XNYS:LNCPR Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012






 


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
                                           
 
FORM 10-Q
                                          
 
 
(Mark One)
x
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the quarterly period ended March 31, 2012
 OR

¨
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the transition period from              to             
 
Commission File Number:  1-6028
 
                                          
 
LINCOLN NATIONAL CORPORATION
(Exact name of registrant as specified in its charter)
 
                                          
 
   
               Indiana                
35-1140070
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
   
150 N. Radnor Chester Road, Suite A305, Radnor, Pennsylvania
19087
(Address of principal executive offices)
(Zip Code)
 
(484) 583-1400
(Registrant’s telephone number, including area code)
 
Not Applicable
(Former name, former address and former fiscal year, if changed since last report.)
 
                                          
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x    No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x    No ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):

Large accelerated filer x   Accelerated filer ¨ Non-accelerated filer ¨ (Do not check if a smaller reporting company)
Smaller reporting company ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ¨ No x
 
As of April 30, 2012, there were 285,414,653 shares of the registrant’s common stock outstanding.

 

       
 
 

 
Lincoln National Corporation
 
Table of Contents

Item
       
Page          
 
PART I
 
 
1.
Financial Statements
1
 
       
2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
40
 
   
Forward-Looking Statements – Cautionary Language
40
 
   
Introduction
41
 
   
    Executive Summary
41
 
   
    Critical Accounting Policies and Estimates
42
 
   
    Acquisitions and Dispositions
44
 
   
Results of Consolidated Operations
45
 
   
Results of Annuities
46
 
   
Results of Retirement Plan Services
51
 
   
Results of Life Insurance
57
 
   
Results of Group Protection
64
 
   
Results of Other Operations
67
 
   
Realized Gain (Loss) and Benefit Ratio Unlocking
69
 
   
Consolidated Investments
71
 
   
Review of Consolidated Financial Condition
85
 
   
    Liquidity and Capital Resources
85
 
   
Other Matters
88
 
   
    Other Factors Affecting Our Business
88
 
   
    Recent Accounting Pronouncements
88
 
     
3.
Quantitative and Qualitative Disclosures About Market Risk
88
 
       
4.
Controls and Procedures
91          
 
       
PART II
 
 
       
1.
Legal Proceedings
92
 
       
2.
Unregistered Sales of Equity Securities and Use of Proceeds
92
 
       
6.
Exhibits
92
 
       
 
Signatures
93
 
       
 
Exhibit Index for the Report on Form 10-Q
         E-1
 
 
 
 
 
 

 

PART I – FINANCIAL INFORMATION
Item 1.  Financial Statements
LINCOLN NATIONAL CORPORATION
CONSOLIDATED BALANCE SHEETS
(in millions, except share data)

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
As of
 
 
As of
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
March 31,
 
December 31,
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2012 
 
 
2011 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(Unaudited)
 
 
 
 
ASSETS
 
 
 
 
 
 
 
 
Investments:
 
 
 
 
 
 
 
 
 
Available-for-sale securities, at fair value:
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities (amortized cost: 2012 - $69,889; 2011 - $68,988)
 
$
 76,254 
 
 
$
 75,433 
 
 
 
Variable interest entities' fixed maturity securities (amortized cost: 2012 - $674; 2011 - $673)
 
 
 702 
 
 
 
 700 
 
 
 
Equity securities (cost: 2012 - $114; 2011 - $135)
 
 
 126 
 
 
 
 139 
 
 
Trading securities
 
 
 2,650 
 
 
 
 2,675 
 
 
Mortgage loans on real estate
 
 
 6,938 
 
 
 
 6,942 
 
 
Real estate
 
 
 113 
 
 
 
 137 
 
 
Policy loans
 
 
 2,842 
 
 
 
 2,884 
 
 
Derivative investments
 
 
 2,244 
 
 
 
 3,151 
 
 
Other investments
 
 
 1,043 
 
 
 
 1,069 
 
 
 
 
Total investments
 
 
 92,912 
 
 
 
 93,130 
 
Cash and invested cash
 
 
 3,516 
 
 
 
 4,510 
 
Deferred acquisition costs and value of business acquired
 
 
 6,880 
 
 
 
 6,776 
 
Premiums and fees receivable
 
 
 437 
 
 
 
 408 
 
Accrued investment income
 
 
 1,026 
 
 
 
 981 
 
Reinsurance recoverables
 
 
 6,534 
 
 
 
 6,526 
 
Funds withheld reinsurance assets
 
 
 866 
 
 
 
 874 
 
Goodwill
 
 
 2,273 
 
 
 
 2,273 
 
Other assets
 
 
 2,486 
 
 
 
 2,536 
 
Separate account assets
 
 
 91,088 
 
 
 
 83,477 
 
 
 
 
 
 
Total assets
 
$
 208,018 
 
 
$
 201,491 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
Future contract benefits
 
$
 18,784 
 
 
$
 19,813 
 
Other contract holder funds
 
 
 70,027 
 
 
 
 69,466 
 
Short-term debt
 
 
 300 
 
 
 
 300 
 
Long-term debt
 
 
 5,606 
 
 
 
 5,391 
 
Reinsurance related embedded derivatives
 
 
 158 
 
 
 
 168 
 
Funds withheld reinsurance liabilities
 
 
 1,043 
 
 
 
 1,045 
 
Deferred gain on business sold through reinsurance
 
 
 375 
 
 
 
 394 
 
Payables for collateral on investments
 
 
 2,875 
 
 
 
 3,733 
 
Variable interest entities' liabilities
 
 
 149 
 
 
 
 193 
 
Other liabilities
 
 
 4,352 
 
 
 
 4,273 
 
Separate account liabilities
 
 
 91,088 
 
 
 
 83,477 
 
 
 
 
 
Total liabilities
 
 
 194,757 
 
 
 
 188,253 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Contingencies and Commitments (See Note 8)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Stockholders' Equity
 
 
 
 
 
 
 
 
Preferred stock - 10,000,000 shares authorized; Series A - 9,632 and 10,072 shares
 
 
 
 
 
 
 
 
 
issued and outstanding as of March 31, 2012, and December 31, 2011, respectively
 
 
 - 
 
 
 
 - 
 
Common stock - 800,000,000 shares authorized; 285,412,303 and 291,319,222 shares
 
 
 
 
 
 
 
 
 
issued and outstanding as of March 31, 2012, and December 31, 2011, respectively
 
 
 7,448 
 
 
 
 7,590 
 
Retained earnings
 
 
 3,191 
 
 
 
 2,969 
 
Accumulated other comprehensive income (loss)
 
 
 2,622 
 
 
 
 2,679 
 
 
 
 
 
Total stockholders' equity
 
 
 13,261 
 
 
 
 13,238 
 
 
 
 
 
 
Total liabilities and stockholders' equity
 
$
 208,018 
 
 
$
 201,491 
 

See accompanying Notes to Consolidated Financial Statements
 
 

 
1

 
LINCOLN NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited, in millions, except per share data)
 
 

 
 
For the Three
 
 
 
Months Ended
 
 
 
March 31,
 
 
 
2012
 
2011
 
Revenues
 
 
 
 
 
Insurance premiums
  $ 589   $ 568  
Insurance fees
    907     818  
Net investment income
    1,166     1,191  
Realized gain (loss):
             
     Total other-than-temporary impairment losses on securities
    (97 )   (44 )
     Portion of loss recognized in other comprehensive income
    50     3  
          Net other-than-temporary impairment losses on securities
             
               recognized in earnings
    (47 )   (41 )
          Realized gain (loss), excluding other-than-temporary
             
               impairment losses on securities
    (38 )   43  
                    Total realized gain (loss)
    (85 )   2  
Amortization of deferred gain on business sold through reinsurance
    19     19  
Other revenues and fees
    118     120  
          Total revenues
    2,714     2,718  
Benefits and Expenses
             
Interest credited
    625     614  
Benefits
    858     835  
Underwriting, acquisition, insurance and other expenses
    856     768  
Interest and debt expense
    68     72  
     Total benefits and expenses
    2,407     2,289  
          Income (loss) from continuing operations before taxes
    307     429  
          Federal income tax expense (benefit)
    61     115  
               Income (loss) from continuing operations
    246     314  
               Income (loss) from discontinued operations, net of federal
             
                    income taxes
    (1 )   -  
                         Net income (loss)
    245     314  
                         Other comprehensive income (loss), net of tax
    (57 )   22  
                              Comprehensive income (loss)
  $ 188   $ 336  
 
             
Earnings (Loss) Per Common Share - Basic
             
Income (loss) from continuing operations
  $ 0.85   $ 1.00  
Income (loss) from discontinued operations
    -     -  
     Net income (loss)
  $ 0.85   $ 1.00  
 
             
Earnings (Loss) Per Common Share - Diluted
             
Income (loss) from continuing operations
  $ 0.83   $ 0.97  
Income (loss) from discontinued operations
    -     -  
     Net income (loss)
  $ 0.83   $ 0.97  

See accompanying Notes to Consolidated Financial Statements
 
 

 
2

 
LINCOLN NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(Unaudited, in millions, except per share data)
 
 

 
 
For the Three
 
 
 
Months Ended
 
 
 
March 31,
 
 
 
2012
 
2011
 
Common Stock
 
 
 
 
 
Balance as of beginning-of-year
  $ 7,590   $ 8,124  
Stock compensation/issued for benefit plans
    8     2  
Retirement of common stock/cancellation of shares
    (150 )   (62 )
     Balance as of end-of-period
    7,448     8,064  
 
             
Retained Earnings
             
Balance as of beginning-of-year
    2,969     3,933  
Cumulative effect from adoption of new accounting standards
    -     (1,095 )
Net income (loss)
    245     314  
Retirement of common stock
    -     (13 )
Dividends declared:  Common (2012 - $0.080; 2011 - $0.050)
    (23 )   (17 )
     Balance as of end-of-period
    3,191     3,122  
 
             
Accumulated Other Comprehensive Income (Loss)
             
Balance as of beginning-of-year
    2,679     748  
Cumulative effect from adoption of new accounting standards
    -     103  
Other comprehensive income (loss), net of tax
    (57 )   22  
     Balance as of end-of-period
    2,622     873  
          Total stockholders' equity as of end-of-period
  $ 13,261   $ 12,059  

See accompanying Notes to Consolidated Financial Statements
 
 

 
3

 

 
 
For the Three
 
 
 
Months Ended
 
 
 
March 31,
 
 
 
2012
 
2011
 
Cash Flows from Operating Activities
 
 
 
 
 
Net income (loss)
  $ 245   $ 314  
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
             
     Deferred acquisition costs, value of business acquired, deferred sales inducements
             
          and deferred front-end loads deferrals and interest, net of amortization
    (44 )   (31 )
     Trading securities purchases, sales and maturities, net
    15     5  
     Change in premiums and fees receivable
    (29 )   (66 )
     Change in accrued investment income
    (45 )   (56 )
     Change in future contract benefits and other contract holder funds
    (144 )   124  
     Change in reinsurance related assets and liabilities
    (2 )   (67 )
     Change in federal income tax accruals
    185     131  
     Realized (gain) loss
    85     (2 )
     Amortization of deferred gain on business sold through reinsurance
    (19 )   (19 )
     (Gain) loss on disposal of discontinued operations
    1     -  
     Other
    34     7  
          Net cash provided by (used in) operating activities
    282     340  
 
             
Cash Flows from Investing Activities
             
Purchases of available-for-sale securities
    (2,497 )   (3,111 )
Sales of available-for-sale securities
    185     556  
Maturities of available-for-sale securities
    1,341     1,431  
Purchases of other investments
    (830 )   (855 )
Sales or maturities of other investments
    780     740  
Increase (decrease) in payables for collateral on investments
    (858 )   (105 )
Other
    (34 )   (23 )
          Net cash provided by (used in) investing activities
    (1,913 )   (1,367 )
 
             
Cash Flows from Financing Activities
             
Issuance of long-term debt, net of issuance costs
    298     -  
Deposits of fixed account values, including the fixed portion of variable
    2,391     2,570  
Withdrawals of fixed account values, including the fixed portion of variable
    (1,320 )   (1,200 )
Transfers to and from separate accounts, net
    (556 )   (772 )
Common stock issued for benefit plans and excess tax benefits
    (3 )   (5 )
Repurchase of common stock
    (150 )   (75 )
Dividends paid to common and preferred stockholders
    (23 )   (16 )
          Net cash provided by (used in) financing activities
    637     502  
 
             
Net increase (decrease) in cash and invested cash, including discontinued operations
    (994 )   (525 )
Cash and invested cash, including discontinued operations, as of beginning-of-year
    4,510     2,741  
     Cash and invested cash, including discontinued operations, as of end-of-period
  $ 3,516   $ 2,216  

See accompanying Notes to Consolidated Financial Statements
 
 

 
4

 
LINCOLN NATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
 

1.  Nature of Operations and Basis of Presentation

Nature of Operations

Lincoln National Corporation and its majority-owned subsidiaries (“LNC” or the “Company,” which also may be referred to as “we,” “our” or “us”) operate multiple insurance businesses through four business segments.  See Note 13 for additional details.  The collective group of businesses uses “Lincoln Financial Group” as its marketing identity.  Through our business segments, we sell a wide range of wealth protection, accumulation and retirement income products.  These products include institutional and/or retail fixed and indexed annuities, variable annuities, universal life insurance (“UL”), variable universal life insurance (“VUL”), linked-benefit UL, term life insurance, mutual funds and group life, disability and dental.

Basis of Presentation

The accompanying unaudited consolidated financial statements are prepared in accordance with United States of America generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions for the Securities and Exchange Commission (“SEC”) Quarterly Report on Form 10-Q, including Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements.  Therefore, the information contained in the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 (“2011 Form 10-K”), should be read in connection with the reading of these interim unaudited consolidated financial statements.

Certain GAAP policies, which significantly affect the determination of financial position, results of operations and cash flows, are summarized in our 2011 Form 10-K.

In the opinion of management, these statements include all normal recurring adjustments necessary for a fair presentation of the Company’s results.  Operating results for the three month period ended March 31, 2012, are not necessarily indicative of the results that may be expected for the full year ending December 31, 2012.  All material intercompany accounts and transactions have been eliminated in consolidation.

See Note 2 “Financial Services – Insurance Industry Topic” below for information about the retrospective restatement of amounts due to the adoption of new accounting guidance.  In addition, certain amounts reported in prior years’ consolidated financial statements have been reclassified to conform to the presentation adopted in the current year.  These reclassifications had no effect on net income or stockholders’ equity of the prior years.

2.  New Accounting Standards

Adoption of New Accounting Standards

Comprehensive Income Topic

In June 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-05, “Presentation of Comprehensive Income” (“ASU 2011-05”), with an objective of increasing the prominence of items reported in other comprehensive income (“OCI”); however, in December 2011, the FASB deferred a portion of the presentation requirements by issuing ASU No. 2011-12, “Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05” (“ASU 2011- 12”).  For a more detailed description of ASU 2011-05 and ASU 2011-12, see “Future Adoption of New Accounting Standards – Comprehensive Income Topic” in Note 2 of our 2011 Form 10-K.  We adopted the provisions of ASU 2011-05 as of January 1, 2012, after considering the deferral in ASU 2011-12, and have included a single continuous statement of comprehensive income in Item 1 of this quarterly report on Form 10-Q for the quarterly period ended March 31, 2012.

Fair Value Measurements and Disclosures Topic

In May 2011, the FASB issued ASU No. 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards” (“ASU 2011-04”), which was issued to create a consistent framework for the application of fair value measurement across jurisdictions. For a more detailed description of ASU 2011-04 see “Future Adoption of New Accounting Standards – Fair Value Measurements and Disclosures Topic” in Note 2 of our 2011 Form 10-K.  We adopted the provisions of ASU 2011-04 effective January 1, 2012, and have included the additional disclosures required for fair value measurements in Note 12 for the quarterly period ended March 31, 2012.

 
5

 


Financial Services – Insurance Industry Topic

In October 2010, the FASB issued ASU No. 2010-26, “Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts” (“ASU 2010-26”), which clarifies the types of costs incurred by an insurance entity that can be capitalized in the acquisition of insurance contracts.  Only those costs incurred that result directly from and are essential to the successful acquisition of new or renewal insurance contracts may be capitalized as deferrable acquisition costs.  The determination of deferability must be made on a contract-level basis.

Prior to the adoption of ASU 2010-26, we defined deferred acquisition costs (“DAC”) as commissions and other costs of acquiring UL insurance, VUL insurance, traditional life insurance, annuities and other investments contracts that vary with and are related primarily to new or renewal business, regardless of whether the acquisition efforts were successful or unsuccessful.  Upon the adoption of ASU 2010-26, we revised our accounting policy to only defer acquisition costs directly related to successful contract acquisitions or renewals, and excluded from DAC those costs incurred for soliciting potential customers, market research, training, administration, management of distribution and underwriting functions, unsuccessful acquisition or renewal efforts and product development.  In addition, indirect acquisition costs including administrative costs, rent, depreciation, occupancy costs, equipment costs and other general overhead are excluded from DAC.  The costs that are considered non-deferrable acquisition costs under ASU 2010-26 are expensed in the period incurred.
 
 
We adopted the provisions of ASU 2010-26 as of January 1, 2012, and elected to retrospectively restate all prior periods.  The following summarizes the prior period increases (decreases) (in millions) reflected in our Consolidated Balance Sheets and Consolidated Statements of Stockholders’ Equity related to the adoption:

 
 
As of December 31,
 
 
 
2011
 
2010
 
Assets
 
 
 
 
 
Deferred acquisition costs
  $ (1,415 ) $ (1,516 )
 
             
Liabilities and Stockholders' Equity
             
Other liabilities - deferred income taxes
  $ (490 ) $ (524 )
 
             
Stockholders' equity:
             
     Retained earnings
    (1,157 )   (1,095 )
     Accumulated other comprehensive income (loss)
    232     103  
          Total stockholders' equity
    (925 )   (992 )
               Total liabilities and stockholders' equity
  $ (1,415 ) $ (1,516 )

The following summarizes the prior period increases (decreases) to income from continuing operations and earnings (loss) per share (“EPS”) (in millions, except per share data) reflected in our Consolidated Statements of Comprehensive Income (Loss) for the three months ended March 31, 2011, related to the adoption:

Revenues
 
 
 
Realized gain (loss)
  $ 4  
 
       
Expenses
       
Underwriting, acquisition, insurance and other expenses
    (43 )
     Income (loss) from continuing operations before taxes
    (39 )
     Federal income tax expense (benefit)
    14  
          Income (loss) from continuing operations
  $ (25 )
 
       
Earnings (Loss) Per Common Share - Basic
  $ (0.08 )
 
       
Earnings (Loss) Per Common Share - Diluted
  $ (0.08 )


 
6

 

Intangibles – Goodwill and Other Topic

In September 2011, the FASB issued ASU No. 2011-08, “Testing Goodwill for Impairment” (“ASU 2011-08”), which provides an option to first assess qualitative factors to determine if it is necessary to complete the two-step goodwill impairment test.  For a more detailed description of ASU 2011-08, see “Future Adoption of New Accounting Standards – Intangibles – Goodwill and Other Topic” in Note 2 of our 2011 Form 10-K.  We adopted the provisions of ASU 2011-08 effective January 1, 2012.  The adoption did not have a material effect on our consolidated financial condition and results of operations.
 
 
Transfers and Servicing Topic

In April 2011, the FASB issued ASU No. 2011-03, “Reconsideration of Effective Control for Repurchase Agreements” (“ASU 2011-03”), which revises the criteria for assessing effective control for repurchase agreements and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity.  For a more detailed description of ASU 2011-03, see “Future Adoption of New Accounting Standards – Transfers and Servicing Topic” in Note 2 of our 2011 Form 10-K.  We adopted the provisions of ASU 2011-03 effective January 1, 2012.  The adoption did not have a material effect on our consolidated financial condition and results of operations.

Future Adoption of New Accounting Standards

Balance Sheet Topic

In December 2011, the FASB issued ASU No. 2011-11, “Disclosures about Offsetting Assets and Liabilities” (“ASU 2011-11”), to address certain comparability issues between financial statements prepared in accordance with GAAP and those prepared in accordance with International Financial Reporting Standards.  For a more detailed description of ASU 2011-11, see “Future Adoption of New Accounting Standards – Balance Sheet Topic” in Note 2 of our 2011 Form 10-K.  We will adopt the disclosure requirements in ASU 2011-11 beginning with our first quarter 2013 financial statements and are currently evaluating the appropriate location for these disclosures in the notes to our financial statements.

3.  Variable Interest Entities (“VIEs”)
 
Consolidated VIEs
 
See Note 4 in our 2011 Form 10-K for a detailed discussion of our consolidated VIEs, which information is incorporated herein by reference.

The following summarizes information regarding the credit-linked note (“CLN”) structures (dollars in millions) as of March 31, 2012:

 
Amount and Date of Issuance
 
 
    $400     $200  
 
   
December
   
April
 
 
    2006     2007  
Original attachment point (subordination)
    5.50 %     2.05 %  
Current attachment point (subordination)
    4.17 %     1.48 %  
Maturity
12/20/2016
 
3/20/2017
 
Current rating of tranche
    B+  
Ba2
 
Current rating of underlying collateral pool
 
Aa1-B3
 
Aaa-Caa1
 
Number of defaults in underlying collateral pool
    2     2  
Number of entities
    123     99  
Number of countries
    19     22  


 
7

 

The following summarizes the exposure of the CLN structures’ underlying collateral by industry and rating as of March 31, 2012:

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
AAA
 
AA
 
A
 
BBB
 
BB
 
B
 
CCC
 
Total
Industry
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Telecommunications
%
 
0.3 
%
 
5.1 
%
 
4.8 
%
 
0.3 
%
 
0.5 
%
 
%
 
11.0 
%
Financial intermediaries
0.3 
%
 
2.8 
%
 
6.9 
%
 
0.5 
%
 
%
 
%
 
%
 
10.5 
%
Oil and gas
%
 
0.7 
%
 
1.0 
%
 
4.6 
%
 
%
 
%
 
%
 
6.3 
%
Utilities
%
 
%
 
2.6 
%
 
2.0 
%
 
%
 
%
 
%
 
4.6 
%
Chemicals and plastics
%
 
%
 
2.3 
%
 
1.2 
%
 
0.3 
%
 
%
 
%
 
3.8 
%
Drugs
0.3 
%
 
2.7 
%
 
0.7 
%
 
%
 
%
 
%
 
%
 
3.7 
%
Retailers (except food and drug)
%
 
%
 
2.1 
%
 
0.9 
%
 
0.5 
%
 
%
 
%
 
3.5 
%
Industrial equipment
%
 
%
 
3.0 
%
 
0.3 
%
 
%
 
%
 
%
 
3.3 
%
Sovereign
%
 
0.7 
%
 
1.6 
%
 
1.0 
%
 
%
 
%
 
%
 
3.3 
%
Food products
%
 
0.3 
%
 
1.8 
%
 
1.1 
%
 
%
 
%
 
%
 
3.2 
%
Conglomerates
%
 
2.6 
%
 
0.5 
%
 
%
 
%
 
%
 
%
 
3.1 
%
Forest products
%
 
%
 
%
 
1.6 
%
 
1.4 
%
 
%
 
%
 
3.0 
%
Other
%
 
2.5 
%
 
15.5 
%
 
17.8 
%
 
3.2 
%
 
1.4 
%
 
0.3 
%
 
40.7 
%
     Total
0.6 
%
 
12.6 
%
 
43.1 
%
 
35.8 
%
 
5.7 
%
 
1.9 
%
 
0.3 
%
 
100.0 
%

Asset and liability information (dollars in millions) for these consolidated VIEs included on our Consolidated Balance Sheets was as follows:

   
As of March 31, 2012
 
As of December 31, 2011
 
   
Number
 
 
 
 
 
Number
 
 
 
 
 
   
of
 
Notional
 
Carrying
 
of
 
Notional
 
Carrying
 
     Instruments  
Amounts
 
Value
 
Instruments
 
Amounts
 
Value
 
Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
     Asset-backed credit card loan
    N/A   $ -   $ 596     N/A   $ -   $ 592  
     U.S. Government bonds
    N/A     -     106     N/A     -     108  
Excess mortality swap
    1     100     -     1     100     -  
               Total assets (1)
    1   $ 100   $ 702     1   $ 100   $ 700  
                                       
Liabilities
                                     
Non-qualifying hedges:
                                     
     Credit default swaps
    2   $ 600   $ 224     2   $ 600   $ 295  
     Contingent forwards
    2     -     (3 )   2     -     (4 )
          Total non-qualifying hedges
    4     600     221     4     600     291  
Federal income tax
    N/A     -     (72 )   N/A     -     (98 )
               Total liabilities (2)
    4   $ 600   $ 149     4   $ 600   $ 193  

(1)  
     Reported in VIEs’ fixed maturity securities on our Consolidated Balance Sheets.
(2)  
     Reported in VIEs’ liabilities on our Consolidated Balance Sheets.

For details related to the fixed maturity available-for-sale (“AFS”) securities for these VIEs, see Note 4.

As described more fully in Note 1 of our 2011 Form 10-K, we regularly review our investment holdings for other-than-temporary impairment (“OTTI”).  Based upon this review, we believe that the fixed maturity securities were not other-than-temporarily impaired as of March 31, 2012.


 
8

 

The gains (losses) for these consolidated VIEs (in millions) recorded on our Consolidated Statements of Comprehensive Income (Loss) were as follows:

 
For the Three
 
 
Months Ended
 
 
March 31,
 
 
2012
 
2011
 
Non-Qualifying Hedges
 
 
 
 
Credit default swaps
$ 71   $ 8  
Contingent forwards
  (2 )   (2 )
     Total non-qualifying hedges (1)
$ 69   $ 6  

(1)  
     Reported in realized gain (loss) on our Consolidated Statements of Comprehensive Income (Loss).
 
Unconsolidated VIEs

See Note 4 in our 2011 Form 10-K for a detailed discussion of our unconsolidated VIEs, which information is incorporated herein by reference.

4.  Investments

AFS Securities

Pursuant to the Fair Value Measurements and Disclosures Topic of the FASB Accounting Standards CodificationTM (“ASC”), we have categorized AFS securities into a three-level hierarchy, based on the priority of the inputs to the respective valuation technique.  The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3), as described in Note 1 in our 2011 Form 10-K, which also includes additional disclosures regarding our fair value measurements.

The amortized cost, gross unrealized gains, losses and OTTI and fair value of AFS securities (in millions) were as follows:

 
 
As of March 31, 2012
 
 
 
Amortized
 
Gross Unrealized
 
Fair
 
 
 
Cost
 
Gains
 
Losses
 
OTTI
 
Value
 
Fixed maturity securities:
 
 
 
 
 
 
 
 
 
 
 
     Corporate bonds
  $ 55,255   $ 5,854   $ 407   $ 103   $ 60,599  
     U.S. Government bonds
    450     41     5     -     486  
     Foreign government bonds
    585     65     -     -     650  
     Residential mortgage-backed securities ("RMBS")
    7,196     524     48     100     7,572  
     Commercial mortgage-backed securities ("CMBS")
    1,533     76     67     19     1,523  
     Collateralized debt obligations ("CDOs")
    117     -     15     -     102  
     State and municipal bonds
    3,497     637     8     -     4,126  
     Hybrid and redeemable preferred securities
    1,256     62     122     -     1,196  
     VIEs' fixed maturity securities
    674     28     -     -     702  
          Total fixed maturity securities
    70,563     7,287     672     222     76,956  
Equity securities
    114     19     7     -     126  
               Total AFS securities
  $ 70,677   $ 7,306   $ 679   $ 222   $ 77,082  


 
9

 


 
 
As of December 31, 2011
 
 
 
Amortized
 
Gross Unrealized
 
Fair
 
 
 
Cost
 
Gains
 
Losses
 
OTTI
 
Value
 
Fixed maturity securities:
 
 
 
 
 
 
 
 
 
 
 
     Corporate bonds
  $ 53,661   $ 6,185   $ 517   $ 68   $ 59,261  
     U.S. Government bonds
    439     55     -     -     494  
     Foreign government bonds
    668     65     -     -     733  
     RMBS
    7,690     548     73     126     8,039  
     CMBS
    1,642     73     106     9     1,600  
     CDOs
    121     -     19     -     102  
     State and municipal bonds
    3,490     566     9     -     4,047  
     Hybrid and redeemable preferred securities
    1,277     50     170     -     1,157  
     VIEs' fixed maturity securities
    673     27     -     -     700  
          Total fixed maturity securities
    69,661     7,569     894     203     76,133  
Equity securities
    135     16     12     -     139  
               Total AFS securities
  $ 69,796   $ 7,585   $ 906   $ 203   $ 76,272  

The amortized cost and fair value of fixed maturity AFS securities by contractual maturities (in millions) were as follows:

 
 
As of March 31, 2012
 
 
 
Amortized
 
Fair
 
 
 
Cost
 
Value
 
Due in one year or less
  $ 2,854   $ 2,914  
Due after one year through five years
    12,020     12,955  
Due after five years through ten years
    22,816     25,040  
Due after ten years
    24,027     26,850  
     Subtotal
    61,717     67,759  
Mortgage-backed securities ("MBS")
    8,729     9,095  
CDOs
    117     102  
          Total fixed maturity AFS securities
  $ 70,563   $ 76,956  

Actual maturities may differ from contractual maturities because issuers may have the right to call or pre-pay obligations.


 
10

 

The fair value and gross unrealized losses, including the portion of OTTI recognized in OCI, of AFS securities (dollars in millions), aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, were as follows:

 
As of March 31, 2012
 
 
Less Than or Equal
 
Greater Than
 
 
 
 
to Twelve Months
 
Twelve Months
 
Total
 
 
 
 
Gross
 
 
 
Gross
 
 
 
Gross
 
 
 
 
Unrealized
 
 
 
Unrealized
 
 
 
Unrealized
 
 
Fair
 
Losses and
 
Fair
 
Losses and
 
Fair
 
Losses and
 
 
Value
 
OTTI
 
Value
 
OTTI
 
Value
 
OTTI
 
Fixed maturity securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
     Corporate bonds
  $ 3,186   $ 194   $ 1,335   $ 316   $ 4,521   $ 510  
     U.S. Government bonds
    213     5     1     -     214     5  
     RMBS
    572     99     351     49     923     148  
     CMBS
    119     22     130     64     249     86  
     CDOs
    3     1     75     14     78     15  
     State and municipal bonds
    2     -     26     8     28     8  
  Hybrid and redeemable preferred securities
    159     6     370     116     529     122  
          Total fixed maturity securities
    4,254     327     2,288     567     6,542     894  
Equity securities
    12     7     -     -     12     7  
               Total AFS securities
  $ 4,266   $ 334   $ 2,288   $ 567   $ 6,554   $ 901  
 
                                     
Total number of AFS securities in an unrealized loss position
    828  

 
As of December 31, 2011
 
 
Less Than or Equal
 
Greater Than
 
 
 
 
to Twelve Months
 
Twelve Months
 
Total
 
 
 
 
Gross
 
 
 
Gross
 
 
 
Gross
 
 
 
 
Unrealized
 
 
 
Unrealized
 
 
 
Unrealized
 
 
Fair
 
Losses and
 
Fair
 
Losses and
 
Fair
 
Losses and
 
 
Value
 
OTTI
 
Value
 
OTTI
 
Value
 
OTTI
 
Fixed maturity securities:
 
 
 
 
 
 
 
 
 
 
 
 
     Corporate bonds
$ 2,848   $ 162   $ 1,452   $ 423   $ 4,300   $ 585  
     RMBS
  565     125     429     74     994     199  
     CMBS
  178     15     146     100     324     115  
     CDOs
  9     1     80     18     89     19  
     State and municipal bonds
  31     -     30     9     61     9  
  Hybrid and redeemable preferred securities
  324     23     353     147     677     170  
          Total fixed maturity securities
  3,955     326     2,490     771     6,445     1,097  
Equity securities
  38     12     -     -     38     12  
               Total AFS securities
$ 3,993   $ 338   $ 2,490   $ 771   $ 6,483   $ 1,109  
 
                                   
Total number of AFS securities in an unrealized loss position
    897  

For information regarding our investments in VIEs, see Note 3.


 
11

 

We perform detailed analysis on the AFS securities backed by pools of residential and commercial mortgages that are most at risk of impairment based on factors discussed in Note 1 in our 2011 Form 10-K.  Selected information for these securities in a gross unrealized loss position (in millions) was as follows:

 
As of March 31, 2012
 
 
Amortized
 
Fair
 
Unrealized
 
 
Cost
 
Value
 
Loss
 
Total
 
 
 
 
 
 
AFS securities backed by pools of residential mortgages
$ 1,875   $ 1,480   $ 395  
AFS securities backed by pools of commercial mortgages
  367     270     97  
     Total
$ 2,242   $ 1,750   $ 492  
 
                 
Subject to Detailed Analysis
                 
AFS securities backed by pools of residential mortgages
$ 1,862   $ 1,467   $ 395  
AFS securities backed by pools of commercial mortgages
  109     59     50  
     Total
$ 1,971   $ 1,526   $ 445  

 
 
As of December 31, 2011
 
 
 
Amortized
 
Fair
 
Unrealized
 
 
 
Cost
 
Value
 
Loss
 
Total
 
 
 
 
 
 
 
AFS securities backed by pools of residential mortgages
  $ 2,023   $ 1,553   $ 470  
AFS securities backed by pools of commercial mortgages
    472     344     128  
     Total
  $ 2,495   $ 1,897   $ 598  
 
                   
Subject to Detailed Analysis
                   
AFS securities backed by pools of residential mortgages
  $ 2,015   $ 1,545   $ 470  
AFS securities backed by pools of commercial mortgages
    126     61     65  
     Total
  $ 2,141   $ 1,606   $ 535  

For the three months ended March 31, 2012 and 2011, we recorded OTTI for AFS securities backed by pools of residential and commercial mortgages of $21 million, pre-tax, and before associated amortization expense for DAC, value of business acquired (“VOBA”), deferred sales inducements (“DSI”) and deferred front-end loads (“DFEL”), of which $(21) million and $(26) million, respectively, was recognized in OCI and $42 million and $47 million, respectively, was recognized in net income (loss).

The fair value, gross unrealized losses, the portion of OTTI recognized in OCI (in millions) and number of AFS securities where the fair value had declined and remained below amortized cost by greater than 20% were as follows:

 
As of March 31, 2012
 
 
 
 
 
 
 
 
Number
 
Fair
 
Gross Unrealized
 
of
 
Value
 
Losses
 
OTTI
 
Securities (1)
Less than six months
$ 81   $ 32   $ 3     23
Six months or greater, but less than nine months
  111     42     14     19
Nine months or greater, but less than twelve months
  50     17     14     16
Twelve months or greater
  579     343     151     166
     Total
$ 821   $ 434   $ 182     224


 
12

 


 
As of December 31, 2011
 
 
 
 
 
 
 
 
Number
 
Fair
 
Gross Unrealized
 
of
 
Value
 
Losses
 
OTTI
 
Securities (1)
Less than six months
$ 385   $ 125   $ 31   56
Six months or greater, but less than nine months
  53     30     12   18
Nine months or greater, but less than twelve months
  2     -     1   7
Twelve months or greater
  615     470     111   175
     Total
$ 1,055   $ 625   $ 155   256

(1)  
     We may reflect a security in more than one aging category based on various purchase dates.

We regularly review our investment holdings for OTTI.  Our gross unrealized losses on AFS securities decreased $208 million for the three months ended March 31, 2012.  As discussed further below, we believe the unrealized loss position as of March 31, 2012, did not represent OTTI as we did not intend to sell these fixed maturity AFS securities, it is not more likely than not that we will be required to sell the fixed maturity AFS securities before recovery of their amortized cost basis, the estimated future cash flows were equal to or greater than the amortized cost basis of the debt securities, or we had the ability and intent to hold the equity AFS securities for a period of time sufficient for recovery.

Based upon this evaluation as of March 31, 2012, management believed we had the ability to generate adequate amounts of cash from our normal operations (e.g., insurance premiums and fees and investment income) to meet cash requirements with a prudent margin of safety without requiring the sale of our temporarily-impaired securities.

As of March 31, 2012, the unrealized losses associated with our corporate bond securities were attributable primarily to securities that were backed by commercial loans and individual issuer companies.  For our corporate bond securities with commercial loans as the underlying collateral, we evaluated the projected credit losses in the underlying collateral and concluded that we had sufficient subordination or other credit enhancement when compared with our estimate of credit losses for the individual security and we expected to recover the entire amortized cost for each security.  For individual issuers, we performed detailed analysis of the financial performance of the issuer and determined that we expected to recover the entire amortized cost for each security.

As of March 31, 2012, the unrealized losses associated with our MBS and CDOs were attributable primarily to collateral losses and credit spreads.  We assessed for credit impairment using a cash flow model as discussed above.  The key assumptions included default rates, severities and prepayment rates.  We estimated losses for a security by forecasting the underlying loans in each transaction.  The forecasted loan performance was used to project cash flows to the various tranches in the structure, as applicable.  Our forecasted cash flows also considered, as applicable, independent industry analyst reports and forecasts, sector credit ratings and other independent market data.  Based upon our assessment of the expected credit losses of the security given the performance of the underlying collateral compared to our subordination or other credit enhancement, we expected to recover the entire amortized cost basis of each security.

As of March 31, 2012, the unrealized losses associated with our hybrid and redeemable preferred securities were attributable primarily to wider credit spreads caused by illiquidity in the market and subordination within the capital structure, as well as credit risk of specific issuers.  For our hybrid and redeemable preferred securities, we evaluated the financial performance of the issuer based upon credit performance and investment ratings and determined we expected to recover the entire amortized cost of each security.


 
13

 

Changes in the amount of credit loss of OTTI recognized in net income (loss) where the portion related to other factors was recognized in OCI (in millions) on fixed maturity AFS securities were as follows:

 
For the Three
 
 
Months Ended
 
 
March 31,
 
 
2012
 
2011
 
Balance as of beginning-of-period
$ 390   $ 319  
     Increases attributable to:
           
          Credit losses on securities for which an OTTI was not previously recognized
  34     25  
          Credit losses on securities for which an OTTI was previously recognized
  23     22  
     Decreases attributable to:
           
          Securities sold
  (37 )   (14 )
               Balance as of end-of-period
$ 410   $ 352  

During the three months ended March 31, 2012 and 2011, we recorded credit losses on securities for which an OTTI was not previously recognized as we determined the cash flows expected to be collected would not be sufficient to recover the entire amortized cost basis of the debt security.  The credit losses we recorded on securities for which an OTTI was not previously recognized were attributable primarily to one or a combination of the following reasons:

·  
     Failure of the issuer of the security to make scheduled payments;
·  
     Deterioration of creditworthiness of the issuer;
·  
     Deterioration of conditions specifically related to the security;
·  
     Deterioration of fundamentals of the industry in which the issuer operates;
·  
     Deterioration of fundamentals in the economy including, but not limited to, higher unemployment and lower housing prices; and
·  
     Deterioration of the rating of the security by a rating agency.

We recognize the OTTI attributed to the noncredit portion as a separate component in OCI referred to as unrealized OTTI on AFS securities.

Details of the amount of credit loss of OTTI recognized in net income (loss) where the portion related to other factors was recognized in OCI (in millions), were as follows:

 
As of March 31, 2012
 
 
 
 
Gross Unrealized
 
 
 
OTTI in
 
 
Amortized
 
 
 
Losses and
 
Fair
 
Credit
 
 
Cost
 
Gains
 
OTTI
 
Value
 
Losses
 
Corporate bonds
$ 242   $ 1   $ 100   $ 143   $ 63  
RMBS
  688     4     100     592     290  
CMBS
  39     -     19     20     57  
     Total
$ 969   $ 5   $ 219   $ 755   $ 410  

 
As of December 31, 2011
 
 
 
 
Gross Unrealized
 
 
 
OTTI in
 
 
Amortized
 
 
 
Losses and
 
Fair
 
Credit
 
 
Cost
 
Gains
 
OTTI
 
Value
 
Losses
 
Corporate bonds
$ 169   $ 1   $ 67   $ 103   $ 51  
RMBS
  690     1     128     563     301  
CMBS
  17     -     10     7     38  
     Total
$ 876   $ 2   $ 205   $ 673   $ 390  


 
14

 

Mortgage Loans on Real Estate

Mortgage loans on real estate principally involve commercial real estate.  The commercial loans are geographically diversified throughout the U.S. with the largest concentrations in California and Texas, which accounted for approximately 32% of mortgage loans on real estate as of March 31, 2012, and December 31, 2011.

The following provides the current and past due composition of our mortgage loans on real estate (in millions):

 
 
As of
 
  As of
 
 
 
March 31,
 
December 31,
 
 
2012
 
  2011
 
Current
  $ 6,853   $ 6,858  
60 to 90 days past due
    -     26  
Greater than 90 days past due
    99     76  
Valuation allowance associated with impaired mortgage loans on real estate
    (27 )   (31 )
Unamortized premium (discount)
    13     13  
     Total carrying value
  $ 6,938   $ 6,942  

The number of impaired mortgage loans on real estate, each of which had an associated specific valuation allowance, and the carrying value of impaired mortgage loans on real estate (dollars in millions) were as follows:

 
 
As of
 
As of
 
 
March 31,
December 31,
 
 
2012
 
2011
 
Number of impaired mortgage loans on real estate
 
10
 
12
 
 
 
 
 
 
 
 
 
Principal balance of impaired mortgage loans on real estate
 
$
 85 
 
$
 100 
 
Valuation allowance associated with impaired mortgage loans on real estate
 
 
 (27
)
 
 (31
)
     Carrying value of impaired mortgage loans on real estate
 
$
 58 
 
$
 69 
 

The average carrying value on the impaired mortgage loans on real estate (in millions) was as follows:

 
For the Three
 
 
Months Ended
 
 
March 31,
 
 
2012
 
2011
 
Average carrying value for impaired mortgage loans on real estate
$ 64   $ 55  
Interest income recognized on impaired mortgage loans on real estate
  -     1  
Interest income collected on impaired mortgage loans on real estate
  -     1  


 
15

 

As described in Note 1 in our 2011 Form 10-K, we use the loan-to-value and debt-service coverage ratios as credit quality indicators for our mortgage loans, which were as follows (dollars in millions):

 
As of March 31, 2012
 
As of December 31, 2011
 
 
 
 
 
 
   
Debt-
 
 
   
 
   
Debt-
 
 
 
 
 
 
   
Service
 
 
   
 
   
Service
 
 
Principal
 
% of
 
Coverage
 
Principal
   
% of
 
Coverage
 
Loan-to-Value
Amount
 
Total
 
Ratio
 
Amount
   
Total
 
Ratio
 
Less than 65%
  $ 5,419   77.9   %     1.62   $ 5,338     76.7   <