PHL VARIABLE INSURANCE CO /CT/ - FORM 10-Q - September 12, 2014

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
—————————
FORM 10-Q
—————————
(Mark one)
 
 
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 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 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 twelve 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 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
¨
Accelerated filer
¨
Non-accelerated filer
þ
Smaller reporting company
¨
 
 
 
 
 (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 September 4, 2014, there were 500 shares of the registrant’s common stock outstanding.

The registrant is filing this Quarterly Report on Form 10-Q with the reduced disclosure format permitted by General Instruction H(1)(a) and (b) of Form 10-Q.
 


Explanatory Note

This Quarterly Report on Form 10-Q for the period ended September 30, 2013 (this “Form 10-Q”) is being filed by PHL Variable Insurance Company (“we,” “our,” “us,” the “Company,” or “PHL Variable”) subsequent to the filing of the Company’s Annual Report on Form 10-K for the year ended December 31, 2013, which was filed with the Securities and Exchange Commission (the “SEC”) on August 22, 2014 (the “2013 Form 10-K”). The 2013 Form 10-K contains audited financial statements of the Company for the years ended December 31, 2013, 2012 and 2011 and unaudited financial information presented for each quarter during the fiscal year 2013.

The Company filed a Current Report on Form 8-K with the SEC on September 18, 2012 (as was amended by Forms 8-K/A filed by the Company on November 8, 2012, March 15, 2013 and April 24, 2013, respectively) disclosing its conclusion that certain of its previously issued annual audited and unaudited financial statements contained in its historical Annual Reports on Form 10-K and Quarterly Reports on Form 10-Q should no longer be relied upon and should be restated.

In the Company’s Annual Report on Form 10-K for the year ended December 31, 2012, which was filed with the SEC on April 25, 2014 (the “2012 Form 10-K”), the Company restated and corrected the following financial statements of the Company (the “Restatement”): (i) the audited balance sheet as of December 31, 2011 and statements of income and comprehensive income, statements of cash flows, statements of changes in stockholder’s equity and cash flows for each of the years ended December 31, 2011 and 2010; and (ii) the unaudited statements of income and comprehensive income, unaudited balance sheets, unaudited statements of cash flow and unaudited statements of changes in stockholder’s equity for the periods ended March 31 and June 30, 2012 and for each of the quarterly periods in fiscal year 2011. In addition, prior periods have been amended for the retrospective adoption of amendments to ASC 944, Financial Services - Insurance (ASU 2010-26, “Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts”) and correction of accounting errors related to the adoption as originally reported in the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2012. The 2012 Form 10-K was filed by the Company in lieu of the Company separately filing with the SEC amendments to its previously filed Annual Reports on Form 10-K for each of the years ended December 31, 2011 and 2010 and its previously filed Quarterly Reports on Form 10-Q for the quarterly periods ended March 31 and June 30, 2012, and March 31, June 30 and September 30, 2011.

The unaudited financial statements for the three and nine month periods ended September 30, 2012 contained in this Form 10-Q are consistent with the restated and amended financial statements for the year ended December 31, 2012 and the three and nine month periods ended September 30, 2012 contained in the 2012 Form 10-K, and reflects corrections that were made during the Restatement process impacting such periods and to amend such unaudited financial statements for the impact of the retrospective adoption of amended accounting guidance. The unaudited financial statements for the three and nine month periods ended September 30, 2013 contained in this Form 10-Q are consistent with those contained in the 2013 Form 10-K.

The information contained in this Form 10-Q serves to update the financial statements of the Company for the year ended December 31, 2012 contained in the 2012 Form 10-K, but does not serve to update the financial statements of the Company for the year ended December 31, 2013 contained in the 2013 Form 10-K.



2


3

PART I. FINANCIAL INFORMATION


Item 1.    FINANCIAL STATEMENTS

PHL VARIABLE INSURANCE COMPANY
Unaudited Balance Sheets
($ in millions, except share data)
September 30, 2013 and December 31, 2012

 
September 30, 2013
 
December 31, 2012
ASSETS:
 

 
 

Available-for-sale debt securities, at fair value (amortized cost of $3,207.2 and $2,798.1)
$
3,252.1

 
$
2,972.3

Short-term investments
55.0

 
244.9

Limited partnerships and other investments
10.3

 
6.7

Policy loans, at unpaid principal balances
65.6

 
61.0

Derivative instruments
190.7

 
149.4

Fair value investments
53.1

 
38.5

Total investments
3,626.8

 
3,472.8

Cash and cash equivalents
218.1

 
83.1

Accrued investment income
29.7

 
23.2

Receivables
14.3

 
16.2

Reinsurance recoverable
484.8

 
427.1

Deferred policy acquisition costs
458.5

 
426.2

Deferred income taxes, net
25.8

 
16.2

Receivable from related parties
2.0

 
—

Other assets
190.4

 
135.5

Separate account assets
2,049.5

 
2,061.8

Total assets
$
7,099.9

 
$
6,662.1

 
 
 
 
LIABILITIES:
 

 
 

Policy liabilities and accruals
$
1,974.9

 
$
1,876.2

Policyholder deposit funds
2,660.9

 
2,349.8

Payable to related parties
12.6

 
11.0

Other liabilities
143.7

 
68.2

Separate account liabilities
2,049.5

 
2,061.8

Total liabilities
6,841.6

 
6,367.0

 
 
 
 
COMMITMENTS AND CONTINGENT LIABILITIES (Note 13)


 


 
 
 
 
STOCKHOLDER’S EQUITY:
 

 
 

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

 
2.5

Additional paid-in capital
802.2

 
802.2

Accumulated other comprehensive income (loss)
5.6

 
11.4

Retained earnings (accumulated deficit)
(552.0
)
 
(521.0
)
Total stockholder’s equity
258.3

 
295.1

Total liabilities and stockholder’s equity
$
7,099.9

 
$
6,662.1


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

4

PHL VARIABLE INSURANCE COMPANY
Unaudited Statements of Income and Comprehensive Income
($ in millions)
Three and Nine Months Ended September 30, 2013 and 2012

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2013
 
2012
 
2013
 
2012
 
 
 
 
 
 
 
 
REVENUES:
 

 
 

 
 

 
 

Premiums
$
3.1

 
$
0.8

 
$
11.3

 
$
3.2

Insurance and investment product fees
94.0

 
92.3

 
271.3

 
280.5

Net investment income
36.3

 
33.3

 
103.4

 
96.5

Net realized investment gains (losses):
 

 
 

 
 

 
 

Total other-than-temporary impairment (“OTTI”) losses
(0.2
)
 
(0.7
)
 
(0.5
)
 
(4.4
)
Portion of OTTI gains (losses) recognized in
  other comprehensive income (“OCI”)
—

 
(0.3
)
 
(0.9
)
 
1.8

Net OTTI losses recognized in earnings
(0.2
)
 
(1.0
)
 
(1.4
)
 
(2.6
)
Net realized investment gains (losses), excluding OTTI losses
(2.6
)
 
4.8

 
(8.1
)
 
(10.1
)
Net realized investment gains (losses)
(2.8
)
 
3.8

 
(9.5
)
 
(12.7
)
Total revenues
130.6

 
130.2

 
376.5

 
367.5

 
 
 
 
 
 
 
 
BENEFITS AND EXPENSES:
 

 
 

 
 

 
 

Policy benefits
91.8

 
157.4

 
271.7

 
310.8

Policy acquisition cost amortization
22.2

 
24.3

 
62.8

 
92.6

Other operating expenses
29.2

 
24.8

 
89.2

 
75.7

Total benefits and expenses
143.2

 
206.5

 
423.7

 
479.1

Income (loss) before income taxes
(12.6
)
 
(76.3
)
 
(47.2
)
 
(111.6
)
Income tax expense (benefit)
2.6

 
4.3

 
(16.2
)
 
23.6

Net income (loss)
$
(15.2
)
 
$
(80.6
)
 
$
(31.0
)
 
$
(135.2
)
 
 
 
 
 
 
 
 
FEES PAID TO RELATED PARTIES (Note 11)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
COMPREHENSIVE INCOME (LOSS):
 

 
 

 
 

 
 

Net income (loss)
$
(15.2
)
 
$
(80.6
)
 
$
(31.0
)
 
$
(135.2
)
Other comprehensive income (loss) before income taxes:
 

 
 

 
 

 
 

Unrealized investment gains (losses), net of related offsets
9.9

 
2.0

 
(15.5
)
 
18.7

Less: Income tax expense (benefit) related to:
 

 
 

 
 

 
 

Unrealized investment gains (losses), net of related offsets
(0.3
)
 
7.1

 
(9.7
)
 
17.1

Other comprehensive income (loss), net of income taxes
10.2

 
(5.1
)
 
(5.8
)
 
1.6

Comprehensive income (loss)
$
(5.0
)
 
$
(85.7
)
 
$
(36.8
)
 
$
(133.6
)

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

5

PHL VARIABLE INSURANCE COMPANY
Unaudited Statements of Cash Flows
($ in millions)
Nine Months Ended September 30, 2013 and 2012
 
Nine Months Ended September 30,
 
2013
 
2012
OPERATING ACTIVITIES:
 

 
 

Net income (loss)
$
(31.0
)
 
$
(135.2
)
Net realized investment (gains) losses
9.5

 
12.7

Policy acquisition costs deferred
(49.6
)
 
(63.7
)
Policy acquisition cost amortization
62.8

 
92.6

Interest credited
64.0

 
49.7

Equity in earnings of limited partnerships and other investments
(0.3
)
 
(0.1
)
Change in:
 

 
 

Accrued investment income
(8.5
)
 
(10.6
)
Deferred income taxes, net
—

 
(6.4
)
Receivables
1.9

 
5.4

Reinsurance recoverable
(57.7
)
 
(43.1
)
Policy liabilities and accruals
(70.7
)
 
(36.9
)
Due to/from affiliate
(0.4
)
 
(22.9
)
Other operating activities, net
7.4

 
(4.5
)
Cash provided by (used for) operating activities
(72.6
)
 
(163.0
)
 
 
 
 
INVESTING ACTIVITIES:
 

 
 

Purchases of:
 

 
 

Available-for-sale debt securities
(672.3
)
 
(585.9
)
Short-term investments
(224.8
)
 
(329.8
)
Derivative instruments
(62.7
)
 
(93.3
)
Fair value investments
(21.1
)
 
(2.9
)
Sales, repayments and maturities of:
 

 
 

Available-for-sale debt securities
261.2

 
297.0

Short-term investments
414.8

 
295.9

Derivative instruments
27.4

 
16.2

Fair value investments
5.7

 
4.2

Contributions to limited partnerships
(3.5
)
 
(1.6
)
Distributions from limited partnerships
0.4

 
0.3

Policy loans, net
(2.7
)
 
3.7

Other investing activities, net
0.1

 
(1.0
)
Cash provided by (used for) investing activities
(277.5
)
 
(397.2
)
 
 
 
 
FINANCING ACTIVITIES:
 

 
 

Policyholder deposit fund deposits
690.7

 
812.3

Policyholder deposit fund withdrawals
(434.6
)
 
(381.7
)
Net transfers to/from separate accounts
229.0

 
197.3

Cash provided by (used for) financing activities
485.1

 
627.9

Change in cash and cash equivalents
135.0

 
67.7

Cash and cash equivalents, beginning of year
83.1

 
49.5

Cash and cash equivalents, end of year
$
218.1

 
$
117.2

 
 
 
 
Supplemental Disclosure of Cash Flow Information
 
 
 
Income taxes paid (refunded)
$
(25.5
)
 
$
27.8

Non-Cash Transactions During the Year
 

 
 

Investment exchanges
$
30.5

 
$
25.6


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

6

PHL VARIABLE INSURANCE COMPANY
Unaudited Statements of Changes in Stockholder’s Equity
($ in millions)
Nine Months Ended September 30, 2013 and 2012

 
Nine Months Ended September 30,
 
2013
 
2012
COMMON STOCK:
 
 
 
Balance, beginning of period
$
2.5

 
$
2.5

Balance, end of period
$
2.5

 
$
2.5

 
 
 
 
ADDITIONAL PAID-IN CAPITAL:
 

 
 

Balance, beginning of period
$
802.2

 
$
802.2

Balance, end of period
$
802.2

 
$
802.2

 
 
 
 
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS):
 

 
 

Balance, beginning of period
$
11.4

 
$
2.6

Other comprehensive income (loss)
(5.8
)
 
1.6

Balance, end of period
$
5.6

 
$
4.2

 
 
 
 
RETAINED EARNINGS (ACCUMULATED DEFICIT):
 

 
 

Balance, beginning of period
$
(521.0
)
 
$
(383.3
)
Net income (loss)
(31.0
)
 
(135.2
)
Balance, end of period
$
(552.0
)
 
$
(518.5
)
 
 
 
 
TOTAL STOCKHOLDER’S EQUITY:
 

 
 

Balance, beginning of period
$
295.1

 
$
424.0

Change in stockholder’s equity
(36.8
)
 
(133.6
)
Balance, end of period
$
258.3

 
$
290.4


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

7

PHL VARIABLE INSURANCE COMPANY
Notes to Unaudited Financial Statements
Three and Nine Months Ended September 30, 2013 and 2012

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 unaudited financial statements in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”), which differs materially from the accounting practices prescribed by various insurance regulatory authorities.

Certain prior year amounts have been reclassified to conform to the current year presentation. These financial statements include all adjustments (consisting primarily of accruals) considered necessary for the fair statement of the balance sheet, statements of income and comprehensive income, statements of cash flows and statements of changes in stockholders’ equity for the interim periods. Certain financial information that is not required for interim reporting has been omitted. Financial results for the nine months ended September 30, 2013 are not necessarily indicative of full year results. Results for the quarter end and nine months ended September 30, 2013 include $0 and $3.2 million, respectively, of income related to out-of-period adjustments. Such amounts are not material to any period presented. These financial statements should be read in conjunction with the financial statements for the year ended December 31, 2012 contained in the 2012 Form 10-K.

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 (the “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.


8

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.

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.


9

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.
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

Our significant accounting policies are presented in the notes to our financial statements for the year ended December 31, 2012 contained in the 2012 Form 10-K. There have been no significant changes since the filing of the year-end December 31, 2012 financial statements discussed above.


3.    Reinsurance

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 $484.8 million and $427.1 million as of September 30, 2013 and December 31, 2012, respectively. Other reinsurance activity is shown below.

Direct Business and Reinsurance:
Three Months Ended
 
Nine Months Ended
($ in millions)
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
 
 
 
 
 
 
 
 
Direct premiums
$
18.2

 
$
16.7

 
$
60.3

 
$
52.8

Premiums ceded to non-affiliate reinsurers [1]
(15.1
)
 
(15.9
)
 
(49.0
)
 
(49.6
)
Premiums
$
3.1

 
$
0.8

 
$
11.3

 
$
3.2

 
 
 
 
 
 
 
 
Direct policy benefits incurred
$
87.2

 
$
75.0

 
$
184.6

 
$
214.4

Policy benefits assumed from non-affiliate reinsureds
—

 
1.0

 
—

 
2.5

Policy benefits ceded to:
 

 
 

 
 

 
 

  Affiliate reinsurers
—

 
(6.9
)
 
(9.0
)
 
(9.2
)
  Non-affiliate reinsurers
(50.5
)
 
(20.4
)
 
(84.5
)
 
(94.1
)
Policy benefits ceded to reinsurers
(50.5
)
 
(27.3
)
 
(93.5
)
 
(103.3
)
Premiums paid to:
 

 
 

 
 

 
 

  Affiliate reinsurers
5.5

 
5.5

 
16.6

 
15.0

  Non-affiliate reinsurers
17.1

 
18.7

 
27.8

 
42.4

Premiums paid to reinsurers [2]
22.6

 
24.2

 
44.4

 
57.4

Policy benefits [3]
$
59.3

 
$
72.9

 
$
135.5

 
$
171.0

———————
[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.

10

[3]
Policy benefit amounts above exclude changes in reserves, interest credited to policyholders and other items, which total $32.5 million and $84.5 million net of reinsurance, for the three months ended September 30, 2013 and 2012, respectively, and $136.2 million and $139.8 million, net of reinsurance, for the nine months ended September 30, 2013 and 2012, 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 September 30, 2013, five major reinsurance companies account for approximately 71% of the reinsurance recoverable.

4.    Deferred Policy Acquisition Costs

The balances of and changes in deferred policy acquisition costs (“DAC”) as of and for the periods ended September 30, 2013 and 2012 are as follows:

Deferred Policy Acquisition Costs:
Three Months Ended
 
Nine Months Ended
($ in millions)
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
 
 
 
 
 
 
 
 
Policy acquisition costs deferred
$
16.0

 
$
20.4

 
$
49.6

 
$
63.7

Costs amortized to expenses:
 

 
 

 
 

 
 

Recurring costs
(21.7
)
 
(5.1
)
 
(59.7
)
 
(78.2
)
Assumption unlocking
—

 
(1.2
)
 
—

 
(1.2
)
Realized investment gains (losses)
(0.5
)
 
(18.0
)
 
(3.1
)
 
(13.2
)
Offsets to net unrealized investment gains or losses
  included in AOCI [1]
1.6

 
5.8

 
45.5

 
(25.6
)
Change in deferred policy acquisition costs
(4.6
)
 
1.9

 
32.3

 
(54.5
)
Deferred policy acquisition costs, beginning of period
463.1

 
432.7

 
426.2

 
489.1

Deferred policy acquisition costs, end of period
$
458.5

 
$
434.6

 
$
458.5

 
$
434.6

———————
[1]
An offset to DAC and accumulated other comprehensive income (“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 DAC amortized using gross profits or gross margins would result.

During the three and nine months ended September September 30, 2013 and 2012, deferred expenses primarily consisted of 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 DAC. 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.


11

Changes in Deferred Sales Inducement Activity:
Three Months Ended
 
Nine Months Ended
($ in millions)
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
 
 
 
 
 
 
 
 
Deferred asset, beginning of period
$
72.6

 
$
47.3

 
$
60.9

 
$
49.7

Sales inducements deferred
2.7

 
2.9

 
8.2

 
12.5

Amortization charged to income
(1.9
)
 
(2.3
)
 
(5.4
)
 
(6.2
)
Offsets to net unrealized investment gains or losses
  included in AOCI
0.2

 
10.2

 
9.9

 
2.1

Deferred asset, end of period
$
73.6

 
$
58.1

 
$
73.6

 
$
58.1



12

6.    Investing Activities

Debt securities

The following tables present the debt securities available-for-sale by sector held at September 30, 2013 and December 31, 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.

Fair Value and Cost of Securities:
September 30, 2013
($ in millions)
Amortized
Cost
 
Gross Unrealized Gains [1]
 
Gross Unrealized Losses [1]
 
Fair
Value
 
OTTI Recognized in AOCI [2]
 
 
 
 
 
 
 
 
 
 
U.S. government and agency
$
69.6

 
$
3.7

 
$
(0.8
)
 
$
72.5

 
$
—

State and political subdivision
143.3

 
5.8

 
(4.8
)
 
144.3

 
(0.2
)
Foreign government
56.4

 
3.0

 
(0.2
)
 
59.2

 
—

Corporate
2,096.6

 
78.4

 
(51.9
)
 
2,123.1

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

 
13.9

 
(1.5
)
 
254.3

 
(0.5
)
Residential mortgage-backed (“RMBS”)
431.0

 
10.1

 
(8.5
)
 
432.6

 
(8.5
)
CDO/CLO
66.4

 
1.7

 
(1.4
)
 
66.7

 
(3.0
)
Other asset-backed
102.0

 
3.7

 
(6.3
)
 
99.4

 
—

Available-for-sale debt securities
$
3,207.2

 
$
120.3

 
$
(75.4
)
 
$
3,252.1

 
$
(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)
Amortized
Cost
 
Gross Unrealized Gains [1]
 
Gross Unrealized Losses [1]
 
Fair
Value
 
OTTI Recognized 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.


13

Maturities of Debt Securities:
September 30, 2013
($ in millions)
Amortized
Cost
 
Fair
Value
 
 
 
 
Due in one year or less
$
26.4

 
$
26.9

Due after one year through five years
164.8

 
175.2

Due after five years through ten years
316.0

 
325.8

Due after ten years
1,858.7

 
1,871.2

CMBS/RMBS/ABS/CDO/CLO [1]
841.3

 
853.0

Total
$
3,207.2

 
$
3,252.1

———————
[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 September 30, 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:
 
 
 
($ in millions)
September 30, 2013
 
December 31, 2012
 
 
 
 
Debt securities, available-for-sale
 

 
 

Proceeds from sales
$
50.4

 
$
160.0

Proceeds from maturities/repayments
213.7

 
285.3

Gross investment gains from sales, prepayments and maturities
8.6

 
22.8

Gross investment losses from sales and maturities
(0.3
)
 
(0.7
)
 
 
As of
Aging of Temporarily Impaired
September 30, 2013
Debt Securities:
Less than 12 months
 
Greater than 12 months
 
Total
($ in millions)
Fair
Value
 
Unrealized Losses
 
Fair
Value
 
Unrealized Losses
 
Fair
Value
 
Unrealized Losses
Debt Securities
 

 
 

 
 

 
 

 
 

 
 

U.S. government and agency
$
13.6

 
$
(0.4
)
 
$
3.5

 
$
(0.4
)
 
$
17.1

 
$
(0.8
)
State and political subdivision
48.9

 
(3.9
)
 
4.2

 
(0.9
)
 
53.1

 
(4.8
)
Foreign government
17.3

 
(0.2
)
 
—

 
—

 
17.3

 
(0.2
)
Corporate
773.8

 
(33.6
)
 
71.7

 
(18.3
)
 
845.5

 
(51.9
)
CMBS
31.2

 
(1.1
)
 
5.4

 
(0.4
)
 
36.6

 
(1.5
)
RMBS
121.1

 
(5.1
)
 
39.9

 
(3.4
)
 
161.0

 
(8.5
)
CDO/CLO
16.1

 
(0.2
)
 
24.7

 
(1.2
)
 
40.8

 
(1.4
)
Other asset-backed
12.5

 
(0.6
)
 
6.2

 
(5.7
)
 
18.7

 
(6.3
)
Total temporarily impaired
  securities
$
1,034.5

 
$
(45.1
)
 
$
155.6

 
$
(30.3
)
 
$
1,190.1

 
$
(75.4
)
Below investment grade
$
40.8

 
$
(2.2
)
 
$
27.5

 
$
(9.1
)
 
$
68.3

 
$
(11.3
)
Number of securities
 

 
284

 
 

 
69

 
 

 
353


Unrealized losses on below-investment-grade debt securities with a fair value depressed by more than 20% of amortized cost totaled $6.9 million at September 30, 2013, of which $6.7 million was depressed by more than 20% of amortized cost for more than 12 months.


14

These securities were considered to be temporarily impaired at September 30, 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.
Aging of Temporarily Impaired
December 31, 2012
Debt Securities:
Less than 12 months
 
Greater than 12 months
 
Total
($ in millions)
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
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.

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 September 30, 2013, management does not have the intention to sell, nor does it expect to be required to sell, these securities prior to their recovery.


15

OTTIs recorded on available-for-sale debt securities in the first nine months of 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 related to such credit-related circumstances were $0.2 million for the third quarter of 2013 and $1.0 million for the third quarter of 2012 and $1.4 million for the first nine months of 2013 and $2.6 million for the first nine months of 2012. There were no limited partnerships and other investment OTTIs for the three and nine months ended September 30, 2013 and 2012.

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 for the third quarter of 2013 and $(0.3) million for the third quarter of 2012 and $(0.9) million for the first nine months of 2013 and $1.8 million for the first nine months of 2012.

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 Debt Securities for
Three Months Ended
 
Nine Months Ended
which a Portion of the OTTI Loss was Recognized in OCI:
September 30,
 
September 30,
($ in millions)
2013
 
2012
 
2013
 
2012
 
 
 
 
 
 
 
 
Balance, beginning of period
$
(18.5
)
 
$
(20.0
)
 
$
(17.8
)
 
$
(21.3
)
  Add: Credit losses on securities not previously impaired [1]
—

 
(0.2
)
 
—

 
(0.5
)
  Add: Credit losses on securities previously impaired [1]
—

 
(0.4
)
 
(0.7
)
 
(1.4
)
Less: Credit losses on securities impaired due to intent to sell
—

 
—

 
—

 
—

Less: Credit losses on securities sold
0.3

 
1.0

 
0.3

 
3.6

  Less: Increases in cash flows expected on
    previously impaired securities
—

 
—

 
—

 
—

Balance, end of period
$
(18.2
)
 
$
(19.6
)
 
$
(18.2
)
 
$
(19.6
)
———————
[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 $7.4 million and direct equity of $2.9 million as of September 30, 2013 and private equity of $6.7 million as of December 31, 2012.

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.


16

Sources of Net Investment Income:
Three Months Ended
 
Nine Months Ended
($ in millions)
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
 
 
 
 
 
 
 
 
Debt securities [1]
$
34.7

 
$
31.7

 
$
99.3

 
$
92.7

Policy loans
0.7

 
0.7

 
2.2

 
2.3

Limited partnerships and other investments
0.3

 
0.8

 
1.6

 
1.8

Fair value investments
0.9

 
0.4

 
1.5

 
0.6

Total investment income
36.6

 
33.6

 
104.6

 
97.4

Less: Investment expenses
0.3

 
0.3

 
1.2

 
0.9

Net investment income
$
36.3

 
$
33.3

 
$
103.4

 
$
96.5

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

Net realized investment gains (losses)

Sources and Types of
Three Months Ended
 
Nine Months Ended
Net Realized Investment Gains (Losses):
September 30,
 
September 30,
($ in millions)
2013
 
2012
 
2013
 
2012
 
 
 
 
 
 
 
 
Total other-than-temporary debt impairments
$
(0.2
)
 
$
(0.7
)
 
$
(0.5
)
 
$
(4.4
)
Portion of loss recognized in OCI
—

 
(0.3
)
 
(0.9
)
 
1.8

Net debt impairments recognized in earnings
$
(0.2
)
 
$
(1.0
)
 
$
(1.4
)
 
$
(2.6
)
 
 
 
 
 
 
 
 
Debt security impairments:
 

 
 

 
 

 
 

U.S. government and agency
$
—

 
$
—

 
$
—

 
$
—

State and political subdivision
—

 
—

 
—

 
—

Foreign government
—

 
—

 
—

 
—

Corporate
—

 
—

 
—

 
—

CMBS
—

 
—

 
(0.2
)
 
(0.1
)
RMBS
(0.2
)
 
(0.8
)
 
(1.0
)
 
(2.1
)
CDO/CLO
—

 
(0.1
)
 
(0.2
)
 
(0.1
)
Other asset-backed
—

 
(0.1
)
 
—

 
(0.3
)
Net debt security impairments
(0.2
)
 
(1.0
)
 
(1.4
)
 
(2.6
)
Equity security impairments
—

 
—

 
—

 
—

Impairment losses
(0.2
)
 
(1.0
)
 
(1.4
)
 
(2.6
)
Debt security transaction gains
3.0

 
20.8

 
8.6

 
21.4

Debt security transaction losses
—

 
(0.1
)
 
(0.3
)
 
(0.2
)
Limited partnerships and other investment gains
—

 
—

 
—

 
—

Limited partnerships and other investment losses
—

 
(0.3
)
 
—

 
(0.4
)
Net transaction gains (losses)
3.0

 
20.4

 
8.3

 
20.8

Derivative instruments
(14.0
)
 
(18.0
)
 
(30.1
)
 
(33.5
)
Embedded derivatives [1]
8.4

 
6.6

 
13.7

 
6.1

Related party reinsurance derivatives
—

 
(4.2
)
 
—

 
(3.5
)
Net realized investment gains (losses),
  excluding impairment losses
$
(2.6
)
 
$
4.8

 
$
(8.1
)
 
$
(10.1
)
Net realized investment gains (losses),
  including impairment losses
$
(2.8
)
 
$
3.8

 
$
(9.5
)
 
$
(12.7
)
———————
[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.


17

Unrealized investment gains (losses)

Sources of Changes in
Three Months Ended
 
Nine Months Ended
Net Unrealized Investment Gains (Losses):
September 30,
 
September 30,
($ in millions)
2013
 
2012
 
2013
 
2012
 
 
 
 
 
 
 
 
Debt securities
$
(3.1
)
 
$
51.0

 
$
(129.3
)
 
$
112.5

Equity securities
—

 
—

 
—

 
—

Other investments
(0.2
)
 
—

 
(0.1
)
 
—

Net unrealized investment gains (losses)
$
(3.3
)
 
$
51.0

 
$
(129.4
)
 
$
112.5

 
 
 
 
 
 
 
 
Net unrealized investment gains (losses)
$
(3.3
)
 
$
51.0

 
$
(129.4
)
 
$
112.5

Applicable to DAC
(1.6
)
 
(5.8
)
 
(45.5
)
 
25.6

Applicable to other actuarial offsets
(11.6
)
 
54.8

 
(68.4
)
 
68.2

Applicable to deferred income tax expense (benefit)
(0.3
)
 
7.1

 
(9.7
)
 
17.1

Offsets to net unrealized investment gains (losses)
(13.5
)
 
56.1

 
(123.6
)
 
110.9

Net unrealized investment gains (losses) included in OCI
$
10.2

 
$
(5.1
)
 
$
(5.8
)
 
$
1.6


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 $7.9 million and $2.1 million as of September 30, 2013 and December 31, 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.


18

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 $178.4 million and $182.5 million at September 30, 2013 and December 31, 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 September 30, 2013, we were exposed to the credit concentration risk of two issuers, JPMorgan Chase Bank NA and Goldman Sachs International, representing exposure 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 September 30, 2013, we held derivative assets, net of liabilities, with a fair value of $108.0 million. Derivative credit exposure was diversified with eleven different counterparties. We also had debt securities of these counterparties with a fair value of $40.6 million as of September 30, 2013. Our maximum amount of loss due to credit risk with these issuers was $148.6 million as of September 30, 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. For the three and nine months ended September 30, 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 $1.9 billion and $1.8 billion at September 30, 2013 and December 31, 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:
September 30,
 
December 31,
($ in millions)
2013
 
2012
 
 
 
 
Debt securities
$
326.8

 
$
369.3

Equity funds
1,537.3

 
1,516.3

Other
47.8

 
49.7

Total
$
1,911.9

 
$
1,935.3



19

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 DAC.
•
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 DAC.

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:
As of
($ in millions)
September 30, 2013
 
Annuity
GMDB
 
Annuity
GMIB
 
 
 
 
Liability balance as of January 1, 2013
$
10.8

 
$
20.9

Incurred
1.8

 
(2.2
)
Paid
(2.4
)
 
—

Change due to net unrealized gains or losses included in AOCI
—

 
(0.1
)
Assumption unlocking
—

 
—

Liability balance as of September 30, 2013
$
10.2

 
$
18.6


Changes in Guaranteed Insurance Benefit Liability Balances:
Year Ended
($ in millions)
December 31, 2012
 
Annuity
GMDB
 
Annuity
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



20

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 as defined in the 2012 Form 10-K:

GMDB and GMIB Benefits by Type:
 
 
 
 
 
($ in millions)
Account
Value
 
NAR
after Reinsurance
 
Average
Attained Age
of Annuitant
 
 
 
 
 
 
September 30, 2013
 
 
 
 
 
GMDB return of premium
$
732.4

 
$
2.3

 
63
GMDB step up
1,405.6

 
8.8

 
63
GMDB earnings enhancement benefit (“EEB”)
35.8

 
0.1

 
64
GMDB greater of annual step up and roll up
26.7

 
5.6

 
67
Total GMDB at September 30, 2013
2,200.5

 
$
16.8

 
 
Less: General account value with GMDB
299.1

 
 

 
 
Subtotal separate account liabilities with GMDB
1,901.4

 
 

 
 
Separate account liabilities without GMDB
148.1

 
 

 
 
Total separate account liabilities
$
2,049.5

 
 

 
 
GMIB [1] at September 30, 2013
$
388.5

 
 

 
64
 
 
 
 
 
 
December 31, 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.

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.


21

The assumptions used for calculating GMWB, GMDB and Chronic Care guarantees are consistent with those used for amortizing DAC. 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.

Changes in Guaranteed Liability Balances:
Fixed Indexed Annuity
($ in millions)
GMWB & GMDB
 
September 30,
 
December 31,
 
2013
 
2012
 
 
 
 
Liability balance, beginning of period
$
103.6

 
$
5.6

Incurred
44.9

 
40.1

Paid
(0.2
)
 
—

Change due to net unrealized gains or losses included in AOCI
(47.7
)
 
57.9

Assumption unlocking
—

 
—

Liability balance, end of period
$
100.6

 
$
103.6


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 DAC..

Changes in Guaranteed Liability Balances:
Universal Life
($ in millions)
Secondary Guarantees
 
September 30,
 
December 31,
 
2013
 
2012
 
 
 
 
Liability balance, beginning of period
$
115.8

 
$
100.6

Incurred
31.9

 
22.6

Paid
(11.8
)
 
(9.5
)
Change due to net unrealized gains or losses included in AOCI
(1.8
)
 
2.1

Assumption unlocking
—

 
—

Liability balance, end of period
$
134.1

 
$
115.8



22

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 DAC.

Changes in Additional Liability Balances:
Universal Life
($ in millions)
Profits Followed by Losses
 
September 30,
 
December 31,
 
2013
 
2012
 
 
 
 
Liability balance, beginning of period
$
300.4

 
$
203.0

Expenses
45.3

 
37.1

Change due to net unrealized gains or losses included in AOCI
(17.0
)
 
16.9

Assumption unlocking
—

 
43.4

Liability balance, end of period
$
328.7

 
$
300.4


Embedded derivatives

Variable annuity embedded derivatives

Certain separate account variable products may contain a GMWB, GMAB and/or COMBO rider as defined in the 2012 Form
10-K. These features are accounted for as embedded derivatives as described below.

Non-Insurance Guaranteed Product Features:
 
 
 
($ in millions)
Account
Value
 
Average
Attained Age
of Annuitant
 
 
 
 
September 30, 2013
 
 
 
GMWB
$
553.3

 
64
GMAB
377.3

 
58
COMBO
7.2

 
62
Total at September 30, 2013
$
937.8

 
 
 
 
 
 
December 31, 2012
 

 
 
GMWB
$
547.4

 
63
GMAB
379.5

 
58
COMBO
8.3

 
61
Total at December 31, 2012
$
935.2

 
 

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.


23

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.

Variable Annuity Embedded Derivative Liabilities:
September 30,
 
December 31,
($ in millions)
2013
 
2012
 
 
 
 
GMWB
$
(0.2
)
 
$
14.3

GMAB
4.2

 
14.3

COMBO
(0.4
)
 
(0.3
)
Total variable annuity embedded derivative liabilities
$
3.6

 
$
28.3


There were no benefit payments made for the GMWB and GMAB in the nine months ended September 30, 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. Several additional inputs reflect our internally developed assumptions related to lapse rates and other policyholder behavior. The fair value of these embedded derivatives was $69.0 million and $51.2 million as of September 30, 2013 and December 31, 2012, respectively. In order to manage the risk associated with these equity indexed-crediting features, we hedge using equity index options as described in 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 for the three and nine months ended September 30, 2013 are $8.4 million and $13.7 million, respectively. Embedded derivatives gains and (losses) recognized in earnings for the three and nine months ended September 30, 2012 are $6.6 million and $6.1 million, 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 September 30, 2013 and December 31, 2012, $8.5 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.


24

Derivative Instruments:
 Maturity
 
 Notional Amount
 
Fair Value as of
($ in millions)
 
 
September 30, 2013
 
 
 
Assets
 
Liabilities [1]
 
 
 
 
 
 
 
 
  Interest rate swaps
2016 - 2027
 
$
160.0

 
$
6.8

 
$
7.2

Variance swaps
2015 - 2017
 
0.9

 
—

 
7.3

Swaptions
2024 - 2025
 
1,402.0

 
22.2

 
—

Put options
2015 - 2022
 
391.0

 
41.0

 
—

Call options
2013 - 2018
 
1,623.9

 
105.4

 
68.2

Equity futures
2013
 
155.8

 
15.3

 
—

Total derivative instruments
 
 
$
3,733.6

 
$
190.7

 
$
82.7

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

Derivative Instruments:
 
 
 
 
Fair Value as of
($ in millions)
 Maturity
 
 Notional Amount
 
December 31, 2012
 
 
 
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
Three Months Ended
 
Nine Months Ended
Realized Investment Gains (Losses):
September 30,
 
September 30,
($ in millions)
2013
 
2012
 
2013
 
2012
 
 
 
 
 
 
 
 
Derivative instruments by type
 
 
 
 
 
 
 
Interest rate swaps
$
(2.9
)
 
$
(1.1
)
 
$
(8.9
)
 
$
(0.3
)
Variance swaps
(1.2
)
 
(1.8
)
 
(3.0
)
 
(6.4
)
Swaptions
(4.7
)
 
—

 
8.9

 
(0.2
)
Put options
(8.5
)
 
(11.8
)
 
(29.1
)
 
(13.7
)
Call options
10.9

 
7.5

 
30.6

 
7.5

Equity futures
(7.6
)
 
(10.8
)
 
(28.6
)
 
(20.4
)
Embedded derivatives
8.4

 
6.6

 
13.7

 
6.1

Related party reinsurance derivatives
—

 
(4.2
)
 
—

 
(3.5
)
Total derivative instrument gains (losses) recognized in
  realized investment gains (losses)
$
(5.6
)
 
$
(15.6
)
 
$
(16.4
)
 
$
(30.9
)

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.


25

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.

 
September 30, 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
$
190.7

 
$
—

 
$
190.7

 
$
(82.7
)
 
$
—

 
$
108.0

Total derivative liabilities
$
(82.7
)
 
$
—

 
$
(82.7
)
 
$
82.7

 
$
—

 
$
—

 
 
 
 
 
 
 
 
 
 
 
 
 
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 $8.5 million and $8.5 million as of September 30, 2013 and December 31, 2012, respectively, that exceeds the net liability resulting from the aggregate derivative positions with a corresponding counterparty is excluded.


26

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 September 30, 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.


27

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 September 30, 2013 and December 31, 2012, respectively.

 
As of
Fair Values of Financial Instruments by Level:
September 30, 2013
($ in millions)
Level 1
 
Level 2
 
Level 3
 
Total
Assets
 

 
 

 
 

 
 

Available-for-sale debt securities
 
 
 
 
 
 
 
U.S. government and agency
$
—

 
$
13.4

 
$
59.1

[1]
$
72.5

State and political subdivision
—

 
19.9

 
124.4

 
144.3

Foreign government
—

 
55.9

 
3.3

 
59.2

Corporate
—

 
1,107.9

 
1,015.2

 
2,123.1

CMBS
—

 
213.1

 
41.2

 
254.3

RMBS
—

 
242.2

 
190.4

 
432.6

CDO/CLO
—

 
—

 
66.7

 
66.7

Other asset-backed
—

 
17.6

 
81.8

 
99.4

Total available-for-sale debt securities
—

 
1,670.0

 
1,582.1

 
3,252.1

Short-term investments
55.0

 
—

 
—

 
55.0

Derivative assets
15.3

 
175.4

 
—

 
190.7

Related party reinsurance derivative asset
—

 
—

 
—

 
—

Fair value investments
—

 
13.7

 
39.4

 
53.1

Separate account assets
2,049.5

 
—

 
—

 
2,049.5

Total assets
$
2,119.8

 
$
1,859.1

 
$
1,621.5

 
$
5,600.4

Liabilities
 

 
 

 
 

 
 

Derivative liabilities
$
—

 
$
82.7

 
$
—

 
$
82.7

Embedded derivatives
—

 
—

 
72.6

 
72.6

Total liabilities
$
—

 
$
82.7

 
$
72.6

 
$
155.3

———————
[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 quarter ended September 30, 2013.


28

 
As of
Fair Values of Financial Instruments by Level:
December 31, 2012
($ in millions)
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.

 
As of
Fair Values of Corporates by Level and Sector:
September 30, 2013
($ in millions)
Level 1
 
Level 2
 
Level 3
 
Total
Corporates
 

 
 

 
 

 
 

Consumer
$
—

 
$
286.8

 
$
391.0

 
$
677.8

Energy
—

 
128.0

 
69.7

 
197.7

Financial services
—

 
434.3

 
238.4

 
672.7

Technical/communications
—

 
72.5

 
22.0

 
94.5

Transportation
—

 
20.3

 
64.0

 
84.3

Utilities
—

 
77.4

 
144.5

 
221.9

Other
—

 
88.6

 
85.6

 
174.2

Total corporates
$
—

 
$
1,107.9

 
$
1,015.2

 
$
2,123.1



29

 
As of
Fair Values of Corporates by Level and Sector:
December 31, 2012
($ in millions)
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.

 
Three Months Ended
Level 3 Financial Assets:
September 30, 2013
($ in millions)
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]
$
47.1

 
$
16.4

 
$
(3.1
)
 
$
—

 
$
—

 
$
—

 
$
(1.3
)
 
$
59.1

State and political subdivision
104.3

 
21.5

 
(0.3
)
 
—

 
—

 
—

 
(1.1
)
 
124.4

Foreign government
3.3

 
—

 
—

 
—

 
—

 
—

 
—

 
3.3

Corporate
955.9

 
62.8

 
(5.8
)
 
17.5

 
(6.3
)
 
—

 
(8.9
)
 
1,015.2

CMBS
33.5

 
8.1

 
(0.3
)
 
—

 
—

 
—

 
(0.1
)
 
41.2

RMBS
202.5

 
0.3

 
(8.6
)
 
4.7

 
—

 
(0.1
)
 
(8.4
)
 
190.4

CDO/CLO
67.6

 
8.4

 
(2.8
)
 
—

 
—

 
—

 
(6.5
)
 
66.7

Other asset-backed
73.9

 
12.8

 
(3.6
)
 
—

 
—

 
(0.1
)
 
(1.2
)
 
81.8

Total available-for-sale
  debt securities
1,488.1

 
130.3

 
(24.5
)
 
22.2

 
(6.3
)
 
(0.2
)
 
(27.5
)
 
1,582.1

Related party reinsurance
  derivative asset
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Fair value investments
34.4

 
6.5

 
(1.3
)
 
—

 
—

 
(0.2
)
 
—

 
39.4

Total assets
$
1,522.5

 
$
136.8

 
$
(25.8
)
 
$
22.2

 
$
(6.3
)
 
$
(0.4
)
 
$
(27.5
)
 
$
1,621.5

———————
[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.


30

 
Three Months Ended
Level 3 Financial Assets:
September 30, 2012
($ in millions)
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]
$
27.7

 
$
0.7

 
$
(0.1
)
 
$
—

 
$
—

 
$
—

 
$
0.3

 
$
28.6

State and political subdivision
90.1

 
5.1

 
(0.4
)
 
—

 
—

 
—

 
(1.4
)
 
93.4

Foreign government
7.2

 
—

 
—

 
—

 
—

 
—

 
0.6

 
7.8

Corporate
664.5

 
60.8

 
(2.1
)
 
—

 
(6.1
)
 
—

 
15.6

 
732.7

CMBS
17.8

 
—

 
—

 
—

 
—

 
—

 
0.2

 
18.0

RMBS
247.3

 
1.7

 
(7.5
)
 
—

 
—

 
(0.4
)
 
4.5

 
245.6

CDO/CLO
57.3

 
—

 
(1.9
)
 
—

 
—

 
0.2

 
3.3

 
58.9

Other asset-backed
71.1

 
3.5

 
(3.2
)
 
13.2

 
—

 
—

 
(1.2
)
 
83.4

Total available-for-sale
  debt securities
1,183.0

 
71.8

 
(15.2
)
 
13.2

 
(6.1
)
 
(0.2
)
 
21.9

 
1,268.4

Related party reinsurance
  derivative asset
4.2

 
—

 
—

 
—

 
—

 
(4.2
)
 
—

 
—

Fair value investments
28.9

 
1.9

 
(2.6
)
 
—

 
—

 
0.1

 
—

 
28.3

Total assets
$
1,216.1

 
$
73.7

 
$
(17.8
)
 
$
13.2

 
$
(6.1
)
 
$
(4.3
)
 
$
21.9

 
$
1,296.7

———————
[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.

 
Nine Months Ended
Level 3 Financial Assets:
September 30, 2013
($ in millions)
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

 
$
40.0

 
$
(3.3
)
 
$
—

 
$
—

 
$
—

 
$
(3.5
)
 
$
59.1

State and political subdivision
116.1

 
35.3

 
(0.9
)
 
—

 
—

 
—

 
(26.1
)
 
124.4

Foreign government
8.0

 
—

 
—

 
1.6

 
(6.1
)
 
—

 
(0.2
)
 
3.3

Corporate
801.5

 
250.5

 
(10.8
)
 
40.9

 
(10.9
)
 
—

 
(56.0
)
 
1,015.2

CMBS
19.3

 
23.7

 
(0.3
)
 
—

 
(1.5
)
 
(0.1
)
 
0.1

 
41.2

RMBS
222.6

 
1.0

 
(19.4
)
 
5.1

 
—

 
(0.3
)
 
(18.6
)
 
190.4

CDO/CLO
56.8

 
31.1

 
(5.7
)
 
—

 
—

 
(0.3
)
 
(15.2
)
 
66.7

Other asset-backed
80.1

 
13.4

 
(4.7
)
 
—

 
—

 
—

 
(7.0
)
 
81.8

Total available-for-sale
  debt securities
1,330.3

 
395

 
(45.1
)
 
47.6

 
(18.5
)
 
(0.7
)
 
(126.5
)
 
1,582.1

Related party reinsurance
  derivative asset
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Fair value investments
22.7

 
21.1

 
(2.5
)
 
—

 
—

 
(1.9
)
 
—

 
39.4

Total assets
$
1,353.0

 
$
416.1

 
$
(47.6
)
 
$
47.6

 
$
(18.5
)
 
$
(2.6
)
 
$
(126.5
)
 
$
1,621.5

———————
[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.



31

 
Nine Months Ended
Level 3 Financial Assets:
September 30, 2012
($ in millions)
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

 
$
2.5

 
$
(3.7
)
 
$
—

 
$
—

 
$
—

 
$
(1.9
)
 
$
28.6

State and political subdivision
48.7

 
20.0

 
(0.8
)
 
12.9

 
—

 
—

 
12.6

 
93.4

Foreign government
3.1

 
3.5

 
—

 
—

 
—

 
—

 
1.2

 
7.8

Corporate
513.8

 
218.9

 
(10.3
)
 
20.0

 
(14.2
)
 
—

 
4.5

 
732.7

CMBS
35.4

 
—

 
(0.5
)
 
—

 
(18.0
)
 
—

 
1.1

 
18.0

RMBS
268.0

 
1.3

 
(26.9
)
 
—

 
—

 
(0.9
)
 
4.1

 
245.6

CDO/CLO
62.5

 
—

 
(3.5
)
 
—

 
—

 
0.2

 
(0.3
)
 
58.9

Other asset-backed
81.2

 
9.5

 
(5.9
)
 
—

 
(1.8
)
 
—

 
0.4

 
83.4

Total available-for-sale
  debt securities
1,044.4

 
255.7

 
(51.6
)
 
32.9

 
(34.0
)
 
(0.7
)
 
21.7

 
1,268.4

Related party reinsurance
  derivative asset
3.5

 
—

 
—

 
—

 
—

 
(3.5
)
 
—

 
—

Fair value investments
27.5

 
2.9

 
(3.7
)
 
—

 
—

 
1.6

 
—

 
28.3

Total assets
$
1,075.4

 
$
258.6

 
$
(55.3
)
 
$
32.9

 
$
(34.0
)
 
$
(2.6
)
 
$
21.7

 
$
1,296.7

———————
[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 Derivative Liabilities
($ in millions)
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2013
 
2012
 
2013
 
2012
 
 
 
 
 
 
 
 
Balance, beginning of period
$
76.9

 
$
87.5

 
$
79.5

 
$
82.4

Net purchases/(sales)
4.1

 
2.2

 
6.8

 
6.8

Transfers into Level 3
—

 
—

 
—

 
—

Transfers out of Level 3
—

 
—

 
—

 
—

Realized (gains) losses [1]
(8.4
)
 
(6.6
)
 
(13.7
)
 
(6.1
)
Balance, end of period
$
72.6

 
$
83.1

 
$
72.6

 
$
83.1

———————
[1]
Realized gains and losses are included in net realized investment gains on the statements of income and comprehensive income.


32

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.

The following tables present quantitative estimates about unobservable inputs used in the fair value measurement of significant categories of internally priced assets:

 
As of
Level 3 Assets: [1]
September 30, 2013
($ in millions)
 
 
 
 
 
 
 
 
Fair
Value
 
Valuation
Technique(s)
 
Unobservable
Input
 
Range (Weighted Average)
 
 
 
 
 
 
 
 
U.S. government and agency
$
59.1

 
Discounted cash flow
 
Yield
 
1.08%-4.01% (2.83%)
State and political subdivision
$
45.5

 
Discounted cash flow
 
Yield
 
2.36%-4.23% (3.57%)
Corporate
$
801.0

 
Discounted cash flow
 
Yield
 
1.19%-6.44% (3.60%)
Other asset-backed
$
11.5

 
Discounted cash flow
 
Yield
 
2.23% -3.13% (2.37%)
 
 

 
 
 
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
 
0.35%
 
 
 
 
 
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.
 
As of
Level 3 Assets: [1]
December 31, 2012
($ in millions)
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%)
 
 

 
 
 
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.


33

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.

The following tables present quantitative estimates about unobservable inputs used in the fair value measurement of internally priced liabilities:

 
As of
Level 3 Liabilities:
September 30, 2013
($ in millions)
Fair Value
 
Valuation Technique(s)
 
Unobservable Input
 
Range
 
 
 
 
 
 
 
 
Embedded derivatives
$
69.0

 
Budget method
 
Swap curve
 
0.22%-3.46%
(FIA)
 
 
 
 
Mortality rate
 
75% of A2000 basic table
 
 
 
 
 
Lapse rate
 
0.60%-35.00%
 
 
 
 
 
CSA
 
3.99%
Embedded derivatives
(GMAB / GMWB)
$
3.6

 
Risk neutral stochastic
  valuation methodology
 
Volatility surface
 
11.46%-51.22%
 
 
 
 
 
Swap curve
 
0.14%-3.88%
 
 
 
 
 
Mortality rate
 
75% of A2000 basic table
 
 
 
 
 
Lapse rate
 
0.00%-60.00%
 
 
 
 
 
CSA
 
3.99%

 
As of
Level 3 Liabilities:
December 31, 2012
($ in millions)
Fair Value
 
Valuation Technique(s)
 
Unobservable Input
 
Range
 
 
 
 
 
 
 
 
Embedded derivatives
$
51.2

 
Budget method
 
Swap curve
 
0.21%-2.50%
(FIA)
 
 
 
 
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%


34

 
As of
Level 3 Assets and Liabilities by Pricing Source:
September 30, 2013
($ in millions)
Internal [1]
 
External [2]
 
Total
Assets
 

 
 

 
 

Available-for-sale debt securities
 
 
 
 
 
  U.S. government and agency [3]
$
59.1

 
$
—

 
$
59.1

State and political subdivision
45.5

 
78.9

 
124.4

Foreign government
—

 
3.3

 
3.3

Corporate
801.0

 
214.2

 
1,015.2

CMBS
—

 
41.2

 
41.2

RMBS
—

 
190.4

 
190.4

CDO/CLO
—

 
66.7

 
66.7

Other asset-backed
11.5

 
70.3

 
81.8

Total available-for-sale debt securities
917.1

 
665.0

 
1,582.1

Related party reinsurance derivative asset
—

 
—

 
—

Fair value investments
0.8

 
38.6

 
39.4

Total assets
$
917.9

 
$
703.6

 
$
1,621.5

Liabilities
 

 
 

 
 

Embedded derivatives
$
72.6

 
$
—

 
$
72.6

Total liabilities
$
72.6

 
$
—

 
$
72.6

———————
[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.


35

 
As of
Level 3 Assets and Liabilities by Pricing Source:
December 31, 2012
($ in millions)
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.

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:

 
 
 
As of
 
As of
Carrying Amounts and Fair Values
 
 
September 30, 2013
 
December 31, 2012
of Financial Instruments:
Fair Value
Hierarchy Level
 
Carrying
Value
 
Fair
Value
 
Carrying
Value
 
Fair
Value
($ in millions)
 
 
 
 
Financial assets:
 
 
 
 
 
 
 
 
 
Policy loans
Level 3
 
$
65.6

 
$
65.1

 
$
61.0

 
$
60.6

Cash and cash equivalents
Level 1
 
$
218.1

 
$
218.1

 
$
83.1

 
$
83.1

 
 
 
 
 
 
 
 
 
 
Financial liabilities:
 
 
 

 
 

 
 

 
 

Investment contracts
Level 3
 
$
2,660.9

 
$
2,662.0

 
$
2,349.8

 
$
2,355.4


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.


36

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.


10.    Income Taxes

It is our policy to estimate taxes for interim periods based on estimated annual effective tax rates which are derived, in part, from expected annual pre-tax income. However, the change in the deferred income balances, income tax benefit and expense and related valuation allowance for the three months ended September 30, 2013 have been computed based on the first nine months of 2013 as a discrete period.
The tax expense of $2.6 million for the three months ended September 30, 2013 is comprised entirely of a $2.6 million of current taxes. The tax benefit of $16.2 million for the nine months ended September 30, 2013 includes a $16.2 million estimated current tax benefit.

We recorded a deferred tax asset, net of deferred tax liabilities and valuation allowances, of $25.8 million as of September 30, 2013. Consistent with the prior period, the deferred tax asset not offset by a valuation allowance relates to gross unrealized losses on available-for-sale debt securities. For the three months ended September 30, 2013, we recognized a net increase in the valuation allowance of $3.6 million. For the nine months ended September 30, 2013, we recognized a net decrease in the valuation allowance of $2.2 million. Accounting guidance requires that changes in the valuation allowance be allocated to various financial statement components of income or loss.

During the first quarter of 2013, the Company generated taxable income sufficient to fully utilize its life group related net operating loss carryforwards; however, due to the limited ability to offset non-life group losses with life group taxable income, significant net operating losses attributable to the non-life group remain. However, as a result of the pre-tax loss in the third quarter of 2013, it is unlikely that a reduction in the existing valuation allowance will occur during the fourth quarter of 2013.

We have concluded that a valuation allowance on the deferred tax assets attributable to available-for-sale debt securities with gross unrealized losses was not required due to our ability and intent to hold these securities until recovery of fair value or contractual maturity, thereby avoiding realization of taxable capital losses. This conclusion is consistent with prior periods.

The Company and its subsidiaries file consolidated, combined, unitary or separate income tax returns in the U.S. federal, various state and foreign jurisdictions. The Company is no longer subject to U.S. federal income tax examinations by tax authorities for years before 2011.

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. In addition, we do not anticipate that there will be additional payments made or refunds received within the next 12 months with respect to the years under audit. We do not anticipate any increases to the existing unrecognized tax benefits that would have a significant impact on the financial position of the Company.



37

11.    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 insurance 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 $23.1 million and $15.9 million for the three months ended September 30, 2013 and 2012, respectively, and $70.3 million and $53.2 million for the nine months ended September 30, 2013 and 2012, respectively. Amounts payable to Phoenix Life were $9.1 million and $4.4 million as of September 30, 2013 and December 31, 2012, respectively.

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 4 in Part II, Item 8 “Financial Statements and Supplementary Data,” of our 2012 Form 10-K for additional information on related party transactions.

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 $1.6 million and $1.6 million for the three months ended September 30, 2013 and 2012, respectively, and $4.8 million and $4.9 million for the nine months ended September 30, 2013 and 2012, 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 $15.2 million and $20.1 million for the three months ended September 30, 2013 and 2012, respectively, and $48.4 million and $62.0 million for the nine months ended September 30, 2013 and 2012, respectively. Amounts payable to Phoenix Life were $1.5 million and $8.0 million as of September 30, 2013 and December 31, 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 $2.2 million and $2.7 million for the three months ended September 30, 2013 and 2012, respectively, and $7.0 million and $8.7 million for the nine months ended September 30, 2013 and 2012, respectively. Commission amounts payable to Saybrus were $0.8 million and $0.9 million as of September 30, 2013 and December 31, 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 September 30, 2013 and 2012, respectively. Commission amounts payable to Saybrus Equity were immaterial as of September 30, 2013 and December 31, 2012, respectively.


38

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 from Phoenix Life of $0.7 million as of September 30, 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 $0.0 million as of September 30, 2013 and immaterial amounts due to Phoenix Life and Annuity as of December 31, 2012. We do not charge any fees for this service.


12.    Accumulated Other Comprehensive Income

Changes in each component of AOCI attributable to the Company for the period ended September 30 are as follows below (net of tax):

Accumulated Other Comprehensive Income (Loss)
 
 
Net Unrealized Gains / (Losses) on All Other Investments [1]
 
Total
($ in millions)
Net unrealized Gains / (Losses) on Investments where Credit-related OTTI was Recognized [1]
 
 
As restated and amended [2]
 
 
 
 
 
Balance as of December 31, 2011
$
(7.4
)
 
$
10.0

 
$
2.6

Change in component during the period
5.4

 
(3.8
)
 
1.6

Balance as of September 30, 2012
$
(2.0
)
 
$
6.2

 
$
4.2

 
 
 
 
 
 
Balance as of December 31, 2012
$
(1.3
)
 
$
12.7

 
$
11.4

Change in component during the period before reclassifications
3.6

 
(5.0
)
 
(1.4
)
Amounts reclassified from AOCI
(0.4
)
 
(4.0
)
 
(4.4
)
Balance as of September 30, 2013
$
1.9

 
$
3.7

 
$
5.6

———————
[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).
[2]
Except for the change in component during 2013 and the balance as of September 30, 2013 and December 31, 2012.


39

Reclassifications from AOCI consist of the following:

AOCI
 
Amounts Reclassified from AOCI
 
Affected Line Item in the
 Statements of Income and Comprehensive Income
($ in millions)
 
Three Months Ended 
 September 30, 2013
 
Nine Months Ended 
 September 30, 2013
 
 
 
 
 
 
 
 
 
Net unrealized gains/(losses) on investments where
  credit-related OTTI was recognized
 
 
 
 
 
 
Available-for-sale securities
 
$
0.1

 
$
0.6

 
Net realized capital gains (losses)
 
 
0.1

 
0.6

 
Total before income taxes
 
 
—

 
0.2

 
Income tax expense (benefit)
 
 
$
0.1

 
$
0.4

 
Net income (loss)
Net unrealized investment gains/(losses) on
  all other investments
 
 
 
 
 
 
Available-for-sale securities
 
$
2.5

 
$
6.2

 
Net realized capital gains (losses)
 
 
2.5

 
6.2

 
Total before income taxes
 
 
0.9

 
2.2

 
Income tax expense (benefit)
 
 
$
1.6

 
$
4.0

 
Net income (loss)
Total amounts reclassified from AOCI
 
$
1.7

 
$
4.4

 
Net income (loss)


13.    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 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, Phoenix and PHL Variable submitted an Offer of Settlement with the SEC pursuant to which Phoenix and PHL Variable 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, Phoenix and PHL Variable 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. Phoenix and PHL Variable 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.

Phoenix 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.


40

On July 16, 2014, Phoenix and PHL Variable submitted an Amended Offer of Settlement with the SEC (the “Amended Offer”) pursuant to which Phoenix and PHL Variable 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. Phoenix and PHL Variable 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 Phoenix or PHL Variable 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.

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-Q, 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. Phoenix filed its Annual Report on Form10-K for the year ended December 31, 2013 with the SEC on August 6, 2014. Phoenix filed its Quarterly Report on Form 10-Q for the period ended March 31, 2013, June 30, 2013 and September 30, 2013 with the SEC on September 11, 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-Q, PHL Variable 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. PHL Variable filed its Annual Report on Form 10-K for the year ended December 31, 2013 with the SEC on August 22, 2014.


41

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 suit against Phoenix, Phoenix Life and PHL Variable in the United States District Court for the Central District of California; the 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 Phoenix 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 alleging that Phoenix Life and PHL Variable 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 Phoenix, Phoenix Life, PHL Variable, 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 Life 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 cases. 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.

Phoenix Life’s subsidiary, PHL Variable, 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 PHL Variable 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 PHL Variable’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. Litigations, 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.

Complaints to state insurance departments regarding PHL Variable’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 PHL Variable to take remedial action in response to complaints by a single policyholder. PHL Variable 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).

42


Phoenix Life and PHL Variable 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.

Regulatory matters

State regulatory bodies, the SEC, the Financial Industry Regulatory Authority, 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 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 and market conduct examinations of the Company and two other Connecticut-domiciled insurance affiliates. A financial examination report from the Connecticut Insurance Department was issued on May 28, 2014. We expect to receive final market conduct examination reports in 2014.

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.


14.    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 November 8, 2013, we filed a Notification of Late Filing on Form 12b-25 with the SEC disclosing that we would be unable to timely file our Third Quarter 2013 Quarterly Report on Form 10-Q with the SEC.

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 Form 10-K with the SEC.

On April 25, 2014, we filed our 2012 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 Quarterly Report on Form 10-Q for the period ending March 31, 2014 with the SEC.

43

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 Quarterly Report on Form 10-Q for the period ending June 30, 2014 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 The Phoenix Companies, Inc. 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.

Capital Contribution

On the year ended December 30, 2013, Phoenix purchased a $30.0 million surplus note from the Company and made a $45.0 million capital contribution to further benefit the Company.

SEC Cease-and-Desist Order

See Note 14 to these financial statements for additional information regarding the SEC Cease-and-Desist Order, as amended.



44

Item 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD-LOOKING STATEMENTS

The discussion in this Quarterly Report on Form 10-Q 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 PNX and the Company; (v) the risk of PNX’s failure to file its delayed SEC filings by March 16, 2015, the extended deadline for providing these delayed SEC filings to the bond trustee, as well as the risk associated with seeking additional consents from bondholders of PNX’s outstanding 7.45% Quarterly Interest Bonds Due 2032 regarding these delayed filings; (vi) the outcome of litigation and claims as well as regulatory examinations, investigations, proceedings and orders arising out of the Restatement and the failure by the Company and PNX to file SEC reports on a timely basis; (vii) further downgrades or withdrawals of our debt or financial strength credit ratings, which could increase policy surrenders and withdrawals, adversely affect our relationships with distributors, reduce new sales, limit our ability to trade in derivatives and increase our costs of, or reduce our access to, future borrowings; (viii) our inability to hedge our positions due to our inability to replace hedges as a result of our credit rating; (ix) the incurrence of significant Restatement-related expenses; (x) diversion of management and other human resources attention from the operation of our business; (xi) the risk that the Company’s and Phoenix Life’s restatements, the delay in our filing of periodic reports with the SEC and errors corrected in subsequent statutory financial statement filings with state insurance regulators could result in regulatory investigations, examinations and/or inquiries, which may increase compliance costs and the potential for additional regulatory investigations, proceedings or other claims; and (xiii) 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-Q, 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-Q, such statements or disclosures will be deemed to modify or supersede such statements in this Form 10-Q.


45

MANAGEMENT’S NARRATIVE ANALYSIS OF THE RESULTS OF OPERATIONS

This section reviews our financial condition as of September 30, 2013 as compared with December 31, 2012; our results of operations for the three and nine months ended September 30, 2013 and 2012; and, where appropriate, factors that may affect our future financial performance. This discussion should be read in conjunction with the unaudited financial statements and notes contained in this filing as well as in conjunction with our financial statements in our 2012 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.

For the first nine months of 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 (“DAC”).

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 DAC 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.

46

•
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.

•
DAC 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 DAC. 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. 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. Depending on the product, these 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 and 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 and variable universal life 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

•
Policy benefits. Policy benefits decreased $39.1 million for the nine months ended September 30, 2013 compared with the nine months ended September 30, 2012. The decrease in policy benefit expense is primarily driven by an unlock charge of $43.4 million in the third quarter of 2012 associated with the profits followed by losses reserve. The unlock charge was associated with the annual assumption review that was performed in the third quarter of 2012 while the annual assumption review is performed in the fourth quarter in 2013.

•
DAC. Policy acquisition cost amortization decreased $29.8 million in the nine months ended September 30, 2013, compared to the nine months ended September 30, 2012. The decrease in amortization for the nine months ended September 30, 2013 is primarily attributable to continued decrease in amortization on the universal life business for which there are limited new deferrals and for which amortization as a portion of the total DAC cost asset remains consistent.

•
Operating expenses. Other operating expenses increased $13.5 million to $89.2 million in the nine months ended September 30, 2013, compared to $75.7 million for the nine months ended September 30, 2012. The increase in operating expenses was due to higher professional fees and outside services primarily as a result of the Restatement.


47

•
Income taxes. The Company recorded income tax benefit of $16.2 million for the nine months ended September 30, 2013 compared with $23.6 million income tax expense for the nine months ended September 30, 2012.

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

See Note 2 to our financial statements in this Form 10-Q for a discussion of new accounting standards.

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. 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 EGPs and estimated gross margins 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. Actual results could differ from these estimates.

A complete description of our critical accounting estimates is set forth in the 2012 Form 10-K. Management believes that those critical accounting estimates as set forth in the 2012 Form 10-K are important to understanding our financial condition and financial statements.


48

Results of Operations

Summary Financial Data:
Three Months Ended
 
Increase (decrease) and
($ in millions)
September 30,
 
percentage change
 
2013
 
2012
 
2013 vs. 2012
REVENUES:
 

 
 

 
 

 
 

Premiums
$
3.1

 
$
0.8

 
$
2.3

 
NM

Insurance and investment product fees
94.0

 
92.3

 
1.7

 
2
%
Net investment income
36.3

 
33.3

 
3.0

 
9
%
Net realized investment gains (losses):
 

 
 

 
 
 
 
Total OTTI losses
(0.2
)
 
(0.7
)
 
0.5

 
(71
%)
Portion of OTTI gains (losses) recognized in OCI
—

 
(0.3
)
 
0.3

 
(100
%)
Net OTTI losses recognized in earnings
(0.2
)
 
(1.0
)
 
0.8

 
(80
%)
Net realized investment gains (losses), excluding OTTI losses
(2.6
)
 
4.8

 
(7.4
)
 
NM

Net realized investment gains (losses)
(2.8
)
 
3.8

 
(6.6
)
 
NM

Total revenues
130.6

 
130.2

 
0.4

 
—
%
 
 
 
 
 
 
 
 
BENEFITS AND EXPENSES:
 

 
 

 
 

 
 

Policy benefits
91.8

 
157.4

 
(65.6
)
 
(42
%)
Policy acquisition cost amortization
22.2

 
24.3

 
(2.1
)
 
(9
%)
Other operating expenses
29.2

 
24.8

 
4.4

 
18
%
Total benefits and expenses
143.2

 
206.5

 
(63.3
)
 
(31
%)
Income (loss) before income taxes
(12.6
)
 
(76.3
)
 
63.7

 
(83
%)
Income tax expense (benefit)
2.6

 
4.3

 
(1.7
)
 
(40
%)
Net income (loss)
$
(15.2
)
 
$
(80.6
)
 
$
65.4

 
(81
%)
———————
Not meaningful (NM)

Analysis of Results of Operations

Three months ended September 30, 2013 compared with three months ended September 30, 2012

The Company recorded a net loss of $15.2 million for the three months ended September 30, 2013 compared with a net loss of $80.6 million for the three months ended September 30, 2012. The decrease in the net loss is primarily due to a reduction in policy benefits of $65.6 million. The decrease in policy benefits is primarily attributable to an unlock charge of $43.4 million in the third quarter of 2012 associated with the profits followed by losses reserve. The unlock charge was associated with the annual assumption review that was performed in the third quarter of 2012 while the annual assumption review is performed in the fourth quarter in 2013.


49

Summary Financial Data:
Nine Months Ended
 
Increase (decrease) and
($ in millions)
September 30,
 
percentage change
 
2013
 
2012
 
2013 vs. 2012
REVENUES:
 

 
 

 
 

 
 

Premiums
$
11.3

 
$
3.2

 
$
8.1

 
NM

Insurance and investment product fees
271.3

 
280.5

 
(9.2
)
 
(3
%)
Net investment income
103.4

 
96.5

 
6.9

 
7
%
Net realized investment gains (losses):
 

 
 
 
 
 
 
Total OTTI losses
(0.5
)
 
(4.4
)
 
3.9

 
(89
%)
Portion of OTTI gains (losses) recognized in OCI
(0.9
)
 
1.8

 
(2.7
)
 
NM

Net OTTI losses recognized in earnings
(1.4
)
 
(2.6
)
 
1.2

 
(46
%)
Net realized investment gains (losses), excluding OTTI losses
(8.1
)
 
(10.1
)
 
2.0

 
(20
%)
Net realized investment gains (losses)
(9.5
)
 
(12.7
)
 
3.2

 
(25
%)
Total revenues
376.5

 
367.5

 
9.0

 
2
%
 
 
 
 
 
 
 
 
BENEFITS AND EXPENSES:
 

 
 

 
 

 
 

Policy benefits
271.7

 
310.8

 
(39.1
)
 
(13
%)
Policy acquisition cost amortization
62.8

 
92.6

 
(29.8
)
 
(32
%)
Other operating expenses
89.2

 
75.7

 
13.5

 
18
%
Total benefits and expenses
423.7

 
479.1

 
(55.4
)
 
(12
%)
Income (loss) before income taxes
(47.2
)
 
(111.6
)
 
64.4

 
(58
%)
Income tax expense (benefit)
(16.2
)
 
23.6

 
(39.8
)
 
NM

Net income (loss)
$
(31.0
)
 
$
(135.2
)
 
$
104.2

 
(77
%)
———————
Not meaningful (NM)

Analysis of Results of Operations

Nine months ended September 30, 2013 compared with nine months ended September 30, 2012

The Company recorded a net loss of $31.0 million for the nine months ended September 30, 2013 compared with a net loss of $135.2 million for the nine months ended September 30, 2012. The decrease in the net loss is primarily due to the following items:

•
Policy benefits decreased $39.1 million for the nine months ended September 30, 2013 compared with the nine months ended September 30, 2012. The decrease in policy benefit expense is primarily driven by an unlock charge of $43.4 million in the third quarter of 2012 associated with the profits followed by losses reserve. The unlock charge was associated with the annual assumption review that was performed in the third quarter of 2012 while the annual assumption review is performed in the fourth quarter in 2013.

•
Policy acquisition cost amortization decreased $29.8 million in the nine months ended September 30, 2013, compared to the nine months ended September 30, 2012. The decrease in amortization for the nine months ended September 30, 2013 is primarily attributable to continued decrease in amortization on the universal life business for which there are limited new deferrals and for which amortization as a portion of the total DAC asset remains consistent.

•
The Company recognized a tax benefit of $16.2 million for the nine months ended September 30, 2013 compared with a $23.6 million income tax expense for the nine months ended September 30, 2012.

Partially offsetting the increase in results were the following items:

•
Other operating expenses increased $13.5 million to $89.2 million in the nine months ended September 30, 2013, compared to $75.7 million for the nine months ended September 30, 2012. The increase in operating expenses was due to higher professional fees and outside services primarily as a result of the Restatement.


50

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 September 30, 2013, our available-for-sale debt securities, with a fair value of $3,252.1 million, represented 89.7% of total investments.

Available-for-Sale Debt Securities Ratings by Percentage:
 
As of
($ in millions)
 
September 30, 2013
 
 
 
 
Fair
Value
 
% of
Fair
Value
 
Amortized
Cost
 
% of
Amortized
Cost
NAIC
 
S&P Equivalent
 
Rating
 
Designation
 
 
 
 
 
 
 
 
 
 
 
 
1
 
AAA/AA/A
 
$
1,785.0

 
54.9
%
 
$
1,754.6

 
54.7
%
2
 
BBB
 
1,288.7

 
39.6
%
 
1,268.9

 
39.5
%
 
 
Total investment grade
 
3,073.7

 
94.5
%
 
3,023.5

 
94.2
%
3
 
BB
 
142.0

 
4.4
%
 
146.6

 
4.6
%
4
 
B
 
22.1

 
0.7
%
 
23.2

 
0.7
%
5
 
CCC and lower
 
7.7

 
0.2
%
 
8.6

 
0.3
%
6
 
In or near default
 
6.6

 
0.2
%
 
5.3

 
0.2
%
 
 
Total available-for-sale debt securities
 
$
3,252.1

 
100.0
%
 
$
3,207.2

 
100.0
%

Available-for-Sale Debt Securities by Type:
As of
($ in millions)
September 30, 2013
 
 
 
 
 
Unrealized Gains (Losses)
 
Fair
Value
 
Amortized
Cost
 
Gross
Gains
 
Gross
Losses
 
Net
 
 
 
 
 
 
 
 
 
 
U.S. government and agency
$
72.5

 
$
69.6

 
$
3.7

 
$
(0.8
)
 
$
2.9

State and political subdivision
144.3

 
143.3

 
5.8

 
(4.8
)
 
1.0

Foreign government
59.2

 
56.4

 
3.0

 
(0.2
)
 
2.8

Corporate
2,123.1

 
2,096.6

 
78.4

 
(51.9
)
 
26.5

CMBS
254.3

 
241.9

 
13.9

 
(1.5
)
 
12.4

RMBS
432.6

 
431.0

 
10.1

 
(8.5
)
 
1.6

CDO/CLO
66.7

 
66.4

 
1.7

 
(1.4
)
 
0.3

Other asset-backed
99.4

 
102.0

 
3.7

 
(6.3
)
 
(2.6
)
Total available-for-sale debt securities
$
3,252.1

 
$
3,207.2

 
$
120.3

 
$
(75.4
)
 
$
44.9



51

 
As of
Available-for-Sale Debt Securities by Type and Credit Quality:
September 30, 2013
($ in millions)
Investment Grade
 
Below Investment Grade
 
Fair Value
 
Cost
 
Fair Value
 
Cost
 
 
 
 
 
 
 
 
U.S. government and agency
$
72.5

 
$
69.6

 
$
—

 
$
—

State and political subdivision
144.3

 
143.3

 
—

 
—

Foreign government
55.9

 
53.3

 
3.3

 
3.1

Corporate
2,023.0

 
1,995.8

 
100.1

 
100.8

CMBS
250.3

 
237.7

 
4.0

 
4.2

RMBS
377.6

 
375.9

 
55.0

 
55.1

CDO/CLO
58.3

 
59.1

 
8.4

 
7.3

Other asset-backed
91.8

 
88.8

 
7.6

 
13.2

Total available-for-sale debt securities
$
3,073.7

 
$
3,023.5

 
$
178.4

 
$
183.7

 
 
 
 
 
 
 
 
Percentage of total available-for-sale debt securities
94.5%
 
94.3%
 
5.5%
 
5.7%

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 September 30, 2013 in our available-for-sale debt securities and short-term investment portfolio are banking (6.7%), electric utilities (6.1%), diversified financial services (4.9%), oil (4.4%) and insurance (3.1%).

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.

 
As of
Fair Value of Eurozone Exposure by Country:
September 30, 2013
($ in millions)
Sovereign
 
Financial
 
All
 
 
 
% of Debt
 
Debt
 
Institutions
 
Other
 
Total
 
Securities [2]
 
 
 
 
 
 
 
 
 
 
Spain
$
—

 
$
1.0

 
$
7.7

 
$
8.7

 
0.2
%
Ireland
—

 
—

 
7.0

 
7.0

 
0.2
%
Italy
—

 
—

 
2.2

 
2.2

 
0.1
%
Total
—

 
1.0

 
16.9

 
17.9

 
0.5
%
 
 
 
 
 
 
 
 
 
 
All other Eurozone [1]
—

 
12.8

 
92.9

 
105.7

 
3.2
%
Total
$
—

 
$
13.8

 
$
109.8

 
$
123.6

 
3.7
%
———————
[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.


52

Most of our RMBS portfolio is highly rated. At September 30, 2013, 87.9% of the total residential portfolio was rated investment grade. We hold $61.1 million of RMBS investments backed by prime rated mortgages, $85.2 million backed by Alt-A mortgages and $46.5 million backed by sub-prime mortgages, which combined amount to 5.0% of our total investments. The majority of our prime, Alt-A, and sub-prime exposure is investment grade, with 81% rated NAIC-1 and 7% 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 as of September 30, 2013 totaled $1.0 million. These impairments consist of $0.1 million from prime, $0.8 million from Alt-A and $0.1 million from sub-prime securities.

Residential Mortgage-Backed Securities:
 
As of
($ in millions)
September 30, 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
$
260.1

 
$
259.4

 
6.8
%
 
100.0
%
 
—
%
 
—
%
 
—
%
 
—
%
 
—
%
Prime
60.2

 
61.1

 
1.6
%
 
54.2
%
 
35.2
%
 
10.6
%
 
—
%
 
—
%
 
—
%
Alt-A
84.0

 
85.2

 
2.2
%
 
53.2
%
 
8.3
%
 
31.6
%
 
—
%
 
6.9
%
 
—
%
Sub-prime
46.3

 
46.5

 
1.2
%
 
57.9
%
 
8.3
%
 
22.8
%
 
11.0
%
 
—
%
 
—
%
Total
$
450.6

 
$
452.2

 
11.8
%
 
80.7
%
 
7.2
%
 
9.7
%
 
1.1
%
 
1.3
%
 
—
%
———————
[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 $19.6 million classified as fair value investments on the balance sheet. For these fair value investments, there is no impact to OCI as carrying value is equal to market value.
[2]
Percentages based on market value of total investments and cash and cash equivalents.

Prime Mortgage-Backed Securities:
 
 
As of
($ in millions)
 
September 30, 2013
 
 
 
 
 
 
 
 
 
 
Year of Issue
Rating
 
S&P Equivalent
Designation
 
Amortized
Cost
 
Market
Value
 
% General
Account [1]
 
Post-
2007
 
2007
 
2006
 
2005
 
2004
 
2003 and
Prior
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
NAIC-1
 
AAA/AA/A
 
$
32.6

 
$
33.1

 
0.9
%
 
—
%
 
—
%
 
6.0
%
 
29.0
%
 
36.1
%
 
28.9
%
NAIC-2
 
BBB
 
21.2

 
21.5

 
0.5
%
 
—
%
 
3.1
%
 
8.9
%
 
27.1
%
 
57.7
%
 
3.2
%
NAIC-3
 
BB
 
6.4

 
6.5

 
0.2
%
 
—
%
 
—
%
 
—
%
 
47.2
%
 
51.0
%
 
1.8
%
NAIC-4
 
B
 
—

 
—

 
—
%
 
—
%
 
—
%
 
—
%
 
—
%
 
—
%
 
—
%
NAIC-5
 
CCC and below
 
—

 
—

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

 
—

 
—
%
 
—
%
 
—
%
 
—
%
 
—
%
 
—
%
 
—
%
Total
 
 
 
$
60.2

 
$
61.1

 
1.6
%
 
—
%
 
1.1
%
 
6.4
%
 
30.2
%
 
45.3
%
 
17.0
%
———————
[1]
Percentages based on market value


53

Alt-A Mortgage-Backed Securities:
 
 
As of
($ in millions)
 
September 30, 2013
 
 
 
 
 
 
 
 
 
 
Year of Issue
Rating
 
S&P Equivalent
Designation
 
Amortized
Cost
 
Market
Value
 
% General
Account [1]
 
Post-
2007
 
2007
 
2006
 
2005
 
2004
 
2003 and
Prior
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
NAIC-1
 
AAA/AA/A
 
$
44.9

 
$
45.3

 
1.2
%
 
3.5
%
 
7.2
%
 
12.1
%
 
21.6
%
 
33.9
%
 
21.7
%
NAIC-2
 
BBB
 
7.1

 
7.1

 
0.2
%
 
—
%
 
—
%
 
—
%
 
—
%
 
56.0
%
 
44.0
%
NAIC-3
 
BB
 
26.2

 
26.9

 
0.7
%
 
—
%
 
—
%
 
—
%
 
11.0
%
 
63.2
%
 
25.8
%
NAIC-4
 
B
 
—

 
—

 
—
%
 
—
%
 
—
%
 
—
%
 
—
%
 
—
%
 
—
%
NAIC-5
 
CCC and below
 
5.8

 
5.9

 
0.1
%
 
—
%
 
—
%
 
—
%
 
100.0
%
 
—
%
 
—
%
NAIC-6
 
In or near default
 
—

 
—

 
—
%
 
—
%
 
—
%
 
—
%
 
—
%
 
—
%
 
—
%
Total
 
 
 
$
84.0

 
$
85.2

 
2.2
%
 
1.9
%
 
3.8
%
 
6.4
%
 
21.9
%
 
42.6
%
 
23.4
%
———————
[1]
Percentages based on market value of total investments and cash and cash equivalents.

Sub-Prime Mortgage-Backed Securities:
 
 
As of
($ in millions)
 
September 30, 2013
 
 
 
 
 
 
 
 
 
 
Year of Issue
Rating
 
S&P Equivalent
Designation
 
Amortized
Cost
 
Market
Value
 
% General
Account [1]
 
Post-
2007
 
2007
 
2006
 
2005
 
2004
 
2003 and
Prior
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
NAIC-1
 
AAA/AA/A
 
$
25.6

 
$
26.9

 
0.7
%
 
—
%
 
11.0
%
 
17.5
%
 
22.4
%
 
8.8
%
 
40.3
%
NAIC-2
 
BBB
 
4.0

 
3.9

 
0.1
%
 
—
%
 
—
%
 
—
%
 
73.3
%
 
—
%
 
26.7
%
NAIC-3
 
BB
 
11.0

 
10.6

 
0.3
%
 
—
%
 
76.8
%
 
—
%
 
1.2
%
 
—
%
 
22.0
%
NAIC-4
 
B
 
5.5

 
5.1

 
0.1
%
 
—
%
 
—
%
 
—
%
 
100.0
%
 
—
%
 
—
%
NAIC-5
 
CCC and below
 
—

 
—

 
—
%
 
—
%
 
—
%
 
—
%
 
—
%
 
—
%
 
—
%
NAIC-6
 
In or near default
 
0.2

 
—

 
—
%
 
—
%
 
—
%
 
—
%
 
0.1
%
 
—
%
 
99.9
%
Total
 
 
 
$
46.3

 
$
46.5

 
1.2
%
 
—
%
 
23.9
%
 
10.2
%
 
30.3
%
 
5.1
%
 
30.5
%
———————
[1]
Percentages based on market value of total investments and cash and cash equivalents.


54

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:
 
 
As of
($ in millions)
 
September 30, 2013
 
 
 
 
 
 
 
 
 
 
Year of Issue
Rating
 
S&P Equivalent Designation
 
Amortized Cost [1]
 
Market Value [1]
 
% General Account [2]
 
Post-
2007
 
2007
 
2006
 
2005
 
2004 and Prior
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
NAIC-1
 
AAA/AA/A
 
$
240.5

 
$
253.3

 
6.6
%
 
62.9
%
 
7.2
%
 
14.5
%
 
11.8
%
 
3.6
%
NAIC-2
 
BBB
 
3.2

 
3.0

 
0.1
%
 
—
%
 
—
%
 
85.6
%
 
14.4
%
 
—
%
NAIC-3
 
BB
 
3.5

 
3.4

 
0.1
%
 
—
%
 
51.6
%
 
48.4
%
 
—
%
 
—
%
NAIC-4
 
B
 
—

 
—

 
—
%
 
—
%
 
—
%
 
—
%
 
—
%
 
—
%
NAIC-5
 
CCC and below
 
—

 
—

 
—
%
 
—
%
 
—
%
 
—
%
 
—
%
 
—
%
NAIC-6
 
In or near default
 
2.3

 
2.5

 
—
%
 
—
%
 
—
%
 
—
%
 
—
%
 
100.0
%
Total
 
 
 
$
249.5

 
$
262.2

 
6.8
%
 
60.7
%
 
7.6
%
 
15.7
%
 
11.6
%
 
4.4
%
———————
[1]
Includes commercial mortgage-backed CDOs with amortized cost and market values of $1.9 million and $2.3 million, respectively. CMBS holdings in this exhibit include $5.6 million classified as fair value investments on the balance sheet. For these fair value investments, there is no impact to OCI as carrying value is equal to market value.
[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.


55

Sources and Types of
Three Months Ended
 
Nine Months Ended
Net Realized Investment Gains (Losses):
September 30,
 
September 30,
($ in millions)
2013
 
2012
 
2013
 
2012
 
 
 
 
 
 
 
 
Total other-than-temporary debt impairment losses
$
(0.2
)
 
$
(0.7
)
 
$
(0.5
)
 
$
(4.4
)
Portion of loss recognized in OCI
—

 
(0.3
)
 
(0.9
)
 
1.8

Net debt impairment losses recognized in earnings
$
(0.2
)
 
$
(1.0
)
 
$
(1.4
)
 
$
(2.6
)
Debt security impairments:
 

 
 

 
 

 
 

U.S. government and agency
$
—

 
$
—

 
$
—

 
$
—

State and political subdivision
—

 
—

 
—

 
—

Foreign government
—

 
—

 
—

 
—

Corporate
—

 
—

 
—

 
—

CMBS
—

 
—

 
(0.2
)
 
(0.1
)
RMBS
(0.2
)
 
(0.8
)
 
(1.0
)
 
(2.1
)
CDO/CLO
—

 
(0.1
)
 
(0.2
)
 
(0.1
)
Other asset-backed
—

 
(0.1
)
 
—

 
(0.3
)
Net debt security impairments
(0.2
)
 
(1.0
)
 
(1.4
)
 
(2.6
)
Limited partnerships and other investment impairments
—

 
—

 
—

 
—

Impairment losses
(0.2
)
 
(1.0
)
 
(1.4
)
 
(2.6
)
Debt security transaction gains
3.0

 
20.8

 
8.6

 
21.4

Debt security transaction losses
—

 
(0.1
)
 
(0.3
)
 
(0.2
)
Limited partnerships and other investment
  transaction gains
—

 
—

 
—

 
—

Limited partnerships and other investment
  transaction losses
—

 
(0.3
)
 
—

 
(0.4
)
Net transaction gains (losses)
3.0

 
20.4

 
8.3

 
20.8

Derivative instruments
(14.0
)
 
(18.0
)
 
(30.1
)
 
(33.5
)
Embedded derivatives [1]
8.4

 
6.6

 
13.7

 
6.1

Related party reinsurance derivatives
—

 
(4.2
)
 
—

 
(3.5
)
Net realized investment gains (losses),
  excluding impairment losses
$
(2.6
)
 
$
4.8

 
$
(8.1
)
 
$
(10.1
)
Net realized investment gains (losses),
  including impairment losses
$
(2.8
)
 
$
3.8

 
$
(9.5
)
 
$
(12.7
)
———————
[1]
Includes the change in fair value of embedded derivatives associated with fixed index annuity indexed crediting and variable annuity GMWB, GMAB and COMBO riders. See Note 7 to our financial statements in this Form 10-Q 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 September 30, 2013, management does not have the intention to sell, nor does it expect to be required to sell, these securities prior to their recovery.


56

OTTIs recorded on available-for-sale debt securities in the first nine months of 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 $0.2 million for the third quarter of 2013 and $1.0 million for the third quarter of 2012 and $1.4 million for the first nine months of 2013 and $2.6 million for the first nine months of 2012. There were no limited partnerships and other investment OTTIs for the three and nine months ended September 30, 2013 and 2012.

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 for the third quarter of 2013 and $(0.3) million for the third quarter of 2012 and $(0.9) million for the first nine months of 2013 and $1.8 million for the first nine months of 2012.

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 Debt Securities for
Three Months Ended
 
Nine Months Ended
which a Portion of the OTTI Loss was Recognized in OCI:
September 30,
 
September 30,
($ in millions)
2013
 
2012
 
2013
 
2012
 
 
 
 
 
 
 
 
Balance, beginning of period
$
(18.5
)
 
$
(20.0
)
 
$
(17.8
)
 
$
(21.3
)
  Add: Credit losses on securities not previously impaired [1]
—

 
(0.2
)
 
—

 
(0.5
)
  Add: Credit losses on securities previously impaired [1]
—

 
(0.4
)
 
(0.7
)
 
(1.4
)
Less: Credit losses on securities impaired due to intent to sell
—

 
—

 
—

 
—

Less: Credit losses on securities sold
0.3

 
1.0

 
0.3

 
3.6

  Less: Increases in cash flows expected on
    previously impaired securities
—

 
—

 
—

 
—

Balance, end of period
$
(18.2
)
 
$
(19.6
)
 
$
(18.2
)
 
$
(19.6
)
———————
[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]
September 30,
 
Dec 31,
($ in millions)
2013
 
2012
 
 
 
 
U.S. government and agency
$
—

 
$
—

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

 
—

Corporate
(1.5
)
 
(1.5
)
CMBS
(0.5
)
 
(0.6
)
RMBS
(8.5
)
 
(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.


57

 
As of
Duration of Gross Unrealized Losses on Securities:
September 30, 2013
($ in millions)
 
 
0 – 6
 
6 – 12
 
Over 12
 
Total
 
Months
 
Months
 
Months
Available-for-sale debt securities
 
 
 

 
 

 
 

Total fair value
$
1,190.1

 
$
876.7

 
$
157.8

 
$
155.6

Total amortized cost
1,265.5

 
910.5

 
169.1

 
185.9

Unrealized losses
$
(75.4
)
 
$
(33.8
)
 
$
(11.3
)
 
$
(30.3
)
Number of securities
353

 
237

 
47

 
69

Investment grade:
 

 
 

 
 

 
 

Unrealized losses
$
(64.1
)
 
$
(32.2
)
 
$
(10.7
)
 
$
(21.2
)
Below investment grade:
 

 
 

 
 

 
 

Unrealized losses
$
(11.3
)
 
$
(1.6
)
 
$
(0.6
)
 
$
(9.1
)

For available-for-sale debt securities with gross unrealized losses, 85% of the unrealized losses after offsets pertain to investment grade securities and 15% of the unrealized losses after offsets pertain to below-investment-grade securities at September 30, 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.

 
As of
Duration of Gross Unrealized Losses on Securities:
September 30, 2013
($ in millions)
 
 
0 – 6
 
6 – 12
 
Over 12
 
Total
 
Months
 
Months
 
Months
Available-for-sale debt securities
 
 
 

 
 

 
 

Unrealized losses over 20% of cost
$
(19.5
)
 
$
(0.2
)
 
$
—

 
$
(19.3
)
Number of securities
12

 
1

 
—

 
11

Investment grade:
 

 
 

 
 

 
 

Unrealized losses over 20% of cost
$
(12.6
)
 
$
—

 
$
—

 
$
(12.6
)
Below investment grade:
 

 
 

 
 

 
 

Unrealized losses over 20% of cost
$
(6.9
)
 
$
(0.2
)
 
$
—

 
$
(6.7
)

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.

The primary liquidity risks regarding cash inflows from our 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 our current and anticipated sources of liquidity are adequate to meet our present and anticipated needs.


58

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.

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 places 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 rating.
The financial strength ratings as of September 4, 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.

Contractual Obligations and Commercial Commitments

As of September 30, 2013, there were no significant changes to our outstanding contractual obligations and commercial commitments as disclosed in our 2012 Form 10-K.

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.


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Employee benefit expense allocated to us for these benefits totaled $0.9 million and $1.0 million for the three months ended September 30, 2013 and 2012, respectively. Employee benefit expense allocated to us for these benefits totaled $2.6 million and $3.1 million for the nine months ended September 30, 2013 and 2012, respectively. Phoenix Life made no contributions to the pension plans in the first quarter of 2013. However, during the second and third quarters of 2013 Phoenix Life made contributions of which $1.0 million and $2.5 million were allocated to us, respectively. Phoenix Life does not expect to make any additional contributions to the pension plans by December 31, 2013. On July 6, 2012, the Surface Transportation Extension Act of 2012, Part II, was enacted into law and is effective immediately. The law includes certain pension funding stabilization provisions, which Phoenix Life took advantage of in 2012.

Off-Balance Sheet Arrangements

As of September 30, 2013 and December 31, 2012, we did not have any significant off-balance sheet arrangements as defined by Item 303(a)(4)(ii) of SEC Regulation S-K.

Reinsurance

We maintain reinsurance agreements to limit potential losses, reduce exposure to larger risks and provide additional capacity for growth. 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, 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 September 30, 2013, five major reinsurance companies account for approximately 71% of the reinsurance recoverable.

Statutory Capital and Surplus

Our statutory basis capital and surplus (including asset valuation reserve (“AVR”)) decreased from $321.0 million at December 31, 2012 to $284.4 million at September 30, 2013. The principal factors resulting in this decrease were net income unrealized capital losses of $20.0 million and $36.2 million of lower admitted deferred tax assets offset by $23.4 million of net income.

Enterprise Risk Management

Our ultimate parent company, PNX, has an enterprise-wide risk management program under which PHL Variable operations are covered. We have an enterprise-wide risk management program. 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.

See our 2013 Form 10-K, which was filed out of sequence, for information regarding our enterprise risk management and which is reflective of our exposure to operational or market risk at September 30, 2013.


Item 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

See our 2013 Form 10-K, which was filed out of sequence, for information about our management of market risk. There were no material changes in our market risk exposure at September 30, 2013.



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Item 4.    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 Quarterly Report on Form 10-Q, the Company carried out an evaluation under the supervision of and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, as of September 30, 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 Chief Executive Officer and Chief Financial Officer concluded that, as of September 30, 2013, the Company’s disclosure controls and procedures were not effective because of the material weaknesses in internal control over financial reporting described in Part II, Item 9A of the 2013 Form 10-K. As disclosed in the 2013 Form 10-K, the Chief Executive Officer and Chief Financial Officer previously concluded that, as of December 31, 2013, the Company’s disclosure controls and procedures were not effective because of the material weaknesses in internal control over financial reporting described in Part II, Item 9A of the 2013 Form 10-K. Management has concluded that the material weaknesses that were present at December 31, 2013 were also present at September 30, 2013. These material weaknesses included deficiencies in the period-end financial reporting process which includes the timely preparation and filing of the Company’s financial statements.
 
To address these material weaknesses, management performed additional analyses and other procedures 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 Quarterly Report on Form 10-Q fairly present, in all material respects, the Company’s financial condition, results of operations and cash flows for the periods presented and that this Quarterly Report on Form 10-Q 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.

Previously Identified Material Weaknesses

As previously disclosed in the 2013 Form 10-K, management 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 the Committee of Sponsoring Organizations of the Treadway Commission. For a discussion of the material weaknesses in internal control over financial reporting, please see “Controls and Procedures” in Part II, Item 9A of the 2013 Form 10-K.

Remediation Status

As disclosed in the 2013 Form 10-K, to remediate the material weaknesses referenced above, the Company has implemented or plans to implement the remediation initiatives described in Part II, Item 9A of the 2013 Form 10-K and will continue to evaluate the remediation and may in the future implement additional measures.

Changes in Internal Control Over Financial Reporting

During the quarter, management implemented certain remediation initiatives discussed in Part II, Item 9A of the 2013 Form 10-K. However, there were no material changes to the Company’s internal control over financial reporting during the third quarter of 2013 that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.



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PART II. OTHER INFORMATION

Item 1.    Legal Proceedings

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. It is believed that the outcome of our litigation and arbitration matters 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.

For a discussion of legal proceedings as of September 30, 2013, see “Legal Proceedings” in Part I, Item 3 of our 2013 Form 10-K, which was filed out of sequence.

See “Risk Factors” in Part I, Item 1A of our 2013 Form 10-K, which was filed out of sequence, and Note 13 to our financial statements in this Form 10-Q for additional information.


Item 1A.    Risk Factors

The Company is subject to risks and uncertainties, any of which could have a significant or material adverse effect on our business, financial condition, liquidity or financial statements. You should carefully consider the risk factors disclosed in Part I, Item 1A of our 2013 Form 10-K, which was filed out of sequence. The risks described herein and therein are not the only ones we face. This information should be considered carefully together with the other information contained in this report and the other reports and materials the Company files with the SEC.

As of September 30, 2013, there were no material changes to the Company’s risk factors disclosed in Part I, Item 1A of our 2013 Form 10-K, which was filed out of sequence.


Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds

(a)
Not applicable.
(b)
Not applicable.
(c)
Not applicable.


Item 3.    Defaults Upon Senior Securities

Not applicable.


Item 4.    Mine Safety Disclosures

Not applicable.


Item 5.    Other Information

(a)    Not applicable.

(b)    No material changes.



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Item 6.    Exhibits

Exhibit
 
 
 
 
 
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

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.


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SIGNATURE

Pursuant to the requirements 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: September 12, 2014
By:
/s/ Bonnie J. Malley
 
Bonnie J. Malley
 
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)


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PHL VARIABLE INSURANCE CO /CT/ Reports

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