10-K 1 phlvic-20131231x10k.htm 10-K PHLVIC-2013.12.31-10K


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
—————————
FORM 10-K
—————————
(Mark one)
þ
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2013

OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________

Commission file number 333-20277

PHL VARIABLE INSURANCE COMPANY
(Exact name of registrant as specified in its charter)
Connecticut
06-1045829
(State or other jurisdiction of
(I.R.S. Employer Identification No.)
incorporation or organization)
 
 
 
One American Row, Hartford, Connecticut
06102-5056
(Address of principal executive offices)
(Zip Code)
 
 
(860) 403-5000
(Registrant’s telephone number, including area code)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.   YES ¨    NO þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.   YES ¨    NO þ

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   YES ¨   NO þ

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES ¨     NO þ

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Annual Report on Form 10-K or any amendment to this Annual Report on Form 10-K.   þ

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o
Accelerated filer o
Non-accelerated filer þ
Smaller reporting company o
 
 
(Do not check if smaller reporting company)
 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).   YES ¨    NO þ

PHL Variable Insurance Company is a wholly owned indirect subsidiary of The Phoenix Companies, Inc., and there is no market for the registrant’s common stock. As of August 21, 2014, there were 500 shares of the registrant’s common stock outstanding.

The registrant is filing this Form 10-K with the reduced disclosure format permitted by General Instruction (I)(1)(a) and (b) of Form 10-K.




Explanatory Note

This Annual Report on Form 10-K for the year ended December 31, 2013 (this “Form 10-K”) is being filed with the Securities and Exchange Commission (the “SEC”) by PHL Variable Insurance Company (“we,” “our,” “us,” the “Company,” or “PHL Variable”) prior to the filing of the Company’s Quarterly Reports on Form 10-Q for each of the periods ended March 31, June 30 and September 30, 2013 (the “2013 Quarterly Periods”). However, this Form 10-K does contain interim unaudited quarterly information for each of the four quarterly periods in 2013. Pursuant to the Order (as defined below), the Company intends to file Forms 10-Q covering each of the 2013 Quarterly Periods following the filing of this Form 10-K.

The Company filed a Current Report on Form 8-K with the Securities and Exchange Commission (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 filed prior to September 18, 2012 should no longer be relied upon and should be restated (the “Restatement”). On April 25, 2014, the Company filed its Annual Report on Form 10-K for the year ended December 31, 2012 (the “2012 Form 10-K”) with the SEC containing the Restatement.

On February 12, 2014, PHL Variable and its ultimate parent, The Phoenix Companies, Inc. (“PNX” or “Phoenix”), submitted an Offer of Settlement with the SEC pursuant to which PHL Variable and Phoenix consented to the issuance of the form of an Order Instituting Cease-and-Desist Proceedings Pursuant to Section 21C of the Securities Exchange Act of 1934, Making Findings and Imposing a Cease-and-Desist Order (the “March 2014 Order”). The March 2014 Order was approved by the SEC on March 21, 2014. Pursuant to the March 2014 Order, PHL Variable and Phoenix have been directed to cease and desist from committing or causing any violations and any future violations of Section 13(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and Rules 13a-1 and 13a-13 thereunder and Section 15(d) of the Exchange Act and Rules 15d-1 and 15d-13 thereunder. PHL Variable and PNX each paid a civil monetary penalty in the amount of $375,000 to the U.S. Treasury following the entry of the March 2014 Order.

PNX filed the 2012 Form 10-K a day after the date required by the March 2014 Order, filed its third quarter 2012 Form 10-Q eight days after the date required by the March 2014 Order, and announced on June 3, 2014 that it would not file its 2013 Annual Report on Form 10-K by the date required by the March 2014 Order. PHL Variable filed its 2012 Form 10-K ten days after the date required by the March 2014 Order and announced on June 3, 2014 that it would not file its 2013 Annual Report on Form 10- K by the date required by the March 2014 Order. PHL Variable filed its third quarter 2012 Form 10-Q in compliance with the March 2014 Order.

On July 16, 2014, the Company and PHL Variable submitted an Amended Offer of Settlement with the SEC (the “Amended Offer”) pursuant to which PHL Variable and Phoenix consented to the issuance of the form of an Order Amending Order Instituting Cease-and-Desist Proceedings Pursuant to Section 21C of the Securities Exchange Act of 1934, Making Findings, and Imposing a Cease-and-Desist Order (the “Amended Order”). Except as amended by the Amended Order, which was
approved by the SEC on August 1, 2014, the March 2014 Order remains in effect. PHL Variable and Phoenix each paid a civil monetary penalty in the amount of $100,000 to the U.S. Treasury following the entry of the Amended Order, and will be required to pay the following additional monetary penalties with respect to a future late filing of any PHL Variable and/or Phoenix periodic report covered by the Amended Order: $20,000 per filing for the first week in which a filing is delinquent, plus, for each week or partial week thereafter an additional amount equal to the sum of a) $20,000 and b) $5,000 multiplied by the number of complete weeks that the filing has been delinquent before the week in which the late filing is made. PNX filed its Annual Report on Form 10-K for the year ended December 31, 2013 with the SEC on August 6, 2014 in compliance with the Amended Order. As of the date of filing of this Form 10-K, each of PHL Variable and Phoenix are subject to certain amended deadlines for their respective SEC periodic reports, as further described in the risk factor regarding the March 2014 Order and the Amended Order under “Risks Related to the Restatement, Failure to File Timely Periodic Reports with the SEC and our Internal Control Over Financial Reporting” contained in “Item 1A: Risk Factors” in Part I of this Form 10-K. This Form 10-K is being filed in accordance with the Amended Order.


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The delay in the filing of this Form 10-K is primarily as a result of the Restatement, Phoenix’s restatement of its financial statements prepared in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”), Phoenix’s insurance company subsidiaries’ restatements of their respective U.S. GAAP financial statements, and the utilization of interim measures taken to address weaknesses in the Company’s internal control over financial reporting, which has added to the time necessary to both prepare the Company’s U.S. GAAP financial statements for the year ended December 31, 2013 and complete the related audit process. Financial statements contained in this Form 10-K for periods ended on or prior to June 30, 2012 reflect the Restatement. Further, certain disclosures in this Form 10-K relating to our business, risk factors, legal proceedings and related matters are updated to include certain information for periods after December 31, 2013 through the date of the filing of this Form 10-K.

As of the date of filing of this Form 10-K, the Company has not filed any periodic reports under the Exchange Act for any period in 2014 and, as a result, U.S. GAAP financial information of the Company for 2014 has not yet been made publicly available.

For additional information regarding certain risks associated with the Company’s failure to file timely periodic reports and resume a timely filing schedule under the Exchange Act, please see the risk factors under “Risks Related to the Restatement, Failure to File Timely Periodic Reports with the SEC and our Internal Control Over Financial Reporting” contained in “Item 1A: Risk Factors” in Part I of this Form 10-K.


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TABLE OF CONTENTS

Part I
 
Page
 
 
 
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
 
 
 
Part II
 
 
 
 
 
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
 
 
 
Part III
 
 
 
 
 
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
 
 
 
Part IV
 
 
 
 
 
Item 15.
 
 
Signatures
 
 
Exhibit Index



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PART I

Unless otherwise stated, “we,” “our” or “us” means PHL Variable Insurance Company (the “Company” or “PHL Variable”). Furthermore, “Phoenix Life” refers to Phoenix Life Insurance Company and “PNX” or “Phoenix” refers to The Phoenix Companies, Inc.

Item 1.
Business

Overview

We provide life insurance and annuity products through independent agents and financial advisors. Our policyholder base includes both affluent and middle market consumers, with our more recent business concentrated in the middle market. Most of our life insurance in force is permanent life insurance (universal life and variable universal life) insuring one or more lives. Our annuity products include fixed and variable annuities with a variety of death benefit and guaranteed living benefit options.

In 2013, 99% of PHL Variable product sales, as defined by total annuity deposits and total life premium, were annuities, and 89% of those sales were fixed indexed annuities.

Saybrus Partners, Inc. (“Saybrus”), an affiliate, provides dedicated life insurance and other consulting services to financial advisors in partner companies, as well as support for sales of Phoenix’s product line through independent distribution organizations.

Target Market

Our current target market consists of middle market and mass affluent families and individuals planning for or living in retirement. This market has a variety of financial planning needs, such as tax-deferred savings, safety of principal, guaranteed income during retirement, income replacement and death benefits. Our target customer is age 50 or older with investable assets of $500,000 or less. Historically, our marketing strategies focused on high-net-worth and affluent households with sophisticated estate planning and other financial needs, and the majority of our life insurance and annuities in force reflects this market focus.

Competition

We operate in a highly competitive industry. While there is no single company that we identify as a dominant competitor in our business, many of our competitors are substantially larger, have better financial strength ratings, more financial resources and greater marketing and distribution capabilities. Our products compete with similar products sold by other insurance companies and also with savings and investment products offered by banks, asset managers and broker-dealers.

We believe our competitive strengths include product features, underwriting and mortality risk management expertise, partnering capabilities and value-added support provided to our distributors. Our ability to compete is based on these as well as other factors, including investment performance, service, price, distribution capabilities, scale, commission structure, brand recognition and financial strength ratings.

Major Products

Annuities

Fixed Indexed Annuities: This product provides single premium deferred annuities that offer a fixed interest account and a variety of indexed accounts that allow contract owners to earn index credits based on the performance of specific equity market or other price indices. Our major source of revenue on these contracts is the excess of investment income earned over interest and index credits, if any. Most contracts allow contract owners to change accounts once a year. One of the most popular indexed accounts credits contract owners’ accounts with a return equal to the annual appreciation of the S&P 500 index, subject to a specified cap. Caps are changed regularly to reflect current market conditions; during 2013, caps ranged from 1.25% to 5.50%. Certain contracts also provide “premium bonuses,” which we contribute to contract owner account balances at issue and which also earn interest or index credits. Approximately 28% of indexed annuity deposits in 2013 included premium bonuses ranging from 4% to 10% of the initial deposit.


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Contract owners also may elect a guaranteed minimum withdrawal benefit (“GMWB”), which for a separate fee provides a guaranteed income stream for the lifetime of the contract owners. The amount of income available is based on a separate “benefit base” that increases at a guaranteed rate established when the contract is sold and that is independent of the growth of the account balance. Withdrawals may begin immediately or after several years. Once a contract owner elects to receive income, withdrawals are first made from the account balance. If and when the balance is depleted, we continue to make the guaranteed income payments. In 2013, approximately 93% of all indexed annuity contracts sold included a GMWB. Certain annuities with a GMWB also include an enhanced withdrawal benefit (“EWB”) that allows for an additional amount of guaranteed income if certain qualifying conditions are met (confinement to a nursing care facility and/or inability to perform activities of daily living). In 2013, approximately 20% of all indexed annuity contracts sold included an EWB. Certain fixed indexed annuities include a guaranteed minimum death benefit (“GMDB”), pursuant to which beneficiaries receive an amount in excess of contract value if the annuitant dies in exchange for an additional fee. In 2013, approximately 37% of all indexed annuity contracts sold included a GMDB.

Fixed Annuities: This product meets the needs of clients who want a guaranteed rate of return over a specified period. The contract owner receives a guaranteed rate of return over the initial interest rate guarantee period and has the option to elect a new guarantee period at the end of the initial term, at then current rates, subject to certain minimums.

Single Premium Immediate Annuities: This product provides guaranteed income beginning immediately, including one product that is designed for use in elder-care planning in conjunction with government benefits.

Variable Annuities: This product allows contract owners to direct deposits into a variety of separate investment accounts (accounts that are maintained separately from the other assets of the Company) or into the general accounts of the Company. Deposits allocated to the general account earn interest at a specified rate of return determined by us, subject to certain minimums. In the separate investment accounts, the contract owner bears the risk of investment results. We credit to the separate investment accounts the return on the underlying investments in the separate account specified net of specified fees and charges.

We collect fees for the management of these various investment accounts and assess charges against these accounts for the administrative services we provide. Our major sources of revenue from variable annuities are mortality and expense fees charged to the contract owner, generally determined as a percentage of the market value of any underlying separate account balances and a portion of the fees we collect for the management of the various investment accounts.

Many of our variable annuities include guaranteed minimum death, accumulation, withdrawal and income benefits.

Life Insurance

Universal Life: This product provides permanent insurance coverage with a tax deferred savings element. It allows the policyholder to adjust the frequency and amount of premium payments subject to certain limitations. Premiums, net of cost of insurance charges and administrative expenses, are invested in our general account and are credited interest at rates determined by us, subject to certain minimums. We retain the right within limits to adjust the fees we assess for providing administrative services and the rate we charge for the cost of insurance; these may be adjusted by us but may not exceed guaranteed contractual limits. Some universal life products provide secondary guarantees that protect the policy’s death benefit even if there is insufficient value in the policy to pay the monthly deduction.

Indexed Universal Life: This product is a type of universal life where premiums may be allocated to a fixed interest account and/or a variety of indexed accounts that allow policyholders to earn index credits based on the performance of specific equity market or other price indices.


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Variable Universal Life: This product is similar to universal life, except that premiums may be directed into a variety of separate investment accounts (accounts that are maintained separately from the other assets of the Company) or into the general accounts of the Company. In separate investment accounts, the policyholder bears the entire risk of the investment results. We collect fees for the management of these various investment accounts and the net return is credited directly to the policyholder’s accounts. Account balances invested in the general account earn interest at rates determined by us, subject to certain minimums. Specific charges are made against the accounts for administrative expenses and cost of insurance charges. We retain the right, within limits, to adjust the fees we assess for providing administrative services and the rate we charge for the cost of insurance; these may be adjusted by us but may not exceed guaranteed contractual limits. With some variable universal products, maintaining a certain premium level provides the policyholder with guarantees that protect the policy’s death benefit if, due to adverse investment experience, the policyholder’s account balance is zero.

Variable annuities, a limited number of fixed annuities and variable life products offered by the Company are registered under the federal securities laws. The Company has not offered these products to new customers since our audited financial statements for the most recent fiscal year end, in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”), have not yet been completed. Existing customers with existing contracts have been able to continue to invest in these products and change investment elections, but certain investment alternatives have closed for new investment.

Distribution and Related Services

Independent Producers: We distribute our products through independent producers who serve the middle market and are typically affiliated with one or more independent marketing organizations (“IMOs”). We have established selling agreements with IMOs representing more than 11,500 independent producers. In 2013, nearly 2,200 producers sold our products. Our distribution strategy for IMOs is to continue to expand the number of relationships and producers who do business with us by providing competitive products at competitive commission rates, providing exclusive product designs and features to certain IMOs, and enhancing our servicing and support technology.

Saybrus Partners, Inc.: Saybrus, Phoenix’s distribution company, sells Phoenix products through selected independent producers and IMOs and provides consulting services to partner firms in support of policies written by companies other than Phoenix. Saybrus’ revenues primarily consist of commissions based on successful sales.

Investments

Investment activities are an integral part of our business and net investment income is a significant component of our total revenues. We manage investments in our general account to match the durations of our insurance liabilities. We invest primarily in high-grade public and privately placed debt securities, balancing credit risk with investment yield. As of December 31, 2013, 96.0% of our total available-for-sale debt securities portfolio was investment grade. We invest a small percentage of our assets in limited partnerships and other investments that have variable returns. While our returns are more volatile, these asset classes have contributed substantially to our investment returns over time. As of December 31, 2013, 0.3% of cash and total investments were allocated to this asset class.

Hedging

Certain features of our variable and indexed annuity products expose us to risks such as equity price risk, equity volatility risk and interest rate risk. We hedge certain of those risks using derivatives. Our focus is on hedging the economic exposure related to potential future claims. For example, we hedge fixed indexed annuity premiums directed into indexed accounts by purchasing options designed to fund the index credits on these accounts. Our hedges generally do not qualify for hedge accounting and may result in significant reported accounting gains or losses. In addition, our hedges may expose us to counterparty credit risk. As of December 31, 2013, our net mark-to-market exposure to derivative counterparties prior to credit valuation adjustment (“CVA”) was $128.0 million, and the post CVA net mark-to-market exposure was $127.0 million. All of our counterparties had a credit rating of A or better with at least one Nationally Recognized Statistical Rating Organization (“NRSRO”). For additional information regarding hedging related business risks, please see the risk factors entitled “We may not be able to hedge our positions due to the inability to replace hedges as a result of our credit rating” and “Guaranteed benefits within our products that protect policyholders against significant downturns in equity markets may decrease our earnings, increase the volatility of our results if hedging strategies prove ineffective, result in higher hedging costs and expose us to increased counterparty risk, which may have a material adverse effect on our results of operations, financial condition and liquidity” contained in “Item 1A: Risk Factors” in Part I of this Form 10-K.


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Policy Administration

As of December 31, 2013, we had 59,202 life insurance policies and 60,094 annuity contracts in force. Our Customer Care Center services policies on a number of administrative systems, supporting both policyholders and their advisors or agents. The cost of servicing policies is a significant component of our overall operating expenses. Servicing of some policies is outsourced to vendors who specialize in insurance policy administration.

Reinsurance

We use reinsurance agreements to limit potential losses, reduce exposure to larger risks and provide capital relief with respect to certain statutory requirements. We remain liable to the extent that reinsuring companies may not be able to meet their obligations under reinsurance agreements in effect. Failure of the reinsurers to honor their obligations could result in losses to the Company. Since we bear the risk of nonpayment, on a quarterly basis we evaluate the financial condition of our reinsurers and monitor concentrations of credit risk. Based on our review of their financial statements, reputation in the reinsurance marketplace and other relevant information, we believe that we have no material exposure to uncollectible life reinsurance. At December 31, 2013, five major reinsurance companies account for approximately 73% of the reinsurance recoverable.

We cede risk to other insurers under various agreements that cover individual life insurance policies. The amount of risk ceded depends on our evaluation of the specific risk and applicable retention limits. For business sold prior to December 31, 2010, our retention limit on any one life is $10 million for single life and joint first-to-die policies and $12 million for joint last-to-die policies. Beginning January 1, 2011, our retention limit on new business is $5 million for single life and joint first-to-die policies and $6 million for second-to-die policies. We also assume reinsurance from other insurers. Typically our reinsurance contracts allow us to recapture ceded policies after a specified period. This right is valuable in the event our mortality experience is sufficiently favorable to make it financially advantageous for us to reassume the risk rather than continue paying reinsurance premiums.

See Note 3 to our financial statements under “Item 8: Financial Statements and Supplementary Data” in this Form 10-K for additional information regarding reinsurance.

Regulation

We are subject to regulation and supervision in each jurisdiction where they conduct business. Areas of regulation include the following:

Financial considerations, including standards of solvency, statutory reserves, reinsurance and capital adequacy;
Trade practices, market conduct and licensing of companies and agents;
Mandating certain insurance benefits and regulating certain premium rates;
Approval of policy forms and certain other related materials;
Permitted types and concentration of investments;
Permitted dividends or other distributions, as well as transactions between affiliates and changes in control; and
Approval of interest payments on surplus notes.

We file regular reports, including detailed annual financial statements, with insurance regulatory authorities and are subject to periodic examination by such authorities. See Notes 15 and 18 to our financial statements under “Item 8: Financial Statements and Supplementary Data” in this Form 10-K for additional information regarding late filings.

The National Association of Insurance Commissioners (“NAIC”) provides standardized insurance industry accounting and reporting guidance. However, statutory accounting principles continue to be established by individual state laws, regulations and permitted practices.

Most of the jurisdictions in which we are admitted to transact business require us to participate in guaranty associations, which are organized to pay certain contractual insurance benefits owed pursuant to insurance policies issued by impaired, insolvent or failed insurers. These associations levy assessments, up to prescribed limits, on all member insurers in a particular state on the basis of the proportionate share of the premiums written by member insurers in the lines of business in which the impaired, insolvent or failed insurer is engaged.


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As part of their regulatory oversight process, state insurance departments conduct periodic detailed examinations of the books, records, accounts and business practices of insurers domiciled in their states. State insurance departments also have the authority to conduct examinations of non-domiciliary insurers that are licensed in their states. PHL Variable is currently under market conduct examination by the Connecticut Insurance Department. The Connecticut Insurance Department issued a financial examination report of PHL Variable on May 28, 2014. We expect to receive a final market conduct examination report in 2014.

Annually, we are required to conduct an analysis of the adequacy of all statutory reserves. In each case, a qualified actuary must submit an opinion which states that the statutory reserves, when considered in light of the assets held with respect to such reserves, make good and sufficient provision for the associated contractual obligations and related expenses of the insurer. If such an opinion cannot be provided, the insurer must set up additional reserves by moving funds from surplus. The most recent opinions were provided on a timely basis.

PHL Variable reports its risk based capital (“RBC”) based on a formula calculated by applying factors to various risk characteristics of the insurer. The major categories of risks involved are asset risk, insurance risk, interest rate risk, market risk and business risk. The formula is used as an early warning tool by regulators to identify possible inadequately capitalized insurers for purposes of initiating regulatory action and not as a means to rank insurers generally. State insurance laws provide insurance regulators the authority to require various actions by, or take various actions against, insurers whose RBC ratio does not meet or exceed certain levels. As of December 31, 2013, PHL Variable’s RBC ratio was in excess of 250% of company action level risk based capital, the highest regulatory threshold.

Most states, including Connecticut, have enacted legislation or adopted administrative regulations affecting the acquisition of control of insurance companies, as well as transactions between insurance companies and persons controlling them. Most states require administrative approval of the direct or indirect acquisition of 10% or more of the outstanding voting securities of an insurance company incorporated in the state.


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General Development of Business

PHL Variable was incorporated in Connecticut in 1981. Our principal executive offices are located at One American Row, Hartford, Connecticut 06102-5056. Our telephone number is (860) 403-5000. Our web site is located at www.phoenixwm.com. (This and all other URLs included herein are intended to be inactive textual references only. They are not intended to be an active hyperlink to our web site. The information on our web site is not, and is not intended to be, part of this Form 10-K and is not incorporated into this report by reference.)

Our parent company, Phoenix Life, is a wholly owned subsidiary of PNX.

The following chart illustrates our corporate structure as of December 31, 2013.

 
 
 
 
 
 
 
 
 
 
 
 
 
The Phoenix Companies, Inc.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
100%
 
85%
 
100%
 
 
 
 
 
 
 
 
 
Phoenix Life
Insurance Company
 
Saybrus Partners, Inc.
 
Other Subsidiaries
 
 
 
 
 
 
 
 
 
 
100%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
PM Holdings, Inc.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
100%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
PHL Variable Insurance
Company
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
100%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other Subsidiaries
 
 
 
 
 
 
 
 
 
 
 
 
 
 


Item 1A.
Risk Factors

Risks Related to the Restatement, Failure to File Timely Periodic Reports with the SEC and
our Internal Control Over Financial Reporting.

We face risks related to the Restatement, the restatement of historical financial statements of our indirect parent, The Phoenix Companies, Inc. and that, following the filing of this Form 10-K, we remain delayed in our SEC reporting obligations.

As discussed in the 2012 Form 10-K in the Explanatory Note and in Note 2 to our financial statements under “Item 8: Financial Statements and Supplementary Data” in the 2012 Form 10-K (and as previously reported in our Current Report on Form 8-K, filed with the SEC on September 18, 2012, as amended by Forms 8-K/A filed with the SEC on November 8, 2012, March 15, 2013 and April 24, 2013, respectively), the Company’s audit committee concluded that certain of the Company’s previously issued financial statements should no longer be relied upon and should be restated because of certain errors in those financial statements. Additionally, as previously reported by our indirect parent, PNX, in a Current Report on Form 8-K filed with the SEC on November 8, 2012, as amended by Forms 8-K/A filed by PNX with the SEC on March 15, 2013 and April 24, 2013, respectively, management of PNX concluded that certain of PNX’s previously issued financial statements should no longer be relied upon and should be restated because of certain errors in those financial statements.


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On April 25, 2014, the Company filed with the SEC the 2012 Form 10-K containing audited financial statements of PHL Variable for the years ended December 31, 2012, 2011 and 2010 and interim unaudited financial statements presented for each quarter during the fiscal years 2012 and 2011, which in each case are presented on a restated and amended basis to the extent previously filed in a periodic report by the Company with the SEC and other disclosures regarding the Restatement. On April 1, 2014, PNX filed with the SEC its 2012 Annual Report Form 10-K containing audited financial statements of PNX for the years ended December 31, 2012, 2011 and 2010 and interim unaudited financial statements presented for each quarter during the fiscal years 2012 and 2011, which in each case are presented on a restated and amended basis to the extent previously filed in a periodic report by PNX with the SEC and other disclosures regarding its U.S. GAAP restatement.

As a result of the Restatement, our SEC reporting obligations remain delayed as of the filing date of this Form 10-K, and we cannot assure when we will resume a timely filing schedule with respect to our SEC reports. Even after we complete these delayed filings, we expect to continue to face many of the risks and challenges related to the Restatement, including the following:

we may fail 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;
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;
our failure to have current financial information available;
the risk of failure to comply with the filing deadlines included in the SEC’s Cease-and-Desist Order, dated March 21, 2014, as amended by the Amended Cease-and-Desist-Order, dated August 1, 2014, including that the SEC may seek sanctions against or deregister PNX and the Company;
the risk of PNX’s failure to file its delayed SEC filings and 2014 Quarterly Reports on Form 10-Q by March 16, 2015, the extended deadline for providing these SEC filings to the bond trustee, as well as the risk associated with seeking additional consents from PNX’s bondholders of PNX’s outstanding 7.45% Quarterly Interest Bonds Due 2032 regarding these SEC filings;
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;
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;
our inability to hedge our positions due to our inability to replace hedges as a result of our credit rating;
the incurrence of significant expenses related to the Restatement, the U.S. GAAP restatement undertaken by PNX, the remediation of weaknesses in our internal control over financial reporting and disclosure controls and procedures, and the preparation of this Form 10-K and our delayed SEC reports;
diversion of management and other human resources attention from the operation of our business;
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
risks associated with our failure to file certain reports with state regulatory authorities.

We cannot assure that all of the risks and challenges described above will be eliminated and that lost business opportunities can be recaptured or that general reputational harm will not persist. If one or more of the foregoing risks or challenges persist, our business, operations and financial condition are likely to be materially and adversely affected.


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We have concluded that there are material weaknesses in our internal control over financial reporting, which have materially adversely affected our ability to timely and accurately report our results of operations and financial condition. These material weaknesses have not been fully remediated as of the filing date of this Form 10-K and we cannot assure you that other material weaknesses will not be identified in the future. If we fail to maintain an effective system of internal controls, the accuracy and timing of our financial reporting may be adversely affected.

As reported in “Item 9A: Controls and Procedures” of this Form 10-K, we have concluded that there are material weaknesses in our internal control over financial reporting and that our disclosure controls and procedures are ineffective as of December 31, 2013. Some of the interim measures we have taken to address weaknesses in our internal control over financial reporting are manual, which are more time consuming to prepare, more prone to errors than computerized systems, and require more exhaustive audit processes. It is necessary for us to maintain effective internal control over financial reporting to prevent fraud and errors and to maintain effective disclosure controls and procedures so that we can provide timely and reliable financial and other information. A failure to maintain adequate internal controls may adversely affect our ability to provide financial statements that accurately reflect our financial condition and timely report information. This could cause investors to lose confidence in our reported financial and other information and cause an adverse effect on our business and results of operations. A failure to correct material weaknesses in our internal controls and to replace interim measures taken to address weaknesses could result in further restatements of financial statements and correction of other information filed with the SEC.

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.

The completion of our Restatement involved many months of review and analysis, including highly technical analyses of our contracts and business practices, estimates and assumptions made by management, tax accounting and the proper application of relevant accounting rules and pronouncements. Many of the enhancements and changes to our processes are ongoing as of the filing date of this Form 10-K and we continue to integrate the complex changes we have already made. Given the complexity and scope of these exercises, and notwithstanding the extensive time, effort and expense that went into them, we cannot assure you that these extraordinary processes were adequate to identify and correct all material errors in our historical financial statements or that additional accounting errors will not come to light in the future in these or other areas.

While we have performed additional analyses and other procedures, and either implemented or plan to implement and test remediation measures as of the filing date of this Form 10-K, the previously identified material weaknesses have not been fully addressed and remediated. We continue to improve our internal control over financial reporting and disclosure controls and procedures by, among other things:

enhancing our existing accounting policies and procedures;
implementing changes in our finance and accounting organization;
adopting new accounting and reporting processes and procedures; and
introducing new or enhanced accounting systems and processes.

As a result, we cannot assure you that we will not discover additional errors, that future financial reports will not contain material misstatements or omissions, that future restatements will not be required, that we will be able to timely complete our remaining SEC filings for periods subsequent to this Form 10-K, or that we will be able to timely comply with our reporting obligations in the future.

We have effected the Restatement through the filing of a single, multi-year comprehensive Annual Report on Form 10-K for the year ended December 31, 2012. We have not received any assurance from the SEC that such a comprehensive report satisfies our Restatement filing obligations and, if it is ultimately determined that it does not, we may be required to amend that comprehensive report and/or file other amended reports to effect the Restatement. This would require us to devote substantial internal and external resources and cause us to incur significant fees and expenses for additional audit services as well as accounting and other consulting services. These fees and expenses, as well as the substantial time devoted by our management to make such filings with the SEC, could have a material adverse effect on our business, profitability and financial condition.


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Because we remain delayed in our SEC reporting obligations, we do not have current financial information available.

We have not yet filed our Quarterly Reports on Form 10-Q for each of the quarterly periods ended June 30, 2014, March 31, 2014, September 30, 2013, June 30, 2013 and March 31, 2013 (the “Delayed SEC Reports”). We are likely to be unable to file our Quarterly Report on Form 10-Q for the period ended September 30, 2014 on a timely basis and we expect to be current with all of our and PNX’s periodic reporting obligations by December 12, 2014. Until we file the Delayed SEC Reports and are otherwise current in our SEC filing requirements, there is a lack of current publicly available information concerning the results of operations and financial condition of the Company. Our ability to file the Delayed SEC Reports and resume a timely filing schedule with respect to our SEC reports is subject to a number of contingencies, including but not limited to, whether we continue to identify errors in our financial statements and whether existing systems and processes can be timely updated, supplemented or replaced.

We have previously announced that until we become current in our SEC reporting requirements and have filed with the SEC new registration statements or amendments to our existing registration statements covering our products to include required financial information, we will continue to not issue any new SEC-registered life insurance and annuity contracts. Phoenix Life similarly has announced that it will continue to not issue any new SEC-registered life insurance and annuity contracts until it has filed with the SEC amendments to its product registration statements to include updated financial information. Phoenix Life is delayed in filing certain U.S. GAAP financial statements with the SEC which it is required to file as a result of its SEC-registered life insurance and annuity contracts. In addition, until the Company becomes current in its SEC reporting requirements and the Company and Phoenix Life have filed with the SEC new registration statements or amendments to their existing registration statements covering their products to include required information, there will be ongoing uncertainty regarding our ability to continue to accept premiums, or to process certain other investment transaction requests, associated with our and Phoenix Life’s outstanding SEC-registered annuity and life contracts. In such an event, these actions may have a material adverse impact on our future revenues, our competitive position and consumer perception of our products, and our retention of existing contracts and may result in claims related to these SEC-registered products against us, PNX and Phoenix Life, any of which could have a material adverse effect on the Company’s business and financial results. In addition, in connection with our product offerings, we rely on third party vendors to supply vendor-generated products. Our failure to be current in our SEC filings may cause such vendors to terminate their relationships with us, which in turn may cause us to terminate many of our product offerings.

The Company and PNX have failed to comply with filing deadlines included in the SEC’s Cease-and-Desist Order, dated March 21, 2014, and may fail to comply with the filing deadlines included in the Amended Cease-and-Desist Order, dated August 1, 2014, and if the Company and/or PNX fail to become timely under the Exchange Act as provided in the Amended Order and otherwise fail to comply with their respective filing obligations under the Exchange Act, the SEC may seek sanctions against both the Company and PNX. The Company and PNX may be subject to further investigation and potential regulatory action.

On February 12, 2014, the Company and PNX submitted an Offer of Settlement with the SEC pursuant to which the Company and PNX consented to the issuance of the form of an Order Instituting Cease-and-Desist Proceedings Pursuant to Section 21C of the Securities Exchange Act of 1934, Making Findings, and Imposing a Cease-and-Desist Order (the “March 2014 Order”). The March 2014 Order was approved by the SEC on March 21, 2014. Pursuant to the March 2014 Order, PNX and the Company have been directed to cease and desist from committing or causing any violations and any future violations of Section 13(a) of the Exchange Act and Rules 13a-1 and 13a-13 thereunder and Section 15(d) of the Exchange Act and Rules 15d-1 and 15d-13 thereunder.

The Company and PNX each paid a civil monetary penalty in the amount of $375,000 to the U.S. Treasury following the entry of the March 2014 Order.

PNX filed the 2012 Form 10-K a day after the date required by the March 2014 Order, filed its third quarter 2012 Form 10-Q eight days after the date required by the March 2014 Order, and announced on June 3, 2014 that it would not file its 2013 Annual Report on Form 10-K by the date required by the March 2014 Order. PHL Variable filed its 2012 Form 10-K ten days after the date required by the March 2014 Order and announced on June 3, 2014 that it would not file its 2013 Annual Report on Form 10- K by the date required by the March 2014 Order. PHL Variable filed its third quarter 2012 Form 10-Q in compliance with the March 2014 Order.


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On July 16, 2014, PNX and the Company submitted an Amended Offer of Settlement with the SEC (the “Amended Offer”) pursuant to which the Company and PNX consented to the issuance of the form of an Order Amending Order Instituting Cease-and-Desist Proceedings Pursuant to Section 21C of the Securities Exchange Act of 1934, Making Findings, and Imposing a Cease-and-Desist Order (the “Amended Order”). Except as amended by the Amended Order, which was approved by the SEC on August 1, 2014, the March 2014 Order remains in effect. PNX and the Company each paid a civil monetary penalty in the amount of $100,000 to the U.S. Treasury following the entry of the Amended Order, and will be required to pay the following additional monetary penalties with respect to a future late filing of any Company and/or PNX periodic report covered by the Amended Order: $20,000 per filing for the first week in which a filing is delinquent, plus, for each week or partial week thereafter an additional amount equal to the sum of a) $20,000 and b) $5,000 multiplied by the number of complete weeks that the filing has been delinquent before the week in which the late filing is made. PNX filed its Annual Report on Form 10-K for the year ended December 31, 2013 with the SEC on August 6, 2014 in compliance with the Amended Order.

The following table sets forth the deadlines in the Amended Order for the Company’s SEC periodic reports:

Phoenix Timetable of SEC Periodic Reports
Form
Period
Amended Deadline
10-K
Year ended December 31, 2013
August 6, 2014
10-Q
Quarterly Period ended March 31, 2013
September 10, 2014
10-Q
Quarterly Period ended June 30, 2013
September 10, 2014
10-Q
Quarterly Period ended September 30, 2013
September 10, 2014
10-Q
Quarterly Period ended March 31, 2014
October 17, 2014
10-Q
Quarterly Period ended June 30, 2014
October 24, 2014
10-Q
Quarterly Period ended September 30, 2014
December 5, 2014

As of the date of filing of this Form 10-K, PNX believes it will become a timely filer with the filing of its Annual Report on Form 10-K for the year ending December 31, 2014.
The following table sets forth the deadlines in the Amended Order for PHL Variable’s SEC periodic reports:

PHL Variable Timetable of SEC Periodic Reports
Form
Period
Amended Deadline
10-K
Year ended December 31, 2013
August 22, 2014
10-Q
Quarterly Period ended March 31, 2013
September 12, 2014
10-Q
Quarterly Period ended June 30, 2013
September 12, 2014
10-Q
Quarterly Period ended September 30, 2013
September 12, 2014
10-Q
Quarterly Period ended March 31, 2014
October 21, 2014
10-Q
Quarterly Period ended June 30, 2014
October 28, 2014
10-Q
Quarterly Period ended September 30, 2014
December 12, 2014

As of the date of filing of this Form 10-K, the Company believes it will become a timely filer with the filing of its Annual Report on Form 10-K for the year ending December 31, 2014. This Form 10-K was filed in compliance with the Amended Order.


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The SEC has a broad range of potential actions, in addition to those set forth in the Amended Order, that may be taken against PNX and the Company for failure to comply with the undertakings in the March 2014 Order and the Amended Order noted above. Further, PNX is providing to the SEC certain information and documentation regarding the Restatement and the staff of the SEC has indicated to PNX that the matter remains subject to further investigation and potential further regulatory action. We cannot predict the outcome of any of such investigations or actions related to these or other matters. An adverse ruling in any SEC enforcement action or other regulatory proceeding could impose upon the Company and/or PNX fines, penalties, or other remedies, including the suspension of trading of PNX’s securities or deregistration of PNX and the Company under the Exchange Act, which could have a material adverse effect on our results of operations and financial condition. Even if we are successful in defending against an SEC enforcement action or other regulatory proceeding, such an action or proceeding may be time consuming, expensive and diverting management from the operation of our business and could have a material adverse effect on our business, financial condition and results of operations. In the event of any such action or proceeding, we may also become subject to costly indemnification obligations to current or former officers, directors, or employees.

If PNX fails to file one or more of the Relevant PNX SEC Reports by March 16, 2015, it may seek additional consents from certain bondholders to extend the date for providing its Relevant SEC Reports to the Indenture Trustee.

The reporting covenant (“Reporting Covenant”) contained in the indenture (the “Indenture”) covering PNX’s outstanding 7.45% Quarterly Interest Bonds due 2032 (the “Bonds”), requires PNX to file with the trustee (“Trustee”), within fifteen days after it is required to file with the SEC, copies of the annual reports, quarterly reports and of the information, documents and other reports that PNX is required to file with the SEC pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934, as amended, and the rules and regulations adopted by the SEC thereunder. Additionally, under the Indenture, the Trustee or the holders (“Holders”) of 25% or more of the outstanding principal amount of the Bonds have the right to notify PNX if they believe PNX has breached a covenant under the Indenture and may, following any applicable cure periods, declare an Event of Default and cause the outstanding principal amount of the Bonds to become immediately due and payable.

Because of the delay in filing PNX’s 2012 Annual Report on Form 10-K and certain of its delayed SEC reports, the Trustee under the Indenture covering the Bonds sent notices of default under the Indenture initiating the 60-day cure periods thereunder. Consequently, PNX sought and successfully obtained the consents of Holders representing a majority of the outstanding principal amount of the Bonds (“Requisite Consents”) to amend the Indenture, and to provide related waivers, that allowed PNX to ultimately extend the date for providing its 2012 Annual Report on Form 10-K, its Quarterly Report on Form 10-Q for the third quarter 2012, its 2013 Quarterly Reports on Form 10-Q, its 2013 Form 10-K, and its 2014 Quarterly Reports on Forms 10-Q (collectively, the “Relevant PNX SEC Reports”) to the Trustee to a date on or prior to March 16, 2015. If PNX fails to file one or more of the Relevant PNX SEC Reports by March 16, 2015, PNX may seek an additional consent from the Holders to amend the Indenture, and to provide a related waiver, that will allow PNX to extend the date for providing such Relevant PNX SEC Reports to the Trustee.

If PNX does seek an additional consent from Holders to amend the Indenture and to provide a related waiver, there can be no assurance that it will receive the Requisite Consents to any additional amendments and waivers of the Reporting Covenant on a timely basis, or at all, or that the extension of the Reporting Covenant for the Relevant PNX SEC Reports will extend for a sufficient period of time to avoid an Event of Default, an acceleration event or other adverse impact on our business operations that may result therefrom. If PNX is unsuccessful in curing the default or obtaining the Requisite Consents to such additional amendments and waivers, the Trustee or the Holders of 25% or more of the outstanding principal amount of the Bonds will be able to accelerate payment of outstanding principal on the Bonds for the existing breach of the Reporting Covenant in accordance with the Indenture. In the event that Holders of a majority in principal amount of the Bonds do not provide PNX with the Requisite Consents to such amendments and waivers and determine to accelerate payment of the Bonds, PNX may lack the ability to meet those obligations out of its currently available cash and liquid assets available at the holding company. Although PNX believes that it could take actions designed to satisfy its obligations under the Indenture, there can be no assurance that any of these actions would be sufficient, available or available on satisfactory terms, any of which could materially and adversely impact PNX’s and our business, liquidity and financial position. Even if PNX is successful in amending the Indenture and obtaining a waiver from the Holders, there can be no assurances that PNX will make the filings with the SEC or the Trustee by such extended date, which could result in a default under the Indenture.


15



The outcome of litigation and other 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 are unpredictable and any orders, actions or rulings not in our favor could have a material adverse effect on our financial condition, liquidity or results of operations.

The circumstances which gave rise to the Restatement, the U.S. GAAP restatements by PNX and Phoenix Life and the related SEC filing delays continue to create the risk of litigation and claims by investors and examinations, investigations, proceedings and orders by regulatory authorities, which could be expensive and damaging to our business and financial condition. For additional information regarding litigation related business risks, please see the risk factor below under “Risks Related to our Business” entitled, “Legal actions and proceedings are inherent in our businesses and could adversely affect our results of operations or financial position or harm our business or reputation.”

In connection with the Restatement, the failure by the Company to file the Delayed SEC Reports and become a timely filer under the Exchange Act, and PNX’s failure to file its corresponding SEC reports and become a timely filer under the Exchange Act, as well as the reported weaknesses in internal control over financial reporting, may subject the Company and PNX to a broad range of potential actions that may be taken against the Company and PNX by the staff of the SEC, including, but not limited to, a cease and desist order, suspension of trading of PNX’s securities, deregistration of PNX or the Company and/or the assessment of possible civil monetary penalties.

Any orders, actions or rulings relating to any of the foregoing that are not in our favor could have a material adverse effect on our financial condition, liquidity or results of operations.

The events which caused the need for the Restatement and the failure to timely file the 2012 Form 10-K, this Form 10-K and certain of our other delayed SEC reports have resulted in certain rating agencies placing us on negative credit watch, downgrading our credit ratings and/or withdrawing these ratings and further credit rating downgrades of our financial strength ratings or withdrawal of these ratings are possible. These downgrades or withdrawals could result in an increase in policy surrenders and withdrawals, adversely affect 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.

Rating agencies assign the Company and Phoenix Life financial strength ratings, and assign PNX debt ratings, based in each case on their opinions of the ability by the Company, PNX and Phoenix Life to meet their respective financial obligations.

Our ratings relative to other companies in the industry affect our competitive position. The Company, PNX and Phoenix Life and their securities have been placed on negative credit ratings watch and/or downgraded or withdrawn by certain rating agencies in connection with the events which caused the need for this Restatement and the failure to timely file the 2012 Form 10-K and certain of our and PNX’s delayed SEC reports. These recent developments and any future rating downgrades or withdrawals may cause reputational damage, which could materially and adversely affect our ability to distribute our products through unaffiliated third parties, new sales of our products, the persistency of existing customers, increase policy surrenders and withdrawals and our ability to borrow. We cannot predict what actions rating agencies may take, or what actions we may take in response. At this time, we cannot estimate the impact of specific future rating agency actions on sales or persistency. Financial statement restatements may result in downgrades or withdrawals of our financial strength credit ratings, which could increase policy surrenders and withdrawals, adversely affect 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, any of which could negatively impact our liquidity. Such an increase would decrease our earnings, could reduce access to financing and have a material adverse effect on our operations.

In light of the difficulties experienced by many financial institutions, including insurance companies, rating agencies have increased the frequency and scope of their credit reviews and requested additional information from the companies that they rate, including us. They may also adjust upward the capital and other requirements employed in the rating agency models for maintenance of certain ratings levels.


16



We may not be able to hedge our positions due to the inability to replace hedges as a result of our credit rating.

We use derivative instruments to hedge the liability exposure and the volatility of earnings associated with certain variable and fixed indexed annuity liabilities. Certain derivative counterparty agreements of certain subsidiaries contain provisions that permit the parties to terminate the agreements upon the occurrence of a default under the Indenture covering the Bonds. In addition, certain of these agreements require our financial strength rating to be above a certain threshold. Given that our financial strength ratings are below a specified credit rating threshold in certain of our derivative agreements, the counterparties can request immediate payment, demand immediate and ongoing full collateralization on derivative instruments in net liability positions, or trigger a termination of existing derivatives and/or future derivative transactions. In certain derivative counterparty agreements, our financial strength ratings are below the specified threshold levels and have been since March 2009.

If we are forced to terminate any derivative agreements, we may be unable to replace the derivative positions, thereby increasing our exposure to periods of significant and sustained downturns in equity markets, increased equity volatility, or reduced interest rates, which could result in an increase in the valuation of the future policy benefit associated with such products and result in a material adverse effect on our earnings and financial condition.

We have incurred and expect to continue to incur significant expenses related to the Restatement, the remediation of weaknesses in our internal control over financial reporting and disclosure controls and procedures, the preparation of this Form 10-K and the Delayed SEC Reports, and the efforts otherwise necessary for the Company and PNX to each become a timely filer under the Exchange Act.

We have devoted and expect to continue to devote substantial internal and external resources to remediation relating to the Restatement, the PNX U.S. GAAP restatement, and the preparation and filing of this Form 10-K and the preparation of the Delayed SEC Reports, and otherwise becoming a timely filer under the Exchange Act. As a result of these efforts, we have incurred and expect that we will continue to incur significant incremental fees and expenses for additional auditor services, financial and other consulting services, legal services, consent waivers as well as the implementation and maintenance of systems and processes that will need to be updated, supplemented or replaced. These expenses, as well as the substantial time devoted by our management towards identifying and addressing any internal weaknesses in our internal control over financial reporting and our disclosure controls and procedures, could have a material adverse effect on our business, profitability and financial condition. For additional information regarding principal accounting fees and services, please see Part III, Item 14 of this Form 10-K.

The Restatement process, the preparation of this Form 10-K, the preparation of the Delayed SEC Reports, and the efforts otherwise necessary for the Company and PNX to each become a timely filer under the Exchange Act have diverted, and continue to divert, management and other human resources from the operation of our business. The absence of timely and accurate financial information may hinder our ability to effectively manage the business of the Company.

The Restatement process and the preparation of this Form 10-K, the Delayed SEC Reports, and the efforts otherwise necessary for the Company and PNX to each become a timely filer under the Exchange Act have diverted, and continue to divert, management and other human resources from the operation of our business. As a result of the delay in completing the Restatement, we have delayed filing our Delayed SEC Reports and we are likely to be unable to file our Quarterly Report on Form 10-Q for the period ending September 30, 2014 on a timely basis and we expect to be current with all of our and PNX’s periodic reporting obligations by December 12, 2014. The Board of Directors, members of management, and the accounting, legal, administrative and other staff of the Company and PNX have spent significant time on the Restatement and the U.S. GAAP restatements of the Company and Phoenix Life, and continue to spend significant time on the preparation of the Delayed SEC Reports, related disclosures and remediation of disclosure controls and procedures and internal control over financial reporting of the Company and PNX’s insurance company subsidiaries, and efforts otherwise necessary for the Company and PNX to each become a timely filer under the Exchange Act. These resources have been, and will likely continue to be, diverted from the strategic and day-to-day management of our business. In addition, current, accurate financial information is essential to the management of our complex business, including controlling the financial risk associated with the products that the Company offers and sells. The absence of current publicly available financial information may make it more difficult to accomplish the strategic objectives of the Company.


17



The Company 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.

As a result of PNX’s U.S. GAAP financial statement restatement, certain errors were found in our and Phoenix Life’s financial statements prepared in accordance with Statements of Statutory Accounting Principles (“Statutory”) filed with the applicable state insurance regulators. Those errors were corrected in subsequent filings with the applicable state insurance regulators. We do not believe the state insurance regulators will deem it necessary to adjust our or Phoenix Life’s historical unaudited Statutory financial statement filings with the applicable state insurance regulators. However, PNX concluded that the audited Statutory financial statements for the year ended December 31, 2012 filed by Phoenix Life with its applicable state insurance regulators, which restate Statutory financial statements for the year ended December 31, 2011, materially differ from the annual unaudited Statutory financial statements for the year ended December 31, 2012 previously filed by Phoenix Life. Also, the fact of the Restatement, PNX’s and Phoenix Life’s restatements, and the delay in our filing of periodic reports with the SEC, could result in various regulatory bodies conducting examinations or investigations and/or making inquiries of us and Phoenix Life concerning compliance with applicable laws and regulations, which may increase our compliance costs and the potential for regulatory investigations or proceedings or other claims. Any existing or future litigation, investigations, proceedings or claims that we, PNX and Phoenix Life are or could become involved in, or become the subject of, could have a material adverse effect on our financial condition, liquidity or financial statements.

Our failure to file, or timely file, audited Statutory financial statements with state regulatory authorities may result in, among other things, the imposition of sanctions and penalties against us, which could have a material adverse effect on our financial condition, results of operations and cash flows.

We are required to file audited Statutory financial statements with the applicable regulatory authorities annually. As a result of the Restatement, we filed our audited Statutory financial statements for 2012 after the initial due date but within extensions granted by our domiciliary insurance regulator.

We have not timely filed our 2013 annual audited Statutory financial statements with our applicable state insurance regulators. We have received from our domiciliary insurance regulator extensions for submission of our 2013 annual audited Statutory financial statements and management’s report on internal control over financial reporting. We intend to seek further extensions, as necessary. If such extensions are not granted, failure to timely file such audited Statutory financial statements and management’s report can result in, among other things, the imposition of sanctions and penalties, including operating restrictions, which could have a material adverse effect on our financial condition, results of operations and cash flows.



18



Risks Related to Our Business

Our business, financial condition, and results of operations could be materially and adversely affected by unfavorable economic developments and the performance of the debt and equity markets.

Economic and market conditions materially and adversely affected us in the last recession. The economy may once again deteriorate. The resulting lack of credit, increase in defaults, lack of confidence in the financial sector, volatility in the financial markets and reduced business activity could materially and adversely affect our business, financial condition and results of operations.

These effects include, but are not limited to, the following:

Lower fee revenue and higher expenses. Significant declines in equity markets would decrease assets in our variable annuity and variable life product lines, resulting in lower fee income and increased amortization of deferred policy acquisition costs.
Realized and unrealized losses in our fixed income portfolio. The value of the portfolio would be depressed by general interest rate increases or credit spread widening, as well as by illiquidity and by changes in assumptions we use to estimate the fair value of securities. Bonds supported by residential and commercial mortgages could experience losses if the delinquency rates of the underlying mortgage loans increase.
Realized and unrealized losses in alternative asset classes. We invest in private equity funds which generate returns that are more volatile than other asset classes and are relatively illiquid and, therefore, may be harder to value or sell in adverse market conditions.
Higher statutory reserve and capital requirements. Certain regulatory reserve and capital requirements incorporate actual and expected future capital market conditions and could increase materially in the event of significant equity market declines or changes in interest rates, credit spreads and credit default rates.
Losses due to changes in accounting estimates. Significant accounting estimates may be materially affected by the equity and debt markets and their impact on expected customer behavior. For example, in setting amortization schedules for our deferred policy acquisition costs, we make assumptions about future market performance, interest rates and policyholder behavior.
Increased funding requirements for our ultimate parent company’s pension plan. Future market declines could result in additional funding requirements. Also, the funding requirements of our ultimate parent company’s pension plan are sensitive to interest rate changes. Should interest rates decrease materially, the plan liabilities would increase.
Hedging losses or increased reserve requirements in our variable annuity business. We use derivatives to hedge the value of certain guaranteed benefits. These hedges and other management procedures could prove ineffective, especially during times of significant market volatility. For benefits that are not hedged, such as minimum death benefits and minimum income benefits we could be required to increase reserves in the event of a significant decline in the equity markets.

Persistent low interest rates or significant increases in interest rates could adversely affect our business and results of operations.

Our products expose us to significant interest rate risk. A substantial portion of our business is spread-based, meaning that profitability depends on our ability to invest premiums at yields in excess of the rates we credit to policyholders. The current low interest rate environment has meant that we have invested or reinvested cash flows at substantially lower yields than our existing portfolio yield, while our ability to reduce credited rates has been limited by contractual minimums. Persistent low interest rates could compound this spread compression. In addition, they could cause additional premium payments on products with flexible premium features, repayment of policy loans and lower policy surrenders.

Persistent low interest rates could also result in higher statutory reserve and capital requirements. The Company and its insurance company affiliates are subject to annual asset adequacy testing, which requires additional reserves to be posted if projected asset cash flows and future premiums are not able to support future policy claims and surrenders under a range of possible scenarios.

Low interest rates have also increased the liability of our pension plans and other post-employment benefits. Further declines in interest rates could result in additional increases in these liabilities.


19



Conversely, if interest rates rise significantly, we could face an increase in unrealized losses in our investment portfolio. At the same time, it could cause life insurance policy loans, surrenders and withdrawals to increase as policyholders seek investments with higher returns. This could require us to sell invested assets at a time when their prices are depressed, which could cause us to realize investment losses.

Legal actions and proceedings are inherent in our businesses and could adversely affect our results of operations or financial position or harm our businesses or reputation.

We are regularly involved in litigation and arbitration, both as a defendant and as a plaintiff. In addition, various regulatory bodies regularly make inquiries of us and, from time to time, conduct examinations or investigations concerning our compliance with, among other things, insurance laws, securities laws, laws governing the activities of broker-dealers and other laws and regulations affecting our registered products. We are, and in the future may be, subject to and involved in legal actions and proceedings in the ordinary course of our businesses. Some of these proceedings have been brought, and may be brought in the future, on behalf of various alleged classes of complainants. In certain of these matters, the plaintiffs are seeking large and/or indeterminate amounts, including punitive or exemplary damages. Furthermore, certain institutional investors have purchased, or may purchase in the future, large numbers of Company policies in the secondary market and have asserted, or may assert, claims against us before regulatory agencies and in litigation. Substantial legal liability in these or future legal actions could have an adverse effect on us or cause us reputational harm, which in turn could, among other items, harm our business prospects, result in regulatory or legislative responses and have an adverse effect on our financial statements.

It is difficult to predict or determine the ultimate outcome of legal or regulatory proceedings or to provide reasonable ranges of potential losses. We believe that the outcomes of our litigation and regulatory matters are not likely, either individually or in the aggregate, to have a material adverse effect on our financial statements. However, given the large or indeterminate amounts and/or other remedies sought in certain of these matters and the inherent unpredictability of litigation and regulatory matters, it is possible that an adverse outcome in certain matters could, from time to time, have a material adverse effect on the way we conduct our business and our financial condition, liquidity or financial statements in particular quarterly or annual periods. For a more detailed discussion of certain current litigation and other proceedings please refer to the discussion under “Item 3: Legal Proceedings” of this Form 10-K.

Our actuarial reserve calculations, particularly for universal life death benefits and guaranteed annuity benefits, require many assumptions and significant management judgment, which, if incorrect, could adversely affect our results of operations and financial condition.

We establish reserves to pay future policyholder benefits and claims. A significant proportion of our reserves do not represent policyholder funds but rather are actuarial estimates based on assumptions that include future premiums, benefits, claims, expenses, interest credits, investment results (including equity market returns), mortality, morbidity and persistency. As a result, we cannot be certain that the assets supporting our policy liabilities, together with future premiums, will be sufficient for payment of benefits and claims. If, in the future, we determine this to be the case, we would need to increase our reserves in the period in which we make the determination, which would adversely affect our results of operations.

We may experience losses if capital market conditions, mortality or longevity experience, policyholder behavior (e.g., persistency, premium payments, benefit utilization rates) or other factors differ significantly from the assumptions that we used in pricing products or that are reflected in our current financial results.

We set prices for our insurance and annuity products based upon capital market assumptions, expected mortality or longevity, and expected policyholder behavior. For capital market assumptions such as equity market returns and investment portfolio yields we use current market observations, historical information and management judgment. For mortality and longevity rates we use standard actuarial tables, company experience and management judgment. For policyholder behavior assumptions we use available industry and company data. Assumptions used in pricing our products generally are consistent with assumptions used to initially determine the amortization of deferred policy acquisition costs. Adverse experience relative to these assumptions could have a material adverse effect on our results from operations and financial condition.

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 and subsequent contraction of premium financing suggest that the reasons for some purchases of our products changed. At the same time, prior to 2009, we 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.


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Deviations in experience from our pricing assumptions have had, and could continue to have, an adverse effect on the profitability of certain universal life products. Most of our current products permit us to increase charges and adjust crediting rates during the life of the policy or contract (subject to guarantees in the policies and contracts). In 2011 and 2010, we implemented increases in the cost of insurance rates for certain universal life policies. However, these and any other permitted adjustments do not allow us to recoup past losses and may not be sufficient to maintain profitability in the future. In addition, increasing charges on in force policies or contracts may adversely affect our relationships with distributors, future sales and surrenders. Furthermore, some of our in force business consists of products that do not permit us to adjust the charges and credited rates of in force policies or contracts.

Our recent development of fixed indexed annuity products has required us to make pricing assumptions about the behavior of policyholders in a market segment with which we are not historically familiar and for product features for which there is limited long-term industry experience. In particular, if our pricing assumptions with respect to persistency and benefit utilization in the future prove inaccurate, we may experience an adverse impact on our results of operations or financial condition.

Adverse experience relative to our pricing assumptions could also result in higher amortization of deferred policy acquisition costs. The recovery of deferred policy acquisition costs is dependent upon the future profitability of the related business. See “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Estimates” in this Form 10-K. If our estimates of future gross profits or margins cannot support the continued amortization or recovery of deferred policy acquisition costs the amortization of such costs is accelerated in the period in which the pricing assumptions are changed, resulting in an “unlocking” charge to income. Such adjustments may in the future have a material adverse effect on our results of operations or financial condition.

We have limited access to external sources of liquidity and financing.

Our current financial strength and credit ratings limit our access to external sources of liquidity and financing. During periods of capital market volatility, this access could be further constrained, and the cost of financing could increase significantly. Our ongoing needs for liquidity include policy claims, surrenders, policy loans, commissions, interest and operating expenses. In addition, we may from time to time have discrete needs for liquidity, such as contributions to our pension plan or legal settlements. Our principal sources of liquidity are insurance premiums, annuity considerations, deposit funds and cash flow from our investment portfolio. Sales of assets that are readily convertible into cash represent an additional source. We do not have in place credit facilities or letters of credit that we could draw upon to meet our liquidity requirements. Without sufficient liquidity, we could be forced to realize investment losses, deplete capital or curtail certain of our operations, which would adversely impact our results of operations and financial condition.

Guaranteed benefits within our products that protect policyholders against significant downturns in equity markets may decrease our earnings, increase the volatility of our results if hedging strategies prove ineffective, result in higher hedging costs and expose us to increased counterparty risk, which may have a material adverse effect on our results of operations, financial condition and liquidity.

Certain of our products include guaranteed benefits. These include GMDBs, guaranteed minimum accumulation benefits (“GMABs”), GMWBs and guaranteed minimum income benefits (“GMIBs”). Periods of significant and sustained downturns in equity markets, increased equity volatility or reduced interest rates could result in an increase in the valuation of the future policy benefit associated with such products, resulting in a reduction to earnings. We use derivative instruments to hedge the liability exposure and the volatility of earnings associated with some of these liabilities and, even when these and other actions would otherwise successfully mitigate the risks related to these benefits, we remain liable for the guaranteed benefits in the event that derivative counterparties are unable or unwilling to pay. In addition, we are subject to the risk that hedging and other management procedures prove ineffective or that unanticipated policyholder behavior, including lower withdrawals or mortality, combined with adverse market events, produces economic losses beyond the scope of the risk management techniques employed. Hedging instruments we hold to manage product and other risks have not, and may continue to not, perform as intended or expected, resulting in higher realized losses. Market conditions can also result in losses on product related hedges and such losses may not be recovered in the pricing of the underlying products being hedged. These factors, individually or collectively, may adversely affect our profitability, financial condition or liquidity.


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Our risk management policies and procedures may leave us exposed to unidentified or unanticipated risk, which could adversely affect our businesses or result in losses.

We have devoted significant resources to develop and periodically update our risk management policies and procedures to reflect our ongoing review of our risks. However, our policies and procedures to monitor and manage risks may not be fully effective and may leave us exposed to unidentified and unanticipated risks. We use models in many aspects of our operations, including but not limited to the pricing of products, estimation of actuarial reserves, amortization of deferred policy acquisition costs, and the valuation of certain other assets and liabilities. These models rely on assumptions and projections that are inherently uncertain. In addition, the risk of a natural or man-made catastrophe, pandemic, malicious act, terrorist act, or the occurrence of climate change, could adversely affect mortality, morbidity, or other relevant factors and, as a result, have a significant negative impact on our business. Our risk management efforts and other precautionary plans and activities may not adequately predict the impact on our business from such events.

Management of operational, legal and regulatory risks requires, among other things, policies and procedures to record properly and verify a large number of transactions and events, and these policies and procedures may not be fully effective. Past or future misconduct by our employees or employees of our vendors could result in violations of law by us, regulatory sanctions and/or serious reputational or financial harm and the precautions we take to prevent and detect this activity may not be effective in all cases. A failure of our computer systems or a compromise of their security could also subject us to regulatory sanctions or other claims, harm our reputation, interrupt our operations and adversely affect our business, results of operations or financial condition.

Our statutory capital could decrease or our capital requirements could increase and adversely affect our business.

Accounting standards and statutory capital and reserve requirements for these entities are prescribed by their respective insurance regulators and the National Association of Insurance Commissioners (“NAIC”). In addition, NAIC regulations define minimum risk-based capital (“RBC”) requirements relating to insurance, business, asset and interest rate risks, which are intended to be used by insurance regulators to identify deteriorating or weakly capitalized companies. Separately, some rating agencies have their own capital models that are used to assess capital adequacy as part of the rating process.

Statutory surplus and regulatory or capital requirements may increase or decrease due to a variety of factors, including but not limited to the following: the amount of statutory income generated by the Company and its insurance company affiliates, unrealized gains or losses on equity and certain fixed income holdings, unrealized gains or losses on derivatives, changes in interest rates and equity market levels, changes in the credit quality of our fixed income investments, changes in policy reserves, funding requirements of our pension plan, additional reserve requirements as a result of annually required asset adequacy testing, changes in the capital models or applicable risk factors, and changes in statutory accounting rules or regulatory determinations. Most of these factors are outside of our control. One or more of these factors could significantly decrease statutory surplus or increase required RBC. If so, we could experience downgrades, loss of distribution relationships, higher surrenders and increased regulatory supervision.

We may be unsuccessful in our efforts to generate earnings growth in new market segments, particularly the sale of fixed indexed annuities to middle market customers.

We are implementing a business plan that leverages existing product manufacturing strengths and partnering capabilities to focus new business development in areas that are less capital intensive and appeal to distributors with middle market clients. We have limited experience in the middle market and in the design and sale of fixed indexed annuities. These products have required us to institute new processes for ensuring product suitability, executing hedges using derivatives and processing transactions. In addition, the ultimate profitability of these products is significantly influenced by future investment earnings, policy holder behavior and estimates of longevity. If the new risk management processes we designed prove inadequate, or if future investment earnings, policyholder behavior or longevity differs significantly from expectations, our results from operations may be adversely affected and our growth may not be sustained.


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Our valuation of debt securities and equity securities may include methodologies, estimations and assumptions that are subject to differing interpretations and could result in changes to investment valuations that may materially and adversely affect our results of operations and financial condition.

We record debt securities at fair value on our balance sheet. During periods of market disruption, including periods of significantly rising or high interest rates, rapidly widening credit spreads or illiquidity, the valuation of securities may require the adoption of certain estimates and assumptions. In addition, prices provided by independent broker quotes or independent pricing services that are used in the determination of fair value can vary significantly for a particular security. As a result, valuations may include inputs and assumptions that require greater estimation and judgment as well as valuation methods which are more complex. These values may not be ultimately realizable in a market transaction, and may change very rapidly as market conditions change or assumptions are modified. Significant changes in value may have a material adverse effect on our results of operations and financial condition. In addition, a decline in fair value below the amortized cost of a security requires management to assess whether an other-than-temporary impairment (“OTTI”) has occurred. The decision on whether to record an OTTI or write-down is determined in part by our assessment of the financial condition and prospects of a particular issuer, projections of future cash flows and recoverability of the particular security as well as management’s assertion of whether it is more likely than not that we will sell the securities before recovery. See “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Estimates” in this Form 10-K for further information regarding our impairment decision-making process. Management’s determination of whether a decline in value is other than temporary includes our analysis of the underlying credit and our intention and ability not to have to sell the security, versus the extent and duration of a decline in value. Our conclusions on such assessments may ultimately prove to be incorrect as facts and circumstances change, which could result in a material adverse effect on our results of operation and financial condition.

We may incur losses if our reinsurers are unwilling or unable to meet their obligations under reinsurance agreements. The availability, pricing and terms of reinsurance may not be sufficient to protect us against losses.

We use reinsurance agreements to limit potential losses, reduce exposure to larger risks and provide capital relief with regard to certain reserves. Under these reinsurance arrangements, other insurers assume a portion of our losses and related expenses; however, we remain liable as the direct insurer on all risks reinsured. Consequently, reinsurance arrangements do not eliminate our obligation to pay claims and we assume credit risk with respect to our ability to recover amounts due from our reinsurers. Although we regularly evaluate the financial condition of our reinsurers, the inability or unwillingness of any reinsurer to meet its financial obligations could negatively affect our operating results. In addition, market conditions beyond our control determine the availability and cost of reinsurance. No assurances can be made that reinsurance will remain available to the same extent and on the same terms and rates as have been historically available. If we are unable to maintain our current level of reinsurance or purchase new reinsurance protection in amounts that we consider sufficient and at prices that we consider acceptable, we would have to either accept an increase in our net exposure or develop other alternatives to reinsurance. Any of these alternatives may adversely affect our business, financial condition or operating results.

We might be unable to attract or retain personnel who are key to our business.

The success of our business is dependent to a large extent on our ability to attract and retain key employees. Competition in the job market for senior executives and professionals such as sales personnel, technology professionals, actuaries and investment professionals can be intense. In general, our employees are not subject to employment contracts or non-compete agreements. Difficulty in attracting and retaining employees could have a negative impact on us. Further, for as long as we remain delayed with our SEC reporting obligations, we are likely to continue to experience a certain amount of difficulty attracting and retaining highly qualified personnel, particularly at more senior levels, due to concerns about our status, and our ability to use our common stock to retain and motivate employees will also continue to be a challenge and subject us to certain restrictions.

Our business operations and results could be adversely affected by inadequate performance of third-party relationships.

We are dependent on certain third-party relationships to maintain essential business operations. These services include, but are not limited to, information technology infrastructure, application systems support, transfer agent and cash management services, custodial services, records storage management, backup tape management, security pricing services, medical information, payroll, and employee benefit programs.

We periodically negotiate provisions and renewals of these agreements and there can be no assurance that their terms will remain acceptable to such third parties or us. An interruption in our continuing relationship with certain of these third parties or any material delay or inability to deliver essential services could materially affect our business operations and adversely affect our results of operations.

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We face strong competition in our businesses from insurance companies and other financial services firms. If we are unable to price our products competitively or provide competitive service we could lose existing customers or fail to attract new customers.

We operate in a highly competitive industry. While there is no single company that we identify as a dominant competitor in our business, many of our competitors are substantially larger and enjoy better financial strength ratings, more financial resources and greater marketing and distribution capabilities. Our products compete with similar products sold by other insurance companies and also with savings and investment products offered by banks, asset managers, and broker-dealers. Larger competitors with better financial strength ratings, greater financial resources, marketing and distribution capabilities are better positioned competitively. Larger firms are also able to better withstand market disruption, offer more competitive pricing, and more effectively access debt and equity capital. Moreover, a significant proportion of sales in the life insurance and annuity industries represent exchanges from one company’s to another company’s products. To the extent that a more competitive product alternative with better product features is offered by another company, we could experience higher policy surrenders.

If we fail to compete effectively in this environment, our results of operations and financial condition could be materially and adversely affected.

Tax law and policy are frequently reviewed and changed by the Internal Revenue Service and Congress and future changes in laws or regulations could increase our tax costs and tax assets or make some of our products less attractive to consumers.

Significant and fundamental changes in U.S. federal income tax laws, U.S. Treasury and other regulations have been made in recent years and additional changes are likely. Any such change may affect us. Moreover, judicial decisions, regulations or administrative pronouncements could unfavorably affect our tax costs and tax assets or make certain of our products less attractive to consumers.

Certain products we offer, primarily life insurance and annuities, receive favorable tax treatment under current federal and state tax law. This favorable treatment may be considered as providing certain of our products a competitive tax advantage over non-insurance products. In particular, for individual owners of life insurance policies and annuity contracts, earnings credited to these policies and contracts are tax-deferred until such time as the amounts are withdrawn from the policies or contracts. This differs from the treatment of dividend or interest earnings on other investments. Moreover, for life insurance, the death benefit proceeds are often received tax free. While an increasing proportion of our annuity contracts are issued in connection with Individual Retirement Accounts (“IRAs”), for which the tax-deferral benefit is the same regardless of whether the IRA is in connection with an annuity, annuities in IRAs often provide lifetime payout guarantees not offered by other IRA investments.

The tax consequences associated with our products could be altered at any time by legislative, judicial, or administrative action. Any such action that increases the taxation on our products or reduces the taxation on competing products could lessen the advantage or create a disadvantage for certain of our products making them less competitive.

In the recent past, there have been proposals to modify the tax treatment of IRAs, including one that would result in more rapid taxation of after-death distributions. These proposals do not target annuities in IRAs, but would impact all IRAs to the same extent. As a result, many of the competing IRA investment options would also be impacted.
With respect to life insurance company taxation, the administration’s budget proposals in recent years have included changes in the computation of the dividends received deduction relative to both general account and separate account dividends. If enacted, these actions could increase our taxable income and unfavorably impact our tax provision which would reduce our net income. The current administration has proposed certain other changes which, if adopted, could have a material adverse effect on our financial position and our ability to sell our products and could result in the surrender of some existing contracts and policies.

We also benefit from certain tax provisions available to most insurance corporations, including but not limited to, tax-exempt bond interest, dividends-received deductions, tax credits (such as foreign tax credits), and insurance reserve deductions. Congress, as well as foreign, state and local governments, also considers from time to time legislation that could modify or eliminate these benefits, as well as other corporate tax provisions, thereby increasing our tax costs. If such legislation were to be adopted, our balance sheet and results of operations could be adversely impacted.

We cannot predict whether any relevant tax legislation will be enacted, what the impact of such legislation would be on our tax costs and sales of our products, what the specific terms of any such legislation will be or whether any such legislation would have a material adverse effect on our financial condition and results of operations.


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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, any of which could adversely affect our business, results of operations, financial condition or liquidity.

We are subject to extensive laws and regulations administered and enforced by a number of different governmental authorities including state insurance regulators, state securities administrators, the SEC, the New York Stock Exchange, the Financial Industry Regulatory Authority, the U.S. Department of Justice, state attorneys general, and foreign regulators. In light of recent events involving certain financial institutions and the last recession, the U.S. government has heightened its oversight of the financial services industry. In addition, it is possible that these authorities may adopt enhanced or new regulatory requirements intended to prevent future crises in the financial services industry and to assure the stability of institutions under their supervision. We cannot estimate whether such regulatory proposals will be adopted, or what impact, if any, such regulation could have on our business, operating results, financial condition or liquidity.

Each of the authorities that regulates us exercises a degree of interpretive latitude. Consequently, we are subject to the risk that compliance with any particular regulator’s or enforcement authority’s interpretation of a legal issue may not result in compliance with another regulator’s or enforcement authority’s interpretation of the same issue, particularly when compliance is judged in hindsight. In addition, there is risk that any particular regulator’s or enforcement authority’s interpretation of a legal issue may change over time to our detriment, or that changes in the overall legal environment may, even absent any particular regulator’s or enforcement authority’s interpretation of a legal issue changing, cause us to change our views regarding the actions we need to take from a legal risk management perspective, thus necessitating changes to our practices that may, in some cases, limit our ability to grow and improve the profitability of our business.

On July 21, 2010, the President signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”), which implements significant changes in the financial regulatory landscape and will impact institutions operating in many segments of the financial services industry, including the Company. Although certain provisions became effective immediately, many of the Act’s provisions require adoption of rules that will govern implementation. The Act may, among other things, increase our regulatory compliance burden by requiring us to invest management attention and resources to evaluate and make necessary changes to our policies and procedures and the manner in which we conduct our business. The U. S. government has created the Federal Insurance Office (“FIO”) under the Act as a branch of the U. S. Treasury Department. Under its charge to improve consumer protection, the FIO may regulate actual product design and mandate additional disclosure rules. We are uncertain as to the impact that this new legislation and regulatory guidance will have on the Company and cannot assure that it will not adversely affect our financial condition and results of operations.

State insurance laws regulate most aspects of our U.S. insurance businesses, and the Company and its insurance company affiliates are regulated by the insurance departments of the states in which they are domiciled and licensed. State insurance regulators and the NAIC regularly re-examine existing laws and regulations applicable to insurance companies and their products. State laws in the U.S. grant insurance regulatory authorities broad administrative powers with respect to, among other things:

Financial considerations, including standards of solvency, statutory reserves, reinsurance, and capital adequacy;
Trade practices, market conduct, and licensing of companies and agents;
Mandating certain insurance benefits and regulating certain premium rates;
Approval of policy forms and certain other related materials;
Permitted types and concentration of investments; and
Permitted dividends or other distributions, as well as transactions between affiliates and changes in control.

Changes in these laws and regulations, or in interpretations thereof, are often made for the benefit of the consumer at the expense of the insurer and thus could have a material adverse effect on our business, operating results, financial condition and liquidity. Compliance with these laws and regulations is also time consuming and personnel-intensive, and changes in these laws and regulations may increase our direct and indirect compliance costs and other expenses of doing business, thus having an adverse effect on our business, operating results, financial condition and liquidity.


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Regulatory actions or examinations could result in financial losses or harm to our businesses.

Various regulatory bodies regularly make inquiries of us and, from time to time, conduct examinations or investigations concerning our compliance with, among other things, insurance laws, securities laws, and laws governing the activities of broker-dealers. During the past several years, there has been a significant increase in federal and state regulatory activity relating to financial services companies, with a number of recent regulatory inquiries focusing on valuation and cost of insurance increase issues. Financial services companies have also been the subject of broad industry inquiries by state regulators and attorneys general which do not appear to be company-specific, such as business practices upon notification of death. We continue to cooperate with the applicable regulatory authorities in these matters. We may be subject to further related or unrelated inquiries or actions in the future. In light of recent events involving certain financial institutions, the U.S. government has heightened its oversight of the financial services industry in general and of the insurance industry in particular. Further, recent adverse economic and market events may have the effect of encouraging litigation, arbitration and regulatory action in response to the increased frequency and magnitude of investment losses, which may result in unfavorable judgments, awards and settlements, regulatory fines and an increase in our related legal expenses.

It is not feasible to predict or determine the ultimate outcome of regulatory proceedings or to provide reasonable ranges of potential losses. We believe that the outcomes of regulatory matters are not likely, either individually or in the aggregate, to have a material adverse effect on our financial condition. However, given the inherent unpredictability of regulatory matters, it is possible that an adverse outcome in certain matters could, from time to time, have a material adverse effect on our financial statements in particular quarterly or annual periods.

Changes in accounting standards issued by the Financial Accounting Standards Board or other standard-setting bodies may adversely affect our financial statements.

Our financial statements are subject to the application of U.S. GAAP, which is periodically revised and/or expanded. Accordingly, from time to time we are required to adopt new or revised accounting standards or guidance issued by recognized authoritative bodies, including the Financial Accounting Standards Board.

It is possible that future accounting standards which we are required to adopt could change the current accounting treatment that we apply to our financial statements and that such changes could significantly affect our reported financial condition and results of operations. See Note 2 to our financial statements under “Item 8: Financial Statements and Supplementary Data - Adoption of New Accounting Standards” in this Form 10-K for more information.


Item 1B.
Unresolved Staff Comments

As of December 31, 2013, the Company had no unresolved SEC staff comments regarding its periodic or current reports.


Item 2.
Properties

Our executive headquarters consist of our main office building at One American Row in Hartford, Connecticut, which we own and occupy. As of December 31, 2013, we also leased space in two garages in Hartford, Connecticut for employee parking, one of which was terminated as of June 1, 2014. Property is also leased for our home office in East Greenbush, New York.


Item 3.
Legal Proceedings

See Note 16 to our financial statements under “Item 8: Financial Statements and Supplementary Data” in this Form 10-K for a discussion of our legal proceedings, which is incorporated herein by reference.


Item 4.
Mine Safety Disclosures

Not applicable.



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PART II

Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Common Stock

Shares of our common stock are not publicly traded and are all owned indirectly by our ultimate parent company, PNX.

Dividends

In 2013, 2012 and 2011, we did not pay any dividends.


Item 6.
Selected Financial Data

We have omitted this information from this report pursuant to General Instructions (I)(1)(a) and (b) of Form 10-K and are filing this Form 10-K with the reduced disclosure format permitted by that General Instruction.



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Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

Management’s narrative analysis of the results of operations is presented in lieu of Management’s Discussion and Analysis of Financial Condition and Results of Operations, pursuant to General Instruction (I)(2)(a) of Form 10-K.

FORWARD-LOOKING STATEMENTS

The discussion in this Form 10-K may contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. We intend for these forward-looking statements to be covered by the safe harbor provisions of the federal securities laws relating to forward-looking statements. These forward-looking statements include statements relating to trends in, or representing management’s beliefs about our future transactions, strategies, operations and financial results and often contain words such as “will,” “anticipate,” “believe,” “plan,” “estimate,” “expect,” “intend,” “is targeting,” “may,” “should” and other similar words or expressions. Forward-looking statements are made based upon management’s current expectations and beliefs concerning trends and future developments and their potential effects on us. They are not guarantees of future performance. Our actual business, financial condition or results of operations may differ materially from those suggested by forward-looking statements as a result of risks and uncertainties which include, among others: (A) risks related to the Restatement, failure to file timely periodic reports with the SEC and our internal control over financial reporting, which include (i) the potential failure to remediate material weaknesses in our internal control over financial reporting and other material weaknesses may be identified in the future, which would adversely affect the accuracy and timing of our financial reporting; (ii) the extraordinary processes undertaken to effect the Restatement may not have been adequate to identify and correct all errors in our historical financial statements and, as a result, we may discover additional errors and our financial statements remain subject to the risk of future restatement; (iii) our failure to have current financial information available; (iv) the risk of failure to comply with the filing deadlines included in the SEC’s Cease-and-Desist Order, dated March 21, 2014, as amended by the Amended Cease-and-Desist Order, dated August 1, 2014, including that the SEC may seek sanctions against or deregister PNX and the Company; (v) the risk of PNX’s failure to file its delayed SEC filings and its 2014 Quarterly Reports on Form 10-Q by March 16, 2015, the extended deadline for providing these SEC filings to the bond trustee, as well as the risk associated with seeking additional consents from bondholders of its outstanding 7.45% Quarterly Interest Bonds Due 2032 regarding these SEC 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 expenses related to the Restatement, the U.S. GAAP restatement undertaken by PNX, the remediation of weaknesses in our internal control over financial reporting and disclosure controls and procedures, and the preparation of this Form 10-K and our delayed SEC reports; (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 Form 10-K, even if such results changes or circumstances make it clear that any forward-looking information will not be realized. If we make any future public statements or disclosures which modify or impact any of the forward-looking statements contained in or accompanying this Form 10-K, such statements or disclosures will be deemed to modify or supersede such statements in this Form 10-K.


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MANAGEMENT’S DISCUSSION AND ANALYSIS

Management’s discussion and analysis reviews our financial condition at December 31, 2013 and 2012; our results of operations for the years 2013, 2012 and 2011; and, where appropriate, factors that may affect our future financial performance. This discussion should be read in conjunction with our financial statements in this Form 10-K.

Executive Overview

Business

We provide life insurance and annuity products through independent agents and financial advisors. Our policyholder base includes both affluent and middle market consumers, with our more recent business concentrated in the middle market. Most of our life insurance in force is permanent life insurance (universal life and variable universal life) insuring one or more lives. Our annuity products include fixed and variable annuities with a variety of death benefit and guaranteed living benefit options.

In 2013, 99% of PHL Variable product sales, as defined by total annuity deposits and total life premium, were annuities, and 89% of those sales were fixed indexed annuities.

Saybrus Partners, Inc. (“Saybrus”), an affiliate, provides dedicated life insurance and other consulting services to financial advisors in partner companies, as well as support for sales of Phoenix’s product line through independent distribution organizations.

Earnings Drivers

Our profitability is driven by interaction of the following elements:

Fees on life and annuity products consist primarily of: (i) cost of insurance (“COI”) charges, which are based on the difference between policy face amounts and the account values (referred to as the NAR); (ii) asset-based fees (including mortality and expense charges for variable annuities) which are calculated as a percentage of assets under management within our separate accounts; (iii) premium-based fees to cover premium taxes and renewal commissions; and (iv) surrender charges.
Policy benefits include death claims net of reinsurance cash flows, including ceded premiums and recoverables, interest credited to policyholders and changes in policy liabilities and accruals. Certain universal life reserves are based on management’s assumptions about future COI fees and interest margins which, in turn, are affected by future premium payments, surrenders, lapses and mortality rates. Actual experience can vary significantly from these assumptions, resulting in greater or lesser changes in reserves. In addition, we regularly review and reset our assumptions in light of actual experience, which can result in material changes to these reserves.

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.

Certain of our variable annuity contracts include guaranteed minimum death and income benefits. The change in the liability associated with these guarantees is included in policy benefits. The value of these liabilities is sensitive to changes in equity markets, equity market volatility and interest rates, as well as subject to management assumptions regarding future surrenders, rider utilization rates and mortality.

In addition, the universal life block of business has experience which produces profits in earlier periods followed by losses in later periods for which an additional liability is required to be held above the account value liability. These reserves for future losses are determined by accruing ratably over historical and anticipated positive income. The assumptions used in estimating these liabilities are consistent with those used for amortizing deferred policy acquisition costs and are subject to the same variability and risk, and these factors can vary significantly from period to period.

Interest margins consist of net investment income earned on universal life, fixed indexed annuities and other policyholder funds, gains on options purchased to fund index credits less the interest or index credits applied to policyholders on those funds. Interest margins also include investment income on assets supporting the Company’s surplus.

29



Non-deferred operating expenses are expenses related to servicing policies, premium taxes, reinsurance allowances, non-deferrable acquisition expenses and commissions and general overhead. They also include pension and other benefit costs which involve significant estimates and assumptions.

Deferred policy acquisition cost amortization is based on the amount of expenses deferred, actual results in each quarter and management’s assumptions about the future performance of the business. The amount of future profit or margin is dependent principally on investment returns in our separate accounts, interest and default rates, reinsurance costs and recoveries, mortality, surrender rates, premium persistency and expenses. These factors enter into management’s estimates of gross profits or margins, which generally are used to amortize deferred policy acquisition costs. Actual equity market movements, net investment income in excess of amounts credited to policyholders, claims payments and other key factors can vary significantly from our assumptions, resulting in a misestimate of gross profits or margins, and a change in amortization, with a resulting impact to income. In addition, we regularly review and reset our assumptions in light of actual experience, which can result in material changes in amortization.

Net realized investment gains or losses related to investments and hedging programs include transaction gains and losses, OTTIs and changes in the value of certain derivatives and embedded derivatives. Certain of our variable and fixed annuity contracts include guaranteed minimum withdrawal and accumulation benefits which are classified as embedded derivatives. The fair value of the embedded derivative liability is calculated using significant management estimates, including: (i) the expected value of index credits on the next policy anniversary dates; (ii) the interest rate used to project the future growth in the contract liability; (iii) the discount rate used to discount future benefit payments, which includes an adjustment for our credit worthiness; and (iv) the expected costs of annual call options that will be purchased in the future to fund index credits beyond the next policy anniversary. These factors can vary significantly from period to period.

Income tax expense/benefit consists of both current and deferred tax provisions. The computation of these amounts is a function of pre-tax income or loss and the application of relevant tax law and U.S. GAAP accounting guidance. In assessing the realizability of our deferred tax assets, we make significant judgments with respect to projections of future taxable income, the identification of prudent and feasible tax planning strategies and the reversal pattern of the Company’s book-to-tax differences that are temporary in nature. We also consider the expiration dates and amounts of carryforwards related to net operating losses, capital losses, foreign tax credits and general business tax credits. Based on our assessment, we have recorded a valuation allowance against a significant portion of our deferred tax assets based upon our conclusion that there is insufficient objective positive evidence to overcome the significant negative evidence from our cumulative losses in recent years. This assessment could change in the future, resulting in a release of the valuation allowance and a benefit to income.

Under U.S. GAAP, premiums and deposits for variable life, universal life and annuity products are not immediately recorded as revenues. For certain investment options of variable products, deposits are reflected on our balance sheets as an increase in separate account liabilities. Premiums and deposits for universal life, fixed annuities and certain investment options of variable annuities are reflected on our balance sheets as an increase in policyholder liabilities. Premiums and deposits for other products are reflected on our balance sheets as an increase in policy liabilities and accruals.

Recent Trends in Earnings Drivers

Net realized investment gains (losses). Net realized investment gains, excluding OTTI, of $5.4 million were recognized for the twelve months ended December 31, 2013 compared to net realized investment losses, excluding OTTI, of $19.5 million for the twelve months ended December 31, 2012. The change in the net realized investment gains is primarily attributable to a decrease in realized losses on derivatives that are used to hedge the risks associated with variable annuity guarantees and the fixed indexed annuity liabilities. For the twelve months ended December 31, 2013 there were losses on derivative investments of $23.1 million, while there were losses of $49.0 million for the twelve months ended December 31, 2012. The continued improvement in the equity markets results in losses on the derivatives that are used to hedge the risk associated with the variable annuity guarantees, that are offset by gains on the derivatives that are used to hedge the risks associated with the fixed indexed annuities. The fixed indexed annuity hedging gains were more significant in 2013 due to more significant increases in the equity market in 2013 than in 2012, as well as additional derivatives purchased due to continued sales of fixed indexed annuities.


30



Policy benefits. Policy benefits decreased $110.3 million for the twelve months ended December 31, 2013 compared with the twelve months ended December 31, 2012. The decrease in policy benefit expenses is primarily due to gains on guaranteed insurance benefit liabilities and reserves for profits followed by losses of $84.1 million as a result of assumption changes made during the annual comprehensive review of assumptions in the fourth quarter of 2013. The most significant driver of the positive 2013 unlock results was the incorporation of a mortality improvement assumption in the overall mortality table, which resulted in improved expected mortality on universal life and variable universal life products.

Operating expenses. Operating expenses increased by $13.2 million for the twelve months ended December 31, 2013 compared with the twelve months ended December 31, 2012. The increase in operating expenses was a result of higher professional fees and outside consulting services primarily as a result of the restatement.

Income taxes. The effective tax rate for 2013 and 2012 was (63.8%) and (13.3%) respectively. The principal cause of the difference between the effective rate and the U.S. statutory rate of 35% in 2013 was the dividend deduction and a decrease in the valuation allowance on the pre-tax income. The principal cause of the difference between the effective rate and the U.S. statutory rate of 35% in 2012 was the dividend received deduction and an increase in the valuation allowance on the pre-tax loss.

Strategy and Outlook

We are focused on the following key strategic pillars, which have defined our strategy since 2009:

Balance sheet strength;
Policyholder service;
Operational efficiency; and
Profitable growth.

We believe this strategy has produced a firm foundation and positioned us for continued growth, even as our business remains sensitive to general economic conditions and capital market trends including equity markets and interest rates.

We believe there is significant demand for our products among middle market households seeking to accumulate assets and secure lifetime income during retirement. The current low interest rate environment provides limited opportunities for consumers to protect principal and generate predictable income. Our indexed annuity products are positioned favorably vis-à-vis traditional investments such as bank certificates of deposits.

Recent trends in the life insurance industry may affect our mortality, policy persistency and premium persistency. The evolution of the financial needs of policyholders, the emergence of a secondary market for life insurance, and increased availability and subsequent contraction of premium financing suggest that the reasons for purchasing our products have changed. Deviations in experience from our assumptions have had, and could continue to have, an adverse effect on the profitability of certain universal life products. Most of our current products permit us to increase charges and adjust crediting rates during the life of the policy or contract (subject to guarantees in the policies and contracts). We have made, and may in the future make, such adjustments.

Impact of New Accounting Standards

For a discussion of accounting standards and changes in accounting, see Note 2 to our financial statements under “Item 8: Financial Statements and Supplementary Data” in this Form 10-K.


31



Critical Accounting Estimates

The discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with U.S. GAAP. U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Critical accounting estimates are reflective of significant judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.

Certain of our critical accounting estimates are as follows:

Deferred Policy Acquisition Costs

We amortize deferred policy acquisition costs (“DAC”) based on the related policy’s classification. For universal life, variable universal life and deferred annuities, deferred policy acquisition costs are amortized in proportion to estimated gross profits (“EGPs”) discussed more fully below. EGPs are also used to amortize other assets and liabilities in the Company’s balance sheets, such as sales inducement assets (“SIA”) and unearned revenue reserves (“URR”). Components of EGPs are used to determine reserves for universal life and fixed indexed and variable annuity contracts with death and other insurance benefits such as guaranteed minimum death and guaranteed minimum income benefits. EGPs are based on historical and anticipated future experience which is updated periodically.

Deferred policy acquisition costs are adjusted through other comprehensive income (“OCI”) each period as a result of unrealized gains or losses on securities classified as available-for-sale in a process commonly referred to as shadow accounting. This adjustment is required in order to reflect the impact of these unrealized amounts as if these unrealized amounts had been realized.

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:

Significant Assumption
 
Product
 
Explanation and Derivation
 
 
 
 
 
Separate account investment return
 
 
Variable Annuities
(8.0% long-term return assumption)
Variable Universal Life
(8.0% long-term return assumption)
 
Separate account return assumptions are derived from the long-term returns observed in the asset classes in which the separate accounts are invested. Short-term deviations from the long-term expectations are expected to revert to the long-term assumption over five years.
 
Interest rates and default rates
 
Fixed and Indexed Annuities
Universal Life
 
 
Investment returns are based on the current yields and maturities of our fixed income portfolio combined with expected reinvestment rates given current market interest rates. Reinvestment rates are assumed to revert to long-term rates implied by the forward yield curve and long-term default rates. Contractually permitted future changes in credited rates are assumed to help support investment margins.
 


32



Significant Assumption
 
Product
 
Explanation and Derivation
 
 
 
 
 
Mortality / longevity
 
Universal Life
Variable Universal Life
Fixed and Indexed Annuities
 
Mortality assumptions are based on Company experience over a rolling five-year period plus supplemental data from industry sources and trends. A mortality improvement assumption is also incorporated into the overall mortality table. These assumptions can vary by issue age, gender, underwriting class and policy duration.
 
Policyholder behavior – policy persistency
 
Universal Life
Variable Universal Life
Variable Annuities
Fixed and Indexed Annuities
 
Policy persistency assumptions vary by product and policy year and are updated based on recently observed experience. Policyholders are generally assumed to behave rationally; hence rates are typically lower when surrender penalties are in effect or when policy benefits are more valuable.
 
Policyholder behavior – premium persistency
 
Universal Life
Variable Universal Life
 
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 recently observed 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).
 
Expenses
 
All products
 
Projected maintenance expenses to administer policies in force are based on annually updated studies of expenses incurred.
 
Reinsurance costs / recoveries
 
Universal Life
Variable Universal Life
Variable Annuities
 
Projected reinsurance costs are based on treaty terms currently in force. Recoveries are based on the Company’s assumed mortality and treaty terms. Treaty recaptures are based on contract provisions and management’s intentions.

Annually, we complete a comprehensive assumption review where management makes a determination of best estimate assumptions based on a comprehensive review of recent experience and industry trends. Assumption changes resulting from this review may change our estimates of EGPs in the DAC, SIA, and URR models, as well as projections within the death benefit and other insurance benefit reserving models, the profits followed by losses reserve models, and cost of reinsurance models. Throughout the year, we may also update the assumptions and adjust these balances if emerging data indicates a change is warranted. All assumption changes, whether resulting from the annual comprehensive review or from other periodic assessments, are considered an unlock in the period of revision and adjust the DAC, SIA, URR, death and other insurance benefit reserves, profits followed by losses reserve, and cost of reinsurance balances in the balance sheets with an offsetting benefit or charge to income to reflect such changes in the period of the revision. An unlock that results in an after-tax benefit generally occurs as a result of actual experience or future expectations of product profitability being more favorable than 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 less favorable than previous estimates.

Our process to assess the reasonableness of the EGPs uses internally developed models together with consideration of applicable recent experience and analysis of market and industry trends and other events. Actual gross profits that vary from management’s estimates in a given reporting period may also result in increases or decreases in the rate of amortization recorded in the period.

An analysis is performed annually to assess if there are sufficient gross profits to recover the deferred policy acquisition costs associated with business written during the year. If the estimates of gross profits cannot support the recovery of deferred policy acquisition costs, the amount deferred is reduced to the recoverable amount.


33



Over the last several years, the Company has revised a number of assumptions that have resulted in changes to expected future gross profits. The most significant assumption updates resulting in a change to future gross profits and the amortization of DAC, SIA and URR in 2013 are related to changes in expected premium persistency, and the incorporation of a mortality improvement assumption. Other of the more significant drivers of changes to expected gross profits over the last several years include changes in expected separate account investment returns due to changes in equity markets; changes in expected future interest rates and default rates based on continued experience and expected interest rate changes; changes in mortality, lapses and other policyholder behavior assumptions that are updated to reflect more recent policyholder and industry experience; and changes in expected policy administration expenses.
Policy Liabilities and Accruals

Generally, future policy benefits are payable over an extended period of time and related liabilities are calculated recognizing future expected benefits, expenses and premiums. Such liabilities are established based on methods and underlying assumptions in accordance with U.S. GAAP and applicable actuarial standards. Principal assumptions used in the establishment of liabilities for future policy benefits are mortality, morbidity, policyholder behavior, investment returns, inflation, expenses and other contingent events as appropriate. These assumptions are intended to estimate the experience for the period the policy benefits are payable. Utilizing these assumptions, liabilities are established on a cohort basis, as appropriate. If experience is less favorable than assumed, additional liabilities may be established, resulting in a charge to policyholder benefits and claims.

Additional policyholder liabilities for guaranteed benefits on variable annuity and on fixed index annuity contracts are based on estimates of the expected value of benefits in excess of the projected account balance, recognizing the excess over the accumulation period based on total expected assessments. Because these estimates are sensitive to capital market movements, amounts are calculated using multiple future economic scenarios.

Additional policyholder liabilities are established for certain contract features that could generate significant reductions to future gross profits (e.g., death benefits when a contract has zero account value and a no-lapse guarantee). The liabilities are accrued over the lifetime of the block based on assessments. The assumptions used in estimating these liabilities are consistent with those used for amortizing deferred policy acquisition costs, and are, thus, subject to the same variability and risk. The assumptions of investment performance and volatility for variable and equity index products are consistent with historical experience of the appropriate underlying equity indices.

We expect that our universal life block of business will generate profits followed by losses and, therefore, we establish an additional liability to accrue for the expected losses over the period of expected profits. The assumptions used in estimating these liabilities are consistent with those used for amortizing deferred policy acquisition costs and are subject to the same variability and risk.

The Company periodically reviews its estimates of actuarial liabilities for policyholder benefits and compares them with its actual experience. Differences between actual experience and the assumptions used in pricing these policies and guarantees, as well as in the establishment of the related liabilities, result in variances in profit and could result in losses.

See Note 2 to our financial statements under “Item 8: Financial Statements and Supplementary Data” and the “Enterprise Risk Management” section of “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Form 10-K for more information.


34



Embedded Derivative Liabilities

We make guarantees on certain variable annuity contracts, including GMAB, GMWB and COMBO as well as provide credits based on the performance of certain indices (“index credits”) on our fixed indexed annuity contracts that meet the definition of an embedded derivative. The GMAB, GMWB and COMBO embedded derivative liabilities associated with our variable annuity contracts are accounted for at fair value, using a risk neutral stochastic valuation methodology with changes in fair value recorded in realized investment gains. The inputs to our fair value methodology include estimates derived from the asset derivatives market, including the equity volatility and the swap curve. Several additional inputs are not obtained from independent sources, but instead reflect our internally developed assumptions related to mortality rates, lapse rates and policyholder behavior. The fair value of the embedded derivative liabilities associated with the index credits on our fixed indexed annuity contracts is calculated using the budget method with changes in fair value recorded in realized investment gains. The initial value under the budget method is established based on the fair value of the options used to hedge the liabilities. The value of the index credits in future years is estimated to be the budgeted amount. The budget amount is based on the impact of projected interest rates on the discounted liabilities. Several additional inputs reflect our internally developed assumptions related to lapse rates and policyholder behavior. As there are significant unobservable inputs included in our fair value methodology for these embedded derivative liabilities, we consider the above-described methodology as a whole to be Level 3 within the fair value hierarchy.

Our fair value calculation of embedded derivative liabilities includes a credit standing adjustment (the “CSA”). The CSA represents the adjustment that market participants would make to reflect the risk that guaranteed benefit obligations may not be fulfilled (“non-performance risk”). We estimate our CSA using the credit spread (based on publicly available credit spread indices) for financial services companies similar to the Company and its insurance company affiliates.

The CSA is updated every quarter and, therefore, the fair value will change with the passage of time even in the absence of any other changes that would affect the valuation. For example, the December 31, 2013 fair value of $74.8 million would increase to $79.7 million if the spread were decreased by 50 basis points. If the spread were increased by 50 basis points, the fair value would decrease to $70.2 million.

Valuation of Debt Securities

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.

Fair Value of Securities
As of
by Pricing Source: [1]
December 31, 2013
($ in millions)
Fixed
 
% of
 
Maturities
 
Total
 
at Fair Value
 
Fair Value
Priced via independent market quotations
$
2,367.8

 
67.5
%
Priced via matrices
988.8

 
28.2
%
Priced via broker quotations
50.9

 
1.5
%
Priced via other methods
18.8

 
0.5
%
Short-term investments [2]
81.0

 
2.3
%
Total
$
3,507.3

 
100.0
%
———————
[1]
Inclusive of short-term investments.
[2]
Short-term investments are valued at amortized cost, which approximates fair value.

See Note 9 to our financial statements under Item 8 “Financial Statements and Supplementary Data” in this Form 10-K for additional disclosures of our fair value methodologies.


35



Other-than-Temporary Impairments on Available-for-Sale Securities

We recognize realized investment losses when declines in fair value of debt securities are considered to be an OTTI.

For debt securities, the other-than-temporarily impaired amount is separated into the amount related to a credit loss and is reported as net realized investment losses included in earnings and any amounts related to other factors are recognized in OCI. The credit loss component represents the difference between the amortized cost of the security and the net present value of its projected future cash flows discounted at the effective interest rate implicit in the debt security prior to impairment. Any remaining difference between the fair value and amortized cost is recognized in accumulated other comprehensive income (“AOCI”). Subsequent to the recognition of an OTTI, the impaired security is accounted for as if it had been purchased on the date of impairment at an amortized cost basis equal to the previous amortized cost basis less the OTTI recognized in earnings. We will continue to estimate the present value of future expected cash flows and, if significantly greater than the new cost basis, we will accrete the difference as investment income on a prospective basis once the Company has determined that the interest income is likely to be collected.

In evaluating whether a decline in value is other-than-temporary, we consider several factors including, but not limited to, the following:

the extent and the duration of the decline;
the reasons for the decline in value (credit event, interest related or market fluctuations);
our intent to sell the security, or whether it is more likely than not that we will be required to sell it before recovery; and
the financial condition and near term prospects of the issuer.

A debt security impairment is deemed other-than-temporary if:

we either intend to sell the security, or it is more likely than not that we will be required to sell the security before recovery; or
it is probable we will be unable to collect cash flows sufficient to recover the amortized cost basis of the security.

Impairments due to deterioration in credit that result in a conclusion that the present value of cash flows expected to be collected will not be sufficient to recover the amortized cost basis of the security are considered other-than-temporary. Other declines in fair value (for example, due to interest rate changes, sector credit rating changes or company-specific rating changes) that result in a conclusion that the present value of cash flows expected to be collected will not be sufficient to recover the amortized cost basis of the security may also result in a conclusion that an OTTI has occurred.

On a quarterly basis, we evaluate securities in an unrealized loss position for potential recognition of an OTTI. In addition, we maintain a watch list of securities in default, near default or otherwise considered by our investment professionals as being distressed, potentially distressed or requiring a heightened level of scrutiny. We also identify securities whose fair value has been below amortized cost on a continuous basis for zero to six months, six months to 12 months and greater than 12 months.

We employ a comprehensive process to determine whether or not a security in an unrealized loss position is other-than-temporarily impaired. This assessment is done on a security-by-security basis and involves significant management judgment. The assessment of whether impairments have occurred is based on management’s evaluation of the underlying reasons for the decline in estimated fair value. The Company’s review of its debt securities for impairments includes an analysis of the total gross unrealized losses by severity and/or age of the gross unrealized loss, as summarized in the, “Duration of Gross Unrealized Losses on Securities” section. An extended and severe unrealized loss position on a debt security may not have any impact on the ability of the issuer to service all scheduled interest and principal payments and the Company’s evaluation of recoverability of all contractual cash flows or the ability to recover an amount at least equal to its amortized cost based on the present value of the expected future cash flows to be collected. In contrast, for certain equity securities, greater weight and consideration are given by the Company to an extended decline in market value and the likelihood such market value decline will recover.

Specifically for structured securities, to determine whether a collateralized security is impaired, we obtain underlying data from the security’s trustee and analyze it for performance trends. A security-specific stress analysis is performed using the most recent trustee information. This analysis forms the basis for our determination of the future expected cash flows to be collected for the security.


36



See Note 6 to our financial statements under “Item 8: Financial Statements and Supplementary Data” and the “Debt Securities” and “Enterprise Risk Management” sections of “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Form 10-K for more information.

Income Taxes

We account for income taxes in accordance with ASC 740, Accounting for Income Taxes.

We are included in the consolidated federal income tax return filed by PNX and are party to a tax sharing agreement by and among PNX and its subsidiaries. In accordance with this agreement, federal income taxes are allocated as if they had been calculated on a separate company basis, except that benefits for any net operating losses or other tax credits generated by the Company will be provided at the earlier of when such loss or credit is utilized in the consolidated federal tax return and when the tax attribute would have otherwise expired.

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, 2013.

As of December 31, 2013, 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 $74.2 million has been recorded on net deferred tax assets of $102.2 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 $28.0 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 a decrease of $31.7 million in net loss and an increase of $0.5 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. The impact of payments that differ from the recognized liability are reflected in the period in which the examinations are completed.

The Company has minimal uncertain tax positions and accordingly, the liability for uncertain tax positions is not material to the financial statements.

See Note 10 to our financial statements under “Item 8: Financial Statements and Supplementary Data” in this Form 10-K for more information related to income taxes.

Litigation Contingencies

The Company is a party to legal actions and is involved in regulatory investigations. Given the inherent unpredictability of these matters, it is difficult to estimate the impact on our financial position. Liabilities are established when it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. On a quarterly and annual basis, the Company reviews relevant information with respect to liabilities for litigation, regulatory investigations, and litigation-related contingencies to be reflected in the Company’s financial statements. It is possible that an adverse outcome in certain of the Company’s litigation or the use of different assumptions in the determination of amounts recorded could have a material effect upon the Company’s net income or cash flows in particular quarterly or annual periods.


37



Results of Operations

Summary Financial Data:
Years Ended
 
Increase (decrease) and
($ in millions)
December 31,
 
percentage change
 
2013
 
2012
 
2013 vs. 2012
 
 
 
 
 
 
REVENUES:
 
 
 
 
 
 
 
Premiums
$
13.9

 
$
8.5

 
$
5.4

 
64
%
Insurance and investment product fees
367.6

 
365.3

 
2.3

 
1
%
Net investment income
140.8

 
130.9

 
9.9

 
8
%
Net realized investment gains (losses):
 
 
 
 
 
 
 
Total other-than-temporary impairment (“OTTI”) losses
(1.1
)
 
(5.0
)
 
3.9

 
(78
%)
  Portion of OTTI losses recognized in
    other comprehensive income (“OCI”)
(0.9
)
 
2.2

 
(3.1
)
 
NM

Net OTTI losses recognized in earnings
(2.0
)
 
(2.8
)
 
0.8

 
(29
%)
Net realized investment gains (losses), excluding OTTI losses
5.4

 
(19.5
)
 
24.9

 
NM

Net realized investment gains (losses)
3.4

 
(22.3
)
 
25.7

 
NM

Total revenues
525.7

 
482.4

 
43.3

 
9
 %
BENEFITS AND EXPENSES:
 
 
 
 
 
 
 
Policy benefits
286.5

 
396.8

 
(110.3
)
 
(28
%)
Policy acquisition cost amortization
88.4

 
103.5

 
(15.1
)
 
(15
%)
Other operating expenses
116.8

 
103.6

 
13.2

 
13
%
Total benefits and expenses
491.7

 
603.9

 
(112.2
)
 
(19
%)
Income (loss) before income taxes
34.0

 
(121.5
)
 
155.5

 
NM

Income tax expense (benefit)
(21.7
)
 
16.2

 
(37.9
)
 
NM

Net income (loss)
$
55.7

 
$
(137.7
)
 
$
193.4

 
NM

———————
Not meaningful (NM)

Analysis of Results of Operations

Year ended December 31, 2013 compared to year ended December 31, 2012

The Company recorded net income of $55.7 million for the twelve months ended December 31, 2013 as compared with a net loss of $137.7 million for the twelve months ended December 31, 2012. The increase in net income is primarily due to the following items:

Net realized investment gains, excluding OTTI, of $5.4 million were recognized for the twelve months ended December 31, 2013 compared to net realized investment losses, excluding OTTI, of $19.5 million for the twelve months ended December 31, 2012. The change in the net realized investment gains is primarily attributable to a decrease in realized losses on derivatives that are used to hedge the risks associated with variable annuity guarantees and the fixed indexed annuity liabilities. For the twelve months ended December 31, 2013 there were losses on derivative investments of $23.1 million, while there were losses of $49.0 million for the twelve months ended December 31, 2012. The continued improvement in the equity markets results in losses on the derivatives that are used to hedge the risk associated with the variable annuity guarantees, that are offset by gains on the derivatives that are used to hedge the risks associated with the fixed indexed annuities. The fixed indexed annuity hedging gains were more significant in 2013 due to more significant increases in the equity market in 2013 than in 2012, as well as additional derivatives purchased due to continued sales of fixed indexed annuities.

Policy benefits decreased $110.3 million for the twelve months ended December 31, 2013 compared with the twelve months ended December 31, 2012. The decrease in policy benefit expenses is primarily due to gains on guaranteed insurance benefit liabilities and reserves for profits followed by losses of $84.1 million as a result of assumption changes made during the annual comprehensive review of assumptions in the fourth quarter of 2013. The most significant driver of the positive 2013 unlock results was the incorporation of a mortality improvement assumption in the overall mortality table, which resulted in improved expected mortality on universal life and variable universal life products.

38



Income taxes provided a benefit of $21.7 million for the twelve months ended December 31, 2013 compared with an expense of $16.2 million for the twelve months ended December 31, 2012. The primary driver of the income tax benefit is a decrease in the valuation allowance of $31.7.

Partially offsetting the increase in net income were the following items:

Operating expenses increased by $13.2 million for the twelve months ended December 31, 2013 compared with the twelve months ended December 31, 2012. The increase in operating expenses was a result of higher professional fees and outside consulting services primarily as a result of the restatement.

Effects of Inflation

For the years 2013, 2012 and 2011, inflation did not have a material effect on our results of operations.

Enterprise Risk Management

Our ultimate parent company, PNX, has an enterprise-wide risk management program under which PHL Variable operations are covered. Our Chief Risk Officer reports to the Chief Executive Officer and monitors our risk management activities. The Chief Risk Officer provides regular reports to the Board without the presence of other members of management. Our risk management governance consists of several management committees to oversee and address issues pertaining to all our major risks—operational, market and product—as well as capital management. In all cases, these committees include one or more of our Chief Executive Officer, Chief Financial Officer, Chief Investment Officer and Chief Risk Officer.

Operational Risk

Operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. As reported in “Item 9A: Controls and Procedures” of this Form 10-K, the Company has concluded that there are material weaknesses in its internal control over financial reporting, which have materially adversely affected its ability to timely and accurately report its results of operations and financial condition, and that its disclosure controls and procedures are ineffective as of December 31, 2013. These material weaknesses have not been fully remediated as of the filing date of this report and the Company cannot assure that other material weaknesses will not be identified in the future. It is necessary for the Company to maintain effective internal control over financial reporting to prevent fraud and errors, and to maintain effective disclosure controls and procedures so that it can provide timely and reliable financial and other information. If the Company fails to maintain an effective system of internal controls, the accuracy and timing of its financial reporting may be adversely affected. Further, the absence of timely and reliable financial and other information about the Company’s business operations may inhibit the Company’s ability to identify operational risk. A failure to correct material weaknesses in our internal controls could result in further restatements of financial statements and correction of other information filed with the SEC. See “Item 1A: Risk Factors” in Part I of this Form 10-K for a description of these and other risks that may impact the Company’s operations. Also see “Item 9A: Controls and Procedures” in Part II of this Form 10-K for more information regarding these weaknesses, an evaluation of the effectiveness of the Company’s disclosure controls and procedures, and the Company’s remediation plans.

PNX has established an Operational Risk Committee, chaired by the Chief Risk Officer, to develop an enterprise-wide framework for managing operational risks. This committee meets periodically and includes membership that represents all significant operating, financial and staff departments of PNX. Among the risks the committee reviews and manages and for which it provides general oversight are business continuity risk, disaster recovery risk and risks related to the Company’s information technology systems.

Market Risk

Market risk is the risk that we will incur losses due to adverse changes in market rates and prices. We have exposure to market risk through both our investment activities and our insurance operations. Our investment objective is to maximize after-tax investment return within defined risk parameters. Our primary sources of market risk are:

interest rate risk, which relates to the market price and cash flow variability associated with changes in market interest rates;
credit risk, which relates to the uncertainty associated with the ongoing ability of an obligor to make timely payments of principal and interest; and
equity risk, which relates to the volatility of prices for equity and equity-like investments, such as limited partnerships.

39



We measure, manage and monitor market risk associated with our insurance and annuity business, as part of our ongoing commitment to fund insurance liabilities. We have developed an integrated process for managing the interaction between product features and market risk. This process involves our Corporate Finance, Corporate Portfolio Management and Life and Annuity Product Development departments. These areas coordinate with each other and report results and make recommendations to our Asset-Liability Management Committee (“ALCO”) chaired by the Chief Risk Officer.

We also measure, manage and monitor market risk associated with our investments, both those backing insurance liabilities and those supporting surplus. This process primarily involves Corporate Portfolio Management. This organization makes recommendations and reports results to our Investment Policy Committee, chaired by the Chief Investment Officer. Please refer to the sections that follow, including “Debt Securities,” following this discussion of Enterprise Risk Management, for more information on our investment risk exposures. Within the parameters specified in our investment policy, we regularly refine our allocations based on factors including ratings, duration and type of fixed income security to appropriately balance market risk exposure and expected return.

Interest Rate Risk Management

Interest rate risk is the risk that we will incur economic losses due to adverse changes in interest rates. Our debt security investments include U.S. and foreign government bonds, securities issued by government agencies, corporate bonds, asset-backed securities and mortgage-backed securities, most of which are exposed to changes in medium-term and long-term U.S. Treasury rates. Our exposure to interest rate changes results primarily from our significant holdings of fixed rate investments and our interest-sensitive insurance liabilities. Our insurance liabilities largely comprise dividend-paying universal life policies and annuity contracts.

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 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.

We also manage interest rate risk by purchasing securities that feature prepayment restrictions and call protection. Our product design and pricing strategies include the use of surrender charges or restrictions on withdrawals in some products. We regularly undertake a sensitivity analysis that calculates liability durations under various cash flow scenarios. In addition, we monitor the short- and medium-term asset and liability cash flows profiles by portfolio to manage our liquidity needs.

One of the key measures we use to quantify our interest rate exposure is duration, a measure of the sensitivity of the fair value of assets and liabilities to changes in interest rates. For example, if interest rates increase by 100 basis points, or 1%, the fair value of an asset or liability with a duration of five is expected to decrease by 5%. We believe that as of December 31, 2013, our asset and liability portfolio durations were reasonably matched.

The Company uses an industry recognized analytic model to calculate the fair value of its fixed income portfolio. The Company’s interest rate sensitivity analysis reflects the change in market value assuming a +/-100 basis point parallel shift in the yield curve. The down 100 basis point shift is floored at zero to prevent rates from going negative. The table below shows the estimated interest rate sensitivity of our fixed income financial instruments measured in terms of fair value.

Interest Rate Sensitivity of
As of
Fixed Income Financial Instruments:
December 31, 2013
($ in millions)
-100 Basis
 
 
 
+100 Basis
 
Point
 
 
 
Point
 
Change
 
Fair Value
 
Change
 
 
 
 
 
 
Cash and short-term investments
$
262.1

 
$
262.0

 
$
261.7

Available-for-sale debt securities
3,628.4

 
3,426.3

 
3,231.1

Fair value investments [1]
50.2

 
48.6

 
46.9

Totals
$
3,940.7

 
$
3,736.9

 
$
3,539.7

———————
[1]
Includes debt securities where the fair value option has been elected.


40



See Note 9 to our financial statements under “Item 8: Financial Statements and Supplementary Data” in this Form 10-K for more information on fair value instruments.

We also use derivative financial instruments, primarily interest rate swaps, to manage our residual exposure to fluctuations in interest rates. We enter into derivative contracts with a number of highly rated financial institutions, to both diversify and reduce overall counterparty credit risk exposure.

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.

The table below shows the interest rate sensitivity of our derivatives measured in terms of fair value, excluding derivative liabilities embedded in products. These exposures will change as our insurance liabilities are created and discharged and as a result of portfolio and risk management activities.

Interest Rate Sensitivity of
As of
Derivatives:
December 31, 2013
($ in millions)
 
 
Weighted-
 
-100
 
 
 
+100 Basis
 
 
 
Average
 
Basis
 
 
 
Basis
 
Notional
 
Term
 
Point
 
 
 
Point
 
Amount
 
(Years)
 
Change
 
Fair Value
 
Change
 
 
 
 
 
 
 
 
 
 
Equity Futures [1]
$
159.7

 
0.3
 
$
12.5

 
$
12.5

 
$
12.1

Interest Rate Swap
139.0

 
7.9
 
1.0

 
(2.9
)
 
(6.2
)
Variance Swap
0.9

 
3.0
 
(8.0
)
 
(7.9
)
 
(7.8
)
Call Option [2]
155.3

 
0.1
 
21.9

 
22.0

 
22.0

Put Option
391.0

 
5.1
 
35.1

 
29.5

 
24.6

Swaption
3,902.0

 
1.1
 
7.0

 
30.7

 
99.0

Total
$
4,747.9

 
 
 
$
69.5

 
$
83.9

 
$
143.7

———————
[1]
Equity futures fair value includes margin account cash balance of $12.5 million.
[2]
Excludes call options, hedging fixed indexed annuity products.

See Note 8 to our financial statements under “Item 8: Financial Statements and Supplementary Data” in this Form 10-K for more information on derivative instruments.

To calculate duration for liabilities, we project liability cash flows under a number of stochastically generated interest rate scenarios and discount them to a net present value using a risk-free market rate increased for CSA. For interest-sensitive liabilities the projected cash flows 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 an alternative level of interest rates and by determining the percentage change in fair value from the base case.

Liabilities in excess of the policyholder account balance for universal life contracts, some of which contain secondary guarantees, are generally determined by estimating the expected value of benefits and expenses when claims are triggered and recognizing those benefits and expenses over the accumulation period based on total expected assessments. The assumptions used in estimating these liabilities are consistent with those used for amortizing deferred policy acquisition costs. The universal life block of business has experience which produces profits in earlier periods followed by losses in later periods for which a liability is required to be held in addition to the policy liabilities recorded.

See the “Critical Accounting Estimates” section above for more information on deferred policy acquisition costs and policy liabilities and accruals.


41



To estimate the impact of a 100 basis point increase or decrease in interest rates, the Company revised estimated future new money yields thereby modifying future expected portfolio returns. These shocks resulted in higher or lower investment margins and discount rates for products subject to loss recognition and profits followed by losses. All material, interest sensitive blocks of business were considered; the most significant of which is universal life. We measured the impact upon deferred policy acquisition costs and policy liabilities.

Management believes that the Company’s exposure to interest rate volatility related to its fixed index annuity product is limited and has been omitted from the analysis below. This exposure is limited due to the short duration of the indexed credit feature and the lack of guaranteed minimum benefit exposure that varies with interest rates associated on the product.

The table below shows the interest rate sensitivity of our deferred policy acquisition costs and policy liabilities.

Interest Rate Sensitivity of
As of
Deferred Policy Acquisition Costs and
December 31, 2013
Policy Liabilities:
($ in millions)
-100 Basis Point Change
 
Deferred Policy Acquisition Costs [1]
 
+100 Basis Point Change
 
-100 Basis Point Change
 
Policy Liabilities [1]
 
+100 Basis Point Change
 
 
 
 
 
 
 
 
 
 
 
 
Universal and variable universal life
$
186.4

 
$
192.6

 
$
194.6

 
$
433.9

 
$
368.8

 
$
359.4

Other life and annuity products [2]

 

 

 
46.9

 
44.4

 
42.3

———————
[1]
The values below represent changes to balances before adjustment for unrealized gains/losses.
[2]
Includes term life and payout annuity products subject to loss recognition.

The selection of a 100 basis point immediate increase or decrease in interest rates at all points on the yield curve is a hypothetical rate scenario used to demonstrate potential risk. While a 100 basis point immediate increase or decrease of this type does not represent our view of future market changes, it is a hypothetical near-term change that illustrates the potential effect of such events. Although these measurements provide a representation of interest rate sensitivity, they are based on our exposures at a point in time and may not be representative of future market results. These exposures will change as a result of new business, management’s assessment of changing market conditions and available investment opportunities.

Credit Risk Management

We manage credit risk through the fundamental analysis of the underlying obligors, issuers and transaction structures. Through internal staff and an outsource relationship, we employ experienced credit analysts who review obligors’ management, competitive position, cash flow, coverage ratios, liquidity and other key financial and non-financial information. These analysts recommend the investments needed to fund our liabilities while adhering to diversification and credit rating guidelines. In addition, when investing in private debt securities, we rely upon broad access to management information, negotiated protective covenants, call protection features and collateral protection. We review our debt security portfolio regularly to monitor the performance of obligors and assess the stability of their current credit ratings.

We also manage credit risk through industry and issuer diversification and asset allocation. Maximum exposure to an issuer or derivatives counterparty is defined by quality ratings, with higher quality issuers having larger exposure limits. We have an overall limit on below-investment-grade rated issuer exposure. In addition to monitoring counterparty exposures under current market conditions, exposures are monitored on the basis of a hypothetical “stressed” market environment involving a specific combination of declines in stock market prices and interest rates and a spike in implied option activity.

Equity Risk Management

Equity risk is the risk that we will incur economic losses due to adverse changes in equity prices. At December 31, 2013, we held certain financial instruments that are sensitive to equity market movements, primarily related to our holdings of common stock and mutual funds, private equity partnership interests and other equities, as well as fair value equity instruments, equity options and other investments. We manage equity price risk through industry and issuer diversification and asset allocation techniques.


42



The table below shows the sensitivity of our investments that are sensitive to public equity market movements measured in terms of their fair value.

Sensitivity to
As of
Public Equity Market Movements:
December 31, 2013
($ in millions)
Balance after
-10% Equity
Price Change
 
Fair
Value
 
Balance after
+10% Equity
Price Change
 
 
 
 
 
 
 
 
 
 
Limited partnerships and other investments [1]
$
7.1

 
$
7.9

 
$
8.7

 
Derivative instruments [2]
90.3

 
83.9

 
78.7

 
———————
[1]
Includes private equity funds. The value of private equity investments are not highly correlated to public equity markets, because of their liquidity and valuation methodologies. Direct private equity investments have been included in the sensitivity because they have equity exposure for the Company.
[2]
Primarily includes swaptions, put options, call options and equity futures, excluding those associated with the fixed indexed annuity products.

Certain liabilities are sensitive to equity market movements. Our exposure to changes in equity prices primarily results from our variable annuity and variable life products. 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.

Certain variable annuity products sold by us contain GMDBs. The GMDB feature provides annuity contract owners with a guarantee that the benefit received at death will be no less than a prescribed amount. This minimum amount is based on the net deposits paid into the contract, the net deposits accumulated at a specified rate, the highest historical account value on a contract anniversary or, if a contract has more than one of these features, the greatest of these values. To the extent that the GMDB is higher than the current account value at the time of death, the Company incurs a cost. This typically results in an increase in annuity policy benefits in periods of declining financial markets and in periods of stable financial markets following a decline. As of December 31, 2013, the difference between the GMDB and the current account value (NAR) for all existing contracts was $13.7 million. This was our exposure to loss had all contract owners died on December 31, 2013. See Note 7 to our financial statements under “Item 8: Financial Statements and Supplementary Data” in this Form 10-K for more information.

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.

Management believes that the Company’s exposure to equity market volatility related to its fixed index annuity product is limited and has been omitted from the analysis below. This exposure is limited to the indexed credit feature of the product, which is reasonably managed through the Company’s ongoing hedging program.

See Note 4 to our financial statements under “Item 8: Financial Statements and Supplementary Data” in this Form 10-K for more information regarding deferred policy acquisition costs.


43



The table below shows the estimated equity risk sensitivity of our liability products that are sensitive to equity market movements measured in terms of their fair value.

Equity Risk Sensitivity of
As of
Our Liability Products:
December 31, 2013
($ in millions)
Balance after
-10% Equity
Price Change
 
Fair
Value
 
Balance after
+10% Equity
Price Change
 
 
 
 
 
 
 
 
 
 
GMAB [1]
$
3.7

 
$
1.5

 
$
(0.7
)
 
GMWB [1]
(2.3
)
 
(5.1
)
 
(7.8
)
 
COMBO [1]
(0.3
)
 
(0.4
)
 
(0.4
)
 
———————
[1]
The values above represent changes to balances before adjustment for unrealized gains/losses.

The selection of a 10% increase or decrease in equity prices is a hypothetical rate scenario used to demonstrate potential risk. While a 10% increase or decrease does not represent our view of future market changes, it is a hypothetical near-term change that illustrates the potential effect of such events. Although these fair value measurements provide a representation of equity market sensitivity, they are based on our exposures at a point in time and may not be representative of future market results. These exposures will change as a result of new business, management’s assessment of changing market conditions and available investment opportunities.

Estimated Fair Value Measurement

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.

Using professional judgment and experience, we evaluate and weigh the relevance and significance of all readily available market information to determine the best estimate of fair value. The fair values investments with unobservable inputs are determined by management after considering prices from our pricing vendors. Fair values for debt securities are primarily based on yield curve analysis along with ratings and spread data. Other inputs may be considered for fair value calculations including published indexed data, sector specific performance, comparable price sources and similar traded securities.

See Note 9 to our financial statements under “Item 8: Financial Statements and Supplementary Data” in this Form 10-K for additional information regarding the estimated fair value of investments.

Debt Securities
 
We invest in a variety of debt securities. We classify these investments into various sectors using industry conventions; however, our classifications may differ from similarly titled classifications of other companies. We classify debt securities into investment grade and below-investment-grade securities based on ratings prescribed by the National Association of Insurance Commissioners (“NAIC”). In a majority of cases, these classifications will coincide with ratings assigned by one or more Nationally Recognized Statistical Rating Organizations (“NRSROs”); however, for certain structured securities, the NAIC designations may differ from NRSRO designations based on the amortized cost of the securities in our portfolio.

Our available-for-sale debt securities portfolio consists primarily of investment grade publicly traded and privately placed corporate bonds, residential mortgage-backed securities (“RMBS”), commercial mortgage-backed securities (“CMBS”) and other asset-backed securities. As of December 31, 2013, our available-for-sale debt securities, with a fair value of $3,426.3 million, represented 88.5% of total investments.


44



Available-for-Sale Debt Securities Ratings by Percentage:
 
As of
($ in millions)
 
December 31, 2013
 
 
 
 
Fair
Value
 
% of
Fair
Value
 
Amortized
Cost
 
% of
Amortized
Cost
NAIC
 
S&P Equivalent
 
Rating
 
Designation
 
 
 
 
 
 
 
 
 
 
 
 
1
 
AAA/AA/A
 
$
1,936.3

 
56.5
%
 
$
1,924.4

 
56.6
%
2
 
BBB
 
1,352.3

 
39.4
%
 
1,343.6

 
39.4
%
 
 
Total investment grade
 
3,288.6

 
95.9
%
 
3,268.0

 
96.0
%
3
 
BB
 
108.8

 
3.2
%
 
105.9

 
3.1
%
4
 
B
 
19.5

 
0.6
%
 
20.0

 
0.6
%
5
 
CCC and lower
 
2.8

 
0.1
%
 
3.8

 
0.1
%
6
 
In or near default
 
6.6

 
0.2
%
 
4.9

 
0.2
%
 
 
Total available-for-sale debt securities
 
$
3,426.3

 
100.0
%
 
$
3,402.6

 
100.0
%

Available-for-Sale Debt Securities by Type:
As of
($ in millions)
December 31, 2013
 
 
 
 
 
Unrealized Gains (Losses)
 
Fair
Value
 
Amortized
Cost
 
Gross
Gains
 
Gross
Losses
 
Net
 
 
 
 
 
 
 
 
 
 
U.S. government and agency
$
68.6

 
$
66.1

 
$
3.3

 
$
(0.8
)
 
$
2.5

State and political subdivision
154.6

 
156.2

 
3.8

 
(5.4
)
 
(1.6
)
Foreign government
65.5

 
63.1

 
2.7

 
(0.3
)
 
2.4

Corporate
2,207.3

 
2,194.9

 
69.5

 
(57.1
)
 
12.4

CMBS
253.7

 
241.9

 
13.0

 
(1.2
)
 
11.8

RMBS
509.8

 
513.7

 
7.9

 
(11.8
)
 
(3.9
)
CDO/CLO
70.9

 
70.6

 
1.7

 
(1.4
)
 
0.3

Other asset-backed
95.9

 
96.1

 
3.7

 
(3.9
)
 
(0.2
)
Total available-for-sale debt securities
$
3,426.3

 
$
3,402.6

 
$
105.6

 
$
(81.9
)
 
$
23.7


Available-for-Sale Debt Securities by Type and Credit Quality:
As of
($ in millions)
December 31, 2013
 
Investment Grade
 
Below Investment Grade
 
Fair Value
 
Amortized Cost
 
Fair Value
 
Amortized Cost
 
 
 
 
 
 
 
 
U.S. government and agency
$
68.6

 
$
66.1

 
$

 
$

State and political subdivision
154.6

 
156.2

 

 

Foreign government
62.2

 
60.0

 
3.3

 
3.1

Corporate
2,096.5

 
2,085.0

 
110.8

 
109.9

CMBS
249.6

 
237.8

 
4.1

 
4.1

RMBS
500.2

 
504.6

 
9.6

 
9.1

CDO/CLO
64.3

 
65.4

 
6.6

 
5.2

Other asset-backed
92.6

 
92.9

 
3.3

 
3.2

Total available-for-sale debt securities
$
3,288.6

 
$
3,268.0

 
$
137.7

 
$
134.6

Percentage of total available-for-sale debt securities
96.0%
 
95.9%
 
4.0%
 
4.1%

We manage credit risk through industry and issuer diversification. Maximum exposure to an issuer is defined by quality ratings, with higher quality issuers having larger exposure limits. Our investment approach emphasizes a high level of industry diversification. The top five industry holdings as of December 31, 2013 in our available-for-sale debt and short-term investment portfolio were banking (6.5%), electrical utilities (5.8%), diversified financial services (5.1%), oil (4.1%), and real estate investment trusts (3.2%).


45



Eurozone Exposure

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.

Fair Value of Eurozone Exposure by Country
As of
($ in millions)
December 31, 2013
 
Sovereign
 
Financial
 
All
 
 
 
% of Debt
 
Debt
 
Institutions
 
Other
 
Total
 
Securities [2]
 
 
 
 
 
 
 
 
 
 
Spain
$

 
$
1.0

 
$
7.9

 
$
8.9

 
0.2
%
Ireland

 

 
6.9

 
6.9

 
0.2
%
Italy

 

 
2.2

 
2.2

 
0.1
%
Total

 
1.0

 
17.0

 
18.0

 
0.5
%
All other Eurozone [1]

 
13.0

 
92.1

 
105.1

 
3.0
%
Total
$

 
$
14.0

 
$
109.1

 
$
123.1

 
3.5
%
———————
[1]
Includes Finland, France, Germany, Luxembourg and Netherlands.
[2]
Inclusive of available-for-sale debt securities and short-term investments.

Residential Mortgage-Backed Securities

We invest directly in RMBS. 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. At December 31, 2013, 97.9% of the total residential portfolio was rated investment grade. We hold $58.2 million of RMBS investments backed by prime rated mortgages, $73.9 million backed by Alt-A mortgages and $45.8 million backed by sub-prime mortgages, which combined amount to 4.3% of our total investments. The majority of our prime, Alt-A, and sub-prime exposure is investment grade, with 94% being rated NAIC-1 and another 4% rated NAIC-2. 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 during the year ended December 31, 2013 totaled $1.5 million. These impairments consist of $0.1 million from prime, $1.0 million from Alt-A and $0.4 million from sub-prime.

Residential Mortgage-Backed Securities:
($ in millions)
As of December 31, 2013
 
 
 
 
 
 
 
NAIC Rating
 
 
 
 
 
 
 
1
 
2
 
3
 
4
 
5
 
6
 
 
 
 
 
 
 
AAA/
 
 
 
 
 
 
 
CCC
 
In or
 
Amortized
 
Market
 
% General
 
AA/
 
 
 
 
 
 
 
And
 
Near
 
Cost [1]
 
Value [1]
 
Account [2]
 
A
 
BBB
 
BB
 
B
 
Below
 
Default
Collateral
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agency
$
357.8

 
$
350.9

 
8.7
%
 
100.0
%
 
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
Prime
57.3

 
58.2

 
1.4
%
 
79.3
%
 
16.1
%
 
4.6
%
 
0.0
%
 
0.0
%
 
0.0
%
Alt-A
73.2

 
73.9

 
1.8
%
 
78.9
%
 
12.1
%
 
9.0
%
 
0.0
%
 
0.0
%
 
0.0
%
Sub-prime
44.7

 
45.8

 
1.1
%
 
93.5
%
 
3.1
%
 
1.2
%
 
2.2
%
 
0.0
%
 
0.0
%
Total
$
533.0

 
$
528.8

 
13.0
%
 
94.2
%
 
3.7
%
 
1.9
%
 
0.2
%
 
0.0
%
 
0.0
%
———————
[1]
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 $19.0 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.
[2]
Percentages based on market value of total investments and cash and cash equivalents.

46



Prime Mortgage-Backed Securities:
 
 
 
 
 
 
 
 
 
 
 
 
($ in millions)
 
As of December 31, 2013
 
 
 
 
 
 
 
 
 
 
Year of Issue
 
 
S&P Equivalent
 
Amortized
 
Market
 
% Investment
 
Post-
 
 
 
 
 
 
 
 
 
2003 and
Rating
 
Designation
 
Cost
 
Value
 
Assets [1]
 
2007
 
2007
 
2006
 
2005
 
2004
 
Prior
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
NAIC-1
 
AAA/AAA/A
 
$
45.4

 
$
46.2

 
1.1
%
 
0.0
%
 
0.0
%
 
4.3
%
 
27.0
%
 
48.9
%
 
19.8
%
NAIC-2
 
BBB
 
9.3

 
9.4

 
0.2
%
 
0.0
%
 
6.6
%
 
18.3
%
 
49.7
%
 
18.5
%
 
6.9
%
NAIC-3
 
BB
 
2.6

 
2.6

 
0.1
%
 
0.0
%
 
0.0
%
 
0.0
%
 
21.0
%
 
79.0
%
 
0.0
%
NAIC-4
 
B
 

 

 
%
 
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
NAIC-5
 
CCC and below
 

 

 
%
 
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
NAIC-6
 
In or near default
 

 

 
%
 
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
 
100.0
%
 
0.0
%
Total
 
 
 
$
57.3

 
$
58.2

 
1.4
%
 
0.0
%
 
1.1
%
 
6.4
%
 
30.4
%
 
45.3
%
 
16.8
%
———————
[1]
Percentages based on market value of total investments and cash and cash equivalents.
Alt-A Mortgage-Backed Securities:
 
 
 
 
 
 
 
 
 
 
 
 
($ in millions)
 
As of December 31, 2013
 
 
 
 
 
 
 
 
 
 
Year of Issue
 
 
S&P Equivalent
 
Amortized
 
Market
 
% Investment
 
Post-
 
 
 
 
 
 
 
 
 
2003 and
Rating
 
Designation
 
Cost
 
Value
 
Assets [1]
 
2007
 
2007
 
2006
 
2005
 
2004
 
Prior
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
NAIC-1
 
AAA/AAA/A
 
$
57.9

 
$
58.3

 
1.4
%
 
2.0
%
 
5.2
%
 
8.8
%
 
12.9
%
 
44.3
%
 
26.8
%
NAIC-2
 
BBB
 
8.9

 
9.0

 
0.2
%
 
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
 
83.3
%
 
16.7
%
NAIC-3
 
BB
 
6.4

 
6.6

 
0.2
%
 
0.0
%
 
0.0
%
 
0.0
%
 
43.6
%
 
27.6
%
 
28.8
%
NAIC-4
 
B
 

 

 
%
 
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
NAIC-5
 
CCC and below
 

 

 
%
 
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
NAIC-6
 
In or near default
 

 

 
%
 
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
Total
 
 
 
$
73.2

 
$
73.9

 
1.8
%
 
1.6
%
 
4.1
%
 
6.9
%
 
14.1
%
 
47.6
%
 
25.7
%
———————
[1]
Percentages based on market value of total investments and cash and cash equivalents.

Sub-Prime Mortgage-Backed Securities:
 
 
 
 
 
 
 
 
 
 
 
 
($ in millions)
 
As of December 31, 2013
 
 
 
 
 
 
 
 
 
 
Year of Issue
 
 
S&P Equivalent
 
Amortized
 
Market
 
% Investment
 
Post-
 
 
 
 
 
 
 
 
 
2003 and
Rating
 
Designation
 
Cost
 
Value
 
Assets [1]
 
2007
 
2007
 
2006
 
2005
 
2004
 
Prior
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
NAIC-1
 
AAA/AAA/A
 
$
41.7

 
$
42.8

 
1.1
%
 
0.0
%
 
26.4
%
 
9.4
%
 
27.4
%
 
4.3
%
 
32.5
%
NAIC-2
 
BBB
 
1.4

 
1.4

 
%
 
0.0
%
 
0.0
%
 
0.0
%
 
100.0
%
 
0.0
%
 
0.0
%
NAIC-3
 
BB
 
0.5

 
0.6

 
%
 
0.0
%
 
0.0
%
 
100.0
%
 
0.0
%
 
0.0
%
 
0.0
%
NAIC-4
 
B
 
1.1

 
1.0

 
%
 
0.0
%
 
0.0
%
 
0.0
%
 
100.0
%
 
0.0
%
 
0.0
%
NAIC-5
 
CCC and below
 

 

 
%
 
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
NAIC-6
 
In or near default
 

 

 
%
 
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
 
100.0
%
Total
 
 
 
$
44.7

 
$
45.8

 
1.1
%
 
0.0
%
 
24.7
%
 
10.0
%
 
30.9
%
 
4.0
%
 
30.4
%
———————
[1]
Percentages based on market value of total investments and cash and cash equivalents.


47



Commercial Mortgage-Backed Securities

We invest directly in CMBS. 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.

Commercial Mortgage-Backed Securities:
 
 
 
 
 
 
 
 
 
 
($ in millions)
 
As of December 31, 2013
 
 
 
 
 
 
 
 
 
 
Year of Issue
Rating
 
S&P
Equivalent
Designation
 
Amortized
Cost
 
Market
Value [1]
 
% Investment Assets [2]
 
Post-
2007
 
2007
 
2006
 
2005
 
2004 and
Prior
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
NAIC-1
 
AAA/AAA/A
 
$
239.9

 
$
251.9

 
6.2
%
 
66.9
%
 
5.0
%
 
13.8
%
 
11.1
%
 
3.2
%
NAIC-2
 
BBB
 
2.8

 
2.8

 
0.1
%
 
0.0
%
 
0.0
%
 
85.1
%
 
14.9
%
 
0.0
%
NAIC-3
 
BB
 
3.5

 
3.4

 
0.1
%
 
0.0
%
 
51.7
%
 
48.3
%
 
0.0
%
 
0.0
%
NAIC-4
 
B
 

 

 
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
NAIC-5
 
CCC and below
 

 

 
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
NAIC-6
 
In or near default
 
2.2

 
2.5

 
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
 
100.0
%
Total
 
 
 
$
248.4

 
$
260.6

 
6.4
%
 
64.6
%
 
5.5
%
 
14.9
%
 
10.9
%
 
4.1
%
———————
[1]
Includes commercial mortgage-backed CDOs with amortized cost and market values of $2.0 million and $2.3 million, respectively. CMBS holdings in this exhibit include $4.5 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.
[2]
Percentages based on market value of total investments and cash and cash equivalents.

Realized Gains and Losses

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 OTTI 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.


48



Net realized investment gains (losses)

Sources and Types of Net Realized Investment Gains (Losses):
Years Ended December 31,
($ in millions)
2013
 
2012
 
2011
 
 
 
 
 
 
Total other-than-temporary debt impairments
$
(1.1
)
 
$
(5.0
)
 
$
(9.7
)
Portion of loss recognized in OCI
(0.9
)
 
2.2

 
6.9

Net debt impairments recognized in earnings
$
(2.0
)
 
$
(2.8
)
 
$
(2.8
)
Debt security impairments:
 
 
 
 
 
U.S. government and agency
$

 
$

 
$

State and political subdivision

 
(0.1
)
 

Foreign government

 

 

Corporate

 

 
(0.4
)
CMBS
(0.3
)
 
(0.1
)
 
(0.4
)
RMBS
(1.5
)
 
(1.9
)
 
(1.5
)
CDO/CLO
(0.2
)
 
(0.4
)
 
(0.4
)
Other asset-backed

 
(0.3
)
 
(0.1
)
Net debt security impairments
(2.0
)
 
(2.8
)
 
(2.8
)
Equity security impairments

 

 
(0.4
)
Impairment losses
(2.0
)
 
(2.8
)
 
(3.2
)
Debt security transaction gains
11.3

 
22.8

 
2.5

Debt security transaction losses
(0.4
)
 
(0.7
)
 
(0.7
)
Limited partnerships and other investment gains

 

 
0.1

Limited partnerships and other investment losses

 
(0.3
)
 
(0.1
)
Net transaction gains (losses)
10.9

 
21.8

 
1.8

Derivative instruments
(23.1
)
 
(49.0
)
 
6.2

Embedded derivatives [1]
17.6

 
11.2

 
(33.2
)
Related party reinsurance derivatives

 
(3.5
)
 
9.0

Assets valued at fair value

 

 

Net realized investment gains (losses), excluding impairment losses
5.4

 
(19.5
)
 
(16.2
)
Net realized investment gains (losses), including impairment losses
$
3.4

 
$
(22.3
)
 
$
(19.4
)
———————
[1]
Includes the change in fair value of embedded derivatives associated with fixed index annuity indexed crediting feature and variable annuity GMWB, GMAB and COMBO riders. See Note 8 to our financial statements under “Item 8: Financial Statements and Supplementary Data” in this Form 10-K for additional disclosures.

Other-than-Temporary Impairments

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, 2013, management does not have the intention to sell, nor does it expect to be required to sell, these securities prior to their recovery.


49



OTTIs recorded on available-for-sale debt securities in 2013 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 were $2.0 million in 2013, $2.8 million in 2012 and $2.8 million in 2011. There were equity security OTTIs of $0 in 2013, $0 in 2012 and $0.4 million in 2011. There were no limited partnerships and other investment OTTIs in 2013, 2012 and 2011.

In addition to these credit-related impairments recognized through earnings, we impaired securities to fair value through other comprehensive loss for any impairments related to non-credit related factors. These types of impairments were driven primarily by market or sector credit spread widening or by a lack of liquidity in the securities. The amount of impairments recognized as an adjustment to other comprehensive loss due to these factors was $(0.9) million in 2013, $2.2 million in 2012 and $6.9 million in 2011.

The following table presents a roll-forward of pre-tax credit losses recognized in earnings related to available-for-sale debt securities for which a portion of the OTTI was recognized in OCI.

Credit Losses Recognized in Earnings on Available-for-Sale Debt Securities for
As of December 31,
which a Portion of the OTTI Loss was Recognized in OCI:
2013
 
2012
 
2011
($ in millions)
 
 
 
 
 
Balance, beginning of period
$
(17.8
)
 
$
(21.3
)
 
$
(19.9
)
  Add: Credit losses on securities not previously impaired [1]
(0.3
)
 
(1.4
)
 
(1.0
)
  Add: Credit losses on securities previously impaired [1]
(0.8
)
 
(1.2
)
 
(1.4
)
Less: Credit losses on securities impaired due to intent to sell

 

 

Less: Credit losses on securities sold
0.3

 
6.1

 
1.0

Less: Increases in cash flows expected on previously impaired securities

 

 

Balance, end of period
$
(18.6
)
 
$
(17.8
)
 
$
(21.3
)
———————
[1]
Additional credit losses on securities for which a portion of the OTTI loss was recognized in AOCI are included within net OTTI losses recognized in earnings on the statements of income and comprehensive income.

Unrealized Gains and Losses

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).

Available-for-Sale Debt Securities Non-Credit OTTI Losses in AOCI, by Security Type: [1]
As of December 31,
($ in millions)
2013 [1]
 
2012
 
 
 
 
U.S. government and agency
$

 
$

State and political subdivision
(0.2
)
 
(0.2
)
Foreign government

 

Corporate
(1.5
)
 
(1.5
)
CMBS
(0.4
)
 
(0.6
)
RMBS
(8.6
)
 
(9.0
)
CDO/CLO
(3.0
)
 
(3.3
)
Other asset-backed

 

Total available-for-sale debt securities non-credit OTTI losses in AOCI
$
(13.7
)
 
$
(14.6
)
———————
[1]
Represents the amount of non-credit OTTI losses recognized in AOCI excluding net unrealized gains or losses subsequent to the date of impairment.


50



Duration of Gross Unrealized Losses on Securities:
As of
($ in millions)
December 31, 2013
 
 
 
0 – 6
 
6 – 12
 
Over 12
 
Total
 
Months
 
Months
 
Months
Available-for-sale debt securities
 
 
 
 
 
 
 
Total fair value
$
1,424.6

 
$
447.0

 
$
777.6

 
$
200.0

Total amortized cost
1,506.5

 
454.8

 
823.6

 
228.1

Unrealized losses
$
(81.9
)
 
$
(7.8
)
 
$
(46.0
)
 
$
(28.1
)
Number of securities
404

 
120

 
205

 
79

Investment grade:
 
 
 
 
 
 
 
Unrealized losses
$
(78.2
)
 
$
(7.7
)
 
$
(44.2
)
 
$
(26.3
)
Below investment grade:
 
 
 
 
 
 
 
Unrealized losses
$
(3.7
)
 
$
(0.1
)
 
$
(1.8
)
 
$
(1.8
)

For available-for-sale debt securities with gross unrealized losses, 95.6% of the unrealized losses after offsets pertain to investment grade securities and 4.4% of the unrealized losses after offsets pertain to below-investment-grade securities at December 31, 2013.

The following table represents those securities whose fair value is less than 80% of amortized cost (significant unrealized loss) that have been at a significant unrealized loss position on a continuous basis.

Duration of Gross Unrealized Losses on Securities:
As of
($ in millions)
December 31, 2013
 
 
 
0 – 6
 
6 – 12
 
Over 12
 
Total
 
Months
 
Months
 
Months
Available-for-sale debt securities
 
 
 
 
 
 
 
Unrealized losses over 20% of cost
$
(12.1
)
 
$
(0.7
)
 
$

 
$
(11.4
)
Number of securities
10

 
2

 

 
8

Investment grade:
 

 
 
 
 
 
 
Unrealized losses over 20% of cost
$
(11.0
)
 
$
(0.5
)
 
$

 
$
(10.5
)
Below investment grade:
 

 
 
 
 
 
 
Unrealized losses over 20% of cost
$
(1.1
)
 
$
(0.2
)
 
$

 
$
(0.9
)

Liquidity and Capital Resources

In the normal course of business, we enter into transactions involving various types of financial instruments such as debt securities. These instruments have credit risk and also may be subject to risk of loss due to interest rate and market fluctuations.

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.
 

51



Summary Cash Flows:
Years Ended December 31,
($ in millions)
2013
 
2012
 
 
 
 
Cash used for operating activities
$
(130.5
)
 
$
(165.4
)
Cash used for investing activities
(487.3
)
 
(627.2
)
Cash provided by financing activities
715.7

 
826.2

Change in cash and cash equivalents
$
97.9

 
$
33.6


2013 compared to 2012

Cash used for operating activities decreased by $34.9 million during the year ended December 31, 2013 compared to the year ended December 31, 2012. This decrease was driven by lower death benefits paid for universal life during 2013 in conjunction with reduced commissions paid related to lower sales of our fixed indexed annuity product. Partially offsetting this increase were increased audit and consulting fees related to the Restatement.

Cash flows used for investing activities decreased $139.9 million during the year ended December 31, 2013 compared to the year ended December 31, 2012 as a result of an decrease in purchases of short term investments. This is primarily driven by less cash being provided by financing and operating activities, namely due to a reduction in deposits and an increase in withdrawals of fixed index annuities, combined with significantly increased holdings of cash and cash equivalents in lieu of reinvestment.

Cash flows provided by financing activities decreased $110.5 million during the year ended December 31, 2013. This decline was primarily a result of a decrease in policyholder deposits of fixed indexed annuities when compared to 2012. Offsetting this decline was the issuance of $30.0 million of debt during 2013, which were purchased by PNX. See Note 11 to our financial statements under “Indebtedness due to affiliate” under "Item 8. Financial Statements and Supplementary Data" in this Form 10-K for additional information on this transaction.

Annuity Actuarial Reserves and Deposit Fund Liability
As of December 31,
Withdrawal Characteristics:
2013
 
2012
($ in millions)
Amount [1]
 
Percent
 
Amount [1]
 
Percent
 
 
 
 
 
 
 
 
Not subject to discretionary withdrawal provision
$
177.1

 
4
%
 
$
187.7

 
5
%
Subject to discretionary withdrawal without adjustment
312.1

 
7
%
 
311.5

 
7
%
Subject to discretionary withdrawal with
  market value adjustment
2,078.9

 
46
%
 
1,727.8

 
41
%
Subject to discretionary withdrawal at contract value
  less surrender charge
29.6

 
1
%
 
35.8

 
1
%
Subject to discretionary withdrawal at market value
1,903.2

 
42
%
 
1,922.3

 
46
%
Total annuity contract reserves and deposit fund liability
$
4,500.9

 
100
%
 
$
4,185.1

 
100
%
———————
[1]
Annuity contract reserves and deposit fund liability amounts are reported on a statutory basis, which more accurately reflects the potential cash outflows and include variable product liabilities. Annuity contract reserves and deposit fund liabilities are monetary amounts that an insurer must have available to provide for future obligations with respect to its annuities and deposit funds. These are liabilities in our financial statements prepared in conformity with statutory accounting practices. These amounts are at least equal to the values available to be withdrawn by policyholders.

Individual life insurance policies are less susceptible to withdrawals than annuity contracts because policyholders may incur surrender charges and be required to undergo a new underwriting process in order to obtain a new insurance policy. As indicated in the table above, most of our annuity contract reserves and deposit fund liabilities are subject to withdrawals at market value.

The cash value of certain individual life insurance policies increase over the lives of the policies. Policyholders have the right to borrow an amount up to a certain percentage of the cash value on those policies. As of December 31, 2013, we had approximately $689.8 million in cash values with respect to which policyholders had rights to take policy loans. For eligible policies, the majority of policy loans are at variable interest rates that are reset annually on the policy anniversary. Policy loans at December 31, 2013 were $66.1 million.


52



The primary liquidity risks regarding cash inflows from the investing activities are the risks of default by debtors, interest rate and other market volatility, and potential illiquidity of investments. We closely monitor and manage these risks.

We believe that the existing and expected sources of liquidity are adequate to meet both current and anticipated needs.

Ratings

Rating agencies assign financial strength ratings to Phoenix Life and its subsidiaries based on their opinions of the companies’ ability to meet their financial obligations. A downgrade or withdrawal of any of our credit ratings could negatively impact our liquidity. For additional information regarding certain risks associated with our credit ratings, please see the risk factors under “Risks Related to the Restatement, Failure to File Timely Periodic Reports with the SEC and our Internal Control Over Financial Reporting.” contained in “Item 1A: Risk Factors” in Part I of this Form 10-K.

On August 28, 2013, A.M. Best Company, Inc. downgraded our financial strength rating from B+ to B. The rating was also removed from under review with negative implications and assigned a stable outlook. On April 9, 2013, A.M. Best Company, Inc. maintained their under review with negative implications outlook on our financial strength rating of B+. On December 7, 2012, A.M. Best Company, Inc. placed our B+ financial strength rating under review with negative implications. On January 13, 2012, A.M. Best Company, Inc. affirmed our financial strength rating of B+. They changed their outlook from stable to positive. On February 8, 2011, A.M. Best Company, Inc. affirmed our financial strength rating of B+ and changed their outlook from negative to stable.

On January 14, 2014, Moody’s Investor Services withdrew all ratings of The Phoenix Companies, Inc. including the Ba2 financial strength rating of the Company’s life insurance subsidiaries 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 August 12, 2014, Standard & Poor's lowered its financial strength ratings on Phoenix Life and PHL Variable to B+ from BB- and affirmed its B- long-term counterparty credit rating on The Phoenix Companies, Inc. They removed the ratings from CreditWatch and assigned a negative outlook. They also affirmed The Phoenix Companies, Inc.'s long-term counterparty credit rating. On May 20, 2014, Standard & Poor’s placed our financial strength rating of BB- and senior debt rating of B- on CreditWatch with negative implications. 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 ratings.

The financial strength ratings as of August 21, 2014 were as follows:

 
 
Financial Strength Ratings of
 
 
Rating Agency
 
Phoenix Life and PHL Variable
 
Outlook
 
 
 
 
 
A.M. Best Company, Inc.
 
B
 
Stable
Standard & Poor’s
 
B+
 
Negative

Reference in this report to any credit rating is intended for the limited purposes of discussing or referring to changes in our credit ratings or aspects of our liquidity or costs of funds. Such reference cannot be relied on for any other purposes, or used to make any inference concerning future performance, future liquidity or any future credit rating.


53



Financial Condition

Balance Sheets:
As of December 31,
 
Increase (decrease) and
percentage change
($ in millions)
2013
 
2012
 
2013 vs. 2012
ASSETS
 
 
 
 
 
 
 
Available-for-sale debt securities, at fair value
$
3,426.3

 
$
2,972.3

 
$
454.0

 
15
%
Short-term investments
81.0

 
244.9

 
(163.9
)
 
(67
%)
Limited partnerships and other investments
10.5

 
6.7

 
3.8

 
57
%
Policy loans, at unpaid principal balances
66.1

 
61.0

 
5.1

 
8
%
Derivative instruments
237.8

 
149.4

 
88.4

 
59
%
Fair value investments
48.6

 
38.5

 
10.1

 
26
%
Total investments
3,870.3

 
3,472.8

 
397.5

 
11
%
Cash and cash equivalents
181.0

 
83.1

 
97.9

 
118
%
Accrued investment income
27.3

 
23.2

 
4.1

 
18
%
Receivables
8.6

 
16.2

 
(7.6
)
 
(47
%)
Reinsurance recoverable
500.6

 
427.1

 
73.5

 
17
%
Deferred policy acquisition costs
462.3

 
426.2

 
36.1

 
8
%
Deferred income taxes, net
28.0

 
16.2

 
11.8

 
73
%
Receivable from related parties
2.6

 

 
2.6

 
NM

Other assets
174.8

 
135.5

 
39.3

 
29
%
Separate account assets
2,052.7

 
2,061.8

 
(9.1
)
 
%
Total assets
$
7,308.2

 
$
6,662.1

 
$
646.1

 
10
%
 
 
 
 
 
 
 
 
LIABILITIES
 
 
 
 
 
 
 
Policy liabilities and accruals
$
1,899.0

 
$
1,876.2

 
$
22.8

 
1
%
Policyholder deposit funds
2,762.8

 
2,349.8

 
413.0

 
18
%
Indebtedness due to affiliate
30.0

 

 
30.0

 
100
%
Payable to related parties
14.1

 
11.0

 
3.1

 
28
%
Other liabilities
177.1

 
68.2

 
108.9

 
160
%
Separate account liabilities
2,052.7

 
2,061.8

 
(9.1
)
 
%
Total liabilities
6,935.7

 
6,367.0

 
568.7

 
9
%
 
 
 
 
 
 
 
 
STOCKHOLDER’S EQUITY
 
 
 
 
 
 
 
Common stock
2.5

 
2.5

 

 
%
Additional paid in capital
847.2

 
802.2

 
45.0

 
6
%
Accumulated other comprehensive loss
(11.9
)
 
11.4

 
(23.3
)
 
NM

Retained earnings (accumulated deficit)
(465.3
)
 
(521.0
)
 
55.7

 
(11
%)
Total stockholder’s equity
372.5

 
295.1

 
77.4

 
26
%
Total liabilities and stockholder’s equity
$
7,308.2

 
$
6,662.1

 
$
646.1

 
10
%
———————
Not meaningful (NM)

December 31, 2013 compared to December 31, 2012

Assets

The increase in total investments was primarily the result of purchases of new securities due to new deposits in the annuity business. Partially offsetting this were declines in the market value of available-for-sale debt securities resulting from increases in interest rates during 2013 and decreases in cash and short-term investments.


54



The increase in derivative instruments is primarily due to gains on the call options that are used to hedge the fixed indexed annuity business. This increase in derivative assets is offset by increases in derivative liabilities, which are recorded within other liabilities. The net derivative position of $127.0 million as of December 31, 2013 has not fluctuated significantly from the net derivative position of $103.7 million as of December 31, 2012.

The increase in reinsurance recoverables is primarily due to large claims at the end of 2013 that were not yet reimbursed by third-party reinsurers.

The increases in deferred policy acquisition costs overall are primarily driven by increases in the shadow component that offsets unrealized losses on investments within AOCI. The deferrals of commissions on new sales of fixed indexed annuities were relatively stable and were more than offset by continued amortization of previously deferred costs.

The increase in other assets is primarily due to an increase in the current tax asset recoverable from PNX, due to the existing tax sharing agreement.

Liabilities and Stockholder’s Equity

Policyholder deposit funds increased during the twelve months ended December 31, 2013 primarily as a result of continued sales of fixed indexed annuities.

The Company issued $30 million of surplus notes on December 30, 2013 which were purchased by PNX. The notes are due on December 30, 2043 and interest is paid annually at a rate of 10.5%.

The increase in other liabilities is due to additional accrued expenses related to audit and consulting services, and an increase in the fair value of derivative liabilities. The increase in the fair value of the derivative liabilities is offset by increases in derivative assets, which are recorded within investments. The net derivative position of $127.0 million as of December 31, 2013 has not fluctuated significantly from the net derivative position of $103.7 million as of December 31, 2012.

The increase in total stockholder’s equity was primarily a result of the net income recognized for the twelve months ended December 31, 2013 and capital contributions of $45.0 million during 2013. Partially offsetting these increases were additional accumulated other comprehensive losses associated with unrealized losses on available-for-sale debt securities due to the rise in interest rates during 2013.

Contractual Obligations and Commercial Commitments

Contractual Obligations and Commercial Commitments:
As of
($ in millions)
December 31, 2013
 
Total
 
2014
 
2015-2016
 
2017-2018
 
Thereafter
Contractual Obligations Due
 
 
 
 
 
 
 
 
 
Purchase liabilities [1]
$
9.1

 
$
1.9

 
$
3.8

 
$
3.0

 
$
0.4

Policyholder contractual obligation [2]
12,658.0

 
731.5

 
1,495.9

 
1,344.3

 
9,086.3

Total contractual obligations [3]
$
12,667.1

 
$
733.4

 
$
1,499.7

 
$
1,347.3

 
$
9,086.7

Commercial Commitment Expirations
 
 
 
 
 
 
 
 
 
Other long-term liabilities [4]
$
70.7

 
$
70.3

 
$
0.4

 
$

 
$

Total commercial commitments
$
70.7

 
$
70.3

 
$
0.4

 
$

 
$

———————
[1]
Purchase liabilities relate to open purchase orders and other contractual obligations. This does not include purchases made by our ultimate parent company for which the resulting expenses are allocated to us when incurred.
[2]
Policyholder contractual obligations represent estimated benefits from life insurance and annuity contracts issued by us. Policyholder contractual obligations also include separate account liabilities, which are contractual obligations of the separate account assets established under applicable state insurance laws and are legally insulated from our general account assets.
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 2 to our financial statements under “Item 8: Financial Statements and Supplementary Data” in this 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, 2013 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.

55



[3]
We do not anticipate any increases to unrecognized tax benefits that would have a significant impact on the financial position of the Company. Therefore, no unrecognized tax benefits have been excluded from this table. See Note 10 to our financial statements under “Item 8: Financial Statements and Supplementary Data” in this Form 10-K for additional information on unrecognized tax benefits.
[4]
Other long-term liabilities 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.

Obligations Related to Pension and Postretirement Employee Benefit Plans

Our ultimate parent company provides employees with post-employment benefits that include retirement benefits, through pension and savings plans, and other benefits, including health care and life insurance. This includes three defined benefit pension plans. We incur applicable employee benefit expenses through the process of cost allocation by PNX.

Employee benefit expense allocated to us for these benefits totaled $3.2 million, $4.6 million and $7.6 million for 2013, 2012 and 2011, respectively. Over the next 12 months, Phoenix Life expects to make contributions to the pension plan of which approximately $6.4 million will be allocated to us. On July 6, 2012, the Surface Transportation Extension Act of 2012, Part II, was enacted into law and was effective immediately. The law includes certain pension funding stabilization provisions, which the Company has taken advantage of in 2012.

See Note 13 to our financial statements under “Item 8: Financial Statements and Supplementary Data” in this Form 10-K for more information.

Off-Balance Sheet Arrangements

As of December 31, 2013, we did not have any significant off-balance sheet arrangements as defined by Item 303(a)(4)(ii) of SEC Regulation S-K.

Reinsurance

We use reinsurance agreements to limit potential losses, reduce exposure to larger risks and provide capital relief with regard to certain reserves. We remain liable to the extent that reinsuring companies may not be able to meet their obligations under reinsurance agreements in effect. Failure of the reinsurers to honor their obligations could result in losses to the Company. Since we bear the risk of nonpayment, on a quarterly basis we evaluate the financial condition of our reinsurers and monitor concentrations of credit risk. Based on our review of their financial statements, reputation in the reinsurance marketplace and other relevant information, we believe that we have no material exposure to uncollectible life reinsurance. At December 31, 2013, five major reinsurance companies account for approximately 73% of the reinsurance recoverable.

Statutory Capital and Surplus and Risk-Based Capital

Our statutory basis capital and surplus including asset valuation reserve (“AVR”) decreased from $321.0 million at December 31, 2012 to $235.2 million at December 31, 2013. The principal factor resulting in this decrease was $123.1 million of reserve strengthening, including consideration of results from asset adequacy analysis. This was partially offset by $45.0 million of capital contributions received from PM Holdings, Inc. and $30 million relating to the issuance of surplus notes issued by PHL Variable and purchased by PNX.

Connecticut Insurance Law requires that Connecticut life insurers report their RBC. RBC is based on a formula calculated by applying factors to various asset, premium and statutory reserve items. The formula takes into account the risk characteristics of the insurer, including asset risk, insurance risk, interest rate risk and business risk. The Connecticut Insurance Department has regulatory authority to require various actions by, or take various actions against, insurers whose Total Adjusted Capital (capital and surplus plus AVR) does not exceed certain RBC levels.

The levels of regulatory action, the trigger point and the corrective actions required are summarized below:

Company Action Level – results when Total Adjusted Capital falls below 100% of Company Action Level at which point the Company must file a comprehensive plan to the state insurance regulators;

Regulatory Action Level – results when Total Adjusted Capital falls below 75% of Company Action Level where in addition to the above, insurance regulators are required to perform an examination or analysis deemed necessary and issue a corrective order specifying corrective actions;


56



Authorized Control Level – results when Total Adjusted Capital falls below 50% of Company Action Level RBC 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

Mandatory Control Level – results when Total Adjusted Capital falls below 35% of Company Action Level where insurance regulators are required to place the Company under regulatory control.

The estimated RBC of PHL Variable as of December 31, 2013 was in excess of 250% of the Company Action Level.

See Note 15 to our financial statements under “Item 8: Financial Statements and Supplementary Data” in this Form 10-K for more information.


Item 7A.
Quantitative and Qualitative Disclosures About Market Risk

For information about our management of market risk, see “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Form 10-K under the heading “Enterprise Risk Management.”


Item 8.
Financial Statements and Supplementary Data

The Financial Statements and Supplementary Data required by this item are presented beginning on page F-1.


Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None.


Item 9A.
Controls and Procedures

Evaluation of Disclosure Controls and Procedures

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed, in the reports the Company files or submits under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to the Company’s management, including its President and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

In connection with the preparation of this Form 10-K, the Company carried out an evaluation under the supervision of and with the participation of the Company’s management, including the President and Chief Financial Officer, as of December 31, 2013, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act. Based upon this evaluation, the President and Chief Financial Officer concluded that as of December 31, 2013 the Company’s disclosure controls and procedures were not effective because of the material weaknesses described below under “Management’s Annual Report on Internal Control Over Financial Reporting.” The material weaknesses described below were first identified and reported in the 2012 Form 10-K.and have not been fully remediated as of December 31, 2013 due to insufficient time to fully evaluate, implement and assess the design and operating effectiveness of the related controls.

To address the material weaknesses described below, the Company performed additional analysis and other procedures (as further described below under the subheading “Management’s Remediation Initiatives”) to ensure that the Company’s financial statements were prepared in accordance with U.S. GAAP. Accordingly, the Company’s management believes that the financial statements included in this Form 10-K fairly present, in all material respects, the Company’s financial condition, results of operations and cash flows for the periods presented and that this Form 10-K does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the periods covered by this report.


57



Management’s Annual Report on Internal Control Over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The Company’s system of internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with U.S. GAAP. Internal control over financial reporting includes those policies and procedures that pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company to provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company, and to provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect every misstatement. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may decrease over time.

Management, including the President and Chief Financial Officer, has conducted an assessment, including testing, of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2013, based on the criteria in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).

A material weakness is a deficiency or combination of deficiencies in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis. Management has concluded that as of December 31, 2013, the material weaknesses in internal control over financial reporting described below have not been fully remediated due to insufficient time to fully evaluate, implement and assess the design and operating effectiveness of the related controls.

The material weaknesses included deficiencies in the period-end financial reporting process including the processing of journal entries and the preparation and review of account reconciliations, insufficient complement of personnel with a level of accounting knowledge commensurate with the Company’s financial reporting requirements and ineffective monitoring and review activities.

The above material weaknesses also contributed to the following material weaknesses in internal control over financial reporting which have been identified and included in management’s assessment as of December 31, 2013:

1.
Actuarial Finance and Valuation – The Company did not maintain effective controls over the actuarial process. Specifically:
The Company did not maintain effective controls to review and approve assumptions and methodologies used in the determination of actuarially derived insurance policy liability estimates.
The Company did not maintain effective systems and controls to appropriately measure actuarially derived balances for its fixed indexed annuity products.
The Company did not maintain effective controls over key actuarial spreadsheets and certain key reports to ensure the reliability of data, assumptions and valuation calculations.
The Company did not maintain effective controls over the application of U.S. GAAP to universal life reserves.

2.
Investments – The Company did not maintain effective controls over certain investment processes. Specifically:

The Company did not maintain effective controls over the recognition and measurement of impaired investments.
The Company did not maintain effective controls over the recognition and measurement of certain elements of net investment income as well as identifying embedded derivatives related to structured securities.
The Company did not maintain effective controls over internally priced securities, including private placement debt securities.
The Company did not maintain effective controls over classification in the fair value hierarchy disclosure.
The Company did not maintain effective controls to properly recognize and measure counterparty non-performance risk on non-collateralized derivatives.


58



3.
Reinsurance Accounting – The Company did not maintain effective controls for complex reinsurance treaties. Specifically:

The Company did not maintain effective controls to analyze, document and review U.S. GAAP accounting for reinsurance transactions at inception.
The Company did not maintain effective controls to analyze, document, review and appropriately account for related party reinsurance transactions including accounting for gains/losses at inception and actuarial valuation of reinsurance balances.

4.
Cash flows and changes in classifications – The Company did not maintain effective controls over the presentation of cash and cash flows. Specifically, the Company did not maintain effective controls over the preparation and review of appropriate detail to support the classification of activity in the statements of cash flows. In addition, there were not effective controls for assessing the classification of cash and related balances for presentation in the balance sheets.

5.
Access to applications and data – The Company did not maintain effective information technology general controls related to restricted access. Specifically, the Company did not maintain effective controls for granting, removing and reviewing access to ensure appropriate segregation of duties and restricted access to programs and data.

Each of these control deficiencies contributed to misstatements of the previously mentioned financial statements. Additionally, these control deficiencies could result in a material misstatement to the annual or interim financial statements that would not be prevented or detected. Accordingly, management has concluded that these control deficiencies constitute material weaknesses.

As a result of the material weaknesses in internal control over financial reporting described above, management has concluded that, as of December 31, 2013, the Company’s internal control over financial reporting was not effective based on the criteria established in Internal Control - Integrated Framework (1992) issued by COSO.

Management Changes

The Company has made a number of management changes in the finance organization with a focus on increasing U.S. GAAP knowledge and improving financial reporting processes in the organization. These changes include the appointment of a Chief Financial Officer, Chief Accounting Officer and head of actuarial finance. The Company also appointed a new Chief Risk Officer, a new head of Internal Audit and hired additional certified public accountants and actuaries with U.S. GAAP expertise to supplement the staff charged with compiling and filing its U.S. GAAP results. In addition, the Company has established a financial reporting controls committee comprised of members of senior management. The committee was established to provide oversight to the Company’s efforts for ensuring appropriate internal control over financial reporting including, but not limited to, remediation of material weaknesses and other control deficiencies, controls testing, and prioritization and allocation of resources.

Management’s Remediation Initiatives

Since the identification of the material weaknesses, management has taken steps to strengthen its finance skills, capabilities and control environment, and continues to enhance the Company’s financial control governance structure, align and enhance the Company’s skills and financial roles and responsibilities for each functional group within the organization as well as implement additional policies and procedures to improve the overall system of internal control over financial reporting. To remediate the material weaknesses described in “Management’s Annual Report on Internal Control Over Financial Reporting” above, the Company has implemented or plans to implement the measures described below and will continue to evaluate the remediation and may in the future implement additional measures.

1.
Actuarial Finance and Valuation – Upon identification of the material weakness, management performed the following procedures to gain assurance related to the accuracy of the Company’s financial reporting process:

Performed procedures on the affected actuarial balances to ensure the reasonableness of the amounts being reported. The Company:
Validated the profit followed by loss reserve for the Universal Life and Variable Universal Life blocks of business
Performed a detailed attribution analysis for reserve changes for fixed indexed annuities
Performed a detailed analysis at the cohort level for all deferred policy acquisition cost and unearned revenue reserve calculations
Validated deficiency reserves for the term insurance and payout annuity blocks

59



Validated effects of excess reinsurance on variable universal life and universal life estimated gross profits
Reconciled actual gross profit to the general ledger for all product lines

Engaged an external actuarial advisor to provide staff augmentation and assist with the following activities:
Review and enhancement of current U.S. GAAP valuation analytics    
Identification and correction of actuarial related errors
Review updates to the methods, process and assumptions associated with the U.S. GAAP unlocking process
Review and document U.S. GAAP valuation methods and assumptions
Project management of work streams
Maintain an interim fixed indexed annuity reserve model

The Company’s implemented and planned remediation measures are intended to address material weaknesses related to Actuarial Finance. The Company’s remediation measures include the following:

Implemented
Aligned staff responsibilities by product
Upgraded staff including hiring experienced U.S. GAAP actuaries
Enhanced the process of assumption setting by establishing an assumption governance committee
Formalized documentation standards to ensure consistent documentation of assumptions and methods across product lines
Partnered with pricing actuaries to improve the process and testing for new product models and assumptions
Hired a new head of actuarial finance with U.S. GAAP actuarial experience
Aligned and added actuarial resources to ensure the number and level of financial actuarial experts was appropriate
Held third party workshops and training resulting in the development of an enhanced analytics process

Planned
Design and implement detailed actuarial remediation plan including the following activities:
People and Skills
Manage key person risk succession plan
Develop a cross-functional team, including Information Technology resources, for initiatives related to any remediation activities and new product implementation
Assign dedicated staff to new business initiatives

Control and Governance
Establish a formal peer review process
Enhance model governance process

Technology
Consolidate life and variable annuity valuation systems and enhance fixed indexed annuity valuation system

Process
Simplify and streamline manual processes and the close process

2.
Investments – Upon identification of the material weakness, management performed the following procedures to gain assurance related to the accuracy of the Company’s financial reporting process:

Performed the following procedures on the affected investment balances to ensure the reasonableness of the amounts being reported:

Impaired investments process
All impairments identified during the reporting year 2013 have been reviewed and approved by the Chief Investment Officer and Chief Accounting Officer


60



Amortization and accretion for structured securities
The accounting models and amortization methods and assumptions for the structured securities portfolio have been reviewed and approved by the Chief Investment Officer and Chief Accounting Officer
Assessed a sample of the structured securities portfolio using the appropriate accounting models to access the accuracy of third party service provider calculations

Investment related reconciliations
An enhanced reconciliation process has been implemented and all key investment accounting reconciliations have been performed

Private placement debt securities
Each bond’s cash flows and all other critical inputs to run new and revised valuation models have been validated
Continued to engage an external advisor to provide assistance in evaluating investment and fair value disclosures as well as significant accounting policy disclosures for compliance with U.S. GAAP
Replaced the existing valuation model for sinking fund bonds with a new interim discounted cash flow model that was developed and validated by an external advisor
All debt securities were valued based on external third-party information

Derivative valuation
A new process and controls for measuring the non-performance risk related to non-collateralized derivative assets was designed and implemented.

The Company’s implemented and planned remediation measures are intended to address material weaknesses related to Investments. The Company’s remediation measures include the following:

Implemented
Hired a new head of Investment Accounting with U.S. GAAP investment experience
Aligned and added investment accounting resources to ensure the number and level of qualified accountants was appropriate

Planned
Design and implement a detailed investment remediation plan including the following activities:

People and Skills
Evaluate the current staffing model for Investment Accounting and Corporate Portfolio Management to ensure sufficient personnel with knowledge, experience and training

Controls and Governance
Conduct a detailed assessment of internal controls and related supporting documentation for controls and processes related to Investment Accounting and Corporate Portfolio Management and disclosure policy in an effort to enhance controls across these areas

Technology
Develop a plan to replace the interim accounting systems and valuation models with a more robust, sustainable and controlled accounting and valuation system

Process
Simplify and streamline manual processes and the close process
Evaluate current organizational structure of Investment Accounting and Corporate Portfolio Management to ensure appropriate support and oversight of investment accounting and valuation activities.
Design new processes and controls for Investment Accounting and Corporate Portfolio Management, specifically the assessment of impaired investments, amortization and accretion processes, investment related reconciliations, valuation and leveling of private placement debt, valuation of certain derivative instruments and accounting for Other Invested Assets


61



3.
Reinsurance Accounting – Upon identification of the material weakness, management performed the following procedures to gain assurance related to the accuracy of the Company’s financial reporting process
Monitored all complex reinsurance contract activity to ensure appropriate accounting in accordance with U.S. GAAP

The Company’s implemented and planned remediation measures are intended to address material weaknesses related to Reinsurance Accounting. The Company’s remediation measures include the following:

Implemented
Reviewed and enhanced accounting analysis of existing complex reinsurance treaties
Strengthened the accounting policy documentation standards for certain transactions, including complex reinsurance treaties and the implementation of new U.S. GAAP standards

Planned
Review and enhance all processes and controls related to reinsurance accounting
Evaluate the current governance and staffing model for reinsurance accounting

4.
Cash flows and changes in classifications – Upon identification of the material weakness, management performed the following procedures to gain assurance related to the accuracy of the Company’s financial reporting process:

Evaluated U.S. GAAP guidance for certain cash flow reporting disclosures
Evaluated reclassification of control disbursement balances to ensure appropriate netting and reclassifications were performed
Reviewed all cash accounts to ensure cash collateral accounts were reclassified and reported as restricted cash within the balance sheet
Performed additional procedures on the statement of cash flows to ensure the reasonableness of the amounts being reported. The Company:
Evaluated the processes and data files supporting deposit and withdrawal activities for certain life products
Performed a detailed analysis of interest credited for all products including the interest for all policy loans
Performed a detail analysis of all investing activities; and
Documented interim processes and data sources for assembling cash flow data for all transaction types

The Company’s planned remediation measures are intended to address material weaknesses related to cash flow and cash balance reporting. The Company’s remediation measures include the following:

Planned
Review, enhance and document accounting policies and procedures regarding the preparation of the statements of cash flows, cash balance reporting and related disclosures
Provide all members of Corporate Finance, and those providing data into the cash flow and cash balance reporting process, training on the enhanced process and controls
Enhance cash flow reporting and disclosure package by reviewing all source materials used in the preparation of the cash flow statement and assembling a prototype reporting package that includes policy matters as well as a detailed reconciliation of cash flows by type and classification

5.
Access to Applications and Data – Upon identification of the material weakness, management performed the following procedures to gain assurance related to the accuracy of the Company’s financial reporting process:

Performed an assessment of segregation of duties; management identified relevant business risks related to all key financial and administrative applications, including all business risks arising from excessive user access. Management identified the relevant mitigating controls which were determined to be effective
Evaluated the results of the testing performed around the Company’s change management procedures
Performed a review of the Company’s entity level controls related to fraud monitoring and confirmed that these functions were found to be effective


62



The Company’s implemented and planned remediation measures are intended to address the material weakness related to Access to Applications and Data. The Company’s remediation measures include the following:

Implemented
Redesigned the user access entitlement process to include the following procedures:
Enhanced user access request and approval process by requiring more detailed role-based provisioning requests
Implemented a quality control review following the provisioning of access rights for all new hires.

Planned
Design and implement detailed user access review remediation plan

Control deficiencies not constituting material weaknesses

In addition to the material weaknesses described in “Management’s Report on Internal Control Over Financial Reporting,” management has identified other deficiencies in internal control over financial reporting that did not constitute material weaknesses as of December 31, 2013. The Company has implemented and/or plans to substantially implement during 2014 various measures to remediate these control deficiencies and has undertaken other interim measures to address these control deficiencies, as discussed above.

Managements Conclusions

Management has developed a plan for the implementation of the foregoing remediation efforts and will monitor the implementation. In addition, under the direction of the financial reporting controls committee as well as the Audit and Finance Committee of the Board, management will continue to review and make necessary changes to the overall design of the Company’s internal control environment, as well as to policies and procedures to improve the overall effectiveness of internal control over financial reporting. Management believes the efforts discussed above will remediate the material weaknesses. As the Company continues to evaluate and work to improve its internal control over financial reporting, management may determine to take additional measures to address control deficiencies or determine to modify the remediation plan described above.

Further, no system of controls, no matter how well designed and operated, can provide absolute assurance that the objectives of the system of controls will be met, and no evaluation of controls can provide absolute assurance that all control deficiencies or material weaknesses have been or will be detected. Given the breadth of the control deficiencies and material weaknesses described above, there is no assurance that the Company’s remediation efforts have been or will be fully effective. As described above and in Item 1A (Risk Factors), these material weaknesses have not been fully remediated as of the filing date of this Form 10-K. If the Company’s remediation efforts do not prove effective and control deficiencies and material weaknesses persist or occur in the future, the accuracy and timing of our financial reporting may be adversely affected.
 
Changes in Internal Control Over Financial Reporting

Except for certain of management’s implemented remediation measures discussed above, there were no changes to the Company’s internal control over financial reporting during the fourth quarter of 2013 that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.


Item 9B.
Other Information

None.



63



PART III

Item 10.
Directors, Executive Officers and Corporate Governance

We have omitted this information from this report pursuant to General Instruction (I)(1)(a) and (b) of Form 10-K and are filing this Form 10-K with the reduced disclosure format permitted by that General Instruction.


Item 11.
Executive Compensation

We have omitted this information from this report pursuant to General Instruction (I)(1)(a) and (b) of Form 10-K and are filing this Form 10-K with the reduced disclosure format permitted by that General Instruction.


Item 12.
Security Ownership of Certain Beneficial Owners and Management

We have omitted this information from this report pursuant to General Instruction (I)(1)(a) and (b) of Form 10-K and are filing this Form 10-K with the reduced disclosure format permitted by that General Instruction.


Item 13.
Certain Relationships and Related Transactions, and Director Independence

We have omitted this information from this report pursuant to General Instruction (I)(1)(a) and (b) of Form 10-K and filing this Form 10-K with the reduced disclosure format permitted by that General Instruction.


Item 14.
Principal Accounting Fees and Services

A description of the fees earned by PwC for services rendered to the Company for each of the two years in the period ended December 31, 2013 is provided below. Fees in 2012 primarily relate to additional fees associated with the restatement of the Company’s financial statements billed and allocated in 2012 and 2013. Amounts recorded within the 2013 financial statements were $12,434,859.

 
2013
 
2012
 
 
 
 
Audit fees
$
1,610,125

 
$
12,595,620

Audit-related fees

 

Tax fees

 

All other fees

 

Total fees
$
1,610,125

 
$
12,595,620


Audit Fees: Audit fees consist of fees billed and allocated for professional service rendered for the annual audits of the Company’s financial statements and the review of the Company’s interim condensed financial statements. Audit fees also include fees for services that are closely related to the audit, such as consents related to SEC registration statements and audits of the Company’s sponsored separate accounts.

Audit Committee: Prior to each fiscal year, the PNX Audit Committee receives a written report from PwC describing the elements expected to be performed in the course of its audit of the PNX consolidated financial statements and those of its insurance company subsidiaries, including PHL Variable, for the coming year. The PNX Audit Committee may approve the scope and fees not only for the proposed audit, but also for various recurring audit-related services. For services of its independent registered public accounting firm that are neither audit-related nor recurring, a Company vice president may submit in writing a request to the Company’s internal auditor, accompanied by approval of the Company’s Chief Financial Officer or Chief Accounting Officer. The PNX Audit Committee may pre-approve the requested service as long as it is not a prohibited non-audit service and the performance of such service would be consistent with all applicable rules on auditor independence. The PNX Audit Committee may also delegate pre-approval authority to one or more of its members.

64



PART IV

Item 15.
Exhibits, Financial Statement Schedules

(a)
Documents filed as part of this Form 10-K include:

1.
Financial Statements. The financial statements listed in Part II of the Table of Contents to this Form 10-K are filed as part of this Form 10-K;
2.
Financial Statement Schedules. All financial statement schedules are omitted as they are not applicable or the information is shown in the financial statements or notes thereto; and
3.
Exhibits. Those items listed in the Exhibit Index in Section E of this Form 10-K which are marked with an (*) are filed with this Form 10-K.

*    *    *    *    *



65



SIGNATURES


Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

PHL VARIABLE INSURANCE COMPANY
(Registrant)

Dated:
August 22, 2014
By: /s/ James D. Wehr
 
 
James D. Wehr
 
 
President
 
 
(Principal Executive Officer)
 
 
 
Dated:
August 22, 2014
By: /s/ Bonnie J. Malley
 
 
Bonnie J. Malley
 
 
Executive Vice President and Chief Financial Officer
 
 
(Principal Financial Officer)
 
 
 
Dated:
August 22, 2014
By: /s/ Douglas C. Miller
 
 
Douglas C. Miller
 
 
Senior Vice President and Chief Accounting Officer
 
 
(Principal Accounting Officer)


Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below, dated August 22, 2014, by the following persons on behalf of the Registrant and in the capacities indicated.


/s/ Edward W. Cassidy
 
/s/ Christopher M. Wilkos
Edward W. Cassidy, Director
 
Christopher M. Wilkos, Director
 
 
 
/s/ Thomas M. Buckingham
 
 
Thomas M. Buckingham, Director
 
 
 
 
 


66



EXHIBIT INDEX

Exhibit
 
 
 
 
 
3.1
 
Form of Amended and Restated Certificate of Incorporation (as amended and restated effective May 31, 1994) (incorporated herein by reference to Exhibit 3.1 to the PHL Variable Insurance Company’s Form 10-K filed March 31, 2006)
 
 
 
3.2
 
Bylaws of PHL Variable Life Insurance Company (as amended and restated effective May 16, 2002) (incorporated herein by reference to Exhibit 3.2 to the PHL Variable Insurance Company’s Form 10-K filed March 31, 2006)
 
 
 
10.1
 
Services Agreement effective as of January 1, 1995 by and among PHL Variable Insurance Company, Phoenix Life Insurance Company, American Life and Reassurance Company, Phoenix American Life Insurance Company and Phoenix Home Life Mutual Insurance Company (incorporated herein by reference to Exhibit 10.1 to the PHL Variable Insurance Company’s Form 10-K filed March 31, 2006)
 
 
 
10.2
 
Investment Management Agreement effective as of January 1, 1995 by and between PHL Variable Insurance Company and Phoenix Investment Counsel, Inc. (incorporated herein by reference to Exhibit 10.2 to the PHL Variable Insurance Company’s Form 10-K filed March 31, 2006)
 
 
 
10.3
 
Amendment #1 (effective as of January 1, 1998) to the Investment Management Agreement dated as of January 1, 1995 by and between PHL Variable Insurance Company and Phoenix Investment Counsel, Inc. (incorporated herein by reference to Exhibit 10.3 to the PHL Variable Insurance Company’s Form 10-K filed March 31, 2006)
 
 
 
10.4
 
Amended and Restated Tax Allocation Agreement dated as of January 1, 2001 by and among The Phoenix Companies, Inc. and most of its subsidiaries (incorporated herein by reference to Exhibit 10.4 to the PHL Variable Insurance Company’s Form 10-K filed March 31, 2006)
 
 
 
10.5
 
Amendment #1 (effective as of January 1, 2006) to the Amended and Restated Tax Allocation Agreement dated as of January 1, 2001 by and among The Phoenix Companies, Inc. and most of its subsidiaries (incorporated herein by reference to Exhibit 10.5 to the PHL Variable Insurance Company’s Form 10-K filed March 31, 2006)
 
 
 
31.1
 
Certification of James D. Wehr, President, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
 
 
 
31.2
 
Certification of Bonnie J. Malley, Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
 
 
 
32
 
Certification by James D. Wehr, President and Bonnie J. Malley, Chief Financial Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*
 
 
 
101.INS
 
XBRL Instance Document*
 
 
 
101.SCH
 
XBRL Taxonomy Extension Schema Document*
 
 
 
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase Document*
 
 
 
101.LAB
 
XBRL Taxonomy Extension Label Linkbase Document*
 
 
 
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase Document*
 
 
 
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase Document*

* Filed herewith

We will furnish any exhibit upon the payment of a reasonable fee, which fee shall be limited to our reasonable expenses in furnishing such exhibit. Requests for copies should be directed to: Corporate Secretary, PHL Variable Insurance Company, One American Row, P.O. Box 5056, Hartford, Connecticut 06102-5056.



E-1







Report of Independent Registered Public Accounting Firm



To the Board of Directors and Stockholder of
PHL Variable Insurance Company:


In our opinion, the accompanying balance sheets and the related statements of income and comprehensive income, of changes in stockholder's equity, and of cash flows present fairly, in all material respects, the financial position of PHL Variable Insurance Company at December 31, 2013 and 2012, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2013 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

As described in Note 11 to the financial statements, the Company has entered into significant transactions with its affiliates.

/s/ PricewaterhouseCoopers, LLP

Hartford, Connecticut
August 22, 2014



F-1



PHL VARIABLE INSURANCE COMPANY
Balance Sheets
($ in millions, except share data)
December 31, 2013 and 2012

 
2013
 
2012
ASSETS:
 
 
 
Available-for-sale debt securities, at fair value (amortized cost of $3,402.6 and $2,798.1)
$
3,426.3

 
$
2,972.3

Short-term investments
81.0

 
244.9

Limited partnerships and other investments
10.5

 
6.7

Policy loans, at unpaid principal balances
66.1

 
61.0

Derivative instruments
237.8

 
149.4

Fair value investments
48.6

 
38.5

Total investments
3,870.3

 
3,472.8

Cash and cash equivalents
181.0

 
83.1

Accrued investment income
27.3

 
23.2

Receivables
8.6

 
16.2

Reinsurance recoverable
500.6

 
427.1

Deferred policy acquisition costs
462.3

 
426.2

Deferred income taxes, net
28.0

 
16.2

Receivable from related parties
2.6

 

Other assets
174.8

 
135.5

Separate account assets
2,052.7

 
2,061.8

Total assets
$
7,308.2

 
$
6,662.1

 
 
 
 
LIABILITIES:
 
 
 
Policy liabilities and accruals
$
1,899.0

 
$
1,876.2

Policyholder deposit funds
2,762.8

 
2,349.8

Indebtedness due to affiliate
30.0

 

Payable to related parties
14.1

 
11.0

Other liabilities
177.1

 
68.2

Separate account liabilities
2,052.7

 
2,061.8

Total liabilities
6,935.7

 
6,367.0

 
 
 
 
COMMITMENTS AND CONTINGENT LIABILITIES (Note 16)


 


 
 
 
 
STOCKHOLDER’S EQUITY:
 
 
 
Common stock, $5,000 par value: 1,000 shares authorized; 500 shares issued
2.5

 
2.5

Additional paid-in capital
847.2

 
802.2

Accumulated other comprehensive income (loss)
(11.9
)
 
11.4

Retained earnings (accumulated deficit)
(465.3
)
 
(521.0
)
Total stockholder’s equity
372.5

 
295.1

Total liabilities and stockholder’s equity
$
7,308.2

 
$
6,662.1


The accompanying notes are an integral part of these financial statements.


F-2



PHL VARIABLE INSURANCE COMPANY
Statements of Income and Comprehensive Income
($ in millions)
Years Ended December 31, 2013, 2012 and 2011

 
2013
 
2012
 
2011
REVENUES:
 
 
 
 
 
Premiums
$
13.9

 
$
8.5

 
$
2.3

Insurance and investment product fees
367.6

 
365.3

 
394.3

Net investment income
140.8

 
130.9

 
101.1

Net realized investment gains (losses):
 
 
 
 
 
Total other-than-temporary impairment (“OTTI”) losses
(1.1
)
 
(5.0
)
 
(10.1
)
Portion of OTTI losses recognized in other comprehensive income (“OCI”)
(0.9
)
 
2.2

 
6.9

Net OTTI losses recognized in earnings
(2.0
)
 
(2.8
)
 
(3.2
)
Net realized investment gains (losses), excluding OTTI losses
5.4

 
(19.5
)
 
(16.2
)
Net realized investment gains (losses)
3.4

 
(22.3
)
 
(19.4
)
Total revenues
525.7

 
482.4

 
478.3

 
 
 
 
 
 
BENEFITS AND EXPENSES:
 
 
 
 
 
Policy benefits
286.5

 
396.8

 
302.6

Policy acquisition cost amortization
88.4

 
103.5

 
109.5

Other operating expenses
116.8

 
103.6

 
92.5

Total benefits and expenses
491.7

 
603.9

 
504.6

Income (loss) before income taxes
34.0

 
(121.5
)
 
(26.3
)
Income tax expense (benefit)
(21.7
)
 
16.2

 
(6.3
)
Net income (loss)
$
55.7

 
$
(137.7
)
 
$
(20.0
)
 
 
 
 
 
 
FEES PAID TO RELATED PARTIES (Note 11)
 
 
 
 
 
 
 
 
 
 
 
COMPREHENSIVE INCOME (LOSS):
 
 
 
 
 
Net income (loss)
$
55.7

 
$
(137.7
)
 
$
(20.0
)
Other comprehensive income (loss), before income taxes:
 
 
 
 
 
  Unrealized investment gains (losses), net of related offsets
(35.1
)
 
33.7

 
19.7

Less: Income tax expense (benefit) related to:
 
 
 
 
 
Unrealized investment gains (losses), net of related offsets
(11.8
)
 
24.9

 
4.2

Other comprehensive income (loss), net of income taxes
(23.3
)
 
8.8

 
15.5

Comprehensive income (loss)
$
32.4

 
$
(128.9
)
 
$
(4.5
)

The accompanying notes are an integral part of these financial statements.


F-3



PHL VARIABLE INSURANCE COMPANY
Statements of Cash Flows
($ in millions)
Years Ended December 31, 2013, 2012 and 2011

 
2013
 
2012
 
2011
OPERATING ACTIVITIES:
 
 
 
 
 
Net income (loss)
$
55.7

 
$
(137.7
)
 
$
(20.0
)
Net realized investment (gains) losses
(3.4
)
 
22.3

 
19.4

Policy acquisition costs deferred
(66.7
)
 
(69.2
)
 
(100.7
)
Amortization of deferred policy acquisition costs
88.4

 
103.5

 
109.5

Interest credited
91.2

 
69.5

 
60.9

Equity in earnings of limited partnerships and other investments
(0.4
)
 
(0.1
)
 
(0.2
)
Change in:
 
 
 
 
 
Accrued investment income
(7.2
)
 
(8.5
)
 
(12.2
)
Deferred income taxes

 
(13.4
)
 
(6.9
)
Receivables
7.6

 
(3.5
)
 
(3.2
)
Reinsurance recoverable
(73.5
)
 
(26.1
)
 
(7.7
)
Policy liabilities and accruals
(224.0
)
 
(56.4
)
 
(128.3
)
Due to/from affiliate
0.5

 
(7.5
)
 
21.1

Other operating activities, net
1.3

 
(38.3
)
 
(54.0
)
Cash provided by (used for) operating activities
(130.5
)
 
(165.4
)
 
(122.3
)
 
 
 
 
 
 
INVESTING ACTIVITIES:
 
 
 
 
 
Purchases of:
 
 
 
 
 
Available-for-sale debt securities
(985.6
)
 
(852.8
)
 
(1,133.7
)
Short-term investments
(324.8
)
 
(574.7
)
 
(325.5
)
Derivative instruments
(89.0
)
 
(98.1
)
 
(46.1
)
Fair value investments
(21.1
)
 
(5.7
)
 
(34.3
)
Sales, repayments and maturities of:
 
 
 
 
 
Available-for-sale debt securities
389.0

 
438.1

 
250.1

Short-term investments
489.8

 
425.8

 
288.3

Derivative instruments
42.9

 
26.7

 
63.8

Fair value investments
10.1

 
12.4

 
7.7

Contributions to limited partnerships
(4.3
)
 
(2.1
)
 
(1.2
)
Distributions from limited partnerships
7.8

 
0.3

 
0.1

Policy loans, net
(2.8
)
 
3.9

 
(2.9
)
Other investing activities, net
0.7

 
(1.0
)
 
(0.6
)
Cash provided by (used for) investing activities
(487.3
)
 
(627.2
)
 
(934.3
)
 
 
 
 
 
 
FINANCING ACTIVITIES:
 
 
 
 
 
Policyholder deposit fund deposits
920.8

 
1,074.7

 
1,225.4

Policyholder deposit fund withdrawals
(605.2
)
 
(513.8
)
 
(465.0
)
Net transfers to/from separate accounts
325.1

 
265.3

 
311.6

Capital Contributions from Parent
45.0

 

 

Debt Issued
30.0

 

 

Cash provided by (used for) financing activities
715.7

 
826.2

 
1,072.0

Change in cash and cash equivalents
97.9

 
33.6

 
15.4

Cash and cash equivalents, beginning of year
83.1

 
49.5

 
34.1

Cash and cash equivalents, end of year
$
181.0

 
$
83.1

 
$
49.5

 
 
 
 
 
 
Supplemental Disclosure of Cash Flow Information
 
 
 
 
 
Income taxes paid (refunded)
$
(24.9
)
 
$
40.9

 
$
(2.5
)
 
 
 
 
 
 
Non-Cash Transactions During the Year
 
 
 
 
 
Investment exchanges
$
33.4

 
$
28.6

 
$
26.4


The accompanying notes are an integral part of these financial statements.


F-4



PHL VARIABLE INSURANCE COMPANY
Statements of Changes in Stockholder’s Equity
($ in millions)
Years Ended December 31, 2013, 2012 and 2011

 
2013
 
2012
 
2011
COMMON STOCK:
 
 
 
 
 
Balance, beginning of period
$
2.5

 
$
2.5

 
$
2.5

Balance, end of period
$
2.5

 
$
2.5

 
$
2.5

 
 
 
 
 
 
ADDITIONAL PAID-IN CAPITAL:
 
 
 
 
 
Balance, beginning of period
$
802.2

 
$
802.2

 
$
802.2

Capital contributions from parent
45.0

 

 

Balance, end of period
$
847.2

 
$
802.2

 
$
802.2

 
 
 
 
 
 
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS):
 
 
 
 
 
Balance, beginning of period
$
11.4

 
$
2.6

 
$
(12.9
)
Other comprehensive income (loss)
(23.3
)
 
8.8

 
15.5

Balance, end of period
$
(11.9
)
 
$
11.4

 
$
2.6

 
 
 
 
 
 
RETAINED EARNINGS (ACCUMULATED DEFICIT):
 
 
 
 
 
Balance, beginning of period
$
(521.0
)
 
$
(383.3
)
 
$
(363.3
)
  Net income (loss)
55.7

 
(137.7
)
 
(20.0
)
Balance, end of period
$
(465.3
)
 
$
(521.0
)
 
$
(383.3
)
 
 
 
 
 
 
TOTAL STOCKHOLDER’S EQUITY:
 
 
 
 
 
Balance, beginning of period
$
295.1

 
$
424.0

 
$
428.5

  Change in stockholder’s equity
77.4

 
(128.9
)
 
(4.5
)
Balance, end of period
$
372.5

 
$
295.1

 
$
424.0


The accompanying notes are an integral part of these financial statements.


F-5



PHL VARIABLE INSURANCE COMPANY
Notes to Financial Statements
Years Ended December 31, 2013, 2012 and 2011


1.
Organization and Operations

PHL Variable Insurance Company (“we,” “our,” “us,” “PHL Variable” or the “Company”) is a life insurance company offering variable and fixed annuity and life insurance products. It is a wholly owned subsidiary of PM Holdings, Inc., and PM Holdings, Inc. is a wholly owned subsidiary of Phoenix Life Insurance Company (“Phoenix Life”), which is a wholly owned subsidiary of The Phoenix Companies, Inc. (“PNX” or “Phoenix”), a New York Stock Exchange listed company. Saybrus Partners, Inc. (“Saybrus”), an affiliate, provides dedicated life insurance and other consulting services to financial advisors in partner companies, as well as support for sales of our product line through independent distribution organizations.


2.
Basis of Presentation and Significant Accounting Policies

We have prepared these financial statements in accordance with U.S. GAAP which differ materially from the accounting practices prescribed by various insurance regulatory authorities. In addition, certain prior year amounts have been reclassified to conform to the current year presentation. Results for the year ended December 31, 2013 include $3.2 million of income related to out of period adjustments. Such amounts are not material to any period presented.

Use of estimates

In preparing these financial statements in conformity with U.S. GAAP, we are required to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Significant estimates and assumptions are made in the determination of estimated gross profits (“EGPs”) used in the valuation and amortization of assets and liabilities associated with universal life and annuity contracts; policyholder liabilities and accruals; valuation of investments in debt securities; limited partnerships and other investments; valuation of deferred tax assets; and accruals for contingent liabilities. We are also subject to estimates made by our ultimate parent company related to discount rates and other assumptions for our pension and other post-employment benefits liabilities; and accruals for contingent liabilities. Actual results could differ from these estimates.

Adoption of new accounting standards

Reporting Amounts Reclassified Out of Accumulated Other Comprehensive Income

In February 2013, the Financial Accounting Standards Board (“FASB”) issued updated guidance regarding the presentation of comprehensive income (ASU 2013-02). Under the guidance, an entity would separately present information about significant items reclassified out of accumulated other comprehensive income by component as well as changes in accumulated other comprehensive income balances by component in either the financial statements or the notes to the financial statements. The guidance does not change the items that are reported in other comprehensive income. The guidance does not change when an item of other comprehensive income must be reclassified to net income and does not amend any existing requirements for reporting net income or other comprehensive income. The guidance was effective for the first interim or annual reporting period beginning after December 15, 2012 and was applied prospectively. See Note 12 to these financial statements for the disclosures required by this guidance.

Disclosures about Offsetting Assets and Liabilities

In December 2011 and January 2013, the FASB issued amended guidance to ASC 210, Balance Sheet, with respect to disclosure of offsetting assets and liabilities as part of the effort to establish common requirements in accordance with U.S. GAAP. This amended guidance requires the disclosure of both gross information and net information about both financial instruments and derivative instruments eligible for offset in our balance sheets and instruments and transactions subject to an agreement similar to a master netting arrangement. This guidance was effective for periods beginning on or after January 1, 2013, with respective disclosures required retrospectively for all comparative periods presented. See Note 8 to these financial statements for the disclosures required by this guidance.


F-6



2.
Basis of Presentation and Significant Accounting Policies (continued)

Definition of a Business Entity

In December 2013, the FASB issued updated guidance establishing a single definition of a public entity for use in financial accounting and reporting guidance. This new guidance is effective for all current and future reporting periods and did not have a significant effect on the Company’s financial position, results of operations, or financial statement disclosures.

Accounting standards not yet adopted

Investment Companies: Amendments to the Scope, Measurement and Disclosure Requirements

In June 2013, the FASB issued updated guidance clarifying the characteristics of an investment company and requiring new disclosures. Under the guidance, all entities regulated under the Investment Company Act of 1940 automatically qualify as investment companies, while all other entities need to consider both the fundamental and typical characteristics of an investment company in determining whether they qualify as investment companies. This new guidance is effective for interim or annual reporting periods that begin after December 15, 2013 and should be applied prospectively. This guidance is not expected to have a significant effect on the Company’s financial position, results of operations or financial statement disclosures.

Obligations Resulting for Joint and Several Liability Agreements for Which the Total Amount of the Obligation is Fixed at the Reporting Date

In February 2013, the FASB issued new guidance regarding liabilities (ASU 2013-04, Liabilities (Topic 405): Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation Is Fixed at the Reporting Date), effective retrospectively for fiscal years beginning after December 15, 2013 and interim periods within those years. The amendments require an entity to measure obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of the guidance is fixed at the reporting date, as the sum of the amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors and any additional amount the reporting entity expects to pay on behalf of its co-obligors. In addition, the amendments require an entity to disclose the nature and amount of the obligation, as well as other information about the obligation. This guidance is not expected to have a significant effect on the Company’s financial position, results of operations or financial statement disclosures.

Accounting for Troubled Debt Restructurings by Creditors

In January 2014, the FASB issued updated guidance for troubled debt restructurings clarifying when an in substance repossession or foreclosure occurs, and when a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan. The new guidance is effective for annual periods and interim periods within those annual periods, beginning after December 15, 2014. This guidance can be elected for prospective adoption or by using a modified retrospective transition method. This guidance is not expected to have a significant effect on the Company’s financial position, results of operations or financial statement disclosures.

Accounting for Investments in Qualified Affordable Housing Projects

In January 2014, the FASB issued updated guidance regarding investments in flow-through limited liability entities that manage or invest in affordable housing projects that qualify for the low-income housing tax credit. Under the guidance, an entity is permitted to make an accounting policy election to amortize the initial cost of its investment in proportion to the tax credits and other tax benefits received and recognize the net investment performance in the statement of operations as a component of income tax expense (benefit) if certain conditions are met. The new guidance is effective for annual periods and interim reporting periods within those annual periods, beginning after December 15, 2014, and should be applied retrospectively to all periods presented. This guidance is not expected to have a significant effect on the Company’s financial position, results of operations or financial statement disclosures.

Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or Tax Credit Carryforward Exists

In July 2013, the FASB issued updated guidance regarding the presentation of unrecognized tax benefits when net operating loss carryforwards, similar tax losses, or tax credit carryforwards exist. This new guidance is effective for interim or annual reporting periods that begin after December 15, 2013, and should be applied prospectively, with early application permitted.

F-7



2.
Basis of Presentation and Significant Accounting Policies (continued)

This guidance is not expected to have a significant effect on the Company’s financial position, results of operations or financial statement disclosures.

Significant accounting policies

Investments

Debt Securities

Our debt securities classified as available-for-sale are reported on our balance sheets at fair value. Fair value is based on quoted market price, 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 (private placement debt securities), by quoted market prices of comparable instruments (untraded public debt securities) and by independent pricing sources or internally developed pricing models. We recognize unrealized gains and losses on investments in debt securities that we classify as available-for-sale. We report these unrealized investment gains and losses as a component of OCI, net of the relevant policyholder obligations, applicable deferred policy acquisition costs (“DAC”) and applicable deferred income taxes. Realized investment gains and losses are recognized on a first in first out basis.

Limited Partnerships and Other Investments

Limited partnerships, infrastructure funds, hedge funds and joint venture interests in which we do not have voting control or power to direct activities are recorded using the equity method of accounting. These investments include private equity, mezzanine funds, infrastructure funds, hedge funds of funds and direct equity investments. The equity method of accounting requires that the investment be initially recorded at cost and the carrying amount of the investment subsequently adjusted to recognize our share of the earnings or losses. We record our equity in the earnings in net investment income using the most recent financial information received from the partnerships. Recognition of net investment income is generally on a three-month delay due to the timing of the related financial statements. The contributions to and distributions from limited partnerships are classified as investing activities within the statement of cash flows.

The Company routinely evaluates these investments for impairments. For equity method investees, the Company considers financial and other information provided by the investee, other known information and inherent risks in the underlying investments, as well as future capital commitments, in determining whether an impairment has occurred. The Company considers its cost method investments for other-than-temporary impairments (“OTTI”) when the carrying value of such investments exceeds the net asset value (“NAV”). The Company takes into consideration the severity and duration of this excess when determining whether the cost method investment is other-than-temporarily impaired. When an OTTI has occurred, the impairment loss is recorded within net investment gains (losses).

Loans are occasionally restructured in a troubled debt restructuring. These restructurings generally include one or more of the following: full or partial payoffs outside of the original contract terms; changes to interest rates; extensions of maturity; or additions or modifications to covenants. When restructurings occur, they are evaluated individually to determine whether the restructuring or modification constitutes a “troubled debt restructuring” as defined by authoritative accounting guidance. In a troubled debt restructuring where the Company receives assets in full or partial satisfaction of the debt, any specific valuation allowance is reversed and a direct write down of the loan is recorded for the amount of the allowance and any additional loss, net of recoveries, or any gain is recorded for the difference between the fair value of the assets received and the recorded investment in the loan. Any remaining loan is evaluated prospectively for impairment based on the credit review process noted above. When a loan is restructured in a troubled debt restructuring, the impairment of the loan is remeasured using the modified terms and the loan’s original effective yield and the allowance for loss is adjusted accordingly. Subsequent to the modification, income is recognized prospectively based on the modified terms of the loans in accordance with the income recognition policy noted above.

Policy Loans

Policy loans are carried at their unpaid principal balances and are collateralized by the cash values of the related policies. The majority of policy loans are at variable interest rates that are reset annually on the policy anniversary.


F-8



2.
Basis of Presentation and Significant Accounting Policies (continued)

Fair Value Instruments

Debt securities held at fair value include securities held for which changes in fair values are recorded in earnings. The securities held at fair value are designated as trading securities, as well as those debt securities for which we have elected the fair value option (“FVO”) and certain available-for-sale structured securities held at fair value. The changes in fair value and any interest income of these securities are reflected in earnings as part of “net investment income.” See Note 9 to these financial statements for additional disclosures related to these securities.

Derivative Instruments

We recognize derivative instruments on the balance sheets at fair value. The derivative contracts are reported as assets in derivative instruments or liabilities in other liabilities on the balance sheets, excluding embedded derivatives. Embedded derivatives, as discussed below, are recorded on the balance sheets bifurcated from the associated host contract.

The Company economically hedges variability of cash flows to be received or paid related to certain recognized assets and/or liabilities. All changes in the fair value of derivatives, including net receipts and payments, are included in net realized investment gains and losses without consideration of changes in the fair value of the economically associated assets or liabilities. We do not designate the purchased derivatives related to living benefits or index credits as hedges for accounting purposes.

Our derivatives are not designated as hedges for accounting purposes. All changes in the fair value, including net receipts and payments, are included in net realized investment gains and losses without consideration of changes in the fair value of the economically associated assets or liabilities.

Short-Term Investments

Short-term investments include securities with a maturity of one year or less but greater than three months at a time of purchase and are stated at estimated fair value or amortized cost, which approximates estimated fair value.

Net Investment Income

For asset-backed and fixed maturity debt securities, we recognize interest income using a constant effective yield based on estimated cash flow timing and economic lives of the securities. For high credit quality asset-backed securities, effective yields are recalculated based on actual payments received and updated prepayment expectations, and the amortized cost is adjusted to the amount that would have existed had the new effective yield been applied since acquisition with a corresponding charge or credit to net investment income. For asset-backed securities that are not high credit quality, effective yields are recalculated and adjusted prospectively based on changes in expected undiscounted future cash flows. For certain credit impaired asset-backed securities, effective yields are recalculated and adjusted prospectively to reflect significant increases in undiscounted expected future cash flows and changes in the contractual benchmark interest rate on variable rate securities. Any prepayment fees on fixed maturities and mortgage loans are recorded when earned in net investment income. We record the net income from investments in partnerships and joint ventures in net investment income.

Other-Than-Temporary Impairments on Available-For-Sale Securities

We recognize realized investment losses when declines in fair value of debt securities are considered to be an OTTI.

For debt securities, the other-than-temporarily impaired amount is separated into the amount related to a credit loss and is reported as net realized investment losses included in earnings and any amounts related to other factors are recognized in OCI. The credit loss component represents the difference between the amortized cost of the security and the net present value of its projected future cash flows discounted at the effective interest rate implicit in the debt security prior to impairment. Any remaining difference between the fair value and amortized cost is recognized in AOCI. Subsequent to the recognition of an OTTI, the impaired security is accounted for as if it had been purchased on the date of impairment at an amortized cost basis equal to the previous amortized cost basis less the OTTI recognized in earnings. We will continue to estimate the present value of future expected cash flows and, if significantly greater than the new cost basis, we will accrete the difference as investment income on a prospective basis once the Company has determined that the interest income is likely to be collected.


F-9



2.
Basis of Presentation and Significant Accounting Policies (continued)

In evaluating whether a decline in value is other-than-temporary, we consider several factors including, but not limited to, the following:

the extent and the duration of the decline;
the reasons for the decline in value (credit event, interest related or market fluctuations);
our intent to sell the security, or whether it is more likely than not that we will be required to sell it before recovery; and
the financial condition and near term prospects of the issuer.

A debt security impairment is deemed other-than-temporary if:

we either intend to sell the security, or it is more likely than not that we will be required to sell the security before recovery; or
it is probable we will be unable to collect cash flows sufficient to recover the amortized cost basis of the security.

Impairments due to deterioration in credit that result in a conclusion that the present value of cash flows expected to be collected will not be sufficient to recover the amortized cost basis of the security are considered other-than-temporary. Other declines in fair value (for example, due to interest rate changes, sector credit rating changes or company-specific rating changes) that result in a conclusion that the present value of cash flows expected to be collected will not be sufficient to recover the amortized cost basis of the security may also result in a conclusion that an OTTI has occurred.

On a quarterly basis, we evaluate securities in an unrealized loss position for potential recognition of an OTTI. In addition, we maintain a watch list of securities in default, near default or otherwise considered by our investment professionals as being distressed, potentially distressed or requiring a heightened level of scrutiny. We also identify securities whose fair value has been below amortized cost on a continuous basis for zero to six months, six months to 12 months and greater than 12 months.

We employ a comprehensive process to determine whether or not a security in an unrealized loss position is other-than-temporarily impaired. This assessment is done on a security-by-security basis and involves significant management judgment. The assessment of whether impairments have occurred is based on management’s evaluation of the underlying reasons for the decline in estimated fair value. The Company’s review of its fixed maturity securities for impairments includes an analysis of the total gross unrealized losses by severity and/or age of the gross unrealized loss. An extended and severe decline in value on a fixed maturity security may not have any impact on the ability of the issuer to service all scheduled interest and principal payments and the Company’s evaluation of recoverability of all contractual cash flows or the ability to recover an amount at least equal to its amortized cost based on the present value of the expected future cash flows to be collected.

Specifically for structured securities, to determine whether a collateralized security is impaired, we obtain underlying data from the security’s trustee and analyze it for performance trends. A security-specific stress analysis is performed using the most recent trustee information. This analysis forms the basis for our determination of the future expected cash flows to be collected for the security.

Cash and Cash Equivalents

Cash and cash equivalents include cash on hand, amounts due from banks, money market instruments and other debt instruments with original maturities of three months or less. Negative cash balances are reclassified to other liabilities.

Deferred Policy Acquisition Costs

We defer incremental direct costs related to the successful sale of new or renewal contracts. Incremental direct costs are those costs that result directly from and are essential to the sale of a contract. These costs include principally commissions, underwriting and policy issue expenses, all of which vary with and are primarily related to production of new business.


F-10



2.
Basis of Presentation and Significant Accounting Policies (continued)

We amortize deferred policy acquisition costs based on the related policy’s classification. For universal life, variable universal life and deferred annuities, deferred policy acquisition costs are amortized in proportion to EGPs as discussed more fully below. EGPs are also used to amortize other assets and liabilities in the Company’s balance sheets, such as sales inducement assets (“SIA”) and unearned revenue reserves (“URR”). Components of EGPs are used to determine reserves for universal life and fixed, indexed and variable annuity contracts with death and other insurance benefits such as guaranteed minimum death and guaranteed minimum income benefits. EGPs are based on historical and anticipated future experience which is updated periodically.

In addition, deferred policy acquisition costs are adjusted through OCI each period as a result of unrealized gains or losses on securities classified as available-for-sale in a process commonly referred to as shadow accounting. This adjustment is required in order to reflect the impact of these unrealized amounts as if these unrealized amounts had been realized.

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:


F-11



2.
Basis of Presentation and Significant Accounting Policies (continued)

Significant Assumption
 
Product
 
Explanation and Derivation
 
 
 
 
 
Separate account investment return
 
 
Variable Annuities
(8.0% long-term return assumption)
Variable Universal Life
(8.0% long-term return assumption)
 
Separate account return assumptions are derived from the long-term returns observed in the asset classes in which the separate accounts are invested. Short-term deviations from the long-term expectations are expected to revert to the long-term assumption over five years.
 
Interest rates and default rates
 
Fixed and Indexed Annuities
Universal Life
 
 
Investment returns are based on the current yields and maturities of our fixed income portfolio combined with expected reinvestment rates given current market interest rates. Reinvestment rates are assumed to revert to long-term rates implied by the forward yield curve and long-term default rates. Contractually permitted future changes in credited rates are assumed to help support investment margins.
 
Mortality / longevity
 
Universal Life
Variable Universal Life
Fixed and Indexed Annuities
 
 
Mortality assumptions are based on Company experience over a rolling five-year period plus supplemental data from industry sources and trends. A mortality improvement assumption is also incorporated into the overall mortality table. These assumptions can vary by issue age, gender, underwriting class and policy duration.

Policyholder behavior – policy persistency
 
Universal Life
Variable Universal Life
Variable Annuities
Fixed and Indexed Annuities
 
 
Policy persistency assumptions vary by product and policy year and are updated based on recently observed experience. Policyholders are generally assumed to behave rationally; hence rates are typically lower when surrender penalties are in effect or when policy benefits are more valuable.
Policyholder behavior – premium persistency
 
Universal Life
Variable Universal Life
 
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 recently observed 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 cost of insurance (“COI”) charges).
 
Expenses
 
All products
 
Projected maintenance expenses to administer policies in force are based on annually updated studies of expenses incurred.
 
Reinsurance costs / recoveries
 
Universal Life
Variable Universal Life
Variable Annuities
 
 
Projected reinsurance costs are based on treaty terms currently in force. Recoveries are based on the Company’s assumed mortality and treaty terms. Treaty recaptures are based on contract provisions and management’s intentions.

Annually, we complete a comprehensive assumption review where management makes a determination of best estimate assumptions based on a comprehensive review of recent experience and industry trends. Assumption changes resulting from this review may change our estimates of EGPs in the DAC, SIA, and URR models, as well as projections within the death benefit and other insurance benefit reserving models, the profits followed by losses reserve models, and cost of reinsurance models. Throughout the year, we may also update the assumptions and adjust these balances if emerging data indicates a change is warranted. All assumption changes, whether resulting from the annual comprehensive review or from other periodic assessments, are considered an unlock in the period of revision and adjust the DAC, SIA, URR, death and other insurance benefit reserves, profits followed by losses reserve, and cost of reinsurance balances in the balance sheets with an offsetting benefit or charge to income to reflect such changes in the period of the revision. An unlock that results in an after-tax benefit generally occurs as a result of actual experience or future expectations of product profitability being more favorable than 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 less favorable than previous estimates.


F-12



2.
Basis of Presentation and Significant Accounting Policies (continued)

Our process to assess the reasonableness of the EGPs uses internally developed models together with consideration of applicable recent experience and analysis of market and industry trends and other events. Actual gross profits that vary from management’s estimates in a given reporting period may also result in increases or decreases in the rate of amortization recorded in the period.

An analysis is performed annually to assess if there are sufficient gross profits to recover the deferred policy acquisition costs associated with business written during the year. If the estimates of gross profits cannot support the recovery of deferred policy acquisition costs, the amount deferred is reduced to the recoverable amount.

Over the last several years, the Company has revised a number of assumptions that have resulted in changes to expected future gross profits. The most significant assumption updates resulting in a change to future gross profits and the amortization of DAC, SIA and URR in 2013 are related to changes in expected premium persistency, and the incorporation of a mortality improvement assumption. Other of the more significant drivers of changes to expected gross profits over the last several years include changes in expected separate account investment returns due to changes in equity markets; changes in expected future interest rates and default rates based on continued experience and expected interest rate changes; changes in mortality, lapses and other policyholder behavior assumptions that are updated to reflect more recent policyholder and industry experience; and changes in expected policy administration expenses.

Separate account assets and liabilities

Separate account assets related to policyholder funds are carried at fair value with an equivalent amount recorded as separate account liabilities. Deposits, net investment income and realized investment gains and losses for these accounts are excluded from revenues and the related liability increases are excluded from benefits and expenses. Fees assessed to the contract owners for management services are included in revenues when services are rendered.

Policy liabilities and accruals

Policy liabilities and accruals include future benefit liabilities for certain life and annuity products. Generally, future policy benefits are payable over an extended period of time and related liabilities are calculated recognizing future expected benefits, expenses and premiums. Such liabilities are established based on methods and underlying assumptions in accordance with U.S. GAAP and applicable actuarial standards. Principal assumptions used in the establishment of liabilities for future policy benefits are mortality, morbidity, policyholder behavior, investment returns, inflation, expenses and other contingent events as appropriate. These assumptions are intended to estimate the experience for the period the policy benefits are payable. Utilizing these assumptions, liabilities are established on a cohort basis, as appropriate. If experience is less favorable than assumed, additional liabilities may be established, resulting in a charge to policyholder benefits and claims.

Additional policyholder liabilities for guaranteed benefits on variable annuity and on fixed index annuity contracts are based on estimates of the expected value of benefits in excess of the projected account balance, recognizing the excess over the accumulation period based on total expected assessments. Because these estimates are sensitive to capital market movements, amounts are calculated using multiple future economic scenarios.

Additional policyholder liabilities are established for certain contract features that could generate significant reductions to future gross profits (e.g., death benefits when a contract has zero account value and a no-lapse guarantee). The liabilities are accrued over the lifetime of the block based on assessments. The assumptions used in estimating these liabilities are consistent with those used for amortizing deferred policy acquisition costs and are, thus, subject to the same variability and risk. The assumptions of investment performance and volatility for variable and equity index products are consistent with historical experience of the appropriate underlying equity indices.

We expect that our universal life block of business will generate profits followed by losses and therefore we establish an additional liability to accrue for the expected losses over the period of expected profits. The assumptions used in estimating these liabilities are consistent with those used for amortizing deferred policy acquisition costs and are subject to the same variability and risk.


F-13



2.
Basis of Presentation and Significant Accounting Policies (continued)

The liability for universal life-type contracts primarily includes the balance that accrues to the benefit of the policyholders as of the financial statement date, including interest credited at rates which range from 3.0% to 4.5%, amounts that have been assessed to compensate us for services to be performed over future periods, accumulated account deposits, withdrawals and any amounts previously assessed against the policyholder that are refundable. There may also be a liability recorded for contracts that include additional death or other insurance benefit features as discussed above.

The Company periodically reviews its estimates of actuarial liabilities for policyholder benefits and compares them with its actual experience. Differences between actual experience and the assumptions used in pricing these policies and guarantees, as well as in the establishment of the related liabilities, result in variances in profit and could result in losses.

Policy liabilities and accruals also include liabilities for outstanding claims, losses and loss adjustment expenses based on individual case estimates for reported losses and estimates of unreported losses based on past experience. The Company does not establish claim liabilities until a loss has occurred. However, unreported losses and loss adjustment expenses includes estimates of claims that the Company believes have been incurred but have not yet been reported as of the balance sheet date.

Embedded derivatives

Certain contracts contain guarantees that are accounted for as embedded derivative instruments. These guarantees are assessed to determine if a separate instrument with the same terms would qualify as a derivative and if they are not clearly and closely related to the economic characteristics of the host contract. Contract guarantees that meet these criteria are reported separately from the host contract and reported at fair value.

The guaranteed minimum withdrawal benefit (“GMWB”), guaranteed minimum accumulation benefit (“GMAB”) and combination rider (“COMBO”) represent embedded derivative liabilities in the variable annuity contracts. These liabilities are accounted for at fair value within policyholder deposit funds on the balance sheets with changes in the fair value of embedded derivatives recorded in realized investment gains on the statements of income and comprehensive income. The fair value of the GMWB, GMAB and COMBO obligation is calculated based on actuarial and capital market assumptions related to the projected cash flows, including benefits and related contract charges, over the lives of the contracts, incorporating expectations concerning policyholder behavior. As markets change, contracts mature and actual policyholder behavior emerges, these assumptions are continually evaluated and may from time to time be adjusted.

Fixed indexed annuities offer a variety of index options: policy credits that are calculated based on the performance of an outside equity market or other index over a specified term. The index options represent embedded derivative liabilities accounted for at fair value within policyholder deposit funds on the balance sheets with changes in fair value recorded in realized investment gains and losses in the statements of income and comprehensive income. The fair value of these index options is based on the impact of projected interest rates and equity markets and is discounted using the projected interest rate. Several additional inputs reflect our internally developed assumptions related to lapse rates and policyholder behavior.

See Note 7 to these financial statements for additional information regarding embedded derivatives.

Policyholder deposit funds

Amounts received as payment for certain deferred annuities and other contracts without life contingencies are reported as deposits to policyholder deposit funds. The liability for deferred annuities and other contracts without life contingencies is equal to the balance that accrues to the benefit of the contract owner as of the financial statement date which includes the accumulation of deposits plus interest credited, less withdrawals and amounts assessed through the financial statement date as well as accumulated policyholder dividends and the liability representing the fair value of embedded derivatives associated with those contracts.

Contingent liabilities

Management evaluates each contingent matter separately and in aggregate. Amounts related to contingent liabilities are accrued if it is probable that a liability has been incurred and an amount is reasonably estimable.


F-14



2.
Basis of Presentation and Significant Accounting Policies (continued)

Revenue recognition

We recognize premiums for long-duration life insurance products as revenue when due from policyholders. We match benefits, losses and related expenses with premiums over the related contract periods.

Amounts received as payment for interest sensitive life contracts, deferred annuities and contracts without life contingencies are considered deposits and are not included in revenue. Revenues from these products consist primarily of fees assessed during the period against the policyholders’ account balances for mortality charges, policy administration charges and surrender charges. Fees assessed that represent compensation for services to be provided in the future are deferred and amortized into revenue over the life of the related contracts in proportion to EGPs.

Certain variable annuity contracts and fixed index annuity contract riders provide the holder a guarantee that the benefit received upon death or annuitization will be no less than a minimum prescribed amount. These benefits are accounted for as insurance benefits. Certain variable annuity contracts features and fixed index annuity index options are considered embedded derivatives. See Note 7 to these financial statements for additional information.

Reinsurance

Premiums, policy benefits and operating expenses related to our term insurance policies are stated net of reinsurance ceded to other companies, except for amounts associated with certain modified coinsurance contracts which are reflected in the Company’s financial statements based on the application of the deposit method of accounting. Estimated reinsurance recoverables and the net estimated cost of reinsurance are recognized over the life of the reinsured treaty using assumptions consistent with those used to account for the policies subject to the reinsurance.

For universal life and variable universal life contracts, reinsurance premiums and ceded benefits are reflected net within policy benefits. Reinsurance recoverables are recognized in the same period as the related reinsured claim. The net cost or benefit of reinsurance (the present value of all expected ceded premium payments and expected future benefit payments) is recognized over the life of the reinsured treaty using assumptions consistent with those used to account for the policies subject to the reinsurance.

Operating expenses

Operating expenses are recognized on the accrual basis which are allocated to the Company by Phoenix Life. Expenses allocated may not be indicative of a standalone company. See Note 11 to these financial statements for additional information regarding the service agreement.

Income taxes

Income tax expense or benefit is recognized based upon amounts reported in the financial statements and the provisions of currently enacted tax laws. 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. Valuation allowances on deferred tax assets are recorded to the extent that management concludes that it is more likely than not that an asset will not be realized.

We recognize current income tax assets and liabilities for estimated income taxes refundable or payable based on the income tax returns. We recognize deferred income tax assets and liabilities for the estimated future income tax effects of temporary differences and carryovers. Temporary differences are the differences between the financial statement carrying amounts of assets and liabilities and their tax bases, as well as the timing of income or expense recognized for financial reporting and tax purposes of items not related to assets or liabilities. If necessary, we establish valuation allowances to reduce the carrying amount of deferred income tax assets to amounts that are more likely than not to be realized. We periodically review the adequacy of these valuation allowances and record any increase or reduction in allowances in accordance with intraperiod allocation rules. We assess all significant tax positions to determine if a liability for an uncertain tax position is necessary and, if so, the impact on the current or deferred income tax balances. Also, if indicated, we recognize interest or penalties related to income taxes as a component of the income tax provision.


F-15



2.
Basis of Presentation and Significant Accounting Policies (continued)

We are included in the consolidated federal income tax return filed by PNX and are party to a tax sharing agreement by and among PNX and its subsidiaries. In accordance with this agreement, federal income taxes are allocated as if they had been calculated on a separate company basis, except that benefits for any net operating losses or other tax credits generated by the Company will be provided at the earlier of when such loss or credit is utilized in the consolidated federal tax return and when the tax attribute would have otherwise expired.

Audit fees and other professional services associated with the Restatement

Professional fees associated with the restatement of the 2012 Form 10-K which was filed on April 30, 2014 are being recognized and expensed as incurred and totaled $18.6 million in 2013.


3.
Reinsurance

We use reinsurance agreements to limit potential losses, reduce exposure to larger risks and provide capital relief with regard to certain reserves.

The amount of risk ceded depends on our evaluation of the specific risk and applicable retention limits. For business sold prior to December 31, 2010, our retention limit on any one life is $10 million for single life and joint first-to-die policies and $12 million for joint last-to-die policies. Beginning January 1, 2011, our retention limit on new business is $5 million for single life and joint first-to-die policies and $6 million for second-to-die policies. We also assume reinsurance from other insurers.

Our reinsurance program cedes various types of risks to other reinsurers primarily under yearly renewable term and coinsurance agreements. Yearly renewable term and coinsurance agreements result in passing all or a portion of the risk to the reinsurer. Under coinsurance agreements on our term insurance policies, the reinsurer receives a proportionate amount of the premiums less an allowance for commissions and expenses and is liable for a corresponding proportionate amount of all benefit payments. Under our yearly renewable term agreements, the ceded premium represents a charge for the death benefit coverage.

During 2008, the Company and Phoenix Life, a related party, entered into a reinsurance agreement. Under this agreement, the Company cedes risk associated with certain universal life contracts and the associated riders to Phoenix Life. The reinsurance transaction between the Company and Phoenix Life is structured as a coinsurance agreement. At the inception of the contract a gain was recognized primarily due to the ceding commission received from Phoenix Life and the difference between the U.S. GAAP and statutory basis reserve balances. The gain on this transaction is being amortized over the remaining life of the reinsured contracts.

Effective October 1, 2009, the Company and Phoenix Life and Annuity Company coinsured all the benefit risks, net of existing reinsurance, on their term life business in force.

On July 1, 2012 the Company recaptured the business associated with a reinsurance contract with Phoenix Life, whereby we ceded to Phoenix Life certain of the liabilities related to guarantees on our annuity products. This contract qualified as a freestanding derivative and the derivative asset previously reported within receivable from related parties was reversed at the time of recapture.

Trust agreements and irrevocable letters of credit aggregating $26.7 million at December 31, 2013 have been arranged with commercial banks in our favor to collateralize the ceded reserves.

Reinsurance recoverable includes balances due from reinsurers for paid and unpaid losses and is presented net of an allowance for uncollectable reinsurance. The reinsurance recoverable balance is $500.6 million and $427.1 million as of December 31, 2013 and 2012, respectively. Other reinsurance activity is shown below.


F-16



3.
Reinsurance (continued)

Direct Business and Reinsurance:
Years Ended December 31,
($ in millions)
2013
 
2012
 
2011
 
 
 
 
 
 
Direct premiums
$
80.9

 
$
79.2

 
$
77.1

Premiums ceded to non-affiliate reinsurers [1]
(67.0
)
 
(70.7
)
 
(74.8
)
Premiums
$
13.9

 
$
8.5

 
$
2.3

 
 
 
 
 
 
Direct policy benefits incurred
$
258.5

 
$
281.4

 
$
161.4

Policy benefits assumed from non-affiliate reinsureds
0.2

 
1.0

 
3.8

Policy benefits ceded to:
 
 
 
 
 
Affiliate reinsurers
(18.0
)
 
(13.7
)
 
(5.3
)
Non-affiliate reinsurers
(119.5
)
 
(114.7
)
 
(86.0
)
Policy benefits ceded to reinsurers
(137.5
)
 
(128.4
)
 
(91.3
)
Premiums paid to:
 
 
 
 
 
Affiliate reinsurers
22.3

 
20.1

 
19.7

Non-affiliate reinsurers
44.4

 
60.8

 
58.7

Premiums paid to reinsurers [2]
66.7

 
80.9

 
78.4

Policy benefits [3]
$
187.9

 
$
234.9

 
$
152.3

 
 
 
 
 
 
Direct life insurance in-force
$
58,198.8

 
$
62,701.8

 
$
68,205.1

Life insurance in-force assumed from reinsureds
93.2

 
78.5

 
66.1

Life insurance in-force ceded to:
 
 
 
 
 
Affiliate reinsurers
(1,622.9
)
 
(1,859.3
)
 
(2,520.7
)
Non-affiliate reinsurers
(42,957.9
)
 
(46,950.4
)
 
(49,800.1
)
Life insurance in-force ceded to reinsurers
(44,580.8
)
 
(48,809.7
)
 
(52,320.8
)
Life insurance in-force
$
13,711.2

 
$
13,970.6

 
$
15,950.4

Percentage of amount assumed to net insurance in-force
0.7%
 
0.6%
 
0.4%
———————
[1]
Primarily represents premiums ceded to reinsurers related to term insurance policies.
[2]
For universal life and variable universal life contracts, premiums paid to reinsurers are reflected within policy benefits. See Note 2 to these financial statements for additional information regarding significant accounting policies.
[3]
Policy benefit amounts above exclude changes in reserves, interest credited to policyholders and other items, which total $98.6 million, $161.9 million and $150.3 million, net of reinsurance, for the years ended December 31, 2013, 2012 and 2011, respectively.

We remain liable to the extent that reinsuring companies may not be able to meet their obligations under reinsurance agreements in effect. Failure of the reinsurers to honor their obligations could result in losses to the Company. Since we bear the risk of nonpayment, on a quarterly basis we evaluate the financial condition of our reinsurers and monitor concentrations of credit risk. Based on our review of their financial statements, reputation in the reinsurance marketplace and other relevant information, we believe that we have no material exposure to uncollectible life reinsurance. At December 31, 2013, five major reinsurance companies account for approximately 73% of the reinsurance recoverable.



F-17



4.
Deferred Policy Acquisition Costs

The balances of and changes in deferred policy acquisition costs as of and for the years ended December 31, are as follows:

Deferred Policy Acquisition Costs:
Years Ended December 31,
($ in millions)
2013
 
2012
 
2011
 
 
 
 
 
 
Policy acquisition costs deferred
$
66.7

 
$
69.8

 
$
100.7

Costs amortized to expenses:
 

 
 

 
 

Recurring costs
(80.3
)
 
(102.6
)
 
(108.1
)
Assumption unlocking
1.6

 
(1.4
)
 
(1.3
)
Realized investment gains (losses)
(9.7
)
 
0.5

 
(0.1
)
Offsets to net unrealized investment gains or losses included in AOCI [1]
57.8

 
(29.2
)
 
(37.4
)
Change in deferred policy acquisition costs
36.1

 
(62.9
)
 
(46.2
)
Deferred policy acquisition costs, beginning of period
426.2

 
489.1

 
535.3

Deferred policy acquisition costs, end of period
$
462.3

 
$
426.2

 
$
489.1

———————
[1]
An offset to deferred policy acquisition costs and AOCI is recorded each period to the extent that, had unrealized holding gains or losses from securities classified as available-for-sale actually been realized, an adjustment to deferred policy acquisition costs amortized using gross profits or gross margins would result.

During the years ended December 31, 2013, 2012 and 2011, deferred expenses primarily consisted of third-party commissions related to fixed indexed annuity sales.


5.
Sales Inducements

The Company currently offers bonus payments to contract owners on certain of its individual life and annuity products. Expenses incurred related to bonus payments are deferred and amortized over the life of the related contracts in a pattern consistent with the amortization of deferred policy acquisition costs. The Company unlocks the assumption used in the amortization of the deferred sales inducement asset consistent with the unlock of assumptions used in determining EGPs. Deferred sales inducements are included in other assets on the balance sheets and amortization of deferred sales inducements is included in other operating expense on the statements of income and comprehensive income.

Changes in Deferred Sales Inducement Activity:
Years Ended December 31,
($ in millions)
2013
 
2012
 
2011
 
 
 
 
 
 
Deferred asset, beginning of period
$
60.9

 
$
49.7

 
$
20.4

Sales inducements deferred
10.7

 
15.4

 
48.3

Amortization charged to income
(7.3
)
 
(6.8
)
 
(4.9
)
Offsets to net unrealized investment gains or losses included in AOCI
11.4

 
2.6

 
(14.1
)
Deferred asset, end of period
$
75.7

 
$
60.9

 
$
49.7



6.
Investing Activities

Debt securities

The following tables present the debt securities available-for-sale by sector held at December 31, 2013 and 2012, respectively. The unrealized loss amounts presented below include the non-credit loss component of OTTI losses. We classify these investments into various sectors in line with industry conventions.


F-18



6.
Investing Activities (continued)

Fair Value and Cost of Securities:
December 31, 2013
($ in millions)
 
 
Gross
 
Gross
 
 
 
OTTI
 
Amortized
 
Unrealized
 
Unrealized
 
Fair
 
Recognized
 
Cost
 
Gains [1]
 
Losses [1]
 
Value
 
in AOCI [2]
 
 
 
 
 
 
 
 
 
 
U.S. government and agency
$
66.1

 
$
3.3

 
$
(0.8
)
 
$
68.6

 
$

State and political subdivision
156.2

 
3.8

 
(5.4
)
 
154.6

 
(0.2
)
Foreign government
63.1

 
2.7

 
(0.3
)
 
65.5

 

Corporate
2,194.9

 
69.5

 
(57.1
)
 
2,207.3

 
(1.5
)
Commercial mortgage-backed (“CMBS”)
241.9

 
13.0

 
(1.2
)
 
253.7

 
(0.4
)
Residential mortgage-backed (“RMBS”)
513.7

 
7.9

 
(11.8
)
 
509.8

 
(8.6
)
CDO/CLO
70.6

 
1.7

 
(1.4
)
 
70.9

 
(3.0
)
Other asset-backed
96.1

 
3.7

 
(3.9
)
 
95.9

 

Available-for-sale debt securities
$
3,402.6

 
$
105.6

 
$
(81.9
)
 
$
3,426.3

 
$
(13.7
)
———————
[1]
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.
[2]
Represents the amount of non-credit OTTI losses recognized in AOCI excluding net unrealized gains or losses subsequent to the date of impairment. The table above 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.

Fair Value and Cost of Securities:
December 31, 2012
($ in millions)
 
 
Gross
 
Gross
 
 
 
OTTI
 
Amortized
 
Unrealized
 
Unrealized
 
Fair
 
Recognized
 
Cost
 
Gains [1]
 
Losses [1]
 
Value
 
in AOCI [2]
 
 
 
 
 
 
 
 
 
 
U.S. government and agency
$
35.8

 
$
4.8

 
$
(0.4
)
 
$
40.2

 
$

State and political subdivision
120.5

 
10.9

 
(0.5
)
 
130.9

 
(0.2
)
Foreign government
44.4

 
7.4

 

 
51.8

 

Corporate
1,776.9

 
144.6

 
(24.0
)
 
1,897.5

 
(1.5
)
CMBS
229.6

 
26.0

 
(1.6
)
 
254.0

 
(0.6
)
RMBS
412.6

 
17.5

 
(7.6
)
 
422.5

 
(9.0
)
CDO/CLO
59.2

 
1.8

 
(4.2
)
 
56.8

 
(3.3
)
Other asset-backed
119.1

 
6.0

 
(6.5
)
 
118.6

 

Available-for-sale debt securities
$
2,798.1

 
$
219.0

 
$
(44.8
)
 
$
2,972.3

 
$
(14.6
)
———————
[1]
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.
[2]
Represents the amount of non-credit OTTI losses recognized in AOCI excluding net unrealized gains or losses subsequent to the date of impairment. The table above 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.



F-19



6.
Investing Activities (continued)

Maturities of Debt Securities:
December 31, 2013
($ in millions)
Amortized
 
Fair
 
Cost
 
Value
 
 
 
 
Due in one year or less
$
36.1

 
$
36.8

Due after one year through five years
438.5

 
464.0

Due after five years through ten years
1,227.7

 
1,225.4

Due after ten years
778.0

 
769.8

CMBS/RMBS/ABS/CDO/CLO [1]
922.3

 
930.3

Total
$
3,402.6

 
$
3,426.3

———————
[1]
CMBS, RMBS, ABS, CDO and CLO are not listed separately in the table as each security does not have a single fixed maturity.

The maturities of debt securities, as of December 31, 2013, are summarized in the table above by contractual maturity. Actual maturities may differ from contractual maturities as certain borrowers have the right to call or prepay obligations with or without call or prepayment penalties, and we have the right to put or sell certain obligations back to the issuers.

The following table depicts the sources of available-for-sale investment proceeds and related investment gains (losses).

Sales of Available-for-Sale Securities:
As of December 31,
($ in millions)
2013
 
2012
 
2011
Debt securities, available-for-sale
 
 
 
 
 
Proceeds from sales
$
90.0

 
$
160.0

 
$
68.5

Proceeds from maturities/repayments
286.1

 
285.3

 
180.0

Gross investment gains from sales, prepayments and maturities
11.3

 
22.8

 
2.4

Gross investment losses from sales and maturities
(0.4
)
 
(0.7
)
 
(0.8
)

Aging of Temporarily Impaired
As of
Debt Securities:
December 31, 2013
($ in millions)
Less than 12 months
 
Greater than 12 months
 
Total
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Value
 
Losses
 
Value
 
Losses
 
Value
 
Losses
Debt Securities
 
 
 
 
 
 
 
 
 
 
 
U.S. government and agency
$
14.5

 
$
(0.8
)
 
$

 
$

 
$
14.5

 
$
(0.8
)
State and political subdivision
65.3

 
(4.4
)
 
4.0

 
(1.0
)
 
69.3

 
(5.4
)
Foreign government
17.0

 
(0.3
)
 

 

 
17.0

 
(0.3
)
Corporate
806.5

 
(38.3
)
 
120.5

 
(18.8
)
 
927.0

 
(57.1
)
CMBS
39.4

 
(1.1
)
 
3.0

 
(0.1
)
 
42.4

 
(1.2
)
RMBS
243.5

 
(8.5
)
 
40.3

 
(3.3
)
 
283.8

 
(11.8
)
CDO/CLO
30.5

 
(0.3
)
 
24.1

 
(1.1
)
 
54.6

 
(1.4
)
Other asset-backed
7.9

 
(0.1
)
 
8.0

 
(3.8
)
 
15.9

 
(3.9
)
Total temporarily impaired securities
$
1,224.6

 
$
(53.8
)
 
$
199.9

 
$
(28.1
)
 
$
1,424.5

 
$
(81.9
)
Below investment grade
$
33.7

 
$
(1.9
)
 
$
12.1

 
$
(1.7
)
 
$
45.8

 
$
(3.6
)
Number of securities
 
 
325

 
 
 
79

 
 
 
404



F-20



6.
Investing Activities (continued)

Unrealized losses on below-investment-grade debt securities with a fair value depressed by more than 20% of amortized cost totaled $1.0 million at December 31, 2013, of which $0.8 million was depressed by more than 20% of amortized cost for more than 12 months.

These securities were considered to be temporarily impaired at December 31, 2013 because each of these securities had performed, and are expected to perform, in accordance with original contractual terms. In addition, management does not have the intention to sell nor does it expect to be required to sell these securities prior to their recovery.

As of December 31, 2013, available-for-sale securities in an unrealized loss position for over 12 months consisted of 79 debt securities. The debt securities primarily consist of asset backed securities and corporate securities, which have depressed values due primarily to an increase in interest rates since the purchase of these securities. Unrealized losses were not recognized in earnings on these debt securities since the Company neither intends to sell the securities nor do we believe that it is more likely than not that it will be required to sell these securities before recovery of their amortized cost basis. Additionally, based on a security-by-security analysis, we expect to recover the entire amortized cost basis of these securities. Securities in a loss position with a duration of less than 12 months have generally experienced declines in value due to rising interest rates but the Company expects to recover the entire amortized cost basis of these securities. In our evaluation of each security, management considers the actual recovery periods for these securities in previous periods of broad market declines. For securities with significant declines, individual security level analysis is performed, which considers any credit enhancements, expectations of defaults on underlying collateral and other available market data, including industry analyst reports and forecasts.
Aging of Temporarily Impaired
As of
Debt Securities:
December 31, 2012
($ in millions)
Less than 12 months
 
Greater than 12 months
 
Total
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Value
 
Losses
 
Value
 
Losses
 
Value
 
Losses
Debt Securities
 
 
 
 
 
 
 
 
 
 
 
U.S. government and agency
$

 
$

 
$
3.5

 
$
(0.4
)
 
$
3.5

 
$
(0.4
)
State and political subdivision
4.8

 
(0.3
)
 
1.0

 
(0.2
)
 
5.8

 
(0.5
)
Foreign government

 

 

 

 

 

Corporate
114.5

 
(1.7
)
 
64.7

 
(22.3
)
 
179.2

 
(24.0
)
CMBS
0.7

 
(0.1
)
 
10.6

 
(1.5
)
 
11.3

 
(1.6
)
RMBS
24.1

 
(0.2
)
 
52.6

 
(7.4
)
 
76.7

 
(7.6
)
CDO/CLO

 

 
39.0

 
(4.2
)
 
39.0

 
(4.2
)
Other asset-backed
0.9

 

 
10.7

 
(6.5
)
 
11.6

 
(6.5
)
Total temporarily impaired securities
$
145.0

 
$
(2.3
)
 
$
182.1

 
$
(42.5
)
 
$
327.1

 
$
(44.8
)
Below investment grade
$
7.8

 
$
(0.5
)
 
$
63.4

 
$
(25.4
)
 
$
71.2

 
$
(25.9
)
Number of securities
 
 
48

 
 
 
89

 
 
 
137


Unrealized losses on below-investment-grade debt securities with a fair value depressed by more than 20% of amortized cost totaled $21.6 million at December 31, 2012, of which $21.6 million was depressed by more than 20% of amortized cost for more than 12 months.

These securities were considered to be temporarily impaired at December 31, 2012 because each of these securities had performed, and are expected to perform, in accordance with original contractual terms. In addition, management does not have the intention to sell nor does it expect to be required to sell these securities prior to their recovery.


F-21



6.
Investing Activities (continued)

As of December 31, 2012, available-for-sale securities in an unrealized loss position for over 12 months consisted of 89 debt securities. The debt securities primarily consist of asset backed securities and corporate securities, which have depressed values due primarily to an increase in interest rates since the purchase of these securities. Unrealized losses were not recognized in earnings on these debt securities since the Company neither intends to sell the securities nor do we believe that it is more likely than not that it will be required to sell these securities before recovery of their amortized cost basis. Additionally, based on a security-by-security analysis, we expect to recover the entire amortized cost basis of these securities. Securities in a loss position with a duration of less than 12 months have generally experienced declines in value due to rising interest rates but the Company expects to recover the entire amortized cost basis of these securities. In our evaluation of each security, management considers the actual recovery periods for these securities in previous periods of broad market declines. For securities with significant declines, individual security level analysis is performed, which considers any credit enhancements, expectations of defaults on underlying collateral and other available market data, including industry analyst reports and forecasts.

Evaluating temporarily impaired available-for-sale securities

In management’s evaluation of temporarily impaired securities, many factors about individual issuers of securities as well as our best judgment in determining the cause of a decline in the estimated fair value are considered in the assessment of potential near-term recovery in the security’s value. Some of those considerations include, but are not limited to: (i) duration of time and extent to which the estimated fair value has been below cost or amortized cost; (ii) for debt securities, if the Company has the intent to sell or will more likely than not be required to sell a particular security before the decline in estimated fair value below amortized cost recovers; (iii) whether the issuer is experiencing significant financial difficulties and the potential for impairments of that issuer’s securities; (iv) pervasive issues across an entire industry sector/sub-sector; and (v) for structured securities, assessing any changes in the forecasted cash flows, the quality of underlying collateral, expectations of prepayment speeds, loss severity and payment priority of tranches held.

Other-than-temporary impairments

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, 2013, 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 were primarily concentrated in structured securities. These impairments were driven primarily by increased collateral default rates. In our judgment, these credit events and 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 $2.0 million in 2013, $2.8 million in 2012 and $2.8 million in 2011. Total equity impairments recognized through earnings were $0.4 million in 2011. There were no equity impairments recognized in 2013 and 2012. There were no limited partnerships and other investment OTTIs in 2013, 2012 and 2011.

In addition to these credit-related impairments recognized through earnings, we impaired securities to fair value through other comprehensive loss for any impairments related to non-credit related factors. These types of impairments were driven primarily by market or sector credit spread widening or by a lack of liquidity in the securities. The amount of impairments recognized as an adjustment to other comprehensive loss due to these factors was $(0.9) million in 2013, $2.2 million in 2012 and $6.9 million in 2011.


F-22



6.
Investing Activities (continued)

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.

Credit Losses Recognized in Earnings on Available-for-Sale Debt Securities for
As of December 31,
which a Portion of the OTTI Loss was Recognized in OCI:
2013
 
2012
 
2011
($ in millions)
 
 
 
 
 
Balance, beginning of period
$
(17.8
)
 
$
(21.3
)
 
$
(19.9
)
  Add: Credit losses on securities not previously impaired [1]
(0.3
)
 
(1.4
)
 
(1.0
)
  Add: Credit losses on securities previously impaired [1]
(0.8
)
 
(1.2
)
 
(1.4
)
Less: Credit losses on securities impaired due to intent to sell

 

 

Less: Credit losses on securities sold
0.3

 
6.1

 
1.0

Less: Increases in cash flows expected on previously impaired securities

 

 

Balance, end of period
$
(18.6
)
 
$
(17.8
)
 
$
(21.3
)
———————
[1]
Additional credit losses on securities for which a portion of the OTTI loss was recognized in AOCI are included within net OTTI losses recognized in earnings on the statements of income and comprehensive income.

Limited partnerships and other investments

Limited partnerships and other investments consist of private equity investments of $7.9 million and direct equity investments of $2.6 million as of December 31, 2013, and private equity investments of $6.7 million as of December 31, 2012.

Statutory deposits

Pursuant to certain statutory requirements, as of December 31, 2013 and 2012, we had on deposit securities with a fair value of $1.9 million and $2.4 million, respectively, in insurance department special deposit accounts. We are not permitted to remove the securities from these accounts without approval of the regulatory authority.

Net investment income

Net investment income is comprised primarily of interest income, including amortization of premiums and accretion of discounts on structured securities, based on yields which are changed due to expectations in projected principal and interest cash flows, gains and losses on securities measured at fair value and earnings from investments accounted for under the equity method of accounting.

Sources of Net Investment Income:
Years Ended December 31,
($ in millions)
2013
 
2012
 
2011
 
 
 
 
 
 
Debt securities [1]
$
135.0

 
$
122.5

 
$
94.8

Policy loans
2.9

 
3.1

 
3.1

Limited partnerships and other investments
1.8

 
2.2

 
1.8

Fair value investments
2.6

 
4.0

 
2.8

Total investment income
142.3

 
131.8

 
102.5

Less: Investment expenses
1.5

 
0.9

 
1.4

Net investment income
$
140.8

 
$
130.9

 
$
101.1

———————
[1]
Includes net investment income on short-term investments.


F-23



6.
Investing Activities (continued)

Net realized investment gains (losses)

Sources and Types of Net Realized Investment Gains (Losses):
Years Ended December 31,
($ in millions)
2013
 
2012
 
2011
 
 
 
 
 
 
Total other-than-temporary debt impairments
$
(1.1
)
 
$
(5.0
)
 
$
(9.7
)
Portion of loss recognized in OCI
(0.9
)
 
2.2

 
6.9

Net debt impairments recognized in earnings
$
(2.0
)
 
$
(2.8
)
 
$
(2.8
)
Debt security impairments:
 

 
 

 
 

U.S. government and agency
$

 
$

 
$

State and political subdivision

 
(0.1
)
 

Foreign government

 

 

Corporate

 

 
(0.4
)
CMBS
(0.3
)
 
(0.1
)
 
(0.4
)
RMBS
(1.5
)
 
(1.9
)
 
(1.5
)
CDO/CLO
(0.2
)
 
(0.4
)
 
(0.4
)
Other asset-backed

 
(0.3
)
 
(0.1
)
Net debt security impairments
(2.0
)
 
(2.8
)
 
(2.8
)
Equity security impairments

 

 
(0.4
)
Impairment losses
(2.0
)
 
(2.8
)
 
(3.2
)
Debt security transaction gains
11.3

 
22.8

 
2.5

Debt security transaction losses
(0.4
)
 
(0.7
)
 
(0.7
)
Limited partnerships and other investment gains

 

 
0.1

Limited partnerships and other investment losses

 
(0.3
)
 
(0.1
)
Net transaction gains (losses)
10.9

 
21.8

 
1.8

Derivative instruments
(23.1
)
 
(49.0
)
 
6.2

Embedded derivatives [1]
17.6

 
11.2

 
(33.2
)
Related party reinsurance derivatives

 
(3.5
)
 
9.0

Assets valued at fair value

 

 

Net realized investment gains (losses), excluding impairment losses
5.4

 
(19.5
)
 
(16.2
)
Net realized investment gains (losses), including impairment losses
$
3.4

 
$
(22.3
)
 
$
(19.4
)
———————
[1]
Includes the change in fair value of embedded derivatives associated with fixed index annuity indexed crediting feature and variable annuity GMWB, GMAB and COMBO riders. See Note 7 to these financial statements for additional disclosures.


F-24



6.
Investing Activities (continued)

Unrealized investment gains (losses)

Sources of Changes in Net Unrealized Investment Gains (Losses):
Years Ended December 31,
($ in millions)
2013
 
2012
 
2011
 
 
 
 
 
 
Debt securities
$
(150.5
)
 
$
123.0

 
$
77.2

Equity securities

 

 
0.1

Other investments
0.1

 
(0.2
)
 
(0.1
)
Net unrealized investment gains (losses)
$
(150.4
)
 
$
122.8

 
$
77.2

 
 
 
 
 
 
Net unrealized investment gains (losses)
$
(150.4
)
 
$
122.8

 
$
77.2

Applicable to deferred policy acquisition cost
(57.8
)
 
29.2

 
37.4

Applicable to other actuarial offsets
(57.5
)
 
59.9

 
20.1

Applicable to deferred income tax expense (benefit)
(11.8
)
 
24.9

 
4.2

Offsets to net unrealized investment gains (losses)
(127.1
)
 
114.0

 
61.7

Net unrealized investment gains (losses) included in OCI
$
(23.3
)
 
$
8.8

 
$
15.5


Non-consolidated variable interest entities

We hold limited partnership interests with various VIEs primarily as a passive investor in private equity limited partnerships and through direct investments, in which the general partners are not related parties. As the Company is not the general partner in any VIE structures, consolidation is based on evaluation of the primary beneficiary. This analysis includes a review of the VIE’s capital structure, nature of the VIE’s operations and purpose and the Company’s involvement with the entity. When determining the need to consolidate a VIE, the design of the VIE is evaluated as well as any exposed risks of the Company’s investment. As we do not have both: (i) the power to direct the activities of the VIE that most significantly impact the economic performance of the entity; and (ii) the obligation to absorb losses of the entity that could be potentially significant to the VIE or the right to receive benefits from the entity that could be potentially significant, we do not consolidate these VIEs. These investments are accounted for under the equity method of accounting and are included in limited partnerships and other investments on our balance sheets. We reassess our VIE determination with respect to an entity on an ongoing basis.

The carrying value of our investments in non-consolidated VIEs (based upon sponsor values and financial statements of the individual entities) for which we are not the primary beneficiary was $15.6 million and $2.1 million as of December 31, 2013 and 2012, respectively. The maximum exposure to loss is equal to the carrying amounts plus any unfunded commitments of the Company. Such a maximum loss would be expected to occur only upon bankruptcy of the issuer or investee. The Company has not provided nor intends to provide financial support to these entities unless contractually required. We do not have the contractual option to redeem these limited partnership interests but receive distributions based on the liquidation of the underlying assets. The Company must generally request general partner consent to transfer or sell its fund interests. The Company performs ongoing qualitative analysis of its involvement with VIEs to determine if consolidation is required.

In addition, the Company makes passive investments in structured securities issued by VIEs, for which the Company is not the manager, which are included in CMBS, RMBS, CDO/CLO and other asset-backed securities within available-for-sale debt securities, and in fair value investments, in the balance sheets. The Company has not provided financial or other support with respect to these investments other than its original investment. For these investments, the Company determined it is not the primary beneficiary due to the size of our investment relative to the structured securities issued by the VIE, the level of credit subordination which reduces the Company’s obligation to absorb losses or right to receive benefits, and the Company’s lack of power over the activities that most significantly impact the economic performance of the VIEs. The Company’s maximum exposure to loss on these investments is limited to the amount of our investment.


F-25



6.
Investing Activities (continued)

Issuer and counterparty credit exposure

Credit exposure related to issuers and derivatives counterparties is inherent in investments and derivative contracts with positive fair value or asset balances. We manage credit risk through the analysis of the underlying obligors, issuers and transaction structures. We review our debt security portfolio regularly to monitor the performance of obligors and assess the stability of their credit ratings. We also manage credit risk through industry and issuer diversification and asset allocation. Included in fixed maturities are below-investment-grade assets totaling $137.7 million and $182.5 million at December 31, 2013 and 2012, respectively. Maximum exposure to an issuer or derivative counterparty is defined by quality ratings, with higher quality issuers having larger exposure limits. As of December 31, 2013, we were not exposed to the credit concentration risk of any issuer representing greater than 10.0% of stockholder’s equity other than U.S. government and government agencies backed by the faith and credit of the U.S. government. We monitor credit exposures by actively monitoring dollar limits on transactions with specific counterparties. We have an overall limit on below-investment-grade rated issuer exposure. Additionally, the creditworthiness of counterparties is reviewed periodically. We generally use ISDA Master Agreements which include Credit Support Annexes which include collateral provisions to reduce counterparty credit exposures. To further mitigate the risk of loss on derivatives, we only enter into contracts in which the counterparty is a financial institution with a rating of A or higher from at least one Nationally Recognized Statistical Rating Organization.

As of December 31, 2013, we held derivative assets, net of liabilities, with a fair value of $127.0 million. Derivative credit exposure was diversified with eleven different counterparties. We also had debt securities of these counterparties with a fair value of $43.6 million as of December 31, 2013. Our maximum amount of loss due to credit risk with these issuers was $170.6 million as of December 31, 2013. See Note 8 to these financial statements for additional information regarding derivatives.


7.
Separate Accounts, Death Benefits and Other Insurance Benefit Features and Embedded Product Derivatives

Separate accounts

Separate account products are those for which a separate investment and liability account is maintained on behalf of the policyholder. Investment objectives for these separate accounts vary by fund account type, as outlined in the applicable fund prospectus or separate account plan of operations. We have variable annuity and variable life insurance contracts that are classified as separate account products. The assets supporting these contracts are carried at fair value and are reported as separate account assets with an equivalent amount reported as separate account liabilities. Amounts assessed against the policyholder for mortality, administration and other services are included within revenue in fee income. In 2013 and 2012, there were no gains or losses on transfers of assets from the general account to a separate account.

Assets with fair value and carrying value of $2.0 billion and $1.8 billion at December 31, 2013 and 2012, respectively, supporting fixed indexed annuities are maintained in accounts that are legally segregated from the other assets of the Company, but policyholders do not direct the investment of those assets and the investment performance does not pass through to the policyholders. These assets supporting fixed indexed annuity contracts are reported within the respective investment line items on the balance sheets.

On May 21, 2012, the employee pension plan surrendered its variable annuity contract with PHL Variable. All assets held within the employee pension plan separate account were subsequently transferred to the direct control of the plan’s trustee. This resulted in a decrease in separate account assets and liabilities of $464.2 million during the year ended December 31, 2012.

Separate Account Investments of Account Balances of Variable Annuity Contracts with Insurance Guarantees:
December 31,
($ in millions)
2013
 
2012
 
 
 
 
Debt securities
$
322.1

 
$
369.3

Equity funds
1,538.7

 
1,516.3

Other
47.4

 
49.7

Total
$
1,908.2

 
$
1,935.3



F-26



7.
Separate Accounts, Death Benefits and Other Insurance Benefit Features and Embedded Product Derivatives (continued)

Death benefits and other insurance benefit features

Variable annuity guaranteed benefits

We establish policy benefit liabilities for minimum death and income benefit guarantees relating to certain annuity policies as follows:

Liabilities associated with the guaranteed minimum death benefit (“GMDB”) are determined by estimating the expected value of death benefits in excess of the projected account balance and recognizing the excess ratably over the expected life of the contract based on total expected assessments. The assumptions used for calculating the liabilities are generally consistent with those used for amortizing deferred policy acquisition costs.

Liabilities associated with the guaranteed minimum income benefit (“GMIB”) are determined by estimating the expected value of the income benefits in excess of the projected account balance at the date of annuitization and recognizing the excess ratably over the accumulation period based on total expected assessments. The assumptions used for calculating such guaranteed income benefit liabilities are generally consistent with those used for amortizing deferred policy acquisition costs.

For variable annuities with GMDB and GMIB, reserves for these guarantees are calculated and recorded in policy liabilities and accruals on our balance sheets. Changes in the liability are recorded in policy benefits on our statements of income and comprehensive income. We regularly evaluate estimates used and adjust the additional liability balances, with a related charge or credit to benefit expense if actual experience or other evidence suggests that earlier assumptions should be revised.

Changes in Guaranteed Insurance Benefit Liability Balances:
Year Ended
($ in millions)
December 31, 2013
 
Annuity
 
Annuity
 
GMDB
 
GMIB
 
 
 
 
Liability balance as of January 1, 2013
$
10.8

 
$
20.9

Incurred
2.0

 
(3.4
)
Paid
(2.7
)
 

Change due to net unrealized gains or losses included in AOCI

 
(0.1
)
Assumption unlocking
6.9

 
(7.9
)
Liability balance as of December 31, 2013
$
17.0

 
$
9.5


Changes in Guaranteed Insurance Benefit Liability Balances:
Year Ended
($ in millions)
December 31, 2012
 
Annuity
 
Annuity
 
GMDB
 
GMIB
 
 
 
 
Liability balance as of January 1, 2012
$
10.8

 
$
17.0

Incurred
1.0

 
3.8

Paid
(1.0
)
 

Change due to net unrealized gains or losses included in AOCI

 
0.3

Assumption unlocking

 
(0.2
)
Liability balance as of December 31, 2012
$
10.8

 
$
20.9



F-27



7.
Separate Accounts, Death Benefits and Other Insurance Benefit Features and Embedded Product Derivatives (continued)

Changes in Guaranteed Insurance Benefit Liability Balances:
Year Ended
($ in millions)
December 31, 2011
 
Annuity
 
Annuity
 
GMDB
 
GMIB
 
 
 
 
Liability balance as of January 1, 2011
$
11.2

 
$
17.3

Incurred
1.5

 
(0.7
)
Paid
(1.9
)
 

Change due to net unrealized gains or losses included in AOCI

 

Assumption unlocking

 
0.4

Liability balance as of December 31, 2011
$
10.8

 
$
17.0


For those guarantees of benefits that are payable in the event of death, the net amount at risk (“NAR”) is generally defined as the benefit payable in excess of the current account balance at our balance sheet date. We have entered into reinsurance agreements to reduce the net amount of risk on certain death benefits. Following are the major types of death benefits currently in force:

GMDB and GMIB Benefits by Type:
 
 
NAR
 
Average
($ in millions)
Account
 
after
 
Attained Age
 
Value
 
Reinsurance
 
of Annuitant
2013
 
 
 
 
 
GMDB return of premium
$
728.8

 
$
1.8

 
63
GMDB step up
1,401.0

 
7.0

 
63
GMDB earnings enhancement benefit (“EEB”)
35.9

 
0.1

 
64
GMDB greater of annual step up and roll up
26.7

 
4.8

 
68
Total GMDB at December 31, 2013
2,192.4

 
$
13.7

 
 
Less: General account value with GMDB
294.7

 
 
 
 
Subtotal separate account liabilities with GMDB
1,897.7

 
 
 
 
Separate account liabilities without GMDB
155.0

 
 
 
 
Total separate account liabilities
$
2,052.7

 
 
 
 
GMIB [1] at December 31, 2013
$
385.7

 
 
 
64
2012
 
 
 
 
 
GMDB return of premium
$
755.9

 
$
5.7

 
62
GMDB step up
1,412.4

 
21.7

 
62
GMDB earnings enhancement benefit (“EEB”)
37.4

 
0.1

 
63
GMDB greater of annual step up and roll up
26.7

 
7.4

 
67
Total GMDB at December 31, 2012
2,232.4

 
$
34.9

 
 
Less: General account value with GMDB
311.3

 
 
 
 
Subtotal separate account liabilities with GMDB
1,921.1

 
 
 
 
Separate account liabilities without GMDB
140.7

 
 
 
 
Total separate account liabilities
$
2,061.8

 
 
 
 
GMIB [1] at December 31, 2012
$
403.3

 
 
 
64
———————
[1]
Policies with a GMIB also have a GMDB, however these benefits are not additive. When a policy terminates due to death, any NAR related to GMIB is released. Similarly, when a policy goes into benefit status on a GMIB, its GMDB NAR is released.


F-28



7.
Separate Accounts, Death Benefits and Other Insurance Benefit Features and Embedded Product Derivatives (continued)

Return of Premium: The death benefit is the greater of current account value or premiums paid (less any adjusted partial withdrawals).

Step Up: The death benefit is the greater of current account value, premiums paid (less any adjusted partial withdrawals) or the annual step up amount prior to the oldest original owner attaining a certain age. On and after the oldest original owner attains that age, the death benefit is the greater of current account value or the death benefit at the end of the contract year prior to the oldest original owner’s attaining that age plus premium payments (less any adjusted partial withdrawals) made since that date.

Earnings Enhancement Benefit: The death benefit is the greater of the premiums paid (less any adjusted partial withdrawals) or the current account value plus the EEB. The EEB is an additional amount designed to reduce the impact of taxes associated with distributing contract gains upon death.

Greater of Annual Step Up and Annual Roll Up: The death benefit is the greatest of premium payments (less any adjusted partial withdrawals), the annual step up amount, the annual roll up amount or the current account value prior to the oldest original owner attaining age 81. On and after the oldest original owner attained age 81, the death benefit is the greater of current account value or the death benefit at the end of the contract year prior to the oldest original owner’s attained age of 81 plus premium payments (less any adjusted partial withdrawals) made since that date.

GMIB: The benefit is a series of monthly fixed annuity payments paid upon election of the rider. The monthly benefit is based on the greater of the sum of premiums (less any adjusted partial withdrawals) accumulated at an effective annual rate on the exercise date or 200% of the premiums paid (less any adjusted partial withdrawals) and a set of annuity payment rates that vary by benefit type and election age.

Fixed indexed annuity guaranteed benefits

Many of our fixed indexed annuities contain guaranteed benefits. We establish policy benefit liabilities for minimum death and minimum withdrawal benefit guarantees relating to these policies as follows:

Liabilities associated with the GMWB and Chronic Care guarantees are determined by estimating the value of the withdrawal benefits expected to be paid after the projected account value depletes and recognizing the value ratably over the accumulation period based on total expected assessments. Liabilities associated with the GMWB for the fixed indexed annuities differ from those contained on variable annuities in that the GMWB feature and the underlying contract, exclusive of the equity index crediting option, are fixed income instruments.
Liabilities associated with the GMDB are determined by estimating the expected value of death benefits in excess of the projected account balance and recognizing the excess ratably over the expected life of the contract based on total expected assessments.

The assumptions used for calculating GMWB, GMDB and Chronic Care guarantees are consistent with those used for amortizing deferred policy acquisition costs. We regularly evaluate estimates used and adjust the additional liability balances, with a related charge or credit to benefit expense if actual experience or other evidence suggests that earlier assumptions should be revised. The GMWB, GMDB and Chronic Care guarantees on fixed indexed annuities are recorded in policy liabilities and accruals on our balance sheets.


F-29



7.
Separate Accounts, Death Benefits and Other Insurance Benefit Features and Embedded Product Derivatives (continued)

Changes in Guaranteed Liability Balances:
Fixed Indexed Annuity
($ in millions)
GMWB and GMDB
 
Year Ended December 31,
 
2013
 
2012
 
2011
 
 
 
 
 
 
Liability balance, beginning of period
$
103.6

 
$
5.6

 
$
0.5

Incurred
62.5

 
40.1

 
5.1

Paid
(0.3
)
 

 

Change due to net unrealized gains or losses included in AOCI
(57.1
)
 
57.9

 

Assumption unlocking
(18.7
)
 

 

Liability balance, end of period
$
90.0

 
$
103.6

 
$
5.6


Universal life

Liabilities for universal life contracts in excess of the account balance, some of which contain secondary guarantees, are generally determined by estimating the expected value of benefits and expenses when claims are triggered and recognizing those benefits and expenses over the accumulation period based on total expected assessments. The assumptions used in estimating these liabilities are consistent with those used for amortizing deferred policy acquisition costs.

Changes in Guaranteed Liability Balances:
Universal Life
($ in millions)
Secondary Guarantees
 
Year Ended December 31,
 
2013
 
2012
 
2011
 
 
 
 
 
 
Liability balance, beginning of period
$
115.8

 
$
100.6

 
$
89.9

Incurred
43.3

 
22.6

 
16.0

Paid
(14.3
)
 
(9.5
)
 
(6.3
)
Change due to net unrealized gains or losses included in AOCI
(2.2
)
 
2.1

 
1.0

Assumption unlocking
10.6

 

 

Liability balance, end of period
$
153.2

 
$
115.8

 
$
100.6


In addition, the universal life block of business has experience which produces profits in earlier periods followed by losses in later periods for which additional reserves are required to be held above the account value liability. These reserves are accrued ratably over historical and anticipated positive income to offset the future anticipated losses. The assumptions used in estimating these liabilities are consistent with those used for amortizing deferred policy acquisition costs. The most significant driver of the positive 2013 unlock results in these reserves was the incorporation of a mortality improvement assumption in the overall mortality table, which resulted in improved expected mortality on these products.

Changes in Additional Liability Balances:
Universal Life
($ in millions)
Profits Followed by Losses
 
Year Ended December 31,
 
2013
 
2012
 
2011
 
 
 
 
 
 
Liability balance, beginning of period
$
300.4

 
$
203.0

 
$
109.7

Expenses
48.6

 
37.1

 
138.8

Change due to net unrealized gains or losses included in AOCI
(0.6
)
 
16.9

 
0.4

Assumption unlocking
(75.0
)
 
43.4

 
(45.9
)
Liability balance, end of period
$
273.4

 
$
300.4

 
$
203.0



F-30



7.
Separate Accounts, Death Benefits and Other Insurance Benefit Features and Embedded Product Derivatives (continued)

Embedded derivatives

Variable annuity embedded derivatives

Certain separate account variable products may contain a GMWB, GMAB and/or COMBO rider. These features are accounted for as embedded derivatives as described below.

Non-Insurance Guaranteed Product Features:
 
 
Average
($ in millions)
Account
 
Attained Age
 
Value
 
of Annuitant
2013
 
 
 
GMWB
$
551.1

 
64
GMAB
370.9

 
59
COMBO
7.0

 
63
Total at December 31, 2013
$
929.0

 
 
2012
 
 
 
GMWB
$
547.4

 
63
GMAB
379.5

 
58
COMBO
8.3

 
61
Total at December 31, 2012
$
935.2

 
 

The GMWB rider guarantees the contract owner a minimum amount of withdrawals and benefit payments over time, regardless of the investment performance of the contract, subject to an annual limit. Optional resets are available. In addition, these contracts have a feature that allows the contract owner to receive the guaranteed annual withdrawal amount for as long as they are alive.

The GMAB rider provides the contract owner with a minimum accumulation of the contract owner’s purchase payments deposited within a specific time period, adjusted for withdrawals, after a specified amount of time determined at the time of issuance of the variable annuity contract.

The COMBO rider includes either the GMAB or GMWB rider as well as the GMDB rider at the contract owner’s option.

On July 1, 2012 the Company recaptured the business associated with a reinsurance contract with Phoenix Life, whereby we ceded to Phoenix Life certain of the liabilities related to guarantees on our annuity products. This contract qualified as a freestanding derivative and the derivative asset previously reported within receivable from related parties was reversed at the time of recapture. The derivative asset was $3.5 million at December 31, 2011.

The GMWB, GMAB and COMBO features represent embedded derivative liabilities in the variable annuity contracts that are required to be reported separately from the host variable annuity contract. These liabilities are recorded at fair value within policyholder deposit funds on the balance sheets with changes in fair value recorded in realized investment gains on the statements of income and comprehensive income. The fair value of the GMWB, GMAB and COMBO obligation is calculated based on actuarial and capital market assumptions related to the projected cash flows, including benefits and related contract charges, over the lives of the contracts, incorporating expectations concerning policyholder behavior. As markets change, contracts mature and actual policyholder behavior emerges, these assumptions are continually evaluated and may from time to time be adjusted. Embedded derivative liabilities for GMWB, GMAB and COMBO are shown in the table below.


F-31



7.
Separate Accounts, Death Benefits and Other Insurance Benefit Features and Embedded Product Derivatives (continued)

Variable Annuity Embedded Derivative Liabilities:
As of December 31,
($ in millions)
2013
 
2012
 
 
 
 
GMWB
$
(5.1
)
 
$
14.3

GMAB
1.4

 
14.3

COMBO
(0.4
)
 
(0.3
)
Total variable annuity embedded derivative liabilities
$
(4.1
)
 
$
28.3


There were no benefit payments made for the GMWB and GMAB during 2013 and 2012. We have established a risk management strategy under which we hedge our GMAB, GMWB and COMBO exposure using equity index options, equity index futures, equity index variance swaps, interest rate swaps and swaptions.

Fixed indexed annuity embedded derivatives

Fixed indexed annuities may also contain a variety of index-crediting options: policy credits that are calculated based on the performance of an outside equity market or other index over a specified term. These index options are embedded derivative liabilities that are required to be reported separately from the host contract. These index options are accounted for at fair value and recorded in policyholder deposits within the balance sheets with changes in fair value recorded in realized investment gains, in the statements of income and comprehensive income. The fair value of these index options is calculated using the budget method. See Note 9 to these financial statements for additional information. Several additional inputs reflect our internally developed assumptions related to lapse rates and other policyholder behavior. The fair value of these embedded derivatives was $78.9 million and $51.2 million as of December 31, 2013 and 2012, respectively. In order to manage the risk associated with these equity indexed-crediting features, we hedge using equity index options. See Note 8 to these financial statements for additional information.

Embedded derivatives realized gains and losses

Changes in the fair value of embedded derivatives associated with variable annuity and fixed indexed annuity contracts are recorded as realized investment gains and losses within the statements of income and comprehensive income. Embedded derivatives gains and (losses) recognized in earnings are $17.6 million and $11.2 million for the years ended December 31, 2013 and 2012, respectively.


8.
Derivative Instruments

We use derivative financial instruments, including options, futures and swaps as a means of hedging exposure to interest rate, equity price change, equity volatility and foreign currency risk. This includes our surplus hedge which utilizes futures and options to hedge against declines in equity markets and the resulting statutory capital and surplus impact. We also use derivative instruments to economically hedge our exposure on living benefits offered on certain of our variable annuity products as well as index credits on our fixed indexed annuity products.

The Company seeks to enter into over-the-counter (“OTC”) derivative transactions pursuant to master agreements that provide for a netting of payments and receipts by counterparty. As of December 31, 2013 and 2012, $7.8 million and $8.5 million, respectively, of cash and cash equivalents were held as collateral by a third party related to our derivative transactions.

Our derivatives are not designated as hedges for accounting purposes.


F-32



8.
Derivative Instruments (continued)

Derivative Instruments:
 
 
 
 
Fair Value as of
($ in millions)
 
 
 
 
December 31, 2013
 
 
 
Notional
 
 
 
 
 
Maturity
 
Amount
 
Assets
 
Liabilities [1]
 
 
 
 
 
 
 
 
Interest rate swaps
2016 - 2027
 
$
139.0

 
$
3.9

 
$
6.8

Variance swaps
2015 - 2017
 
0.9

 

 
7.9

Swaptions
2014 - 2015
 
3,902.0

 
30.7

 

Put options
2015 - 2022
 
391.0

 
29.5

 

Call options
2014 - 2018
 
1,701.6

 
161.2

 
96.1

Equity futures
2014
 
159.7

 
12.5

 

Total derivative instruments
 
 
$
6,294.2

 
$
237.8

 
$
110.8

———————
[1]
Derivative liabilities are included in other liabilities on the balance sheets.

Derivative Instruments:
 
 
 
 
Fair Value as of
($ in millions)
 
 
Notional
 
December 31, 2012
 
Maturity
 
Amount
 
Assets
 
Liabilities [1]
 
 
 
 
 
 
 
 
Interest rate swaps
2016-2027
 
$
180.0

 
$
15.5

 
$
7.7

Variance swaps
2015-2017
 
0.9

 

 
4.4

Swaptions
2024
 
25.0

 

 

Put options
2015-2022
 
391.0

 
69.5

 

Call options
2013-2017
 
1,328.4

 
50.6

 
33.6

Equity futures
2013
 
182.9

 
13.8

 

Total derivative instruments
 
 
$
2,108.2

 
$
149.4

 
$
45.7

———————
[1]
Derivative liabilities are included in other liabilities on the balance sheets.

Derivative Instrument Gains (Losses) Recognized in Realized Investment Gains (Losses):
Years Ended
($ in millions)
December 31,
 
2013
 
2012
 
2011
Derivative instruments by type
 
 
 
 
 
Interest rate swaps
$
(11.4
)
 
$
(1.7
)
 
$
6.9

Variance swaps
(3.6
)
 
(7.9
)
 
3.5

Swaptions
17.3

 
(0.2
)
 
(0.8
)
Put options
(40.7
)
 
(20.9
)
 
10.6

Call options
60.1

 
0.9

 
(8.9
)
Equity futures
(44.8
)
 
(19.2
)
 
(5.1
)
Embedded derivatives
17.6

 
11.2

 
(33.2
)
Related party reinsurance derivatives

 
(3.5
)
 
9.0

Total derivative instrument gains (losses) recognized in realized investment gains (losses)
$
(5.5
)
 
$
(41.3
)
 
$
(18.0
)

Interest Rate Swaps

We maintain an overall interest rate risk management strategy that primarily incorporates the use of interest rate swaps as hedges of our exposure to changes in interest rates. Our exposure to changes in interest rates primarily results from our commitments to fund interest-sensitive insurance liabilities, as well as from our significant holdings of fixed rate financial instruments. We use interest rate swaps that effectively convert variable rate cash flows to fixed cash flows in order to hedge the interest rate risks associated with guaranteed minimum living benefit (GMAB/GMWB) rider liabilities.


F-33



8.
Derivative Instruments (continued)

Interest Rate Options

We use interest rate options, such as swaptions, to hedge against market risks to assets or liabilities from substantial changes in interest rates. An interest rate swaption gives us the right but not the obligation to enter into an underlying swap. Swaptions are options on interest rate swaps. All of our swaption contracts are receiver swaptions, which give us the right to enter into a swap where we will receive the agreed-upon fixed rate and pay the floating rate. If the market conditions are favorable and the swap is needed to continue hedging our in force liability business, we will exercise the swaption and enter into a fixed rate swap. If a swaption contract is not exercised by its option maturity date, it expires with no value.

Exchange Traded Future Contracts

We use equity index futures to hedge the market risks from changes in the value of equity indices, such as S&P 500, associated with guaranteed minimum living benefit (GMAB/GMWB) rider liabilities. Positions are short-dated, exchange-traded futures with maturities of three months.

Equity Index Options

We use equity indexed options to hedge against market risks from changes in equity markets, volatility and interest rates.

An equity index option affords us the right to make or receive payments based on a specified future level of an equity market index. We may use exchange-trade or OTC options.

Generally, we have used a combination of equity index futures, interest rate swaps, variance swaps and long-dated put options to hedge our GMAB and GMWB liabilities and equity index call options to hedge our indexed annuity option liabilities.

Offsetting of Derivative Assets/Liabilities

The Company may enter into netting agreements with counterparties that permit the Company to offset receivables and payables with such counterparties. The following tables present the gross fair value amounts, the amounts offset and net position of derivative instruments eligible for offset in the Company’s balance sheets that are subject to an enforceable master netting arrangement upon certain termination events, irrespective of whether they are offset in the balance sheet.

 
December 31, 2013
Offsetting of
 
 
Gross
 
 
 
Gross amounts not offset
 
 
Derivative Assets/Liabilities:
Gross
 
amounts
 
Net amounts
 
in the balance sheet
 
 
($ in millions)
amounts
 
offset in the
 
presented in the
 
Financial
 
Cash collateral
 
 
 
recognized [1]
 
balance sheet
 
balance sheet
 
instruments
 
pledged [2]
 
Net amount
 
 
 
 
 
 
 
 
 
 
 
 
Total derivative assets
$
237.8

 
$

 
$
237.8

 
$
(110.2
)
 
$

 
$
127.6

Total derivative liabilities
$
(110.8
)
 
$

 
$
(110.8
)
 
$
110.2

 
$
0.6

 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2012
Offsetting of
 
 
Gross
 
 
 
Gross amounts not offset
 
 
Derivative Assets/Liabilities:
Gross
 
amounts
 
Net amounts
 
in the balance sheet
 
 
($ in millions)
amounts
 
offset in the
 
presented in the
 
Financial
 
Cash collateral
 
 
 
recognized [1]
 
balance sheet
 
balance sheet
 
instruments
 
pledged [2]
 
Net amount
 
 
 
 
 
 
 
 
 
 
 
 
Total derivative assets
$
149.4

 
$

 
$
149.4

 
$
(45.7
)
 
$

 
$
103.7

Total derivative liabilities
$
(45.7
)
 
$

 
$
(45.7
)
 
$
45.7

 
$

 
$

———————
[1]
Amounts include all derivative instruments, irrespective of whether there is a legally enforceable master netting arrangement in place.
[2]
Cash collateral pledged with derivative counterparties is recorded within other assets on the balance sheets. The Company pledges cash collateral to offset certain individual derivative liability positions with certain counterparties. Cash collateral of $7.2 million and $8.5 million as of December 31, 2013 and 2012, respectively, that exceeds the net liability resulting from the aggregate derivative positions with a corresponding counterparty is excluded.


F-34



8.
Derivative Instruments (continued)

Contingent features

Derivative counterparty agreements may contain certain provisions that require our insurance companies’ financial strength rating to be above a certain threshold. If our financial strength ratings were to fall below a specified rating threshold, certain derivative counterparties could request immediate payment or demand immediate and ongoing full collateralization on derivative instruments in net liability positions, or trigger a termination of existing derivatives and/or future derivative transactions.

In certain derivative counterparty agreements, our financial strength ratings are below the specified threshold levels. However, the Company held no derivative instruments as of December 31, 2013 in a net aggregate liability position payable to any counterparty (i.e., such derivative instruments have fair values in a net asset position payable to the Company if such holdings were liquidated).


9.
Fair Value of Financial Instruments

ASC 820-10 defines and establishes the framework for measuring fair value. The framework is based on inputs that are used in the valuation and a fair value hierarchy based on the quality of those inputs. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The input levels, are defined as follows:

Level 1 – inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets. Level 1 securities include highly liquid government bonds and exchange-traded equities.
Level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. Examples of such instruments include government-backed mortgage products, certain collateralized mortgage and debt obligations and certain high-yield debt securities.
Level 3 – inputs to the valuation methodology are unobservable and significant to the fair value measurement. Unobservable inputs reflect management’s own assumptions about inputs in which market participants would use in pricing these types of assets or liabilities. Level 3 financial instruments include values which are determined using pricing models and third-party evaluation. Additionally, the determination of some fair value estimates utilizes significant management judgments or best estimates.

Investments for which fair value is based upon unadjusted quoted market prices are reported as Level 1. The number of quotes the issuer obtains per instrument will vary depending on the security type and availability of pricing data from pricing vendors. The Company has defined a pricing hierarchy among independent, nationally recognized pricing vendors ("pricing vendors") to determine ultimate value used and also reviews significant discrepancies among pricing vendors to determine final value used. Prices from pricing services are not adjusted, but the Company may obtain a broker quote or use an internal model to price a security if it believes vendor prices do not reflect fair value. We receive quoted market prices from pricing vendors. When quoted prices are not available, we use these pricing vendors to give an estimated fair value. If quoted prices, or an estimated price from our pricing vendors are not available or we determine that the price is based on disorderly transactions or in inactive markets, fair value is based upon internally developed models or obtained from an independent third-party broker. We primarily use 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.


F-35



9.
Fair Value of Financial Instruments (continued)

Management is responsible for the fair value of investments and the methodologies and assumptions used to estimate fair value. The fair value process is evaluated quarterly by the Pricing Committee, which is comprised of the Chief Investment Officer, Chief Accounting Officer and the Head of Investment Accounting. The purpose of the Committee is to ensure the Company follows objective and reliable valuation practices, as well as approving changes to valuation methodologies and pricing sources. Using professional judgment and experience, we evaluate and weigh the relevance and significance of all readily available market information to determine the best estimate of fair value.

The fair values of Level 2 investments are determined by management after considering prices from our pricing vendors. Fair values for debt securities are primarily based on yield curve analysis along with ratings and spread data. Other inputs may be considered for fair value calculations including published indexed data, sector specific performance, comparable price sources and similar traded securities. Management reviews all Level 2 and Level 3 market prices on a quarterly basis.

The following is a description of our valuation methodologies for assets and liabilities measured at fair value. Such valuation methodologies were applied to all of the assets and liabilities carried at fair value in each respective classification.

Debt securities

We use pricing vendors to estimate fair value for the majority of our public debt securities. The pricing vendors’ estimates are based on market data and use pricing models that vary by asset class and incorporate available trade, bid and other market information. The methodologies used by these vendors are reviewed and understood by management through discussion with and information provided by these vendors. The Company assesses the reasonableness of individual security values received from pricing vendors through various analytical techniques. Management also assesses whether the assumptions used appear reasonable and consistent with the objective of determining fair value. When our pricing vendors are unable to obtain evaluations based on market data, fair value is determined by obtaining a direct broker quote. Management reviews these broker quotes and valuation techniques to determine whether they are appropriate and consistently applied. Broker quotes are evaluated based on the Company’s assessment of the broker’s knowledge of, and history in trading, the security and the Company’s understanding of inputs used to derive the broker quote. Management also assesses reasonableness of individual security values similar to the pricing vendor review noted above.

For our private placement investments, we estimated fair value using internal models. Private placement securities are generally valued using a matrix pricing approach which categorizes these securities into groupings using remaining average life and credit rating as the two criteria to determine a grouping. The Company obtains current credit spread information from private placement dealers based on the criteria described and adds that spread information to U.S. Treasury rates corresponding to the life of each security to determine a discount rate for pricing. A small number of private placement securities are internally valued using models or analyst judgment. Fair values determined internally are also subject to management review to ensure that valuation models and inputs appear reasonable.

U.S. Government and Agency Securities

We value public U.S. government and agency debt by obtaining fair value estimates from our pricing vendors. For our private placement government and agency debt, our fair value is based on internal models using either a discounted cash flow or spread matrix which incorporates U.S. Treasury yields, market spreads and average life calculations. For short-term investments, we equate fair value to amortized cost due to their relatively short duration and limited exposure to credit risk.

State and Political Subdivisions

Public state and political subdivision debt is valued by obtaining fair value estimates from our pricing vendors. For our private placement debt securities, our fair value is based on internal models using either a discounted cash flow or spread matrix which incorporates U.S. Treasury yields, market spreads and average life calculations.

Foreign Government

We obtain fair value estimates from pricing vendors to value foreign government debt.


F-36



9.
Fair Value of Financial Instruments (continued)

Corporate Bonds

For the majority of our public corporate debt, we obtain fair value estimates from our pricing vendors. For public corporate debt in which we cannot obtain fair value estimates from our pricing vendors, we receive a direct quote from a broker. In most cases, we will obtain a direct broker quote from the broker that facilitated the deal. For our private placement debt securities, our fair value is based on internal models using either a discounted cash flow or spread matrix which incorporates U.S. Treasury yields, market spreads and average life calculations. For private fixed maturities, fair value is determined using a discounted cash flow model, which utilizes a discount rate based upon the average of spread surveys collected from private market intermediaries who are active in both primary and secondary transactions and takes into account, among other factors, the credit quality and industry sector of the issuer and the reduced liquidity associated with private placements. In determining the fair value of certain debt securities, the discounted cash flow model may also use unobservable inputs, which reflect the Company’s own assumptions about the inputs market participants would use in pricing the security.

RMBS, CMBS, CDO/CLO and Other Asset-Backed Securities

For structured securities, the majority of the fair value estimates are provided by our pricing vendors. When a fair value estimate is not available from the pricing vendors, we estimate fair value using direct broker quotes or internal models which use a discounted cash flow technique. These models consider the best estimate of cash flows until maturity to determine our ability to collect principal and interest and compare this to the anticipated cash flows when the security was purchased. In addition, management judgment is used to assess the probability of collecting all amounts contractually due to us. After consideration is given to the available estimates relevant to assessing the collectibility, including historical events, current conditions and reasonable forecasts, an estimate of future cash flows is determined. This includes evaluating the remaining payment terms, prepayment speeds, the underlying collateral, expected defaults using current default data and the financial condition of the issuer. Other factors considered are composite credit ratings, industry forecast, analyst reports and other relevant market data, similar to those the Company believes market participants would use.

Limited partnerships and other investments

Our limited partnerships are accounted for using equity method accounting. We carry these investments on the balance sheets at the capital value we obtain from the financial statement we received from the general partner. Typically, our carrying value is based on a financial statement one quarter in arrears to accommodate the timing of receipt of financial statements. These financial statements are generally audited annually. Generally the information received is deemed an appropriate approximation of the fair value of these fund investments and no adjustments are made to the financial statements received. Management also has open communication with each fund manager and generally views the information reported from the underlying funds as the best information available to record its investments.

Separate account assets

Our separate account assets consist of mutual funds that are frequently traded. Since 2003, investments owned by The Phoenix Companies, Inc. Employee Pension Plan (the “Plan”) Trust were sold to PHL Variable and the investments converted to ownership by the Trust to the Employee Pension Separate Account (“EPP SA”). The Plan’s Trust purchased a group flexible premium variable accumulation deferred annuity contract. As of May 21, 2012, the Plan surrendered the EPP SA contract for full value and the Plan’s underlying investments are no longer held in the separate account. Certain investments related to fixed income, equities and foreign securities were transferred to Mercer Trust Company for investment management purposes in a group trust investment arrangement. The remaining investments continued with their respective investment managers. These securities are valued using the market approach in which unadjusted market quotes are used. We include these securities in Level 1 of our hierarchy.

Derivatives

Exchange-traded derivatives are valued using quoted prices and are classified within Level 1 of the valuation hierarchy. However, few classes of derivative contracts are listed on an exchange. Therefore, the majority of our derivative positions are OTC derivative financial instruments, valued using third-party vendor derivative valuation systems that use as their basis readily observable market parameters, such as swap rates and volatility assumptions. These positions are classified within Level 2 of the valuation hierarchy. Such OTC derivatives include vanilla interest rate swaps, equity index options, swaptions, variance swaps and cross currency swaps. Nevertheless, we review and validate the resulting fair values against those provided to us monthly by the derivative counterparties for reasonableness.

F-37



9.
Fair Value of Financial Instruments (continued)

Fair values for OTC derivative financial instruments, mostly options and swaps, represent the present value of amounts estimated to be received from or paid to a marketplace participant in exchange of these instruments (i.e., the amount we would expect to receive in a derivative asset assignment or would expect to pay to have a derivative liability assumed). These derivatives are valued using third-party derivative valuation models which take into account the net present value of estimated future cash flows and capital market assumptions which are derived from directly observable prices from other OTC trades and exchange-traded derivatives. Such assumptions include swap rates and swaption volatility obtained from Bloomberg, as well as equity index volatility and dividend yields provided by OTC derivative dealers.

The fair value of OTC derivative financial instruments is also adjusted for the credit risk of the counterparty in cases in which there are no collateral offsets. To estimate the impact on fair value of a market participant’s view of counterparty non-performance risk we use a credit default swap (“CDS”)-based approach in measuring this counterparty non-performance risk by looking at the cost of obtaining credit protection in the CDS market for the aggregate fair value exposure amount over the remaining life of derivative contracts, given the counterparty’s rating. The resulting upfront CDS premium, calculated using Bloomberg analytics, serves as a reasonable estimate of the default provision for the non-performance risk or counterparty valuation adjustment to the fair valuation of non-collateralized OTC derivative financial instruments.

Certain new and/or complex instruments may have immature or limited markets or require more sophistication in derivative valuation methodology. As a result, the pricing models used for valuation of these instruments often incorporate significant estimates and assumptions that market participants would use in pricing the instrument, which may impact the results of operations reported in the financial statements. Hence, instead of valuing these instruments using third-party vendor valuation systems, we rely on the fair market valuations reported to us monthly by the derivative counterparties. Fair values for OTC derivatives are verified using observed estimates about the costs of hedging the risk and other trades in the market. As the markets for these products develop, we continually refine our pricing models to correlate more closely to the market risk of these instruments.

Valuation of embedded derivatives

We make guarantees on certain variable annuity contracts, including those with GMAB, GMWB and COMBO riders. We also provide credits based on the performance of certain indices (“index credits”) on our fixed indexed annuity contracts. Both contract types have features that meet the definition of an embedded derivative. The GMAB, GMWB and COMBO embedded derivative liabilities associated with our variable annuity contracts are accounted for at fair value using a risk neutral stochastic valuation methodology with changes in fair value recorded in realized investment gains. The inputs to our fair value methodology include estimates derived from the asset derivatives market, including equity volatilities and the swap curves. Several additional inputs are not obtained from independent sources, but instead reflect our internally developed assumptions related to mortality rates, lapse rates and other policyholder behavior.

The fair value of the embedded derivative liabilities associated with the index credits on our fixed indexed annuity contracts is calculated using the budget method with changes in fair value recorded in realized investment gains. Under the budget method, the value of the initial index option is based on the fair value of the option purchased to hedge the index. The value of the index credits paid in future years is estimated to be the annual budgeted amount. Budgeted amounts are estimated based on available investment income using assumed investment returns and projected liability values. As there are significant unobservable inputs included in our fair value methodology for these embedded derivative liabilities, we consider the methods as described above as a whole to be Level 3 within the fair value hierarchy.

Our fair value calculation of embedded derivative liabilities includes a credit standing adjustment (the “CSA”). The CSA represents the adjustment that market participants would make to reflect the risk that guaranteed benefit obligations may not be fulfilled (“non-performance risk”). We estimate our CSA using the credit spread (based on publicly available credit spread indices) for financial services companies similar to the Company’s life insurance subsidiaries. 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.

The following tables present the financial instruments carried at fair value on a recurring basis by ASC 820-10 valuation hierarchy (as described above). There were no financial instruments carried at fair value on a non-recurring basis as of December 31, 2013 and 2012, respectively.


F-38



9.
Fair Value of Financial Instruments (continued)

Fair Values of Financial Instruments by Level:
As of
($ in millions)
December 31, 2013
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets
 
 
 
 
 
 
 
Available-for-sale debt securities
 
 
 
 
 
 
 
U.S. government and agency
$

 
$
9.8

 
$
58.8

[1]
$
68.6

State and political subdivision

 
20.8

 
133.8

 
154.6

Foreign government

 
62.2

 
3.3

 
65.5

Corporate

 
1,105.0

 
1,102.3

 
2,207.3

CMBS

 
221.8

 
31.9

 
253.7

RMBS

 
333.9

 
175.9

 
509.8

CDO/CLO

 

 
70.9

 
70.9

Other asset-backed

 
13.6

 
82.3

 
95.9

Total available-for-sale debt securities

 
1,767.1

 
1,659.2

 
3,426.3

Short-term investments
80.0

 
1.0

 

 
81.0

Derivative assets
12.5

 
225.3

 

 
237.8

Related party reinsurance derivative asset

 

 

 

Fair value investments

 
13.0

 
35.6

 
48.6

Separate account assets
2,052.7

 

 

 
2,052.7

Total assets
$
2,145.2

 
$
2,006.4

 
$
1,694.8

 
$
5,846.4

Liabilities
 
 
 
 
 
 
 
Derivative liabilities
$

 
$
110.8

 
$

 
$
110.8

Embedded derivatives

 

 
74.8

 
74.8

Total liabilities
$

 
$
110.8

 
$
74.8

 
$
185.6

———————
[1]
Includes securities whose underlying collateral is an obligation of a U.S. government entity.

There were no transfers of assets between Level 1 and Level 2 during the year ended December 31, 2013.


F-39



9.
Fair Value of Financial Instruments (continued)

Fair Values of Financial Instruments by Level:
As of
($ in millions)
December 31, 2012
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets
 
 
 
 
 
 
 
Available-for-sale debt securities
 
 
 
 
 
 
 
U.S. government and agency
$

 
$
14.3

 
$
25.9

[1]
$
40.2

State and political subdivision

 
14.8

 
116.1

 
130.9

Foreign government

 
43.8

 
8.0

 
51.8

Corporate

 
1,096.0

 
801.5

 
1,897.5

CMBS

 
234.7

 
19.3

 
254.0

RMBS

 
199.9

 
222.6

 
422.5

CDO/CLO

 

 
56.8

 
56.8

Other asset-backed

 
38.5

 
80.1

 
118.6

Total available-for-sale debt securities

 
1,642.0

 
1,330.3

 
2,972.3

Short-term investments
244.9

 

 

 
244.9

Derivative assets
13.8

 
135.6

 

 
149.4

Related party reinsurance derivative asset

 

 

 

Fair value investments

 
15.8

 
22.7

 
38.5

Separate account assets
2,061.8

 

 

 
2,061.8

Total assets
$
2,320.5

 
$
1,793.4

 
$
1,353.0

 
$
5,466.9

Liabilities
 
 
 
 
 
 
 
Derivative liabilities
$

 
$
45.7

 
$

 
$
45.7

Embedded derivatives

 

 
79.5

 
79.5

Total liabilities
$

 
$
45.7

 
$
79.5

 
$
125.2

———————
[1]
Includes securities whose underlying collateral is an obligation of a U.S. government entity.

There were no transfers of assets between Level 1 and Level 2 during the year ended December 31, 2012.

The following tables present corporates carried at fair value on a recurring basis by sector.

Fair Values of Corporates by Level and Sector:
As of
($ in millions)
December 31, 2013
 
Level 1
 
Level 2
 
Level 3
 
Total
Corporates
 
 
 
 
 
 
 
Consumer
$

 
$
288.9

 
$
377.0

 
$
665.9

Energy

 
137.7

 
95.4

 
233.1

Financial services

 
440.3

 
262.2

 
702.5

Technical/communications

 
32.8

 
25.4

 
58.2

Transportation

 
25.0

 
85.1

 
110.1

Utilities

 
83.6

 
154.3

 
237.9

Other

 
96.7

 
102.9

 
199.6

Total corporates
$

 
$
1,105.0

 
$
1,102.3

 
$
2,207.3



F-40



9.
Fair Value of Financial Instruments (continued)

Fair Values of Corporates by Level and Sector:
As of
($ in millions)
December 31, 2012
 
Level 1
 
Level 2
 
Level 3
 
Total
Corporates
 
 
 
 
 
 
 
Consumer
$

 
$
352.9

 
$
389.5

 
$
742.4

Energy

 
79.6

 
18.8

 
98.4

Financial services

 
361.9

 
165.8

 
527.7

Technical/communications

 
45.4

 
7.6

 
53.0

Transportation

 
9.3

 
29.8

 
39.1

Utilities

 
116.9

 
134.2

 
251.1

Other

 
130.0

 
55.8

 
185.8

Total corporates
$

 
$
1,096.0

 
$
801.5

 
$
1,897.5


Level 3 financial assets and liabilities

The following tables set forth a summary of changes in the fair value of our Level 3 financial assets and liabilities. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The securities which were transferred as of the end of each reporting period into Level 3 were due to decreased
market observability of similar assets and/or changes to significant inputs, such as downgrades or price declines. Transfers out of Level 3 were due to increased market activity on comparable assets or observability of inputs.

Level 3 Financial Assets:
As of
($ in millions)
December 31, 2013
 
Balance, beginning of period
 
Purchases
 
Sales
 
Transfers into
Level 3
 
Transfers out of
Level 3
 
Realized and unrealized gains (losses) included in income [1]
 
Unrealized gains (losses) included in OCI
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Available-for-sale debt securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. government and agency [2]
$
25.9

 
$
44.3

 
$
(4.3
)
 
$

 
$

 
$

 
$
(7.1
)
 
$
58.8

State and political subdivision
116.1

 
47.8

 
(1.5
)
 

 

 

 
(28.6
)
 
133.8

Foreign government
8.0

 

 

 
1.6

 
(6.1
)
 

 
(0.2
)
 
3.3

Corporate
801.5

 
364.8

 
(12.8
)
 
41.6

 
(10.9
)
 

 
(81.9
)
 
1,102.3

CMBS
19.3

 
19.3

 
(0.7
)
 

 
(1.5
)
 
(0.2
)
 
(4.3
)
 
31.9

RMBS
222.6

 
1.3

 
(28.9
)
 
5.1

 

 
(0.4
)
 
(23.8
)
 
175.9

CDO/CLO
56.8

 
36.6

 
(6.6
)
 

 

 
(0.3
)
 
(15.6
)
 
70.9

Other asset-backed
80.1

 
13.4

 
(6.0
)
 

 

 

 
(5.2
)
 
82.3

Total available-for-sale
  debt securities
1,330.3

 
527.5

 
(60.8
)
 
48.3

 
(18.5
)
 
(0.9
)
 
(166.7
)
 
1,659.2

Related party reinsurance
  derivative asset

 

 

 

 

 

 

 

Fair value investments
22.7

 
21.1

 
(3.8
)
 

 

 
(4.4
)
 

 
35.6

Total assets
$
1,353.0

 
$
548.6

 
$
(64.6
)
 
$
48.3

 
$
(18.5
)
 
$
(5.3
)
 
$
(166.7
)
 
$
1,694.8

———————
[1]
Reflected in realized investment gains and losses for all assets except fair value investments which are included in net investment income.
[2]
Includes securities whose underlying collateral is an obligation of a U.S. government entity.


F-41



9.
Fair Value of Financial Instruments (continued)

Level 3 Financial Assets:
As of
($ in millions)
December 31, 2012
 
Balance, beginning of period
 
Purchases
 
Sales
 
Transfers into
Level 3
 
Transfers out of
Level 3
 
Realized and unrealized gains (losses) included in income [1]
 
Unrealized gains (losses) included in OCI
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Available-for-sale debt securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. government and agency [2]
$
31.7

 
$
3.2

 
$
(6.7
)
 
$

 
$

 
$

 
$
(2.3
)
 
$
25.9

State and political subdivision
48.7

 
41.9

 
(0.8
)
 
12.9

 

 

 
13.4

 
116.1

Foreign government
3.1

 
3.5

 

 

 

 

 
1.4

 
8.0

Corporate
513.8

 
297.1

 
(16.2
)
 
21.0

 
(14.2
)
 

 

 
801.5

CMBS
35.4

 

 
(0.6
)
 
1.1

 
(17.1
)
 

 
0.5

 
19.3

RMBS
268.0

 
1.6

 
(38.9
)
 

 

 
2.0

 
(10.1
)
 
222.6

CDO/CLO
62.5

 
2.8

 
(5.3
)
 

 

 
(0.3
)
 
(2.9
)
 
56.8

Other asset-backed
81.2

 
9.5

 
(7.6
)
 

 
(1.8
)
 

 
(1.2
)
 
80.1

Total available-for-sale
  debt securities
1,044.4

 
359.6

 
(76.1
)
 
35.0

 
(33.1
)
 
1.7

 
(1.2
)
 
1,330.3

Related party reinsurance
  derivative asset
3.5

 

 

 

 

 
(3.5
)
 

 

Fair value investments
27.5

 
5.7

 
(11.5
)
 

 

 
1.0

 

 
22.7

Total assets
$
1,075.4

 
$
365.3

 
$
(87.6
)
 
$
35.0

 
$
(33.1
)
 
$
(0.8
)
 
$
(1.2
)
 
$
1,353.0

———————
[1]
Reflected in realized investment gains and losses for all assets except fair value investments which are included in net investment income.
[2]
Includes securities whose underlying collateral is an obligation of a U.S. government entity.

Level 3 Financial Liabilities:
Embedded Derivatives
($ in millions)
Years Ended December 31,
 
2013
 
2012
 
 
 
 
Balance, beginning of period
$
79.5

 
$
82.3

Net purchases/(sales)
12.9

 
8.4

Transfers into Level 3

 

Transfers out of Level 3

 

Realized (gains) losses [1]
(17.6
)
 
(11.2
)
Balance, end of period
$
74.8

 
$
79.5

———————
[1]
Realized gains and losses are included in net realized investment gains on the statements of income and comprehensive income.

Significant unobservable inputs used in the fair value measurement of Level 3 assets are yield, prepayment rate, default rate, recovery rate and reinvestment spread. Keeping other inputs unchanged, an increase in yield, default rate or prepayment rate would decrease the fair value of the asset while an increase in recovery rate, or reinvestment spread would result in an increase to the fair value of the asset. Yields are a function of the underlying U.S. Treasury rates and asset spreads, and changes in default and recovery rates are dependent on overall market conditions.


F-42



9.
Fair Value of Financial Instruments (continued)

The following tables present quantitative estimates about unobservable inputs used in the fair value measurement of significant categories of internally priced assets.

Level 3 Assets: [1]
As of
($ in millions)
December 31, 2013
 
Fair
Value
 
Valuation
Technique(s)
 
Unobservable
Input
 
Range (Weighted Average)
 
 
 
 
 
 
 
 
U.S. government and agency
$
58.8

 
Discounted cash flow
 
Yield
 
1.07%-5.00% (3.18%)
State and political subdivision
$
45.4

 
Discounted cash flow
 
Yield
 
2.44%-5.79% (3.88%)
Corporate
$
874.1

 
Discounted cash flow
 
Yield
 
1.06%-6.75% (3.81%)
Other asset-backed
$
11.3

 
Discounted cash flow
 
Yield
 
2.10%-3.41% (2.30%)
 
 
 
Discounted cash flow
 
Prepayment rate
 
2%
 
 
 
 
 
Default rate
 
2.53% for 48 mos then .37% thereafter
 
 
 
 
 
Recovery rate
 
10% (TRUPS)
Fair value investments
$
0.8

 
Discounted cash flow
 
Default rate
 
0.25%
 
 
 
 
 
Recovery rate
 
45%
———————
[1]
Excludes Level 3 assets which are valued based upon non-binding independent third-party valuations or third-party price information for which unobservable inputs are not reasonably available to us.

Level 3 Assets: [1]
As of
($ in millions)
December 31, 2012
 
Fair
Value
 
Valuation
Technique(s)
 
Unobservable
Input
 
Range (Weighted Average)
 
 
 
 
 
 
 
 
U.S. government and agency
$
25.9

 
Discounted cash flow
 
Yield
 
1.46%-3.29% (2.57%)
State and political subdivision
$
58.0

 
Discounted cash flow
 
Yield
 
1.94%-3.53% (2.94%)
Corporate
$
649.6

 
Discounted cash flow
 
Yield
 
1.47%-6.33% (3.01%)
CDO/CLO
$
3.4

 
Discounted cash flow
 
Prepayment rate
 
20% (CLOs)
 
 
 
 
 
Default rate
 
2.5% (CLOs)
 
 
 
 
 
Recovery rate
 
65% (Loans), 35% (High yield bonds),
  45% (Investment grade bonds)
 
 
 
 
 
Reinvestment spread
 
3 mo LIBOR + 400bps (CLOs)
Other asset-backed
$
2.8

 
Discounted cash flow
 
Yield
 
2.61%-9.50% (4.97%)
 
 
 
Discounted cash flow
 
Prepayment rate
 
2%
 
 
 
 
 
Default rate
 
2.53% for 48 mos then .33% thereafter
 
 
 
 
 
Recovery rate
 
10% (TRUPS)
Fair value investments
$
0.8

 
Discounted cash flow
 
Default rate
 
0.24%
 
 
 
 
 
Recovery rate
 
45%
———————
[1]
Excludes Level 3 assets which are valued based upon non-binding independent third-party valuations or third-party price information for which unobservable inputs are not reasonably available to us.

Significant unobservable inputs used in the fair value measurement of variable annuity GMAB and GMWB type liabilities are equity volatility, swap curve, mortality and lapse rates and an adjustment for non-performance risk. Keeping other inputs unchanged, an increase in the equity volatility would increase the fair value of the liability while an increase in the swap curve or CSA would result in a decrease to the fair value of the liability. The impact of changes in mortality and lapse rates are dependent on overall market conditions. The fair value of fixed indexed annuity and indexed universal life embedded derivative related to index credits is calculated using the swap curve, future option budget, mortality and lapse rates, as well as an adjustment for non-performance risk. Keeping other inputs unchanged, an increase in any of these significant unobservable inputs would result in a decrease of the fixed indexed annuity embedded derivative liability.

F-43



9.
Fair Value of Financial Instruments (continued)

The following tables present quantitative estimates about unobservable inputs used in the fair value measurement of internally priced liabilities.

Level 3 Liabilities:
As of
($ in millions)
December 31, 2013
 
Fair Value
 
Valuation Technique(s)
 
Unobservable Input
 
Range
 
 
 
 
 
 
 
 
Embedded derivatives (FIA)
$
78.9

 
Budget method
 
Swap curve
 
0.19% - 3.79%
 
 
 
 
 
Mortality rate
 
103% or 97% 2012 IAM basic table
with scale G2
 
 
 
 
 
Lapse rate
 
0.02% - 47.15%
 
 
 
 
 
CSA
 
3.23%
Embedded derivatives
(GMAB / GMWB)
$
(4.1
)
 
Risk neutral stochastic
  valuation methodology
 
Volatility surface
 
10.85% - 46.33%
 
 
 
 
 
Swap curve
 
0.15% - 4.15%
 
 
 
 
 
Mortality rate
 
105% 2012 IAM basic table with
scale G2
 
 
 
 
 
Lapse rate
 
0.00% - 40.00%
 
 
 
 
 
CSA
 
3.23%

Level 3 Liabilities:
As of
($ in millions)
December 31, 2012
 
Fair Value
 
Valuation Technique(s)
 
Unobservable Input
 
Range
 
 
 
 
 
 
 
 
Embedded derivatives (FIA)
$
51.2

 
Budget method
 
Swap curve
 
0.21% - 2.50%
 
 
 
 
 
Mortality rate
 
75% of A2000 basic table
 
 
 
 
 
Lapse rate
 
1.00% - 35.00%
 
 
 
 
 
CSA
 
4.47%
Embedded derivatives
(GMAB / GMWB)
$
28.3

 
Risk neutral stochastic
  valuation methodology
 
Volatility surface
 
11.67% - 50.83%
 
 
 
 
 
Swap curve
 
0.36% - 3.17%
 
 
 
 
 
Mortality rate
 
75% of A2000 basic table
 
 
 
 
 
Lapse rate
 
0.00% - 60.00%
 
 
 
 
 
CSA
 
4.47%


F-44



9.
Fair Value of Financial Instruments (continued)
Level 3 Assets and Liabilities by Pricing Source:
As of
($ in millions)
December 31, 2013
 
Internal [1]
 
External [2]
 
Total
Assets
 
 
 
 
 
Available-for-sale debt securities
 
 
 
 
 
  U.S. government and agency [3]
$
58.8

 
$

 
$
58.8

State and political subdivision
45.4

 
88.4

 
133.8

Foreign government

 
3.3

 
3.3

Corporate
874.1

 
228.2

 
1,102.3

CMBS

 
31.9

 
31.9

RMBS

 
175.9

 
175.9

CDO/CLO

 
70.9

 
70.9

Other asset-backed
11.3

 
71.0

 
82.3

Total available-for-sale debt securities
989.6

 
669.6

 
1,659.2

Related party reinsurance derivative asset

 

 

Fair value investments
0.8

 
34.8

 
35.6

Total assets
$
990.4

 
$
704.4

 
$
1,694.8

Liabilities
 
 
 
 
 
Embedded derivatives
$
74.8

 
$

 
$
74.8

Total liabilities
$
74.8

 
$

 
$
74.8

———————
[1]
Represents valuations reflecting both internally-derived and market inputs, as well as third-party information or quotes.
[2]
Represents unadjusted prices from independent pricing services, third-party financial statements and independent indicative broker quotes where pricing inputs are not readily available.
[3]
Includes securities whose underlying collateral is an obligation of a U.S. government entity.

Level 3 Assets and Liabilities by Pricing Source:
As of
($ in millions)
December 31, 2012
 
Internal [1]
 
External [2]
 
Total
Assets
 
 
 
 
 
Available-for-sale debt securities
 
 
 
 
 
  U.S. government and agency [3]
$
25.9

 
$

 
$
25.9

State and political subdivision
58.0

 
58.1

 
116.1

Foreign government

 
8.0

 
8.0

Corporate
649.6

 
151.9

 
801.5

CMBS

 
19.3

 
19.3

RMBS

 
222.6

 
222.6

CDO/CLO
3.4

 
53.4

 
56.8

Other asset-backed
2.8

 
77.3

 
80.1

Total available-for-sale debt securities
739.7

 
590.6

 
1,330.3

Related party reinsurance derivative asset

 

 

Fair value investments
0.8

 
21.9

 
22.7

Total assets
$
740.5

 
$
612.5

 
$
1,353.0

Liabilities
 
 
 
 
 
Embedded derivatives
$
79.5

 
$

 
$
79.5

Total liabilities
$
79.5

 
$

 
$
79.5

———————
[1]
Represents valuations reflecting both internally-derived and market inputs, as well as third-party information or quotes.
[2]
Represents unadjusted prices from independent pricing services, third-party financial statements and independent indicative broker quotes where pricing inputs are not readily available.
[3]
Includes securities whose underlying collateral is an obligation of a U.S. government entity.

F-45



9.
Fair Value of Financial Instruments (continued)

Financial instruments not carried at fair value

The Company is required by U.S. GAAP to disclose the fair value of certain financial instruments including those that are not carried at fair value. The following table discloses the Company’s financial instruments where the carrying amounts and fair values differ:

Carrying Amounts and Fair Values
 
 
As of December 31,
of Financial Instruments:
Fair Value
 
2013
 
2012
($ in millions)
Hierarchy
 
Carrying
 
Fair
 
Carrying
 
Fair
 
Level
 
Value
 
Value
 
Value
 
Value
Financial assets:
 
 
 
 
 
 
 
 
 
Policy loans
Level 3
 
$
66.1

 
$
65.6

 
$
61.0

 
$
60.6

Cash and cash equivalents
Level 1
 
$
181.0

 
$
181.0

 
$
83.1

 
$
83.1

Financial liabilities:
 
 
 
 
 
 
 

 
 

Investment contracts
Level 3
 
$
2,762.8

 
$
2,763.8

 
$
2,349.8

 
$
2,355.4

Surplus notes
Level 3
 
$
30.0

 
$
30.0

 
$

 
$


Fair value of policy loans

The fair value of fixed rate policy loans is calculated using a discounted cash flow model based upon current U.S. Treasury rates and historical loan repayment patterns. For floating rate policy loans the fair value is the amount due, excluding interest, as of the reporting date.

Fair value of investment contracts

We determine the fair value of guaranteed interest contracts by using a discount rate based upon the appropriate U.S. Treasury rate to calculate the present value of projected contractual liability payments through final maturity. We determine the fair value of deferred annuities and supplementary contracts without life contingencies with an interest guarantee of one year or less at the amount of the policy reserve. In determining the fair value of deferred annuities and supplementary contracts without life contingencies with interest guarantees greater than one year, we use a discount rate based upon the appropriate U.S. Treasury rate to calculate the present value of the projected account value of the policy at the end of the current guarantee period.

Deposit type funds, including pension deposit administration contracts, dividend accumulations and other funds left on deposit not involving life contingencies, have interest guarantees of less than one year for which interest credited is closely tied to rates earned on owned assets. For these liabilities, we assume fair value to be equal to the stated liability balances.

The fair value of these investment contracts are categorized as Level 3.

Indebtedness

The fair value of surplus notes is determined with reference to the fair value of Phoenix’s senior unsecured bonds including consideration of the different features in the two securities. See Note 11 to these financial statements for additional information.


10.
Income Taxes

Phoenix and PHL Variable file a consolidated U.S. Federal income tax return. The Company also files combined, unitary and separate income tax returns in various states.


F-46



10.
Income Taxes (continued)

Significant Components of Income Taxes:
Years Ended December 31,
($ in millions)
2013
 
2012
 
2011
Income tax expense (benefit) attributable to:
 
 
 
 
 
Current
$
(21.7
)
 
$
27.7

 
$
0.6

Deferred

 
(11.5
)
 
(6.9
)
Income tax expense (benefit)
$
(21.7
)
 
$
16.2

 
$
(6.3
)

Reconciliation of Effective Income Tax Rate:
Years Ended December 31,
($ in millions)
2013
 
2012
 
2011
 
 
 
 
 
 
Income (loss) before income taxes
$
34.0

 
$
(121.5
)
 
$
(26.3
)
Income tax expense (benefit) at statutory rate of 35.0%
11.9

 
(42.5
)
 
(9.2
)
Dividend received deduction
(1.2
)
 
(1.5
)
 
(2.0
)
Valuation allowance increase (release)
(31.7
)
 
60.2

 
4.1

Other, net
(0.7
)
 

 
0.8

Income tax expense (benefit)
$
(21.7
)
 
$
16.2

 
$
(6.3
)
Effective income tax rates
(63.8%)
 
(13.3%)
 
23.9%

Allocation of Income Taxes:
Years Ended December 31,
($ in millions)
2013
 
2012
 
2011
 
 
 
 
 
 
Income tax expense (benefit)
$
(21.7
)
 
$
16.2

 
$
(6.3
)
Income tax from OCI:
 
 
 

 
 

Unrealized investment (gains) losses
(11.8
)
 
24.9

 
4.2

Pension

 

 

Policy dividend obligation and deferred policy acquisition cost

 

 

Other

 

 

Income tax related to cumulative effect of change in accounting

 

 

Total income tax recorded to all components of income
$
(33.5
)
 
$
41.1

 
$
(2.1
)

Deferred Income Tax Balances Attributable to Temporary Differences:
As of December 31,
($ in millions)
2013
 
2012
Deferred income tax assets
 
 
 
Future policyholder benefits
$
270.0

 
$
276.7

Unearned premiums / deferred revenues

 

Investments

 

Net operating and capital loss carryover benefits

 
1.7

Other
0.8

 
0.2

Available-for-sale debt securities
28.0

 
16.2

Alternative minimum tax credits
2.1

 
1.8

Subtotal
300.9

 
296.6

Valuation allowance
(74.2
)
 
(105.4
)
Total deferred income tax assets, net of valuation allowance
226.7

 
191.2

Deferred income tax liabilities
 
 
 
Deferred policy acquisition costs
(101.7
)
 
(92.2
)
Investments
(78.7
)
 
(77.8
)
Other
(18.3
)
 
(5.0
)
Gross deferred income tax liabilities
(198.7
)
 
(175.0
)
Net deferred income tax assets
$
28.0

 
$
16.2


F-47



10.
Income Taxes (continued)

As of December 31, 2013, we performed our assessment of the realization of deferred tax assets. This assessment included consideration of all available evidence – both positive and negative – weighted to the extent the evidence was objectively verifiable. In performing this assessment, the Company considered the existence of 2013 GAAP pre-tax income of $34.0 million driven primarily by gains on guaranteed insurance benefit liabilities and actuarial assumption changes. Although this GAAP income does allow for realization of some deferred tax assets, Management, does not view this pre-tax income to be indicative of sustainable core earnings and accordingly, does not view this income as a substantial form of positive evidence because this income did not arise until the fourth quarter of 2013.

With the existence of PHL Variable and parent company life subgroup taxable profits in recent years, the Company has experienced some utilization of its tax loss carryovers and incurred current federal income tax. Under U.S. federal tax law, taxes paid by PHL Variable and the life subgroup are available for recoupment in the event of future losses. Under GAAP, the ability to carryback losses and recoup taxes paid can be considered as a source of income when assessing the realization of deferred tax assets. The Company believes that the consolidated return will remain taxable in the near term and as such, we do not believe the taxes paid in the current and prior years will be recouped. Accordingly, management has not deemed the PHL Variable taxes paid in current and prior tax years as a viable source of income when performing its valuation allowance assessment.

Further, we believe that the continued existence of significant negative evidence illustrated by a three year cumulative loss before tax is significant enough to overcome any positive evidence that exists with respect to the 2013 pretax operating results. Further additional negative evidence, includes but is not limited to, material weaknesses in internal controls over financial reporting which adversely affect the accuracy of the Company’s financial data, continued costs associated with the financial restatement, risk of failure to comply with the filing deadlines expressed by the SEC, and downgrades of financial strength credit ratings which have the potential to increase policy surrenders and withdrawals.

Due to the application of our tax sharing agreement, positive and negative evidence at both the parent and subsidiary levels have been considered in our assessment of deferred tax asset realizability at the subsidiary level. Due to the significance of the negative evidence at both the parent and subsidiary levels, as well as the weight given to the objective nature of the cumulative losses in recent years, and after consideration of all available evidence, we concluded that our estimates of future taxable income, timing of the reversal of existing taxable temporary differences and certain tax planning strategies did not provide sufficient positive evidence to assert that it is more likely than not that certain deferred tax assets would be realizable. To the extent either PHL Variable or PNX can demonstrate the ability to generate sustained profitability in the future, the valuation allowance could potentially be reversed resulting in a benefit to income tax expense.

As of December 31, 2013, 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 $74.2 million has been recorded on net deferred tax assets of $102.2 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 $28.0 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 principle 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 a decrease of $31.7 million in net loss and an increase of $0.5 million in OCI-related deferred tax balances.

As of December 31, 2013, we had deferred tax assets of $2.1 million related to alternative minimum tax credit carryovers which do not expire.

The Company is no longer subject to U.S. federal income tax examinations by tax authorities for years before 2011. During 2012, the Company resolved examination issues for tax years 2010 which resulted in adjustments to tax attribute carryforwards. No material unanticipated assessments were incurred, and no adjustment to our liability for uncertain tax positions was required.

There were no unrecognized tax benefits for the years ended December 31, 2013, 2012 and 2011.


F-48



10.
Income Taxes (continued)

Management believes that adequate provisions have been made in the financial statements for any potential assessments that may result from tax examinations and other tax related matters for all open tax years. Based upon the timing and status of our current examinations by taxing authorities, we do not believe that it is reasonably possible that any changes to the balance of unrecognized tax benefits occurring within the next 12 months will result in a significant change to the results of operations, financial condition or liquidity.

The Company has no interest and penalties as income tax expense and no accrued interest and penalties in the related income tax liability for the years ended December 31, 2013 and December 31, 2012.


11.
Related Party Transactions

Capital contributions

During the year ended December 31, 2013, we received $45.0 million in capital contributions from PM Holdings, Inc.

Related party transactions

The amounts included in the following discussion are gross expenses, before deferrals for policy acquisition costs.

Service agreement

The Company has entered into an agreement with Phoenix Life to provide substantially all general operating expenses related to the Company, including rent and employee benefit plan expenses. Expenses are allocated to the Company using specific identification or activity-based costing. The expenses allocated to us were $91.5 million, $71.4 million and $73.3 million for the years ended December 31, 2013, 2012 and 2011, respectively. Amounts payable to Phoenix Life were $6.3 million and $4.4 million as of December 31, 2013 and 2012, respectively.

See Note 13 to these financial statements for additional information on related party transactions.

Reinsurance agreements

During 2008, the Company and Phoenix Life entered into a reinsurance agreement. Under this agreement, the Company cedes risk associated with certain universal life contracts and the associated riders to Phoenix Life. The reinsurance transaction between the Company and Phoenix Life is structured as a coinsurance agreement.

On July 1, 2012 the Company recaptured the business associated with a reinsurance contract with Phoenix Life, whereby we ceded to Phoenix Life certain of the liabilities related to guarantees on our annuity products. This contract qualified as a freestanding derivative and the derivative asset previously reported within receivable from related parties was reversed at the time of recapture.

See Note 3 to these financial statements for additional information on related party transactions.

Investment Advisory agreement

Prior to November 18, 2011, Goodwin Capital Advisers, Inc. (“Goodwin”), an indirect wholly owned subsidiary of PNX, provided investment advisory services to us for a fee. On November 18, 2011, PNX closed on a transaction to sell Goodwin to Conning Holdings Corp. (“Conning Holdings”). Included in the terms of this transaction was a multi-year investment management agreement under which Conning will manage the Company’s publicly-traded fixed income assets. Private placement bond and limited partnership investments previously managed under Goodwin will continue to be managed by PNX under its subsidiary, Phoenix Life. Investment advisory fees incurred by us for Goodwin’s management of general account assets were $0.0 million, $0.0 million and $1.2 million for the years ended December 31, 2013, 2012 and 2011, respectively. There were no amounts payable to Goodwin as of December 31, 2013 and 2012.


F-49



11.
Related Party Transactions (continued)

Underwriting agreements

1851 Securities Inc. (“1851”), a wholly owned subsidiary of PM Holdings, Inc., is the principal underwriter of the Company’s variable life insurance policies and variable annuity contracts. Phoenix Life reimburses 1851 for commissions incurred on our behalf and we in turn reimburse Phoenix Life. Commissions incurred were $6.4 million, $6.5 million and $6.9 million for the years ended December 31, 2013, 2012 and 2011, respectively.

Sales agreements

Phoenix Life pays commissions to producers who sell our non-registered life and annuity products. Commissions paid by Phoenix Life on our behalf were $65.4 million, $73.3 million and $97.3 million for the years ended December 31, 2013, 2012 and 2011, respectively. Amounts payable to Phoenix Life were $1.3 million and $8.0 million as of December 31, 2013 and 2012, respectively.

Saybrus, a majority-owned subsidiary of PNX, provides wholesaling services to various third party distributors and affiliates of variable life insurance and variable annuities. Commissions paid by Saybrus on our behalf were $9.2 million, $11.3 million and $11.2 million as of December 31, 2013, 2012 and 2011, respectively. Commission amounts payable to Saybrus were $0.7 million and $0.9 million as of December 31, 2013 and 2012, respectively.

Saybrus Equity Services, Inc. (“Saybrus Equity”), a wholly owned subsidiary of Saybrus provides wholesaling services to various third party distributors and affiliates of variable life insurance and variable annuities. Commissions paid by Saybrus Equity on our behalf were immaterial as of December 31, 2013, 2012 and 2011, respectively. Commission amounts payable to Saybrus Equity were immaterial as of December 31, 2013 and 2012, respectively.

Processing service agreements

We provide payment processing services for Phoenix Life, wherein we receive deposits on Phoenix Life annuity contracts, and forward those payments to Phoenix Life. During 2006, we began including life insurance premiums in this service. In connection with this service, we had a net amount due to Phoenix Life of $2.6 million as of December 31, 2013 and a net amount due from Phoenix Life of $2.4 million as of December 31, 2012. We do not charge any fees for this service.

We also provide payment processing services for Phoenix Life and Annuity Company (“Phoenix Life and Annuity”), a wholly owned indirect subsidiary of Phoenix Life, wherein we receive deposits on certain Phoenix Life and Annuity annuity contracts, and forward those payments to Phoenix Life and Annuity. During 2006, we began including life insurance premiums in this service. In connection with this service, we had amounts due to Phoenix Life and Annuity of $0.5 million as of December 31, 2013 and immaterial amounts due to Phoenix Life and Annuity as of December 31, 2012. We do not charge any fees for this service.

Indebtedness due to affiliate

PHL Variable issued $30.0 million surplus notes on December 30, 2013 which were purchased by Phoenix. The notes are due on December 30, 2043. Interest payments are at an annual rate of 10.5%, require the prior approval of the Insurance Commissioner of the State of Connecticut and may be made only out of surplus funds as defined under applicable law and regulations of the State of Connecticut. Upon approval by the Insurance Commissioner, the notes may be redeemed at any time, either in whole or in part, at a redemption price of 100% plus accrued interest to the date set for the redemption. Connecticut Law provides that the notes are not part of the legal liabilities of PHL Variable.



F-50



12.
Accumulated Other Comprehensive Income

Changes in each component of AOCI attributable to the Company for the years ended December 31 are as follows below (net of tax):
 
Accumulated Other Comprehensive Income (Loss):
Net Unrealized
 
 
 
 
($ in millions)
Gains / (Losses)
 
 
 
 
 
on Investments
 
 
 
 
 
where
 
Net Unrealized
 
 
 
Credit-related
 
Gains / (Losses)
 
 
 
OTTI was
 
on All Other
 
 
 
Recognized [1]
 
Investments [1]
 
Total
 
 
 
 
 
 
Balance as of December 31, 2011
$
(7.4
)
 
$
10.0

 
$
2.6

Change in component during the year before reclassifications
6.7

 
14.7

 
21.4

Amounts reclassified from AOCI
(0.6
)
 
(12.0
)
 
(12.6
)
Balance as of December 31, 2012
(1.3
)
 
12.7

 
11.4

Change in component during the year before reclassifications
3.9

 
(21.5
)
 
(17.6
)
Amounts reclassified from AOCI
(0.6
)
 
(5.1
)
 
(5.7
)
Balance as of December 31, 2013
$
2.0

 
$
(13.9
)
 
$
(11.9
)
———————
[1]
See Note 6 to these financial statements for additional information regarding offsets to net unrealized investment gains and losses which include policyholder dividend obligation, DAC and other actuarial offsets, and deferred income tax expense (benefit).

Reclassifications from AOCI consist of the following:

AOCI
 
Amounts Reclassified from AOCI
 
Affected Line Item in the
Statements of Income and Comprehensive Income
 
 
For the year ended December 31,
 
 
($ in millions)
 
2013
 
2012
 
2011
 
 
 
 
 
 
 
 
 
 
 
Net unrealized gains/(losses) on investments where credit-related OTTI was recognized
 
 
 
 
 
 
 
 
Available-for-sale securities
 
$
0.9

 
$
0.9

 
$
0.4

 
Net realized capital gains (losses)
 
 
0.9

 
0.9

 
0.4

 
Total before income taxes
 
 
0.3

 
0.3

 
0.1

 
Income tax expense (benefit)
 
 
$
0.6

 
$
0.6

 
$
0.3

 
Net income (loss)
Net unrealized investment gains/(losses)
  on all other investments
 
 
 
 
 
 
 
 
Available-for-sale securities
 
$
7.8

 
$
18.5

 
$
(1.8
)
 
Net realized capital gains (losses)
 
 
7.8

 
18.5

 
(1.8
)
 
Total before income taxes
 
 
2.7

 
6.5

 
(0.6
)
 
Income tax expense (benefit)
 
 
$
5.1

 
$
12.0

 
$
(1.2
)
 
Net income (loss)
Total amounts reclassified from AOCI
 
$
5.7

 
$
12.6

 
$
(0.9
)
 
Net income (loss)


13.
Employee Benefit Plans and Employment Agreements

Our ultimate parent company provides employees with post-employment benefits that include retirement benefits, through pension and savings plans, and other benefits, including health care and life insurance. This includes three defined benefit plans. We incur applicable employee benefit expenses through the process of cost allocation by PNX.


F-51



13.
Employee Benefit Plans and Employment Agreements (continued)

The employee pension plan provides benefits up to the amount allowed under the Internal Revenue Code. The two supplemental plans provide benefits in excess of the primary plan. Retirement benefits under the plans are a function of years of service and compensation. Effective March 31, 2010, all benefit accruals under all of our funded and unfunded defined benefit plans were frozen. This change was announced in 2009 and a curtailment was recognized at that time for the reduction in the expected years of future service.

Our ultimate parent company has historically provided employees with other post-employment benefits that include health care and life insurance. In December 2009, PNX announced the decision to eliminate retiree medical coverage for current employees whose age plus years of service did not equal at least 65 as of March 31, 2010. Employees who remain eligible must still meet all other plan requirements to receive benefits. In addition, the cap on the Company’s contribution to pre-65 retiree medical costs per participant was reduced beginning with the 2011 plan year.

Applicable information regarding the actuarial present value of vested and non-vested accumulated plan benefits, and the net assets of the plans available for benefits, is omitted as the information is not separately calculated for our participation in the plans. PNX, the plan sponsor, established an accrued liability and amounts attributable to us have been allocated.

Employee benefit expense allocated to us totaled $3.2 million, $4.6 million and $7.6 million for 2013, 2012 and 2011, respectively. Over the next 12 months, Phoenix Life expects to make contributions to the pension plan of which $6.4 million will be allocated to us. On July 6, 2012, the Surface Transportation Extension Act of 2012, Part II, was enacted into law and was effective immediately. The law includes certain pension funding stabilization provisions, which the Company took advantage of in 2012.


14.
Share-Based Payments

The Phoenix has a share-based compensation to certain employees and non-employee directors. The Company is included in these plans and has been allocated compensation expense of $1.3 million, $1.1 million and $1.7 million for the years ended December 31, 2013, 2012 and 2011, respectively. The Company’s income tax benefit recognized for stock-based compensation plans was $(0.5) million, $(0.4) million and $(0.6) million for the years ended December 31, 2013, 2012 and 2011, respectively. The Company did not capitalize the cost of stock-based compensation.


15.
Statutory Financial Information and Regulatory Matters

We are required to file annual statements with state regulatory authorities prepared on an accounting basis prescribed or permitted by such authorities. The State of Connecticut Insurance Department (the “Department”) has adopted the National Association of Insurance Commissioners’ (the “NAIC’s”) Accounting Practices and Procedures manual effective January 1, 2001 (“NAIC SAP”) as a component of its prescribed or permitted statutory accounting practices. As of December 31, 2013, 2012 and 2011, the Department has not prescribed or permitted us to use any accounting practices that would materially deviate from NAIC SAP. Statutory surplus differs from equity reported in accordance with U.S. GAAP primarily because policy acquisition costs are expensed when incurred, life insurance reserves are based on different assumptions and deferred tax assets are limited to amounts reversing in a specified period with an additional limitation based upon 10% or 15% of statutory surplus, dependent on meeting certain risk-based capital (“RBC”) thresholds.

Connecticut Insurance Law requires that Connecticut life insurers report their RBC. RBC is based on a formula calculated by applying factors to various assets, premium and statutory reserve items. The formula takes into account the risk characteristics of the insurer, including asset risk, insurance risk, interest rate risk and business risk. Connecticut Insurance Law gives the Connecticut Commissioner of Insurance explicit regulatory authority to require various actions by, or take various actions against, insurers whose total adjusted capital does not exceed certain RBC levels. Our RBC was in excess of 250% of Company Action Level (the level where a life insurance enterprise must submit a comprehensive plan to state insurance regulators) as of December 31, 2013 and 2012.


F-52



15.
Statutory Financial Information and Regulatory Matters (continued)

The information below is taking from the PHL Variable annual statement filed with state regulatory authorities.
Statutory Financial Data: [1]
As of or For the Years Ended December 31,
($ in millions)
2013
 
2012
 
2011
 
 
 
 
 
 
Statutory capital and surplus
$
222.9

 
$
313.5

 
$
312.8

Asset valuation reserve
12.3

 
7.5

 
7.3

Statutory capital, surplus and asset valuation reserve
$
235.2

 
$
321.0

 
$
320.1

Statutory gain (loss) from operations
$
(67.6
)
 
$
61.9

 
$
56.4

Statutory net income (loss)
$
(86.1
)
 
$
49.7

 
$
61.4

———————
[1]
Amounts in statements filed with state regulatory authorities may differ from audited financial statements.

The Company reflected negative net prior period adjustments of $8.1 million in surplus of the Company's quarterly financial statements for the six months ended June 30, 2014 filed with state regulatory authorities.

The Connecticut Insurance Holding Company Act limits the maximum amount of annual dividends and other distributions in any 12-month period to stockholders of Connecticut domiciled insurance companies without prior approval of the Insurance Commissioner. Under current law, we cannot make any dividend distribution during 2014 without prior approval.


16.
Contingent Liabilities

Litigation and arbitration

The Company is regularly involved in litigation and arbitration, both as a defendant and as a plaintiff. The litigation and arbitration naming the Company as a defendant ordinarily involves our activities as an insurer, employer, investor, investment advisor or taxpayer.

It is not feasible to predict or determine the ultimate outcome of all legal or arbitration proceedings or to provide reasonable ranges of potential losses. Management of the Company believes that the outcome of our litigation and arbitration matters described below are not likely, either individually or in the aggregate, to have a material adverse effect on the financial condition of the Company. However, given the large or indeterminate amounts sought in certain of these matters and the inherent unpredictability of litigation and arbitration, it is possible that an adverse outcome in certain matters could, from time to time, have a material adverse effect on the results of operations or cash flows in particular quarterly or annual periods.

SEC Cease-and-Desist Order

On February 12, 2014, PNX and the Company submitted an Offer of Settlement with the SEC pursuant to which PNX and the Company consented to the issuance of the form of an Order Instituting Cease-and-Desist Proceedings Pursuant to Section 21C of the Securities Exchange Act of 1934, Making Findings, and Imposing a Cease-and-Desist Order (the “March 2014 Order”). The March 2014 Order was approved by the SEC on March 21, 2014. Pursuant to the March 2014 Order, PNX and the Company have been directed to cease and desist from committing or causing any violations and any future violations of Section 13(a) of the Exchange Act and Rules 13a-1 and 13a-13 thereunder and Section 15(d) of the Exchange Act and Rules 15d-1 and 15d-13 thereunder. PNX and the Company each paid a civil monetary penalty in the amount of $375,000 to the U.S. Treasury following the entry of the March 2014 Order.

PNX filed the 2012 Form 10-K a day after the date required by the March 2014 Order, filed its third quarter 2012 Form 10-Q eight days after the date required by the March 2014 Order, and announced on June 3, 2014 that it would not file its 2013 Annual Report on Form 10-K by the date required by the March 2014 Order. PHL Variable filed its 2012 Form 10-K ten days after the date required by the March 2014 Order and announced on June 3, 2014 that it would not file its 2013 Annual Report on Form 10- K by the date required by the March 2014 Order. PHL Variable filed its third quarter 2012 Form 10-Q in compliance with the March 2014 Order.


F-53



16.
Contingent Liabilities (continued)

On July 16, 2014, PNX and the Company submitted an Amended Offer of Settlement with the SEC (the “Amended Offer”) pursuant to which PNX and the Company consented to the issuance of the form of an Order Amending Order Instituting Cease-and-Desist Proceedings Pursuant to Section 21C of the Securities Exchange Act of 1934, Making Findings, and Imposing a Cease-and-Desist Order (the “Amended Order”). Except as amended by the Amended Order, which was approved by the SEC on August 1, 2014, the March 2014 Order remains in effect. PNX and the Company each paid a civil monetary penalty in the amount of $100,000 to the U.S. Treasury following the entry of the Amended Order, and will be required to pay the following additional monetary penalties with respect to a future late filing of any Company and/or PNX periodic report covered by the Amended Order: $20,000 per filing for the first week in which a filing is delinquent, plus, for each week or partial week thereafter an additional amount equal to the sum of a) $20,000 and b) $5,000 multiplied by the number of complete weeks that the filing has been delinquent before the week in which the late filing is made. PNX filed its Annual Report on Form 10-K for the year ended December 31, 2013 with the SEC on August 6, 2014 in compliance with the Amended Order.

The following table sets forth the deadlines in the Amended Order for Phoenix’s SEC periodic reports:

Phoenix Timetable of SEC Periodic Reports
Form
Period
Amended Deadline
10-K
Year ended December 31, 2013
August 6, 2014
10-Q
Quarterly Period ended March 31, 2013
September 10, 2014
10-Q
Quarterly Period ended June 30, 2013
September 10, 2014
10-Q
Quarterly Period ended September 30, 2013
September 10, 2014
10-Q
Quarterly Period ended March 31, 2014
October 17, 2014
10-Q
Quarterly Period ended June 30, 2014
October 24, 2014
10-Q
Quarterly Period ended September 30, 2014
December 5, 2014

As of the date of filing of this Form 10-K, Phoenix believes it will become a timely filer with the filing of its Annual Report on Form 10-K for the year ending December 31, 2014.

The following table sets forth the deadlines in the Amended Order for the Company’s SEC periodic reports:

PHL Variable Timetable of SEC Periodic Reports
Form
Period
Amended Deadline
10-K
Year ended December 31, 2013
August 22, 2014
10-Q
Quarterly Period ended March 31, 2013
September 12, 2014
10-Q
Quarterly Period ended June 30, 2013
September 12, 2014
10-Q
Quarterly Period ended September 30, 2013
September 12, 2014
10-Q
Quarterly Period ended March 31, 2014
October 21, 2014
10-Q
Quarterly Period ended June 30, 2014
October 28, 2014
10-Q
Quarterly Period ended September 30, 2014
December 12, 2014

As of the date of filing of this Form 10-K, the Company believes it will become a timely filer with the filing of its Annual Report on Form 10-K for the year ending December 31, 2014. This Form 10-K was filed in compliance with the Amended Order.


F-54



16.
Contingent Liabilities (continued)

Cases Brought by Policy Investors

On June 5, 2012, Wilmington Savings Fund Society, FSB, as successor in interest to Christiana Bank & Trust Company and as trustee of 60 unnamed trusts, filed a complaint against PNX, Phoenix Life and the Company in the United States District Court for the Central District of California; this case was later transferred to the District of Delaware (C.A. No. 13-499-RGA) by order dated March 28, 2013. After the plaintiffs twice amended their complaint, and dropped PNX as a defendant and dropped one of the plaintiff Trusts, the court issued an order on April 9, 2014 dismissing seven of the ten counts, and partially dismissing two more, with prejudice. The court dismissed claims alleged that Phoenix Life and the Company committed RICO violations and fraud by continuing to collect premiums while concealing an intent to later deny death claims. The claims that remain in the case seek a declaration that the policies at issue are valid, and damages relating to cost of insurance increases. We believe we have meritorious defenses against this lawsuit and we intend to vigorously defend against these claims. The outcome of this litigation and any potential losses are uncertain.

On August 2, 2012, Lima LS PLC filed a complaint against PNX, Phoenix Life, the Company, James D. Wehr, Philip K. Polkinghorn, Edward W. Cassidy, Dona D. Young and other unnamed defendants in the United States District Court for the District of Connecticut (Case No. CV12-01122). On July 1, 2013, the defendants’ motion to dismiss the complaint was granted in part and denied in part. Thereafter, on July 31, 2013, the plaintiff served an amended complaint against the same defendants, with the exception that Mr. Cassidy was dropped as a defendant. The plaintiffs allege that Phoenix promoted certain policy sales knowing that the policies would ultimately be owned by investors and then challenging the validity of these policies or denying claims submitted on these policies. Plaintiffs are seeking damages, including punitive and treble damages, attorneys’ fees and a declaratory judgment. We believe we have meritorious defenses against this lawsuit and we intend to vigorously defend against these claims. The outcome of this litigation and any potential losses are uncertain.

Cost of Insurance Cases

By order dated July 12, 2013, two separate classes were certified in an action pending in the United States District Court for the Southern District of New York (C.A. No. 1:11-cv-08405-CM-JCF (U.S. Dist. Ct; S.D.N.Y.)) brought by Martin Fleisher and another plaintiff (the “Fleisher Litigation”), on behalf of themselves and others similarly situated, against Phoenix Life. By subsequent order dated August 26, 2013, the court decertified one of the classes. The complaint in the Fleisher Litigation, filed on November 18, 2011, challenges COI rate adjustments implemented by Phoenix Life, which Phoenix Life maintains were based on policy language permitting such adjustments. The complaint seeks damages for breach of contract. The class certified in the court’s July 12, 2013 order, as limited by the court’s August 26, 2013 order, is limited to holders of Phoenix Life policies issued in New York and subject to New York law. By order dated April 29, 2014, the court denied Martin Fleisher’s motion for summary judgment in the Fleisher Litigation in its entirety, while granting in part and denying in part Phoenix Life’s motion for summary judgment.

The Company, a subsidiary of Phoenix Life, has been named as a defendant in four actions challenging its COI rate adjustments implemented concurrently with the Phoenix Life adjustments. These four cases, which are not styled as class actions, have been brought against the Company by (1) Tiger Capital LLC (C.A. No. 1:12-cv- 02939-CM-JCF; U.S. Dist. Ct; S.D.N.Y., complaint filed on March 14, 2012; the “Tiger Capital Litigation”) and (2-4) U.S. Bank National Association, as securities intermediary for Lima Acquisition LP ((2: C.A. No. 1:12-cv-06811-CM-JCF; U.S. Dist. Ct; S.D.N.Y., complaint filed on November 16, 2011; 3: C.A. No. 1:13-cv-01580-CM-JCF; U.S. Dist. Ct; S.D.N.Y., complaint filed on March 8, 2013; collectively, the “U.S. Bank N.Y. Litigations”)); and 4: C.A. No. 1:13-cv-00368-GMS; U.S. Dist. Ct; D. Del., complaint filed on March 6, 2013; the “Delaware Litigation”). The Tiger Capital Litigation and the two U.S. Bank N.Y. Litigations have been assigned to the same judge as the Fleisher Litigation, and discovery in these four actions, which was coordinated by the court, has concluded. By orders in both U.S. Bank N.Y. Litigations dated May 23, 2014 the court denied U.S. Bank’s motions for summary judgment in their entirety, while granting in part and denying in part the Company’s motions for summary judgment. U.S. Bank moved for reconsideration of the court’s summary judgment decisions in the U.S. Bank N.Y. Litigation, which the court denied by orders dated June 4, 2014. By order in the Tiger Capital Litigation dated July 23, 2014, the court denied Tiger Capital’s motion for summary judgment in its entirety, while granting in part and denying in part PHL Variable’s motion for summary judgment. The Delaware Litigation is proceeding separately and by order dated April 22, 2014 was transferred to the U.S. District Court for the District of Connecticut and assigned a new docket number (C.A. No. 3:14-cv-0555-WWE). The plaintiffs seek damages and attorneys’ fees for breach of contract and other common law and statutory claims.


F-55



16.
Contingent Liabilities (continued)

Complaints to state insurance departments regarding the Company’s COI rate adjustments have also prompted regulatory inquiries or investigations in several states, with two of such states (California and Wisconsin) issuing letters directing the Company to take remedial action in response to complaints by a single policyholder. The Company disagrees with both states’ positions and, on April 30, 2013, Wisconsin commenced an administrative hearing to obtain a formal ruling on its position, which is pending. (OCI Case No. 13-C35362).

The Company and Phoenix Life believe that they have meritorious defenses against all of these lawsuits and regulatory directives and intend to vigorously defend against them. The outcome of these matters is uncertain and any potential losses cannot be reasonably estimated.

Shareholder Action

On April 17, 2013, Robert Strougo, et al. filed a complaint against the Company, James D. Wehr and Peter A. Hofmann in the United States District Court for the District of Connecticut (Case No. 13-CV-547-RNC) (the “Strougo Litigation”). On November 1, 2013, the plaintiffs filed an amended complaint joining Michael E. Hanrahan as an additional individual defendant. The plaintiffs seek to recover on behalf of themselves and a class defined as all persons (other than the defendants) who purchased or otherwise acquired PNX’s securities between May 5, 2009 and August 14, 2013 for claims arising out of PNX’s announced intent to restate previously filed financial statements. The plaintiffs allege that, throughout the class period, PNX made materially false and misleading statements regarding PNX’s business, operational and compliance policies. The plaintiffs seek damages, attorneys’ fees and other litigation costs. On June 2, 2014, prior to moving to certify a class, the plaintiffs voluntarily dismissed the action with prejudice as to the named plaintiffs.

Regulatory matters

State regulatory bodies, the Securities and Exchange Commission (the “SEC”), the Financial Industry Regulatory Authority (“FINRA”), the IRS and other regulatory bodies regularly make inquiries of us and, from time to time, conduct examinations or investigations concerning our compliance with laws and regulations related to, among other things, our insurance and broker-dealer subsidiaries, securities offerings and registered products. We endeavor to respond to such inquiries in an appropriate way and to take corrective action if warranted. Further, PNX is providing to the SEC certain information and documentation regarding the Restatement and the staff of the SEC has indicated to PNX that the matter remains subject to further investigation and potential further regulatory action. We cannot predict the outcome of any of such investigations or actions related to these or other matters.

Regulatory actions may be difficult to assess or quantify. The nature and magnitude of their outcomes may remain unknown for substantial periods of time. It is not feasible to predict or determine the ultimate outcome of all pending inquiries, investigations, legal proceedings and other regulatory actions, or to provide reasonable ranges of potential losses. Based on current information, we believe that the outcomes of our regulatory matters are not likely, either individually or in the aggregate, to have a material adverse effect on our financial condition. However, given the inherent unpredictability of regulatory matters, it is possible that an adverse outcome in certain matters could, from time to time, have a material adverse effect on our financial statements in particular quarterly or annual periods.

State Insurance Department Examinations

During 2012 and 2013, the Connecticut Insurance Department conducted its routine financial examination of the Company and two other Connecticut-domiciled insurance affiliates. A report from the Connecticut Insurance Department was issued on May 28, 2014. We expect to receive final market conduct examination reports in 2014.

In 2013, the Connecticut Insurance Department commenced a market conduct examination of the Company and two other Connecticut-domiciled insurance affiliates. The report from this examination will also be available in 2014.


F-56



16.
Contingent Liabilities (continued)

Unclaimed Property Inquiries

In late 2012, PNX and the Company and their affiliates received separate notices from Unclaimed Property Clearing House (“UPCH”) and Kelmar Associates, LLC (“Kelmar”) that UPCH and Kelmar had been authorized by the unclaimed property administrators in certain states to conduct unclaimed property audits. The audits began in 2013 and are being conducted on the PNX enterprise with a focus on death benefit payments; however, all amounts owed by any aspect of the PNX enterprise are also a focus. This includes any payments to vendors, brokers, former employees and shareholders. UPCH represents 33 states and the District of Columbia and Kelmar represents six states.


17.
Supplemental Unaudited Quarterly Financial Information

The following tables reflect unaudited summarized quarterly financial results during the years ended December 31, 2013 and 2012.
Summarized Selected Quarterly Financial Data:
Quarter Ended
($ in millions)
Mar 31, [1]
 
June 30,
 
Sept 30,
 
Dec 31,
 
2013
 
 
 
 
 
 
 
 
Revenues
$
108.8

 
$
137.1

 
$
130.6

 
$
149.2

 
 
 
 
 
 
 
 
Benefits and expenses
$
131.1

 
$
149.4

 
$
143.2

 
$
68.0

 
 
 
 
 
 
 
 
Income tax expense (benefit)
$
(1.9
)
 
$
(16.9
)
 
$
2.6

 
$
(5.5
)
 
 
 
 
 
 
 
 
Net income (loss)
$
(20.4
)
 
$
4.6

 
$
(15.2
)
 
$
86.7

———————
[1]
Results for the quarter ended March 31, 2013 include $3.2 million of income (loss) related to out of period adjustments. Such amounts are not material to any period presented.

Summarized Selected Quarterly Financial Data:
Quarter Ended
($ in millions)
Mar 31,
 
June 30,
 
Sept 30,
 
Dec 31,
 
2012
 
 
 
 
 
 
 
 
Revenues
$
125.6

 
$
111.7

 
$
130.2

 
$
114.9

 
 
 
 
 
 
 
 
Benefits and expenses
$
129.3

 
$
143.3

 
$
206.5

 
$
124.8

 
 
 
 
 
 
 
 
Income tax expense (benefit)
$
18.8

 
$
0.5

 
$
4.3

 
$
(7.4
)
 
 
 
 
 
 
 
 
Net income (loss)
$
(22.5
)
 
$
(32.1
)
 
$
(80.6
)
 
$
(2.5
)



F-57



17.
Supplemental Unaudited Quarterly Financial Information (continued)

($ in millions)
Statements of Income and Comprehensive Income
 
Three months ended
 
Mar 31,
 
June 30,
 
Sept 30,
 
Dec 31,
 
2013
REVENUES:
 
 
 
 
 
 
 

Premiums
$
3.1

 
$
5.1

 
$
3.1

 
$
2.6

Insurance and investment product fees
90.1

 
87.2

 
94.0

 
96.3

Net investment income
33.0

 
34.1

 
36.3

 
37.4

Net realized investment gains (losses):
 
 
 
 
 
 
 
Total OTTI losses
(0.3
)
 

 
(0.2
)
 
(0.6
)
Portion of OTTI losses recognized in OCI
(0.7
)
 
(0.2
)
 

 

Net OTTI losses recognized in earnings
(1.0
)
 
(0.2
)
 
(0.2
)
 
(0.6
)
Net realized investment gains (losses), excluding OTTI losses
(16.4
)
 
10.9

 
(2.6
)
 
13.5

Net realized investment gains (losses)
(17.4
)
 
10.7

 
(2.8
)
 
12.9

Total revenues
108.8

 
137.1

 
130.6

 
149.2

 
 
 
 
 
 
 
 

BENEFITS AND EXPENSES:
 
 
 
 
 
 
 

Policy benefits
88.5

 
91.4

 
91.8

 
14.8

Policy acquisition cost amortization
14.0

 
26.6

 
22.2

 
25.6

Other operating expenses
28.6

 
31.4

 
29.2

 
27.6

Total benefits and expenses
131.1

 
149.4

 
143.2

 
68.0

Income (loss) before income taxes
(22.3
)
 
(12.3
)
 
(12.6
)
 
81.2

Income tax expense (benefit)
(1.9
)
 
(16.9
)
 
2.6

 
(5.5
)
Net income (loss)
$
(20.4
)
 
$
4.6

 
$
(15.2
)
 
$
86.7

 
 
 
 
 
 
 
 
COMPREHENSIVE INCOME (LOSS):
 
 
 
 
 
 
 
Net income (loss)
$
(20.4
)
 
$
4.6

 
$
(15.2
)
 
$
86.7

Other comprehensive income (loss) before income taxes:
 
 
 
 
 
 
 
  Unrealized investment gains (losses), net of related offsets
(13.3
)
 
(12.1
)
 
9.9

 
(19.6
)
Less: Income tax expense (benefit) related to:
 
 
 
 
 
 
 
Unrealized investment gains (losses), net of related offsets
2.7

 
(12.1
)
 
(0.3
)
 
(2.1
)
Other comprehensive income (loss), net of income taxes
(16.0
)
 

 
10.2

 
(17.5
)
Comprehensive income (loss)
$
(36.4
)
 
$
4.6

 
$
(5.0
)
 
$
69.2



F-58



17.
Supplemental Unaudited Quarterly Financial Information (continued)
($ in millions)
Statements of Income
and Comprehensive Income
 
For the period ended
 
June 30,
 
Sept 30,
 
2013
REVENUES:
 
 
 
Premiums
$
8.2

 
$
11.3

Insurance and investment product fees
177.3

 
271.3

Net investment income
67.1

 
103.4

Net realized investment gains (losses):
 
 
 
Total OTTI losses
(0.3
)
 
(0.5
)
Portion of OTTI losses recognized in OCI
(0.9
)
 
(0.9
)
Net OTTI losses recognized in earnings
(1.2
)
 
(1.4
)
Net realized investment gains (losses), excluding OTTI losses
(5.5
)
 
(8.1
)
Net realized investment gains (losses)
(6.7
)
 
(9.5
)
Total revenues
245.9

 
376.5

 
 
 
 
BENEFITS AND EXPENSES:
 
 
 
Policy benefits, excluding policyholder dividends
179.9

 
271.7

Policy acquisition cost amortization
40.6

 
62.8

Other operating expenses
60.0

 
89.2

Total benefits and expenses
280.5

 
423.7

Loss before income taxes
(34.6
)
 
(47.2
)
Income tax expense (benefit)
(18.8
)
 
(16.2
)
Net income (loss)
$
(15.8
)
 
$
(31.0
)
 
 
 
 
COMPREHENSIVE INCOME (LOSS):
 
 
 
Net income (loss)
$
(15.8
)
 
$
(31.0
)
Other comprehensive income (loss) before income taxes:
 
 
 
  Unrealized investment gains (losses), net of related offsets
(25.4
)
 
(15.5
)
Less: Income tax expense (benefit) related to:
 
 
 
Unrealized investment gains (losses), net of related offsets
(9.4
)
 
(9.7
)
Other comprehensive income (loss), net of income taxes
(16.0
)
 
(5.8
)
Comprehensive income (loss)
$
(31.8
)
 
$
(36.8
)



F-59



17.
Supplemental Unaudited Quarterly Financial Information (continued)

($ in millions, except share data)
Balance Sheets
 
For the period ended
 
Mar 31,
 
June 30,
 
Sept 30,
 
2013
ASSETS:
 
 
 
 
 
Available-for-sale debt securities, at fair value
$
3,054.7

 
$
3,162.2

 
$
3,252.1

Short-term investments
224.9

 
165.0

 
55.0

Limited partnerships and other investments
5.7

 
7.2

 
10.3

Policy loans, at unpaid principal balances
61.5

 
62.8

 
65.6

Derivative investments
186.6

 
199.3

 
190.7

Fair value investments
46.5

 
48.8

 
53.1

Total investments
3,579.9

 
3,645.3

 
3,626.8

Cash and cash equivalents
116.2

 
123.9

 
218.1

Accrued investment income
29.0

 
25.7

 
29.7

Receivables
9.8

 
8.6

 
14.3

Reinsurance recoverable
444.1

 
455.5

 
484.8

Deferred policy acquisition costs
433.6

 
463.1

 
458.5

Deferred income taxes, net
13.4

 
25.5

 
25.8

Receivables from related parties

 
6.0

 
2.0

Other assets
162.2

 
182.4

 
190.4

Separate account assets
2,109.5

 
2,021.3

 
2,049.5

Total assets
$
6,897.7

 
$
6,957.3

 
$
7,099.9

 
 
 
 
 
 
LIABILITIES:
 
 
 
 
 
Policy liabilities and accruals
$
1,930.8

 
$
1,926.5

 
$
1,974.9

Policyholder deposit funds
2,468.1

 
2,566.5

 
2,660.9

Payable to related parties
15.5

 
18.3

 
12.6

Other liabilities
115.1

 
161.4

 
143.7

Separate account liabilities
2,109.5

 
2,021.3

 
2,049.5

Total liabilities
6,639.0

 
6,694.0

 
6,841.6

 
 
 
 
 
 
COMMITMENTS AND CONTINGENT LIABILITIES (Note 16)


 


 


 
 
 
 
 
 
STOCKHOLDERS EQUITY:
 
 
 
 
 
Common stock, $5,000 par value: 1,000 shares authorized; 500 shares issued
2.5

 
2.5

 
2.5

Additional paid-in capital
802.2

 
802.2

 
802.2

Accumulated other comprehensive gain (loss)
(4.6
)
 
(4.6
)
 
5.6

Retained earnings (accumulated deficit)
(541.4
)
 
(536.8
)
 
(552.0
)
Total stockholders equity
258.7

 
263.3

 
258.3

Total liabilities and stockholders equity
$
6,897.7

 
$
6,957.3

 
$
7,099.9




F-60



17.
Supplemental Unaudited Quarterly Financial Information (continued)

($ in millions)
Statement of
Changes in Stockholder
s Equity
 
For the period ended
 
Mar 31,
 
June 30,
 
Sept 30,
 
2013
COMMON STOCK:
 
 
 
 
 
  Balance, beginning of period
$
2.5

 
$
2.5

 
$
2.5

  Balance, end of period
$
2.5

 
$
2.5

 
$
2.5

 
 
 
 
 
 
ADDITIONAL PAID-IN CAPITAL:
 
 
 
 
 
  Balance, beginning of period
$
802.2

 
$
802.2

 
$
802.2

    Capital contributions from parent

 

 

  Balance, end of period
$
802.2

 
$
802.2

 
$
802.2

 
 
 
 
 
 
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS):
 
 
 
 
 
  Balance, beginning of period
$
11.4

 
$
11.4

 
$
11.4

    Other comprehensive income (loss)
(16.0
)
 
(16.0
)
 
(5.8
)
  Balance, end of period
$
(4.6
)
 
$
(4.6
)
 
$
5.6

 
 
 
 
 
 
RETAINED EARNINGS (ACCUMULATED DEFICIT):
 
 
 
 
 
  Balance, beginning of period
$
(521.0
)
 
$
(521.0
)
 
$
(521.0
)
    Net income (loss)
(20.4
)
 
(15.8
)
 
(31.0
)
  Balance, end of period
$
(541.4
)
 
$
(536.8
)
 
$
(552.0
)
 
 
 
 
 
 
TOTAL STOCKHOLDERS EQUITY:
 
 
 
 
 
  Balance, beginning of period
$
295.1

 
$
295.1

 
$
295.1

    Change in stockholder’s equity
(36.4
)
 
(31.8
)
 
(36.8
)
  Stockholders equity, end of period
$
258.7

 
$
263.3

 
$
258.3




F-61



17.
Supplemental Unaudited Quarterly Financial Information (continued)

($ in millions)
Statements of Cash Flows
 
For the period ended
 
Mar 31,
 
June 30,
 
Sept 30,
 
2013
OPERATING ACTIVITIES:
 
 
 
 
 
Net income (loss)
$
(20.4
)
 
$
(15.8
)
 
$
(31.0
)
Net realized investment (gains) losses
17.4

 
6.7

 
9.5

Policy acquisition costs deferred
(17.2
)
 
(33.5
)
 
(49.6
)
Amortization of deferred policy acquisition costs
14.0

 
40.6

 
62.8

Interest credited
18.4

 
40.1

 
64.0

Equity in earnings of limited partnerships and other investments
0.8

 
(0.1
)
 
(0.3
)
Change in:
 
 
 
 
 
  Accrued investment income
(6.8
)
 
(3.7
)
 
(8.5
)
  Deferred income taxes

 

 

  Receivables
6.4

 
7.6

 
1.9

  Reinsurance recoverable
(17.0
)
 
(28.4
)
 
(57.7
)
  Policy liabilities and accruals
(55.5
)
 
(59.5
)
 
(70.7
)
  Due to/from affiliate
4.5

 
1.3

 
(0.4
)
Other operating activities, net
3.6

 
(4.4
)
 
7.4

Cash provided by (used for) operating activities
(51.8
)
 
(49.1
)
 
(72.6
)
 
 
 
 
 
 
INVESTING ACTIVITIES:
 
 
 
 
 
Purchases of:
 
 
 
 
 
  Available-for-sale debt securities
(155.0
)
 
(429.8
)
 
(672.3
)
  Short-term investments
(224.8
)
 
(224.8
)
 
(224.8
)
  Derivative instruments
(35.1
)
 
(50.1
)
 
(62.7
)
  Fair value investments
(9.8
)
 
(14.6
)
 
(21.1
)
Sales, repayments and maturities of:
 
 
 
 
 
  Available-for-sale debt securities
73.4

 
151.3

 
261.2

  Short-term investments
244.9

 
304.8

 
414.8

  Derivative instruments
7.7

 
15.8

 
27.4

  Fair value investments
1.7

 
3.7

 
5.7

Contributions to limited partnerships
(0.3
)
 
(0.4
)
 
(3.5
)
Distributions from limited partnerships

 
0.1

 
0.4

Policy loans, net
0.2

 
(0.6
)
 
(2.7
)
Other investing activities, net
0.1

 
0.1

 
0.1

Cash provided by (used for) investing activities
(97.0
)
 
(244.5
)
 
(277.5
)
 
 
 
 
 
 
FINANCING ACTIVITIES:
 
 
 
 
 
Policyholder deposit fund deposits
247.2

 
469.9

 
690.7

Policyholder deposit fund withdrawals
(135.3
)
 
(280.0
)
 
(434.6
)
Net transfers to/from separate accounts
70.0

 
144.5

 
229.0

Cash provided by (used for) financing activities
181.9

 
334.4

 
485.1

Change in cash and cash equivalents
33.1

 
40.8

 
135.0

Cash and cash equivalents, beginning of period
83.1

 
83.1

 
83.1

Cash and cash equivalents, end of period
$
116.2

 
$
123.9

 
$
218.1

 
 
 
 
 
 
Supplemental Disclosure of Cash Flow Information
 
 
 
 
 
Income taxes paid (refunded)
$
(3.7
)
 
$
(9.0
)
 
$
(25.5
)
 
 
 
 
 
 
Non-Cash Transactions During the Year
 
 
 
 
 
Investment exchanges
$
19.0

 
$
29.6

 
$
30.5



F-62



18.
Subsequent Events

Management and Organizational Changes

On August 11, 2014, Phoenix announced the resignation of Douglas C. Miller as Senior Vice President and Chief Accounting Officer of Phoenix and the appointment of Ernest McNeill, Jr. as Senior Vice President and Chief Accounting Officer of Phoenix, each effective August 25, 2014.

Late Filings

On February 28, 2014, we filed a Notification of Late Filing on Form 12b-25 with the SEC disclosing that we would be unable to timely file our 2013 Annual Report on Form 10-K with the SEC.

On May 12, 2014, we filed a Notification of Late Filing on Form 12b-25 with the SEC disclosing that we would be unable to timely file our first quarter 2014 Quarterly Report on Form 10-Q with the SEC.

On August 8, 2014, we filed a Notification of Late Filing on Form 12b-25 with the SEC disclosing that we would be unable to timely file our second quarter 2014 Quarterly Report on Form 10-Q with the SEC.

Rating Agency Actions

On January 14, 2014, Moody’s Investor Services withdrew the Ba2 financial strength rating of the Company.

On May 20, 2014, Standard & Poor’s Ratings Services placed its ‘B-’, long-term counterparty credit rating on Phoenix and its ‘BB-’ long-term counterparty credit and financial strength ratings on Phoenix Life and the Company on CreditWatch with negative implications.

On August 12, 2014, Standard & Poor's Ratings Services lowered its financial strength ratings on Phoenix Life and the Company to 'B+' from 'BB-' and affirmed its 'B-' long-term counterparty credit rating on Phoenix. They removed the ratings from CreditWatch and assigned a negative outlook. They also affirmed Phoenix's long-term counterparty credit rating.

SEC Cease-and-Desist Order

See Note 16 to these financial statements for additional information regarding the SEC Cease-and-Desist Order, as amended.


F-63