| PHOENIX COMPANIES INC/DE Item 1A Risk Factors Poor relative investment performance of some of our equity asset management strategies has led to material redemptions which have reduced assets under management and revenues |
| We could have continued underperformance and outflows |
| As of December 31, 2005, 61prca of third-party assets under management underperformed against their respective three-year benchmarks |
| Partly as a result, our asset management business experienced net outflows of dlra5dtta6 billion during the year |
| This poor relative performance could continue, which could result in lower assets under management and lower revenues |
| Poor performance of the equity markets could adversely affect sales and assets under management of our asset management, variable universal life and variable annuity products, as well as the performance of other equity investments and potential future pension plan funding requirements |
| The United States equity markets can be volatile and experience both periods of strong growth and of substantial declines |
| There are three ways in which equity market declines and volatility have affected, or have the potential to affect, us negatively |
| • First, because the fee revenues of our asset management and, to a lesser degree, variable products businesses are based on the value of assets under our management, poor performance of the equity markets limits our fee revenues by reducing the value of the assets we manage |
| • Second, the funding requirements of our pension plan are dependent on the performance of the equity markets |
| As of December 31, 2005, the portfolio funding the Company’s pension plan consisted of 67prca equities |
| In a severe market decline, the value of the assets supporting the pension plan would decrease, increasing the requirement for future funding |
| This funding requirement would increase our expenses and decrease our earnings |
| • Third, significant market volatility or declines could cause potential purchasers of our products to refrain from purchasing, and current owners to withdraw from the markets or reduce their exposure to equity products |
| Changes in interest rates could harm cash flow and profitability in our life and annuity businesses |
| Our life insurance and annuity businesses are sensitive to interest rate changes |
| In periods of increasing interest rates, life insurance policy loans, surrenders and withdrawals could increase as policyholders seek investments with higher perceived returns |
| This could require us to sell invested assets at a time when their prices are depressed by the increase in interest rates, which could cause us to realize investment losses |
| Conversely, during periods of declining interest rates, we could experience increased premium payments on products with flexible premium features, repayment of policy loans and increased percentages of policies remaining in force |
| We would obtain lower returns on investments made with these cash flows |
| In addition, borrowers may prepay or redeem mortgages and bonds in our investment portfolio so that we might have to reinvest those proceeds in lower yielding investments |
| As a consequence of these factors, we could experience a decrease in the spread between the returns on our investment portfolio and amounts credited to policyholders and contractholders, which could adversely affect our profitability |
| 16 _________________________________________________________________ [75]Table of Contents We depend on non-affiliated distribution for our product sales and if our relationships with these distributors were harmed, we could suffer a loss in revenues |
| We distribute our products through non-affiliated advisors, broker-dealers and other financial intermediaries |
| There is substantial competition for business within most of these distributors |
| We believe that our sales through these distributors depend on factors such as our financial strength, the quality of our products and on the services we provide to, and the relationships we develop with, our distributors |
| Our largest distributors of life insurance include a subsidiary of State Farm Mutual Automobile Company, or State Farm, and National Financial Partners, or NFP In 2005, State Farm accounted for approximately 36prca and NFP accounted for approximately 14prca of our new life insurance and annuity sales based on first year commissions |
| We have had distribution arrangements with State Farm since our initial public offering in 2001 and with NFP since 1995 |
| Our distributors are generally free to sell products from a variety of providers, which makes it important for us to continually offer distributors products and services they find attractive |
| We may not be able to establish or maintain satisfactory relationships with distributors if our products or services do not meet their needs |
| Accordingly, our revenues and profitability would suffer |
| Downgrades to PNX’s debt ratings and Phoenix Life’s financial strength ratings could increase policy surrenders and withdrawals, adversely affect relationships with distributors, reduce new sales and earnings from certain of our life insurance products and increase our future borrowing costs |
| Rating agencies assign Phoenix Life financial strength ratings, and assign us debt ratings, based in each case on their opinions of the relevant company’s ability to meet its financial obligations |
| Financial strength ratings reflect a rating agency’s view of an insurance company’s ability to meet its obligations to its insureds |
| These ratings are therefore key factors underlying the competitive position of life insurers |
| The current financial strength and debt ratings are set forth in the chart below |
| A (“Excellent”) bbb (“Adequate”) Fitch A+ (“Strong”) BBB+ (“Strong”) Standard & Poor’s A (“Strong”) BBB (“Good”) Moody’s A3 (“Good”) Baa3 (“Adequate”) Fitch, Standard & Poor’s and Moody’s each have a stable outlook for our ratings, while AM Best had a negative outlook as of December 31, 2005 |
| On February 27, 2006, AM Best affirmed our A financial strength rating and improved its outlook for the Company to stable from negative |
| Downgrades could adversely affect our reputation and, hence, our relationships with existing distributors and our ability to establish additional distributor relationships |
| If this were to occur, we might experience a decline in sales of certain products and the persistency of existing customers |
| At this time, we cannot estimate the impact on sales or persistency |
| A significant decline in our sales or persistency could have a material adverse effect on our financial results |
| Any rating downgrades may result in increased interest costs in connection with future borrowings |
| Downgrades may also trigger defaults or repurchase obligations |
| 17 _________________________________________________________________ [76]Table of Contents We might need to fund deficiencies in our closed block, which would result in a reduction in net income and could result in a reduction in investments in our on-going business |
| We have allocated assets to our closed block to produce cash flows that, together with additional revenues from the closed block policies, are reasonably expected to support our obligations relating to these policies |
| Our allocation of assets to the closed block was based on actuarial assumptions about the performance of policies in the closed block and the continuation of the non-guaranteed policyholder dividend scales in effect for 2000, as well as assumptions about the investment earnings the closed block assets will generate over time |
| Since actual performance is likely to be different from these assumptions, it is possible that the cash flows generated by the closed block assets and the anticipated revenues from the policies included in the closed block will prove insufficient to provide for the benefits guaranteed under these policies even if the non-guaranteed policyholder dividend scale were to be reduced |
| If this were to occur, we would have to fund the resulting shortfall from assets outside of the closed block, which could adversely affect our profitability |
| Our business operations, investment returns, and profitability could be adversely impacted by inadequate performance of third-party relationships |
| We are dependent on certain third-party relationships to maintain essential business operations |
| These services include, but are not limited to, information technology infrastructure, application systems support, mutual fund and shareholder accounting services, transfer agent and cash management services, custodial services, records storage management, backup tape management, security pricing services, medical information, payroll, and employee benefit programs |
| In addition, we maintain contractual relationships with certain investment advisory and investment management firms to leverage their expertise |
| These firms manage select investments or portions of portfolios under sub-advisory agreements |
| We periodically negotiate provisions and renewals of these relationships and there can be no assurance that such terms will remain acceptable to such third parties or us |
| An interruption in our continuing relationship with certain of these third parties or any material delay or inability to deliver essential services could materially affect our business operations and, potentially, adversely affect our profitability |
| The independent trustees of our mutual funds and closed-end funds, intermediary program sponsors, managed account clients and institutional asset management clients could terminate their contracts with us |
| This would reduce our investment management fee revenues |
| Each of the mutual funds and closed-end funds for which PXP acts as investment advisor or sub-advisor is registered under the Investment Company Act of 1940 and is governed by a board of trustees or board of directors |
| Each fund’s board has the duty of deciding annually whether to renew the contract under which PXP manages the fund |
| Board members have a fiduciary duty to act in the best interests of the shareholders of their funds |
| Either the board members or, in limited circumstances, the shareholders may terminate an advisory contract with PXP and move the assets to another investment advisor |
| The board members also may deem it to be in the best interests of a fund’s shareholders to make other decisions adverse to us, such as reducing the compensation paid to PXP or imposing restrictions on PXP’s management of the fund |
| Our asset management agreements with intermediary program sponsors (who “wrap,” or make available, our investment products within the management agreements they have with their own clients), direct managed account clients and institutional clients are generally terminable by these sponsors and clients upon short notice without penalty |
| As a result, there would be little impediment to these sponsors or clients terminating our agreements if they became dissatisfied with our performance |
| The termination of any of the above agreements relating to a material portion of assets under management would adversely affect our investment management fee revenues and could require us to take a charge to earnings as a result of the impairment of the goodwill or intangible assets associated with our asset managers |
| The success of our business is dependent to a large extent on our ability to attract and retain key employees |
| Competition in the job market for professionals such as securities analysts, portfolio managers, sales personnel and actuaries is generally intense |
| In general, our employees are not subject to employment contracts or non-compete agreements |
| Any inability to retain our key employees, or attract and retain additional qualified employees, could have a negative impact on us |
| Goodwill or intangible assets associated with our asset management business could become impaired requiring a non-cash charge to earnings in the event of significant market declines, net outflows of assets, or losses of investment management contracts |
| As of December 31, 2005, our asset management business had dlra750dtta2 million in goodwill and intangible assets |
| The amount of goodwill and intangible assets on our balance sheet is supported by the assets under management and the related revenues of the business |
| It might be necessary to recognize an impairment of these assets if we experience: • a drop in assets under management due to a significant market decline or continued outflows such as in 2005 when we had net outflows of dlra5dtta6 billion; • the termination of a material investment management contract, such as one with one of our mutual funds, were terminated; or • material outflows if clients opt to withdraw their funds following the departure of a key employee |
| If required, the recognition of a material impairment of these assets could lead to downgrades in our credit ratings or in our financial strength ratings |
| We face strong competition in our businesses from mutual fund companies, banks, asset management firms and other insurance companies |
| This competition could impair our ability to retain existing customers, attract new customers and maintain our profitability |
| We face strong competition in each of our businesses, comprising life insurance, annuities and asset management |
| We believe that our ability to compete is based on a number of factors, including product features, investment performance, service, price, distribution capabilities, scale, commission structure, name recognition and financial strength ratings |
| While there is no single company that we identify as a dominant competitor in our business overall, our actual and potential competitors include a large number of mutual fund companies, banks, asset management firms and other insurance companies, many of which have advantages over us in one or more of the above competitive factors |
| Recent industry consolidation, including acquisitions of insurance and other financial services companies in the United States by international companies, has resulted in larger competitors with financial resources, marketing and distribution capabilities and brand identities that are stronger than ours |
| Larger firms also may be able to offer, due to economies of scale, more competitive pricing than we can |
| In addition, some of our competitors are regulated differently than we are, which may give them a competitive advantage; for example, many non-insurance company providers of financial services are not subject to the costs and complexities of insurance regulation by multiple states |
| If we do not compete effectively in this environment, our profitability and financial condition would be materially adversely affected |
| We could have material losses in the future from our discontinued reinsurance business |
| In 1999, we discontinued our reinsurance operations through a combination of sale, reinsurance and placement of certain retained group accident and health reinsurance business into run-off |
| We adopted a formal plan to stop writing new contracts covering these risks and to end the existing contracts as soon as those contracts would permit |
| However, we remain liable for claims under those contracts |
| 19 _________________________________________________________________ [78]Table of Contents We have established reserves for claims and related expenses that we expect to pay on our discontinued group accident and health reinsurance business |
| These reserves are based on currently known facts and estimates about, among other things, the amount of insured losses and expenses that we believe we will pay, the period over which they will be paid, the amounts we believe we will collect from our retrocessionaires and the likely legal and administrative costs of winding down the business |
| Our total reserves, including reserves for amounts recoverable from retrocessionaires, were dlra60dtta0 million as of December 31, 2005 |
| Our total amounts recoverable from retrocessionaires related to paid losses were dlra20dtta0 million as of December 31, 2005 |
| We expect our reserves and reinsurance to cover the run-off of the business; however, the nature of the underlying risks is such that the claims may take years to reach the reinsurers involved |
| Therefore, we expect to pay claims out of existing estimated reserves for up to ten years as the level of business diminishes |
| In addition, unfavorable or favorable claims and/or reinsurance recovery experience is reasonably possible and could result in our recognition of additional losses or gains, respectively, in future years |
| In addition, we are involved in disputes relating to certain portions of our discontinued group accident and health reinsurance business |
| See Note 17 to our consolidated financial statements in this Form 10-K for more information |
| In establishing our reserves described above for the payment of insured losses and expenses on this discontinued business, we have made assumptions about the likely outcome of the disputes referred to above, including an assumption that substantial recoveries would be available from our reinsurers on all of our discontinued reinsurance business |
| However, the inherent uncertainty of arbitrations and lawsuits, including the uncertainty of estimating whether any settlements we may enter into in the future would be on favorable terms, makes it hard to predict outcomes with certainty |
| Given the need to use estimates in establishing loss reserves, and the difficulty in predicting the outcome of arbitrations and lawsuits, our actual net ultimate exposure likely will differ from our current estimate |
| If future facts and circumstances differ significantly from our estimates and assumptions about future events with respect to the disputes referred to above or other portions of our discontinued reinsurance business, our current reserves may need to be increased materially, with a resulting material adverse effect on our results of operations and financial condition |
| Some of the Bush administration’s legislative proposals would reduce or eliminate the benefit of deferral of taxation for our insurance and annuity products |
| In addition, legislation eliminating or modifying either the federal estate tax or the federal taxation of investment income could adversely affect sales of and revenues from our life and annuity products |
| The attractiveness to our customers of many of our products is due, in part, to favorable tax treatment |
| Current federal income tax laws generally permit the tax-deferred accumulation of earnings on the premiums paid by the holders of annuities and life insurance products |
| Legislative changes that have the effect of reducing the taxes imposed on investment income could reduce or eliminate the relative benefit of such deferral of taxation for our insurance and annuity products |
| The tax rate on long-term capital gains and certain dividend income has been reduced until 2008 and President Bush’s 2006 budget proposal would make these rate reductions permanent |
| If this happens, it could have a negative impact on our sales and revenues from life and annuity products |
| The President’s Advisory Panel on Federal Tax Reform recently proposed fundamental changes to the federal income tax law that include taxation of most inside build-up on life insurance policies and annuity contracts, enhanced and simplified alternatives for tax deferred savings for retirement and other purposes, substantial reductions in federal income taxes on capital gains and dividend income and other proposals that would tend to reduce or eliminate the relative tax advantages of our life and annuity products |
| Other comprehensive changes to the tax system have been proposed, including the adoption of a flat tax, value-added tax or similar alternative structure, the creation of new and expanded vehicles for tax-exempt savings and lower taxes on investment income |
| Substantial modifications to Social Security have also been proposed |
| The likelihood that any of these proposals would ultimately be enacted, and the potential impact of these proposals, if enacted, cannot be reasonably estimated |
| 20 _________________________________________________________________ [79]Table of Contents Some of our life insurance products are specifically designed and marketed as policies that help a decedent’s heirs to pay estate tax |
| Legislation enacted in the spring of 2001 increased the size of estates exempt from the federal estate tax, phased in reductions in the estate tax rate between 2002 and 2009 and repealed the estate tax entirely in 2010 |
| This legislation, despite its reinstatement of the estate tax in 2011, increased uncertainty in the market and has had a negative effect on our revenues, from sales of second-to-die life insurance policies |
| Second-to-die policies are often purchased by two people whose assets are largely illiquid, and whose heirs otherwise might have to attempt to liquidate part of the estate in order to pay the tax |
| President Bush and members of Congress have expressed a desire to modify the existing legislation, which could result in faster or more complete reduction or repeal of the estate tax |
| Changes in insurance and securities regulation could affect our profitability by imposing further restrictions on the conduct of our business |
| Our life insurance and annuity businesses are subject to comprehensive state regulation and supervision throughout the United States |
| State insurance regulators and the National Association of Insurance Commissioners, or the NAIC, continually reexamine existing laws and regulations, and may impose changes in the future that put further regulatory burdens on us, thereby increasing our costs of doing business or otherwise harm our business |
| This could have a material adverse effect on our results of operations and financial condition |
| The United States federal government does not directly regulate the insurance business |
| However, federal legislation and administrative policies in areas which include employee benefit plan regulation, financial services regulation and federal taxation and securities laws could significantly affect each of our businesses, most notably our costs |
| We and some of the policies, contracts and other products that we offer are subject to various levels of regulation under the federal securities laws administered by the SEC as well as regulation by those states and foreign countries in which we provide investment advisory services, offer products or conduct other securities-related activities |
| We could be restricted in the conduct of our business for failure to comply with such laws and regulations |
| Future laws and regulations, or the interpretation thereof, could have a material adverse effect on our results of operations and financial condition by increasing our expenses in order to comply with these laws and regulations |