XNYS:FFG FBL Financial Group Inc Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

XNYS:FFG Fair Value Estimate
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XNYS:FFG Consider Buying
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
 
FORM 10-Q

(Mark one)
 
 
[X]
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
 
 
 
For the quarterly period ended March 31, 2012
 
 
 
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: 1-11917
(Exact name of registrant as specified in its charter)
 
 
 
Iowa
 
42-1411715
(State of incorporation)
 
(I.R.S. Employer Identification No.)
 
 
 
5400 University Avenue, West Des Moines, Iowa
 
50266-5997
(Address of principal executive offices)
 
(Zip Code)
 
 
 
(515) 225-5400
(Registrant's telephone number, including area code)
 
 
 
 
(Former name, former address and former fiscal year, if changed since last report)
 
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [ ] No
 
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 (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). [X] Yes [ ] No
 
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 definitions 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 [X]
Non-accelerated filer [ ]
Smaller reporting company [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). [ ] Yes [X] No
 
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the last practicable date:
 Title of each class
 
Outstanding at May 1, 2012
Class A Common Stock, without par value
 
26,502,823
Class B Common Stock, without par value
 
1,192,990



FBL FINANCIAL GROUP, INC.
FORM 10-Q FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2012
TABLE OF CONTENTS



PART I.
FINANCIAL INFORMATION
 
 
 
 
Item 1.
Financial Statements (Unaudited)
 
 
Consolidated Balance Sheets
 
Consolidated Statements of Comprehensive Income
 
Consolidated Statements of Changes in Stockholders' Equity
 
Consolidated Statements of Cash Flows
 
Notes to Consolidated Financial Statements
 
 
 
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
 
 
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
 
 
 
Item 4.
Controls and Procedures
 
 
 
PART II.
OTHER INFORMATION
 
 
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
 
 
 
Item 6.
Exhibits
 
 
 
SIGNATURES
 
    


1


ITEM 1. FINANCIAL STATEMENTS

FBL FINANCIAL GROUP, INC.
CONSOLIDATED BALANCE SHEETS (Unaudited)
(Dollars in thousands)

 
March 31,
2012
 
December 31,
2011
Assets
 
 
 
Investments:
 
 
 
Fixed maturities - available for sale, at fair value (amortized cost: 2012 - $5,341,307; 2011 - $5,189,994)
$
5,742,044

 
$
5,570,550

Equity securities - available for sale, at fair value (cost: 2012 - $51,448; 2011 - $55,697)
54,221

 
57,432

Mortgage loans
532,555

 
552,359

Real estate
4,672

 
2,541

Policy loans
173,277

 
172,368

Short-term investments
31,590

 
41,756

Other investments
368

 
189

Total investments
6,538,727

 
6,397,195

 
 
 
 
Cash and cash equivalents
302,836

 
296,339

Restricted debt defeasance trust assets

 
211,627

Securities and indebtedness of related parties
73,898

 
64,516

Accrued investment income
73,355

 
67,200

Amounts receivable from affiliates
5,885

 
3,942

Reinsurance recoverable
100,393

 
94,685

Deferred acquisition costs
248,751

 
260,256

Value of insurance in force acquired
26,442

 
25,781

Current income taxes recoverable
13,273

 
16,334

Other assets
80,523

 
67,590

Assets held in separate accounts
655,755

 
603,903

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total assets
$
8,119,838

 
$
8,109,368


 

2




FBL FINANCIAL GROUP, INC.
CONSOLIDATED BALANCE SHEETS (Continued)
(Dollars in thousands)

 
March 31,
2012
 
December 31,
2011
Liabilities and stockholders' equity
 
 
 
Liabilities:
 
 
 
Future policy benefits:
 
 
 
Interest sensitive products
$
3,850,220

 
$
3,744,857

Traditional life insurance and accident and health products
1,415,168

 
1,401,995

Other policy claims and benefits
43,170

 
40,488

Supplementary contracts without life contingencies
361,890

 
359,663

Advance premiums and other deposits
217,579

 
211,573

Amounts payable to affiliates
631

 
713

Short-term debt payable to non-affiliates

 
174,258

Long-term debt payable to affiliates
49,971

 
49,968

Long-term debt payable to non-affiliates
97,000

 
97,000

Stock repurchase obligation
112,538

 

Deferred income taxes
103,909

 
100,341

Other liabilities
99,239

 
122,180

Liabilities related to separate accounts
655,755

 
603,903

Total liabilities
7,007,070

 
6,906,939

 
 
 
 
Stockholders' equity:
 
 
 
FBL Financial Group, Inc. stockholders' equity:
 
 
 
Preferred stock, without par value, at liquidation value - authorized 10,000,000 shares, issued and outstanding 5,000,000 Series B shares
3,000

 
3,000

Class A common stock, without par value - authorized 88,500,000 shares, issued and outstanding 26,502,769 shares in 2012 and 29,457,644 shares in 2011
122,238

 
129,684

Class B common stock, without par value - authorized 1,500,000 shares, issued and outstanding 1,192,990 shares
7,522

 
7,522

Accumulated other comprehensive income
180,839

 
177,845

Retained earnings
799,074

 
884,263

Total FBL Financial Group, Inc. stockholders' equity
1,112,673

 
1,202,314

Noncontrolling interest
95

 
115

Total stockholders' equity
1,112,768

 
1,202,429

Total liabilities and stockholders' equity
$
8,119,838

 
$
8,109,368














See accompanying notes.

3


FBL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
(Dollars in thousands, except per share data)

 
Three months ended March 31,
 
2012
 
2011
Revenues:
 
 
 
Interest sensitive product charges
$
25,232

 
$
24,129

Traditional life insurance premiums
43,123

 
41,387

Net investment income
86,888

 
83,785

Net realized capital gains on sales of investments
879

 
2,260

 

 
 
Total other-than-temporary impairment losses
(11,301
)
 
(5,727
)
Non-credit portion in other comprehensive income
9,779

 
3,575

Net impairment losses recognized in earnings
(1,522
)
 
(2,152
)
Other income
5,005

 
4,999

Total revenues
159,605

 
154,408

 
 
 
 
Benefits and expenses:
 
 
 
Interest sensitive product benefits
49,082

 
46,621

Traditional life insurance benefits
39,111

 
36,598

Policyholder dividends
4,244

 
4,300

Underwriting, acquisition and insurance expenses
32,727

 
33,251

Interest expense
1,982

 
2,388

Loss on debt redemption
33

 

Other expenses
5,790

 
4,881

Total benefits and expenses
132,969

 
128,039

 
26,636

 
26,369

Income taxes
(8,758
)
 
(8,318
)
Equity income, net of related income taxes
1,621

 
731

Net income from continuing operations
19,499

 
18,782

Discontinued operations:
 
 
 
Loss on sale of subsidiary
(2,252
)
 

Income (loss) from discontinued operations, net of tax
(680
)
 
6,267

Total income (loss) from discontinued operations
(2,932
)
 
6,267

Net income
16,567

 
25,049

Net loss attributable to noncontrolling interest
20

 
2

Net income attributable to FBL Financial Group, Inc.
$
16,587

 
$
25,051

 
 
 
 
Comprehensive income
$
19,561

 
$
41,795

 
 
 
 
Earnings per common share:
 
 
 
Income from continuing operations
$
0.64

 
$
0.61

Income (loss) from discontinued operations
(0.10
)
 
0.20

Earnings per common share
$
0.54

 
$
0.81

Earnings per common share - assuming dilution:
 
 
 
Income from continuing operations
$
0.63

 
$
0.60

Income (loss) from discontinued operations
(0.10
)
 
0.20

Earnings per common share - assuming dilution
$
0.53

 
$
0.80

 
 
 
 
Cash dividends per common share
$
0.1000

 
$
0.0625


See accompanying notes.

4


FBL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Unaudited)
(Dollars in thousands)
 
FBL Financial Group, Inc. Stockholders' Equity
 
 
 
 
 
Series B Preferred Stock
 
Class A and Class B Common Stock (a)
 
Accumulated Other Comprehensive Income
 
Retained Earnings
 
Non-
controlling Interest
 
Total Stockholders' Equity
Balance at January 1, 2011    
$
3,000

 
$
125,687

 
$
51,644

 
$
864,303

 
$
92

 
$
1,044,726

Comprehensive income
 
 
 
 
 
 
 
 
 
 

Net income - three months ended March 31, 2011

 

 

 
25,051

 
(2
)
 
25,049

Change in net unrealized investments gains/losses

 

 
18,895

 

 

 
18,895

Non-credit impairment losses

 

 
(2,144
)
 

 

 
(2,144
)
Change in underfunded status of other postretirement benefit plans

 

 
(5
)
 

 

 
(5
)
Total comprehensive income (b)
 
 
 
 
 
 
 
 
 
 
41,795

Stock-based compensation, including the net issuance of 192,604 common shares under compensation plans

 
4,919

 

 

 

 
4,919

Dividends on preferred stock

 

 

 
(38
)
 

 
(38
)
Dividends on common stock

 

 

 
(1,903
)
 

 
(1,903
)
Balance at March 31, 2011
$
3,000

 
$
130,606

 
$
68,390

 
$
887,413

 
$
90

 
$
1,089,499

 
 
 
 
 
 
 
 
 
 
 
 
Balance at January 1, 2012    
$
3,000

 
$
137,206

 
$
177,845

 
$
884,263

 
$
115

 
$
1,202,429

Total comprehensive income
 
 
 
 
 
 
 
 
 
 

Net income - three months ended March 31, 2012

 

 

 
16,587

 
(20
)
 
16,567

Change in net unrealized investments gains/losses

 

 
9,446

 

 

 
9,446

Non-credit impairment losses

 

 
(6,356
)
 

 

 
(6,356
)
Change in underfunded status of other postretirement benefit plans

 

 
(96
)
 

 

 
(96
)
Total comprehensive income (b)
 
 
 
 
 
 
 
 
 
 
19,561

Stock-based compensation, including the net issuance of 242,179 common shares under compensation plans

 
6,628

 

 

 

 
6,628

Purchase of 3,197,054 shares of common stock

 
(14,074
)
 

 
(98,676
)
 

 
(112,750
)
Dividends on preferred stock

 

 

 
(38
)
 

 
(38
)
Dividends on common stock

 

 

 
(3,062
)
 

 
(3,062
)
Balance at March 31, 2012
$
3,000

 
$
129,760

 
$
180,839

 
$
799,074

 
$
95

 
$
1,112,768


(a)
All activity for the periods shown relates to Class A Common Stock.
(b)
Comprehensive income attributable to FBL Financial Group, Inc. aggregated $19,581 for the three months ended March 31, 2012 and $41,797 for the 2011 period.

















See accompanying notes.

5


FBL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Dollars in thousands)

 
Three months ended March 31,
 
2012
 
2011
Operating activities (a)
 
 
 
Net income
$
16,567

 
$
25,049

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Interest credited to account balances
34,539

 
111,326

Charges for mortality, surrenders and administration
(22,534
)
 
(28,808
)
Net realized losses on investments
643

 
7,940

Change in fair value of derivatives
155

 
(18,103
)
Increase in traditional life and accident and health benefit liabilities
13,173

 
8,361

Deferral of acquisition costs
(13,709
)
 
(30,331
)
Amortization of deferred acquisition costs and value of insurance in force
8,815

 
39,824

Change in reinsurance recoverable
(5,708
)
 
(2,135
)
Provision for deferred income taxes
3,080

 
(4,209
)
Loss on sale of subsidiary
2,252

 

Loss on debt redemption
33

 

Other
(49,628
)
 
(10,809
)
Net cash provided by (used in) operating activities
(12,322
)
 
98,105

 
 
 
 
Investing activities (a)
 
 
 
Sales, maturities or repayments:
 
 
 
Fixed maturities - available for sale
144,641

 
287,393

Equity securities - available for sale
6,312

 

Mortgage loans
20,607

 
21,570

Derivative instruments

 
45,064

Policy loans
8,919

 
11,038

Acquisitions:
 
 
 
Fixed maturities - available for sale
(284,947
)
 
(565,554
)
Equity securities - available for sale
(1,958
)
 
(247
)
Mortgage loans
(2,200
)
 
(17,050
)
Derivative instruments
(99
)
 
(12,318
)
Policy loans
(9,828
)
 
(10,193
)
Securities and indebtedness of related parties
(9,312
)
 
(5,223
)
Short-term investments, net change
10,166

 
156,716

Purchases and disposals of property and equipment, net
35

 
(1,565
)
Net cash used in investing activities
(117,664
)
 
(90,369
)



6


FBL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Dollars in thousands)

 
Three months ended March 31,
 
2012
 
2011
Financing activities (a)
 
 
 
Contract holder account deposits
$
197,828

 
$
393,377

Contract holder account withdrawals
(100,598
)
 
(290,651
)
Transfer from restricted debt defeasance trusts
211,627

 

Repayments of debt
(174,258
)
 

Excess tax deductions on stock-based compensation
2,117

 
223

Issuance of common stock, net of repurchases
2,867

 
3,456

Dividends paid
(3,100
)
 
(1,941
)
Net cash provided by financing activities
136,483

 
104,464

Increase in cash and cash equivalents
6,497

 
112,200

Cash and cash equivalents at beginning of period
296,339

 
4,794

Cash and cash equivalents at end of period
$
302,836

 
$
116,994

 
 
 
 
Supplemental disclosures of cash flow information (a)
 
 
 
Cash paid (received) during the period for:
 
 
 
Interest
$
5,458

 
$
6,463

Income taxes
(1,430
)
 
(10,431
)
Non-cash operating activity:
 
 
 
Deferral of sales inducements
590

 
13,463

Non-cash financing activity:
 
 
 
Stock repurchase obligation
(112,538
)
 


(a) Our consolidated statements of cash flows combine the cash flows from discontinued operations with the cash flows from continuing operations within each major category (operating, investing and financing) of the statement and supplemental disclosures.























See accompanying notes.

7


FBL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
March 31, 2012

1. Significant Accounting Policies

Basis of Presentation

The accompanying unaudited consolidated financial statements of FBL Financial Group, Inc. (we or the Company) have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. Our financial statements include all adjustments (consisting of normal recurring accruals) necessary for a fair presentation of our financial position and results of operations.

Operating results for the three month period ended March 31, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012. We encourage you to refer to our consolidated financial statements and notes for the year ended December 31, 2011 included in our Annual Report on Form 10-K for a complete description of our material accounting policies. Also included in the Form 10-K is a description of areas of judgments and estimates and other information necessary to understand our financial position and results of operations.

See Note 2 for information on the recent sale of our former subsidiary, EquiTrust Life Insurance Company (EquiTrust Life). Financial results of this business component have been reclassified in the prior period financial statements and excluded from the notes to the consolidated financial statements, unless otherwise noted.

Adoption of Recent Accounting Pronouncements

Effective January 1, 2012, we adopted guidance issued by the Financial Accounting Standards Board (FASB) related to accounting for costs associated with acquiring or renewing insurance contracts. This guidance defines allowable deferred acquisition costs as the incremental direct cost of contract acquisition and certain costs related directly to underwriting, policy issuance and processing. This guidance also allows for the deferral of advertising costs if directly linked to a sale. We have applied the guidance retrospectively, resulting in a reduction to stockholders' equity of $75.8 million at January 1, 2012 and $101.7 million at January 1, 2011. Income from continuing operations for the first quarter of 2011 was reduced by $0.9 million ($0.03 per basic and diluted common share). Income from discontinued operations for the first quarter of 2011 was reduced by $0.6 million ($0.02 per basic and diluted common share). The following tables present the effect of the change on financial statement line items for prior periods that were retrospectively adjusted:
Consolidated Balance Sheet
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2011
 
 
 
 Prior to Adoption
 
Currently Reported
 
Impact
 
(Dollars in thousands)
Assets:
 
 
 
 
 
Deferred acquisition costs
$
376,797

 
$
260,256

 
$
(116,541
)
Liabilities:
 
 
 
 
 
Deferred income taxes
141,130

 
100,341

 
(40,789
)
Stockholders' equity:
 
 
 
 
 
Accumulated other comprehensive income
149,622

 
177,845

 
28,223

Retained earnings
988,238

 
884,263

 
(103,975
)
Impact to stockholders' equity
 
 
 
 
$
(75,752
)


8

March 31, 2012

Consolidated Statement of Comprehensive Income
 
 
 
 
 
 
 
 
 
 
 
 
March 31, 2011
 
 
 
 Prior to Adoption
 
Currently Reported
 
Impact
 
(Dollars in thousands)
Benefits and expenses:
 
 
 
 
 
Underwriting, acquisition and insurance expenses
$
31,939

 
$
33,251

 
$
(1,312
)
Income taxes
8,777

 
8,318

 
459

Income from continuing operations
 
 
 
 
(853
)
Discontinued operations:
 
 
 
 
 
Income from discontinued operations
6,855

 
6,267

 
(588
)
Net income attributable to FBL Financial Group, Inc.
 
 
 
 
$
(1,441
)

Effective January 1, 2012, we adopted guidance issued by the FASB related to the presentation of comprehensive income. This guidance requires us to report components of comprehensive income in either (1) a continuous statement of comprehensive income or (2) two separate but consecutive statements. This guidance removes the presentation option allowing comprehensive income disclosures in the statement of changes in stockholders' equity, but does not change the items that must be reported in other comprehensive income. We have elected to present a single continuous statement for the 2012 interim reporting periods and expect to present a separate statement of comprehensive income immediately following our consolidated statements of operations for annual periods. Other than this presentation change, the adoption of this guidance did not have any impact on our consolidated financial statements.

Reclassifications

The 2011 consolidated financial statements have been reclassified to conform to the current financial statement presentation.

2. Discontinued Operations

On December 30, 2011, we sold our wholly-owned subsidiary, EquiTrust Life. The loss on sale of subsidiary recorded during the quarter ended March 31, 2012 includes a $3.5 million pre-tax reduction in the preliminary purchase price due to post-closing adjustments based on a final statutory net worth reconciliation. The adoption of new accounting guidance related to deferred acquisition costs discussed in Note 1 reduced the loss on sale reported in the fourth quarter of 2011 by $14.4 million, after tax. The total after-tax loss on the sale of EquiTrust Life after these adjustments was $56.4 million.

In addition, we have entered into an agreement with EquiTrust Life to provide interim and transition services for a period of up to six months, beginning immediately after closing, with EquiTrust Life retaining the option to extend the agreement with respect to certain of the services for up to six additional months. Transition-related expenses are being reimbursed by the buyer and are estimated to be approximately $3.1 million for the six-month period. For the three months ended March 31, 2012, other income includes $1.5 million from transition-related fee income.

As a result of the sale, our consolidated financial statements are presented to reflect the operations of the component sold as discontinued operations. A summary of income (loss) from discontinued operations is as follows:

Condensed Statements of Income (Loss) from Discontinued Operations
 
 
 
 
Three months ended March 31,
 
2012
 
2011
 
(Dollars in thousands)
Revenues
$

 
$
136,895

Benefits and expenses
(191
)
 
(123,976
)
Interest expense allocation
(855
)
 
(3,722
)
Equity income

 
1,029

Income taxes
366

 
(3,959
)
Income (loss) from discontinued operations
$
(680
)
 
$
6,267


Charges recorded in connection with the disposal of business included estimates that are subject to subsequent adjustment. Interest expense in 2012 relates to unaffiliated debt extinguished on January 30, 2012 as discussed below.

9

March 31, 2012


Notes Redemptions

In connection with the EquiTrust Life sale, we redeemed $225.0 million of our long-term debt in accordance with the mandatory redemption provisions of the underlying notes. This included $50.0 million Senior Notes with our affiliate, Farm Bureau Property & Casualty Insurance Company (Farm Bureau Property & Casualty), which was extinguished on December 30, 2011. The remaining $175.0 million of unaffiliated debt was extinguished on January 30, 2012, at the make-whole redemption price of $210.9 million. On December 30, 2011, we exercised the provisions of the trust indentures and deposited $211.6 million into two irrevocable defeasance trusts for the principal, accrued interest and estimated make-whole premium. The trust funds were not withdrawable by us, and consisted of $126.4 million in cash and $85.2 million in short-term investments at December 31, 2011. The note holders were paid from assets in the trusts on January 30, 2012.
 
The make-whole redemption premium was based on U.S. Treasury yields and considered an embedded derivative. Due to the EquiTrust Life sale, this derivative liability had a fair value of $33.1 million at December 31, 2011. The change in fair value during the first quarter of 2012 was offset by the write-off of deferred debt issuance costs and reported as loss on debt redemption in the consolidated statements of comprehensive income.

3. Investment Operations

Fixed Maturity and Equity Securities
 
Available-For-Sale Fixed Maturity and Equity Securities by Investment Category
 
 
 
March 31, 2012
 
Amortized
 Cost
 
Gross
 Unrealized
 Gains
 
Gross
 Unrealized
 Losses (1)
 
Estimated
 Fair
 Value
 
(Dollars in thousands)
Fixed maturities:
 
 
 
 
 
 
 
Corporate (2)
$
2,728,755

 
$
284,045

 
$
(28,141
)
 
$
2,984,659

Residential mortgage-backed
673,764

 
39,486

 
(13,780
)
 
699,470

Commercial mortgage-backed
463,017

 
37,961

 
(8,686
)
 
492,292

Other asset-backed
437,709

 
6,500

 
(22,419
)
 
421,790

Collateralized debt obligation (3)
29

 

 

 
29

United States Government and agencies
44,507

 
6,809

 

 
51,316

State, municipal and other governments
993,526

 
102,525

 
(3,563
)
 
1,092,488

Total fixed maturities
$
5,341,307

 
$
477,326

 
$
(76,589
)
 
$
5,742,044

 
 
 
 
 
 
 
 
Equity securities:
 
 
 
 
 
 
 
Non-redeemable preferred stocks
$
28,149

 
$
2,568

 
$
(632
)
 
$
30,085

Common stocks
23,299

 
837

 

 
24,136

Total equity securities
$
51,448

 
$
3,405

 
$
(632
)
 
$
54,221


10

March 31, 2012

 
December 31, 2011
 
Amortized
 Cost
 
Gross
 Unrealized
 Gains
 
Gross
 Unrealized
 Losses (1)
 
Estimated
 Fair
 Value
 
(Dollars in thousands)
Fixed maturities :
 
 
 
 
 
 
 
Corporate (2)
$
2,650,113

 
$
290,688

 
$
(42,654
)
 
$
2,898,147

Residential mortgage-backed
652,585

 
39,789

 
(16,435
)
 
675,939

Commercial mortgage-backed
452,980

 
46,935

 
(9,020
)
 
490,895

Other asset-backed
392,182

 
2,058

 
(26,080
)
 
368,160

Collateralized debt obligation (3)
270

 

 

 
270

United States Government and agencies
45,231

 
7,446

 

 
52,677

State, municipal and other governments
996,633

 
92,968

 
(5,139
)
 
1,084,462

Total fixed maturities
$
5,189,994

 
$
479,884

 
$
(99,328
)
 
$
5,570,550

 
 
 
 
 
 
 
 
Equity securities:
 
 
 
 
 
 
 
Non-redeemable preferred stocks
$
33,149

 
$
1,777

 
$
(524
)
 
$
34,402

Common stocks
22,548

 
482

 

 
23,030

Total equity securities
$
55,697

 
$
2,259

 
$
(524
)
 
$
57,432


(1)
Gross unrealized losses include non-credit losses on other-than-temporarily impaired corporate securities totaling $5.3 million at March 31, 2012 and December 31, 2011, other asset-backed securities totaling $12.1 million at March 31, 2012 and December 31, 2011, and residential mortgage-backed securities totaling $10.7 million at March 31, 2012 and $0.9 million at December 31, 2011.
 
 
(2)
Corporate securities include certain hybrid preferred securities with a carrying value of $123.2 million at March 31, 2012 and $116.7 million at December 31, 2011. Corporate securities also include redeemable preferred stock with a carrying value of $5.6 million at March 31, 2012 and $5.5 million at December 31, 2011.
 
 
(3)
The collateralized debt obligation includes an embedded credit derivative, accordingly changes in its fair value are realized as derivative income (loss) which is included within net investment income in the consolidated statements of comprehensive income.

Short-term investments have been excluded from the above schedules as amortized cost approximates fair value for these securities.

Available-For-Sale Fixed Maturities by Maturity Date
 
 
 
 
 
 
 
 
March 31, 2012
 
Amortized
 Cost
 
Estimated
Fair Value
 
(Dollars in thousands)
Due in one year or less
$
80,123

 
$
81,473

Due after one year through five years
500,405

 
530,590

Due after five years through ten years
1,226,761

 
1,361,879

Due after ten years
1,959,528

 
2,154,550

 
3,766,817

 
4,128,492

Mortgage-backed and other asset-backed
1,574,490

 
1,613,552

Total fixed maturities
$
5,341,307

 
$
5,742,044


Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Fixed maturities not due at a single maturity date have been included in the above table in the year of final contractual maturity.


11

March 31, 2012

Net Unrealized Gains (Losses) on Investments in Accumulated Other Comprehensive Income
 
 
 
 
 
March 31,
2012
 
December 31,
2011
 
(Dollars in thousands)
Unrealized appreciation (depreciation) on:
 
 
 
Fixed maturities - available for sale
$
400,737

 
$
380,556

Equity securities - available for sale
2,773

 
1,735

 
403,510

 
382,291

Adjustments for assumed changes in amortization pattern of:
 
 
 
Deferred acquisition costs
(122,510
)
 
(104,875
)
Value of insurance in force acquired
(10,974
)
 
(12,281
)
Unearned revenue reserve
8,176

 
8,312

Provision for deferred income taxes
(97,353
)
 
(95,688
)
 
180,849

 
177,759

Proportionate share of net unrealized investment losses of equity investees
(13
)
 
(13
)
Net unrealized investment gains
$
180,836

 
$
177,746


The changes in net unrealized investment gains and losses are recorded net of deferred income taxes and other adjustments for assumed changes in the amortization pattern of deferred acquisition costs, value of insurance in force acquired and unearned revenue reserve totaling $18.1 million for the three months ended March 31, 2012 and $62.0 million for the three months ended March 31, 2011. Subsequent changes in fair value of securities, for which a previous non-credit other-than-temporary impairment loss was recognized in accumulated other comprehensive income, are reported along with changes in fair value for which no other-than-temporary impairment losses were previously recognized.

Fixed Maturity and Equity Securities with Unrealized Losses by Length of Time
 
 
 
 
 
March 31, 2012
 
 
Less than one year
 
One year or more
 
Total
Description of Securities
 
Estimated
 Fair Value
 
Unrealized Losses
 
Estimated
 Fair Value
 
Unrealized Losses
 
Estimated Fair Value
 
Unrealized Losses
 
 
(Dollars in thousands)
Fixed maturities:
 
 
 
 
 
 
 
 
 
 
 
 
Corporate
 
$
202,642

 
$
(6,552
)
 
$
128,222

 
$
(21,589
)
 
$
330,864

 
$
(28,141
)
Residential mortgage-backed
 
56,923

 
(650
)
 
57,208

 
(13,130
)
 
114,131

 
(13,780
)
Commercial mortgage-backed
 
38,423

 
(1,517
)
 
37,477

 
(7,169
)
 
75,900

 
(8,686
)
Other asset-backed
 
86,037

 
(1,869
)
 
55,184

 
(20,550
)
 
141,221

 
(22,419
)
State, municipal and other governments
 
14,599

 
(133
)
 
21,369

 
(3,430
)
 
35,968

 
(3,563
)
Total fixed maturities
 
$
398,624

 
$
(10,721
)
 
$
299,460

 
$
(65,868
)
 
$
698,084

 
$
(76,589
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Equity securities:
 
 
 
 
 
 
 
 
 
 
 
 
Non-redeemable preferred stocks
 
$
2,861

 
$
(139
)
 
$
7,506

 
$
(493
)
 
$
10,367

 
$
(632
)
Total equities securities
 
$
2,861

 
$
(139
)
 
$
7,506

 
$
(493
)
 
$
10,367

 
$
(632
)


12

March 31, 2012

 
 
December 31, 2011
 
 
Less than one year
 
One year or more
 
Total
Description of Securities
 
Estimated
 Fair Value
 
Unrealized Losses
 
Estimated
 Fair Value
 
Unrealized Losses
 
Estimated Fair Value
 
Unrealized Losses
 
 
(Dollars in thousands)
Fixed maturities:
 
 
 
 
 
 
 
 
 
 
 
 
Corporate
 
$
248,879

 
$
(9,787
)
 
$
134,913

 
$
(32,867
)
 
$
383,792

 
$
(42,654
)
Residential mortgage-backed
 
19,923

 
(293
)
 
56,309

 
(16,142
)
 
76,232

 
(16,435
)
Commercial mortgage-backed
 
44,732

 
(3,872
)
 
39,790

 
(5,148
)
 
84,522

 
(9,020
)
Other asset-backed
 
82,801

 
(3,632
)
 
49,580

 
(22,448
)
 
132,381

 
(26,080
)
State, municipal and other governments
 
2,932

 
(45
)
 
50,328

 
(5,094
)
 
53,260

 
(5,139
)
Total fixed maturities
 
$
399,267

 
$
(17,629
)
 
$
330,920

 
$
(81,699
)
 
$
730,187

 
$
(99,328
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Equity securities:
 
 
 
 
 
 
 
 
 
 
 
 
Non-redeemable preferred stocks
 
$
2,878

 
$
(122
)
 
$
7,598

 
$
(402
)
 
$
10,476

 
$
(524
)
Total equity securities
 
$
2,878

 
$
(122
)
 
$
7,598

 
$
(402
)
 
$
10,476

 
$
(524
)

Included in the above tables are 208 securities from 169 issuers at March 31, 2012 and 249 securities from 204 issuers at December 31, 2011. The unrealized losses in fixed maturities are primarily due to wider spreads between the risk-free and corporate and other bond yields relative to the spreads when the securities were purchased. Because we do not intend to sell or do not believe we will be required to sell these fixed maturities before their anticipated recovery of amortized cost, we do not consider these investments to be other-than-temporarily impaired at March 31, 2012. The following summarizes the more significant unrealized losses of fixed maturities by investment category as of March 31, 2012.

Corporate securities: The unrealized losses on corporate securities represent 36.7% of our total unrealized losses. The largest losses remain in the finance sector ($164.7 million carrying value and $15.3 million unrealized loss). The largest unrealized losses in the finance sector were in the banking ($92.7 million carrying value and $11.2 million unrealized loss) and the real estate investment trust ($20.8 million carrying value and $1.8 million unrealized loss) sub-sectors. The unrealized losses across the finance sector are primarily attributable to a general widening in spread levels relative to the spreads at which we acquired the securities. Finance sector spreads have narrowed but remain historically wide in comparison to the narrowing experienced in the remaining sectors, contributing to the proportionately larger amount of unrealized losses for this sector.

The next largest unrealized loss on corporate securities is in the utilities sector ($46.8 million carrying value and $4.1 million unrealized loss). The unrealized loss in this sector is generally due to spread widening among several issuers that continue to experience a challenging operating environment.

Residential mortgage-backed securities: The unrealized losses on residential mortgage-backed securities represent 18.0% of our total unrealized losses, and were caused primarily by continued uncertainty regarding mortgage defaults on Alt-A loans. We purchased most of these investments at a discount to their face amount and the contractual cash flows of these investments are based on mortgages and other assets backing the securities.

Commercial mortgage-backed securities: The unrealized losses on commercial mortgage-backed securities represent 11.3% of our total unrealized losses and were caused primarily by spread widening and industry concerns regarding the potential for future commercial mortgage defaults. The contractual cash flows of these investments are based on mortgages backing the securities. Unrealized losses on military housing bonds were mainly attributed to a limited number of investors and negative publicity regarding this sector. The military housing bonds are also impacted by lack of printed underlying ratings on insured bonds.

Other asset-backed securities: The unrealized losses on other asset-backed securities represent 29.3% of our total unrealized losses, and were caused primarily by concerns regarding defaults on subprime mortgages and home equity loans. We purchased most of these investments at a discount to their face amount and the contractual cash flows of these investments are based on mortgages and other assets backing the securities.

State, municipal and other governments: The unrealized losses on state, municipal and other governments represent 4.7% of our total unrealized losses, and were primarily caused by general spread widening relative to spreads at which we acquired the bonds. The decline in fair value is primarily attributable to increased spreads on lower-rated bonds and market concerns regarding specific areas of the sector.

13

March 31, 2012


Equity securities: We had $0.6 million of gross unrealized losses on investment grade non-redeemable perpetual preferred securities within the finance sector as of March 31, 2012. These securities provide periodic cash flows, contain call features and are similarly rated and priced like other long-term callable bonds and are evaluated for other-than-temporary impairment similar to fixed maturities. The decline in fair value is primarily attributable to market concerns regarding the sector.

Excluding mortgage and asset-backed securities, no securities from the same issuer had an aggregate unrealized loss in excess of $4.0 million at March 31, 2012. The $4.0 million unrealized loss is from hybrid Tier 1 capital bonds in the financial sector. With respect to mortgage and asset-backed securities not backed by the United States Government, no securities from the same issuer had an aggregate unrealized loss in excess of $9.8 million at March 31, 2012. The $9.8 million unrealized loss from one issuer relates to three different securities that are backed by different pools of Alt-A residential mortgage loans. All three of the securities are rated non-investment grade and the largest unrealized loss totaled $5.2 million.

The carrying values of all our investments are reviewed on an ongoing basis for credit deterioration. When our review indicates a decline in fair value for a fixed maturity security is other than temporary and we do not intend to sell or believe we will be required to sell the security before recovery of our amortized cost, a specific write down is charged to earnings for the credit loss and a specific charge is recognized in accumulated other comprehensive income for the non-credit loss component. If we intend to sell or believe we will be required to sell a fixed maturity security before its recovery, the full amount of the impairment write down to fair value is charged to earnings. For all equity securities, the full amount of an other-than-temporary impairment write down is recognized as a realized loss on investments in the statements of operations and the new cost basis for the security is equal to its fair value.

We monitor the financial condition and operations of the issuers of fixed maturities and equity securities that could potentially have a credit impairment that is other than temporary. In determining whether or not an unrealized loss is other than temporary, we review factors such as:

historical operating trends;
business prospects;
status of the industry in which the company operates;
analyst ratings on the issuer and sector;
quality of management;
size of unrealized loss;
level of current market interest rates compared to market interest rates when the security was purchased;
length of time the security has been in an unrealized loss position;
for fixed maturities, our intent to sell and whether it is more likely than not that we would be required to sell prior to recovery; and
for equity securities, our ability and intent to hold the security for a period of time that allows for the recovery in value.

In order to determine the credit and non-credit impairment loss for fixed maturities, every quarter we estimate the future cash flows we expect to receive over the remaining life of the instrument as well as review our plans to hold or sell the instrument. Significant assumptions regarding the present value of expected cash flows for each security are used when an other-than-temporary impairment occurs and there is a non-credit portion of the unrealized loss that won't be recognized in earnings. Our assumptions for residential mortgage-backed securities, commercial mortgage-backed securities and other asset-backed securities include collateral pledged, guarantees, vintage, anticipated principal and interest payments, prepayments, default levels, severity assumptions, delinquency rates and the level of nonperforming assets for the remainder of the investments' expected term. We use a single best estimate of cash flows approach and use the effective yield prior to the date of impairment to calculate the present value of cash flows. Our assumptions for corporate and other fixed maturities include anticipated principal and interest payments and an estimated recovery value, generally based on a percentage return of the current market value.

After an other-than-temporary write down of all equity securities and any fixed maturities with a credit-only impairment, the cost basis is generally not adjusted for subsequent recoveries in fair value. For fixed maturities for which we can reasonably estimate future cash flows after a write down, the discount or reduced premium recorded, based on the new cost basis, is amortized over the remaining life of the security. Amortization in this instance is computed using the prospective method and the current estimate of the amount and timing of future cash flows.


14

March 31, 2012

Credit Loss Component of Other-Than-Temporary Impairments on Fixed Maturities

The following table sets forth the amount of credit loss impairments on fixed maturities we held as of the dates indicated for which a portion of the other-than-temporary impairment was recognized in other comprehensive income and corresponding changes in such amounts.

 
Three months ended March 31,
 
2012
 
2011
 
(Dollars in thousands)
Balance at beginning of period
$
(22,479
)
 
$
(29,336
)
Increases for which an impairment was not previously recognized
(847
)
 

Increases to previously impaired investments

 
(713
)
Reductions due to investments sold
25

 
53

Reductions due to change of intent to not hold investments
40

 
273

Balance at end of period
$
(23,261
)
 
$
(29,723
)

In addition to the other-than-temporary impairment losses recognized above, we also incurred other-than-temporary impairment losses on fixed maturities not previously impaired, which based on declines in credit quality or other circumstances changed our intent to retain the securities. Other-than-temporary impairment losses of $0.6 million for the three-month period ended March 31, 2012 and $1.4 million for the three-month period ended March 31, 2011 were recognized on these securities.

Realized Gains (Losses) - Recorded in Income 
 
 
 
 
 
 
 
 
Three months ended March 31,
 
2012
 
2011
 
(Dollars in thousands)
Realized gains (losses) on sales of investments
 
 
 
Fixed maturities - available for sale:
 
 
 
Gross gains
$
421

 
$
2,250

Gross losses
(414
)
 

Equity securities - available for sale:
105

 

Mortgage loans
767

 

Securities and indebtedness of related parties

 
10

Net impairment loss recognized in earnings
(1,522
)
 
(2,152
)
Realized gains (losses) on investments recorded in income
$
(643
)
 
$
108


Proceeds from sales of fixed maturities available totaled $27.1 million at March 31, 2012 and $17.9 million at March 31, 2011.

Realized gains and losses on sales of investments are determined on the basis of specific identification.

Mortgage Loans

Our mortgage loan portfolio consists principally of commercial mortgage loans that we have originated. Our lending policies require that the loans be collateralized by the value of the related property, establish limits on the amount that can be loaned to one borrower and require diversification by geographic location and collateral type. We originate loans with an initial loan to value ratio that provides sufficient excess collateral to absorb losses should we be required to foreclose and take possession of the collateral. In order to identify impairment losses timely, management maintains and reviews a watch list of mortgage loans that have heightened risk. These loans may include those with borrowers delinquent on contractual payments, borrowers experiencing financial difficulty, increases in rental real estate vacancies and significant declines in collateral value. We evaluate each of our mortgage loans individually and establish an allowance as needed for possible losses against our mortgage loan portfolio. An allowance is needed for loans in which we do not believe we will collect all amounts due according to the contractual terms of the respective loan agreements or a modification which has been classified as a troubled debt restructuring.


15

March 31, 2012

Any loans delinquent on contractual payments are considered non-performing. Non-performing loans totaled $16.8 million at March 31, 2012 and $18.9 million at December 31, 2011. At March 31, 2012, there were two non-performing loans over 90 days past due on contractual payments with a carrying value of $16.8 million. At December 31, 2011, there were three non-performing loan over 90 days past due on contractual payments with a carrying value of $18.9 million. During the first quarter of 2012, we foreclosed on one non-performing loan with a book value of $2.1 million at December 31, 2011 and took possession of the real estate with an appraised value of $2.4 million. We discontinued the accrual of interest on one loan totaling $1.9 million at March 31, 2012 and two loans totaling $4.0 million at December 31, 2011. We continued to accrue for the other non-performing loan as we believe that we will collect all of the amounts due.

Mortgage Loans by Collateral Type
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
March 31, 2012
 
December 31, 2011
Collateral Type
 
Carrying Value
 
Percent of Total
 
Carrying Value
 
Percent of Total
 
 
(Dollars in thousands)
Office
 
$
228,334

 
42.9
%
 
$
234,853

 
42.5
%
Retail
 
173,513

 
32.6

 
178,954

 
32.4

Industrial
 
122,666

 
23.0

 
130,498

 
23.6

Other
 
8,042

 
1.5

 
8,054

 
1.5

Total
 
$
532,555

 
100.0
%
 
$
552,359

 
100.0
%

Mortgage Loans by Geographic Location within the United States
 
 
 
 
 
 
 
 
 
 
 
 
 
March 31, 2012
 
December 31, 2011
Region of the United States
 
Carrying Value
 
Percent of Total
 
Carrying Value
 
Percent of Total
 
 
(Dollars in thousands)
South Atlantic
 
$
156,851

 
29.6
%
 
$
162,363

 
29.4
%
Pacific
 
98,220

 
18.4

 
99,486

 
18.0

East North Central
 
82,782

 
15.5

 
93,159

 
16.9

West North Central
 
71,860

 
13.5

 
70,277

 
12.7

West South Central
 
46,483

 
8.7

 
49,184

 
8.9

Mountain
 
27,023

 
5.1

 
28,099

 
5.1

Other
 
49,336

 
9.2

 
49,791

 
9.0

Total
 
$
532,555

 
100.0
%
 
$
552,359

 
100.0
%

Mortgage Loans by Loan-to-Value Ratio (1)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
March 31, 2012
 
December 31, 2011
 

Carrying Value
 
Percent of Total
 
Carrying Value
 
Percent of Total
 
(Dollars in thousands)
0% - 50%
$
176,274

 
33.1
%
 
$
144,915

 
26.2
%
51% - 60%
129,746

 
24.4

 
172,318

 
31.2

61% - 70%
177,289

 
33.2

 
171,146

 
31.0

71% - 80%
47,356

 
8.9

 
55,247

 
10.0

81% - 90%
1,890

 
0.4

 
8,733

 
1.6

Total
$
532,555

 
100.0
%
 
$
552,359

 
100.0
%
(1)
Loan-to-value ratio using most recent appraised value. Appraisals are updated periodically including when there is indication of a possible significant collateral decline or loan modification and refinance requests.


16

March 31, 2012

Mortgage Loans by Year of Origination
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
March 31, 2012
 
December 31, 2011
 
Carrying Value
 
Percent of Total
 
Carrying Value
 
Percent of Total
 
(Dollars in thousands)
2012
$
2,200

 
0.4
%
 
$

 
%
2011
48,292

 
9.1

 
48,557

 
8.8

2010
28,296

 
5.3

 
28,578

 
5.2

2008
71,782

 
13.5

 
72,246

 
13.1

2007 and prior
381,985

 
71.7

 
402,978

 
72.9

Total
$
532,555

 
100.0
%
 
$
552,359

 
100.0
%

 Impaired Mortgage Loans
 
 
 
March 31, 2012
 
December 31, 2011
 
(Dollars in thousands)
Recorded investment
$
6,481

 
$
6,294

Unpaid principal balance
7,860

 
8,053

Related allowance
1,379

 
1,759

 Allowance on Mortgage Loans
 
Three months ended March 31,
 
2012
 
2011
 
(Dollars in thousands)
Balance at beginning of period
$
1,759

 
$
1,759

Allowances established
20

 

Charge offs
(400
)
 

Balance at end of period
$
1,379

 
$
1,759


Variable Interest Entities

We evaluate our variable interest entity (VIE) investees to determine whether the level of our direct ownership interest, our rights to manage operations or our obligation to provide ongoing financial support are such that we are the primary beneficiary of the entity, and are then required to consolidate it for financial reporting purposes. None of our VIE investees were required to be consolidated during 2012 or 2011. Our VIE investments are as follows:

 
March 31, 2012
 
December 31, 2011
 
Carrying Value
 
Maximum Exposure to Loss
 
Carrying Value
 
Maximum Exposure to Loss
 
(Dollars in thousands)
Real estate limited partnerships
$
17,895

 
$
17,895

 
$
17,948

 
$
17,948


We did not have any commitments for further fundings to investees designated as VIEs during 2012 or 2011.

Other

At March 31, 2012, we had committed to provide additional funds for investments in limited partnerships. The amounts of these unfunded commitments totaled $52.1 million.

4. Derivative Instruments

As discussed in Note 2, the make-whole redemption feature of our unaffiliated senior notes was an embedded derivative based on U.S. Treasury yields at December 31, 2011. This derivative liability had a fair value of $33.1 million at December 31, 2011 and zero at March 31, 2012 due to the repayment of debt during the first quarter. The derivative liability was reported in other

17

March 31, 2012

liabilities in the consolidated balance sheet. The change in fair value is included in the loss on debt redemption line in the consolidated statements of comprehensive income.

We are not significantly involved in hedging activities and have limited exposure to derivatives. We do not apply hedge accounting to any of our derivative positions. Derivative assets, which are primarily reported in reinsurance recoverable and other investments, totaled $4.3 million at March 31, 2012 and $3.7 million at December 31, 2011. Our derivative assets consist of derivatives embedded within our modified coinsurance agreements, collateralized debt obligation and call options which provide an economic hedge for a small block of index annuity contracts. Derivative liabilities, excluding the make-whole redemption feature, totaled $0.4 million at March 31, 2012 and December 31, 2011 and include derivatives embedded within our index annuity contracts and derivatives embedded within our modified coinsurance agreements. The net loss recognized on these derivatives was $0.4 million for the three months ended March 31, 2012 and March 31, 2011.

During prior years we held interest rate swaps to manage the interest rate risk associated with a portion of our flexible premium deferred annuity contracts. A $50.0 million notional amount interest rate swap associated with the deferred annuity contracts matured on June 1, 2011.

5. Fair Values

The carrying and estimated fair values of our financial instruments are as follows:

Fair Values and Carrying Values
 
 
 
 
 
 
 
 
 
March 31, 2012
 
December 31, 2011
 
Carrying Value
 
Fair Value
 
Carrying Value
 
Fair Value
 
(Dollars in thousands)
Assets
 
 
 
 
 
 
 
Fixed maturities - available for sale
$
5,742,044

 
$
5,742,044

 
$
5,570,550

 
$
5,570,550

Equity securities - available for sale
54,221

 
54,221

 
57,432

 
57,432

Mortgage loans
532,555

 
568,945

 
552,359

 
581,273

Policy loans
173,277

 
221,433

 
172,368

 
229,202

Other investments
268

 
268

 
84

 
84

Cash and short-term investments
334,426

 
334,426

 
338,095

 
338,095

Restricted debt defeasance trust assets

 

 
211,627

 
211,627

Reinsurance recoverable
3,981

 
3,981

 
3,391

 
3,391

Assets held in separate accounts
655,755

 
655,755

 
603,903

 
603,903

 
Liabilities
 
 
 
 
 
 
 
Future policy benefits
$
3,063,151

 
$
3,111,829

 
$
2,963,374

 
$
2,944,748

Supplemental contracts without life contingencies
361,890

 
323,241

 
359,663

 
311,355

Advance premiums and other deposits
205,564

 
205,564

 
200,353

 
200,353

Short-term debt

 

 
174,258

 
175,000

Long-term debt
146,971

 
105,756

 
146,968

 
101,670

Stock repurchase obligation
112,538

 
112,538

 

 

Other liabilities
80

 
80

 
33,208

 
33,208

Liabilities related to separate accounts
655,755

 
644,682

 
603,903

 
592,813


Fair value is based on an exit price, which is 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. As not all financial instruments are actively traded, various valuation methods may be used to estimate fair value. These methods rely on observable data and where observable data is not available, the best information available. Significant judgment may be required to interpret the data and select the assumptions used in the valuation estimates, particularly when observable market data is not available.

In the discussion that follows, we have ranked our financial instruments by the level of judgment used in the determination of the fair values presented above. The levels are defined as follows:

Level 1 - Fair values are based on unadjusted quoted prices in active markets for identical assets or liabilities.

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March 31, 2012


Level 2 - Fair values are based on inputs, other than quoted prices from active markets, that are observable for the asset or liability, either directly or indirectly.

Level 3 - Fair values are based on significant unobservable inputs for the asset or liability.

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, a financial instrument's level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the financial instrument. From time to time there may be movements between levels as inputs become more or less observable, which may depend on several factors including the activity of the market for the specific security, the activity of the market for similar securities, the level of risk spreads and the source of the information from which we obtain the information. Transfers in or out of any level are measured as of the beginning of the period.


The following methods and assumptions were used in estimating the fair value of our financial instruments:

Fixed maturities:

Level 1 fixed maturities consist of U.S. Treasury issues that are actively traded, allowing us to use current market prices as an estimate of their fair value.

Level 2 fixed maturities consist of corporate, mortgage and other asset-backed, United States Government agencies and private placement securities with observable market data, and in some circumstance recent trade activity. We obtain our Level 2 fixed maturity fair values from a variety of external independent pricing sources with access to observable data for these instruments. These external sources consider recent trade values, if available, and rely on matrix pricing utilizing observable data which we would expect a market participant to use. Matrix pricing uses a discounted cash flow analysis using a spread over U.S. Treasury bond yields, considers call features and is adjusted for maturity/average life differences. Spread adjustments also reflect, as applicable, a liquidity premium and take into account a variety of factors including, but not limited to, senior unsecured versus secured status, par amount outstanding, number of holders, maturity, average life, composition of lending group and debt rating.

Level 3 fixed maturity securities include private placements as well as corporate, mortgage and other asset-backed and state and municipal securities for which there is little or no current market data available. We use external pricing sources, or if prices are not available will estimate fair value internally. Fair values of private investments in Level 3 are determined by reference to public market, private transactions or valuations for comparable companies or assets in the relevant asset class when such amounts are available. For other securities where an exit price based on relevant observable inputs is not obtained, the fair value is determined using a matrix calculation. Fair values estimated through use of matrix pricing methods rely on an estimate of credit spreads to a risk free U.S. Treasury yield. Selecting the credit spread requires judgment based on an understanding of the security and may include a market liquidity premium. Our selection of comparable companies as well as the level of spread requires significant judgment. Increases in spreads used in our matrix models, or those used to value comparable companies, will result in a decrease in discounted cash flows used, and accordingly in the estimated fair value of the security.

We obtain fixed maturity fair values from a variety of external independent pricing services, including brokers, with access to observable data including recent trade information, if available. In certain circumstances in which an external price is not available for a Level 3 security, we will internally estimate its fair value. Our process for evaluation and selection of the fair values includes:

Follow a “pricing waterfall” policy, which establishes the pricing source preference for a particular security or security type. The order of preference is based on our evaluation of the valuation methods used, the source's knowledge of the instrument and the reliability of the prices we have received from the source in the past. Our valuation policy dictates that fair values are initially sought from third party pricing services. If our review of the prices received from our preferred source indicates an inaccurate price, we will use an alternative source within the waterfall and document the decision. In the event that fair values are not available from one of our external pricing services or upon review of the fair values provided it is determined that they may not be reflective of market conditions, those securities are submitted to brokers familiar with the security to obtain non-binding price quotes. Broker quotes tend to be used in limited circumstances such

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as for newly issued, private placement and other instruments that are not widely traded. For those securities for which an externally provided fair value is not available we use cash flow modeling techniques to estimate fair value.

Evaluate third party pricing source estimation methodologies to assess whether they will provide a fair value which approximates a market exit price.

Perform an overall analysis of portfolio fair value movement against general movements in interest rates and spreads.

Compare month-to-month price trends to detect unexpected price fluctuation based on our knowledge of the market and the particular instrument. As fluctuations are noted, we will perform further research which may include discussions with the original pricing source or other external sources to ensure we are in agreement with the valuation.

Compare prices between different pricing sources for unusual disparity.

Meet monthly with our Investment Committee, who oversees our valuation process, to discuss valuation practices and observations during the pricing process.

Equity securities:

Level 1 equity securities consist of listed common stocks and mutual funds that are actively traded, allowing us to use current market prices as an estimate of their fair value.

Level 2 equity securities consist of common stock issued by the Federal Home Loan Bank, with estimated fair value based on the current redemption value of the shares and non-redeemable preferred stock with estimated fair value obtained from external pricing sources using a matrix pricing approach.

Level 3 equity securities consist of a non-redeemable preferred stock for which no active market exists, and fair value estimates for these securities is based on the values of comparable securities which are actively traded. Increases in spreads used in our matrix models, or those used to value comparable companies, will result in a decrease in discounted cash flows used, and accordingly in the estimated fair value of the security.

In the case where external pricing services are used for certain Level 1 and Level 2 equity securities, our review process is consistent with the process used to determine the fair value of fixed maturity securities discussed above.

Mortgage loans:

Mortgage loans are not measured at fair value on a recurring basis. Mortgage loans are a Level 3 measurement as there is no current market for the loans as we are not actively involved in the purchase and sale of these loans. The fair value of our mortgages is estimated internally using a matrix pricing approach which we would expect to use to acquire a seasoned loan. Along with specific loan terms, two key management assumptions are required including the risk rating of the loan (our current rating system A-highest quality, B-moderate quality, C-low quality and W-watch or F-foreclosure) and spreads over the U.S. Treasury yield curve. Loans are reviewed and rated annually and adjusted quarterly should significant changes occur, with spreads updated on a quarterly basis. Our determination of each loan's risk rating as well as selection of the credit spread requires significant judgment. A higher risk rating, as well as an increase in spreads, would result in a decrease in discounted cash flows used, and accordingly the fair value of the loan.

Policy loans:

Policy loans are not measured at fair value on a recurring basis. Policy loans are a Level 3 measurement as there is no current market, as they are specifically tied to the underlying insurance policy. The loans are relatively risk free as they cannot exceed the cash surrender value of the insurance policy. Fair values are estimated by discounting expected cash flows using a risk-free interest rate based on the U.S. Treasury curve. An increase in spreads would result in a decrease in discounted cash flows used, and accordingly the fair value of the loan.


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Other investments:

Level 2 other investments include call options with fair values based on counterparty market prices adjusted for a credit component of the counterparty.

Cash and short-term investments:

Level 1 cash and short-term investments are highly liquid instruments for which historical cost approximates fair value.

Restricted debt defeasance trust assets:

Level 1 restricted debt defeasance trust assets consist of cash and listed mutual funds that are actively traded, allowing us to use current market prices as an estimate of their fair value.

Reinsurance recoverable:

Level 2 reinsurance recoverable includes embedded derivatives in our modified coinsurance contracts under which we cede or assume business. Fair values of these embedded derivatives are based on the difference between the fair value and the cost basis of the underlying fixed maturities.

Assets held in separate accounts:

Level 1 assets held in separate accounts consist of mutual funds that are actively traded, allowing us to use current market prices as an estimate of their fair value.

Future policy benefits, supplemental contracts without life contingencies and advance premiums and other deposits:

Level 3 policy related financial instruments are those for which there is no active market. These are not measured at fair value on a recurring basis. Fair values of our liabilities under contracts not involving significant mortality or morbidity risks (principally deferred annuities, deposit administration funds, funding agreements and supplementary contracts) are estimated using one of two methods. For contracts with known maturities, fair value is determined using discounted cash flow valuation techniques based on current interest rates adjusted to reflect our credit risk and an additional provision for adverse deviation. For deposit liabilities with no defined maturities, fair value is the amount payable on demand. Significant judgment is required in selecting the assumptions used to estimate the fair values of these financial instruments. For contracts with known maturities, increases in current rates will result in a decrease in discounted cash flows and a decrease in the estimated fair value of the policy obligation.

Certain annuity contracts include embedded derivatives and are measured at fair value on a recurring basis. These embedded derivatives are a Level 3 measurement. The fair value of the embedded derivatives is based on the discounted excess of projected account values (including a risk margin) over projected guaranteed account values. The key unobservable inputs required in the projection of future values which require management judgment include the risk margin as well as the credit risk of our company. Should the risk margin increase or the credit risk decrease the discounted cash flows and the estimated fair value of the obligation will increase.

Short-term and long-term debt:

Short-term and long-term debt are not measured at fair value on a recurring basis. Short-term and long-term debt are a Level 3 measurement. The fair value of our outstanding debt at March 31, 2012 and excluding our short-term debt at December 31, 2011, is estimated using a discounted cash flow method based on the market's assessment or our current incremental borrowing rate for similar types of borrowing arrangements adjusted, as needed, to reflect our credit risk. Fair value of the short-term debt in 2011 was equal to the par value as the related fair value for the make-whole redemption price is reflected as an embedded derivative in other liabilities. Our selection of the credit spread requires significant judgment. A decrease in the spread will increase the estimated fair value of the outstanding debt.

Stock repurchase obligation:

Level 2 stock repurchase obligation is a short-term obligation, originated on March 27, 2012 and fully settled for its carrying amount by April 11, 2012. Its carrying value approximates its fair value.


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March 31, 2012

Other liabilities:

Level 2 other liabilities include the embedded derivatives in our modified coinsurance contracts under which we cede business. Fair values of these derivatives are based on the difference between the fair value and the cost basis of the underlying fixed maturities.

Level 3 other liabilities include an embedded derivative related to the make-whole redemption feature of our unaffiliated senior notes. Fair value was determined using a discounted cash flow valuation analysis based on applicable U.S. Treasury rates and make-whole spread.

Liabilities related to separate accounts:

Separate account liabilities are not measured at fair value on a recurring basis. Level 3 separate account liabilities fair value is based on the cash surrender value of the underlying contract, which is the cost we would incur the extinguish the liability.

Valuation of our Financial Instruments Measured on a Recurring Basis by Hierarchy Levels
 
 
 
March 31, 2012
 
Quoted prices in active markets
 for identical assets (Level 1)
 
Significant other observable
 inputs (Level 2)
 
Significant unobservable
 inputs (Level 3)
 
Total
 
(Dollars in thousands)
Assets
 
 
 
 
 
 
 
Corporate securities
$

 
$
2,888,809

 
$
95,850

 
$
2,984,659

Residential mortgage-backed securities

 
697,211

 
2,259

 
699,470

Commercial mortgage-backed securities

 
479,539

 
12,753

 
492,292

Other asset-backed securities

 
397,896

 
23,894

 
421,790

Collateralized debt obligation

 

 
29

 
29

United States Government and agencies
15,098

 
27,853

 
8,365

 
51,316

State, municipal and other governments

 
1,088,304

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