XNYS:SFG StanCorp Financial Group Inc Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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Table of Contents

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 June 30, 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: 1-14925

STANCORP FINANCIAL GROUP, INC.

(Exact name of registrant as specified in its charter)

 

Oregon   93-1253576

(State or other jurisdiction

of incorporation or organization)

 

(I.R.S. Employer

Identification No.)

1100 SW Sixth Avenue, Portland, Oregon, 97204

(Address of principal executive offices, including zip code)

(971) 321-7000

(Registrant’s telephone number, including area code)

NONE

(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.    Yes  x    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 (§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).    Yes  x    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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:

 

Large Accelerated filer   x

 

Accelerated filer   ¨

  

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  ¨    No  x

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

As of July 27, 2012, there were 44,121,733 shares of the registrant’s common stock, no par value, outstanding.


Table of Contents

TABLE OF CONTENTS

 

 

PART I.    FINANCIAL INFORMATION   

ITEM 1.

  

FINANCIAL STATEMENTS

  
  

Unaudited Consolidated Statements of Income for the three and six months ended June 30, 2012 and 2011

     1   
  

Unaudited Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2012 and 2011

     2   
  

Unaudited Consolidated Balance Sheets at June 30, 2012 and December 31, 2011

     3   
  

Unaudited Consolidated Statements of Changes in Shareholders’ Equity for the six months ended June 30, 2012 and the year ended December 31, 2011

     4   
  

Unaudited Consolidated Statements of Cash Flows for the six months ended June 30, 2012 and 2011

     5   
  

Condensed Notes to Unaudited Consolidated Financial Statements

     6   

ITEM 2.

  

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     36   

ITEM 3.

  

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     70   

ITEM 4.

  

CONTROLS AND PROCEDURES

     70   
PART II.    OTHER INFORMATION   

ITEM 1.

  

LEGAL PROCEEDINGS

     71   

ITEM 1A.

  

RISK FACTORS

     71   

ITEM 2.

  

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

     74   

ITEM 3.

  

DEFAULTS UPON SENIOR SECURITIES

     75   

ITEM 4.

  

MINE SAFETY DISCLOSURES

     75   

ITEM 5.

  

OTHER INFORMATION

     75   

ITEM 6.

  

EXHIBITS

     76   

SIGNATURES

     77   


Table of Contents

PART I.    FINANCIAL INFORMATION

ITEM 1:    FINANCIAL STATEMENTS

STANCORP FINANCIAL GROUP, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF INCOME

(Dollars in millions—except share data)

 

    Three Months Ended
June 30,
    Six Months Ended
June 30,
 
    2012     2011     2012     2011  

Revenues:

       

Premiums

  $ 548.1     $ 537.0     $ 1,101.4     $ 1,070.8  

Administrative fees

    29.8       29.5       58.4       58.9  

Net investment income

    151.4       152.6       311.1       309.6  

Net capital losses:

       

Total other-than-temporary impairment losses on fixed maturity securities—available-for-sale

    (1.7     (0.5     (2.5     (1.4

All other net capital losses

    (2.3     (12.6     (1.7     (14.2
 

 

 

   

 

 

   

 

 

   

 

 

 

Total net capital losses

    (4.0     (13.1     (4.2     (15.6
 

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

    725.3       706.0       1,466.7       1,423.7  
 

 

 

   

 

 

   

 

 

   

 

 

 

Benefits and expenses:

       

Benefits to policyholders

    475.9       452.4       925.9       892.5  

Interest credited

    39.2       40.0       86.4       80.4  

Operating expenses

    116.7       118.1       240.6       236.4  

Commissions and bonuses

    51.3       54.2       106.7       113.0  

Premium taxes

    9.5       8.9       19.5       18.3  

Interest expense

    9.8       9.8       19.5       19.5  

Net decrease (increase) in deferred acquisition costs, value of business acquired and other intangible assets

    0.3       (2.0     (2.2     (10.4
 

 

 

   

 

 

   

 

 

   

 

 

 

Total benefits and expenses

    702.7       681.4       1,396.4       1,349.7  
 

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

    22.6       24.6       70.3       74.0  

Income taxes

    2.6       6.8       15.1       22.9  
 

 

 

   

 

 

   

 

 

   

 

 

 

Net income

  $ 20.0     $ 17.8     $ 55.2     $ 51.1  
 

 

 

   

 

 

   

 

 

   

 

 

 

Net income per common share:

       

Basic

  $ 0.45     $ 0.40     $ 1.25     $ 1.12  

Diluted

    0.45       0.40       1.24       1.12  

Weighted-average common shares outstanding:

       

Basic

    44,266,776       44,868,646       44,296,945       45,398,006  

Diluted

    44,354,720       45,056,472       44,407,325       45,619,277  

See Condensed Notes to Unaudited Consolidated Financial Statements.

 

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Table of Contents

STANCORP FINANCIAL GROUP, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF

COMPREHENSIVE INCOME

(Dollars in millions)

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
         2012             2011             2012             2011      

Net income

   $         20.0     $         17.8     $         55.2     $         51.1  

Other comprehensive income, net of tax:

        

Unrealized gains on securities—available-for-sale:

        

Net unrealized capital gains on securities—available-for-sale(1)

   $ 39.3     $ 35.0     $ 40.6     $ 26.0  

Reclassification adjustment for net capital gains included in net income(2)

     (0.6     (1.2     (1.4     (4.0

Employee benefit plans:

        

Prior service credit and net losses arising during the period, net(3)

     —          —          0.4       1.5  

Reclassification adjustment for amortization to net periodic pension cost, net(4)

     1.6       0.8       3.2       1.6  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other comprehensive income, net of tax

     40.3       34.6       42.8       25.1  
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

   $ 60.3     $ 52.4     $ 98.0     $ 76.2  
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

Net of taxes of $21.2 million and $18.8 million for the three months ended June 30, 2012 and 2011, respectively; and $21.9 million and $14.0 million for six months ended June 30, 2012 and 2011, respectively.

(2)

Net of taxes of $(0.3) million and $(0.6) million for the three months ended June 30, 2012 and 2011, respectively; and $(0.8) million and $(2.2) million for six months ended June 30, 2012 and 2011, respectively.

(3)

Net of taxes of $0.2 million and $0.8 million for six months ended June 30, 2012 and 2011, respectively.

(4)

Net of taxes of $0.9 million and $0.4 million for the three months ended June 30, 2012 and 2011, respectively; and $1.7 million and $0.9 million for six months ended June 30, 2012 and 2011, respectively.

See Condensed Notes to Unaudited Consolidated Financial Statements.

 

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STANCORP FINANCIAL GROUP, INC.

UNAUDITED CONSOLIDATED BALANCE SHEETS

(Dollars in millions)

 

    June 30,
2012
     December 31,
2011
 
A S S E T S     

Investments:

    

Fixed maturity securities—available-for-sale (amortized cost of $6,359.4 and $6,209.9)

  $         6,977.2      $         6,769.5  

Commercial mortgage loans, net

    5,098.7        4,902.3  

Real estate, net

    104.1        92.7  

Other invested assets

    184.4        130.9  
 

 

 

    

 

 

 

Total investments

    12,364.4        11,895.4  

Cash and cash equivalents

    129.5        138.4  

Premiums and other receivables

    125.4        118.8  

Accrued investment income

    112.0        111.7  

Amounts recoverable from reinsurers

    956.1        949.3  

Deferred acquisition costs, value of business acquired and other intangible assets, net

    350.4        344.9  

Goodwill

    36.0        36.0  

Property and equipment, net

    96.7        101.3  

Other assets

    103.5        113.9  

Separate account assets

    4,867.2        4,593.5  
 

 

 

    

 

 

 

Total assets

  $ 19,141.2      $ 18,403.2  
 

 

 

    

 

 

 

L I A B I L I T I E S   A N D   S H A R E H O L D E R S’   E Q U I T Y

    

Liabilities:

    

Future policy benefits and claims

  $ 5,773.0      $ 5,683.6  

Other policyholder funds

    5,280.7        5,078.1  

Deferred tax liabilities, net

    138.2        103.0  

Short-term debt

    251.0        251.2  

Long-term debt

    301.2        300.9  

Other liabilities

    444.4        402.5  

Separate account liabilities

    4,867.2        4,593.5  
 

 

 

    

 

 

 

Total liabilities

    17,055.7        16,412.8  
 

 

 

    

 

 

 

Commitments and contingencies (See Note 10)

    

Shareholders’ equity:

    

Preferred stock, 100,000,000 shares authorized; none issued

    —           —     

Common stock, no par, 300,000,000 shares authorized; 44,116,208 and 44,268,859 shares issued at June 30, 2012 and December 31, 2011, respectively

    79.5        82.4  

Accumulated other comprehensive income

    277.9        235.1  

Retained earnings

    1,728.1        1,672.9  
 

 

 

    

 

 

 

Total shareholders’ equity

    2,085.5        1,990.4  
 

 

 

    

 

 

 

Total liabilities and shareholders’ equity

  $ 19,141.2      $ 18,403.2  
 

 

 

    

 

 

 

See Condensed Notes to Unaudited Consolidated Financial Statements.

 

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STANCORP FINANCIAL GROUP, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF

CHANGES IN SHAREHOLDERS’ EQUITY

(Dollars in millions)

 

                Accumulated
Other
 Comprehensive 
Income
     Retained
Earnings
    Total
  Shareholders’ 
Equity
 
    Common Stock         
    Shares            Amount                

Balance, January 1, 2011

    46,159,387     $     158.2     $ 160.9      $         1,575.5     $ 1,894.6  

Net income

    —          —          —           136.7       136.7  

Other comprehensive income, net of tax

    —          —          74.2        —          74.2  

Common stock:

          

Repurchased

    (2,180,100     (90.3     —           —          (90.3

Issued under share-based compensation plans, net

    289,572       14.5       —           —          14.5  

Dividends declared on common stock

    —          —          —           (39.3     (39.3
 

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Balance, December 31, 2011

    44,268,859       82.4       235.1        1,672.9       1,990.4  
 

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Net income

    —          —          —           55.2       55.2  

Other comprehensive income, net of tax

    —          —          42.8        —          42.8  

Common stock:

          

Repurchased

    (279,700     (10.0     —           —          (10.0

Issued under share-based compensation plans, net

    127,049       7.1       —           —          7.1  
 

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Balance, June 30, 2012

      44,116,208     $ 79.5     $ 277.9      $ 1,728.1     $ 2,085.5  
 

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

See Condensed Notes to Unaudited Consolidated Financial Statements.

 

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STANCORP FINANCIAL GROUP, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In millions)

 

    Six Months Ended June 30,  
    2012     2011  

Operating:

   

Net income

  $             55.2     $             51.1  

Adjustments to reconcile net income to net cash provided by operating activities:

   

Net realized capital losses

    4.2       15.6  

Depreciation and amortization

    59.9       62.3  

Deferral of acquisition costs, value of business acquired and other intangible assets, net

    (38.6     (44.4

Deferred income taxes

    13.2       (6.3

Changes in other assets and liabilities:

   

Receivables and accrued income

    (13.5     (15.0

Future policy benefits and claims

    87.6       76.9  

Other, net

    32.0       (8.0
 

 

 

   

 

 

 

Net cash provided by operating activities

    200.0       132.2  
 

 

 

   

 

 

 

Investing:

   

Proceeds from sale, maturity, or repayment of fixed maturity securities—available-for-sale

    426.3       571.8  

Proceeds from sale or repayment of commercial mortgage loans

    302.4       229.4  

Proceeds from sale of real estate

    4.0       29.4  

Acquisition of fixed maturity securities—available-for-sale

    (577.5     (667.0

Acquisition or origination of commercial mortgage loans

    (518.5     (493.3

Acquisition of real estate

    (0.6     (2.7

Acquisition of other invested assets

    (32.7     (29.7

Acquisition of property and equipment, net

    (8.5     (6.5
 

 

 

   

 

 

 

Net cash used in investing activities

    (405.1     (368.6
 

 

 

   

 

 

 

Financing:

   

Policyholder fund deposits

    980.8       1,019.5  

Policyholder fund withdrawals

    (778.2     (748.6

Short-term debt, net

    (0.2     (0.8

Long-term debt

    0.3       (0.5

Issuance of common stock

    3.5       6.2  

Repurchases of common stock

    (10.0     (80.3
 

 

 

   

 

 

 

Net cash provided by financing activities

    196.2       195.5  
 

 

 

   

 

 

 

Decrease in cash and cash equivalents

    (8.9     (40.9

Cash and cash equivalents, beginning of period

    138.4       152.0  
 

 

 

   

 

 

 

Cash and cash equivalents, end of period

  $ 129.5     $ 111.1  
 

 

 

   

 

 

 

Supplemental disclosure of cash flow information:

   

Cash paid during the period for:

   

Interest

  $ 101.7     $ 104.2  

Income taxes

    0.8       59.5  

Non-cash transactions:

   

Real estate acquired through commercial mortgage loan foreclosure

    13.3       10.1  

Commercial mortgage loans originated on real estate sold

    0.8       14.5  

See Condensed Notes to Unaudited Consolidated Financial Statements.

 

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CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

As used in this Form 10-Q, the terms “StanCorp,” “Company,” “we,” “us” and “our” refer to StanCorp Financial Group, Inc. and its subsidiaries, unless the context otherwise requires.

 

1.

ORGANIZATION, PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION

StanCorp, headquartered in Portland, Oregon, is a holding company and conducts business through wholly-owned operating subsidiaries throughout the United States (“U.S”). Through its subsidiaries, StanCorp has the authority to underwrite insurance products in all 50 states. StanCorp operates through two segments: Insurance Services and Asset Management as well as an Other category. See “Note 5—Segments.”

StanCorp has the following wholly-owned operating subsidiaries: Standard Insurance Company (“Standard”), The Standard Life Insurance Company of New York, Standard Retirement Services, Inc. (“Standard Retirement Services”), StanCorp Equities, Inc. (“StanCorp Equities”), StanCorp Mortgage Investors, LLC (“StanCorp Mortgage Investors”), StanCorp Investment Advisers, Inc. (“StanCorp Investment Advisers”), StanCorp Real Estate, LLC (“StanCorp Real Estate”), Standard Management, Inc. (“Standard Management”) and Adaptu, LLC (“Adaptu”).

Standard, the Company’s largest subsidiary, underwrites group and individual disability insurance and annuity products, group life and accidental death and dismemberment (“AD&D”) insurance, and provides group dental and group vision insurance, absence management services and retirement plan products. Founded in 1906, Standard is domiciled in Oregon, licensed in all states except New York, and licensed in the District of Columbia and the U.S. territories of Guam and the Virgin Islands.

The Standard Life Insurance Company of New York was organized in 2000 and is licensed to provide group long term and short term disability insurance, individual disability insurance, group life and AD&D insurance and group dental insurance in New York.

The Standard is a service mark of StanCorp and its subsidiaries and is used as a brand mark and marketing name by Standard and The Standard Life Insurance Company of New York.

Standard Retirement Services administers and services StanCorp’s retirement plans group annuity contracts and trust products. Retirement plan products are offered in all 50 states through Standard or Standard Retirement Services.

StanCorp Equities is a limited broker-dealer and member of the Financial Industry Regulatory Authority. StanCorp Equities serves as principal underwriter and distributor for group variable annuity contracts issued by Standard and as the broker of record for certain retirement plans using the trust platform. StanCorp Equities carries no customer accounts but provides supervision and oversight for the distribution of group variable annuity contracts and of the sales activities of all registered representatives employed by StanCorp Equities and its affiliates.

StanCorp Mortgage Investors originates and services fixed-rate commercial mortgage loans for the investment portfolios of the Company’s insurance subsidiaries. StanCorp Mortgage Investors also generates additional fee income from the origination and servicing of commercial mortgage loans participated to institutional investors.

StanCorp Investment Advisers is a Securities and Exchange Commission (“SEC”) registered investment adviser providing performance analysis, fund selection support, model portfolios and other investment advisory, financial planning, and investment management services to its retirement plan clients, individual investors and subsidiaries of StanCorp.

StanCorp Real Estate is a property management company that owns and manages the Hillsboro, Oregon home office properties and other properties held for investment and held for sale. StanCorp Real Estate also manages the Portland, Oregon home office properties.

Standard Management has owned and managed certain real estate properties held for sale.

Adaptu provides an online service to help users plan and manage their financial lives.

Standard holds interests in low-income housing tax credit investments. These interests do not meet the requirements for consolidation under existing accounting standards, and thus the Company’s interests in the low-income housing tax credit investments are accounted for under the equity method of accounting. The total investment in these interests was $181.8 million and $128.0 million at June 30, 2012 and December 31, 2011, respectively.

In October 2010, the Financial Accounting Standards Board (‘FASB’) issued Accounting Standards Update (‘ASU’) No. 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts. ASU No. 2010-26 amends the codification guidance for insurance entities to eliminate the diversity of accounting treatment related to deferred acquisition costs (‘DAC’). The Company has adopted this standard retrospectively as of January 1, 2012, and comparative financial statements of prior periods have been adjusted.

The accompanying unaudited consolidated financial statements of StanCorp and its subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and in conformance with the requirements of Form 10-Q pursuant to the rules and regulations of the SEC. Accordingly, they do not include all of the information and disclosures required by GAAP for complete financial statements. Intercompany balances and transactions have been eliminated on a consolidated basis. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the financial statement date, and the reported amounts of revenues and expenses during the period. Actual results may differ from those estimates. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation of the Company’s financial condition at June 30, 2012, and for the results of operations for the three and six months ended June 30, 2012 and 2011, and cash flows for the six months ended June 30, 2012 and 2011. Interim results for the three and six months ended June 30, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012. This report should be read in conjunction with

 

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Table of Contents

the Company’s 2011 annual report on Form 10-K and the Company’s current report on Form 8-K dated July 18, 2012 which updated certain items in the Company’s annual report on Form 10-K for the retrospective adoption of ASU No. 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts.

 

2.

NET INCOME PER COMMON SHARE

Net income per basic common share was calculated by dividing net income by the weighted-average number of common shares outstanding. Net income per diluted common share, as calculated using the treasury stock method, reflects the potential dilutive effects of stock award grants and exercises of dilutive outstanding stock options. The computation of diluted weighted-average earnings per share does not include stock options with an option exercise price greater than the average market price because they are antidilutive and inclusion would increase earnings per share.

The following table sets forth the calculation of net income per basic and diluted weighted-average common shares outstanding:

 

    Three Months Ended
June 30,
     Six Months Ended
June 30,
 
    2012      2011      2012      2011  

Net income (in millions)

  $ 20.0      $ 17.8      $ 55.2      $ 51.1  
 

 

 

    

 

 

    

 

 

    

 

 

 

Basic weighted-average common shares outstanding

    44,266,776        44,868,646        44,296,945        45,398,006  

Stock options

    87,944        187,826        106,584        219,275  

Stock awards

    —           —           3,796        1,996  
 

 

 

    

 

 

    

 

 

    

 

 

 

Diluted weighted-average common shares outstanding

    44,354,720        45,056,472        44,407,325        45,619,277  
 

 

 

    

 

 

    

 

 

    

 

 

 

Net income per common share:

          

Net income per basic common share

  $ 0.45      $ 0.40      $ 1.25      $ 1.12  

Net income per diluted common share

    0.45        0.40        1.24        1.12  

Antidilutive shares not included in net income per diluted common share calculation

    2,199,670        1,367,485        2,139,650        1,270,435  

 

3.

SHARE-BASED COMPENSATION

The Company has two active share-based compensation plans: the 2002 Stock Incentive Plan (“2002 Plan”) and the 1999 Employee Share Purchase Plan (“ESPP”). The 2002 Plan authorizes the Board of Directors to grant incentive or non-statutory stock options and stock awards to eligible employees and certain related parties. Of the 4.8 million shares of common stock authorized for the 2002 Plan, 0.9 million shares or options for shares remain available for grant at June 30, 2012. The Company’s ESPP allows eligible employees to purchase StanCorp common stock at a discount. Of the 3.5 million shares authorized for the ESPP, 1.7 million shares remain available for issuance at June 30, 2012.

The following table sets forth the total compensation cost and related income tax benefit under the Company’s share-based compensation plans:

 

    Three Months Ended
June 30,
     Six Months Ended
June 30,
 
    2012      2011      2012      2011  
    (In millions)  

Compensation cost

  $ 1.6      $ 1.5      $ 3.9      $ 3.1  

Related income tax benefit

    0.5        0.5        1.3        1.1  

The Company has provided three types of share-based compensation pursuant to the 2002 Plan: option grants, stock award grants and director stock grants.

Option Grants

Options are granted to officers and certain non-officer employees. Options are granted with an exercise price equal to the closing market price of StanCorp common stock on the grant date. Options generally vest in equal installments on the first four anniversaries of the vesting reference date.

The Company granted 225,133 and 236,785 options for the first six months of 2012 and 2011, respectively, at a weighted-average exercise price of $39.58 and $45.46, respectively. The fair value of each option award granted was estimated using the Black-Scholes option pricing model as of the grant date. The weighted-average grant date fair value of options granted for the first six months of 2012 and 2011 was $14.44 and $17.48, respectively.

The compensation cost of stock options is recognized over the vesting period, which is also the period over which the grantee must provide services to the Company. At June 30, 2012, the total compensation cost related to unvested option awards that had not yet been recognized in the financial statements was $7.1 million. This compensation cost will be recognized over a weighted-average period of 2.7 years.

 

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Stock Award Grants

The Company grants performance-based stock awards (“Performance Shares”) to designated senior officers. The payout for these awards is based on the Company’s financial performance over a three-year period. Performance Share grants represent the maximum number of shares of StanCorp common stock issuable to the designated senior officers. The actual number of shares issued at the end of the performance period is based on satisfaction of employment and Company financial performance conditions, with a portion of the shares withheld to cover required tax withholding. Under the 2002 Plan, the Company had 0.6 million shares available for issuance as stock award grants at June 30, 2012.

The Company granted 179,818 and 116,978 Performance Shares for the first six months of 2012 and 2011, respectively.

The Company issued 9,899 and 4,906 shares of StanCorp common stock for the first six months of 2012 and 2011, respectively, to redeem Performance Shares that vested following the 2011 and 2010 performance periods, net of Performance Shares withheld to cover the required taxes.

The fair value of the Performance Shares is determined based on the closing market price of StanCorp common stock on the grant date.

The compensation cost that the Company will ultimately recognize as a result of these stock awards is dependent on the Company’s financial performance. Assuming that the maximum performance is achieved for each performance goal, $15.3 million in additional compensation cost would be recognized through 2014. Assuming that the target performance is achieved for each performance goal, $8.1 million in additional compensation cost would be recognized through 2014. Assuming that the maximum performance is achieved this cost is would be recognized over a weighted-average period of 1.8 years.

Director Stock Grants

Effective May 7, 2012, each director who is not an employee of the Company receives annual compensation of StanCorp common stock with a fair value equal to $100,000 based on the closing market price of StanCorp common stock on the day of the annual shareholders meeting.

The Company issued 9,489 and 10,399 shares of StanCorp common stock for the second quarters of 2012 and 2011, respectively, related to the annual Director stock grant.

Employee Share Purchase Plan

The Company’s ESPP allows eligible employees to purchase StanCorp common stock at a 15% discount of the lesser of the closing market price of StanCorp common stock on either the commencement date or the final date of each six-month offering period. Under the terms of the plan, each eligible employee may elect to have up to 10% of the employee’s gross total cash compensation for the period withheld to purchase StanCorp common stock. No employee may purchase StanCorp common stock having a fair market value in excess of $25,000 in any calendar year.

The following table sets forth the compensation cost and related income tax benefit under the Company’s ESPP:

 

    Three Months Ended
June 30,
     Six Months Ended
June 30,
 
    2012      2011      2012      2011  
    (In millions)  

Compensation cost

  $ 0.3      $ 0.3      $ 0.9      $ 0.8  

Related income tax benefit

    0.1        0.1        0.3        0.3  

 

4.

RETIREMENT BENEFITS

Pension Benefits

The Company has two non-contributory defined benefit pension plans: the employee pension plan and the agent pension plan. The employee pension plan is for all eligible employees of the Company, and the agent pension plan is for former field employees and agents. The defined benefit pension plans provide benefits based on years of service and final average pay. Both plans are sponsored by Standard and administered by Standard Retirement Services and are closed to new participants. Participation in the defined benefit pension plans is generally limited to eligible employees whose date of employment began before 2003.

Under the employee pension plan, a participant is entitled to a normal retirement benefit once the participant reaches age 65. A participant can also receive a normal, unreduced retirement benefit once the sum of his or her age plus years of service is at least 90.

The Company recognizes the funded status of the pension plans as an asset or liability on the balance sheet. The funded status is measured as the difference between the fair value of the plan assets and the projected benefit obligation as of the year-end balance sheet date. While the Company is not obligated to make any contributions to its pension plans for 2012, it does evaluate the funding status of these plans annually in the fourth quarter.

 

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The following table sets forth the components of net periodic benefit cost and other changes in plan assets and benefit obligations recognized in other comprehensive income for pension benefits:

 

    Three Months Ended
June 30,
    Six Months Ended
June 30,
 
    2012     2011     2012     2011  
    (In millions)  

Components of net periodic benefit cost:

       

Service cost

  $ 2.4     $ 2.5     $ 4.9     $ 5.0  

Interest cost

    4.2       4.6       8.3       9.1  

Expected return on plan assets

    (6.7     (5.6     (13.3     (11.2

Amortization of prior service cost

    0.1       0.1       0.3       0.3  

Amortization of net actuarial loss

    2.3       1.0       4.4       1.9  
 

 

 

   

 

 

   

 

 

   

 

 

 

Net periodic benefit cost

    2.3       2.6       4.6       5.1  
 

 

 

   

 

 

   

 

 

   

 

 

 

Other changes in plan assets and benefit obligation recognized in other comprehensive income:

       

Amortization of prior service cost

    (0.1     (0.1     (0.3     (0.3

Amortization of net actuarial loss

    (2.3     (1.0     (4.4     (1.9
 

 

 

   

 

 

   

 

 

   

 

 

 

Total recognized in other comprehensive income

    (2.4     (1.1     (4.7     (2.2
 

 

 

   

 

 

   

 

 

   

 

 

 

Total recognized in net periodic benefit cost and other comprehensive income

  $ (0.1   $ 1.5     $ (0.1   $ 2.9  
 

 

 

   

 

 

   

 

 

   

 

 

 

Postretirement Benefits Other Than Pensions

Standard sponsors and administers a postretirement benefit plan that includes medical and prescription drug benefits. A group term life insurance benefit was curtailed as of December 31, 2011. Eligible retirees are required to contribute specified amounts for medical and prescription drug benefits that are determined periodically and are based on retirees’ length of service and age at retirement. Participation in the postretirement benefit plan is limited to employees who had reached the age of 40, or whose combined age and length of service was equal to or greater than 45 years as of January 1, 2006. This plan is closed to new participants.

The Company recognizes the funded status of the postretirement benefit plan as an asset or liability on the balance sheet. The funded status is measured as the difference between the fair value of the plan assets and the accumulated benefit obligation.

 

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The following table sets forth the components of net periodic benefit cost and other amounts recognized in other comprehensive income for postretirement benefits:

 

    Three Months Ended
June 30,
    Six Months Ended
June 30,
 
    2012     2011     2012     2011  
    (In millions)  

Components of net periodic benefit cost:

       

Service cost

  $ 0.2     $ 0.4     $ 0.4     $ 0.4  

Interest cost

    0.5       0.5       0.9       1.0  

Expected return on plan assets

    (0.2     (0.2     (0.4     (0.4

Amortization of prior service credit

    (0.1     (0.1     (0.2     (0.1
 

 

 

   

 

 

   

 

 

   

 

 

 

Net periodic benefit cost

    0.4       0.6       0.7       0.9  
 

 

 

   

 

 

   

 

 

   

 

 

 

Other changes in plan assets and benefit obligation recognized in other comprehensive income:

       

Net gain

    —          —          (0.7     (2.3

Amortization of prior service cost

    0.1       0.1       0.2       0.1  
 

 

 

   

 

 

   

 

 

   

 

 

 

Total recognized in other comprehensive income

    0.1       0.1       (0.5     (2.2
 

 

 

   

 

 

   

 

 

   

 

 

 

Total recognized in net periodic benefit cost and other comprehensive income

  $ 0.5     $ 0.7     $ 0.2     $ (1.3
 

 

 

   

 

 

   

 

 

   

 

 

 

Deferred Compensation Plans

Eligible employees are covered by a qualified deferred compensation plan sponsored by Standard under which a portion of the employee contribution is matched. Employees not eligible for the employee pension plan are eligible for an additional non-elective employer contribution. Contributions to the plan were $2.3 million and $2.7 million for the second quarters of 2012 and 2011, respectively, and $5.4 million and $5.8 million for the first six months of 2012 and 2011, respectively.

Eligible executive officers, directors, agents and group producers may participate in one of several non-qualified deferred compensation plans under which a portion of the deferred compensation for participating executive officers, agents and group producers is matched. The liability for the plans was $10.3 million at June 30, 2012 and $10.7 million at December 31, 2011.

Non-Qualified Supplemental Retirement Plan

Eligible executive officers are covered by a non-qualified supplemental retirement plan (“non-qualified plan”). Under the non-qualified plan, a participant is entitled to a normal retirement benefit once the participant reaches age 65. A participant can also receive a normal, unreduced retirement benefit once the sum of his or her age plus years of service is at least 90. The Company recognizes the unfunded status of the non-qualified plan in other liabilities on the balance sheet. The unfunded status was $28.8 million and $28.5 million at June 30, 2012 and December 31, 2011, respectively. Expenses were $0.7 million and $0.7 million for the second quarters of 2012 and 2011, respectively, and were $1.3 million and $1.4 million for the first six months of 2012 and 2011, respectively. The net loss and prior service cost, net of tax, excluded from the net periodic benefit cost and reported as a component of accumulated other comprehensive income was $5.4 million and $5.7 million at June 30, 2012 and December 31, 2011, respectively.

 

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Table of Contents
5.

SEGMENTS

StanCorp operates through two reportable segments: Insurance Services and Asset Management, as well as an Other category. Subsidiaries, or operating segments, have been aggregated to form the Company’s reportable segments. Resources are allocated and performance is evaluated at the segment level. The Insurance Services segment offers group and individual disability insurance, group life and AD&D insurance, group dental and group vision insurance, and absence management services. The Asset Management segment offers full-service 401(k) plans, 403(b) plans, 457 plans, defined benefit plans, money purchase pension plans, profit sharing plans and non-qualified deferred compensation products and services. This segment also offers investment advisory and management services, financial planning services, commercial mortgage loan origination and servicing, individual fixed-rate annuity products, group annuity contracts and retirement plan trust products. The Other category includes return on capital not allocated to the product segments, holding company expenses, operations of certain unallocated subsidiaries, interest on debt, unallocated expenses, net capital gains and losses related to the impairment or the disposition of the Company’s invested assets and adjustments made in consolidation.

Intersegment revenues are comprised of administrative fee revenues charged by the Asset Management segment to manage the fixed maturity securities—available-for-sale (“fixed maturity securities”) and commercial mortgage loan portfolios for the Company’s insurance subsidiaries.

The following table sets forth intersegment revenues:

 

    Three Months Ended
June 30,
     Six Months Ended
June 30,
 
    2012      2011      2012      2011  
    (In millions)  

Intersegment administrative fee revenues

  $ 4.4      $ 4.3      $ 8.8      $ 8.2  

 

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Table of Contents

The following table sets forth premiums, administrative fee revenues and net investment income by major product line or category within each of the Company’s segments:

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
             2012                     2011                     2012                     2011          
     (In millions)  

Premiums:

        

Insurance Services:

        

Group life and AD&D

   $ 223.8     $ 224.5     $ 448.7     $ 446.1  

Group long term disability

     200.2       201.4       404.4       401.5  

Group short term disability

     54.0       52.5       107.8       103.9  

Group other

     19.6       20.2       39.5       40.0  

Experience rated refunds

     7.1       (5.7     11.2       (10.2
  

 

 

   

 

 

   

 

 

   

 

 

 

Total group insurance

     504.7       492.9       1,011.6       981.3  

Individual disability insurance

     41.8       42.7       86.0       84.8  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Insurance Services premiums

     546.5       535.6       1,097.6       1,066.1  
  

 

 

   

 

 

   

 

 

   

 

 

 

Asset Management:

        

Retirement plans

     0.4       —          1.2       0.7  

Individual annuities

     1.2       1.4       2.6       4.0  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Asset Management premiums

     1.6       1.4       3.8       4.7  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total premiums

   $ 548.1     $ 537.0     $ 1,101.4     $ 1,070.8  
  

 

 

   

 

 

   

 

 

   

 

 

 

Administrative fees:

        

Insurance Services:

        

Group insurance

   $ 4.2     $ 2.9     $ 7.2     $ 5.5  

Individual disability insurance

     —          —          0.1       0.1  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Insurance Services administrative fees

     4.2       2.9       7.3       5.6  
  

 

 

   

 

 

   

 

 

   

 

 

 

Asset Management:

        

Retirement plans

     22.3       23.2       44.5       46.2  

Other financial services businesses

     7.7       7.7       15.4       15.3  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Asset Management administrative fees

     30.0       30.9       59.9       61.5  
  

 

 

   

 

 

   

 

 

   

 

 

 

Other

     (4.4     (4.3     (8.8     (8.2
  

 

 

   

 

 

   

 

 

   

 

 

 

Total administrative fees

   $ 29.8     $ 29.5     $ 58.4     $ 58.9  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net investment income:

        

Insurance Services:

        

Group insurance

   $ 70.5     $ 72.0     $ 141.8     $ 143.3  

Individual disability insurance

     13.1       13.4       26.4       26.5  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Insurance Services net investment income

     83.6       85.4       168.2       169.8  
  

 

 

   

 

 

   

 

 

   

 

 

 

Asset Management:

        

Retirement plans

     23.4       22.0       46.8       44.4  

Individual annuities

     37.7       39.5       84.6       83.8  

Other financial services businesses

     3.5       3.4       6.3       6.3  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Asset Management net investment income

     64.6       64.9       137.7       134.5  
  

 

 

   

 

 

   

 

 

   

 

 

 

Other

     3.2       2.3       5.2       5.3  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total net investment income

   $ 151.4     $ 152.6     $ 311.1     $ 309.6  
  

 

 

   

 

 

   

 

 

   

 

 

 

 

12


Table of Contents

The following tables set forth select segment information:

 

     Insurance
    Services    
    Asset
Management
    Other     Total  
     (In millions)  

Three Months Ended June 30, 2012

        

Revenues:

        

Premiums

   $ 546.5     $ 1.6     $         —        $       548.1  

Administrative fees

     4.2       30.0       (4.4     29.8  

Net investment income

     83.6       64.6       3.2       151.4  

Net capital losses

     —          —          (4.0     (4.0
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     634.3       96.2       (5.2     725.3  
  

 

 

   

 

 

   

 

 

   

 

 

 

Benefits and expenses:

        

Benefits to policyholders

     471.0       4.9       —          475.9  

Interest credited

     1.0       38.2       —          39.2  

Operating expenses

     86.5       29.3       0.9       116.7  

Commissions and bonuses

     42.0       9.3       —          51.3  

Premium taxes

     9.5       —          —          9.5  

Interest expense

     —          —          9.8       9.8  

Net (increase) decrease in deferred acquisition costs, value of business acquired and other intangible assets

     1.0       (0.7     —          0.3  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total benefits and expenses

     611.0       81.0       10.7       702.7  
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

   $ 23.3     $ 15.2     $ (15.9   $ 22.6  
  

 

 

   

 

 

   

 

 

   

 

 

 
     Insurance
    Services    
    Asset
Management
    Other     Total  
     (In millions)  

Three Months Ended June 30, 2011

        

Revenues:

        

Premiums

   $ 535.6     $ 1.4     $ —        $ 537.0  

Administrative fees

     2.9       30.9       (4.3     29.5  

Net investment income

     85.4       64.9       2.3       152.6  

Net capital losses

     —          —          (13.1     (13.1
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     623.9       97.2       (15.1     706.0  
  

 

 

   

 

 

   

 

 

   

 

 

 

Benefits and expenses:

        

Benefits to policyholders

     448.1       4.3       —          452.4  

Interest credited

     1.6       38.4       —          40.0  

Operating expenses

     85.7       28.9       3.5       118.1  

Commissions and bonuses

     43.7       10.5       —          54.2  

Premium taxes

     8.8       0.1       —          8.9  

Interest expense

     —          —          9.8       9.8  

Net increase in deferred acquisition costs, value of business acquired and other intangible assets

     (0.9     (1.1     —          (2.0
  

 

 

   

 

 

   

 

 

   

 

 

 

Total benefits and expenses

     587.0       81.1       13.3       681.4  
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

   $ 36.9     $ 16.1     $ (28.4   $ 24.6  
  

 

 

   

 

 

   

 

 

   

 

 

 

 

 

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Table of Contents
     Insurance
    Services    
    Asset
Management
     Other     Total  
     (In millions)  

Six Months Ended June 30, 2012

         

Revenues:

         

Premiums

   $ 1,097.6     $ 3.8      $         —        $ 1,101.4  

Administrative fees

     7.3       59.9        (8.8     58.4  

Net investment income

     168.2       137.7        5.2       311.1  

Net capital losses

     —          —           (4.2     (4.2
  

 

 

   

 

 

    

 

 

   

 

 

 

Total revenues

     1,273.1       201.4        (7.8     1,466.7  
  

 

 

   

 

 

    

 

 

   

 

 

 

Benefits and expenses:

         

Benefits to policyholders

     915.7       10.2        —          925.9  

Interest credited

     2.6       83.8        —          86.4  

Operating expenses

     179.1       59.5        2.0       240.6  

Commissions and bonuses

     90.7       16.0        —          106.7  

Premium taxes

     19.5       —           —          19.5  

Interest expense

     —          —           19.5       19.5  

Net (increase) decrease in deferred acquisition costs, value of business acquired and other intangible assets

     (3.9     1.7        —          (2.2
  

 

 

   

 

 

    

 

 

   

 

 

 

Total benefits and expenses

     1,203.7       171.2        21.5       1,396.4  
  

 

 

   

 

 

    

 

 

   

 

 

 

Income (loss) before income taxes

   $ 69.4     $ 30.2      $ (29.3   $ 70.3  
  

 

 

   

 

 

    

 

 

   

 

 

 

Total assets

   $ 8,256.4     $ 10,464.2      $ 420.6     $ 19,141.2  
  

 

 

   

 

 

    

 

 

   

 

 

 
     Insurance
    Services    
    Asset
Management
     Other     Total  
     (In millions)  

Six Months Ended June 30, 2011

         

Revenues:

         

Premiums

   $ 1,066.1     $ 4.7      $ —        $ 1,070.8  

Administrative fees

     5.6       61.5        (8.2     58.9  

Net investment income

     169.8       134.5        5.3       309.6  

Net capital losses

     —          —           (15.6     (15.6
  

 

 

   

 

 

    

 

 

   

 

 

 

Total revenues

     1,241.5       200.7        (18.5     1,423.7  
  

 

 

   

 

 

    

 

 

   

 

 

 

Benefits and expenses:

         

Benefits to policyholders

     882.4       10.1        —          892.5  

Interest credited

     2.6       77.8        —          80.4  

Operating expenses

     172.2       58.3        5.9       236.4  

Commissions and bonuses

     94.2       18.8        —          113.0  

Premium taxes

     18.2       0.1        —          18.3  

Interest expense

     —          —           19.5       19.5  

Net (increase) decrease in deferred acquisition costs, value of business acquired and other intangible assets

     (11.0     0.6        —          (10.4
  

 

 

   

 

 

    

 

 

   

 

 

 

Total benefits and expenses

     1,158.6       165.7        25.4       1,349.7  
  

 

 

   

 

 

    

 

 

   

 

 

 

Income (loss) before income taxes

   $ 82.9     $ 35.0      $ (43.9   $ 74.0  
  

 

 

   

 

 

    

 

 

   

 

 

 

Total assets

   $ 7,916.1     $ 10,132.9      $ 376.5     $ 18,425.5  
  

 

 

   

 

 

    

 

 

   

 

 

 

 

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Table of Contents
6.

FAIR VALUE

Assets and liabilities recorded at fair value are disclosed using a three-level hierarchy. The classification of assets and liabilities within the hierarchy is based on whether the inputs to the valuation methodology used for measurement are observable or unobservable. Observable inputs reflect market-derived or market-based information obtained from independent sources while unobservable inputs reflect the Company’s estimates about market data.

The fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value into three broad levels: Level 1 inputs are based upon quoted prices in active markets for identical assets or liabilities that the Company can access at the measurement date. Level 2 inputs are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. Level 3 inputs are generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect the Company’s estimates of assumptions that market participants would use in pricing the asset or liability.

There are three types of valuation techniques used to measure assets and liabilities recorded at fair value:

   

The market approach, which uses prices or other relevant information generated by market transactions involving identical or comparable assets or liabilities.

   

The income approach, which uses the present value of cash flows or earnings.

   

The cost approach, which uses replacement costs more readily adaptable for valuing physical assets.

The Company uses both the market and income approach in its fair value measurements. These measurements are discussed in more detail below.

The following table sets forth the estimated fair value and the carrying value of each financial instrument:

 

    June 30, 2012  
    Carrying Value      Fair
Value
     Level 1      Level 2      Level 3  
    (In millions)  

Assets:

             

Fixed maturity securities:

 

U.S. government and agency bonds

  $ 433.8      $ 433.8      $ —         $ 433.8      $ —     

U.S. state and political subdivision bonds

    177.6        177.6        —           175.8        1.8  

Foreign government bonds

    71.8        71.8        —           71.8        —     

Corporate bonds

    6,281.6        6,281.6        —           6,223.0        58.6  

S&P 500 Index options

    12.4        12.4        —           —           12.4  
 

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturity securities

  $       6,977.2      $       6,977.2      $       —         $       6,904.4      $           72.8  
 

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Commercial mortgage loans, net

  $ 5,098.7      $ 5,696.4      $ —         $ —         $ 5,696.4  

Policy loans

    2.7        2.7        —           —           2.7  

Separate account assets

    4,867.2        4,867.2        4,724.5        142.7        —     

Liabilities:

             

Total other policyholder funds, investment
type contracts

  $ 4,645.2      $ 4,955.7      $ —         $ —         $ 4,955.7  

Index-based interest guarantees

    56.0        56.0        —           —           56.0  

Short-term debt

    251.0        258.6        —           258.6        —     

Long-term debt

    301.2        282.1        —           282.1        —     

 

15


Table of Contents
     December 31, 2011  
     Carrying
Value
     Fair
Value
     Level 1      Level 2      Level 3  
     (In millions)  

Assets:

              

Fixed maturity securities:

  

U.S. government and agency bonds

   $ 452.1      $ 452.1      $ —         $ 451.6      $ 0.5  

U.S. state and political subdivision bonds

     178.8        178.8        —           177.4        1.4  

Foreign government bonds

     72.1        72.1        —           72.1        —     

Corporate bonds

     6,059.3        6,059.3        —           5,995.3        64.0  

S&P 500 Index options

     7.2        7.2        —           —           7.2  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturity securities

   $     6,769.5      $     6,769.5      $         —         $     6,696.4      $         73.1  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Commercial mortgage loans, net

   $ 4,902.3      $ 5,450.9      $ —         $ —         $ 5,450.9  

Policy loans

     2.9        2.9        —           —           2.9  

Separate account assets

     4,593.5        4,593.5        4,444.4        149.1        —     

Liabilities:

              

Total other policyholder funds, investment type contracts

   $ 4,449.2      $ 4,804.8      $ —         $ —         $ 4,804.8  

Index-based interest guarantees

     49.5        49.5        —           —           49.5  

Short-term debt

     251.2        263.7        —           263.7        —     

Long-term debt

     300.9        272.0        —           272.0        —     

Financial Instruments Not Recorded at Fair Value

The Company did not elect to measure and record commercial mortgage loans, policy loans, other policyholders funds that are investment-type contracts, short-term debt, or long-term debt at fair value on the consolidated balance sheets.

For disclosure purposes, the fair values of commercial mortgage loans were estimated using an option-adjusted discounted cash flow valuation. The valuation includes both observable market inputs and estimated model parameters.

Significant observable inputs to the valuation include:

   

Indicative quarter-end pricing for a package of loans similar to those originated by the Company near quarter-end.

   

U.S. Government treasury yields.

   

Indicative yields from industrial bond issues.

   

The contractual terms of nearly every mortgage subject to valuation.

Significant estimated parameters include:

   

A liquidity premium that is estimated from historical loan sales and is applied over and above base yields.

   

Adjustments in interest rate spread based on an aggregate portfolio loan-to-value ratio, estimated from historical differential yields with respect to loan-to-value ratios.

   

Projected prepayment activity.

For policy loans, the carrying value represents historical cost but approximates fair value. While potentially financial instruments, policy loans are an integral component of the insurance contract and have no maturity date.

The fair value of other policyholder funds that are investment-type contracts was calculated using the income approach in conjunction with the cost of capital method. The parameters used for discounting in the calculation were estimated using the perspective of the principal market for the contracts under consideration. The principal market consists of other insurance carriers with similar contracts on their books.

The fair value for short-term and long-term debt was predominantly based on quoted market prices as of June 30, 2012 and December 31, 2011, and trades occurring close to June 30, 2012 and December 31, 2011.

Financial Instruments Measured and Recorded at Fair Value

Fixed maturity securities, Standard & Poor’s (“S&P”) 500 Index call options (“S&P 500 Index options”) and index-based interest guarantees embedded in indexed annuities (“index-based interest guarantees”) are recorded at fair value on a recurring basis. In the Company’s consolidated statements of income and comprehensive income, unrealized gains and losses are reported in other comprehensive income for fixed maturity securities, in net investment income for S&P 500 Index options and in interest credited for index-based interest guarantees.

Separate account assets represent segregated funds held for the exclusive benefit of contract holders. The activities of the account primarily relate to participant-directed 401(k) contracts. Separate account assets are recorded at fair value on a recurring basis, with changes in fair value recorded in separate account liabilities. Separate account assets consist of mutual funds. The mutual funds’ fair value is determined through Level 1 and Level 2 inputs. The majority of the separate account assets are valued using quoted prices in an active market with the remainder of the assets valued using quoted prices from an independent pricing service. The Company reviews the values obtained from the pricing service for reasonableness through analytical procedures and performance reviews.

 

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Table of Contents

Fixed maturity securities are comprised of the following classes:

   

U.S. government and agency bonds.

   

U.S. state and political subdivision bonds.

   

Foreign government bonds.

   

Corporate bonds.

   

S&P 500 Index options.

The fixed maturity securities are diversified across industries, issuers and maturities. The Company calculates fair values for all classes of fixed maturity securities using valuation techniques described below. They are placed into three levels depending on the valuation technique used to determine the fair value of the securities.

The Company uses an independent pricing service to assist management in determining the fair value of these assets. The pricing service incorporates a variety of information observable in the market in its valuation techniques, including:

   

Reported trading prices.

   

Benchmark yields.

   

Broker-dealer quotes.

   

Benchmark securities.

   

Bids and offers.

   

Credit ratings.

   

Relative credit information.

   

Other reference data.

The pricing service also takes into account perceived market movements and sector news, as well as a bond’s terms and conditions, including any features specific to that issue that may influence risk, and thus marketability. Depending on the security, the priority of the use of observable market inputs may change as some observable market inputs may not be relevant or additional inputs may be necessary. The Company generally obtains one value from its primary external pricing service. On a case-by-case basis, the Company may obtain further quotes or prices from additional parties as needed.

The pricing service provides quoted market prices when available. Quoted prices are not always available due to bond market inactivity. The pricing service obtains a broker quote when sufficient information, such as security structure or other market information, is not available to produce a valuation. Valuations and quotes obtained from third party commercial pricing services are non-binding and do not represent quotes on which one may execute the disposition of the assets.

The significant unobservable inputs used in the fair value measurement of the reporting entity’s bonds are valuations and quotes received from secondary pricing service, analytical reviews and broker quotes. Significant increases or decreases in any of those inputs in isolation would result in a significantly lower or higher fair value measurement. Generally, a change in the assumption used for the pricing evaluation is accompanied by a directionally similar change in the assumption used for the methodologies.

The Company performs control procedures over the external valuations at least quarterly through a combination of procedures that include an evaluation of methodologies used by the pricing service, analytical reviews and performance analysis of the prices against statistics and trends, back testing of sales activity and maintenance of a securities watch list. As necessary, the Company compares prices received from the pricing service to prices independently estimated by the Company utilizing discounted cash flow models or through performing independent valuations of inputs and assumptions similar to those used by the pricing service in order to ensure prices represent a reasonable estimate of fair value. Although the Company does identify differences from time to time as a result of these validation procedures, the Company did not make any significant adjustments as of June 30, 2012 or December 31, 2011.

S&P 500 Index options and certain fixed maturity securities were valued using Level 3 inputs. The Level 3 fixed maturity securities were valued using matrix pricing, independent broker quotes and other standard market valuation methodologies. The fair value was determined using inputs that were not observable or could not be derived principally from, or corroborated by, observable market data. These inputs included assumptions regarding liquidity, estimated future cash flows and discount rates. Unobservable inputs to these valuations are based on management’s judgment or estimation obtained from the best sources available. The Company’s valuations maximize the use of observable inputs, which include an analysis of securities in similar sectors with comparable maturity dates and bond ratings. Broker quotes are validated by management for reasonableness in conjunction with information obtained from matrix pricing and other sources.

The Company calculates the fair value for its S&P 500 Index options using the Black-Scholes option pricing model and parameters derived from market sources. The Company’s valuations maximize the use of observable inputs, which include direct price quotes from the Chicago Board Options Exchange (“CBOE”) and values for on-the-run treasury securities and London Interbank Offered Rate (“LIBOR”) as reported by Bloomberg. Unobservable inputs are estimated from the best sources available to the Company and include estimates of future gross dividends to be paid on the stocks underlying the S&P 500 Index, estimates of bid-ask spreads, and estimates of implied volatilities on options. Valuation parameters are calibrated to replicate the actual end-of-day market quotes for options trading on the CBOE. The Company performs additional validation procedures such as the daily observation of market activity and conditions and the tracking and analyzing of actual quotes provided by banking counterparties each time the Company purchases options from them. Additionally, in order to help validate the values derived through the procedures noted above, the Company obtains indicators of value from representative investment banks.

The Company uses the income approach valuation technique to determine the fair value of index-based interest guarantees. The liability is the present value of future cash flows attributable to the projected index growth in excess of cash flows driven by fixed interest rate guarantees for the indexed annuity product. Level 3 assumptions for policyholder behavior and future index interest rate declarations significantly influence the calculation. Index-based interest guarantees are included in the other policyholder funds line on the Company’s consolidated balance sheet.

 

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Table of Contents

While valuations for the S&P 500 Index options are sensitive to a number of variables, valuations for S&P 500 Index options purchased are most sensitive to changes in the estimates of bid ask spreads, or the S&P 500 Index value, and the implied volatilities of this index. Significant fluctuations in any of those inputs in isolation would result in a significantly lower or higher fair value measurement. Generally, an increase or decrease used in the assumption for the implied volatilities and in the S&P 500 Index value would result in a directionally similar change in the fair value of the asset.

Valuations for the index-based interest guarantees are sensitive to a number of variables, but are most sensitive to the S&P 500 Index value, the implied volatilities of this index, and LIBOR as reported by Bloomberg. Generally, a significant increase or decrease used in the assumption for the implied volatilities and in the S&P 500 Index value would result in a directionally similar change, while an increase or decrease in LIBOR would result in a directionally opposite change in the fair value of the liability.

Valuations for commercial mortgage loans and real estate owned measured on a nonrecurring basis are sensitive to a number of variables, but are most sensitive to the capitalization rate. Generally, an increase or decrease used in the assumption for the capitalization rate would result in a directionally similar change in the fair value of the asset.

Quantitative information regarding significant unobservable inputs used in Level 3 valuation of assets and liabilities measured and recorded at fair value is as follows:

 

    June 30, 2012
(Dollars in millions)
    Fair Value    

Valuation Technique

 

Unobservable Input

  Range of inputs

S&P 500 Index options

  $ 12.4     

Black-Scholes Option Pricing model

 

Various assumptions

  (a)

Index-based interest guarantees

    56.0    

Discounted Cash Flow

 

Expected future option purchase

  1%-5%
     

Various assumptions

  (b)
   

Black-Scholes Option Pricing model

 

Various assumptions

  (a)

Commercial mortgage loans

    55.4    

Appraisals

 

Discount for dated appraisal

  0%-50%
   

Cash Flows

 

Capitalization rate (c)

  7%-14%

Real estate owned

    27.0    

Appraisals

 

Discount for dated appraisal

  0%-50%

 

(a)

Represents various assumptions derived from market data, which include estimates of bid ask spreads and the implied volatilities for the S&P 500 index.

(b)

Represents various actuarial assumptions which include combined lapse, mortality and withdrawal decrement rates which generally have a range of inputs from 5%-36%.

(c)

Capitalization rates are used as an internal analysis in converting the underlying property’s income to an estimated property value.

 

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Table of Contents

The following tables set forth the reconciliation for all assets and liabilities measured at fair value on a recurring basis using significant unobservable Level 3 inputs:

 

    Three Months Ended June 30, 2012  
    Assets     Liabilities  
    U.S.
Government
and Agency
Bonds
    U.S. State
and Political
Subdivision
Bonds
     Corporate
Bonds
    S&P 500
Index
Options
    Total
    Assets    
    Index-
Based
Interest
Guarantees
 
    (In millions)  

Beginning balance

  $ —        $ 1.8      $ 53.1     $ 14.3     $ 69.2     $ 55.3  

Total realized/unrealized gains (losses):

            

Included in net income

    —          —           —          (2.3     (2.3     (1.7

Included in other comprehensive income (loss)

    —          —           —          —          —          —     

Purchases, issuances, sales and settlements:

            

Purchases

    —          —           —          2.8       2.8       —     

Issuances

    —          —           —          —          —          3.1  

Sales

    —          —           —          —          —          —     

Settlements

    —          —           —          (2.4     (2.4     (0.7

Transfers into level 3

    —          —           5.5       —          5.5       —     

Transfers out of level 3

    —          —           —          —          —          —     
 

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

  $ —        $ 1.8      $ 58.6     $ 12.4     $ 72.8     $ 56.0  
 

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 
    Three Months Ended June 30, 2011  
    Assets     Liabilities  
    U.S.
Government
and Agency
Bonds
    U.S. State
and Political
Subdivision
Bonds
     Corporate
Bonds
    S&P 500
Index
Options
    Total
    Assets    
    Index-
Based
Interest
Guarantees
 
    (In millions)  

Beginning balance

  $ 0.9     $ 1.4      $ 56.0     $ 14.2     $ 72.5     $ 50.8  

Total realized/unrealized gains (losses):

            

Included in net income

    —          —           —          0.8       0.8       0.1  

Included in other comprehensive income (loss)

    (0.2     —           0.1       —          (0.1     —     

Purchases, issuances, sales and settlements:

            

Purchases

    —          —           —          2.4       2.4       —     

Issuances

    —          —           —          —          —          0.6  

Sales

    —          —           (0.9     —          (0.9     —     

Settlements

    —          —           —          (4.6     (4.6     (0.4

Transfers into level 3

    —          —           —          —          —          —     

Transfers out of level 3

    —          —           —          —          —          —     
 

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

  $ 0.7     $ 1.4      $ 55.2     $ 12.8     $ 70.1     $ 51.1  
 

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents
    Six Months Ended June 30, 2012  
    Assets     Liabilities  
    U.S.
Government
and Agency
Bonds
    U.S. State
and  Political
Subdivision
Bonds
    Corporate
Bonds
    S&P 500
Index
Options
    Total
Assets
    Index-
Based
Interest
Guarantees
 
    (In millions)  

Beginning balance

  $ 0.5     $ 1.4     $ 64.0     $ 7.2     $ 73.1     $ 49.5  

Total realized/unrealized gains (losses):

           

Included in net income

    —          —          —          4.4       4.4       4.7  

Included in other comprehensive income (loss)

    —          —          (1.4     —          (1.4     —     

Purchases, issuances, sales and settlements:

           

Purchases

    —          —          —          4.8       4.8       —     

Issuances

    —          —          —          —          —          3.2  

Sales

    —          —          —          —          —          —     

Settlements

    —          —          —          (4.0     (4.0     (1.4

Transfers into level 3

    —          0.4       5.5       —          5.9       —     

Transfers out of level 3

    (0.5     —          (9.5     —          (10.0     —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

  $ —        $ 1.8     $ 58.6     $ 12.4     $ 72.8     $ 56.0  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    Six Months Ended June 30, 2011  
    Assets     Liabilities  
    U.S.
Government
and Agency
Bonds
    U.S. State
and Political
Subdivision
Bonds
    Corporate
Bonds
    S&P 500
Index
Options
    Total
Assets
    Index-
Based
Interest
Guarantees
 
    (In millions)  

Beginning balance

  $ 0.9     $ 1.7     $ 59.0     $ 13.3     $ 74.9     $ 48.5  

Total realized/unrealized gains (losses):

           

Included in net income

    —          —          —          3.8       3.8       2.1  

Included in other comprehensive income (loss)

    (0.2     0.1       (2.1     —          (2.2     —     

Purchases, issuances, sales and settlements:

           

Purchases

    —          —          —          4.7       4.7       —     

Issuances

    —          —          —          —          —          1.2  

Sales

    —          —          (1.7     —          (1.7     —     

Settlements

    —          —          —          (9.0     (9.0     (0.7

Transfers into level 3

    —          —          —          —          —          —     

Transfers out of level 3

    —          (0.4     —          —          (0.4     —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

  $ 0.7     $ 1.4     $ 55.2     $ 12.8     $ 70.1     $ 51.1  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

For all periods disclosed above, fixed maturity securities transferred into Level 3 from Level 2 are the result of the Company being unable to obtain observable assumptions in the market. Fixed maturity securities transferred out of Level 3 into Level 2 are the result of the Company being able to obtain observable assumptions in the market. There were no transfers between Level 1 and Level 2 for the second quarter of 2012 and 2011.

 

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Table of Contents

The following table sets forth the changes in unrealized gains (losses) included in net income relating to positions that the Company continued to hold:

 

    Three Months Ended
June  30,
    Six Months Ended
June  30,
 
    2012     2011     2012     2011  
    (In millions)  

Assets:

       

S&P 500 Index options

  $             (0.6   $             0.4     $             2.5     $             1.9  

Liabilities:

       

Index-based interest guarantees

  $ (1.9   $ (1.2   $ (8.4   $ (4.5

Changes to the fair value of fixed maturity securities, excluding S&P 500 Index options, were recorded in other comprehensive income. Changes to the fair value of the S&P 500 Index options were recorded to net investment income. Changes to the fair value of the index-based interest guarantees were recorded as interest credited. The interest credited amount included negative interest on policyholder funds due to changes in the Level 3 actuarial assumptions of $1.1 million and $1.5 million for the second quarters and first six months of 2012 and 2011, respectively.

Certain assets and liabilities are measured at fair value on a nonrecurring basis such as impaired commercial mortgage loans with specific allowances for losses and real estate acquired in satisfaction of debt through foreclosure or the acceptance of deeds in lieu of foreclosure on commercial mortgage loans (“real estate owned”). The impaired commercial mortgage loans and real estate owned are valued using Level 3 measurements. These Level 3 inputs are reviewed for reasonableness by management and evaluated on a quarterly basis. The commercial mortgage loan measurements include valuation of the market value of the asset using general underwriting procedures and appraisals. Real estate owned is initially recorded at estimated net realizable value, which includes an estimate for disposal costs. These amounts may be adjusted in a subsequent period as independent appraisals are received.

The following table sets forth the assets measured at fair value on a nonrecurring basis as of June 30, 2012 that the Company continued to hold:

 

    June 30, 2012  
    Total      Level 1      Level 2      Level 3  
    (In millions)  

Commercial mortgage loans

  $             55.4      $             —         $             —         $             55.4  

Real estate owned

    27.0        —           —           27.0  
 

 

 

    

 

 

    

 

 

    

 

 

 

Total assets measured at fair value on a nonrecurring basis

  $ 82.4      $ —         $ —         $ 82.4  
 

 

 

    

 

 

    

 

 

    

 

 

 

Commercial mortgage loans measured on a nonrecurring basis with a carrying amount of $74.5 million were written down to their fair value of $55.4 million, less selling costs, at June 30, 2012. The specific commercial mortgage loan loss allowance related to these commercial mortgage loans was $24.6 million at June 30, 2012. The real estate owned measured on a nonrecurring basis as of June 30, 2012, and still held at June 30, 2012 had capital losses totaling $0.6 million for the first six months of 2012. Real estate owned measured on a nonrecurring basis represents newly acquired properties or properties whose value has been adjusted based on pending sale or other market information.

The following table sets forth the assets measured at fair value on a nonrecurring basis as of June 30, 2011 that the Company continued to hold:

 

    December 31, 2011  
    Total      Level 1      Level 2      Level 3  
    (In millions)  

Commercial mortgage loans

  $ 49.2      $ —         $ —         $ 49.2  

Real estate owned

    50.1        —           —           50.1  
 

 

 

    

 

 

    

 

 

    

 

 

 

Total assets measured at fair value on a nonrecurring basis

  $               99.3      $               —         $               —         $               99.3  
 

 

 

    

 

 

    

 

 

    

 

 

 

Commercial mortgage loans measured on a nonrecurring basis with a carrying amount of $75.8 million were written down to their fair value of $49.2 million, less selling costs, at December 31, 2011. The specific commercial mortgage loan loss allowance related to these commercial mortgage loans was $26.6 million at December 31, 2011. The real estate owned measured on a nonrecurring basis as of December 31, 2011, and still held at December 31, 2011 had capital losses totaling $3.5 million for 2011. See “Note 7—Investments—Commercial Mortgage Loans” for further disclosures regarding the commercial mortgage loan loss allowance.

 

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7.

INVESTMENTS

Fixed Maturity Securities

The following tables set forth amortized costs, gross unrealized gains and losses and fair values of the Company’s fixed maturity securities:

 

    June 30, 2012  
    Amortized
Cost
     Unrealized
Gains
     Unrealized
Losses
    Fair
Value
 
    (In millions)  

U.S. government and agency bonds

  $ 369.8      $ 64.0      $ —        $ 433.8  

U.S. state and political subdivision bonds

    160.7        16.9        —          177.6  

Foreign government bonds

    61.5        10.3        —          71.8  

Corporate bonds

    5,755.0        533.5        (6.9     6,281.6  

S&P 500 Index options

    12.4        —           —          12.4  
 

 

 

    

 

 

    

 

 

   

 

 

 

  Total fixed maturity securities

  $              6,359.4      $             624.7      $               (6.9   $          6,977.2  
 

 

 

    

 

 

    

 

 

   

 

 

 

 

    December 31, 2011  
    Amortized
Cost
     Unrealized
Gains
     Unrealized
Losses
    Fair
Value
 
    (In millions)  

U.S. government and agency bonds

  $ 387.8      $ 64.3      $ —        $ 452.1  

U.S. state and political subdivision bonds

    164.8        14.0        —          178.8  

Foreign government bonds

    61.7        10.4        —          72.1  

Corporate bonds

    5,588.4        491.8        (20.9     6,059.3  

S&P 500 Index options

    7.2        —           —          7.2  
 

 

 

    

 

 

    

 

 

   

 

 

 

  Total fixed maturity securities

  $             6,209.9      $             580.5      $             (20.9   $         6,769.5  
 

 

 

    

 

 

    

 

 

   

 

 

 

The following table sets forth the amortized costs and fair values of the Company’s fixed maturity securities by contractual maturity:

 

    June 30, 2012      December 31, 2011  
    Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
 
    (In millions)  

Due in one year or less

  $ 746.6      $ 761.0      $ 632.7      $ 645.0  

Due after one year through five years

    2,687.4        2,874.9        2,534.6        2,693.6  

Due after five years through ten years

    2,068.4        2,301.9        2,173.9        2,392.5  

Due after ten years

    857.0        1,039.4        868.7        1,038.4  
 

 

 

    

 

 

    

 

 

    

 

 

 

  Total fixed maturity securities

  $              6,359.4      $          6,977.2      $          6,209.9      $          6,769.5  
 

 

 

    

 

 

    

 

 

    

 

 

 

Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations. Callable bonds without make-whole provisions represented 7.6%, or $533.7 million, of the Company’s fixed maturity securities portfolio at June 30, 2012. At June 30, 2012, the Company did not have any direct exposure to sub-prime or Alt-A mortgages in its fixed maturity securities portfolio. At June 30, 2012, the Company’s foreign government bonds category did not have any direct exposure to euro zone government issued debt. At June 30, 2012, fixed maturity securities issued by investment and commercial banks headquartered in the euro zone represented 0.7%, or $49.9 million, of the Company’s fixed maturity security portfolio. The Company did not hold any fixed maturity securities issued by investment and commercial banks headquartered in Portugal, Ireland, Italy, Greece or Spain at June 30, 2012. There were no impairments on fixed maturity securities related to euro zone exposure during the first six months of 2012.

 

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Table of Contents

Gross Unrealized Losses

The following tables set forth the gross unrealized losses and fair value of investments, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position:

 

                                                                  June 30, 2012                                                               
    Total     Less than 12 months     12 or more months  
    Number     Amount     Number     Amount     Number     Amount  
    (Dollars in millions)  

Unrealized losses:

           

Corporate bonds

    201     $ 6.9       182     $ 4.2       19     $ 2.7  

Fair market value of securities with unrealized losses:

           

Corporate bonds

    201     $ 227.9       182     $ 197.9       19     $ 30.0  
                                                             December 31,  2011                                                               
    Total     Less than 12 months     12 or more months  
    Number     Amount     Number     Amount     Number     Amount  
    (Dollars in millions)  

Unrealized losses:

           

Corporate bonds

    360     $ 20.9       334     $ 17.4       26     $ 3.5  

Fair market value of securities with unrealized losses:

           

Corporate bonds

    360     $ 425.3       334     $ 398.0       26     $ 27.3  

The unrealized losses on the investment securities set forth above were primarily due to increases in market interest rates subsequent to their purchase by the Company. Additionally, unrealized losses have been affected by overall economic factors. The Company expects the fair value of these investment securities to recover as the investment securities approach their maturity dates or sooner if market yields for such investment securities decline. The Company does not believe that any of the investment securities are impaired due to credit quality or due to any company or industry specific event. Based on management’s evaluation of the securities and the Company’s intent to hold the securities, and as it is unlikely that the Company will be required to sell the securities, none of the unrealized losses summarized in this table are considered other-than-temporary.

Commercial Mortgage Loans

The Company underwrites mortgage loans on commercial property throughout the United States. In addition to real estate collateral, the Company requires either partial or full recourse on most loans. At June 30, 2012, the Company did not have any direct exposure to sub-prime or Alt-A mortgages in its commercial mortgage loan portfolio.

 

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Table of Contents

The following table sets forth the commercial mortgage loan portfolio by property type, by geographic region within the U.S. and by U.S. state:

 

    June 30, 2012     December 31, 2011  
            Amount                      Percent                     Amount                      Percent          
    (Dollars in millions)  

Property type:

         

Retail

  $ 2,518.9        49.4  %    $ 2,457.8        50.1  % 

Industrial

    952.9        18.7       900.4        18.4  

Office

    918.5        18.0       911.1        18.6  

Hotel/motel

    282.0        5.5       241.9        4.9  

Commercial

    197.6        3.9       187.1        3.8  

Apartment and other

    228.8        4.5       204.0        4.2  
 

 

 

    

 

 

   

 

 

    

 

 

 

Total commercial mortgage loans

  $ 5,098.7        100.0  %    $ 4,902.3        100.0  % 
 

 

 

    

 

 

   

 

 

    

 

 

 

Geographic region*:

         

Pacific

  $ 1,792.1        35.2  %    $ 1,699.3        34.7  % 

South Atlantic

    999.0        19.6       953.8        19.5  

West South Central

    637.7        12.5       605.3        12.3  

Mountain

    596.6        11.7       585.8        11.9  

East North Central

    412.4        8.1       393.4        8.0  

Middle Atlantic

    245.9        4.8       243.8        5.0  

West North Central

    190.0        3.7       184.8        3.8  

East South Central

    128.8        2.5       129.9        2.6  

New England

    96.2        1.9       106.2        2.2  
 

 

 

    

 

 

   

 

 

    

 

 

 

Total commercial mortgage loans

  $ 5,098.7        100.0  %    $ 4,902.3        100.0  % 
 

 

 

    

 

 

   

 

 

    

 

 

 

U.S. state:

         

California

  $ 1,402.6        27.5  %    $ 1,332.0        27.2  % 

Texas

    580.4        11.4       550.8        11.2  

Florida

    311.8        6.1       305.3        6.2  

Georgia

    285.1        5.6       270.1        5.5  

Other states

    2,518.8        49.4       2,444.1        49.9  
 

 

 

    

 

 

   

 

 

    

 

 

 

Total commercial mortgage loans

  $ 5,098.7        100.0  %    $ 4,902.3        100.0  % 
 

 

 

    

 

 

   

 

 

    

 

 

 

 

  *

Geographic regions obtained from the American Council of Life Insurers Mortgage Loan Portfolio Profile.

Through its concentration of commercial mortgage loans in California, the Company is exposed to potential losses from an economic downturn in California as well as certain catastrophes, such as earthquakes and fires that may affect certain areas of the western region. Borrowers are required to maintain fire insurance coverage to provide reimbursement for any losses due to fire. Management diversifies the commercial mortgage loan portfolio within California by both location and type of property in an effort to reduce certain catastrophe and economic exposure. However, diversification may not always eliminate the risk of such losses. Historically, the delinquency rate of the California-based commercial mortgage loans has been substantially below the industry average and consistent with the Company’s experience in other states. The Company does not require earthquake insurance for the properties when it underwrites new loans. However, management does consider the potential for earthquake loss based upon seismic surveys and structural information specific to each property. The Company does not expect a catastrophe or earthquake damage in the western region to have a material adverse effect on its business, financial position, results of operations or cash flows. Currently, the Company’s California exposure is primarily in Los Angeles County, Orange County, San Diego County and the Bay Area Counties. There is a smaller concentration of commercial mortgage loans in the Inland Empire and the San Joaquin Valley where there has been greater economic decline. Due to the concentration of commercial mortgage loans in California, a continued economic decline in California could have a material adverse effect on the Company’s business, financial position, results of operations or cash flows.

The carrying value of commercial mortgage loans represents the outstanding principal balance less a loan loss allowance for probable uncollectible amounts. The commercial mortgage loan loss allowance is estimated based on evaluating known and inherent risks in the loan portfolio and consists of a general and a specific loan loss allowance.

 

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Table of Contents

Impairment Evaluation

The Company continuously monitors its commercial mortgage loan portfolio for potential nonperformance by evaluating the portfolio and individual loans. Key factors that are monitored are as follows:

 

Loan loss experience.

 

Delinquency history.

 

Debt coverage ratio.

 

Loan to value ratio.

 

Refinancing and restructuring history.

 

Request for forbearance history.

If the analysis above indicates a loan might be impaired, it is further analyzed for impairment through the consideration of the following additional factors:

 

Delinquency status.

 

Foreclosure status.

 

Restructuring status.

 

Borrower history.

If it is determined a loan is impaired, a specific allowance is recorded, if necessary.

General Loan Loss Allowance

The general loan loss allowance is based on the Company’s analysis of factors including changes in the size and composition of the loan portfolio, debt coverage ratios, loan to value ratios, actual loan loss experience and individual loan analysis.

Specific Loan Loss Allowance

An impaired commercial mortgage loan is a loan that is not performing to the contractual terms of the loan agreement. A specific allowance for losses is recorded when a loan is considered to be impaired and it is probable that all amounts due will not be collected. The Company also holds specific loan loss allowances on certain performing commercial mortgage loans that it continues to monitor and evaluate. Impaired commercial mortgage loans without specific allowances for losses are those for which the Company has determined that it remains probable that all amounts due will be collected although the timing or nature may be outside the original contractual terms. In addition, for impaired commercial mortgage loans, the Company evaluates the cost to dispose of the underlying collateral, any significant out of pocket expenses the loan may incur and other quantitative information management has concerning the loan. Portions of loans that are deemed uncollectible are written off against the allowance, and recoveries, if any, are credited to the allowance.

The following table sets forth changes in the commercial mortgage loan loss allowance:

 

                 Three Months Ended                              Six Months Ended               
     June 30,     June 30,  
             2012                     2011                     2012                     2011          
     (In millions)  

Commercial mortgage loan loss allowance:

        

Beginning balance

   $ 45.6     $ 39.4     $ 48.1     $ 36.1  

Provision

     5.1       9.3       6.4       18.0  

Charge-offs, net

     (5.1     (5.2     (8.9     (10.6
  

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 45.6     $ 43.5     $ 45.6     $ 43.5  
  

 

 

   

 

 

   

 

 

   

 

 

 

Specific loan loss allowance

   $ 24.6     $ 26.5     $ 24.6     $ 26.5  

General loan loss allowance

     21.0       17.0       21.0       17.0  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial mortgage loan loss allowance

   $ 45.6     $ 43.5     $ 45.6     $ 43.5  
  

 

 

   

 

 

   

 

 

   

 

 

 

The larger commercial mortgage loan loss allowance as of June 30, 2012 compared to June 30, 2011 was primarily due to the net increase in the general reserve during the second quarter and first six months of 2012. The lower provision and charge-offs for the second quarter and first six months of 2012 compared to the same periods of 2011 were primarily related to lower losses associated with foreclosures, accepted deeds in lieu of foreclosure on commercial mortgage loans and other related charges associated with commercial mortgage loans leaving the portfolio during the second quarter and first six months of 2012.

 

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Table of Contents

The following table sets forth the recorded investment in commercial mortgage loans:

 

      June 30, 2012           December 31, 2011    
    (In millions)  

Commercial mortgage loans collectively evaluated for impairment

  $                 5,044.9     $                 4,845.7  

Commercial mortgage loans individually evaluated for impairment

    99.4       104.7  

Commercial mortgage loan loss allowance

    (45.6     (48.1
 

 

 

   

 

 

 

Total commercial mortgage loans

  $ 5,098.7     $ 4,902.3  
 

 

 

   

 

 

 

The Company assesses the credit quality of its commercial mortgage loan portfolio quarterly by reviewing the performance of its portfolio which includes evaluating its performing and nonperforming commercial mortgage loans. Nonperforming commercial mortgage loans include all commercial mortgage loans that are 60 days or more past due and commercial mortgage loans that are not 60 days past due but are not substantially performing to other original contractual terms.

The following tables set forth performing and nonperforming commercial mortgage loans by property type:

 

    June 30, 2012  
    Retail      Office        Industrial        Hotel/
Motel
       Commercial        Apartment
 and Other 
     Total  
    (In millions)  

Performing commercial mortgage loans

  $   2,512.4      $   915.5      $     952.2      $   282.0      $ 196.8      $ 228.8      $   5,087.7  

Nonperforming commercial mortgage loans

    6.5        3.0        0.7        —           0.8        —           11.0  
 

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial mortgage loans

  $ 2,518.9      $ 918.5      $ 952.9      $ 282.0      $ 197.6      $ 228.8      $ 5,098.7  
 

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

    December 31, 2011  
    Retail      Office        Industrial        Hotel/
Motel
       Commercial        Apartment
 and Other 
     Total  
    (In millions)  

Performing commercial mortgage loans

  $   2,442.3      $   898.4      $     895.2      $   241.9      $ 182.0      $ 201.3      $   4,861.1  

Nonperforming commercial mortgage loans

    15.5        12.7        5.2        —           5.1        2.7        41.2  
 

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial mortgage loans

  $ 2,457.8      $ 911.1      $ 900.4      $ 241.9      $ 187.1      $ 204.0      $ 4,902.3  
 

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

The following tables set forth impaired commercial mortgage loans identified in management’s specific review of probable loan losses and the related allowance:

 

     June 30, 2012  
     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
     Amount on
Nonaccrual
Status
 
     (In millions)  

Impaired commercial mortgage loans:

           

Without specific loan loss allowances:

           

Retail

   $ 9.6      $ 9.6      $ —         $ 1.8  

Office

     4.1        4.1        —           3.0  

Industrial

     3.4        3.4        —           —     

Hotel/motel

     5.9        5.9        —           —     

Apartment and other

     1.9        1.9        —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total impaired commercial mortgage loans without specific loan loss allowances

     24.9        24.9        —           4.8  
  

 

 

    

 

 

    

 

 

    

 

 

 

With specific loan loss allowances:

           

Retail

     39.0        39.0        12.9        10.5  

Office

     14.7        14.7        3.9        4.4  

Industrial

     9.6        9.6        2.7        1.7  

Commercial

     8.1        8.1        4.9        3.2  

Apartment and other

     3.1        3.1        0.2        —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total impaired commercial mortgage loans with specific loan loss allowances

     74.5        74.5        24.6        19.8  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total impaired commercial mortgage loans

   $        99.4      $        99.4      $        24.6      $        24.6