
$
405,895
   
(78.6
)
                     
Average Account Values
 
$
5,976,606
 
$
5,716,571
   
4.5
 
                     
Operating Spread
                   
Net investment income yield
   
5.60
%
 
5.33
%
     
Interest credited
   
4.60
   
4.12
       
Operating expenses
   
0.16
   
0.17
       
Operating spread
   
0.84
%
 
1.04
%
     

Operating income declined 14.3% for the first quarter of 2006 compared to the same period of 2005. This decline is primarily due to spread compression of 20 basis points, partially offset by a 4.5% growth in average account balances. The primary driver of the spread compression has been increasing short term interest rates, resulting in higher interest credited rates. The segment continues to review its investment portfolio for opportunities to increase the net investment income yield in an effort to maintain interest spreads. Operating spreads are not expected to change significantly during the remainder of 2006. The moderate growth in average account balances was primarily driven by sales of the Company’s registered funding agreement-backed notes program over the past two years.

Total sales were 78.6% lower than the first quarter of 2005. The Company is not currently participating in the institutional market due to current market conditions and in order to conserve capital in anticipation of the Chase Insurance Group acquisition. This transaction is expected to close during the third quarter of 2006, at which time the segment plans to reenter the institutional market. Both GIC and retail note sales improved during the first quarter of 2006, compared to the same period of 2005.
Asset Protection

The Asset Protection segment primarily markets extended service contracts and credit life and disability insurance to protect consumers’ investments in automobiles and watercraft. In addition, the segment markets an inventory protection product (“IPP”) and a guaranteed asset protection (“GAP”) product. Segment results were as follows:

   
Three Months Ended
March 31
     
   
2006
 
2005
 
Change
 
   
(Dollars in thousands)
     
REVENUES
             
Gross premiums and policy fees
 
$
100,690
 
$
110,375
   
(8.8
)%
Reinsurance ceded
   
(55,393
)
 
(62,302
)
 
(11.1
)
Net premiums and policy fees
   
45,297
   
48,073
   
(5.8
)
Net investment income
   
7,808
   
7,600
   
2.7
 
Other income
   
12,044
   
9,405
   
28.1
 
Total operating revenues
   
65,149
   
65,078
   
0.1
 
                     
BENEFITS AND EXPENSES
                   
Benefits and settlement expenses
   
22,209
   
26,529
   
(16.3
)
Amortization of deferred policy acquisition costs
   
16,920
   
17,546
   
(3.6
)
Other operating expenses
   
17,282
   
14,831
   
16.5
 
Total benefits and expenses
   
56,411
   
58,906
   
(4.2
)
                     
OPERATING INCOME
   
8,738
   
6,172
   
41.6
 
                     
INCOME BEFORE INCOME TAX
 
$
8,738
 
$
6,172
   
41.6
 

The following table summarizes key data for the Asset Protection segment:

   
Three Months Ended
March 31
     
   
2006
 
2005
 
Change
 
   
(Dollars in thousands)