XNYS:PNX Phoenix Companies Inc Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

XNYS:PNX Fair Value Estimate
Premium
XNYS:PNX Consider Buying
Premium
XNYS:PNX Consider Selling
Premium
XNYS:PNX Fair Value Uncertainty
Premium
XNYS:PNX Economic Moat
Premium
XNYS:PNX Stewardship
Premium
 


 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

—————————

FORM 10-Q

—————————

 

(Mark One)

 

 

þ

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934


FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2012


OR


o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934


FOR THE TRANSITION PERIOD FROM __________ TO __________


Commission File Number: 001-16517

[pnx_10q002.gif]

THE PHOENIX COMPANIES, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

06-1599088

(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)

 

 

One American Row, Hartford, Connecticut

06102-5056

(Address of principal executive offices)

(Zip Code)

(860) 403-5000

(Registrant’s telephone number, including area code)


Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   YES þ     NO ¨


Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   YES þ     NO ¨


Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):


Large accelerated filer ¨

Accelerated filer þ

Non-accelerated filer ¨

Smaller reporting company ¨

 

 

(Do not check if smaller reporting company)

 


Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   YES ¨     NO þ


On July 31, 2012, the registrant had 116.0 million shares of common stock outstanding.

 

 










p2

TABLE OF CONTENTS

 

 

 

 

PART I

FINANCIAL INFORMATION

Page

 

 

 

Item 1.

Financial Statements (unaudited)

3

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

45

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

67

Item 4.

Controls and Procedures

68

 

 

 

PART II

OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

69

Item 1A.

Risk Factors

69

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

70

Item 3.

Defaults Upon Senior Securities

70

Item 4.

Mine Safety Disclosures

70

Item 5.

Other Information

70

Item 6.

Exhibits

70

 

 

Signatures

72





2





PART I. FINANCIAL INFORMATION



Item 1.

FINANCIAL STATEMENTS


THE PHOENIX COMPANIES, INC.

Consolidated Balance Sheets

($ in millions, except share data)

June 30, 2012 (unaudited) and December 31, 2011


 

June 30,

 

Dec 31,

 

2012

 

2011

ASSETS:

 

 

 

 

 

Available-for-sale debt securities, at fair value (amortized cost of $11,588.9 and $11,351.8)

$

12,335.3 

 

$

11,890.0 

Available-for-sale equity securities, at fair value (cost of $34.4 and $29.5)

 

42.1 

 

 

35.7 

Limited partnerships and other investments

 

618.5 

 

 

601.3 

Policy loans, at unpaid principal balances

 

2,362.4 

 

 

2,379.3 

Derivative instruments

 

186.6 

 

 

174.8 

Fair value option investments

 

87.0 

 

 

86.6 

Total investments

 

15,631.9 

 

 

15,167.7 

Cash and cash equivalents

 

248.9 

 

 

194.3 

Accrued investment income

 

186.6 

 

 

175.6 

Receivables

 

422.5 

 

 

415.1 

Deferred policy acquisition costs

 

1,076.0 

 

 

1,162.8 

Deferred income taxes

 

91.7 

 

 

118.2 

Other assets

 

156.8 

 

 

164.6 

Discontinued operations assets

 

43.6 

 

 

69.2 

Separate account assets

 

3,336.8 

 

 

3,817.6 

Total assets

$

21,194.8 

 

$

21,285.1 

 

 

 

 

 

 

LIABILITIES:

 

 

 

 

 

Policy liabilities and accruals

$

13,040.1 

 

$

12,981.1 

Policyholder deposit funds

 

2,767.1 

 

 

2,429.4 

Indebtedness

 

426.9 

 

 

426.9 

Other liabilities

 

642.7 

 

 

613.8 

Discontinued operations liabilities

 

34.6 

 

 

58.3 

Separate account liabilities

 

3,336.8 

 

 

3,817.6 

Total liabilities

 

20,248.2 

 

 

20,327.1 

 

 

 

 

 

 

CONTINGENCIES AND COMMITMENTS (NOTES 18 & 19)

 

 

 

 

 

 

 

 

 

 

 

STOCKHOLDERS’ EQUITY:

 

 

 

 

 

Common stock, $.01 par value: 116.0 million and 116.3 million shares outstanding

 

1.3 

 

 

1.3 

Additional paid-in capital

 

2,631.0 

 

 

2,630.5 

Accumulated other comprehensive loss

 

(124.9)

 

 

(134.8)

Accumulated deficit

 

(1,380.8)

 

 

(1,359.5)

Treasury stock, at cost: 11.7 million and 11.3 million shares

 

(180.0)

 

 

(179.5)

Total stockholders’ equity

 

946.6 

 

 

958.0 

Total liabilities and stockholders’ equity

$

21,194.8 

 

$

21,285.1 


The accompanying unaudited notes are an integral part of these financial statements.



3





THE PHOENIX COMPANIES, INC.

Unaudited Interim Consolidated Statements of Comprehensive Income

($ in millions, except share data)

Three and Six Months Ended June 30, 2012 and 2011


 

Three Months Ended

 

Six Months Ended

 

June 30,

 

June 30,

 

2012

 

2011

 

2012

 

2011

REVENUES:

 

 

 

 

 

 

 

 

 

 

 

Premiums

$

104.3 

 

$

109.3 

 

$

204.5 

 

$

220.3 

Fee income

 

137.2 

 

 

154.6 

 

 

283.7 

 

 

308.4 

Net investment income

 

218.2 

 

 

211.2 

 

 

428.1 

 

 

412.6 

Net realized investment gains (losses):

 

 

 

 

 

 

 

 

 

 

 

  Total other-than-temporary impairment (“OTTI”) losses

 

(15.0)

 

 

(6.6)

 

 

(26.7)

 

 

(14.0)

  Portion of OTTI losses recognized in
    other comprehensive income (“OCI”)

 

9.9 

 

 

3.6 

 

 

15.4 

 

 

5.3 

    Net OTTI losses recognized in earnings

 

(5.1)

 

 

(3.0)

 

 

(11.3)

 

 

(8.7)

  Net realized investment gains (losses), excluding OTTI losses

 

(3.1)

 

 

6.1 

 

 

(12.5)

 

 

(4.4)

Net realized investment gains (losses)

 

(8.2)

 

 

3.1 

 

 

(23.8)

 

 

(13.1)

Total revenues

 

451.5 

 

 

478.2 

 

 

892.5 

 

 

928.2 

 

 

 

 

 

 

 

 

 

 

 

 

BENEFITS AND EXPENSES:

 

 

 

 

 

 

 

 

 

 

 

Policy benefits, excluding policyholder dividends

 

259.0 

 

 

270.8 

 

 

513.1 

 

 

531.2 

Policyholder dividends

 

84.3 

 

 

73.6 

 

 

149.3 

 

 

137.2 

Policy acquisition cost amortization

 

41.8 

 

 

42.8 

 

 

92.0 

 

 

94.1 

Interest expense on indebtedness

 

7.9 

 

 

7.9 

 

 

15.9 

 

 

15.9 

Other operating expenses

 

60.8 

 

 

59.6 

 

 

123.2 

 

 

119.8 

Total benefits and expenses

 

453.8 

 

 

454.7 

 

 

893.5 

 

 

898.2 

Income from continuing operations before income taxes

 

(2.3)

 

 

23.5 

 

 

(1.0)

 

 

30.0 

Income tax expense

 

4.6 

 

 

7.6 

 

 

13.5 

 

 

9.0 

Income (loss) from continuing operations

 

(6.9)

 

 

15.9 

 

 

(14.5)

 

 

21.0 

Loss from discontinued operations, net of income taxes

 

(6.3)

 

 

(0.7)

 

 

(6.8)

 

 

(2.2)

Net income (loss)

$

(13.2)

 

$

15.2 

 

$

(21.3)

 

$

18.8 

 

 

 

 

 

 

 

 

 

 

 

 

EARNINGS PER SHARE:

 

 

 

 

 

 

 

 

 

 

 

Earnings (loss) from continuing operations – basic

$

(0.06)

 

$

0.14 

 

$

(0.12)

 

$

0.18 

Earnings (loss) from continuing operations – diluted

$

(0.06)

 

$

0.14 

 

$

(0.12)

 

$

0.18 

Earnings (loss) from discontinued operations – basic

$

(0.05)

 

$

(0.01)

 

$

(0.06)

 

$

(0.02)

Earnings (loss) from discontinued operations – diluted

$

(0.05)

 

$

(0.01)

 

$

(0.06)

 

$

(0.02)

Net earnings (loss) – basic

$

(0.11)

 

$

0.13 

 

$

(0.18)

 

$

0.16 

Net earnings (loss) – diluted

$

(0.11)

 

$

0.13 

 

$

(0.18)

 

$

0.16 

Basic weighted-average common shares outstanding
  (in thousands)

 

116,232 

 

 

116,325 

 

 

116,272 

 

 

116,265 

Diluted weighted-average common shares outstanding
  (in thousands)

 

116,232 

 

 

117,850 

 

 

116,272 

 

 

117,789 

 

 

 

 

 

 

 

 

 

 

 

 

COMPREHENSIVE INCOME (LOSS):

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

$

(13.2)

 

$

15.2 

 

$

(21.3)

 

$

18.8 

Net unrealized investment gains

 

31.7 

 

 

13.1 

 

 

32.2 

 

 

12.4 

Non-credit portion of OTTI losses recognized in OCI

 

(6.4)

 

 

(2.3)

 

 

(10.0)

 

 

(3.4)

Net pension liability adjustment

 

(13.8)

 

 

2.0 

 

 

(12.5)

 

 

2.7 

Net unrealized other assets

 

— 

 

 

— 

 

 

— 

 

 

1.0 

Net unrealized derivative instruments gains (losses)

 

0.4 

 

 

(0.3)

 

 

0.2 

 

 

(0.8)

Other comprehensive income (loss)

 

11.9 

 

 

12.5 

 

 

9.9 

 

 

11.9 

Comprehensive income (loss)

$

(1.3)

 

$

27.7 

 

$

(11.4)

 

$

30.7 


The accompanying unaudited notes are an integral part of these financial statements.



4





THE PHOENIX COMPANIES, INC.

Unaudited Interim Consolidated Statements of Cash Flows

($ in millions)

Six Months Ended June 30, 2012 and 2011


 

June 30,

 

2012

 

2011

OPERATING ACTIVITIES:

 

 

 

 

 

Net income (loss)

$

(21.3)

 

$

18.8 

Net realized investment losses

 

23.8 

 

 

13.1 

Policy acquisition costs deferred

 

(47.6)

 

 

(63.2)

Amortization of deferred policy acquisition costs

 

92.0 

 

 

94.1 

Amortization and depreciation

 

6.9 

 

 

5.1 

Undistributed equity in earnings of limited partnerships and other investments

 

(41.7)

 

 

(23.3)

Change in:

 

 

 

 

 

  Accrued investment income

 

(18.0)

 

 

(18.1)

  Receivables

 

(8.4)

 

 

(26.7)

  Policy liabilities and accruals

 

(46.9)

 

 

(78.8)

Other, net

 

(8.0)

 

 

13.2 

Cash used for continuing operations

 

(69.2)

 

 

(65.8)

Discontinued operations, net

 

(2.0)

 

 

4.9 

Cash used for operating activities

 

(71.2)

 

 

(60.9)

 

 

 

 

 

 

INVESTING ACTIVITIES:

 

 

 

 

 

Purchases of:

 

 

 

 

 

  Available-for-sale debt securities

 

(1,551.3)

 

 

(1,701.1)

  Available-for-sale equity securities

 

(6.0)

 

 

(5.7)

  Limited partnerships and other investments

 

(45.0)

 

 

(47.9)

  Derivative instruments

 

(29.2)

 

 

(21.5)

  Fair value option investments

 

— 

 

 

— 

Sales, repayments and maturities of:

 

 

 

 

 

  Available-for-sale debt securities

 

1,323.5 

 

 

1,367.0 

  Available-for-sale equity securities

 

0.4 

 

 

1.7 

  Limited partnerships and other investments

 

75.5 

 

 

72.3 

  Derivative instruments

 

12.1 

 

 

28.1 

  Fair value option investments

 

0.1 

 

 

8.6 

Policy loans, net

 

16.9 

 

 

21.5 

Proceeds from sale of subsidiary

 

1.0 

 

 

— 

Premises and equipment additions

 

(2.4)

 

 

(2.2)

Discontinued operations, net

 

4.0 

 

 

(0.3)

Cash used for investing activities

 

(200.4)

 

 

(279.5)

 

 

 

 

 

 

FINANCING ACTIVITIES:

 

 

 

 

 

Policyholder deposit fund deposits

 

650.1 

 

 

959.5 

Policyholder deposit fund withdrawals

 

(323.4)

 

 

(605.9)

Treasury stock acquired

 

(0.5)

 

 

— 

Cash provided by financing activities

 

326.2 

 

 

353.6 

Change in cash and cash equivalents

 

54.6 

 

 

13.2 

Cash and cash equivalents, beginning of period

 

194.3 

 

 

121.9 

Cash and cash equivalents, end of period

$

248.9 

 

$

135.1 

Supplemental Disclosure of Cash Flow Information

 

 

 

 

 

Income taxes paid

$

(3.3)

 

$

(6.9)

Interest expense on indebtedness paid

$

(15.7)

 

$

(17.4)


Included in cash and cash equivalents above is cash held as collateral by a third party of $8.6 million and $8.0 million as of June 30, 2012 and 2011, respectively.


The accompanying unaudited notes are an integral part of these financial statements.



5





THE PHOENIX COMPANIES, INC.

Unaudited Interim Consolidated Statements of Changes in Stockholders’ Equity

($ in millions)

Six Months Ended June 30, 2012 and 2011


 

June 30,

 

2012

 

2011

COMMON STOCK:

 

 

 

 

 

  Balance, beginning of period

$

1.3 

 

$

1.3 

    Common shares issued

 

— 

 

 

— 

  Balance, end of period

$

1.3 

 

$

1.3 

 

 

 

 

 

 

ADDITIONAL PAID-IN CAPITAL:

 

 

 

 

 

  Balance, beginning of period

$

2,630.5 

 

$

2,631.0 

    Issuance of shares and compensation expense on stock compensation awards

 

0.5 

 

 

1.4 

  Balance, end of period

$

2,631.0 

 

$

2,632.4 

 

 

 

 

 

 

ACCUMULATED OTHER COMPREHENSIVE LOSS:

 

 

 

 

 

  Balance, beginning of period

$

(134.8)

 

$

(133.8)

  Adjustment for cumulative effect of accounting change

 

— 

 

 

31.1 

    Other comprehensive income

 

9.9 

 

 

11.9 

  Balance, end of period

$

(124.9)

 

$

(90.8)

 

 

 

 

 

 

ACCUMULATED DEFICIT:

 

 

 

 

 

  Balance, beginning of period

$

(1,359.5)

 

$

(1,163.5)

  Adjustment for cumulative effect of accounting change

 

— 

 

 

(243.6)

    Net income (loss)

 

(21.3)

 

 

18.8 

  Balance, end of period

$

(1,380.8)

 

$

(1,388.3)

 

 

 

 

 

 

TREASURY STOCK, AT COST:

 

 

 

 

 

  Balance, beginning of period

$

(179.5)

 

$

(179.5)

    Change in treasury stock

 

(0.5)

 

 

— 

  Balance, end of period

$

(180.0)

 

$

(179.5)

 

 

 

 

 

 

TOTAL STOCKHOLDERS’ EQUITY:

 

 

 

 

 

  Balance, beginning of period, as adjusted

$

958.0 

 

$

943.0 

    Change in stockholders’ equity

 

(11.4)

 

 

32.1 

  Stockholders’ equity, end of period

$

946.6 

 

$

975.1 


The accompanying unaudited notes are an integral part of these financial statements.




6





THE PHOENIX COMPANIES, INC.

Notes to Unaudited Interim Consolidated Financial Statements

Three and Six Months Ended June 30, 2012 and 2011




1.

Organization and Description of Business


The Phoenix Companies, Inc. (“we,” “our,” “us,” the “Company,” or “Phoenix”) is a holding company and our operations are conducted through subsidiaries, principally Phoenix Life Insurance Company (“Phoenix Life”) and PHL Variable Insurance Company (“PHL Variable”). We 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 insuring one or more lives. Our annuity products include fixed and variable annuities with a variety of death benefit and guaranteed living benefit options.


We operate two business segments: Life and Annuity and Saybrus. The Life and Annuity segment includes individual life insurance and annuity products including universal life and variable universal life and fixed and variable annuities. It also includes the results of our closed block, which consists primarily of participating whole life products. Saybrus is our distribution company that provides dedicated consulting services to partner companies as well as wholesaling support for the Phoenix Life and PHL Variable product lines.


Since 2009, we have focused on selling products and services that are less capital intensive and less sensitive to our ratings. In 2011 and the first six months of 2012, Phoenix product sales were primarily in fixed indexed annuities. Sales of other insurance companies’ policies through Saybrus were also expanded during the same period.



2.

Basis of Presentation and Significant Accounting Policies


We have prepared these unaudited financial statements in accordance with accounting principles generally accepted in the United States of America (“GAAP”), which differ materially from the accounting practices prescribed by various insurance regulatory authorities. Our interim consolidated financial statements include the accounts of the Company and its subsidiaries. Intercompany balances and transactions have been eliminated in consolidating these financial statements. As of December 31, 2011, the Company changed from the direct to the indirect method of reporting its consolidated cash flow statement. Prior year consolidated cash flow statements, as well as other prior year amounts, have been reclassified to conform to the current year presentation.


These financial statements include all adjustments (consisting primarily of accruals) considered necessary for the fair statement of the consolidated balance sheet, consolidated statements of comprehensive income, and consolidated statements of cash flows for the interim periods. Certain financial information that is not required for interim reporting has been omitted. The interim financial statements should be read in conjunction with the consolidated financial statements included in our 2011 Annual Report on Form 10-K. Financial results for the three and six months ended June 30, 2012 are not necessarily indicative of full year results.


Adjustments Related to Prior Years


A net loss from continuing operations of $14.5 million was recognized during the six months ended June 30, 2012. This reflects approximately $3.0 million associated with the correction of errors related to 2011, which decreased income from continuing operations recognized during 2012. We have assessed the impact of these errors and have determined that the errors were not material to any prior periods or previously issued financial statements.




7





2.

Basis of Presentation and Significant Accounting Policies (continued)


Use of estimates


In preparing these financial statements in conformity with GAAP, we are required 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 periods. Significant estimates and assumptions are made in the determination of estimated gross profits (“EGPs”) used in the valuation and amortization of assets and liabilities associated with universal life and annuity contracts; policyholder liabilities and accruals; valuation of investments in debt and equity securities; limited partnerships and other investments; valuation of deferred tax assets; pension and other post-employment benefits liabilities; and accruals for contingent liabilities. Actual results could differ from these estimates.


Adoption of new accounting standards


Amendments to the Presentation of Comprehensive Income


In June 2011, the Financial Accounting Standards Board (the “FASB”) issued amended guidance to ASC 220, Comprehensive Income, with respect to the presentation of comprehensive income as part of the effort to establish common requirements in accordance with GAAP and International Financial Reporting Standards (“IFRS”). This amended guidance requires entities to present all non-owner changes in stockholders’ equity either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The amendments do not affect which components of comprehensive income are recognized in net income or comprehensive income, or when an item of other comprehensive income must be classified to net income. The computation and presentation of earnings per share also does not change. This guidance was adopted in the first quarter of 2012. Disclosures in Note 12 reflect the retrospective adoption of this guidance. Other than additional disclosures, adoption of this guidance did not have a material effect on our consolidated financial statements.


Amendments to Fair Value Measurement and Disclosure Requirements


In May 2011, the FASB issued amended guidance to ASC 820, Fair Value Measurement, with respect to measuring fair value and related disclosures as part of the effort to establish common requirements in accordance with GAAP and IFRS. The amended guidance clarifies that the concept of highest and best use should only be used in the valuation of non-financial assets, specifies how to apply fair value measurements to instruments classified in stockholders’ equity and requires that premiums or discounts be applied consistent with what market participants would use absent Level 1 inputs. The amendment also explicitly requires additional disclosures related to the valuation of assets categorized as Level 3 within the fair value hierarchy. Additional disclosures include quantitative information about unobservable inputs, the sensitivity of fair value measurement to changes in unobservable outputs and information on the valuation process used. This guidance was adopted in the first quarter of 2012. Disclosures in Note 10 reflect the prospective adoption of this guidance. Other than additional disclosures, adoption of this guidance did not have a material effect on our consolidated financial statements.


Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts


In October 2010, the FASB issued amended guidance to ASC 944, Financial Services – Insurance, to address the diversity in practice for accounting for costs associated with acquiring or renewing insurance contracts. The amendment clarifies the definition of acquisition costs (i.e., costs which qualify for deferral) to incremental direct costs that result directly from, and are essential to, a contract and would not have been incurred by the insurance entity had the contract transaction not occurred. Therefore, only costs related to successful efforts of acquiring a new, or renewal, contract should be deferred. This guidance was retrospectively adopted on January 1, 2012. The cumulative effect of retrospective adoption reduced deferred policy acquisition costs and beginning stockholders’ equity as of January 1, 2012 by $168.2 million primarily related to lower deferrals associated with expenses not directly related to new policy sales.




8





2.

Basis of Presentation and Significant Accounting Policies (continued)


The tables below show selected financial data as adjusted for the retrospective adoption noted above. Adoption of the standard did not affect the previously reported totals for net cash flows provided by (used for) operating, investing or financing activities.


Summarized Selected Annual Financial Data:

Year Ended December 31,

($ in millions)

2011

 

2010

 

2009

 

2008

 

 

 

 

 

 

 

 

 

 

 

 

Deferred policy acquisition costs, as previously reported

$

1,317.6 

 

$

1,444.3 

 

$

1,916.0 

 

$

2,708.3 

Impact of adoption

 

(154.8)

 

 

(197.8)

 

 

(279.4)

 

 

(355.5)

Deferred policy acquisition costs, as revised

$

1,162.8 

 

$

1,246.5 

 

$

1,636.6 

 

$

2,352.8 

 

 

 

 

 

 

 

 

 

 

 

 

Deferred tax asset, as previously reported

$

118.3 

 

$

116.4 

 

$

166.2 

 

$

435.2 

Impact of adoption

 

(0.1)

 

 

— 

 

 

9.9

 

 

129.6 

Deferred tax asset, as revised

$

118.2 

 

$

116.4 

 

$

176.1 

 

$

564.8 

 

 

 

 

 

 

 

 

 

 

 

 

Policy liabilities and accruals, as previously reported

$

12,967.8 

 

$

12,992.5 

 

$

13,151.1 

 

$

13,932.9 

Impact of adoption

 

13.3 

 

 

14.6 

 

 

15.9 

 

 

14.9 

Policy liabilities and accruals, as revised

$

12,981.1 

 

$

13,007.1 

 

$

13,167.0 

 

$

13,947.8 

 

 

 

 

 

 

 

 

 

 

 

 

Total equity, as previously reported

$

1,126.2 

 

$

1,155.5 

 

$

1,131.1 

 

$

865.1 

Impact of adoption

 

(168.2)

 

 

(212.5)

 

 

(285.4)

 

 

(240.7)

Total equity, as revised

$

958.0 

 

$

943.0 

 

$

845.7 

 

$

624.4 


Summarized Selected Quarterly Financial Data:

Quarter Ended

($ in millions)

Dec 31,

 

Sept 30,

 

June 30,

 

Mar 31,

 

2011

 

 

 

 

 

 

 

 

 

 

 

 

Policy benefits, excluding policyholder dividends, as previously reported

$

283.2 

 

$

268.2 

 

$

271.1 

 

$

260.7 

Impact of adoption

 

(0.3)

 

 

(0.4)

 

 

(0.3)

 

 

(0.3)

Policy benefits, excluding policyholder dividends, as revised

$

282.9 

 

$

267.8 

 

$

270.8 

 

$

260.4 

 

 

 

 

 

 

 

 

 

 

 

 

Policy acquisition cost amortization, as previously reported

$

38.7 

 

$

57.5 

 

$

51.8 

 

$

62.7 

Impact of adoption

 

(8.1)

 

 

(11.0)

 

 

(9.0)

 

 

(11.6)

Policy acquisition cost amortization, as revised

$

30.6 

 

$

46.5 

 

$

42.8 

 

$

51.1 

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses, as previously reported

$

69.7 

 

$

57.2 

 

$

58.9 

 

$

59.3 

Impact of adoption

 

0.3 

 

 

0.4 

 

 

0.3 

 

 

0.4 

Operating expenses, as revised

$

70.0 

 

$

57.6 

 

$

59.2 

 

$

59.7 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations, before income tax,
  as previously reported

$

(7.4)

 

$

29.8 

 

$

14.5 

 

$

(4.9)

Impact of adoption

 

8.1 

 

 

11.0

 

 

9.0 

 

 

11.5 

Income from continuing operations, before income tax, as revised

$

0.7 

 

$

40.8 

 

$

23.5 

 

$

6.6 

 

 

 

 

 

 

 

 

 

 

 

 

Income tax expense (benefit), as previously reported

$

(0.5)

 

$

(6.7)

 

$

9.4 

 

$

(0.3)

Impact of adoption

 

0.1 

 

 

— 

 

 

(1.8)

 

 

1.8 

Income tax expense (benefit), as revised

$

(0.4)

 

$

(6.7)

 

$

7.6 

 

$

1.5 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss), as previously reported

$

(22.0)

 

$

31.8 

 

$

4.4 

 

$

(6.1)

Impact of adoption

 

8.0 

 

 

11.0 

 

 

10.8 

 

 

9.7 

Net income (loss), as revised

$

(14.0)

 

$

42.8 

 

$

15.2 

 

$

3.6 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings (loss) per share, as previously reported

$

(0.19)

 

$

0.27 

 

$

0.04 

 

$

(0.05)

Impact of adoption

 

0.07 

 

 

0.10 

 

 

0.09 

 

 

0.08 

Earnings (loss) per share, as revised

$

(0.12)

 

$

0.37 

 

$

0.13 

 

$

0.03 




9





2.

Basis of Presentation and Significant Accounting Policies (continued)


Summarized Selected Annual Financial Data:

Year Ended December 31,

($ in millions)

2011

 

2010

 

2009

 

2008

 

 

 

 

 

 

 

 

 

 

 

 

Policy benefits, excluding policyholder dividends, as previously reported

$

1,083.2 

 

$

1,090.0 

 

$

1,179.6 

 

$

1,260.7 

Impact of adoption

 

(1.3)

 

 

(1.3)

 

 

(1.4)

 

 

(0.5)

Policy benefits, excluding policyholder dividends, as revised

$

1,081.9 

 

$

1,088.7 

 

$

1,178.2 

 

$

1,260.2 

 

 

 

 

 

 

 

 

 

 

 

 

Policy acquisition cost amortization, as previously reported

$

210.6 

 

$

298.2 

 

$

260.6 

 

$

406.0 

Impact of adoption

 

(39.7)

 

 

(51.9)

 

 

(57.9)

 

 

(116.2)

Policy acquisition cost amortization, as revised

$

170.9 

 

$

246.3 

 

$

202.7 

 

$

289.8 

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses, as previously reported

$

245.2 

 

$

291.2 

 

$

303.5 

 

$

254.9 

Impact of adoption

 

1.3 

 

 

2.2 

 

 

15.8 

 

 

65.9 

Operating expenses, as revised

$

246.5 

 

$

293.4 

 

$

319.3 

 

$

320.8 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations, before income tax,
  as previously reported

$

32.0 

 

$

(34.7)

 

$

(87.1)

 

$

(295.3)

Impact of adoption

 

39.7 

 

 

51.0 

 

 

43.5 

 

 

50.8 

Income (loss) from continuing operations, before income tax, as revised

$

71.7 

 

$

16.3 

 

$

(43.6)

 

$

(244.5)

 

 

 

 

 

 

 

 

 

 

 

 

Income tax expense (benefit), as previously reported

$

1.9 

 

$

(10.1)

 

$

108.9 

 

$

(118.5)

Impact of adoption

 

0.1 

 

 

12.1 

 

 

123.9 

 

 

(108.6)

Income tax expense (benefit), as revised

$

2.0 

 

$

2.0 

 

$

232.8 

 

$

(227.1)

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss), as previously reported

$

8.1 

 

$

(12.6)

 

$

(319.0)

 

$

(726.0)

Impact of adoption

 

39.6 

 

 

38.9 

 

 

(80.4)

 

 

159.4 

Net income (loss), as revised

$

47.7 

 

$

26.3 

 

$

(399.4)

 

$

(566.6)

 

 

 

 

 

 

 

 

 

 

 

 

Earnings (loss) per share, as previously reported

$

0.07 

 

$

(0.11)

 

$

(2.74)

 

$

(6.35)

Impact of adoption

 

0.34 

 

 

0.33 

 

 

(0.69)

 

 

1.39 

Earnings (loss) per share, as revised

$

0.41 

 

$

0.22 

 

$

(3.43)

 

$

(4.96)


Accounting standards not yet adopted


Disclosures about Offsetting Assets and Liabilities


In December 2011, the FASB issued amended guidance to ASC 210, Balance Sheet, with respect to disclosure of offsetting assets and liabilities as part of the effort to establish common requirements in accordance with GAAP and IFRS. This amended guidance requires the disclosure of both gross information and net information about both financial instruments and derivative instruments eligible for offset in our consolidated balance sheet and instruments and transactions subject to an agreement similar to a master netting arrangement. This guidance is effective for periods beginning on or after January 1, 2013, with respective disclosures required retrospectively for all comparative periods presented. The adoption of this guidance effective January 1, 2013 is not expected to have a material effect on our consolidated financial statements.


Significant Accounting Policies


Our significant accounting policies are presented in the notes to our consolidated financial statements in our 2011 Annual Report on Form 10-K. With the exception of our adoption of new guidance related to accounting for costs associated with acquiring or renewing insurance contracts effective January 1, 2012, there have been no significant changes since year end December 31, 2011. See Note 5 to these financial statements for our updated accounting policy related to this new guidance.





10





3.

Business Combinations 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.


Private placement and limited partnership portfolios previously managed under Goodwin continue to be managed by Phoenix under its subsidiary, Phoenix Life.



4.

Demutualization and Closed Block


In 1999, we began the process of reorganizing and demutualizing our then principal operating company, Phoenix Home Life. We completed the process in June 2001, when all policyholder membership interests in this mutual company were extinguished and eligible policyholders of the mutual company received shares of common stock of The Phoenix Companies, Inc., together with cash and policy credits, as compensation. To protect the future dividends of these policyholders, we also established a closed block for their existing policies.


Because closed block liabilities exceed closed block assets, we have a net closed block liability at June 30, 2012 and December 31, 2011. This net liability represents the maximum future earnings contribution to be recognized from the closed block and the change in this net liability each period is in the earnings contribution recognized from the closed block for the period. To the extent that actual cash flows differ from amounts anticipated, we may adjust policyholder dividends. If the closed block has excess funds, those funds will be available only to the closed block policyholders. However, if the closed block has insufficient funds to make policy benefit payments that are guaranteed, the payments will be made from assets outside of the closed block.


Closed Block Assets and Liabilities:

June 30,

 

Dec 31,

 

 

($ in millions)

2012

 

2011

 

Inception

 

 

 

 

 

 

 

 

 

Debt securities

$

6,379.1 

 

$

6,353.1 

 

$

4,773.1 

Equity securities

 

14.8 

 

 

12.0 

 

 

— 

Limited partnerships and other investments

 

372.4 

 

 

352.8 

 

 

399.0 

Policy loans

 

1,258.0 

 

 

1,280.4 

 

 

1,380.0 

Fair value option investments

 

11.2 

 

 

10.6 

 

 

— 

Total closed block investments

 

8,035.5 

 

 

8,008.9 

 

 

6,552.1 

Cash and cash equivalents

 

34.7 

 

 

14.2 

 

 

— 

Accrued investment income

 

90.6 

 

 

94.2 

 

 

106.8 

Receivables

 

50.7 

 

 

52.2 

 

 

35.2 

Deferred income taxes

 

228.7 

 

 

223.9 

 

 

389.4 

Other closed block assets

 

17.8 

 

 

14.5 

 

 

6.2 

Total closed block assets

 

8,458.0 

 

 

8,407.9 

 

 

7,089.7 

Policy liabilities and accruals

 

8,521.4 

 

 

8,644.5 

 

 

8,301.7 

Policyholder dividends payable

 

235.8 

 

 

240.1 

 

 

325.1 

Policy dividend obligation

 

660.2 

 

 

519.7 

 

 

— 

Other closed block liabilities

 

55.6 

 

 

32.8 

 

 

12.3 

Total closed block liabilities

 

9,473.0 

 

 

9,437.1 

 

 

8,639.1 

Excess of closed block liabilities over closed block assets(1)

$

1,015.0 

 

$

1,029.2 

 

$

1,549.4 

———————

(1)

The maximum future earnings summary to inure to the benefit of the stockholders is represented by the excess of closed block liabilities over closed block assets. All unrealized investment gains (losses), net of income tax, have been allocated to the policyholder dividend obligation.




11





4.

Demutualization and Closed Block (continued)


Closed Block Revenues and Expenses and Changes in

Three Months Ended

 

Six Months Ended

Policyholder Dividend Obligations:

June 30,

 

June 30,

($ in millions)

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

 

Closed block revenues

 

 

 

 

 

 

 

 

 

 

 

Premiums

$

97.2 

 

$

103.8 

 

$

188.9 

 

$

207.0 

Net investment income

 

121.0 

 

 

118.0 

 

 

234.8 

 

 

235.6 

Net realized investment gains (losses)

 

2.9 

 

 

3.2 

 

 

2.0 

 

 

1.6 

Total revenues

 

221.1 

 

 

225.0 

 

 

425.7 

 

 

444.2 

Policy benefits, excluding dividends

 

124.8 

 

 

137.5 

 

 

251.9 

 

 

279.1 

Other operating expenses

 

1.1 

 

 

1.5 

 

 

2.7 

 

 

3.0 

Total benefits and expenses, excluding policyholder dividends

 

125.9 

 

 

139.0 

 

 

254.6 

 

 

282.1 

Closed block contribution to income
  before dividends and income taxes

 

95.2 

 

 

86.0 

 

 

171.1 

 

 

162.1 

Policyholder dividends

 

84.2 

 

 

73.5 

 

 

149.2 

 

 

137.1 

Closed block contribution to income before income taxes

 

11.0 

 

 

12.5 

 

 

21.9 

 

 

25.0 

Applicable income tax expense

 

3.8 

 

 

4.4 

 

 

7.6 

 

 

8.7 

Closed block contribution to income

$

7.2 

 

$

8.1 

 

$

14.3 

 

$

16.3 

 

 

 

 

 

 

 

 

 

 

 

 

Policyholder dividend obligation

 

 

 

 

 

 

 

 

 

 

 

Policyholder dividends provided through earnings

$

84.2 

 

$

73.5 

 

$

149.2 

 

$

137.1 

Policyholder dividends provided through OCI

 

64.5 

 

 

64.0 

 

 

93.5 

 

 

78.7 

Additions to policyholder dividend liabilities

 

148.7 

 

 

137.5 

 

 

242.7 

 

 

215.8 

Policyholder dividends paid

 

(54.1)

 

 

(62.3)

 

 

(106.5)

 

 

(122.8)

Increase in policyholder dividend liabilities

 

94.6 

 

 

75.2 

 

 

136.2 

 

 

93.0 

Policyholder dividend liabilities, beginning of period

 

801.4 

 

 

620.1 

 

 

759.8 

 

 

602.3 

Policyholder dividend liabilities, end of period

 

896.0 

 

 

695.3 

 

 

896.0 

 

 

695.3 

Policyholder dividends payable, end of period

 

(235.8)

 

 

(261.8)

 

 

(235.8)

 

 

(261.8)

Policyholder dividend obligation, end of period

$

660.2 

 

$

433.5 

 

$

660.2 

 

$

433.5 


As of June 30, 2012, the policyholder dividend obligation includes approximately $120.7 million for cumulative closed block earnings in excess of expected amounts calculated at the date of demutualization. These closed block earnings will not inure to stockholders, but will result in additional future dividends to closed block policyholders unless otherwise offset by future performance of the closed block that is less favorable than expected. If actual cumulative performance is less favorable than expected, only actual earnings will be recognized in net income. As of June 30, 2012, the policyholder dividend obligation also includes $539.5 million of net unrealized gains on investments supporting the closed block liabilities.



5.

Deferred Policy Acquisition Costs


Deferred Policy Acquisition Costs:

Three Months Ended

 

Six Months Ended

($ in millions)

June 30,

 

June 30,

 

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

 

Policy acquisition costs deferred

$

21.5 

 

$

29.0 

 

$

47.6 

 

$

63.2 

Costs amortized to expenses:

 

 

 

 

 

 

 

 

 

 

 

  Recurring costs

 

(46.8)

 

 

(42.7)

 

 

(93.2)

 

 

(93.8)

  Realized investment gains (losses)

 

5.0 

 

 

(0.1)

 

 

1.2 

 

 

(0.3)

Offsets to net unrealized investment gains or losses
  included in AOCI(1)

 

(25.8)

 

 

(19.2)

 

 

(42.4)

 

 

(30.7)

Change in deferred policy acquisition costs

 

(46.1)

 

 

(33.0)

 

 

(86.8)

 

 

(61.6)

Deferred policy acquisition costs, beginning of period

 

1,122.1 

 

 

1,217.9 

 

 

1,162.8 

 

 

1,246.5 

Deferred policy acquisition costs, end of period

$

1,076.0 

 

$

1,184.9 

 

$

1,076.0 

 

$

1,184.9 

———————

(1)

An offset to deferred policy acquisition costs and AOCI is recorded each period to the extent that, had unrealized holding gains or losses from securities classified as available-for-sale actually been realized, an adjustment to deferred policy acquisition costs amortized using gross profits or gross margins would result.




12





5.

Deferred Policy Acquisition Costs (continued)


We defer incremental direct costs related to the successful sale of new or renewal contracts. Incremental direct costs are those costs that result directly from and are essential to the sale of a contract. Costs incurred related directly to acquisition activities performed by the insurer are also deferred. During the three and six months ended June 30, 2012 and 2011, deferred expenses primarily consisted of third-party commissions related to fixed indexed annuity sales.


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 EGPs. Policies may be surrendered for value or exchanged for a different one of our products (internal replacement). The deferred policy acquisition cost balance associated with the replaced or surrendered policies is adjusted to reflect these surrenders. In addition, an offset to deferred policy acquisition costs and 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 use of extensive 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.


In addition to our quarterly reviews, we conduct a comprehensive assumption review on an annual basis, or as circumstances warrant. Upon completion of these comprehensive assumption reviews, we revise our assumptions to reflect our current best estimates, thereby changing our estimate of EGPs in the deferred policy acquisition cost amortization models. The deferred policy acquisition cost asset is then adjusted in a process known as “unlocking,” with an offsetting benefit or charge to income.


During the three and six months ended June 30, 2012 and 2011, it was determined that an unlocking was not warranted.



6.

Investing Activities


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.


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.




13





6.

Investing Activities (continued)


Fair Value and Cost of Securities:

June 30, 2012

($ in millions)

 

 

Gross

 

Gross

 

 

 

OTTI

 

Amortized

 

Unrealized

 

Unrealized

 

Fair

 

Recognized

 

Cost

 

Gains

 

Losses

 

Value

 

in AOCI(1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government and agency

$

877.5 

 

$

84.6 

 

$

(5.8)

 

$

956.3 

 

$

— 

State and political subdivision

 

292.4 

 

 

32.6 

 

 

(2.8)

 

 

322.2 

 

 

— 

Foreign government

 

180.4 

 

 

27.0 

 

 

(0.3)

 

 

207.1 

 

 

— 

Corporate

 

6,527.4 

 

 

683.9 

 

 

(128.2)

 

 

7,083.1 

 

 

(5.7)

Commercial mortgage-backed (“CMBS”)

 

982.5 

 

 

64.1 

 

 

(13.7)

 

 

1,032.9 

 

 

(18.8)

Residential mortgage-backed (“RMBS”)

 

1,986.5 

 

 

90.7 

 

 

(61.1)

 

 

2,016.1 

 

 

(99.4)

CDO/CLO

 

272.3 

 

 

5.4 

 

 

(43.2)

 

 

234.5 

 

 

(24.2)

Other asset-backed

 

469.9 

 

 

20.8 

 

 

(7.6)

 

 

483.1 

 

 

(1.2)

Available-for-sale debt securities

$

11,588.9 

 

$

1,009.1 

 

$

(262.7)

 

$

12,335.3 

 

$

(149.3)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amounts applicable to the closed block

$

5,841.6 

 

$

624.3 

 

$

(86.8)

 

$

6,379.1 

 

$

(48.2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Available-for-sale equity securities

$

34.4 

 

$

13.4 

 

$

(5.7)

 

$

42.1 

 

$

(1.9)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amounts applicable to the closed block

$

12.8 

 

$

5.0 

 

$

(3.0)

 

$

14.8 

 

$

(1.0)

———————

(1)

Represents the amount of non-credit OTTI losses recognized in AOCI excluding net unrealized gains or losses subsequent to the date of impairment.


Fair Value and Cost of Securities:

December 31, 2011

($ in millions)

 

 

Gross

 

Gross

 

 

 

OTTI

 

Amortized

 

Unrealized

 

Unrealized

 

Fair

 

Recognized

 

Cost

 

Gains

 

Losses

 

Value

 

in AOCI(1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government and agency

$

708.6 

 

$

80.1 

 

$

(5.3)

 

$

783.4 

 

$

— 

State and political subdivision

 

251.9 

 

 

21.6 

 

 

(2.9)

 

 

270.6 

 

 

— 

Foreign government

 

185.7 

 

 

21.2 

 

 

(1.7)

 

 

205.2 

 

 

— 

Corporate

 

6,167.0 

 

 

603.9 

 

 

(171.5)

 

 

6,599.4 

 

 

(5.7)

CMBS

 

1,109.9 

 

 

53.5 

 

 

(20.3)

 

 

1,143.1 

 

 

(28.0)

RMBS

 

2,132.9 

 

 

80.3 

 

 

(81.9)

 

 

2,131.3 

 

 

(89.6)

CDO/CLO

 

294.2 

 

 

4.5 

 

 

(48.1)

 

 

250.6 

 

 

(24.2)

Other asset-backed

 

501.6 

 

 

11.1 

 

 

(6.3)

 

 

506.4 

 

 

(1.2)

Available-for-sale debt securities

$

11,351.8 

 

$

876.2 

 

$

(338.0)

 

$

11,890.0 

 

$

(148.7)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amounts applicable to the closed block

$

5,908.2 

 

$

568.4 

 

$

(123.5)

 

$

6,353.1 

 

$

(48.5)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Available-for-sale equity securities

$

29.5 

 

$

12.2 

 

$

(6.0)

 

$

35.7 

 

$

— 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amounts applicable to the closed block

$

10.8 

 

$

4.3 

 

$

(3.1)

 

$

12.0 

 

$

— 

———————

(1)

Represents the amount of non-credit OTTI losses recognized in AOCI excluding net unrealized gains or losses subsequent to the date of impairment.




14





6.

Investing Activities (continued)


Aging of Temporarily Impaired Securities:

As of June 30, 2012

($ in millions)

Less than 12 months

 

Greater than 12 months

 

Total

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

Value

 

Losses

 

Value

 

Losses

 

Value

 

Losses

Debt Securities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government and agency

$

1.2 

 

$

— 

 

$

40.7 

 

$

(5.8)

 

$

41.9 

 

$

(5.8)

State and political subdivision

 

10.0 

 

 

(0.1)

 

 

6.4 

 

 

(2.7)

 

 

16.4 

 

 

(2.8)

Foreign government

 

7.6 

 

 

(0.3)

 

 

— 

 

 

— 

 

 

7.6 

 

 

(0.3)

Corporate

 

259.1 

 

 

(14.1)

 

 

452.5 

 

 

(114.1)

 

 

711.6 

 

 

(128.2)

CMBS

 

15.9 

 

 

(0.1)

 

 

63.9 

 

 

(13.6)

 

 

79.8 

 

 

(13.7)

RMBS

 

54.4 

 

 

(2.1)

 

 

420.2 

 

 

(59.0)

 

 

474.6 

 

 

(61.1)

CDO/CLO

 

17.3 

 

 

(0.3)

 

 

143.0 

 

 

(42.9)

 

 

160.3 

 

 

(43.2)

Other asset-backed

 

26.1 

 

 

(1.1)

 

 

41.6 

 

 

(6.5)

 

 

67.7 

 

 

(7.6)

Debt securities

 

391.6 

 

 

(18.1)

 

 

1,168.3 

 

 

(244.6)

 

 

1,559.9 

 

 

(262.7)

Equity securities

 

2.7 

 

 

(4.9)

 

 

0.4 

 

 

(0.8)

 

 

3.1 

 

 

(5.7)

Total temporarily impaired securities

$

394.3 

 

$

(23.0)

 

$

1,168.7 

 

$

(245.4)

 

$

1,563.0 

 

$

(268.4)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amounts inside the closed block

$

159.8 

 

$

(10.6)

 

$

492.9 

 

$

(79.2)

 

$

652.7 

 

$

(89.8)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amounts outside the closed block

$

234.5 

 

$

(12.4)

 

$

675.8 

 

$

(166.2)

 

$

910.3 

 

$

(178.6)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amounts outside the closed block
  that are below investment grade

$

63.5 

 

$

(4.4)

 

$

227.9 

 

$

(107.1)

 

$

291.4 

 

$

(111.5)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Number of securities

 

 

 

 

215 

 

 

 

 

 

601 

 

 

 

 

 

816 


Unrealized losses on below-investment-grade debt securities outside the closed block with a fair value of less than 80% of amortized cost totaled $93.6 million at June 30, 2012, of which $80.3 million was below 80% of amortized cost for more than 12 months.


Unrealized losses on below-investment-grade debt securities held in the closed block with a fair value of less than 80% of amortized cost totaled $27.2 million at June 30, 2012, of which $17.4 million was below 80% of amortized cost for more than 12 months.


These securities were considered to be temporarily impaired at June 30, 2012 because each of these securities had performed, and is expected to perform, in accordance with original contractual terms. In addition, management does not have the intention to sell, nor does it expect to be required to sell, these securities prior to their recovery.




15





6.

Investing Activities (continued)


Aging of Temporarily Impaired Securities:

As of December 31, 2011

($ in millions)

Less than 12 months

 

Greater than 12 months

 

Total

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

Value

 

Losses

 

Value

 

Losses

 

Value

 

Losses

Debt Securities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government and agency

$

— 

 

$

— 

 

$

41.2 

 

$

(5.3)

 

$

41.2 

 

$

(5.3)

State and political subdivision

 

26.1 

 

 

(0.1)

 

 

6.3 

 

 

(2.8)

 

 

32.4 

 

 

(2.9)

Foreign government

 

25.6 

 

 

(1.7)

 

 

— 

 

 

— 

 

 

25.6 

 

 

(1.7)

Corporate

 

373.0 

 

 

(20.1)

 

 

512.1 

 

 

(151.4)

 

 

885.1 

 

 

(171.5)

CMBS

 

141.3 

 

 

(2.5)

 

 

56.8 

 

 

(17.8)

 

 

198.1 

 

 

(20.3)

RMBS

 

174.6 

 

 

(6.4)

 

 

432.5 

 

 

(75.5)

 

 

607.1 

 

 

(81.9)

CDO/CLO

 

9.3 

 

 

(0.1)

 

 

165.0 

 

 

(48.0)

 

 

174.3 

 

 

(48.1)

Other asset-backed

 

103.6 

 

 

(2.4)

 

 

68.4 

 

 

(3.9)

 

 

172.0 

 

 

(6.3)

Debt securities

 

853.5 

 

 

(33.3)

 

 

1,282.3 

 

 

(304.7)

 

 

2,135.8 

 

 

(338.0)

Equity securities

 

4.2 

 

 

(5.2)

 

 

0.4 

 

 

(0.8)

 

 

4.6 

 

 

(6.0)

Total temporarily impaired securities

$

857.7 

 

$

(38.5)

 

$

1,282.7 

 

$

(305.5)

 

$

2,140.4 

 

$

(344.0)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amounts inside the closed block

$

317.6 

 

$

(18.0)

 

$

556.8 

 

$

(108.6)

 

$

874.4 

 

$

(126.6)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amounts outside the closed block

$

540.1 

 

$

(20.5)

 

$

725.9 

 

$

(196.9)

 

$

1,266.0 

 

$

(217.4)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amounts outside the closed block
  that are below investment grade

$

61.5 

 

$

(4.5)

 

$

260.0 

 

$

(128.8)

 

$

321.5 

 

$

(133.3)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Number of securities

 

 

 

 

502 

 

 

 

 

 

664 

 

 

 

 

 

1,166 


Unrealized losses on below-investment-grade debt securities outside the closed block with a fair value of less than 80% of amortized cost totaled $113.3 million at December 31, 2011, of which $88.0 million was below 80% of amortized cost for more than 12 months.


Unrealized losses on below-investment-grade debt securities held in the closed block with a fair value of less than 80% of amortized cost totaled $37.8 million at December 31, 2011, of which $16.0 million was below 80% of amortized cost for more than 12 months.


These securities were considered to be temporarily impaired at December 31, 2011 because each of these securities had performed, and is expected to perform, in accordance with original contractual terms. In addition, management does not have the intention to sell, nor does it expect to be required to sell, these securities prior to their recovery.


Maturities of Debt Securities:

June 30, 2012

 

December 31, 2011

($ in millions)

Amortized

 

Fair

 

Amortized

 

Fair

 

Cost

 

Value

 

Cost

 

Value

 

 

 

 

 

 

 

 

 

 

 

 

Due in one year or less

$

823.9 

 

$

833.9 

 

$

519.9 

 

$

525.3 

Due after one year through five years

 

2,113.4 

 

 

2,268.5 

 

 

2,139.3 

 

 

2,292.8 

Due after five years through ten years

 

2,485.8 

 

 

2,720.8 

 

 

2,229.0 

 

 

2,405.2 

Due after ten years

 

2,454.6 

 

 

2,745.5 

 

 

2,425.0 

 

 

2,635.3 

CMBS/RMBS/ABS/CDO/CLO

 

3,711.2 

 

 

3,766.6 

 

 

4,038.6 

 

 

4,031.4 

Total

$

11,588.9 

 

$

12,335.3 

 

$

11,351.8 

 

$

11,890.0 


The maturities of debt securities, as of June 30, 2012, are summarized in the table above by contractual maturity. Actual maturities may differ from contractual maturities as certain borrowers have the right to call or prepay obligations with or without call or prepayment penalties, and we have the right to put or sell certain obligations back to the issuers.




16





6.

Investing Activities (continued)


Other-than-temporary impairments


Management assessed all securities in an unrealized loss position in determining whether impairments were temporary or other than temporary. In reaching its conclusions, management exercised significant judgment and 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 June 30, 2012, management does not have the intention to sell, nor does it expect to be required to sell, these securities prior to their recovery.


Fixed income OTTIs recorded in the first half of 2012 were primarily concentrated in structured securities. These impairments were driven primarily by increased collateral default rates. 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 $3.6 million for the second quarter of 2012 and $3.0 million for the second quarter of 2011 and $9.8 million for the first half of 2012 and $8.7 million for the first half of 2011. There were equity security OTTIs of $1.5 million for the three and six months ended June 30, 2012 and no equity security OTTIs for the first quarter of 2011 or for the first half of 2011. There were no limited partnership and other investment OTTIs for the first quarter of 2012 and 2011 or for the first half of 2012 or 2011.


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 $9.9 million for the second quarter of 2012, $3.6 million for the second quarter of 2011, $15.4 million for the first half of 2012 and $5.3 million for the first half of 2011.


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

Three Months Ended

 

Six Months Ended

which a Portion of the OTTI Loss was Recognized in OCI:

June 30,

 

June 30,

($ in millions)

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

 

Balance, beginning of period

$

(79.1)

 

$

(62.6)

 

$

(73.8)

 

$

(60.4)

  Add: Credit losses on securities not previously impaired(1)

 

(1.5)

 

 

(1.8)

 

 

(3.6)

 

 

(5.9)

  Add: Credit losses on securities previously impaired(1)

 

(3.3)

 

 

(1.1)

 

 

(6.5)

 

 

(2.3)

  Less: Credit losses on securities impaired due to intent to sell

 

— 

 

 

— 

 

 

— 

 

 

— 

  Less: Credit losses on securities sold

 

0.2 

 

 

— 

 

 

0.2 

 

 

3.1 

  Less: Increases in cash flows expected on
  previously impaired securities

 

— 

 

 

— 

 

 

— 

 

 

— 

Balance, end of period

$

(83.7)

 

$

(65.5)

 

$

(83.7)

 

$

(65.5)

———————

(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 comprehensive income.




17





6.

Investing Activities (continued)


Limited partnerships and other investments


Limited Partnerships and Other Investments:

June 30,

 

Dec 31,

($ in millions)

2012

 

2011

 

 

 

 

 

 

Private equity

$

255.8 

 

$

241.3 

Mezzanine funds

 

196.1 

 

 

189.9 

Infrastructure funds

 

36.3 

 

 

35.7 

Hedge funds

 

30.0 

 

 

30.0 

Leverage lease

 

19.9 

 

 

20.3 

Mortgage and real estate

 

6.7 

 

 

11.6 

Direct equity

 

26.7 

 

 

25.4 

Other alternative assets

 

47.0 

 

 

47.1 

Limited partnerships and other investments

$

618.5 

 

$

601.3 

 

 

 

 

 

 

Amounts applicable to the closed block

$

372.4 

 

$

352.8 


Net investment income


Sources of Net Investment Income:

Three Months Ended

 

Six Months Ended

($ in millions)

June 30,

 

June 30,

 

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

 

Debt securities

$

152.4 

 

$

155.8 

 

$

305.1 

 

$

304.0 

Equity securities

 

1.2 

 

 

— 

 

 

1.9 

 

 

0.6 

Limited partnerships and other investments

 

69.0 

 

 

57.5 

 

 

128.4 

 

 

110.0 

Fair value option investments

 

(1.0)

 

 

(0.2)

 

 

0.8 

 

 

2.2 

Total investment income

 

221.6 

 

 

213.1 

 

 

436.2 

 

 

416.8 

Less: Discontinued operations

 

0.5 

 

 

0.5 

 

 

1.2 

 

 

1.0 

Less: Investment expenses

 

2.9 

 

 

1.4 

 

 

6.9 

 

 

3.2 

Net investment income

$

218.2 

 

$

211.2 

 

$

428.1 

 

$

412.6 

 

 

 

 

 

 

 

 

 

 

 

 

Amounts applicable to the closed block

$

121.0 

 

$

118.0 

 

$

234.8 

 

$

235.6 




18





6.

Investing Activities (continued)


Net realized investment gains (losses)


Sources and Types of

Three Months Ended

 

Six Months Ended

Net Realized Investment Gains (Losses):

June 30,

 

June 30,

($ in millions)

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

 

Total other-than-temporary debt impairment losses

$

(13.5)

 

$

(6.6)

 

$

(25.2)

 

$

(14.0)

Portion of loss recognized in OCI

 

9.9 

 

 

3.6 

 

 

15.4 

 

 

5.3 

Net debt impairment losses recognized in earnings

$

(3.6)

 

$

(3.0)

 

$

(9.8)

 

$

(8.7)

 

 

 

 

 

 

 

 

 

 

 

 

Debt security impairments:

 

 

 

 

 

 

 

 

 

 

 

  U.S. government and agency

$

— 

 

$

— 

 

$

— 

 

$

— 

  State and political subdivision

 

— 

 

 

— 

 

 

— 

 

 

— 

  Foreign government

 

— 

 

 

— 

 

 

— 

 

 

— 

  Corporate

 

— 

 

 

(0.2)

 

 

(0.6)

 

 

(4.6)

  CMBS

 

(1.0)

 

 

— 

 

 

(1.2)

 

 

— 

  RMBS

 

(2.3)

 

 

(2.7)

 

 

(7.4)

 

 

(4.0)

  CDO/CLO

 

(0.1)

 

 

— 

 

 

(0.1)

 

 

— 

  Other asset-backed

 

(0.2)

 

 

(0.1)

 

 

(0.5)

 

 

(0.1)

Net debt security impairments

 

(3.6)

 

 

(3.0)

 

 

(9.8)

 

 

(8.7)

Equity security impairments

 

(1.5)

 

 

— 

 

 

(1.5)

 

 

— 

Limited partnerships and other investment impairments

 

— 

 

 

— 

 

 

— 

 

 

— 

Impairment losses

 

(5.1)

 

 

(3.0)

 

 

(11.3)

 

 

(8.7)

Debt security transaction gains(1)

 

5.8 

 

 

5.5 

 

 

8.0 

 

 

9.4 

Debt security transaction losses(1)

 

(2.4)

 

 

(1.2)

 

 

(3.4)

 

 

(3.1)

Equity security transaction gains

 

— 

 

 

0.1 

 

 

— 

 

 

0.1 

Equity security transaction losses

 

— 

 

 

— 

 

 

— 

 

 

— 

Limited partnerships and other investment transaction gains

 

0.6 

 

 

— 

 

 

1.4 

 

 

— 

Limited partnerships and other investment transaction losses

 

— 

 

 

— 

 

 

— 

 

 

(1.6)

Net transaction gains

 

4.0 

 

 

4.4 

 

 

6.0 

 

 

4.8 

Derivative instruments

 

13.1 

 

 

5.0 

 

 

(23.0)

 

 

(15.1)

Embedded derivatives(2)

 

(19.1)

 

 

(4.7)

 

 

3.7 

 

 

4.9 

Fair value option investments

 

(1.1)

 

 

1.4 

 

 

0.8 

 

 

1.0 

Net realized investment gains (losses),
  excluding impairment losses

 

(3.1)

 

 

6.1 

 

 

(12.5)

 

 

(4.4)

Net realized investment gains (losses),
  including impairment losses

$

(8.2)

 

$

3.1 

 

$

(23.8)

 

$

(13.1)

———————

(1)

Proceeds from the sale of available-for-sale debt securities were $296.0 million and $396.1 million for the three months ended June 30, 2012 and 2011, respectively. Proceeds from the sale of available-for-sale debt securities were $402.3 million and $693.1 million for the six months ended June 30, 2012 and 2011, respectively.

(2)

Includes the change in fair value of embedded derivatives associated with variable annuity GMWB, GMAB, GPAF and COMBO riders. See Note 8 to these financial statements for additional disclosures.




19





6.

Investing Activities (continued)


Unrealized investment gains (losses)


Sources of Changes in

Three Months Ended

 

Six Months Ended

Net Unrealized Investment Gains (Losses):

June 30,

 

June 30,

($ in millions)

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

 

Debt securities

$

129.5 

 

$

102.0 

 

$

208.2 

 

$

149.8 

Equity securities

 

0.1 

 

 

(3.7)

 

 

1.5 

 

 

(3.9)

Other investments

 

— 

 

 

— 

 

 

— 

 

 

— 

Net unrealized investment gains

$

129.6 

 

$

98.3 

 

$

209.7 

 

$

145.9 

 

 

 

 

 

 

 

 

 

 

 

 

Net unrealized investment gains

$

129.6 

 

$

98.3 

 

$

209.7 

 

$

145.9 

Applicable closed block policyholder dividend obligation

 

64.5 

 

 

64.0 

 

 

93.5 

 

 

78.7 

Applicable deferred policy acquisition cost

 

25.8 

 

 

19.2 

 

 

42.4 

 

 

30.7 

Applicable future policyholder benefits

 

4.5 

 

 

— 

 

 

18.3 

 

 

— 

Applicable deferred income tax expense

 

9.5 

 

 

4.3 

 

 

33.3 

 

 

27.5 

Offsets to net unrealized investment gains

 

104.3 

 

 

87.5 

 

 

187.5 

 

 

136.9 

Net unrealized investment gains included in OCI

$

25.3 

 

$

10.8 

 

$

22.2 

 

$

9.0 


Non-consolidated variable interest entities


Entities which do not have sufficient equity at risk to allow the entity to finance its activities without additional financial support or in which the equity investors, as a group, do not have the characteristic of a controlling financial interest are referred to as VIEs. We perform ongoing assessments of our investments in VIEs to determine whether we have a controlling financial interest in the VIE and therefore would be considered to be the primary beneficiary. An entity would be considered a primary beneficiary and be required to consolidate a VIE when the entity has both the power to direct the activities of a VIE that most significantly affect the entity’s economic performance and the obligation to absorb losses, or right to receive benefits, that could potentially be significant to the VIE. We reassess our VIE determination with respect to an entity on an ongoing basis.


We are involved with various entities that are deemed to be VIEs primarily as a passive investor in private equity limited partnerships and through direct investments, in which we are not related to the general partner. These investments are accounted for under the equity method of accounting and are included in limited partnerships and other investments on our balance sheet. The following table presents the carrying value of assets and liabilities, and the maximum exposure to loss relating to significant VIEs for which we are not the primary beneficiary.


Carrying Value of Assets and Liabilities

June 30, 2012

 

December 31, 2011

and Maximum Exposure Loss Relating

 

 

 

 

Maximum

 

 

 

 

 

Maximum

to Variable Interest Entities:

 

 

 

 

Exposure

 

 

 

 

 

Exposure

($ in millions)

Assets

 

Liabilities

 

to Loss

 

Assets

 

Liabilities

 

to Loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Limited partnerships

$

568.7 

 

$

— 

 

$

568.7 

 

$

552.1 

 

$

— 

 

$

552.1 

Direct equity investments

 

26.7 

 

 

— 

 

 

26.7 

 

 

25.4 

 

 

— 

 

 

25.4 

Receivable

 

7.3 

 

 

— 

 

 

7.3 

 

 

6.6 

 

 

— 

 

 

6.6 

Total

$

602.7 

 

$

— 

 

$

602.7 

 

$

584.1 

 

$

— 

 

$

584.1 


The asset value of our investments in VIEs (based upon sponsor values and financial statements of the individual entities) for which we are not the primary beneficiary was $602.7 million as of June 30, 2012. Our maximum exposure to loss related to these non-consolidated VIEs is limited to the amount of our investment.




20





6.

Investing Activities (continued)


Issuer and counterparty credit exposure


Credit exposure related to issuers and derivatives counterparties is inherent in investments and derivative contracts with positive fair value or asset balances. We manage credit risk through the analysis of the underlying obligors, issuers and transaction structures. We review our debt security portfolio regularly to monitor the performance of obligors and assess the stability of their credit ratings. We also manage credit risk through industry and issuer diversification and asset allocation. Maximum exposure to an issuer or derivative counterparty is defined by quality ratings, with higher quality issuers having larger exposure limits. As of June 30, 2012, we were not exposed to any credit concentration risk of a single issuer greater than 10% of stockholders’ equity other than U.S. government and government agencies backed by the faith and credit of the U.S. government. We have an overall limit on below-investment-grade rated issuer exposure. To further mitigate the risk of loss on derivatives, we enter into contracts in which the counterparty is a financial institution with a rating of A or higher from at least one rating agency.


As of June 30, 2012, we held derivative assets, net of liabilities, with a fair value of $144.9 million. Derivative credit exposure was diversified with nine different counterparties. We also had debt securities of these issuers with a fair value of $160.3 million as of June 30, 2012. Our maximum amount of loss due to credit risk with these issuers was $305.2 million as of June 30, 2012. See Note 9 to these financial statements for more information regarding derivatives.



7.

Financing Activities


Indebtedness at Carrying Value:

June 30,

 

Dec 31,

($ in millions)

2012

 

2011

 

 

 

 

 

 

7.15% surplus notes

$

174.1 

 

$

174.1 

7.45% senior unsecured bonds

 

252.8 

 

 

252.8 

Total indebtedness

$

426.9 

 

$

426.9 


Our 7.15% surplus notes are an obligation of Phoenix Life and are due December 15, 2034. The carrying value of the 2034 notes is net of $0.9 million of unamortized original issue discount. Interest payments are at an annual rate of 7.15%, require the prior approval of the New York Department of Financial Services (“NYDFS”) (formerly known as the State of New York Insurance Department) and may be made only out of surplus funds which the NYDFS determines to be available for such payments under New York Insurance Law. The notes may be redeemed at the option of Phoenix Life at any time at the “make-whole” redemption price set forth in the offering circular. New York Insurance Law provides that the notes are not part of the legal liabilities of Phoenix Life.


Our senior unsecured bonds were issued in December 2001 for gross proceeds of $300.0 million (net proceeds of $290.6 million) and mature in January 2032. We pay interest at an annual rate of 7.45%. We may redeem any or all of the bonds at a redemption price equal to 100% of principal plus accrued and unpaid interest to the redemption date. We have repurchased a cumulative amount of $47.3 million of par value of these bonds as of June 30, 2012. During 2011, we purchased $0.8 million of par value of these bonds for $0.6 million, resulting in a gain of $0.2 million. During 2010 and prior years, we repurchased $46.5 million of par value of these bonds for $24.8 million, resulting in a gain of $21.7 million.


We have recorded indebtedness at unpaid principal balances of each instrument net of issue discount. The Company or its subsidiaries may, from time to time, purchase its debt securities in the open market subject to considerations including, but not limited to, market conditions, relative valuations, capital allocation and the determination that it is in the best interest of the Company and its stakeholders.


Future minimum annual principal payments on indebtedness as of June 30, 2012 are $252.8 million in 2032 and $175.0 million in 2034.




21





7.

Financing Activities (continued)


Interest Expense on Indebtedness, including

Three Months Ended

 

Six Months Ended

Amortization of Debt Issuance Costs:

June 30,

 

June 30,

($ in millions)

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

 

Surplus notes

$

3.1 

 

$

3.1 

 

$

6.3 

 

$

6.3 

Senior unsecured bonds

 

4.8 

 

 

4.8 

 

 

9.6 

 

 

9.6 

Interest expense on indebtedness

$

7.9 

 

$

7.9 

 

$

15.9 

 

$

15.9 


Common stock dividends


During the six months ended June 30, 2012 and the year ended December 31, 2011, we did not pay any stockholder dividends.



8.

Separate Accounts, Death Benefits and Other Insurance Benefit Features


Separate account products are those for which a separate investment and liability account is maintained on behalf of the policyholder. Investment objectives for these separate accounts vary by fund account type, as outlined in the applicable fund prospectus or separate account plan of operations. Our separate account products include variable annuities, fixed indexed annuities and variable life insurance contracts. The assets supporting these contracts are carried at fair value. Assets supporting variable annuity and variable life contracts are reported as separate account assets with an equivalent amount reported as separate account liabilities. The assets supporting fixed indexed annuity contracts are reported within the respective investment line items on the consolidated balance sheet. Amounts assessed against the policyholder for mortality, administration, and other services are included within revenue in fee income. For the three and six month periods ended June 30, 2012 and 2011, there were no gains or losses on transfers of assets from the general account to a separate account.


On May 21, 2012, the employee pension plan surrendered its variable annuity contract with PHL Variable. All assets held within the employee pension plan separate account were subsequently transferred to the direct control of the plan’s trustee. This resulted in a decrease in separate account assets and liabilities of $464.2 million during the quarter ended June 30, 2012.


Separate Account Investments of Account Balances of Variable Annuity Contracts with Guarantees:

June 30,

 

Dec 31,

($ in millions)

2012

 

2011

 

 

 

 

 

 

Debt securities

$

492.2 

 

$

515.4 

Equity funds

 

1,860.9 

 

 

1,883.3 

Other

 

78.9 

 

 

81.7 

Total

$

2,432.0 

 

$

2,480.4 


Investments of Account Balances of Fixed Indexed Annuity Contracts with Guarantees:

June 30,

 

Dec 31,

($ in millions)

2012

 

2011

 

 

 

 

 

 

Debt securities

$

1,227.9 

 

$

972.4 

Equity funds

 

— 

 

 

— 

Other

 

— 

 

 

— 

Total

$

1,227.9 

 

$

972.4 


Variable annuity guaranteed benefits


Many of our variable annuity contracts offer various guaranteed minimum death, accumulation, withdrawal and income benefits.




22





8.

Separate Accounts, Death Benefits and Other Insurance Benefit Features (continued)


We establish policy benefit liabilities for minimum death and income benefit guarantees relating to certain annuity policies as follows:


·

Liabilities associated with the guaranteed minimum death benefit (“GMDB”) are determined by estimating the expected value of death benefits in excess of the projected account balance and recognizing the excess ratably over the accumulation period based on total expected assessments. The assumptions used for calculating the liabilities are generally consistent with those used for amortizing deferred policy acquisition costs.

·

Liabilities associated with the guaranteed minimum income benefit (“GMIB”) are determined by estimating the expected value of the income benefits in excess of the projected account balance at the date of annuitization and recognizing the excess ratably over the accumulation period based on total expected assessments. The assumptions used for calculating such guaranteed income benefit liabilities are generally consistent with those used for amortizing deferred policy acquisition costs.


For variable annuities with GMDB and GMIB, reserves for these guarantees are calculated and recorded in policy liabilities and accruals on our balance sheet. Changes in the liability are recorded in policy benefits, excluding policyholder dividends, on our statements of comprehensive income. We regularly evaluate estimates used and adjust the additional liability balances, with a related charge or credit to benefit expense if actual experience or other evidence suggests that earlier assumptions should be revised.


Changes in Guaranteed Liability Balances:

As of

($ in millions)

June 30, 2012

 

Variable Annuity

 

GMDB

 

GMIB

 

 

 

 

 

 

Liability balance as of January 1, 2012

$

4.9 

 

$

17.8 

Incurred

 

(0.6)

 

 

3.7 

Paid

 

0.7 

 

 

— 

Liability balance as of June 30, 2012

$

5.0 

 

$

21.5 


Changes in Guaranteed Liability Balances:

Year Ended

($ in millions)

December 31, 2011

 

Variable Annuity

 

GMDB

 

GMIB

 

 

 

 

 

 

Liability balance as of January 1, 2011

$

4.6 

 

$

18.1 

Incurred

 

(1.8)

 

 

(0.3)

Paid

 

2.1 

 

 

— 

Liability balance as of December 31, 2011

$

4.9 

 

$

17.8 


For those guarantees of benefits that are payable in the event of death, the net amount at risk is generally defined as the benefit payable in excess of the current account balance at our balance sheet date. We have entered into reinsurance agreements to reduce the net amount of risk on certain death benefits. Following are the major types of death benefits currently in-force:




23





8.

Separate Accounts, Death Benefits and Other Insurance Benefit Features (continued)


Variable Annuity GMDB Benefits by Type:

 

 

Net Amount

 

Average

($ in millions)

Account

 

at Risk after

 

Attained Age

 

Value

 

Reinsurance

 

of Annuitant

 

 

 

 

 

 

 

 

 

GMDB return of premium

$

832.8 

 

$

13.5 

 

 

62

GMDB step up

 

1,371.7 

 

 

73.7 

 

 

63

GMDB earnings enhancement benefit (“EEB”)

 

38.7 

 

 

0.2 

 

 

63

GMDB greater of annual step up and roll up

 

26.7 

 

 

8.2 

 

 

66

Total GMDB at June 30, 2012

$

2,269.9 

 

$

95.6 

 

 

 

 

 

 

 

 

 

 

 

 

GMDB return of premium

$

870.2 

 

$

23.4 

 

 

61

GMDB step up

 

1,398.4 

 

 

118.6 

 

 

63

GMDB earnings enhancement benefit (“EEB”)

 

39.8 

 

 

0.4 

 

 

62

GMDB greater of annual step up and roll up

 

27.1 

 

 

8.8 

 

 

66

Total GMDB at December 31, 2011

$

2,335.5 

 

$

151.2 

 

 

 


Return of Premium: The death benefit is the greater of current account value or premiums paid (less any adjusted partial withdrawals).


Step Up: The death benefit is the greater of current account value, premiums paid (less any adjusted partial withdrawals) or the annual step up amount prior to the oldest original owner attaining a certain age. On and after the oldest original owner attains that age, the death benefit is the greater of current account value or the death benefit at the end of the contract year prior to the oldest original owner’s attaining that age plus premium payments (less any adjusted partial withdrawals) made since that date.


Earnings Enhancement Benefit: The death benefit is the greater of the premiums paid (less any adjusted partial withdrawals) or the current account value plus the EEB. The EEB is an additional amount designed to reduce the impact of taxes associated with distributing contract gains upon death.


Greater of Annual Step Up and Annual Roll Up: The death benefit is the greatest of premium payments (less any adjusted partial withdrawals), the annual step up amount, the annual roll up amount or the current account value prior to the eldest original owner attaining age 81. On and after the eldest original owner attained age 81, the death benefit is the greater of current account value or the death benefit at the end of the contract year prior to the eldest original owner’s attained age of 81 plus premium payments (less any adjusted partial withdrawals) made since that date.


We also offer certain separate account variable products with a guaranteed minimum withdrawal benefit (“GMWB”), guaranteed minimum accumulation benefit (“GMAB”), guaranteed payout annuity floor (“GPAF”) and combination rider (“COMBO”).


Additional Insurance Benefits:

 

 

Average

($ in millions)

Account

 

Attained Age

 

Value

 

of Annuitant

 

 

 

 

 

GMWB

$

557.9 

 

63

GMIB

 

425.1 

 

63

GMAB

 

389.3 

 

57

GPAF

 

16.8 

 

77

COMBO

 

9.9 

 

61

Total at June 30, 2012

$

1,399.0 

 

 

 

 

 

 

 

GMWB

$

555.4 

 

62

GMIB

 

442.1 

 

63

GMAB

 

385.6 

 

57

GPAF

 

21.8 

 

77

COMBO

 

10.1 

 

61

Total at December 31, 2011

$

1,415.0 

 

 




24





8.

Separate Accounts, Death Benefits and Other Insurance Benefit Features (continued)


The GMWB rider guarantees the contract owner a minimum amount of withdrawals and benefit payments over time, regardless of the investment performance of the contract, subject to an annual limit. Optional resets are available. In addition, these contracts have a feature that allows the contract owner to receive the guaranteed annual withdrawal amount for as long as they are alive.


The GMAB rider provides the contract owner with a minimum accumulation of the contract owner’s purchase payments deposited within a specific time period, adjusted for withdrawals, after a specified amount of time determined at the time of issuance of the variable annuity contract.


The GPAF rider provides the contract owner with a minimum payment amount if the variable annuity payment falls below this amount on the payment calculation date.


The COMBO rider includes the GMAB and GMWB riders as well as the GMDB rider at the contract owner’s option.


The GMWB, GMAB, GPAF and COMBO represent embedded derivative liabilities in the variable annuity contracts that are required to be reported separately from the host variable annuity contract. These investments are accounted for at fair value within policyholder deposit funds on the consolidated balance sheet with changes in fair value recorded in realized investment gains on the consolidated statements of comprehensive income. The fair value of the GMWB, GMAB, GPAF and COMBO obligation is calculated based on actuarial and capital market assumptions related to the projected cash flows, including benefits and related contract charges, over the lives of the contracts, incorporating expectations concerning policyholder behavior. As markets change, contracts mature and actual policyholder behavior emerges, we continually evaluate and may from time to time adjust these assumptions.


Embedded derivative liabilities for GMWB, GMAB, GPAF and COMBO are shown in the table below. There were no benefit payments made related to the GMWB and GMAB riders during the six months ended June 30 2012 or during the six months ended June 30, 2011. Benefit payments made for GPAF riders were $0.1 million for the six months ended June 30, 2012 and $0.1 million for the six months ended June 30, 2011. In order to manage the risk associated with these variable annuity embedded derivative liabilities, we have established a risk management strategy under which we hedge our GMAB, GMWB and COMBO exposure using equity index options, equity index futures, equity index variance swaps, interest rate swaps and swaptions.


Variable Annuity Embedded Derivative Liabilities:

June 30,

 

Dec 31,

($ in millions)

2012

 

2011

 

 

 

 

 

 

GMWB

$

18.3 

 

$

17.0 

GMAB

 

20.9 

 

 

25.2 

GPAF

 

1.3 

 

 

2.3 

COMBO

 

(0.3)

 

 

(0.3)

Total variable annuity embedded derivative liabilities

$

40.2 

 

$

44.2 


Fixed indexed annuity guaranteed benefits


Many of our fixed indexed annuities offer guaranteed minimum withdrawal and death benefits.


Liabilities associated with the GMWB for the fixed indexed annuities differ from those offered on variable annuities in that there is less exposure to capital market risk due to the fixed nature of the underlying contract. These liabilities are determined by estimating the expected value of the withdrawal benefits in excess of the projected account balance at the date of election and recognizing the excess ratably over the accumulation period based on total expected assessments. The assumptions used for calculating such guaranteed withdrawal benefit liabilities are consistent with those used for amortizing deferred policy acquisition costs. Some of these riders also offer a GMDB in addition to the withdrawal benefits.


The GMWB and GMDB guarantees are recorded in policy liabilities and accruals on our balance sheet. Changes in the liability are recorded in policy benefits, excluding policyholder dividends, on our statements of comprehensive income. We regularly evaluate estimates used and adjust the additional liability balances, with a related charge or credit to benefit expense if actual experience or other evidence suggests that earlier assumptions should be revised.




25





8.

Separate Accounts, Death Benefits and Other Insurance Benefit Features (continued)


Changes in Guaranteed Liability Balances:

Fixed Indexed Annuity

($ in millions)

GMWB & GMDB

 

June 30,

 

Dec 31,

 

2012

 

2011

 

 

 

 

 

 

Liability balance, beginning of period

$

5.6 

 

$

0.2 

Incurred

 

6.2 

 

 

5.4 

Paid

 

— 

 

 

— 

Liability balance, end of period

$

11.8 

 

$

5.6 


Fixed indexed annuities also offer a variety of index options: policy credits that are calculated based on the performance of an outside equity market or other index over a specified term. The index options represent embedded derivative liabilities that are required to be reported separately from the host contract. These investments are accounted for at fair value within policyholder deposits within the consolidated balance sheet with changes in fair value recorded in policy benefits, excluding dividends, in the consolidated statements of comprehensive income. The fair value of these index options is calculated 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.


Fixed indexed annuity embedded derivatives were $115.2 million and $78.3 million as of June 30, 2012 and December 31, 2011, respectively. In order to manage the risk associated with these fixed indexed annuity options, we hedge using equity index options.


Universal life


Liabilities for universal life are generally determined by estimating the expected value of losses when death benefits exceed revenues and recognizing those benefits ratably over the accumulation period based on total expected assessments. The assumptions used in estimating these liabilities are consistent with those used for amortizing deferred policy acquisition costs. A single set of best estimate assumptions is used since these insurance benefits do not vary significantly with capital market conditions. At June 30, 2012 and December 31, 2011, we held additional universal life benefit reserves in accordance with death benefit and other insurance benefit reserves of $145.3 million and $146.6 million, respectively.



9.

Derivative Instruments


Derivative instruments


We use derivative financial instruments, including options, futures and swaps as a means of hedging exposure to interest rate, equity price change, equity volatility and foreign currency risk. This includes our surplus hedge which utilizes futures and options to hedge against declines in equity markets and the resulting statutory capital and surplus impact. We also use derivative instruments to economically hedge our exposure on living benefits offered on certain of our variable products as well as index credits on our fixed indexed annuity products.


The Company seeks to enter into over-the-counter (“OTC”) derivative transactions pursuant to master agreements that provide for a netting of payments and receipts by counterparty. As of June 30, 2012 and December 31, 2011, $8.6 million and $8.0 million, respectively, of cash and cash equivalents were held as collateral by a third party related to our derivative transactions.


Our derivatives generally do not qualify for hedge accounting, with the exception of cross currency swaps. We do not designate the purchased derivatives related to variable annuity living benefits or fixed indexed annuity index credits as hedges for accounting purposes.




26





9.

Derivative Instruments (continued)


Derivative Instruments:

 

 

Fair Value as of June 30, 2012

 

Fair Value as of December 31, 2011

($ in millions)

 

 

Notional

 

 

 

 

 

Notional

 

 

 

 

 

Maturity

 

Amount

 

Assets

 

Liabilities

 

Amount

 

Assets

 

Liabilities

Non-hedging derivative instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  Interest rate swaps

2017-2026

 

$

156.0 

 

$

17.2 

 

$

6.9 

 

$

131.0 

 

$

15.0 

 

$

5.2 

  Variance swaps

2015-2017

 

 

0.9 

 

 

— 

 

 

1.3 

 

 

0.9 

 

 

3.2 

 

 

— 

  Swaptions

2024

 

 

25.0 

 

 

0.1 

 

 

— 

 

 

25.0 

 

 

0.3 

 

 

— 

  Put options

2015-2022

 

 

406.0 

 

 

100.1 

 

 

— 

 

 

406.0 

 

 

109.6 

 

 

— 

  Call options

2012-2017

 

 

635.5 

 

 

50.8 

 

 

33.5 

 

 

355.0 

 

 

28.0 

 

 

19.0 

  Equity futures

2012

 

 

207.7 

 

 

18.0 

 

 

— 

 

 

70.0 

 

 

18.5 

 

 

— 

 

 

 

 

1,431.1 

 

 

186.2 

 

 

41.7 

 

 

987.9 

 

 

174.6 

 

 

24.2 

Hedging derivative instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  Cross currency swaps

2016

 

 

10.0 

 

 

0.4 

 

 

— 

 

 

15.0 

 

 

0.2 

 

 

— 

 

 

 

 

10.0 

 

 

0.4 

 

 

— 

 

 

15.0 

 

 

0.2 

 

 

— 

Total derivative instruments

 

 

$

1,441.1 

 

$

186.6 

 

$

41.7 

 

$

1,002.9 

 

$

174.8 

 

$

24.2 


Derivative Instrument Realized Gains (Losses)

Three Months Ended

 

Six Months Ended

Recognized in Earnings:

June 30,

 

June 30,

($ in millions)

2012

 

2011

 

2012

 

2011

Derivative instruments by type

 

 

 

 

 

 

 

 

 

 

 

  Interest rate swaps

$

2.4 

 

$

1.8 

 

$

0.6 

 

$

1.5 

  Variance swaps

 

0.9 

 

 

(0.3)

 

 

(4.5)

 

 

(1.7)

  Swaptions

 

— 

 

 

(0.2)

 

 

(0.2)

 

 

(0.9)

  Put options

 

15.0 

 

 

5.4 

 

 

(9.6)

 

 

(8.5)

  Call options

 

(9.8)

 

 

(1.6)

 

 

0.1 

 

 

0.1 

  Equity futures

 

4.6 

 

 

(0.1)

 

 

(9.4)

 

 

(5.6)

  Cross currency swaps

 

— 

 

 

— 

 

 

— 

 

 

— 

Total derivative instrument realized gains (losses)
  recognized in earnings

$

13.1 

 

$

5.0 

 

$

(23.0)

 

$

(15.1)


Interest Rate Swaps


We maintain an overall interest rate risk management strategy that primarily incorporates the use of interest rate swaps as hedges of our exposure to changes in interest rates. Our exposure to changes in interest rates primarily results from our commitments to fund interest-sensitive insurance liabilities, as well as from our significant holdings of fixed rate financial instruments. We use interest rate swaps that effectively convert variable rate cash flows to fixed cash flows in order to hedge the interest rate risks associated with guaranteed minimum living benefit (GMAB/GMWB) rider liabilities.


Interest Rate Options


We use interest rate options, such as swaptions, to hedge against market risks to assets or liabilities from substantial changes in interest rates. An interest rate swaption gives us the right but not the obligation to enter into an underlying swap. Swaptions are options on interest rate swaps. All of our swaption contracts are receiver swaptions, which give us the right to enter into a swap where we will receive the agreed-upon fixed rate and pay the floating rate. If the market conditions are favorable and the swap is needed to continue hedging our inforce liability business, we will exercise the swaption and enter into a fixed rate swap. If a swaption contract is not exercised by its option maturity date, it expires with no value.


Exchange Traded Future Contracts


We use equity index futures to hedge the market risks from changes in the value of equity indices, such as S&P 500, associated with guaranteed minimum living benefit (GMAB/GMWB) rider liabilities. Positions are short-dated, exchange-traded futures with maturities of three months.




27





9.

Derivative Instruments (continued)


Equity Index Options


We use equity indexed options to hedge against market risks from changes in equity markets, volatility and interest rates.


An equity index option affords us the right to make or receive payments based on a specified future level of an equity market index. We may use exchange-trade or OTC options.


Generally, we have used a combination of equity index futures, interest rate swaps, variance swaps and long-dated put options to hedge its GMAB and GMWB liabilities and equity index call options to hedge its indexed annuity option liabilities.


Cross Currency Swaps


We use cross currency swaps to hedge against market risks from changes in foreign currency exchange rates. Currency swaps are used to swap bond asset cash flows denominated in a foreign currency back to U.S. dollars. Under foreign currency swaps, we agree with another party (referred to as the counterparty) to exchange principal and periodic interest payments denominated in foreign currency for payments in U.S. dollars.


Contingent features


Derivative counterparty agreements may contain certain provisions that require our insurance companies’ financial strength rating to be above a certain threshold. If our financial strength ratings were to fall below a specified rating threshold, certain derivative counterparties could request immediate payment or demand immediate and ongoing full collateralization on derivative instruments in net liability positions, or trigger a termination of existing derivatives and/or future derivative transactions.


In certain derivative counterparty agreements, our financial strength ratings are below the specified threshold levels. However, the Company held no derivative instruments as of June 30, 2012 in a net aggregate liability position payable to any counterparty (i.e., such derivative instruments have fair values in a net asset position payable to the Company if such holdings were liquidated).



10.

Fair Value of Financial Instruments


ASC 820-10 defines and establishes the framework for measuring fair value. The framework is based on inputs that are used in the valuation and a fair value hierarchy based on the quality of those inputs used to measure fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.


A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels, from highest to lowest, are defined as follows:


·

Level 1 – inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets. Level 1 securities include highly liquid government bonds and exchange-traded equities.

·

Level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. Examples of such instruments include government-backed mortgage products, certain collateralized mortgage and debt obligations and certain high-yield debt securities.

·

Level 3 – inputs to the valuation methodology are unobservable and significant to the fair value measurement. Securities classified within Level 3 include broker quoted investments, certain residual interests in securitizations and other less liquid securities. Most valuations that are based on brokers’ prices are classified as Level 3 due to a lack of transparency in the process they use to develop prices.




28





10.

Fair Value of Financial Instruments (continued)


A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.


Investments, in which fair value is based upon unadjusted quoted market prices, are reported as Level 1. We receive quoted market prices from an independent third party, nationally recognized pricing vendor (“pricing vendor”). When quoted prices are not available, we use a pricing vendor to give an estimated fair value in which amounts are included in Level 2 of the hierarchy. If quoted prices, or an estimated price from the pricing vendor are not available or we determine that the price is based on disorderly transactions or in inactive markets, fair value is based upon internally developed models. These internal models use primarily market-based or independently-sourced market parameters, including interest rate yield curves, option volatilities and currency rates. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments include amounts to reflect counterparty credit quality, our own creditworthiness, liquidity and unobservable parameters that are applied consistently over time. The majority of the valuations of Level 3 assets were internally calculated or obtained from independent third-party broker quotes.


Management reviews all Level 2 and Level 3 market prices on a quarterly basis. Level 2 prices are grouped by asset class validated by using any combination of the following:


·

Yield curve analysis

·

Published index data

·

Ratings data

·

Spread data

·

Sector specific economics / performance

·

Alternative / comparable price sources (if available)

·

Price stratification to prior price

·

Similar traded securities


Level 3 prices are validated on an individual security basis using multiple indicators which may include any combination of the following:


·

Coupon rate

·

Maturity data

·

Quality ratings

·

Comparison price analysis

·

Sector / asset class specific index data

·

Vintage year / seasoning of issue (structured products)

·

Cash flow analysis

·

Alternative / comparable price sources (if available)


The following is a description of our valuation methodologies for assets and liabilities measured at fair value. Such valuation methodologies were applied to all of the assets and liabilities carried at fair value.


Available-for-sale debt securities


We use a pricing vendor to estimate fair value for the majority of our available-for-sale debt securities. The pricing vendor’s evaluations are based on market data and use pricing models that vary by asset class and incorporate available trade, bid and other market information. For investments that are not priced by the pricing vendor, we estimated fair value using an internal matrix. The internal matrix uses underlying source data from independent third parties for treasury yields, market spreads and average life calculations. Because our internal matrix prices are derived from observable market data, we include these estimates in Level 2 of our hierarchy.




29





10.

Fair Value of Financial Instruments (continued)


Structured Securities


For structured securities, the majority of the fair value estimates are provided by our pricing vendor. When pricing is not available from the pricing vendor, we obtain fair value information from brokers or use internal models. These models consider the best estimate of cash flows until maturity to determine our ability to collect principal and interest and compare this to the anticipated cash flows when the security was purchased. In addition, management judgment is used to assess the probability of collecting all amounts contractually due to us. After consideration is given to the available information relevant to assessing the collectibility, including historical events, current conditions and reasonable forecasts, an estimate of future cash flows is determined. This includes evaluating the remaining payment terms, prepayment speeds, the underlying collateral, expected defaults using current default data and the financial condition of the issuer. Other factors considered are composite credit ratings, industry forecast, analyst reports and other relevant market data are also considered, similar to those the Company believes market participants would use.


To determine fair values for certain structured, collateralized loan obligations (“CLO”) and collateralized debt obligation (“CDO”) assets for which current pricing indications either do not exist, or are based on inactive markets or sparse transactions, we utilize model pricing using a third-party forecasting application that leverages historical trustee information for each modeled security. Principal and interest cash flows are modeled under various default scenarios for a given tranche of a security in accordance with its contractual cash flow priority of claim and subordination with respect to credit losses. The key assumptions include the level of annual default rates, loss-given-default or recovery rate, collateral prepayment rate and reinvestment spread.


Fair value is then determined based on discounted projected cash flows. We use a discount rate based upon a combination of the current U.S. Treasury rate plus the most recent gross CDO/CLO spreads (including the corresponding swap spread) by original tranche rating, which is representative of the inherent credit risk exposure in a deal’s capital structure.


The majority of the internal valuations calculated for structured securities are reported in Level 3 of the valuation hierarchy.


Derivatives


Exchange-traded derivatives valued using quoted prices are classified within Level 1 of the valuation hierarchy. However, few classes of derivative contracts are listed on an exchange. Therefore, the majority of our derivative positions are valued using internally developed models that use as their basis readily observable market parameters. These positions are classified within Level 2 of the valuation hierarchy. Such derivatives include basic interest rate swaps, options and credit default swaps.


Fair values for OTC derivative financial instruments, principally forwards, options and swaps, represent the present value of amounts estimated to be received from or paid to a marketplace participant in settlement of these instruments (i.e., the amount we would expect to receive in a derivative asset assignment or would expect to pay to have a derivative liability assumed). These derivatives are valued using pricing models based on the net present value of estimated future cash flows and directly observed prices from exchange-traded derivatives or other OTC trades, while taking into account the counterparty’s credit ratings, or our own credit ratings, as appropriate. Determining the fair value for OTC derivative contracts can require a significant level of estimation and management judgment.


New and/or complex instruments may have immature or limited markets. As a result, the pricing models used for valuation often incorporate significant estimates and assumptions that market participants would use in pricing the instrument, which may impact the results of operations reported in the consolidated financial statements. For long-dated and illiquid contracts, extrapolation methods are applied to observed market data in order to estimate inputs and assumptions that are not directly observable. This enables us to mark to market all positions consistently when only a subset of prices is directly observable. Values for OTC derivatives are verified using observed information about the costs of hedging the risk and other trades in the market. As the markets for these products develop, we continually refine our pricing models to correlate more closely to the market risk of these instruments.


Retained interest in securitization


Retained interests in securitizations do not trade in an active, open market with readily observable prices. Accordingly, we estimate the fair value of certain retained interests in securitizations using discounted cash flow (“DCF”) models.




30





10.

Fair Value of Financial Instruments (continued)


For certain other retained interests in securitizations, a single interest rate path DCF model is used and generally includes assumptions based upon projected finance charges related to the securitized assets, estimated net credit losses, prepayment assumptions and contractual interest paid to third-party investors. Changes in the assumptions used may have a significant impact on our valuation of retained interests and such interests are, therefore, typically classified within Level 3 of the valuation hierarchy.


We compare the fair value estimates and assumptions to observable market data where available and to actual portfolio experience.


Private equity investments


The valuation of non-public private equity investments requires significant management judgment due to the absence of quoted market prices, an inherent lack of liquidity and the long-term nature of such assets. Private equity investments are valued initially based upon transaction price. The carrying values of private equity investments are adjusted either upwards or downwards from the transaction price to reflect expected exit values as evidenced by financing and sale transactions with third parties, or when determination of a valuation adjustment is confirmed through ongoing reviews by senior investment managers. A variety of factors are reviewed and monitored to assess positive and negative changes in valuation including, but not limited to, current operating performance and future expectations of the particular investment, industry valuations of comparable public companies, changes in market outlook and the third-party financing environment over time. In determining valuation adjustments resulting from the investment review process, emphasis is placed on current company performance and market conditions. Private equity investments are included in Level 3 of the valuation hierarchy.


Private equity investments may also include publicly held equity securities, generally obtained through the initial public offering of privately held equity investments. Such securities are marked-to-market at the quoted public value less adjustments for regulatory or contractual sales restrictions. Discounts for restrictions are quantified by analyzing the length of the restriction period and the volatility of the equity security.


Valuation of embedded derivatives


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 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 the Company’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 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. The impact of the CSA related to variable annuity GMAB and GMWB embedded derivatives at June 30, 2012 and December 31, 2011 was a reduction of $26.7 million and $36.0 million in the reserves associated with these riders, respectively.




31





10.

Fair Value of Financial Instruments (continued)


The following tables present the financial instruments carried at fair value by ASC 820-10 valuation hierarchy (as described above).


Fair Values of Financial Instruments by Level:

As of June 30, 2012

($ in millions)

Level 1

 

Level 2

 

Level 3

 

Total

Assets

 

 

 

 

 

 

 

 

 

 

 

Available-for-sale debt securities

 

 

 

 

 

 

 

 

 

 

 

  U.S. government and agency

$

570.7 

 

$

385.6 

 

$

— 

 

$

956.3 

  State and political subdivision

 

— 

 

 

322.2 

 

 

— 

 

 

322.2 

  Foreign government

 

— 

 

 

207.1 

 

 

— 

 

 

207.1 

  Corporate

 

— 

 

 

6,861.3 

 

 

221.8 

 

 

7,083.1 

  CMBS

 

— 

 

 

1,001.0 

 

 

31.9 

 

 

1,032.9 

  RMBS

 

— 

 

 

1,975.5 

 

 

40.6 

 

 

2,016.1 

  CDO/CLO

 

— 

 

 

8.3 

 

 

226.2 

 

 

234.5 

  Other asset-backed

 

— 

 

 

446.5 

 

 

36.6 

 

 

483.1 

Available-for-sale equity securities

 

1.5 

 

 

— 

 

 

40.6 

 

 

42.1 

Derivative assets

 

18.0 

 

 

168.6 

 

 

— 

 

 

186.6 

Separate account assets

 

3,336.8 

 

 

— 

 

 

— 

 

 

3,336.8 

Fair value option investments(1)

 

21.9 

 

 

— 

 

 

65.1 

 

 

87.0 

Total assets

$

3,948.9 

 

$

11,376.1 

 

$

662.8 

 

$

15,987.8 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

Derivative liabilities

$

— 

 

$

41.7 

 

$

— 

 

$

41.7 

Embedded derivatives

 

— 

 

 

— 

 

 

155.4 

 

 

155.4 

Total liabilities

$

— 

 

$

41.7 

 

$

155.4 

 

$

197.1 

———————

(1)

Fair value option investments at June 30, 2012 include $65.1 million of available-for-sale debt securities in which the fair value option has been elected. In addition, we have also elected the fair value option for available-for-sale equity securities backing our deferred compensation liabilities at $21.9 million as of June 30, 2012. Changes in the fair value of these assets are reflected in results from continuing operations.


There were no transfers of assets between Level 1 and Level 2 during the quarter ended June 30, 2012.


Fair Values of Financial Instruments by Level:

As of December 31, 2011

($ in millions)

Level 1

 

Level 2

 

Level 3

 

Total

Assets

 

 

 

 

 

 

 

 

 

 

 

Available-for-sale debt securities

 

 

 

 

 

 

 

 

 

 

 

  U.S. government and agency

$

385.2 

 

$

398.2 

 

$

— 

 

$

783.4 

  State and political subdivision

 

— 

 

 

270.6 

 

 

— 

 

 

270.6 

  Foreign government

 

— 

 

 

205.2 

 

 

— 

 

 

205.2 

  Corporate

 

— 

 

 

6,389.8 

 

 

209.6 

 

 

6,599.4 

  CMBS

 

— 

 

 

1,084.4 

 

 

58.7 

 

 

1,143.1 

  RMBS

 

— 

 

 

2,090.1 

 

 

41.2 

 

 

2,131.3 

  CDO/CLO

 

— 

 

 

7.5 

 

 

243.1 

 

 

250.6 

  Other asset-backed

 

— 

 

 

460.2 

 

 

46.2 

 

 

506.4 

Available-for-sale equity securities

 

1.5 

 

 

0.3 

 

 

33.9 

 

 

35.7 

Derivative assets

 

18.5 

 

 

156.3 

 

 

— 

 

 

174.8 

Separate account assets(1)

 

3,690.3 

 

 

78.3 

 

 

— 

 

 

3,768.6 

Fair value option investments(2)

 

22.2 

 

 

— 

 

 

64.4 

 

 

86.6 

Total assets

$

4,117.7 

 

$

11,140.9 

 

$

697.1 

 

$

15,955.7 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

Derivative liabilities

$

— 

 

$

24.2 

 

$

— 

 

$

24.2 

Embedded derivatives

 

— 

 

 

— 

 

 

122.5 

 

 

122.5 

Total liabilities

$

— 

 

$

24.2 

 

$

122.5 

 

$

146.7 

———————

(1)

Excludes $40.1 million in limited partnerships and real estate investments accounted for on the equity method as well as $8.9 million in cash and cash equivalents and money market funds.

(2)

Fair value option investments at December 31, 2011 include $64.4 million of available-for-sale debt securities in which the fair value option has been elected. In addition, we have also elected the fair value option for available-for-sale equity securities backing our deferred compensation liabilities at $22.2 million as of December 31, 2011. Changes in the fair value of these assets are reflected in results from continuing operations.



32





10.

Fair Value of Financial Instruments (continued)


There were no transfers of assets between Level 1 and Level 2 during the year ended December 31, 2011.


Level 3 financial assets and liabilities


The following tables set forth a summary of changes in the fair value of our Level 3 financial assets and liabilities. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. For example, a hypothetical derivative contract with Level 1, Level 2 and significant Level 3 inputs would be classified as a Level 3 financial instrument in its entirety. Subsequently, even if only Level 1 and Level 2 inputs are adjusted, the resulting gain or loss is classified as Level 3. Further, Level 3 instruments are frequently hedged with instruments that are classified as Level 1 or Level 2 and, accordingly, gains or losses reported as Level 3 in the table below may be offset by gains or losses attributable to instruments classified in Level 1 or 2 of the fair value hierarchy.


Level 3 Financial Assets:

Three Months Ended June 30, 2012

($ in millions)

 

 

 

 

Corp &

 

Asset-

 

 

 

Common

 

Fair Value

 

Total

 

CDO/CLO

 

RMBS

 

Other

 

Backed

 

CMBS

 

Stock

 

Options

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, beginning of period

$

249.1 

 

$

46.9 

 

$

210.5 

 

$

38.5 

 

$

51.4 

 

$

35.5 

 

$

66.2 

 

$

698.1 

Purchases

 

15.9 

 

 

— 

 

 

5.4 

 

 

0.2 

 

 

— 

 

 

1.7 

 

 

— 

 

 

23.2 

Sales

 

(32.3)

 

 

(0.3)

 

 

(3.5)

 

 

(1.3)

 

 

(1.7)

 

 

— 

 

 

(0.1)

 

 

(39.2)

Transfers into Level 3(1)

 

— 

 

 

— 

 

 

44.6 

 

 

— 

 

 

— 

 

 

4.9 

 

 

— 

 

 

49.5 

Transfers out of Level 3(2)

 

(8.3)

 

 

(0.3)

 

 

(37.7)

 

 

— 

 

 

(18.6)

 

 

— 

 

 

— 

 

 

(64.9)

Realized gains (losses)
  included in earnings

 

— 

 

 

— 

 

 

— 

 

 

(0.7)

 

 

(1.0)

 

 

— 

 

 

(0.1)

 

 

(1.8)

Unrealized gains (losses)
  included in OCI

 

1.5 

 

 

(5.8)

 

 

2.5 

 

 

(0.1)

 

 

1.8 

 

 

(1.5)

 

 

— 

 

 

(1.6)

Amortization/accretion

 

0.3 

 

 

0.1 

 

 

— 

 

 

— 

 

 

— 

 

 

— 

 

 

(0.9)

 

 

(0.5)

Balance, end of period

$

226.2 

 

$

40.6 

 

$

221.8 

 

$

36.6 

 

$

31.9 

 

$

40.6 

 

$

65.1 

 

$

662.8 

———————

(1)

Transfers into Level 3 for the three months ended June 30, 2012 represent securities for which Level 2 input assumptions for valuation pricing were no longer applicable.

(2)

Transfers out of Level 3 for the three months ended June 30, 2012 represent securities for which reliable Level 2 input assumptions for valuation pricing became obtainable.


Level 3 Financial Assets:

Six Months Ended June 30, 2012

($ in millions)

 

 

 

 

Corp &

 

Asset-

 

 

 

Common

 

Fair Value

 

Total

 

CDO/CLO

 

RMBS

 

Other

 

Backed

 

CMBS

 

Stock

 

Options

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, beginning of period

$

243.1 

 

$

41.2 

 

$

209.6 

 

$

46.2 

 

$

58.7 

 

$

33.9 

 

$

64.4 

 

$

697.1 

Purchases

 

16.1 

 

 

— 

 

 

38.5 

 

 

0.2 

 

 

— 

 

 

6.3 

 

 

— 

 

 

61.1 

Sales

 

(33.3)

 

 

(0.7)

 

 

(17.9)

 

 

(5.0)

 

 

(6.1)

 

 

— 

 

 

(0.1)

 

 

(63.1)

Transfers into Level 3(1)

 

2.5 

 

 

— 

 

 

24.5 

 

 

— 

 

 

— 

 

 

0.3 

 

 

— 

 

 

27.3 

Transfers out of Level 3(2)

 

(8.4)

 

 

(0.2)

 

 

(38.5)

 

 

— 

 

 

(24.2)

 

 

— 

 

 

— 

 

 

(71.3)

Realized gains (losses)
  included in earnings

 

0.2 

 

 

— 

 

 

(0.6)

 

 

(1.0)

 

 

(1.0)

 

 

0.1 

 

 

(0.1)

 

 

(2.4)

Unrealized gains (losses)
  included in OCI

 

5.4 

 

 

0.2 

 

 

6.2 

 

 

(3.8)

 

 

4.5 

 

 

— 

 

 

— 

 

 

12.5 

Amortization/accretion

 

0.6 

 

 

0.1 

 

 

— 

 

 

— 

 

 

— 

 

 

— 

 

 

0.9 

 

 

1.6 

Balance, end of period

$

226.2 

 

$

40.6 

 

$

221.8 

 

$

36.6 

 

$

31.9 

 

$

40.6 

 

$

65.1 

 

$

662.8 

———————

(1)

Transfers into Level 3 for the six months ended June 30, 2012 represent securities for which Level 2 input assumptions for valuation pricing were no longer applicable.

(2)

Transfers out of Level 3 for the six months ended June 30, 2012 represent securities for which reliable Level 2 input assumptions for valuation pricing became obtainable.




33





10.

Fair Value of Financial Instruments (continued)


Level 3 Financial Assets:

Three Months Ended June 30, 2011

($ in millions)

 

 

 

 

Corp &

 

Asset-

 

 

 

Common

 

Fair Value

 

Total

 

CDO/CLO

 

RMBS

 

Other

 

Backed

 

CMBS

 

Stock

 

Options

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, beginning of period

$

253.8 

 

$

53.7 

 

$

269.1 

 

$

78.0 

 

$

73.7 

 

$

50.2 

 

$

29.8 

 

$

808.3 

Purchases

 

0.1 

 

 

— 

 

 

20.5 

 

 

13.7 

 

 

5.7 

 

 

— 

 

 

— 

 

 

40.0 

Sales

 

(14.9)

 

 

(0.6)

 

 

(8.5)

 

 

(11.5)

 

 

(1.2)

 

 

(0.2)

 

 

(0.1)

 

 

(37.0)

Transfers into Level 3(1)

 

— 

 

 

— 

 

 

18.8 

 

 

— 

 

 

— 

 

 

— 

 

 

— 

 

 

18.8 

Transfers out of Level 3(2)

 

— 

 

 

(4.7)

 

 

(10.4)

 

 

(16.3)

 

 

(0.2)

 

 

— 

 

 

— 

 

 

(31.6)

Realized gains (losses)
  included in earnings

 

(0.2)

 

 

— 

 

 

(0.2)

 

 

(1.0)

 

 

— 

 

 

— 

 

 

0.1 

 

 

(1.3)

Unrealized gains (losses)
  included in OCI

 

(2.1)

 

 

(0.5)

 

 

4.3 

 

 

1.0 

 

 

(0.2)

 

 

(3.5)

 

 

0.3 

 

 

(0.7)

Amortization/accretion

 

0.8 

 

 

0.1 

 

 

0.1 

 

 

— 

 

 

— 

 

 

— 

 

 

— 

 

 

1.0 

Balance, end of period

$

237.5 

 

$

48.0 

 

$

293.7 

 

$

63.9 

 

$

77.8 

 

$

46.5 

 

$

30.1 

 

$

797.5 

———————

(1)

Transfers into Level 3 for the three months ended June 30, 2011 represent securities for which Level 2 input assumptions for valuation pricing were no longer applicable.

(2)

Transfers out of Level 3 for the three months ended June 30, 2011 represent securities for which reliable Level 2 input assumptions for valuation pricing became obtainable.


Level 3 Financial Assets:

Six Months Ended June 30, 2011

($ in millions)

 

 

 

 

Corp &

 

Asset-

 

 

 

Common

 

Fair Value

 

Total

 

CDO/CLO

 

RMBS

 

Other

 

Backed

 

CMBS

 

Stock

 

Options

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, beginning of period

$

251.6 

 

$

50.6 

 

$

268.4 

 

$

67.9 

 

$

56.3 

 

$

46.3 

 

$

38.2 

 

$

779.3 

Purchases

 

0.2 

 

 

4.4 

 

 

31.1 

 

 

36.8 

 

 

20.7 

 

 

3.9 

 

 

— 

 

 

97.1 

Sales

 

(24.4)

 

 

(1.3)

 

 

(24.4)

 

 

(15.3)

 

 

(1.8)

 

 

(0.3)

 

 

(8.5)

 

 

(76.0)

Transfers into Level 3(1)

 

— 

 

 

— 

 

 

21.6 

 

 

— 

 

 

— 

 

 

0.9 

 

 

— 

 

 

22.5 

Transfers out of Level 3(2)

 

— 

 

 

(4.6)

 

 

(10.4)

 

 

(24.6)

 

 

(0.2)

 

 

— 

 

 

— 

 

 

 (39.8)

Realized gains (losses)
  included in earnings

 

(0.6)

 

 

— 

 

 

(0.6)

 

 

(1.5)

 

 

— 

 

 

— 

 

 

(1.4)

 

 

 (4.1)

Unrealized gains (losses)
  included in OCI

 

9.7 

 

 

(1.3)

 

 

7.8 

 

 

0.6 

 

 

2.8 

 

 

(4.3)

 

 

1.8 

 

 

17.1 

Amortization/accretion

 

1.0 

 

 

0.2 

 

 

0.2 

 

 

— 

 

 

— 

 

 

— 

 

 

— 

 

 

1.4 

Balance, end of period

$

237.5 

 

$

48.0 

 

$

293.7 

 

$

63.9 

 

$

77.8 

 

$

46.5 

 

$

30.1 

 

$

797.5 

———————

(1)

Transfers into Level 3 for the six months ended June 30, 2011 represent securities for which Level 2 input assumptions for valuation pricing were no longer applicable.

(2)

Transfers out of Level 3 for the six months ended June 30, 2011 represent securities for which reliable Level 2 input assumptions for valuation pricing became obtainable.


Level 3 Financial Liabilities:

Embedded Derivative Liabilities

($ in millions)

Three Months Ended

 

Six Months Ended

 

June 30,

 

June 30,

 

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

 

Balance, beginning of period

$

114.5 

 

$

27.4 

 

$

122.5 

 

$

27.4 

Net purchases/(sales)

 

13.7 

 

 

10.9 

 

 

28.3 

 

 

24.1 

Transfers into Level 3

 

— 

 

 

— 

 

 

— 

 

 

— 

Transfers out of Level 3

 

(1.9)

 

 

— 

 

 

(3.5)

 

 

— 

Realized (gains) losses

 

18.7 

 

 

5.1 

 

 

(3.0)

 

 

(7.5)

Unrealized (gains) losses included in other comprehensive loss

 

— 

 

 

— 

 

 

— 

 

 

— 

Deposits less benefits

 

— 

 

 

— 

 

 

— 

 

 

— 

Change in fair value(1)

 

10.4 

 

 

— 

 

 

11.1 

 

 

(0.6)

Amortization/accretion

 

— 

 

 

— 

 

 

— 

 

 

— 

Balance, end of period

$

155.4 

 

$

43.4 

 

$

155.4 

 

$

43.4 

———————

(1)

Represents change in fair value related to fixed index credits recognized in policy benefits, excluding policy holder dividends, on the consolidated statements of comprehensive income.



34





10.

Fair Value of Financial Instruments (continued)


The unobservable inputs used in the fair value measurement of CDO/CLO and fair value options are prepayment rates, default rates, recovery rates, and reinvestment spread. Significant changes in any of these inputs on its own may result in a significant change in the fair value measurement, particularly for subordinated tranches. Generally, for a CDO/CLO whose collateral’s weighted-average spread is higher than the assumed reinvestment spread, an increase in prepayment rates would decrease the fair value while the deal remains within its reinvestment period. If the weighted-average spread is lower than the assumed reinvestment spread, an increase in prepayment rates would increase the fair value. Keeping all other inputs unchanged, a significant increase in the annual default rates would likely result in a decrease to fair value.


The following table presents quantitative information about unobservable inputs used in the fair value measurement of internally priced assets.


Level 3 Assets:

 

As of June 30, 2012

($ in millions)

 

Fair Value

 

Valuation Technique(s)

 

Unobservable Input

 

Range

 

 

 

 

 

 

 

 

 

 

CDO/CLO

 

$

198.8 

 

Discounted cash flow

 

Prepayment rate

 

20% (CLOs)

 

 

 

 

 

 

 

Default rate

 

2.5% (CLOs)

 

 

 

 

 

 

 

Recovery rate

 

65% (Loans), 35% (High yield bonds),
  45% (Investment grade bonds)

 

 

 

 

 

 

 

Reinvestment spread

 

3 mo LIBOR + 400bps (CLOs)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair value option

 

$

20.6 

 

Discounted cash flow

 

Default rate

 

0.6% - 0.8% (CDOs)

  investments

 

 

 

 

 

 

Recovery rate

 

45% (Investment grade bonds)

 

 

 

 

 

 

 

 

 

 

 

 

 

8.1 

 

Benchmark to index

 

Barclays US high yield other
  finance return

 

100%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other asset-backed

 

$

2.5 

 

Discounted cash flow

 

Discount margin based on
  forward 1mo LIBOR curve

 

.3% - 1.8%

 

 

 

 

 

 

 

 

 

 

 

 

 

7.4 

 

Discounted cash flow

 

Prepayment rate

 

20% (CLOs)

 

 

 

 

 

 

 

Default rate

 

2.53% for 48 mos then .33% thereafter

 

 

 

 

 

 

 

Recovery rate

 

65% (Loans)

 

 

 

 

 

 

 

Reinvestment spread

 

3mo LIBOR + 400bps (CLOs)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Level 3 assets(1)

 

$

237.4 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

———————

(1)

Excludes $425.4 million of Level 3 assets which are valued based upon non-binding independent third-party valuations for which unobservable inputs are not reasonably available to us.


Significant unobservable inputs used in the fair value measurement of variable annuity GMAB and GMWB liabilities are volatility surface, swap curve, mortality and lapse rates and an adjustment for non-performance risk. Keeping other inputs unchanged, an increase in the volatility surface would increase the fair value of the liability while a decrease in the swap curve or CSA would result in a decrease the fair value of the liability. The impact of changes in mortality and lapse rates are dependent on overall market conditions. Significant unobservable inputs used in the fair value measurement of the GPAF liability are interest and mortality rates. Increases in either of these inputs would result in a decrease of the GPAF fair value liability. The fair value of fixed indexed annuity embedded derivative related to index credits is calculated using the swap curve, mortality and lapse rates, as well as an adjustment for non-performance risk. Keeping other inputs unchanged, an increase in any of these significant unobservable inputs would result in a decrease of the fixed indexed annuity embedded derivative liability.




35





10.

Fair Value of Financial Instruments (continued)


The following table presents quantitative information about unobservable inputs used in the fair value measurement of internally priced liabilities.


Level 3 Liabilities:

 

As of June 30, 2012

($ in millions)

 

Fair Value

 

Valuation Technique(s)

 

Unobservable Input

 

Range

 

 

 

 

 

 

 

 

 

 

Embedded derivatives
(GMAB / GMWB)

 

$

38.9 

 

Risk neutral stochastic
  valuation methodology

 

Volatility surface

 

12.26% - 48.88%

 

 

 

 

 

 

 

Swap curve

 

0.17% - 2.61%

 

 

 

 

 

 

 

Mortality rate

 

75% of A2000 basic table

 

 

 

 

 

 

 

Lapse rate

 

0.00% - 60.00%

 

 

 

 

 

 

 

CSA

 

5.03%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Embedded derivatives
(GPAF)

 

$

1.3 

 

Real world single scenario
  cash flow projection

 

Interest rate

 

3.46%

 

 

 

 

 

 

 

Mortality rate

 

70% 1994 MGDB

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Embedded derivatives

 

$

115.2 

 

Budget method

 

Swap curve

 

0.17% - 2.61%

(Index credits)

 

 

 

 

 

 

Mortality rate

 

75% of A2000 basic table

 

 

 

 

 

 

 

Lapse rate

 

1.00% - 35.00%

 

 

 

 

 

 

 

CSA

 

5.03%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Level 3 liabilities

 

$

155.4 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


Fair value of financial instruments


The Company is required by GAAP to disclose the fair value of certain financial instruments including those that are not carried at fair value. The following table discloses the Company’s financial instruments where the carrying amounts and fair values differ:


Carrying Amounts and Fair Values of Financial Instruments:

As of June 30, 2012

 

As of December 31, 2011

($ in millions)

Carrying

 

Fair

 

Carrying

 

Fair

 

Value

 

Value

 

Value

 

Value

Financial liabilities:

 

 

 

 

 

 

 

 

 

 

 

Investment contracts

$

2,767.1 

 

$

2,776.8 

 

$

2,429.4 

 

$

2,440.7 

Indebtedness

 

426.9 

 

 

344.9 

 

 

426.9 

 

 

322.0 


Fair value of investment contracts


We determine the fair value of guaranteed interest contracts by using a discount rate based upon the appropriate U.S. Treasury rate to calculate the present value of projected contractual liability payments through final maturity. We determine the fair value of deferred annuities and supplementary contracts without life contingencies with an interest guarantee of one year or less at the amount of the policy reserve. In determining the fair value of deferred annuities and supplementary contracts without life contingencies with interest guarantees greater than one year, we use a discount rate based upon the appropriate U.S. Treasury rate to calculate the present value of the projected account value of the policy at the end of the current guarantee period.


Deposit type funds, including pension deposit administration contracts, dividend accumulations, and other funds left on deposit not involving life contingencies, have interest guarantees of less than one year for which interest credited is closely tied to rates earned on owned assets. For these liabilities, we assume fair value to be equal to the stated liability balances.


The fair value of these investment contracts are categorized as Level 3.




36





10.

Fair Value of Financial Instruments (continued)


Indebtedness


Fair value of our senior unsecured bonds is based upon quoted market prices. The fair value of surplus notes is determined by professional judgment and readily available market data. Senior unsecured bonds are classified as Level 1 and surplus notes are classified as Level 3 within the fair value hierarchy.



11.

Income Taxes


It is our policy to estimate taxes for interim periods based on estimated annual effective tax rates which are derived, in part, from expected annual pre-tax income. However, the change in the deferred income taxes and related valuation allowance for the three and six months ended June 30, 2012 has been computed based on the first six months of 2012 as a discrete period. Similarly, the current tax expense of $4.6 million and $13.5 million for the three and six months ended June 30, 2012, respectively, is determined based upon the first six months of 2012 as a discrete period. The current tax provision represents the estimated tax liability under the alternative minimum tax (“AMT”) system. Despite our net operating loss carryforwards, certain provisions of the Internal Revenue Code place limits on the ability to fully offset current period taxable income under the AMT system.


We recorded a deferred tax asset, net of deferred tax liabilities and valuation allowances, of $91.7 million as of June 30, 2012. Consistent with the prior period, the deferred tax asset not offset by a valuation allowance relates to gross unrealized losses on available-for-sale debt securities. For the three months ended June 30, 2012, we recognized a net increase in the valuation allowance of $5.4 million. For the six months ended June 30, 2012, excluding  the increase in the valuation allowance related to the adoption of a new accounting standard of $58.8 million (see Note 2 to these financial statements), we recognized a net increase in the valuation allowance of $31.2 million. 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 for the three months ended June 30, 2012 corresponds to an increase of $8.4 million in income statement related deferred tax balances and a decrease of $3.0 million in OCI related deferred tax balances. The net increase to the valuation allowance for the six months ended June 30, 2012 corresponds to an increase of $17.6 million in income statement related deferred tax balances and an increase of $13.6 million in OCI related deferred tax balances.


We believe it is reasonably possible that the Company will begin to record positive three-year cumulative income during the second half of 2012, which would represent positive evidence of our ability to realize deferred tax assets that are presently offset by a valuation allowance. During the second quarter, the Company generated taxable income sufficient to fully utilize its life group related net operating loss carryforwards; however, significant net operating losses attributable to the non-life group remain. The Company will continue to assess this accumulating positive evidence, which may result in a reduction of the existing valuation allowance and a corresponding benefit to the income tax provision reflected in continuing operations during the second half of 2012.


We have concluded that a valuation allowance on the 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.


The Company and its subsidiaries file consolidated, combined, unitary or separate income tax returns in the U.S. federal, various state and foreign jurisdictions. The Company is no longer subject to U.S. federal income tax examinations by tax authorities for years before 2010.


Based upon the timing and status of our current examinations by taxing authorities, we do not believe that it is reasonably possible that any changes to the balance of unrecognized tax benefits occurring within the next 12 months will result in a significant change to the results of operations, financial condition or liquidity. In addition, we do not anticipate that there will be additional payments made or refunds received within the next 12 months with respect to the years under audit. We do not anticipate any increases to the existing unrecognized tax benefits that would have a significant impact on the financial position of the Company.





37





12.

Other Comprehensive Income


Sources of Other Comprehensive Income:

Three Months Ended June 30,

($ in millions)

2012

 

2011

 

Gross

 

Net

 

Gross

 

Net

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gains on investments

$

128.1 

 

$

24.3 

 

$

99.7 

 

$

11.2 

Adjustments for net realized investment gains (losses) on
  available-for-sale securities included in net income

 

1.5 

 

 

1.0 

 

 

(1.4)

 

 

(0.4)

Net unrealized investment gains

 

129.6 

 

 

25.3 

 

 

98.3 

 

 

10.8 

Pension liability adjustment

 

(21.2)

 

 

(13.8)

 

 

3.0 

 

 

2.0 

Other assets

 

— 

 

 

— 

 

 

0.1 

 

 

— 

Net unrealized gains (losses) on derivative instruments

 

0.6 

 

 

0.4 

 

 

(0.4)

 

 

(0.3)

Other comprehensive income

 

109.0 

 

$

11.9 

 

 

101.0 

 

$

12.5 

Applicable policyholder dividend obligation

 

64.5 

 

 

 

 

 

64.0 

 

 

 

Applicable deferred policy acquisition cost amortization

 

25.8 

 

 

 

 

 

19.2 

 

 

 

Applicable future policyholder benefits

 

4.5 

 

 

 

 

 

— 

 

 

 

Applicable deferred income tax expense

 

2.3 

 

 

 

 

 

5.3 

 

 

 

Offsets to other comprehensive income

 

97.1 

 

 

 

 

 

88.5 

 

 

 

Other comprehensive income

$

11.9 

 

 

 

 

$

12.5 

 

 

 


Sources of Other Comprehensive Income:

Six Months Ended June 30,

($ in millions)

2012

 

2011

 

Gross

 

Net

 

Gross

 

Net

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gains on investments

$

203.2 

 

$

13.9 

 

$

143.6 

 

$

6.2 

Adjustments for net realized investment gains on
  available-for-sale securities included in net income

 

6.5 

 

 

8.3 

 

 

2.3 

 

 

2.8 

Net unrealized investment gains

 

209.7 

 

 

22.2 

 

 

145.9 

 

 

9.0 

Pension liability adjustment

 

(19.1)

 

 

(12.5)

 

 

4.1 

 

 

2.7 

Other assets

 

— 

 

 

— 

 

 

1.7 

 

 

1.0 

Net unrealized gains (losses) on derivative instruments

 

0.3 

 

 

0.2 

 

 

(1.2)

 

 

(0.8)

Other comprehensive income

 

190.9 

 

$

9.9 

 

 

150.5 

 

$

11.9 

Applicable policyholder dividend obligation

 

93.5 

 

 

 

 

 

78.7 

 

 

 

Applicable deferred policy acquisition cost amortization

 

42.4 

 

 

 

 

 

30.7 

 

 

 

Applicable future policyholder benefits

 

18.3 

 

 

 

 

 

— 

 

 

 

Applicable deferred income tax expense

 

26.8 

 

 

 

 

 

29.2 

 

 

 

Offsets to other comprehensive income

 

181.0 

 

 

 

 

 

138.6 

 

 

 

Other comprehensive income

$

9.9 

 

 

 

 

$

11.9 

 

 

 



13.

Employee Benefits


Pension and other postretirement benefits


We provide our employees with postretirement benefits that include retirement benefits, primarily through a savings plan, and other benefits, including health care and life insurance. The components of pension and postretirement benefit costs follow:


Components of Pension Benefit Costs:

Three Months Ended

 

Six Months Ended

($ in millions)

June 30,

 

June 30,

 

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

 

Service cost

$

0.2 

 

$

0.2 

 

$

0.4 

 

$

0.5 

Interest cost

 

8.7 

 

 

8.9 

 

 

17.3 

 

 

17.9 

Expected return on plan assets

 

(8.7)

 

 

(9.1)

 

 

(17.3)

 

 

(18.2)

Net loss amortization

 

2.6 

 

 

1.6 

 

 

5.2 

 

 

3.3 

Pension benefit cost

$

2.8 

 

$

1.6 

 

$

5.6 

 

$

3.5 




38





13.

Employee Benefits (continued)


Components of Other Postretirement Benefit Costs:

Three Months Ended

 

Six Months Ended

($ in millions)

June 30,

 

June 30,

 

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

 

Service cost

$

0.1 

 

$

0.1 

 

$

0.2 

 

$

0.2 

Interest cost

 

0.6 

 

 

0.7 

 

 

1.2 

 

 

1.3 

Prior service cost amortization

 

(0.3)

 

 

(0.5)

 

 

(0.7)

 

 

(1.0)

Other postretirement benefit cost

$

0.4 

 

$

0.3 

 

$

0.7 

 

$

0.5 


For the three months ended June 30, 2012, other comprehensive loss includes unrealized gains of $13.7 million, net of taxes, relating to the amortization of net prior service costs and net gains/losses. For the six months ended June 30, 2012, other comprehensive loss includes unrealized gains of $12.4 million, net of taxes, relating to the amortization of net prior service costs and net gains/losses. Effective March 31, 2010, the benefit accruals under all defined benefit pension plans were frozen.


During the three months ended June 30, 2012, we made contributions of $3.6 million to the pension plan. During the six months ended June 30, 2012, we made contributions of $7.0 million to the pension plan. We expect to make additional contributions of approximately $9.4 million by December 31, 2012. On July 6, 2012, the Surface Transportation Extension Act of 2012, Part II, was enacted into law and is effective immediately. The law includes certain pension funding stabilization provisions. We are evaluating its impact.


Savings plans


During the three months ended June 30, 2012 and 2011, we incurred costs of $1.1 million and $1.5 million, respectively, for contributions to our savings plans. During the six months ended June 30, 2012 and 2011, we incurred costs of $2.4 million and $2.7 million, respectively, for contributions to our savings plans.


Effective April 1, 2010, employees (except Saybrus employees) participating in the Company savings plans are eligible to receive an employer discretionary contribution according to the plan terms.



14.

Share-Based Payment


We provide share-based compensation to certain of our employees and non-employee directors, as further described below. The compensation cost that has been charged against income for these plans is summarized in the following table:


Share-Based Compensation Plans:

Three Months Ended

 

Six Months Ended

($ in millions)

June 30,

 

June 30,

 

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

 

Compensation cost charged to income from continuing operations

$

0.5 

 

$

0.9 

 

$

2.0 

 

$

2.1 

Income tax expense (benefit) before valuation allowance

$

(0.2)

 

$

(0.3)

 

$

(0.7)

 

$

(0.1)


We did not capitalize any of the cost of stock-based compensation during the three and six month periods ended June 30, 2012 and 2011. In satisfaction of stock-based compensation, shares issued may be made available from authorized but unissued shares or shares may be purchased on the open market.


Stock options


We have stock option plans under which we grant options for a fixed number of common shares to employees and non-employee directors. Our options have an exercise price equal to the market value of the shares at the date of grant. Each option, once vested, entitles the holder to purchase one share of our common stock. The employees’ options generally vest over a three-year period while the directors’ options vest immediately. Certain options involve both service and market criteria and vest at the later of a stated number of years from the grant date or when the market criterion has been met. If the market criterion has not been met within five years from the grant date, options are forfeited. The fair values of options granted are measured as of the grant date and expensed ratably over the vesting period.




39





14.

Share-Based Payment (continued)


As of June 30, 2012, 1,921,337 of outstanding stock options were exercisable, with a weighted-average exercise price of $9.93 per share. There were no options granted during the three and six months ended June 30, 2012.


Restricted stock units


We have restricted stock unit (“RSU”) plans under which we grant RSUs to employees and non-employee directors. RSUs granted to employees are performance-vested, time-vested or a combination thereof. Each RSU, once vested, entitles the holder to one share of our common stock when the restriction expires. We recognize compensation expense over the vesting period of the RSUs, which is generally three years for each employee award. Director RSU awards vest immediately.


During the six months ended June 30, 2012, 144,978 director RSUs were awarded. As of June 30, 2012, there were 2,576,756 time-vested RSUs outstanding with a weighted-average grant price of $2.79 and 340,476 performance-vested RSUs outstanding with a weighted-average grant price of $2.75.


Liability awards


During the six months ended June 30, 2012 and 2011, the Company issued awards that are intended to be settled in cash. As a result, these awards are remeasured at the end of each reporting period until settlement. As of June 30, 2012, $2.4 million was accrued for these awards.



15.

Earnings Per Share


The following table presents a reconciliation of shares used in calculating basic earnings (loss) per common share to those used in calculating diluted earnings (loss) per common share.


Shares Used in Calculation of Basic and Diluted

Three Months Ended

 

Six Months Ended

Earnings per Share:

June 30,

 

June 30,

(in thousands)

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

Weighted-average common shares outstanding

116,232 

 

116,325 

 

116,272 

 

116,265 

Weighted-average effect of dilutive potential common shares:

 

 

 

 

 

 

 

  Restricted stock units

1,544 

 

1,520 

 

1,510 

 

1,519 

  Stock options

— 

 

 

— 

 

Potential common shares

1,544 

 

1,525 

 

1,510 

 

1,524 

Less: Potential common shares excluded from calculation
  due to operating losses

1,544 

 

— 

 

1,510 

 

— 

Dilutive potential common shares

— 

 

1,525 

 

— 

 

1,524 

Weighted-average common shares outstanding,
  including dilutive potential common shares

116,232 

 

117,850 

 

116,272 

 

117,789 


As a result of the net loss from continuing operations for the three and six months ended June 30, 2012, the Company is required to use basic weighted-average common shares outstanding in the calculation of diluted earnings per share for those periods, since the inclusion of shares of restricted stock units and options would have been anti-dilutive to the earnings per share calculation.



16.

Segment Information


In managing our business, we analyze segment performance on the basis of operating income. Operating income, as well as components of and financial measures derived from operating income, are non-GAAP financial measures.


Management believes that these measures provide additional insight into the underlying trends in our operations and are the internal performance measures we use in the management of our operations, including our compensation plans and planning processes. However, our non-GAAP financial measures should not be considered as substitutes for net income or measures that are derived from or incorporate net income and may be different from similarly titled measures of other companies. Investors should evaluate both GAAP and non-GAAP financial measures when reviewing our performance.



40





16.

Segment Information (continued)


Operating income is calculated by excluding realized investment gains (losses) as their amount and timing may be subject to management’s investment decisions. Changes in net income related to fixed indexed annuity options purchased to fund annual index credits are included within the adjustment for realized investment gains (losses) as they fluctuate from quarter to quarter based upon the changes in fair value. Also excluded from net income are changes related to fixed index annuity embedded derivatives as they vary from quarter to quarter based upon the assumptions used to discount those liabilities. Operating income is also adjusted to include amortization of option premium and proceeds received upon options expiring specific to fixed indexed annuities.


The accounting policies of the reportable operating segments are the same as those described in our Significant Accounting Policies in Note 2 in our 2011 Annual Report on Form 10-K. We allocate net investment income based on the assets allocated to the segments. We allocate certain costs and expenses to the segments based on a review of the nature of the costs, time studies and other methodologies.


Segment Information

Three Months Ended

 

Six Months Ended

on Revenues:

June 30,

 

June 30,

($ in millions)

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

 

Life and Annuity(1)

$

449.2 

 

$

476.2 

 

$

888.1 

 

$

924.3 

Saybrus Partners

 

5.0 

 

 

4.2 

 

 

10.2 

 

 

8.0 

Less: intercompany revenues(2)

 

2.7 

 

 

2.2 

 

 

5.8 

 

 

4.1 

Total revenues

$

451.5 

 

$

478.2 

 

$

892.5 

 

$

928.2 

———————

(1)

Includes intercompany interest revenue of $0.1 million and $0.2 million for the three months ended June 30, 2012 and 2011, respectively, and $0.3 million and $0.5 million for the six months ended June 30, 2012 and 2011, respectively.

(2)

All intercompany balances are eliminated in consolidating the financial statements.


Results of Operations by Segment as Reconciled to

Three Months Ended

 

Six Months Ended

to Consolidated Net Income:

June 30,

 

June 30,

($ in millions)

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

 

Life and Annuity operating income

$

8.0 

 

$

24.5 

 

$

28.4 

 

$

47.4 

Saybrus Partners operating income (loss)

 

(0.1)

 

 

(0.4)

 

 

0.4 

 

 

(1.5)

Less: Applicable income tax expense

 

4.6 

 

 

7.6 

 

 

13.5 

 

 

9.0 

Income (loss) from discontinued operations, net of income taxes

 

(6.3)

 

 

(0.7)

 

 

(6.8)

 

 

(2.2)

Net realized investment gains (losses)

 

(8.2)

 

 

3.1 

 

 

(23.8)

 

 

(13.1)

Fixed indexed annuity derivatives

 

(4.8)

 

 

— 

 

 

(3.5)

 

 

— 

Deferred policy acquisition cost and policy dividend obligation
  impacts, net of taxes

 

2.8 

 

 

(3.7)

 

 

(2.5)

 

 

(2.8)

Net income (loss)

$

(13.2)

 

$

15.2 

 

$

(21.3)

 

$

18.8 


We have not provided asset information for the segments as the assets attributable to Saybrus are not significant relative to the assets of our consolidated balance sheet. All third-party interest revenue and interest expense of the Company reside within the Life and Annuity segment.



17.

Discontinued Operations


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, these operations are reflected as discontinued operations. On June 23, 2010, we completed the divestiture of PFG and closed the transaction.


The definitive agreement contains a provision requiring us 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 but does not name the Company as a party to the litigation. We intend to defend these matters vigorously based on our indemnity commitment. See Note 18 to these financial statements related to contingencies remaining from the sale.



41





17.

Discontinued Operations (continued)


Net losses of $0.5 million and $0.7 million were recognized during the three months ended June 30, 2012 and 2011, respectively, primarily related to accrued legal fees attributable to these matters. Net losses of $1.0 million and $2.2 million were recognized during the six months ended June 30, 2012 and 2011, respectively, primarily related to accrued legal fees attributable to these matters.


Phoenix Life and Reassurance Company of New York


Included in 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 NYDFS 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. We have reclassified prior period financial statements to conform to this change.


No net income related to PLARNY was recognized during the three and six months ended June 30, 2012 and 2011.


Discontinued Reinsurance Operations


In 1999, we discontinued our reinsurance operations through a combination of sale, reinsurance and placement of certain retained group accident and health reinsurance business into run-off. We adopted a formal plan to stop writing new contracts covering these risks and to end the existing contracts as soon as those contracts would permit. However, we remain liable for claims under contracts which have not been commuted.


We have established reserves for claims and related expenses that we expect to pay on our discontinued group accident and health reinsurance business. These reserves are based on currently known facts and estimates about, among other things, the amount of insured losses and expenses that we believe we will pay, the period over which they will be paid, the amount of reinsurance we believe we will collect from our retrocessionaires and the likely legal and administrative costs of winding down the business. Net losses of $5.8 million were recognized during the three and six months ended June 30, 2012 primarily due to the commutation of certain contracts. There was no net income recognized during the three and six months ended June 30, 2011. See Note 18 to these financial statements for additional discussion on remaining liabilities of our discontinued reinsurance operations.



18.

Contingent Liabilities


Litigation and Arbitration


We are regularly involved in litigation and arbitration, both as a defendant and as a plaintiff. The litigation and arbitration naming us as a defendant ordinarily involves our activities as an insurer, employer, investor or investment advisor.


It is not feasible to predict or determine the ultimate outcome of all legal or arbitration proceedings or to provide reasonable ranges of potential losses. Based on current information, we believe that the outcomes of our litigation and arbitration matters are not likely, either individually or in the aggregate, to have a material adverse effect on our consolidated financial condition. However, given the large or indeterminate amounts sought in certain of these matters and the inherent unpredictability of litigation and arbitration, it is possible that an adverse outcome in certain matters could, from time to time, have a material adverse effect on our consolidated financial statements in particular quarterly or annual periods.


On June 5, 2012, Wilmington Savings Fund Society, FSB, as successor in interest to Christiana Bank & Trust Company and as trustee of 60 unnamed trusts, filed a complaint against PHL Variable, Phoenix Life and The Phoenix Companies, Inc. in the United States District Court for the Central District of California (Case No. CV12-04926). The plaintiffs allege that the Company promoted certain policy sales knowing that the policies would ultimately be owned by investors and then challenging the validity of these policies or denying claims submitted on same. Plaintiffs are seeking damages, including punitive and treble damages, attorneys’ fees and a declaratory judgment. We have meritorious defenses against the lawsuit and we intend to vigorously defend against these claims. The outcome of this litigation and any potential losses are uncertain.




42





18.

Contingent Liabilities (continued)


The definitive agreement to sell PFG contains a provision requiring us 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 but does not name the Company as a party to the litigation. We intend to defend these matters vigorously based on our indemnity commitment.


Carol Curran, et al. v. AGL Life Assurance Co. et al. is a case filed in the state district court in Boulder County, Colorado that falls under the indemnification with Tiptree. The Company is not a party to the lawsuit. On August 8, 2011, the state district court judge certified a class action. The parties are engaged in pre-trial discovery. The outcome of this litigation is uncertain and the amount of potential loss in the event of an adverse outcome cannot be estimated.


Regulatory Matters


State regulatory bodies, the Securities and Exchange Commission (the “SEC”), the Financial Industry Regulatory Authority (“FINRA”), the IRS and other regulatory bodies regularly make inquiries of us and, from time to time, conduct examinations or investigations concerning our compliance with laws and regulations related to, among other things, our insurance and broker-dealer subsidiaries, securities offerings and registered products. We endeavor to respond to such inquiries in an appropriate way and to take corrective action if warranted.


Regulatory actions may be difficult to assess or quantify. The nature and magnitude of their outcomes may remain unknown for substantial periods of time. It is not feasible to predict or determine the ultimate outcome of all pending inquiries, investigations, legal proceedings and other regulatory actions, or to provide reasonable ranges of potential losses. Based on current information, we believe that the outcomes of our regulatory matters are not likely, either individually or in the aggregate, to have a material adverse effect on our consolidated financial condition. However, given the inherent unpredictability of regulatory matters, it is possible that an adverse outcome in certain matters could, from time to time, have a material adverse effect on our consolidated financial statements in particular quarterly or annual periods.


Unclaimed Property Inquiry


On July 5, 2011, the NYDFS issued a letter (“308 Letter”) requiring life insurers doing business in New York to use data available on the U.S. Social Security Administration’s Death Master File or a similar database to identify instances where death benefits under life insurance policies, annuities, and retained asset accounts are payable, to locate and pay beneficiaries under such contracts, and to report the results of the use of the data. Additionally, the insurers are required to report on their success in finding and making payments to beneficiaries or escheatment of funds deemed abandoned under state laws. We estimate the remaining amount of claim and interest payments to beneficiaries or state(s) to be $2.2 million ($0.3 million after policy dividend obligation and deferred policy acquisition cost offsets). This amount has been recorded in policy liabilities and accruals.


Discontinued Reinsurance Operations


In 1999, we discontinued our reinsurance operations through a combination of sale, reinsurance and placement of certain retained group accident and health reinsurance business into run-off. We adopted a formal plan to stop writing new contracts covering these risks and to end the existing contracts as soon as those contracts would permit. However, we remain liable for claims under contracts which have not been commuted.


For example, we participate in a workers’ compensation reinsurance pool formerly managed by Unicover Managers, Inc. (“Unicover”). The pool ceased accepting new risks in early 1999. Further, we were a retrocessionaire (meaning a reinsurer of other reinsurers) of the Unicover pool. We have been involved in disputes relating to the activities of Unicover. These disputes have been substantially resolved or settled.


Our discontinued group accident and health reinsurance operations also include other (non-Unicover) workers’ compensation reinsurance contracts and personal accident reinsurance contracts, including contracts assumed in the London market. We have been engaged in arbitrations, disputes or investigations with several ceding companies over the validity of, or amount of liabilities assumed under, their contracts. These arbitrations, disputes or investigations have been substantially resolved or settled.




43





18.

Contingent Liabilities (continued)


We bought retrocessional reinsurance for a significant portion of our assumed reinsurance liabilities. Some of the retrocessionaires have disputed the validity of, or amount of liabilities assumed under, their contracts with us. Most of these disputes with retrocessionaires have been resolved or settled.


We have established reserves for claims and related expenses that we expect to pay on our discontinued group accident and health reinsurance business. These reserves are based on currently known facts and estimates about, among other things, the amount of insured losses and expenses that we believe we will pay, the period over which they will be paid, the amount of reinsurance we believe we will collect from our retrocessionaires and the likely legal and administrative costs of winding down the business.


We expect our reserves and reinsurance to cover the run-off of the business; however, unfavorable or favorable claims and/or reinsurance recovery experience is reasonably possible and could result in our recognition of additional losses or gains, respectively, in future years. Given the uncertainty associated with litigation and other dispute resolution proceedings, as well as the lack of sufficient claims information, the range of any reasonably possible additional future losses or gains is not currently estimable. However, it is our opinion, based on current information and after consideration of the provisions made in these consolidated financial statements, that any future adverse or favorable development of recorded reserves and/or reinsurance recoverables will not have a material adverse effect on our consolidated financial position. Nevertheless, it is possible that future developments could have a material adverse effect on our consolidated financial statements in particular quarterly or annual periods.


Our total policy liabilities and accruals were $34.8 million as of June 30, 2012 and $59.1 million as of December 31, 2011. The decrease to policy liabilities and accruals was primarily related to cash settlements due to the commutation of certain contracts in the second quarter of 2012. Our total amounts recoverable from retrocessionaires related to paid losses were $0.3 million as of June 30, 2012 and $2.5 million as of December 31, 2011.



19.

Other Commitments


As part of its normal investment activities, the Company enters into agreements to fund limited partnerships that make debt and equity investments. As of June 30, 2012, the Company had unfunded commitments of $210.0 million under such agreements, of which $68.8 million is expected to be funded by December 31, 2012.


In addition, the Company enters into agreements to purchase private placement investments. At June 30, 2012, the Company had open commitments of $85.4 million under such agreements which are expected to be funded by December 31, 2012.



20.

Subsequent Events


On June 28, 2012, the Company issued a press release announcing a 1-for-20 reverse stock split of the Company’s common stock effective August 10, 2012 and an odd lot program that may be conducted following the reverse stock split. The reverse stock split is expected to reduce the shares of common stock outstanding from approximately 116.0 million to approximately 5.8 million.


On August 2, 2012, the Company and its subsidiaries, PHL Variable and Phoenix Life were named in a lawsuit brought by Lima LS PLC. The suit alleges that the Company sold policies knowing that the policies would ultimately be owned by investors and then challenging the validity of these policies or denying claims submitted on same. The suit names certain current and former executive officers in addition to the corporate defendants. The Company intends to defend against these claims vigorously. The outcome of this case and any potential losses are uncertain.





44





Item 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS


FORWARD-LOOKING STATEMENTS


The discussion in this Quarterly Report on Form 10-Q 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; (xxv) the expected benefits of the reverse stock split may not be realized or maintained; and (xxvi) 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-Q, 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-Q, such statements or disclosures will be deemed to modify or supersede such statements in this Form 10-Q.



MANAGEMENT’S DISCUSSION AND ANALYSIS


This section reviews our consolidated financial condition as of June 30, 2012 as compared with December 31, 2011; our consolidated results of operations for the three and six months ended June 30, 2012 and 2011; and, where appropriate, factors that may affect our future financial performance. This discussion should be read in conjunction with the unaudited interim financial statements and notes contained in this filing as well as in conjunction with our consolidated financial statements for the year ended December 31, 2011 in our 2011 Annual Report on Form 10-K.




45





Executive Overview


Business


The Phoenix Companies, Inc. (“we,” “our,” “us,” the “Company,” or “Phoenix”) 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 and the first six months of 2012, Phoenix product sales were primarily in fixed indexed annuities. Sales of other insurance companies’ policies were expanded 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 in this Form 10-Q for more information on 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.




46





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 e