We prepared the following financial data, other than statutory data, in conformity with GAAP. We derived the statutory data from the Annual Statements of our Life Companies 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 GAAP.
Management’s discussion and analysis reviews our consolidated financial condition at December 31, 2009 and 2008; our consolidated results of operations for the years 2009, 2008 and 2007; and, where appropriate, factors that may affect our future financial performance. This discussion should be read in conjunction with “Selected Financial Data” included in Item 6 and our consolidated financial statements in this Annual Report on Form 10-K.
We provide life insurance and annuity products through third-party distributors, supported by wholesalers and financial planning specialists employed by us. Our historical expertise is in the high-net-worth and affluent market. More recently, we also have begun to focus on the needs of the broader middle market. The principal focus of our life insurance business is on permanent life insurance (universal and variable universal life) insuring one or more lives. Our annuity products include deferred and immediate and fixed variable annuities with a variety of death benefit and guaranteed living benefit options.
A substantial but gradually declining share of our earnings is derived 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, subject to the maintenance of a positive policyholder dividend obligation. See Note 4 to our consolidated financial statements included under “Item 8: Financial Statements and Supplementary Data” in this Annual Report on Form 10-K for more information on the closed block.
Apart from the closed block, our profitability is driven by interaction of the following elements:
Mortality margins in our universal and variable universal life product lines. We earn cost of insurance (“COI”) fees based on the difference between face amounts and the account values (referred to as the net amount at risk or NAR). We pay policyholder benefits and set up reserves for future benefit payments on these products. We define mortality margins as the difference between these fees and benefit costs. Mortality margins are affected by:
Deferred policy acquisition cost amortization, which 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, investment income in excess of the amounts credited to policyholders, surrender and lapse rates, death claims and other benefit payments, premium persistency, funding patterns and expenses. These factors enter into management’s estimates of gross profits or margins, which generally are used to amortize deferred policy acquisition costs. Actual equity market movements, net investment income in excess of amounts credited to policyholders, claims payments and other key factors can vary significantly from our assumptions, resulting in a misestimate of gross profits or margins, and a change in amortization, with a resulting impact to income. In addition, we regularly review and reset our assumptions in light of actual experience, which can result in material changes in amortization.
Net realized investment gains or losses on our general account investments and hedging programs.
Deferred policy acquisition cost. Deferred policy cost amortization decreased by $145.4 million to $260.6 million in 2009, compared to $406.0 million in 2008. In 2009, we had an unlocking of assumptions related to deferred policy acquisition costs resulting in an acceleration of amortization of $42.5 million, as compared to an unlocking impact to amortization of $162.1 million in 2008. In 2009, these deferred policy acquisition cost unlocking adjustments were partially offset by $24.5 million and, in 2008, included an additional $20.3 million in related unlocking adjustments affecting death benefit and other insurance benefit reserves and unearned fee revenues. We revised our estimates of future net investment income, mortality experience, cost of insurance charges, policy maintenance expenses, premium persistency and lapses and, in 2008, equity market movements resulted in a reduction in overall projected gross profits or margins, and an acceleration of the amortization of deferred policy acquisition costs.
Mortality margins. Prior to the impact of the unlocking noted above, mortality margins in universal life decreased by $37.6 million to $152.1 million in 2009, compared to $189.7 million in 2008, resulting from unfavorable mortality in 2009. Mortality margins in variable universal life increased by $4.1 million to $52.0 million in 2009, compared to $47.9 million in 2008, resulting from favorable mortality in 2009. Fluctuations in mortality are inherent in our lines of business.
Net realized investment gains or losses on our general account investments. In 2009, we had net realized losses of $102.2 million, compared to net realized losses of $295.8 million in 2008. Realized losses in 2009 were primarily driven by other-than-temporary impairment losses of $108.4 million, partially offset by transaction-related gains of $6.2 million. Realized losses in 2008 were driven by other-than-temporary impairment losses of $245.0 million and transaction-related losses of $50.8 million.
Income taxes. In 2009, the Company recorded income tax expense of $109.1 million to continuing operations compared to an income tax benefit of $118.2 million in 2008. The income tax expense in 2009 reflects an increase in the valuation allowance of $168.4 million after intraperiod accounting. The amount of the valuation allowance was determined based on our estimates of future taxable income over the periods in which the deferred tax assets are expected to reverse, including consideration of expiration of loss carryovers and credits.
Following are recent rating actions that may contribute to these adverse effects, which could be compounded should we experience additional downgrades:
On February 12, 2010, Standard & Poor’s downgraded our financial strength rating from BB to BB- and lowered our senior debt rating from B- to CCC+. They maintained their negative outlook on all ratings.
The actions by these and other distribution partners were primarily in response to downgrades by rating agencies and ultimately reduce our ability to borrow. We have responded by refocusing our strategy on less rating-sensitive activities and market segments.
In 2003, we acquired the remaining interest in PFG Holdings, Inc. (“PFG”), the holding company for our private placement operation. In November 2007, we amended the original purchase agreement to extend the term for achievement of performance targets related to additional purchase consideration through the end of 2009 and to establish a more objective mechanism to value PFG and calculate the final amount of contingent consideration. As of December 31, 2009, the performance targets that required additional cash payments were not achieved and no remaining obligation existed relating to the purchase agreement.
In the fourth quarter of 2009, we were actively pursuing the sale of PFG and its subsidiaries, including AGL Life Assurance Company. On January 4, 2010, we signed a definitive agreement to sell PFG to Tiptree Financial Partners, LP and expect the transaction to close in the second quarter of 2010. However, we cannot assure that the transaction will close or that the closing will occur at the currently anticipated time. This transfer of ownership is subject to regulatory approval. Because of the expected divestiture, we have determined that these operations should be reflected as discontinued operations. As such, the consolidated balance sheets have been presented with the gross assets and liabilities of discontinued operations in separate lines and the consolidated statements of income and comprehensive income have been presented with the net results from discontinued operations, shown after the results from continuing operations. For comparative purposes, we have reclassified our prior period financial presentation to conform to this change. We recognized a loss of $22.7 million in 2009 on the anticipated sale.
The amortization of deferred policy acquisition costs and present value of future profits requires the use of various assumptions, estimates and judgments about the future. EGPs for products sold in a particular year are aggregated into cohorts. Future EGPs are then projected for the estimated lives of the contracts within each cohort. The assumptions developed as part of our annual process are based on our current best estimates of future events. Assumptions considered to be significant in the development of EGPs include separate account fund performance, surrender and lapse rates, interest margin, mortality, premium persistency, funding patterns, expenses and reinsurance costs and recoveries. These assumptions are reviewed on a regular basis and are based on our past experience, industry studies, regulatory requirements and estimates about the future.
Underlying assumptions for future periods of EGPs are not altered unless experience deviates significantly from original assumptions. For example, when lapses of our insurance products meaningfully exceed levels assumed in determining the amortization of deferred policy acquisition costs, we adjust amortization to reflect the change in future premiums or EGPs resulting from the unexpected lapses. If revised EGPs based on new assumptions are lower, we would increase deferred policy acquisition cost amortization resulting in a reduction in the deferred policy acquisition cost asset. Favorable experience on key assumptions could result in a decrease to deferred policy acquisition cost amortization and an increase in the deferred policy acquisition costs asset.
Our fair value calculation 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 (“nonperformance risk”). In analyzing various alternatives to the CSA calculation, we determined that we could not use credit default swap spreads as there are no such observable instruments on Phoenix’s life insurance subsidiaries nor could we consistently obtain an observable price on the surplus notes issued by Phoenix Life, as the surplus notes are not actively traded. Therefore, when discounting the rider cash flows for calculation of the liability, we calculate the CSA by using the Fair Market Sector Curve USD Finance (BBB) index that reflects the credit spread for financial services companies similar to the Company’s life insurance subsidiaries.
This average credit spread is recalculated every quarter and so the fair value will change with the passage of time even in the absence of any other changes that affect the valuation. For example, the December 31, 2009 fair value of $25.5 million would increase to $28.0 million if the chosen spread decreased by 50 basis points. If the chosen spread increased by 50 basis points the fair value would decrease to $23.2 million.
For goodwill and other intangible assets, we perform impairment tests on an annual basis or in the event there is a reason to believe their fair values have been impaired. We compare the calculated fair value to the recorded values and record an impairment, if warranted. As of December 31, 2009, we had no goodwill recorded on our balance sheet and intangible assets of $0.7 million related to continuing operations and $2.5 million related to discontinued operations.
We recognize realized investment losses when declines in fair value of debt and equity securities are considered to be other-than-temporary. For debt securities, the other-than-temporarily impaired amount is separated into the amount related to a credit loss and is reported as net realized investment losses included in earnings, and any amounts related to other factors are recognized in other comprehensive income. The credit loss component is calculated using our best estimate of the present value of cash flows expected to be collected from the debt security, by discounting the expected cash flows at the effective interest rate implicit in the security at the time of acquisition. Subsequent to recognition of an impairment loss, the difference between the new cost basis and the cash flows expected to be collected is accreted as interest income.
In evaluating whether a decline in value is other than temporary, we consider several factors including, but not limited to the following:
On a quarterly basis, we review all securities for potential recognition of an other-than-temporary impairment. We maintain a watch list of securities in default, near default or otherwise considered by our investment professionals as being distressed, potentially distressed or requiring a heightened level of scrutiny. We also identify all securities whose carrying value has been below amortized cost on a continuous basis for zero to six months, six months to 12 months and greater than 12 months. Using this analysis, coupled with our watch list, we review all securities whose fair value is less than 80% of amortized cost (significant unrealized loss) with emphasis on below investment grade securities with a continuous significant unrealized loss in excess of six months. In addition, we review securities that experienced lesser declines in value on a more selective basis to determine whether any are other-than-temporarily impaired.
the expiration dates and amounts of carryforwards related to net operating losses, capital losses, foreign tax credits and general business tax credits.
These negative developments during 2009 highlighted the possibility that unexpected events may adversely affect future financial projections. Accordingly, although we project earnings in the core life subgroup business beyond 2009, we did not rely on these projections when assessing the realizability of our deferred tax assets.
For the twelve months ended December 31, 2009, we recorded a net decrease in the valuation allowance of $34.7 million. The net reduction includes an increase in the valuation allowance related to beginning of the year deferred tax assets in the amount of $136.0 million. This increase was offset by a reduction in the valuation allowance of $158.1 million related to a revision of the amount estimated for 2008 capital losses related to the Virtus spin-off, and a decrease in the valuation allowance of $12.6 million related to the adoption of a new accounting standard (see Note 2 to our consolidated financial statements included under “Item 8: Financial Statements and Supplementary Data” in this Annual Report on Form 10-K). The revision of this estimate had no impact on our consolidated results from continuing operations or on our consolidated shareholders’ equity. The valuation allowance activity, excluding the Virtus item, is reflected as elements of income from continuing operations and other comprehensive income.
As of December 31, 2009, we had deferred income tax assets of $14.6 million related to foreign tax credit carryovers, which are expected to expire between the 2011 and 2017 tax years. As of December 31, 2009, we had deferred income tax assets of $36.6 million related to general business tax credit carryovers, which are expected to expire between the years 2022 and 2029. At the end of 2009, a full valuation allowance was carried relative to the foreign tax and general business tax credits.
This decision affected benefits attributed to past service for employees that were not grandfathered into retiree coverage as well as the expected years of future service for the reduction in the cap for retiree medical costs. Both a negative plan amendment and curtailment were recognized as a result of the plan changes. The net effect was a reduction of our projected benefit obligation.
Net investment income declined by $125.9 million to $787.2 million in 2009 from $913.1 million in 2008, primarily from lower investment income on alternative investments. The lower investment income included the following:
Deferred policy cost amortization decreased by $145.4 million to $260.6 million in 2009, from $406.0 million in 2008. In 2009, we had an unlocking assumptions related to deferred policy acquisition costs resulting in an acceleration of amortization of $42.5 million, as compared to an unlocking impact to amortization of $162.1 million in 2008. These deferred policy acquisition cost unlocking adjustments were partially offset by $24.5 million and $20.3 million in 2009 and 2008, respectively, of related unlocking adjustments affecting death benefit and other insurance benefit reserves and unearned fee revenues. We revised our estimates of future net investment income, mortality experience, cost of insurance charges, policy maintenance expenses, premium persistency and lapses. In 2009, a change in the cost of insurance rates for certain single life universal life policies, effective April 1, 2010, resulted in an increase in overall projected gross profits or margins, and a slowing of the amortization of deferred policy acquisition costs. In 2008, equity market movements resulted in a reduction in overall projected gross profits or margins, and an acceleration of the amortization of deferred policy acquisition costs.
In 2009, we had net realized losses of $102.2 million, compared to net realized losses of $295.8 million in 2008. Realized losses in 2009 were primarily driven by other-than-temporary impairment losses of $108.4 million, partially offset by transaction-related gains of $6.2 million. Realized losses in 2008 were driven by other-than-temporary impairment losses of $245.0 million and transaction-related losses of $50.8 million.
Our tax expense related to continuing operations increased by $227.3 million to $109.1 million in 2009 from a tax benefit of $118.2 million in 2008. In 2009, we increased the valuation allowance on the net deferred tax asset by $168.4 million after intraperiod accounting. The amount of the valuation allowance was determined based on our estimates of future taxable income over the periods in which the deferred tax assets are expected to reverse, including consideration of expiration of loss carryovers and credits.
Year ended December 31, 2008 compared to year ended December 31, 2007
Results for year ended December 31, 2008 reflect losses in our discontinued asset management operations as well as negative impacts from the decline in equity markets and return on variable products. The consolidated net loss for the year was $726.0 million, or $6.35 per diluted share.
The net loss from continuing operations of $176.5 in 2008 compares to net income of $113.7 million in 2007, or a decline of $290.2 million. This result reflected unlocking of deferred policy acquisition costs resulting in accelerated amortization of $183.8 million, as compared to an unlocking of $4.1 million in 2007. It also reflected the adverse impacts of the markets on our investments, specifically overall declines and credit spread widening, resulting in $295.8 million in realized capital losses.
Mortality margins in universal life and variable universal life products increased to $237.6 million in 2008, compared to $173.1 million in 2007, or $64.5 million. This reflects a $98.9 million increase in cost of insurance fees, partially offset by a $34.4 million increase in benefits. While fluctuations in mortality are inherent in our business, this improvement primarily reflects growth in the block of business over recent years. Fee revenues increased to $133.9 million in 2008, compared to $130.8 million in 2007, or $3.1 million. The increase was driven by higher premium-based fees of $7.7 million on our universal life and variable universal life products, partially offset by lower asset-based fees of $4.6 million on our variable annuity products.
For the year ended December 31, 2009, annuity funds on deposit increased compared to a decrease in the comparable prior year. The primary drivers of these improvements were stronger fund performance from stronger equity markets and a reduction in the dollar amount of surrenders. These improvements were partially offset by lower deposits in 2009 as compared to 2008. The decline in deposits reflects the loss of several key distribution relationships in early 2009.
For the year ended December 31, 2008, variable universal life funds on deposit decreased by $555.2 million compared to an increase of $59.9 million in the prior year period. This change was primarily driven by weak equity market performance in late 2008.
For the years 2009, 2008 and 2007, inflation did not have a material effect on our consolidated results of operations.
Operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. The Operational Risk Committee, chaired by the Chief Risk Officer, develops an enterprise-wide framework for managing operational risks. This committee meets periodically and includes membership that represents all significant operating, financial and staff departments of the Company. Among the risks the committee reviews and manages and for which it provides general oversight are business continuity risk, disaster recovery risk and risks related to the Company’s information technology systems.
We also measure, manage and monitor market risk associated with our general account investments, both those backing insurance liabilities and those supporting surplus. This process involves Corporate Portfolio Management and Goodwin, our Hartford-based asset management affiliate. These organizations work together, make recommendations and report results to our Investment Policy Committee, chaired by the Chief Investment Officer. Please refer to the sections that follow, including “Debt and Equity Securities Held in General Account”, for more information on our investment risk exposures. We regularly refine our policies and procedures to appropriately balance market risk exposure and expected return.
Certain annuity products sold by our Life Companies contain guaranteed minimum death benefits. The guaranteed minimum death benefit (“GMDB”) feature provides annuity contract owners with a guarantee that the benefit received at death will be no less than a prescribed amount. This minimum amount is based on the net deposits paid into the contract, the net deposits accumulated at a specified rate, the highest historical account value on a contract anniversary or, if a contract has more than one of these features, the greatest of these values. To the extent that the GMDB is higher than the current account value at the time of death, the Company incurs a cost. This typically results in an increase in annuity policy benefits in periods of declining financial markets and in periods of stable financial markets following a decline. As of December 31, 2009 and 2008, the difference between the GMDB and the current account value (net amount at risk) for all existing contracts was $292.9 million and $716.5 million, respectively. This is our exposure to loss should all of our contract owners have died on either December 31, 2009 or 2008. See Note 11 to our consolidated financial statements under “Item 8: Financial Statements and Supplementary Data” in this Annual Report on Form 10-K for more information.
We sponsor defined benefit pension plans for our employees. For GAAP accounting purposes, we assumed an 8.5% long-term rate of return on plan assets in the most recent valuations, performed as of December 31, 2009. To the extent there are deviations in actual returns, there will be changes in our projected expense and funding requirements. As of December 31, 2009, the projected benefit obligation for our funded and unfunded defined benefit plans was in excess of plan assets by $161.3 million and $130.4 million, respectively. We made payments totaling $3.6 million to the pension plans during 2009. We made no payments to the pension plans during 2008. Over the next 12 months, Phoenix Life expects to make contributions of approximately $29 million, of which approximately $17 million will be funded in the first quarter of 2010.
Each year, the majority of our general account’s net cash flows are invested in investment grade debt securities. In addition, we maintain a target portfolio allocation of between 6% and 10% of debt securities in below investment grade rated bonds. As of December 31, 2009, our total below investment grade securities totaled $1,113.5 million, or 10.8%, of our total debt security portfolio. Of that amount, $644.1 million, or 6.2%, of our debt security portfolio was invested in the BB category. The percentage of below investment grade bonds exceeded our target range because of the significant number of downgrades in the fixed income markets during 2009. Our intent is to manage the percentage back to within the range through selective sales of below investment grade securities while minimizing realized losses. Allocations are based on our assessment of relative value and the likelihood of enhancing risk-adjusted portfolio returns. The size of our allocation to below investment grade bonds is also constrained by the size of our net worth. We are subject to the risk that the issuers of the debt securities we own may default on principal and interest payments, particularly in the event of a major economic downturn. Our investment strategy has been to invest the majority of our below investment grade rated bond exposure in the BB rating category, which is equivalent to a Securities Valuation Office (“SVO”) securities rating of 3. The BB rating category is the highest quality tier within the below investment grade universe, and BB rated securities historically experienced lower defaults compared to B or CCC rated bonds.
Our general account debt and equity securities are classified as available-for-sale and are reported at fair value with unrealized gains or losses included in equity. Accordingly, the carrying value of such securities reflects their fair value at the balance sheet date. Fair value is based on quoted market price, where available. When quoted market prices are not available, we estimate fair value for debt securities by discounting projected cash flows based on market interest rates currently being offered on similar terms to borrowers of similar credit quality, by quoted market prices of comparable instruments and by independent pricing sources or internally developed pricing models. Investments whose value, in our judgment, is considered to be other-than-temporarily impaired are written down to fair value as a charge to net realized investment losses and, in certain instances, a charge to other comprehensive income. The cost basis of these written-down investments is adjusted to fair value at the date the determination of impairment is made. The new cost basis is not changed for subsequent recoveries in value.
The weakness in the U.S. residential real estate markets, tighter credit standards and rising unemployment continue to impact the RMBS market. Delinquency rates for all sectors of the RMBS market, including sub-prime, Alt-A and prime, are above historical averages.
Management exercised significant judgment with respect to certain securities in determining whether impairments were other than temporary. This included securities with $145.4 million ($42.2 million after offsets) of gross unrealized losses of 50% or more for which no other-than-temporary impairment was ultimately indicated. In making its assessments, management used a number of issuer-specific quantitative and qualitative assessments of the probability of receiving contractual cash flows, including the issue’s implied yields to maturity, cumulative default rate based on the issue’s 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 exposure, as well as fundamentals such as issuer credit and liquidity metrics, business outlook and industry conditions. In addition to these reviews, management in each case assessed whether it is more likely than not that we will be required to sell the security before recovery. 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.
Preferred Term Group - With a fair value of $22.1 million and an unrealized loss of $49.0 million, these are multi-class, cash flow CDOs. The Company invests in the senior tranches of the CDOs that can withstand significant immediate defaults before losing any principal. Due to the senior nature of our tranches, we expect that we will be able to collect cash flows sufficient to recover the entire cost basis of the security and, therefore, this issue does not merit an other-than-temporary impairment.
LNR CDO Ltd 2002-1A DFX - With a fair value of $3.5 million and an unrealized loss of $8.5 million, this security is a seasoned, mezzanine tranche of an $800 million CMBS CDO originally rated A-/A-/A3 and currently rated BBB-/BBB+/Ba2 by Fitch/S&P/Moody’s respectively. The Company’s tranche of this security has a remaining average life of 2.25 years and is current on principal and interest. There are no indications that the Company will not receive 100% of contractual cash flows and, therefore, an other-than-temporary impairment is not required.
Corporate debt securities make up approximately 41% of the unrealized loss balance. Of these securities with unrealized losses, approximately 57% are of investment grade quality. This asset class, in general, continues to experience depressed valuations despite high ratings, relatively low default rates and continued ability to pay obligations.
Upon adoption of the amended guidance, we recognized a cumulative effect adjustment. For previously recognized other-than-temporary impairments, we calculated the credit and non-credit components and recorded the related impacts in accumulated deficit and accumulated other comprehensive income, respectively. The cumulative effect recognized in stockholders’ equity was $20.4 million after offsets such as deferred policy acquisition costs, policy dividend obligations in the closed block, and related tax effects. The cumulative effect consisted of a decrease to accumulated deficit of $11.8 million after offsets and a decrease to accumulated other comprehensive loss of $8.6 million after offsets, and included an adjustment of $12.6 million to the deferred tax valuation allowance.
In addition to these credit-related impairments recognized through earnings, we impaired securities to fair value through other comprehensive loss. These 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 $93.1 million in 2009.
The following tables present certain information with respect to our gross unrealized losses related to our investments in general account debt securities, both outside and inside the closed block, as of December 31, 2009. In the tables, we separately present information that is applicable to unrealized losses both outside and inside the closed block. See Note 8 to our consolidated financial statements under “Item 8: Financial Statements and Supplementary Data” in this Annual Report on Form 10-K for more information regarding the closed block. Applicable deferred policy acquisition costs and deferred income taxes further reduce the effect on our comprehensive income.
Cash for operating activities decreased $639.7 million for the year ended December 31, 2009 versus 2008. The primary driver of this decrease was higher policy benefits of $856.8 million related to higher surrenders and benefit payments in 2009 which was partially offset by the repayment of loan balances upon surrender as reflected in cash from investing activities below. Premiums collected also decreased $106.3 million, primarily related to decrease in renewal premiums on participating policies within the closed block. In addition, there was a decrease in net investment income of $50.9 million as a result of lower investment yields and fewer cash distributions from venture capital investments. These items were partially offset by a reduction of policy acquisition costs paid of $330.3 million, as a result of lower sales, and an increase in fee income of $34.7 million, primarily related to higher cost of insurance fees.
Cash from investing activities increased by $421.6 million. The primary driver of this fluctuation was an increase of $283.8 million from repayment of outstanding loan balances primarily associated with one large surrender in the second quarter of 2009. The cash flows associated with surrenders are reflected in cash for operating activities which is offset by any outstanding loan balances at the time of surrender which is reflected in cash from investing activities. Investment purchases net of sales increased $180.7 million, which was partially offset by a decrease of $47.1 related to the deconsolidation of CDOs as of January 1, 2009.
Cash from operating activities decreased $161.5 million compared to 2007. This decrease was primarily driven by higher death benefits paid of $217.2 million and a decrease in investment income of $65.2 million. The higher death benefits were due to death claims incurred in late 2007, but not paid until early 2008. Lower investment income was primarily due to lower yields and lower earnings on alternative investments. These items were partially offset by higher fees of $76.3 million, primarily cost of insurance on our universal life products and lower acquisition costs of $63.4 million as a result of lower universal life sales. Historically cash flows from operations have been positive, but the timing of the payment for the death benefits in January 2008 caused the current year to have higher than usual death benefits.
At December 31, 2008, the Company and its subsidiary, Phoenix Life (Phoenix Life, together with the Company, the “Borrowers”) had a $100 million unsecured senior revolving credit facility. The Company terminated the credit facility effective March 13, 2009. As of the termination date, there were no borrowings on the credit facility. The Company will evaluate the costs and benefits of replacing the facility as part of its ongoing liquidity management.
The Life Companies’ liquidity requirements principally relate to: the liabilities associated with various life insurance and annuity products; the payment of dividends by Phoenix Life to the parent company; operating expenses; contributions to subsidiaries; and payment of principal and interest by Phoenix Life on its outstanding debt obligation. Liabilities arising from life insurance and annuity products include the payment of benefits, as well as cash payments in connection with policy surrenders, withdrawals and loans. The Life Companies also have liabilities arising from the runoff of the remaining discontinued group accident and health reinsurance operations.
Historically, our Life Companies have used cash flow from operations and investing activities to fund liquidity requirements. Their principal cash inflows from life insurance and annuities activities come from premiums, annuity deposits and charges on insurance policies and annuity contracts. In the case of Phoenix Life, cash inflows also include dividends, distributions and other payments from subsidiaries. Principal cash inflows from investing activities result from repayments of principal, proceeds from maturities, sales of invested assets and investment income. The principal cash inflows from our discontinued group accident and health reinsurance operations come from our reinsurance, recoveries from other retrocessionaires and investing activities.
On May 4, 2009, we informed Fitch Ratings Ltd. that, due to our expense management initiatives, we would no longer provide non-public information to the agency and would cease paying annual rating fees.
Given these developments, it is possible that rating agencies will heighten the level of scrutiny that they apply to us, will increase the frequency and scope of their credit reviews, will request additional information from us, and may adjust upward the capital and other requirements employed in their models for maintenance of certain ratings levels.
Cash and cash equivalents decreased due to a shift in early 2009 from cash equivalents to investments in highly liquid securities that are classified as available-for-sale debt securities. Additionally, the Company began shifting to longer-term investments late in 2009 as our liquidity needs have lessened.
The deferred policy acquisition cost decrease was primarily driven by universal life and traditional life blocks of business which had significantly lower unrealized losses on debt securities.
The deferred income tax asset decreased due to the net increase in the valuation allowance and the effect of significant net unrealized appreciation in available-for-sale securities.
Discontinued operations assets decreased primarily related to a significant withdrawal from a group annuity contract from PFG’s separate account assets.
The decrease in policyholder deposit funds was primarily attributable to an increase in cost of insurance charges, higher surrenders and lower sales of universal life funds on deposit.
Non-recourse collateralized debt obligations decreased to zero from the deconsolidation of the remaining two CDOs in the first quarter of 2009 (see Note 9 to our consolidated financial statements included under “Item 8: Financial Statements and Supplementary Data” in this Annual Report on Form 10-K) with a corresponding decrease to zero in available-for-sale debt and equity securities pledged as collateral.
Discontinued operations liabilities decreased primarily related to a significant withdrawal from a group annuity contract from PFG’s separate account assets.
Other purchase liabilities relate to open purchase orders and other contractual obligations. This amount does not include our expected pension contribution of approximately $29 million in 2010. See Note 17 to our consolidated financial statements under “Item 8: Financial Statements and Supplementary Data” in this Annual Report on Form 10-K for additional information on pension and other postretirement benefits.
Future obligations are based on our estimate of future investment earnings, mortality, surrenders and applicable policyholder dividends. Included in the amounts above are policyholder dividends generated by estimated favorable future investment and mortality, in excess of guaranteed amounts for our closed block. Actual obligations in any single year, or ultimate total obligations, may vary materially from these estimates as actual experience emerges. As described in Note 2 to our consolidated financial statements under “Item 8: Financial Statements and Supplementary Data” in this Annual Report on Form 10-K, policy liabilities and accruals are recorded on the balance sheet in amounts adequate to meet the estimated future obligations of the policies in force. The policyholder obligations reflected in the table above exceed the policy liabilities, policyholder deposit fund liabilities and separate account liabilities reported on our December 31, 2009 consolidated balance sheet because the above amounts do not reflect future investment earnings and future premiums and deposits on those policies. Separate account obligations will be funded by the cash flows from separate account assets, while the remaining obligations will be funded by cash flows from investment earnings on general account assets and premiums and deposits on contracts in force.
Due to the uncertainty of the timing of future cash flows associated with our unrecognized tax benefits at December 31, 2009, we are unable to make reasonably reliable estimates of the period of cash settlement with the respective taxing authorities. Therefore, $0.1 million of unrecognized tax benefits have been excluded from this table. See Note 15 to our consolidated financial statements under “Item 8: Financial Statements and Supplementary Data” in this Annual Report on Form 10-K for additional information on unrecognized tax benefits.
We have three defined benefit pension plans covering our employees. The employee pension plan, covering substantially all of our employees, provides benefits up to the amount allowed under the Internal Revenue Code. The two supplemental plans provide benefits in excess of the primary plan. Retirement benefits under the plans are a function of years of service and compensation. The employee pension plan is funded with assets held in a trust, while the supplemental plans are unfunded.
The changes in the projected benefit obligations of the employee plan and the supplemental plans at December 31, 2009 as compared to December 31, 2008 are principally the result of accrued service cost and interest cost.
We made payments totaling $3.6 million to the pension plans during 2009. We made no payments to the pension plans during 2008. Over the next 12 months, Phoenix Life expects to make contributions of approximately $29 million, of which approximately $17 million will be funded in the first quarter of 2010. In December 2009, we announced that, effective March 31, 2010, we are freezing all benefit accruals under our funded and unfunded defined benefit plans.
We also have a postretirement benefit plan, which is unfunded and had projected benefit obligations of $(61.6) million and $(66.1) million as of December 31, 2009 and 2008, respectively.
Phoenix Life’s and its subsidiaries’ combined statutory basis capital and surplus (including AVR) decreased from $853.7 million at December 31, 2008 to $576.9 million at December 31, 2009. The principal factors resulting in this decrease were losses from operations of $33.1 million, net realized losses of $145.6 million, unrealized investment losses of $102.7 million and changes in deferred taxes and non-admitted assets of $58.0 million.
See Note 21 to our consolidated financial statements under “Item 8: Financial Statements and Supplementary Data” in this Annual Report on Form 10-K regarding the Life Companies’ statutory financial information and regulatory matters.