Our executive headquarters consist of our main office building at One American Row in Hartford, Connecticut, which we own and occupy. As of December 31, 2013, we also leased space in two garages in Hartford, Connecticut for employee parking, one of which was terminated as of June 1, 2014. Property is also leased for our home office in East Greenbush, New York.
We prepared the following financial data, other than statutory data, in conformity with U.S. GAAP. We derived the statutory data from the Annual Statements of our Life Companies as filed with state insurance regulatory authorities and prepared it in accordance with statutory accounting practices prescribed or permitted by state insurance regulators, which vary in certain material respects from U.S. GAAP.
The discussion in this Form 10-K may contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. We intend for these forward-looking statements to be covered by the safe harbor provisions of the federal securities laws relating to forward-looking statements. These forward-looking statements include statements relating to trends in, or representing management’s beliefs about our future transactions, strategies, operations and financial results and often contain words such as “will,” “anticipate,” “believe,” “plan,” “estimate,” “expect,” “intend,” “is targeting,” “may,” “should” and other similar words or expressions. Forward-looking statements are made based upon management’s current expectations and beliefs concerning trends and future developments and their potential effects on us. They are not guarantees of future performance. Our actual business, financial condition or results of operations may differ materially from those suggested by forward-looking statements as a result of risks and uncertainties which include, among others: (A) risks related to the Restatement, failure to file timely periodic reports with the SEC and our internal control over financial reporting, which include (i) the potential failure to remediate material weaknesses in our internal control over financial reporting and other material weaknesses may be identified in the future, which would adversely affect the accuracy and timing of our financial reporting; (ii) the extraordinary processes undertaken to effect the Restatement may not have been adequate to identify and correct all errors in our historical financial statements and, as a result, we may discover additional errors and our financial statements remain subject to the risk of future restatement; (iii) our failure to have current financial information available; (iv) the risk of failure to comply with the filing deadlines included in the SEC’s Cease-and-Desist Order, dated March 21, 2014, as amended by the Amended Cease-and-Desist Order, dated August 1, 2014, including that the SEC may seek sanctions against or deregister the Company and PHL Variable; (v) the risk of failure to file our delayed SEC filings and our 2014 Quarterly Reports on Form 10-Q by March 16, 2015, the extended deadline for providing these SEC filings to the bond trustee, as well as the risk associated with seeking additional consents from bondholders of our outstanding 7.45% Quarterly Interest Bonds Due 2032 regarding these SEC filings; (vi) the risk that the delay in filing our annual report for the year ended December 31, 2013 and any failure to satisfy other NYSE listing requirements could cause the NYSE to commence suspension or delisting procedures with respect to our securities, including our common stock; (vii) the outcome of litigation and claims as well as regulatory examinations, investigations, proceedings and orders arising out of the Restatement and the failure by the Company and PHL Variable to file SEC reports on a timely basis; (viii) further downgrades or withdrawals of our debt or financial strength credit ratings, which could increase policy surrenders and withdrawals, adversely affect our relationships with distributors, reduce new sales, limit our ability to trade in derivatives and increase our costs of, or reduce our access to, future borrowings; (ix) our inability to hedge our positions due to our inability to replace hedges as a result of our credit rating; (x) the incurrence of significant expenses related to the Restatement, the U.S. GAAP restatements undertaken by our insurance company subsidiaries, the remediation of weaknesses in our internal control over financial reporting and disclosure controls and procedures, and the preparation of this Form 10-K and our delayed SEC reports; (xi) diversion of management and other human resources attention from the operation of our business; (xii) our inability to access alternate financing arrangements to fund our ongoing operations and our inability to register securities for offer and sale with the SEC under the Securities Act until we have filed the delayed SEC filings and are otherwise current with our relevant SEC filing obligations; (xiii) risks associated with PHL Variable’s delay in its SEC reporting obligations and its inability to amend and update its existing registration statements filed under the Securities Act and the Investment Company Act of 1940, as amended (the “Investment Company Act”), as well as risks associated with Phoenix Life’s inability to amend and update its existing registration statements filed under the Securities Act and the Investment Company Act; and (xiv) risks associated with our insurance company subsidiaries’ failure to file certain reports with state regulatory authorities; (B) risks related to our business, which include (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 effect of interest rate fluctuations on our business and results of operations; (iii) the potential adverse effect of legal actions and proceedings inherent in our business on our results of operations, financial position, business or reputation; (iv) 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; (v) the possibility that mortality rates, persistency rates, funding levels or other factors may differ significantly from our assumptions used in pricing products; (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 availability, pricing and terms of reinsurance coverage generally and the inability or unwillingness of our reinsurers to meet their obligations to us specifically; (xii) our ability to attract and retain key personnel in a competitive environment and while delayed in our SEC reporting obligations; (xiii) our dependence on third parties to maintain critical business and administrative functions; (xiv) the strong competition we face in our business from banks, insurance companies and other financial services firms; (xv) 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; (xvi) the potential need to fund deficiencies in our closed block; (xvii) changes in tax law and policy may affect us directly or indirectly through the cost of, the demand for or profitability of our products or services; (xviii) the possibility that federal and state regulation may increase our cost of doing business, impose additional reserve or capital requirements, levy financial assessments or constrain our operating and financial flexibility; (xix) regulatory actions or examinations may harm our business; (xx) potential future material losses from our discontinued reinsurance business; and (xxi) changes in accounting standards; and (C) other risks and uncertainties described herein or in any of our filings with the SEC. Certain other factors which may impact our business, financial condition or results of operations or which may cause actual results to differ from such forward-looking statements are discussed or included in our periodic reports filed with the SEC and are available on our website at www.phoenixwm.com under “Investor Relations.” You are urged to carefully consider all such factors. We do not undertake or plan to update or revise forward-looking statements to reflect actual results, changes in plans, assumptions, estimates or projections, or other circumstances occurring after the date of this Form 10-K, even if such results changes or circumstances make it clear that any forward-looking information will not be realized. If we make any future public statements or disclosures which modify or impact any of the forward-looking statements contained in or accompanying this Form 10-K, such statements or disclosures will be deemed to modify or supersede such statements in this Form 10-K.
Management’s discussion and analysis reviews our consolidated financial condition at December 31, 2013 and 2012; our consolidated results of operations for the years 2013, 2012 and 2011; and, where appropriate, factors that may affect our future financial performance. This discussion should be read in conjunction with “Item 6: Selected Financial Data” and our consolidated financial statements in this Form 10-K.
value-added support provided to distributors by our wholesalers and operating personnel.
A substantial but gradually declining amount of our Life and Annuity segment earnings derive from the closed block, which consists primarily of participating life insurance policies sold prior to our demutualization and initial public offering in 2001. We do not expect the net income contribution from the closed block to deviate materially from its actuarially projected path as long as actual cumulative earnings meet or exceed expected cumulative earnings. See Note 4 to our consolidated financial statements under “Item 8: Financial Statements and Supplementary Data” in this Form 10-K for more information on the closed block.
Deferred policy acquisition cost amortization is based on the amount of expenses deferred, actual results in each quarter and management’s assumptions about the future performance of the business. The amount of future profit or margin is dependent principally on investment returns in our separate accounts, interest and default rates, reinsurance costs and recoveries, mortality, surrender rates, premium persistency and expenses. These factors enter into management’s estimates of gross profits or margins, which generally are used to amortize deferred policy acquisition costs. Actual equity market movements, net investment income in excess of amounts credited to policyholders, claims payments and other key factors can vary significantly from our assumptions, resulting in a misestimate of gross profits or margins, and a change in amortization, with a resulting impact to income. In addition, we regularly review and reset our assumptions in light of actual experience, which can result in material changes in amortization.
Policy benefits. Policy benefits decreased $139.6 million in the twelve months ended December 31, 2013 compared with the twelve months ended December 31, 2012. The decrease in policy benefit expenses is primarily due to gains on guaranteed insurance benefit liabilities and reserves for profits followed by losses of $121.0 million as a result of assumption changes made during the annual comprehensive review of assumptions in the fourth quarter of 2013. The most significant driver of the positive 2013 unlock results was the incorporation of a mortality improvement assumption in the overall mortality table, which resulted in improved expected mortality on universal life and variable universal life products.
Operating expenses. Non-deferred operating expenses excluding Saybrus increased $77.9 million to $312.5 million in 2013 compared to $234.6 million in 2012. The increase in operating expenses was a result of higher professional fees and outside consulting and legal services, largely as a result of the Restatement.
Income taxes. The effective tax rate for 2013 and 2012 was 56.8% and 2.4% respectively. The principal cause of the difference between the effective rate and the U.S. statutory rate of 35% in 2013 was the change in valuation allowance, state income taxes, return to provision dividend received deduction and expired tax attribute carryforwards. The principal cause of the difference between the effective rate and the U.S. statutory rate of 35% in 2012 was the dividend received deduction, expired tax attribute carryforwards and an increase in the valuation allowance on the pre-tax loss.
Critical accounting estimates are reflective of significant judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.
We amortize deferred policy acquisition costs (“DAC”) 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 (“EGMs”) arising principally from investment results, mortality, dividends to policyholders and expense margins. For universal life, variable universal life and deferred annuities, deferred policy acquisition costs are amortized in proportion to estimated gross profits (“EGPs”) discussed more fully below. EGPs are also used to amortize other assets and liabilities in the Company’s consolidated balance sheets, such as sales inducement assets (“SIA”) and unearned revenue reserves (“URR”). Components of EGPs are used to determine reserves for universal life and fixed indexed and variable annuity contracts with death and other insurance benefits such as guaranteed minimum death and guaranteed minimum income benefits. Both EGMs and EGPs are based on historical and anticipated future experience which is updated periodically.
An analysis is performed annually to assess if there are sufficient gross profits to recover the deferred policy acquisition costs associated with business written during the year. If the estimates of gross profits cannot support the recovery of deferred policy acquisition costs, the amount deferred is reduced to the recoverable amount.
Over the last several years, the Company has revised a number of assumptions that have resulted in changes to expected future gross profits. The most significant assumption updates resulting in a change to future gross profits and the amortization of DAC, SIA and URR in 2013 are related to changes in expected premium persistency, and the incorporation of a mortality improvement assumption. Other of the more significant drivers of changes to expected gross profits over the last several years include changes in expected separate account investment returns due to changes in equity markets; changes in expected future interest rates and default rates based on continued experience and expected interest rate changes; changes in mortality, lapses and other policyholder behavior assumptions that are updated to reflect more recent policyholder and industry experience; and changes in expected policy administration expenses.
See Note 2 to our consolidated financial statements under “Item 8: Financial Statements and Supplementary Data” and the “Enterprise Risk Management” section of “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Form 10-K for more information.
The CSA is updated every quarter and, therefore, the fair value will change with the passage of time even in the absence of any other changes that would affect the valuation. For example, the December 31, 2013 fair value of $74.8 million would increase to $79.6 million if the spread were decreased by 50 basis points. If the spread were increased by 50 basis points, the fair value would decrease to $70.1 million.
See Note 13 to our consolidated financial statements under “Item 8: Financial Statements and Supplementary Data” in this Form 10-K for additional disclosures of our fair value methodologies.
For debt securities, the other-than-temporarily impaired amount is separated into the amount related to a credit loss and is reported as net realized investment losses included in earnings and any amounts related to other factors are recognized in OCI. The credit loss component represents the difference between the amortized cost of the security and the net present value of its projected future cash flows discounted at the effective interest rate implicit in the debt security prior to impairment. Any remaining difference between the fair value and amortized cost is recognized in accumulated other comprehensive income (“AOCI”). Subsequent to the recognition of an OTTI, the impaired security is accounted for as if it had been purchased on the date of impairment at an amortized cost basis equal to the previous amortized cost basis less the OTTI recognized in earnings. We will continue to estimate the present value of future expected cash flows and, if significantly greater than the new cost basis, we will accrete the difference as investment income on a prospective basis once the Company has determined that the interest income is likely to be collected.
Equity securities are determined to be other-than-temporarily impaired based on management judgment and the consideration of the issuer’s financial condition along with other relevant facts and circumstances. Those securities which have been in a continuous decline for over twelve months and declines in value that are severe and rapid are considered for reasonability of whether the impairment would be temporary. Although there may be sustained losses for over twelve months or losses that are severe and rapid, additional information related to the issuer performance may indicate that such losses are not other-than-temporary.
The assessment of whether impairments have occurred is based on management’s evaluation of the underlying reasons for the decline in estimated fair value. The Company’s review of its debt and equity securities for impairments includes an analysis of the total gross unrealized losses by severity and/or age of the gross unrealized loss, as summarized in the “Duration of Gross Unrealized Losses on Securities” section. An extended and severe unrealized loss position on a debt security may not have any impact on the ability of the issuer to service all scheduled interest and principal payments and the Company’s evaluation of recoverability of all contractual cash flows or the ability to recover an amount at least equal to its amortized cost based on the present value of the expected future cash flows to be collected. In contrast, for certain equity securities, greater weight and consideration are given by the Company to an extended decline in market value and the likelihood such market value decline will recover.
Specifically for structured securities, to determine whether a collateralized security is impaired, we obtain underlying data from the security’s trustee and analyze it for performance trends. A security-specific stress analysis is performed using the most recent trustee information. This analysis forms the basis for our determination of the future expected cash flows to be collected for the security.
The assumptions used may differ materially from actual results due to, among other factors, changing market and economic conditions and changes in participant demographics. These differences may have a significant effect on the Company’s consolidated financial statements and liquidity. See Note 16 to our consolidated financial statements under “Item 8: Financial Statements and Supplementary Data” in this Form 10-K information on these and other assumptions used in measuring liabilities relating to the Company’s pension and other postretirement benefits.
We have historically provided our employees with other post-employment benefits that include health care and life insurance. In December 2009, we announced the decision to eliminate retiree medical coverage for active employees whose age plus years of service did not equal at least 65 as of March 31, 2010. Employees who remain eligible must still meet all other plan requirements to receive benefits.
See Note 16 to our consolidated financial statements under “Item 8: Financial Statements and Supplementary Data” in this Form 10-K for more information on our pension and other post-employment benefits.
Policyholder dividends decreased $105.1 million for the twelve months ended December 31, 2013 compared to the twelve months ended December 31, 2012 primarily due to a decrease in revenue from lower net investment income and a decrease in premiums as total in-force life insurance policies within the closed block continue to decline as the block ages.
Premium revenue decreased $50.7 million for the twelve months ended December 31, 2013 compared with the twelve months ended December 31, 2012 as a result of lower renewal premiums and paid up additions on policies within the closed block due to declining policies in force. The lower premiums in the closed block are offset by reductions in policyholder dividends.
Operating expenses increased by $82.1 million for the twelve months ended December 31, 2013, compared to the twelve months ended December 31, 2012. The increase in operating expenses was a result of higher professional fees and outside consulting and legal services primarily as a result of the Restatement.
A net loss from discontinued operations of $2.6 million was recognized for the twelve months ended December 31, 2013, compared to a net loss of $15.6 million for the twelve months ended December 31, 2012. The change is primarily the result of outside legal fees in the prior year as well as the commutation of certain contracts in the second quarter of 2012 that did not recur in 2013.
The Company recorded a net loss from continuing operations for the twelve months ended December 31, 2012 of $152.3 million, or $(26.40) per share, compared with a net loss from continuing operations of $9.6 million, or $(1.65) per share for the twelve months ended December 31, 2011. The decrease in results from continuing operations is primarily the result of the following items:
Policy benefits increased $29.1 million for the twelve months ended December 31, 2012 compared with the twelve months ended December 31, 2011. The increase in policy benefit expense was a result of higher death benefits for universal life and traditional whole life products as a result of negative mortality experience during 2012, primarily in the third quarter. Annuity benefits increased largely due to changes in reserves on fixed indexed annuities associated with minimum death and income benefit guarantees, which were driven by increased sales during the year. Policy benefit expenses of $36.3 million were incurred during 2012 due to reserve unlocking adjustments as a result of our annual comprehensive review of actuarial assumptions in the third quarter of 2012. These expenses were partially offset by lower policy benefits within the closed block.
Net investment income increased by $6.4 million for the twelve months ended December 31, 2012 compared to the twelve months ended December 31, 2011. The increase was due to higher investment income on long-term debt securities as a result of additional purchases during the year and higher returns on private equity investments. These increases were partially offset by lower interest income on policy loans due to the declining balance of policy loans outstanding.
Gain on debt repurchase increased by $11.7 million for the twelve months ended December 31, 2012 compared with the twelve months ended December 31, 2011. The Company repurchased $48.3 million par value of surplus notes during 2012.
The Company recorded an income tax benefit of $3.7 million from continuing operations in 2012, compared to an income tax expense of $12.3 million from continuing operations in 2011. In 2012, a current tax expense of $15.6 million was recognized related to the accrual of regular taxes, offset by available credits up to the alternative minimum tax liability. This current tax expense was offset by a deferred tax benefit of $19.3 million that results from the application of ASC 740 intraperiod allocation rules. These rules allow for the benefitting of current year losses in continuing operations when an increase to the valuation allowance is avoided due to the existence of current year income elsewhere reported in the financial statements (e.g., discontinued operations, other comprehensive income). In 2011, a current tax expense of $12.3 million was recognized related to alternative minimum tax.
Operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. As reported in “Item 9A: Controls and Procedures” of this Form 10-K, the Company has concluded that there are material weaknesses in its internal control over financial reporting, which have materially adversely affected its ability to timely and accurately report its results of operations and financial condition, and that its disclosure controls and procedures are ineffective as of December 31, 2013. These material weaknesses have not been fully remediated as of the filing date of this report and the Company cannot assure that other material weaknesses will not be identified in the future. It is necessary for the Company to maintain effective internal control over financial reporting to prevent fraud and errors, and to maintain effective disclosure controls and procedures so that it can provide timely and reliable financial and other information. If the Company fails to maintain an effective system of internal controls, the accuracy and timing of its financial reporting may be adversely affected. Further, the absence of timely and reliable financial and other information about the Company’s business operations may inhibit the Company’s ability to identify operational risk. A failure to correct material weaknesses in our internal controls could result in further restatements of financial statements and correction of other information filed with the SEC. See “Item 1A: Risk Factors” in Part I of this Form 10-K for a description of these and other risks that may impact the Company’s operations. Also see “Item 9A: Controls and Procedures” in Part II of this Form 10-K for more information regarding these weaknesses, an evaluation of the effectiveness of the Company’s disclosure controls and procedures, and the Company’s remediation plans.
We also manage interest rate risk by purchasing securities that feature prepayment restrictions and call protection. Our product design and pricing strategies include the use of surrender charges or restrictions on withdrawals in some products. We regularly undertake a sensitivity analysis that calculates liability durations under various cash flow scenarios. In addition, we monitor the short- and medium-term asset and liability cash flows profiles by portfolio to manage our liquidity needs.
See Note 13 to our consolidated financial statements under “Item 8: Financial Statements and Supplementary Data” in this Form 10-K for more information on fair value instruments.
See Note 12 to our consolidated financial statements under “Item 8: Financial Statements and Supplementary Data” in this Form 10-K for more information on derivative instruments.
Liabilities in excess of the policyholder account balance for universal life contracts, some of which contain secondary guarantees, are generally determined by estimating the expected value of benefits and expenses when claims are triggered and recognizing those benefits and expenses 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. The universal life block of business has experience which produces profits in earlier periods followed by losses in later periods for which a liability is required to be held in addition to the policy liabilities recorded.
See the “Critical Accounting Estimates” section above for more information on deferred policy acquisition costs and policy liabilities and accruals.
Equity risk is the risk that we will incur economic losses due to adverse changes in equity prices. At December 31, 2013, we held certain financial instruments that are sensitive to equity market movements, including available-for-sale equity securities, primarily related to our holdings of common stock and mutual funds, private equity partnership interests and other equities, as well as fair value equity instruments, equity options and other investments. We manage equity price risk through industry and issuer diversification and asset allocation techniques.
Management believes that the Company’s exposure to equity market volatility related to its fixed index annuity product is limited and has been omitted from the analysis below. This exposure is limited to the indexed credit feature of the product, which is reasonably managed through the Company’s ongoing hedging program.
See Note 6 to our consolidated financial statements under “Item 8: Financial Statements and Supplementary Data” in this Form 10-K for more information regarding deferred policy acquisition costs.
See Note 13 to our consolidated financial statements under “Item 8: Financial Statements and Supplementary Data” in this Form 10-K for additional information regarding the estimated fair value of investments.
We invest in a variety of debt and equity securities. We classify these investments into various sectors using industry conventions; however, our classifications may differ from similarly titled classifications of other companies. We classify debt securities into investment grade and below-investment-grade securities based on ratings prescribed by the National Association of Insurance Commissioners (“NAIC”). In a majority of cases, these classifications will coincide with ratings assigned by one or more Nationally Recognized Statistical Rating Organizations (“NRSROs”); however, for certain structured securities, the NAIC designations may differ from NRSRO designations based on the amortized cost of the securities in our portfolio.
We manage credit risk through industry and issuer diversification. Maximum exposure to an issuer is defined by quality ratings, with higher quality issuers having larger exposure limits. Our investment approach emphasizes a high level of industry diversification. The top five industry holdings as of December 31, 2013 in our available-for-sale debt and short-term investment portfolio were banking (7.4%), electrical utilities (5.9%), oil (4.3%), diversified financial services (3.8%) and insurance (3.1%).
Percentages based on market value of total investments and cash and cash equivalents
Includes the change in fair value of embedded derivatives associated with fixed index annuity indexed crediting feature and variable annuity GMWB, GMAB and COMBO riders. See Note 11 to our consolidated financial statements under “Item 8: Financial Statements and Supplementary Data” in this Form 10-K for additional disclosures.
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 changes or by changes in liquidity in the securities. The amount of impairments recognized as an adjustment to other comprehensive loss due to these factors was $(4.8) million in 2013, $22.9 million in 2012 and $38.5 million in 2011.
The following tables present certain information with respect to our gross unrealized gains and losses related to our investments in debt securities as of December 31, 2013. We separately present information that is applicable to unrealized losses both outside and inside the closed block. See Note 8 to our consolidated financial statements under “Item 8: Financial Statements and Supplementary Data” in this Form 10-K for more information regarding the closed block. Applicable deferred policy acquisition costs and deferred income taxes further reduce the effect of unrealized gains and losses on our comprehensive income.
Cash used for operating activities decreased by $74.2 million during the year ended December 31, 2013 compared to the year ended December 31, 2012. This decrease was driven by lower death benefits for universal life, variable universal life and traditional life products resulting from positive mortality experience during 2013 in conjunction with reduced commissions paid related to lower sales of our fixed indexed annuity product. Partially offsetting this increase were lower renewal premiums on our legacy blocks of business due to a declining in force population and increased audit and consulting fees related to the Restatement.
Cash flows used for investing activities decreased $269.1 million during the year ended December 31, 2013 compared to the year ended December 31, 2012 as a result of a greater increase in sales and maturities relative to purchases. This is primarily driven by less cash being provided by financing and operating activities, namely due to a reduction in deposits and an increase in withdrawals of fixed index annuities, combined with increased holdings of cash and cash equivalents in lieu of reinvestment.
Cash flows provided by financing activities decreased $277.7 million during the year ended December 31, 2012. This decline was primarily a result of a decrease in policyholder deposits exceeding a decrease in withdrawals and lower sales of fixed indexed annuities when compared to 2011. Further, the Company repurchased $48.3 million par amount of its outstanding 7.15% surplus notes for aggregate consideration of $36.2 million during 2012. See Note 9 to our consolidated financial statements under “Item 8: Financial Statements and Supplementary Data” in this Form 10-K for additional information on financing activities.
We sponsor post-employment benefit plans through pension and savings plans for employees of Phoenix Life. Funding of the majority of these obligations is provided by Phoenix Life on a 100% cost reimbursement basis through administrative services agreements with the holding company. See Note 16 to our consolidated financial statements under “Item 8: Financial Statements and Supplementary Data” in this Form 10-K for additional information.
The $50.1 million increase in cash provided by operating activities for the year ended December 31, 2013, compared to the year ended December 31, 2012, was due to an increase in net payments to/from subsidiaries of $51.7 million. These receipts were driven by intercompany tax payments for the use of the parent company’s ordinary and capital losses. The amount paid by the subsidiaries was reduced by cash payments to the IRS.
Cash used by for financing activities decreased due to no financing activities in 2013 compared to the treasury stock repurchased as part of the 1-for-20 reverse stock split of its common stock following market close on August 10, 2012.
The $9.3 million increase in cash used for operating activities for the year ended December 31, 2012, compared to the year ended December 31, 2011, was primarily attributable to an increase in taxes paid of $15.1 million.
The decrease in cash provided by investing activities increased due mainly to $160.4 million increase in purchases of available-for-sale debt securities offset by an $83.0 million increase in cash inflows from the sales, repayments, and maturities of available-for-sale debt securities and an increase of $7.0 million in dividends from Phoenix Life.
Historically, our Life Companies have used cash flow from operations and investing activities to fund liquidity requirements. Their principal cash inflows from life insurance and annuities come from premiums, annuity deposits and charges on insurance policies and annuity contracts. In the case of Phoenix Life, cash inflows also include dividends, distributions and other payments from subsidiaries. Principal cash inflows from investing activities result from repayments of principal, proceeds from maturities, sales of invested assets and investment income. The principal cash inflows from our discontinued group accident and health reinsurance operations come from our reinsurance, recoveries from other retrocessionaires and investing activities.
On September 20, 2012, the Board authorized a program to repurchase up to an aggregate amount of $25,000,000 (not including fees and expenses) of the Company’s outstanding common stock shares. Under the stock repurchase program, purchases may be made from time to time in the open market, in accelerated stock buyback arrangements, in privately negotiated transactions or otherwise, subject to market prices and other conditions. No time limit was placed on the duration of the program, which may be modified, extended or terminated by the Board at any time. The Board also terminated the Company’s previously existing stock repurchase program. No shares were repurchased in 2012 or 2013.
Rating agencies assign Phoenix Life financial strength ratings and assign the holding company debt ratings based in each case on their opinions of the relevant company’s ability to meet its financial obligations. A downgrade or withdrawal of any of our credit ratings could negatively impact our liquidity. For additional information regarding certain risks associated with our credit ratings, please see the risk factors under “Risks Related to the Restatement, Failure to File Timely Periodic Reports with the SEC and our Internal Control Over Financial Reporting.” contained in “Item 1A: Risk Factors” in Part I of this Form 10-K.
On August 28, 2013, A.M. Best Company, Inc. downgraded our financial strength rating from B+ to B and our senior debt rating from b+ to b. The financial strength rating was removed from under review with negative implications and assigned a stable outlook. The senior debt rating was removed from under review with negative implications and assigned a negative outlook. On April 9, 2013, A.M. Best Company, Inc. maintained under review with negative implications on our financial strength rating of B+ and lowered our senior debt rating from bb- to b+. On December 7, 2012, A.M. Best Company, Inc. placed under review with negative implications our financial strength rating of B+ and our senior debt rating of bb-. On January 13, 2012, A.M. Best Company, Inc. affirmed our financial strength rating of B+ and our senior debt rating of bb-. They changed their outlook on our ratings from stable to positive.
The increase in derivative instruments is primarily due to gains on the call options that are used to hedge the fixed indexed annuity business. This increase in derivative assets is offset by increases in derivative liabilities, which are recorded within other liabilities. The net derivative position of $131.6 million as of December 31, 2013 has not fluctuated significantly from the net derivative position of $111.6 million as of December 31, 2012.
Deferred policy acquisition costs increased overall as a result of the deferral of commissions on new sales of our fixed indexed annuities, but generally decreased for the other products. This is a result of continued amortization of previously deferred costs, that was partially offset by increases in the shadow component that offsets unrealized losses on investments within AOCI, and a positive impact due to the unlocking of assumptions in 2013. The table below presents deferred policy acquisition cost by product.
Dividend obligations decreased during the twelve months ended December 31, 2013 primarily as a result of unrealized losses on the investments supporting the closed block, which increased due to increases in interest rates during 2013.
The decrease in the pension liability was due to a decrease in the projected benefit obligation resulting from changes in the discount rate assumption and an increase in plan assets.
The increase in other liabilities is due to additional accrued expenses related to audit and consulting services and an increase in the fair value of derivative liabilities as a result of the equity market performance during 2013. The increase in the derivative liabilities is offset by the increase in the fair value of the derivative assets.
Annuity funds on deposit increased $460.3 million during the year ended December 31, 2013 compared to an increase of $546.7 million for the year ended December 31, 2012. For the year ended December 31, 2013 deposits declined, offset by stronger market performance in 2013 than in 2012 with relatively stable fees, and benefits and surrenders compared to the overall funds on deposit.
Universal life funds on deposit decreased $14.9 million and $66.1 million during the years ended December 31, 2012 and 2011, respectively. The smaller decline in 2012 as compared to 2011 was primarily driven by a decrease in surrenders.
Future obligations are based on our estimate of future investment earnings, mortality, surrenders and applicable policyholder dividends. Included in the amounts above are policyholder dividends generated by estimated favorable future investment and mortality, in excess of guaranteed amounts for our closed block. Actual obligations in any single year, or ultimate total obligations, may vary materially from these estimates as actual experience emerges. As described in Note 2 to our consolidated financial statements under “Item 8: Financial Statements and Supplementary Data” in this Form 10-K, policy liabilities and accruals are recorded on the consolidated balance sheets in amounts adequate to meet the estimated future obligations of the policies in force. The policyholder obligations reflected in the table above exceed the policy liabilities, Policyholder deposit fund liabilities and separate account liabilities reported on our December 31, 2013 consolidated balance sheets because the above amounts do not reflect future investment earnings and future premiums and deposits on those policies. Separate account obligations will be funded by the cash flows from separate account assets, while the remaining obligations will be funded by cash flows from investment earnings on general account assets and premiums and deposits on contracts in force.
On September 14, 2011, we entered into a definitive agreement to sell Goodwin Capital Advisers, Inc. (“Goodwin”) to Conning Holdings. Also, on September 14, 2011, we entered into multi-year investment management agreements with Conning under which Conning will manage the Company’s publicly traded fixed income assets. Because of the ongoing cash flows associated with the investment management agreements, results of these operations have been reflected within continuing operations. The transaction closed on November 18, 2011.
We have three defined benefit pension plans. The employee pension plan provides benefits up to the amount allowed under the Internal Revenue Code. The two supplemental plans provide benefits to certain executives in excess of the primary plan. Retirement benefits under the plans are a function of years of service and compensation. Effective March 31, 2010, all benefit accruals under all of our funded and unfunded defined benefit plans were frozen.
The employee pension plan is a qualified plan that is funded with assets held in a trust. It is the Company’s practice to make contributions to the qualified pension plan at least sufficient to avoid benefit restrictions under funding requirements of the Pension Protection Act of 2006. This generally requires the Company to maintain assets that are at least 80% of the plan’s liabilities as calculated under the applicable regulations at the end of the prior year. Under these regulations, the qualified pension plan is currently funded above 80% of the funding target liabilities as of December 31, 2013.
The funded status of the qualified pension plan based on the projected benefit obligations for the years ended December 31, 2013 and 2012 are summarized in the following table:
The changes in the projected benefit obligations of the employee plan at December 31, 2013 as compared to December 31, 2012 were principally the result of actuarial gains due to assumption changes.
The changes in the projected benefit obligations of the supplemental plans at December 31, 2013 as compared to December 31, 2012 were principally the result of accrued interest cost and actuarial losses due to assumption changes.
We also have a postretirement benefit plan, which is unfunded and had projected benefit obligations of $36.5 million and $40.6 million as of December 31, 2013 and 2012, respectively. We fund periodic benefit payments under this plan from cash flows from operations as they become due.
We have entered into agreements with certain key executives of the Company that will, in certain circumstances, provide separation benefits upon the termination of the executive’s employment by the Company for reasons other than death, disability, cause or retirement, or by the executive for “good reason,” as defined in the agreements. The agreements provide this protection only if the termination occurs following (or is effectively connected with) the occurrence of a change of control, as defined in the agreements. As soon as reasonably possible upon a change in control, as so defined, we are required to make an irrevocable contribution to a trust in an amount sufficient to pay benefits due under these agreements. See Note 16 to our consolidated financial statements under “Item 8: Financial Statements and Supplementary Data” in this Form 10-K for more information on our pension and other post-employment benefits.
We have agreements with certain of our employees that provide for additional retirement benefits. In the year ended December 31, 2013, the estimated liability for these benefits was $16.9 million.
We do not have any off-balance sheet arrangements that are reasonably likely to have a material effect on the financial condition, results of operations, liquidity, or capital resources of the Company. The Company does have unfunded commitments to purchase investments in limited partnerships and private placements and a commitment for infrastructure services which are disclosed in Note 24 to our consolidated financial statements under “Item 8: Financial Statements and Supplementary Data” in this Form 10-K.