Management's Discussion and Analysis of Financial Condition and Results of
Operations
FORWARD-LOOKING STATEMENTS
The discussion in this Annual Report on Form 10-K may contain "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. We intend for these forward-looking statements to be covered by the
safe harbor provisions of the federal securities laws relating to
forward-looking statements. These forward-looking statements include statements
relating to trends in, or representing management's beliefs about our future
transactions, strategies, operations and financial results, and often contain
words such as "will," "anticipate," "believe," "plan," "estimate," "expect,"
"intend," "is targeting," "may," "should" and other similar words or
expressions. Forward-looking statements are made based upon management's current
expectations and beliefs concerning trends and future developments and their
potential effects on us. They are not guarantees of future performance. Our
actual business, financial condition or results of operations may differ
materially from those suggested by forward-looking statements as a result of
risks and uncertainties which include, among others: (i) unfavorable general
economic developments including, but not limited to, specific related factors
such as the performance of the debt and equity markets; (ii) the potential
adverse affect of interest rate fluctuations on our business and results of
operations; (iii) the impact on our results of operations and financial
condition of any required increase in our reserves for future policyholder
benefits and claims if such reserves prove to be inadequate; (iv) the
possibility that mortality rates, persistency rates, funding levels or other
factors may differ significantly from our assumptions used in pricing products;
(v) the effect of limited access to external sources of liquidity and financing;
(vi) the effect of guaranteed benefits within our products; (vii) potential
exposure to unidentified or unanticipated risk that could adversely affect our
businesses or result in losses; (viii) the consequences related to variations in
the amount of our statutory capital could adversely affect our business;
(ix) the possibility that we may not be successful in our efforts to implement a
business plan focused on new market segments; (x) changes in our investment
valuations based on changes in our valuation methodologies, estimations and
assumptions; (xi) the impact of downgrades in our debt or financial strength
ratings; (xii) the availability, pricing and terms of reinsurance coverage
generally and the inability or unwillingness of our reinsurers to meet their
obligations to us specifically; (xiii) our ability to attract and retain key
personnel in a competitive environment; (xiv) our dependence on third parties to
maintain critical business and administrative functions; (xv) the strong
competition we face in our business from banks, insurance companies and other
financial services firms; (xvi) our reliance, as a holding company, on dividends
and other payments from our subsidiaries to meet our financial obligations and
pay future dividends, particularly since our insurance subsidiaries' ability to
pay dividends is subject to regulatory restrictions; (xvii) the potential need
to fund deficiencies in our closed block; (xviii) tax developments may affect us
directly or indirectly through the cost of, the demand for or profitability of
our products or services; (xix) the possibility that the actions and initiatives
of the federal and state governments, including those that we elect to
participate in, may not improve adverse economic and market conditions generally
or our business, financial condition and results of operations specifically;
(xx) regulatory developments or actions may harm our business; (xxi) legal
actions could adversely affect our business or reputation; (xxii) potential
future material losses from our discontinued reinsurance business;
(xxiii) changes in accounting standards; (xxiv) the potential effect of a
material weakness in our internal control over financial reporting on the
accuracy of our reported financial results; and (xxv) other risks and
uncertainties described herein or in any of our filings with the SEC. Certain
other factors which may impact our business, financial condition or results of
operations or which may cause actual results to differ from such forward-looking
statements are discussed or included in our periodic reports filed with the SEC
and are available on our website at www.phoenixwm.com under "Investor
Relations." You are urged to carefully consider all such factors. We do not
undertake or plan to update or revise forward-looking statements to reflect
actual results, changes in plans, assumptions, estimates or projections, or
other circumstances occurring after the date of this Form 10-K, even if such
results changes or circumstances make it clear that any forward-looking
information will not be realized. If we make any future public statements or
disclosures which modify or impact any of the forward-looking statements
contained in or accompanying this Form 10-K, such statements or disclosures will
be deemed to modify or supersede such statements in this Form 10-K.
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MANAGEMENT'S DISCUSSION AND ANALYSISManagement's discussion and analysis reviews our consolidated financial
condition at December 31, 2011 and 2010; our consolidated results of operations
for the years 2011, 2010 and 2009; and, where appropriate, factors that may
affect our future financial performance. This discussion should be read in
conjunction with "Selected Financial Data" included in Item 6 and our
consolidated financial statements in this Annual Report on Form 10-K.
Executive Overview
Business
The Phoenix Companies, Inc. (the "Company" or "PNX") is a holding company
incorporated in Delaware. Our operating subsidiaries provide life insurance and
annuity products through independent agents and financial advisors. Our
policyholder base includes both affluent and middle market consumers, with our
more recent business concentrated in the middle market. Most of our life
insurance in force is permanent life insurance (whole life, universal life and
variable universal life) insuring one or more lives. Our annuity products
include deferred fixed and variable annuities with a variety of death benefit
and guaranteed living benefit options.
We believe our competitive strengths include:
·
competitive and innovative products;
·
underwriting and mortality risk management expertise;
·
ability to develop business partnerships; and
·
value-added support provided to distributors by our wholesalers and operating
personnel.
Since 2009, we have focused on selling products and services that are less
capital intensive and less sensitive to our ratings. In 2011, 93% of Phoenix
product sales were fixed indexed annuities. In addition, we have expanded sales
of other insurance companies' policies through our distribution subsidiary,
Saybrus Partners, Inc. ("Saybrus").
We operate two businesses segments: Life and Annuity and Saybrus. The Life and
Annuity segment includes individual life insurance and annuity products,
including our closed block. Saybrus provides dedicated life insurance and other
consulting services to financial advisors in partner companies, as well as
support for sales of Phoenix's product line through independent distribution
organizations.
Earnings Drivers
A substantial but gradually declining amount of our Life and Annuity segment
earnings derive from the closed block, which consists primarily of participating
life insurance policies sold prior to our demutualization and initial public
offering in 2001. We do not expect the net income contribution from the closed
block to deviate materially from its actuarially projected path as long as
actual cumulative earnings meet or exceed expected cumulative earnings. See
Note 4 to our consolidated financial statements under Item 8 "Financial
Statements and Supplementary Data" in this Annual Report on Form 10-K for more
information on the closed block.
Apart from the closed block, our Life and Annuity segment's profitability is
driven by interaction of the following elements:
·
Fees on life and annuity products. Fees consist primarily of (1) cost of
insurance charges, which are based on the difference between policy face amounts
and the account values (referred to as the net amount at risk); (2) asset-based
fees (including mortality and expense charges for variable annuities) which are
calculated as a percentage of assets under management within our separate
accounts; (3) premium-based fees to cover premium taxes and renewal commissions;
and (4) surrender charges.
·
Policy benefits include death claims net of reinsurance cash flows, including
ceded premiums and recoverables, interest credited to policyholders and changes
in reserves for future claims payments. Certain universal life reserves are
based on management's assumptions about future cost of insurance fees and
interest margins which, in turn, are affected by future premium payments,
surrenders, lapses and mortality rates. Actual experience can vary significantly
from these assumptions, resulting in greater or lesser changes in reserves. In
addition, we regularly review and reset our assumptions in light of actual
experience, which can result in material changes to these reserves.
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For fixed indexed annuities, policy benefits include the change in the liability
associated with guaranteed minimum withdrawal benefits and the fair value of an
embedded derivative liability. The assumptions used to calculate the guaranteed
minimum withdrawal liability are consistent with those used for amortizing
deferred policy acquisition costs. The fair value of the embedded derivative
liability is calculated using significant management estimates, including (1)
the expected value of index credits on the next policy anniversary dates, (2)
the interest rate used to project the future growth in the contract liability,
(3) the discount rate used to discount future benefit payments, which includes
an adjustment for our credit worthiness; and (4) the expected costs of annual
call options that will be purchased in the future to fund index credits beyond
the next policy anniversary. These factors can vary significantly from period to
period.
Certain of our variable annuity contracts include guaranteed minimum death and
income benefits. The change in the liability associated with these guarantees is
included in policy benefits. The value of these liabilities is sensitive to
changes in equity markets, equity market volatility and interest rates, as well
as subject to management assumptions regarding future surrenders, rider
utilization rates and mortality.
·
Interest margins. Interest margins consist of net investment income earned on
universal life, fixed indexed annuities and other policyholder funds, gains on
options purchased to fund index credits less the interest or index credits
applied to policyholders on those funds. Interest margins also include
investment income on assets supporting the Company's surplus.
·
Non-deferred operating expenses are expenses related to servicing policies,
premium taxes, reinsurance allowances, non-deferrable acquisition expenses and
commissions and general overhead. They also include pension and other benefit
costs which involve significant estimates and assumptions.
·
Deferred policy acquisition cost amortization is based on the amount of expenses
deferred, actual results in each quarter and management's assumptions about the
future performance of the business. The amount of future profit or margin is
dependent principally on investment returns in our separate accounts, interest
and default rates, reinsurance costs and recoveries, mortality, surrender rates,
premium persistency and expenses. These factors enter into management's
estimates of gross profits or margins, which generally are used to amortize
deferred policy acquisition costs. Actual equity market movements, net
investment income in excess of amounts credited to policyholders, claims
payments and other key factors can vary significantly from our assumptions,
resulting in a misestimate of gross profits or margins, and a change in
amortization, with a resulting impact to income. In addition, we regularly
review and reset our assumptions in light of actual experience, which can result
in material changes in amortization.
·
Net realized investment gains or losses related to investments and hedging
programs include transaction gains and losses, OTTIs and changes in the value of
certain derivatives. Certain of our variable annuity contracts include
guaranteed minimum withdrawal and accumulation benefits. The change in fair
value related to the embedded derivative is also included in net realized gains
or losses.
·
Income tax expense/benefit consists of both current and deferred tax provisions.
Computation of these amounts is a function of pre-tax income and the application
of relevant tax law and GAAP accounting guidance. In valuing our deferred tax
assets, we make significant judgments with respect to the reversal of certain
temporary book-to-tax differences, specifically estimates of future taxable
income over the periods in which the deferred tax assets are expected to
reverse, including consideration of the expiration dates and amounts of
carryforwards related to net operating losses, capital losses, foreign tax
credits and general business tax credits. We have recorded a valuation allowance
against a significant portion of our deferred tax assets based on our assessment
of the realizability of those assets. This assessment could change in the
future, resulting in a release of the valuation allowance and a benefit to
income.
Under GAAP, premiums and deposits for variable life, universal life and annuity
products are not recorded as revenues. For certain investment options of
variable products, deposits are reflected on our balance sheet as an increase in
separate account liabilities. Premiums and deposits for universal life, fixed
annuities and certain investment options of variable annuities are reflected on
our balance sheet as an increase in policyholder deposit funds. Premiums and
deposits for other products are reflected on our balance sheet as an increase in
policy liabilities and accruals.
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Saybrus is a fee-based business driven by the commission revenue earned on
consultation services provided to partner companies as well as on sales of
Phoenix Life and PHL Variable product lines. These fees are offset by
compensation-related expenses attributable to our sales force.
Recent Trends in Earnings Drivers
·
Fees on life and annuity products. Prior to the impact of the deferred policy
acquisition cost unlocking noted below, fees on our life and annuity products
declined $4.1 million in 2011 compared to 2010. The decline in fees was
primarily a result of lower surrenders and a decline in funds under management
in universal life, variable universal life and variable annuity products.
Offsetting these declines was an increase in non-asset based fees related to
fixed indexed annuities. In addition, cost of insurance fees declined $23.3
million, primarily related to lower universal life insurance in force.
·
Policy benefits. Policy benefits decreased $6.8 million in 2011 compared to
2010. Unlocking adjustments increased policy benefits by $4.8 million in 2011
compared to a decrease of $7.7 million in 2010. Excluding the impact of
unlocking, the decrease in policy benefit expense on life insurance products was
primarily a result of lower interest credited consistent with declining funds
under management on universal life products, partially offset by higher death
benefits. In addition, the change in fair value of the fixed indexed annuity
embedded derivatives and the liabilities associated with guarantees resulted in
expense of $2.5 million and $5.4 million, respectively, in 2011. Expense related
to the change in value of variable annuity guarantees was $30.3 million in 2011
compared to a benefit of $11.6 million in 2010.
·
Interest margins. Universal life interest margins increased primarily as a
result of lower interest credited consistent with declining funds under
management, partially offset by lower net investment income. Annuity interest
margins increased primarily as a result of higher investment income attributable
to growth in fixed indexed annuity funds under management. Investment income on
assets backing surplus was $24.1 million in 2011, compared to $32.9 million in
2010. The decrease of $8.8 million was related to changes in valuation on
partnership investments.
·
Operating expenses. Non-deferred operating expenses decreased $40.6 million to
$225.7 million in 2011, compared to $266.3 million in 2010. The decrease in
operating expenses was a result of lower professional fees and outside services
as well as lower compensation related expenses.
·
Deferred policy acquisition cost. Excluding the impact of realized investment
gains, deferred policy acquisition cost amortization decreased $89.7 million to
$210.7 million in 2011. This decrease in amortization was attributable to the
unlocking of assumptions as a result of annual comprehensive reviews of
assumptions in the third quarters of 2011 and 2010. The unlocking resulted in an
overall decrease in amortization of $2.9 million in 2011, compared to an
acceleration of amortization of $46.4 million in 2010. In 2011, the unlocking
primarily related to changes in assumptions for universal life policies which
resulted in a decrease of $35.8 million from higher expected fees partially
offset by an increase of $34.0 million from lower premium persistency. In 2010,
the unlocking was primarily driven by increased lapses in portions of our
universal life business, which resulted in $36.6 million of additional
amortization. Excluding the impact of the unlocking, amortization was lower by
$41.4 million primarily related to universal life as a result of less favorable
mortality experience during 2011.
·
Net realized investment gains or losses on investments. Net realized investment
losses increased $6.5 million to $16.4 million in 2011, compared to $9.9 million
in 2010. The increase in net realized investment losses was primarily a result
of a decline in net transaction gains of $28.3 million. In addition, realized
losses related to fair value options were $0.6 million in 2011 compared to
realized gains of $3.5 million in 2010. These declines were offset by $23.9
million of lower impairment losses for 2011 compared to 2010. Realized losses on
derivative assets and liabilities improved $2.0 million during 2011. This
improvement was primarily attributable to $17.2 million of lower realized losses
on a surplus hedge, which utilizes futures and options to hedge against declines
in equity markets and the resulting statutory capital and surplus impact. This
improvement was offset by a $16.6 million increase in realized losses on
embedded derivative liabilities and a $2.5 million decrease in realized gains on
derivatives associated with variable annuity guarantees. Realized gains
associated with variable annuity guarantees included a gain of $15.9 million for
2011 associated with the non-performance risk factor compared to a gain of $1.4
million for 2010.
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·
Income taxes. The Company recorded an income tax expense of $1.9 million to
continuing operations in 2011, compared to an income tax benefit of $10.1
million to continuing operations in 2010. A deferred tax expense of $1.4 million
in 2011 related to the establishment of a valuation allowance on a
beginning-of-the-year deferred tax balance, which was not previously recognized.
Additionally, current tax expense of $0.5 million was recognized related to
alternative minimum tax ("AMT"). In 2010, as a result of an exception to the
intraperiod allocation rules in accordance with ASC 740-20, Accounting for
Income Taxes - Intraperiod Tax Allocation, a $12.1 million tax benefit was
recorded to continuing operations, which was partially offset by current tax
expense of $2.0 million.
Since its formation in the fourth quarter of 2009, Saybrus' results of
operations have steadily improved as revenue has increased and expenses have
declined. Inclusive of intercompany transactions, revenue in 2011 was $18.2
million, compared with $6.0 million in 2010. Of these amounts, revenue of $11.3
million and $2.7 million was earned from the sales of Phoenix life and annuity
products in 2011 and 2010, respectively. Operating expenses declined to $19.5
million in 2011 from $25.0 million in 2010. This decline was primarily driven by
a decrease in compensation related expenses.
Strategy and Outlook
Since 2009, we have taken significant actions to reduce expenses, effectively
manage our in force business, reduce balance sheet risk, increase liquidity and
pursue new growth opportunities. These actions are beginning to have their
intended effect and, we believe, position us for profitability in 2012 and
beyond. However, our business and results from operations are sensitive to
general economic conditions as well as capital market trends, including equity
markets and interest rates.
We expect to continue to focus on the following key strategic pillars in 2012:
·
Balance sheet strength;
·
Policyholder service;
·
Operational efficiency; and
·
Profitable growth.
We believe there is significant demand for our products among middle market
households seeking to accumulate assets and secure lifetime income during
retirement. The current low interest rate environment provides limited
opportunities for consumers to protect principal and generate predictable
income. Our indexed annuity products are positioned favorably vis-à-vis
traditional investments such as bank certificates of deposits.
Recent trends in the life insurance industry may affect our mortality, policy
persistency and premium persistency. The evolution of the financial needs of
policyholders, the emergence of a secondary market for life insurance, and
increased availability and subsequent contraction of premium financing suggest
that the reasons for purchasing our products changed. Deviations in experience
from our assumptions have had, and could continue to have, an adverse effect on
the profitability of certain universal life products. Most of our current
products permit us to increase charges and adjust crediting rates during the
life of the policy or contract (subject to guarantees in the policies and
contracts). We have made, and may in the future make, such adjustments.
Recent Developments
Formation of Distribution Company
On November 3, 2009, we announced the formation of a distribution company
subsidiary, Saybrus and that Saybrus had entered into an agreement with
financial services firm Edward Jones to provide life insurance consulting
services to the firm's financial advisors. Phoenix formed Saybrus as part of a
series of actions to strengthen its market position and strategy. Saybrus
provides dedicated consultation services to partner companies, as well as
support for Phoenix's product line within our own distribution channels. Saybrus
signed additional consulting clients in 2010 and 2011.
Suspension of Distribution Relationships
In March 2009, our two largest life and annuity distributors, State Farm and
National Life Group, stopped selling Phoenix products. The actions by these and
other distribution partners were primarily in response to downgrades by rating
agencies and ultimately reduce our ability to borrow. We have responded by
refocusing our strategy on less rating-sensitive activities and market segments.
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Recent Acquisitions and Dispositions
Goodwin Capital Advisers, Inc.
On September 14, 2011, we entered into a definitive agreement to sell Goodwin
Capital Advisers, Inc. ("Goodwin") to Conning Holdings Corp. ("Conning
Holdings"). Also, on September 14, 2011, we entered into multi-year investment
management agreements with Conning, Inc. ("Conning") under which Conning will
manage the Company's publicly-traded fixed income assets. Because of the ongoing
cash flows associated with the investment management agreements, results of
these operations have been reflected within continuing operations. The
transaction closed on November 18, 2011. A realized gain of $4.0 million was
recognized on the sale during the fourth quarter of 2011.
Private placement bond and limited partnership investments previously managed
under Goodwin will continue to be managed by Phoenix under its subsidiary,
Phoenix Life.
PFG Holdings, Inc.
On January 4, 2010, we signed a definitive agreement to sell PFG and its
subsidiaries, including AGL Life Assurance Company, to Tiptree. Because of the
divestiture, we determined that these operations are reflected as discontinued
operations. On June 23, 2010, the Company completed the divestiture of PFG and
closed the transaction.
The definitive agreement contains a provision requiring the Company to indemnify
Tiptree for any losses due to actions resulting from certain specified acts or
omissions associated with the divested business prior to closing. There has been
litigation filed that falls within this provision of the agreement. The Company
intends to defend these matters vigorously. See Note 24 to our consolidated
financial statements under "Item 8: Financial Statements and Supplementary Data"
in this Annual Report on Form 10-K for additional information.
Phoenix Life and Reassurance Company of New York
Included within the January 4, 2010 agreement with Tiptree was a provision for
the purchase of PLARNY pending regulatory approval. On September 24, 2010,
approval was obtained from the State of New York Insurance Department for
Tiptree and PFG Holdings Acquisition Corporation to acquire PLARNY. The
transaction closed on October 6, 2010. Because of the divestiture, these
operations are reflected as discontinued operations.
Impact of New Accounting Standards
For a discussion of accounting standards and change in accounting, see Note 2 to
our consolidated financial statements under "Item 8: Financial Statements and
Supplementary Data" in this Annual Report on Form 10-K.
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Critical Accounting Estimates
The discussion and analysis of our financial condition and results of operations
are based upon our consolidated financial statements, which have been prepared
in accordance with GAAP. GAAP requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
date of the consolidated financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates. Critical accounting estimates are reflective of
significant judgments, often as a result of the need to make estimates about the
effect of matters that are inherently uncertain.
Certain of our critical accounting estimates are as follows:
Deferred Policy Acquisition Costs
We amortize deferred policy acquisition costs based on the related policy's
classification. For individual participating life insurance policies, deferred
policy acquisition costs are amortized in proportion to estimated gross margins.
For universal life, variable universal life and accumulation annuities, deferred
policy acquisition costs are amortized in proportion to estimated gross profits
("EGPs"). Policies may be surrendered for value or exchanged for a different one
of our products (internal replacement). The deferred policy acquisition costs
balance associated with the replaced or surrendered policies is adjusted to
reflect these surrenders. In addition, an offset to deferred policy acquisition
costs and accumulated other comprehensive income ("AOCI") is recorded each
period for unrealized gains or losses on securities classified as
available-for-sale as if they had been realized, an adjustment to deferred
policy acquisition costs amortized using gross profits or gross margins would
result.
The projection of EGPs requires the extensive use of actuarial assumptions,
estimates and judgments about the future. Future EGPs are generally projected on
a policy-by-policy basis for the estimated lives of the contracts. Assumptions
are set separately for each product and are reviewed at least annually based on
our current best estimates of future events. The following table summarizes the
most significant assumptions used in the categories set forth below:
Significant Assumption Product Explanation and Derivation
Separate account Variable Annuities Separate account return assumptions
investment return (6.0% long-term are derived from the long-term
return assumption) returns observed in the asset
classes in which the separate
Variable Universal accounts are invested, reduced by
Life fund fees and mortality and expense
(6.9% long-term charges. Short-term deviations from
return assumption) the long-term expectations are
expected to revert to the long-term
assumption over five years.
Interest rates and Fixed and Indexed Investment returns are based on the
default rates Annuities current yields and maturities of our
Universal Life fixed income portfolio combined with
Closed Block expected reinvestment rates given
current market interest rates.
Reinvestment rates are assumed to
revert to long-term rates implied by
the forward yield curve and
long-term default rates.
Contractually permitted future
changes in credited rates are
assumed to help support investment
margins.
Mortality / longevity Universal Life Mortality assumptions are based on
Variable Universal Company experience over a rolling
Life five-year period plus supplemental
Immediate Annuities data from industry sources and
Indexed Annuities trends. These assumptions vary by
issue age, gender, underwriting
class and policy duration.
Policyholder behavior Universal Life Surrender assumptions vary by
- surrenders Variable Universal product and year and are updated
Life with experience studies.
Variable Annuities Policyholders are generally assumed
Fixed and Indexed to behave rationally; hence rates
Annuities are typically lower when surrender
penalties are in effect or when
policy benefits are more valuable.
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Significant Assumption Product Explanation and Derivation
Policyholder behavior Universal Life Future premiums and related fees are
- premium persistency Variable Universal Life projected based on contractual
terms, product illustrations at the
time of sale and expected policy
lapses without value. Assumptions
are updated based on actual
experience studies and include
anticipated future changes if the
Company has a high degree of
confidence that such changes will be
implemented (e.g., change in cost of
insurance charges).
Expenses All products Projected maintenance expenses to
administer policies in force are
based on annually updated studies of
expenses incurred.
Reinsurance costs / Universal Life Projected reinsurance costs are
recoveries Variable Universal Life based on treaty terms currently in
Variable Annuities force. Recoveries are based on the
Company's assumed mortality and
treaty terms. Treaty recaptures are
based on contract provisions and
management's intentions.
To determine the reasonableness of the prior assumptions used and their impact
on previously projected account values and the related EGPs, we evaluate, on a
quarterly basis, our previously projected EGPs. Our process to assess the
reasonableness of our EGPs involves the use of internally developed models
together with actual experience, analysis of market and industry trends, and
other external events. Actual gross profits that vary from management's initial
estimates in a given reporting period, result in increases or decreases in the
rate of amortization recorded in the period.
In addition to our quarterly reviews, we conduct a comprehensive assumption
review on an annual basis, or as circumstances warrant. We generally only update
the assumptions and adjust the deferred policy acquisition cost balance in the
quarterly period in which this comprehensive review is performed, unless a
material change that we feel is indicative of a long-term trend is observed in
an interim period.
Upon completion of these reviews, we revise our assumptions to reflect our
current best estimate, thereby changing our estimate of EGPs in the deferred
policy acquisition cost and unearned revenue amortization models, as well as
projections within the death benefit and other insurance benefit reserving
models. The deferred policy acquisition cost asset, the unearned revenue
reserves and death benefit and other insurance benefit reserves are then
adjusted with an offsetting benefit or charge to income to reflect such changes
in the period of the revision, a process known as "unlocking." Finally, an
analysis is performed periodically to assess whether there are sufficient gross
margins or gross profits to amortize the remaining deferred policy acquisition
costs balances. If the estimates of gross profits or margins cannot support the
continued amortization or recovery of deferred policy acquisition costs, the
amortization of such costs is accelerated in the period in which the assumptions
are changed, resulting in a charge to income.
Over the last several years, the Company has revised a number of assumptions,
resulting in changes to expected future gross profits:
·
Separate account returns: Declines in equity markets have been reflected in the
separate account return assumptions for variable annuities and variable
universal life business to maintain reasonable reversion-to-mean rates of
return. As part of our analysis of separate account returns, we performed two
sensitivity tests. If, at December 31, 2011, we had reprojected EGPs using a 100
basis point lower separate account return assumption (after fund fees and
mortality and expense charges) and used our current best estimate assumptions
for all other assumptions, the estimated increase to amortization and decrease
to net income would have been approximately $6.1 million, before taxes.
Conversely, a 100 basis point increase in the separate account return assumption
would have decreased amortization and increased net income by approximately $3.8
million, before taxes.
·
Interest rates and default rates: The long-term decline in interest rates has
resulted in reduced EGPs for certain products and may increase future
amortization related to certain products. However, the impact of such a change
would depend, among other things, on changes in long-term default rates, the
relative change between short-term and long-term interest rates, the ability and
management's preparedness to change policy credited rates or insurance charges,
and management's view on how sustained a decrease in interest rates would be.
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·
Policyholder behavior: Changes in surrender and premium persistency assumptions
have been based on actual experience and have resulted in both increases and
decreases to projected EGPs. Policyholder behavior assumptions have been
difficult to predict because they are subject to a combination of individual and
external environmental factors. The impact of such changes is not uniform across
different types of policies or time periods, with increases in amortization for
some policies or time periods offset by decreases in others. In addition,
changes in policyholder charges or credited rates directly affect EGPs and may
also affect policyholder behavior in the future.
·
Expenses: Reductions in the Company's cost structure have lowered policy
administration expense assumptions embedded in EGPs. The impact of future
reductions in policy administration expense could further increase EGPs and
benefit net income.
Policy Liabilities and Accruals
Reserves are liabilities representing estimates of amounts that will come due to
policyholders at some point in the future. Certain death and other insurance
benefit features require an additional liability be held above the account value
liability representing the present value of future benefits in excess of
policyholders' funds and recognizing this excess ratably based on expected
assessments. For universal life policies, we calculate this liability based on
our best estimate of surrender and lapse rates, interest margin, mortality,
premium persistency, funding patterns, and reinsurance costs and recoveries.
Coincident with our deferred policy acquisition cost reviews, these assumptions
are assessed on a regular basis based on our past experience, industry studies,
regulatory requirements and estimates about the future. Additional policyholder
liabilities related to GMIB and GMDB variable annuity contract riders are
calculated using stochastic projections as they tend to vary with capital market
movements.
See Note 2 to our consolidated financial statements under "Item 8: Financial
Statements and Supplementary Data" and the "Enterprise Risk Management" section
of "Item 7: Management's Discussion and Analysis of Financial Condition and
Results of Operations" in this Annual Report on Form 10-K for more information.
Embedded Derivative Liabilities
We make guarantees on certain variable annuity contracts, including GMAB and
GMWB as well as provide credits based on the performance of certain indices
("index credits") on our fixed indexed annuity contracts that meet the
definition of an embedded derivative. The GMAB and GMWB embedded derivative
liabilities associated with our variable annuity contracts are accounted for at
fair value, using a risk neutral stochastic valuation methodology with changes
in fair value recorded in realized investment gains. The inputs to our fair
value methodology include information derived from the asset derivatives market,
including the volatility surface and the swap curve. Several additional inputs
are not obtained from independent sources, but instead reflect our internally
developed assumptions related to mortality rates, lapse rates and policyholder
behavior. The fair value of the embedded derivative liabilities associated with
the index credits on our fixed indexed annuity contracts is calculated using the
budget method with changes in fair value recorded in policy benefits. The
initial value under the budget method is established based on the fair value of
the options used to hedge the liabilities. The budget amount for future years is
based on the impact of projected interest rates on the discounted liabilities.
Several additional inputs reflect our internally developed assumptions related
to lapse rates and policyholder behavior. As there are significant unobservable
inputs included in our fair value methodology for these embedded derivative
liabilities, we consider the above-described methodology as a whole to be Level
3 within the fair value hierarchy.
Our fair value calculation of variable annuity GMAB and GMWB embedded derivative
liabilities includes a credit standing adjustment (the "CSA"). The CSA
represents the adjustment that market participants would make to reflect the
risk that guaranteed benefit obligations may not be fulfilled ("non-performance
risk"). In analyzing various alternatives to the CSA calculation, we determined
that we could not use credit default swap spreads as there are no such
observable instruments on Phoenix's life insurance subsidiaries nor could we
consistently obtain an observable price on the surplus notes issued by Phoenix
Life, as the surplus notes are not actively traded. Therefore, when discounting
the rider cash flows for calculation of the fair value of the liability, we
calculated the CSA that reflects the credit spread (based on a Standard & Poor's
BB- credit rating) for financial services companies similar to the Company's
life insurance subsidiaries.
This average credit spread is recalculated every quarter and, therefore, the
fair value will change with the passage of time even in the absence of any other
changes that would affect the valuation. For example, the December 31, 2011 fair
value of $41.9 million would increase to $44.7 million if the chosen spread were
decreased by 50 basis points. If the chosen spread were increased by 50 basis
points, the fair value would decrease to $39.3 million. The impact of the CSA at
December 31, 2011 and 2010 was a reduction of $36.0 million and $19.9 million in
the reserves associated with these riders, respectively.
30
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Valuation of Debt and Equity Securities
We classify our debt and equity securities as available-for-sale and report them
in our balance sheet at fair value. Fair value is based on quoted market price,
where available. When quoted market prices are not available, we estimate fair
value by discounting debt security cash flows to reflect interest rates
currently being offered on similar terms to borrowers of similar credit quality,
by quoted market prices of comparable instruments and by independent pricing
sources or internally developed pricing models.
Fair Value of Fixed Maturity Securities As of December 31, 2011
by Pricing Source: Fixed % of
($ in millions) Maturities Total
at Fair Value Fair Value
Priced via independent market quotations $ 7,876.9 66.2%
Priced via matrices 3,037.3 25.5%
Priced via broker quotations 211.2 1.8%
Priced via other methods 496.4 4.2%
Short-term investments(1) 268.2 2.3%
Total $ 11,890.0 100.0%
-------
(1)
Short-term investments are valued at amortized cost, which approximates fair
value.
See Note 14 to our consolidated financial statements under Item 8 "Financial
Statements and Supplementary Data" in this Annual Report on Form 10-K for
additional disclosures of our fair value methodologies.
Other-than-Temporary Impairments
We recognize realized investment losses when declines in fair value of debt and
equity securities are considered to be other-than-temporary.
For debt securities, the other-than-temporarily impaired amount is separated
into the amount related to a credit loss and is reported as net realized
investment losses included in earnings, and any amounts related to other factors
are recognized in OCI. The credit loss component represents the difference
between the amortized cost of the security and the net present value of its
projected future cash flows discounted at the effective interest rate implicit
in the debt security prior to impairment. Any remaining difference between the
fair value and amortized cost is recognized in OCI. Subsequent to the
recognition of an OTTI, the impaired security is accounted for as if it had been
purchased on the date of impairment at an amortized cost basis equal to the
previous amortized cost basis less the OTTI recognized in earnings. We will
continue to estimate the present value of future expected cash flows and, if
significantly greater than the new cost basis, we will accrete the difference as
investment income on a prospective basis once the Company has determined that
the interest income is likely to be collected.
In evaluating whether a decline in value is other than temporary, we consider
several factors including, but not limited to, the following:
·
the extent and the duration of the decline;
·
the reasons for the decline in value (credit event, interest related or market
fluctuations);
·
our intent to sell the security, or whether it is more likely than not that we
will be required to sell it before recovery; and
·
the financial condition and near term prospects of the issuer.
A debt security impairment is deemed other than temporary if:
·
we either intend to sell the security, or it is more likely than not that we
will be required to sell the security before recovery; or
·
it is probable we will be unable to collect cash flows sufficient to recover the
amortized cost basis of the security.
31
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Impairments due to deterioration in credit that result in a conclusion that the
present value of cash flows expected to be collected will not be sufficient to
recover the amortized cost basis of the security are considered other than
temporary. Other declines in fair value (for example, due to interest rate
changes, sector credit rating changes or company-specific rating changes) that
result in a conclusion that the present value of cash flows expected to be
collected will not be sufficient to recover the amortized cost basis of the
security may also result in a conclusion that an OTTI has occurred.
On a quarterly basis, we review all securities in an unrealized loss position
for potential recognition of an OTTI. In addition, we maintain a watch list of
securities in default, near default or otherwise considered by our investment
professionals as being distressed, potentially distressed or requiring a
heightened level of scrutiny. We also identify all securities whose fair value
has been below amortized cost on a continuous basis for zero to six months, six
months to 12 months and greater than 12 months.
We employ a comprehensive process to determine whether or not a security in an
unrealized loss position is other-than-temporarily impaired. This assessment is
done on a security-by-security basis and involves significant management
judgment. The assessment of whether impairments have occurred is based on
management's evaluation of the underlying reasons for the decline in estimated
fair value. The Company's review of its fixed maturity and equity securities for
impairments includes an analysis of the total gross unrealized losses by three
categories of severity and/or age of the gross unrealized loss, as summarized on
pages 47,48 and 49, "Duration of Gross Unrealized Losses on Securities". An
extended and severe unrealized loss position on a fixed maturity security may
not have any impact on the ability of the issuer to service all scheduled
interest and principal payments and the Company's evaluation of recoverability
of all contractual cash flows or the ability to recover an amount at least equal
to its amortized cost based on the present value of the expected future cash
flows to be collected. In contrast, for certain equity securities, greater
weight and consideration are given by the Company to a decline in market value
and the likelihood such market value decline will recover.
Specifically for structured securities, to determine whether a collateralized
security is impaired, we obtain underlying data from the security's trustee and
analyze it for performance trends. A security-specific stress analysis is
performed using the most recent trustee information. This analysis forms the
basis for our determination of whether the security will pay in accordance with
the contractual cash flows.
The closed block policyholder dividend obligation, applicable deferred policy
acquisition costs and applicable income taxes, which offset realized investment
gains and losses and OTTIs, are each reported separately as components of net
income.
See Note 8 to our consolidated financial statements under "Item 8: Financial
Statements and Supplementary Data" and the "Debt and Equity Securities" and
"Enterprise Risk Management" sections of "Item 7: Management's Discussion and
Analysis of Financial Condition and Results of Operations" in this Annual Report
on Form 10-K for more information.
Deferred Income Taxes
We account for income taxes in accordance with ASC 740, Accounting for Income
Taxes. Deferred tax assets and/or liabilities are determined by multiplying the
differences between the financial reporting and tax reporting bases for assets
and liabilities by the enacted tax rates expected to be in effect when such
differences are recovered or settled. The effect on deferred taxes of a change
in tax rates is recognized in income in the period that includes the enactment
date. Valuation allowances on deferred tax assets are estimated based on our
assessment of the realizability of such amounts.
As of December 31, 2011, we performed our assessment of the realization of
deferred tax assets. This assessment included consideration of the gross
deferred tax liabilities as a source of income as well as the cumulative loss
incurred over the three-year period ended December 31, 2011. As a result of the
cumulative loss and all other relevant considerations, we concluded that our
estimates of future taxable income and certain tax planning strategies did not
constitute sufficient positive evidence to assert that it is more likely than
not that certain deferred tax assets would be realizable before expiration. We
believe it is reasonably possible that the Company will begin to record positive
three-year cumulative income during 2012, which could result in a reduction of
the valuation allowance and a benefit to income tax expense.
As of December 31, 2011, a valuation allowance of $254.5 million has been
recorded on net deferred tax assets of $372.7 million. We have concluded that a
valuation allowance on the remaining $118.2 million of deferred tax assets
attributable to available-for-sale debt securities with gross unrealized losses
was not required due to our ability and intent to hold these securities until
recovery of fair value or contractual maturity, thereby avoiding realization of
taxable capital losses. This conclusion is consistent with prior periods.
32
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For the year ended December 31, 2011, we recognized a net increase in the
valuation allowance of $13.5 million compared to 2010. Accounting guidance
requires that changes in the valuation allowance be allocated to various
financial statement components of income or loss. The net increase to the
valuation allowance corresponds to an increase of $1.6 million in income
statement related deferred tax balances and an increase of $11.9 million in
OCI-related deferred tax balances. The increase of $1.6 million in income
statement related deferred tax balances is comprised of an increase of $7.8
million recorded to discontinued operations partially offset by a decrease of
$6.2 million recorded to continuing operations. These movements in the valuation
allowance offset movements in the net pre-valuation allowance deferred tax
balances.
The tax provision reported in continuing operations of $1.9 million consists
primarily of a deferred tax expense of $1.4 million related to the establishment
of a valuation allowance on a beginning-of-the-year deferred tax balance, which
was not previously recognized. Additionally, current tax expense of $0.5 million
was recognized related to AMT. For the AMT, the expected deferred tax asset
offset to the AMT credit carryforward was eliminated by an increase in the
valuation allowance.
As of December 31, 2011, $314.1 million of net operating and capital loss
carryover benefits were included in the deferred tax asset. Of this amount,
$170.8 million related to $487.9 million of federal net operating losses that
are scheduled to expire between the years 2021 and 2031. An additional $136.2
million related to $389.2 million of federal capital losses that are scheduled
to expire between the years 2012 and 2016, with $18.8 million and $205.5 million
expiring in 2012 and 2013, respectively. The remaining amount of $7.1 million is
attributable to state income tax net operating losses.
As of December 31, 2011, we had deferred income tax assets of $2.0 million
related to foreign tax credit carryovers, which are expected to expire between
the 2015 and 2020 tax years. As of December 31, 2011, we had deferred income tax
assets of $35.3 million related to general business tax credit carryovers, which
are expected to expire between the years 2022 and 2031. Additionally, we had
deferred income tax assets of $1.7 million related to AMT credit carryovers.
See Note 15 to our consolidated financial statements under "Item 8: Financial
Statements and Supplementary Data" in this Annual Report on Form 10-K for more
information related to income taxes.
Pension and Other Post-Employment Benefits
We have three defined benefit pension plans covering our employees. The employee
pension plan, covering substantially all of our employees, provides benefits up
to the amount allowed under the Internal Revenue Code. The two supplemental
plans provide benefits in excess of the primary plan. Retirement benefits under
the plans are a function of years of service and compensation. Effective
March 31, 2010, all benefit accruals under all of our defined benefit plans were
frozen. This change was announced in 2009 and a curtailment was recognized at
that time for the reduction in the expected years of future service.
We have historically provided our employees with other post-employment benefits
that include health care and life insurance. In December 2009, we announced the
decision to eliminate retiree medical coverage for current employees whose age
plus years of service did not equal at least 65 as of March 31, 2010. Employees
who remain eligible must still meet all other plan requirements to receive
benefits. In addition, the cap on the company's contribution to pre-65 retiree
medical costs per participant will be reduced beginning with the 2011 plan year.
This decision affected benefits attributed to past service for employees that
were not grandfathered into retiree coverage as well as the expected years of
future service for the reduction in the cap for retiree medical costs. Both a
negative plan amendment and curtailment were recognized as a result of the plan
changes. The net effect was a reduction of our projected benefit obligation.
See Note 17 to our consolidated financial statements under "Item 8: Financial
Statements and Supplementary Data" in this Annual Report on Form 10-K for more
information on our pension and other post-employment benefits.
33
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Consolidated Results of Operations
Summary Consolidated Increase (decrease) and
Financial Data: Years Ended December 31, percentage change
($ in millions, except
per share data) 2011 2010 2009 2011
vs. 2010 2010 vs. 2009
REVENUES
Premiums $ 459.1 $ 521.4 $ 583.9 $ (62.3) (12%) $ (62.5) (11%)
Fee income 597.1 630.2 648.1 (33.1) (5%) (17.9) (3%)
Net investment income 809.9 844.6 786.7 (34.7) (4%) 57.9 7%
Net realized investment
gains (losses):
Total
other-than-temporary
impairment
("OTTI") losses (64.6) (105.2) (201.5) 40.6 39% 96.3 48%
Portion of OTTI losses
recognized in
other comprehensive
income ("OCI") 38.9 55.6 93.1 (16.7) (30%) (37.5) (40%)
Net OTTI losses
recognized
in earnings (25.7) (49.6) (108.4) 23.9 48% 58.8 54%
Net realized investment
gains,
excluding OTTI losses 9.3 39.7 6.2 (30.4)
(77%) 33.5 NM
Net realized investment
losses (16.4) (9.9) (102.2) (6.5) (66%) 92.3 90%
Total revenues 1,849.7 1,986.3 1,916.5 (136.6) (7%) 69.8 4%
BENEFITS AND EXPENSES
Policy benefits,
excluding policyholder
dividends 1,083.2 1,090.0 1,179.6 (6.8) (1%) (89.6) (8%)
Policyholder dividends 246.9 309.8 226.8 (62.9) (20%) 83.0 37%
Policy acquisition cost
amortization 210.6 298.2 260.6 (87.6) (29%) 37.6 14%
Interest expense on
indebtedness 31.8 31.8 33.1 - NM (1.3) (4%)
Other operating expenses 245.2 291.2 303.5 (46.0) (16%) (12.3) (4%)
Total benefits and
expenses 1,817.7 2,021.0 2,003.6 (203.3) (10%) 17.4 1%
Income (loss) from
continuing operations
before income taxes 32.0 (34.7) (87.1) 66.7 192% 52.4 60%
Income tax expense
(benefit) 1.9 (10.1) 108.9 12.0 119% (119.0) (109%)
Income (loss) from
continuing operations 30.1 (24.6) (196.0) 54.7
222% 171.4 87%
Income (loss) from
discontinued
operations, net of
income taxes (22.0) 12.0 (123.0) (34.0) NM 135.0 110%
Net income (loss) $ 8.1 $ (12.6) $ (319.0) $ 20.7 164% $ 306.4 96%
Earnings (loss) per
share:
Basic $ 0.07 $ (0.11) $ (2.74) $ 0.18 164% $ 2.63 96%
Diluted $ 0.07 $ (0.11) $ (2.74) $ 0.18 164% $ 2.63 96%
Weighted-average common
shares
outstanding (in
millions) 116.5 116.3 116.5 0.2 NM (0.2) NM
Weighted-average common
shares
outstanding and dilutive
potential
common shares (in
millions) 118.0 116.3 116.5 1.7 1% (0.2) NM
-------
Not meaningful (NM)
Analysis of Consolidated Results of Operations
Year ended December 31, 2011 compared to year ended December 31, 2010
Net income from continuing operations for 2011 was $30.1 million, or $0.26 per
share, compared to a net loss from continuing operations of $24.6 million, or
$(0.21) per share for 2010. The increase in results from continuing operations
reflects lower policy acquisition cost amortization, lower operating expenses
and improvement in net realized investment losses. These items were partially
offset by lower premiums and fee income as well as higher income tax expense.
34
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Policy acquisition cost amortization decreased $87.6 million to $210.6 million
in 2011. This decrease in amortization was attributable to the unlocking of
assumptions as a result of annual comprehensive reviews of assumptions in the
third quarters of 2011 and 2010. The unlocking resulted in an overall decrease
in amortization of $2.9 million in 2011, compared to an acceleration of
amortization of $46.4 million in 2010. In 2011, the unlocking primarily related
to changes in assumptions for universal life policies which resulted in a
decrease of $35.8 million from higher expected fees partially offset by an
increase of $34.0 million from lower premium persistency. In 2010, the unlocking
was primarily driven by increased lapses in portions of our universal life
business which resulted in $36.6 million of additional amortization. Excluding
the impact of the unlocking, amortization was lower by $41.4 million primarily
related to universal life as a result of less favorable mortality experience
during 2011.
Operating expenses decreased $46.0 million to $245.2 million in 2011, compared
to $291.2 million in 2010. The decrease in operating expenses was a result of
lower professional fees and outside services as well as lower compensation
related expenses.
The Company recorded an income tax expense of $1.9 million to continuing
operations in 2011, compared to an income tax benefit of $10.1 million to
continuing operations in 2010. A deferred tax expense of $1.4 million in 2011
was related to the establishment of a valuation allowance on a
beginning-of-the-year deferred tax balance, which was not previously recognized.
Additionally, current tax expense of $0.5 million was recognized related to AMT.
In 2010, as a result of an exception to the intraperiod allocation rules in
accordance with ASC 740-20, Accounting for Income Taxes - Intraperiod Tax
Allocation, a $12.1 million tax benefit was recorded to continuing operations,
which was partially offset by current tax expense of $2.0 million.
Net realized investment losses increased $6.5 million to $16.4 million in 2011,
compared to $9.9 million in 2010. The increase in net realized investment losses
was primarily a result of a decline in net transaction gains of $28.3 million.
In addition, realized losses related to fair value options were $0.6 million in
2011 compared to realized gains of $3.5 million in 2010. These declines were
offset by $23.9 million of lower impairment losses for 2011 compared to 2010.
Realized losses on derivative assets and liabilities improved $2.0 million
during 2011. This improvement was primarily attributable to $17.2 million of
lower realized losses on a surplus hedge, which utilizes futures and options to
hedge against declines in equity markets and the resulting statutory capital and
surplus impact. This improvement was offset by a $16.6 million increase in
realized losses on embedded derivative liabilities and a $2.5 million decrease
in realized gains on derivatives associated with variable annuity guarantees.
Realized gains associated with variable annuity guarantees included a gain of
$15.9 million for 2011 associated with the non-performance risk factor compared
to a gain of $1.4 million for 2010.
Premium revenue declined as a result of lower renewal premiums on traditional
life lines of business, as well as lower paid up additions on policies within
the closed block, as a result of the change in the 2011 dividend scale.
Fees on our life and annuity products declined as a result of lower surrenders
and a decline in funds under management on universal life, variable universal
life and variable annuity products. Offsetting these declines was an increase in
non-asset based fees related to fixed indexed annuities. In addition, cost of
insurance fees declined $23.3 million primarily related to lower net insurance
in force in our universal life lines of business.
A net loss from discontinued operations of $22.0 million was recognized during
2011 which was primarily attributable to our discontinued group accident and
health reinsurance operations as we strengthened reserves to reflect
developments in the contracts underlying the block. See Note 21 to our
consolidated financial statements in this Form 10-K for more information on
discontinued operations.
Year ended December 31, 2010 compared to year ended December 31, 2009
We recorded a net loss from continuing operations of $24.6 million, or $(0.21)
per share, for 2010 compared to a net loss from continuing operations of $196.0
million, or $(1.68) per share, for 2009. The improvement in results from
continuing operations reflects increased net investment income, lower net
realized investment losses, lower policy benefits and lower income tax expense.
These improvements were partially offset by lower premiums, higher policyholder
dividends, and higher policy acquisition cost amortization.
35
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Net investment income increased by $57.9 million to $844.6 million for 2010
compared to $786.7 million for 2009. The increase was primarily due to improved
valuations and distributions from limited partnerships and other investments.
These increases were partially offset by a decline in net investment income
related to long-term debt securities as a result of lower yields and loss in
income on previously impaired bonds.
Net realized investment losses improved $92.3 million to $9.9 million for 2010,
compared to $102.2 million for 2009. The improvement in realized losses was a
result of a significant decline in OTTIs. In addition, realized losses on
derivative assets and liabilities improved to $7.9 million in 2010 compared to
$31.0 million in 2009. This was primarily attributable to embedded derivatives
associated with variable and fixed indexed annuity guarantees which had a gain
of $11.1 million in 2010 versus a loss of $31.0 million in 2009. Of this
improvement in embedded derivatives, $29.7 million was associated with the
non-performance risk factor. This was partially offset by losses of $19.0
million on our surplus hedge that was entered into during 2010.
Policy benefits decreased $89.6 million to $1,090.0 million for 2010 from
$1,179.6 million for 2009. Unlocking adjustments of $7.7 million and $18.7
million in 2010 and 2009, respectively, decreased overall death benefit and
other insurance benefit reserves. Excluding the impact of unlocking,
policyholder benefits decreased primarily as a result of the decrease in
policyholder dividend obligations in the closed block as a result of the change
in the 2011 dividend scale and improved mortality for universal life.
We recorded an income tax benefit of $10.1 million to continuing operations in
2010, compared to an income tax expense of $108.9 million in 2009. As a result
of an exception to the intraperiod allocation rules in accordance with ASC
740-20, Accounting for Income Taxes - Intraperiod Tax Allocation, a $12.1
million tax benefit was recorded to continuing operations, which was partially
offset by current tax expense of $2.0 million. In 2009, tax expense of $108.9
million was recognized primarily as a result of the establishment of a full
valuation allowance, net of unrealized losses on available-for-sale debt
securities.
The decline in premiums was primarily related to the closed block as the number
of policies in-force continues to decline.
Policy acquisition cost amortization increased $37.6 million to $298.2 million
in 2010 from $260.6 million in 2009. An unlocking of assumptions related to
deferred policy acquisition costs resulted in an acceleration of amortization of
$46.4 million in 2010 and $42.5 million in 2009. Excluding the impact of
unlocking, amortization related to universal life increased as a result of
higher mortality margins. Amortization related to annuities, excluding the
impact of unlocking, also increased as a result of lower market performance and
smaller improvement in the net amount at risk related to death benefit and other
insurance benefit reserves. This was partially offset by lower amortization on
the closed block as a result of decrease in surrenders.
For the year ended December 31, 2009, the net loss from discontinued operations
primarily consisted of $71.7 million of reserve strengthening related to our
discontinued accident and health business and a loss of $48.5 million associated
with PFG. The loss related to PFG included $27.0 million for the impairment of
goodwill and $22.7 million recognized as the loss on sale.
Income Taxes
The effective tax rate for 2011, 2010 and 2009 was 5.9%, 29.1% and (125.0%),
respectively. The principal cause of the difference between the effective rate
and the U.S. statutory rate of 35% in 2011 was the dividend received deduction
and a decrease in the valuation allowance. The principal cause of the difference
between the effective tax rate and the U.S. statutory rate of 35% in 2010 was an
adjustment to tax attribute carryovers as a result of the effective settlement
of an IRS audit, partially offset by a decrease in the valuation allowance.
See Note 15 to our consolidated financial statements under "Item 8: Financial
Statements and Supplementary Data" in this Annual Report on Form 10-K for more
information related to income taxes.
Effects of Inflation
For the years 2011, 2010 and 2009, inflation did not have a material effect on
our consolidated results of operations.
36
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Enterprise Risk Management
We have a comprehensive, enterprise-wide risk management program. Our Chief Risk
Officer reports to the Chief Financial Officer and monitors our risk management
activities. The Chief Risk Officer provides regular reports to our Board of
Directors without the presence of other members of management. Our risk
management governance consists of several management committees to oversee and
address issues pertaining to all our major risks-operational, market and
product-as well as capital management. In all cases, these committees include
one or more of our Chief Executive Officer, Chief Financial Officer, Chief
Investment Officer and Chief Risk Officer.
Operational Risk
Operational risk is the risk of loss resulting from inadequate or failed
internal processes, people and systems or from external events. The Operational
Risk Committee, chaired by the Chief Risk Officer, develops an enterprise-wide
framework for managing operational risks. This committee meets periodically and
includes membership that represents all significant operating, financial and
staff departments of the Company. Among the risks the committee reviews and
manages and for which it provides general oversight are business continuity
risk, disaster recovery risk and risks related to the Company's information
technology systems.
Market Risk
Market risk is the risk that we will incur losses due to adverse changes in
market rates and prices. We have exposure to market risk through both our
investment activities and our insurance operations. Our investment objective is
to maximize after-tax investment return within defined risk parameters. Our
primary sources of market risk are:
·
interest rate risk, which relates to the market price and cash flow variability
associated with changes in market interest rates;
·
credit risk, which relates to the uncertainty associated with the ongoing
ability of an obligor to make timely payments of principal and interest; and
·
equity risk, which relates to the volatility of prices for equity and
equity-like investments, such as limited partnerships.
We measure, manage and monitor market risk associated with our insurance and
annuity business, as part of our ongoing commitment to fund insurance
liabilities. We have developed an integrated process for managing the
interaction between product features and market risk. This process involves our
Corporate Finance, Corporate Portfolio Management and Life and Annuity Product
Development departments. These areas coordinate with each other and report
results and make recommendations to our Asset-Liability Management Committee
("ALCO") chaired by the Chief Financial Officer.
We also measure, manage and monitor market risk associated with our investments,
both those backing insurance liabilities and those supporting surplus. This
process primarily involves Corporate Portfolio Management. This organization
makes recommendations and reports results to our Investment Policy Committee,
chaired by the Chief Investment Officer. Please refer to the sections that
follow, including "Debt and Equity Securities", following this discussion of
Enterprise Risk Management, for more information on our investment risk
exposures. We regularly refine our policies and procedures to appropriately
balance market risk exposure and expected return.
Interest Rate Risk Management
Interest rate risk is the risk that we will incur economic losses due to adverse
changes in interest rates. Our exposure to interest rate changes results
primarily from our interest-sensitive insurance liabilities and from our
significant holdings of fixed rate investments. Our insurance liabilities
largely comprise dividend-paying individual whole life and universal life
policies and annuity contracts. Our fixed maturity investments include U.S. and
foreign government bonds, securities issued by government agencies, corporate
bonds, asset-backed securities, mortgage-backed securities and mortgage loans,
most of which are exposed to changes in medium-term and long-term U.S. Treasury
rates.
37
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We manage interest rate risk as part of our asset-liability management and
product development processes. Asset-liability management strategies include the
segmentation of investments by product line and the construction of investment
portfolios designed to satisfy the projected cash needs of the underlying
product liabilities. All asset-liability strategies are approved by the ALCO. We
manage the interest rate risk in portfolio segments by modeling and analyzing
asset and product liability durations and projected cash flows under a number of
interest rate scenarios.
One of the key measures we use to quantify our interest rate exposure is
duration, a measure of the sensitivity of the fair value of assets and
liabilities to changes in interest rates. For example, if interest rates
increase by 100 basis points, or 1%, the fair value of an asset or liability
with a duration of five is expected to decrease by 5%. We believe that as of
December 31, 2011, our asset and liability portfolio durations were
approximately matched but reflected somewhat lower asset durations because of
our continued emphasis on liquidity. We regularly undertake a sensitivity
analysis that calculates liability durations under various cash flow scenarios.
We also calculate key rate durations for assets and liabilities that show the
impact of interest rate changes at specific points on the yield curve. In
addition, we monitor the short- and medium-term asset and liability cash flows
profiles by portfolio to manage our liquidity needs.
To calculate duration for liabilities, we project liability cash flows under a
number of stochastically-generated interest rate scenarios and discount them to
a net present value using a risk-free market rate increased for our own credit
risk. For interest-sensitive liabilities the projected cash flows reflect the
impact of the specific scenarios on policyholder behavior as well as the effect
of minimum guarantees. Duration is calculated by revaluing these cash flows at
an alternative level of interest rates and by determining the percentage change
in fair value from the base case.
We also manage interest rate risk by emphasizing the purchase of securities that
feature prepayment restrictions and call protection. Our product design and
pricing strategies include the use of surrender charges or restrictions on
withdrawals in some products.
The selection of a 100 basis point immediate increase or decrease in interest
rates at all points on the yield curve is a hypothetical rate scenario used to
demonstrate potential risk. While a 100 basis point immediate increase or
decrease of this type does not represent our view of future market changes, it
is a hypothetical near-term change that illustrates the potential effect of such
events. Although these fair value measurements provide a representation of
interest rate sensitivity, they are based on our portfolio exposures at a point
in time and may not be representative of future market results. These exposures
will change as a result of on-going portfolio transactions in response to new
business, management's assessment of changing market conditions and available
investment opportunities.
The table below shows the estimated interest rate sensitivity of our fixed
income financial instruments measured in terms of fair value.
Interest Rate Sensitivity of As of December 31, 2011
Fixed Income Financial Instruments: -100 Basis +100 Basis
($ in millions) Carrying Point Point
Value Change Fair Value Change
Cash and cash equivalents $ 194.3 $ 194.5 $ 194.3 $ 194.1 Available-for-sale debt securities 11,890.0 12,464.4 11,890.0
11,315.8
Totals $ 12,084.3 $ 12,658.9 $ 12,084.3 $ 11,509.9
We use derivative financial instruments, primarily interest rate swaps, to
manage our residual exposure to fluctuations in interest rates. We enter into
derivative contracts with a number of highly rated financial institutions, to
both diversify and reduce overall counterparty credit risk exposure.
We enter into interest rate swap agreements to reduce market risks from changes
in interest rates. We do not enter into interest rate swap agreements for
trading purposes. Under interest rate swap agreements, we exchange cash flows
with another party at specified intervals for a set length of time based on a
specified notional principal amount. Typically, one of the cash flow streams is
based on a fixed interest rate set at the inception of the contract and the
other is based on a variable rate that periodically resets. No premium is paid
to enter into the contract and neither party makes payment of principal. The
amounts to be received or paid on these swap agreements are accrued and
recognized in net investment income.
38
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The table below shows the interest rate sensitivity of our derivatives measured
in terms of fair value, excluding derivative liabilities embedded in products.
These exposures will change as our insurance liabilities are created and
discharged and as a result of ongoing portfolio and risk management activities.
Interest Rate Sensitivity of As of December 31, 2011
Derivatives: Weighted- -100 +100
($ in millions) Average Basis Basis
Notional Term Point Point
Amount (Years) Change Fair Value Change
Cross currency swaps $ 15.0 3.1 $ 0.2 $ 0.2 $ 0.2
Equity futures 70.0 0.3 (1.0) (1.1) (1.2)
Interest rate swaps 131.0 10.2 17.8 9.8 2.8
Variance swaps 0.9 5.6 3.6 3.2 2.8
Call options 355.0 0.6 8.6 9.0 9.4
Put options 406.0 7.1 126.9 109.7 94.4
Swaptions 25.0 2.3 - 0.3 0.7
Total $ 1,002.9 $ 156.1 $ 131.1 $ 109.1
See Note 13 to our consolidated financial statements under "Item 8: Financial
Statements and Supplementary Data" in this Annual Report on Form 10-K for more
information on derivative instruments.
Credit Risk Management
We manage credit risk through the fundamental analysis of the underlying
obligors, issuers and transaction structures. Through internal staff and an
outsource relationship, we employ experienced credit analysts who review
obligors' management, competitive position, cash flow, coverage ratios,
liquidity and other key financial and non-financial information. These analysts
recommend the investments needed to fund our liabilities while adhering to
diversification and credit rating guidelines. In addition, when investing in
private debt securities, we rely upon broad access to management information,
negotiated protective covenants, call protection features and collateral
protection. We review our debt security portfolio regularly to monitor the
performance of obligors and assess the stability of their current credit
ratings.
We also manage credit risk through industry and issuer diversification and asset
allocation. Maximum exposure to an issuer or derivatives counterparty is defined
by quality ratings, with higher quality issuers having larger exposure limits.
We have an overall limit on below-investment-grade rated issuer exposure. In
addition to monitoring counterparty exposures under current market conditions,
exposures are monitored on the basis of a hypothetical "stressed" market
environment involving a specific combination of declines in stock market prices
and interest rates and a spike in implied option activity.
Equity Risk Management
Equity risk is the risk that we will incur economic losses due to adverse
changes in equity prices. Our exposure to changes in equity prices primarily
results from our variable annuity and variable life products, as well as from
our holdings of common stocks, mutual funds, private equity partnership
interests and other equities. We manage our insurance liability risks on an
integrated basis with other risks through our liability and risk management and
capital and other asset allocation strategies. We also manage equity price risk
through industry and issuer diversification and asset allocation techniques. We
held $35.7 and $47.5 million in available-for-sale equity securities on our
balance sheet as of December 31, 2011 and 2010, respectively.
Certain annuity products sold by our Life Companies contain GMDBs. The GMDB
feature provides annuity contract owners with a guarantee that the benefit
received at death will be no less than a prescribed amount. This minimum amount
is based on the net deposits paid into the contract, the net deposits
accumulated at a specified rate, the highest historical account value on a
contract anniversary or, if a contract has more than one of these features, the
greatest of these values. To the extent that the GMDB is higher than the current
account value at the time of death, the Company incurs a cost. This typically
results in an increase in annuity policy benefits in periods of declining
financial markets and in periods of stable financial markets following a
decline. As of December 31, 2011 and 2010, the difference between the GMDB and
the current account value (net amount at risk) for all existing contracts was
$151.2 million and $116.7 million, respectively. This was our exposure to loss
had all contract owners died on either December 31, 2011 or 2010. See Note 11 to
our consolidated financial statements under "Item 8: Financial Statements and
Supplementary Data" in this Annual Report on Form 10-K for more information.
39
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Certain life and annuity products sold by our Life Companies contain guaranteed
minimum living benefits. These include guaranteed minimum accumulation,
withdrawal, income and payout annuity floor benefits. The GMAB guarantees a
return of deposit to a policyholder after 10 years regardless of market
performance. The GMWB guarantees that a policyholder can withdraw a certain
percentage for life regardless of market performance. The GMIB guarantees that a
policyholder can convert his or her account value into a guaranteed payout
annuity at a guaranteed minimum interest rate and a guaranteed mortality basis,
while also assuming a certain level of growth in the initial deposit. The
guaranteed payout annuity floor benefit ("GPAF") guarantees that the variable
annuity payment will not fall below the dollar amount of the initial payment. We
also offer a combination rider that offers both GMAB and GMDB benefits. We have
established a hedging program for managing the risk associated with our
guaranteed minimum accumulation and withdrawal benefit features. We continue to
analyze and refine our strategies for managing risk exposures associated with
all our separate account guarantees. The liabilities related to these benefits
totaled $62.0 million and $32.1 million at December 31, 2011 and 2010,
respectively.
We analyze the sensitivity of a change in the separate account performance
assumption as it is critical to the development of the EGPs related to our
variable annuity and variable life insurance business. Equity market movements
have a significant impact on the account value of variable life and annuity
products and fees earned. Sustained and significant changes in the equity
markets could therefore have an impact on deferred policy acquisition cost
amortization.
As part of our analysis of separate account returns, we perform two sensitivity
tests. If at December 31, 2011 we had reprojected EGPs using a 100 basis points
lower separate account return assumption (after fund fees and mortality and
expense charges) for both the variable annuity and the variable life businesses
and used our current best estimate assumptions for all other assumptions, the
estimated increase to amortization and decrease to net income would have been
approximately $6.1 million, before taxes.
If, instead, at December 31, 2011 we had reprojected EGPs using a 100 basis
points higher separate account return assumption (after fund fees and mortality
and expense charges) for both the variable annuity and variable life businesses
and used our current best estimate assumptions for all other assumptions, the
estimated decrease to amortization and increase to net income would have been
approximately $3.8 million, before taxes.
See Note 6 to our consolidated financial statements under "Item 8: Financial
Statements and Supplementary Data" in this Annual Report on Form 10-K for more
information regarding deferred policy acquisition costs.
We sponsor defined benefit pension plans for our employees. For GAAP accounting
purposes, we assumed an 8.0% long-term rate of return on plan assets in the most
recent valuations, performed as of December 31, 2011. To the extent there are
deviations in actual returns, there will be changes in our projected expense and
funding requirements. As of December 31, 2011, the projected benefit obligation
for our funded and unfunded defined benefit plans was in excess of plan assets
by $186.7 million and $141.2 million, respectively. We made contributions
totaling $17.4 million and $25.7 million to the pension plans during 2011 and
2010, respectively. Over the next 12 months, we expect to make contributions of
approximately $16.4 million, of which approximately $3.4 million will be made in
the first quarter of 2012.
Effective March 31, 2010, all benefit accruals under all of our defined benefit
plans were frozen. This change was announced in 2009 and a curtailment was
recognized at that time for the reduction in the expected years of future
service.
See Note 17 to our consolidated financial statements under "Item 8: Financial
Statements and Supplementary Data" in this Annual Report on Form 10-K for more
information on our employee benefit plans.
Debt and Equity Securities
We invest in a variety of debt and equity securities. We classify these
investments into various sectors using industry conventions; however, our
classifications may differ from similarly titled classifications of other
companies. We classify debt securities into investment grade and
below-investment-grade securities based on ratings prescribed by the National
Association of Insurance Commissioners ("NAIC"). In a majority of cases, these
classifications will coincide with ratings assigned by one or more Nationally
Recognized Standard Ratings Organizations ("NRSROs"); however, for certain
structured securities, the NAIC designations may differ from NRSRO designations
based on the amortized cost of the securities in our portfolio.
40
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Our debt securities portfolio consists primarily of investment grade publicly
traded and privately placed corporate bonds, residential mortgage-backed
securities ("RMBS"), commercial mortgage-backed securities ("CMBS") and other
asset-backed securities. As of December 31, 2011, our debt securities, with a
fair value of $11,890.0 million, represented 78.4% of total investments.
Debt Securities Ratings by Percentage:
($ in millions) As of December 31, 2011
% of % of
NAIC S&P Equivalent Fair Fair Amortized Amortized
Rating Designation Value Value Cost Cost
1 AAA/AA/A $ 7,008.1 59.0% $ 6,541.1 57.6%
2 BBB 3,916.1 32.9% 3,699.3 32.6%
Total investment grade 10,924.2 91.9% 10,240.4 90.2%
3 BB 568.1 4.8% 650.8 5.7%
4 B 207.9 1.7% 242.9 2.1%
5 CCC and lower 124.4 1.0% 149.3 1.4%
6 In or near default 65.4 0.6% 68.4 0.6%
Total debt securities $ 11,890.0 100.0% $ 11,351.8 100.0%
Debt Securities by Type: As of December 31, 2011
($ in millions) Unrealized Gains (Losses)
Fair Amortized Gross Gross
Value Cost Gains Losses Net
U.S. government and agency $ 783.4 $ 708.6 $ 80.1 $ (5.3) $ 74.8
State and political subdivision 270.6 251.9 21.6 (2.9) 18.7
Foreign government 205.2 185.7 21.2 (1.7) 19.5
Corporate 6,599.4 6,167.0 603.9 (171.5) 432.4
CMBS 1,143.1 1,109.9 53.5 (20.3) 33.2
RMBS 2,131.3 2,132.9 80.3 (81.9) (1.6)
CDO/CLO 250.6 294.2 4.5 (48.1) (43.6)
Other asset-backed 506.4 501.6 11.1 (6.3) 4.8
Total debt securities $ 11,890.0 $ 11,351.8 $ 876.2 $ (338.0) $ 538.2
Debt securities outside closed block
Unrealized gains $ 4,272.7 $ 3,964.9 $ 307.8 $ - $ 307.8
Unrealized losses 1,264.2 1,478.7 - (214.5) (214.5)
Total outside the closed block 5,536.9 5,443.6 307.8 (214.5) 93.3
Debt securities in closed block
Unrealized gains 5,481.5 4,913.1 568.4 - 568.4
Unrealized losses 871.6 995.1 - (123.5) (123.5)
Total in the closed block 6,353.1 5,908.2 568.4 (123.5) 444.9
Total debt securities $ 11,890.0 $ 11,351.8 $ 876.2 $ (338.0) $ 538.2
Debt Securities by Type and Credit Quality: As of December 31, 2011
($ in millions) Investment Grade Below Investment Grade
Fair Amortized Fair Amortized
Value Cost Value Cost
U.S. government and agency $ 780.9 $ 706.1 $ 2.5 $ 2.5
State and political subdivision 256.0 235.6 14.6 16.3
Foreign government 169.8 153.4 35.4 32.3
Corporate 6,027.2 5,520.7 572.2 646.3
CMBS 1,108.4 1,061.3 34.7 48.6
RMBS 2,004.3 1,976.5 127.0 156.4
CDO/CLO 144.6 159.8 106.0 134.4
Other asset-backed 433.0 427.2 73.4 74.4
Total debt securities $ 10,924.2 $ 10,240.6 $ 965.8 $ 1,111.2
Percentage of total debt securities 91.9% 90.2% 8.1% 9.8%
41
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We manage credit risk through industry and issuer diversification. Maximum
exposure to an issuer is defined by quality ratings, with higher quality issuers
having larger exposure limits. Our investment approach emphasizes a high level
of industry diversification. The top five industry holdings as of December 31,
2011 in our debt securities portfolio were banking (6.0%), electrical utilities
(5.3%), insurance (3.6%), oil (3.6%) and diversified financial services (2.7%).
Eurozone Exposure
The following table presents exposure to European debt. We have focused on the
countries experiencing significant economic, fiscal or political strain that
could increase the likelihood of default.
Eurozone Exposure by Country As of December 31, 2011
($ in millions) Sovereign Financial % of Debt
Debt Institutions All Other Total Securities
Spain $ - $ 11.7 $ 50.2 $ 61.9 0.5%
Ireland - 5.2 43.4 48.6 0.4%
Italy - - 16.6 16.6 0.1%
Portugal - - 15.0 15.0 0.1%
Greece - - - - 0.0%
Total - 16.9 125.2 142.1 1.1%
All other Eurozone(1) - 62.7 156.6 219.3 1.9%
Total $ - $ 79.6 $ 281.8 $ 361.4 3.0%
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(1)
Includes Belgium, Finland, France, Germany, Luxembourg and Netherlands.
Residential Mortgage-Backed Securities
We invest directly in RMBS. To the extent these assets deteriorate in credit
quality and decline in value for an extended period, we may realize impairment
losses. When making investment decisions, we have been focused on identifying
those securities that could withstand significant increases in delinquencies and
foreclosures in the underlying mortgage pools before incurring a loss of
principal.
Most of our RMBS portfolio is highly rated. At December 31, 2011, 94.0% of the
total residential portfolio was rated investment grade. We hold $476.7 million
of RMBS investments backed by prime rated mortgages, $319.5 million backed by
Alt-A mortgages and $158.9 million backed by sub-prime mortgages, which combined
amount to 6.2% of our total investments. The majority of our prime, Alt-A and
sub-prime exposure is investment grade, with 70.5% being rated NAIC-1 and 16.2%
rated NAIC-2. We have employed a disciplined approach in the analysis and
monitoring of our mortgage-backed securities. Our approach involves a monthly
review of each security. Underlying mortgage data is obtained from the
security's trustee and analyzed for performance trends. A security-specific
stress analysis is performed using the most recent trustee information. This
analysis forms the basis for our determination of whether the security will pay
in accordance with the contractual cash flows. RMBS impairments during the year
ended December 31, 2011 totaled $10.3 million. These impairments consist of $3.4
million from prime, $3.8 million from Alt-A and $3.1 million from sub-prime.
42
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Residential Mortgage-Backed Securities:
($ in millions) As of December 31, 2011
NAIC Rating
1 2 3 4 5 6
AAA/ In or
Amortized Market % General AA/ CCC and Near % Closed
Cost(1) Value(1) Account(2) A BBB BB B Below Default Block
Collateral
Agency $ 1,104.0 $ 1,176.2 7.7% 100.0% 0.0% 0.0% 0.0% 0.0% 0.0% 47.1%
Prime 485.8 476.7 3.1% 81.7% 7.9% 9.3% 0.6% 0.3% 0.2% 39.4%
Alt-A 357.7 319.5 2.1% 49.1% 34.5% 11.0% 3.8% 1.5% 0.1% 28.1%
Sub-prime 185.4 158.9 1.0% 79.7% 4.3% 7.6% 5.6% 2.5% 0.3% 13.9%
Total $ 2,132.9 $ 2,131.3 13.9% 86.8% 7.2% 4.3% 1.1% 0.5% 0.1% 40.0%
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(1)
Individual categories may not agree with the Debt Securities by Type table on
previous page due to nature of underlying collateral.
(2)
Percentages based on Market Value.
Prime Mortgage-Backed Securities:
($ in millions) As of December 31, 2011
Year of Issue
S&P
Equivalent Amortized Market % General Post- 2003 and
Rating Designation Cost Value Account(1) 2007 2007 2006 2005 2004 Prior
NAIC-1 AAA/AAA/A $ 392.2 $ 389.7 2.5% 0.0% 2.6% 11.2% 15.0% 35.2% 36.0%
NAIC-2 BBB 39.2 37.9 0.3% 0.0% 0.0% 27.8% 51.1% 21.1% 0.0%
NAIC-3 BB 47.8 44.1 0.3% 0.0% 0.0% 43.6% 48.3% 6.2% 1.9%
NAIC-4 B 3.1 2.9 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
NAIC-5 CCC and
below 1.5 1.2 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 100.0%
NAIC-6 In or near
default 2.0 0.9 0.0% 0.0% 0.0% 0.0% 36.5% 2.4% 61.1%
Total $ 485.8 $ 476.7 3.1% 0.0% 2.2% 15.4% 21.4% 31.0% 30.0%
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(1)
Percentages based on Market Value.
Alt-A Mortgage-Backed Securities:
($ in millions) As of December 31, 2011
Year of Issue
S&P
Equivalent Amortized Market % General Post- 2003 and
Rating Designation Cost Value Account(1) 2007 2007 2006 2005 2004 Prior
NAIC-1 AAA/AAA/A $ 175.2 $ 156.9 1.0% 6.4% 0.0% 20.5% 15.9% 44.5% 12.7%
NAIC-2 BBB 119.3 110.1 0.7% 0.0% 3.7% 8.1% 23.5% 45.5% 19.2%
NAIC-3 BB 41.8 35.1 0.2% 0.0% 0.0% 11.5% 25.1% 46.0% 17.4%
NAIC-4 B 14.9 12.3 0.1% 0.0% 0.0% 0.0% 64.5% 14.9% 20.6%
NAIC-5 CCC and
below 6.1 4.8 0.1% 0.0% 0.0% 0.0% 0.0% 100.0% 0.0%
NAIC-6 In or near
default 0.4 0.3 0.0% 0.0% 0.0% 0.0% 0.0% 100.0% 0.0%
Total $ 357.7 $ 319.5 2.1% 3.2% 1.3% 14.1% 21.1% 44.7% 15.6%
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(1)
Percentages based on Market Value.
43
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Sub-Prime Mortgage-Backed Securities:
($ in millions) As of December 31, 2011
Year of Issue
S&P
Equivalent Amortized Market % General Post- 2003 and
Rating Designation Cost Value Account(1) 2007 2007
2006 2005 2004 Prior
NAIC-1 AAA/AAA/A $ 139.5$ 126.6 0.8% 0.0% 6.1%
7.3% 43.7% 25.0% 17.9%
NAIC-2 BBB 7.0 6.8 0.0% 0.0% 75.4% 0.0% 21.0% 0.0% 3.6%
NAIC-3 BB 18.4 12.2 0.1% 0.0% 62.8% 0.0% 22.6% 0.0% 14.6%
NAIC-4 B 13.3 8.9 0.1% 0.0% 0.0% 48.9% 36.9% 0.0% 14.2%
NAIC-5 CCC and
below 5.6 3.9 0.0% 0.0% 38.0% 0.0% 62.0% 0.0% 0.0%
NAIC-6 In or near
default 1.6 0.5 0.0% 0.0% 0.0% 0.0% 0.7% 0.0% 99.3%
Total $ 185.4 $ 158.9 1.0% 0.0% 13.9% 8.6% 41.0% 19.9% 16.6%
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(1)
Percentages based on Market Value.
Commercial Mortgage-Backed Securities
We invest directly in CMBS. To the extent these assets deteriorate in credit
quality and decline in value for an extended period, we may realize impairment
losses. When making investment decisions, we have been focused on identifying
those securities that could withstand significant increases in delinquencies and
foreclosures in the underlying mortgage pools before incurring a loss of
principal.
Commercial Mortgage-Backed Securities:
($ in millions) As of December 31, 2011
Year of Issue
S&P
Equivalent Amortized Market % General Post- 2004 and % Closed
Rating Designation Cost Value(1) Account(2) 2007 2007 2006 2005 Prior Block
NAIC-1 AAA/AAA/A $ 1,073.2 $ 1,119.7 7.3% 22.1% 5.5% 12.6% 9.2% 50.6% 51.0%
NAIC-2 BBB 10.3 7.6 0.0% 0.0% 0.0% 39.3% 60.7% 0.0% 36.4%
NAIC-3 BB 27.8 23.3 0.2% 0.0% 33.3% 13.9% 43.8% 9.0% 18.5%
NAIC-4 B 11.9 11.1 0.1% 0.0% 0.0% 0.0% 100.0% 0.0% 44.1%
NAIC-5 CCC and
below 25.6 11.3 0.1% 0.0% 0.0% 33.0% 0.0% 67.0% 77.9%
NAIC-6 In or near
default 8.9 3.2 0.0% 0.0% 68.8% 0.0% 0.0% 31.2% 28.4%
Total $ 1,157.7 $ 1,176.2 7.7% 21.0% 6.1% 12.8% 11.0% 49.1% 50.4%
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(1)
Includes commercial mortgage-backed CDOs with amortized cost and market values
of $47.8 million and $33.1 million, respectively.
(2)
Percentages based on Market Value.
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Realized Gains and Losses
The following table presents certain information with respect to realized
investment gains and losses including those on debt securities pledged as
collateral, with losses from OTTI charges reported separately in the table.
These impairment charges were determined based on our assessment of factors
enumerated below, as they pertain to the individual securities determined to be
other-than-temporarily impaired.
Sources and Types of Net Realized Investment Gains
(Losses): Years Ended December 31,
($ in millions) 2011 2010 2009
Total other-than-temporary debt impairments $ (64.6) $ (104.6) $ (186.1)
Portion of loss recognized in OCI 38.9 55.6
93.1
Net debt impairments recognized in earnings $ (25.7) $ (49.0) $ (93.0)
Debt security impairments:
U.S. government and agency $ - $ - $ -
State and political subdivision - - -
Foreign government - - -
Corporate (8.9) (6.9) (40.1)
CMBS (3.6) (6.6) (1.5)
RMBS (10.3) (15.8) (23.6)
CDO/CLO (1.9) (16.0) (19.4)
Other asset-backed (1.0) (3.7) (8.4)
Net debt security impairments (25.7) (49.0)
(93.0)
Equity security impairments - (0.6)
(5.2)
Limited partnerships and other investment impairments - -
(10.2)
Impairment losses (25.7) (49.6)
(108.4)
Debt security transaction gains 13.8 61.2
38.3
Debt security transaction losses (5.9) (15.8)
(62.1)
Equity security transaction gains 3.7 -
2.2
Equity security transaction losses - -
-
Limited partnerships and other investment gains 2.2 3.2
1.4
Limited partnerships and other investment losses (2.0) (4.5)
(3.6)
Sale of Goodwin 4.0 - -
CDO deconsolidation - - 57.0
Net transaction gains 15.8 44.1 33.2
Derivative instruments 27.2 (25.2) (121.1)
Embedded derivatives(1) (33.1) 17.3 90.1
Fair value option investments (0.6) 3.5
4.0
Net realized investment gains, excluding impairment
losses
9.3 39.7
6.2
Net realized investment losses, including impairment
losses $ (16.4) $ (9.9) $ (102.2)
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(1)
Includes the change in fair value of embedded derivatives associated with
variable annuity GMWB, GMAB, GPAF and COMBO riders. See Note 11 to our
consolidated financial statements under "Item 8: Financial Statements and
Supplementary Data" in this Annual Report on Form 10-K for additional
disclosures.
Other-than-Temporary Impairments
Management exercised significant judgment with respect to certain securities in
determining whether impairments are temporary or other than temporary. In
reaching its conclusions, management used a number of issuer-specific
quantitative indicators and qualitative judgments to assess the probability of
receiving a given security's contractual cash flows. This included the issue's
implied yield to maturity, cumulative default rate based on rating, comparisons
of issue-specific spreads to industry or sector spreads, specific trading
activity in the issue, and other market data such as recent debt tenders and
upcoming refinancing requirements. Management also reviewed fundamentals such as
issuer credit and liquidity metrics, business outlook and industry conditions.
Management maintains a watch list of securities that is reviewed for
impairments. Each security on the watch list was evaluated, analyzed and
discussed, with the positive and negative factors weighed in the ultimate
determination of whether or not the security was other-than-temporarily
impaired. For securities for which no OTTI was ultimately indicated at
December 31, 2011, management does not have the intention to sell nor does it
expect to be required to sell these securities prior to their recovery.
45
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Fixed income OTTIs recorded in 2011 were primarily concentrated in structured
securities and corporate bonds. These impairments were driven primarily by
increased collateral default rates and rating downgrades. In our judgment, these
credit events or other adverse conditions of the issuers have caused, or will
most likely lead to, a deficiency in the contractual cash flows related to the
investment. Therefore, based upon these credit events, we have determined that
OTTIs exist. Total debt impairments recognized through earnings related to such
credit-related circumstances were $25.7 million in 2011, $49.0 million in 2010
and $93.0 million in 2009. There were no equity security or limited partnership
and other investment OTTIs in 2011 and $0.6 million and $15.4 million in 2010
and 2009, respectively, were recognized.
In addition to these credit-related impairments recognized through earnings, we
impaired securities to fair value through other comprehensive loss for any
impairments related to non-credit related factors. These types of impairments
were driven primarily by market or sector credit spread widening or by a lack of
liquidity in the securities. The amount of impairments recognized as an
adjustment to other comprehensive loss due to these factors was $38.9 million in
2011, $55.6 million in 2010 and $93.1 million in 2009.
The following table presents a roll-forward of pre-tax credit losses recognized
in earnings related to debt securities for which a portion of the OTTI was
recognized in OCI.
Credit Losses Recognized in Earnings on Debt Securities for As of December 31,
which a Portion of the OTTI Loss was Recognized in OCI: 2011
2010
($ in millions)
Balance, beginning of year $ (60.4)
$ (44.4)
Add: Credit losses on securities not previously impaired(1) (11.6)
(17.1)
Add: Credit losses on securities previously impaired(1) (9.1)
(21.0)
Less: Credit losses on securities impaired due to intent to
sell
-
-
Less: Credit losses on securities sold 7.3
11.4
Less: Credit losses upon adoption of ASC 815 -
10.7
Less: Increases in cash flows expected on previously
impaired securities - -
Balance, end of year $ (73.8) $ (60.4)
-------
(1)
Additional credit losses on securities for which a portion of the OTTI loss was
recognized in AOCI are included within net OTTI losses recognized in earnings on
the statements of income and comprehensive income.
46
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Unrealized Gains and Losses
The following tables present certain information with respect to our gross
unrealized gains and losses related to our investments in debt securities as of
December 31, 2011. We separately present information that is applicable to
unrealized losses both outside and inside the closed block. See Note 8 to our
consolidated financial statements under "Item 8: Financial Statements and
Supplementary Data" in this Annual Report on Form 10-K for more information
regarding the closed block. Applicable deferred policy acquisition costs and
deferred income taxes further reduce the effect of unrealized gains and losses
on our comprehensive income.
Gross and Net As of December 31,
2011
Unrealized Gains (Losses): Total Outside Closed Block Closed Block
($ in millions) Gains Losses Gains Losses Gains Losses
Debt securities
Number of positions 3,526 1,149 2,416 906 1,110 243
Unrealized gains (losses) $ 876.2 $ (338.0) $ 307.8 $ (214.5) $ 568.4 $ (123.5)
Applicable policyholder
dividend obligation
(reduction) 568.4 (123.5) - - 568.4 (123.5)
Applicable deferred policy
acquisition costs
(benefit) 194.5 (121.9) 194.5 (121.9) - -
Applicable deferred income
taxes (benefit) 39.6 (32.4) 39.6 (32.4) - -
Offsets to net unrealized
gains (losses) 802.5 (277.8) 234.1 (154.3) 568.4 (123.5)
Unrealized gains (losses)
after offsets $ 73.7 $ (60.2) $ 73.7 $ (60.2) $ - $ -
Net unrealized gains after
offsets $ 13.5 $ 13.5 $ -
Equity securities
Number of positions 51 17 31 9 20 8
Unrealized gains (losses) $ 12.2 $ (6.0) $ 7.9 $ (2.9) $ 4.3 $ (3.1)
Applicable policyholder
dividend obligation
(reduction) 4.3 (3.1) - - 4.3 (3.1)
Applicable deferred income
taxes (benefit) 2.8 (1.0) 2.8 (1.0) - -
Offsets to net unrealized
gains (losses) 7.1 (4.1) 2.8 (1.0) 4.3 (3.1)
Unrealized gains (losses)
after offsets $ 5.1 $ (1.9) $ 5.1 $ (1.9) $ - $ -
Net unrealized gains after
offsets $ 3.2 $ 3.2 $ -
Net unrealized investment gains and losses on securities classified as
available-for-sale and certain other assets are included in our consolidated
balance sheet as a component of AOCI. The table below presents the special
category of AOCI for debt securities that are other-than-temporarily impaired
when the impairment loss has been split between the credit loss component (in
earnings) and the non-credit component (separate category of AOCI).
Fixed Maturity Non-Credit OTTI Losses in AOCI, by Security Type: As of December 31,
($ in millions) 2011(1) 2010(1)
U.S. government and agency $ - $ -
State and political subdivision - -
Foreign government - -
Corporate (5.7) (5.4)
CMBS (28.0) (18.7)
RMBS (89.6) (72.2)
CDO/CLO (24.2) (19.9)
Other asset-backed (1.2) -
Total fixed maturity non-credit OTTI losses in AOCI $ (148.7) $ (116.2)
-------
(1)
Represents the amount of non-credit OTTI losses recognized in AOCI excluding net
unrealized gains or losses subsequent to the date of impairment.
47
--------------------------------------------------------------------------------
Duration of Gross Unrealized Losses on
Securities: As of December 31, 2011
($ in millions) 0 - 6 6 - 12 Over 12
Total Months Months Months
Debt Securities Outside Closed Block
Total fair value $ 1,264.2 $ 382.9 $ 155.5 $ 725.8
Total amortized cost 1,478.7 395.5 160.9 922.3
Unrealized losses $ (214.5) $ (12.6) $ (5.4) $ (196.5)
Unrealized losses after offsets $ (60.2) $ (4.5) $ (2.5) $ (53.2)
Number of securities 906 289 115 502
Investment grade:
Unrealized losses $ (81.2) $ (9.2) $ (4.3) $ (67.7)
Unrealized losses after offsets $ (25.5) $ (3.4) $ (1.9) $ (20.2)
Below investment grade:
Unrealized losses $ (133.3) $ (3.4) $ (1.1) $ (128.8)
Unrealized losses after offsets $ (34.7) $ (1.1) $ (0.6) $ (33.0)
Equity Securities Outside Closed Block
Unrealized losses $ (2.9) $ (2.5) $ - $ (0.4)
Unrealized losses after offsets $ (1.5) $ (1.2) $ - $ (0.3)
Number of securities 9 5 - 4
For debt securities outside of the closed block with gross unrealized losses,
42.4% of the unrealized losses after offsets pertain to investment grade
securities and 57.6% of the unrealized losses after offsets pertain to
below-investment-grade securities at December 31, 2011.
The following table represents those securities whose fair value is less than
80% of amortized cost (significant unrealized loss) that have been at a
significant unrealized loss position on a continuous basis.
Duration of Gross Unrealized Losses on As of December 31, 2011
Securities Outside Closed Block: 0 - 6 6 - 12 Over 12
($ in millions) Total Months
Months Months
Debt securities outside closed block
Unrealized losses over 20% of cost $ (146.8) $ (34.0) $ (6.0) $ (106.8)
Unrealized losses over 20% of cost after offsets $ (39.3) $ (12.1) $ (2.3) $ (24.9)
Number of securities 183 79 18 86
Investment grade:
Unrealized losses over 20% of cost $ (33.6) $ (13.6) $ (1.2) $ (18.8)
Unrealized losses over 20% of cost after offsets $ (10.0) $ (4.6) $
(0.8) $ (4.6)
Below investment grade:
Unrealized losses over 20% of cost $ (113.2) $ (20.4) $ (4.8) $ (88.0)
Unrealized losses over 20% of cost after offsets $ (29.3) $ (7.5) $
(1.5) $ (20.3)
Equity securities outside closed block
Unrealized losses over 20% of cost $ (2.8) $ (2.4) $ - $ (0.4)
Unrealized losses over 20% of cost after offsets $ (1.4) $ (1.2) $ - $ (0.2)
Number of securities 5 2 1 2
48
--------------------------------------------------------------------------------
Duration of Gross Unrealized Losses on As of December 31, 2011
Securities Inside Closed Block: 0 - 6 6 - 12
Over 12
($ in millions) Total Months Months
Months
Debt securities inside closed block
Total fair value $ 871.6 $ 255.8 $ 59.3 $ 556.5
Total amortized cost 995.1 268.3 62.1 664.7
Unrealized losses $ (123.5) $ (12.5) $ (2.8) $ (108.2) Unrealized losses after offsets $ - $ - $ -
$ -
Number of securities 243 70 19 154
Investment grade:
Unrealized losses $ (71.2) $ (7.5) $ (2.1) $ (61.6) Unrealized losses after offsets $ - $ - $ -
$ -
Below investment grade:
Unrealized losses $ (52.3) $ (5.0) $ (0.7) $ (46.6) Unrealized losses after offsets $ - $ - $ -
$ -
Equity securities inside closed block
Unrealized losses $ (3.1) $ (2.7) $ -
$ (0.4)
Unrealized losses after offsets $ - $ - $ -
$ -
Number of securities 8 4 -
4
For debt securities inside the closed block with gross unrealized losses, there
were no unrealized losses after offsets at December 31, 2011.
The following table represents those securities whose fair value is less than
80% of amortized cost (significant unrealized loss) that have been at a
significant unrealized loss position on a continuous basis.
Duration of Gross Unrealized Losses on As of December
31, 2011
Securities Inside Closed Block: 0 - 6 6 -
12 Over 12
($ in millions) Total Months
Months Months
Debt securities inside closed block
Unrealized losses over 20% of cost $ (67.9) $ (44.5) $
(3.3) $ (20.1)
Unrealized losses over 20% of cost after offsets $ - $ - $
- $ -
Number of securities 52 30 4 18
Investment grade:
Unrealized losses over 20% of cost $ (30.2) $ (26.1) $
- $ (4.1)
Unrealized losses over 20% of cost after offsets $ - $ - $
- $ -
Below investment grade:
Unrealized losses over 20% of cost $ (37.7) $ (18.4) $
(3.3) $ (16.0)
Unrealized losses over 20% of cost after offsets $ - $ - $
- $ -
Equity securities inside closed block
Unrealized losses over 20% of cost $ (2.9) $ (2.5) $
- $ (0.4)
Unrealized losses over 20% of cost after offsets $ - $ - $
- $ -
Number of securities 6 3 1 2
Liquidity and Capital Resources
In the normal course of business, we enter into transactions involving various
types of financial instruments such as debt and equity securities. These
instruments have credit risk and also may be subject to risk of loss due to
interest rate and market fluctuations.
49
--------------------------------------------------------------------------------
Liquidity refers to the ability of a company to generate sufficient cash flow to
meet its cash requirements. The following discussion includes both liquidity and
capital resources as these subjects are interrelated.
The Phoenix Companies, Inc. (consolidated)
Summary Consolidated Cash
Flows: Increase (decrease) and
($ in millions) Years Ended December 31, percentage change
2011 2010 2009 2011 vs. 2010 2010 vs. 2009
Continuing operations:
Cash used for operating
activities $ (157.0) $ (236.0) $ (683.8) $ 79.0 33% $ 447.8 65%
Cash provided by (used
for)
investing activities (686.8) (57.4) 709.6 (629.4)
NM (767.0) (108%)
Cash from (used for)
financing activities 916.2 167.5 (196.8) 748.7
NM 364.3 185%
$ 72.4 $ (125.9) $ (171.0) $ 198.3 158% $ 45.1 26%
Discontinued operations:
Cash provided by (used
for)
operating activities $ 18.6 $ (22.0) $ 100.8 $ 40.6 185% $ (122.8) (122%)
Cash provided by (used
for)
investing activities (18.6) 13.1 (47.1) (31.7) 242% 60.2 128%
Cash provided by
financing activities - - 0.2 - NM (0.2) (100%)
$ - $ 8.9 $ (53.9) $ (8.9) (100%) $ (62.8) (117%)
-------
Not meaningful (NM)
2011 vs. 2010
Continuing Operations
Cash used for operating activities decreased by $79.0 million during the year
ended December 31, 2011 compared to the year ended December 31, 2010. This was
primarily attributable to a $244.0 million decrease in policyholder benefits
consistent with favorable persistency and mortality. While operating cash flows
remain negative as of December 31, 2011, this was primarily driven by cash
surrenders of deposit-type contracts for which funds are readily available in
segregated separate accounts or liquid general account assets.
Cash flows used for investing activities increased $629.4 million during the
year ended December 31, 2011 compared to the year ended December 31, 2010. The
primary driver of this fluctuation was an increase in purchases of
available-for- sale debt securities which was directly attributable to the
increase in deposits related to fixed indexed annuities. In addition, sales of
available-for-sale debt securities declined as a result of lower reinvestment
rates. Cash proceeds of $1.0 million were received related to the sale of
Goodwin in 2011 while $32.9 million of cash proceeds related to the sale of PFG
and PLARNY were received in 2010.
Cash flows provided by financing activities increased $748.7 million to cash
inflows of $916.2 million during the year ended December 31, 2011, compared to
$167.5 million during the year ended December 31, 2010. This improvement was
primarily a result of increase in policyholder deposits related to sales of
fixed indexed annuities. See Note 9 to our consolidated financial statements
under "Item 8: Financial Statements and Supplementary Data" in this Annual
Report on Form 10-K for additional information on financing activities.
Discontinued Operations
Cash flows used for operations related to discontinued operations declined as a
result of the sale of PFG in the second quarter of 2010. This was offset by the
increase in cash flows for investing activities in assets held to back higher
discontinued group accident and health reinsurance reserves reported to us by
certain ceding companies. See Note 21 to our consolidated financial statements
under "Item 8: Financial Statements and Supplementary Data" in this Annual
Report on Form 10-K for additional information on discontinued operations.
50
--------------------------------------------------------------------------------
2010 vs. 2009
Continuing Operations
Cash used for operating activities decreased by $447.8 million for the year
ended December 31, 2010 compared to the year ended December 31, 2009. This was
primarily the result of a decrease in policyholder benefits of $415.5 million
consistent with favorable mortality and lower surrenders as compared with prior
year.
Cash flows used for investing activities decreased $767.0 million during the
year ended December 31, 2010 compared to the year ended December 31, 2009. This
was primarily attributable to the decline in sales and maturities of
available-for-sale debt securities. In addition, outflows for policyholder loan
advances decreased by $215.2 million as a result of repayment of outstanding
loan balances primarily associated with one large surrender in the second
quarter of 2009. Cash proceeds of $32.9 million were received from the sale of
PFG and PLARNY.
Cash flows provided by financing activities were $167.5 million for the year
ended December 31, 2010, an increase of $364.3 million compared to cash flows
for financing activities of $196.8 million for the year ended December 31, 2009.
This was primarily the result of a decrease of $253.8 million in policyholder
withdrawals as a result of lower surrenders. In addition, policyholder deposits
increased $95.6 million as a result of new sales of fixed indexed annuities. See
Note 9 to our consolidated financial statements under Item 8 "Financial
Statements and Supplementary Data" in this Annual Report on Form 10-K for more
information on financing activities.
Discontinued Operations
Net cash flows provided by discontinued operations were positive for the year
ended December 31, 2010, an increase of $62.8 million compared to the year ended
December 31, 2009. This was primarily a result of a decrease in
available-for-sale assets related to the discontinued reinsurance operations
business consistent with the net decline in policyholder benefits and accruals
during 2010. This compared to an increase in available-for-sale assets
consistent with the net increase in policyholder benefits and accruals during
2009.
The Phoenix Companies, Inc. Sources and Uses of Cash (parent company only)
In addition to existing cash and securities, our primary source of liquidity
consists of dividends from Phoenix Life. Under New York Insurance Law, Phoenix
Life is permitted to pay stockholder dividends to the holding company in any
calendar year without prior approval from the New York Department of Financial
Services ("NYDFS") in the amount of the lesser of 10% of Phoenix Life's surplus
to policyholders as of the immediately preceding calendar year or Phoenix Life's
statutory net gain from operations for the immediately preceding calendar year,
not including realized capital gains. Based on this calculation, Phoenix Life
would be able to pay a dividend of $71.8 million in 2012. During the year ended
December 31, 2011, Phoenix Life paid $64.8 million in dividends. In assessing
our ability to pay dividends from Phoenix Life, we also consider the level of
statutory capital and RBC of that entity. Our capitalization increased in the
current and in the prior year; however, Phoenix Life may have less flexibility
to pay dividends to the parent company if we experience future declines. As of
December 31, 2011, we had $853.0 million of statutory capital, surplus and AVR.
Our estimated RBC ratio was in excess of 200% at Phoenix Life. See Note 22 to
our consolidated financial statements under "Item 8: Financial Statements and
Supplementary Data" in this Annual Report on Form 10-K for more information on
Phoenix Life statutory financial information and regulatory matters.
In 2011, 2010 and 2009, the Company did not pay any stockholder dividends.
We sponsor post-employment benefit plans through pension and savings plans for
employees of Phoenix Life. Funding of the majority of these obligations is
provided by Phoenix Life on a 100% cost reimbursement basis through
administrative services agreements with the holding company. See Note 17 to our
consolidated financial statements under "Item 8: Financial Statements and
Supplementary Data" in this Annual Report on Form 10-K for additional
information.
Our principal needs at the holding company level are debt service (net of
amounts due on bonds repurchased), income taxes and operating expenses. Interest
expense on senior unsecured bonds for the years ended December 31, 2011, 2010
and 2009 was $19.3 million, $19.3 million and $20.6 million, respectively. As of
December 31, 2011, future minimum annual principal payments on senior unsecured
bonds are $252.8 million in 2032.
51
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The Phoenix Companies, Inc. Summary Cash Flows (parent company only)
Summary Cash Flows: Years Ended December 31, Increase (decrease) and percentage change
($ in millions) 2011 2010 2009 2011 vs. 2010 2010 vs. 2009
Cash provided by operating
activities $ 44.8 $ 9.2 $ 9.1 $ 35.6 NM $ 0.1 1%
Cash provided by (used for)
investing activities 6.3 (7.7) (29.3) 14.0 182% 21.6 74%
Cash used for financing
activities (0.7) - (13.2) (0.7) 0% 13.2 100%
$ 50.4 $ 1.5 $ (33.4) $ 48.9 NM $ 34.9 104%
-------
Not meaningful (NM)
2011 vs. 2010
The increase in cash provided by operating activities for the year ended
December 31, 2011, compared to the year ended December 31, 2010, was primarily
attributable to a $39.8 million increase in dividends from Phoenix Life.
Outflows used for investing activities decreased with lower capital
contributions to subsidiaries. Additional inflows were recognized from debt
security redemptions.
Cash used for financing activities of $0.7 million related to the repurchase of
senior unsecured bonds.
2010 vs. 2009
Cash provided by operating activities remained flat for the year ended
December 31, 2010, compared with the year ended December 31, 2009. Income tax
benefits declined as a result of the prior year tax benefit recognized for the
year ended December 31, 2009 related to the 2008 spin-off of Virtus. However,
this decline was offset by an increase in cash dividends from subsidiaries as
well as a decline in operating expenses.
Investing activities produced a cash outflow primarily as a result of capital
contributions and advances to subsidiaries. This was partially offset by
proceeds from debt security redemptions as well as proceeds received for the
sale of PFG.
There was no cash activity related to financing activities in the current year
as compared to prior year outflows related to the repurchase of our senior
unsecured bonds.
Life Companies
The Life Companies' liquidity requirements principally relate to: the
liabilities associated with various life insurance and annuity products; the
payment of dividends by Phoenix Life to the parent company; operating expenses;
contributions to subsidiaries; and payment of principal and interest by Phoenix
Life on its outstanding debt obligation. Liabilities arising from life insurance
and annuity products include the payment of benefits, as well as cash payments
in connection with policy surrenders, withdrawals and loans. The Life Companies
also have liabilities arising from the runoff of the remaining discontinued
group accident and health reinsurance operations.
Historically, our Life Companies have used cash flow from operations and
investing activities to fund liquidity requirements. Their principal cash
inflows from life insurance and annuities activities come from premiums, annuity
deposits and charges on insurance policies and annuity contracts. In the case of
Phoenix Life, cash inflows also include dividends, distributions and other
payments from subsidiaries. Principal cash inflows from investing activities
result from repayments of principal, proceeds from maturities, sales of invested
assets and investment income. The principal cash inflows from our discontinued
group accident and health reinsurance operations come from our reinsurance,
recoveries from other retrocessionaires and investing activities.
52
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Annuity Actuarial Reserves and Deposit
Liabilities As of December 31,
Withdrawal Characteristics: 2011
2010
($ in millions) Amount(1) Percent
Amount(1) Percent
Not subject to discretionary withdrawal
provision $ 340.1 6% $ 226.8 4%
Subject to discretionary withdrawal without
adjustment 978.8 18% 997.3 20%
Subject to discretionary withdrawal with
market value adjustment 1,226.2 22% 443.5 9%
Subject to discretionary withdrawal at
contract value
less surrender charge 43.7 1% 53.0 1%
Subject to discretionary withdrawal at
market value 2,895.3 53% 3,352.0 66%
Total annuity contract reserves and deposit
fund liability $ 5,484.1 100% $ 5,072.6 100%
-------
(1)
Annuity contract reserves and deposit fund liability amounts are reported on a
statutory basis, which more accurately reflects the potential cash outflows and
include variable product liabilities. Annuity contract reserves and deposit fund
liabilities are monetary amounts that an insurer must have available to provide
for future obligations with respect to its annuities and deposit funds. These
are liabilities in our financial statements prepared in conformity with
statutory accounting practices. These amounts are at least equal to the values
available to be withdrawn by policyholders.
Individual life insurance policies are less susceptible to withdrawals than
annuity contracts because policyholders may incur surrender charges and be
required to undergo a new underwriting process in order to obtain a new
insurance policy. As indicated in the table above, most of our annuity contract
reserves and deposit fund liabilities are subject to withdrawals at market
value.
Individual life insurance policies, other than term life insurance policies,
increase in cash values over their lives. Policyholders have the right to borrow
an amount up to a certain percentage of the cash value of their policies at any
time. As of December 31, 2011, our Life Companies had approximately $10.9
billion in cash values with respect to which policyholders had rights to take
policy loans. The majority of cash values eligible for policy loans are at
variable interest rates that are reset annually on the policy anniversary.
Policy loans at December 31, 2011 were $2.4 billion.
Aggregate life surrenders in 2011 were 6.5% of related reserves, compared with
8.0% in 2010. Cash, treasuries and agency mortgage-backed securities accounted
for 8.7% of fixed income investments at year end 2011, as compared to 8.5% at
year end 2010. A strong liquidity profile remains a priority for the Company,
but as financial markets and the economy continue to improve the size and
composition of this liquid asset portfolio will change to better meet the needs
of the Company. These actions, along with resources the Company devotes to
monitoring and managing surrender activity, are key components of liquidity
management within the Company.
The primary liquidity risks regarding cash inflows from the investing activities
of our Life Companies are the risks of default by debtors, interest rate and
other market volatility and potential illiquidity of investments. We closely
monitor and manage these risks.
We believe that the existing and expected sources of liquidity for our Life
Companies are adequate to meet both current and anticipated needs.
In 2004, we issued $175.0 million principal of surplus notes with a scheduled
maturity of 30 years for proceeds of $171.6 million, net of discount and issue
costs. Interest payments are at an annual rate of 7.15%, require the prior
approval of the NYDFS and may be made only out of surplus funds which the NYDFS
determines to be available for such payments under New York insurance law.
53
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Ratings
Rating agencies assign Phoenix Life financial strength ratings and assign the
holding company debt ratings based in each case on their opinions of the
relevant company's ability to meet its financial obligations.
On January 13, 2012, A.M. Best Company, Inc. affirmed our financial strength
rating of B+ and our senior debt rating of bb-. They changed their outlook on
our ratings from stable to positive. On February 8, 2011, A.M. Best Company,
Inc. affirmed our financial strength rating of B+ and our senior debt rating of
bb-. They changed their outlook on our ratings from negative to stable.
On December 16, 2011, Moody's Investor Services affirmed our financial strength
rating of Ba2 and our senior debt rating of B3. They changed their outlook on
our ratings from stable to positive.
On March 24, 2011, Standard & Poor's affirmed our financial strength rating of
BB- and our senior debt rating of CCC+. They changed their outlook on our
ratings from negative to stable.
The financial strength and debt ratings as of March 14, 2012 were as follows:
Financial Strength
Rating
Senior Debt Rating
Rating Agency of Phoenix Life Outlook of PNX Outlook
A.M. Best
Company, Inc. B+ Positive bb- Positive
Moody's Ba2 Positive B3 Positive
Standard &
Poor's BB- Stable CCC+ Stable
Reference in this report to any credit rating is intended for the limited
purposes of discussing or referring to changes in our credit ratings or aspects
of our liquidity or costs of funds. Such reference cannot be relied on for any
other purposes, or used to make any inference concerning future performance,
future liquidity or any future credit rating.
54
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Consolidated Financial Condition
Consolidated Balance Sheet: Increase (decrease) and
($ in millions) As of December 31, percentage change
2011 2010 2011 vs. 2010
ASSETS
Available-for-sale debt securities, at fair
value $ 11,890.0 $ 10,893.8 $ 996.2 9%
Available-for-sale equity securities, at fair
value 35.7 47.5 (11.8) (25%)
Limited partnerships and other investments 601.3 600.0 1.3 NM
Policy loans, at unpaid principal balances 2,379.3 2,386.5 (7.2) NM
Derivative instruments 174.8 136.9 37.9 28%
Fair value option investments 86.6 102.1 (15.5) (15%)
Total investments 15,167.7 14,166.8 1,000.9 7%
Cash and cash equivalents 194.3 121.9 72.4 59%
Accrued investment income 175.6 169.5 6.1 4%
Receivables 415.1 405.7 9.4 2%
Deferred policy acquisition costs 1,317.6 1,444.3 (126.7) (9%)
Deferred income taxes 118.2 116.4 1.8 2%
Other assets 164.6 180.5 (15.9) (9%)
Discontinued operations assets 69.2 60.4 8.8 15%
Separate account assets 3,817.6 4,416.8 (599.2) (14%)
Total assets $ 21,439.9 $ 21,082.3 $ 357.6 2%
LIABILITIES
Policy liabilities and accruals $ 12,967.8 $ 12,992.5 $ (24.7) NM
Policyholder deposit funds 2,429.4 1,494.1 935.3 63%
Indebtedness 426.9 427.7 (0.8) NM
Other liabilities 613.7 546.3 67.4 12%
Discontinued operations liabilities 58.3 49.4 8.9 18%
Separate account liabilities 3,817.6 4,416.8 (599.2) (14%)
Total liabilities 20,313.7 19,926.8 386.9 2%
STOCKHOLDERS' EQUITY
Common stock and additional paid in capital 2,631.8 2,632.3 (0.5) NM
Accumulated other comprehensive loss (170.7) (133.8) (36.9) (28%)
Accumulated deficit (1,155.4) (1,163.5) 8.1 1%
Treasury stock (179.5) (179.5) - NM
Total stockholders' equity 1,126.2 1,155.5 (29.3) (3%)
Total liabilities and stockholders' equity $ 21,439.9 $ 21,082.3 $ 357.6 2%
-------
Not meaningful (NM)
December 31, 2011 compared to December 31, 2010
Assets
The increase in total investments was the result of purchases of securities
associated with positive cash flow generated by our annuity business as sales
continue to increase. In addition, the value of available-for-sale debt
securities improved as a result of favorable impacts on fixed income securities
as treasury rates have declined. Fair value option investments decreased
primarily as a result of the sale of securitized financial assets for which an
irrevocable election had been made to use the fair value option.
Deferred policy acquisition costs decreased related to variable universal life,
universal, variable annuities and traditional life products primarily as a
result of amortization for the year ended December 31, 2011. The deferred policy
acquisition cost balance associated with the fixed annuities increased as the
amortization of the block was offset by the increase in deferred expenses
related to sales of our fixed indexed annuities. The table below presents
deferred policy acquisition cost by product.
55
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Composition of Deferred Policy Acquisition Costs Increase (decrease) and
by Product: As of December 31, percentage change
($ in millions) 2011 2010 2011 vs. 2010
Variable universal life $ 206.3 $ 238.5 $ (32.2) (14%)
Universal life 399.8 570.2 (170.4) (30%)
Variable annuities 139.5 156.6 (17.1) (11%)
Fixed annuities 132.9 33.5 99.4 NM
Traditional life 439.1 445.5
(6.4) (1%)
Total deferred policy acquisition costs $ 1,317.6$ 1,444.3 $ (126.7) (9%)
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Not meaningful (NM)
The decline in other assets was a result of a decrease in investment receivables
attributable to a lower volume of investment sales and a decrease in premises
and equipment related to amortization.
Separate accounts decreased primarily from variable annuity surrenders and
universal life fees and cost of insurance charges during 2011.
Liabilities and Stockholders' Equity
Policyholder deposit funds increased primarily as a result of continued sales
growth of fixed indexed annuities as illustrated in the table below entitled
"Annuity Funds on Deposit".
The decrease in total stockholders' equity was primarily a result of other
comprehensive loss from the increase in unrecognized loss and prior service
costs on our pension and other post-employment plans as a result of the decline
in interest rates.
See Note 16 to our consolidated financial statements under "Item 8: Financial
Statements and Supplementary Data" in this Annual Report on Form 10-K for
additional information.
Funds on Deposit
Annuity Funds on Deposit: Years Ended December 31,
($ in millions) 2011 2010 2009
Deposits $ 951.5 $ 220.8 $ 142.6 Performance and interest credited 63.5 452.1 738.8
Fees (55.1) (56.2)
(53.7)
Benefits and surrenders (547.8) (537.3)
(643.4)
Change in funds on deposit 412.1 79.4
184.3
Funds on deposit, beginning of year 4,083.3 4,003.9 3,819.6
Annuity funds on deposit, end of year $ 4,495.4$ 4,083.3$ 4,003.9
2011 vs. 2010
Annuity funds on deposit increased $412.1 million during the year ended
December 31, 2011 compared to an increase of $79.4 million during the year ended
December 31, 2010. The higher increase in 2011 was driven by deposits related to
the growth in sales of the fixed index annuity product partially offset by lower
fund performance and larger surrenders related to variable annuity products.
2010 vs. 2009
Annuity funds on deposit increased during each of the years ended December 31,
2010 and 2009. Funds on deposit increased $104.9 million more during 2009 than
during 2010. While positive market performance contributed to the increase in
both years, the market recovery during 2009 resulted in a larger increase of
funds. Partially offsetting lower market performance was an increase in deposits
over prior year, reflecting new sales of our fixed indexed annuities and lower
surrenders in 2010 compared to 2009.
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Variable Universal Life Funds on Deposit: Years Ended December 31,
($ in millions) 2011 2010 2009
Deposits $ 98.3 $ 108.5 $ 115.8
Performance and interest credited (6.7) 143.6 244.3
Fees and cost of insurance (83.1) (89.1) (95.3)
Benefits and surrenders (141.0) (179.9) (161.4)
Change in funds on deposit (132.5) (16.9) 103.4
Funds on deposit, beginning of year 1,151.6
1,168.5 1,065.1
Variable universal life funds on deposit, end of year $ 1,019.1$ 1,151.6$ 1,168.5
2011 vs. 2010
Variable universal life funds on deposit decreased $132.5 million compared to a
decrease of $16.9 million during the years ended December 31, 2011 and 2010. The
larger decline in 2011 was primarily driven by lower market performance
partially offset by lower surrenders.
2010 vs. 2009
Variable universal life funds on deposit decreased for the year ended
December 31, 2010 compared to an increase during the year ended December 31,
2009. Market performance was lower in 2010 compared to 2009 while surrenders
were slightly higher. Deposits and fees and cost of insurance remained
relatively flat.
Universal Life Funds on Deposit: Years Ended December 31,
($ in millions) 2011 2010 2009
Deposits $ 384.5 $ 336.2 $ 351.4
Interest credited 79.2 85.7 96.6
Fees and cost of insurance (404.5) (420.1)
(434.4)
Benefits and surrenders (125.3) (163.6)
(188.9)
Change in funds on deposit (66.1) (161.8)
(175.3)
Funds on deposit, beginning of year 1,918.9 2,080.7
2,256.0
Universal life funds on deposit, end of year $ 1,852.8$ 1,918.9$ 2,080.7
2011 vs. 2010
Universal life funds on deposit decreased $66.1 million and $161.8 million
during the years ended December 31, 2011 and 2010, respectively. The declines
were lower in 2011 as compared to 2010 as a result of the increase in deposits
as well as a decrease in surrenders.
2010 vs. 2009
Universal life funds on deposit decreased during both years ended December 31,
2010 and 2009. Fees and cost of insurance charges offset deposits and interest
credited during both periods. Benefits and surrenders improved in 2010 compared
to 2009 as a result of favorable mortality experience.
57
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Contractual Obligations and Commercial Commitments
Contractual Obligations and Commercial
Commitments:
($ in millions) As of December 31, 2011
Total 2012 2013 - 2014 2015 - 2016 Thereafter
Contractual Obligations Due
Indebtedness, including interest
payments $ 1,081.7 $ 31.4 $ 62.8 $ 62.8 $ 924.7
Operating lease obligations(1) 18.6 1.6 2.7 2.6 11.7
Other purchase liabilities(2) 119.0 37.6 47.6 27.2 6.6
Policyholder contractual
obligation(3) 40,023.4 2,098.8 4,023.5 3,843.9 30,057.2
Total contractual obligations(4) $ 41,242.7$ 2,169.4$ 4,136.6$ 3,936.5$ 31,000.2
Commercial Commitment
Expirations
Other commercial commitments(5) $ 244.9 $ 95.7 $ 87.6 $ 55.8 $ 5.8
Total commercial commitments $ 244.9 $ 95.7 $ 87.6 $ 55.8 $ 5.8
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(1)
All future obligations for leased property of our discontinued operations were
assumed by the buyer upon completion of the sale on June 23, 2010. See Note 21
to our consolidated financial statements under "Item 8: Financial Statements and
Supplementary Data" in this Annual Report on Form 10-K for additional
information.
(2)
Other purchase liabilities relate to open purchase orders and other contractual
obligations. This amount does not include our expected pension contribution of
approximately $16.4 million in 2012. See Note 17 to our consolidated financial
statements under "Item 8: Financial Statements and Supplementary Data" in this
Annual Report on Form 10-K for additional information on pension and other
postretirement benefits.
(3)
Policyholder contractual obligations represent estimated benefits from life
insurance and annuity contracts issued by our life insurance subsidiaries.
Policyholder contractual obligations also include separate account liabilities,
which are contractual obligations of the separate account assets established
under applicable state insurance laws and are legally insulated from our general
account assets.
Future obligations are based on our estimate of future investment earnings,
mortality, surrenders and applicable policyholder dividends. Included in the
amounts above are policyholder dividends generated by estimated favorable future
investment and mortality, in excess of guaranteed amounts for our closed block.
Actual obligations in any single year, or ultimate total obligations, may vary
materially from these estimates as actual experience emerges. As described in
Note 2 to our consolidated financial statements under "Item 8: Financial
Statements and Supplementary Data" in this Annual Report on Form 10-K, policy
liabilities and accruals are recorded on the balance sheet in amounts adequate
to meet the estimated future obligations of the policies in force. The
policyholder obligations reflected in the table above exceed the policy
liabilities, policyholder deposit fund liabilities and separate account
liabilities reported on our December 31, 2011 consolidated balance sheet because
the above amounts do not reflect future investment earnings and future premiums
and deposits on those policies. Separate account obligations will be funded by
the cash flows from separate account assets, while the remaining obligations
will be funded by cash flows from investment earnings on general account assets
and premiums and deposits on contracts in force.
(4)
We do not anticipate any increases to unrecognized tax benefits that would have
a significant impact on the financial position of the Company. Therefore, no
unrecognized tax benefits have been excluded from this table. See Note 15 to our
consolidated financial statements under "Item 8: Financial Statements and
Supplementary Data" in this Annual Report on Form 10-K for additional
information on unrecognized tax benefits.
(5)
Other commercial commitments relate to agreements to fund limited partnerships.
These commitments can be drawn down by private equity funds as necessary to fund
their portfolio investments through the end of the funding period as stated in
each agreement.
Commitments Related to Recent Business Combinations
Goodwin Capital Advisers, Inc.
On September 14, 2011, we entered into a definitive agreement to sell Goodwin
Capital Advisers, Inc. ("Goodwin") to Conning Holdings. Also, on September 14,
2011, we entered into multi-year investment management agreements with Conning
under which Conning will manage the Company's publicly-traded fixed income
assets. Because of the ongoing cash flows associated with the investment
management agreements, results of these operations have been reflected within
continuing operations. The transaction closed on November 18, 2011. A realized
gain of $4.0 million was recognized on the sale during the fourth quarter of
2011.
Private placement bonds and limited partnership investments previously managed
under Goodwin will continue to be managed by Phoenix under its subsidiary,
Phoenix Life.
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PFG Holdings, Inc.
On January 4, 2010, we signed a definitive agreement to sell PFG and its
subsidiaries, including AGL Life Assurance Company, to Tiptree. Because of the
divestiture, we determined that these operations are reflected as discontinued
operations. On June 23, 2010, the Company completed the divestiture of PFG and
closed the transaction.
The definitive agreement contains a provision requiring the Company to indemnify
Tiptree for any losses due to actions resulting from certain specified acts or
omissions associated with the divested business prior to closing. There has been
litigation filed that falls within this provision of the agreement. The Company
intends to defend these matters vigorously.
Phoenix Life and Reassurance Company of New York
Included within the January 4, 2010 agreement with Tiptree was a provision for
the purchase of PLARNY pending regulatory approval. On September 24, 2010,
approval was obtained from the State of New York Insurance Department for
Tiptree and PFG Holdings Acquisition Corporation to acquire PLARNY. The
transaction closed on October 6, 2010. Because of the divestiture, these
operations are reflected as discontinued operations.
Obligations Related to Pension and Postretirement Employee Benefit Plans
We provide our employees with post-employment benefits that include retirement
benefits, through pension and savings plans, and other benefits, including
health care and life insurance. Employee benefit expense related to these plans
totaled $13.2 million, $20.1 million and $46.7 million for 2011, 2010 and 2009,
respectively.
We have three defined benefit pension plans covering our employees. The employee
pension plan, covering substantially all of our employees, provides benefits up
to the amount allowed under the Internal Revenue Code. The two supplemental
plans provide benefits in excess of the primary plan. Retirement benefits under
the plans are a function of years of service and compensation. Effective
March 31, 2010, all benefit accruals under all of our defined benefit plans were
frozen. This change was announced in 2009 and a curtailment was recognized at
that time for the reduction in the expected years of future service.
Employee Pension Plan
The employee pension plan is a qualified plan that is funded with assets held in
a trust. It is the Company's practice to make contributions to the qualified
pension plan at least sufficient to avoid benefit restrictions under funding
requirements of the Pension Protection Act of 2006. This generally requires the
Company to maintain assets that are at least 80% of the plan's liabilities as
calculated under the applicable regulations at the end of the prior year. Under
these regulations, the qualified pension plan is currently funded at 80% of the
funding target liabilities as of December 31, 2011.
The funded status of the qualified pension plan based on the projected benefit
obligations for the years ended December 31, 2011 and 2010 are summarized in the
following table:
Qualified Employee Pension Plan Funded Status: As of December 31,
($ in millions) 2011 2010
Plan assets, end of year $ 437.9 $ 436.0
Projected benefit obligation, end of year (624.6)
(575.8)
Plan assets less than projected benefit obligations, end of year $ (186.7)
$ (139.8)
To meet the above funding objectives, we made contributions to the pension plan
totaling $17.4 million and $25.7 million during 2011 and 2010, respectively.
Over the next 12 months, we expect to make contributions of approximately $16.4
million from the Company's operating cash flow, of which approximately $3.4
million will be made in the first quarter of 2012.
The changes in the projected benefit obligations of the employee plan at
December 31, 2011 as compared to December 31, 2010 were principally the result
of accrued interest cost and actuarial losses due to assumption changes.
59
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Supplemental Plans
The Company also has two supplemental plans that provide benefits to certain
executives in excess of the primary plan. These plans are unfunded and represent
general obligations of the Company. We fund periodic benefit payments to
retirees as they become due under these plans from cash-flow from operations.
The projected benefit obligations for the years ended December 31, 2011 and 2010
were $141.2 million and $133.3 million, respectively.
The changes in the projected benefit obligations of the supplemental plans at
December 31, 2011 as compared to December 31, 2010 were principally the result
of accrued interest cost and actuarial losses due to assumption changes.
We also have a postretirement benefit plan, which is unfunded and had projected
benefit obligations of $58.8 million and $58.8 million as of December 31, 2011
and 2010, respectively. We fund periodic benefit payments under this plan from
cash flows from operations as they become due.
We have entered into agreements with certain key executives of the Company that
will, under a change in control, provide separation benefits upon the
termination of the executive's employment by the Company for reasons other than
death, disability, cause or retirement, or by the executive for "good reason,"
as defined in the agreements. The agreements provide this protection only if the
termination occurs following (or is effectively connected with) the occurrence
of a change of control, as defined in the agreements. As soon as reasonably
possible upon a change in control, as so defined, we are required to make an
irrevocable contribution to a trust in an amount sufficient to pay benefits due
under these agreements.
We have agreements with certain of our employees that provide for additional
retirement benefits. In the year ended December 31, 2011, the estimated
liability for these guarantees was $17.9 million.
See Note 17 to our consolidated financial statements under "Item 8: Financial
Statements and Supplementary Data" in this Annual Report on Form 10-K for more
information.
Off-Balance Sheet Arrangements
As of December 31, 2011, we did not have any significant off-balance sheet
arrangements as defined by Item 303(a)(4)(ii) of SEC Regulation S-K. See Note 12
to our consolidated financial statements under "Item 8: Financial Statements and
Supplementary Data" in this Annual Report on Form 10-K for more information on
variable interest entities.
Reinsurance
We maintain reinsurance agreements to limit potential losses, reduce exposure to
larger risks and provide additional capacity for growth. We remain liable to the
extent that reinsuring companies may not be able to meet their obligations under
reinsurance agreements in effect. Failure of the reinsurers to honor their
obligations could result in losses to the Company. Since we bear the risk of
nonpayment, we evaluate the financial condition of our reinsurers and monitor
concentrations of credit risk.
Due to the financial distress of Scottish Re and the withdrawal of its ratings
in June, 2009, we are continuing to monitor its financial situation and assess
the recoverability of the reinsurance recoverable on a quarterly basis. As of
December 31, 2011, the Company has ceded reserves of $56.5 million and a
reinsurance receivable balance of $1.9 million with Scottish Re. Based on our
review of its financial statements, reputation in the reinsurance marketplace
and other relevant information, we believe that we have no material exposure to
uncollectible life reinsurance. As such, no allowance has been established.
Effective October 1, 2011, Phoenix Life entered into an agreement that provides
modified coinsurance for approximately one-third of the closed block policies.
This contract did not meet the requirements of risk transfer in accordance with
GAAP. Therefore, assets and liabilities and premiums and benefits are netted on
our consolidated balance sheet and consolidated income statement, respectively,
as the right of offset exists.
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Statutory Capital and Surplus and Risk-Based Capital
Phoenix Life's statutory basis capital and surplus (including AVR) increased
from $763.2 million at December 31, 2010 to $845.7 million at December 31, 2011.
The principal factors resulting in this increase were net gain from operations
of $130.5 million offset by dividends paid to PNX of $64.8 million.
Section 1322 of New York Insurance Law requires that New York life insurers
report their RBC. RBC is based on a formula calculated by applying factors to
various asset, premium and statutory reserve items. The formula takes into
account the risk characteristics of the insurer, including asset risk, insurance
risk, interest rate risk and business risk. Section 1322 gives the NYDFS
explicit regulatory authority to require various actions by, or take various
actions against, insurers whose Total Adjusted Capital (capital and surplus plus
AVR plus one-half the policyholder dividend liability) does not exceed certain
RBC levels. Each of our other life insurance subsidiaries is also subject to
these same RBC requirements.
The levels of regulatory action, the trigger point and the corrective actions
required are summarized below:
Company Action Level - results when Total Adjusted Capital falls below 100% of
Company Action Level at which point the Company must file a comprehensive plan
to the state insurance regulators;
Regulatory Action Level - results when Total Adjusted Capital falls below 75% of
Company Action Level where in addition to the above, insurance regulators are
required to perform an examination or analysis deemed necessary and issue a
corrective order specifying corrective actions;
Authorized Control Level - results when Total Adjusted Capital falls below 50%
of Company Action Level RBC as defined by the NAIC where in addition to the
above, the insurance regulators are permitted but not required to place the
Company under regulatory control; and
Mandatory Control Level - results when Total Adjusted Capital falls below 35% of
Company Action Level where insurance regulators are required to place the
Company under regulatory control.
The estimated RBC of Phoenix Life as of December 31, 2011 was in excess of 200%
of the Company Action Level.
See Note 22 to our consolidated financial statements under "Item 8: Financial
Statements and Supplementary Data" in this Annual Report on Form 10-K regarding
the Life Companies' statutory financial information and regulatory matters.
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
For information about our management of market risk, see "Item 7: Management's
Discussion and Analysis of Financial Condition and Results of Operations" under
the heading "Enterprise Risk Management."
