The discussion in this 2012 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, including that the SEC may seek sanctions against or deregister PNX and the Company;(v) the risk of PNX’s failure to file its delayed SEC filings by March 16, 2015, the extended deadline for providing these delayed SEC filings to the bond trustee, as well as the risk associated with seeking additional consents from bondholders of its outstanding 7.45% Quarterly Interest Bonds Due 2032 regarding these delayed filings; (vi) 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 PNX to file SEC reports on a timely basis; (vii) further downgrades or withdrawals of our 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; (viii) our inability to hedge our positions due to our inability to replace hedges as a result of our credit rating; (ix) the incurrence of significant Restatement-related expenses; (x) diversion of management and other human resources attention from the operation of our business; (xi) the risk that the Company’s and Phoenix Life’s restatements, the delay in our filing of periodic reports with the SEC and errors corrected in subsequent Statutory financial statement filings with state insurance regulators could result in regulatory investigations, examinations and/or inquiries, which may increase compliance costs and the potential for additional regulatory investigations, proceedings or other claims; and (xii) risks associated with our 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) limited access to external sources of liquidity and financing; (vii) the effect of guaranteed benefits within our products; (viii) potential exposure to unidentified or unanticipated risk that could adversely affect our businesses or result in losses; (ix) the consequences related to variations in the amount of our statutory capital could adversely affect our business; (x) the possibility that we may not be successful in our efforts to implement a business plan focused on new market segments; (xi) changes in our investment valuations based on changes in our valuation methodologies, estimations and assumptions; (xii) the availability, pricing and terms of reinsurance coverage generally and the inability or unwillingness of our reinsurers to meet their obligations to us specifically; (xiii) our ability to attract and retain key personnel in a competitive environment and while delayed in our SEC reporting obligations; (xiv) our dependence on third parties to maintain critical business and administrative functions; (xv) the strong competition we face in our business from banks, insurance companies and other financial services firms; (xvi) 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; (xvii) 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; (xvii) regulatory actions or examinations may harm our business; and (xviii) 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 2012 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 2012 Form 10-K, such statements or disclosures will be deemed to modify or supersede such statements in this 2012 Form 10-K.
This management’s narrative analysis provides a review of our financial condition at December 31, 2012 and 2011; our results of operations for the years 2012, 2011 and 2010; and, where appropriate, factors that may affect our future financial performance. This discussion should be read in conjunction with our financial statements in this 2012 Form 10-K.
Subsequent to the Company’s filing of its Form 10-Q for the period ended June 30, 2012, certain errors were identified in the Company’s statement of cash flows for the nine months ended September 30, 2012, as well as for previously reported periods. The Company filed a Current Report on Form 8-K with the SEC on September 18, 2012 (as was amended by Forms 8-K/A filed by the Company on November 8, 2012, March 15, 2013 and April 24, 2013, respectively) disclosing its conclusion that certain of its previously issued annual audited and interim unaudited financial statements contained in its historical Annual Reports on Form 10-K and Quarterly Reports on Form 10-Q should no longer be relied upon and should be restated. During the restatement process, the Company identified and corrected material errors, made certain reclassifications and adjustments to correct previously identified non-material out of period errors and corrected errors in retrospectively adopted amended accounting guidance. The impact of the restatement on the Company’s financial statements is detailed in Note 2 “Restatement and Amendment of Previously Reported Financial Information” to our financial statements and under “Item 8: Financial Statements and Supplementary Data” in this 2012 Form 10-K. As a result of the errors identified during the restatement, management identified material weaknesses in our internal control over financial reporting and concluded that the Company’s disclosure controls and procedures were not effective as of December 31, 2012. These weaknesses, an evaluation of the effectiveness of the Company’s disclosure controls and procedures and the Company’s remediation plans are more fully described in “Item 9A: Controls and Procedures” in Part II of this 2012 Form 10-K.
For fixed indexed annuities, policy benefits include the change in the liability associated with guaranteed minimum withdrawal benefits. The assumptions used to calculate the guaranteed minimum withdrawal liability are consistent with those used for amortizing deferred policy acquisition costs.
Interest margins. Universal life interest margins declined slightly in 2012 compared to 2011 primarily as a result of lower interest credited consistent with declining funds under management. Annuity interest margins increased primarily as a result of higher investment income attributable to growth in fixed indexed annuity funds under management.
Operating expenses. Non-deferred operating expenses increased $11.1 million to $103.6 million in 2012, compared to $92.5 million in 2011. The increase in operating expenses was a result of higher professional fees and outside services and an increase in commissions.
Deferred policy acquisition cost. Policy acquisition cost amortization decreased $6.0 million in 2012 compared to 2011. Excluding the impact of the unlocking, amortization related to universal life decreased as a result of negative mortality experience during the year. Amortization related to annuities decreased primarily as a result of improved market performance. This decrease in amortization was partially offset by the unlocking of assumptions as a result the annual comprehensive review of assumptions in the third quarter of 2012. The unlocking resulted in an increase in amortization of $1.6 million during 2012, compared to an increase in amortization of $1.2 million during 2011,which was the result of an increase in amortization related to fixed and variable annuity policies primarily due to lower spreads due to the low interest rate environment.
We are focused on the following key strategic pillars, which have defined our strategy since 2009:
The Company incurred $18.6 million in 2013 for audit, financial and actuarial consulting, and legal expenses related to the restatement process and preparation of restated financial statements.
For a discussion of accounting standards and change in accounting, see Note 3 to our financial statements under “Item 8: Financial Statements and Supplementary Data” in this 2012 Form 10-K.
The projection of EGPs requires the extensive use of actuarial assumptions, estimates and judgments about the future. Future EGPs are generally projected for the estimated lives of the contracts. Assumptions are set separately for each product and are reviewed at least annually based on our current best estimates of future events. The following table summarizes the most significant assumptions used in the categories set forth below:
Future premiums and related fees are projected based on contractual terms, product illustrations at the time of sale and expected policy lapses without value. Assumptions are updated based on recent experience and include anticipated changes in behavior based on changes in policy charges if the Company has a high degree of confidence that such changes will be implemented (e.g., change in COI charges).
All assumption changes, whether resulting from the annual comprehensive review or from other periodic assessments, are considered an unlock in the period of revision. An unlock adjusts the deferred policy acquisition cost, SIA and URR balances as well as additional death benefit reserves and COI balances in the balance sheets. An unlock that results in an after-tax benefit generally occurs as a result of actual experience or future expectations of product profitability being favorable compared to previous estimates. An unlock that results in an after-tax charge generally occurs as a result of actual experience or future expectations of product profitability being unfavorable compared to previous estimates.
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 or margins cannot support the or recovery of deferred policy acquisition costs, the amount deferred is reduced to the recoverable amount.
Separate account returns: Trends in equity markets have been reflected in the separate account return assumptions for variable annuities and variable universal life business. Our sensitivity analysis of the impact of this assumption indicates that at December 31, 2012, had we reprojected EGPs using a 100 basis point lower separate account return assumption (after fund fees and mortality and expense charges) and used our current best estimate assumptions for all other assumptions, the estimated increase to amortization and decrease to net income would have been approximately $4.2 million, before taxes. Conversely, a 100 basis point increase in the separate account return assumption would have decreased amortization and increased net income by approximately $5.5 million, before taxes.
Expenses: The impact of future changes in policy administration expense could impact EGPs and increase or decrease net income.
See Note 3 to our financial statements under “Item 8: Financial Statements and Supplementary Data” and the “Enterprise Risk Management” section in “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this 2012 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, 2012 fair value of $26.9 million would increase to $29.0 million if the chosen spread were decreased by 50 basis points. If the chosen spread were increased by 50 basis points, the fair value would decrease to $24.9 million. The impact of the CSA related to variable annuity GMAB and GMWB embedded derivatives at December 31, 2012 and 2011 was a reduction of $16.6 million and $36.7 million in the reserves associated with these riders, respectively.
We classify our debt securities as available-for-sale and report them in our balance sheets at fair value. Fair value is based on quoted market price or external third party information, where available. When quoted market prices are not available, we estimate fair value by discounting debt security cash flows to reflect interest rates currently being offered on similar terms to borrowers of similar credit quality, by quoted market prices of comparable instruments and by independent pricing sources or internally developed pricing models.
See Note 10 to our financial statements under Item 8 “Financial Statements and Supplementary Data” in this 2012 Form 10-K for additional disclosures of our fair value methodologies.
In evaluating whether a decline in value is other-than-temporary, we consider several factors including, but not limited to, the following:
See Note 7 to our financial statements under “Item 8: Financial Statements and Supplementary Data” and the Debt Securities and Enterprise Risk Management sections of Management’s Narrative Analysis of the Results of Operations in this 2012 Form 10-K for more information.
Deferred tax assets and/or liabilities are determined by multiplying the differences between the financial reporting and tax reporting bases for assets and liabilities by the enacted tax rates expected to be in effect when such differences are recovered or settled. U.S. GAAP requires an assessment of the realizability of deferred tax assets in order to determine whether a valuation allowance should be recorded. The total deferred tax asset, net of any valuation allowance, represents the deferred tax asset that management estimates to be realizable. The assessment of the realizability of deferred tax assets involves management making assumptions and judgments about all available positive and negative evidence including the reversal of gross deferred tax liabilities, projected future taxable income, prudent and feasible tax planning strategies and recent operating results, including the existence of cumulative income (loss) incurred over the three-year period ended December 31, 2012.
As of December 31, 2012, we concluded that our estimates of future taxable income, certain tax planning strategies and other sources of income did not constitute sufficient positive evidence to assert that it is more likely than not that certain deferred tax assets would be realizable. Accordingly, a valuation allowance of $105.4 million has been recorded on net deferred tax assets of $121.6 million. The valuation allowance recorded constitutes a full valuation allowance on the net deferred tax assets that require future taxable income in order to be realized. The remaining deferred tax asset of $16.2 million attributable to available-for-sale debt securities with gross unrealized losses do not require a valuation allowance due to our ability and intent to hold these securities until recovery of fair or principal value through sale or contractual maturity, thereby avoiding the realization of taxable losses. This conclusion is consistent with prior periods. The impact of the valuation allowance on the allocation of tax to the components of the financial statements included an increase of $60.2 million in net loss and an increase of $11.1 million in OCI-related deferred tax balances.
The calculation of tax liabilities involves uncertainties in applying certain tax laws. ASC 740 provides that a tax benefit that arises from an uncertain tax position that is more likely than not to be upheld upon IRS examination shall be recognized in the financial statements. The more likely than not threshold requires judgments made by management and the related tax liability is adjusted accordingly as new information becomes available. Due to the complexities of such uncertainties, tax payments made upon IRS examination may be materially different from the current estimate of tax liabilities in the event there is disagreement on the tax positions taken. Those payments are reflected in income tax expense in the period in which the examinations are completed.
See Note 11 to our financial statements under “Item 8: Financial Statements and Supplementary Data” in this 2012 Form 10-K for more information.
Policy benefits increased $94.2 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 policies 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 additional sales during the year. Policy benefit expenses of $28.3 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 compared to a decrease in benefit expenses of $12.7 million due to the reserve unlocking during 2011.
Other operating expenses increased $11.1 million to $ 103.6 million for the year ended December 31, 2012, compared with $92.5 million for the year ended December 31, 2011. The increase in operating expenses was a result of higher professional and outside services and an increase in commissions.
The effective tax rate for 2012 and 2011 was 13.3% and (23.9%) respectively. The principal cause of the difference between the effective rate and the U.S. statutory rate of 35% in 2012 was an increase in the valuation allowance on the pre-tax loss and the dividend received deduction. The principal cause of the difference between the effect rate and the U.S. statutory rate of 35.0% in 2011 was an increase in the valuation allowance on the pre-tax loss and the dividend received deduction.
The Company recorded an income tax expense of $16.2 million to continuing operations in 2012, compared to an income tax benefit of $6.3 million to continuing operations in 2011. A current tax expense of $27.7 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 $11.5 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 $0.6 million was recognized related to alternative minimum tax, offset by a deferred tax benefit of $6.9 million related to the same intraperiod allocation rules applicable in 2012.
Three months ended March 31, 2012 vs. three months ended March 31, 2011
The Company recorded a net loss of $22.5 million for the three months ended March 31, 2012, compared with net income of $3.6 million for the three months ended March 31, 2011. The decrease in results reflects lower insurance and investment product fees, partially offset by higher net investment income.
Insurance and investment product fees decreased $4.8 million during the three months ended March 31, 2012 compared with the three months ended March 31, 2011 primarily as a result of lower cost of insurance charges related to declining universal life insurance in force.
Policy acquisition cost amortization increased $6.5 million in the three months ended March 31, 2012 compared to the three months ended March 31, 2011. Amortization related to fixed indexed annuities increased primarily due to higher policy acquisition cost balances resulting from additional policy sales during the period. Partially offsetting these increases, amortization decreased primarily related to variable annuities as a result of improved market performance.
Insurance and investment product fees declined $9.9 million in the quarter ended June 30, 2012 compared with the quarter ended June 30, 2011. Lower fees were primarily a result of a decrease of $7.6 million in cost of insurance charges related to declining life insurance in force and a decrease of $2.5 million in surrender charges consistent with lower policy surrenders.
Net investment income increased by $8.4 million to $32.6 million for the three months ended June 30, 2012 compared to $24.2 million for the three months ended June 30, 2011. The increase was due to higher investment income on long-term debt securities as a result of additional purchases made during the year due to the growth in fixed indexed annuities funds under management.
Policy benefits increased $8.0 million to $91.6 million for the three months ended June 30, 2012 compared with $83.6 million for the three months ended June 30, 2011. The increase in policy benefit expenses was primarily a result of higher annuity benefits due to changes in reserves on fixed indexed annuities associated with minimum death and income benefit guarantees which were driven by additional sales during the period. In addition, life reserves increased due to live rescissions during the quarter. These increases were partially offset by lower universal life benefits due to positive mortality over the quarter.
Net realized investment gains of $3.8 million were recognized for the three months ended September 30, 2012, compared with net realized investment losses of $4.2 million for the three months ended September 30, 2011. Realized investment losses for the 2012 third quarter were due to an impairment loss of $1.0 million on long-term debt securities and a net loss of $25.7 million on derivative assets and embedded derivative liabilities. These losses were partially offset by net realized gains of $20.7 million on long-term debt securities. The derivative loss was attributable to a loss of $10.1 million on derivative contracts associated with our variable and fixed annuity guarantees and a loss of $7.8 million related to our surplus hedge which utilizes futures and options to hedge against declines in equity markets and the resulting statutory capital and surplus impact. These derivative losses were offset by gains of $12.5 million on our embedded derivative assets and liabilities associated with variable and fixed indexed annuity guarantees. A loss of $2.9 million relating to the non-performance risk factor was included in the total derivative loss.
The Company recorded a net loss of $2.5 million for the three months ended December 31, 2012, compared with a net loss of $1.4 million for the three months ended December 31, 2011. The decrease for the fourth quarter of 2012 reflects higher policy benefits and operating expenses and lower insurance and investment product fee income. These declines in results were partially offset by higher net investment income and premiums and lower policy acquisition cost amortization.
Insurance and investment product fees on our life and annuity products decreased $9.7 million in the three months ended December 31, 2012 compared with the three months ended December 31, 2011. Lower fees for the fourth quarter of 2012 were primarily a result of a $13.9 million decrease in COI charges related to declining universal life insurance in force. Partially offsetting these declines were higher investment product fees related to an increase in outstanding annuity policies.
Net realized investment losses of $9.6 million were recognized for the three months ended December 31, 2012, compared with net realized investment losses of $11.3 million for the three months ended December 31, 2011. Realized investment losses for the quarter were due to an impairment loss of $0.2 million on long-term debt securities and a net loss of $20.6 million on derivative assets and embedded derivative liabilities. The derivative loss was attributable to a loss of $12.8 million on derivative contracts associated with our variable and fixed annuity guarantees, a loss of $3.5 million associated with embedded derivatives related to related party reinsurance agreements, and a loss of $2.7 million related to our surplus hedge which utilizes futures and options to hedge against declines in equity markets and the resulting statutory capital and surplus impact. These derivative losses were offset by gains of $8.6 million on our embedded derivative liabilities associated with variable and fixed indexed annuity guarantees. A loss of $2.9 million related to the non-performance risk factor was included in the total derivative loss.
Policy benefits increased $22.6 million for the three months ended December 31, 2012 compared with the three months ended December 31, 2011. The increase in policy benefit expense for the fourth quarter of 2012 was a result of higher death benefits for universal life as a result of negative mortality experience during the 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 additional sales during the year.
The Company recorded an income tax benefit of $7.4 million compared to an income tax expense of $10.5 million for the three months ended December 31, 2012 and 2011, respectively. The benefit as of December 31, 2012 was primarily driven by a $5.1 million benefit that results from the application of ASC 740 intraperiod allocation rules. These rules allow for the benefitting of current year losses 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). This benefit was increased by a $2.3 million current tax benefit.
We manage interest rate risk as part of our asset-liability management and product development processes. Asset-liability management strategies include the segmentation of investments by product line and the construction of investment portfolios designed to satisfy the projected cash needs of the underlying product liabilities. All asset-liability management strategies are approved by the ALCO. We manage the interest rate risk in portfolio segments by modeling and analyzing asset and product liability durations and projected cash flows under a number of interest rate scenarios.
To calculate duration for liabilities, we project liability cash flows and discount them to a net present value using a risk-free market rate adjusted for a spread for credit and pricing margins. For interest-sensitive liabilities the cash flows are projected under a number of stochastically generated interest-rate scenarios and reflect the impact of the specific scenarios on policyholder behavior as well as the effect of minimum guarantees. Duration is calculated by revaluing these cash flows at alternative levels of interest rates (a 'shock-up' and a 'shock-down') and by determining the percentage change in fair value from the base case.
Certain variable annuity products sold by us contain guaranteed minimum living benefits. These include guaranteed minimum accumulation, withdrawal, income and payout annuity floor benefits. The GMAB guarantees a return of deposit to a policyholder after 10 years regardless of market performance. The GMWB guarantees that a policyholder can withdraw a certain percentage for life regardless of market performance. The GMIB guarantees that a policyholder can convert his or her account value into a guaranteed payout annuity at a guaranteed minimum interest rate and a guaranteed mortality basis, while also assuming a certain level of growth in the initial deposit. We also offer a combination rider that offers both GMAB and GMDB benefits. We have established a hedging program for managing the risk associated with our guaranteed minimum accumulation and withdrawal benefit features. We continue to analyze and refine our strategies for managing risk exposures associated with all our separate account guarantees. The liabilities related to these benefits totaled $49.2 million and $63.7 million at December 31, 2012 and 2011, respectively.
See Note 5 to our financial statements under “Item 8: Financial Statements and Supplementary Data” in this 2012 Form 10-K for more information regarding deferred policy acquisition costs.
Fair value is based upon quoted market prices, where available. If listed prices or quotes are not available, or are based on disorderly transactions or inactive markets, fair value is based upon internally developed models that use primarily market-based or independently-sourced market parameters, including interest rate yield curves, option volatilities and currency rates. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments include amounts to reflect counterparty credit quality, our own creditworthiness, liquidity and unobservable parameters that are applied consistently over time.
See Note 10 to our financial statements under “Item 8: Financial Statements and Supplementary Data” in this 2012 Form 10-K for additional information regarding the estimated fair value of investments.
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, 2012 in our debt securities portfolio are banking (6.1%), electric utilities (5.1%), diversified financial services (4.1%), oil (4.0%) and insurance (3.2%).
The following table presents exposure to European debt. We have focused on the countries experiencing significant economic, fiscal or political strain that could increase the likelihood of default.
Individual categories may not agree with the Debt Securities by Type table on previous page due to nature of underlying collateral. In addition, RMBS holdings in this exhibit include $21.9M classified as fair value investments on the balance sheet. For these fair value investments, there is no impact to OCI as carrying value is equal to market value.
Percentages based on market value. CMBS holdings in this exhibit include $8.6 million classified as fair value investments on the balance sheets. For these fair value investments, there is no impact to OCI as carrying value is equal to market value.
Management assessed all securities in an unrealized loss position in determining whether impairments were temporary or other-than-temporary. In reaching its conclusions, management exercised significant judgment and used a number of issuer-specific quantitative indicators and qualitative judgments to assess the probability of receiving a given security’s contractual cash flows. This included the issue’s implied yield to maturity, cumulative default rate based on rating, comparisons of issue-specific spreads to industry or sector spreads, specific trading activity in the issue and other market data such as recent debt tenders and upcoming refinancing requirements. Management also reviewed fundamentals such as issuer credit and liquidity metrics, business outlook and industry conditions. Management maintains a watch list of securities that is reviewed for impairments. Each security on the watch list was evaluated, analyzed and discussed, with the positive and negative factors weighed in the ultimate determination of whether or not the security was other-than-temporarily impaired. For securities for which no OTTI was ultimately indicated at December 31, 2012, management does not have the intention to sell, nor does it expect to be required to sell, these securities prior to their recovery.
Fixed income OTTIs recorded in 2012 were primarily concentrated in structured securities. These impairments were driven primarily by increased collateral default rates. In our judgment, these credit events or other adverse conditions of the collateral have caused, or will most likely lead to, a deficiency in the contractual cash flows related to the investment. Therefore, based upon these credit events, we have determined that OTTIs exist. Total debt impairments recognized through earnings related to such credit-related circumstances were $2.8 million in 2012, $2.8 million in 2011 and $10.8 million in 2010. Total equity impairments recognized through earnings was $0.4 million in 2011. There were no equity impairments recognized in 2012 and 2010. There were no limited partnerships and other investment OTTIs in 2012, 2011 and 2010.
The following table presents a roll-forward of pre-tax credit losses recognized in earnings related to debt securities for which a portion of the OTTI was recognized in OCI.
Adjustment relates to the impact of adoption in 2010 of Accounting Standards Update 2010-11, Derivatives and Hedging (Topic 815), Scope Exception Related to Embedded Credit Derivatives.
Net unrealized investment gains and losses on securities classified as available-for-sale and certain other assets are included in our balance sheets as a component of AOCI. The table below presents the special category of AOCI for debt securities that are other-than-temporarily impaired when the impairment loss has been split between the credit loss component (in earnings) and the non-credit component (separate category of AOCI).
Our liquidity requirements principally relate to the liabilities associated with various life insurance and annuity products and operating expenses. 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.
Historically, we have used cash flow from operations, investing activities and capital contributions from our shareholder to fund liquidity requirements. Our principal cash inflows from life insurance and annuities activities come from premiums, annuity deposits and charges on insurance policies and annuity contracts. Principal cash inflows from investing activities result from repayments of principal, proceeds from maturities, sales of invested assets and investment income.
Cash flows provided by financing activities decreased $245.8 million during the year ended December 31, 2012. This decline was primarily a result of a decrease in policyholder deposits and an increase in withdrawals and lower sales of fixed indexed annuities when compared to 2011.
Cash flows used for investing activities increased $706.4 million during the year ended December 31, 2011 compared to the year ended December 31, 2010. The primary driver of this fluctuation was an increase in purchases of available-for-sale debt securities which was directly attributable to the increase in deposits related to fixed indexed annuities. See Note 7 to our consolidated financial statements under “Item 8: Financial Statements and Supplementary Data” in this 2012 Form 10-K for additional information on investing activities.
Cash flows provided by financing activities increased $757.5 million during the year ended December 31, 2011 compared to the year ended December 31, 2010 primarily as a result of increase in policyholder deposits related to sales of fixed indexed annuities.
Cash used for investing activities decreased $75.4 million during the six months ended June 30, 2012 compared with the six months ended June 30, 2011. The primary driver of this fluctuation was decreased purchases of available-for-sale debt securities resulting from comparable fixed index annuity deposits and less cash being generated from our investment portfolio due to low interest rate environment.
Cash flows used for investing activities decreased by $246.6 million resulting from sales and maturities of available for sale debt outpacing purchases. The fluctuation in purchasing activity was primarily driven by a reduction in deposits from sales of fixed index annuities as compared to September 30, 2011 while sales increased due to an effort to produce capital gains to offset previous capital losses.
We believe that our existing and expected sources of liquidity are adequate to meet both our current and anticipated needs.
On January 14, 2014, Moody’s Investor Services withdrew all ratings of The Phoenix Companies, Inc. including the Ba2 financial strength ratings of the Company and Phoenix Life and the B1 debt rating of Phoenix Life's surplus notes. On September 25, 2013, Moody’s Investor Services maintained the review for downgrade for our Ba2 financial strength rating. On June 21, 2013, Moody’s Investor Services maintained the review for downgrade for our Ba2 financial strength rating. On March 20, 2013, Moody’s Investor Services maintained the review for downgrade for our financial strength rating of Ba2. On December 12, 2012, Moody’s Investor Services placed our financial strength rating of Ba2 under review for downgrade. On December 16, 2011, Moody’s Investor Services affirmed our financial strength rating of Ba2 and changed their outlook from stable to positive.
On May 22, 2013, Standard & Poor’s affirmed our financial strength rating of BB-. All ratings were removed from CreditWatch with Negative Implications and placed on negative outlook. On March 8, 2013, Standard & Poor’s placed our financial strength rating of BB- on CreditWatch Negative. On January 16, 2013, Standard & Poor’s affirmed our financial strength rating of BB-. They also removed the ratings from CreditWatch Negative and returned the outlook to stable. On December 7, 2012, Standard & Poor’s affirmed our financial strength rating of BB- and placed it on CreditWatch Negative. On April 5, 2012, Standard & Poor’s affirmed our financial strength rating of BB- and maintained their stable outlook on our rating. On March 24, 2011, Standard & Poor’s affirmed our financial strength rating of BB- and changed their outlook from negative to stable.
The financial strength ratings as of April 22, 2014 were as follows:
The increase in total investments was the result of purchases of securities associated with positive cash flow generated by our annuity business due to additional sales over the period. In addition, the value of available-for-sale debt securities improved as a result of favorable impacts on fixed income securities as treasury rates have declined during 2012.
Deferred policy acquisition costs decreased primarily related to universal life as a result of amortization during the year ended December 31, 2012. The deferred policy acquisition cost balance associated with fixed annuities increased related to the deferral of commissions on sales of our fixed indexed annuities, partially offset by amortization of previously deferred expenses.
Separate accounts decreased primarily as a result of the transfer of pension assets from a Phoenix separate account to the direct control of the plan’s trustee during the second quarter of 2012. Variable annuity surrenders and lower market performance also contributed to the decline.
The decrease in total stockholder’s equity was primarily a result of the net loss recognized for the twelve months ended December 31, 2012. The net loss was partially offset by a decrease in accumulated other comprehensive loss related to appreciation of investments.
The increase in total investments was the result of purchases of securities associated with positive cash flow generated by our annuity business due to additional sales over the period. In addition, limited partnerships and other investments increased primarily as a result of mezzanine funds.
Deferred policy acquisition costs decreased primarily related to universal life as a result of amortization during the quarter ended March 31, 2012. The deferred policy acquisition cost balance associated with the fixed annuities increased related to the deferral of commissions on sales of our fixed indexed annuities, partially offset by amortization.
Policyholder deposit funds increased primarily as a result of continued sales of fixed indexed annuities.
Separate accounts decreased primarily as a result of the transfer of pension assets from a Phoenix separate account to the direct control of the plan’s trustee. Variable annuity surrenders and lower market performance also contributed to the decline.
Deferred policy acquisition costs decreased primarily related to universal life as a result of amortization during the nine months ended September 30, 2012. The deferred policy acquisition cost balance associated with fixed annuities increased related to the deferral of commissions on sales of our fixed indexed annuities, partially offset by amortization of previously deferred expenses.
Policyholder deposit funds increased during the nine months ended September 30, 2012 primarily as a result of continued sales of fixed indexed annuities.
Future obligations are based on our estimate of future investment earnings, mortality and surrenders. Actual obligations in any single year, or ultimate total obligations, may vary materially from these estimates as actual experience emerges. As described in Note 3 to our financial statements under “Item 8: Financial Statements and Supplementary Data” in this 2012 Form 10-K, policy liabilities and accruals are recorded on the 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, 2012 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.
As of December 31, 2012, we did not have any significant off-balance sheet arrangements as defined by Item 303(a)(4)(ii) of SEC Regulation S-K.
The employee pension plan, covering substantially all 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 all 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. Effective March 31, 2010, all benefit accruals under our funded and unfunded defined benefit plans were frozen.