PLC 10Q 6-30-06

 
 
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 June 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 August 8, 2006: 69,916,711
 


PROTECTIVE LIFE CORPORATION
Quarterly Report on Form 10-Q
For Quarter Ended June 30, 2006
 
INDEX
   
Part I.
Financial Information:
  
Item 1.
Financial Statements (unaudited):
  
 
Consolidated Condensed Statements of Income for the
  
Three and Six Months ended June 30, 2006 and 2005
  
 
Consolidated Condensed Balance Sheets as of June 30, 2006
  
and December 31, 2005
  
 
Consolidated Condensed Statements of Cash Flows for the
  
Six Months ended June 30, 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 4.
Submission of Matters to a Vote of Security Holders
  
   
Item 6.
Exhibits
  
   
   
Signature 
  
   
   



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



   
Three Months Ended
  
Six Months Ended
  
   
June 30
  
June 30
  
   
2006
  
2005
  
2006
  
2005
  
Revenues
Gross premiums and policy fees
  
$
516,182
  
$
484,643
  
$
1,023,876
  
$
953,157
  
Reinsurance ceded
    
(317,740
)
  
(312,511
)
  
(598,410
)
  
(594,663
)
Net premiums and policy fees
    
198,442
    
172,132
    
425,466
    
358,494
  
Net investment income
    
300,734
    
282,374
    
599,799
    
570,327
  
Realized investment gains (losses):
Derivative financial instruments
    
(4,799
)
  
(26,021
)
  
8,538
    
(32,389
)
All other investments
    
14,663
    
12,480
    
19,816
    
40,358
  
Other income
    
53,599
    
45,505
    
102,135
    
89,789
  
Total revenues
    
562,639
    
486,470
    
1,155,754
    
1,026,579
  
 
Benefits and expenses
Benefits and settlement expenses, net of reinsurance ceded:
(three months: 2006 - $290,566; 2005 - $279,484
six months: 2006 - $547,125; 2005 - $544,847)
    
335,937
    
291,636
    
685,545
    
592,070
  
Amortization of deferred policy acquisition costs
    
34,153
    
51,867
    
84,184
    
126,118
  
Other operating expenses, net of reinsurance ceded:
(three months: 2006 - $48,703; 2005 - $54,489
six months: 2006 - $94,994; 2005 - $91,363)
    
89,863
    
69,525
    
172,682
    
143,079
  
Total benefits and expenses
    
459,953
    
413,028
    
942,411
    
861,267
  
Income before income tax
    
102,686
    
73,442
    
213,343
    
165,312
  
Income tax expense
    
35,745
    
25,411
    
74,265
    
57,198
  
Net income
  
$
66,941
  
$
48,031
  
$
139,078
  
$
108,114
  
Net income per share - basic
  
$
0.94
  
$
0.68
  
$
1.96
  
$
1.53
  
Net income per share - diluted
  
$
0.94
  
$
0.68
  
$
1.95
  
$
1.52
  
Cash dividends paid per share
  
$
0.215
  
$
0.195
  
$
0.41
  
$
0.37
  
Average shares outstanding - basic
    
70,805,802
    
70,517,476
    
70,779,151
    
70,496,026
  
Average shares outstanding - diluted
    
71,381,677
    
71,279,363
    
71,469,976
    
71,276,577
  
 
 
See Notes to Consolidated Condensed Financial Statements
 
 
PROTECTIVE LIFE CORPORATION
CONSOLIDATED CONDENSED BALANCE SHEETS
(Dollars in thousands)
(Unaudited)

   
June 30
  
December 31
  
   
2006
  
2005
  
Assets
Investments:
Fixed maturities, at market (amortized cost: 2006 - $15,197,216; 2005 - $15,172,482)
  
$
14,901,325
  
$
15,472,386
  
Equity securities, at market (cost: 2006 - $117,652; 2005 - $114,994)
    
121,215
    
121,012
  
Mortgage loans on real estate
    
3,537,842
    
3,287,745
  
Investment in real estate, net of accumulated depreciation (2006 - $9,056; 2005 - $14,684)
    
57,059
    
72,932
  
Policy loans
    
454,225
    
458,825
  
Other long-term investments
    
290,427
    
279,676
  
Short-term investments
    
734,021
    
776,139
  
Total investments
    
20,096,114
    
20,468,715
  
Cash
    
35,718
    
83,670
  
Accrued investment income
    
204,572
    
189,038
  
Accounts and premiums receivable, net of allowance for uncollectible amounts
(2006 - $3,623; 2005 - $3,296)
    
114,514
    
82,080
  
Reinsurance receivables
    
3,212,207
    
3,020,685
  
Deferred policy acquisition costs
    
2,475,843
    
2,171,988
  
Goodwill
    
49,423
    
49,423
  
Property and equipment, net
    
44,897
    
47,010
  
Other assets
    
151,499
    
140,124
  
Income tax receivable
    
21,581
    
85,807
  
Assets related to separate accounts
Variable annuity
    
2,391,285
    
2,377,124
  
Variable universal life
    
275,261
    
251,329
  
   
$
29,072,914
  
$
28,966,993
  
Liabilities
Policy liabilities and accruals
  
$
12,496,204
  
$
11,895,145
  
Stable value product account balances
    
5,764,856
    
6,057,721
  
Annuity account balances
    
3,328,479
    
3,388,005
  
Other policyholders' funds
    
144,951
    
147,921
  
Other liabilities
    
937,138
    
968,403
  
Deferred income taxes
    
240,774
    
317,317
  
Non-recourse funding obligations
    
200,000
    
125,000
  
Liabilities related to variable interest entities
    
435,980
    
448,093
  
Long-term debt
    
489,532
    
482,532
  
Subordinated debt securities
    
324,743
    
324,743
  
Liabilities related to separate accounts
Variable annuity
    
2,391,285
    
2,377,124
  
Variable universal life
    
275,261
    
251,329
  
     
27,029,203
    
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
    
443,462
    
440,475
  
Treasury stock, at cost (2006 - 3,335,383 shares; 2005 - 3,557,911 shares)
    
(11,968
)
  
(12,765
)
Unallocated stock in Employee Stock Ownership Plan
(2006 - 373,729 shares; 2005 - 480,356 shares)
    
(1,231
)
  
(1,610
)
Retained earnings
    
1,726,146
    
1,615,714
  
Accumulated other comprehensive income (loss):
Net unrealized gains (losses) on investments, net of income tax:
(2006 - $(80,103); 2005 - $57,649)
    
(150,874
)
  
104,489
  
Accumulated gain - hedging, net of income tax: (2006 - $1,955; 2005 - $394)
    
3,682
    
731
  
Minimum pension liability adjustment, net of income tax: (2006 - $(1,132); 2005 - $0)
    
(2,132
)
  
0
  
     
2,043,711
    
2,183,660
  
   
$
29,072,914
  
$
28,966,993
  


See Notes to Consolidated Condensed Financial Statements
 
 
 
PROTECTIVE LIFE CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)
   
Six Months Ended
  
   
June 30
  
   
2006
  
2005
  
Cash flows from operating activities
Net income
  
$
139,078
  
$
108,114
  
Adjustments to reconcile net income to net cash provided by operating activities:
Realized investment (gains) losses
    
(19,816
)
  
(40,358
)
Amortization of deferred policy acquisition costs
    
84,184
    
126,118
  
Capitalization of deferred policy acquisition costs
    
(192,892
)
  
(208,213
)
Depreciation expense
    
6,742
    
7,635
  
Deferred income tax
    
61,393
    
(19,454
)
Accrued income tax
    
59,720
    
7,193
  
Interest credited to universal life and investment products
    
379,760
    
353,739
  
Policy fees assessed on universal life and investment products
    
(232,124
)
  
(197,873
)
Change in reinsurance receivables
    
(191,522
)
  
(133,388
)
Change in accrued investment income and other receivables
    
(47,968
)
  
(300,723
)
Change in policy liabilities and other policyholders' funds
of traditional life and health products
    
539,386
    
381,201
  
Net change in trading securities
    
5,329
    
190
  
Change in other liabilities
    
44,375
    
302,392
  
Other, net
    
2,474
    
23,071
  
Net cash provided by operating activities
    
638,119
    
409,644
  
Cash flows from investing activities
Investments available for sale:
              
Maturities and principal reductions of investments
              
Fixed maturities
    
580,437
    
901,778
  
Equity securities
    
0
    
189
  
Sale of investments
              
Fixed maturities
    
2,496,444
    
2,881,206
  
Equity securities
    
3,520
    
6,199
  
Cost of investments acquired
              
Fixed maturities
    
(3,096,211
)
  
(4,931,094
)
Equity securities
    
(3,343
)
  
(32,114
)
Mortgage loans:
              
New borrowings
    
(489,928
)
  
(304,451
)
Repayments
    
238,972
    
182,005
  
Change in investment real estate, net
    
34,368
    
3,757
  
Change in policy loans, net
    
4,600
    
16,040
  
Change in other long-term investments, net
    
19,124
    
5,598
  
Change in short-term investments, net
    
(21,081
)
  
446,623
  
Purchase of property and equipment
    
(3,053
)
  
(5,283
)
Net cash used in investing activities
    
(236,151
)
  
(829,547
)
Cash flows from financing activities
              
Borrowings under line of credit arrangements and long-term debt
    
89,000
    
52,600
  
Principal payments on line of credit arrangement and long-term debt
    
(82,000
)
  
(34,716
)
Net proceeds from securities sold under repurchase agreements
    
0
    
31,550
  
Payments on liabilities related to variable interest entities
    
(12,113
)
  
(17,356
)
Issuance of non-recourse funding obligations
    
75,000
    
0
  
Dividends to share owners
    
(28,647
)
  
(25,756
)
Investment product deposits and change in universal life deposits
    
991,537
    
1,563,274
  
Investment product withdrawals
    
(1,461,953
)
  
(1,275,863
)
Excess tax benefits on stock based compensation
    
2,668
    
0
  
Other financing activities, net
    
(23,412
)
  
93,890
  
Net cash provided by (used in) financing activities
    
(449,920
)
  
387,623
  
Change in cash
    
(47,952
)
  
(32,280
)
Cash at beginning of period
    
83,670
    
130,596
  
Cash at end of period
  
$
35,718
  
$
98,316
  



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 and six-month periods ended June 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.
 
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
June 30
  
Six Months Ended
June 30
  
   
2006
  
2005
  
2006
  
2005
  
   
(Dollars in thousands)
  
Revenues
                  
Life Marketing
  
$
196,557
  
$
144,013
  
$
415,482
  
$
307,745
  
Acquisitions
    
100,505
    
105,399
    
201,956
    
207,945
  
Annuities
    
67,478
    
66,390
    
131,274
    
159,568
  
Stable Value Products
    
83,060
    
78,166
    
160,439
    
152,660
  
Asset Protection
    
70,303
    
71,947
    
135,452
    
137,025
  
Corporate and Other
    
44,736
    
20,555
    
111,151
    
61,636
  
Total revenues
  
$
562,639
  
$
486,470
  
$
1,155,754
  
$
1,026,579
  
                           
Segment Operating Income
                          
Life Marketing
  
$
51,225
  
$
38,332
  
$
92,006
  
$
77,473
  
Acquisitions
    
18,958
    
21,473
    
38,864
    
42,508
  
Annuities
    
6,150
    
8,145
    
10,891
    
12,209
  
Stable Value Products
    
11,800
    
13,484
    
24,144
    
27,883
  
Asset Protection
    
8,904
    
6,292
    
17,642
    
12,464
  
Corporate and Other
    
6,848
    
9,380
    
18,511
    
21,025
  
Total segment operating income
    
103,885
    
97,106
    
202,058
    
193,562
  
                           
Realized investment gains (losses) - investments(1)
    
4,946
    
5,317
    
4,773
    
10,783
  
Realized investment gains (losses) - derivatives(2)
    
(6,145
)
  
(28,981
)
  
6,512
    
(39,033
)
Income tax expense
    
(35,745
)
  
(25,411
)
  
(74,265
)
  
(57,198
)
Net income
  
$
66,941
  
$
48,031
  
$
139,078
  
$
108,114
  
                           
(1) Realized investment gains (losses) - investments
  
$
14,663
  
$
12,480
  
$
19,816
  
$
40,358
  
 Less participating income from real estate ventures
    
8,168
    
5,883
    
13,494
    
5,883
  
 Less related amortization of DAC
    
1,549
    
1,280
    
1,549
    
23,692
  
   
$
4,946
  
$
5,317
  
$
4,773
  
$
10,783
  
                           
(2) Realized investment gains (losses) - derivatives
  
$
(4,799
)
$
(26,021
)
$
8,538
  
$
(32,389
)
 Less settlements on certain interest rate swaps
    
674
    
2,960
    
2,005
    
6,644
  
 Less derivative gains related to certain annuities
    
672
    
0
    
21
    
0
  
   
$
(6,145
)
$
(28,981
)
$
6,512
  
$
(39,033
)



   
Operating Segment Assets
June 30, 2006
(Dollars in thousands)
  
   
Life
Marketing
  
Acquisitions
  
Annuities
  
Stable Value
Products
  
                   
Investments and other assets
  
$
7,764,884
  
$
3,802,462
  
$
6,123,039
  
$
5,637,154
  
Deferred policy acquisition costs
    
1,824,914
    
373,143
    
152,082
    
17,280
  
Goodwill
    
10,354
    
0
    
0
    
0
  
Total assets
  
$
9,600,152
  
$
4,175,605
  
$
6,275,121
  
$
5,654,434
  
                           
                           
 
    
Asset
Protection
    
Corporate
and Other
    
Adjustments
    
Total
Consolidated
  
                           
Investments and other assets
  
$
831,365
  
$
2,348,884
  
$
39,860
  
$
26,547,648
  
Deferred policy acquisition costs
    
93,889
    
14,535
    
0
    
2,475,843
  
Goodwill
    
38,986
    
83
    
0
    
49,423
  
Total assets
  
$
964,240
  
$
2,363,502
  
$
39,860
  
$
29,072,914
  
                           
                           
                           
 
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 June 30, 2006, and for the six months then ended, the Company's insurance subsidiaries had combined capital and surplus of $1.5 billion and net loss of $86.7 million. At June 30, 2006, the combined asset valuation reserve held by the Company’s insurance subsidiaries was $79.5 million.

The statutory net loss for the six months ended June 30, 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. See additional discussion of the Company’s change during 2005 in its reinsurance strategy in the Life Marketing section of the Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) contained herein.



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
June 30
  
Six Months Ended
June 30
  
   
2006
  
2005
  
2006
  
2005
  
   
(Dollars in thousands, except per share amounts)
  
Calculation of basic earnings per share:
                  
Net income
  
$
66,941
  
$
48,031
  
$
139,078
  
$
108,114
  
                           
Average shares issued and outstanding
    
69,804,417
    
69,618,179
    
69,798,924
    
69,578,030
  
Issuable under various deferred compensation plans
    
1,001,385
    
899,297
    
980,227
    
917,996
  
Weighted shares outstanding - Basic
    
70,805,802
    
70,517,476
    
70,779,151
    
70,496,026
  
                           
Basic earnings per share
  
$
0.94
  
$
0.68
  
$
1.96
  
$
1.53
  
                           
Calculation of diluted earnings per share:
                          
Net income
  
$
66,941
  
$
48,031
  
$
139,078
  
$
108,114
  
                           
Weighted shares outstanding - Basic
    
70,805,802
    
70,517,476
    
70,779,151
    
70,496,026
  
Stock appreciation rights (“SARs”)(a)
    
290,235
    
256,212
    
303,172
    
283,411
  
Issuable under various other stock-back compensation plans
    
285,640
    
505,675
    
387,653
    
497,140
  
Weighted shares outstanding - Diluted
    
71,381,677
    
71,279,363
    
71,469,976
    
71,276,577
  
                           
Diluted earnings per share
  
$
0.94
  
$
0.68
  
$
1.95
  
$
1.52
  
 
(a) Excludes 144,100 and 119,400 SARs as of June 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.


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 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.

In March 2006, the FASB issued Statement of Financial Accounting Standards No. 156, “Accounting for Servicing of Financial Assets - an amendment of FASB Statement 140” (“FAS 156”). FAS156 amends FAS140, “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. FAS156 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, FAS156 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 this new standard, but does not currently believe that its adoption will have a material impact on its financial position or results of operations.

In July 2006, the FASB issued an 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.


7. Comprehensive Income

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

   
Three Months Ended
June 30
  
Six Months Ended
June 30
  
   
2006
  
2005
  
2006
  
2005
  
   
(Dollars in thousands)
  
Net income
  
$
66,941
  
$
48,031
  
$
139,078
  
$
108,114
  
Change in net unrealized gains on investments, net of income tax:
(three months: 2006 - $(57,216); 2005 - $123,035)
six months: 2006 - $(135,519); 2005 - $39,390)
    
(106,632
)
  
228,494
    
(253,903
)
  
73,154
  
Change in accumulated gain-hedging, net of income tax:
(three months: 2006 - $(725); 2005 - $(867)
six months: 2006 - $1,575; $2005 - (1,860))
    
(1,352
)
  
(1,610
)
  
2,951
    
(3,454
)
Minimum pension liability adjustment, net of income tax:
(three months: 2006 - $(1,144); 2005 - $0
six months: 2006 - $(1,144); $2005 - $0)
    
(2,132
)
  
0
    
(2,132
)
  
0
  
Reclassification adjustment for amounts included in
net income, net of income tax:
(three months: 2006 - $(2,128); 2005 - $(4,368)
six months: 2006 - $(779); 2005 - $(14,125))
    
(3,966
)
  
(8,112
)
  
(1,460
)
  
(26,233
)
Comprehensive income (loss)
  
$
(47,141
)
$
266,803
  
$
(115,466
)
$
151,581
  


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
June 30
  
Six Months Ended
June 30
  
   
2006
  
2005
  
2006
  
2005
  
   
(Dollars in thousands)
  
Service cost - Benefits earned during the period
  
$
1,726
  
$
1,691
  
$
4,302
  
$
3,795
  
Interest cost on projected benefit obligations
    
2,162
    
1,736
    
4,658
    
4,144
  
Expected return on plan assets
    
(2,676
)
  
(2,414
)
  
(5,772
)
  
(4,842
)
Amortization of prior service cost
    
54
    
51
    
118
    
133
  
Amortization of actuarial losses
    
774
    
950
    
2,046
    
1,739
  
Net periodic benefit cost
  
$
2,040
  
$
2,014
  
$
5,352
  
$
4,969
  

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 currently estimates that it will contribute up to $6.8 million to this plan in 2006. As of June 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 six months ended June 30, 2006 and 2005 was immaterial.

9. Borrowings

Long Term Debt

At June 30, 2006, the Company had $75.0 million outstanding at a weighted average interest rate of 5.5% under its $200 million revolving line of credit due July 30, 2009. The Company was in compliance with all debt covenants at June 30, 2006.

Non-Recourse Funding Obligations

The Company issued $75 million of non-recourse funding obligations during the first six months of 2006, bringing the total amount outstanding to $200 million at June 30, 2006. The weighted average interest rate as of June 30, 2006, was 6.6%.

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, $2.7 million of excess tax benefits for the first six 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.

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 June 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 788,134.

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, 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 six 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
    
48.60
    
46,900
  
SARs exercised
    
20.32
    
(255,429
)
Balance at June 30, 2006
  
$
29.03
    
1,258,681
  



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

Base Price
SARs
Outstanding
Remaining Life
in Years
Currently
Exercisable
$22.31
524,881
3
524,881
 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 $3.0 million for the first six months of 2006. Additionally, as of June 30, 2006, $14.6 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.

11. Subsequent Events

Chase Insurance Group Acquisition

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 and in the Company’s latest Annual Report on Form 10-K. 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 distribute traditional life insurance and annuity products and four related non-insurance companies (which collectively are referred to as the “Acquired Companies”). The aggregate purchase price for the Acquired Companies was $1.172 billion which was reduced by $272 million in pre-closing dividends paid to the Sellers by the Acquired Companies. The purchase price is subject to post-closing adjustment payments from the Sellers or Protective Life, as the case may be, to reflect the final adjusted book value of the Acquired Companies.

Immediately after the closing of the acquisition, certain of the Acquired Companies 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 Acquired Companies and the Wilton Re Group reinsured approximately 42% of the other insurance business of the Acquired Companies. The aggregate ceding commissions received by the Acquired Companies from these transactions was $319.8 million, which is approximately $231.7 million on an after tax basis.

Additional information regarding the consummation of this transaction may be found in the Company’s Current Report on Form 8-K dated July 10, 2006.


Issuance of Capital Securities

In connection with the Chase Insurance Group acquisition discussed above, on July 3, 2006, the Company issued $200 million of 7.25% Capital Securities due 2066 (the "Capital Securities"). For additional information regarding this transaction, please refer to the Company’s Current Report on Form 8-K dated July 3, 2006.

Western General Acquisition

On July 14, 2006, the Company completed the acquisition of the vehicle extended service contract business of Western General. Western General, headquartered in Calabasas, California, is an industry leading 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.


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; 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 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
June 30
      
Six Months Ended
June 30
      
   
2006
  
2005
  
Change
  
2006
  
2005
  
Change
  
   
(Dollars in thousands)
    
(Dollars in thousands)
      
Segment Operating Income
                          
Life Marketing
  
$
51,225
  
$
38,332
    
33.6
%
$
92,006
  
$
77,473
    
18.8
%
Acquisitions
    
18,958
    
21,473
    
(11.7
)
  
38,864
    
42,508
    
(8.6
)
Annuities
    
6,150
    
8,145
    
(24.5
)
  
10,891
    
12,209
    
(10.8
)
Stable Value Products
    
11,800
    
13,484
    
(12.5
)
  
24,144
    
27,883
    
(13.4
)
Asset Protection
    
8,904
    
6,292
    
41.5
    
17,642
    
12,464
    
41.5
  
Corporate and Other
    
6,848
    
9,380
    
(27.0
)
  
18,511
    
21,025
    
(12.0
)
Total segment operating income
    
103,885
    
97,106
    
7.0
    
202,058
    
193,562
    
4.4
  
                                       
Realized investment gains (losses) - investments(1)
    
4,946
    
5,317
          
4,773
    
10,783
        
Realized investment gains (losses) - derivatives(2)
    
(6,145
)
  
(28,981
)
        
6,512
    
(39,033
)
      
Income tax expense
    
(35,745
)
  
(25,411
)
        
(74,265
)
  
(57,198
)
      
Net income
  
$
66,941
  
$
48,031
    
39.4
  
$
139,078
  
$
108,114
    
28.6
  
                                       
(1) Realized investment gains (losses) - investments
  
$
14,663
  
$
12,480
        
$
19,816
  
$
40,358
        
Less participating income from real estate ventures
    
8,168
    
5,883
          
13,494
    
5,883
        
Less related amortization of DAC
    
1,549
    
1,280
          
1,549
    
23,692
        
   
$
4,946
  
$
5,317
        
$
4,773
  
$
10,783
        
                                       
(2) Realized investment gains (losses) - derivatives
  
$
(4,799
)
$
(26,021
)
      
$
8,538
  
$
(32,389
)
      
Less settlements on certain interest rate swaps
    
674
    
2,960
          
2,005
    
6,644
        
Less derivative gains related to certain annuities
    
672
    
0
          
21
    
0
        
   
$
(6,145
)
$
(28,981
)
      
$
6,512
  
$
(39,033
)
      


Net income for the second quarter and first six months of 2006 reflects a 7.0% and 4.4% growth, respectively, in segment operating income compared to the same periods of 2005. Additionally, net realized investment losses were $1.2 million for the second quarter compared to losses of $23.7 million for the same period of 2005, a favorable change of $22.5 million. For the first six months of 2006, the Company had net realized investment gains of $11.3 million compared to net realized investment losses of $28.3 million for the same period of 2005, a favorable change of $39.6 million. Life Marketing segment operating income was $51.2 million and $92.0 million for the current quarter and year-to-date, respectively, representing increases of 33.6% and 18.8% 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 and favorable DAC unlocking of approximately $14.1 million in the second quarter of 2006, partially offset by higher mortality and operating expenses (net of expenses capitalized). The declines in the Acquisitions segment’s operating income for both the current quarter and year-to-date are due to the normal runoff of the segment’s previously acquired blocks of business. Favorable DAC unlocking of $5.0 million during the second quarter of 2005 drove the 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 15 basis point improvement in interest spread during the current quarter. Spread compression due to increasing short term interest rates caused operating income to decline 12.5% for the second quarter and 13.4% for the first six months of 2006 in the Stable Value Products segment compared to the same periods of 2005. The Asset Protection segment’s 41.5% increases in operating income for both the second quarter and year-to-date are 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 $2.0 million (17%) year-to-date, while IPP earnings are up $3.3 million (1,353%) year-to-date.

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
June 30
      
Six Months Ended
June 30
      
   
2006
  
2005
  
Change
  
2006
  
2005
  
Change
  
 
(Dollars in thousands)
      
(Dollars in thousands)
      
REVENUES
                          
Gross premiums and policy fees
  
$
335,467
  
$
290,333
    
15.5
%
$
660,831
  
$
564,102
    
17.1
%
Reinsurance ceded
    
(247,119
)
  
(235,968
)
  
4.7
    
(455,750
)
  
(435,714
)
  
4.6
  
Net premiums and policy fees
    
88,348
    
54,365
    
62.5
    
205,081
    
128,388
    
59.7
  
Net investment income
    
75,474
    
62,541
    
20.7
    
148,327
    
123,694
    
19.9
  
Other income
    
32,735
    
27,107
    
20.8
    
62,074
    
55,663
    
11.5
  
Total operating revenues
    
196,557
    
144,013
    
36.5
    
415,482
    
307,745
    
35.0
  
                                       
BENEFITS AND EXPENSES
                                      
Benefits and settlement expenses
    
122,432
    
72,994
    
67.7
    
258,331
    
162,777
    
58.7
  
Amortization of deferred policy acquisition costs
    
1,636
    
21,413
    
(92.4
)
  
21,102
    
39,240
    
(46.2
)
Other operating expenses
    
21,264
    
11,274
    
88.6
    
44,043
    
28,255
    
55.9
  
Total benefits and expenses
    
145,332
    
105,681
    
37.5
    
323,476
    
230,272
    
40.5
  
                                       
OPERATING INCOME
    
51,225
    
38,332
    
33.6
    
92,006
    
77,473
    
18.8
  
                                       
INCOME BEFORE INCOME TAX
  
$
51,225
  
$
38,332
    
33.6
  
$
92,006
  
$
77,473
    
18.8
  


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

   
Three Months Ended
June 30
          
Six Months Ended
June 30
      
   
2006
  
2005
  
Change
  
2006
2005
Change
   
(Dollars in thousands)
        
(Dollars in thousands)
      
Sales By Product
                              
Traditional
  
$
35,733
  
$
26,861
    
33.0
%
      
$
73,209
  
$
61,369
    
19.3
%
Universal life
    
16,109
    
41,638
    
(61.3
)
        
47,597
    
74,385
    
(36.0
)
Variable universal life
    
1,628
    
1,197
    
36.0
          
2,913
    
2,335
    
24.8
  
   
$
53,470
  
$
69,696
    
(23.3
)
      
$
123,719
  
$
138,089
    
(10.4
)
                                             
Sales By Distribution Channel
                                            
Brokerage general agents
  
$
32,644
  
$
29,495
    
10.7
        
$
70,823
  
$
65,667
    
7.9
  
Independent agents
    
9,216
    
18,746
    
(50.8
)
        
23,016
    
36,057
    
(36.2
)
Stockbrokers/banks
    
8,082
    
18,004
    
(55.1
)
        
21,649
    
30,629
    
(29.3
)
BOLI / other
    
3,528
    
3,451
    
2.2
          
8,231
    
5,736
    
43.5
  
   
$
53,470
  
$
69,696
    
(23.3
)
      
$
123,719
  
$
138,089
    
(10.4
)
                                             
Average Life Insurance In-Force(1)
                                            
Traditional
  
$
374,705,974
  
$
337,741,129
    
10.9
        
$
368,990,677
  
$
333,005,255
    
10.8
  
Universal life
    
50,337,452
    
44,572,685
    
12.9
          
49,726,677
    
43,862,908
    
13.4
  
   
$
425,043,426
  
$
382,313,814
    
11.2
        
$
418,717,354
  
$
376,868,163
    
11.1
  
                                             
Average Account Values
                                            
Universal life
  
$
4,746,318
  
$
4,037,911
    
17.5
        
$
4,677,818
  
$
3,888,986
    
20.3
  
Variable universal life
    
272,397
    
221,347
    
23.1
          
265,374
    
219,930
    
20.7
  
   
$
5,018,715
  
$
4,259,258
    
17.8
        
$
4,943,192
  
$
4,108,916
    
20.3
  
                                             
Mortality Experience (2)
  
$
(749
)
$
3,819
              
$
(950
)
$
5,071
        
                                             
 
(1) Amounts are not adjusted for reinsurance ceded.
(2) Represents a favorable (unfavorable) variance as compared to pricing assumptions.


 
Operating income increased 33.6% and 18.8% from the first quarter and first six months of 2005, respectively primarily as a result of DAC unlocking during the current quarter. (See additional discussion of this item below.) The increases in total revenues are the result of growth of life insurance in-force and average account values, and were partially offset by higher overall benefits and expenses (37.5% higher for the second quarter and 40.5% higher for the first six months of 2006, as compared to the same periods of 2005). Additionally, as discussed in the Company’s Annual Report on Form 10K 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 62.5% in the current quarter and 59.7% year-to-date 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 20.7% for the quarter and 19.9% year-to-date, reflecting the growth of the segment’s assets caused by the increase in life reserves, offset by lower investment yields, while other income increased 20.8% and 11.5% for the second quarter and first six months of 2006, respectively, primarily due to additional income from the segment’s broker-dealer subsidiary. The increase in income from the broker-dealer subsidiary is the result of increased fees related to variable annuity managed accounts and higher investment advisory fees. 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 67.7% and 58.7% higher than the second quarter and first six months of 2005, respectively, 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. The mortality variance (actual results compared to pricing) for the current quarter and first six months of 2006 was $4.6 million and $6.0 million less favorable, respectively, than the same periods of 2005. The estimated mortality negative impact on earnings for the second quarter and first six months of 2006 was $1.5 million and $2.2 million, respectively, which was approximately $3.6 million and $4.3 million less favorable than the same periods of 2005.

Amortization of DAC was 92.4% and 46.2% lower for the second quarter and first six months of 2006 compared to the same periods of 2005 primarily due to favorable DAC unlocking. An evaluation of DAC, including a review of the underlying assumptions of future mortality, expenses, lapses, premium persistency, investment yields, and interest spreads was performed by the Company on its West Coast Life UL product during the second quarter of 2006. As a result of this review, assumptions were updated based on actual experience and/or expectations for the future. This change in assumptions, and resulting adjustment to DAC, referred to as “unlocking”, resulted in a favorable adjustment of approximately $14.1 million.

Other operating expenses for the segment were as follows:

   
Three Months Ended
June 30
      
Six Months Ended
June 30
      
   
2006
  
2005
  
Change
  
2006
  
2005
  
Change
  
   
(Dollars in thousands)
      
(Dollars in thousands)
      
Insurance Companies:
                          
First year commissions
  
$
76,429
  
$
80,881
    
(5.5)%
$
170,696
  
$
160,929
    
6.1
%
Renewal commissions
    
8,973
    
8,187
    
9.6
    
17,377
    
15,982
    
8.7
  
First year ceding allowances
    
(28,033
)
  
(33,230
)
  
(15.6
)
  
(60,865
)
  
(73,583
)
  
(17.3
)
Renewal ceding allowances
    
(55,129
)
  
(47,664
)
  
15.7
    
(101,460
)
  
(85,790
)
  
18.3
  
General & administrative
    
40,500
    
44,484
    
(9.0
)
  
83,763
    
91,825
    
(8.8
)
Taxes, licenses and fees
    
7,365
    
7,887
    
(6.6
)
  
15,437
    
14,365
    
7.5
  
Other operating expenses incurred
    
50,105
    
60,545
    
(17.2
)
  
124,948
    
123,728
    
1.0
  
                                       
Less commissions, allowances & expenses capitalized
    
(62,948
)
  
(75,704
)
  
(16.8
)
  
(144,590
)
  
(149,049
)
  
(3.0
)
                                       
Other operating expenses
    
(12,843
)
  
(15,159
)
  
(15.3
)
  
(19,642
)
  
(25,321
)
  
(22.4
)
                                       
Marketing Companies:
                                      
Commissions
    
19,781
    
17,599
    
12.4
    
37,077
    
35,697
    
3.9
  
Other
    
14,326
    
8,834
    
62.2
    
26,608
    
17,879
    
48.8
  
Other operating expenses
    
34,107
    
26,433
    
29.0
    
63,685
    
53,576
    
18.9
  
                                       
Other operating expenses
  
$
21,264
  
$
11,274
    
88.6
  
$
44,043
  
$
28,255
    
55.9
  


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. Additionally, 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 29.0% and 18.9% for the second quarter and first six months of 2006, respectively, compared to the same periods of 2005, primarily as a result of higher commissions and other expenses in the segment’s broker-dealer subsidiary associated with the higher revenue. The broker-dealer subsidiary has also incurred additional expenses in the current year related to new business initiatives.

Sales for the segment declined 23.3% and 10.4% versus the second quarter and first six months of 2005, respectively,  primarily due to sharp declines in UL sales. Traditional life sales increased 33.0% and 19.3% for the quarter and year-to-date, respectively. 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 life products. As a result, traditional life sales improved during the second half of 2005, and this upward trend in traditional life sales has continued into 2006. The 61.3% and 36.0% declines in UL sales for the second quarter and first six months of 2006, respectively, are 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 half 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 for both the quarter and year-to-date from the same periods of 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
June 30
      
Six Months Ended
June 30
      
   
2006
  
2005
  
Change
  
2006
  
2005
  
Change
  
   
(Dollars in thousands)
      
(Dollars in thousands)
      
REVENUES
                          
Gross premiums and policy fees
  
$
63,203
  
$