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 September 30, 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 November 8, 2006: 69,934,412
 

 
PROTECTIVE LIFE CORPORATION
Quarterly Report on Form 10-Q
For Quarter Ended September 30, 2006
 
INDEX
 
 
Page
Part I.
Financial Information:
 
     
Item 1.
Financial Statements (unaudited):
 
 
 
2
 
 
3
 
 
4
 
 
5
   
Item 2. 
Management’s Discussion and Analysis of Financial Condition
 
and Results of Operations
17
   
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
46
   
Item 4.
Controls and Procedures
46
   
Part II.
Other Information:
 
     
Item 1A.
Risk Factors
47
   
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
51
   
Item 6.
51
   
   
Signature 
52
   
   
 
1

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

   
Three Months Ended
 
Nine Months Ended
 
   
September 30
 
September 30
 
   
2006
 
2005
 
2006
 
2005
 
Revenues
                         
Gross premiums and policy fees
 
$
637,457
 
$
486,660
 
$
1,651,362
 
$
1,439,817
 
Reinsurance ceded
   
(371,688
)
 
(282,919
)
 
(960,127
)
 
(877,582
)
Net premiums and policy fees
   
265,769
   
203,741
   
691,235
   
562,235
 
Net investment income
   
410,746
   
306,885
   
1,010,545
   
877,212
 
Realized investment gains (losses):
                         
Derivative financial instruments
   
(55,302
)
 
7,662
   
(46,764
)
 
(24,727
)
All other investments
   
78,645
   
3,612
   
98,461
   
43,970
 
Other income
   
62,355
   
47,377
   
164,490
   
137,166
 
Total revenues
   
762,213
   
569,277
   
1,917,967
   
1,595,856
 
Benefits and expenses
                         
Benefits and settlement expenses, net of reinsurance ceded:
                         
(three months: 2006 - $299,119; 2005 - $231,557
                         
nine months: 2006 - $846,244; 2005 - $776,404)
   
488,948
   
333,365
   
1,174,493
   
925,435
 
Amortization of deferred policy acquisition costs and value of businesses acquired
   
67,199
   
57,950
   
151,383
   
184,068
 
Other operating expenses, net of reinsurance ceded:
                         
(three months: 2006 - $176,894; 2005 - $39,437
                         
nine months: 2006 - $271,888; 2005 - $130,800)
   
118,168
   
71,095
   
290,850
   
214,174
 
Total benefits and expenses
   
674,315
   
462,410
   
1,616,726
   
1,323,677
 
Income before income tax
   
87,898
   
106,867
   
301,241
   
272,179
 
Income tax expense
   
30,597
   
36,976
   
104,862
   
94,174
 
Net income
 
$
57,301
 
$
69,891
 
$
196,379
 
$
178,005
 
Net income per share - basic
 
$
0.81
 
$
0.99
 
$
2.77
 
$
2.52
 
Net income per share - diluted
 
$
0.80
 
$
0.98
 
$
2.75
 
$
2.50
 
Cash dividends paid per share
 
$
0.215
 
$
0.195
 
$
0.625
 
$
0.565
 
Average shares outstanding - basic
   
70,811,292
   
70,582,016
   
70,789,982
   
70,525,004
 
Average shares outstanding - diluted
   
71,355,221
   
71,350,044
   
71,431,304
   
71,301,335
 
 
 
2


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


   
September 30
 
December 31
 
   
2006
 
2005
 
Assets
         
Investments:
         
Fixed maturities, at market (amortized cost: 2006 - $20,937,809; 2005 - $15,172,482)
 
$
21,146,307
 
$
15,472,386
 
Equity securities, at market (cost: 2006 - $117,604; 2005 - $114,994)
   
124,495
   
121,012
 
Mortgage loans on real estate
   
3,650,356
   
3,287,745
 
Investment in real estate, net of accumulated depreciation (2006 - $9,231; 2005 - $14,684)
   
52,263
   
72,932
 
Policy loans
   
835,817
   
458,825
 
Other long-term investments
   
290,304
   
279,676
 
Short-term investments
   
1,377,210
   
776,139
 
Total investments
   
27,476,752
   
20,468,715
 
Cash
   
39,285
   
83,670
 
Accrued investment income
   
266,688
   
189,038
 
Accounts and premiums receivable, net of allowance for uncollectible amounts
(2006 - $3,876; 2005 - $3,296)
   
130,427
   
82,080
 
Reinsurance receivables
   
4,541,415
   
3,020,685
 
Deferred policy acquisition costs and value of businesses acquired
   
3,099,726
   
2,171,988
 
Goodwill
   
68,472
   
49,423
 
Property and equipment, net
   
44,569
   
47,010
 
Other assets
   
248,197
   
140,124
 
Income tax receivable
   
0
   
85,807
 
Assets related to separate accounts
             
Variable annuity
   
2,604,488
   
2,377,124
 
Variable universal life
   
285,954
   
251,329
 
   
$
38,805,973
 
$
28,966,993
 
Liabilities
             
Policy liabilities and accruals
 
$
15,667,970
 
$
11,895,145
 
Stable value product account balances
   
5,515,633
   
6,057,721
 
Annuity account balances
   
8,943,078
   
3,388,005
 
Other policyholders' funds
   
340,756
   
147,921
 
Other liabilities
   
1,123,252
   
968,403
 
Accrued income taxes
   
99,428
   
0
 
Deferred income taxes
   
271,894
   
317,317
 
Non-recourse funding obligations
   
250,000
   
125,000
 
Liabilities related to variable interest entities
   
435,756
   
448,093
 
Long-term debt
   
471,132
   
482,532
 
Subordinated debt securities
   
524,743
   
324,743
 
Liabilities related to separate accounts
             
Variable annuity
   
2,604,488
   
2,377,124
 
Variable universal life
   
285,954
   
251,329
 
     
36,534,084
   
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
   
441,589
   
440,475
 
Treasury stock, at cost (2006 - 3,317,683 shares; 2005 - 3,557,911 shares)
   
(11,906
)
 
(12,765
)
Unallocated stock in Employee Stock Ownership Plan
(2006 - 369,854 shares; 2005 - 480,356 shares)
   
(1,231
)
 
(1,610
)
Retained earnings
   
1,768,416
   
1,615,714
 
Accumulated other comprehensive income (loss):
             
Net unrealized gains (losses) on investments, net of income tax:
(2006 - $27,522; 2005 - $57,649)
   
51,541
   
104,489
 
Accumulated gain (loss) - hedging, net of income tax: (2006 - $(5,881); 2005 - $394)
   
(11,014
)
 
731
 
Minimum pension liability adjustment, net of income tax: (2006 - $(1,138); 2005 - $0)
   
(2,132
)
 
0
 
     
2,271,889
   
2,183,660
 
   
$
38,805,973
 
$
28,966,993
 
 
3


PROTECTIVE LIFE CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)
 
   
Nine Months Ended
 
   
September 30
 
   
2006
 
2005
 
Cash flows from operating activities
         
Net income
 
$
196,379
 
$
178,005
 
Adjustments to reconcile net income to net cash provided by operating activities:
             
Realized investment (gains) losses
   
(51,697
)
 
(19,243
)
Amortization of deferred policy acquisition costs and value of businesses acquired
   
151,383
   
184,068
 
Capitalization of deferred policy acquisition costs
   
(270,310
)
 
(325,693
)
Depreciation expense
   
9,943
   
11,763
 
Deferred income tax
   
(32,152
)
 
38,421
 
Accrued income tax
   
155,127
   
(64,978
)
Interest credited to universal life and investment products
   
631,131
   
532,337
 
Policy fees assessed on universal life and investment products
   
(342,255
)
 
(308,330
)
Change in reinsurance receivables
   
(396,811
)
 
(112,414
)
Change in accrued investment income and other receivables
   
(11,320
)
 
(19,424
)
Change in policy liabilities and other policyholders' funds
of traditional life and health products
   
897,463
   
577,425
 
Trading securities:
             
Maturities and principal reductions of investments
   
104,558
   
0
 
Sale of investments
   
2,487,491
   
0
 
Cost of investments acquired
   
(2,181,807
)
 
0
 
Other net change in trading securities
   
(153,812
)
 
2,145
 
Change in other liabilities
   
84,737
   
15,653
 
Other, net
   
495
   
(17,190
)
Net cash provided by operating activities
   
1,278,543
   
672,545
 
Cash flows from investing activities
             
Investments available for sale:
             
Maturities and principal reductions of investments
             
Fixed maturities
   
876,495
   
1,314,338
 
Equity securities
   
0
   
283
 
Sale of investments
             
Fixed maturities
   
3,868,845
   
3,473,728
 
Equity securities
   
3,627
   
9,298
 
Cost of investments acquired
             
Fixed maturities
   
(4,314,116
)
 
(6,511,259
)
Equity securities
   
(3,343
)
 
(48,171
)
Mortgage loans:
             
New borrowings
   
(722,318
)
 
(447,717
)
Repayments
   
357,627
   
346,056
 
Change in investment real estate, net
   
42,258
   
3,249
 
Change in policy loans, net
   
3,616
   
19,266
 
Change in other long-term investments, net
   
11,787
   
12,036
 
Change in short-term investments, net
   
(293,606
)
 
437,993
 
Purchase of property and equipment
   
(4,682
)
 
(8,822
)
Payments for business acquisitions, net of cash acquired of $366,404
   
(567,180
)
 
0
 
Net cash used in investing activities
   
(740,990
)
 
(1,399,722
)
Cash flows from financing activities
             
Borrowings under line of credit arrangements and long-term debt
   
141,600
   
63,100
 
Principal payments on line of credit arrangement and long-term debt
   
(153,000
)
 
(42,725
)
Issuance of capital securities
   
200,000
   
0
 
Net proceeds from securities sold under repurchase agreements
   
0
   
142,850
 
Payments on liabilities related to variable interest entities
   
(12,337
)
 
(17,687
)
Issuance of non-recourse funding obligations
   
125,000
   
100,000
 
Dividends to share owners
   
(43,679
)
 
(39,345
)
Investment product deposits and change in universal life deposits
   
1,808,908
   
2,318,325
 
Investment product withdrawals
   
(2,574,251
)
 
(1,952,911
)
Excess tax benefits on stock based compensation
   
2,865
   
0
 
Other financing activities, net
   
(77,044
)
 
88,539
 
Net cash provided by (used in) financing activities
   
(581,938
)
 
660,146
 
Change in cash
   
(44,385
)
 
(67,031
)
Cash at beginning of period
   
83,670
   
130,596
 
Cash at end of period
 
$
39,285
 
$
63,565
 
 
4


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 and nine-month periods ended September 30, 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.

 

5


3. Recent Acquisitions

Chase Insurance Group Acquisition

As reported in the Company’s Current Report on Form 8-K filed July 10, 2006, on July 3, 2006, Protective Life Insurance Company (“Protective Life”), the Company’s largest operating subsidiary, completed the acquisition contemplated by the Stock Purchase Agreement previously reported in our Current Report on Form 8-K dated February 13, 2006. Pursuant to that agreement with JPMorgan Chase & Co. (“JPMC”) and two of its wholly-owned subsidiaries (collectively, the “Sellers”), Protective Life and its subsidiary West Coast Life Insurance Company purchased from the Sellers the Chase Insurance Group, which consists of five insurance companies that manufacture and administer traditional life insurance and annuity products and four related non-insurance companies (which collectively are referred to as the “Chase Insurance Group”) for a net purchase price of $860.4 million. The aggregate purchase price for the Chase Insurance Group was $825 million, subject to adjustments related to the preliminary adjusted book value and other adjustments based on account values and volume adjustments. The final purchase price is subject to post-closing adjustment payments from Sellers or Protective Life, as the case may be, to reflect the final adjusted book value of the Chase Insurance Group plus estimated transaction costs. The Chase Insurance Group is headquartered in Elgin, Illinois, and offers primarily level premium term and other traditional life products, as well as fixed and variable annuity products. The Chase Insurance Group’s results of operations are included in the Company’s consolidated results of operations beginning July 3, 2006.

This transaction was accounted for under the purchase method of accounting prescribed by SFAS No. 141, “Business Combinations” (“SFAS 141”). SFAS 141 requires that the total purchase price be allocated to the assets acquired and liabilities assumed based on their fair values at the acquisition date. We have reflected our initial allocation of the purchase price based on estimated fair value according to preliminary valuations. Such estimated values may change as additional information is obtained and the value is finalized. The preliminary allocation of the $860.4 million aggregate purchase price to the specific identifiable tangible and intangible assets and liabilities is as follows:

 
Preliminary Fair Value(Dollars in thousands)
ASSETS
     
Investments
$
 6,789,452
 
Policy loans
 
380,608
 
Cash
 
364,531
 
Accrued investment income
 
88,069
 
Accounts and premiums receivable, net
 
9,570
 
Reinsurance receivable
 
1,123,919
 
Value of business acquired and other intangible assets
 
713,014
 
Other assets
 
49,158
 
Assets related to separate accounts
 
110,073
 
Total assets
 
9,628,394
 
   
 
 
LIABILITIES
   
 
Policy liabilities and accruals
 
2,703,997
 
Annuity account balances
 
5,528,849
 
Other policyholders’ funds
 
257,912
 
Other liabilities
 
144,248
 
Accrued income taxes
 
22,925
 
Liabilities related to separate accounts
 
110,073
 
Total liabilities
 
8,768,004
 
       
NET ASSETS ACQUIRED
$
 860,390
 


The Chase Insurance Group acquisition was funded through the issuance of $200 million of capital securities (see Note 10) together with cash. The capital securities will mature and become due and payable, together with any accrued and unpaid interest thereon, on June 30, 2066.

Immediately after the closing of the acquisition, the Company entered into agreements with Allmerica Financial Life Insurance and Annuity Company (“AFLIAC”) and Wilton Reassurance Company and Wilton Reinsurance Bermuda Limited (collectively, the “Wilton Re Group”), whereby AFLIAC reinsured 100% of the variable annuity business of the Chase Insurance Group and the Wilton Re Group reinsured approximately 42% of the other insurance business of the Chase Insurance Group. The aggregate ceding commissions received by the Company from these transactions was $319.8 million, which is approximately $231.7 million on an after tax basis.

 
6


Certain of the reinsurance agreements with AFLAIC and the Wilton Re Group are in the form of modified coinsurance (“Modco”) agreements. Company investments that support these agreements, consisting of fixed maturity and equity securities in designated portfolios, are designated as “trading securities” under GAAP. Investment results for these portfolios, including gains and losses from sales, are passed directly to the reinsurers through the contractual terms of the reinsurance arrangements. Trading securities are carried at fair value and changes in fair value are included in net income as realized investment gains (losses) as they occur. Offsetting these amounts are corresponding changes in the fair value of embedded derivative liabilities associated with the underlying reinsurance arrangements.

Western General Acquisition

On July 14, 2006, the Company completed the acquisition of the vehicle extended service contract business of Western General effective as of July 1, 2006. Western General, headquartered in Calabasas, California, is a provider of vehicle service contracts nationally, focusing primarily on the West Coast market. Western General currently provides extended service contract administration for several automobile manufacturers and provides used car service contracts for a publicly-traded national dealership group.

This transaction was accounted for under the purchase method of accounting prescribed by SFAS No. 141, “Business Combinations” (“SFAS 141”). Western General’s results of operations are included in the Company’s consolidated results of operations beginning July 1, 2006. The purchase price for Western General was $33.0 million, and is subject to contingent consideration based on future performance.

The fair value of Western General’s net assets acquired was $14.2 million. Goodwill of $18.8 million resulted from the excess of purchase price over the fair value of Western General’s net assets. This goodwill was allocated to the Company’s Asset Protection segment. The Company paid a premium over the fair value of Western General’s net assets for a number of potential strategic and financial benefits that are expected to be realized as a result of the acquisition including, but not limited to, the following:

·  
Expanded distribution network
·  
Increased geographic presence
·  
Broader product portfolio in our core product lines
·  
Additional administration capabilities
·  
Greater size and scale with improved earnings diversification


7


SFAS 141 requires that the total purchase price be allocated to the assets acquired and liabilities assumed based on their fair values at the acquisition date. We have reflected our initial allocation of the purchase price based on estimated fair value according to preliminary valuations. Such estimated values may change as additional information is obtained and the value is finalized. The following table summarizes the preliminary fair values of the net assets acquired as of the acquisition date:
 
 
Preliminary Fair Value (Dollars in thousands)
ASSETS
     
Investments
 
$ 18,571
 
Cash
 
1,873
 
Accrued investment income
 
114
 
Accounts and premiums receivable, net
 
16,924
 
Value of business acquired and other intangible assets
 
12,650
 
Goodwill
 
18,813
 
Property and equipment
 
450
 
Other assets
 
9,990
 
Income tax receivable
 
41
 
Deferred income taxes
 
2,735
 
Total assets
 
82,161
 
       
LIABILITIES
     
Policy liabilities and accruals
 
39,596
 
Other liabilities
 
9,607
 
Total liabilities
 
49,203
 
   
 
 
NET ASSETS ACQUIRED
 
$ 32,958
 


Pro forma Condensed Consolidated Results of Operations

The following (unaudited) pro forma condensed consolidated results of operations assume that the acquisitons of both the Chase Insurance Group and Western General were completed as of January 1, 2006 and 2005:
     
 
Three Months Ended
September 30
Nine Months Ended
September 30
 
2006
2005
2006
2005
 
(Dollars in thousands)
Revenue
$762,213
$696,377
$2,160,565
$1,975,558
         
Net Income
$57,301
$83,665
$215,560
$217,950
         
Net income per common share:
       
Basic
$0.81
$1.19
$3.05
$3.09
Diluted
$0.80
$1.17
$3.02
$3.06


The pro forma information above is presented for informational purposes only and is not necessarily indicative of the results of operations that actually would have been achieved had the acquisition been consummated as of that time, nor is it intended to be a projection of future results.

4. Goodwill

The changes in the carrying amount of goodwill for the period ended September 30, 2006, are as follows:
 
Life
Marketing
Asset
Protection
Corporate
and Other
Total
Consolidated
 
(Dollars in thousands)
Balance as of December 31, 2005
$10,354
$38,986
$83
$49,423
Goodwill acquired in current period acquisitions
           0
  18,813
    0
  18,813
Contingent payment related to prior acquisition
           0
       236
    0
       236
Balance as of September 30, 2006
$10,354
$58,035
$83
$68,472
 
8


The $18.8 million increase in goodwill in the Asset Protection segment is related to the Western General acquisition discussed in Note 3. Goodwill also increased by $0.2 million in the Asset Protection segment due to a contingent payment related to the purchase of a small subsidiary in a prior year.

5. 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 and annuity products 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, amortization of deferred policy acquisition costs (“DAC”) and value of businesses acquired (“VOBA”) 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, value of businesses acquired, and goodwill are shown in the segments to which they are attributable.

9


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
September 30
     
Nine Months Ended
September 30
 
   
2006
 
2005
     
2006
 
2005
 
   
(Dollars in thousands)
 
Revenues
                     
Life Marketing
 
$
233,808
 
$
186,950
     
$
649,290
 
$
494,695
 
Acquisitions
   
249,547
   
102,214
       
451,503
   
310,159
 
Annuities
   
68,342
   
64,431
       
199,616
   
223,999
 
Stable Value Products
   
85,255
   
80,418
       
245,694
   
233,078
 
Asset Protection
   
81,035
   
67,723
       
216,487
   
204,748
 
Corporate and Other
   
44,226
   
67,541
       
155,377
   
129,177
 
Total revenues
 
$
762,213
 
$
569,277
     
$
1,917,967
 
$
1,595,856
 
                               
Segment Operating Income (Loss)
                             
Life Marketing
 
$
40,270
 
$
38,014
     
$
132,276
 
$
115,487
 
Acquisitions
   
32,060
   
19,510
       
70,924
   
62,018
 
Annuities
   
5,351
   
4,927
       
16,242
   
17,136
 
Stable Value Products
   
10,429
   
13,743
       
34,573
   
41,626
 
Asset Protection
   
(14,401
)
 
6,102
       
3,241
   
18,566
 
Corporate and Other
   
(3,929
)
 
16,236
       
14,582
   
37,261
 
Total segment operating income
   
69,780
   
98,532
       
271,838
   
292,094
 
                               
Realized investment gains (losses) - investments (1)
   
72,266
   
3,450
       
77,039
   
14,233
 
Realized investment gains (losses) - derivatives (2)
   
(54,148
)
 
4,885
       
(47,636
)
 
(34,148
)
Income tax expense
   
(30,597
)
 
(36,976
)
     
(104,862
)
 
(94,174
)
Net income
 
$
57,301
 
$
69,891
     
$
196,379
 
$
178,005
 
                               
(1)        Realized investment gains (losses) - investments
 
$
78,645
 
$
3,612
     
$
98,461
 
$
43,970
 
Less participating income from real estate ventures
   
0
   
0
       
13,494
   
5,883
 
Less related amortization of DAC
   
6,379
   
162
       
7,928
   
23,854
 
   
$
72,266
 
$
3,450
     
$
77,039
 
$
14,233
 
                               
(2)        Realized investment gains (losses) - derivatives
 
$
(55,302
)
$
7,662
     
$
(46,764
)
$
(24,727
)
Less settlements on certain interest rate swaps
   
654
   
2,777
       
2,659
   
9,421
 
Less derivative losses related to certain annuities
   
(1,808
)
 
0
       
(1,787
)
 
0
 
   
$
(54,148
)
$
4,885
     
$
(47,636
)
$
(34,148
)

The Asset Protection segment’s operating income for the third quarter of 2006 includes a bad debt charge of $26 million related to its Lenders Indemnity product line. This charge is a result of the Company’s assessment of the inability of the servicer of this business and an affiliated reinsurer to meet their obligations to the Company.

10



 
Operating Segment Assets
September 30, 2006
(Dollars in thousands)
 
 
Life
Marketing
 
Acquisitions
 
Annuities
 
Stable Value
Products
 
         
 
     
Investments and other assets
$7,662,582
 
$12,075,879
 
$6,441,083
 
$5,389,729
 
Deferred policy acquisition costs and value of businesses acquired
1,804,742
 
1,011,969
 
111,210
 
16,786
 
Goodwill
10,354
 
0
 
0
 
0
 
Total assets
$9,477,678
 
$13,087,848
 
$6,552,293
 
$5,406,515
 
                 
                 
 
Asset
Protection
 
Corporate
and Other
 
Adjustments
 
Total
Consolidated
 
                 
Investments and other assets
$ 937,260
 
$3,092,557
 
$38,685
 
$35,637,775
 
Deferred policy acquisition costs and value of businesses acquired
98,162
 
56,857
 
0
 
3,099,726
 
Goodwill
58,035
 
83
 
0
 
68,472
 
Total assets
$1,093,457
 
$3,149,497
 
$38,685
 
$38,805,973
 
                 
                 
                 
 
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 and value of businesses acquired
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 and value of businesses acquired
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
 



11


6.  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
September 30
 
Nine Months Ended
September 30
 
 
2006
 
2005
 
2006
 
2005
 
 
(Dollars in thousands, except per share amounts)
 
Calculation of basic earnings per share:
               
Net income
$57,301
 
$69,891
 
$196,379
 
$178,005
 
     
 
         
Average shares issued and outstanding
69,807,783
 
69,678,535
 
69,801,909
 
69,611,900
 
Issuable under various deferred compensation plans
1,003,509
 
903,481
 
988,073
 
913,104
 
Weighted shares outstanding - Basic
70,811,292
 
70,582,016
 
70,789,982
 
70,525,004
 
         
 
     
Basic earnings per share
$0.81
$0.99
$2.77
$2.52
             
 
 
Calculation of diluted earnings per share:
               
Net income
$57,301
 
$69,891
 
$196,379
 
$178,005
 
         
 
     
Weighted shares outstanding - Basic
70,811,292
 
70,582,016
 
70,789,982
 
70,525,004
 
Stock appreciation rights (“SARs”)(a)
267,182
 
316,549
 
291,044
 
294,578
 
Issuable under various other stock-back compensation plans
276,747
 
451,479
 
350,278
 
481,753
 
Weighted shares outstanding - Diluted
71,355,221
 
71,350,044
 
71,431,304
 
71,301,335
 
                 
Diluted earnings per share
$0.80
$0.98
$2.75
$2.50
(a)    Excludes 144,100 and 119,400 SARs as of September 30, 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.


7. Recently Issued Accounting Standards

Statement of Position 05-1. In September 2005, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants (“AcSEC”) issued Statement of Position (“SOP”) 05-1, “Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts” (“SOP 05-1”). SOP 05-1 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 Statement of Financial Accounting Standards (“SFAS”) No. 97 (“SFAS 97”), “Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments.” SOP 05-1 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. Contract modifications that result in a substantially unchanged contract will be accounted for as a continuation of the replaced contract. Contract modifications that result in a substantially changed contract should be accounted for as an extinguishment of the replaced contract, and any unamortized DAC, unearned revenue and deferred sales charges must be written off. SOP 05-1 is to be applied prospectively and is effective for internal replacements occurring in fiscal years beginning after December 15, 2006. The Company plans to adopt SOP 05-1 effective January 1, 2007. The Company is currently evaluating potential effects of SOP 05-1 on our consolidated financial position and results of operations.
 

12


SFAS No. 155 - Accounting for Certain Hybrid Financial Instruments - an amendment of FASB Statements No. 133 and 140. In February 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments - an amendment of FASB Statements No. 133 and 140” (“SFAS155”). SFAS155 amends Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”) and Statement of Financial Accounting Standards No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities” (“SFAS 140”) and resolves issues addressed in SFAS 133 DIG Issue D1, “Application of Statement 133 to Beneficial Interest in Securitized Financial Assets.” SFAS 155 partially eliminates the exemption from applying the bifurcation requirements of SFAS 133 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 SFAS 155, which is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006, but does not currently believe that its adoption will have a material impact on its financial position or results of operations.

    SFAS No. 156 - Accounting for Servicing of Financial Assets - an amendment of FASB Statement No. 140. In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets - an amendment of FASB Statement 140” (“SFAS 156”). SFAS 156 amends SFAS 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” with respect to the accounting for separately recognized servicing assets and servicing liabilities. SFAS 156 requires an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract in certain situations. Additionally, SFAS 156 permits the choice of the amortization method or the fair value measurement method, with changes in fair value recorded in income, for the subsequent measurement for each class of separately recognized servicing assets and servicing liabilities. The statement is effective for fiscal years beginning after September 15, 2006. The Company is currently evaluating SFAS 156, but does not believe that its adoption will have a material impact on its financial position or results of operations.

FASB Interpretation No. 48. In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement 109,” (“FIN 48”). FIN 48 provides guidance on the recognition and measurement of uncertain tax positions. It also addresses changes in judgment with respect to the recognition and measurement of uncertain tax positions, the accrual of any interest and penalties related to tax uncertainties, the balance sheet classification of liabilities resulting from tax uncertainties, and qualitative and quantitative disclosures required. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is currently evaluating the impact of adopting FIN 48 on its financial statements.

SFAS No. 157 - Fair Value Measurements. In September 2006, FASB issued SFAS No. 157, “Fair Value Measurements”. This statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS No. 157 is effective prospectively with a limited form of retrospective application for fiscal years beginning after November 15, 2007 with early adoption encouraged. We are currently evaluating the impact that SFAS No. 157 will have on our consolidated results of operations and financial position.

SFAS No. 158 - Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements No. 87, 88, 106, and 132(R). In September 2006, the FASB issued SFAS No. 158 (“SFAS 158), “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, which amends SFAS No. 87, “Employers’ Accounting for Pensions” (“SFAS 87”), SFAS No. 88, “Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits” (“SFAS 88”), SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions” (“SFAS 106”), and SFAS No. 132 (revised), “Employers’ Disclosures About Pensions and Other Postretirement Benefits” (“SFAS 132(R))”. SFAS 158 requires that the funded status of defined benefit postretirement plans be fully recognized on the statement of financial position, and requires the recognition of changes in the funded status of such plans in the year in which the changes occur through comprehensive income. Additionally, SFAS 158 requires an employer to measure the funded status of a plan as of the date of its year-end statement of financial position. SFAS 158 is effective for fiscal years ending after December 15, 2006 and therefore will be adopted by the Company as of December 31, 2006. This standard will be adopted prospectively, and as a result, prior periods will not be restated. The Company is currently evaluating potential effects of SFAS 158 on our consolidated financial position and results of operations.


13

 
Staff Accounting Bulletin No. 108. In September 2006, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 108 (“SAB 108”) which provides guidance on quantifying financial statement misstatements. SAB 108 requires financial statement misstatements to be quantified in relation to both its impact on the current year income statement (the “rollover” approach) and the current year balance sheet (the “iron curtain” approach). If a misstatement is material under either approach (the “dual approach”) the financial statements must be adjusted for the misstatement.
 
8. Comprehensive Income

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

 
Three Months Ended
September 30
 
Nine Months Ended
September 30
 
 
2006
 
2005
 
2006
 
2005
 
 
(Dollars in thousands)
 
Net income
$ 57,301
 
$ 69,891
 
$196,379
 
$178,005
 
Change in net unrealized gains on investments, net of income tax:
(three months: 2006 - $134,634; 2005 - $(61,309)
nine months: 2006 - $(889); 2005 - $(45,788))
252,245
 
(113,859
(1,666
)
(85,034
Change in accumulated gain-hedging, net of income tax:
(three months: 2006 - $(7,844); 2005 - $3,593
nine months: 2006 - $(6,272); $2005 - $977)
(14,696
)
6,673
 
(11,745
)
1,815
 
Minimum pension liability adjustment, net of income tax:
(three months: 2006 - $0; 2005 - $0
nine months: 2006 - $(1,138); $2005 - $0)
0
 
0
 
(2,132
)
0
 
Reclassification adjustment for amounts included in
net income, net of income tax:
(three months: 2006 - $(26,597); 2005 - $(1,264)
nine months: 2006 - $(27,384); 2005 - $(15,390))
(49,830
(2,348
(51,282
)
(28,581
)
Comprehensive income (loss)
$245,020
 
$ (39,643
)
$129,554
 
$ 66,205
 


9. 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
September 30
 
Nine Months Ended
September 30
 
 
2006
 
2005
 
2006
 
2005
 
 
(Dollars in thousands)
 
Service cost - Benefits earned during the period
$ 2,407
 
$ 1,557
 
$ 6,709
 
$ 5,352
 
Interest cost on projected benefit obligations
1,713
 
1,700
 
6,371
 
5,844
 
Expected return on plan assets
(1,847
)
(1,986
(7,619
(6,828
Amortization of prior service cost
35
 
54
 
153
 
187
 
Amortization of actuarial losses
719
 
714
 
2,765
 
2,453
 
Net periodic benefit cost
$ 3,027
 
$ 2,039
 
$ 8,379
 
$ 7,008
 


The Company previously disclosed in its financial statements for the year ended December 31, 2005, that it expected to contribute $7.0 million to its defined benefit pension plan during 2006. The Company has not yet determined the amount, if any, that it will contribute to this plan in 2006. As of September 30, 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 nine months ended September 30, 2006 and 2005 was immaterial.

14


10. Borrowings

Long Term Debt

At September 30, 2006, the Company had $56.6 million outstanding at a weighted average interest rate of 5.6% under its $200 million revolving line of credit due July 30, 2009. The Company was in compliance with all debt covenants at September 30, 2006.

Non-Recourse Funding Obligations

The Company issued $125.0 million of non-recourse funding obligations during the first nine months of 2006, bringing the total amount outstanding to $250.0 million at September 30, 2006. The weighted average interest rate as of September 30, 2006, was 6.6%.

Issuance of Capital Securities

In connection with the Chase Insurance Group acquisition discussed in Note 3, on July 3, 2006, the Company issued $200.0 million of 7.25% Capital Securities due 2066 (the "Capital Securities").

11. 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,” (“SFAS 123”) 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. SFAS 123R 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 SFAS 123, the adoption of SFAS 123R 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, SFAS 123R requires that an estimate of future award forfeitures be made at the grant date, while SFAS 123 permitted recognition of forfeitures on an as incurred basis. Prior to the adoption of SFAS 123R, 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 SFAS 123R, the Company presented all tax benefits of deductions resulting from payouts of stock based compensation as operating cash flows. SFAS 123R 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 SFAS 123R to be classified as a part of cash flows from financing activities. As a result of adopting SFAS 123R as of January 1, 2006, $2.9 million of excess tax benefits for the first nine months 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 multi-line 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.

15


Performance shares awarded in 2006 and their estimated fair value at grant date are as follows:

Year
Awarded
Performance
Shares
Estimated
Fair Value
   
(Dollars in thousands)
     
2006
135,280
$6,500


Performance shares are equivalent in value to one share of Company Common Stock times the award earned percentage payout. At September 30, 2006, the total outstanding performance shares related to these performance-based plans (including shares issued prior to January 1, 2006) measured at maximum payouts was 801,174.

During 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, upon 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 nine months of 2006 is as follows:
 
Weighted Average
Base Price
No. of SARs
Balance at December 31, 2005
$26.89
 
1,467,210
 
SARs granted
47.36
 
81,970
 
SARs exercised
22.23
 
(326,459)
 
Balance at September 30, 2006
$29.51
 
1,222,721
 


The outstanding SARs at September 30, 2006, were at the following base prices:

Base Price
SARs
Outstanding
Remaining Life
in Years
Currently
Exercisable
$22.31
505,776
3
505,776
  31.29
    2,500
4
    2,500
  32.00
435,000
5
           0
  26.49
  80,000
6
           0
  41.05
117,475
8
   9,175
  48.60
  46,900
9
          0
  45.70
  35,070
9
          0


The SARs issued in 2006 had estimated fair values at grant date of $1.2 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 15.5% to 32.5%, the risk-free interest rate ranged from 4.6% to 5.0%, a dividend rate of 1.7%, 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.

Additionally during 2006, the Company issued 6,500 restricted stock units at a fair value of $45.70 per unit. These awards, with a total fair value of $0.3 million, vest over a three year period.

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 $3.4 million for the first nine months of 2006. Additionally, as of September 30, 2006, $11.5 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.

16


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 SFAS 131, “Disclosures about Segments of an Enterprise and Related Information,” and makes adjustments to its segment reporting as needed.


17


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; publicly held companies in general and financial services companies in particular 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 achieve the expected results from our recent acquisition; 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 or statutory rules or changes to existing accounting or statutory 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 value of business acquired (“VOBA”) 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.
 

18


The following table presents a summary of results and reconciles segment operating income to consolidated net income:

   
Three Months Ended
September 30
       
Nine Months Ended
September 30
     
   
2006
   
2005
 
Change
   
2006
   
2005
 
Change
 
   
 (Dollars in thousands)
       
 (Dollars in thousands)
     
Segment Operating Income (Loss)
                               
Life Marketing
 
$
40,270
   
$
38,014
   
5.9
%
 
$
132,276
   
$
115,487
   
14.5
%
Acquisitions
   
32,060
     
19,510
   
64.3
     
70,924
     
62,018
   
14.4
 
Annuities
   
5,351
     
4,927
   
8.6
     
16,242
     
17,136
   
(5.2
)
Stable Value Products
   
10,429
     
13,743
   
(24.1
)
   
34,573
     
41,626
   
(16.9
)
Asset Protection
   
(14,401
)
   
6,102
   
(336.0
)
   
3,241
     
18,566
   
(82.5
)
Corporate and Other
   
(3,929
)
   
16,236
   
(124.2
)
   
14,582
     
37,261
   
(60.9
)
Total segment operating income
   
69,780
     
98,532
   
(29.2
)
   
271,838
     
292,094
   
(6.9
)
                                             
Realized investment gains (losses) - investments(1)
   
72,266
     
3,450
           
77,039
     
14,233
       
Realized investment gains (losses) - derivatives(2)
   
(54,148
)
   
4,885
           
(47,636
)
   
(34,148
)
     
Income tax expense
   
(30,597
)
   
(36,976
)
         
(104,862
)
   
(94,174
)
     
Net income
 
$
57,301
   
$
69,891
   
(18.0
)
 
$
196,379
   
$
178,005
   
10.3
 
                                             
(1) Realized investment gains (losses) - investments
 
$
78,645
   
$
3,612
         
$
98,461
   
$
43,970
       
Less participating income from real estate ventures
   
0
     
0
           
13,494
     
5,883
       
Less related amortization of DAC
   
6,379
     
162
           
7,928
     
23,854
       
   
$
72,266
   
$
3,450
         
$
77,039
   
$
14,233
       
                                             
(2) Realized investment gains (losses) - derivatives
 
$
(55,302
)
 
$
7,662
         
$
(46,764
)
 
$
(24,727
)
     
Less settlements on certain interest rate swaps
   
654
     
2,777
           
2,659
     
9,421
       
Less derivative losses related to certain annuities
   
(1,808
)
   
0
           
(1,787
)
   
0
       
   
$
(54,148
)
 
$
4,885
         
$
(47,636
)
 
$
(34,148
)
     


Net income for the third quarter and first nine months of 2006 reflects declines of 29.2% and 6.9%, respectively, in segment operating income compared to the same periods of 2005. These declines primarily are the result of charges taken in the Asset Protection and Corporate and Other segments (see below). Net realized investment gains were $18.1 million for the third quarter compared to gains of $8.3 million for the same period of 2005, a favorable change of $9.8 million. For the first nine months of 2006, the Company had net realized investment gains of $29.4 million compared to net realized investment losses of $19.9 million for the same period of 2005, a favorable change of $49.3 million.

Life Marketing segment operating income was $40.3 million and $132.3 million for the current quarter and year-to-date, respectively, representing increases of 5.9% and 14.5% over the same periods of the prior year. These increases were attributable to growth in business in-force due to strong sales in prior periods, favorable DAC unlocking of approximately $14.1 million in the second quarter of 2006, and favorable mortality variances.

The increases in the Acquisitions segment’s operating income for both the current quarter and year-to-date are due to the acquisition of the Chase Insurance Group completed in the third quarter of 2006. This acquisition contributed $13.2 million to the Acquisition segment’s operating income for the third quarter and first nine months of 2006.

Favorable DAC unlocking of $5.0 million during the second quarter of 2005 drove the year-to-date decrease in operating income for the Annuities segment. The impact of the favorable DAC unlocking in 2005 was somewhat offset in 2006 by improvement in the equity markets, increasing account balances, and a 12 basis point improvement in interest spread during the current quarter.

Spread compression due to increasing short term interest rates combined with a decline in average account values caused operating income to decline 24.1% for the third quarter and 16.9% for the first nine months of 2006 in the Stable Value Products segment compared to the same periods of 2005.

 
19


The Asset Protection segment’s 336.0% and 82.5% declines in operating income for the third quarter and first nine months of 2006, respectively, are the result of bad debt charges of $26.0 million and $27.1 million, respectively, in one of the lines the segment is no longer marketing. See additional discussion of this event in the following discussion of results by business segment. Excluding the impact of these charges, operating income for the Asset Protection segment increased 90.1% and 63.4%, respectively, for the current quarter and year-to-date due to improvements in the segment’s service contract line, as well as their inventory protection product (“IPP”) line. Earnings from the service contract line are up $4.3 million (25.2%) year-to-date, while IPP earnings are up $6.8 million year-to-date.

The decline in operating income for the Corporate and Other segment is primarily the result of a $9.0 million charge recorded in the current quarter to strengthen reserves related to the discontinued Residual Value line of business. The reserve strengthening is the result of a further decline in used car prices and an increase in the expected frequency and severity of claims.

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
September 30
       
Nine Months Ended
September 30
     
   
2006
   
2005
 
Change
   
2006
   
2005
 
Change
 
   
(Dollars in thousands)
       
  (Dollars in thousands)
     
REVENUES
                               
Gross premiums and policy fees
 
$
327,355
   
$
297,098
   
10.2
%
 
$
978,215
   
$
861,200
   
13.6
%
Reinsurance ceded
   
(206,269
)
   
(204,572
)
 
0.8
     
(652,048
)
   
(640,286
)
 
1.8
 
Net premiums and policy fees
   
121,086
     
92,526
   
30.9
     
326,167
     
220,914
   
47.6
 
Net investment income
   
80,444
     
66,847
   
20.3
     
228,771
     
190,541
   
20.1
 
Other income
   
32,278
     
27,577
   
17.0
     
94,352
     
83,240
   
13.3
 
Total operating revenues
   
233,808
     
186,950
   
25.1
     
649,290
     
494,695
   
31.3
 
                                             
BENEFITS AND EXPENSES
                                           
Benefits and settlement expenses
   
147,213
     
112,119
   
31.3
     
405,544
     
274,896
   
47.5
 
Amortization of deferred policy acquisition costs
   
21,689
     
23,831
   
(9.0
)
   
42,791
     
63,071
   
(32.2
)
Other operating expenses
   
24,636
     
12,986
   
89.7
     
68,679
     
41,241
   
66.5
 
Total benefits and expenses
   
193,538
     
148,936
   
29.9
     
517,014
     
379,208
   
36.3
 
                                             
OPERATING INCOME
   
40,270
     
38,014
   
5.9
     
132,276
     
115,487
   
14.5
 
                                             
INCOME BEFORE INCOME TAX
 
$
40,270
   
$
38,014
   
5.9
   
$
132,276
   
$
115,487
   
14.5
 
 
20


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

   
Three Months Ended
September 30
       
Nine Months Ended
September 30
     
   
2006
   
2005
 
Change
   
2006
   
2005
 
Change
 
 
(Dollars in thousands)
       
(Dollars in thousands)
     
Sales By Product
                               
Traditional
 
$
39,552
   
$
27,975