Our executive headquarters consist of our main office building at One American Row in Hartford, Connecticut, which we own and occupy. We also lease space in two garages in Hartford, Connecticut for employee parking. Property is also leased for our home offices in East Greenbush, New York and for our field operations elsewhere in the U.S.
The discussion in this Annual Report on 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 strategies, operations and financial results, and often contain words such as “will,” “anticipate,” “believe,” “plan,” “estimate,” “expect,” “intend,” “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. Actual results may differ materially from those suggested by forward-looking statements as a result of risks and uncertainties which include, among others: (i) unfavorable general economic developments including, but not limited to, specific related factors such as the performance of the debt and equity markets and changes in interest rates; (ii) the potential adverse affect of interest rate fluctuations on our business and results of operations; (iii) the effect of continuing adverse capital and credit market conditions on our ability to meet our liquidity needs, our access to capital and our cost of capital; (iv) changes in our investment valuations based on changes in our valuation methodologies, estimations and assumptions; (v) the effect of guaranteed benefits within our products; (vi) potential exposure to unidentified or unanticipated risk that could adversely affect our businesses or result in losses; (vii) the consequences related to variations in the amount of our statutory capital due to factors beyond our control; (viii) the possibility that we not be successful in our efforts to implement a new business plan; (ix) 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; (x) further downgrades in our debt or financial strength ratings; (xi) the possibility that mortality rates, persistency rates, funding levels or other factors may differ significantly from our assumptions used in pricing products; (xii) the possibility of losses due to defaults by others including, but not limited to, issuers of fixed income securities; (xiii) the availability, pricing and terms of reinsurance coverage generally and the inability or unwillingness of our reinsurers to meet their obligations to us specifically; (xiv) our ability to attract and retain key personnel in a competitive environment; (xv) our dependence on third parties to maintain critical business and administrative functions; (xvi) the strong competition we face in our business from banks, insurance companies and other financial services firms; (xvii) our reliance, as a holding company, on dividends and other payments from our subsidiaries to meet our financial obligations and pay future dividends, particularly since our insurance subsidiaries’ ability to pay dividends is subject to regulatory restrictions; (xviii) the potential need to fund deficiencies in our closed block; (xix) tax developments that may affect us directly, or indirectly through the cost of, the demand for or profitability of our products or services; (xx) the possibility that the actions and initiatives of the U.S. Government, including those that we elect to participate in, may not improve adverse economic and market conditions generally or our business, financial condition and results of operations specifically; (xxi) legislative or regulatory developments; (xxii) regulatory or legal actions; (xxiii) potential future material losses from our discontinued reinsurance business; (xxiv) changes in accounting standards; (xxv) the potential impact of a material weakness in our internal control over financial reporting on the accuracy of our reported financial results, investor confidence and our stock price;(xxvi) the risks related to a man-made or natural disaster; (xxvii) risks related to changing climate conditions; and (xxviii) other risks and uncertainties described herein or in any of our filings with the SEC. We undertake no obligation to update or revise publicly any forward-looking statement, whether as a result of new information, future events or otherwise, except as required by law.
In 2009, we initiated a business plan that shifts the focus of new business development to areas that are less capital intensive, less ratings sensitive and not dependent on particular distributors. This plan leverages existing strengths and includes our newly formed distribution subsidiary, Saybrus Partners, Inc., repositioning some of our core life and annuity products for the middle market and establishing new relationships with distributors within that market, and identifying market opportunities for our alternative retirement solutions products.
Fees on our life and annuity products. Fees consist primarily of asset-based (including mortality and expense charges) and premium-based fees which we charge on our variable life and variable annuity products and depend on the premiums collected and account values of those products. Asset-based fees are calculated as a percentage of assets under management within our separate accounts. Fees also include surrender charges. Non-asset-based fees are charged to cover premium taxes and renewal commissions.
Since the middle of 2008, the U.S. economy has experienced unprecedented credit and liquidity issues and entered into a recession. Following several years of rapid credit expansion, a sharp contraction in mortgage lending coupled with dramatic declines in home and commercial real estate prices, rising mortgage defaults and increasing foreclosures, resulted in significant write-downs of asset values by financial institutions. These write-downs, initially of mortgage-backed securities but spreading to most sectors of the credit markets, and to credit default swaps and other derivative securities, caused many financial institutions to seek additional capital, to merge with larger and stronger institutions, to be subsidized by the U.S. government and, in some cases, to fail. Reflecting concern about the stability of the financial markets generally and the strength of counterparties many lenders and institutional investors reduced and, in some cases, ceased to provide funding to borrowers, including other financial institutions. These factors, combined with declining business and consumer confidence and increased unemployment, precipitated an economic slowdown and fears of a prolonged recession.
More specifically, our business is exposed to the performance of the debt and equity markets, which have been materially and adversely affected by economic developments since the middle of 2008. These adverse conditions included, but are not limited to, a lack of buyers for certain assets, volatility, credit spread changes and benchmark interest rate changes. Each of these factors has and may continue to impact the liquidity and value of our investments.
Further, recent trends in the life insurance industry may affect our mortality, persistency and funding levels. The evolution of the financial needs of policyholders and the emergence of a secondary market for life insurance and increased availability of premium financing suggest that the reasons for purchasing our products are changing. At the same time, we also experienced an increase in life insurance sales to older individuals. While we instituted certain controls and procedures to screen applicants, we believe that our sales of universal life products include sales of policies to third party investors who, at the time of policy origination, had no insurable interest in the insured. The effect that these changes may have on our actual experience and profitability will emerge over time.
Effect of Recent Economic Market Conditions and Industry Trends on Earnings Drivers
Interest margins. Investment income on assets backing surplus was a negative $2.3 million in 2009, compared to $24.6 million in 2008. The decrease of $26.9 million was driven by lower income from our alternative investments which are reported to the Company on a one quarter lag basis in accordance with partnership accounting. Universal life interest margins were relatively flat in 2009 compared to 2008 as the Company decreased credited rates to customers to reflect the decline in investment income on assets supporting these products. Variable annuity interest margins showed some modest spread compression.
Fees on our life and annuity products. Excluding the impact of the unlocking noted above, fee revenues decreased by $23.0 million to $110.9 million in 2009, compared to $133.9 million in 2008. The decrease was primarily driven by lower asset-based fees of $10.3 million on our variable annuity products driven by lower account balances reflecting the unfavorable equity markets in late 2008 and early 2009. Additionally, the decrease reflects lower policy and premium-based fees of $12.7 million on our universal life and variable universal life products reflecting lower sales and policies in force.
On January 13, 2010, A.M. Best Company, Inc. downgraded our financial strength rating from B++ to B+ and downgraded our senior debt rating from bb+ to bb-. They maintained their negative outlook on all ratings.
On September 8, 2009, Moody’s Investor Services downgraded our financial strength rating from Baa2 to Ba1 and lowered our senior debt rating from Ba2 to B1. They maintained their negative outlook on all ratings.
On November 3, 2009, we announced the formation of a distribution company subsidiary, Saybrus Partners, Inc. (“Saybrus”) and that Saybrus had entered into an agreement with financial services firm Edward Jones to provide life insurance consulting services to the firm’s financial advisors. Phoenix formed Saybrus as part of a series of actions to strengthen its market position and strategy. Saybrus provides dedicated consultation services to partner companies, as well as support for Phoenix’s product line within our own distribution channels. The initial agreement with Edward Jones is for three years and will focus Saybrus consultants on two new insurance carriers in the Edward Jones retail distribution network, John Hancock Life Insurance Company (U.S.A.) and Pacific Life Insurance Company, both of which have a distribution agreement with Edward Jones.
In March 2009, State Farm suspended the sale of Phoenix products pending a re-evaluation of the relationship between the two companies. During 2008, State Farm was our largest distributor of annuity and life insurance products, accounting for approximately 27% of our total life insurance premiums and approximately 68% of our annuity deposits. On July 30, 2009, we restructured our agreement with State Farm, amending the existing agreement to clarify the service and support we will provide to customers who purchased their policies and contracts through a State Farm agent, as well as State Farm agents themselves. The restructured agreement does not provide for any new sales of our products through the State Farm distribution system. There are approximately 90,000 in-force Phoenix policies and contracts sold through State Farm agents.
Also in March 2009, National Life Group suspended the sale of Phoenix products. In 2008, National Life Group was our second largest distributor of annuity products, accounting for approximately 14% of our annuity deposits.
In 2005, we disposed of our interests in Lombard International Assurance S.A. In the first quarters of 2007 and 2006, we realized after-tax gains of $8.9 million and $6.5 million, respectively, which included earn-out gain consideration received. We are not entitled to any additional consideration related to this sale.
On December 20, 2007, we sold all of the outstanding stock of Emprendimiento Compartido S.A. (“EMCO”), an Argentine wholly-owned subsidiary. We realized an after-tax loss of $4.8 million on this sale. This loss and EMCO’s results up through the date of sale are reported in discontinued operations in our consolidated financial statements in this Annual Report on Form 10-K. Prior year results have also been reported in discontinued operations.
On February 7, 2008, we announced that our Board of Directors had decided to pursue the spin-off of our asset management subsidiary, Virtus Investment Partners, Inc. (“Virtus”), formerly known as Phoenix Investment Partners, Ltd., excluding the assets and business of Goodwin Capital Advisers, Inc. (“Goodwin”), in order to enhance stockholder value. On December 12, 2008, our Board of Directors formally approved the spin-off and declared a dividend payable to each holder of record at the close of business on December 22, 2008 of one share of Virtus common stock for every 20 shares of our common stock held by such holder. We distributed 100% of Virtus common stock to our stockholders (other than shares withheld to satisfy certain withholding obligations) on December 31, 2008. Following the spin-off, we and Virtus are independent of each other and have separate boards of directors and management.
The closed block policyholder dividend obligation, applicable deferred policy acquisition costs and applicable income taxes, which offset realized investment gains and losses and other-than-temporary impairments, are each reported separately as components of net income.
See Note 8 to our consolidated financial statements under “Item 8: Financial Statements and Supplementary Data” and the Debt and Equity Securities and Enterprise Risk Management sections of Management’s Discussion and Analysis of Financial Condition and Results of Operations in this Annual Report on Form 10-K for more information.
As of December 31, 2009, we performed our assessment of net deferred tax assets. Significant management judgment is required in determining the provision for income taxes and, in particular, any valuation allowance recorded against our deferred tax assets. Applying the applicable accounting guidance requires an assessment of all available evidence, positive and negative, regarding the realizability of the net deferred tax assets. Based upon recent results, we have concluded that a cumulative loss in recent years exists. We have historically relied on the following factors in our assessment of the realizability of our net deferred tax assets:
estimates of future taxable income from our operations, including our core life subgroup business;
We considered these factors in our estimate of the reversal pattern of deferred tax assets, using assumptions that we believe are reasonable and consistent with operating results. However, as a result of cumulative pre-tax losses for the thirty-six months ended December 31, 2009, we concluded that our estimates of future taxable income and certain tax planning strategies no longer constituted sufficient positive evidence to assert that it is more likely than not that certain deferred tax assets would be realizable before expiration. We reached this conclusion after consideration of additional negative evidence that emerged during 2009, including rating downgrades, the resulting suspension of sales by major distribution partners, increased transition costs associated with expense management initiatives and continuing unsettled capital and credit market conditions, all of which adversely affected prior income projections.
We have concluded that a valuation allowance on the $166.2 million of deferred tax assets attributable to available-for-sale debt securities with gross unrealized losses was not required due to our ability and intent to hold available-for-sale debt securities with gross unrealized losses until recovery of fair value or contractual maturity to avoid realizing taxable capital losses on those securities.
As of December 31, 2009, we had deferred tax assets of $170.0 million and $132.8 million related to net operating and capital losses, respectively, for federal income tax purposes. The related federal net operating losses of $485.7 million are scheduled to expire between the years 2019 and 2029. The federal capital losses of $379.4 million are scheduled to expire in 2010, 2012, 2013 and 2014. As of December 31, 2009, a valuation allowance of $64.3 million was carried against the capital loss carryforwards after consideration of available capital deferred tax liabilities and tax planning actions. As of December 31, 2009, the deferred tax assets for the net operating loss were considered with other non-capital loss deferred taxes in assessing the necessary valuation allowance.
In December 2009, we announced that, effective March 31, 2010, we are freezing all benefit accruals under our funded and unfunded defined benefit plans. This decision was inclusive of employees who had been grandfathered in the traditional formula (i.e., all participants will stop earning additional years of benefit accrual service and their pension benefit will be based on their earnings history as of March 31, 2010). A curtailment was recognized which lowered our projected benefit obligation for the reduction in the expected years of future service.
Our net loss from continuing operations for 2009 was $195.7 million, or $1.68 per share, which compares to a net loss from continuing operations for 2008 of $176.5 million, or $1.54 per share. The higher loss from continuing operations for 2009 reflects higher tax expense and lower investment income, partially offset by lower deferred policy acquisition cost amortization and lower operating expenses. Including discontinued operations, our net loss for 2009 was $319.0 million, or $2.74 per share, which compares to a net loss for 2008 of $726.0 million, or $6.35 per share. For 2009, the net loss from discontinued operations included $71.7 million of reserve strengthening related to our discontinued accident and health business and $48.5 million associated with PFG, $27.0 million related to the impairment of goodwill and $22.7 million related to the loss on the sale.
Investment income on assets supporting surplus was a negative $2.3 million in 2009, compared to $24.6 million in 2008. The decrease of $26.9 million was from lower income resulting from our alternative investments which are reported to the Company on a one quarter lag basis in accordance with partnership accounting.
Net investment income on surplus and assets supporting the open-block traditional life products decreased to $89.2 million in 2008, compared to $148.7 million in 2007, or $59.5 million. The primary driver was lower yields on debt securities which had an adverse impact on our interest margins. Our universal life interest margins declined to $15.5 million in 2008, compared to $23.6 million in 2007, or $8.1 million. Our variable annuity interest margin declined to $17.5 million in 2008, compared to $23.9 million in 2007, or $6.4 million. Additionally, our interest on surplus declined to $24.6 million in 2008, compared to $78.8 million in 2007, or $54.2 million primarily driven by lower investment income on venture capital partnerships.
Non-deferred expenses decreased to $254.9 million in 2008, compared to $270.1 million in 2007, or $15.2 million, reflecting actions to reduce expenses as we reposition our business to compete in a rapidly changing environment. These expenses also included $6.3 million in costs associated with the spin-off of our asset management business. In addition, higher mortality margins and increasing in-force blocks created higher policy costs amortization expense of $236.2, compared to $188.9 million in 2007. Amortization in 2008 also increased $183.8 million due to an unlocking of assumptions, while 2007 amortization increased by $4.1 million for an unlocking in that year.
Our effective tax rate was higher in 2008 than in 2007 in part due to the release in 2007 of a valuation allowance related to foreign tax credits, partially offset by the release in 2008 of reserves for unrecognized tax benefits related to settlements with taxing authorities.
For the year ended December 31, 2009, variable universal life funds on deposit increased compared to the prior year period. The increase reflected stronger equity markets during the second half of 2009. Partially offsetting the increase was a decrease in deposits from lower sales and renewal premiums, as well as higher surrenders than in the prior year.
Stockholders’ equity increased by $266.0 million to $1,131.1 million for the period ended December 31, 2009, compared with $865.1 million at December 31, 2008, primarily from other comprehensive income of $563.7 million, driven by unrealized gains on available-for-sale debt securities, partially offset by the net loss of $319.0 million. Stockholders’ equity also increased as a result of a cumulative effect adjustment of $20.4 million related to new accounting guidance on previous impairments on debt securities recorded directly to accumulated deficit and accumulated other comprehensive loss. Total assets decreased $1,226.3 million to $24,582.3 million at December 31, 2009, from $25,808.6 million at December 31, 2008, primarily from appreciation of available-for-sale debt securities and separate account assets, partially offset by lower deferred policy acquisition costs and lower deferred income taxes.
The effective tax rate for 2009, 2008 and 2007 was (126.0%), 40.1% and 15.2%, respectively. The principal cause of the difference between the effective rate and the U.S. statutory rate of 35% for 2009 was an increase in the valuation allowance. The principal cause of the difference between the effective tax rate and the U.S. statutory rate of 35% for 2008 was investment income not taxed (i.e., dividend received deduction and low income housing tax credits) and the release of reserves as a result of the effective settlement of an IRS audit.
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 more information related to income taxes.
We have a comprehensive, enterprise-wide risk management program. Our Chief Risk Officer reports to the Chief Financial Officer and monitors our risk management activities. During 2009, as part of our strategic repositioning and overall expense reduction effort, we refined our approach to risk management across the enterprise. We have an Enterprise Risk Management Committee, chaired by the Chief Executive Officer, whose functions are to establish risk management principles, monitor key risks and oversee our risk-management practices. Several management committees oversee and address issues pertaining to all our major risks-operational, market and product-as well as capital management.
We enter into interest rate swap agreements to reduce market risks from changes in interest rates. We do not enter into interest rate swap agreements for trading purposes. Under interest rate swap agreements, we exchange cash flows with another party at specified intervals for a set length of time based on a specified notional principal amount. Typically, one of the cash flow streams is based on a fixed interest rate set at the inception of the contract and the other is based on a variable rate that periodically resets. No premium is paid to enter into the contract and neither party makes payment of principal. The amounts to be received or paid on these swap agreements are accrued and recognized in net investment income.
Equity risk is the risk that we will incur economic losses due to adverse changes in equity prices. Our exposure to changes in equity prices primarily results from our variable annuity and variable life products, as well as from our holdings of common stocks, mutual funds and other equities. We manage our insurance liability risks on an integrated basis with other risks through our liability and risk management and capital and other asset allocation strategies. We also manage equity price risk through industry and issuer diversification and asset allocation techniques. We held $25.2 million in available-for-sale equity securities on our balance sheet as of December 31, 2009. A 10% decline or increase in the relevant equity price would have decreased or increased, respectively, the fair value of these assets by approximately $2.5 million as of December 31, 2009.
Certain life and annuity products sold by our Life Companies contain guaranteed minimum living benefits. These include guaranteed minimum accumulation, withdrawal, income and payout annuity floor benefits. The guaranteed minimum accumulation benefit (“GMAB”) guarantees a return of deposit to a policyholder after 10 years regardless of market performance. The guaranteed minimum withdrawal benefit (“GMWB”) guarantees that a policyholder can withdraw 5% for life regardless of market performance. The guaranteed minimum income benefit (“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. The guaranteed payout annuity floor benefit (“GPAF”) guarantees that the variable annuity payment will not fall below the dollar amount of the initial payment. We have established a hedging program for managing the risk associated with our guaranteed minimum accumulation and withdrawal benefit features. We began hedging our GMAB exposure in 2006 and GMWB exposure during the fourth quarter of 2007. We continue to analyze and refine our strategies for managing risk exposures associated with all our separate account guarantees. The reserves related to these benefits totaled $41.8 million and $140.5 million at December 31, 2009 and 2008, respectively.
We perform analysis with respect to the sensitivity of a change in the separate account performance assumption as it is critical to the development of the EGPs related to our variable annuity and variable life insurance business. Equity market movements have a significant impact on the account value of variable life and annuity products and fees earned. EGPs could increase or decrease with these movements in the equity market. Sustained and significant changes in the equity markets could therefore have an impact on deferred policy acquisition cost amortization.
If, instead, at December 31, 2009 we had used a 100 basis points higher separate account return assumption (after fund fees and mortality and expense charges) for both the variable annuity and variable life businesses and used our current best estimate assumptions for all other assumptions to project account values forward from the current value to reproject EGPs, the estimated decrease to amortization and increase to net income would be approximately $2.9 million, before taxes.
In December 2009, we announced that, effective March 31, 2010, we are freezing all benefit accruals under our funded and unfunded defined benefit plans. This decision was inclusive of employees who had been grandfathered in the traditional formula (i.e., all participants will stop earning additional years of benefit accrual service and their pension benefit will be based on their earnings history as of March 31, 2010). A curtailment was recognized for the reduction in the expected years of future service.
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 other asset-backed securities. As of December 31, 2009, our general account debt securities, with a carrying value of $10,345.5 million, represented 76.7% of total general account investments. Public debt securities represented 70.3% of total debt securities, with the remaining 29.7% represented by private debt securities.
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 has been to create a high level of industry diversification. The top five industry holdings as of December 31, 2009 in our debt securities portfolio were banking (6.5%), electrical utilities (4.8%), insurance (3.6%), diversified financial services (2.9%) and services (2.7%).
We invest directly in RMBS through our general account. To the extent these assets deteriorate in credit quality and decline in value for an extended period, we may realize impairment losses. When making investment decisions, we have been focused on identifying those securities that could withstand significant increases in delinquencies and foreclosures in the underlying mortgage pools before incurring a loss of principal.
Most of our RMBS portfolio is highly rated. As of December 31, 2009, 89% of the total residential portfolio was rated AAA or AA. We have $140.5 million of sub-prime exposure, $186.0 million of Alt-A exposure and $504.2 million of prime exposure, which combined amount to 6% of our general account. Substantially all of our sub-prime, Alt-A and prime exposure is investment grade, with 59% being AAA rated and another 13% in AA securities. We have employed a disciplined approach in the analysis and monitoring of our mortgage-backed securities. Our approach involves a monthly review of each security. Underlying mortgage data is obtained from the security’s trustee and analyzed for performance trends. A security-specific stress analysis is performed using the most recent trustee information. This analysis forms the basis for our determination of whether the security will pay in accordance with the contractual cash flows. RMBS impairments year-to-date totaled $23.6 million, or 1.1% of our RMBS portfolio. These impairments consist of $3.5 million from prime, $13.9 million from Alt-A and $6.2 million from sub-prime.
Includes commercial mortgage-backed CDOs with carrying and market values of $59.1 million and $31.2 million, respectively.
The following table presents certain information with respect to realized investment gains and losses including those on debt securities pledged as collateral, with losses from other-than-temporary impairment charges reported separately in the table. These impairment charges were determined based on our assessment of factors enumerated below, as they pertain to the individual securities determined to be other-than-temporarily impaired.
Impairment losses decreased from $245.0 million in 2008 to $108.4 million in 2009. Affiliate transaction gains of $13.7 million for the year ended December 31, 2007 were attributable to the earn-out associated with the 2005 sale of Lombard. Transaction activity resulted in a net gain of $33.2 million for the year ended December 31, 2009 compared to a net loss of $38.7 million for the year ended December 31, 2008. This increase was primarily due to the realized loss on the sale of equities in the closed block portfolio in 2008 that did not repeat in 2009, in addition to a significant gain in 2009 as a result of the CDO deconsolidation. 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 additional information.
In determining that the securities giving rise to the previously mentioned unrealized losses were not other-than-temporarily impaired, we considered and evaluated the factors cited above. In making these evaluations, we exercised considerable judgment. Accordingly, there can be no assurance that actual results will not differ from our judgments and that such differences may require the future recognition of other-than-temporary impairment charges that could have a material effect on our financial position and results of operations. In addition, the value of, and the realization of any loss on, a debt security or equity security is subject to numerous risks, including interest rate risk, market risk, credit risk and liquidity risk. The magnitude of any loss incurred by us may be affected by the relative concentration of our investments in any one issuer or industry. We have established specific policies limiting the concentration of our investments in any single issuer and industry and believe our investment portfolio is prudently diversified.
The three holdings at December 31, 2009 with the largest unrealized loss balance(s) which are temporarily impaired are:
Farm Credit Bank of Texas - With a fair value of $14.5 million and an unrealized loss of $8.5 million, the Farm Credit Bank of Texas is a member of the Farm Credit System, a nationwide network of cooperatively owned financial institutions established by and subject to the provisions of the Federal Farm Credit Act. As a result, bank members receive the benefits of being a government sponsored entity (GSE). Membership provides reliable funding through Federal Farm Credit System on a joint and several basis and benefits from a $3.0 billion insurance fund. The bank has remained profitable through the current credit crisis and net charge-offs have remained negligible at 0.09% and, therefore, an other-than-temporary impairment is not warranted at this time.
Effective January 1, 2009, we adopted new guidance issued by the FASB which amended requirements for the recognition, presentation, and disclosure of other-than-temporarily impaired investments 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. Investments whose values are considered by us to be other-than-temporarily impaired are written down to fair value. The impairment amount is further separated into the amount related to credit losses, which is recorded as a charge to net realized investment losses included in our earnings, and the amount related to all other factors, which is recognized in other comprehensive income.
Fixed maturity other-than-temporary impairments recorded in 2009 were concentrated in mortgage-backed securities and corporate holdings. These impairments were driven primarily by significant rating downgrades and increased credit default rates. In our judgment, these credit events or other adverse conditions of the issuers have caused, or will most likely lead to, a deficiency in the contractual cash flows related to the investment. Therefore, based upon these credit events, we have determined that other-than-temporary impairments exist. Total impairments recognized through earnings related to such credit-related circumstances were $93.0 million in 2009.
Prospectively, we will account for the other-than-temporarily impaired security as if the debt security had been purchased on the impairment date, using an amortized cost basis equal to the previous cost basis less the amount of the credit loss impairment. We will continue to estimate the present value of future cash flows expected and, if significantly greater than the new cost basis, accrete the difference as interest income.
The following table rolls forward the amount of credit losses recognized in earnings on debt securities held at the beginning of the period, for which a portion of the other-than-temporary impairment was also recognized in other comprehensive income.
Our private equity holdings are reflected in other investments and are accounted for using the equity method of accounting. We assess these holdings for impairments based on whether an entity has:
announced adverse changes or events such as changes or planned changes in senior management, restructurings; and/or
any other factors that indicate that the fair value of the investment may have been negatively impacted.
Total net unrealized losses on debt and equity securities as of December 31, 2009 were $324.2 million (unrealized gains of $349.3 million less unrealized losses of $673.5 million). Of that net amount, $288.7 million was outside the closed block ($74.7 million after offsets for taxes and deferred policy acquisition costs) and $35.5 million was in the closed block ($4.4 million after offsets for taxes, deferred policy acquisition costs and policy dividend obligation).
Net unrealized investment gains and losses on securities classified as available-for-sale and certain other assets are included in the consolidated balance sheet as a component of accumulated other comprehensive income (loss) (“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) and the subsequent changes in fair value.
For debt securities outside of the closed block with gross unrealized losses, 54.7% of the unrealized losses after offsets pertain to investment grade securities and 45.3% of the unrealized losses after offsets pertain to below investment grade securities at December 31, 2009.
Cash from discontinued operations decreased $81.0 million for the year ended December 31, 2009 versus 2008. This was primarily driven by a $34.8 million decrease in financing cash flows resulting from the sale of a portion of our asset management business in 2008.
Cash from discontinued operations decreased $24.0 million primarily due to lower levels of cash settlements in our discontinued reinsurance business and, to a lesser extent, non-recurring expenses associated with the spin-off of our asset management business.
In addition to existing cash and securities, our primary sources of liquidity consist of dividends from Phoenix Life. Under New York Insurance Law, Phoenix Life is permitted to pay stockholder dividends to the holding company in any calendar year without prior 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. Based on this calculation, given unaudited preliminary results, Phoenix Life would be able to pay a dividend of $29.2 million in 2010. In assessing our ability to pay dividends from Phoenix Life, we also consider the level of statutory capital and risk-based capital of that entity. Our capitalization has declined in the past two years and we may have less flexibility to pay dividends to PNX if we experience further declines. As of December 31, 2009, we had $576.9 million of statutory surplus and AVR and our risk-based capital ratio was in excess of 200% at Phoenix Life. See Note 21 to our consolidated financial statements under “Item 8: Financial Statements and Supplementary Data” in this Annual Report on Form 10-K for more information on Phoenix Life statutory financial information and regulatory matters.
On January 6, 2009, we filed an automatic shelf registration statement with the SEC for the potential offering and sale of up to $750 million of debt and equity securities. Because we were a well-known seasoned issuer (“WKSI”) at the time of filing, as defined in Rule 405 under the Securities Act of 1933, the existing shelf registration statement went effective immediately upon filing. On March 5, 2009, the filing date of our 2008 Annual Report on Form 10-K, we lost our status as a WKSI as a result of not satisfying the related minimum market capitalization requirement, which means we may no longer issue debt and equity securities utilizing our prior shelf registration statement. On June 17, 2009, we filed a non-automatic shelf registration with the SEC (our “new shelf registration statement”) for the potential offering and sale of up to $650 million of debt and equity securities. The SEC has indicated that it has no further comments related to the new shelf registration statement. We will evaluate the costs and benefits of having the new shelf registration statement declared effective as part of our ongoing liquidity management.
On December 31, 2008, we completed the spin-off of Virtus Investment Partners, Inc., our asset management subsidiary, into an independent publicly traded asset management firm. The spin-off occurred through a pro rata distribution of Virtus common stock to Phoenix stockholders. The dividend was payable to each holder of record at the close of business on December 22, 2008 in the amount of one share of Virtus common stock for every 20 shares of our common stock held by such holder. No fractional shares were issued. Those stockholders who would otherwise have been entitled to receive fractional shares received cash in lieu of the fractional shares.
Our principal needs at the holding company level are debt service (approximately $20.1 million net of amounts due on bonds repurchased in 2009), income taxes and operating expenses. Future minimum annual principal payments on indebtedness of PNX as of December 31, 2009 are: in 2032, $253.9 million and in 2034, $175.0 million.
Cash received from operating activities decreased from the prior year related to lower cash dividends received from subsidiaries which was partially offset by lower tax payments.
Net cash received from operating activities decreased due to higher expense payments driven by proxy solicitation costs and preparation for the spin-off of our asset management business and a reduction in interest income on intercompany debt.
Cash received from investing activities decreased primarily due to lower net sales of debt securities. This was driven by higher redemptions in 2008 to fund the repayment of our equity unit notes in February.
Cash used for financing activities increased due to the February 2008 repayment of our equity unit notes.
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 up to a certain percentage of the cash value of their policies at any time. As of December 31, 2009, our Life Companies had approximately $11.5 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, 2009 were $2.3 billion.
Rating agencies assign Phoenix Life financial strength ratings and assign the holding company debt ratings based in each case on their opinions of the relevant company’s ability to meet its financial obligations. Rating declines may result in lower sales, higher surrenders and increased or decreased interest costs in connection with future borrowings.
In the second half of 2008, A.M. Best Company, Inc., Moody’s Investors Service and Standard & Poor’s each revised its outlook for the U.S. life insurance sector to negative from stable, citing, among other things, the significant deterioration and volatility in the credit and equity markets, economic and political uncertainty, and the expected impact of realized and unrealized investment losses on life insurers’ capital levels and profitability.
On September 8, 2009, Moody’s Investor Services downgraded our financial strength rating from Baa2 to Ba1 and lowered our senior debt rating from Ba2 to B1. They maintained their negative outlook on all ratings. On March 10, 2009, Moody’s Investor Service downgraded our financial strength rating to Baa2 from Baa1 and downgraded our senior debt rating to Ba2 from Ba1.
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. On August 6, 2009, Standard & Poor’s downgraded our financial strength rating of BBB- to BB and lowered our senior debt rating from B+ to B-. On May 7, 2009, Standard & Poor’s affirmed our financial strength rating of BBB- and lowered our senior debt rating to B+ from BB-. On March 10, 2009, Standard & Poor’s downgraded our financial strength rating to BBB- from BBB and downgraded our senior debt rating to BB- from BB.
We cannot predict what additional actions rating agencies may take, or what actions we may take in response to the actions of rating agencies, which could adversely affect our business. As with other companies in the financial services industry, our ratings could be changed at any time and without any notice by any rating agency.
The financial strength and debt ratings as of February 26, 2010 were as follows:
Available-for-sale debt securities increased primarily due to improvement in unrealized losses from spread tightening in non-treasury sectors partially offset by higher treasury rates.
Policy loans decreased as policy surrenders increased over prior year resulting in repayment of outstanding loan balances.
Available-for-sale debt and equity securities pledged as collateral decreased to zero from the deconsolidation of the remaining two CDOs in the first quarter of 2009 with a corresponding decrease to zero in non-recourse collateralized debt obligations (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).
The increase in separate account assets was primarily attributable to market appreciation.
The decrease in other liabilities was attributable to a reduction in investments payable as well as a reduction in pension and tax liabilities due to the announced freeze of our defined benefit pension plans effective March 31, 2010.
Future operation lease obligations include amounts for leased property of our private placement discontinued operations of $0.4 million in 2010 and $0.1 million in 2011.
Other commercial commitments relate to agreements to fund venture capital partnerships. 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.
We provide our employees with post-employment benefits that include retirement benefits, through pension and savings plans, and other benefits, including health care and life insurance. Employee benefit expense related to these plans totaled $46.7 million, $23.5 million and $26.1 million for 2009, 2008 and 2007, respectively.
Authorized Control Level - results when Total Adjusted Capital falls below 50% of Company Action Level risk-based capital as defined by the NAIC where in addition to the above, the insurance regulators are permitted but not required to place the Company under regulatory control; and
The estimated risk-based capital of Phoenix Life as of December 31, 2009 was in excess of 200% of the Company Action Level.