Our executive headquarters consist of our main office building at One American Row and one other building in Hartford, Connecticut, which we own and occupy. In September 2005, we sold a third Hartford office building, which was no longer needed. In July 2005, we sold the East Greenbush, New York property that had been used for our operations and leased back the space on a short-term basis. We relocated to another leased property in East Greenbush in January 2006. We also lease office space elsewhere in the United States as needed for our operations.
Our selected historical consolidated financial data as of and for each of the five years in the period ended December 31, 2005 follows. We derived the balance sheet data for 2005 and 2004 and the income statement data for the years 2005, 2004 and 2003 from our consolidated financial statements in this Form 10-K. We derived the balance sheet data for 2003, 2002 and 2001 and the income statement data for the years 2002 and 2001 from audited consolidated financial statements not in this Form 10-K. We have reclassified certain amounts for prior years to conform with our 2005 presentation. Prior to June 25, 2001, Phoenix Life was the parent company of our consolidated group. In connection with its demutualization, Phoenix Life became a subsidiary and PNX became the parent company of our consolidated group.
Due to our losses during 2003, 2002 and 2001, the ratio of earnings to fixed charges for those years was less than 1:1. We would need $11.4 million, $113.6 million and $131.6 million in additional earnings for the years 2003, 2002 and 2001, respectively, to achieve a 1:1 coverage ratio.
In accordance with accounting practices prescribed by the New York State Insurance Department, Phoenix Life’s capital and surplus includes $205.2 million, $205.2 million and $175.0 million principal amount of surplus notes outstanding at December 31, 2005, 2004 and 2003, respectively.
Management’s discussion and analysis reviews our consolidated financial condition at December 31, 2005 and 2004; our consolidated results of operations for the years 2005, 2004 and 2003; and, where appropriate, factors that may affect our future financial performance. This discussion should be read in conjunction with “Selected Financial Data” and our consolidated financial statements in this Form 10-K.
We are a manufacturer of insurance, annuity and asset management products for the accumulation, preservation and transfer of wealth. We provide products and services to affluent and high-net-worth individuals through their advisors and to institutions directly and through consultants. We offer a broad range of life insurance, annuity and asset management products and services through a variety of distributors. These distributors include independent advisors and financial services firms who make our products and services available to their clients.
We manufacture our products through two operating segments-Life and Annuity and Asset Management-which include three product lines-life insurance, annuities and asset management. Through Life and Annuity we offer a variety of life insurance and annuity products, including universal, variable universal and term life insurance, and a range of variable annuity offerings. Asset Management comprises two lines of business-retail and institutional.
Through our retail line of business, we provide investment management services through open-end mutual funds, closed-end funds and managed accounts. Managed accounts include intermediary programs sponsored and distributed by non-affiliated broker-dealers and direct managed accounts sold and administered by us. We also provide transfer agency, accounting and administrative services to our open-end mutual funds.
investment options of variable annuities are reflected on our balance sheet as an increase in policyholder deposit funds. Collections for other products are reflected on our balance sheet as an increase in policy liabilities and accruals.
the maintenance of our target spreads between the rate of earnings on our investments and dividend and interest rates credited to customers; and
Effective May 31, 2004, we sold our retail affiliated broker-dealer operations to Linsco/Private Ledger Financial Services, or LPL. As part of this transaction, advisors affiliated with WS Griffith Securities, Inc., or Griffith, and Main Street Management Company, or Main Street, had the opportunity to move to LPL as independent registered representatives. As of December 31, 2005, we have not determined the ultimate persistency of the business written by these advisors, but our experience through that date shows no material deterioration.
During 2004, we incurred a $3.6 million after-tax charge for an impairment of goodwill related to Main Street, offset by a $2.7 million after-tax gain on the sale of the broker-dealer operations. Both the charge and the gain were recorded as realized investment gains and losses. In addition, in connection with this sale, we incurred a $10.2 million after-tax charge related to lease termination costs, offset by a $4.4 million after-tax gain related to curtailment accounting in connection with employee benefit plans. During the second quarter of 2005, we realized a gain of $1.5 million related to contingent consideration based on gross distribution concessions earned by LPL during the first year following the sale.
The mandatorily redeemable noncontrolling interests in our less than wholly-owned asset management subsidiaries were subject to certain agreements, which were executed at the time of the acquisition. Upon acquisition of the remaining outstanding mandatorily redeemable interests, any previous rights under these agreements became nullified. We recorded $77.6 million, $15.2 million and $34.5 million of additional redemption or purchase price in 2005, 2004 and 2003, respectively, related to the redemption of noncontrolling membership interests under these agreements.
During 2004, we sold the stock of Phoenix Global Solutions (India) Pvt. Ltd., our India-based information technology subsidiary, and essentially all of the assets of its United States affiliate, Phoenix Global Solutions, Inc., to Tata Consultancy Services Limited, a division of Tata Sons Ltd. This transaction was not material to our consolidated financial statements.
Financial Instruments with Characteristics of Both Liabilities and Equity: Effective July 1, 2003, we adopted SFAS 150. The effect of our adoption was to reclassify the mandatorily redeemable noncontrolling interests related to our asset management subsidiaries from “minority interest” to “other liabilities” in our consolidated balance sheet. In addition, within our consolidated statement of operations, we reclassified earnings attributed to those interests from the caption “minority interest in net income of subsidiaries” to “other operating expenses.” These changes in presentation were not material to our consolidated financial statements. During 2005, we redeemed the outstanding noncontrolling interests.
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. The following are areas that we believe require significant judgments, together with references to the footnote(s) in which each accounting policy is discussed in relation to our business:
The costs of acquiring new business, principally commissions, underwriting, distribution and policy issue expenses, all of which vary with and are primarily related to production of new business, are deferred. In connection with our 1997 acquisition of the Confederation Life business, we recognized an asset for the PVFP representing the present value of estimated net cash flows embedded in the existing contracts acquired. This asset is included in DAC.
We amortize DAC and PVFP based on the related policy’s classification. For individual participating life insurance policies, DAC and PVFP are amortized in proportion to estimated gross margins. For universal life, variable universal life and accumulation annuities, DAC and PVFP are amortized in proportion to estimated gross profits. Policies may be surrendered for value or exchanged for a different one of our products (internal replacement). The DAC balance associated with the replaced or surrendered policies is amortized to reflect these surrenders.
We regularly evaluate our estimated gross profits to determine if actual experience or other evidence suggests that earlier estimates should be revised. Several assumptions considered to be significant in the development of estimated gross profits include separate account fund performance, surrender and lapse rates, estimated interest spread and estimated mortality. The separate account fund performance assumption is critical to the development of the estimated gross profits related to our variable annuity and variable and interest-sensitive life insurance businesses. The average long-term rate of assumed separate account fund performance used in estimating gross profits was 6.0% for the variable annuity business and 6.9% for the variable life business at December 31, 2005.
See Note 3 to our consolidated financial statements and the Enterprise Risk Management section of Management’s Discussion and Analysis of Financial Condition and Results of Operations in this Form 10-K for more information.
As of December 31, 2005, our deferred income tax assets of $18.7 million related to general business tax credits are expected to expire between the years 2022 and 2025.
Weighted-average common shares outstanding and dilutive potential common shares (in millions)
Total segment income for 2005 of $101.7 million, or $0.99 per diluted share, grew 26% over 2004 total segment income of $80.6 million, or $0.80 per diluted share, which was substantially improved from 2003 total segment income of $57.3 million, or $0.59 per diluted share. The 2005 increase was driven by higher Life and Annuity earnings offset by lower Asset Management and Venture Capital earnings and a higher loss for Corporate and Other in 2005. The increase in total segment income for full year 2004 was the result of higher earnings in the Life and Annuity and Asset Management segments, partially offset by lower Venture Capital earnings and a higher Corporate and Other segment loss in 2004. See Note 2 to our consolidated financial statements in this Form 10-K and “Results of Operations by Segment” below for a discussion of our segment reporting.
Full year 2004 earnings improvements in life and annuity reflect the benefits of expense savings, particularly from the sale of our retail affiliated distribution operations, and strong fundamentals including mortality, higher investment margins and persistency. Life insurance and annuity sales and deposits fell short of our expectations in 2004 and were well below 2003 levels. Life insurance sales were lower in 2004 due to our decision to maintain pricing and risk management discipline, particularly
notes, and issued $175.0 million of 7.15% surplus notes maturing December 15, 2034. We also entered into a $150.0 million three-year, unsecured senior revolving credit facility in 2004.
Corporate and Other segment pre-tax loss for 2005 of $69.6 million was higher than the 2004 and 2003 losses of $59.1 million and $47.8 million, respectively. The full year 2005 results reflect higher interest expense on indebtedness, primarily from our surplus notes refinance transaction in December 2004 and the promissory notes related to the acquisition of the remaining interest in KAR, plus higher allocated corporate expenses as a result of a change in methodology. The full year 2004 results reflect higher earnings from the Company’s international operations offset by higher regulatory, compliance and corporate information technology costs and lower corporate investment income.
Broker-dealer commission and distribution fee revenues decreased $28.2 million, or 50%, in 2005 from 2004, due primarily to a revenue decrease of $28.8 million in the Life and Annuity segment in 2005 as a result of the sale of our retail affiliated broker-dealer operations in May 2004. Asset Management broker-dealer commission and distribution fee revenues increased slightly in 2005.
Total policyholder benefits decreased $85.8 million, or 5%, in 2005 from 2004. Policyholder benefits decreased $45.5 million due primarily to a reduction of in-force policies for traditional life insurance and lower interest credited, particularly for annuities. Dividends decreased $40.3 million in 2005 due primarily to the change in the policyholder dividend obligation liability, which decreased dividend expense by $4.0 million in 2005, the effect of realized gains on the policyholder dividends, which decreased dividend expense by $16.2 million in 2005, and the reduction of the dividend scale in late 2005.
Applicable income taxes decreased $12.8 million, or 32%, in 2005 from 2004, due to additional tax credits earned and tax benefits resulting from the completion of an IRS audit.
Insurance and investment product fees increased $34.0 million, or 7%, in 2004 over 2003 due primarily to a $12.6 million increase in Asset Management fees and a $18.5 million increase in Life and Annuity fees. Asset Management retail and institutional investment product fees, which are asset-based, increased $9.8 million and $6.2 million, respectively, as a result of increased assets under management. These increases were partially offset by lower other investment product fees as a result of decreased volumes in equity trading by certain investment managers, which resulted in lower commissions earned. In 2004, approximately 57% of our management fee
Net investment income decreased $31.7 million, or 3%, in 2004 from 2003, due primarily to lower venture capital earnings, which reflected the effect of less than favorable equity market conditions in 2004 compared to 2003. Mortgage loan income also declined in 2004 compared to 2003, reflecting the continued decline in mortgage loan assets, as the portfolio continues to run-off. Income reflected in the other invested assets category increased in 2004 compared to 2003, benefiting from higher investment income related to two direct equity investments. This increase was partially offset by lower investment income from our debt securities pledged as collateral related to our consolidated CDOs, which decreased $12.1 million from 2003, due primarily to decreased asset levels from paydowns and defaults.
The $85.9 million unrealized gain on trading equity securities in 2004 relates to our investment in Aberdeen. See Notes 1 and 5 to our consolidated financial statements in this Form 10-K for additional information related to our investments in Aberdeen.
Income tax expense of $40.5 million in 2004 increased by $58.8 million from a tax benefit of $18.3 million in 2003. This increase is due primarily to the tax effect of the increase to income before continuing operations before minority interest and equity earnings of affiliates.
Investment income increased $31.2 million, or 3%, in 2005 over 2004, due primarily to higher partnership gains and prepayment fees plus higher investment earnings for universal life insurance, from higher funds on deposit and for annuities, from the extension of asset durations and higher interest rates. These increases were particularly offset by lower earnings from the impact of reinvesting bond maturities at lower interest rates.
Policy benefits and dividends decreased $68.7 million, or 4%, in 2005 from 2004. Dividends decreased $24.1 million and policy benefits and changes in reserves decreased $44.6 million in 2005 from 2004. Dividends decreased in 2005 due primarily to the change in the policyholder dividend obligation, which lowered dividend expense $4.0 million in 2005 compared to 2004 and the reduction in the dividend scale in late 2005. Benefits and changes in reserves decreased in 2005 due primarily to a reduction of in-force policies for traditional life insurance and lower interest credited, particularly for annuities.
Policy acquisition cost amortization increased $3.9 million, or 4%, in 2005 over 2004, due primarily to higher amortization for universal life and annuities offset by the effects of unlocking. Amortization increased for universal life insurance due to higher insurance margins and growth of in-force policies and increased for annuities due to improved investment margins and higher surrenders.
Life and Annuity segment income benefited from a second quarter unlocking of assumptions primarily related to DAC. The unlocking reflected favorable mortality experience, offset by interest rate and spread adjustments for annuities. The effects of the unlocking decreased insurance product fee revenues by $0.3 million, increased the change in policyholder reserves by $3.5 million, increased non-deferred expenses by $0.5 million and decreased DAC amortization by $28.1 million for a net increase in pre-tax segment income of $23.8 million through the second quarter of 2005. However, this initial increase was partially offset by a resulting increase in DAC amortization of $5.8 million during the latter half of the year.
Premium revenue decreased $51.6 million, or 5%, in 2004 from 2003, due primarily to a $51.0 million decrease in participating life insurance premiums. Since our demutualization in 2001, we no longer sell participating life policies, resulting in a decline in renewal participating life premiums. This decline in policies in force results in a reduction of reserves, thereby lowering policyholder benefit costs.
Insurance and investment product fees increased $18.5 million, or 7%, in 2004 over 2003, due primarily to higher universal life insurance fees of $14.3 million, principally from cost of insurance fees and higher annuity fees due primarily to higher fee-based funds on deposit.
Policy benefits and dividends decreased $55.1 million, or 3%, in 2004 from 2003, due primarily to lower benefits and changes in policy reserves and policyholder dividends for participating life from a decline in renewal premiums, as discussed above; lower interest credited from reduced crediting rates principally from universal life; and lower general account funds on deposit for annuities. These decreases were partially offset by higher reserves for annuities and higher benefits for universal life and variable universal life insurance, as well as a larger increase in the policyholder dividend obligation. The increase in universal life and variable universal life benefits was due to a large death claim, for universal life, in the first quarter of 2004 combined with very favorable mortality for both lines of business in 2003.
Variable universal life and universal life funds increased by $280.1 million in 2005 compared to an increase of $281.2 million in 2004. This $1.1 million decrease in the change in funds on deposits is comprised of a decrease in the variable universal change in funds of $77.8 million due primarily to lower deposits, higher surrenders and lower relative performance, offset by an increase in universal life change in funds of $76.7 million, principally from higher deposits and lower surrenders partially offset by higher cost of insurance charges.
Universal life insurance revenue increased $26.2 million, or 12%, in 2005 over 2004, due primarily to the higher cost of insurance fees resulting from growth of in-force business and improved investment earnings from higher funds on deposit and strong investment gains. The increase in revenues for 2005 was partially offset by the effect of unlocking on deferred fee income.
Variable universal life insurance revenue increased $2.3 million, or 2%, in 2004 over 2003, due primarily to higher cost of insurance fees from the growth of in-force business, partially offset by lower fees due to lower premium deposits.
Annuities pre-tax income decreased $0.7 million, or 6%, in 2005 from 2004, due primarily to the effects of unlocking and higher DAC amortization from higher margins and lower persistency. These decreases to pre-tax income were offset by improved investment margins from higher investment earnings and lower interest credited from lower balances subject to guaranteed crediting rates.
In 2005, the effects of unlocking increased pre-tax segment income by $23.8 million through the second quarter, consisting of increases in variable universal life of $28.6 million and universal life of $13.8 million, partially offset by decreases in annuities of $10.7 million and traditional life of $7.9 million. The favorable effect of unlocking was reduced in the second half of 2005 due to higher DAC amortization of $5.8 million, particularly for universal life.
Other pre-tax income increased $1.4 million, or 700%, in 2004 over 2003, due primarily to higher investment earnings, principally from an old block of corporate-owned life insurance, plus a premium received on a bond investment.
Our investment product fee revenues are based on assets under management. Approximately 52% of our investment product fees were based on beginning of quarter assets under management while the remaining 48% were based on end of day balances. End of year and average assets (based on how fees are calculated) under management follow:
Assets under management were $37.4 billion and $42.9 billion, at December 31, 2005 and 2004 respectively. The decrease in assets under management since December 31, 2004 is due primarily to net outflows of $5.6 billion offset, in part, by positive investment performance of $0.2 billion.
Sales of retail products in 2005 were $3.8 billion, consistent with sales in 2004. Redemptions from existing accounts were $8.2 billion, an increase of 13% over 2004. Sales of institutional accounts in 2005 were $6.5 billion, an increase of 127% over 2004. Lost accounts and withdrawals from existing accounts were $7.8 billion, an increase of 28% over 2004. During the third quarter of 2005, one of the collateralized debt obligation trusts we manage, Phoenix-Mistic 2002-1 CDO, Ltd., or Mistic, became callable and was liquidated by its bondholders, which contributed approximately $1.2 billion to the increase in withdrawals.
Two of the three collateralized debt obligation trusts that we consolidate became callable in prior years. The third, Mistic, became callable on September 15, 2005 by its bondholders and was liquidated. The remaining assets of the trust, in excess of remaining liabilities, were distributed to the trust’s equity investors, including our life insurance subsidiary, pro rata based upon the amounts originally invested. Liquidation of this trust resulted in a reduction to zero of all of our assets, liabilities and accumulated other comprehensive income associated with this trust, with our life insurance subsidiary’s share of any residual balance recorded to earnings. As a result of this liquidation, Asset Management recorded approximately $2.2 million of additional fee income in 2005.
Other operating expenses decreased $35.9 million, or 15%, in 2005 compared to 2004, due primarily to a decrease of $28.7 million in employment expenses. The decrease in employment expenses was due primarily to a decrease in incentive compensation expense, which was primarily driven by lower investment product fee revenues. General and administrative expenses remained relatively constant in 2005 compared to 2004, with increases in investment research fees being offset by decreases in clearance costs. Mandatorily redeemable interest costs decreased $7.6 million due to the acquisition of the remaining outstanding mandatorily redeemable noncontrolling interests in certain of our asset management subsidiaries during the second and third quarters of 2005.
Allocated income tax benefits increased $7.0 million in 2005 over 2004 primarily as a result of segment losses in 2005 compared to segment income in 2004.
Investment product fees increased $12.6 million, or 6%, in 2004 over 2003. This increase was due primarily to an increase in average assets under management compared to the prior year. Retail and institutional investment product fees increased $9.8 million and $6.2 million, respectively, as a result of the increase in average assets under management. Other investment product fees decreased $1.7 million due to decreased volumes in equity trading by certain of our clients, which resulted in fewer commissions earned. Approximately 57% of our
There were no impairments of goodwill or other intangible assets in 2004 and 2003.
Our venture capital investments are limited partnership interests in venture capital funds, leveraged buyout funds and other private equity partnerships sponsored and managed by third parties. We record our investments in venture capital partnerships in accordance with the equity method of accounting. (See Venture Capital Partnerships in the Critical Accounting Estimates section of Management’s Discussion and Analysis of Financial Condition and Results of Operations.) Venture capital investments are investments of the general account of Phoenix Life.
Net investment income for the year ended December 31, 2005 decreased $4.5 million from December 31, 2004. This decrease is primarily related to the true-up adjustments to partnerships’ audited financial statements from estimated amounts as of December 31, 2004.
Proceeds from sale of partnership interests and transfer to closed block
The change in venture capital investments for 2005 decreased $137.8 million from the change for 2004. This change is due primarily to our sale of certain partnership interests in December 2005 and the return of capital distributions received in the Venture Capital segment.
Venture capital investments for 2004 increased $38.1 million over the change for 2003, due primarily to proceeds from, and realized losses on, the sale of partnership interests and transfer to the closed block in 2003, which reduced the venture capital balance by $66.5 million. This change was partially offset by a decrease in equity in earnings of $16.9 million and higher distributions, which increased $18.2 million over 2003.
The invested assets in the Life Companies’ general accounts are generally of high quality and broadly diversified across asset classes, sectors and individual credits and issuers. Our investment professionals manage these general account assets in investment segments that support specific product liabilities. These investment segments have distinct investment policies that are structured to support the financial characteristics of the related liabilities within them. Segmentation of assets allows us to manage the risks and measure returns on capital for our various businesses and products.
During 2003, we implemented a comprehensive, enterprise-wide risk management program. Early in 2004 we appointed a Chief Risk Officer, reporting to the Chief Financial Officer, to oversee all of our risk management activities. We have established an Enterprise Risk Management Committee, chaired by the Chief Executive Officer, to ensure our risk management principles are followed and our objectives are accomplished. In addition, we have established several management committees overseeing and addressing issues pertaining to all our major risks-product, market and operations-and capital management.
Operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. We have established an Operational Risk Committee, chaired by the Chief Risk Officer, to develop an enterprise-wide framework for managing and measuring operational risks. This committee meets monthly and has a membership that represents all significant operating, financial and staff departments of the company.
One of the key measures we use to quantify our interest rate exposure is duration, as a measure of the sensitivity of the fair value of assets and liabilities to changes in interest rates. For example, if interest rates increase by 100 basis points, or 1%, the fair value of an asset with a duration of five years is expected to decrease by 5%. We believe that as of December 31, 2005, our asset and liability portfolio durations were well matched, especially for our largest and most interest-sensitive segments. We regularly undertake a sensitivity analysis that calculates liability durations under various cash flow scenarios.
Because experience showed that the duration of the RPE liabilities is longer than we had previously assumed, beginning in the second quarter of 2004 we extended the duration of the assets. In the third quarter of 2005, we shortened the duration of the asset portfolio in response to increasing short-term yields and to higher lapse rates. The net effect of these changes has been to enhance operating income to the point where this product essentially breaks even.
We also manage credit risk through industry and issuer diversification and asset allocation. Maximum exposure to an issuer or derivatives counterparty is defined by quality ratings, with higher quality issuers having larger exposure limits. We have an overall limit on below investment-grade rated issuer exposure.
Certain annuity products sold by our Life Companies contain guaranteed minimum death benefits. The guaranteed minimum death benefit feature provides annuity contract holders 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 guaranteed minimum death benefit 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, 2005 and 2004, the difference between the guaranteed minimum death benefit and the current account value (net amount at risk) for all existing contracts was $82.1 and $125.3 million, respectively. This is our exposure to loss should all of our contractholders have died on either December 31, 2005 or 2004.
Foreign currency exchange risk is the risk that we will incur economic losses due to adverse changes in foreign currency exchange rates. Our functional currency is the U.S. dollar. Our exposure to fluctuations in foreign exchange rates against the U.S. dollar primarily results from our holdings in non-U.S. dollar-denominated debt and equity securities which are not material to our consolidated financial statements at December 31, 2005.
Our general account debt securities portfolio consists primarily of investment-grade publicly traded and privately placed corporate bonds, residential mortgage-backed securities, commercial mortgage-backed securities and asset-backed securities. As of December 31, 2005, our general account debt securities, with a carrying value of $13,404.6 million, represented 81.7% of total general account investments. Public debt securities represented 77.5% of total debt securities, with the remaining 22.5% represented by private debt securities.
We consolidate debt and equity securities on our consolidated balance sheet that are pledged as collateral for the settlement of collateralized obligation liabilities related to two collateralized obligation trusts which we sponsor. See Note 8 of our consolidated financial statements in this Form 10-K for additional information on these debt and equity securities pledged as collateral.
lower defaults compared to B or CCC rated bonds. As of December 31, 2005, our total below investment grade securities totaled $984.3 million, or 7.3%, of our total debt security portfolio. Of that amount, $753.0 million, or 5.6%, of our debt security portfolio was invested in the BB category. Our debt securities having an increased risk of default (those securities with an SVO rating of four or greater which is equivalent to B or below) totaled $231.3 million, or 1.7%, of our total debt security portfolio.
Realized impairment losses on debt and equity securities pledged as collateral relating to our direct investments in the consolidated collateralized obligation trusts are $0.0 million, $3.7 million and $5.9 million for the years ended December 31, 2005, 2004 and 2003, respectively.
Impairment losses decreased from $49.5 million in 2004 to $35.3 million in 2005. Affiliate transaction gains and losses for the year ended December 31, 2005 include a $14.4 million gain on the sale of our equity investment in Lombard and a $10.7 million realized loss on the sale of our equity investment in Aberdeen. Transaction gains of $69.5 million for the year ended December 31, 2005 are significantly higher than the $48.7 million on December 31, 2004. Transaction gains in 2005 include a $86.3 million realized gain on the HRH stock purchase transaction and a $13.9 million loss on the venture capital transaction. Results in 2005 are substantially lower than the $112.3 million in 2003, which included the realized gains on the sale of certain of our debt and equity investments. See Notes 1 and 5 to our consolidated financial statements in this Form 10-K for additional information.
Total net unrealized gains on debt and equity securities were $291.9 million (unrealized gains of $438.2 less unrealized losses of $146.3). Of that net amount, $34.9 million was outside the closed block ($11.3 million after applicable DAC and deferred income taxes) and $257.0 million was in the closed block ($0.0 million after applicable policyholder dividend obligation).
At the end of each reporting period, 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.
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, 2005. In the tables, we separately present information that is applicable to unrealized losses both outside and inside the closed block. We believe it is unlikely that there would be any effect on our net income related to the realization of investment losses inside the closed block due to the current sufficiency of the policyholder dividend obligation liability in the closed block. See Note 3 to our consolidated financial statements in this Form 10-K for more information regarding the closed block. Applicable DAC and deferred income taxes further reduce the effect on our comprehensive income.
For debt securities outside of the closed block with gross unrealized losses, 82.1% of the unrealized losses after offsets pertain to investment grade securities and 17.9% of the unrealized losses after offsets pertain to below investment grade securities at December 31, 2005.
As of December 31, 2004 and 2003, we owned 16.5% of the then outstanding shares of Aberdeen, which we sold to third parties on January 14, 2005 for net proceeds of $70.4 million which resulted in a $7.0 million after-tax realized investment loss. We also owned a $27.5 million convertible subordinated note issued by Aberdeen, which was repaid in full on November 19, 2004. These transactions completed our disposition of our direct financial interests in Aberdeen. See Notes 1 and 5 to our consolidated financial statements in this Form 10-K for more information related to our investments in Aberdeen.
Liquidity refers to the ability of a company to generate sufficient cash flow to meet its cash requirements. The following discussion combines liquidity and capital resources as these subjects are interrelated.
Cash from continuing operations increased $393.4 million in 2005 over 2004, due to proceeds of $129.7 million from the sale of trading equity securities related to Aberdeen and Lombard and to lower payments for operating expenses, policy benefits and tax refunds of $54.3 million, $357.8 million, and $24.9 million, respectively. These positive operating cash flows were partially offset by a reduction in premiums and product fees collected of $126.9 million, lower investment income received of $29.0 million and higher acquisition expenses of $23.0 million. The reduction in policy benefits paid is due primarily to scheduled withdrawals from a group of large corporate-owned life insurance contracts in 2004 that did not recur at the same level in 2005.
Cash from continuing operations decreased $338.6 million, in 2004 from 2003, due primarily to higher benefits paid, which are funded through investing activities. Benefit payments were higher in 2004 due primarily to scheduled surrenders and withdrawals of $184.2 million related to a portion of a group of large corporate-owned policies and higher surrenders for an old run-off block of corporate-owned life insurance and for participating life insurance.
Cash from financing activities decreased $347.1 million, in 2004 from 2003, due to reductions in policyholder deposit fund deposits of $416.9 million in 2004 compared to 2003. This decrease was partially offset by net proceeds from borrowings in 2004 of $41.4 million. See Note 6 to our consolidated financial statements in this Form 10-K for more information on financing activities.
Cash from operating activities increased $28.0 million in 2004 over 2003, due primarily to an increase of $25.2 million in the dividend received from Phoenix Life.
Cash for investing activities decreased $17.7 million in 2004 from 2003, due primarily to a decrease in subsidiary purchases and advances to subsidiaries in 2004.
The credit facility contains covenants that require us at all times to maintain consolidated stockholders’ equity, in accordance with GAAP, excluding the accounting effects of FIN 46(R), of $1,648.4 million, plus 50% of positive quarterly net income and 100% of equity issuances and a maximum consolidated debt-to-capital ratio of 30% and that limit consolidated indebtedness, subject to certain exceptions, to $750.0 million. In addition, Phoenix Life must maintain a minimum risk-based capital ratio of 250% and a minimum A.M. Best financial strength rating of “A-”. Borrowings under the facility are not conditioned on the absence of a material adverse change.
Individual life insurance policies, other than term life insurance policies, increase in cash values over their lives. Policyholders have the right to borrow an amount generally up to the cash value of their policies at any time. As of December 31, 2005, our Life Companies had approximately $12.0 billion in cash values with respect to which policyholders had rights to take policy loans. The majority of cash values eligible for policy loans are at variable interest rates that are reset annually on the policy anniversary. Policy loans at December 31, 2005 were $2.2 billion.
During 2005, Phoenix Life paid dividends of $35.1 million to The Phoenix Companies, Inc., as Phoenix Life’s sole shareholder. Under New York Insurance Law, Phoenix Life can pay dividends to The Phoenix Companies in any calendar year without the approval from the New York Superintendent of Insurance in the amount of the lesser of 10% of Phoenix Life’s surplus to policyholders as of the immediately preceding calendar year or Phoenix Life’s statutory net gain from operations for the immediately preceding calendar year, not including realized capital gains. Phoenix Life’s statutory gain from operations was $106.2 million for the year ended December 31, 2005. The maximum dividend that Phoenix Life can pay in 2006 without prior approval is $88.6 million.
Available-for-sale debt securities decreased by $71.7 million in 2005 from December 31, 2004, due primarily to an increase in interest rates during 2005.
Mortgage loans decreased $79.3 million in 2005 from December 31, 2004, due to principal paydowns and closings with no new purchases.
Venture capital partnerships decreased by $110.2 million in 2005 from December 31, 2004, due primarily to the sale of certain venture capital partnerships in the fourth quarter of 2005. See Note 5 to our consolidated financial statements in this Form 10-K for additional information on venture capital.
Other investments decreased by $61.2 million in 2005 from December 31, 2004, due primarily to the sale of certain hedge fund assets and lower derivative asset values.
Securities pledged as collateral and the associated non-recourse collateralized obligations decreased $974.4 million and $965.3 million, respectively, in 2005 from December 31, 2004, due to the redemption of the Mistic CBO and partial paydowns of certain of the underlying funds. Minority interest also decreased as a result of the Mistic redemption. See Note 8 to our consolidated financial statements in this Form 10-K for additional information on securities pledged as collateral.
Goodwill increased $40.5 million in 2005 from December 31, 2004 related principally to the acquisition of the remaining interest in KAR. See Note 4 to our consolidated financial statements in this Form 10-K for additional information on goodwill.
Policyholder deposit funds decreased $431.7 million in 2005 from December 31, 2004, due primarily to net redemptions from fixed annuities and variable annuities with guaranteed minimum crediting rates.
Indebtedness increased $61.1 million in 2005 from December 31, 2004, due primarily to promissory notes of $67.0 million issued in connection with the acquisition of the remaining minority interest in KAR. See Note 6 to our consolidated financial statements in this Form 10-K for additional information.
Other commercial commitments relate to venture capital partnerships ($105.1 million) and private placements ($61.2 million). The venture capital commitments can be drawn down by private equity funds as necessary to fund their portfolio investments through the end of the funding period as stated in each agreement. The obligations related to private placements are all due to be funded during 2006.
In 2003, we acquired the remaining interest in PFG, the holding company for our private placement operation, for initial consideration of $16.7 million. Under the terms of the purchase agreement, we may be obligated to pay additional consideration of up to $77.4 million to the selling shareholders, including $7.0 million during 2006 and 2007 based on certain financial performance targets being met, and the balance in 2008 based on the appraised value of PFG as of December 31, 2007. During each of the two years in the period ended December 31, 2005, we paid $3.0 million under this obligation.
The increases in the projected benefit obligations of the employee plan and the supplemental plan at December 31, 2005 as compared to December 31, 2004 are principally the result of accrued service cost, interest cost and the effect of a reduction in the discount rate used to calculate the obligation.
We made payments totaling $27.7 million to the pension plan during 2005, including $5.7 million toward the estimated 2005 contribution and $22.0 million of additional contributions. Due to pending legislation, the amount of funding that will be required in the future is uncertain. However, we expect that our required contributions will be between $35.7 million and $68.9 million through 2010, based on current and proposed legislation. Regardless of the outcome of the pending legislation, we expect our estimated contribution for 2006 to be $1.9 million. See Note 11 to our consolidated financial statements in this Form 10-K for more information on our employee benefit plans.
As of December 31, 2005, we did not have any significant off-balance sheet arrangements as defined by Item 303(a)(4)(ii) of SEC Regulation S-K. See Note 8 to our consolidated financial statements in this Form 10-K for more information on variable interest entities.
Phoenix Life’s consolidated statutory basis capital and surplus (including AVR) increased from $1,035.8 million at December 31, 2004 to $1,102.0 million at December 31, 2005. The principal factors resulting in this increase were net income and equity appreciation, offset by a dividend of $35.1 million to the parent and net realized losses on the sale of securities.
State Farm currently owns of record more than five percent of our outstanding common stock. During the years ended December 31, 2005 and 2004, our subsidiaries incurred total compensation of $37.6 million and $32.4 million, respectively, to entities which were either subsidiaries of State Farm or owned by State Farm employees, for the sale of our insurance and annuity products. During the years ended December 31, 2005 and 2004, we made payments of $37.6 million and $32.7 million, respectively, to State Farm entities for this compensation.