XNYS:SYA Symetra Financial Corp Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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Form 10-Q
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 March 31, 2012

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 001-33808

 

 

SYMETRA FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   20-0978027

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

777 108th Avenue NE, Suite 1200

Bellevue, Washington 98004

(Address of principal executive offices, including zip code)

(425) 256-8000

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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. (Check one):

 

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

As of April 30, 2012, the Registrant had 119,095,351 common voting shares outstanding, with a par value of $0.01 per share.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

          Page  
   PART I – FINANCIAL INFORMATION   

Item 1:

   Condensed Financial Statements:   
       Consolidated Balance Sheets      5   
       Consolidated Statements of Income      6   
       Consolidated Statements of Comprehensive Income      7   
       Consolidated Statements of Changes in Stockholders’ Equity      8   
       Consolidated Statements of Cash Flows      9   
       Condensed Notes to Consolidated Financial Statements      10   

Item 2:

   Management’s Discussion and Analysis of Financial Condition and Results of Operations      28   

Item 3:

   Quantitative and Qualitative Disclosures about Market Risk      61   

Item 4:

   Controls and Procedures      61   
   PART II – OTHER INFORMATION   

Item 1:

   Legal Proceedings      62   

Item 1A:

   Risk Factors      62   

Item 6:

   Exhibits      62   

Signatures

        63   

 

2


Table of Contents

Unless the context otherwise requires, references in this quarterly report on Form 10-Q to “we,” “our,” “us” and “the Company” are to Symetra Financial Corporation together with its subsidiaries. References to “Symetra” refer to Symetra Financial Corporation on a stand-alone, non-consolidated basis.

Forward-Looking Statements

This Quarterly Report on Form 10-Q, including Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains statements which constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements, other than statements of current or historical facts included or referenced in this report, that address activities, events or developments that we expect or anticipate will or may occur in the future are forward-looking statements. The words “will,” “believe,” “intend,” “plan,” “expect,” “anticipate,” “project,” “estimate,” “predict,” “potential” and similar expressions also are intended to identify forward-looking statements. These forward-looking statements include, among others, statements with respect to the Company’s:

 

   

estimates or projections of revenues, net income (loss), net income (loss) per share, adjusted operating income (loss), adjusted operating income (loss) per share, market share or other financial forecasts;

 

   

trends in operations, financial performance and financial condition;

 

   

financial and operating targets or plans; and

 

   

business and growth strategy, including prospective products, services and distribution partners.

These statements are based on certain assumptions and analyses made by the Company in light of its experience and perception of historical trends, current conditions and expected future developments, as well as other factors believed to be appropriate under the circumstances. Whether actual results and developments will conform to the Company’s expectations and predictions is subject to a number of risks, uncertainties and contingencies that could cause actual results to differ materially from expectations, including, among others:

 

   

the effects of dramatic fluctuations in interest rates or a prolonged low interest rate environment;

 

   

general economic, market or business conditions, including further economic downturns or other adverse conditions in the global and domestic capital and credit markets;

 

   

the effects of changes in monetary policy, government programs to stimulate mortgage refinancing and significant increases in corporate refinance activity;

 

   

investment losses;

 

   

our ability to successfully execute on our Grow & Diversify strategy;

 

   

recorded reserves for future policy benefits and claims subsequently proving to be inadequate or inaccurate;

 

   

deviations from assumptions used in setting prices for insurance and annuity products, or establishing cash flow testing reserves;

 

   

continued viability of certain products under various economic and other conditions;

 

   

market pricing and competitive trends related to insurance products and services;

 

   

changes in amortization of deferred policy acquisition costs or deferred sales inducements;

 

   

financial strength or credit ratings downgrades;

 

   

the availability and cost of capital and financing;

 

   

the continued availability and cost of reinsurance coverage;

 

   

changes in laws or regulations, or their interpretation, including those that could increase the Company’s business costs and required capital levels;

 

   

the ability of subsidiaries to pay dividends to Symetra;

 

   

the effects of implementation of the Patient Protection and Affordable Care Act (“PPACA”);

 

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Table of Contents
   

the effects of implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd Frank Act”); and

 

   

the risks that are described in Part II, Item 1A — “Risk Factors” in this report; and Part I, Item 1A — “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2011.

Consequently, all of the forward-looking statements made in this report are qualified by these cautionary statements, and there can be no assurance that the actual results or developments anticipated by us will be realized or, even if substantially realized, that they will have the expected consequences to, or effects on, the Company or its business or operations. We assume no obligation to update publicly any such forward-looking statements, whether as a result of new information, future events or otherwise.

 

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Table of Contents

PART I – Financial Information

 

Item 1. Condensed Financial Statements

CONSOLIDATED BALANCE SHEETS

(In millions, except share and per share data)

 

     As of
March 31, 2012
     As of
December 31, 2011
 
     (Unaudited)      (As adjusted)  
ASSETS      

Investments:

     

Available-for-sale securities:

     

Fixed maturities, at fair value (amortized cost: $21,115.7 and $21,061.4, respectively)

   $ 22,944.8      $ 22,905.2  

Marketable equity securities, at fair value (cost: $52.4 and $52.4, respectively)

     48.6        50.3  

Trading securities:

     

Marketable equity securities, at fair value (cost: $373.4 and $365.4, respectively)

     406.0        381.7  

Mortgage loans, net

     2,671.1        2,517.6  

Policy loans

     70.0        69.0  

Investments in limited partnerships (includes $24.3 and $27.8 measured at fair value, respectively)

     245.7        226.9  

Other invested assets

     28.8        21.0  
  

 

 

    

 

 

 

Total investments

     26,415.0        26,171.7  

Cash and cash equivalents

     279.2        242.3  

Accrued investment income

     273.0        269.4  

Reinsurance recoverables

     294.4        295.6  

Deferred policy acquisition costs

     182.1        186.0  

Receivables and other assets

     248.0        222.5  

Separate account assets

     853.0        795.8  
  

 

 

    

 

 

 

Total assets

   $ 28,544.7      $ 28,183.3  
  

 

 

    

 

 

 
LIABILITIES AND STOCKHOLDERS’ EQUITY      

Funds held under deposit contracts

   $ 22,700.6      $ 22,449.5  

Future policy benefits

     390.9        391.2  

Policy and contract claims

     148.0        170.9  

Other policyholders’ funds

     143.2        129.0  

Notes payable

     449.2        449.2  

Deferred income tax liabilities, net

     412.6        395.0  

Other liabilities

     292.5        287.8  

Separate account liabilities

     853.0        795.8  
  

 

 

    

 

 

 

Total liabilities

     25,390.0        25,068.4  

Commitments and contingencies (Note 10)

     

Preferred stock, $0.01 par value; 10,000,000 shares authorized; none issued

     —           —     

Common stock, $0.01 par value; 750,000,000 shares authorized; 119,073,750 issued and outstanding as of March 31, 2012; 118,637,379 issued and outstanding as of December 31, 2011

     1.2        1.2  

Additional paid-in capital

     1,455.9        1,454.6  

Retained earnings

     697.5        631.8  

Accumulated other comprehensive income, net of taxes

     1,000.1        1,027.3  
  

 

 

    

 

 

 

Total stockholders’ equity

     3,154.7        3,114.9  
  

 

 

    

 

 

 

Total liabilities and stockholders’ equity

   $ 28,544.7      $ 28,183.3  
  

 

 

    

 

 

 

See accompanying notes.

 

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Table of Contents

CONSOLIDATED STATEMENTS OF INCOME

(In millions, except per share data)

(Unaudited)

 

     For the Three Months Ended
March 31,
 
     2012     2011  
           (As adjusted)  

Revenues:

    

Premiums

   $ 150.3     $ 120.9  

Net investment income

     320.5       310.0  

Policy fees, contract charges, and other

     46.3       44.7  

Net realized investment gains:

    

Total other-than-temporary impairment losses on securities

     (3.6     (0.9

Less: portion of losses recognized in other comprehensive income

     1.1       —     
  

 

 

   

 

 

 

Net impairment losses recognized in earnings

     (2.5     (0.9

Other net realized investment gains

     28.4       16.5  
  

 

 

   

 

 

 

Total net realized investment gains

     25.9       15.6  
  

 

 

   

 

 

 

Total revenues

     543.0       491.2  

Benefits and expenses:

    

Policyholder benefits and claims

     105.2       92.3  

Interest credited

     229.5       228.3  

Other underwriting and operating expenses

     83.0       71.9  

Interest expense

     8.2       8.0  

Amortization of deferred policy acquisition costs

     15.8       16.3  
  

 

 

   

 

 

 

Total benefits and expenses

     441.7       416.8  

Income from operations before income taxes

     101.3       74.4  

Provision for income taxes:

    

Current

     (6.3     11.2  

Deferred

     32.2       9.7  
  

 

 

   

 

 

 

Total provision for income taxes

     25.9       20.9  
  

 

 

   

 

 

 

Net income

   $ 75.4     $ 53.5  
  

 

 

   

 

 

 

Net income per common share:

    

Basic

   $ 0.55     $ 0.39  

Diluted

   $ 0.55     $ 0.39  

Weighted-average number of common shares outstanding:

    

Basic

     137.776       137.292  

Diluted

     137.781       137.300  

Cash dividends declared per common share

   $ 0.07     $ 0.05  

See accompanying notes.

 

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Table of Contents

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In millions)

(Unaudited)

 

     For the Three Months Ended
March 31,
 
     2012     2011  
           (As adjusted)  

Net income

   $ 75.4     $ 53.5  

Other comprehensive income (loss), net of taxes:

    

Changes in unrealized gains and losses on available-for-sale securities, net of reclassification adjustments (net of taxes of $(6.6) and $3.0)

     (11.9     5.7  

Other-than-temporary impairments on debt securities not related to credit losses (net of taxes of $(0.4) and $0)

     (0.7     —     

Impact of net unrealized investment (gains) losses on deferred policy acquisition costs and deferred sales inducements (net of taxes of $(7.5) and $0.2)

     (14.0     0.4  

Impact of cash flow hedges (net of taxes of $(0.3) and $0)

     (0.6     —     
  

 

 

   

 

 

 

Other comprehensive income (loss)

     (27.2     6.1  
  

 

 

   

 

 

 

Total comprehensive income

   $ 48.2     $ 59.6  
  

 

 

   

 

 

 

See accompanying notes.

 

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Table of Contents

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(In millions)

(Unaudited)

 

     Common
Stock
     Additional
Paid-in
Capital
     Retained
Earnings
    Accumulated
Other
Comprehensive
Income
    Total
Stockholders’
Equity
 

Balances as of January 1, 2011

   $ 1.2      $ 1,450.2      $ 496.7     $ 432.5     $ 2,380.6  

Cumulative effect of adoption—new accounting standard (net of taxes of $(12.9))

     —           —           (29.1     5.1       (24.0

Comprehensive income:

            

Net income, as adjusted

     —           —           53.5       —          53.5  

Other comprehensive income, as adjusted

     —           —           —          6.1       6.1  
            

 

 

 

Total comprehensive income, as adjusted

               59.6  

Stock-based compensation

     —           0.9        —          —          0.9  

Dividends declared

     —           —           (6.9     —          (6.9
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balances as of March 31, 2011, as adjusted

   $ 1.2      $ 1,451.1      $ 514.2     $ 443.7     $ 2,410.2  
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balances as of January 1, 2012, as adjusted

   $ 1.2      $ 1,454.6      $ 631.8     $ 1,027.3     $ 3,114.9  

Comprehensive income:

            

Net income

     —           —           75.4       —          75.4  

Other comprehensive loss

     —           —           —          (27.2     (27.2
            

 

 

 

Total comprehensive income

               48.2  

Stock-based compensation

     —           1.3        —          —          1.3  

Dividends declared

     —           —           (9.7     —          (9.7
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balances as of March 31, 2012

   $ 1.2      $ 1,455.9      $ 697.5     $ 1,000.1     $ 3,154.7  
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

See accompanying notes.

 

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Table of Contents

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In millions)

(Unaudited)

     For the Three Months Ended
March 31,
 
     2012     2011  
           (As adjusted)  

Cash flows from operating activities

    

Net income

   $ 75.4     $ 53.5  

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

    

Net realized investment gains

     (25.9     (15.6

Accretion and amortization of invested assets, net

     10.7       9.8  

Accrued interest on fixed maturities

     (4.7     (7.8

Amortization and depreciation

     6.9       6.0  

Deferred income tax provision

     32.2       9.7  

Interest credited on deposit contracts

     229.5       228.3  

Mortality and expense charges and administrative fees

     (28.5     (26.7

Changes in:

    

Accrued investment income

     (3.6     (9.7

Deferred policy acquisition costs, net

     (3.9     (14.1

Future policy benefits

     (0.3     0.9  

Policy and contract claims

     (22.9     (8.4

Other assets and liabilities

     (27.2     (12.7

Other, net

     0.9       1.0  
  

 

 

   

 

 

 

Total adjustments

     163.2       160.7  
  

 

 

   

 

 

 

Net cash provided by operating activities

     238.6       214.2  

Cash flows from investing activities

    

Purchases of:

    

Fixed maturities and marketable equity securities

     (850.6     (1,089.7

Other invested assets and investments in limited partnerships

     (39.5     (5.4

Issuances of mortgage loans

     (197.6     (183.5

Maturities, calls, paydowns, and other

     433.4       559.4  

Sales of:

    

Fixed maturities and marketable equity securities

     378.3       125.0  

Other invested assets and investments in limited partnerships

     4.1       4.1  

Repayments of mortgage loans

     36.9       32.9  

Other, net

     (1.2     (1.1
  

 

 

   

 

 

 

Net cash used in investing activities

     (236.2     (558.3

Cash flows from financing activities

    

Policyholder account balances:

    

Deposits

     502.8       722.8  

Withdrawals

     (438.4     (332.4

Cash dividends paid on common stock

     (9.7     (6.9

Other, net

     (20.2     (6.1
  

 

 

   

 

 

 

Net cash provided by financing activities

     34.5       377.4  
  

 

 

   

 

 

 

Net increase in cash and cash equivalents

     36.9       33.3  

Cash and cash equivalents at beginning of period

     242.3       274.6  
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 279.2     $ 307.9  
  

 

 

   

 

 

 

Supplemental disclosures of cash flow information

    

Non-cash transactions during the period:

    

Investments in limited partnerships and capital obligations incurred

   $ 2.3     $ 13.4  

Fixed maturities exchanges

     46.2       18.8  

See accompanying notes.

 

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Table of Contents

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(All amounts in millions, except per share data, unless otherwise stated)

(Unaudited)

1. Description of Business

Symetra Financial Corporation is a Delaware corporation that, through its subsidiaries, offers products and services that include retirement, group health and employee benefits products and life insurance, marketed through benefits consultants, financial institutions and independent agents and advisors in all states and the District of Columbia. The Company’s principal products include medical stop-loss insurance, fixed and variable deferred annuities, single premium immediate annuities, individual life insurance and bank-owned life insurance.

2. Summary of Significant Accounting Policies

Basis of Presentation and Use of Estimates

The accompanying interim condensed financial statements include, on a consolidated basis, the accounts of Symetra Financial Corporation and its subsidiaries, which are wholly-owned and are collectively referred to as “the Company”. All significant intercompany transactions and balances have been eliminated.

The interim condensed consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles (GAAP), including the rules and regulations of the Securities and Exchange Commission (SEC), for interim reporting. The preparation of financial statements in conformity with GAAP requires the Company to make estimates and assumptions that may affect the amounts reported in the interim condensed consolidated financial statements and accompanying notes. These interim condensed consolidated financial statements are unaudited but in management’s opinion include all adjustments, consisting of normal recurring adjustments and accruals, necessary for a fair presentation. Certain reclassifications have been made to prior year financial information for it to conform to the current period presentation. In addition, prior period financial information, including information for the three months ended March 31, 2011 and as of March 31, 2011 and December 31, 2011 has been restated to reflect the retrospective adoption of the new accounting standard for deferred policy acquisition costs (DAC). Restated information has been labeled “as adjusted” where applicable.

These interim condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, filed with the SEC. Operating results for the three months ended March 31, 2012 are not necessarily indicative of the results that may be expected for the twelve months ended December 31, 2012.

Adoption of New Accounting Pronouncements

ASU 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts

In October 2010, the FASB issued Accounting Standards Update (ASU) 2010-26, Financial Services—Insurance (Topic 944)—Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts. This ASU limits the amount of deferrable acquisition costs to those incremental costs directly related to the successful acquisition of an insurance contract and clarifies which costs are included in that definition. The Company’s adoption of this standard results in more distribution and new business processing and underwriting costs being expensed as incurred.

Under the new standard, the Company defers costs that are directly related to the successful acquisition or renewal of insurance contracts. These costs include commissions, premium taxes and premium based assessments, the portion of wholesaler distribution costs directly related to contract acquisition, third-party underwriting costs related to contracts that are successfully acquired, and a portion of the salaries and benefits related to employee time spent on the processing of successfully acquired contracts. While the Company has restated DAC amortization to reflect the retrospective reduction in costs deferred, its policies and methodology for amortization have not changed.

 

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CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(All amounts in millions, except per share data, unless otherwise stated)

(Unaudited)

 

The Company retrospectively adopted this standard on January 1, 2012. The Company believes retrospective adoption provides users the most useful financial information because it is comparable between financial periods. The Company has restated its financial information as of December 31, 2011 and for the three months ended March 31, 2011 in these condensed financial statements, as shown below:

 

     As  Previously
Reported
    Adjustment     As Adjusted  
     As of December 31, 2011  

Consolidated Balance Sheets

      

Deferred policy acquisition costs

   $ 215.4     $ (29.4   $ 186.0  

Deferred income tax liabilities, net

     405.3       (10.3     395.0  

Retained earnings

     664.7       (32.9     631.8  

Accumulated other comprehensive income, net of taxes

     1,013.5       13.8       1,027.3  
     For the Three Months Ended  
     March 31, 2011  

Consolidated Statements of Income

      

Other underwriting and operating expenses

   $ 66.0     $ 5.9     $ 71.9  

Amortization of deferred policy acquisition costs

     20.1       (3.8     16.3  

Deferred income tax provision

     10.4       (0.7     9.7  

Net income

     54.9       (1.4     53.5  

Net income per common share:

      

Basic

   $ 0.40     $ (0.01   $ 0.39  

Diluted

   $ 0.40     $ (0.01   $ 0.39  

Consolidated Statements of Comprehensive Income

      

Impact of net unrealized investment (gains) losses on deferred policy acquisition costs and deferred sales inducements, net of taxes

   $ (4.2   $ 4.6     $ 0.4  

Consolidated Statements of Cash Flows

      

Deferred income tax provision

   $ 10.4       (0.7   $ 9.7  

Changes in deferred policy acquisition costs, net

     (16.2   $ 2.1       (14.1

ASU 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure

In May 2011, the FASB issued ASU 2011-04, Fair Value Measurements (Topic 820) – Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in US GAAP and IFRSs. This ASU establishes common definitions of fair value and requirements for measurement and disclosure between U.S. GAAP and International Financial Reporting Standards (IFRS). The measurement principles are generally consistent with current U.S. GAAP and the changes did not have a material impact on our condensed financial statements. Enhanced disclosures include quantitative information about unobservable inputs to Level 3 measurements, when available; qualitative information about the sensitivity of Level 3 measurements to alternative inputs; and classification within the fair value hierarchy of all fair value measurements disclosed. The Company adopted this standard on January 1, 2012. See Note 6 for the Company’s disclosures related to fair value measurements. The Company did not have material Level 3 measurements as of March 31, 2012.

ASU 2011-05, Presentation of Comprehensive Income and ASU 2011-12 Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05

In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220) – Presentation of Comprehensive Income. This ASU requires the components of net income and other comprehensive income (OCI) to be presented either in one continuous statement, referred to as the statement of comprehensive income, or in two separate but consecutive statements. While the new standard changes the presentation of comprehensive income, there are no changes to the components that are recognized in net income or OCI under current accounting standards.

 

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CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(All amounts in millions, except per share data, unless otherwise stated)

(Unaudited)

 

In December 2011, the FASB issued ASU 2011-12, Comprehensive Income (Topic 220) – Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. This ASU indefinitely defers the requirement to present reclassification adjustments out of accumulated other comprehensive income (AOCI) by component in both the statement in which net income is presented and the statement in which OCI is presented.

The Company adopted the standards on January 1, 2012 and included the statements of comprehensive income as a separate statement in the condensed consolidated financial statements.

3. Earnings Per Share

Basic earnings per share represents the amount of earnings for the period available to each share of common stock outstanding during the reporting period. Diluted earnings per share represents the earnings available to each share of common stock outstanding during the reporting period, adjusted for the potential issuance of dilutive common stock.

The Company’s outstanding warrants, exercisable for 18.976 common shares, are considered participating securities because the terms of the agreements entitle the holders to receive any dividends declared on the common stock concurrently with the holders of outstanding shares of common stock, on a one-to-one basis. As a result, the warrants are potential common stock securities that are included in weighted-average common shares outstanding for purposes of computing basic and diluted earnings per share using the two-class method.

The Company has issued equity instruments to employees that are included in the computation of earnings per share, including restricted stock, stock options and shares issued under the employee stock purchase plan. The restricted shares are considered participating securities because the holders are entitled to receive any dividends declared on the common stock concurrently with the holders of outstanding shares of common stock, on a one-to-one basis. Participating restricted stock is included in basic and diluted earnings per share based on the application of the two-class method. Estimated shares to be issued under the employee stock purchase plan were included in diluted earnings per share based on the application of the treasury stock method. For the three months ended March 31, 2012 and 2011, 2.950 stock options were excluded from the computation of diluted earnings per share, based on the application of the treasury stock method, because they were antidilutive.

The following table presents information relating to the Company’s calculations of basic and diluted earnings per share:

 

     For the Three Months Ended  
     March 31,  
     2012      2011  
            (As adjusted)  

Numerator:

     

Net income

   $ 75.4      $ 53.5  
  

 

 

    

 

 

 

Denominator:

     

Weighted-average common shares outstanding—basic

     137.776        137.292  

Add: dilutive effect of certain equity instruments

     0.005        0.008  
  

 

 

    

 

 

 

Weighted-average common shares outstanding—diluted

     137.781        137.300  
  

 

 

    

 

 

 

Net income per common share:

     

Basic

   $ 0.55      $ 0.39  

Diluted

   $ 0.55      $ 0.39  

 

12


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CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(All amounts in millions, except per share data, unless otherwise stated)

(Unaudited)

 

4. Investments

The following tables summarize the Company’s available-for-sale fixed maturities and marketable equity securities. The other-than-temporary impairments (OTTI) in AOCI represent the amount of cumulative non-credit OTTI losses recorded in AOCI for securities that also had a credit-related impairment.

 

     Cost or
Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair Value      OTTI in
AOCI
 

As of March 31, 2012

             

Fixed maturities:

             

U.S. government and agencies

   $ 109.7      $ 2.9      $ (0.1   $ 112.5      $ (0.1

State and political subdivisions

     600.3        33.7        (2.3     631.7        (0.1

Corporate securities

     15,048.1        1,497.8        (131.1     16,414.8        (16.0

Residential mortgage-backed securities

     3,222.3        243.2        (11.4     3,454.1        (26.3

Commercial mortgage-backed securities

     1,678.5        150.3        (3.4     1,825.4        (2.2

Other debt obligations

     456.8        50.4        (0.9     506.3        (3.9
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Total fixed maturities

     21,115.7        1,978.3        (149.2     22,944.8        (48.6

Marketable equity securities, available-for-sale

     52.4        0.2        (4.0     48.6        —     
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 21,168.1      $ 1,978.5      $ (153.2   $ 22,993.4      $ (48.6
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

 

     Cost or
Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair Value      OTTI in
AOCI
 

As of December 31, 2011

             

Fixed maturities:

             

U.S. government and agencies

   $ 60.3      $ 3.8      $ —        $ 64.1      $ (0.1

State and political subdivisions

     609.1        28.0        (1.8     635.3        (0.1

Corporate securities

     14,817.1        1,572.2        (185.0     16,204.3        (16.5

Residential mortgage-backed securities

     3,388.4        254.2        (17.6     3,625.0        (33.9

Commercial mortgage-backed securities

     1,698.1        143.0        (4.1     1,837.0        (2.6

Other debt obligations

     488.4        52.9        (1.8     539.5        (4.1
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Total fixed maturities

     21,061.4        2,054.1        (210.3     22,905.2        (57.3

Marketable equity securities, available-for-sale

     52.4        0.2        (2.3     50.3        —     
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 21,113.8      $ 2,054.3      $ (212.6   $ 22,955.5      $ (57.3
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

The following tables summarize gross unrealized losses and fair values of the Company’s available-for-sale investments. The tables are aggregated by investment category and present separately those securities that have been in a continuous unrealized loss position for less than twelve months and for twelve months or more.

 

     Less Than 12 Months      12 Months or More  
     Fair
Value
     Gross
Unrealized
Losses
    # of
Securities
     Fair
Value
     Gross
Unrealized

Losses
    # of
Securities
 

As of March 31, 2012

               

Fixed maturities:

               

U.S. government and agencies

   $ 7.7      $ (0.1     2      $ —         $ —          —     

State and political subdivisions

     28.6        (0.2     4        55.3        (2.1     8  

Corporate securities

     811.2        (27.8     158        561.7        (103.3     64  

Residential mortgage-backed securities

     159.0        (2.1     36        140.3        (9.3     22  

Commercial mortgage-backed securities

     110.3        (0.7     9        44.6        (2.7     17  

Other debt obligations

     48.3        (0.7     7        7.3        (0.2     4  
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total fixed maturities

   $ 1,165.1      $ (31.6     216      $ 809.2      $ (117.6     115  

Marketable equity securities, available-for-sale

     42.5        (2.9     2        5.0        (1.1     1  
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 1,207.6      $ (34.5     218      $ 814.2      $ (118.7     116  
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

 

13


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CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(All amounts in millions, except per share data, unless otherwise stated)

(Unaudited)

 

     Less Than 12 Months      12 Months or More  
     Fair
Value
     Gross
Unrealized
Losses
    # of
Securities
     Fair
Value
     Gross
Unrealized
Losses
    # of
Securities
 

As of December 31, 2011

               

Fixed maturities:

               

State and political subdivisions

   $ 18.3      $ (0.2     2      $ 87.9      $ (1.6     11  

Corporate securities

     883.2        (50.9     202        601.9        (134.1     66  

Residential mortgage-backed securities

     72.5        (0.8     27        166.1        (16.8     26  

Commercial mortgage-backed securities

     40.0        (0.7     5        54.6        (3.4     18  

Other debt obligations

     80.4        (1.6     9        14.0        (0.2     4  
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total fixed maturities

   $ 1,094.4      $ (54.2     245      $ 924.5      $ (156.1     125  

Marketable equity securities, available-for-sale

     44.7        (1.2     3        5.0        (1.1     1  
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 1,139.1      $ (55.4     248      $ 929.5      $ (157.2     126  
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Based on National Association of Insurance Commissioners (NAIC) ratings as of March 31, 2012 and December 31, 2011, the Company held below-investment-grade fixed maturities with fair values of $1,465.6 and $1,508.1, respectively, and amortized costs of $1,497.5 and $1,583.7, respectively. These holdings amounted to 6.4% and 6.6% of the Company’s investments in fixed maturities at fair value as of March 31, 2012 and December 31, 2011, respectively.

The following table summarizes the amortized cost and fair value of fixed maturities as of March 31, 2012, by contractual years to maturity. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties.

 

     Amortized      Fair  
     Cost      Value  

One year or less

   $ 518.4      $ 531.2  

Over one year through five years

     3,388.5        3,617.0  

Over five years through ten years

     7,278.8        8,020.8  

Over ten years

     4,611.8        5,037.6  

Residential mortgage-backed securities

     3,222.3        3,454.1  

Commercial mortgage-backed securities

     1,678.5        1,825.4  

Other asset-backed securities

     417.4        458.7  
  

 

 

    

 

 

 

Total fixed maturities

   $ 21,115.7      $ 22,944.8  
  

 

 

    

 

 

 

The following table summarizes the Company’s net investment income:

 

     For the Three Months Ended  
     March 31,  
     2012     2011  

Fixed maturities

   $ 284.3     $ 286.7  

Marketable equity securities, available-for-sale

     0.5       0.6  

Marketable equity securities, trading

     2.7       0.9  

Mortgage loans

     40.9       27.9  

Policy loans

     1.0       1.0  

Investments in limited partnerships

     (4.0     (2.6

Other

     1.8       1.3  
  

 

 

   

 

 

 

Total investment income

     327.2       315.8  

Investment expenses

     (6.7     (5.8
  

 

 

   

 

 

 

Net investment income

   $ 320.5     $ 310.0  
  

 

 

   

 

 

 

 

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CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(All amounts in millions, except per share data, unless otherwise stated)

(Unaudited)

 

The following table summarizes the Company’s net realized investment gains (losses):

 

     For the Three Months Ended  
     March 31,  
     2012     2011  

Fixed maturities:

    

Gross gains on sales

   $ 9.9     $ 2.7  

Gross losses on sales

     (2.1     (6.1

Total other-than-temporary impairment losses on securities

     (2.5     (0.9

Other(1)

     3.6       8.2  
  

 

 

   

 

 

 

Total fixed maturities

     8.9       3.9  

Marketable equity securities, trading(2)

     18.0       12.2  

Other invested assets

     (1.0     0.5  

DAC and deferred sales inducement adjustment

     —          (1.0
  

 

 

   

 

 

 

Net realized investment gains

   $ 25.9     $ 15.6  
  

 

 

   

 

 

 

 

(1) This includes net gains on calls and redemptions and changes in the fair value of the Company’s convertible securities held as of period end totaling $3.3 and $1.8 for the three months ended March 31, 2012 and 2011, respectively.
(2) This includes changes in the fair value of trading securities held as of period end, totaling $17.1 and $11.6 of net gains (losses) for the three months ended March 31, 2012 and 2011, respectively.

Other-Than-Temporary Impairments

The Company’s review of investment securities for OTTI includes both quantitative and qualitative criteria. Quantitative criteria include the length of time and amount that each security is in an unrealized loss position (i.e., is underwater) and for fixed maturities, whether expected future cash flows indicate that a credit loss exists.

While all securities are monitored for impairment, the Company’s experience indicates that securities for which the cost or amortized cost exceeds fair value by less than 20% do not represent a significant risk of impairment and, often, fair values recover over time as the factors that caused the declines improve. If the estimated fair value has declined and remained below cost or amortized cost by 20% or more for at least six months, the Company further analyzes the decrease in fair value to determine whether it is an other-than-temporary decline. To make this determination for each security, the Company considers, among other factors:

 

   

Extent and duration of the decline in fair value below cost or amortized cost;

 

   

The financial condition and near-term prospects of the issuer of the security, including any specific events that may affect its operations, earnings potential or compliance with terms and covenants of the security;

 

   

Changes in the financial condition of the security’s underlying collateral;

 

   

Any downgrades of the security by a rating agency;

 

   

Any reduction or elimination of dividends or non-payment of scheduled interest payments;

 

   

Other indications that a credit loss has occurred; and

 

   

For fixed maturities, the Company’s intent to sell or whether it is more likely than not the Company will be required to sell the fixed maturity prior to recovery of its amortized cost, considering any regulatory developments and the Company’s liquidity needs.

For fixed maturities, the Company concludes that an OTTI has occurred if the present value of the cash flows expected to be collected is less than the amortized cost of the security (i.e., a credit loss exists). In order to determine the amount of the credit loss, the Company calculates the recovery value by discounting the current expectations of future cash flows it will recover. The discount rate is the effective interest rate implicit in the underlying fixed maturity, which is the original effective yield for corporate securities or current effective yield for mortgage-backed securities.

 

15


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CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(All amounts in millions, except per share data, unless otherwise stated)

(Unaudited)

 

Determination of OTTI on Corporate Securities

To determine the recovery value, credit loss or intent to sell for a corporate security, the Company performs an analysis related to the underlying issuer including, but not limited to, the following:

 

   

Expected cash flows of the issuer;

 

   

Fundamentals of the industry in which the issuer operates;

 

   

Fundamentals of the issuer to determine what the Company would recover if the issuer were to file for bankruptcy, compared to the price at which the market is trading;

 

   

Earnings multiples for an issuer’s industry or sector of the industry, divided by the outstanding debt to determine an expected recovery value of the security in the case of a liquidation;

 

   

Expectations regarding defaults and recovery rates;

 

   

Changes to the rating of the security by a rating agency; and

 

   

Additional available market information.

Determination of OTTI on Structured Securities

To determine the recovery value, credit loss or intent to sell for a structured security, including residential mortgage-, commercial mortgage- and other asset-backed securities, the Company performs an analysis related to the security including, but not limited to, the following:

 

   

Expected cash flows from the security, including potential variability of prepayments;

 

   

Level of creditworthiness;

 

   

Delinquency ratios and loan-to-value ratios;

 

   

Average cumulative collateral loss, vintage year and level of subordination; and

 

   

Susceptibility to fair value fluctuations due to changes in the interest rate environment.

The following table presents the severity and duration of the gross unrealized losses on the Company’s underwater available-for-sale securities, after the recognition of OTTI:

 

     As of March 31, 2012     As of December 31, 2011  
     Fair
Value
     Gross
Unrealized
Losses
    Fair
Value
     Gross
Unrealized
Losses
 

Fixed maturities

          

Underwater by 20% or more:

          

Less than 6 consecutive months

   $ 43.0      $ (22.4   $ 204.0      $ (77.1

6 consecutive months or more

     143.4        (53.0     56.0        (30.2
  

 

 

    

 

 

   

 

 

    

 

 

 

Total underwater by 20% or more

     186.4        (75.4     260.0        (107.3

All other underwater fixed maturities

     1,787.9        (73.8     1,758.9        (103.0
  

 

 

    

 

 

   

 

 

    

 

 

 

Total underwater fixed maturities

   $ 1,974.3      $ (149.2   $ 2,018.9      $ (210.3
  

 

 

    

 

 

   

 

 

    

 

 

 

Marketable equity securities, available-for-sale

          

Underwater by 20% or more:

          

Less than 6 consecutive months

   $ —         $ —        $ —         $ —     

6 consecutive months or more

     —           —          —           —     
  

 

 

    

 

 

   

 

 

    

 

 

 

Total underwater by 20% or more

     —           —          —           —     

All other underwater marketable equity securities, available-for-sale

     47.5        (4.0     49.7        (2.3
  

 

 

    

 

 

   

 

 

    

 

 

 

Total underwater marketable equity securities, available-for-sale

   $ 47.5      $ (4.0   $ 49.7      $ (2.3
  

 

 

    

 

 

   

 

 

    

 

 

 

The Company reviewed its available-for-sale investments with unrealized losses as of March 31, 2012 in accordance with its impairment policy and determined, after the recognition of other-than-temporary impairments, that the remaining declines in fair value

 

16


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CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(All amounts in millions, except per share data, unless otherwise stated)

(Unaudited)

 

were temporary. The Company did not intend to sell its underwater securities, and it was not more likely than not that the Company will be required to sell the securities before recovery of amortized cost. For fixed maturities, this conclusion is supported by the Company’s spread analyses, cash flow modeling and expected continuation of contractually required principal and interest payments.

Changes in the amount of credit-related OTTI recognized in net income where the portion related to other factors was recognized in OCI were as follows:

 

     For the Three Months Ended  
     March 31,  
     2012     2011  

Balance, beginning of period

   $ 32.5     $ 68.0  

Increases recognized in the current period:

    

For which an OTTI was not previously recognized

     0.9       0.4  

For which an OTTI was previously recognized

     0.3       —     

Decreases attributable to:

    

Securities sold or paid down during the period

     (1.7     (16.2
  

 

 

   

 

 

 

Balance, end of period

   $ 32.0     $ 52.2  
  

 

 

   

 

 

 

5. Mortgage Loans

The Company originates and manages a portfolio of mortgage loans which are secured by first-mortgage liens on income-producing commercial real estate, primarily in the retail, industrial and office building sectors. All loans are underwritten consistently using standards based on loan-to-value (LTV) ratios and debt-service coverage ratios (DSCR) as well as detailed market, property and borrower analyses. The Company’s mortgage loan portfolio is considered a single portfolio segment and class of financing receivable, which is consistent with how the Company assesses and monitors the risk and performance of the portfolio. A large majority of these loans have personal guarantees, and all loans are inspected and evaluated annually. The Company’s mortgage loan portfolio is diversified by geographic region, loan size and scheduled maturities. As of March 31, 2012, 30.8% of the commercial mortgage loans were located in California, primarily in the Los Angeles area, 11.9% were located in Washington and 10.2% were located in Texas.

Allowance for Mortgage Loans

The allowance for losses on mortgage loans provides for the risk of credit loss inherent in the lending process. The allowance includes a portfolio reserve for probable incurred but not specifically identified losses and, as needed, specific reserves for impaired loans. The allowance for losses on mortgage loans is evaluated as of each reporting period and adjustments are recorded when appropriate. To assist in its evaluation of the allowance for loan losses, the Company utilizes the following credit quality indicators to categorize its loans as lower, medium or higher risk:

 

   

Lower Risk Loans – Loans with an LTV ratio of less than 65%, and a DSCR of greater than 1.50.

 

   

Medium Risk Loans – Loans that have an LTV ratio of less than 65% but a DSCR below 1.50, or loans with an LTV ratio between 65% and 80%, and a DSCR of greater than 1.50.

 

   

Higher Risk Loans – All loans with an LTV ratio greater than 80%, or loans which have an LTV ratio between 65% and 80%, and a DSCR of less than 1.50.

The following table sets forth the Company’s mortgage loans by risk category:

 

     As of March 31, 2012     As of December 31, 2011  
     Carrying
Value
    % of Total     Carrying
Value
    % of Total  

Lower Risk

   $ 1,476.8       55.4    $ 1,395.5       55.5 

Medium Risk

     582.7       21.9       617.0       24.5  

Higher Risk

     603.6       22.7       504.7       20.0  
  

 

 

   

 

 

   

 

 

   

 

 

 

Credit quality indicator total

     2,663.1       100.0      2,517.2       100.0 

Loans specifically evaluated for impairment (1)

     15.9         8.3    

Other (2)

     (7.9       (7.9  
  

 

 

     

 

 

   

Total

   $ 2,671.1       $ 2,517.6    
  

 

 

     

 

 

   

 

17


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CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(All amounts in millions, except per share data, unless otherwise stated)

(Unaudited)

 

 

(1) As of March 31, 2012 and December 31, 2011, reserve amounts of $1.2 and $0.3, respectively, were established for loans specifically evaluated for impairment.
(2) Other includes the allowance for loan losses and deferred fees and costs.

In developing its portfolio reserve for incurred but not specifically identified losses, the Company evaluates loans by risk category as well as its past loan experience, commercial real estate market conditions, and third party data for expected losses on loans with similar LTV ratios and DSCRs. Each loan’s LTV ratio and DSCR is updated annually, primarily during the third quarter.

The following table summarizes the Company’s allowance for mortgage loan losses, which includes portfolio and specific reserves:

 

     For the Three Months Ended  
     March 31, 2012  
     2012     2011  

Allowance at beginning of period

   $ 7.4     $ 7.1  

Provision for specific loans

     1.2       —     

Provision for loans not specifically identified

     —          —     

Write-off for foreclosed property

     (0.6     —     
  

 

 

   

 

 

 

Allowance at end of period

   $ 8.0     $ 7.1  
  

 

 

   

 

 

 

Specific reserves are established for impaired loans, for which the Company considers it probable that amounts due according to the terms of the loan agreement will not be collected, and for loans with terms modified in a troubled debt restructuring.

Non-performing loans, defined generally as those in default, close to being in default or more than 90 days past due, are placed on non-accrual status. As of March 31, 2012, one loan with an outstanding principal balance of $7.6, was considered in default and was assessed in our provision for specific loans. As of December 31, 2011, no loans were considered non-performing.

6. Fair Value of Financial Instruments

The Company determines the fair value of its financial instruments based on the fair value hierarchy, which requires an entity to maximize its use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The Company has categorized its financial instruments into the three-level hierarchy, which gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The level within which a fair value measurement falls is determined based on the lowest-level input that is significant to the fair value measurement. The Company’s financial assets recorded at fair value on the consolidated balance sheets and financial instruments not carried at fair value, but disclosed at fair value are categorized as follows:

 

   

Level 1 — Unadjusted quoted prices in active markets for identical instruments. This level primarily consists of exchange-traded marketable equity securities and actively traded mutual fund investments.

 

   

Level 2 — Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-derived valuations whose inputs are observable or whose significant value drivers are observable. This level includes those financial instruments that are valued using industry-standard pricing methodologies or models. All significant inputs are observable or derived from observable information in the marketplace. Financial instruments in this category primarily include certain corporate fixed maturities, government or agency securities and certain mortgage-backed securities.

 

   

Level 3 — Instruments whose significant value drivers are unobservable. This includes financial instruments for which fair value is estimated based on industry-standard pricing methodologies and internally developed models utilizing significant inputs not based on or corroborated by readily available market information. In limited circumstances, this category may also utilize non-binding broker quotes. This category primarily consists of funds held under deposit contracts and mortgage loans.

 

18


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CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(All amounts in millions, except per share data, unless otherwise stated)

(Unaudited)

 

The following tables present the fair value of the Company’s financial instruments classified by the valuation hierarchy described above. The financial instruments are separated between those accounted for at fair value on a recurring basis and those not carried at fair value, but disclosure of fair value is provided. The Company does not have any financial liabilities accounted for at fair value on a recurring basis.

 

     As of March 31, 2012  
     Carrying
Amount
     Fair Value      Level 1      Level 2      Level 3      Level 3 %  

Recurring measurements:

                 

Financial assets:

                 

Fixed maturities, available-for-sale:

                 

U.S. government and agencies

   $ 112.5      $ 112.5      $ —         $ 112.5      $ —           —     

State and political subdivisions

     631.7        631.7        —           631.7        —           —     

Corporate securities

     16,414.8        16,414.8        —           16,353.5        61.3        0.2

Residential mortgage-backed securities

     3,454.1        3,454.1        —           3,451.4        2.7        —     

Commercial mortgage-backed securities

     1,825.4        1,825.4        —           1,809.9        15.5        0.1  

Other debt obligations

     506.3        506.3        —           463.7        42.6        0.2  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturities, available-for-sale

     22,944.8        22,944.8        —           22,822.7        122.1        0.5  

Marketable equity securities, available-for-sale

     48.6        48.6        0.5        43.1        5.0        —     

Marketable equity securities, trading

     406.0        406.0        405.8        —           0.2        —     

Investments in limited partnerships, private equity funds

     24.3        24.3        —           —           24.3        0.1  

Other invested assets

     18.8        18.8        3.2        6.9        8.7        —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total investments carried at fair value

     23,442.5        23,442.5        409.5        22,872.7        160.3        0.6  

Separate account assets

     853.0        853.0        853.0        —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 24,295.5      $ 24,295.5      $ 1,262.5      $ 22,872.7      $ 160.3        0.6
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     Carrying
Amount
     Fair Value      Level 1      Level 2      Level 3  

Other financial instruments subject to fair value disclosure requirements:

              

Financial assets:

              

Mortgage loans

   $ 2,671.1      $ 2,864.8      $ —         $ —         $ 2,864.8  

Investments in limited partnerships, tax credit investments

     221.4        222.9        —           222.9        —     

Cash and cash equivalents

     279.2        279.2        279.2        —           —     

Financial liabilities:

              

Funds held under deposit contracts:

              

Deferred annuities

   $ 10,336.4      $ 10,292.0      $ —         $ —         $ 10,292.0  

Income annuities

     6,606.3        7,977.0        —           —           7,977.0  

Notes payable:

              

Capital Efficient Notes (CENts)

     149.9        145.3        —           —           145.3  

Senior notes

     299.3        305.3        —           —           305.3  

 

19


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CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(All amounts in millions, except per share data, unless otherwise stated)

(Unaudited)

 

     As of December 31, 2011  
     Carrying
Amount
     Fair Value      Level 1      Level 2      Level 3      Level 3 %  

Recurring measurements:

                 

Financial assets:

                 

Fixed maturities, available-for-sale:

                 

U.S. government and agencies

   $ 64.1      $ 64.1      $ —         $ 64.1      $ —           —     

State and political subdivisions

     635.3        635.3        —           635.3        —           —     

Corporate securities (1)

     16,204.3        16,204.3        —           16,112.9        91.4        0.4

Residential mortgage-backed securities

     3,625.0        3,625.0        —           3,625.0        —           —     

Commercial mortgage-backed securities

     1,837.0        1,837.0        —           1,821.1        15.9        0.1  

Other debt obligations (1)

     539.5        539.5        —           459.6        79.9        0.3  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturities, available-for-sale

     22,905.2        22,905.2        —           22,718.0        187.2        0.8  

Marketable equity securities, available-for-sale

     50.3        50.3        0.5        44.8        5.0        —     

Marketable equity securities, trading

     381.7        381.7        381.1        —           0.6        —     

Investments in limited partnerships, private equity funds

     27.8        27.8        —           —           27.8        0.1  

Other invested assets

     15.8        15.8        2.8        8.2        4.8        —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total investments carried at fair value

     23,380.8        23,380.8        384.4        22,771.0        225.4        0.9  

Separate account assets

     795.8        795.8        795.8        —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 24,176.6      $ 24,176.6      $ 1,180.2      $ 22,771.0      $ 225.4        0.9
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     Carrying
Amount
     Fair Value      Level 1      Level 2      Level 3  

Other financial instruments subject to fair value disclosure requirements:

              

Financial assets:

              

Mortgage loans

   $ 2,517.6      $ 2,685.7      $ —         $ —         $ 2,685.7  

Investments in limited partnerships, tax credit investments

     199.1        202.6        —           202.6        —     

Cash and cash equivalents

     242.3        242.3        242.3        —           —     

Financial liabilities:

              

Funds held under deposit contracts:

              

Deferred annuities

   $ 10,158.1      $ 9,985.1      $ —         $ —         $ 9,985.1  

Income annuities

     6,605.6        7,786.1        —           —           7,786.1  

Notes payable:

              

Capital Efficient Notes (CENts)

     149.9        138.0        —           —           138.0  

Senior notes

     299.3        304.8        —           —           304.8  

 

(1) These amounts include certain privately placed fixed maturities that are valued primarily using observable inputs. These securities, totaling $733.8, were included in Level 3 in the prior year financial statements. Upon further evaluation and review of the valuation methodology during the quarter ended March 31, 2012, the Company determined that they are more appropriately reflected as Level 2 measurements as the unobservable inputs were not significant to the overall evaluation. This evaluation did not result in a change to the fair value amounts reported.

Financial Instruments Measured at Fair Value

Fixed Maturities

The vast majority of the Company’s fixed maturities have been classified as Level 2 measurements. To make this assessment, the Company determines whether the market for a security is active and if significant pricing inputs are observable. The Company predominantly utilizes third party independent pricing services to assist management in determining the fair value of its fixed maturity securities. As of March 31, 2012 and December 31, 2011, respectively, pricing services provided prices for 96.1% and 95.9% of the Company’s fixed maturities.

The Company analyzes the prices received from the pricing services to ensure they represent a reasonable estimate of fair value, including analytical reviews of prices between reporting periods. The Company also performs procedures to gain assurance on the overall reasonableness and consistent use of inputs, valuation methodologies and compliance with fair value accounting standards. This includes an annual review of pricing methodologies and inputs by asset class and performing annual due diligence procedures, including deep-dive analyses, back-testing of selected sales activity to determine whether there were significant differences between

 

20


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CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(All amounts in millions, except per share data, unless otherwise stated)

(Unaudited)

 

the market price used to value the security prior to sale and the actual sales price, and corroboration of prices by obtaining multiple pricing quotes for selected securities. Based upon its analyses, the Company has not adjusted prices obtained from the pricing services.

The pricing services provide prices where observable inputs are available, utilizing evaluated pricing models that vary by asset class. If sufficient objectively verifiable information about a security’s valuation is not available, the pricing services will not provide a valuation for the security. In these situations, the security’s fair value is determined using internal pricing models.

As of March 31, 2012, the Company had $887.7, or 3.9%, of its fixed maturities invested in private placement securities. The use of significant observable inputs in determining the fair value of the Company’s investments in private placement securities resulted in the classification of $816.5, or 92.0%, as Level 2 measurements as of March 31, 2012. As of December 31, 2011, the Company had $936.4, or 4.1%, of its fixed maturities invested in private placement securities, of which $816.9, or 87.2%, were classified as Level 2 measurements.

Corporate Securities

As of March 31, 2012 and December 31, 2011, the fair value of the Company’s corporate securities classified as Level 2 measurements was $16,353.5 and $16,112.9, respectively. The following table presents additional information about the composition of the Level 2 corporate securities:

 

     As of March 31, 2012      As of December 31, 2011  
     Amount     % of Total     # of Securities      Amount     % of Total     # of Securities  

Significant security sectors:

             

Industrials

   $ 3,138.2       19.2     220      $ 3,182.4       19.8     247  

Consumer staples

     2,733.6       16.7       164        2,689.6       16.7       170  

Financials

     1,933.7       11.8       199        1,879.3       11.7       243  

Utilities

     1,883.4       11.5       162        1,901.5       11.8       179  

Weighted-average coupon rate

     6.04          6.09    

Weighted-average remaining years to contractual maturity

     11.0            11.2      

The majority of corporate securities classified as Level 2 measurements are priced by independent pricing services utilizing evaluated pricing models. The significant inputs for security evaluations include benchmark yields, reported trades, broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and other reference data, including market research publications. Because many corporate securities do not trade on a daily basis, evaluated pricing applications apply available information through processes such as benchmark curves, benchmarking of like securities, sector groupings and matrix pricing to prepare evaluations.

As of March 31, 2012, $717.8, or 4.4%, of Level 2 corporate securities were privately placed. These securities were valued using a matrix pricing approach. The significant inputs to the measurement are the base credit spread, treasury yield and expected future cash flows of the security, which are all observable inputs. The base spread is determined based on trades of similar publicly-traded securities, and the expected future cash flows are based on the contractual terms of the security. The valuation approach also incorporates an illiquidity spread, determined based on premiums demanded by investors for privately placed securities. The illiquidity spread is an unobservable input, which ranges from 0 to 25 basis points and is based on the credit quality of the security. The illiquidity spread does not significantly impact the resulting valuation.

Residential Mortgage-backed Securities

As of March 31, 2012 and December 31, 2011, the fair value of the Company’s residential mortgage-backed securities (RMBS) classified as Level 2 measurements was $3,451.4 and $3,625.0, respectively. These securities were primarily fixed-rate, with a weighted-average coupon rate of 4.80% and 4.87% as of March 31, 2012 and December 31, 2011, respectively. Agency securities comprised 89.9% and 90.0% of the Company’s Level 2 RMBS as of March 31, 2012 and December 31, 2011, respectively.

 

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CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(All amounts in millions, except per share data, unless otherwise stated)

(Unaudited)

 

The following table presents additional information about the composition of the Level 2 non-agency RMBS securities:

 

     As of March 31, 2012     As of December 31, 2011  
     Fair Value      % of Total     Fair Value      % of Total  

Highest Rating Agency Rating

          

AAA

   $ 116.8        33.5   $ 102.5        28.3

AA through BBB

     27.5        7.9       41.8        11.5  

BB & below

     204.4        58.6       217.9        60.2  
  

 

 

    

 

 

   

 

 

    

 

 

 

Total non-agency RMBS

   $ 348.7        100.0   $ 362.2        100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

Non-agency RMBS with super senior subordination

   $ 216.0        61.9   $ 216.8        59.9

As of March 31, 2012 and December 31, 2011, the Company’s non-agency Level 2 RMBS had a weighted-average credit enhancement of 9.1% and 9.4%, respectively. As of March 31, 2012 and December 31, 2011, $140.5 and $152.3, or 40.3% and 42.0%, respectively, of the Company’s non-agency Level 2 RMBS had an origination or vintage year of 2004 and prior.

Level 2 RMBS securities are priced by independent pricing services that utilize evaluated pricing models. The significant observable inputs for security evaluations include benchmark yields, reported trades, broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and other reference data, including market research publications. Because many RMBS do not trade on a daily basis, evaluated pricing applications apply available information through processes such as benchmark curves, benchmarking of like securities, sector groupings and matrix pricing to prepare evaluations. In addition, the pricing services use models and processes to develop prepayment and interest rate scenarios. The pricing services monitor market indicators, industry and economic events, and their models take into account market convention.

Commercial Mortgage-backed Securities

As of March 31, 2012 and December 31, 2011, the fair value of the Company’s commercial mortgage-backed securities (CMBS) classified as Level 2 measurements was $1,809.9 and $1,821.1, respectively. These were primarily non-agency securities, which comprised 73.9% and 72.1% of Level 2 CMBS as of March 31, 2012 and December 31, 2011, respectively. The non-agency Level 2 CMBS had an estimated weighted-average credit enhancement of 29.0% and 29.2% as of March 31, 2012 and December 31, 2011, respectively, and 94.0% and 94.9% were in the most senior tranche as of March 31, 2012 and December 31, 2011, respectively.

The Company’s Level 2 CMBS had a weighted-average coupon rate of 5.17% and 5.23% as of March 31, 2012 and December 31, 2011, respectively. As of March 31, 2012 and December 31, 2011, respectively, 19.2% and 18.3% of the underlying collateral for these securities was located in New York; 12.7% and 13.0% was located in California; and 7.3% and 7.5% was located in Texas. The underlying collateral primarily consisted of retail shopping centers, comprising 34.6% and 35.0%, and office buildings comprising 30.6% and 29.7%, of these securities as of March 31, 2012 and December 31, 2011, respectively.

Level 2 CMBS securities are priced by independent pricing services that utilize evaluated pricing models. The significant observable inputs for security evaluations include benchmark yields, reported trades, broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, new issues, monthly payment information and other reference data, including market research publications. Because many CMBS do not trade on a daily basis, evaluated pricing applications apply available information through processes, such as benchmark curves, benchmarking of like securities, sector groupings and matrix pricing to prepare evaluations.

Marketable Equity Securities

Marketable equity securities are investments in common stock, including real estate investment trusts (REITs), and certain nonredeemable preferred stocks. The securities primarily consist of investments in publicly traded companies and actively traded mutual fund investments. When the fair values of the Company’s marketable equity securities are based on quoted market prices in active markets for identical assets, they are classified as Level 1 measurements. The fair values of nonredeemable preferred stocks are valued by our independent pricing services utilizing evaluated pricing models and are classified as Level 2 measurements. These valuations are created based on benchmark curves using industry standard inputs and exchange prices of underlying securities and common stock of the same issuer.

 

22


Table of Contents

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(All amounts in millions, except per share data, unless otherwise stated)

(Unaudited)

 

Investments in Limited Partnerships

Investments in limited partnerships recorded at fair value are investments in private equity funds. The Company utilizes the fair value option for these investments, regardless of ownership percentage, to standardize the related accounting and reporting. The fair value is approximated based upon the Company’s proportionate interest in the underlying partnership or fund’s net asset value (NAV). The Company is generally unable to liquidate these investments during the term of the partnership or fund, which range from five to twelve years. As such, the Company classifies these securities as Level 3 measurements.

Separate Accounts

Separate account assets are primarily invested in mutual funds with published NAVs, which are classified as Level 1 measurements.

Rollforward of Financial Instruments Measured at Fair Value on a Recurring Basis Using Significant Unobservable Inputs (Level 3)

The following tables present additional information about assets measured at fair value on a recurring basis and for which significant unobservable inputs (Level 3) were utilized to determine fair value for the three months ended March 31, 2012:

 

                                  Unrealized Gain (Loss)              
                      Transfers           Included in:              
    Balance as
of January 1,
2012
    Purchases     Sales     In and/or
(Out) of
Level 3 (1)
    Other(2)     Net
Income(3)
    Other
Comprehensive
Income
    Realized
Gains
(Losses)(3)
    Balance as of
March 31,
2012
 

Types of Investments:

                 

Corporate securities

  $ 91.4     $ 0.5     $ —        $ (32.7   $ 0.1     $ (0.6   $ 2.7     $ (0.1   $ 61.3  

Residential mortgage-backed securities

    —          2.7       —          —          —          —          —          —          2.7  

Commercial mortgage-backed securities

    15.9       —          —          —          (0.3     —          (0.1     —          15.5  

Other debt obligations

    79.9       —          —          (13.5     (25.2     —          1.0       0.4       42.6  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total fixed maturities, available-for-sale

    187.2       3.2       —          (46.2     (25.4     (0.6     3.6       0.3       122.1  

Marketable equity securities, available-for-sale

    5.0       —          —          —          —          —          —          —          5.0  

Marketable equity securities, trading

    0.6       —          —          (0.4     —          —          —          —          0.2  

Investments in limited partnerships

    27.8       0.2       —          —          (4.1     0.1       —          0.3       24.3  

Other invested assets

    4.8       2.3       —          —          —          1.6       —          —          8.7  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Level 3

  $ 225.4     $ 5.7     $ —        $ (46.6   $ (29.5   $ 1.1     $ 3.6     $ 0.6     $ 160.3  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Transfers into and/or out of Level 3 are reported at the value as of the beginning of the period in which the transfer occurs. Gross transfers into and (out of) Level 3 were $23.1 and $(69.7), respectively, for the three months ended March 31, 2012. Transfers out included certain privately placed fixed maturities for which there was a change in valuation methodology during the first quarter 2012 to a method that uses significant observable inputs.
(2) Other is comprised of transactions such as pay downs, calls, amortization and redemptions.
(3) Realized and unrealized gains and losses for investments in limited partnerships are included in net investment income.

The following table presents additional information about assets measured at fair value on a recurring basis and for which significant unobservable inputs (Level 3) were utilized to determine fair value for the three months ended March 31, 2011:

 

                                     Unrealized Gain (Loss)               
                         Transfers           Included in:               
     Balance as
of January 1,
2011
     Purchases      Sales     In and/or
(Out) of
Level 3(1)
    Other (2)     Net
Income (3)
     Other
Comprehensive
Income
     Realized
Gains
(Losses) (3)
    Balance as of
March 31,
2011
 

Types of Investments:

                      

Corporate securities

     115.5        29.1        (8.5     (4.5     (2.1     —           6.8        (3.9     132.4  

Commercial mortgage-backed securities

     19.1        —           —          —          (1.4     —           —           —          17.7  

Other debt obligations

     90.1        —           (10.8     —          (0.2     —           1.3        (1.7     78.7  
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total fixed maturities, available-for-sale

     224.7        29.1        (19.3     (4.5     (3.7     —           8.1        (5.6     228.8  

Marketable equity securities, available-for-sale

     1.8        —           —          —          —          —           —           —          1.8  

Marketable equity securities, trading

     0.6        —           —          —          —          0.1        —           —          0.7  

Investments in limited partnerships

     36.5        0.1        —          —          (3.8     1.3        —           0.8       34.9  

Other invested assets

     3.8        —           —          —          —          0.6        —           —          4.4  
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total Level 3

   $ 267.4      $ 29.2      $ (19.3   $ (4.5   $ (7.5   $ 2.0      $ 8.1      $ (4.8   $ 270.6  
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

 

(1) Transfers into and/or out of Level 3 are reported at the value as of the beginning of the period in which the transfer occurs. Gross transfers out of Level 3 were $4.5 for the three months ended March 31, 2011.

 

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CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(All amounts in millions, except per share data, unless otherwise stated)

(Unaudited)

 

(2) Other is comprised of transactions such as pay downs, calls, amortization and redemptions.
(3) Realized and unrealized gains and losses for investments in limited partnerships are included in net investment income.

Other Financial Instruments Subject to Fair Value Disclosure Requirements

Cash and cash equivalents consist of demand bank deposits and short-term highly liquid investments with original maturities of three months or less at the time of purchase. Cash equivalents are reported at cost, which approximates fair value, and were $261.8 and $234.0 as of March 31, 2012 and December 31, 2011, respectively. As of March 31, 2012 and December 31, 2011, cash equivalents of $259.9 and $231.5, respectively, were held at a single highly-rated financial institution.

The fair values of the Company’s mortgage loans were measured by discounting the projected future cash flows using the current rate at which the loans would be made to borrowers with similar credit ratings and for the same maturities.

Investments in limited partnerships associated with tax credit investments are carried at amortized cost. Fair value was estimated based on the discounted cash flows over the remaining life of the tax credits, using the original internal rate of return for each investment.

The fair values of funds held under deposit contracts related to investment-type contracts are estimated using an income approach, based on the present value of the discounted cash flows. Cash flows were projected using best estimates for lapses, mortality and expenses, and discounted at a risk-free rate plus a nonperformance risk spread. The carrying value of this balance excludes $5,757.9 and $5,685.8 of liabilities related to insurance contracts as of March 31, 2012 and December 31, 2011, respectively.

The fair values of the Company’s notes payable were based on nonbinding quotes provided by third-parties. This fair value measurement assumes that liabilities were transferred to a market participant of equal credit standing and without consideration for any optional redemption features.

7. Deferred Policy Acquisition Costs (DAC) and Deferred Sales Inducements

The following table provides a reconciliation of the beginning and ending balance for DAC:

 

     For the Three Months Ended  
     March 31,  
     2012     2011  
           (As adjusted)  

Unamortized balance at beginning of period, as adjusted (1)

   $ 368.4     $ 342.5  

Deferral of acquisition costs

     19.7       31.1  

Adjustments related to investment gains

     —          (0.7

Amortization

     (15.8     (16.3
  

 

 

   

 

 

 

Unamortized balance at end of period

     372.3       356.6  

Accumulated effect of net unrealized investment gains

     (190.2     (126.1
  

 

 

   

 

 

 

Balance at end of period

   $ 182.1     $ 230.5  
  

 

 

   

 

 

 

 

(1) The restated accumulated effect of net unrealized investment gains as of January 1, 2012 and 2011 were $(182.4) and $(129.5), respectively.

 

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CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(All amounts in millions, except per share data, unless otherwise stated)

(Unaudited)

 

The following table provides a reconciliation of the beginning and ending balance for deferred sales inducements (DSI), which are included in other assets on the consolidated balance sheets:

 

     For the Three Months Ended  
     March 31,  
     2012     2011  

Unamortized balance at beginning of period

   $ 142.0     $ 105.8  

Capitalizations

     13.3       17.1  

Adjustments related to investment gains

     —          (0.3

Amortization

     (8.4     (6.2
  

 

 

   

 

 

 

Unamortized balance at end of period

     146.9       116.4  

Accumulated effect of net unrealized investment gains

     (101.6     (46.8
  

 

 

   

 

 

 

Balance at end of period

   $ 45.3     $ 69.6  
  

 

 

   

 

 

 

8. Stockholders’ Equity

The following table provides a reconciliation of changes in outstanding shares of common stock:

 

     Common Shares  

Balance as of January 1, 2011

     118.216  

Restricted stock issued, net

     0.298  

Employee stock purchase plan shares issued

     0.124  

Treasury stock (1)

     (0.001
  

 

 

 

Balance as of December 31, 2011

     118.637  
  

 

 

 

Balance as of January 1, 2012

     118.637  

Restricted stock issued, net

     0.396  

Employee stock purchase plan shares issued

     0.042  

Treasury stock (1)

     (0.001
  

 

 

 

Balance as of March 31, 2012

     119.074  
  

 

 

 

 

(1) Represents shares repurchased and subsequently retired to satisfy employee income tax withholding pursuant to the Company’s Equity Plan.

The consolidated statements of comprehensive income presents the changes in unrealized gains and losses on available for sale securities net of reclassification adjustments. The following table summarizes the adjustments to OCI for amounts reclassified from AOCI to net income during the period:

 

     For the Three Months Ended  
     March 31,  
     2012     2011  

Reclassifications included in net income for:

    

Net realized investment gains (net of taxes of $(9.5) and $(5.7))

   $ (17.5   $ (10.4

Other-than-temporary impairments (net of taxes of $3.3 and $3.6)

     6.3       6.6  
  

 

 

   

 

 

 

Reclassifications included in net income

   $ (11.2   $ (3.8
  

 

 

   

 

 

 

9. Stock-Based Compensation

The following table summarizes the Company’s restricted stock activity for the three months ended March 31, 2012:

 

     Number of
Shares
     Weighted-
Average Fair
Value
 

Outstanding as of January 1, 2012

     0.478      $ 13.15  

Shares granted

     0.396        9.91  

Shares vested

     —           —     

Shares forfeited

     —           —     
  

 

 

    

Outstanding as of March 31, 2012

     0.874      $ 11.68  
  

 

 

    

 

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CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(All amounts in millions, except per share data, unless otherwise stated)

(Unaudited)

 

10. Commitments and Contingencies

Litigation

Because of the nature of its business, the Company is subject to legal actions filed or threatened in the ordinary course of its business operations. The Company does not expect that any such litigation, pending or threatened, as of March 31, 2012, will have a material adverse effect on its consolidated financial condition, future operating results or liquidity.

Other Commitments

As of March 31, 2012 and December 31, 2011, unfunded mortgage loan commitments were $93.0 and $105.1, respectively. As of March 31, 2012, the Company had no other material changes to our commitments or contingencies since December 31, 2011.

11. Segment Information

The Company offers a broad range of products and services that include retirement, group health and employee benefits products and life insurance. These operations are managed separately as three divisions, consisting of four business segments based on product groupings, and a fifth reportable segment consisting primarily of unallocated corporate items and surplus investment income. The five segments are: Benefits, Deferred Annuities, Income Annuities, Life and Other.

The following tables present selected financial information by segment and reconcile segment pre-tax adjusted operating income (loss) to amounts reported in the consolidated statements of income.

 

     For the Three Months Ended March 31, 2012  
     Benefits      Deferred
Annuities
    Income
Annuities
     Life     Other     Total  

Operating revenues:

              

Premiums

   $ 140.5      $ —        $ —         $ 9.8     $ —        $ 150.3  

Net investment income

     5.4        134.4       104.1        71.6       5.0       320.5  

Policy fees, contract charges, and other

     3.0        5.1       1.2        31.7       5.3       46.3  

Net realized gains – FIA

     —           1.2       —           —          —          1.2  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total operating revenues

     148.9        140.7       105.3        113.1       10.3       518.3  

Benefits and expenses:

              

Policyholder benefits and claims

     86.6        (0.1     —           18.7       —          105.2  

Interest credited

     —           82.2       84.5        63.2       (0.4     229.5  

Other underwriting and operating expenses

     37.2        19.0       5.7        15.3       5.8       83.0  

Interest expense

     —           —          —           —          8.2       8.2  

Amortization of DAC

     —           13.8       0.6        1.4       —          15.8  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total benefits and expenses

     123.8        114.9       90.8        98.6       13.6       441.7  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Segment pre-tax adjusted operating income (loss)

   $ 25.1      $ 25.8     $ 14.5      $ 14.5     $ (3.3   $ 76.6  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Operating revenues

   $ 148.9      $ 140.7     $ 105.3      $ 113.1     $ 10.3     $ 518.3  

Add: Net realized investment gains (losses), excluding FIA

     —           (0.2     16.3        (0.6     9.2       24.7  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total revenues

     148.9        140.5       121.6        112.5       19.5       543.0  

Total benefits and expenses

     123.8        114.9       90.8        98.6       13.6       441.7  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Income from operations before income taxes

   $ 25.1      $ 25.6     $ 30.8      $ 13.9     $ 5.9     $ 101.3  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

As of March 31, 2012:

              

Total assets

   $ 203.1      $ 12,084.1     $ 7,380.0      $ 6,451.4     $ 2,426.1     $ 28,544.7  

 

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CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(All amounts in millions, except per share data, unless otherwise stated)

(Unaudited)

 

     For the Three Months Ended March 31, 2011  
     Benefits      Deferred
Annuities
    Income
Annuities
     Life      Other     Total  
     (As adjusted)  

Operating revenues:

               

Premiums

   $ 110.0      $ —        $ —         $ 10.9      $ —        $ 120.9  

Net investment income

     4.2        123.1       105.0        71.2        6.5       310.0  

Policy fees, contract charges, and other

     3.3        5.1       0.2        30.7        5.4       44.7  

Net realized gains – FIA

     —           0.5       —           —           —          0.5  
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total operating revenues

     117.5        128.7       105.2        112.8        11.9       476.1  

Benefits and expenses:

               

Policyholder benefits and claims

     74.3        (0.1     —           18.1        —          92.3  

Interest credited

     —           77.6       89.7        61.7        (0.7     228.3  

Other underwriting and operating expenses

     29.2        16.2       5.9        14.6        6.0       71.9  

Interest expense

     —           —          —           —           8.0       8.0  

Amortization of DAC

     —           14.3       0.7        1.3        —          16.3  
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total benefits and expenses

     103.5        108.0       96.3        95.7        13.3       416.8  
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Segment pre-tax adjusted operating income (loss)

   $ 14.0      $ 20.7     $ 8.9      $ 17.1      $ (1.4   $ 59.3  
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Operating revenues

   $ 117.5      $ 128.7     $ 105.2      $ 112.8      $ 11.9     $ 476.1  

Add: Net realized investment gains, excluding FIA

     —           2.9       9.9        0.4        1.9       15.1  
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total revenues

     117.5        131.6       115.1        113.2        13.8       491.2  

Total benefits and expenses

     103.5        108.0       96.3        95.7        13.3       416.8  
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Income from operations before income taxes

   $ 14.0      $ 23.6     $ 18.8      $ 17.5      $ 0.5     $ 74.4  
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

As of March 31, 2011:

               

Total assets, as adjusted

   $ 211.4      $ 10,863.7     $ 6,963.3      $ 6,046.5      $ 2,305.4     $ 26,390.3  

12. Subsequent Events

On May 4, 2012, the Company declared a dividend of $0.07 per common share, or approximately $9.7 in total, to shareholders and warrant holders of record as of May 18, 2012. The dividend will be paid on or about June 1, 2012.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This discussion contains forward-looking statements that involve risk and uncertainties. Our actual results may differ materially from those discussed in, or implied by, any of the forward-looking statements as a result of various factors, including but not limited to those listed under “Forward-Looking Statements.” You should read the following discussion in conjunction with the unaudited interim condensed consolidated financial statements and accompanying condensed notes included in Item 1 – “Condensed Financial Statements” included in this Form 10-Q, our Annual Report for the year ended December 31, 2011, filed with the SEC on February 29, 2012 (“2011 10-K”), as well as our current reports on Form 8-K and other publicly available information. Our fiscal year ends on December 31 of each calendar year.

Management considers certain non-GAAP financial measures, including adjusted operating income, adjusted operating income per common share, pre-tax adjusted operating income, adjusted book value, adjusted book value, as converted, adjusted book value per common share, adjusted book value per common share, as converted, average adjusted book value, and operating return on average equity (ROAE) to be useful to investors in evaluating our financial performance and condition. These measures have been reconciled to their most comparable GAAP financial measures. For a definition and further discussion of these non-GAAP measures, see Item 7 – “Management’s Discussion and Analysis of Financial Condition – Use of non-GAAP Financial Measures” in our 2011 10-K.

Historical financial information has been restated to reflect the retrospective adoption of a new accounting standard for deferred acquisition costs on January 1, 2012. See Note 2 in the accompanying unaudited interim condensed consolidated financial statements for discussion of adoption of new accounting pronouncements.

All dollar and share amounts, except per share data, are in millions unless otherwise stated.

Overview

We are a financial services company in the life insurance industry providing employee benefits, annuities and life insurance through a national network of benefits consultants, financial institutions and independent agents and advisers. Our operations date back to 1957 and many of our distribution relationships have been in place for decades.

Our Operations

We manage our business through three divisions composed of four business segments:

Benefits Division

 

   

Benefits. We offer medical stop-loss insurance, limited benefit medical plans, group life insurance, accidental death and dismemberment insurance and disability income insurance mainly to employer groups of 50 to 5,000 individuals. In addition to our insurance products, we offer managing general underwriter (MGU) services.

Retirement Division

 

   

Deferred Annuities. We offer fixed and variable deferred annuities to consumers who want to accumulate tax-deferred assets for retirement.

 

   

Income Annuities. We offer single premium income annuities (SPIAs) to customers seeking a reliable source of retirement income or to protect against outliving their assets during retirement, and structured settlement annuities to fund third party personal injury settlements. In addition, we offer funding services options to existing structured settlement clients.

Life Division

 

   

Life. We offer a wide array of insurance products such as term and universal life insurance, including single premium life insurance (SPL), bank-owned life insurance (BOLI) and corporate-owned life insurance (COLI).

 

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In addition, we have our Other segment, which consists primarily of investment income on unallocated surplus, unallocated corporate expenses, interest expense on debt, earnings related to our limited partnership interests, the results of small, non-insurance businesses that are managed outside of our divisions, such as our broker-dealer, and inter-segment elimination entries.

See Note 11 to the accompanying unaudited interim condensed consolidated financial statements for the financial results of our segments.

Current Outlook

As we continue to lay the groundwork for future growth, the life insurance industry continues to face a difficult economic environment. The prolonged low-interest rate environment, ongoing concerns over European sovereign debt and credit markets, the United States’ growing deficit, prolonged high-levels of unemployment and the slow economic recovery continue to put pressure on life insurance companies. While the combination of these and other challenges has led to several large competitors exiting certain markets, we continue to seek to create long-term stockholder value by being proactive in maintaining our overall margins and focusing on executing our growth strategies.

While interest rates increased slightly at the end of the first quarter, they have since declined back to near-historic low levels, and continue to be extremely low with the United States Federal Reserve indicating no plans to increase interest rates in the near future. Low interest rates and tight credit spreads continue to be a challenge for our interest-sensitive asset-based businesses, particularly sales of fixed annuities, SPIAs and universal life insurance policies. To mitigate the risk of unfavorable consequences in this environment, such as spread compression on our in force business, we remain proactive in our investment and product strategies, interest-crediting strategies and overall asset-liability management practices. In the first quarter, we sold approximately $107 of lower yielding, higher premium, agency RMBS where the prepayment characteristics of these securities had deteriorated. In doing so, we were able to produce realized gains while reducing our future reinvestment risk. We remain proactive in managing our prepayment and reinvestment risk; we have completed similar transactions in the second quarter and will continue to seek similar transactions in 2012. Looking forward, we continue the pursuit of other investment strategies to help us in the current low interest rate environment, and position us well for rising interest rate scenarios.

To manage our asset yield in this environment, we have been and plan to continue increasing our investments in commercial mortgage loans we underwrite. While interest rates on recently written loans have decreased consistent with the overall level of interest rates, they continue to be an attractive investment opportunity. During the first quarter of 2012, we originated mortgage loans of $197.6 with an average yield of approximately 5.2%. This asset class comprised 10.1% of our invested assets as of March 31, 2012, up from 9.6% as of December 31, 2011.

To manage our way through this uncertain environment and grow profitably, we will continue to focus on the strategies outlined in Item 1 — “Business — Our Strategies” in the 2011 10-K. Our 2012 focus is to continue executing on our Grow & Diversify initiatives, while at the same time remaining focused on our core businesses and maintaining our financial strength ratings.

We believe we have adequate levels of capital to support our current business and to fund organic and transactional growth. Recently, major players in the life insurance industry have exited the life and annuities marketplace. These events may provide opportunities for organic growth of our business and for certain strategic transactions. However, the success of these and other strategies may be affected by the factors discussed in Item 1A — “Risk Factors” and other factors as discussed herein.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with GAAP requires management to adopt accounting policies and make estimates and assumptions that affect amounts reported and disclosed in the unaudited interim condensed consolidated financial statements. The following accounting policies are those we consider to be particularly critical to understanding our condensed financial statements because their application places the most significant demands on our ability to judge the effect of inherently uncertain matters on our financial results:

 

   

The evaluation of OTTI of investments;

 

   

The valuation of investments at fair value;

 

   

The balance, recoverability and amortization of deferred policy acquisition costs and deferred sales inducements; and

 

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The liabilities for future policy benefits and policy and contract claims.

In applying the Company’s accounting policies, management makes subjective and complex judgments that frequently require estimates about matters that are inherently uncertain. Many of these policies, estimates and related judgments are common in the insurance and financial services industries; others are specific to the Company’s businesses and operations. For all of these policies, we caution that future events rarely develop exactly as forecasted, and our best estimates may require adjustment.

On January 1, 2012, we retrospectively adopted a new accounting standard related to the deferral of policy acquisition costs. Our new policy regarding deferrable costs, including the impact of retrospective adoption, is described below. This new accounting standard did not impact the accounting for deferred sales inducements.

Other than as described above, there have been no material changes to the critical accounting estimates listed above, which are described in Item 7 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates” and Note 2 of the notes to the audited financial statements included in the 2011 10-K.

Deferred Policy Acquisition Costs (DAC)

Prior to the adoption of new accounting guidance, deferrable acquisition costs were those that varied with and were primarily related to the acquisition of new or renewal business, regardless of whether the efforts were successful or unsuccessful. Under the new standard, the Company defers only costs that are directly related to the successful acquisition or renewal of insurance contracts, including:

 

   

Commissions for successful contract acquisitions;

 

   

Premium-based taxes and assessments;

 

   

Distribution costs directly related to successful contract acquisition;

 

   

Third-party underwriting costs related to contracts that are successfully acquired; and

 

   

The portion of the salaries and benefits related to employee time spent on the processing of successfully acquired new and renewal contracts.

All other acquisition-related costs, including costs incurred for soliciting potential customers, managing distribution and underwriting functions, training, administration, unsuccessful acquisition or renewal efforts, market research and product development are not deferrable and are expensed in the period incurred. Additionally, upon adoption, policy acquisition costs in our Benefits segment are no longer being deferred, as the application of the new standard to the short-duration contracts in this segment resulted in an immaterial net impact of deferral of acquisition costs.

While the Company has restated DAC amortization to reflect the retrospective reduction in costs deferred, its policies and methodology have not changed. For more information on the impact of adoption, see Note 2 of the condensed notes to the consolidated financial statements.

The following table summarizes our DAC asset balances by segment:

 

     As of March 31,2012     As Adjusted
As of December 31, 2011
 

Deferred Annuities

   $ 265.5     $ 265.5  

Income Annuities

     39.6       37.9  

Life

     67.2       65.0  
  

 

 

   

 

 

 

Total unamortized balance at end of period

     372.3       368.4  

Accumulated effect of net unrealized gains

     (190.2     (182.4
  

 

 

   

 

 

 

Balance at end of period

   $ 182.1     $ 186.0  
  

 

 

   

 

 

 

 

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Amortization of DAC

In our Deferred Annuities, Income Annuities and Life segments, we amortize DAC over the premium paying period or over the lives of the policies in proportion to the future estimated gross profits (EGPs) of each of these product lines, as follows:

 

   

Deferred Annuities. The DAC amortization period is typically 20 years for deferred annuities, although most of the DAC amortization occurs within the first 10 years because the EGPs are highest during such period. It is common for deferred annuity policies to lapse after the surrender charge period expires.

 

   

Income Annuities. The DAC amortization period for SPIAs, including structured settlement annuities, is the benefit payment period. The benefit payment periods vary by policy; however, 80% of the benefits will be paid over the next 45 years and nearly all benefits are paid within 80 years of contract issue.

 

   

Life. The DAC amortization period related to universal life policies is typically 25 years. DAC amortization related to our term life insurance policies is the premium paying period, which ranges from 10 to 30 years.

To determine the EGPs, we make assumptions as to lapse and withdrawal rates, expenses, interest margins, mortality experience, long-term equity market returns and investment performance. Estimating future gross profits is a complex process requiring considerable judgment and forecasting of events well into the future.

Changes to assumptions can have a significant impact on DAC amortization. In the event actual experience differs from our assumptions or our future assumptions are revised, we adjust our EGPs, which could result in a significant increase in amortization expense. EGPs are adjusted quarterly to reflect actual experience to date. For example, for our deferred annuity products, if renewal crediting rates are greater or lower than the renewal crediting rates we assumed in our DAC asset amortization models, we would record a change in amortization expense to reflect the change in our EGPs. For future assumptions we complete a study and refine our estimates of future gross profits at least annually during the third quarter. Upon completion of an assumption study, we revise our assumptions to reflect our current best estimate, thereby changing our estimate of projected EGPs used in the DAC asset amortization models. This is often referred to as “unlocking” the DAC asset amortization model. We also revise future assumptions as needed throughout the year if a significant transaction or trend is identified that would warrant a change in those assumptions.

The following would generally cause an increase in DAC amortization expense:

Actual experience differs from our assumptions:

 

   

increases to interest margins in the current period from increased yields or decreased crediting rates;

 

   

increases to lapse and withdrawal rates in the current period;

 

   

increases to current period expense levels;

 

   

significant investment prepayment activity;

 

   

increases to equity market returns; and

 

   

lower death claims.

Future assumption changes (unlocking):

 

   

decreases in expected future interest margins due to increases in expected renewal crediting rates and/or decreases to expected investment yields;

 

   

increases to expected future lapse and withdrawal rates;

 

   

increases to future expected expense levels;

 

   

significant investment prepayment activity, which results in decreased future interest margins;

 

   

decreases to expected equity market returns; and

 

   

higher expected future death claims.

We regularly conduct DAC recoverability analyses, where we compare the current DAC asset balances with the estimated present value of future profitability of the underlying business. The DAC asset balance is considered recoverable if the present value of future profits is greater than the current DAC asset balance.

 

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In connection with our recoverability analyses, we perform sensitivity analyses on our most significant DAC asset balances, which currently relate to our deferred annuity, universal life, and BOLI products, to capture the effect that certain key assumptions have on DAC asset balances. The sensitivity tests are performed independently, without consideration for any correlation among the key assumptions. The following depicts the sensitivities for our deferred annuity, universal life and BOLI DAC asset balances as of March 31, 2012:

 

   

if we increased our future lapse and withdrawal rate assumptions by a factor of 10%, the DAC asset balance would decrease approximately $5.8;

 

   

if we increased our future expense assumptions by a factor of 10%, the DAC asset balance would decrease approximately $0.5.

In addition, depending on the amount and the type of new business written in the future, we may determine that other assumptions may produce significant variations in our financial results.

We adjust the unamortized DAC balance for the accumulated effect of net unrealized gains or losses, which is recorded net of taxes in AOCI. This adjustment reflects the impact on estimated future gross profits as if the unrealized investment gains and losses had been realized as of the balance sheet date. Currently, our available-for-sale portfolio is in a net unrealized gain position, primarily due to the low interest rate environment, and the corresponding adjustment decreases our DAC balance and AOCI. In periods of rising interest rates, the fair value of our fixed maturities would generally decrease, and this may result in net unrealized investment losses. In such circumstances, the DAC adjustment would increase our DAC balance and increase AOCI. However, this adjustment is limited to cumulative capitalized acquisition costs plus interest, which would be $141.3, net of taxes of $76.1, in our Deferred Annuities segment and $7.5, net of taxes of $4.1, in our Life segment as of March 31, 2012.

New Accounting Standards

For a discussion of recently adopted accounting pronouncements see Note 2 in the accompanying unaudited interim condensed consolidated financial statements.

Sources of Revenues and Expenses

Our primary sources of revenues from our insurance operations are premiums, net investment income and policy fees and contract charges. Our primary sources of expenses from our insurance operations are policyholder benefits and claims, interest credited to policyholder reserves and account balances, and general business and operating expenses, net of DAC. We allocate shared service operating expenses to each segment using multiple factors, including employee headcount, allocated investments, account values and time study results. We also generate net realized investment gains (losses) on sales or impairment of our investments and changes in fair value on our equity trading portfolio.

Each of our four business segments maintains its own portfolio of invested assets, which are managed in accordance with specific guidelines. The net investment income and realized investment gains (losses) are reported in the segment in which they occur. We also allocate surplus net investment income to each segment using a risk-based capital formula. The unallocated portion of net investment income is reported in the Other segment.

Revenues

Premiums

Premiums consist primarily of premiums from our medical stop-loss and individual term and whole life insurance products.

Net investment income

Net investment income represents the income earned on our investments, net of investment expenses, including prepayment related income such as bond make-whole payments. Net investment income also includes gains or losses from changes in the fair value of our investments in private equity fund limited partnerships and interest expense from amortization of tax credit investments.

Policy fees, contract charges and other

Policy fees, contract charges and other includes cost of insurance (COI) charges on our universal life insurance and BOLI policies, mortality expense, surrender and other administrative charges to policyholders, revenues from our non-insurance businesses, and reinsurance allowance fees.

Net realized investment gains (losses)

Net realized investment gains (losses) mainly consists of realized gains (losses) from sales of our investments, realized losses from investment impairments and changes in fair value on our trading portfolio and FIA.

 

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Benefits and Expenses

Policyholder benefits and claims

Policyholder benefits and claims consist of benefits paid and reserve activity on medical stop-loss and individual life and BOLI products.

Interest credited

Interest credited represents interest credited to policyholder reserves and contract holder general account balances, the impact of mortality and funding services activity within our Income Annuities segment, and the amortization of deferred sales inducement assets.

Other underwriting and operating expenses

Other underwriting and operating expenses represent non-deferrable costs related to the acquisition and ongoing maintenance of insurance and investment contracts, including certain non-deferrable commissions, policy issuance expenses and other business and administrative operating costs.

Interest expense

Interest expense primarily includes interest on corporate debt, the impact of interest rate hedging activities on the debt and amortization of debt issuance costs.

Amortization of deferred policy acquisition costs

We defer as assets certain commissions, distribution costs and other underwriting costs that are directly related to the successful acquisition of new and renewal business. Amortization of previously capitalized DAC is recorded as an expense.

Use of non-GAAP Financial Measures

Certain tables and related disclosures in this report include non-GAAP financial measures. We believe these measures provide useful information to investors in evaluating our financial performance or condition. The non-GAAP financial measures discussed below are not substitutes for their most directly comparable GAAP measures. The adjustments made to derive these non-GAAP measures are important to understanding our overall results of operations and financial position and, if evaluated without proper context, these non-GAAP measures possess material limitations. Therefore, our management and board of directors also separately review the items excluded from or added to the most directly comparable GAAP measures to arrive at these non-GAAP measures. In addition, management and our board of directors also analyze each of the comparable GAAP measures in connection with their review of our results of operations and financial position.

For a full discussion of each non-GAAP measure, see Item 7 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Use of non-GAAP Financial Measures” in our 2011 10-K.

 

     As of
March 31,
2012
     As of
December 31,
2011
 

Total stockholders’ equity

   $ 3,154.7      $ 3,114.9  

Less: AOCI

     1,000.1        1,027.3  
  

 

 

    

 

 

 

Adjusted book value*

     2,154.6        2,087.6  

Add: Assumed proceeds from exercise of warrants

     218.1        218.1  
  

 

 

    

 

 

 

Adjusted book value, as converted*

   $ 2,372.7      $ 2,305.7  
  

 

 

    

 

 

 

Book value per common share (1)

   $ 22.85      $ 22.64  
  

 

 

    

 

 

 

Adjusted book value per common share (2)*

   $ 18.09      $ 17.60  
  

 

 

    

 

 

 

Adjusted book value per common share, as converted (3)*

   $ 17.19      $ 16.75  
  

 

 

    

 

 

 

 

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     For the Twelve Months Ended  
     March 31,
2012
    December 31,
2011
 

Return on stockholders’ equity, or ROE

     7.6     7.2

Net income (4)

   $ 217.7     $ 195.8  

Average stockholders’ equity (5)

     2,869.9       2,710.2  

Operating return on average equity, or ROAE*

     10.0     9.5

Adjusted operating income (6)*

   $ 205.8     $ 190.2  

Average adjusted book va