XNYS:RGA Reinsurance Group of America Inc Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

    x

  

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

   For the quarterly period ended June 30, 2012
OR

    ¨

  

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 1-11848

REINSURANCE GROUP OF AMERICA, INCORPORATED

(Exact name of Registrant as specified in its charter)

 

MISSOURI   43-1627032
(State or other jurisdiction   (IRS employer
of incorporation or organization)   identification number)

1370 Timberlake Manor Parkway

Chesterfield, Missouri 63017

(Address of principal executive offices)

(636) 736-7000

(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 July 31, 2012, 73,713,241 shares of the registrant’s common stock were outstanding.

 


Table of Contents

REINSURANCE GROUP OF AMERICA, INCORPORATED AND SUBSIDIARIES

TABLE OF CONTENTS

 

Item

       Page
  PART I – FINANCIAL INFORMATION   

1        

  Financial Statements   
  Condensed Consolidated Balance Sheets (Unaudited)
June 30, 2012 and December 31, 2011
   3
  Condensed Consolidated Statements of Income (Unaudited)
Three and six months ended June 30, 2012 and 2011
   4
  Condensed Consolidated Statements of Comprehensive Income (Unaudited)
Three and six months ended June 30, 2012 and 2011
   5
  Condensed Consolidated Statements of Cash Flows (Unaudited)
Six months ended June 30, 2012 and 2011
   6
  Notes to Condensed Consolidated Financial Statements (Unaudited)    7

2

  Management’s Discussion and Analysis of
Financial Condition and Results of Operations
   43

3

  Quantitative and Qualitative Disclosure About Market Risk    74

4

  Controls and Procedures    74
  PART II – OTHER INFORMATION   

1

  Legal Proceedings    75

1A

  Risk Factors    75

6

  Exhibits    75
  Signatures    76
  Index to Exhibits    77

 

2


Table of Contents

REINSURANCE GROUP OF AMERICA, INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

                                             
    June 30,     December 31,  
    2012     2011  
    (Dollars in thousands, except share data)  

Assets

   

Fixed maturity securities:

   

Available-for-sale at fair value (amortized cost of $14,957,165 and
$14,182,880 at June 30, 2012 and December 31, 2011, respectively)

   $ 17,244,192       $ 16,200,950   

Mortgage loans on real estate (net of allowances of $11,011 and $11,793
at June 30, 2012 and December 31, 2011, respectively)

    1,157,049        991,731   

Policy loans

    1,250,238        1,260,400   

Funds withheld at interest

    5,457,888        5,410,424   

Short-term investments

    49,981        88,566   

Investment receivable

    5,406,898        -   

Other invested assets

    940,605        1,012,541   
 

 

 

   

 

 

 

Total investments

    31,506,851        24,964,612   

Cash and cash equivalents

    957,341        962,870   

Accrued investment income

    182,586        144,334   

Premiums receivable and other reinsurance balances

    1,104,176        1,059,572   

Reinsurance ceded receivables

    626,734        626,194   

Deferred policy acquisition costs

    3,605,008        3,543,925   

Other assets

    361,627        332,466   
 

 

 

   

 

 

 

Total assets

   $ 38,344,323       $ 31,633,973   
 

 

 

   

 

 

 

Liabilities and Stockholders’ Equity

   

Future policy benefits

   $ 10,725,096       $ 9,903,886   

Interest-sensitive contract liabilities

    13,352,601        8,394,468   

Other policy claims and benefits

    3,026,467        2,841,373   

Other reinsurance balances

    249,336        118,219   

Deferred income taxes

    1,785,614        1,679,834   

Other liabilities

    890,687        810,775   

Long-term debt

    1,414,969        1,414,688   

Collateral finance facility

    651,936        652,032   
 

 

 

   

 

 

 

Total liabilities

    32,096,706        25,815,275   

Commitments and contingent liabilities (See Note 8)

   

Stockholders’ Equity:

   

Preferred stock (par value $.01 per share; 10,000,000 shares authorized; no
shares issued or outstanding)

    --        --   

Common stock (par value $.01 per share; 140,000,000 shares authorized;
shares issued: 79,137,758 at June 30, 2012 and December 31, 2011)

    791        791   

Additional paid-in-capital

    1,740,415        1,727,774   

Retained earnings

    3,033,505        2,818,429   

Treasury stock, at cost; 5,415,403 and 5,770,024 shares at
June 30, 2012 and December 31, 2011, respectively

    (326,292)        (346,449)   

Accumulated other comprehensive income

    1,799,198        1,618,153   
 

 

 

   

 

 

 

Total stockholders’ equity

    6,247,617        5,818,698   
 

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 38,344,323       $ 31,633,973   
 

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements (unaudited).

 

3


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REINSURANCE GROUP OF AMERICA, INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 

                                                                                           
    Three months ended June 30,     Six months ended June 30,  
    2012     2011     2012     2011  
    (Dollars in thousands, except per share data)  
Revenues:        

Net premiums

   $ 1,950,661       $ 1,788,676       $ 3,814,143       $ 3,524,806   

Investment income, net of related expenses

    328,334        337,436        669,274        708,476   

Investment related gains (losses), net:

       

Other-than-temporary impairments on fixed maturity securities

    (1,959)        (5,582)        (9,566)        (7,138)   

Other-than-temporary impairments on fixed maturity securities
transferred to (from) accumulated other comprehensive income

    162        292        (7,059)        292   

Other investment related gains (losses), net

    25,598        32,678        83,946        157,854   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total investment related gains (losses), net

    23,801        27,388        67,321        151,008   

Other revenues

    72,957        50,477        117,990        102,122   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

    2,375,753        2,203,977        4,668,728        4,486,412   
 

 

 

   

 

 

   

 

 

   

 

 

 

Benefits and Expenses:

       

Claims and other policy benefits

    1,625,446        1,520,013        3,205,595        2,989,462   

Interest credited

    66,697        96,196        154,739        202,259   

Policy acquisition costs and other insurance expenses

    335,939        274,519        643,573        620,766   

Other operating expenses

    105,541        97,161        215,639        203,311   

Interest expense

    23,360        25,818        46,682        50,387   

Collateral finance facility expense

    2,878        3,101        5,845        6,303   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total benefits and expenses

    2,159,861        2,016,808        4,272,073        4,072,488   
 

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

    215,892        187,169        396,655        413,924   

Provision for income taxes

    74,781        63,225        132,226        141,060   
 

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 141,111       $ 123,944       $ 264,429       $ 272,864   
 

 

 

   

 

 

   

 

 

   

 

 

 

Earnings per share:

       

Basic earnings per share

   $ 1.91       $ 1.68       $ 3.59       $ 3.71   

Diluted earnings per share

   $ 1.91       $ 1.66       $ 3.57       $ 3.68   

Dividends declared per share

   $ 0.18       $ 0.12       $ 0.36       $ 0.24   

See accompanying notes to condensed consolidated financial statements (unaudited).

 

4


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REINSURANCE GROUP OF AMERICA, INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)

(Unaudited)

 

                                                                                           
    Three months ended June 30,     Six months ended June 30,  
    2012     2011     2012     2011  

Comprehensive income:

       

Net income

  $ 141,111      $ 123,944      $ 264,429      $ 272,864   

Other comprehensive income, net of income tax:

       

Change in foreign currency translation adjustments

    (16,865)        11,487        7,215        35,894   

Change in net unrealized gain on investments

    203,156        151,582        167,741        115,764   

Change in other-than-temporary impairment losses on fixed maturity securities

    (106)        (190)        4,588        (190)   

Changes in pension and other postretirement plan adjustments

    1,211        358        1,501        572   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total other comprehensive income

    187,396        163,237        181,045        152,040   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total comprehensive income, net of income tax

  $ 328,507      $ 287,181      $ 445,474      $ 424,904   
 

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

5


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REINSURANCE GROUP OF AMERICA, INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

                                             
    Six months ended June 30,  
    2012     2011  
    (Dollars in thousands)  

Cash Flows from Operating Activities:

   

Net income

   $ 264,429       $ 272,864   

Adjustments to reconcile net income to net cash provided by

operating activities:

   

Change in operating assets and liabilities:

   

Accrued investment income

    (38,182)        (31,378)   

Premiums receivable and other reinsurance balances

    (47,370)        66,922   

Deferred policy acquisition costs

    (63,690)        61,339   

Reinsurance ceded receivable balances

    (540)        (11,307)   

Future policy benefits, other policy claims and benefits, and
other reinsurance balances

    755,790        332,611   

Deferred income taxes

    (5,469)        (42,189)   

Other assets and other liabilities, net

    62,682       41,262   

Amortization of net investment premiums, discounts and other

    (69,347)        (67,755)   

Investment related gains, net

    (67,321)        (151,008)   

Excess tax benefits from share-based payment arrangement

    24        (2,690)   

Other, net

    27,251        69,143   
 

 

 

   

 

 

 

Net cash provided by operating activities

    818,257        537,814   

Cash Flows from Investing Activities:

   

Sales of fixed maturity securities available-for-sale

    1,759,932        1,791,826   

Maturities of fixed maturity securities available-for-sale

    104,008        164,043   

Purchases of fixed maturity securities available-for-sale

    (2,518,580)        (2,341,291)   

Cash invested in mortgage loans

    (225,005)        (44,679)   

Cash invested in policy loans

    (1,589)        (8,928)   

Cash invested in funds withheld at interest

    (60,145)        (10,563)   

Principal payments on mortgage loans on real estate

    46,313        19,283   

Principal payments on policy loans

    11,752        7,683   

Change in short-term investments and other invested assets

    98,530        (74,600)   
 

 

 

   

 

 

 

Net cash used in investing activities

    (784,784)        (497,226)   

Cash Flows from Financing Activities:

   

Dividends to stockholders

    (26,524)        (17,703)   

Repurchase of collateral finance facility securities

    --        (7,586)   

Net proceeds from long-term debt issuance

    --        394,410   

Proceeds from redemption and remarketing of trust preferred securities

    --        154,588   

Maturity of trust preferred securities

    --        (159,455)   

Purchases of treasury stock

    (6,924)        (340,220)   

Excess tax benefits from share-based payment arrangement

    (24)        2,690   

Exercise of stock options, net

    (651)        15,605   

Change in cash collateral for derivative positions

    (15,096)        8,010   

Deposits on universal life and
other investment type policies and contracts

    79,134        288,424   

Withdrawals on universal life and
other investment type policies and contracts

    (70,753)        (147,774)   
 

 

 

   

 

 

 

Net cash (used in) provided by financing activities

    (40,838)        190,989   

Effect of exchange rate changes on cash

    1,836        15,735   
 

 

 

   

 

 

 

Change in cash and cash equivalents

    (5,529)        247,312   

Cash and cash equivalents, beginning of period

    962,870        463,661   
 

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 957,341       $ 710,973   
 

 

 

   

 

 

 

Supplementary information:

   

Cash paid for interest

   $ 49,094       $ 47,054   

Cash paid for income taxes, net of refunds

   $ 40,735       $ 105,107   

See accompanying notes to condensed consolidated financial statements (unaudited).

 

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REINSURANCE GROUP OF AMERICA, INCORPORATED AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

1.       Organization and Basis of Presentation

Reinsurance Group of America, Incorporated (“RGA”) is an insurance holding company that was formed on December 31, 1992. The accompanying unaudited condensed consolidated financial statements of RGA and its subsidiaries (collectively, the “Company”) have been prepared in conformity with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation have been included. Results for the three and six months ended June 30, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012. There were no subsequent events, other than as disclosed in Note 13 – “Subsequent Event,” that would require disclosure or adjustments to the accompanying condensed consolidated financial statements through the date the financial statements were issued. These unaudited condensed consolidated financial statements include the accounts of RGA and its subsidiaries, all intercompany accounts and transactions have been eliminated. They should be read in conjunction with the Company’s 2011 Annual Report on Form 10-K (“2011 Annual Report”) filed with the Securities and Exchange Commission (“SEC”) on February 29, 2012 and the consolidated financial statements and notes thereto included in the Company’s 2012 Current Report on Form 8-K (“DAC Current Report”) filed with the SEC on July 13, 2012.

In October 2010, the Financial Accounting Standards Board (“FASB”) amended the general accounting principles for Financial Services – Insurance as it relates to accounting for costs associated with acquiring or renewing insurance contracts. This amendment clarified that only those costs that result directly from and are essential to the contract transaction and that would not have been incurred had the contract transaction not occurred can be capitalized. It also defined acquisitions costs as costs that are related directly to the successful acquisitions of new or renewal insurance contracts.

The Company filed the DAC Current Report in response to its adoption of the amendment described above on January 1, 2012 on a retrospective basis. The DAC Current Report reflects the impact of the adoption of this amendment on the Company’s previously filed financial statements and other disclosures included in the 2011 Annual Report, including that (i) only cost related directly to the successful acquisition of new or renewal contracts can be capitalized as deferred acquisition costs and (ii) all other acquisition-related costs must be expensed as incurred. In connection therewith, the Company adjusted the presentation of certain prior-period information to conform to the new accounting principles. The Company believes retrospective adoption provides the most comparable and useful financial information for financial statement users. Likewise, the financial statements and notes thereto presented in this Quarterly Report on Form 10-Q have been adjusted to reflect the retrospective adoption of these accounting principles.

The following tables present the effects of the retrospective adoption of the new accounting principles to the Company’s previously reported condensed consolidated statement of income and condensed consolidated statement of cash flows for the three and six months ended June 30, 2011 (in thousands, except share amounts):

 

                                                                                                           
    Three months ended June 30, 2011  
    As Reported     Adjustments     As Amended  

Benefits and Expenses:

     

Policy acquisition costs and other insurance expenses

    $ 261,282        $ 13,237        $ 274,519   

Income before income taxes

    200,406        (13,237)        187,169   

Provision for income taxes

    67,518        (4,293)        63,225   
 

 

 

   

 

 

   

 

 

 

Net income

    $ 132,888        $ (8,944)        $ 123,944   
 

 

 

   

 

 

   

 

 

 

Earnings per share:

     

Basic earnings per share

    $ 1.80        $ (0.12)        $ 1.68   

Diluted earnings per share

    $ 1.78        $ (0.12)        $ 1.66   

 

7


Table of Contents
                                                                                                           
    Six months ended June 30, 2011  
    As Reported     Adjustments     As Amended  

Benefits and Expenses:

     

Policy acquisition costs and other insurance expenses

    $ 592,435        $ 28,331       $ 620,766   

Income before income taxes

    442,255        (28,331)        413,924   

Provision for income taxes

    148,551        (7,491)        141,060   
 

 

 

   

 

 

   

 

 

 

Net income

    $ 293,704        $ (20,840)        $ 272,864   
 

 

 

   

 

 

   

 

 

 

Earnings per share:

     

Basic earnings per share

    $ 3.99        $ (0.28)        $ 3.71   

Diluted earnings per share

    $ 3.96        $ (0.28)        $ 3.68   
    Six months ended June 30, 2011  
    As Reported     Adjustments     As Amended  

Cash Flows from Operating Activities:

     

Net Income

    $ 293,704        $ (20,840)        $ 272,864   

Change in operating assets and liabilities

     

Deferred policy acquisition costs

    33,008        28,331        61,339   

Deferred income taxes

    (34,698)        (7,491)        (42,189)   

2.       Earnings Per Share

The following table sets forth the computation of basic and diluted earnings per share on net income (in thousands, except per share information):

 

                                                                                                                           
    Three months ended
June 30,
    Six months ended
June 30,
 
     2012     2011     2012     2011  

Earnings:

       

Net income (numerator for basic and diluted calculations)

    $ 141,111        $ 123,944        $ 264,429        $ 272,864   

Shares:

       

Weighted average outstanding shares (denominator for basic calculation)

    73,718        73,971        73,646        73,593   

Equivalent shares from outstanding stock options(1)

    336        559        402        591   
 

 

 

   

 

 

   

 

 

   

 

 

 

Denominator for diluted calculation

    74,054        74,530        74,048        74,184   
 

 

 

   

 

 

   

 

 

   

 

 

 

Earnings per share:

       

Basic

    $ 1.91        $ 1.68        $ 3.59        $ 3.71   

Diluted

    $ 1.91        $ 1.66        $ 3.57        $ 3.68   

 

(1)

Year-to-date amounts are the weighted average of the individual quarterly amounts.

The calculation of common equivalent shares does not include the impact of options having a strike or conversion price that exceeds the average stock price for the earnings period, as the result would be antidilutive. The calculation of common equivalent shares also excludes the impact of outstanding performance contingent shares, as the conditions necessary for their issuance have not been satisfied as of the end of the reporting period. For the three months ended June 30, 2012, approximately 1.8 million stock options and approximately 0.7 million performance contingent shares were excluded from the calculation. For the three months ended June 30, 2011, no stock options and approximately 0.8 million performance contingent shares were excluded from the calculation.

 

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3.      Accumulated Other Comprehensive Income

The balance of and changes in each component of accumulated other comprehensive income (“AOCI”) for the six months ended June 30, 2012 and 2011 are as follows (dollars in thousands):

 

                                                                                                                           
    Accumulated Other Comprehensive Income (Loss), Net of Income  Tax  
    Accumulated                    
    Currency     Unrealized     Pension and        
    Translation     Appreciation     Postretirement        
    Adjustments     of Securities     Benefits     Total  

Balance, December 31, 2011

  $ 229,795      $ 1,419,318      $ (30,960)      $ 1,618,153   

Change in component during the period

    7,215        172,329        1,501        181,045   
 

 

 

   

 

 

   

 

 

   

 

 

 

Balance, June 30, 2012

  $ 237,010      $ 1,591,647      $ (29,459)      $ 1,799,198   
 

 

 

   

 

 

   

 

 

   

 

 

 
    Accumulated Other Comprehensive Income (Loss), Net of Income  Tax  
    Accumulated                    
    Currency     Unrealized     Pension and        
    Translation     Appreciation     Postretirement        
    Adjustments     of Securities     Benefits     Total  

Balance, December 31, 2010

  $ 255,295      $ 651,449      $ (14,560)      $ 892,184   

Change in component during the period

    35,894        115,574        572        152,040   
 

 

 

   

 

 

   

 

 

   

 

 

 

Balance, June 30, 2011

  $ 291,189      $ 767,023      $ (13,988)      $ 1,044,224   
 

 

 

   

 

 

   

 

 

   

 

 

 

4.      Investments

The Company had total cash and invested assets of $32.5 billion and $25.9 billion at June 30, 2012 and December 31, 2011, respectively, as illustrated below (dollars in thousands):

 

                                                         
    June 30, 2012     December 31, 2011  

Fixed maturity securities, available-for-sale

  $ 17,244,192      $ 16,200,950   

Mortgage loans on real estate

    1,157,049        991,731   

Policy loans

    1,250,238        1,260,400   

Funds withheld at interest

    5,457,888        5,410,424   

Short-term investments

    49,981        88,566   

Investment receivable

    5,406,898        --   

Other invested assets

    940,605        1,012,541   

Cash and cash equivalents

    957,341        962,870   
 

 

 

   

 

 

 

Total cash and invested assets

  $ 32,464,192      $ 25,927,482   
 

 

 

   

 

 

 

All investments held by the Company are monitored for conformance to the qualitative and quantitative limits prescribed by the applicable jurisdiction’s insurance laws and regulations. In addition, the operating companies’ boards of directors periodically review their respective investment portfolios. The Company’s investment strategy is to maintain a predominantly investment-grade, fixed maturity securities portfolio, which will provide adequate liquidity for expected reinsurance obligations and maximize total return through prudent asset management. The Company’s asset/liability duration matching differs between operating segments. Based on Canadian reserve requirements, the Canadian liabilities are matched with long-duration Canadian assets. The duration of the Canadian portfolio exceeds twenty years. The average duration for all portfolios, when consolidated, ranges between eight and ten years.

The Company participates in a securities borrowing program whereby securities, which are not reflected on the Company’s condensed consolidated balance sheets, are borrowed from a third party. The Company is required to maintain a minimum of 100% of the market value of the borrowed securities as collateral. The Company had borrowed securities with an amortized cost and an estimated fair value of $237.5 million and $150.0 million as of June 30, 2012 and December 31, 2011, respectively. The borrowed securities are used to provide collateral under an affiliated reinsurance transaction.

 

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Investment Income, Net of Related Expenses

Major categories of investment income, net of related expenses consist of the following (dollars in thousands):

 

                                                                                                                   
    Three months ended
June 30,
       Six months ended
June 30,
 
    2012     2011        2012     2011  

Fixed maturity securities available-for-sale

  $ 193,388      $ 191,030         $ 384,806      $ 375,591   

Mortgage loans on real estate

    16,000        13,593           30,966        27,328   

Policy loans

    16,334        16,724           33,117        33,095   

Funds withheld at interest

    62,992        111,700           178,006        264,760   

Short-term investments

    781        883           1,769        1,808   

Investment receivable

    36,752                  36,752          

Other invested assets

    11,356        10,512           22,679        20,210   
 

 

 

   

 

 

      

 

 

   

 

 

 

Investment revenue

    337,603        344,442           688,095        722,792   

Investment expense

    (9,269)        (7,006)           (18,821)        (14,316)   
 

 

 

   

 

 

      

 

 

   

 

 

 

Investment income, net of related expenses

  $ 328,334      $ 337,436         $ 669,274      $ 708,476   
 

 

 

   

 

 

      

 

 

   

 

 

 

Investment Related Gains (Losses), Net

Investment related gains (losses), net consist of the following (dollars in thousands):

 

                                                                                                           
    Three months ended
June 30,
       Six months ended
June 30,
 
    2012     2011        2012     2011  

Fixed maturity and equity securities available for sale:

          

Other-than-temporary impairment losses on fixed maturities

  $ (1,959)      $ (5,582)         $ (9,566)      $ (7,138)   

Portion of loss recognized in accumulated other comprehensive income (before taxes)

    162        292           (7,059)        292   
 

 

 

   

 

 

      

 

 

   

 

 

 

Net other-than-temporary impairment losses on fixed maturities recognized in earnings

    (1,797)        (5,290)           (16,625)        (6,846)   

Impairment losses on equity securities

    (2,186)        (3,680)           (3,025)        (3,680)   

Gain on investment activity

    26,593        28,208           48,905        57,584   

Loss on investment activity

    (8,918)        (6,653)           (16,422)        (13,567)   

Other impairment losses and change in mortgage loan provision

    1,762        (3,186)           (4,081)        (2,610)   

Derivatives and other, net

    8,347        17,989           58,569        120,127   
 

 

 

   

 

 

      

 

 

   

 

 

 

Total investment related gains (losses), net

  $ 23,801      $ 27,388         $ 67,321      $ 151,008   
 

 

 

   

 

 

      

 

 

   

 

 

 

The net other-than-temporary impairment losses on fixed maturity securities recognized in earnings of $16.6 million and $6.8 million in the first six months of 2012 and 2011, respectively, are primarily due to a decline in value of structured securities with exposure to commercial mortgages and general credit deterioration in select corporate and foreign securities. The decreases in derivatives and other for the three and six months ended June 30, 2012 is primarily due to changes in the fair value of embedded derivative liabilities associated with modified coinsurance and funds withheld treaties and guaranteed minimum benefit riders.

During the three months ended June 30, 2012 and 2011, the Company sold fixed maturity and equity securities with fair values of $153.5 million and $135.0 million at losses of $8.9 million and $6.7 million, respectively. During the six months ended June 30, 2012 and 2011, the Company sold fixed maturity and equity securities with fair values of $401.6 million and $331.6 million at losses of $16.4 million and $13.6 million, respectively. The Company generally does not engage in short-term buying and selling of securities.

Other-Than-Temporary Impairments

As discussed in Note 2 – “Summary of Significant Accounting Policies” of the DAC Current Report, a portion of certain other-than-temporary impairment (“OTTI”) losses on fixed maturity securities are recognized in AOCI. For these securities the net amount recognized in earnings (“credit loss impairments”) represents the difference between the amortized cost of the security and the net present value of its projected future cash flows discounted at the effective interest rate implicit in the debt security prior to impairment. Any remaining difference between the fair value and amortized cost is recognized in AOCI. The following table sets forth the amount of pre-tax credit loss impairments on fixed maturity securities held by the Company as of the dates indicated, for which a portion of the OTTI loss was recognized in AOCI, and the corresponding changes in such amounts (dollars in thousands):

 

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    Three months ended June 30,  
    2012     2011  

Balance, beginning of period

  $ 62,236      $ 47,949   

Initial impairments - credit loss OTTI recognized on securities not previously impaired

    60        1,473   

Additional impairments - credit loss OTTI recognized on securities previously impaired

    161        3,780   

Credit loss OTTI previously recognized on securities impaired to fair value during the period

    (8,288)        --   

Credit loss OTTI previously recognized on securities which matured, paid down, prepaid or were sold during the period

    (8,266)        (718)   
 

 

 

   

 

 

 

Balance, end of period

  $ 45,903      $ 52,484   
 

 

 

   

 

 

 
    Six months ended June 30,  
    2012     2011  

Balance, beginning of period

  $ 63,947      $ 47,291   

Initial impairments - credit loss OTTI recognized on securities not previously impaired

    1,962        1,473   

Additional impairments - credit loss OTTI recognized on securities previously impaired

    8,881        4,438   

Credit loss OTTI previously recognized on securities impaired to fair value during the period

    (19,669)        --   

Credit loss OTTI previously recognized on securities which matured, paid down, prepaid or were sold during the period

    (9,218)        (718)   
 

 

 

   

 

 

 

Balance, end of period

  $ 45,903      $ 52,484   
 

 

 

   

 

 

 

Fixed Maturity and Equity Securities Available-for-Sale

The following tables provide information relating to investments in fixed maturity and equity securities by sector as of June 30, 2012 and December 31, 2011 (dollars in thousands):

 

                                                                                                                                                     
                                  Other-than-  
                      Estimated           temporary  
June 30, 2012:   Amortized     Unrealized     Unrealized     Fair     % of     impairments  
    Cost     Gains     Losses     Value     Total     in AOCI  

Available-for-sale:

           

Corporate securities

  $ 7,675,473      $ 792,051      $ 65,615      $ 8,401,909        48.7 %      $ --   

Canadian and Canadian provincial governments

    2,579,161        1,350,301        88        3,929,374        22.8           --   

Residential mortgage-backed securities

    1,007,793        78,727        7,958        1,078,562        6.3           (520)   

Asset-backed securities

    469,616        12,746        41,311        441,051        2.6           (3,521)   

Commercial mortgage-backed securities

    1,308,668        107,284        67,905        1,348,047        7.8           (6,119)   

U.S. government and agencies

    218,164        31,761        11        249,914        1.4           --   

State and political subdivisions

    204,108        34,066        8,398        229,776        1.3           --   

Other foreign government, supranational and foreign government-sponsored enterprises

    1,494,182        73,916        2,539        1,565,559        9.1           --   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total fixed maturity securities

  $ 14,957,165      $ 2,480,852      $ 193,825      $ 17,244,192        100.0 %      $ (10,160)   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Non-redeemable preferred stock

  $ 73,265      $ 5,170      $ 2,465      $ 75,970        95.9 %     

Other equity securities

    2,235        1,001              3,227        4.1        
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Total equity securities

  $ 75,500      $ 6,171      $ 2,474      $ 79,197        100.0 %     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

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                                  Other-than-  
                      Estimated           temporary  
December 31, 2011:   Amortized     Unrealized     Unrealized     Fair     % of     impairments  
    Cost     Gains     Losses     Value     Total     in AOCI  

Available-for-sale:

           

Corporate securities

  $ 6,931,958      $ 654,519      $ 125,371      $ 7,461,106        46.0 %      $ --   

Canadian and Canadian provincial governments

    2,507,802        1,362,160        29        3,869,933        23.9           --   

Residential mortgage-backed securities

    1,167,265        76,393        16,424        1,227,234        7.6           (1,042)   

Asset-backed securities

    443,974        11,692        53,675        401,991        2.5           (5,256)   

Commercial mortgage-backed securities

    1,233,958        87,750        79,489        1,242,219        7.7           (12,225)   

U.S. government and agencies

    341,087        32,976        61        374,002        2.3           --   

State and political subdivisions

    184,308        24,419        3,341        205,386        1.3           --   

Other foreign government, supranational and foreign government-sponsored enterprises

    1,372,528        50,127        3,576        1,419,079        8.7           --   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total fixed maturity securities

  $ 14,182,880      $ 2,300,036      $ 281,966      $ 16,200,950        100.0 %      $ (18,523)   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Non-redeemable preferred stock

  $ 82,488      $ 4,677      $ 8,982      $ 78,183        68.6 %     

Other equity securities

    35,352        1,903        1,538        35,717        31.4        
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Total equity securities

  $ 117,840      $ 6,580      $ 10,520      $ 113,900        100.0 %     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

The Company enters into various collateral arrangements that require both the pledging and acceptance of fixed maturity securities as collateral, which are excluded from the tables above. The Company pledged fixed maturity securities as collateral to derivative and reinsurance counterparties with an amortized cost of $23.3 million and $29.0 million, and an estimated fair value of $26.4 million and $32.6 million, as of June 30, 2012 and December 31, 2011 respectively, which are included in other invested assets in the condensed consolidated balance sheets.

The Company received fixed maturity securities as collateral from derivative and reinsurance counterparties with an estimated fair value of $31.4 million and $1.0 million, as of June 30, 2012 and December 31, 2011, respectively. Subject to certain constraints, the Company is permitted by contract to sell or re-pledge this collateral; however, as of June 30, 2012 and December 31, 2011, none of the collateral had been sold or re-pledged.

As of June 30, 2012, the Company held securities with a fair value of $1,185.1 million that were issued by the Canadian province of Ontario and $1,129.0 million that were issued by an entity that is guaranteed by the Canadian province of Quebec, both of which exceeded 10% of total stockholders’ equity. As of December 31, 2011, the Company held securities with a fair value of $1,171.2 million that were issued by the Canadian province of Ontario and $1,107.7 million that were issued by an entity that is guaranteed by the Canadian province of Quebec, both of which exceeded 10% of total stockholders’ equity.

The amortized cost and estimated fair value of fixed maturity securities available-for-sale at June 30, 2012 are shown by contractual maturity in the table below. Actual maturities can differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. At June 30, 2012, the contractual maturities of investments in fixed maturity securities were as follows (dollars in thousands):

 

    Amortized     Fair  
    Cost     Value  

Available-for-sale:

   

Due in one year or less

  $ 153,228      $ 155,606   

Due after one year through five years

    2,734,890        2,866,290   

Due after five year through ten years

    4,269,704        4,695,994   

Due after ten years

    5,013,266        6,658,641   

Asset and mortgage-backed securities

    2,786,077        2,867,661   
 

 

 

   

 

 

 

Total

  $             14,957,165      $             17,244,192   
 

 

 

   

 

 

 

 

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The tables below show the major industry types of the Company’s corporate fixed maturity holdings as of June 30, 2012 and December 31, 2011 (dollars in thousands):

 

June 30, 2012:   Amortized Cost     Estimated
Fair Value
    % of Total  

Finance

  $             2,618,913      $             2,762,847                    32.9%   

Industrial

    3,834,519        4,257,907        50.7     

Utility

    1,213,333        1,372,024        16.3     

Other

    8,708        9,131        0.1     
 

 

 

   

 

 

   

 

 

 

Total

  $ 7,675,473      $ 8,401,909        100.0%   
 

 

 

   

 

 

   

 

 

 

 

December 31, 2011:   Amortized Cost     Estimated
Fair Value
    % of Total  

Finance

  $             2,411,175      $             2,442,149                    32.7%   

Industrial

    3,402,099        3,760,187        50.4     

Utility

    1,115,384        1,255,090        16.9     

Other

    3,300        3,680        -      
 

 

 

   

 

 

   

 

 

 

Total

  $ 6,931,958      $ 7,461,106        100.0%   
 

 

 

   

 

 

   

 

 

 

The creditworthiness of Greece, Ireland, Italy, Portugal and Spain, commonly referred to as “Europe’s peripheral region,” is under ongoing stress and uncertainty due to high debt levels and economic weakness. The Company did not have exposure to sovereign fixed maturity securities, which includes global government agencies, from Europe’s peripheral region as of June 30, 2012 and December 31, 2011. In addition, the Company did not purchase or sell credit protection, through credit default swaps, referenced to sovereign entities of Europe’s peripheral region. The tables below show the Company’s exposure to sovereign fixed maturity securities originated in countries other than Europe’s peripheral region, included in “Other foreign government, supranational and foreign government-sponsored enterprises,” as of June 30, 2012 and December 31, 2011 (dollars in thousands):

 

June 30, 2012:   Amortized Cost     Estimated
Fair Value
    % of Total  

Australia

  $             475,097      $             490,913                    37.2%   

Japan

    214,420        220,390        16.7     

United Kingdom

    124,547        136,672        10.3     

South Africa

    66,353        68,691        5.2     

New Zealand

    52,684        53,231        4.0     

Cayman Islands

    48,133        53,013        4.0     

Germany

    40,406        42,863        3.2     

Other

    236,277        256,300        19.4     
 

 

 

   

 

 

   

 

 

 

Total

  $ 1,257,917      $ 1,322,073        100.0 %   
 

 

 

   

 

 

   

 

 

 

 

December 31, 2011:   Amortized Cost     Estimated
Fair Value
    % of Total  

Australia

  $             437,713      $             446,694                    39.1%   

Japan

    214,994        219,276        19.2     

United Kingdom

    118,618        130,106        11.4     

Germany

    72,926        75,741        6.6     

New Zealand

    51,547        51,544        4.5     

South Africa

    37,624        38,528        3.4     

South Korea

    30,592        32,025        2.8     

Other

    139,927        148,792        13.0     
 

 

 

   

 

 

   

 

 

 

Total

  $ 1,103,941      $ 1,142,706        100.0%   
 

 

 

   

 

 

   

 

 

 

The tables below show the Company’s exposure to non-sovereign fixed maturity and equity securities, based on the security’s country of issuance, from Europe’s peripheral region as of June 30, 2012 and December 31, 2011 (dollars in thousands):

 

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June 30, 2012:   Amortized Cost     Estimated
Fair Value
    % of Total  

Financial institutions:

     

Ireland

  $         3,477      $         3,864                6.1%   

Spain

    23,486        20,865        32.9     
 

 

 

   

 

 

   

 

 

 

Total financial institutions

    26,963        24,729        39.0     
 

 

 

   

 

 

   

 

 

 

Other:

     

Ireland

    12,476        13,042        20.6     

Italy

    3,544        3,438        5.4     

Spain

    24,420        22,148        35.0     
 

 

 

   

 

 

   

 

 

 

Total other

    40,440        38,628        61.0     
 

 

 

   

 

 

   

 

 

 

Total

  $ 67,403      $ 63,357        100.0%   
 

 

 

   

 

 

   

 

 

 
December 31, 2011:   Amortized Cost     Estimated
Fair Value
    % of Total  

Financial institutions:

     

Ireland

  $ 4,084      $ 4,397        5.9%   

Spain

    25,565        20,378        27.6     
 

 

 

   

 

 

   

 

 

 

Total financial institutions

    29,649        24,775        33.5     
 

 

 

   

 

 

   

 

 

 

Other:

     

Ireland

    12,474        13,149        17.8     

Italy

    2,898        2,808        3.8     

Spain

    34,459        33,137        44.9     
 

 

 

   

 

 

   

 

 

 

Total other

    49,831        49,094        66.5     
 

 

 

   

 

 

   

 

 

 

Total

  $ 79,480      $ 73,869        100.0%   
 

 

 

   

 

 

   

 

 

 

Unrealized Losses for Fixed Maturity and Equity Securities Available-for-Sale

The following table presents the total gross unrealized losses for the 752 and 940 fixed maturity and equity securities as of June 30, 2012 and December 31, 2011, respectively, where the estimated fair value had declined and remained below amortized cost by the indicated amount (dollars in thousands):

 

    June 30, 2012     December 31, 2011  
    Gross
Unrealized
Losses
    % of Total     Gross
Unrealized
Losses
    % of Total  

Less than 20%

  $         77,198                39.3%      $         131,155                44.8%   

20% or more for less than six months

    6,739        3.4          51,503        17.6     

20% or more for six months or greater

    112,362        57.3          109,828        37.6     
 

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 196,299        100.0%      $ 292,486        100.0%   
 

 

 

   

 

 

   

 

 

   

 

 

 

As of June 30, 2012 and December 31, 2011, respectively, 58.4% and 65.3% of these gross unrealized losses were associated with investment grade securities. The unrealized losses on these securities decreased primarily due to a decline in interest rates since December 31, 2011.

The Company’s determination of whether a decline in value is other-than-temporary includes analysis of the underlying credit and the extent and duration of a decline in value. The Company’s credit analysis of an investment includes determining whether the issuer is current on its contractual payments, evaluating whether it is probable that the Company will be able to collect all amounts due according to the contractual terms of the security and analyzing the overall ability of the Company to recover the amortized cost of the investment. The Company continues to consider valuation declines as a potential indicator of credit deterioration. The Company believes that due to fluctuating market conditions and an extended period of economic uncertainty, the extent and duration of a decline in value have become less indicative of when there has been credit deterioration with respect to a fixed maturity security since it may not have an impact on the ability of the issuer to service all scheduled payments and the Company’s evaluation of the recoverability of all contractual cash flows or the ability to recover an amount at least equal to amortized cost. In the Company’s impairment review process, the duration and severity of an unrealized loss position for equity securities are given greater weight and consideration given the lack of contractual cash flows or deferability features.

The following tables present the estimated fair values and gross unrealized losses, including other-than-temporary impairment losses reported in AOCI, for 752 and 940 fixed maturity and equity securities that have estimated fair values below amortized cost as of June 30, 2012 and December 31, 2011, respectively (dollars in thousands). These investments are presented by class and grade of security, as well as the length of time the related market value has remained below amortized cost.

 

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Table of Contents
                                                                                                                                   
    Less than 12 months     12 months or greater     Total  
June 30, 2012:   Estimated
       Fair Value      
    Gross
    Unrealized     
Losses
    Estimated
    Fair  Value    
    Gross
    Unrealized     
Losses
    Estimated
    Fair  Value    
    Gross
    Unrealized     
Losses
 

Investment grade securities:

           

Corporate securities

    $ 397,287        $ 12,765        $ 299,074       $ 41,570        $ 696,361        $ 54,335   

Canadian and Canadian provincial governments

    10,573        88        --        --        10,573        88   

Residential mortgage-backed securities

    36,106        425        54,545        6,573        90,651        6,998   

Asset-backed securities

    59,722        938        101,011        24,734        160,733        25,672   

Commercial mortgage-backed securities

    129,450        2,590        73,130        12,757        202,580        15,347   

U.S. government and agencies

    4,004        11        --        --        4,004        11   

State and political subdivisions

    24,191        2,532        18,688        5,866        42,879        8,398   

Other foreign government, supranational and foreign government-sponsored enterprises

    79,976        465        33,620        1,449        113,596        1,914   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total investment grade securities

    741,309        19,814        580,068        92,949        1,321,377        112,763   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Non-investment grade securities:

           

Corporate securities

    135,253        4,001        49,063        7,279        184,316        11,280   

Residential mortgage-backed securities

    2,025        178        9,858        782        11,883        960   

Asset-backed securities

          18        19,374        15,621        19,381        15,639   

Commercial mortgage-backed securities

    12,483        1,218        73,062        51,340        85,545        52,558   

Other foreign government, supranational and foreign government-sponsored enterprises

    11,779        625        --        --        11,779        625   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total non-investment grade securities

    161,547        6,040        151,357        75,022        312,904        81,062   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total fixed maturity securities

    $ 902,856        $ 25,854        $ 731,425        $ 167,971        $ 1,634,281        $ 193,825   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Non-redeemable preferred stock

    $ 1,743        $ 245        $ 17,280        $ 2,220        $ 19,023        $ 2,465   

Other equity securities

    --        --        309              309         
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total equity securities

    $ 1,743        $ 245        $ 17,589        $ 2,229        $ 19,332        $ 2,474   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    Less than 12 months     12 months or greater     Total  
December 31, 2011:   Estimated
      Fair Value      
    Gross
    Unrealized    
Losses
    Estimated
    Fair Value    
    Gross
    Unrealized    
Losses
    Estimated
    Fair Value    
    Gross
    Unrealized    
Losses
 

Investment grade securities:

           

Corporate securities

    $ 790,758        $ 40,180        $ 286,244        $ 63,117        $ 1,077,002        $ 103,297   

Canadian and Canadian provincial governments

    3,094        29        --        --        3,094        29   

Residential mortgage-backed securities

    128,622        3,549        58,388        10,382        187,010        13,931   

Asset-backed securities

    101,263        3,592        93,910        29,036        195,173        32,628   

Commercial mortgage-backed securities

    109,455        3,538        58,979        22,001        168,434        25,539   

U.S. government and agencies

    1,764        61        --        --        1,764        61   

State and political subdivisions

    21,045        1,845        12,273        1,268        33,318        3,113   

Other foreign government, supranational and foreign government-sponsored enterprises

    148,416        1,085        16,588        2,491        165,004        3,576   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total investment grade securities

    1,304,417        53,879        526,382        128,295        1,830,799        182,174   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Non-investment grade securities:

           

Corporate securities

    212,795        10,852        47,310        11,222        260,105        22,074   

Residential mortgage-backed securities

    23,199        712        10,459        1,781        33,658        2,493   

Asset-backed securities

    2,363        940        21,275        20,107        23,638        21,047   

Commercial mortgage-backed securities

    34,918        7,220        62,357        46,730        97,275        53,950   

State and political subdivisions

    4,000        228        --        --        4,000        228   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total non-investment grade securities

    277,275        19,952        141,401        79,840        418,676        99,792   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total fixed maturity securities

    $ 1,581,692        $ 73,831        $ 667,783        $ 208,135        $ 2,249,475        $ 281,966   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Non-redeemable preferred stock

    $ 19,516        $ 4,478        $ 15,694        $ 4,504        $ 35,210        $ 8,982   

Other equity securities

    1,662        602        5,905        936        7,567        1,538   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total equity securities

    $ 21,178        $ 5,080        $ 21,599        $ 5,440        $ 42,777        $ 10,520   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

As of June 30, 2012, the Company does not intend to sell these fixed maturity securities and does not believe it is more likely than not that it will be required to sell these fixed maturity securities before the recovery of the fair value up to the current amortized cost of the investment, which may be maturity. However, unforeseen facts and circumstances may cause the Company to sell fixed maturity securities in the ordinary course of managing its portfolio to meet certain diversification, credit quality, asset-liability management and liquidity guidelines.

 

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Table of Contents

As of June 30, 2012, the Company has the ability and intent to hold the equity securities until the recovery of the fair value up to the current cost of the investment. However, unforeseen facts and circumstances may cause the Company to sell equity securities in the ordinary course of managing its portfolio to meet certain diversification, credit quality and liquidity guidelines.

Unrealized losses on non-investment grade securities are principally related to asset-backed securities, residential mortgage-backed securities and commercial mortgage-backed securities and were the result of wider credit spreads resulting from higher risk premiums since the time of initial purchase, largely due to macroeconomic conditions and credit market deterioration, including the impact of lower real estate valuations. As of June 30, 2012 and December 31, 2011, approximately $67.7 million and $68.6 million, respectively, of gross unrealized losses greater than 12 months was associated with non-investment grade asset and mortgage-backed securities. This class of securities was evaluated based on actual and projected collateral losses relative to the securities’ positions in the respective securitization trusts and security specific expectations of cash flows. This evaluation also takes into consideration credit enhancement, measured in terms of (i) subordination from other classes of securities in the trust that are contractually obligated to absorb losses before the class of security the Company owns, and (ii) the expected impact of other structural features embedded in the securitization trust beneficial to the class of securities the Company owns, such as overcollateralization and excess spread.

Mortgage Loans on Real Estate

Mortgage loans represented approximately 3.6% and 3.8% of the Company’s cash and invested assets as of June 30, 2012 and December 31, 2011, respectively. The Company makes mortgage loans on income producing properties, such as apartments, retail and office buildings, light warehouses and light industrial facilities. Loan-to-value ratios at the time of loan approval are 75% or less.

Information regarding the Company’s credit quality indicators for its recorded investment in mortgage loans, gross of valuation allowances, as of June 30, 2012 and December 31, 2011 is as follows (dollars in thousands):

 

Internal credit risk grade:         June 30, 2012               December 31, 2011      

High investment grade

  $ 306,845      $ 252,333   

Investment grade

    656,968        526,608   

Average

    92,668        105,177   

Watch list

    95,727        91,037   

In or near default

    15,852        28,369   
 

 

 

   

 

 

 

Total

  $ 1,168,060      $ 1,003,524   
 

 

 

   

 

 

 

The age analysis of the Company’s past due recorded investment in mortgage loans, gross of valuation allowances, as of June 30, 2012 and December 31, 2011 is as follows (dollars in thousands):

 

          June 30, 2012               December 31, 2011      

31-60 days past due

  $ 18,211      $ 21,800   

61-90 days past due

    3,610        --   

Greater than 90 days

    14,367        20,316   
 

 

 

   

 

 

 

Total past due

    36,188        42,116   

Current

    1,131,872        961,408   
 

 

 

   

 

 

 

Total

  $ 1,168,060      $ 1,003,524   
 

 

 

   

 

 

 

The following table presents the recorded investment in mortgage loans, by method of evaluation of credit loss, and the related valuation allowances, by type of credit loss, at (dollars in thousands):

 

          June 30, 2012               December 31, 2011      

Mortgage loans:

   

Evaluated individually for credit losses

  $ 47,808      $ 60,904   

Evaluated collectively for credit losses

    1,120,252        942,620   
 

 

 

   

 

 

 

Mortgage loans, gross of valuation allowances

    1,168,060        1,003,524   
 

 

 

   

 

 

 

Valuation allowances:

   

Specific for credit losses

    6,959        8,188   

Non-specifically identified credit losses

    4,052        3,605   
 

 

 

   

 

 

 

Total valuation allowances

    11,011        11,793   
 

 

 

   

 

 

 

Mortgage loans, net of valuation allowances

  $ 1,157,049      $ 991,731   
 

 

 

   

 

 

 

 

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Table of Contents

Information regarding the Company’s loan valuation allowances for mortgage loans for the three months ended June 30, 2012 and 2011 is as follows (dollars in thousands):

 

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

Balance, beginning of period

  $ 14,650      $ 5,664      $ 11,793      $ 6,239   

Charge-offs

    (1,876)        (1,157)        (4,069)        (1,157)   

Provision (release)

    (1,763)        3,185        3,287        2,610   
 

 

 

   

 

 

   

 

 

   

 

 

 

Balance, end of period

  $ 11,011      $ 7,692      $ 11,011      $ 7,692   
 

 

 

   

 

 

   

 

 

   

 

 

 

Information regarding the portion of the Company’s mortgage loans that were impaired as of June 30, 2012 and December 31, 2011 is as follows (dollars in thousands):

 

                                                                                                                       
    Unpaid
Principal
Balance
    Recorded
Investment
    Related
Allowance
    Carrying
Value
 

June 30, 2012:

       

Impaired mortgage loans with no valuation allowance recorded

  $ 10,066      $ 9,523      $ --     $ 9,523   

Impaired mortgage loans with valuation allowance recorded

    38,424        38,285        6,959        31,326   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total impaired mortgage loans

  $ 48,490      $ 47,808      $ 6,959      $ 40,849   
 

 

 

   

 

 

   

 

 

   

 

 

 

December 31, 2011:

       

Impaired mortgage loans with no valuation allowance recorded

  $ 32,088      $ 31,496      $ --     $ 31,496   

Impaired mortgage loans with valuation allowance recorded

    29,724        29,408        8,188        21,220   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total impaired mortgage loans

  $ 61,812      $ 60,904      $ 8,188      $ 52,716   
 

 

 

   

 

 

   

 

 

   

 

 

 

 

The Company’s average investment in impaired mortgage loans and the related interest income are reflected in the table below for the periods indicated (dollars in thousands):

 

   

    Three Months Ended  
    June 30, 2012     June 30, 2011  
    Average
Investment(1)
    Interest
Income
    Average
Investment(1)
    Interest
Income
 

Impaired mortgage loans with no valuation allowance recorded

  $ 10,585      $ 28      $ 12,720       $ 51   

Impaired mortgage loans with valuation allowance recorded

    41,747        410        23,908        209   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 52,332      $ 438      $ 36,628      $ 260   
 

 

 

   

 

 

   

 

 

   

 

 

 
       
    Six Months Ended  
    June 30, 2012     June 30, 2011  
    Average
Investment(1)
    Interest
Income
    Average
Investment(1)
    Interest
Income
 

Impaired mortgage loans with no valuation allowance recorded

  $ 17,555       $ 197      $ 14,114       $ 93   

Impaired mortgage loans with valuation allowance recorded

    37,634         718        22,187         453   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 55,189      $ 915      $ 36,301      $ 546   
 

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Average

recorded investment represents the average loan balances as of the beginning of period and all subsequent quarterly end of period balances.

The Company did not acquire any impaired mortgage loans during the six months ended June 30, 2012 and 2011. The Company had $14.4 million and $20.3 million of mortgage loans, gross of valuation allowances, that were on nonaccrual status at June 30, 2012 and December 31, 2011, respectively.

Investment Receivable

During the second quarter of 2012, the Company added a large fixed deferred annuity reinsurance transaction in its U.S. Asset Intensive sub-segment. This transaction increased the Company’s invested asset base by approximately $5.4 billion which is reflected on the condensed consolidated balance sheet as an investment receivable. The transaction is considered a non-cash transaction in the condensed consolidated statement of cash flows. Investment receivable represented approximately 16.7% of the Company’s cash and invested assets as of June 30, 2012 which represents cash, cash equivalents and invested assets, valued as of the effective date of the transaction, and the related accrued investment income expected to be received. The Company recorded these assets as a receivable since they were not received until July 31, 2012 and August 3, 2012, see Note 13 – “Subsequent Event” for more information.

 

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Table of Contents

Other Invested Assets

Other invested assets include equity securities, limited partnership interests, structured loans and derivative contracts. Other invested assets represented approximately 2.9% and 3.9% of the Company’s cash and invested assets as of June 30, 2012 and December 31, 2011, respectively. Carrying values of these assets as of June 30, 2012 and December 31, 2011 are as follows (dollars in thousands):

 

                                                                                 
    June 30, 2012     December 31, 2011  

Equity securities

  $ 79,197      $ 113,900   

Limited partnerships and joint ventures

    300,385        251,315   

Structured loans

    238,367        281,022   

Derivatives

    250,460        257,050   

Other

    72,196        109,254   
 

 

 

   

 

 

 

Total other invested assets

  $ 940,605      $ 1,012,541   
 

 

 

   

 

 

 

5.       Derivative Instruments

The following table presents the notional amounts and fair value of derivative instruments as of June 30, 2012 and December 31, 2011 (dollars in thousands):

 

                                                                                                                                                           
    June 30, 2012     December 31, 2011  
    Notional     Carrying Value/Fair Value     Notional     Carrying Value/Fair Value  
    Amount     Assets     Liabilities     Amount     Assets     Liabilities  

Derivatives not designated as hedging instruments:

           

Interest rate swaps(1)

    $ 2,875,588        $ 344,157        $ 188,142        $ 2,748,317        $ 184,842        $ 18,702   

Financial futures(1)

    245,481        --        --        277,814        --        --   

Foreign currency forwards(1)

    44,400        3,275        --        24,400        4,560        --   

Consumer price index swaps(1)

    101,455        388        --        101,069        766        --   

Credit default swaps(1)

    644,500        990        7,812       649,500        1,313        10,949   

Equity options(1)

    710,461        94,300        --        510,073        90,106        --   

Synthetic guaranteed investment contracts
(“GICs”)(1)

    1,003,914        --        --        --        --        --   

Embedded derivatives in:

           

Modified coinsurance or funds
withheld arrangements(2)

    --        --        375,337        --        --        361,456   

Indexed annuity products(3)

    --        4,416        733,655        --        4,945        751,523   

Variable annuity products(3)

    --        --        205,272        --        --        276,718   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total non-hedging derivatives

    5,625,799        447,526        1,510,218        4,311,173        286,532        1,419,348   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Derivatives designated as hedging instruments:

           

Interest rate swaps(1)

    56,465        1,044        325        56,250        133        960   

Foreign currency swaps(1)

    646,653        236        23,390        621,578        286        23,996   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total hedging derivatives

    703,118        1,280        23,715        677,828        419        24,956   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total derivatives

    $ 6,328,917        $ 448,806        $ 1,533,933        $ 4,989,001        $ 286,951        $ 1,444,304   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

Carried on the Company’s condensed consolidated balance sheets in other invested assets or other liabilities, at fair value.

(2)

Embedded liability is included on the condensed consolidated balance sheets with the host contract in funds withheld at interest, at fair value.

(3)

Embedded liability is included on the condensed consolidated balance sheets with the host contract in interest-sensitive contract liabilities, at fair value. Embedded asset is included on the condensed consolidated balance sheets in reinsurance ceded receivables.

Accounting for Derivative Instruments and Hedging Activities

The Company does not enter into derivative instruments for speculative purposes. As discussed below under “Non-qualifying Derivatives and Derivatives for Purposes Other Than Hedging,” the Company uses various derivative instruments for risk management purposes that either do not qualify or have not been qualified for hedge accounting treatment, including derivatives used to economically hedge changes in the fair value of liabilities associated with the reinsurance of variable annuities with guaranteed living benefits. As of June 30, 2012 and December 31, 2011, the Company held interest rate swaps that were designated and qualified as cash flow hedges of interest rate risk. As of June 30, 2012 and December 31, 2011, the Company held foreign currency swaps that were designated and qualified as fair value hedges of a portion of its net investment in its foreign operations. As of June 30, 2012 and December 31, 2011, the Company also had derivative instruments that were not designated as hedging instruments. See Note 2 – “Summary of Significant Accounting Policies” of the Company’s DAC Current Report for a detailed discussion of the accounting treatment for derivative instruments, including embedded derivatives. Derivative instruments are carried at fair value and generally require an insignificant amount of cash at inception of the contracts.

 

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Fair Value Hedges

During the fourth quarter of 2011 the Company removed the fair value hedge designation for its interest rate swaps. However, prior to the fourth quarter of 2011 the Company designated and accounted for certain interest rate swaps that convert fixed rate investments to floating rate investments as fair value hedges when they meet the requirements of the general accounting principles for Derivatives and Hedging. The gain or loss on the hedged item attributable to the hedged benchmark interest rate and the offsetting gain or loss on the related interest rate swaps for the three and six months ended June 30, 2011 were (dollars in thousands):

 

Type of Fair Value
Hedge

 

Hedged Item

  Gains (Losses)
Recognized for
Derivatives
    Gains (Losses)
Recognized for
Hedged Items
    Ineffectiveness
Recognized in
Investment Related
Gains (Losses)
 

For the three months ended June 30, 2011:

     

Interest rate swaps

  Fixed rate fixed maturities   $ (489)      $ 694     $ 205  

For the six months ended June 30, 2011:

     

Interest rate swaps

  Fixed rate fixed maturities   $ (266)      $ 596     $ 330  

A regression analysis was used, both at the inception of the hedge and on an ongoing basis, to determine whether each derivative used in a hedge transaction is highly effective in offsetting changes in the hedged item. All components of each derivative’s gain or loss were included in the assessment of hedge effectiveness.

Cash Flow Hedges

The Company designates and accounts for certain interest rate swaps, in which the cash flows are denominated in different currencies, commonly referred to as cross-currency swaps, as cash flow hedges when they meet the requirements of the general accounting principles for Derivatives and Hedging.

The following table presents the components of AOCI, before income tax, and the condensed consolidated income statement classification where the gain or loss is recognized related to cash flow hedges for the three months ended June 30, 2012 (dollars in thousands):

 

    Three months ended     Six months ended  
    June 30, 2012     June 30, 2012  

Accumulated other comprehensive income (loss), balance beginning of period

  $ (862)      $ (828)   

Gains (losses) deferred in other comprehensive income (loss) on the effective portion of cash flow hedges

    464        787   

Amounts reclassified to investment related gains (losses), net

    --        --   

Amounts reclassified to investment income

    (321)        (678)   
 

 

 

   

 

 

 

Accumulated other comprehensive income (loss), balance end of period

  $ (719)      $ (719)   
 

 

 

   

 

 

 

As of June 30, 2012, the before-tax deferred net gains on derivative instruments recorded in AOCI that are expected to be reclassified to earnings during the next twelve months are $0.9 million. This expectation is based on the anticipated interest payments on hedged investments in fixed maturity securities that will occur over the next twelve months, at which time the Company will recognize the deferred net gains (losses) as an adjustment to investment income over the term of the investment cash flows. There were no hedged forecasted transactions, other than the receipt or payment of variable interest payments on existing financial instruments, for the three and six months ended June 30, 2012. The Company had no derivative instruments that were designated and qualified as cash flow hedges for the three and six months ended June 30, 2011.

The following table presents the effects of derivatives in cash flow hedging relationships on the condensed consolidated statements of income and AOCI for the three and six months ended June 30, 2012 (dollars in thousands):

 

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Derivatives in Cash Flow

Hedging Relationships

  Amount of Gains
(Losses) Deferred in
AOCI on Derivatives
    Amount and Location of Gains (Losses)
Reclassified from AOCI into Income (Loss)
    Amount and Location of Gains (Losses)
Recognized in Income (Loss) on Derivatives
 
    (Effective Portion)     (Effective Portion)     (Ineffective Portion and Amounts Excluded
from Effectiveness Testing)
 
          Investment Related
Gains (Losses)
    Investment Income     Investment Related
Gains (Losses)
    Investment Income  

For the three months ended June 30, 2012:

         

Interest rate swaps

  $ 464     $ --      $ 321     $ 27     $ --   

For the six months ended June 30, 2012:

         

Interest rate swaps

  $ 787     $ --      $ 678     $ 3     $ --   

Hedges of Net Investments in Foreign Operations

The Company uses foreign currency swaps to hedge a portion of its net investment in certain foreign operations against adverse movements in exchange rates. The following table illustrates the Company’s net investments in foreign operations (“NIFO”) hedges for the three and six months ended June 30, 2012 and 2011 (dollars in thousands):

 

    Derivative Gains (Losses) Deferred in AOCI  
        For the three months ended             For the six months ended      

Type of NIFO Hedge (1) (2)

          2012                     2011                     2012                     2011          

Foreign currency swaps

  $ 6,642     $ (9,916)      $ (4,003)      $ (25,020)   

 

(1)

There were no sales or substantial liquidations of net investments in foreign operations that would have required the reclassification of gains or losses from accumulated other comprehensive income (loss) into investment income during the periods presented.

 

(2)

There was no ineffectiveness recognized for the Company’s hedges of net investments in foreign operations.

The cumulative foreign currency translation gain (loss) recorded in AOCI related to these hedges was $0.1 million and $4.1 million at June 30, 2012 and December 31, 2011, respectively. If a foreign operation was sold or substantially liquidated, the amounts in AOCI would be reclassified to the condensed consolidated statements of income. A pro rata portion would be reclassified upon partial sale of a foreign operation.

Non-qualifying Derivatives and Derivatives for Purposes Other Than Hedging

The Company uses various other derivative instruments for risk management purposes that either do not qualify or have not been qualified for hedge accounting treatment, including derivatives used to economically hedge changes in the fair value of liabilities associated with the reinsurance of variable annuities with guaranteed living benefits. The gain or loss related to the change in fair value for these derivative instruments is recognized in investment related gains (losses), in the condensed consolidated statements of income, except where otherwise noted. For the three months ended June 30, 2012 and 2011, the Company recognized investment related gains (losses) of $82.1 million and $28.5 million, respectively, and $(11.3) million and $2.6 million for the six months ended June 30, 2012 and 2011, respectively, related to derivatives (not including embedded derivatives) that do not qualify or have not been qualified for hedge accounting.

Interest Rate Swaps

Interest rate swaps are used by the Company primarily to reduce market risks from changes in interest rates and to alter interest rate exposure arising from mismatches between assets and liabilities (duration mismatches). With an interest rate swap, the Company agrees with another party to exchange, at specified intervals, the difference between two rates, which can be either fixed-rate or floating-rate interest amounts, tied to an agreed-upon notional principal amount. These transactions are executed pursuant to master agreements that provide for a single net payment or individual gross payments at each due date.

Financial Futures

Exchange-traded equity futures are used primarily to economically hedge liabilities embedded in certain variable annuity products. With exchange-traded equity futures transactions, the Company agrees to purchase or sell a specified number of contracts, the value of which is determined by the relevant stock indices, and to post variation margin on a daily basis in an amount equal to the difference between the daily estimated fair values of those contracts. The Company enters into exchange-traded equity futures with regulated futures commission merchants that are members of the exchange.

 

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Equity Options

Equity index options are used by the Company primarily to hedge minimum guarantees embedded in certain variable annuity products. To hedge against adverse changes in equity indices volatility, the Company buys put options. The contracts are net settled in cash based on differentials in the indices at the time of exercise and the strike price.

Consumer Price Index Swaps

Consumer price index (“CPI”) swaps are used by the Company primarily to economically hedge liabilities embedded in certain insurance products where value is directly affected by changes in a designated benchmark consumer price index. With a CPI swap transaction, the Company agrees with another party to exchange the actual amount of inflation realized over a specified period of time for a fixed amount of inflation determined at inception. These transactions are executed pursuant to master agreements that provide for a single net payment or individual gross payments to be made by the counterparty at each due date. Most of these swaps will require a single payment to be made by one counterparty at the maturity date of the swap.

Foreign Currency Swaps

Foreign currency swaps are used by the Company to reduce the risk from fluctuations in foreign currency exchange rates associated with its assets and liabilities denominated in foreign currencies. With a foreign currency swap transaction, the Company agrees with another party to exchange, at specified intervals, the difference between one currency and another at a forward exchange rate calculated by reference to an agreed upon principal amount. The principal amount of each currency is exchanged at the inception and termination of the currency swap by each party. The Company may also use foreign currency swaps to economically hedge the foreign currency risk associated with certain of its net investments in foreign operations.

Foreign Currency Forwards

Foreign currency forwards are used by the Company to reduce the risk from fluctuations in foreign currency exchange rates associated with its assets and liabilities denominated in foreign currencies. With a foreign currency forward transaction, the Company agrees with another party to deliver a specified amount of an identified currency at a specified future date. The price is agreed upon at the time of the contract and payment for such a contract is made in a different currency at the specified future date.

Credit Default Swaps

The Company sells protection under single name credit default swaps and credit default swap index tranches to diversify its credit risk exposure in certain portfolios and, in combination with purchasing securities, to replicate characteristics of similar investments based on the credit quality and term of the credit default swap. Credit default triggers for indexed reference entities and single name reference entities are defined in the contracts. The Company’s maximum exposure to credit loss equals the notional value for credit default swaps. In the event of default for credit default swaps, the Company is typically required to pay the protection holder the full notional value less a recovery rate determined at auction.

The Company’s maximum amount at risk on credit default swaps, assuming the value of the underlying referenced securities is zero, was $619.0 million and $614.0 million at June 30, 2012 and December 31, 2011, respectively.

The Company also purchases credit default swaps to reduce its risk against a drop in bond prices due to credit concerns of certain bond issuers. If a credit event, as defined by the contract, occurs, the Company is able to put the bond back to the counterparty at par.

Synthetic GICs

The Company sells fee-based synthetic GICs which include investment-only, stable value contracts, to retirement plans. The assets are owned by the trustees of such plans, who invest the assets under the terms of investment guidelines agreed to with the Company. The contracts contain a guarantee of a minimum rate of return on participant balances supported by the underlying assets, and a guarantee of liquidity to meet certain participant-initiated plan cash flow requirements. These contracts are accounted for as derivatives, recorded at fair value and classified as interest rate derivatives.

Embedded Derivatives

The Company has certain embedded derivatives which are required to be separated from their host contracts and reported as derivatives. Host contracts include reinsurance treaties structured on a modified coinsurance (“modco”) or funds withheld basis. Changes in fair values of embedded derivatives on modco or funds withheld treaties are net of an increase (decrease) in investment related gains, net of $6.3 million and $(0.4) million for the three months and $(57.2) million and $(24.3) million for the six months ended June 30, 2012 and 2011, respectively, associated with the Company’s own credit risk. Changes in fair values of embedded derivatives on variable annuity contracts are net of an increase in investment related gains (losses), net of $14.6 million and $51.6 million for the three and six months ended June 30, 2012, respectively,

 

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associated with the Company’s own credit risk. Additionally, the Company reinsures equity-indexed annuity and variable annuity contracts with benefits that are considered embedded derivatives, including guaranteed minimum withdrawal benefits, guaranteed minimum accumulation benefits, and guaranteed minimum income benefits. The related gains (losses) and the effect on net income after amortization of deferred acquisition costs (“DAC”) and income taxes for the three months ended June 30, 2012 and 2011 are reflected in the following table (dollars in thousands):

 

    Three months ended
June 30,
    Six months ended
June 30,
 
    2012     2011     2012     2011  

Embedded derivatives in modco or funds withheld arrangements included in investment related gains

  $ (4,453)      $ 10,525      $ (13,881)      $ 101,060   

After the associated amortization of DAC and taxes, the related amounts included in net income

    (2,598)                3,788        (665)                22,971   

Embedded derivatives in variable annuity contracts included in investment related gains

    (74,929)        (25,860)        71,446        6,794   

After the associated amortization of DAC and taxes, the related amounts included in net income

    (16,175)        (7,414)        (1,093)        1,387   

Amounts related to embedded derivatives in equity-indexed annuities included in benefits and expenses

    27,138        (32,077)        7,399        (73,348)   

After the associated amortization of DAC and taxes, the related amounts included in net income

            15,378        (13,192)                29,248        (49,842)   

Non-hedging Derivatives

A summary of the effect of non-hedging derivatives, including embedded derivatives, on the Company’s income statement for the three and six months ended June 30, 2012 and 2011 is as follows (dollars in thousands):

 

        Gain (Loss) for the Three Months Ended
June 30,
 

Type of Non-hedging Derivative

 

Income Statement Location of Gain (Loss)

  2012     2011  

Interest rate swaps

  Investment related gains (losses), net   $ 73,342      $ 25,343   

Financial futures

  Investment related gains (losses), net     11,074        (2,873)   

Foreign currency forwards

  Investment related gains (losses), net     516        595   

CPI swaps

  Investment related gains (losses), net     (1,431)        503   

Credit default swaps

  Investment related gains (losses), net     (4,795)        988   

Equity options

  Investment related gains (losses), net     3,367        3,919   

Embedded derivatives in:

     

Modified coinsurance or funds withheld arrangements

  Investment related gains (losses), net     (4,453)        10,525   

Indexed annuity products

  Policy acquisition costs and other insurance expenses     859        4,026   

Indexed annuity products

  Interest credited     26,279        (36,101)   

Variable annuity products

  Investment related gains (losses), net     (74,929)        (25,860)   
   

 

 

   

 

 

 

Total non-hedging derivatives

    $ 29,829      $ (18,935)   
   

 

 

   

 

 

 
        Gain (Loss) for the Six Months Ended
June 30,
 

Type of Non-hedging Derivative

 

Income Statement Location of Gain (Loss)

  2012     2011  

Interest rate swaps

  Investment related gains (losses), net   $ 25,990      $ 14,613   

Financial futures

  Investment related gains (losses), net     (6,335)        (14,296)   

Foreign currency forwards

  Investment related gains (losses), net     (1,093)        (260)   

CPI swaps

  Investment related gains (losses), net     (2,233)        1,315   

Credit default swaps

  Investment related gains (losses), net     7,019        1,880   

Equity options

  Investment related gains (losses), net     (34,616)        (650)   

Embedded derivatives in:

     

Modified coinsurance or funds withheld arrangements

  Investment related gains (losses), net     (13,881)        101,060   

Indexed annuity products

  Policy acquisition costs and other insurance expenses     (139)        12,119   

Indexed annuity products

  Interest credited     7,538        (85,466)   

Variable annuity products

  Investment related gains (losses), net     71,446        6,794   
   

 

 

   

 

 

 

Total non-hedging derivatives

    $ 53,696      $ 37,109   
   

 

 

   

 

 

 

Credit Risk

The Company manages its credit risk related to over-the-counter derivatives by entering into transactions with creditworthy counterparties, maintaining collateral arrangements and through the use of master agreements that provide for a single net payment to be made by one counterparty to another at each due date and upon termination. As exchange-traded futures are affected through regulated exchanges, and positions are marked to market on a daily basis, the Company has minimal exposure to credit-related losses in the event of nonperformance by counterparties.

 

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The Company enters into various collateral arrangements, which require both the posting and accepting of collateral in connection with its derivative instruments. Collateral agreements contain attachment thresholds that may vary depending on the posting party’s ratings. Additionally, a decline in the Company’s or the counterparty’s credit ratings to specified levels could result in potential settlement of the derivative positions under the Company’s agreements with its counterparties. The Company also has exchange-traded futures, which require the maintenance of a margin account.

The Company’s credit exposure related to derivative contracts is generally limited to the fair value at the reporting date plus or minus any collateral posted or held by the Company. Information regarding the Company’s credit exposure related to its over-the-counter derivative contracts and margin account for exchange-traded futures at June 30, 2012 and December 31, 2011 are reflected in the following table (dollars in thousands):

 

                                                               
    June 30, 2012     December 31, 2011  

Estimated fair value of derivatives in net asset position

  $ 224,721      $ 227,399   

Securities pledged to counterparties as collateral(1)

    22,654        27,052   

Cash pledged from counterparties as collateral(2)

    (226,384)        (241,480)   

Securities pledged from counterparties as collateral(3)

    (31,404)        (997)   
 

 

 

   

 

 

 

Net credit exposure

  $ (10,413)      $ 11,974   
 

 

 

   

 

 

 

Margin account related to exchange-traded futures(2)

  $ 9,564      $ 18,153   
 

 

 

   

 

 

 

 

(1)

Consists of U.S. Treasury securities, included in other invested assets.

(2)

Included in cash and cash equivalents.

(3)

Consists of U.S. Treasury securities.

6.      Fair Value of Assets and Liabilities

Fair Value Measurement

General accounting principles for Fair Value Measurements and Disclosures define fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. These principles also establish a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value and describes three levels of inputs that may be used to measure fair value:

 

Level 1

Quoted prices in active markets for identical assets or liabilities. The Company’s Level 1 assets and liabilities include investment securities that are traded in exchange markets.

 

Level 2

Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or market standard valuation techniques and assumptions with significant inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Such observable inputs include benchmarking prices for similar assets in active, liquid markets, quoted prices in markets that are not active and observable yields and spreads in the market. The Company’s Level 2 assets and liabilities include investment securities with quoted prices that are traded less frequently than exchange-traded instruments and derivative contracts whose values are determined using market standard valuation techniques. This category primarily includes corporate securities, Canadian and Canadian provincial government securities, and residential and commercial mortgage-backed securities, among others. Level 2 valuations are generally obtained from third party pricing services for identical or comparable assets or liabilities or through the use of valuation methodologies using observable market inputs. Prices from services are validated through analytical reviews and assessment of current market activity.

 

Level 3

Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the related assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using market standard valuation techniques described above. When observable inputs are not available, the market standard techniques for determining the estimated fair value of certain securities that trade infrequently, and therefore have little transparency, rely on inputs that are significant to the estimated fair value and that are not observable in the market or cannot be derived principally from or corroborated by observable market data. These unobservable inputs can be based in large part on management judgment or estimation and cannot be supported by reference to market activity. Even though unobservable, management believes these inputs are based on assumptions deemed appropriate given the circumstances and consistent with what other market participants would use when pricing similar assets and liabilities. For the Company’s invested assets, this category generally includes corporate securities (primarily private placements), asset-backed securities (including those with exposure to subprime mortgages), and to a lesser extent, certain residential and commercial mortgage-backed securities, among others.

 

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Prices are determined using valuation methodologies such as discounted cash flow models and other similar techniques. Non-binding broker quotes, which are utilized when pricing service information is not available, are reviewed for reasonableness based on the Company’s understanding of the market, and are generally considered Level 3. Under certain circumstances, based on its observations of transactions in active markets, the Company may conclude the prices received from independent third party pricing services or brokers are not reasonable or reflective of market activity. In those instances, the Company would apply internally developed valuation techniques to the related assets or liabilities. Additionally, the Company’s embedded derivatives, all of which are associated with reinsurance treaties, are classified in Level 3 since their values include significant unobservable inputs.

When inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest priority level input that is significant to the fair value measurement in its entirety. For example, a Level 3 fair value measurement may include inputs that are observable (Levels 1 and 2) and unobservable (Level 3). Therefore, gains and losses for such assets and liabilities categorized within Level 3 may include changes in fair value that are attributable to both observable inputs (Levels 1 and 2) and unobservable inputs (Level 3).

Assets and Liabilities by Hierarchy Level

Assets and liabilities measured at fair value on a recurring basis as of June 30, 2012 and December 31, 2011 are summarized below (dollars in thousands):

 

                                                                                                               
June 30, 2012:         Fair Value Measurements Using:  
    Total     Level 1     Level 2     Level 3  

Assets:

       

Fixed maturity securities – available-for-sale:

       

Corporate securities

  $ 8,401,909      $ 69,954      $ 7,337,941      $ 994,014   

Canadian and Canadian provincial governments

    3,929,374        --        3,929,374        --   

Residential mortgage-backed securities

    1,078,562        --        1,028,971        49,591   

Asset-backed securities

    441,051        --        312,693        128,358   

Commercial mortgage-backed securities

    1,348,047        --        1,232,314        115,733   

U.S. government and agencies securities

    249,914        182,787        67,127        --   

State and political subdivision securities

    229,776        --        215,290        14,486   

Other foreign government supranational and foreign
government-sponsored enterprises

    1,565,559        222,591        1,342,968        --   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total fixed maturity securities – available-for-sale

    17,244,192        475,332        15,466,678        1,302,182   

Funds withheld at interest – embedded derivatives

    (375,337)        --        --        (375,337)   

Cash equivalents

    378,595        378,595        --        --   

Short-term investments

    3,704        110        3,594        --   

Other invested assets:

       

Non-redeemable preferred stock

    75,970        62,131        13,839        --   

Other equity securities

    3,227        --        --        3,227   

Derivatives:

       

Interest rate swaps

    156,866        --        156,866        --   

Foreign currency forwards

    3,275        --        3,275        --   

CPI swaps

    388        --        388        --   

Credit default swaps

    (4,369)        --        (4,369)        --   

Equity options

    94,300        --        94,300        --   

Collateral

    26,448        20,813        5,635        --   

Other

    10,595        10,595        --        --   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total other invested assets

    366,700        93,539        269,934        3,227   

Reinsurance ceded receivable – embedded derivatives

    4,416        --        --        4,416   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 17,622,270      $ 947,576      $ 15,740,206      $ 934,488   
 

 

 

   

 

 

   

 

 

   

 

 

 

Liabilities:

       

Interest sensitive contract liabilities – embedded derivatives

  $ 938,927      $ --      $ --      $ 938,927   

Other liabilities:

       

Derivatives:

       

Interest rate swaps

    132        --        132        --   

Credit default swaps

    2,453        --        2,453        --   

Foreign currency swaps

    23,154        --        23,154        --   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total other liabilities

    25,739        --        25,739        --   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 964,666      $ --      $ 25,739      $ 938,927   
 

 

 

   

 

 

   

 

 

   

 

 

 

 

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December 31, 2011:         Fair Value Measurements Using:  
    Total     Level 1     Level 2     Level 3  

Assets:

       

Fixed maturity securities – available-for-sale:

       

Corporate securities

  $ 7,461,106      $ 76,097      $ 6,410,840      $ 974,169   

Canadian and Canadian provincial governments

    3,869,933        --        3,869,933        --   

Residential mortgage-backed securities

    1,227,234        --        1,145,579        81,655   

Asset-backed securities

    401,991        --        208,499        193,492   

Commercial mortgage-backed securities

    1,242,219        --        1,126,243        115,976   

U.S. government and agencies securities

    374,002        300,514        73,488        --   

State and political subdivision securities

    205,386        12,894        182,119        10,373   

Other foreign government, supranational and foreign
government-sponsored enterprises

    1,419,079        223,440        1,195,639        --   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total fixed maturity securities – available-for-sale

    16,200,950        612,945        14,212,340        1,375,665   

Funds withheld at interest – embedded derivatives

    (361,456)        --        --        (361,456)   

Cash equivalents

    504,522        504,522        --        --   

Short-term investments

    46,671        37,155        9,516        --   

Other invested assets:

       

Non-redeemable preferred stock

    78,183        58,906        19,277        --   

Other equity securities

    35,717        5,308        18,920        11,489   

Derivatives:

       

Interest rate swaps

    168,484        --        168,484        --   

Foreign currency forwards

    4,560        --        4,560        --   

CPI swaps

    766        --        766        --   

Credit default swaps

    (4,003)        --        (4,003)        --   

Equity options

    87,243        --        87,243        --   

Collateral

    32,622        27,052        5,570        --   

Other

    59,373        59,373        --        --   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total other invested assets

    462,945        150,639        300,817        11,489   

Reinsurance ceded receivable – embedded derivatives

    4,945        --        --        4,945   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 16,858,577      $ 1,305,261      $ 14,522,673      $ 1,030,643   
 

 

 

   

 

 

   

 

 

   

 

 

 

Liabilities:

       

Interest sensitive contract liabilities – embedded derivatives

  $ 1,028,241      $ --      $ --      $ 1,028,241   

Other liabilities:

       

Derivatives:

       

Interest rate swaps

    3,171        --        3,171        --   

Credit default swaps