Phoenix Life and Annuity Company (a wholly-owned subsidiary of PM Holdings, Inc.) Financial Statements December 31, 2012 and December 31, 2011 and

Transcription

1 Phoenix Life and Annuity Company (a wholly-owned subsidiary of PM Holdings, Inc.) Financial Statements December 31, 2012 and December 31, 2011 and 2010, as restated and amended

2 TABLE OF CONTENTS Independent Auditor s Report F-3 F-4 Balance Sheets as of December 31, 2012 and December 31, 2011, as restated and amended F-5 Statements of Income and Comprehensive Income for the years ended December 31, 2012 and December 31, 2011 and 2010, as restated and amended F-6 Statements of Cash Flows for the years ended December 31, 2012 and December 31, 2011 and 2010, as restated and amended F-7 Statements of Changes in Stockholder s Equity for the years ended December 31, 2012 and December 31, 2011 and 2010, as restated and amended F-8 Notes to Financial Statements F-9 F-47 Page F-2

3 To the Board of Directors and Stockholder of Phoenix Life and Annuity Company: Independent Auditor's Report We have audited the accompanying financial statements of Phoenix Life and Annuity Company which comprise the balance sheets as of December 31, 2012 and 2011, and the related statements of income and comprehensive income, of stockholder s equity and of cash flows for the for each of the three years in the period ended December 31, Management's Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of the financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error. Auditor's Responsibility Our responsibility is to express an opinion on the financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on our judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, we consider internal control relevant to the Company's preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Phoenix Life and Annuity Company at December 31, 2012 and 2011, and the results of its operations and its cash flows for the three years then ended in accordance with accounting principles generally accepted in the United States of America. PricewaterhouseCoopers LLP, 125 High Street, Boston, MA T: (617) , F: (617) ,

4 Emphasis 0f Matters As discussed in Note 2 to the financial statements, the Company has restated its 2011 and 2010 financial statements to correct errors. Our opinion is not modified with respect to this matter. As discussed in Note 2 to the financial statements, as of January 1, 2012, the Company retrospectively adopted the amended accounting guidance for costs incurred by insurance companies that can be capitalized in connection with acquiring or renewing insurance contracts. Our opinion is not modified with respect to this matter. As discussed in Note 9 to the financial statements, the Company has significant transactions with its affiliates. It is possible that the terms of these transactions are not the same as those that would result from transactions among wholly unrelated parties. Our opinion is not modified with respect to this matter. May 2,

5 PHOENIX LIFE AND ANNUITY COMPANY Balance Sheets ($ in thousands, except share data) December 31, 2012 and As restated and amended ASSETS: Available-for-sale debt securities, at fair value (amortized cost of $21,847 and $24,926) $ 23,423 $ 25,935 Policy loans, at unpaid principal balances 1,915 2,259 Fair value investments Total investments 25,857 28,554 Cash and cash equivalents 7,929 10,439 Accrued investment income Due and uncollected premium 1,472 1,034 Reinsurance recoverables 46,770 43,384 Deferred policy acquisition costs 2,370 3,238 Deferred income taxes, net 3,429 4,207 Other assets 3,625 4,180 Separate account assets 4,861 5,621 Total assets $ 96,513 $ 100,919 LIABILITIES: Policy liabilities and accruals $ 65,537 $ 70,410 Other liabilities 2,925 2,745 Separate account liabilities 4,861 5,621 Total liabilities 73,323 78,776 CONTINGENT LIABILITIES (Note 13) STOCKHOLDER S EQUITY: Common stock, $100 par value: 40,000 shares authorized; 25,000 shares issued 2,500 2,500 Additional paid-in capital 19,664 19,664 Accumulated other comprehensive income Retained earnings (accumulated deficit) 428 (311) Total stockholder s equity 23,190 22,143 Total liabilities and stockholder s equity $ 96,513 $ 100,919 The accompanying notes are an integral part of these financial statements. F-5

6 PHOENIX LIFE AND ANNUITY COMPANY Statements of Income and Comprehensive Income ($ in thousands) Years Ended December 31, 2012, 2011 and As restated and amended As restated and amended REVENUES: Premiums $ 22 $ 16 $ 453 Fee income 1,324 1,019 1,388 Net investment income 1,437 1,336 1,562 Net realized investment gains (losses): Total other-than-temporary impairment ( OTTI ) losses (32) (551) (186) Portion of OTTI losses recognized in other comprehensive income ( OCI ) Net OTTI losses recognized in earnings (32) (442) (69) Net realized investment gains, excluding OTTI losses Net realized investment gains (losses) 175 (240) 5 Total revenues 2,958 2,131 3,408 BENEFITS AND EXPENSES: Policy benefits Policy acquisition cost amortization Other operating expenses Total benefits and expenses 1,822 2,105 2,380 Income before income taxes 1, ,028 Income tax expense (benefit) 397 (22) 364 Net income $ 739 $ 48 $ 664 COMPREHENSIVE INCOME (LOSS): Net income $ 739 $ 48 $ 664 Other comprehensive income (loss) before income taxes: Net unrealized investment gains (losses) before income taxes 478 (96) 1,068 Non-credit portion of OTTI losses recognized in OCI before income taxes (109) (117) Other comprehensive income (loss) before income taxes 478 (205) 951 Less: Income tax expense (benefit) related to: Net unrealized investment gains (losses) 170 (35) 374 Non-credit portion of OTTI losses recognized in OCI (38) (41) Total income tax expense (benefit) 170 (73) 333 Other comprehensive income (loss), net of income taxes 308 (132) 618 Comprehensive income (loss) $ 1,047 $ (84) $ 1,282 The accompanying notes are an integral part of these financial statements. F-6

7 PHOENIX LIFE AND ANNUITY COMPANY Statements of Cash Flows ($ in thousands) Years Ended December 31, 2012, 2011 and As restated and amended As restated and amended OPERATING ACTIVITIES: Net income $ 739 $ 48 $ 664 Net realized investment (gains) losses (175) 240 (5) Policy acquisition costs deferred (3) Policy acquisition cost amortization Interest credited Change in: Accrued investment income (8) 99 (13) Deferred income taxes 609 (17) 660 Due and uncollected premium (599) Reinsurance recoverables (3,226) 1,309 4,027 Policy liabilities and accruals (2,187) (1,652) (5,443) Due to/from affiliate 1,113 (198) (322) Other assets and other liabilities, net (403) 314 (3,490) Cash provided by (used for) operating activities (2,763) 2,035 (2,104) INVESTING ACTIVITIES: Purchases of: Available-for-sale debt securities (7,551) (3,687) (21,651) Sales, repayments and maturities of: Available-for-sale debt securities 10,619 10,985 20,927 Policy loans, net (161) Cash provided by (used for) investing activities 3,458 7,437 (885) FINANCING ACTIVITIES: Policyholder deposit fund deposits Policyholder deposit fund withdrawals (5,107) (1,583) (7,107) Net transfers to/from separate accounts 1,151 1,140 2,784 Dividend to parent (2,292) Cash provided by (used for) financing activities (3,205) 389 (5,638) Change in cash and cash equivalents (2,510) 9,861 (8,627) Cash and cash equivalents, beginning of year 10, ,205 Cash and cash equivalents, end of year $ 7,929 $ 10,439 $ 578 The accompanying notes are an integral part of these financial statements. F-7

8 PHOENIX LIFE AND ANNUITY COMPANY Statements of Changes in Stockholder s Equity ($ in thousands) Years Ended December 31, 2012, 2011 and As restated As restated and amended(1) and amended(1) COMMON STOCK: Balance, beginning of period $ 2,500 $ 2,500 $ 2,500 Balance, end of period $ 2,500 $ 2,500 $ 2,500 ADDITIONAL PAID-IN CAPITAL: Balance, beginning of period $ 19,664 $ 19,664 $ 19,664 Capital contributions from parent Balance, end of period $ 19,664 $ 19,664 $ 19,664 ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS): Balance, beginning of period $ 290 $ 422 $ (196) Other comprehensive income (loss) 308 (132) 618 Balance, end of period $ 598 $ 290 $ 422 RETAINED EARNINGS (ACCUMULATED DEFICIT): Balance, beginning of period $ (311) $ (359) $ 1,269 Net income Common stock dividends (2,292) Balance, end of period $ 428 $ (311) $ (359) TOTAL STOCKHOLDER S EQUITY: Balance, beginning of period $ 22,143 $ 22,227 $ 23,237 Change in stockholder s equity 1,047 (84) (1,010) Balance, end of period $ 23,190 $ 22,143 $ 22,227 (1) Amounts reflect the cumulative impact of the retrospective adoption of amended guidance to ASC 944, Financial Services - Insurance (ASU ), as detailed more fully within Footnote 2 to these financial statements. The accompanying notes are an integral part of these financial statements. F-8

9 PHOENIX LIFE AND ANNUITY COMPANY Notes to Financial Statements ($ in thousands) Years Ended December 31, 2012, 2011 and Organization and Description of Business Phoenix Life and Annuity Company ( we, our, us or the Company ) is a life insurance company offering life insurance products. It is a wholly-owned subsidiary of PM Holdings, Inc. and is a wholly-owned subsidiary of Phoenix Life Insurance Company ( Phoenix Life ), which is a wholly-owned subsidiary of The Phoenix Companies, Inc. ( The Phoenix Companies or PNX ), a New York Stock Exchange listed company. The Company did not write material new contracts during the years ended December 31, 2012 and Restatement and Amendment of Previously Reported Financial Information During the preparation of The Phoenix Companies Form 10-Q for the period ended September 30, 2012, certain errors were identified within the statement of cash flows for the nine months ended September 30, 2012, as well as for previously reported periods. Following the identification of these errors, management initiated a comprehensive internal review of the Company s historical financial information and identified additional errors. As part of its internal review, the Company evaluated the financial reporting process and the resulting financial statements as well as the appropriateness of prior accounting and reporting decisions in accordance with accounting principles generally accepted in the United States of America ( U.S. GAAP ). As a result, the Company has restated and amended its financial statements as of and for the years ended December 31, 2011 and 2010 to: (i) adjust for impact of these errors; (ii) record previously identified out-of-period errors that were previously determined not to be material individually, or in the aggregate, in the appropriate period; and (iii) amend the financial statements for the impact of the retrospective adoption of amended accounting guidance discussed more fully in the Revision for the Retrospective Adoption of Amended Accounting Guidance section below. The Company has classified the errors that were affected by the restatement into the following major categories: 1. Actuarial Finance (which includes three subcategories as noted more fully below) 2. Investments - Structured Securities 3. Cash Flows and Changes in Classification In addition to these three categories, there are certain items labeled other restatement adjustments which primarily relate to previously recorded out-of-period errors that were previously identified and determined not to be material individually or in the aggregate. The Company reconsidered each of these errors individually or in the aggregate during the course of the restatement and concluded that certain of these previously identified errors, namely actuarial, would be most appropriately presented within the separately identifiable subcategories as noted in more detail within the Actuarial Finance section below, with the remaining errors most appropriately categorized into other restatement adjustments rather than any of the three major categories. In an effort to provide greater transparency into these remaining other restatement adjustments, the Company has provided additional details underlying select errors for certain financial statement line items, as deemed appropriate. These details are presented in the financial statement tables detailed more fully within this Note below. F-9

10 2. Restatement and Amendment of Previously Reported Financial Information (continued) The following table summarizes the effect of the correction of these errors on net income as applicable by category of error. Increase (decrease) For the year ended ($ in thousands) December 31, Net income (loss) as previously reported $ 97 $ (264) Restatement adjustments:(1) Actuarial finance: - Accounting for certain universal life type products (236) (101) - Loss recognition 161 (117) - Other actuarial errors (577) 1,184 Investments Structured securities: 5 (6) Other restatement adjustments 111 (3) Total restatement adjustments before income taxes (536) 957 Total income tax expense (benefit) of restatement adjustments (215) 328 Total restatement adjustments after income taxes (321) 629 Net income (loss) before retrospective adoption, net of income taxes (224) 365 Retrospective adoption, net of income taxes(2) Net income, as restated and amended $ 48 $ 664 (1) All restatement adjustments are presented on a before-tax basis with total tax expense (benefit) presented separately. (2) For additional information, see Revision for the Retrospective Adoption of Amended Accounting Guidance described more fully below in this Note. Actuarial Finance The Company determined that there were errors related to the actuarial valuation of insurance liabilities and policy acquisition cost amortization. Errors were identified related to data, assumptions and valuation methodologies and separated into the following sub-categories detailed below. Accounting for Certain Universal Life Type Products: Certain of the Company s universal life products have benefit features that are expected to produce profits in earlier periods followed by losses in later periods. Under U.S. GAAP accounting, the Company is required to establish reserves for the anticipated benefits that exceed the projected contract value and arise from these features. The Company did not properly evaluate certain benefit features and, therefore, did not properly establish the required reserves. The resulting changes in the reserve accruals had a secondary impact on gross profits used to amortize deferred acquisition costs and unearned revenue reserves. In addition, the Company must periodically assess each of its lines of business for a potential premium deficiency including evaluating experience and if the line of business is expected to produce profits in earlier years followed by losses in later years. The Company did not properly assess the universal life or variable universal life lines of business for this profits followed by losses condition. Accordingly, the Company accrued additional reserves over the restatement period to provide for expected losses in the future. The Company also determined it was using inappropriate approximations of reinsurance that when aggregated did not properly reflect the underlying reinsurance costs accurately within the models it uses to amortize deferred policy acquisition costs and to value policyholder liabilities. The impact of the correction of this reinsurance modeling error indirectly impacted the balances discussed above. In addition, the impact of this error indirectly impacted the calculation of the Shadow Accounting error which is a separately identifiable component of the actuarial errors and, accordingly, is described within the Shadow Accounting section of Actuarial Finance directly below. F-10

11 2. Restatement and Amendment of Previously Reported Financial Information (continued) Investments The impact of the correction of these errors on the financial statements is presented in the Summary of Correction of Errors table within this Note below. Shadow Accounting: Under U.S. GAAP accounting, assets and liabilities that are backed by a portfolio of assets classified as available-for-sale must be adjusted to reflect the amount of unrealized gains or unrealized losses as if the amounts were realized with a corresponding offset to other comprehensive income (loss) in a process commonly referred to as shadow accounting. The Company failed to recognize all of the relationships between the available-for-sale assets and the supported assets and liabilities in calculating these adjustments. During the restatement, the shadow accounting policy and valuation process were corrected to ensure all interrelated assets and liabilities were being properly identified and to ensure that the impacts of these unrealized gains or losses were properly recorded. The impact of the correction of these errors on the financial statements is presented in the Summary of Correction of Errors table within this Note below. Loss Recognition: Under U.S. GAAP accounting, the Company must periodically assess the net liability (net of deferred policy acquisition costs) to ensure it is sufficient to provide for the expected policyholder benefits and related expenses. Upon analysis, the Company determined that for certain lines of business the locked-in historical estimates used to calculate the policyholder liabilities were insufficient. Upon identification of loss recognition events, the Company reduced its deferred policy acquisition cost asset and established additional liabilities to rectify the insufficiency in the net liability which was identified for certain lines of business. The impact of the correction of these errors on the financial statements is presented in the Summary of Correction of Errors table within this Note below. Other Actuarial Errors: Included within these amounts are all actuarial out-of-period errors as well as other individually immaterial errors which were identified during the restatement process in conjunction with management s comprehensive balance sheet review and relating to the Company s actuarial assumptions, approximations and valuation methods/models for its life and annuity business. The impact of the correction of these errors on the financial statements is presented in the Summary of Correction of Errors table within this Note below. The Company determined that there were errors related to investment valuation and the accounting treatment for these investments which are specifically identified errors in the following sub-categories as detailed below. Structured Securities The Company did not appropriately maintain a process over the assessment of accounting methodologies used to determine the appropriate interest income models. This resulted in improper income recognition and impairments for certain structured securities. In addition, the Company did not properly assess securitized financial assets for potential embedded derivatives which, when properly assessed, resulted in the reclassification of assets to fair value investments. The reclassification of these assets results in the recognition of the change in fair value of these assets in net investment income. The impact of the correction of these errors on the statements of comprehensive income is presented in the Summary of Correction of Errors table within this Note below. F-11

12 2. Restatement and Amendment of Previously Reported Financial Information (continued) Cash Flows and Changes in Classifications Statement of Cash Flows The Company identified errors within its previously issued statement of cash flows which primarily consisted of: (i) the incorrect classification of deposits and withdrawals of universal life products as cash flows used for operating activities; (ii) the incorrect classification of capitalized interest on policy loans as an investing activity; (iii) certain other classification errors within cash flows from investing activities primarily related to investment purchases and sales; and (iv) the net impact of all other errors previously and separately described within this Note. The impact of the correction of these errors to each individual financial statement line item within the statement of cash flows is summarized below and included in detail within the restated and amended statement of cash flows within this Note. Increase (decrease) For the year ended ($ in thousands) December 31, Statement of Cash Flows Cash provided by (used for) operating activities $ (437) $ 3,251 Cash provided by (used for) investing activities Cash provided by (used for) financing activities 389 (3,346) In addition to these errors noted above, the Company made certain changes in presentation to enhance disclosure of certain cash activity within the statement of cash flows. Most significantly: (i) interest credited to policyholder accounts has been separately disclosed within cash flows used for operating activities; and (ii) deposits into and withdrawals from separate accounts have been presented gross, rather than net, within cash flows provided by financing activities which are also reflected in the correction of errors above and within the restated and amended statement of cash flows within this Note. These changes in presentation did not have any impact on total cash flows provided by (used for) operating, investing activities or financing activities. Changes in Classifications The Company made corrections to: (i) present outstanding checks and to properly reclassify certain suspense accounts and (ii) reflect direct and ceded reinsurance liabilities gross in the balance sheets, resulting in ceded policy liabilities being reclassified from policy liabilities and accruals to reinsurance recoverables. These corrections had no impact to net income or total stockholder s equity. The impact of the changes in classification are reflected in the correction of errors column in the Summary of Correction of Errors table within this Note. Revision for the Retrospective Adoption of Amended Accounting Guidance In October 2010, the Financial Accounting Standards Board (the FASB ) issued amended guidance to ASC 944, Financial Services Insurance, to address the diversity in practice for accounting for costs associated with acquiring or renewing insurance contracts. The amendment clarifies the definition of acquisition costs (i.e., costs which qualify for deferral) to include only incremental direct costs that result directly from, and are essential to, a contract and would not have been incurred by the insurance entity had the contract transaction not occurred. Therefore, only costs related to successful efforts of acquiring a new, or renewal, contract should be deferred. This guidance was retrospectively adopted on January 1, 2012 and such retrospective adoption results in amendments to previously reported balances as shown in the table below as if the guidance was applied at the inception of all policies in force. The cumulative effect of retrospective adoption reduced deferred policy acquisition costs and beginning stockholder s equity by $1,975 thousand as of January 1, In any period, the adoption resulted in a decrease in policy acquisition cost amortization due to the reduced deferred policy acquisition cost asset. Adjustments for the retrospective adoption reflect the impact of the adoption after consideration of correcting the errors associated with the restatement as noted more fully in the tables reflecting the impact of the retrospective adoption on financial statements presented within this Note below. F-12

13 2. Restatement and Amendment of Previously Reported Financial Information (continued) Increase (decrease) Summary of Correction of Errors December 31, 2011 Balance Sheet Impacts (1) ($ in thousands) Actuarial Finance Changes in Classification Accounting for UL Type products Shadow Accounting Loss Recognition Other Actuarial Investments Structured Securities Cash and Suspense Reinsurance Other Restatement Adjustments Total Correction of Errors (2) ASSETS: Available-for-sale debt securities, at fair value $ $ $ $ $ (360) $ $ $ $ (360) Policy loans, at unpaid principal balances Fair value investments Total investments Cash and cash equivalents Accrued investment income Due and uncollected premium Reinsurance recoverables Deferred policy acquisition costs 486 (445) (1,900) (1,859) Deferred income taxes, net Other assets Separate account assets Total assets $ 486 $ (445) $ (1,900) $ 121 $ $ 238 $ 729 $ 728 $ (43) LIABILITIES: Policy liabilities and accruals $ 189 $ 80 $ (121) $ 120 $ $ $ 729 $ $ 997 Other liabilities 238 (3) 235 Separate account liabilities Total liabilities (121) (3) 1,232 STOCKHOLDER S EQUITY: Common stock Additional paid-in capital Accumulated other comprehensive income (1,129) (653) Accumulated deficit (337) (1) (5) 308 Total stockholder s equity (3) (337) (1,129) (345) Total stockholder s equity cumulative impact (4) (1,823) (606) 261 (930) Total stockholder s equity impact 297 (525) (1,779) (1,275) Total liabilities and stockholder s equity $ 486 $ (445) $ (1,900) $ 121 $ $ 238 $ 729 $ 728 $ (43) (1) (2) (3) (4) All amounts are shown before income taxes, unless otherwise noted. Amounts represent the total correction of errors which is also presented in the tables on the following pages. Amounts represent restatement changes made to the 2011 and 2010 periods as presented. Amounts represent cumulative impact of restatement changes to periods prior to F-13

14 2. Restatement and Amendment of Previously Reported Financial Information (continued) Increase (decrease) ($ in thousands) Actuarial Finance Accounting for UL Type Shadow products Accounting Summary of Correction of Errors December 31, 2011 Income Statement and Comprehensive Income Impacts (1) Loss Recognition Other Actuarial Investments Structured Securities Other Restatement Adjustments Total Correction of Errors (2) REVENUES: Premiums $ $ $ $ $ $ $ Fee income (32) 14 (18) Net investment income 5 5 Net realized investment gains (losses): Total OTTI losses Portion of OTTI losses recognized in OCI (118) (118) Net OTTI losses recognized in earnings Net realized investment gains, excluding OTTI losses Net realized investment gains (losses) Total revenues (32) 14 5 (13) BENEFITS AND EXPENSES: Policy benefits ,129 Policy acquisition cost amortization (137) (147) (211) (495) Other operating expenses (111) (111) Total benefits and expenses 204 (147) 577 (111) 523 Income before income taxes (236) 161 (577) (536) Income tax expense (benefit) (215) (215) Net income (loss) $ (236) $ $ 161 $ (577) $ 5 $ 326 $ (321) (1) (2) COMPREHENSIVE INCOME (LOSS): Net income (loss) $ (236) $ $ 161 $ (577) $ 5 $ 326 $ (321) Other comprehensive income (loss) before income taxes: Net unrealized investment gains before income taxes 209 (5) Non-credit portion of OTTI losses recognized in OCI before income taxes Other comprehensive income (loss) before income taxes 209 (5) Less: Income tax expense (benefit) related to: Net unrealized investment gains (losses) Non-credit portion of OTTI losses recognized in OCI Total income tax expense (benefit) Other comprehensive income, net of income taxes 209 (5) Comprehensive income (loss) $ (236) $ 209 $ 161 $ (577) $ $ 335 $ (108) All amounts are shown before income taxes, unless otherwise noted. Amounts represent the total Summary of Correction of Actuarial Finance Errors which is further aggregated into the Summary of Correction of Errors in the following pages. F-14

15 2. Restatement and Amendment of Previously Reported Financial Information (continued) Summary of Correction of Errors December 31, 2010 Increase (decrease) Income Statement and Comprehensive Income Impacts (1) ($ in thousands) Actuarial Finance Accounting for UL Type products Shadow Accounting Loss Recognition Other Actuarial Investments Structured Securities Other Restatement Adjustments F-15 Total Correction of Errors (2) REVENUES: Premiums $ $ $ $ $ $ $ Fee income (13) Net investment income (6) (6) Net realized investment gains (losses): Total OTTI losses Portion of OTTI losses recognized in OCI Net OTTI losses recognized in earnings Net realized investment gains, excluding OTTI losses Net realized investment gains (losses) Total revenues (13) 81 (6) 62 BENEFITS AND EXPENSES: Policy benefits 133 (1,184) (1,051) Policy acquisition cost amortization (45) Other operating expenses 3 3 Total benefits and expenses (1,184) 3 (895) Income before income taxes (101) (117) 1,184 (6) (3) 957 Income tax expense (benefit) Net income (loss) $ (101) $ $ (117) $ 1,184 $ (6) $ (331) $ 629 COMPREHENSIVE INCOME (LOSS): Net income (loss) $ (101) (117) 1,184 (6) (331) 629 Other comprehensive income (loss) before income taxes: Net unrealized investment gains before income taxes (1,338) (379) Non-credit portion of OTTI losses recognized in OCI before income taxes Other comprehensive income (loss) before income taxes (1,338) (379) Less: Income tax expense (benefit) related to: Net unrealized investment gains (losses) Non-credit portion of OTTI losses recognized in OCI Total income tax expense (benefit) Other comprehensive income, net of income taxes (1,338) (866) Comprehensive income (loss) $ (101) $ (1,338) $ (117) $ 1,184 $ $ 135 $ (237) (1) All amounts are shown before income taxes, unless otherwise noted. (2) Amounts represent the total Summary of Correction of Actuarial Finance Errors which is further aggregated into the Summary of Correction of Errors in the following pages..

16 2. Restatement and Amendment of Previously Reported Financial Information (continued) Balance Sheet ($ in thousands) As of December 31, 2011 Adjusted prior to the As previously Correction Retrospective Retrospective As restated reported of errors(1) Adoption Adoption(2) and amended ASSETS: Available-for-sale debt securities, at fair value $ 26,295 $ (360) $ 25,935 $ $ 25,935 Policy loans, at unpaid principal balances 2,259 2,259 2,259 Fair value investments Total investments 28,554 28,554 28,554 Cash and cash equivalents 10,439 10,439 10,439 Accrued investment income Due and uncollected premium ,034 1,034 Reinsurance recoverables 42, , Deferred policy acquisition costs 6,020 (1,859) 4,161 (923) 3,238 Deferred income taxes, net 2, ,137 1,070 4,207 Other assets 3, ,180 4,180 Separate account assets 5,621 5,621 5,621 Total assets $ 100,815 $ (43) $ 100,772 $ 147 $ 100,919 LIABILITIES: Policy liabilities and accruals(3) $ 67,291 $ 997 $ 68,288 $ 2,122 $ 70,410 Other liabilities 2, ,745 2,745 Separate account liabilities 5,621 5,621 5,621 Total liabilities 75,422 1,232 76,654 2,122 78,776 STOCKHOLDER S EQUITY: Common stock, $100 par value: 40,000 shares authorized; 25,000 shares issued 2,500 2,500 2,500 Additional paid-in capital 19,664 19,664 19,664 Accumulated other comprehensive income 479 (339) Accumulated deficit 2,750 (936) 1,814 (2,125) (311) Total stockholder s equity 25,393 (1,275) 24,118 (1,975) 22,143 Total liabilities and stockholder s equity $ 100,815 $ (43) $ 100,772 $ 147 $ 100,919 (1) (2) (3) Adjustments related to the correction of errors reflect amounts prior to the retrospective adoption of amended guidance to ASC 944, Financial Services Insurance. See footnote 2 below for additional information regarding these amounts and the retrospective adoption. Adjustments related to the retrospective adoption of amended guidance to ASC 944, Financial Services Insurance as described more fully in this Note. Included within policyholder liabilities and accruals is the post-asu gross profits followed by losses reserve of $101 thousand. The corresponding net post-asu amount of $95 thousand reported within the financial statements includes $(6) thousand of shadow profits followed by losses, both of which are described further within the Actuarial Finance section of this Note. F-16

17 2. Restatement and Amendment of Previously Reported Financial Information (continued) Statement of Income and Comprehensive Income ($ in thousands) As of and for the year ended December 31, 2011 Adjusted prior to the As previously Correction retrospective Retrospective As restated reported of errors(1) Adoption Adoption(2) and amended REVENUES: Premiums $ 16 $ $ 16 $ $ 16 Fee income 1,037 (18) 1,019 1,019 Net investment income 1, ,336 1,336 Net realized investment gains (losses): Total OTTI losses (669) 118 (551) (551) Portion of OTTI losses recognized in OCI 227 (118) Net OTTI losses recognized in earnings (442) (442) (442) Net realized investment gains (losses), excluding OTTI losses Net realized investment losses (240) (240) (240) Total revenues 2,144 (13) 2,131 2,131 BENEFITS AND EXPENSES: Policy benefits (93) 1,129 1,036 (194) 842 Policy acquisition cost amortization 1,083 (495) 588 (226) 362 Other operating expenses 1,012 (111) Total benefits and expenses 2, ,525 (420) 2,105 Income (loss) before income taxes 142 (536) (394) Income tax expense (benefit) 45 (215) (170) 148 (22) Net income (loss) $ 97 $ (321) $ (224) $ 272 $ 48 COMPREHENSIVE INCOME (LOSS): Net income (loss) $ 97 $ (321) $ (224) $ 272 $ 48 Other comprehensive income (loss) before income tax(3): Net unrealized investment gains before income tax (254) (187) (96) Non-credit portion of OTTI losses recognized in OCI before income tax (227) 118 (109) (109) Other comprehensive income (loss) before income taxes (481) 463 (18) (187) (205) Less: Income tax expense (benefit) related to:(3) Net unrealized investment gains (178) (66) (35) Non-credit portion of OTTI losses recognized in OCI (79) 41 (38) (38) Total income tax expense (benefit) (257) 250 (7) (66) (73) Other comprehensive income, net of tax (224) 213 (11) (121) (132) Comprehensive income (loss) $ (127) $ (108) $ (235) $ 151 $ (84) (1) (2) (3) Adjustments related to the correction of errors reflect amounts prior to the retrospective adoption of amended guidance to ASC 944, Financial Services Insurance. See footnote 2 below for additional information regarding these amounts and the retrospective adoption. Adjustments related to the retrospective adoption of amended guidance to ASC 944, Financial Services Insurance as described more fully in the Note. In addition to adjustments described within this footnote the correction of errors column contains reclassifications related to changes in presentation of components of other comprehensive income. F-17

18 2. Restatement and Amendment of Previously Reported Financial Information (continued) Statement of Income and Comprehensive Income ($ in thousands) As of and for the year ended December 31, 2010 Adjusted prior to the As previously Correction retrospective Retrospective As restated reported of errors(1) Adoption Adoption(2) and amended REVENUES: Premiums $ 453 $ $ 453 $ $ 453 Fee income 1, ,388 1,388 Net investment income 1,568 (6) 1,562 1,562 Net realized investment gains (losses): Total OTTI losses (186) (186) (186) Portion of OTTI losses recognized in OCI Net OTTI losses recognized in earnings (69) (69) (69) Net realized investment gains (losses), excluding OTTI losses Net realized investment gains (losses) Total revenues 3, ,408 3,408 BENEFITS AND EXPENSES: Policy benefits 2,192 (1,051) 1,141 (153) 988 Policy acquisition cost amortization ,152 (306) 846 Other operating expenses Total benefits and expenses 3,734 (895) 2,839 (459) 2,380 Income (loss) before income taxes (388) ,028 Income tax expense (benefit) (124) Net income (loss) $ (264) $ 629 $ 365 $ 299 $ 664 COMPREHENSIVE INCOME (LOSS): Net income (loss) $ (264) $ 629 $ 365 $ 299 $ 664 Other comprehensive income (loss) before income tax:(3) Net unrealized investment gains before income tax 807 (379) ,068 Non-credit portion of OTTI losses recognized in OCI before income tax (117) (117) (117) Other comprehensive income (loss) before income taxes 690 (379) Less: Income tax expense (benefit) related to:(3) Net unrealized investment gains (337) Non-credit portion of OTTI losses recognized in OCI (41) (41) (41) Total income tax expense (benefit) (378) Other comprehensive income, net of tax 1,068 (866) Comprehensive income (loss) $ 804 $ (237) $ 567 $ 715 $ 1,282 (1) (2) (3) Adjustments related to the correction of errors reflect amounts prior to the retrospective adoption of amended guidance to ASC 944, Financial Services Insurance. See footnote 2 below for additional information regarding these amounts and the retrospective adoption. Adjustments related to the retrospective adoption of amended guidance to ASC 944, Financial Services Insurance as described more fully in the Note. In addition to adjustments described within this footnote the correction of errors column contains reclassifications related to changes in presentation of components of other comprehensive income. F-18

19 2. Restatement and Amendment of Previously Reported Financial Information (continued) Statement of Cash Flows ($ in thousands) For the period ended December 31, 2011 Adjusted prior to the As previously Correction retrospective Retrospective As restated reported of errors(1) Adoption Adoption(2) and amended OPERATING ACTIVITIES: Net income (loss) $ 97 $ (321) $ (224) $ 272 $ 48 Net realized investment losses Policy acquisition costs deferred Policy acquisition cost amortization 1,083 (495) 588 (226) 362 Interest credited Change in: Accrued investment income 131 (32) Deferred income taxes (231) 67 (164) 147 (17) Due and uncollected premium Reinsurance recoverables 1, ,309 1,309 Policy liabilities and accruals (866) (593) (1,459) (193) (1,652) Due to/from affiliate (198) (198) (198) Other operating activities, net 972 (658) Cash provided by (used for) operating activities 2,472 (437) 2,035 2,035 INVESTING ACTIVITIES: Purchases of: Available-for-sale debt securities (3,687) (3,687) (3,687) Sales, repayments and maturities of: Available-for-sale debt securities 10, ,985 10,985 Policy loans, net Other investing activities, net Cash provided by investing activities 7, ,437 7,437 FINANCING ACTIVITIES: Policyholder deposit fund deposits Policyholder deposit fund withdrawals (1,583) (1,583) (1,583) Net transfers to/from separate accounts 1,140 1,140 1,140 Cash provided by (used for) by financing activities Change in cash and cash equivalents 9,879 (18) 9,861 9,861 Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year $ 10,439 $ $ 10,439 $ $ 10,439 (1) (2) Adjustments related to the correction of errors reflect amounts prior to the retrospective adoption of amended guidance to ASC 944, Financial Services Insurance. See footnote 2 below for additional information regarding these amounts and the retrospective adoption. Adjustments related to the retrospective adoption of amended guidance to ASC 944, Financial Services Insurance as described more fully in this Note. F-19

20 2. Restatement and Amendment of Previously Reported Financial Information (continued) Statement of Cash Flows ($ in thousands) For the period ended December 31, 2010 Adjusted prior to the As previously Correction retrospective Retrospective As restated reported of errors(1) Adoption Adoption(2) and amended OPERATING ACTIVITIES: Net income (loss) $ (264) $ 629 $ 365 $ 299 $ 664 Net realized investment losses (5) (5) (5) Policy acquisition costs deferred (3) (3) (3) Policy acquisition cost amortization ,152 (306) 846 Interest credited Change in: Accrued investment income 36 (49) (13) (13) Deferred income taxes Due and uncollected premium Reinsurance recoverables 4,028 (1) 4,027 4,027 Policy liabilities and accruals (5,251) (38) (5,289) (154) (5,443) Due to/from affiliate (322) (322) (322) Other operating activities, net (5,058) 1,568 (3,490) (3,490) Cash provided by (used for) operating activities (5,355) 3,251 (2,104) (2,104) INVESTING ACTIVITIES: Purchases of: Available-for-sale debt securities (21,651) (21,651) (21,651) Sales, repayments and maturities of: Available-for-sale debt securities 20,927 20,927 20,927 Policy loans, net (215) 54 (161) (161) Other investing activities, net Cash used for investing activities (939) 54 (885) (885) FINANCING ACTIVITIES: Policyholder deposit fund deposits Policyholder deposit fund withdrawals (7,107) (7,107) (7,107) Net transfers to/from separate accounts 2,784 2,784 2,784 Dividend to parent (2,292) (2,292) (2,292) Cash used for financing activities (2,292) (3,346) (5,638) (5,638) Change in cash and cash equivalents (8,586) (41) (8,627) (8,627) Cash and cash equivalents, beginning of year 9, ,205 9,205 Cash and cash equivalents, end of year $ 560 $ 18 $ 578 $ $ 578 (1) (2) Adjustments related to the correction of errors reflect amounts prior to the retrospective adoption of amended guidance to ASC 944, Financial Services Insurance. See footnote 2 below for additional information regarding these amounts and the retrospective adoption. Adjustments related to the retrospective adoption of amended guidance to ASC 944, Financial Services Insurance as described more fully in this Note. F-20

21 2. Restatement and Amendment of Previously Reported Financial Information (continued) Statement of Changes in Stockholder s Equity ($ in thousands) For the period ended December 31, 2011 Adjusted prior to the As previously Correction retrospective Retrospective As restated reported of errors(1) Adoption Adoption(2) and amended COMMON STOCK: Balance, beginning of period $ 2,500 $ $ 2,500 $ $ 2,500 Balance, end of period $ 2,500 $ $ 2,500 $ $ 2,500 ADDITIONAL PAID-IN CAPITAL: Balance, beginning of period $ 19,664 $ $ 19,664 $ $ 19,664 Balance, end of period $ 19,664 $ $ 19,664 $ $ 19,664 ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS): Balance, beginning of period $ 703 $ (552) $ 151 $ 271 $ 422 Other comprehensive income (loss) (224) 213 (11) (121) (132) Balance, end of period $ 479 $ (339) $ 140 $ 150 $ 290 RETAINED EARNINGS (ACCUMULATED DEFICIT): Balance, beginning of period $ 2,653 $ (615) $ 2,038 $ (2,397) $ (359) Net income (loss) 97 (321) (224) Balance, end of period $ 2,750 $ (936) $ 1,814 $ (2,125) $ (311) TOTAL STOCKHOLDER S EQUITY: Balance, beginning of period $ 25,520 $ (1,167) $ 24,353 $ (2,126) $ 22,227 Change in stockholder s equity (127) (108) (235) 151 (84) Balance, end of period $ 25,393 $ (1,275) $ 24,118 $ (1,975) $ 22,143 (1) (2) Adjustments related to the correction of errors reflect amounts prior to the retrospective adoption of amended guidance to ASC 944, Financial Services Insurance. See footnote 2 below for additional information regarding these amounts and the retrospective adoption. Adjustments related to the retrospective adoption of amended guidance to ASC 944, Financial Services Insurance as described more fully in this Note. F-21

22 2. Restatement and Amendment of Previously Reported Financial Information (continued) Statement of Changes in Stockholder s Equity ($ in thousands) For the period ended December 31, 2010 Adjusted prior to the As previously Correction retrospective Retrospective As restated reported of errors(1) Adoption Adoption(2) and amended COMMON STOCK: Balance, beginning of period $ 2,500 $ $ 2,500 $ $ 2,500 Balance, end of period $ 2,500 $ $ 2,500 $ $ 2,500 ADDITIONAL PAID-IN CAPITAL: Balance, beginning of period 19,664 $ $ 19,664 $ $ 19,664 Balance, end of period $ 19,664 $ $ 19,664 $ $ 19,664 ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS): Balance, beginning of period $ (365) $ 314 $ (51) $ (145) $ (196) Other comprehensive income 1,068 (866) Balance, end of period $ 703 $ (552) $ 151 $ 271 $ 422 RETAINED EARNINGS (ACCUMULATED DEFICIT): Balance, beginning of period $ 5,209 $ (1,244) $ 3,965 $ (2,696) $ 1,269 Net income (loss) (264) Common stock dividends (2,292) (2,292) (2,292) Balance, end of period $ 2,653 $ (615) $ 2,038 $ (2,397) $ (359) TOTAL STOCKHOLDER S EQUITY: Balance, beginning of period $ 27,008 $ (930) $ 26,078 $ (2,841) $ 23,237 Change in stockholder s equity (1,488) (237) (1,725) 715 (1,010) Balance, end of period $ 25,520 $ (1,167) $ 24,353 $ (2,126) $ 22,227 (1) (2) Adjustments related to the correction of errors reflect amounts prior to the retrospective adoption of amended guidance to ASC 944, Financial Services Insurance. See footnote 2 below for additional information regarding these amounts and the retrospective adoption. Adjustments related to the retrospective adoption of amended guidance to ASC 944, Financial Services Insurance as described more fully in this Note. F-22

23 3. Basis of Presentation and Significant Accounting Policies We have prepared these financial statements in accordance with U.S. GAAP which differ materially from the accounting practices prescribed by various insurance regulatory authorities. As of December 31, 2011, the Company changed from the direct to the indirect method of reporting its cash flow statement. Certain prior year amounts have been reclassified to conform to the current year presentation, primarily as a result of the adoption of new accounting standards as described more fully below. 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 deferred policy acquisition costs; policyholder liabilities and accruals; valuation of investments in debt securities; 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 expense. Actual results could differ from these estimates. Adoption of new accounting standards Amendments to the Presentation of Comprehensive Income In June 2011, the Financial Accounting Standards Board (the FASB ) issued amended guidance to ASC 220, Comprehensive Income, with respect to the presentation of comprehensive income as part of the effort to establish common requirements between U.S. GAAP and International Financial Reporting Standards ( IFRS ). This amended guidance requires entities to present all non-owner changes in stockholder s equity either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The amendments do not affect which components of comprehensive income are recognized in net income or comprehensive income, or when an item of other comprehensive income must be classified to net income. The computation and presentation of earnings per share also does not change. This guidance was adopted in the first quarter of Other than the required changes in presentation and the additional disclosures, adoption of this guidance did not have a material effect on our financial statements. Amendments to Fair Value Measurement and Disclosure Requirements In May 2011, the FASB issued amended guidance to ASC 820, Fair Value Measurement, with respect to measuring fair value and related disclosures as part of the effort to establish common requirements in accordance with U.S. GAAP and IFRS. The amended guidance clarifies that the concept of highest and best use should only be used in the valuation of nonfinancial assets, specifies how to apply fair value measurements to instruments classified in stockholder s equity and requires that premiums or discounts be applied consistent with what market participants would use absent Level 1 inputs. The amendment also explicitly requires additional disclosures related to the valuation of assets categorized as Level 3 within the fair value hierarchy. Additional disclosures include quantitative information about unobservable inputs, the sensitivity of fair value measurement to changes in unobservable outputs and information on the valuation process used. This guidance was adopted in the first quarter of Disclosures in Note 7 reflect the prospective adoption of this guidance. Other than additional disclosures, adoption of this guidance did not have a material effect on our financial statements. Revision for the Retrospective Adoption of Amended Accounting Guidance In October 2010, the FASB issued amended guidance to ASC 944, Financial Services Insurance, to address the diversity in practice for accounting for costs associated with acquiring or renewing insurance contracts. The amendment clarifies the definition of acquisition costs (i.e., costs which qualify for deferral) to include only incremental direct costs that result directly from, and are essential to, a contract and would not have been incurred by the insurance entity had the contract transaction not occurred. Therefore, only costs related to successful efforts of acquiring a new, or renewal, contract should be deferred. This guidance was retrospectively adopted on January 1, 2012 and such retrospective adoption results in amendments to previously reported balances as shown in Note 2 as if the guidance was applied at the inception of all policies in force. The cumulative effect of retrospective adoption reduced deferred policy acquisition costs and beginning stockholder s equity by $1,975 thousand as of January 1, In any period, the adoption resulted in a decrease in policy acquisition cost amortization due to the reduced deferred policy acquisition cost asset. F-23