Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
x
Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended
March 31, 2010
or
o
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 00
1-11339
Protective
Life Corporation
(Exact name of registrant as specified in its
charter)
Delaware
|
|
95-2492236
|
(State or other jurisdiction of
incorporation or organization)
|
|
(IRS Employer Identification Number)
|
2801
Highway 280 South
Birmingham,
Alabama 35223
(Address of principal executive offices and
zip code)
(205)
268-1000
(Registrants 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
o
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
o
No
o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer, or a smaller reporting company.
See definition of accelerated filer and large accelerated filer in Rule 12b-2
of the Exchange Act. (Check one):
Large accelerated filer
x
|
|
Accelerated Filer
o
|
|
|
|
Non-accelerated filer
o
|
|
Smaller Reporting Company
o
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b-2
of the Act). Yes
o
No
x
Number
of shares of Common Stock, $0.50 Par Value, outstanding as of May 5, 2010:
85,601,589
Table of Contents
PROTECTIVE LIFE CORPORATION
CONSOLIDATED
CONDENSED STATEMENTS OF INCOME
(Unaudited)
|
|
For
The Three Months Ended March 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
(Dollars In Thousands, Except Per Share Amounts)
|
|
Revenues
|
|
|
|
|
|
Premiums and policy fees
|
|
$
|
628,772
|
|
$
|
659,152
|
|
Reinsurance ceded
|
|
(305,829
|
)
|
(358,299
|
)
|
Net of reinsurance ceded
|
|
322,943
|
|
300,853
|
|
Net investment income
|
|
411,997
|
|
421,685
|
|
Realized investment gains (losses):
|
|
|
|
|
|
Derivative financial instruments
|
|
(23,072
|
)
|
92,433
|
|
All other investments
|
|
47,899
|
|
(41,843
|
)
|
Other-than-temporary impairment losses
|
|
(21,856
|
)
|
(117,314
|
)
|
Portion of loss recognized in other comprehensive income
(before taxes)
|
|
9,987
|
|
27,488
|
|
Net impairment losses recognized in earnings
|
|
(11,869
|
)
|
(89,826
|
)
|
Other income
|
|
43,872
|
|
38,663
|
|
Total revenues
|
|
791,770
|
|
721,965
|
|
Benefits and expenses
|
|
|
|
|
|
Benefits and settlement expenses, net of
reinsurance ceded:
(three months: 2010 - $302,701; 2009 - $334,694)
|
|
507,295
|
|
504,359
|
|
Amortization of deferred policy acquisition costs
and value
of business acquired
|
|
81,289
|
|
113,648
|
|
Other operating expenses, net of reinsurance ceded:
(three months: 2010 - $43,424; 2009 - $55,065)
|
|
101,910
|
|
71,802
|
|
Total benefits and expenses
|
|
690,494
|
|
689,809
|
|
Income before income tax
|
|
101,276
|
|
32,156
|
|
Income tax expense
|
|
31,570
|
|
10,021
|
|
Net income
|
|
69,706
|
|
22,135
|
|
Less: Net income (loss) attributable to
noncontrolling interests
|
|
(73
|
)
|
|
|
Net income available to PLCs
common shareowners
(1)
|
|
$
|
69,779
|
|
$
|
22,135
|
|
|
|
|
|
|
|
Net income available to PLCs common shareowners -
basic
|
|
$
|
0.81
|
|
$
|
0.31
|
|
Net income available to PLCs common shareowners -
diluted
|
|
$
|
0.80
|
|
$
|
0.31
|
|
Cash dividends paid per share
|
|
$
|
0.12
|
|
$
|
0.12
|
|
|
|
|
|
|
|
Average shares outstanding - basic
|
|
86,500,199
|
|
70,850,571
|
|
Average shares outstanding - diluted
|
|
87,551,386
|
|
71,392,134
|
|
(1)
Protective Life Corporation and subsidiaries
(PLC)
See Notes to Consolidated Condensed Financial
Statements
3
Table of Contents
PROTECTIVE
LIFE CORPORATION
CONSOLIDATED
CONDENSED BALANCE SHEETS
(Unaudited)
|
|
As
of
|
|
|
|
March 31,
|
|
December 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
(Dollars In Thousands)
|
|
Assets
|
|
|
|
|
|
Investments:
|
|
|
|
|
|
Fixed maturities, at fair value (amortized cost:
2010 - $23,142,353; 2009 - $23,228,317)
|
|
$
|
23,203,026
|
|
$
|
22,830,427
|
|
Equity securities, at fair value (cost: 2010 -
$281,726; 2009 - $280,615)
|
|
280,703
|
|
275,497
|
|
Mortgage loans (2010 includes: $990,739 related to
securitizations - See Note 4)
|
|
4,861,699
|
|
3,877,087
|
|
Investment real estate, net of accumulated
depreciation (2010 - $922; 2009 - $803)
|
|
25,068
|
|
25,188
|
|
Policy loans
|
|
783,580
|
|
794,276
|
|
Other long-term investments
|
|
198,014
|
|
204,754
|
|
Short-term investments
|
|
647,952
|
|
1,049,609
|
|
Total investments
|
|
30,000,042
|
|
29,056,838
|
|
Cash
|
|
202,934
|
|
205,325
|
|
Accrued investment income
|
|
308,779
|
|
285,350
|
|
Accounts and premiums receivable, net of allowance
for uncollectible amounts (2010 - $5,016; 2009 - $5,170)
|
|
49,941
|
|
56,216
|
|
Reinsurance receivables
|
|
5,445,109
|
|
5,333,401
|
|
Deferred policy acquisition costs and value of
business acquired
|
|
3,634,057
|
|
3,663,350
|
|
Goodwill
|
|
117,081
|
|
117,856
|
|
Property and equipment, net of accumulated
depreciation (2010 - $125,452; 2009 - $123,709)
|
|
36,909
|
|
37,037
|
|
Other assets
|
|
168,274
|
|
176,303
|
|
Income tax receivable
|
|
14,225
|
|
115,447
|
|
Deferred income tax
|
|
|
|
|
|
Assets related to separate accounts
|
|
|
|
|
|
Variable annuity
|
|
3,306,242
|
|
2,948,457
|
|
Variable universal life
|
|
334,134
|
|
316,007
|
|
Total Assets
|
|
$
|
43,617,727
|
|
$
|
42,311,587
|
|
Liabilities
|
|
|
|
|
|
Policy liabilities and accruals
|
|
$
|
18,676,646
|
|
$
|
18,548,267
|
|
Stable value product account balances
|
|
3,453,950
|
|
3,581,150
|
|
Annuity account balances
|
|
10,035,799
|
|
9,911,040
|
|
Other policyholders funds
|
|
534,740
|
|
515,078
|
|
Other liabilities
|
|
907,330
|
|
715,110
|
|
Mortgage loan backed certificates
|
|
110,679
|
|
|
|
Deferred income taxes
|
|
718,070
|
|
553,062
|
|
Non-recourse funding obligations
|
|
575,000
|
|
575,000
|
|
Long-term debt
|
|
1,619,852
|
|
1,644,852
|
|
Subordinated debt securities
|
|
524,743
|
|
524,743
|
|
Liabilities related to separate accounts
|
|
|
|
|
|
Variable annuity
|
|
3,306,242
|
|
2,948,457
|
|
Variable universal life
|
|
334,134
|
|
316,007
|
|
Total liabilities
|
|
40,797,185
|
|
39,832,766
|
|
Commitments and contingencies -
Note 7
|
|
|
|
|
|
Shareowners equity
|
|
|
|
|
|
Preferred Stock; $1 par value, shares authorized:
4,000,000; Issued: None
|
|
|
|
|
|
Common Stock, $.50 par value, shares authorized:
2010 and 2009 - 160,000,000; shares issued: 2010 and 2009 - 88,776,960
|
|
44,388
|
|
44,388
|
|
Additional paid-in-capital
|
|
579,915
|
|
576,887
|
|
Treasury stock, at cost (2010 - 3,175,602 shares;
2009 - 3,196,157 shares)
|
|
(25,997
|
)
|
(25,929
|
)
|
Retained earnings
|
|
2,278,443
|
|
2,204,644
|
|
Accumulated other comprehensive income (loss):
|
|
|
|
|
|
Net unrealized gains (losses) on investments, net
of income tax: (2010 -$22,469; 2009 - $(121,737))
|
|
41,729
|
|
(225,648
|
)
|
Net unrealized (losses) gains relating to
other-than-temporary impaired investments for which a portion has been
recognized in earnings, net of income tax: (2010 - $(20,199); 2009 -
$(16,704))
|
|
(37,513
|
)
|
(31,021
|
)
|
Accumulated loss - hedging, net of income tax:
(2010 - $(7,733); 2009 - $(10,182))
|
|
(14,361
|
)
|
(18,327
|
)
|
Postretirement benefits liability adjustment, net
of income tax: (2010 -$(24,538); 2009 - $(24,862))
|
|
(45,571
|
)
|
(46,173
|
)
|
Total Protective Life Corporations shareowners
equity
|
|
2,821,033
|
|
2,478,821
|
|
Noncontrolling interest
|
|
(491
|
)
|
|
|
Total equity
|
|
2,820,542
|
|
2,478,821
|
|
Total liabilities and shareowners
equity
|
|
$
|
43,617,727
|
|
$
|
42,311,587
|
|
See Notes to Consolidated Condensed Financial
Statements
4
Table of Contents
PROTECTIVE LIFE CORPORATION
CONSOLIDATED CONDENSED STATEMENTS
OF SHAREOWNERS EQUITY
(Unaudited)
|
|
|
|
|
|
|
|
|
|
Accumulated
Other
|
|
Total
Protective
Life
Corporations
shareowners
equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
Income (Loss)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Minimum
Pension
Liability
Adjustments
|
|
|
|
|
|
|
|
|
Common
Stock
|
|
Additional
Paid-In-
Capital
|
|
Treasury
Stock
|
|
Retained
Earnings
|
|
Net
Unrealized
Gains / (Losses)
on Investments
|
|
Accumulated
Gain / (Loss)
Hedging
|
|
|
|
Non
controlling
Interest
|
|
|
|
|
|
|
Total
Equity
|
|
|
|
|
|
|
|
(Dollars In Thousands)
|
|
|
|
|
|
|
|
Balance, December 31, 2009
|
|
$
|
44,388
|
|
$
|
576,887
|
|
$
|
(25,929
|
)
|
$
|
2,204,644
|
|
$
|
(256,669
|
)
|
$
|
(18,327
|
)
|
$
|
(46,173
|
)
|
$
|
2,478,821
|
|
$
|
|
|
$
|
2,478,821
|
|
Net income for the three months ended
March 31, 2010
|
|
|
|
|
|
|
|
69,779
|
|
|
|
|
|
|
|
69,779
|
|
(73
|
)
|
69,706
|
|
Change in net unrealized gains/losses on
investments (net of income tax - $142,481)
|
|
|
|
|
|
|
|
|
|
263,959
|
|
|
|
|
|
263,959
|
|
|
|
263,959
|
|
Reclassification adjustment for investment amounts
included in net income (net of income tax - $1,725)
|
|
|
|
|
|
|
|
|
|
3,418
|
|
|
|
|
|
3,418
|
|
|
|
3,418
|
|
Change in net unrealized gains/losses relating to
other-than-temporary impaired investments for which a portion has been
recognized in earnings (net of income tax $(3,495))
|
|
|
|
|
|
|
|
|
|
(6,492
|
)
|
|
|
|
|
(6,492
|
)
|
|
|
(6,492
|
)
|
Change in accumulated gain (loss) hedging (net of income
tax - $3,423)
|
|
|
|
|
|
|
|
|
|
|
|
5,718
|
|
|
|
5,718
|
|
|
|
5,718
|
|
Reclassification adjustment for hedging amounts
included in net income (net of income tax - $(974))
|
|
|
|
|
|
|
|
|
|
|
|
(1,752
|
)
|
|
|
(1,752
|
)
|
|
|
(1,752
|
)
|
Change in minimum pension liability adjustment (net
of income tax - $324)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
602
|
|
602
|
|
|
|
602
|
|
Comprehensive income for the three months ended
March 31, 2010
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
335,232
|
|
(73
|
)
|
335,159
|
|
Cash dividends ($0.120 per share)
|
|
|
|
|
|
|
|
(10,270
|
)
|
|
|
|
|
|
|
(10,270
|
)
|
|
|
(10,270
|
)
|
Cumulative effect adjustments
|
|
|
|
|
|
|
|
14,290
|
|
|
|
|
|
|
|
14,290
|
|
|
|
14,290
|
|
Noncontrolling interest
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(418
|
)
|
(418
|
)
|
Stock-based compensation
|
|
|
|
3,028
|
|
(68
|
)
|
|
|
|
|
|
|
|
|
2,960
|
|
|
|
2,960
|
|
Balance, March 31, 2010
|
|
$
|
44,388
|
|
$
|
579,915
|
|
$
|
(25,997
|
)
|
$
|
2,278,443
|
|
$
|
4,216
|
|
$
|
(14,361
|
)
|
$
|
(45,571
|
)
|
$
|
2,821,033
|
|
$
|
(491
|
)
|
$
|
2,820,542
|
|
See Notes to Consolidated Condensed Financial
Statements
5
Table of
Contents
PROTECTIVE LIFE CORPORATION
CONSOLIDATED CONDENSED STATEMENTS
OF CASH FLOWS
(Unaudited)
|
|
For
The Three Months Ended March 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
(Dollars In Thousands)
|
|
Cash flows from operating
activities
|
|
|
|
|
|
Net income
|
|
$
|
69,706
|
|
$
|
22,135
|
|
Adjustments to reconcile net income to net cash
provided by operating activities:
|
|
|
|
|
|
Realized investment losses (gains)
|
|
(12,958
|
)
|
39,236
|
|
Amortization of deferred policy acquisition costs
and value of business acquired
|
|
81,289
|
|
113,648
|
|
Capitalization of deferred policy acquisition costs
|
|
(121,980
|
)
|
(119,554
|
)
|
Depreciation expense
|
|
1,949
|
|
2,438
|
|
Deferred income tax
|
|
(1,340
|
)
|
9,369
|
|
Accrued income tax
|
|
101,222
|
|
(7,799
|
)
|
Interest credited to universal life and investment
products
|
|
246,524
|
|
253,017
|
|
Policy fees assessed on universal life and
investment products
|
|
(150,168
|
)
|
(150,170
|
)
|
Change in reinsurance receivables
|
|
(111,708
|
)
|
(19,029
|
)
|
Change in accrued investment income and other
receivables
|
|
(22,039
|
)
|
(3,670
|
)
|
Change in policy liabilities and other
policyholders funds of traditional life and health products
|
|
61,857
|
|
77,546
|
|
Trading securities:
|
|
|
|
|
|
Maturities and principal reductions of investments
|
|
89,700
|
|
121,410
|
|
Sale of investments
|
|
244,133
|
|
282,938
|
|
Cost of investments acquired
|
|
(272,249
|
)
|
(260,714
|
)
|
Other net change in trading securities
|
|
(26,432
|
)
|
(31,031
|
)
|
Change in other liabilities
|
|
180,972
|
|
(110,248
|
)
|
Other, net
|
|
26,904
|
|
(11,654
|
)
|
Net cash provided by operating
activities
|
|
385,382
|
|
207,868
|
|
Cash flows from investing
activities
|
|
|
|
|
|
Investments available-for-sale:
|
|
|
|
|
|
Maturities and principal reductions of investments
|
|
593,314
|
|
705,861
|
|
Sale of investments
|
|
1,035,081
|
|
188,431
|
|
Cost of investments acquired
|
|
(2,408,262
|
)
|
(634,967
|
)
|
Mortgage loans:
|
|
|
|
|
|
New borrowings
|
|
(30,531
|
)
|
(106,445
|
)
|
Repayments
|
|
70,515
|
|
94,507
|
|
Change in investment real estate, net
|
|
120
|
|
171
|
|
Change in policy loans, net
|
|
10,696
|
|
10,316
|
|
Change in other long-term investments, net
|
|
(17,531
|
)
|
3,639
|
|
Change in short-term investments, net
|
|
412,723
|
|
227,288
|
|
Purchase of property and equipment
|
|
(1,711
|
)
|
(240
|
)
|
Net cash (used in) provided by
investing activities
|
|
(335,586
|
)
|
488,561
|
|
Cash flows from financing activities
|
|
|
|
|
|
Borrowings under line of credit arrangements and
long-term debt
|
|
15,000
|
|
42,000
|
|
Principal payments on line of credit arrangement
and long-term debt
|
|
(40,000
|
)
|
|
|
Dividends to shareowners
|
|
(10,270
|
)
|
(8,392
|
)
|
Investments product deposits and change in
universal life deposits
|
|
785,155
|
|
626,159
|
|
Investment product withdrawals
|
|
(797,767
|
)
|
(1,337,254
|
)
|
Other financing activities, net
|
|
(4,305
|
)
|
12,348
|
|
Net cash used in financing
activities
|
|
(52,187
|
)
|
(665,139
|
)
|
Change in cash
|
|
(2,391
|
)
|
31,290
|
|
Cash at beginning of period
|
|
205,325
|
|
149,358
|
|
Cash at end of period
|
|
$
|
202,934
|
|
$
|
180,648
|
|
See
Notes to Consolidated Condensed Financial Statements
6
Table of Contents
PROTECTIVE
LIFE CORPORATION
NOTES
TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS
OF PRESENTATION
Basis of
Presentation
The
accompanying unaudited consolidated condensed financial statements of
Protective Life Corporation and subsidiaries (the Company) have
been prepared in accordance with accounting principles generally accepted in
the United States of America (GAAP) for interim financial information
and with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the disclosures
required by GAAP for complete financial statements. In the opinion of
management, the accompanying financial statements reflect all adjustments
(consisting only of normal recurring items) necessary for a fair statement of
the results for the interim periods presented. Operating results for the three
month period ended March 31, 2010, are not necessarily indicative of the
results that may be expected for the year ending December 31, 2010. The
year-end consolidated condensed balance sheet data was derived from audited
financial statements, but does not include all disclosures required by GAAP.
For further information, refer to the consolidated financial statements and notes
thereto included in the Companys Annual Report on Form 10-K for the year
ended December 31, 2009.
The operating results of
companies in the insurance industry have historically been subject to
significant fluctuations due to changing competition, economic conditions,
interest rates, investment performance, insurance ratings, claims, persistency,
and other factors.
Reclassifications
Certain
reclassifications have been made in the previously reported financial
statements and accompanying notes to make the prior year amounts comparable to
those of the current year. Such reclassifications had no effect on previously
reported net income or shareowners equity.
Entities
Included
The consolidated
condensed financial statements include the accounts of Protective Life
Corporation and subsidiaries and its affiliate companies in which the Company
holds a majority voting or economic interest. Intercompany balances and
transactions have been eliminated.
2. SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES
Accounting
Pronouncements Recently Adopted
Accounting Standard Update (ASU or Update) No. 2010-06
Fair Value Measurements and Disclosures Improving Disclosures about Fair
Value Measurements
.
In January of 2010, Financial Accounting
Standards Board (FASB) issued ASU No. 2010-06 Fair Value Measurements
and Disclosures Improving Disclosures about Fair Value Measurements.
This Update provides amendments to Subtopic 820-10 that requires the following
new disclosures. 1) A reporting entity should disclose separately the amounts
of significant transfers in and out of Level 1 and Level 2 fair value
measurements and describe the reasons for the transfers. 2) In the
reconciliation for fair value measurements using significant unobservable
inputs (Level 3), a reporting entity should present separately information
about purchases, sales, issuances, and settlements (that is, on a gross basis
rather than as one net number).
This Update provides amendments to Subtopic 820-10
that clarifies existing disclosures. 1) A reporting entity should provide fair
value measurement disclosures for each class of assets and liabilities. 2) A
reporting entity should provide disclosures about the valuation techniques and
inputs used to measure fair value for both recurring and nonrecurring fair
value measurements. Those disclosures are required for fair value measurements
that fall in either Level 2 or Level 3. This Update also includes conforming
amendments to the guidance on employers
7
Table of Contents
disclosures about postretirement benefit plan assets
(Subtopic 715-20). The conforming amendments to Subtopic 715-20 change the
terminology from
major categories
of assets to
classes
of assets and provide a cross reference to the
guidance in Subtopic 820-10 on how to determine appropriate classes to present
fair value disclosures. This Update is effective for interim and annual
reporting periods beginning after December 15, 2009, which became
effective for the Company for the period ending March 31, 2010, except for
the disclosures about purchases, sales, issuances, and settlements in the roll
forward of activity in Level 3 fair value measurements. Those disclosures are
effective for fiscal years beginning after December 15, 2010, and for
interim periods within those fiscal years. This Update did not have a material
impact on the Companys consolidated results of operations or financial
position.
ASU No. 2009-16 Transfers and Servicing
Accounting for Transfers of Financial Assets
. In December of 2009, FASB issued ASU No. 2009-16
Transfers and Services Accounting for Transfers of Financial Assets. The
amendments in this Update incorporate FASB Statement No. 166,
Accounting for Transfers of Financial Assets an
amendment of SFAS No. 140
into the Accounting Standards
Codification (ASC). That Statement was issued by the Board on June 12,
2009. This Update enhances the information that a reporting entity provides
in its financial reports about a transfer of financial assets; the effects of a
transfer on its financial position, financial performance, and cash flows; and
a continuing interest in transferred financial assets. This Update also
eliminates the concept of a qualifying special-purpose entity (QSPE), changes
the requirements for de-recognition of financial assets, and calls upon sellers
of the assets to make additional disclosures. This Update is effective for
interim or annual reporting periods beginning after November 15, 2009.
This guidance was effective for the Company on January 1, 2010. As of January 1,
2010, the Company held interests in two previous transfers of financial assets
to QSPEs, the 2007 Commercial Mortgage Securitization and the 1996 1999
Commercial Mortgage Securitization. As part of adoption of this guidance the
Company reviewed these entities as part of our consolidation analysis of
variable interest entities (VIEs). The conclusion of the review was
that the former QSPEs should be consolidated by the Company. Please refer to
Note 4,
Variable Interest Entities
for more
information. The Company has not transferred any financial assets since
the adoption of this standard. The Company will apply this guidance to all
future transfers of financial assets
.
ASU No. 2009-17
Consolidations Improvements to Financial Reporting by Enterprises Involved
with Variable Interest Entities
.
In December of 2009, FASB issued ASU
No. 2009-17 Consolidations Improvements to Financial Reporting by
Enterprises Involved with Variable Interest Entities. The amendments to this
Update incorporate FASB Statement No. 167,
Amendments to FASB Interpretation No. 46(R)
(SFAS
No. 167)
into the ASC. SFAS
No. 167 was issued by the Board on June 12, 2009. This Statement
applies to all investments in VIEs beginning for the Company on January 1,
2010. This analysis will include QSPEs used for securitizations as SFAS No. 166
eliminated the concept of a QSPE which subjects former QSPEs to the provisions
of FIN 46(R) as amended by this statement. Based on our review of our December 31,
2009 information, the impact of adoption of ASU No. 2009-17 (SFAS No. 167)
resulted in the consolidation of two securitization trusts, the 2007 Commercial
Mortgage Securitization and the 1996 1999 Commercial Mortgage Securitization.
Please refer to Note 4,
Variable Interest Entities
for more information regarding the consolidation of these two
trusts.
Accounting Pronouncements Not Yet Adopted
ASU No. 2010-15 Financial ServicesInsurance
How Investments Held through Separate Accounts Affect an Insurers
Consolidation Analysis of Those Investments
.
The amendments in this Update clarify that an
insurance entity should not consider any separate account interests held for
the benefit of policy holders in an investment to be the insurers
interests. The entity should not combine general account and separate
account interests in the same investment when assessing the investment for
consolidation. Additionally, the amendments do not require an insurer to
consolidate an investment in which a separate account holds a controlling
financial interest if the investment is not or would not be consolidated in the
standalone financial statements of the separate account. The amendments in
this Update also provide guidance on how an insurer should consolidate an
investment fund in situations in which the insurer concludes that consolidation
is required. This Update is effective for fiscal years beginning after December 15,
2010. For the Company this Update will be effective January 1,
2011. The Company is currently evaluating the impact of this update.
Significant
Accounting Policies
For a full description of
significant accounting policies, see Note 2 of Notes to Consolidated Financial
Statements included in the Companys Annual Report on Form 10-K for the
year ended December 31, 2009.
There were no significant
changes to the Companys accounting policies during the three months ended March 31,
2010.
8
Table of Contents
3
. INVESTMENT
OPERATIONS
Net realized investment gains
(losses) for all other investments are summarized as follows:
|
|
For
The
|
|
|
|
Three
Months Ended
|
|
|
|
March 31,
2010
|
|
|
|
(Dollars In Thousands)
|
|
Fixed maturities
|
|
$
|
6,726
|
|
Equity securities
|
|
|
|
Impairments on fixed maturity securities
|
|
(11,869
|
)
|
Impairments on equity securities
|
|
|
|
Mark-to-market Modco trading portfolio
|
|
44,093
|
|
Mortgage loans and other investments
|
|
(2,920
|
)
|
|
|
$
|
36,030
|
|
For the three months ended March 31, 2010,
gross realized gains on investments available-for-sale (fixed maturities,
equity securities, and short-term investments) were $8.2 million and gross
realized losses were $13.3 million, including $11.8 million of impairment
losses.
For the three months ended March 31, 2010, the
Company sold securities in an unrealized gain position with a fair value
(proceeds) of $951.0 million. The gain realized on the sale of these securities
was $8.2 million.
For the three months ended March 31, 2010, the
Company sold securities in an unrealized loss position with a fair value
(proceeds) of $102.7 million. The loss realized on the sale of these securities
was $1.5 million.
The amortized cost and estimated fair value of the
Companys investments classified as available-for-sale as of March 31,
2010, are as follows:
|
|
|
|
Gross
|
|
Gross
|
|
|
|
|
|
Amortized
|
|
Unrealized
|
|
Unrealized
|
|
Estimated
|
|
|
|
Cost
|
|
Gains
|
|
Losses
|
|
Fair
Value
|
|
|
|
(Dollars In Thousands)
|
|
2010
|
|
|
|
|
|
|
|
|
|
Fixed maturities:
|
|
|
|
|
|
|
|
|
|
Bonds
|
|
|
|
|
|
|
|
|
|
Residential mortgage-backed securities
|
|
$
|
3,490,896
|
|
$
|
43,895
|
|
$
|
(335,792
|
)
|
$
|
3,198,999
|
|
Commercial mortgage-backed securities
|
|
134,263
|
|
6,517
|
|
(644
|
)
|
140,136
|
|
Other asset-backed securities
|
|
970,112
|
|
2,157
|
|
(77,661
|
)
|
894,608
|
|
U.S. government-related securities
|
|
1,229,543
|
|
2,819
|
|
(5,543
|
)
|
1,226,819
|
|
Other government-related securities
|
|
147,979
|
|
3,670
|
|
(628
|
)
|
151,021
|
|
States, municipals, and political subdivisions
|
|
530,267
|
|
11,405
|
|
(3,054
|
)
|
538,618
|
|
Corporate bonds
|
|
13,688,531
|
|
682,086
|
|
(268,554
|
)
|
14,102,063
|
|
|
|
20,191,591
|
|
752,549
|
|
(691,876
|
)
|
20,252,264
|
|
Equity securities
|
|
276,734
|
|
6,779
|
|
(6,173
|
)
|
277,340
|
|
Short-term investments
|
|
411,453
|
|
19
|
|
-
|
|
411,472
|
|
|
|
$
|
20,879,778
|
|
$
|
759,347
|
|
$
|
(698,049
|
)
|
$
|
20,941,076
|
|
As of March 31, 2010, the Company had an
additional $3.0 billion of fixed maturities, $3.4 million of equity securities,
and $236.5 million of short-term investments classified as trading securities.
9
Table of Contents
The amortized cost and fair
value of available-for-sale fixed maturities as of March 31, 2010, by
expected maturity, are shown below. Expected maturities of securities without a
single maturity date are allocated based on estimated rates of prepayment that
may differ from actual rates of prepayment.
|
|
Amortized
|
|
Fair
|
|
|
|
Cost
|
|
Value
|
|
|
|
(Dollars In Thousands)
|
|
Due in one year or less
|
|
$
|
699,109
|
|
$
|
708,345
|
|
Due after one year through five years
|
|
6,064,953
|
|
6,002,729
|
|
Due after five years through ten years
|
|
5,066,713
|
|
5,141,721
|
|
Due after ten years
|
|
8,360,816
|
|
8,399,469
|
|
|
|
$
|
20,191,591
|
|
$
|
20,252,264
|
|
Each quarter the Company
reviews investments with unrealized losses and tests for other-than-temporary
impairments. The Company analyzes various factors to determine if any specific
other-than-temporary asset impairments exist. These include, but are not
limited to: 1) actions taken by rating agencies, 2) default by the
issuer, 3) the significance of the decline, 4) an assessment of the
Companys intent to sell the security (including a more likely than not
assessment of whether the Company will be required to sell the security) before
recovering the securitys amortized cost, 5) the time period during which
the decline has occurred, 6) an economic analysis of the issuers
industry, and 7) the financial strength, liquidity, and recoverability of
the issuer. Management performs a security by security review each quarter in
evaluating the need for any other-than-temporary impairments. Although no set
formula is used in this process, the investment performance, collateral
position, and continued viability of the issuer are significant measures
considered, and in some cases, an analysis regarding the Companys expectations
for recovery of the securitys entire amortized cost basis through the receipt
of future cash flows is performed. Once a determination has been made that a
specific other-than-temporary impairment exists, the securitys basis is
adjusted and an other-than-temporary impairment is recognized. Equity
securities that are other-than-temporarily impaired are written down to fair
value with a realized loss recognized in earnings. Other-than-temporary
impairments to debt securities that the Company does not intend to sell and
does not expect to be required to sell before recovering the securitys
amortized cost are written down to discounted expected future cash flows (post
impairment cost) and credit losses are recorded in earnings. The difference
between the securities discounted expected future cash flows and the fair
value of the securities is recognized in other comprehensive income (loss) as a
non-credit portion of the recognized other-than-temporary impairment. When
calculating the post impairment cost for residential mortgage-backed
securities, commercial mortgage-backed securities, and other asset-backed
securities, the Company considers all known market data related to cash flows
to estimate future cash flows. When calculating the post impairment cost for
corporate debt securities, the Company considers all contractual cash flows to
estimate expected future cash flows. To calculate the post impairment cost, the
expected future cash flows are discounted at the original purchase yield. Debt
securities that the Company intends to sell or expects to be required to sell
before recovery are written down to fair value with the change recognized in
earnings.
During the three months
ended March 31, 2010, the Company recorded other-than-temporary
impairments of investments of $21.9 million. Of the $21.9 million of
impairments for the three months ended March 31, 2010, $11.9 million was
recorded in earnings and $10.0 million was recorded in other comprehensive
income (loss). For the three months ended March 31, 2010, there were no
other-than-temporary impairments related to equity securities and $21.9 million
of other-than-temporary impairments related to debt securities.
For
the three months ended March 31, 2010, other-than-temporary impairments
related to debt securities that the Company does not intend to sell and does
not expect to be required to sell prior to recovering amortized cost were $21.9
million, with $11.9 million of credit losses recognized on debt securities in
earnings and $10.0 million of non-credit losses recorded in other comprehensive
income (loss). During the same period, there were no other-than-temporary
impairments related to debt securities that the Company intends to sell or
expects to be required to sell.
10
Table of
Contents
The
following chart is a rollforward of credit losses on debt securities held by
the Company for which a portion of an other-than-temporary impairment was
recognized in other comprehensive income (loss):
|
|
For The
|
|
|
|
Three Months Ended March 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
(Dollars In Thousands)
|
|
Beginning balance
|
|
$
|
25,076
|
|
$
|
|
|
Additions for newly impaired securities
|
|
6,556
|
|
40,014
|
|
Additions for previously impaired securities
|
|
1,734
|
|
|
|
Reductions for previously impaired securities due to
a change in expected cash flows
|
|
|
|
|
|
Reductions for previously impaired securities that were
sold in the current period
|
|
|
|
|
|
Other
|
|
|
|
|
|
Ending balance
|
|
$
|
33,366
|
|
$
|
40,014
|
|
The
following table includes the Companys investments gross unrealized losses and
fair value that are not deemed to be other-than-temporarily impaired,
aggregated by investment category and length of time that individual securities
have been in a continuous unrealized loss position as of March 31, 2010:
|
|
Less
Than 12 Months
|
|
12
Months or More
|
|
Total
|
|
|
|
Fair
|
|
Unrealized
|
|
Fair
|
|
Unrealized
|
|
Fair
|
|
Unrealized
|
|
|
|
Value
|
|
Loss
|
|
Value
|
|
Loss
|
|
Value
|
|
Loss
|
|
|
|
(Dollars In Thousands)
|
|
Residential mortgage-backed securities
|
|
$
|
235,861
|
|
$
|
(3,229
|
)
|
$
|
2,030,022
|
|
$
|
(332,563
|
)
|
$
|
2,265,883
|
|
$
|
(335,792
|
)
|
Commercial mortgage-backed securities
|
|
|
|
|
|
6,365
|
|
(644
|
)
|
6,365
|
|
(644
|
)
|
Other asset-backed securities
|
|
370,508
|
|
(34,410
|
)
|
295,095
|
|
(43,251
|
)
|
665,603
|
|
(77,661
|
)
|
U.S. government-related securities
|
|
835,995
|
|
(5,542
|
)
|
59
|
|
(1
|
)
|
836,054
|
|
(5,543
|
)
|
Other government-related securities
|
|
41,197
|
|
(613
|
)
|
19,985
|
|
(15
|
)
|
61,182
|
|
(628
|
)
|
States, municipals, and political subdivisions
|
|
166,499
|
|
(3,027
|
)
|
466
|
|
(27
|
)
|
166,965
|
|
(3,054
|
)
|
Corporate bonds
|
|
1,622,818
|
|
(30,998
|
)
|
2,278,594
|
|
(237,556
|
)
|
3,901,412
|
|
(268,554
|
)
|
Equities
|
|
1,357
|
|
(697
|
)
|
51,199
|
|
(5,476
|
)
|
52,556
|
|
(6,173
|
)
|
|
|
$
|
3,274,235
|
|
$
|
(78,516
|
)
|
$
|
4,681,785
|
|
$
|
(619,533
|
)
|
$
|
7,956,020
|
|
$
|
(698,049
|
)
|
The
residential mortgage-backed securities (RMBS) have a gross unrealized loss
greater than 12 months of $332.6 million as of March 31, 2010. These
losses relate to a widening in spreads and defaults as a result of continued
weakness in the residential housing market. Factors such as the credit
enhancement within the deal structure, the average life of the securities, and
the performance of the underlying collateral support the recoverability of the
investments.
The
corporate bonds category has gross unrealized losses greater than 12 months of
$237.6 million as of March 31, 2010. These losses relate primarily to
fluctuations in credit spreads. The aggregate decline in market value of these
securities was deemed temporary due to positive factors supporting the
recoverability of the respective investments. Positive factors considered
include credit ratings, the financial health of the issuer, the continued
access of the issuer to capital markets, and other pertinent information
including the Companys ability and intent to hold these securities to
recovery.
The
Company does not consider these unrealized loss positions to be
other-than-temporary, based on the factors discussed and because the Company
has the ability and intent to hold these investments until the fair values
recover, and does not intend to sell or expect to be required to sell the
securities before recovering the Companys amortized cost of debt securities.
As
of March 31, 2010, the Company had bonds in its available-for-sale
portfolio, which were rated below investment grade of $2.8 billion and had an
amortized cost of $3.2 billion. In addition, included in the Companys trading
portfolio, the Company held $376.5 million of securities which were rated below
investment grade. Approximately $634.4 million of the below investment grade
bonds were not publicly traded.
11
Table of
Contents
The
change in unrealized gains (losses), net of income tax, on fixed maturity and
equity securities, classified as available-for-sale is summarized as follows:
|
|
For
The
|
|
|
|
Three
Months Ended
|
|
|
|
March 31,
2010
|
|
|
|
(Dollars In Thousands)
|
|
Fixed maturities
|
|
$
|
298,066
|
|
Equity securities
|
|
3,721
|
|
|
|
|
|
|
4.
VARIABLE INTEREST ENTITIES
In June of 2009, the FASB amended the guidance related to VIEs
which was later codified in the ASC through ASU No. 2009-17. Among other
accounting and disclosure requirements, this guidance replaces the
quantitative-based risks and rewards calculation for determining which
enterprise has a controlling financial interest in a VIE with an approach
focused on identifying which enterprise has the power to direct the activities
of a VIE that most significantly impact its economics and the obligation to
absorb losses of the entity or the right to receive benefits from the entity
that could potentially be significant to the VIE. Additionally, the FASB
amended the guidance related to accounting for transfers of financial assets
which was later codified in the ASC through ASU No. 2009-16.
This guidance, among other requirements, removed the
concept of a QSPE used for the securitization of financial assets. Previously,
QSPEs were excluded from the guidance related to VIEs. Upon adoption of ASU No. 2009-17
and ASU No. 2009-16 on January 1, 2010, the Company will no longer
exclude QSPEs from the analysis of VIEs.
As part of adopting these updates, the Company updated its process for
evaluating VIEs. The Companys analysis consists of a review of entities in
which the Company has an ownership interest that is less than 100% (excluding
debt and equity securities held as trading and available-for-sale), as well as
entities with which the Company has significant contracts or other
relationships that could possibly be considered variable interests. The Company
reviews the characteristics of each of these applicable entities and compares
those characteristics to the criteria of a VIE set forth in Topic 810 of the
FASB ASC. If the entity is determined to be a VIE, the Company then performs a
detailed review of all significant contracts and relationships (individually an
interest, collectively interests) with the entity to determine whether the
interest would be considered a variable interest under the guidance. The
Company then performs a qualitative review of all variable interests with the
entity and determines whether the Company: 1) has the power to direct the
activities of the VIE that most significantly impact the VIEs economic
performance and 2) the obligation to absorb losses of the VIE that could
potentially be significant to the VIE or the right to receive benefits from the
entity that could potentially be significant to the VIE.
Based on this analysis the Company had interests in two former QSPEs that
were determined to be VIEs as of January 1, 2010. These two VIEs were
trusts used to facilitate commercial mortgage loan securitizations. The
determining factor was that the trusts had negligible or no equity at risk. The
Companys variable interests in the trusts are created by the contract to
service the mortgage loans held by the trusts as well as the retained
beneficial interests in certain of these securities issued by the trusts. The
activities that most significantly impact the economics of the trusts are
predominantly related to the servicing of the mortgage loans, such as timely
collection of principal and interest, direction of foreclosure proceedings, and
management and sale of foreclosed real estate owned by the trusts. The Company
is the servicer responsible for these activities and has the sole power to
appoint such servicer through its beneficial interests in the securities. These
criteria give the Company the power to direct the activities of the trusts that
most significantly impact the trusts economic performance. Additionally, the
Company is obligated, as an owner of the securities issued by the trusts, to
absorb its share of losses on the securities. The Companys share of losses
could potentially be significant to the trusts. Based on the fact that the
Company has the power to direct the activities that most significantly impact
the economics of the trusts and the obligation to absorb losses that could
potentially be significant, it was determined that the Company is the primary
beneficiary of the trusts, thus resulting in consolidation.
The assets of the trusts consist entirely of commercial mortgage loans
and accrued interest, which are restricted and can only be used to satisfy the
obligations of the trusts. The obligations of the trusts consist of commercial
mortgage-backed certificates. The assets and obligations of the trusts are
equal and thus, the trusts have no equity interest. The certificates are direct
obligations of the trusts and are not guaranteed by the Company. The Company
has no other obligations to the trusts other than those that are customary for
a servicer of mortgage loans.
12
Table of Contents
Over the life of the trusts, the Company has not provided and will not
provide any financial or other support to the trusts other than customary
actions taken by a servicer of mortgage loans.
The following
adjustments to the Companys consolidated condensed balance sheet were made as
of January 1, 2010:
Adjustments to the Consolidated Condensed Balance Sheets
|
|
|
|
|
|
|
As of
|
|
|
|
January 1, 2010
|
|
|
|
(Dollars In Thousands)
|
|
Assets
|
|
|
|
Fixed maturities:
|
|
|
|
Commercial mortgage-backed securities at fair value
(amortized cost - $873,196)
|
|
$
|
(844,535
|
)
(1)
|
Mortgage loans - securitized (net of loan loss
reserve of $1.1 million)
|
|
1,018,000
|
(5)
|
Total investments
|
|
173,465
|
|
Accrued investment income
|
|
361
|
(5)
|
Total Assets
|
|
$
|
173,826
|
|
Liabilities
|
|
|
|
Deferred income taxes
|
|
$
|
17,744
|
(2)
|
Mortgage loan backed certificates
|
|
124,580
|
(5)
|
Other liabilities
|
|
(1,400
|
)
(3)
|
Total liabilities
|
|
140,924
|
|
Shareowners equity
|
|
|
|
Retained earnings
|
|
14,290
|
(5)
|
Accumulated other comprehensive income (loss)
|
|
18,612
|
(4)
|
Total shareowners equity
|
|
32,902
|
|
Total liabilities and shareowners
equity
|
|
$
|
173,826
|
|
(1)
|
The
noncash portion for the consolidated condensed statements of cash flows for
the three months ended March 31, 2010, was $873.2 million.
|
(2)
|
The
noncash portion for the consolidated condensed statements of cash flows for
the three months ended March 31, 2010, was $7.7 million.
|
(3)
|
The
other liabilities did not have an effect on the consolidated condensed
statements of cash flows for the three months ended March 31, 2010.
|
(4)
|
The
accumulated other comprehensive income (loss) did not have an effect on the
consolidated condensed statements of cash flows for the three months ended March 31,
2010.
|
(5)
|
The
noncash portion for the consolidated condensed statements of cash flows for
the three months ended March 31, 2010, is the amount presented.
|
|
The
adjustments had a net zero impact to the consolidated condensed statements of
cash flows.
|
The reduction in fixed maturity commercial mortgage-backed securities
(CMBS) represents the beneficial interests held by the Company that have been
removed due to the consolidation of the trusts. This amount is reflected in
fixed maturities on the consolidated condensed balance sheet.
The increase in mortgage loans represents the mortgage loans held by
the trusts that have been consolidated. This balance is net of a loan loss
reserve of $1.1 million.
The increase in accrued investment income is the result of accruing
interest on the entire pool of mortgage loans.
The increase in deferred income taxes is a result of a change in
temporary tax differences arising from the adjustments to retained earnings.
The mortgage loan backed certificates liability represents the
commercial mortgage-backed securities issued by the trusts and held by third
parties. This amount is included in other liabilities in the consolidated
condensed balance sheet.
The decrease in other liabilities is a decrease in amounts payable to
the trusts of approximately $1.4 million. Upon consolidation of the trusts as
of January 1, 2010, the Company adjusted retained earnings to reflect
after tax interest income not recognized in prior periods due to the
securitization of the commercial mortgage loans. If the Company had held the
mortgage loans as opposed to the retained beneficial interest securities, the
Companys retained earnings would have been $14.3 million higher over the life
of the securities.
The
adjustment to accumulated other comprehensive income (loss) was a result of
different accounting basis for mortgage loans and the CMBS. As of December 31,
2009, the retained beneficial interest securities were carried at fair value in
the balance sheet and had an after tax unrealized loss in accumulated other
comprehensive income (loss) of $18.6 million. Upon consolidation of the trusts
on January 1, 2010, the Company consolidated the mortgage loans held by
the trusts which are carried at amortized cost less any related loan loss
reserve. The retained beneficial interest securities as well as the associated
unrealized loss were eliminated in consolidation.
13
Table of Contents
5.
GOODWILL
During the three months
ended March 31, 2010, the Company decreased its goodwill balance by
approximately $0.8 million. The decrease was due to an adjustment in the
Acquisitions segment related to tax benefits realized during 2010 on the
portion of tax goodwill in excess of GAAP basis goodwill. As of March 31,
2010, the Company had an aggregate goodwill balance of $117.1 million.
Accounting for goodwill
requires an estimate of the future profitability of the associated lines of
business to assess the recoverability of the capitalized acquisition goodwill.
The Company evaluates the carrying value of goodwill at the segment (or
reporting unit) level at least annually and between annual evaluations if
events occur or circumstances change that would more likely than not reduce the
fair value of the reporting unit below its carrying amount. Such circumstances
could include, but are not limited to: 1) a significant adverse change in
legal factors or in business climate, 2) unanticipated competition, or
3) an adverse action or assessment by a regulator. When evaluating whether
goodwill is impaired, the Company compared its estimate of the fair value of
the reporting unit to which the goodwill is assigned to the reporting units
carrying amount, including goodwill. The Company utilizes a fair value
measurement (which includes a discounted cash flows analysis) to assess the
carrying value of the reporting units in consideration of the recoverability of
the goodwill balance assigned to each reporting unit as of the measurement
date. The Companys material goodwill balances are attributable to its
operating segments (which are considered to be reporting units). The cash flows
used to determine the fair value of the Companys reporting units are dependent
on a number of significant assumptions. The Companys estimates are subject to change
given the inherent uncertainty in predicting future results and cash flows,
which are impacted by such things as policyholder behavior, competitor pricing,
capital limitations, new product introductions, and specific industry and
market conditions. Additionally, the discount rate used is based on the Companys
judgment of the appropriate rate for each reporting unit based on the relative
risk associated with the projected cash flows. As of December 31, 2009,
the Company performed its annual evaluation of goodwill and determined that no
adjustment to impair goodwill was necessary.
The Company also considers its market capitalization
in assessing the reasonableness of the fair values estimated for its reporting
units in connection with its goodwill impairment testing. In considering the
Companys March 31, 2010 common equity price, which was lower than its
book value per share, the Company noted several factors that would result in
its market capitalization being lower than the fair value of its reporting
units that are tested for goodwill impairment. Such factors that would not be
reflected in the valuation of the Companys reporting units with goodwill
include, but are not limited to: potential equity dilution; negative market
sentiment, different valuation methodologies that resulted in low valuations,
and increased risk premium for holding investments in mortgage-backed
securities and commercial mortgage loans. Deterioration of or adverse market
conditions for certain businesses may have a significant impact on the fair
value of the Companys reporting units. As previously noted, the fair value of
the Companys operating segments support the goodwill balance as of March 31,
2010. In the Companys view, the decline in market capitalization does not invalidate
the Companys fair value assessment related to the recoverability of goodwill
in its reporting units, and did not result in a triggering or impairment event.
6
.
DEBT AND OTHER OBLIGATIONS
The
Company had no significant changes to its debt structure during the three
months ended March 31, 2010.
7.
COMMITMENTS
AND CONTINGENCIES
The Company is
contingently liable to obtain a $20 million letter of credit under
indemnity agreements with directors. Such agreements provide insurance
protection in excess of the directors and officers liability insurance
in-force at the time up to $20 million. Should certain events occur
constituting a change in control, the Company must obtain the letter of credit
upon which directors may draw for defense or settlement of any claim relating
to performance of their duties as directors. The Company has similar agreements
with certain of its officers providing up to $10 million in
indemnification that are not secured by the obligation to obtain a letter of
credit. These obligations are in addition to the customary obligation to
indemnify officers and directors contained in the Companys bylaws.
Under insurance guaranty
fund laws, in most states insurance companies doing business therein can be
assessed up to prescribed limits for policyholder losses incurred by insolvent
companies. The Company does not believe such assessments will be materially
different from amounts already provided for in the financial statements.
14
Table of
Contents
Most of these laws do
provide, however, that an assessment may be excused or deferred if it would
threaten an insurers own financial strength.
A number of civil jury verdicts
have been returned against insurers, broker dealers and other providers of
financial services involving sales, refund or claims practices, alleged agent
misconduct, failure to properly supervise representatives, relationships with
agents or persons with whom the insurer does business, and other matters. Often
these lawsuits have resulted in the award of substantial judgments that are
disproportionate to the actual damages, including material amounts of punitive
and non-economic compensatory damages. In some states, juries, judges, and
arbitrators have substantial discretion in awarding punitive non-economic
compensatory damages which creates the potential for unpredictable material
adverse judgments or awards in any given lawsuit or arbitration. Arbitration
awards are subject to very limited appellate review. In addition, in some class
action and other lawsuits, companies have made material settlement payments.
The Company, in the ordinary course of business, is involved in such litigation
and arbitration. The occurrence of such litigation and arbitration may become
more frequent and/or severe when general economic conditions have deteriorated.
Although the Company cannot predict the outcome of any such litigation or
arbitration, the Company does not believe that any such outcome will have a
material impact on its financial condition or results of the operations.
8.
COMPREHENSIVE INCOME (LOSS)
The following table sets
forth the Companys comprehensive income (loss) for the periods presented
below:
|
|
For
The
|
|
|
|
Three
Months Ended
|
|
|
|
March 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
(Dollars In Thousands)
|
|
Net income
|
|
$
|
69,706
|
|
$
|
22,135
|
|
Change in net unrealized gains (losses) on
investments, net of income tax: (2010 - $142,481; 2009 - $(24,446))
|
|
263,959
|
|
(43,705
|
)
|
Change in net unrealized gains (losses) relating to
other-than-temporary impaired investments for which a portion has been
recognized in earnings, net of income tax: (2010 - $(3,495); 2009 - $(9,621))
|
|
(6,492
|
)
|
(17,867
|
)
|
Change in accumulated (loss) gain - hedging, net of
income tax: (2010 - $3,423; 2009 - $7,859)
|
|
5,718
|
|
14,392
|
|
Minimum pension liability adjustment, net of income
tax: (2010 - $324; 2009 - $177)
|
|
602
|
|
329
|
|
Reclassification adjustment for investment amounts
included in net income, net of income tax: (2010 - $1,725; 2009 - $29,849)
|
|
3,418
|
|
54,423
|
|
Reclassification adjustment for hedging amounts
included in net income, net of income tax: (2010 - $(974); 2009 - $(263)
|
|
(1,752
|
)
|
(720
|
)
|
Comprehensive income (loss)
|
|
335,159
|
|
28,987
|
|
Comprehensive income (loss) attributable to
noncontrolling interests
|
|
73
|
|
|
|
Comprehensive income (loss) attributable to
Protective Life Corporation
|
|
$
|
335,232
|
|
$
|
28,987
|
|
9.
STOCK-BASED COMPENSATION
The criteria for payment
of performance awards is based primarily upon a comparison of the Companys
average return on average equity over a four-year period (earlier upon the
death, disability, or retirement of the executive, or in certain circumstances,
upon a change in control of the Company) to that of a comparison group of
publicly held life and multi-line insurance companies. For the 2008 awards, if
the Companys results are below the 25th percentile of the comparison group, no
portion of the award is earned. For the 2005-2007 awards, if the Companys
results are below the 40th percentile of the comparison group, no portion of
the award is earned. If the Companys results are at or above the
90th percentile, the award maximum is earned. Awards are paid in shares of
the Companys Common Stock. There were no performance share awards issued
during the three months ended March 31, 2010 or 2009.
15
Table of
Contents
SARs have been granted to
certain officers of the Company to provide long-term incentive compensation
based solely on the performance of the Companys common stock. The SARs are
exercisable either five years after the date of grants or in three or four
equal annual installments beginning one year after the date of grant (earlier
upon the death, disability, or retirement of the officer, or in certain
circumstances, of a change in control of the Company) and expire after ten
years or upon termination of employment. The SARs activity as well as
weighted-average base price is as follows:
|
|
Weighted-Average
|
|
|
|
|
|
Base
Price per share
|
|
No. of
SARs
|
|
Balance as of December 31, 2009
|
|
$
|
22.28
|
|
2,469,202
|
|
SARs granted
|
|
18.34
|
|
344,400
|
|
SARs exercised / forfeited / expired
|
|
22.06
|
|
(434,072
|
)
|
Balance as of March 31, 2010
|
|
$
|
21.75
|
|
2,379,530
|
|
The SARs issued for the
three months ended March 31, 2010, had estimated fair values at grant date
of $3.3 million. These fair values were estimated using a Black-Scholes
option pricing model. The assumptions used in this pricing model varied
depending on the vesting period of awards. Assumptions used in the model for
the 2010 SARs granted (the simplified method under the ASC Compensation-Stock
Compensation Topic was used for the 2010 awards) were as follows: an expected
volatility of 69.4%, a risk-free interest rate of 2.6%, a dividend rate of
2.4%, a zero percent forfeiture rate, and an expected exercise date of 2016.
The Company will pay an amount in stock equal to the difference between the
specified base price of the Companys common stock and the market value at the
exercise date for each SAR.
Additionally,
the Company
issued
360,450
restricted stock units for the three months ended March 31, 2010. These awards had a total fair value at grant
date of $6.6 million. Approximately half of these restricted stock units
vest in 2013, and the remainder vest in 2014.
10. EMPLOYEE
BENEFIT PLANS
Components of the net
periodic benefit cost of the Companys defined benefit pension plan and
unfunded excess benefits plan are as follows:
|
|
For
The
|
|
|
|
Three
Months Ended
|
|
|
|
March 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
(Dollars In Thousands)
|
|
Service cost benefits earned during the period
|
|
$
|
2,068
|
|
$
|
1,889
|
|
Interest cost on projected benefit obligation
|
|
2,357
|
|
2,395
|
|
Expected return on plan assets
|
|
(2,312
|
)
|
(2,531
|
)
|
Amortization of prior service cost
|
|
(98
|
)
|
(98
|
)
|
Amortization of actuarial losses
|
|
1,026
|
|
568
|
|
Total benefit cost
|
|
$
|
3,041
|
|
$
|
2,223
|
|
During the three months
ended March 31, 2010, the Company did not make a contribution to its
defined benefit pension plan. The Company will make contributions in future
periods as necessary to satisfy minimum funding requirements.
In addition to pension
benefits, the Company provides life insurance benefits to eligible retirees and
limited healthcare benefits to eligible retirees who are not yet eligible for
Medicare. For a closed group of retirees over age 65, the Company provides
a prescription drug benefit. The cost of these plans for the three months ended
March 31, 2010 was immaterial to the Companys financial statements.
16
Table of Contents
11. EARNINGS
PER SHARE
Basic earnings
per share is
computed by dividing net income available to PLCs common shareowners by the
weighted-average number of common shares outstanding
during
the period, including
shares issuable under various deferred compensation plans. Diluted earnings per
share is computed by dividing net income available to PLCs common
shareowners by the weighted-average number of common shares and dilutive
potential common shares outstanding during the period, assuming the shares were
not anti-dilutive, including shares issuable under various stock-based
compensation plans and stock purchase contracts.
A reconciliation of the numerators and denominators of
the basic and diluted earnings per share is presented below:
|
|
For
The Three Months Ended March 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
(Dollars In Thousands, Except Per Share Amounts)
|
|
Calculation of basic earnings per
share:
|
|
|
|
|
|
Net income available to
PLCs common shareowners
|
|
$
|
69,779
|
|
$
|
22,135
|
|
|
|
|
|
|
|
Average shares issued and outstanding
|
|
85,587,188
|
|
69,941,246
|
|
Issuable under various deferred compensation plans
|
|
913,011
|
|
909,325
|
|
Weighted shares outstanding - Basic
|
|
86,500,199
|
|
70,850,571
|
|
|
|
|
|
|
|
Per share:
|
|
|
|
|
|
Net income available to
PLCs common shareowners
- basic
|
|
$
|
0.81
|
|
$
|
0.31
|
|
|
|
|
|
|
|
Calculation of diluted earnings
per share:
|
|
|
|
|
|
Net income available to
PLCs common shareowners
|
|
$
|
69,779
|
|
$
|
22,135
|
|
|
|
|
|
|
|
Weighted shares outstanding - Basic
|
|
86,500,199
|
|
70,850,571
|
|
Stock appreciation rights (SARs)
(1)
|
|
459,037
|
|
218,685
|
|
Issuable under various other stock-based
compensation plans
|
|
155,118
|
|
199,102
|
|
Restricted stock units
|
|
437,032
|
|
123,776
|
|
Weighted shares outstanding - Diluted
|
|
87,551,386
|
|
71,392,134
|
|
|
|
|
|
|
|
Per share:
|
|
|
|
|
|
Net income available to
PLCs common shareowners
- diluted
|
|
$
|
0.80
|
|
$
|
0.31
|
|
(1)
Excludes 1,475,645 and 1,554,373 SARs as
of March 31, 2010 and 2009, respectively, that are antidilutive. In the
event the average market price exceeds the issue price of the SARs, such rights
would be dilutive to the Companys earnings per share and will be included in
the Companys calculation of the diluted average shares outstanding, for
applicable periods.
12. INCOME
TAXES
During the three months
ended March 31, 2010, earnings were impacted favorably by $2.8 million due
to the release of unrecognized income tax benefits of tax basis policy
liabilities as well as the closing of the statute of limitation for the 2005
tax year. This release regarding tax basis policy liabilities was prompted by
the Internal Revenue Services recent technical guidance confirming the Companys
historical calculations. The Company does not expect to have any material
adjustments, within the next twelve months, to its balance of unrecognized
income tax benefits in any of the tax jurisdictions in which it conducts its
business operations.
The
Company has computed its effective income tax rate for the three months ended March 31,
2010, based upon its estimate of its annual 2010 income. For the three months
ended March 31, 2009, due to the unpredictability at that time of future
investment losses and certain elements of operating income, the Company was not
able to reasonably estimate an expected annual effective tax rate. Instead, the
Company computed an effective income tax rate based upon year-to-date reported
income. The effective tax rate for the three months ended March 31, 2010,
and for the same period in the prior year was 31.2%.
17
Table of Contents
Based
on the Companys current assessment of future taxable income, including
available tax planning opportunities, the Company anticipates that it is more
likely than not that it will generate sufficient taxable income to realize its
deferred tax assets; and therefore, the Company did not record a valuation
allowance against its material deferred tax assets as of March 31, 2010.
13. FAIR
VALUE OF FINANCIAL INSTRUMENTS
Effective
January 1, 2008, the Company determined the fair value of its financial
instruments based on the fair value hierarchy established in FASB guidance
referenced in the Fair Value Measurements and Disclosures Topic which requires an
entity to maximize the use of observable inputs and minimize the use of
unobservable inputs when measuring fair value. In the first quarter of 2009,
the Company adopted the provisions from the FASB guidance that is referenced in
the Fair Value Measurements and Disclosures Topic for non-financial assets and
liabilities (such as property and equipment, goodwill, and other intangible
assets) that are required to be measured at fair value on a periodic basis. The
effect on the Companys periodic fair value measurements for non-financial
assets and liabilities was not material.
The Company has
categorized its financial instruments, based on the priority of the inputs to
the valuation technique, into a three level hierarchy. 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). If the inputs used to measure fair value fall within different
levels of the hierarchy, the category level is based on the lowest priority
level input that is significant to the fair value measurement of the
instrument.
Financial assets and
liabilities recorded at fair value on the consolidated condensed balance sheets
are categorized as follows:
·
Level 1:
Unadjusted quoted prices for identical
assets or liabilities in an active market.
·
Level 2:
Quoted prices in markets that are not
active or significant inputs that are observable either directly or indirectly.
Level 2 inputs include the following:
a)
Quoted prices for similar assets or
liabilities in active markets
b)
Quoted prices for identical or similar
assets or liabilities in non-active markets
c)
Inputs other than quoted market prices
that are observable
d)
Inputs that are derived principally from
or corroborated by observable market data through correlation or other means.
·
Level 3:
Prices or valuation techniques that
require inputs that are both unobservable and significant to the overall fair
value measurement. They reflect managements own assumptions about the
assumptions a market participant would use in pricing the asset or liability.
18
Table of Contents
The following table
presents the Companys hierarchy for its assets and liabilities measured at
fair value on a recurring basis as of March 31, 2010:
|
|
Level
1
|
|
Level
2
|
|
Level
3
|
|
Total
|
|
|
|
(Dollars In Thousands)
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
Fixed maturity securities - available-for-sale
|
|
|
|
|
|
|
|
|
|
Residential mortgage-backed securities
|
|
$
|
|
|
$
|
3,198,977
|
|
$
|
22
|
|
$
|
3,198,999
|
|
Commercial mortgage-backed securities
|
|
|
|
140,136
|
|
|
|
140,136
|
|
Other asset-backed securities
|
|
|
|
295,492
|
|
599,116
|
|
894,608
|
|
U.S. government-related securities
|
|
981,717
|
|
229,951
|
|
15,151
|
|
1,226,819
|
|
States, municipals, and political subdivisions
|
|
|
|
538,532
|
|
86
|
|
538,618
|
|
Other government-related securities
|
|
14,992
|
|
136,029
|
|
|
|
151,021
|
|
Corporate bonds
|
|
100
|
|
14,006,596
|
|
95,367
|
|
14,102,063
|
|
Total fixed maturity securities - available-for-sale
|
|
996,809
|
|
18,545,713
|
|
709,742
|
|
20,252,264
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturity securities - trading
|
|
|
|
|
|
|
|
|
|
Residential mortgage-backed securities
|
|
|
|
517,809
|
|
3,563
|
|
521,372
|
|
Commercial mortgage-backed securities
|
|
|
|
130,790
|
|
|
|
130,790
|
|
Other asset-backed securities
|
|
|
|
16,167
|
|
48,450
|
|
64,617
|
|
U.S. government-related securities
|
|
325,211
|
|
24,030
|
|
3,310
|
|
352,551
|
|
States, municipals, and political subdivisions
|
|
|
|
102,819
|
|
|
|
102,819
|
|
Other government-related securities
|
|
|
|
156,093
|
|
|
|
156,093
|
|
Corporate bonds
|
|
|
|
1,595,549
|
|
26,971
|
|
1,622,520
|
|
Total fixed maturity securities - trading
|
|
325,211
|
|
2,543,257
|
|
82,294
|
|
2,950,762
|
|
Total fixed maturity securities
|
|
1,322,020
|
|
21,088,970
|
|
792,036
|
|
23,203,026
|
|
Equity securities
|
|
209,208
|
|
98
|
|
71,397
|
|
280,703
|
|
Other long-term investments
(1)
|
|
|
|
13,660
|
|
16,962
|
|
30,622
|
|
Short-term investments
|
|
622,234
|
|
25,718
|
|
|
|
647,952
|
|
Total investments
|
|
2,153,462
|
|
21,128,446
|
|
880,395
|
|
24,162,303
|
|
Cash
|
|
202,934
|
|
|
|
|
|
202,934
|
|
Other assets
|
|
5,468
|
|
|
|
|
|
5,468
|
|
Assets related to separate acccounts
|
|
|
|
|
|
|
|
|
|
Variable annuity
|
|
3,306,242
|
|
|
|
|
|
3,306,242
|
|
Variable universal life
|
|
334,134
|
|
|
|
|
|
334,134
|
|
Total assets measured at fair value on a recurring
basis
|
|
$
|
6,002,240
|
|
$
|
21,128,446
|
|
$
|
880,395
|
|
$
|
28,011,081
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
Annuity account balances
(2)
|
|
$
|
|
|
$
|
|
|
$
|
150,630
|
|
$
|
150,630
|
|
Other liabilities
(1)
|
|
|
|
32,983
|
|
128,235
|
|
161,218
|
|
Total liabilities measured at fair value on a
recurring basis
|
|
$
|
|
|
$
|
32,983
|
|
$
|
278,865
|
|
$
|
311,848
|
|
(1)
Includes
certain freestanding and embedded derivatives.
|
(2)
Represents liabilities related to equity indexed annuities.
|
19
Table of Contents
The following table
presents the Companys hierarchy for its assets and liabilities measured at
fair value on a recurring basis as of December 31, 2009:
|
|
Level
1
|
|
Level
2
|
|
Level
3
|
|
Total
|
|
|
|
(Dollars In Thousands)
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
Fixed maturity securities - available-for-sale
|
|
|
|
|
|
|
|
|
|
Other asset-backed securities
|
|
$
|
|
|
$
|
360,797
|
|
$
|
693,930
|
|
$
|
1,054,727
|
|
Commercial mortgage-backed securitites
|
|
|
|
143,486
|
|
844,535
|
|
988,021
|
|
Residential mortgage-backed securities
|
|
|
|
3,370,688
|
|
23
|
|
3,370,711
|
|
U.S. government-related securities
|
|
444,302
|
|
30,198
|
|
15,102
|
|
489,602
|
|
States, municipals, and political subdivisions
|
|
|
|
350,632
|
|
86
|
|
350,718
|
|
Other government-related securities
|
|
16,992
|
|
389,379
|
|
|
|
406,371
|
|
Corporate bonds
|
|
200
|
|
13,127,347
|
|
86,328
|
|
13,213,875
|
|
Total fixed maturity securities -
available-for-sale
|
|
461,494
|
|
17,772,527
|
|
1,640,004
|
|
19,874,025
|
|
Fixed maturity securities - trading
|
|
277,108
|
|
2,574,205
|
|
105,089
|
|
2,956,402
|
|
Total fixed maturity securities
|
|
738,602
|
|
20,346,732
|
|
1,745,093
|
|
22,830,427
|
|
Equity securities
|
|
204,697
|
|
92
|
|
70,708
|
|
275,497
|
|
Other long-term investments
(1)
|
|
|
|
22,926
|
|
16,525
|
|
39,451
|
|
Short-term investments
|
|
983,123
|
|
66,486
|
|
|
|
1,049,609
|
|
Total investments
|
|
1,926,422
|
|
20,436,236
|
|
1,832,326
|
|
24,194,984
|
|
Cash
|
|
205,325
|
|
|
|
|
|
205,325
|
|
Other assets
|
|
4,977
|
|
|
|
|
|
4,977
|
|
Assets related to separate acccounts
|
|
|
|
|
|
|
|
|
|
Variable annuity
|
|
2,948,457
|
|
|
|
|
|
2,948,457
|
|
Variable universal life
|
|
316,007
|
|
|
|
|
|
316,007
|
|
Total assets measured at fair value on a recurring
basis
|
|
$
|
5,401,188
|
|
$
|
20,436,236
|
|
$
|
1,832,326
|
|
$
|
27,669,750
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
Annuity account balances
(2)
|
|
$
|
|
|
$
|
|
|
$
|
149,893
|
|
$
|
149,893
|
|
Other liabilities
(1)
|
|
|
|
43,045
|
|
105,838
|
|
148,883
|
|
Total liabilities measured at fair value on a recurring
basis
|
|
$
|
|
|
$
|
43,045
|
|
$
|
255,731
|
|
$
|
298,776
|
|
(1)
Includes certain freestanding and embedded derivatives.
|
(2)
Represents liabilities related to equity indexed annuities.
|
Determination of fair values
The
valuation methodologies used to determine the fair values of assets and
liabilities reflect market participant assumptions and are based on the
application of the fair value hierarchy that prioritizes observable market
inputs over unobservable inputs. The Company determines the fair values of
certain financial assets and financial liabilities based on quoted market
prices, where available. The Company also determines certain fair values based
on future cash flows discounted at the appropriate current market rate. Fair
values reflect adjustments for counterparty credit quality, the Companys
credit standing, liquidity, and where appropriate, risk margins on unobservable
parameters. The following is a discussion of the methodologies used to
determine fair values for the financial instruments as listed in the above
table.
20
Table of Contents
The fair value of fixed
maturity, short-term, and equity securities is determined by management after
considering one of three primary sources of information: third party pricing
services, non-binding independent broker quotations, or pricing matrices.
Security pricing is applied using a waterfall approach whereby publicly
available prices are first sought from third party pricing services, the
remaining unpriced securities are submitted to independent brokers for
non-binding prices, or lastly, securities are priced using a pricing matrix.
Typical inputs used by these three pricing methods include, but are not limited
to: benchmark yields, reported trades, broker/dealer quotes, issuer spreads,
two-sided markets, benchmark securities, bids, offers, and reference data
including market research publications. Third party pricing services price over
90% of the Companys fixed maturity securities. Based on the typical trading
volumes and the lack of quoted market prices for fixed maturities, third party
pricing services derive the majority of security prices from observable market
inputs such as recent reported trades for identical or similar securities
making adjustments through the reporting date based upon available market
observable information outlined above. If there are no recent reported trades,
the third party pricing services and brokers may use matrix or model processes
to develop a security price where future cash flow expectations are developed
based upon collateral performance and discounted at an estimated market rate.
Certain securities are priced via independent non-binding broker quotations,
which are considered to have no significant unobservable inputs. When using
non-binding independent broker quotations, the Company obtains one quote per
security, typically from the broker from which we purchased the security. A
pricing matrix is used to price securities for which the Company is unable to
obtain or effectively rely on either a price from a third party pricing service
or an independent broker quotation.
The
pricing matrix used by the Company begins with current spread levels to
determine the market price for the security. The credit spreads, assigned by
brokers, incorporate the issuers credit rating, liquidity discounts,
weighted-average of contracted cash flows, risk premium, if warranted, due to
the issuers industry, and the securitys time to maturity. The Company uses
credit ratings provided by nationally recognized rating agencies.
For
securities that are priced via non-binding independent broker quotations, the
Company assesses whether prices received from independent brokers represent a
reasonable estimate of fair value through an analysis using internal and
external cash flow models developed based on spreads and, when available,
market indices. The Company uses a market-based cash flow analysis to validate
the reasonableness of prices received from independent brokers. These
analytics, which are updated daily, incorporate various metrics (yield curves,
credit spreads, prepayment rates, etc.) to determine the valuation of such
holdings. As a result of this analysis, if the Company determines there is a
more appropriate fair value based upon the analytics, the price received from
the independent broker is adjusted accordingly. The Company did not adjust any
quotes or prices received from brokers during the three months ended March 31,
2010.
The
Company has analyzed the third party pricing services valuation methodologies
and related inputs and has also evaluated the various types of securities in
its investment portfolio to determine an appropriate fair value hierarchy level
based upon trading activity and the observability of market inputs that is in
accordance with the Fair Value Measurements and Disclosures Topic of the ASC.
Based on this evaluation and investment class analysis, each price was
classified into Level 1, 2, or 3. Most prices provided by third party pricing
services are classified into Level 2 because the significant inputs used in
pricing the securities are market observable and the observable inputs are
corroborated by the Company. Since the matrix pricing of certain debt
securities includes significant non-observable inputs, they are classified as
Level 3.
Asset-Backed Securities
This
category mainly consists of residential mortgage-backed securities, commercial
mortgage-backed securities, and other asset-backed securities (collectively
referred to as asset-backed securities ABS).
As of March 31, 2010, the Company held $4.3 billion of ABS
classified as level 2. These securities are priced from information from a
third party pricing service and independent broker quotes. The third party
pricing services and brokers mainly value securities using both a market and
income approach to valuation. As part of
this valuation process they consider the following characteristics of the item
being measured to be relevant inputs: 1) weighted-average coupon rate, 2)
weighted-average years to maturity, 3) types of underlying assets, 4)
weighted-average coupon rate of the underlying assets, 5) weighted-average
years to maturity of the underlying assets, 6) seniority level of the tranches
owned, and 7) credit ratings of the securities.
After
reviewing these characteristics of the ABS, the third party pricing service and
brokers use certain inputs to determine the value of the security. For ABS
classified as Level 2, the valuation would consist of predominantly market
observable inputs such as, but not limited to: 1) monthly principal and
interest payments on
21
Table of Contents
the underlying assets, 2)
average life of the security, 3) prepayment speeds, 4) credit spreads, 5)
treasury and swap yield curves, and 6) discount margin.
As
of March 31, 2010, the Company held $651.2 million of Level 3 ABS. These
securities are predominantly auction rate securities (ARS) whose underlying
collateral is at least 97% guaranteed by the Federal Family Education Loan
Program (FFELP). The model uses the discount margin and projected average
life of comparable actively traded FFELP student loan-backed floating-rate
asset-backed securities, along with a discount related to the current
illiquidity of the ARS. These comparable securities are selected based on their
underlying assets (i.e. FFELP-backed student loans) and vintage. As a result of
the ARS market collapse during 2008, the Company prices its ARS using an
internally developed model which utilizes a market based approach to valuation.
As part of the valuation process the Company reviews the following
characteristics of the ARS in determining the relevant inputs: 1) weighted-average
coupon rate, 2) weighted-average years to maturity, 3) types of underlying
assets, 4) weighted-average coupon rate of the underlying assets, 5)
weighted-average years to maturity of the underlying assets, 6) seniority level
of the tranches owned, and 7) credit ratings of the securities.
ABSs
classified as Level 3 had, but were not limited to, the following inputs:
Investment grade credit rating
|
|
100.0%
|
|
Weighted-average yield
|
|
1.58%
|
|
Amortized cost
|
|
$699.8
million
|
|
Weighted-average life
|
|
2.73
years
|
|
Corporate, U.S. Government, and Other government related bonds
As
of March 31, 2010, the Company classified approximately $16.8 billion of
corporate bonds, U.S. government-related securities, and other
government-related securities as Level 2. The fair value of the Level 2 bonds
and securities is predominantly priced by broker quotes and a third party
pricing service. The Company has reviewed the valuation techniques of the
brokers and third party pricing service and has determined that such techniques
used Level 2 market observable inputs. The following characteristics of the
bonds and securities are considered to be the primary relevant inputs to the
valuation: 1) weighted-average coupon rate, 2) weighted-average years to
maturity, 3) seniority, and 4) credit ratings.
The
brokers and third party pricing service utilizes a valuation model that
consists of a hybrid income and market approach to valuation. The pricing model
utilizes the following inputs: 1) principal and interest payments, 2) treasury yield
curve, 3) credit spreads from new issue and secondary trading markets, 4)
dealer quotes with adjustments for issues with early redemption features, 5)
liquidity premiums present on private placements, and 6) discount margins from
dealers in the new issue market.
As
of March 31, 2010, the Company classified approximately $140.9 million of
bonds and securities as Level 3 valuations. The fair value of the Level 3 bonds
and securities are derived from an internal pricing model that utilizes a
hybrid market/income approach to valuation. The Company reviews the following
characteristics of the bonds and securities to determine the relevant inputs to
use in the pricing model: 1) coupon rate, 2) years to maturity, 3) seniority,
4) embedded options, 5) trading volume, and 6) credit ratings.
Level
3 bonds and securities primarily represent investments in illiquid, off-the-run
bonds for which no price is readily available. To determine a price, the
Company uses a discounted cash flow model with both observable and unobservable
inputs. These inputs are entered into an industry standard pricing model to
determine the final price of the security. These inputs include: 1) principal
and interest payments, 2) coupon, 3) sector and issuer level spreads, 4)
underlying collateral, 5) credit ratings, 6) maturity, 7) embedded options, 8)
recent new issuance, 9) comparative bond analysis, and 10) an illiquidity
premium.
22
Table of Contents
Bonds and securities
classified as Level 3 had, but were not limited to, the following
weighted-average inputs:
Investment grade credit rating
|
|
91.48%
|
|
Weighted-average yield
|
|
4.38%
|
|
Weighted-average coupon
|
|
6.52%
|
|
Amortized cost
|
|
$130.7
million
|
|
Weighted-average stated maturity
|
|
5.49
years
|
|
Equities
As
of March 31, 2010, the Company held approximately $71.5 million of equity
securities classified as Level 2 and Level 3. These equity securities consist
primarily of Federal Home Loan Bank stock. The Company believes that the cost
of these investments approximates fair value.
Other long-term investments and Other liabilities
Other
long-term investments and other liabilities consist entirely of free standing
and embedded derivative instruments. Refer to Note 14,
Derivative
Financial Instruments
for additional information related to
derivatives. Derivative instruments are
valued using exchange prices, independent broker quotations, or pricing
valuation models, which utilize market data inputs. Excluding embedded
derivatives, as of March 31, 2010, 54.1% of derivatives based upon
notional values were priced using exchange prices or independent broker
quotations. The remaining derivatives were priced by pricing valuation models,
which predominantly utilize observable market data inputs. Inputs used to value
derivatives include, but are not limited to, interest swap rates, credit
spreads, interest and equity volatility, equity index levels, and treasury
rates. The Company performs monthly analysis on derivative valuations that
includes both quantitative and qualitative analysis.
Derivative
instruments classified as Level 1 include futures and certain options, which
are traded on active exchange markets.
Derivative
instruments classified as Level 2 primarily include interest rate, inflation,
currency exchange, and credit default swaps. These derivative valuations are
determined using independent broker quotations, which are corroborated with
observable market inputs.
Derivative
instruments classified as Level 3 were total return swaps and embedded
derivatives and include at least one non-observable significant input. A
derivative instrument containing Level 1 and Level 2 inputs will be classified
as a Level 3 financial instrument in its entirety if it has at least one
significant Level 3 input.
The
Company utilizes derivative instruments to manage the risk associated with
certain assets and liabilities. However, the derivative instruments may not be
classified within the same fair value hierarchy level as the associated assets
and liabilities. Therefore, the changes in fair value on derivatives reported
in Level 3 may not reflect the offsetting impact of the changes in fair value
of the associated assets and liabilities.
The
guaranteed minimum withdrawal benefit (GMWB) embedded derivative is carried
at fair value in other assets and other liabilities on the Companys
consolidated condensed balance sheet. The changes in fair value are
recorded in earnings as Realized investment gains (losses) Derivative
financial
instruments
, refer to Note
14
Derivative Financial Instruments
for more information related to GMWB embedded derivative gains and
losses. The fair value of the GMWB embedded derivative is derived through
the income method of valuation using a valuation model that projects future
cash flows using 1,000 risk neutral equity scenarios and policyholder behavior
assumptions. The risk neutral scenarios are generated using the current
swap curve and projected equity volatilities and correlations. The
projected equity volatilities are based on historical volatility and near-term
equity market implied volatilities. The equity correlations are based on
historical price observations. For policyholder behavior assumptions, we
use our expected lapse and utilization assumptions and update these assumptions
for our actual experience, as necessary. The Company assumes mortality of 65%
of the National Association of Insurance Commissioners 1994 Variable Annuity
GMDB Mortality Table. The present value of the cash flows is found using
the discount rate curve, which is LIBOR plus a credit spread (to represent the
Companys non-performance risk). As a result of using significant
unobservable inputs, the GMWB embedded derivative is categorized as Level
3. These assumptions are reviewed on a quarterly basis.
23
Table of Contents
The
Company has ceded certain blocks of policies under modified coinsurance
agreements in which the investment results of the underlying portfolios are
passed directly to the reinsurers. As a result, these agreements are deemed to
contain embedded derivatives that must be reported at fair value. Changes in
fair value of the embedded derivatives are reported in earnings. The
investments supporting these agreements are designated as trading securities;
therefore changes in fair value are reported in earnings. The fair value of the
embedded derivatives represents the Future Policy Benefit Reserves (net of
related policy loans) over the unrealized gains and losses of the trading
securities. As a result, changes in fair value of the embedded derivatives
reported in earnings are largely offset by the changes in fair value of the
investments.
Annuity account balances
The equity indexed annuity (EIA)
model calculates the present value of future benefit cash flows less the
projected future profits to quantify the net liability that is held as a
reserve. This calculation is done on a stochastic basis using 1,000 risk
neutral equity scenarios. The cash flows are discounted using LIBOR plus a
credit spread. Best estimate assumptions are used for partial withdrawals,
lapses, expenses and asset earned rate with a risk margin applied to
each. These assumptions are reviewed annually as a part of the formal
unlocking process.
Included
in the chart below, are current key assumptions which include risk margins for
the Company. These assumptions are reviewed for reasonableness on a
quarterly basis.
Asset Earned Rate
|
|
6.10%
|
|
Admin Expense per Policy
|
|
$95
|
|
Partial Withdrawal Rate (for ages less than 70)
|
|
1.65%
|
|
Partial Withdrawal Rate (for ages 70 and greater)
|
|
4.40%
|
|
Mortality
|
|
65%
of 94 MGDB table
|
|
Lapse
|
|
2%
to 50% depending on the surrender charge period
|
|
Return on Assets
|
|
1.5%
to 1.85% depending on the guarantee period
|
|
The discount rate for the
equity indexed annuities is based on an upward sloping rate curve which is
updated each quarter. The discount rates for March 31, 2010, ranged from a
one month rate of 0.75%, a 5 year rate of 3.84%, and a 30 year rate of 5.63%.
Separate Accounts
Separate
account assets are invested in open-ended mutual funds and are included in
Level 1.
24
Table of Contents
The following table presents a reconciliation of the
beginning and ending balances for fair value measurements for the three months
ended March 31, 2010, for which the Company has used significant
unobservable inputs (Level 3):
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gains
(losses)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
included
in
|
|
|
|
|
|
Total
Realized and Unrealized
|
|
|
|
|
|
|
|
Earnings
|
|
|
|
|
|
Gains
(losses)
|
|
|
|
|
|
|
|
related
to
|
|
|
|
|
|
|
|
Included
in
|
|
Purchases,
|
|
|
|
|
|
Instruments
|
|
|
|
|
|
|
|
Other
|
|
Issuances,
and
|
|
Transfers
in
|
|
|
|
still
held at
|
|
|
|
Beginning
|
|
Included
in
|
|
Comprehensive
|
|
Settlements
|
|
and/or
out of
|
|
Ending
|
|
the
Reporting
|
|
|
|
Balance
|
|
Earnings
|
|
Income
|
|
(net)
|
|
Level
3
|
|
Balance
|
|
Date
|
|
|
|
(Dollars
In Thousands)
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
maturity securities - available-for-sale
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
asset-backed securities
|
|
$
|
693,930
|
|
$
|
5,868
|
|
$
|
(1,937
|
)
|
$
|
(89,407
|
)
|
$
|
(9,338
|
)
|
$
|
599,116
|
|
$
|
|
|
Commercial
mortgage-backed securities
|
|
844,535
|
|
|
|
38,281
|
|
(882,816
|
)
(3)
|
|
|
|
|
|
|
Residential
mortgage-backed securities
|
|
23
|
|
4
|
|
|
|
(5
|
)
|
|
|
22
|
|
|
|
U.S.
government-related securities
|
|
15,102
|
|
|
|
46
|
|
3
|
|
|
|
15,151
|
|
|
|
States,
municipals, and political subdivisions
|
|
86
|
|
|
|
|
|
|
|
|
|
86
|
|
|
|
Other
government-related securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
bonds
|
|
86,328
|
|
|
|
5,781
|
|
3,108
|
|
150
|
|
95,367
|
|
|
|
Total
fixed maturity securities - available-for-sale
|
|
1,640,004
|
|
5,872
|
|
42,171
|
|
(969,117
|
)
|
(9,188
|
)
|
709,742
|
|
|
|
Fixed
maturity securities - trading
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
asset-backed securities
|
|
47,509
|
|
696
|
|
|
|
245
|
|
|
|
48,450
|
|
(858
|
)
|
Commercial
mortgage-backed securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential
mortgage-backed securities
|
|
7,244
|
|
27
|
|
|
|
(320
|
)
|
(3,388
|
)
|
3,563
|
|
159
|
|
U.S.
government-related securities
|
|
3,310
|
|
2
|
|
|
|
(2
|
)
|
|
|
3,310
|
|
2
|
|
States,
municipals, and political subdivisions
|
|
4,994
|
|
77
|
|
|
|
|
|
(5,071
|
)
|
|
|
|
|
Other
government-related securities
|
|
41,965
|
|
1,058
|
|
|
|
(47
|
)
|
(42,976
|
)
|
|
|
|
|
Corporate
bonds
|
|
67
|
|
(82
|
)
|
|
|
26,986
|
|
|
|
26,971
|
|
(82
|
)
|
Total
fixed maturity securities - trading
|
|
105,089
|
|
1,778
|
|
|
|
26,862
|
|
(51,435
|
)
|
82,294
|
|
(779
|
)
|
Total
fixed maturity securities
|
|
1,745,093
|
|
7,650
|
|
42,171
|
|
(942,255
|
)
|
(60,623
|
)
|
792,036
|
|
(779
|
)
|
Equity
securities
|
|
70,708
|
|
|
|
|
|
689
|
|
|
|
71,397
|
|
|
|
Other
long-term investments
(1)
|
|
16,525
|
|
437
|
|
|
|
|
|
|
|
16,962
|
|
437
|
|
Short-term
investments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
investments
|
|
1,832,326
|
|
8,087
|
|
42,171
|
|
(941,566
|
)
|
(60,623
|
)
|
880,395
|
|
(342
|
)
|
Total
assets measured at fair value on a recurring basis
|
|
$
|
1,832,326
|
|
$
|
8,087
|
|
$
|
42,171
|
|
$
|
(941,566
|
)
|
$
|
(60,623
|
)
|
$
|
880,395
|
|
$
|
(342
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Annuity
account balances
(2)
|
|
$
|
149,893
|
|
$
|
(2,103
|
)
|
$
|
|
|
$
|
1,366
|
|
$
|
|
|
$
|
150,630
|
|
$
|
|
|
Other
liabilities
(1)
|
|
105,838
|
|
(22,397
|
)
|
|
|
|
|
|
|
128,235
|
|
(22,397
|
)
|
Total
liabilities measured at fair value on a recurring basis
|
|
$
|
255,731
|
|
$
|
(24,500
|
)
|
$
|
|
|
$
|
1,366
|
|
$
|
|
|
$
|
278,865
|
|
$
|
(22,397
|
)
|
(1)
Represents certain freestanding and embedded derivatives.
(2)
Represents
liabilities related to equity indexed annuities.
(3)
Represents mortgage loan held by the trusts that have been consolidated upon
the adoption of ASU No. 2009-17. See Note 4,
Variable Interest Entities
.
For the three months ended March 31, 2010, $0.2 million
of securities were transferred into Level 3. This amount was transferred
entirely from Level 2. These transfers resulted from securities that were
priced by independent pricing services or brokers in previous quarters, using
no significant unobservable inputs, but were priced internally using
significant unobservable inputs where market observable inputs were no longer
available as of March 31, 2010.
For
the three months ended March 31, 2010, $60.8 million of securities were
transferred out of Level 3. This amount was transferred entirely to Level 2.
These transfers resulted from securities that were previously valued using an
internal model that utilized significant unobservable inputs but were valued by
independent pricing services or brokers, utilizing non significant unobservable
inputs, as of March 31, 2010.
For
the three months ended March 31, 2010, there were no transfers between
Level 1 and 2.
25
Table of Contents
The
following table presents a reconciliation of the beginning and ending balances
for fair value measurements for the three months ended March 31, 2009, for
which the Company has used significant unobservable inputs (Level 3):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gains
(losses)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
included
in
|
|
|
|
|
|
Total
Realized and Unrealized
|
|
|
|
|
|
|
|
Earnings
|
|
|
|
|
|
Gains
(losses)
|
|
|
|
|
|
|
|
related
to
|
|
|
|
|
|
|
|
Included
in
|
|
Purchases,
|
|
|
|
|
|
Instruments
|
|
|
|
|
|
|
|
Other
|
|
Issuances,
and
|
|
Transfers
in
|
|
|
|
still
held at
|
|
|
|
Beginning
|
|
Included
in
|
|
Comprehensive
|
|
Settlements
|
|
and/or
out of
|
|
Ending
|
|
the
Reporting
|
|
|
|
Balance
|
|
Earnings
|
|
Income
|
|
(net)
|
|
Level
3
|
|
Balance
|
|
Date
|
|
|
|
(Dollars
In Thousands)
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
maturity securities - available-for-sale
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
asset-backed securities
|
|
$
|
682,710
|
|
$
|
(31
|
)
|
$
|
22,961
|
|
$
|
(243
|
)
|
$
|
|
|
$
|
705,397
|
|
$
|
|
|
Commercial
mortgage-backed securities
|
|
855,817
|
|
|
|
2,079
|
|
(6,175
|
)
|
|
|
851,721
|
|
|
|
Residential
mortgage-backed securities
|
|
34
|
|
|
|
|
|
(2
|
)
|
|
|
32
|
|
|
|
U.S.
government-related securities
|
|
10,072
|
|
|
|
(142
|
)
|
14,862
|
|
|
|
24,792
|
|
|
|
States,
municipals, and political subdivisions
|
|
93
|
|
|
|
|
|
|
|
|
|
93
|
|
|
|
Other
government-related securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
bonds
|
|
78,770
|
|
104
|
|
1,079
|
|
(32,010
|
)
|
21,445
|
|
69,388
|
|
|
|
Total
fixed maturity securities - available-for-sale
|
|
1,627,496
|
|
73
|
|
25,977
|
|
(23,568
|
)
|
21,445
|
|
1,651,423
|
|
|
|
Fixed
maturity securities - trading
|
|
32,645
|
|
493
|
|
|
|
31,212
|
|
(25,342
|
)
|
39,008
|
|
30
|
|
Total
fixed maturity securities
|
|
1,660,141
|
|
566
|
|
25,977
|
|
7,644
|
|
(3,897
|
)
|
1,690,431
|
|
30
|
|
Equity
securities
|
|
76,411
|
|
|
|
231
|
|
(7,559
|
)
|
|
|
69,083
|
|
|
|
Other
long-term investments
(1)
|
|
256,973
|
|
21,943
|
|
|
|
|
|
|
|
278,916
|
|
21,943
|
|
Short-term
investments
|
|
1,161
|
|
|
|
(216
|
)
|
|
|
(108
|
)
|
837
|
|
|
|
Total
investments
|
|
1,994,686
|
|
22,509
|
|
25,992
|
|
85
|
|
(4,005
|
)
|
2,039,267
|
|
21,973
|
|
Total
assets measured at fair value on a recurring basis
|
|
$
|
1,994,686
|
|
$
|
22,509
|
|
$
|
25,992
|
|
$
|
85
|
|
$
|
(4,005
|
)
|
$
|
2,039,267
|
|
$
|
21,973
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Annuity
account balances
(2)
|
|
$
|
152,762
|
|
$
|
946
|
|
$
|
|
|
$
|
(1,010
|
)
|
$
|
|
|
$
|
152,826
|
|
$
|
|
|
Other
liabilities
(1)
|
|
113,311
|
|
58,434
|
|
|
|
|
|
|
|
54,877
|
|
58,434
|
|
Total
liabilities measured at fair value on a recurring basis
|
|
$
|
266,073
|
|
$
|
59,380
|
|
$
|
|
|
$
|
(1,010
|
)
|
$
|
|
|
$
|
207,703
|
|
$
|
58,434
|
|
(1)
Represents certain freestanding
and embedded derivatives.
(2)
Represents liabilities related to
equity indexed annuities.
Total
realized and unrealized gains (losses) on Level 3 assets and liabilities are
primarily reported in either realized investment gains (losses) within the
consolidated condensed statements of income or other comprehensive income
(loss) within shareowners equity based on the appropriate accounting treatment
for the item.
Purchases, sales,
issuances, and settlements, net, represent the activity that occurred during
the period that results in a change of the asset or liability but does not
represent changes in fair value for the instruments held at the beginning of
the period. Such activity primarily relates to purchases and sales of fixed
maturity securities and issuances and settlements of equity indexed annuities.
The
Company reviews the fair value hierarchy classifications each reporting period.
Changes in the observability of the valuation attributes may result in a
reclassification of certain financial assets or liabilities. Such
reclassifications are reported as transfers in and out of Level 3 at the
beginning fair value for the reporting period in which the changes occur. The
asset transfers in the table(s) above primarily related to positions moved
from Level 3 to Level 2 as the Company determined that certain inputs were
observable.
The
amount of total gains (losses) for assets and liabilities still held as of the
reporting date primarily represents changes in fair value of trading securities
and certain derivatives that exist as of the reporting date and the change in
fair value of equity indexed annuities.
26
Table of Contents
Estimated Fair Value of Financial
Instruments
The carrying amounts and estimated fair values of its
financial instruments as of the periods shown below are as follows:
|
|
As
of
|
|
|
|
March 31,
2010
|
|
December 31,
2009
|
|
|
|
Carrying
|
|
|
|
Carrying
|
|
|
|
|
|
Amounts
|
|
Fair
Values
|
|
Amounts
|
|
Fair
Values
|
|
|
|
(Dollars In Thousands)
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
Mortgage loans on real estate
|
|
$
|
4,861,699
|
|
$
|
5,157,747
|
|
$
|
3,883,414
|
|
$
|
4,130,285
|
|
Policy loans
|
|
783,580
|
|
783,580
|
|
794,276
|
|
794,276
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
Stable value product account balances
|
|
$
|
3,453,950
|
|
$
|
3,624,281
|
|
$
|
3,581,150
|
|
$
|
3,758,422
|
|
Annuity account balances
|
|
10,035,799
|
|
9,853,726
|
|
9,911,040
|
|
9,655,208
|
|
Mortgage loan backed certificates
|
|
110,679
|
|
115,014
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Debt:
|
|
|
|
|
|
|
|
|
|
Bank borrowings
|
|
$
|
260,000
|
|
$
|
260,000
|
|
$
|
285,000
|
|
$
|
285,000
|
|
Senior and Medium-Term Notes
|
|
1,359,852
|
|
1,408,564
|
|
1,359,852
|
|
1,331,855
|
|
Subordinated debt securities
|
|
524,743
|
|
489,005
|
|
524,743
|
|
453,523
|
|
Non-recourse funding obligations
|
|
575,000
|
|
421,957
|
|
575,000
|
|
378,205
|
|
Except as noted below, fair values were estimated using quoted market
prices.
Fair Value Measurements
Mortgage loans on real estate
The Company estimates the
fair value of mortgage loans using an internally developed model. This model
includes inputs derived by the Company based on assumed discount rates relative
to the Companys current mortgage loan lending rate and an expected cash flow
analysis based on a review of the mortgage loan terms. The model also contains
the Companys determined representative risk adjustment assumptions related to
nonperformance and liquidity risks.
Policy loans
The Company believes the
fair value of policy loans approximates book value. Policy loans are funds
provided to policy holders in return for a claim on the account value of the
policy. The funds provided are limited to a certain percent of the account
balance. The nature of policy loans is to have low default risk as the loans
are fully collateralized by the value of the policy. The majority of policy
loans do not have a stated maturity and the balances and accrued interest are
repaid with proceeds from the policy account balance. Due to the collateralized
nature of policy loans and unpredictable timing of repayments, the Company
believes the fair value of policy loans approximates carrying value.
Stable value product and Annuity account
balances
The Company estimates the
fair value of stable value product account balances and annuity account
balances using models based on discounted expected cash flows. The discount
rates used in the models were based on a current market rate for similar
financial instruments.
Bank borrowings
The
Company believes the fair value of its bank borrowings approximates carrying
value.
27
Table of Contents
Non-recourse funding obligations
As of March 31, 2010,
the Company estimated the fair value of its non-recourse funding obligations
using internal discounted cash flow models. The discount rates used in the
model were based on a current market yield for similar financial instruments.
14. DERIVATIVE FINANCIAL
INSTRUMENTS
The Company utilizes a risk
management strategy that incorporates the use of derivative financial
instruments to reduce exposure to interest rate risk, inflation risk, currency
exchange risk, and equity market risk. These strategies are developed through
the asset/liability committees analysis of data from financial simulation
models and other internal and industry sources, and are then incorporated into
the Companys risk management program.
Derivative instruments
expose the Company to credit and market risk and could result in material
changes from period to period. The Company minimizes its credit risk by
entering into transactions with highly rated counterparties. The Company
manages the market risk associated with interest rate and foreign exchange
contracts by establishing and monitoring limits as to the types and degrees of
risk that may be undertaken. The Company monitors its use of derivatives in
connection with its overall asset/liability management programs and strategies.
Derivative instruments that
are used as part of the Companys interest rate risk management strategy
include interest rate swaps, interest rate futures, interest rate options, and
interest rate swaptions. The Companys inflation risk management strategy
involves the use of swaps that requires the Company to pay a fixed rate and
receive a floating rate that is based on changes in the Consumer Price Index (CPI).
The Company uses foreign currency swaps to manage its exposure to changes in
the value of foreign currency denominated stable value contracts. No foreign
currency swaps remain outstanding. The Company also uses S&P 500
®
options to mitigate its exposure to the value
of equity indexed annuity contracts.
The
Company has sold credit default protection on liquid traded indices to enhance
the return on its investment portfolio. These credit default swaps create
credit exposure similar to an investment in publicly issued fixed maturity cash
investments. Outstanding credit default swaps relate to the Investment Grade Series 9
Index and have terms to December 2017. Defaults within the Investment
Grade Series 9 Index that exceeded the 10% attachment point would require
the Company to perform under the credit default swaps, up to the 15% exhaustion
point. The maximum potential amount of future payments (undiscounted) that the
Company could be required to make under the credit derivatives is
$25.0 million. As of March 31, 2010, the fair value of the credit
derivatives was a liability of $1.7 million. As of March 31, 2010,
the Company had collateral of $1.8 million posted with the counterparties to
credit default swaps. The collateral is counterparty specific and is not tied
to any one contract. If the credit default swaps needed to be settled
immediately, the Company would need to post no additional payments.
As a result of the ongoing disruption in the credit markets, the fair
value of these derivatives has fluctuated in response to changing market
conditions. The Company believes that the unrealized loss recorded on the
$25.0 million notional of credit default swaps is not indicative of the
economic value of the investment.
The Company records its
derivative instruments in the consolidated condensed balance sheet in other
long-term investments and other liabilities in accordance with GAAP, which
requires that all derivative instruments be recognized in the balance sheet at
fair value. The accounting for GAAP changes in fair value of a derivative
instrument depends on whether it has been designated and qualifies as part of a
hedging relationship and further, on the type of hedging relationship. For
those derivative instruments that are designated and qualify as hedging
instruments, a company must designate the hedging instrument, based upon the
exposure being hedged, as a fair value hedge, cash flow hedge, or a hedge
related to foreign currency exposure. For derivatives that are designated and
qualify as cash flow hedges, the effective portion of the gain or loss realized
on the derivative instrument is reported as a component of other comprehensive
income and reclassified into earnings in the same period during which the
hedged transaction impacts earnings. The remaining gain or loss on these
derivatives is recognized as ineffectiveness in current earnings during the
period of the change. For derivatives that are designated and qualify as fair
value hedges, the gain or loss on the derivative instrument as well as the
offsetting loss or gain on the hedged item attributable to the hedged risk are
recognized in current earnings during the period of change in fair values.
Effectiveness of the Companys hedge relationships is assessed on a quarterly
basis. The Company accounts for changes in fair values of derivatives that are
not part of a qualifying hedge relationship through earnings in the
28
Table of Contents
period of change. Changes in
the fair value of derivatives that are recognized in current earnings are
reported in realized investment gains (losses) - derivative financial
instruments.
Cash-Flow Hedges
·
During 2004 and
2005, in connection with the issuance of inflation adjusted funding agreements,
the Company entered into swaps to convert the floating CPI-linked interest rate
on the contracts to a fixed rate. The Company paid a fixed rate on the swap and
received a floating rate equal to the CPI change paid on the funding
agreements.
·
During 2006 and
2007, the Company entered into interest rate swaps to convert LIBOR based
floating rate interest payments on funding agreements to fixed rate interest
payments.
Other Derivatives
The Company also uses
various other derivative instruments for risk management purposes that either
do not qualify for hedge accounting treatment or have not currently been
designated by the Company for hedge accounting treatment. Changes in the fair
value of these derivatives are recognized in earnings during the period of
change.
·
The Company
uses interest rate swaps to convert the fixed interest rate payments on certain
of its debt obligations to a floating rate. Interest is exchanged periodically
on the notional value, with the Company receiving the fixed rate and paying
various LIBOR-based rates. As of March 31, 2010, the Company did not hold
any positions in these swaps. For the three months ended March 31, 2009,
the Company recognized pre-tax losses of $0.1 million representing the change
in value of these derivatives and related net settlements.
·
The Company
also uses short positions in interest rate futures to mitigate the interest
rate risk associated with its mortgage loan commitments. There were no
outstanding positions as of March 31, 2010. For the three months ended March 31,
2009, the Company recognized pre-tax gains of $2.3 million as a result of
changes in value of these future positions.
·
The Company
uses certain interest rate swaps to mitigate interest rate risk related to
floating rate exposures. The Company recognized a pre-tax loss of $2.4 million
and a pre-tax gain of $14.1 million on interest rate swaps for the three months
ended March 31, 2010 and 2009, respectively.
·
The Company uses other swaps
and options to manage risk related to other exposures. For the three months
ended March 31, 2010 and 2009, the Company recognized pre-tax gains of
$0.8 million and gains less than $0.1 million, respectively, for the change in
fair value of these derivatives.
·
The Company is involved in various modified
coinsurance and funds withheld arrangements which contain embedded derivatives
that must be reported at fair value. Changes in fair value are recorded in
current period earnings. The investment portfolios that support the related
modified coinsurance reserves and funds withheld arrangements had
mark-to-market changes which substantially offset the gains or losses on these
embedded derivatives.
·
The Company markets certain variable annuity
products with a GMWB rider. The GMWB component is considered an embedded
derivative, not considered to be clearly and closely related to the host
contract. The Company recognized pre-tax gains of $9.1 million and $19.8
million related to these embedded derivatives for the three months ended March 31,
2010 and 2009, respectively.
·
The Company
entered into credit default swaps and various other derivative positions to
enhance the return on its investment portfolio. The Company reported net
pre-tax gains of $0.5 million and net pre-tax losses of $4.3 million related to
credit default swaps for the three months ended March 31, 2010 and 2009,
respectively, from the change in swaps fair value and premium income.
29
Table of Contents
The tables below present information about the nature
and accounting treatment of the Companys primary derivative financial
instruments and the location in and effect on the consolidated condensed
financial statements for the periods presented below:
|
|
As
of March 31, 2010
|
|
As
of December 31, 2009
|
|
|
|
Notional
|
|
Fair
|
|
Notional
|
|
Fair
|
|
|
|
Amount
|
|
Value
|
|
Amount
|
|
Value
|
|
|
|
(Dollars In Thousands)
|
|
Other long-term investments
|
|
|
|
|
|
|
|
|
|
Derivatives not designated as hedging instruments:
(1)
|
|
|
|
|
|
|
|
|
|
Interest rate
|
|
$
|
50,000
|
|
$
|
9,103
|
|
$
|
75,000
|
|
$
|
16,174
|
|
Embedded derivative - Modco reinsurance treaties
|
|
29,578
|
|
1,676
|
|
1,883,109
|
|
5,907
|
|
Embedded derivative - GMWB
|
|
664,160
|
|
15,247
|
|
429,562
|
|
10,579
|
|
Other
|
|
45,412
|
|
4,596
|
|
66,250
|
|
6,791
|
|
|
|
$
|
789,150
|
|
$
|
30,622
|
|
$
|
2,453,921
|
|
$
|
39,451
|
|
Other liabilities
|
|
|
|
|
|
|
|
|
|
Cash flow hedges:
|
|
|
|
|
|
|
|
|
|
Inflation
|
|
$
|
343,526
|
|
$
|
12,508
|
|
$
|
343,526
|
|
$
|
19,141
|
|
Interest rate
|
|
175,000
|
|
9,055
|
|
175,000
|
|
11,965
|
|
Derivatives not designated as hedging instruments:
(1)
|
|
|
|
|
|
|
|
|
|
Credit default swaps
|
|
25,000
|
|
1,746
|
|
25,000
|
|
2,172
|
|
Interest rate
|
|
110,000
|
|
8,078
|
|
110,000
|
|
7,011
|
|
Embedded derivative - Modco reinsurance treaties
|
|
2,908,034
|
|
108,202
|
|
1,077,376
|
|
81,339
|
|
Embedded derivative GMWB
|
|
735,392
|
|
19,967
|
|
660,090
|
|
24,423
|
|
Other
|
|
6,879
|
|
1,662
|
|
12,703
|
|
2,832
|
|
|
|
$
|
4,303,831
|
|
$
|
161,218
|
|
$
|
2,403,695
|
|
$
|
148,883
|
|
(1)
Additional
information on derivatives not designated as hedging instruments is referenced
under the ASC Derivatives and Hedging Topic.
Gain (Loss)
on Derivatives in Cash Flow Hedging Relationship
|
|
For The
Three Months Ended March 31, 2010
|
|
|
|
Realized
|
|
Benefits
and
|
|
Other
|
|
|
|
investment
|
|
settlement
|
|
comprehensive
|
|
|
|
gains
(losses)
|
|
expenses
|
|
income
(loss)
|
|
|
|
(Dollars In Thousands)
|
|
Gain (loss) recognized in other
comprehensive
income (loss)
(effective
portion):
|
|
|
|
|
|
|
|
Interest rate
|
|
$
|
|
|
$
|
|
|
$
|
(1,259
|
)
|
Inflation
|
|
|
|
|
|
5,422
|
|
|
|
|
|
|
|
|
|
Gain (loss) reclassified from
accumulated other
comprehensive
income (loss) into income
(effective portion):
|
|
|
|
|
|
|
|
Interest rate
|
|
$
|
|
|
$
|
(1,991
|
)
|
$
|
|
|
Inflation
|
|
|
|
(621
|
)
|
|
|
|
|
|
|
|
|
|
|
Gain (loss) recognized in income
(ineffective
portion):
|
|
|
|
|
|
|
|
Inflation
|
|
$
|
360
|
|
$
|
|
|
$
|
|
|
30
Table of Contents
Gain (Loss)
on Derivatives in Cash Flow Hedging Relationship
|
|
For
The Three Months Ended March 31, 2009
|
|
|
|
Realized
|
|
Benefits
and
|
|
Other
|
|
|
|
investment
|
|
settlement
|
|
comprehensive
|
|
|
|
gains
(losses)
|
|
expenses
|
|
income
(loss)
|
|
|
|
(Dollars In Thousands)
|
|
Gain (loss) recognized in other
comprehensive income (loss)
(effective portion):
|
|
|
|
|
|
|
|
Interest rate
|
|
$
|
|
|
$
|
|
|
$
|
12,674
|
|
Inflation
|
|
|
|
|
|
998
|
|
|
|
|
|
|
|
|
|
Gain (loss) reclassified from
accumulated other comprehensive income (loss) into income
(effective
portion):
|
|
|
|
|
|
|
|
Interest rate
|
|
$
|
|
|
$
|
(2,116
|
)
|
$
|
|
|
Inflation
|
|
|
|
(1,846
|
)
|
|
|
|
|
|
|
|
|
|
|
Gain (loss) recognized in income
(ineffective
portion):
|
|
|
|
|
|
|
|
Inflation
|
|
$
|
707
|
|
$
|
|
|
$
|
|
|
Based on the expected
cash flows of the underlying hedged items, the Company expects to reclassify
$6.0 million out of accumulated other comprehensive income (loss) into earnings
during the next twelve months.
Gain (Loss) on Derivatives Not Designated as Hedging
Instruments
(1)
Realized investment gains
(losses) - derivative financial instruments
|
|
For The
Three Months Ended March 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
(Dollars In Thousands)
|
|
Interest rate risk:
|
|
|
|
|
|
Interest rate swaps
|
|
$
|
(2,392
|
)
|
$
|
2,296
|
|
Mortgage loan commitments
|
|
|
|
14,148
|
|
Credit risk
|
|
505
|
|
(4,337
|
)
|
Embedded derivative - Modco reinsurance treaties
|
|
(31,094
|
)
|
60,632
|
|
Embedded derivative - GMWB
|
|
9,124
|
|
19,801
|
|
Other
|
|
785
|
|
(107
|
)
|
|
|
$
|
(23,072
|
)
|
$
|
92,433
|
|
(1)
Additional
information on derivatives not designated as hedging instruments is referenced
under the ASC Derivatives and Hedging Topic.
Realized investment gains (losses) - all other investments
|
|
For The
Three Months Ended March 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
(Dollars In Thousands)
|
|
Fixed income Modco trading portfolio
(1)
|
|
$
|
44,093
|
|
$
|
(45,878
|
)
|
|
|
|
|
|
|
|
|
(1)
The Company elected to include the use
of alternate disclosures for trading activities.
31
Table of
Contents
15.
OPERATING
SEGMENTS
The Company has several operating segments each having
a strategic focus. An operating segment is distinguished by products, channels
of distribution, and/or other strategic distinctions. The Company periodically
evaluates its operating segments, as prescribed in the ASC Segment Reporting
Topic, and makes adjustments to its segment reporting as needed. A brief
description of each segment follows.
·
The Life Marketing segment markets level
premium term insurance (traditional), universal life, variable universal
life, and bank-owned life insurance (BOLI) products on a national basis
primarily through networks of independent insurance agents and brokers,
stockbrokers, and independent marketing organizations.
·
The Acquisitions segment focuses on
acquiring, converting, and servicing policies acquired from other companies.
The segments primary focus is on life insurance policies and annuity products
that were sold to individuals. In the ordinary course of business, the
Acquisitions segment regularly considers acquisitions of blocks of policies or
insurance companies. The level of the segments acquisition activity is
predicated upon many factors, including available capital, operating capacity,
and market dynamics. Policies acquired through the Acquisitions segment are closed
blocks of business (no new policies are being marketed). Therefore, earnings
and account values are expected to decline as the result of lapses, deaths, and
other terminations of coverage unless new acquisitions are made.
·
The Annuities segment markets and
supports fixed and variable annuity products. These products are primarily sold
through broker-dealers, financial institutions, and independent agents and
brokers.
·
The Stable Value Products segment sells
guaranteed funding agreements to special purpose entities that in turn issue
notes or certificates in smaller, transferable denominations. The segment also
markets fixed and floating rate funding agreements directly to the trustees of
municipal bond proceeds, institutional investors, bank trust departments, and
money market funds. Additionally, the segment markets guaranteed investment
contracts to 401(k) and other qualified retirement savings plans.
·
The Asset Protection segment primarily
markets extended service contracts and credit life and disability insurance to
protect consumers investments in automobiles, watercraft, and recreational
vehicles. In addition, the segment markets a guaranteed asset protection (GAP)
product.
·
The Corporate and Other segment primarily
consists of net investment income (including the impact of carrying excess
liquidity), expenses not attributable to the segments above (including net
investment income on capital and interest on debt), and a trading portfolio
that was previously part of a variable interest entity. This segment also
includes earnings from several non-strategic or runoff lines of business
(primarily cancer insurance, residual value insurance, surety insurance, and
group annuities), various investment-related transactions, and the operations
of several small subsidiaries.
The Company uses the same
accounting policies and procedures to measure segment operating income (loss)
and assets as it uses to measure consolidated net income available to PLCs
common shareowners and assets. Segment operating income (loss) is income before
income tax excluding net realized investment gains and losses (net of the
related amortization of deferred acquisition costs (DAC) and value of
business acquired (VOBA) and participating income from real estate ventures),
and the cumulative effect of change in accounting principle. Periodic
settlements of derivatives associated with corporate debt and certain
investments and annuity products are included in realized gains and losses but
are considered part of operating income because the derivatives are used to
mitigate risk in items affecting consolidated and segment operating income
(loss). Segment operating income (loss) represents the basis on which the
performance of the Companys business is internally assessed by management.
Premiums and policy fees, other income, benefits and settlement expenses, and
amortization of DAC/VOBA are attributed directly to each operating segment. Net
investment income is allocated based on directly related assets required for
transacting the business of that segment. Realized investment gains (losses)
and other operating expenses are allocated to the segments in a manner that
most appropriately reflects the operations of that segment. Investments and
other assets are allocated based on statutory policy liabilities, while
DAC/VOBA and goodwill are shown in the segments to which they are attributable.
During the first quarter of
2010, the Company recorded a $7.8 million decrease in reserves related to the final
settlement in the runoff Lenders Indemnity line of business.
There were no significant intersegment
transactions during the three months ended March 31, 2010 and 2009.
32
Table of Contents
The following tables summarize financial information
for the Companys segments:
|
|
For
The
|
|
|
|
Three
Months Ended
|
|
|
|
March 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
(Dollars In Thousands)
|
|
Revenues
|
|
|
|
|
|
Life Marketing
|
|
$
|
309,004
|
|
$
|
281,851
|
|
Acquisitions
|
|
198,717
|
|
199,234
|
|
Annuities
|
|
140,580
|
|
129,945
|
|
Stable Value Products
|
|
47,956
|
|
66,564
|
|
Asset Protection
|
|
66,431
|
|
66,855
|
|
Corporate and Other
|
|
29,082
|
|
(22,484
|
)
|
Total revenues
|
|
$
|
791,770
|
|
$
|
721,965
|
|
Segment Operating Income (Loss)
|
|
|
|
|
|
Life Marketing
|
|
$
|
40,678
|
|
$
|
42,510
|
|
Acquisitions
|
|
31,369
|
|
33,621
|
|
Annuities
|
|
18,187
|
|
(575
|
)
|
Stable Value Products
|
|
11,027
|
|
20,207
|
|
Asset Protection
|
|
13,067
|
|
6,280
|
|
Corporate and Other
|
|
(16,132
|
)
|
(9,247
|
)
|
Total segment operating income
|
|
98,196
|
|
92,796
|
|
Realized investment (losses) gains - investments
(1)
|
|
35,816
|
|
(131,747
|
)
|
Realized investment (losses) gains - derivatives
(2)
|
|
(32,663
|
)
|
71,107
|
|
Income tax expense
|
|
(31,570
|
)
|
(10,021
|
)
|
Net income available to
PLCs common shareowners
|
|
$
|
69,779
|
|
$
|
22,135
|
|
|
|
|
|
|
|
|
|
(1)
Realized
investment (losses) gains - investments
|
|
$
|
36,030
|
|
$
|
(131,669
|
)
|
Less: related amortization of DAC
|
|
214
|
|
78
|
|
|
|
$
|
35,816
|
|
$
|
(131,747
|
)
|
|
|
|
|
|
|
(2)
Realized
investment gains (losses) - derivatives
|
|
$
|
(23,072
|
)
|
$
|
92,433
|
|
Less: settlements on certain interest rate swaps
|
|
42
|
|
2,238
|
|
Less: derivative activity related to certain
annuities
|
|
9,549
|
|
19,088
|
|
|
|
$
|
(32,663
|
)
|
$
|
71,107
|
|
33
Table of
Contents
|
|
Operating
Segment Assets
|
|
|
|
As
of March 31, 2010
|
|
|
|
(Dollars In Thousands)
|
|
|
|
Life
|
|
|
|
|
|
Stable
Value
|
|
|
|
Marketing
|
|
Acquisitions
|
|
Annuities
|
|
Products
|
|
Investments and other assets
|
|
$
|
9,002,317
|
|
$
|
9,094,172
|
|
$
|
10,764,136
|
|
$
|
3,442,817
|
|
Deferred policy acquisition costs and value of
business acquired
|
|
2,313,171
|
|
814,688
|
|
399,305
|
|
11,133
|
|
Goodwill
|
|
10,192
|
|
44,136
|
|
|
|
|
|
Total assets
|
|
$
|
11,325,680
|
|
$
|
9,952,996
|
|
$
|
11,163,441
|
|
$
|
3,453,950
|
|
|
|
Asset
|
|
Corporate
|
|
|
|
Total
|
|
|
|
Protection
|
|
and
Other
|
|
Adjustments
|
|
Consolidated
|
|
Investments and other assets
|
|
$
|
724,110
|
|
$
|
6,813,630
|
|
$
|
25,407
|
|
$
|
39,866,589
|
|
Deferred policy acquisition costs and value of
business acquired
|
|
91,764
|
|
3,996
|
|
|
|
3,634,057
|
|
Goodwill
|
|
62,670
|
|
83
|
|
|
|
117,081
|
|
Total assets
|
|
$
|
878,544
|
|
$
|
6,817,709
|
|
$
|
25,407
|
|
$
|
43,617,727
|
|
|
|
Operating
Segment Assets
|
|
|
|
As
of December 31, 2009
|
|
|
|
(Dollars In Thousands)
|
|
|
|
Life
|
|
|
|
|
|
Stable
Value
|
|
|
|
Marketing
|
|
Acquisitions
|
|
Annuities
|
|
Products
|
|
Investments and other assets
|
|
$
|
8,753,212
|
|
$
|
9,136,474
|
|
$
|
9,977,456
|
|
$
|
3,569,038
|
|
Deferred policy acquisition costs and value of
business acquired
|
|
2,277,256
|
|
839,829
|
|
430,704
|
|
12,112
|
|
Goodwill
|
|
10,192
|
|
44,911
|
|
|
|
|
|
Total assets
|
|
$
|
11,040,660
|
|
$
|
10,021,214
|
|
$
|
10,408,160
|
|
$
|
3,581,150
|
|
|
|
Asset
|
|
Corporate
|
|
|
|
Total
|
|
|
|
Protection
|
|
and Other
|
|
Adjustments
|
|
Consolidated
|
|
Investments and other assets
|
|
$
|
742,456
|
|
$
|
6,325,373
|
|
$
|
26,372
|
|
$
|
38,530,381
|
|
Deferred policy acquisition costs and value of
business acquired
|
|
97,499
|
|
5,950
|
|
|
|
3,663,350
|
|
Goodwill
|
|
62,670
|
|
83
|
|
|
|
117,856
|
|
Total assets
|
|
$
|
902,625
|
|
$
|
6,331,406
|
|
$
|
26,372
|
|
$
|
42,311,587
|
|
34
Table
of Contents
16.
SUBSEQUENT
EVENTS
On April 23, 2010, Golden Gate III Vermont
Captive Insurance Company (Golden Gate III), a newly formed, indirect wholly
owned subsidiary of the Company, entered into a Reimbursement Agreement (the Reimbursement
Agreement) with UBS AG, Stamford Branch, as issuing lender (UBS). Under
the Reimbursement Agreement, on April 23, 2010, UBS issued a letter of
credit (the LOC) in the initial amount of $505 million to a trust for the
benefit of the Companys indirect wholly owned subsidiary, West Coast Life
Insurance Company (WCL). Subject to certain conditions, the amount of
the LOC will be periodically increased up to a maximum of $610 million in
2013. The term of the LOC is expected to be eight years, subject to
certain conditions including capital contributions made to Golden Gate III by
one of its affiliates. The LOC was issued to support certain obligations of
Golden Gate III to WCL for a portion of reserves related to level premium term
life insurance policies reinsured by Golden Gate III from WCL under an
indemnity reinsurance agreement effective April 1, 2010. These
policies were originally ceded by WCL to Golden Gate Captive Insurance Company
(Golden Gate), an indirect wholly owned subsidiary of the Company domiciled
in South Carolina, and were recaptured by WCL and ceded to Golden Gate III
concurrent with this transaction. The estimated average annual expense of
the LOC under generally accepted accounting principles is approximately $11
million, after-tax.
Pursuant to the terms of the Reimbursement Agreement,
in the event amounts are drawn under the LOC by the trustee on behalf of WCL,
Golden Gate III will be obligated, subject to certain conditions, to reimburse
UBS for the amount of any draw and any interest thereon. The Reimbursement
Agreement is non-recourse to the Company, Protective Life Insurance Company (PLICO)
and WCL, meaning that none of these companies are liable to reimburse UBS for
any drawn amounts or interest thereon. Pursuant to the terms of a letter
agreement with UBS, the Company has agreed to guarantee the payment of fees to
UBS under the Reimbursement Agreement. Pursuant to the Reimbursement
Agreement, Golden Gate III has collateralized its obligations to UBS by
granting UBS a security interest in its assets.
On April 28, 2010,
Golden Gate, a South Carolina special purpose financial captive and wholly
owned subsidiary of PLICO, redeemed $180 million of Series B Surplus Notes
held by PLC. On April 29, 2010, PLC used the proceeds of this
redemption to repay $180 million of the outstanding balance on its revolving
line of credit facility (the Credit Facility), resulting in an outstanding
balance of $80 million under the Credit Facility on such date. In addition, on April 27,
2010, Golden Gates Board of Directors authorized the payment of a dividend in
the amount of $250 million to PLICO to be paid in one or more payments on or
after April 27, 2010
.
The
Company has evaluated the effects of events subsequent to March 31, 2010,
and the date we filed our consolidated condensed financial statements with the
United States Securities and Exchange Commission.
All accounting and disclosure requirements related to
subsequent events are included in our consolidated condensed financial
statements.
35
Table of
Contents
Item 2. Managements Discussion and Analysis of
Financial Condition and Results of Operations
The following Managements Discussion and Analysis
of Financial Condition and Results of Operations (MD&A) should be
read in conjunction with our consolidated condensed financial statements
included under Part I, Item 1,
Financial Statements (Unaudited)
,
of this Quarterly Report on Form 10-Q and our audited consolidated
financial statements for the year ended December 31, 2009, included in our
Annual Report on Form 10-K.
For
a more complete understanding of our business and current period results,
please read the following MD&A in conjunction with our latest Annual Report
on Form 10-K and other filings with the United States Securities and
Exchange Commission (the SEC).
Certain
reclassifications have been made in the previously reported financial
statements and accompanying notes to make the prior period amounts comparable
to those of the current period. Such reclassifications had no effect on
previously reported net income or shareowners equity.
FORWARD-LOOKING
STATEMENTS CAUTIONARY LANGUAGE
This report reviews our
financial condition and results of operations including our liquidity and
capital resources. Historical information is presented and discussed, and where
appropriate, factors that may affect future financial performance are also
identified and discussed. Certain statements made in this report include forward-looking
statements within the meaning of the Private Securities Litigation Reform Act
of 1995. Forward-looking statements include any statement that may predict,
forecast, indicate, or imply future results, performance, or achievements
instead of historical facts and may contain words like believe, expect, estimate,
project, budget, forecast, anticipate, plan, will, shall, may,
and other words, phrases, or expressions with similar meaning. Forward-looking
statements involve risks and uncertainties, which may cause actual results to
differ materially from the results contained in the forward-looking statements,
and we cannot give assurances that such statements will prove to be correct.
Given these risks and uncertainties, investors should not place undue reliance
on forward-looking statements as a prediction of actual results. We undertake
no obligation to publicly update any forward-looking statements, whether as a
result of new information, future developments or otherwise. For more
information about the risks, uncertainties and other factors that could affect
our future results, please see Part I, Item II,
Risks and
Uncertainties
and Part II, Item 1A,
Risk Factors
,
of this report, as well as Part I, Item 1A,
Risk Factors
,
of our Annual Report on Form 10-K for the fiscal year ended December 31,
2009.
OVERVIEW
Our business
We are a holding company
headquartered in Birmingham, Alabama, with subsidiaries that provide financial
services through the production, distribution, and administration of insurance
and investment products. Founded in 1907, Protective Life Insurance Company (PLICO)
is our largest operating subsidiary. Unless the context otherwise requires, the
Company, we, us, or our refers to the consolidated group of Protective
Life Corporation and our subsidiaries.
We have several operating
segments, each having a strategic focus. An operating segment is distinguished
by products, channels of distribution, and/or other strategic distinctions. We
periodically evaluate our operating segments as prescribed in the Accounting
Standards Codification (ASC) Segment Reporting Topic, and make adjustments to
our segment reporting as needed.
Our operating segments
are Life Marketing, Acquisitions, Annuities, Stable Value Products, Asset
Protection, and Corporate and Other.
·
Life Marketing
-
We market level premium term insurance (traditional),
universal life (UL), variable universal life, and bank-owned life
insurance (BOLI) products on a national basis primarily through networks
of independent insurance agents and brokers, stockbrokers, and independent
marketing organizations.
·
Acquisitions
- We focus on acquiring, converting, and
servicing policies acquired from other companies. The segments primary focus is on life
insurance policies and annuity products sold to
36
Table of
Contents
individuals.
In the ordinary
course of business, the Acquisitions segment regularly considers acquisitions
of blocks of policies or insurance companies. The level of the segments
acquisition activity is predicated upon many factors, including available
capital, operating capacity, and market dynamics. Policies acquired through the
Acquisition segment are closed blocks of business (no new policies are being
marketed). Therefore, earnings and
account values are expected to decline as the result of lapses, deaths, and
other terminations of coverage unless new acquisitions are made.
·
Annuities
- We market and support fixed and
variable annuity products. These products are primarily sold through
broker
-dealers, financial institutions, and
independent agents and brokers.
·
Stable Value Products
- We sell guaranteed funding
agreements (GFAs) to special purpose entities that in turn issue notes
or certificates in smaller, transferable denominations. The segment also
markets fixed and floating rate funding agreements directly to the trustees of
municipal bond proceeds, institutional investors, bank trust
departments
, and money market funds. Additionally,
the segment markets guaranteed investment contracts (GICs) to 401(k) and
other qualified retirement savings plans.
·
Asset Protection
- We primarily market extended service
contracts and credit life and disability insurance to protect consumers
investments
in automobiles, watercraft, and
recreational vehicles. In addition, the segment markets a GAP product.
·
Corporate and Other
- This segment primarily consists of net
investment income (including the impact of carrying excess liquidity), expenses
not attributable to the segments above (including net investment income on
capital and interest on debt), and a trading portfolio that was previously part
of a variable interest entity. This segment also includes earnings from several
non-strategic or runoff lines of business (primarily cancer insurance, residual
value insurance, surety insurance, and group annuities), various
investment-related transactions, and the operations of several small
subsidiaries.
EXECUTIVE SUMMARY
We delivered solid financial
results in the first quarter. Across the board, our operating segments produced
results that were in line with or exceeded our expectations. As compared to the
first quarter of last year, total life insurance sales increased 17.4%,
universal life sales increased 65.9% (and exceeded term sales in this quarter),
annuity sales increased 30.0% and extended service contract sales increased
9.3%. Mortality also continued to trend favorably in the quarter. As we look to
the remainder of the year, we expect continued positive momentum as we move
forward with our plans to introduce innovative, differentiated products to our
markets, invest excess liquidity, optimize capital deployment and grow our
distribution networks.
In addition, earnings were
impacted favorably by $2.8 million during the three months ended March 31,
2010, due to the release of unrecognized income tax benefits relating to
tax-basis policy liabilities. This release was prompted by the Internal Revenue
Services recent technical guidance confirming our historical calculations.
Significant
financial information related to each of our segments is included in Results
of Operations.
37
Table of Contents
RISKS AND UNCERTAINTIES
The
factors which could affect our future results include, but are not limited to,
general economic conditions and the following risks and uncertainties:
General
·
exposure to the risks of natural and man-made
catastrophes, pandemics, malicious and terrorist acts that could adversely
affect our operations and results;
·
computer viruses, network security breaches,
disasters, or other unanticipated events could affect our data processing
systems or those of our business partners and could damage our business and
adversely affect our financial condition and results of operations;
·
actual experience may differ from managements
assumptions and estimates and negatively affect our results;
·
we may not realize our anticipated financial
results from our acquisitions strategy;
·
we are dependent on the performance of
others;
·
our risk management policies and procedures
could leave us exposed to unidentified or unanticipated risk, which could
negatively affect our business or result in losses;
Financial environment
·
interest rate fluctuations could negatively
affect our interest earnings and spread income or otherwise impact our
business;
·
our investments are subject to market,
credit, legal, and regulatory risks, which could be heightened during periods
of extreme volatility or disruption in the financial and credit markets;
·
equity market volatility could negatively
impact our business;
·
credit market volatility or disruption could
adversely impact our financial condition or results from operations;
·
our ability to grow depends in large part
upon the continued availability of capital;
·
we could be adversely affected by a ratings
downgrade or other negative action by a ratings organization;
·
a loss of policyholder confidence in our
insurance subsidiaries could lead to higher than expected levels of
policyholder surrenders and withdrawal of funds;
·
we could be forced to sell investments at a
loss to cover policyholder withdrawals;
·
disruption of the capital and credit markets
could negatively affect our ability to meet our liquidity and financing needs;
·
difficult conditions in the economy generally
could adversely affect our business and results from operations;
·
continued deterioration of general economic
conditions could result in a severe and extended economic recession, which
could materially adversely affect our business and results from operations;
·
there can be no assurance that the actions of
the United States Government or other governmental and regulatory bodies for
the purpose of stabilizing the financial markets will achieve their intended
effect;
·
we may be required to establish a valuation
allowance against our deferred tax assets, which could materially adversely
affect our results of operations, financial condition, and capital position;
·
we could be adversely affected by an
inability to access our credit facility;
·
our financial condition or results of
operations could be adversely impacted if our assumptions regarding the fair
value and future performance of our investments differ from actual experience;
·
the amount of statutory capital we have and
must hold to maintain our financial strength and credit ratings and meet other
requirements can vary significantly from time to time and is sensitive to a
number of factors outside of our control;
·
we are a holding company and depend on the
ability of our subsidiaries to transfer funds to us to meet our obligations and
pay dividends;
38
Table of Contents
Industry
·
insurance companies are highly regulated and
subject to numerous legal restrictions and regulations;
·
changes to tax law or interpretations of
existing tax law could adversely affect our ability to compete with
non-insurance products or reduce the demand for certain insurance products;
·
financial services companies are frequently
the targets of litigation, including class action litigation, which could
result in substantial judgments;
·
publicly held companies in general and the
financial services industry in particular are sometimes the target of law
enforcement investigations and the focus of increased regulatory scrutiny;
·
new accounting rules, changes to existing
accounting rules, or the grant of permitted accounting practices to competitors
could negatively impact us;
·
reinsurance introduces variability in our
statements of income;
·
our reinsurers could fail to meet assumed
obligations, increase rates, or be subject to adverse developments that could
affect us;
·
policy claims fluctuate from period to period
resulting in earnings volatility;
Competition
·
we operate in a mature, highly competitive
industry, which could limit our ability to gain or maintain our position in the
industry and negatively affect profitability;
·
our ability to maintain competitive unit
costs is dependent upon the level of new sales and persistency of existing
business;
·
a ratings downgrade could adversely affect
our ability to compete; and
·
we may not be able to protect our
intellectual property and could also be subject to infringement claims.
For
more information about the risks, uncertainties, and other factors that could
affect our future results, please see Part II, Item 1A of this report and
our Annual Reports on Forms 10-K.
CRITICAL ACCOUNTING POLICIES
Our
accounting policies inherently require the use of judgments relating to a
variety of assumptions and estimates, in particular expectations of current and
future mortality, morbidity, persistency, expenses, and interest rates. Because
of the inherent uncertainty when using the assumptions and estimates, the
effect of certain accounting policies under different conditions or assumptions
could be materially different from those reported in the consolidated condensed
financial statements. For a complete listing of our critical accounting policies,
refer to our Annual Report on Form 10-K for the year ended December 31,
2009.
RESULTS
OF OPERATIONS
In the following
discussion, segment operating income (loss) is defined as income before income
tax excluding net realized investment gains and losses (net of the related
deferred acquisitions costs (DAC) and value of business acquired (VOBA) and
participating income from real estate ventures), and the cumulative effect of
change in accounting principle. Periodic settlements of derivatives associated
with corporate debt and certain investments and annuity products are included
in realized gains and losses but are considered part of segment operating
income (loss) because the derivatives are used to mitigate risk in items
affecting segment operating income (loss). Management believes that segment
operating income (loss) provides relevant and useful information to investors,
as it represents the basis on which the performance of our business is
internally assessed. Although the items excluded from segment operating income
(loss) may be significant components in understanding and assessing our overall
financial performance, management believes that segment operating income
enhances an investors understanding of our results of operations by
highlighting the income usually attributable to the normal, recurring
operations of our business. However, segment operating income should not be
viewed as a substitute for
accounting principles generally accepted in
the United States of America (GAAP)
net income available to PLCs common shareowners. In
addition, our segment operating income (loss) measures may not be comparable to
similarly titled measures reported by other companies.
39
Table of Contents
The following table
presents a summary of results and reconciles segment operating income (loss) to
consolidated net income available to PLCs common shareowners:
|
|
For
The
|
|
|
|
|
|
Three
Months Ended
|
|
|
|
|
|
March 31,
|
|
|
|
|
|
2010
|
|
2009
|
|
Change
|
|
|
|
(Dollars In Thousands)
|
|
|
|
Segment Operating Income (Loss)
|
|
|
|
|
|
|
|
Life Marketing
|
|
$
|
40,678
|
|
$
|
42,510
|
|
(4.3
|
)%
|
Acquisitions
|
|
31,369
|
|
33,621
|
|
(6.7
|
)
|
Annuities
|
|
18,187
|
|
(575
|
)
|
n/m
|
|
Stable Value Products
|
|
11,027
|
|
20,207
|
|
(45.4
|
)
|
Asset Protection
|
|
13,067
|
|
6,280
|
|
n/m
|
|
Corporate and Other
|
|
(16,132
|
)
|
(9,247
|
)
|
74.5
|
|
Total segment operating income
|
|
98,196
|
|
92,796
|
|
5.8
|
|
Realized investment gains (losses) - investments
(1)(3)
|
|
35,816
|
|
(131,747
|
)
|
|
|
Realized investment gains (losses) - derivatives
(2)
|
|
(32,663
|
)
|
71,107
|
|
|
|
Income tax expense
|
|
(31,570
|
)
|
(10,021
|
)
|
|
|
Net income available to
PLCs common shareowners
|
|
$
|
69,779
|
|
$
|
22,135
|
|
n/m
|
|
|
|
|
|
|
|
|
|
(1)
Realized
investment gains (losses) - investments
(3)
|
|
$
|
36,030
|
|
$
|
(131,669
|
)
|
|
|
Less: related amortization of DAC
|
|
214
|
|
78
|
|
|
|
|
|
$
|
35,816
|
|
$
|
(131,747
|
)
|
|
|
|
|
|
|
|
|
|
|
(2)
Realized
investment gains (losses) - derivatives
|
|
$
|
(23,072
|
)
|
$
|
92,433
|
|
|
|
Less: settlements on certain interest rate swaps
|
|
42
|
|
2,238
|
|
|
|
Less: derivative activity related to certain
annuities
|
|
9,549
|
|
19,088
|
|
|
|
|
|
$
|
(32,663
|
)
|
$
|
71,107
|
|
|
|
(3)
Includes other-than-temporary
impairments of $11.9 million and $89.8 million for the three months ended March 31,
2010 and 2009, respectively.
For
The Three Months Ended March 31, 2010 compared to The Three Months Ended March 31,
2009
Net income available to PLCs common shareowners for
the three months ended March 31, 2010, included a $5.4 million, or
5.8%, increase in segment operating income. The increase was primarily related
to an $18.8 million increase in operating income in the Annuities segment and a
$6.8 million increase in the Asset Protection segment. These increases were
partially offset by a decrease of $1.8 million in operating income in the Life
Marketing segment, a $9.2 million decrease in the Stable Value Products
segment, a $2.3 million decrease in the Acquisition segment, and a $6.9 million
decrease in operating income in the Corporate and Other segment. Changes in
fair value related to the Corporate and Other trading portfolio and the
Annuities segment increased operating earnings by $11.6 million for the three
months ended March 31, 2010.
We
experienced net realized gains of $13.0 million for the three months ended March 31,
2010, compared to net realized losses of $39.2 million for the three months
ended March 31, 2009. The gains realized for the three months ended March 31,
2010, were primarily caused by $9.1 million of gains related to guaranteed
minimum withdrawal benefits (GMWB) embedded derivative valuation changes,
$13.0 million of gains related to the net activity related to the modified
coinsurance portfolio and derivative activity, and $6.7 million of gains
related to sale activity. Offsetting these gains were $11.9 million of
other-than-temporary impairment credit-related losses and mark-to-market losses
of $2.4 million on interest rate swaps.
·
Life Marketing segment o
perating income was $40.7 million for the
three months ended March 31, 2010, representing a decrease of $1.8
million, or 4.3%, from the three months ended March 31, 2009. The decrease
was primarily due to lower allocated investment income on the traditional line
of business and higher insurance company operating expenses, partly offset by
more favorable mortality results.
40
Table of Contents
·
Acquisitions segment operating income was
$31.4 million
for the
three months ended March 31, 2010, a decrease of $2.3 million, or 6.7%,
compared to the three months ended March 31, 2009, primarily due to the
expected runoff of the blocks of business and less favorable mortality results.
·
Annuities
segment operating income was $18.2 million for the
three months ended March 31, 2010, compared to an operating loss of $0.6
million for the three months ended March 31, 2009, an increase of $18.8
million. This change included an unfavorable $7.4 million variance related to
fair value changes, of which $2.2 million was related to the equity indexed
annuity (EIA) product and $5.2 million was related to embedded derivatives
associated with the variable annuity (VA) GMWB rider. The remaining $25.6
million increase in operating income was primarily driven by a $19.2 million
unlocking charge recorded within the VA line during the three months ended March 31,
2009. Other items accounted for the remainder of the variance, including a $3.5
million increase in earnings related to wider spreads and average account value
growth of 52% in the single premium deferred annuity (SPDA) line.
·
Stable Value Products segment operating
income was $11.0 million and decreased $9.2 million, or 45.4%, for the
three months ended March 31, 2010, compared to the three months ended March 31,
2009. The decrease in operating earnings resulted from a decline in average
account values and lower operating spreads. In addition, no income was
generated from the early retirement of funding agreements backing medium-term
notes for the three months ended March 31, 2010, compared with $1.5
million for the first quarter of 2009. The operating spread decreased 39 basis
points to 126 basis points for the three months ended March 31, 2010,
compared to an operating spread of 165 basis points during the three months
ended March 31, 2009.
·
Asset Protection segment operating income was $13.1 million,
representing an increase of $6.8 million for the three months ended March 31,
2010, compared to the three months ended March 31, 2009. First quarter
income was comprised of $5.5 million of income from core operations and $7.6
million of income from runoff lines. Credit insurance earnings decreased
$1.5 million compared to the prior y
ear, primarily due to
unfavorable loss experience and higher expenses. Service contract earnings
declined $0.5 million, or 9.6%, compared to the prior year, primarily due to
higher loss ratios and higher expenses in certain product lines. Earnings from
other products increased $8.8 million for the three months ended March 31,
2010 compared to the prior year. The increase in other products was primarily
from a $7.8 million reserve release in the first quarter of 2010 related to the
final settlement in the runoff Lenders Indemnity line of business. Favorable
loss experience in the GAP product line also contributed to the increase.
·
Corporate and Other segment operating
loss was $16.1 million for the three months ended March 31, 2010,
compared to a loss of $9.2 million for the three months ended March 31,
2009. The variance was primarily due to an increase of interest expense of
$11.9 million. Partially offsetting this decrease to earnings was an
improvement of $5.8 million in investment income, and a $0.7 million
improvement in the trading portfolio, compared to the three months ended March 31,
2009.
41
Table of
Contents
Life Marketing
Segment
results of operations
Segment results were as
follows:
|
|
For
The
|
|
|
|
|
|
Three
Months Ended
|
|
|
|
|
|
March 31,
|
|
|
|
|
|
2010
|
|
2009
|
|
Change
|
|
|
|
(Dollars In Thousands)
|
|
|
|
REVENUES
|
|
|
|
|
|
|
|
Gross premiums and policy fees
|
|
$
|
373,390
|
|
$
|
375,658
|
|
(0.6
|
)%
|
Reinsurance ceded
|
|
(176,752
|
)
|
(207,164
|
)
|
(14.7
|
)
|
Net premiums and policy fees
|
|
196,638
|
|
168,494
|
|
16.7
|
|
Net investment income
|
|
91,144
|
|
93,527
|
|
(2.5
|
)
|
Other income
|
|
21,222
|
|
19,830
|
|
7.0
|
|
Total operating revenues
|
|
309,004
|
|
281,851
|
|
9.6
|
|
BENEFITS AND EXPENSES
|
|
|
|
|
|
|
|
Benefits and settlement expenses
|
|
220,556
|
|
195,410
|
|
12.9
|
|
Amortization of deferred policy acquisition costs
|
|
34,078
|
|
35,728
|
|
(4.6
|
)
|
Other operating expenses
|
|
13,692
|
|
8,203
|
|
66.9
|
|
Total benefits and expenses
|
|
268,326
|
|
239,341
|
|
12.1
|
|
INCOME BEFORE INCOME TAX
|
|
40,678
|
|
42,510
|
|
(4.3
|
)
|
OPERATING INCOME
|
|
$
|
40,678
|
|
$
|
42,510
|
|
(4.3
|
)
|
42
Table of
Contents
The following table summarizes key data for the Life
Marketing segment:
|
|
For
The
|
|
|
|
|
|
Three
Months Ended
|
|
|
|
|
|
March 31,
|
|
|
|
|
|
2010
|
|
2009
|
|
Change
|
|
|
|
(Dollars In Thousands)
|
|
|
|
Sales By Product
|
|
|
|
|
|
|
|
Traditional
|
|
$
|
20,764
|
|
$
|
23,151
|
|
(10.3
|
)%
|
Universal life
|
|
21,267
|
|
12,819
|
|
65.9
|
|
Variable universal life
|
|
936
|
|
642
|
|
45.8
|
|
|
|
$
|
42,967
|
|
$
|
36,612
|
|
17.4
|
|
Sales By Distribution Channel
|
|
|
|
|
|
|
|
Brokerage general agents
|
|
$
|
26,351
|
|
$
|
21,464
|
|
22.8
|
|
Independent agents
|
|
6,691
|
|
7,280
|
|
(8.1
|
)
|
Stockbrokers / banks
|
|
8,971
|
|
7,173
|
|
25.1
|
|
BOLI / other
|
|
954
|
|
695
|
|
37.3
|
|
|
|
$
|
42,967
|
|
$
|
36,612
|
|
17.4
|
|
Average Life Insurance In-force
(1)
|
|
|
|
|
|
|
|
Traditional
|
|
$
|
497,128,581
|
|
$
|
483,531,806
|
|
2.8
|
|
Universal life
|
|
53,604,563
|
|
52,991,628
|
|
1.2
|
|
|
|
$
|
550,733,144
|
|
$
|
536,523,434
|
|
2.6
|
|
Average Account Values
|
|
|
|
|
|
|
|
Universal life
|
|
$
|
5,418,442
|
|
$
|
5,352,302
|
|
1.2
|
|
Variable universal life
|
|
324,071
|
|
236,712
|
|
36.9
|
|
|
|
$
|
5,742,513
|
|
$
|
5,589,014
|
|
2.7
|
|
|
|
|
|
|
|
|
|
Traditional Life Mortality
Experience
(2)
|
|
$
|
13,049
|
|
$
|
546
|
|
|
|
Universal Life Mortality
Experience
(2)
|
|
$
|
1,437
|
|
$
|
1,486
|
|
|
|
(1)
Amounts
are not adjusted for reinsurance ceded.
(2)
Represents
the estimated pre-tax earnings impact resulting from mortality variances. We
periodically review and update as appropriate our key assumptions in
calculating mortality. Changes to these assumptions result in adjustments,
which may increase or decrease previously reported mortality amounts.
43
Table of
Contents
Operating expenses detail
O
ther operating expenses for the segment were as
follows:
|
|
For
The
|
|
|
|
|
|
Three
Months Ended
|
|
|
|
|
|
March 31,
|
|
|
|
|
|
2010
|
|
2009
|
|
Change
|
|
|
|
(Dollars In Thousands)
|
|
|
|
Insurance Companies:
|
|
|
|
|
|
|
|
First year commissions
|
|
$
|
51,657
|
|
$
|
42,376
|
|
21.9
|
%
|
Renewal commissions
|
|
8,614
|
|
9,087
|
|
(5.2
|
)
|
First year ceding allowances
|
|
(2,088
|
)
|
(4,309
|
)
|
(51.5
|
)
|
Renewal ceding allowances
|
|
(45,870
|
)
|
(51,044
|
)
|
(10.1
|
)
|
General & administrative
|
|
39,905
|
|
36,622
|
|
9.0
|
|
Taxes, licenses, and fees
|
|
7,983
|
|
7,301
|
|
9.3
|
|
Other operating expenses incurred
|
|
60,201
|
|
40,033
|
|
50.4
|
|
Less: commissions, allowances & expenses capitalized
|
|
(67,413
|
)
|
(51,509
|
)
|
30.9
|
|
Other insurance company operating expenses
|
|
(7,212
|
)
|
(11,476
|
)
|
(37.2
|
)
|
Marketing Companies:
|
|
|
|
|
|
|
|
Commissions
|
|
15,898
|
|
14,685
|
|
8.3
|
|
Other operating expenses
|
|
5,006
|
|
4,994
|
|
0.2
|
|
Other marketing company operating expenses
|
|
20,904
|
|
19,679
|
|
6.2
|
|
Other operating expenses
|
|
$
|
13,692
|
|
$
|
8,203
|
|
66.9
|
|
For
The Three Months Ended March 31, 2010 compared to The Three Months Ended March 31,
2009
Segment operating income
Operating income was
$40.7 million for the three months ended March 31, 2010, representing a
decrease of $1.8 million, or 4.3%, from the three months ended March 31,
2009. The decrease was primarily due to lower allocated investment income on
the traditional line of business and higher insurance company operating
expenses, partly offset by more favorable mortality results.
Operating
revenues
Total revenues for the
three months ended March 31, 2010, increased $27.2 million, or 9.6%,
compared to the three months ended March 31, 2009. This increase was the
result of higher premiums and policy fees in the segments traditional and
universal life lines and higher investment income in the universal life product
line due to increases in net in-force reserves and was partially offset by
lower sales in the segments marketing companies and lower investment income on
the Companys traditional and BOLI product lines.
Net
premiums and policy fees
Net premiums and policy
fees increased by $28.1 million, or 16.7%, for the three months ended March 31,
2010, compared to the three months ended March 31, 2009, primarily due to
an increase in retention levels on certain traditional life products and
continued growth in universal life in-force business. Our maximum retention
level for newly issued traditional life and universal life products is generally
$2,000,000.
Net investment income
Net investment income in
the segment decreased $2.4 million, or 2.5%, for the three months ended March 31,
2010, compared to the three months ended March 31, 2009. Traditional life
statutory reserving methodology changes have reduced our statutory reserves,
thus reducing the investment income allocated to the segment. In addition, the
impact of our traditional and universal life capital markets programs on
investment income allocated to the segment caused a reduction of $5.0 million
between the first quarter of 2009 and the first quarter of 2010.
44
Table of
Contents
Other income
Other income increased $1.4 million, or 7.0%, for
the three months ended March 31, 2010, compared to the three months ended March 31,
2009. The increase relates primarily to higher fees on variable universal life
funds and interest on modified coinsurance transactions.
Benefits
and settlement expenses
Benefits and settlement
expenses increased by $25.1 million, or 12.9%, for the three months ended March 31,
2010, compared to the three months ended March 31, 2009, due to growth in
retained life insurance in-force, increased retention levels on certain newly
written traditional life products, and higher credited interest on UL products
resulting from increases in account values, partly offset by more favorable
mortality. The estimated mortality impact to earnings related to traditional
and universal life products, for the three months ended March 31, 2010,
was favorable by $14.5 million and was approximately $12.5 million more
favorable than the estimated mortality impact on earnings for the three months
ended March 31, 2009.
Amortization
of DAC
DAC amortization
decreased $1.7 million, or 4.6%, for the three months ended March 31,
2010, compared to the three months ended March 31, 2009. The decrease
primarily relates to more favorable unlocking on BOLI business partly offset by
growth in retained life insurance in-force compared to 2009.
Other
operating expenses
Other operating expenses
increased $5.5 million, or 66.9%, for the three months ended March 31,
2010, compared to the three months ended March 31, 2009. This increase
reflects higher marketing company expenses associated with higher broker dealer
sales, partially higher general administrative expenses, and a reduction in
reinsurance allowances.
Sales
Sales for the segment
increased $6.4 million, or 17.4%, for the three months ended March 31,
2010, compared to the three months ended March 31, 2009, as increased
universal life sales more than offset lower traditional sales. Lower sales
levels of traditional products were primarily the result of pricing changes
implemented on certain of our products resulting in a less competitive product
positioning. Universal life sales increased $8.4 million, or 65.9%, for the
three months ended March 31, 2010, compared to the three months ended March 31,
2009, primarily due to our increased focus on the product line.
Reinsurance
Currently, the Life
Marketing segment reinsures significant amounts of its life insurance in-force.
Pursuant to the underlying reinsurance contracts, reinsurers pay allowances to
the segment as a percentage of both first year and renewal premiums.
Reinsurance allowances represent the amount the reinsurer is willing to pay for
reimbursement of acquisition costs incurred by the direct writer of the
business. A portion of reinsurance allowances received is deferred as part of
DAC and a portion is recognized immediately as a reduction of other operating
expenses. As the non-deferred portion of allowances reduces operating expenses
in the period received, these amounts represent a net increase to operating
income during that period.
Reinsurance allowances do
not affect the methodology used to amortize DAC or the period over which such
DAC is amortized. However, they do affect the amounts recognized as DAC
amortization. DAC on universal life-type, limited-payment long duration, and
investment contracts business is amortized based on the estimated gross profits
of the policies in-force. Reinsurance allowances are considered in the
determination of estimated gross profits, and therefore, impact DAC amortization
on these lines of business. Deferred reinsurance allowances on level term
business as required by the ASC Financial Services-Insurance Topic are recorded
as ceded DAC, which is amortized over estimated ceded premiums of the policies
in force. Thus, deferred reinsurance allowances on policies as required under
the Financial Services-Insurance Topic may impact DAC amortization.
45
Table of
Contents
Impact of reinsurance
Reinsurance
impacted the Life Marketing
segment line items as shown in the following table:
Life Marketing Segment
Line Item Impact of Reinsurance
|
|
For
The
|
|
|
|
Three
Months Ended
|
|
|
|
March 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
(Dollars In Thousands)
|
|
REVENUES
|
|
|
|
|
|
Reinsurance ceded
|
|
$
|
(176,752
|
)
|
$
|
(207,164
|
)
|
BENEFITS AND EXPENSES
|
|
|
|
|
|
Benefit and settlement expenses
|
|
(194,005
|
)
|
(218,639
|
)
|
Amortization of deferred policy acquisition costs
|
|
(7,864
|
)
|
(12,392
|
)
|
Other operating expenses
(1)
|
|
(31,295
|
)
|
(32,211
|
)
|
Total benefits and expenses
|
|
(233,164
|
)
|
(263,242
|
)
|
|
|
|
|
|
|
NET IMPACT OF REINSURANCE
(2)
|
|
$
|
56,412
|
|
$
|
56,078
|
|
|
|
|
|
|
|
Allowances received
|
|
$
|
(47,958
|
)
|
$
|
(55,353
|
)
|
Less: Amount deferred
|
|
16,663
|
|
23,142
|
|
Allowances recognized
(ceded other operating expenses)
(1)
|
|
$
|
(31,295
|
)
|
$
|
(32,211
|
)
|
(1)
Other
operating expenses ceded per the income statement are equal to reinsurance allowances
recognized after capitalization.
(2)
Assumes no investment income on
reinsurance. Foregone investment income would substantially reduce the
favorable impact of reinsurance. The Company estimates that the impact of
foregone investment income would reduce the net impact of reinsurance by 90% to
130%.
The
table above does not reflect the impact of reinsurance on our net investment
income. By ceding business to the assuming companies, we forgo investment
income on the reserves ceded. Conversely, the assuming companies will receive
investment income on the reserves assumed which will increase the assuming
companies profitability on the business we cede. The net investment income
impact to us and the assuming companies has not been quantified. The impact of
including foregone investment income would be to substantially reduce the
favorable net impact of reinsurance reflected above. We estimate that the
impact of foregone investment income would be to reduce the net impact of
reinsurance presented in the table above by 90% to 130%. The Life Marketing
segments reinsurance programs do not materially impact the other income line
of our income statement.
As
shown above, reinsurance had a favorable impact on the Life Marketing segments
operating income for the periods presented above. The impact of reinsurance is
largely due to our quota share coinsurance program in place prior to mid-2005.
Under that program, generally 90% of the segments traditional new business was
ceded to reinsurers. Since mid-2005, a much smaller percentage of overall term
business was ceded due to our change in reinsurance strategy on traditional
business discussed previously. As a result of that change, the relative impact
of reinsurance on the Life Marketing segments overall results is expected to
decrease over time. While the significance of reinsurance is expected to
decline over time, the overall impact of reinsurance for a given period may
fluctuate due to variations in mortality and unlocking of balances under the
ASC Financial Services-Insurance Topic.
46
Table of
Contents
For The Three Months Ended March 31,
2010 compared to The Three Months Ended March 31, 2009
The decrease in ceded premiums above for the three
months ended March 31, 2010, compared to the three months ended March 31,
2009, was caused primarily by lower ceded traditional life premiums and policy
fees of $29.2 million.
Ceded benefits and
settlement expenses were lower for the three months ended March 31, 2010,
compared to the three months ended March 31, 2009, due to lower increases
in ceded reserves and decreased ceded claims. Traditional ceded benefits
decreased $33.7 million for the three months ended March 31, 2010,
compared to the three months ended March 31, 2009, due to a lower increase
in ceded reserves and lower ceded death benefits. Universal life ceded benefits
increased $0.4 million for the three months ended March 31, 2010, compared
to the three months ended March 31, 2009, as higher ceded claims were
partly offset by a lower change in ceded reserves. Ceded universal life claims
were $8.4 million higher for the three months ended March 31, 2010,
compared to the three months ended March 31, 2009.
Ceded amortization of
deferred policy acquisitions costs decreased for the three months ended March 31,
2010, compared to the three months ended March 31, 2009, primarily due to
the differences in unlocking between the two periods.
Total allowances received
for the three months ended March 31, 2010, decreased from the three months
ended March 31, 2009, due to the change in our traditional life
reinsurance strategy.
47
Table
of Contents
Acquisitions
Segment
results of operations
Segment
results
were as follows:
|
|
For
The
|
|
|
|
|
|
Three
Months Ended
|
|
|
|
|
|
March 31,
|
|
|
|
|
|
2010
|
|
2009
|
|
Change
|
|
|
|
(Dollars In Thousands)
|
|
|
|
REVENUES
|
|
|
|
|
|
|
|
Gross premiums and policy fees
|
|
$
|
160,721
|
|
$
|
178,676
|
|
(10.0
|
)%
|
Reinsurance ceded
|
|
(93,134
|
)
|
(109,607
|
)
|
(15.0
|
)
|
Net premiums and policy fees
|
|
67,587
|
|
69,069
|
|
(2.1
|
)
|
Net investment income
|
|
115,401
|
|
123,541
|
|
(6.6
|
)
|
Other income
|
|
1,273
|
|
1,403
|
|
(9.3
|
)
|
Total operating revenues
|
|
184,261
|
|
194,013
|
|
(5.0
|
)
|
Realized gains (losses) - investments
|
|
44,519
|
|
(52,463
|
)
|
|
|
Realized gains (losses) - derivatives
|
|
(30,063
|
)
|
57,684
|
|
|
|
Total revenues
|
|
198,717
|
|
199,234
|
|
|
|
BENEFITS AND EXPENSES
|
|
|
|
|
|
|
|
Benefits and settlement expenses
|
|
133,474
|
|
138,731
|
|
(3.8
|
)
|
Amortization of deferred policy acquisition costs
and value of business acquired
|
|
13,195
|
|
17,563
|
|
(24.9
|
)
|
Other operating expenses
|
|
6,223
|
|
4,098
|
|
51.9
|
|
Operating benefits and expenses
|
|
152,892
|
|
160,392
|
|
(4.7
|
)
|
Amortization of DAC / VOBA related to realized
gains (losses) - investments
|
|
143
|
|
178
|
|
|
|
Total benefits and expenses
|
|
153,035
|
|
160,570
|
|
(4.7
|
)
|
INCOME BEFORE INCOME TAX
|
|
45,682
|
|
38,664
|
|
18.2
|
|
Less: realized gains (losses)
|
|
14,456
|
|
5,221
|
|
|
|
Less: related amortization of DAC
|
|
(143
|
)
|
(178
|
)
|
|
|
OPERATING INCOME
|
|
$
|
31,369
|
|
$
|
33,621
|
|
(6.7
|
)
|
48
Table of
Contents
The following table
summarizes key data for the Acquisitions segment:
|
|
For
The
|
|
|
|
|
|
Three
Months Ended
|
|
|
|
|
|
March 31,
|
|
|
|
|
|
2010
|
|
2009
|
|
Change
|
|
|
|
(Dollars In Thousands)
|
|
|
|
Average Life Insurance In-Force
(1)
|
|
|
|
|
|
|
|
Traditional
|
|
$
|
189,300,917
|
|
$
|
202,610,702
|
|
(6.6
|
)%
|
Universal life
|
|
27,324,752
|
|
28,958,227
|
|
(5.6
|
)
|
|
|
$
|
216,625,669
|
|
$
|
231,568,929
|
|
(6.5
|
)
|
Average Account Values
|
|
|
|
|
|
|
|
Universal life
|
|
$
|
2,755,125
|
|
$
|
2,864,653
|
|
(3.8
|
)
|
Fixed annuity
(2)
|
|
3,425,604
|
|
3,763,165
|
(4)
|
(9.0
|
)
|
Variable annuity
|
|
139,690
|
|
125,655
|
|
11.2
|
|
|
|
$
|
6,320,419
|
|
$
|
6,753,473
|
|
(6.4
|
)
|
Interest Spread - UL &
Fixed Annuities
|
|
|
|
|
|
|
|
Net investment income yield
(3)
|
|
5.89
|
%
|
6.02
|
%
|
|
|
Interest credited to policyholders
|
|
4.28
|
|
4.16
|
|
|
|
Interest spread
|
|
1.61
|
%
|
1.86
|
%
|
|
|
(1)
Amounts
are not adjusted for reinsurance ceded.
(2)
Includes general account balances held
within variable annuity products and is net of coinsurance ceded.
(3)
Includes
available-for-sale and trading portfolios. Available-for-sale portfolio yields
were 6.34% and 6.37% for the three months ended March 31, 2010 and 2009,
respectively.
(4)
Certain
changes in methodology were made in the current year. Prior years have been
adjusted to comparable to current year.
For
The Three Months Ended March 31, 2010 compared to The Three Months Ended March 31,
2009
Segment
operating income
Operating income was
$31.4 million for the three months ended March 31, 2010, a decrease of
$2.3 million, or 6.7%, compared to the three months ended March 31, 2009,
primarily due to the expected runoff of the blocks of business and less
favorable mortality results.
Revenues
Net premiums and policy
fees decreased $1.5 million, or 2.1%, for the three months ended March 31,
2010, compared to the three months ended March 31, 2009, primarily due to
runoff of the in-force business. Net investment income decreased $8.1 million,
or 6.6%, for the three months ended March 31, 2010, compared to the three
months ended March 31, 2009, due to runoff of the segments in-force
business and lower overall yields, resulting in a reduction of invested assets
and lower investment income.
Benefits
and expenses
Total benefits and
expenses decreased $7.5 million, or 4.7%, for the three months ended March 31,
2010, compared to the three months ended March 31, 2009. The decrease
related primarily to the expected runoff of the in-force business and
fluctuations in mortality.
49
Table of
Contents
Reinsurance
The
Acquisitions segment currently reinsures portions of both its life and annuity
in-force. The cost of reinsurance to the segment is reflected in the chart
shown below.
Impact
of reinsurance
Reinsurance
impacted the
Acquisitions segment line items as shown in the following table:
Acquisitions Segment
Line Item Impact of Reinsurance
|
|
For
The
|
|
|
|
Three
Months Ended
|
|
|
|
March 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
(Dollars In Thousands)
|
|
REVENUES
|
|
|
|
|
|
Reinsurance ceded
|
|
$
|
(93,134
|
)
|
$
|
(109,607
|
)
|
BENEFITS AND EXPENSES
|
|
|
|
|
|
Benefit and settlement expenses
|
|
(85,069
|
)
|
(92,222
|
)
|
Amortization of deferred policy acquisition costs
|
|
(5,422
|
)
|
(5,781
|
)
|
Other operating expenses
|
|
(12,785
|
)
|
(14,959
|
)
|
Total benefits and expenses
|
|
(103,276
|
)
|
(112,962
|
)
|
|
|
|
|
|
|
NET IMPACT OF REINSURANCE
|
|
$
|
10,142
|
|
$
|
3,355
|
|
The segments reinsurance
programs do not materially impact the other income line of the income
statement. In addition, net investment income generally has no direct impact on
reinsurance cost. However, by ceding business to the assuming companies, we
forgo investment income on the reserves ceded to the assuming companies.
Conversely, the assuming companies will receive investment income on the
reserves assumed which will increase the assuming companies profitability on
business assumed from the Company. For business ceded under modified
coinsurance arrangements, the amount of investment income attributable to the
assuming company is included as part of the overall change in policy reserves
and, as such, is reflected in benefit and settlement expenses. The net
investment income impact to us and the assuming companies has not been
quantified as it is not fully reflected in our consolidated condensed financial
statements.
The net impact of
reinsurance increased $6.8 million for the three months ended March 31,
2010, compared to the three months ended March 31, 2009, as decreases in
ceded premiums more than offset decreases in benefits, amortization of deferred
acquisition costs, and expenses largely due to higher ceded claims and
surrenders.
50
Table of Contents
Annuities
Segment
results of operations
Segment results were as follows:
|
|
For
The
|
|
|
|
|
|
Three
Months Ended
|
|
|
|
|
|
March 31,
|
|
|
|
|
|
2010
|
|
2009
|
|
Change
|
|
|
|
(Dollars In Thousands)
|
|
|
|
REVENUES
|
|
|
|
|
|
|
|
Gross premiums and policy fees
|
|
$
|
8,775
|
|
$
|
10,985
|
|
(20.1
|
)%
|
Reinsurance ceded
|
|
(37
|
)
|
(42
|
)
|
(11.9
|
)
|
Net premiums and policy fees
|
|
8,738
|
|
10,943
|
|
(20.1
|
)
|
Net investment income
|
|
116,197
|
|
102,982
|
|
12.8
|
|
Realized gains (losses) - derivatives
|
|
9,549
|
|
19,088
|
|
(50.0
|
)
|
Other income
|
|
5,994
|
|
3,380
|
|
77.3
|
|
Total operating revenues
|
|
140,478
|
|
136,393
|
|
3.0
|
|
Realized gains (losses) - investments
|
|
102
|
|
(6,448
|
)
|
|
|
Total revenues
|
|
140,580
|
|
129,945
|
|
8.2
|
|
BENEFITS AND EXPENSES
|
|
|
|
|
|
|
|
Benefits and settlement expenses
|
|
94,241
|
|
85,808
|
|
9.8
|
|
Amortization of deferred policy acquisition costs
and value of business acquired
|
|
19,600
|
|
45,185
|
|
(56.6
|
)
|
Other operating expenses
|
|
8,450
|
|
5,975
|
|
41.4
|
|
Operating benefits and expenses
|
|
122,291
|
|
136,968
|
|
(10.7
|
)
|
Amortization of DAC / VOBA related to realized
gains (losses) - investments
|
|
71
|
|
(100
|
)
|
|
|
Total benefits and expenses
|
|
122,362
|
|
136,868
|
|
(10.6
|
)
|
INCOME (LOSS) BEFORE INCOME TAX
|
|
18,218
|
|
(6,923
|
)
|
n/m
|
|
Less: realized gains (losses)
|
|
102
|
|
(6,448
|
)
|
|
|
Less: related amortization of DAC
|
|
(71
|
)
|
100
|
|
|
|
OPERATING INCOME (LOSS)
|
|
$
|
18,187
|
|
$
|
(575
|
)
|
n/m
|
|
51
Table of
Contents
The following table
summarizes key data for the Annuities segment:
|
|
For
The
|
|
|
|
|
|
Three
Months Ended
|
|
|
|
|
|
March 31,
|
|
|
|
|
|
2010
|
|
2009
|
|
Change
|
|
|
|
(Dollars In Thousands)
|
|
|
|
Sales
|
|
|
|
|
|
|
|
Fixed annuity
|
|
$
|
218,029
|
|
$
|
297,680
|
|
(26.8
|
)%
|
Variable annuity
|
|
349,936
|
|
139,056
|
|
151.7
|
|
|
|
$
|
567,965
|
|
$
|
436,736
|
|
30.0
|
|
Average Account Values
|
|
|
|
|
|
|
|
Fixed annuity
(1)
|
|
$
|
7,600,963
|
|
$
|
6,682,367
|
|
13.7
|
|
Variable annuity
|
|
2,909,757
|
|
1,764,353
|
|
64.9
|
|
|
|
$
|
10,510,720
|
|
$
|
8,446,720
|
|
24.4
|
|
Interest Spread - Fixed Annuities
(2)
|
|
|
|
|
|
|
|
Net investment income yield
|
|
6.12
|
%
|
6.13
|
%
|
|
|
Interest credited to policyholders
|
|
4.63
|
|
4.91
|
|
|
|
Interest spread
|
|
1.49
|
%
|
1.22
|
%
|
|
|
|
|
As
of March 31,
|
|
|
|
|
|
2010
|
|
2009
|
|
Change
|
|
GMDB - Net amount at risk
(3)
|
|
$
|
321,424
|
|
$
|
903,345
|
|
(64.4
|
)%
|
GMDB Reserves
|
|
|
|
10,864
|
|
(100.0
|
)
|
GMWB Reserves
|
|
4,721
|
|
13,609
|
|
(65.3
|
)
|
Account value subject to GMWB
rider
|
|
1,434,230
|
|
434,063
|
|
n/m
|
|
S&P 500® Index
|
|
1,169
|
|
798
|
|
46.5
|
|
|
|
|
|
|
|
|
|
|
|
(1)
Includes
general account balances held within variable annuity products.
(2)
Interest
spread on average general account values.
(3)
Guaranteed
death benefits in excess of contract holder account balance.
For
The Three Months Ended March 31, 2010 compared to The Three Months Ended March 31,
2009
Segment operating income
Segment operating income
was $18.2 million for the three months ended March 31, 2010, compared to
an operating loss of $0.6 million for the three months ended March 31, 2009,
an increase of $18.8 million. This change included an unfavorable $7.4 million
variance related to fair value changes, of which $2.2 million was related to
the EIA product and $5.2 million was related to embedded derivatives associated
with the VA GMWB rider. The remaining $25.6 million increase in operating
income was primarily driven by a $19.2 million unlocking charge recorded within
the VA line during the three months ended March 31, 2009. Other items
accounted for the remainder of the variance, including a $3.5 million increase
in earnings related to wider spreads and average account value growth of 52% in
the SPDA line.
Operating revenues
Segment operating
revenues increased $4.1 million, or 3.0%, for the three months ended March 31,
2010, compared to the three months ended March 31, 2009, primarily due to
an increase in net investment income and other revenue, which was partially
offset by decreases in policy fees and gains on derivatives. Average fixed
account balances grew 13.7% for the three months ended March 31, 2010,
resulting in higher investment income.
52
Table of
Contents
Benefits and settlement expenses
Benefits
and settlement expenses increased $8.4 million, or 9.8%, for the three months
ended March 31, 2010, compared to the three months ended March 31,
2009. This increase was primarily the result of higher credited interest,
higher unearned premium reserve amortization, and an unfavorable variance in
fair value changes in the EIA line. Offsetting this increase was a favorable
change of $8.7 million in unlocking and a favorable change of $4.0 million in
VA death benefit payments for the three months ended March 31, 2010,
compared to the three months ended March 31, 2009. Favorable unlocking of
$0.1 million was recorded by the segment for the three months ended March 31,
2010.
Amortization
of DAC
The decrease in DAC
amortization for the three months ended March 31, 2010, compared to the
three months ended March 31, 2009, was primarily due to a reduction in
surrender charge revenue in the market value adjusted (MVA) line, fair value
changes on the VA GMWB rider, and a $10.8 million unlocking charge in the VA
line during the three months ended March 31, 2009. Fair value changes on
the VA GMWB rider caused a decrease in amortization of $6.4 million. Favorable
DAC unlocking of $0.7 million was recorded by the segment during the three
months ended March 31, 2010.
Sales
Total sales increased
$131.2 million, or 30.0%, for the three months ended March 31, 2010,
compared to the three months ended March 31, 2009. Sales of fixed
annuities decreased $79.7 million, or 26.8%, for the three months ended March 31,
2010, compared to the three months ended March 31, 2009. The decrease in
fixed annuity sales was driven by reduced sales in the EIA, MVA, and immediate
annuity lines and was primarily attributable to a lower interest rate
environment. MVA sales decreased $92.6 million, or 78.9%, for the three ended March 31,
2010, compared to the three months ended March 31, 2009. SPDA sales
increased by $32.8 million, or 21.7%, for the three months ended March 31,
2010, compared to the three months ended March 31, 2009, primarily due to expansion
of our distribution channels. Sales of variable annuities increased $210.9
million for the three months ended March 31, 2010, compared to the three
months ended March 31, 2009, primarily due to improved sales management
efforts.
53
Table of
Contents
Stable Value Products
Segment
results of operations
Segment results were as
follows:
|
|
For
The
|
|
|
|
|
|
Three
Months Ended
|
|
|
|
|
|
March 31,
|
|
|
|
|
|
2010
|
|
2009
|
|
Change
|
|
|
|
(Dollars In Thousands)
|
|
|
|
REVENUES
|
|
|
|
|
|
|
|
Net investment income
|
|
$
|
46,420
|
|
$
|
63,176
|
|
(26.5
|
)%
|
Other income
|
|
|
|
1,526
|
|
(100.0
|
)
|
Realized gains (losses)
|
|
1,536
|
|
1,862
|
|
(17.5
|
)
|
Total revenues
|
|
47,956
|
|
66,564
|
|
(28.0
|
)
|
BENEFITS AND EXPENSES
|
|
|
|
|
|
|
|
Benefits and settlement expenses
|
|
33,731
|
|
42,585
|
|
(20.8
|
)
|
Amortization of deferred policy acquisition costs
|
|
979
|
|
927
|
|
5.6
|
|
Other operating expenses
|
|
683
|
|
983
|
|
(30.5
|
)
|
Total benefits and expenses
|
|
35,393
|
|
44,495
|
|
(20.5
|
)
|
INCOME BEFORE INCOME TAX
|
|
12,563
|
|
22,069
|
|
(43.1
|
)
|
Less: realized gains (losses)
|
|
1,536
|
|
1,862
|
|
|
|
OPERATING INCOME
|
|
$
|
11,027
|
|
$
|
20,207
|
|
(45.4
|
)
|
The following table
summarizes key data for the Stable Value Products segment:
|
|
For The
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
March 31,
|
|
|
|
|
|
2010
|
|
2009
|
|
Change
|
|
|
|
(Dollars In
Thousands)
|
|
|
|
Sales
|
|
|
|
|
|
|
|
GIC
|
|
$
|
1,000
|
|
$
|
|
|
n/m
|
%
|
GFA - Direct Institutional
|
|
150,000
|
|
|
|
n/m
|
|
GFA - Registered Notes -
Institutional
|
|
|
|
|
|
n/m
|
|
GFA - Registered Notes -
Retail
|
|
|
|
|
|
n/m
|
|
|
|
$
|
151,000
|
|
$
|
|
|
n/m
|
|
|
|
|
|
|
|
|
|
Average
Account Values
|
|
$
|
3,494,977
|
|
$
|
4,523,563
|
|
(22.7
|
)
|
Ending
Account Values
|
|
$
|
3,454,186
|
|
$
|
4,360,991
|
|
(20.8
|
)
|
|
|
|
|
|
|
|
|
Operating
Spread
|
|
|
|
|
|
|
|
Net investment income yield
|
|
5.31
|
%
|
5.58
|
%
|
|
|
Interest credited
|
|
3.86
|
|
3.76
|
|
|
|
Operating expenses
|
|
0.19
|
|
0.17
|
|
|
|
Operating spread
|
|
1.26
|
%
|
1.65
|
%
(1)
|
|
|
(1)
Excludes
one-time funding agreement retirement gains.
54
Table of Contents
For
The Three Months Ended March 31, 2010 compared to The Three Months Ended March 31,
2009
Segment operating income
Operating income was
$11.0 million and decreased $9.2
million, or 45.4%, for
the three months ended March 31, 2010, compared to the three months ended March 31,
2009. The decrease in operating earnings resulted from a decline in average
account values and lower operating spreads. In addition, no income was
generated from the early retirement of funding agreements backing medium-term
notes for the three months ended March 31, 2010, compared with $1.5
million for the first quarter of 2009. The operating spread decreased 39 basis
points to 126 basis points for the three months ended March 31, 2010,
compared to an operating spread of 165 basis points during the three months
ended March 31, 2009.
Sales
During the three months
ended March 31, 2010, we chose to re-enter the stable value market. Total
sales were $151.0 million for the three months ended March 31, 2010.
55
Table of
Contents
Asset Protection
Segment
results of operations
Segment results were as
follows:
|
|
For
The
|
|
|
|
|
|
Three
Months Ended
|
|
|
|
|
|
March 31,
|
|
|
|
|
|
2010
|
|
2009
|
|
Change
|
|
|
|
(Dollars In Thousands)
|
|
|
|
REVENUES
|
|
|
|
|
|
|
|
Gross premiums and policy fees
|
|
$
|
79,515
|
|
$
|
86,935
|
|
(8.5
|
)%
|
Reinsurance ceded
|
|
(35,906
|
)
|
(41,485
|
)
|
(13.4
|
)
|
Net premiums and policy fees
|
|
43,609
|
|
45,450
|
|
(4.1
|
)
|
Net investment income
|
|
7,497
|
|
8,932
|
|
(16.1
|
)
|
Other income
|
|
15,325
|
|
12,473
|
|
22.9
|
|
Total operating revenues
|
|
66,431
|
|
66,855
|
|
(0.6
|
)
|
BENEFITS AND EXPENSES
|
|
|
|
|
|
|
|
Benefits and settlement expenses
|
|
18,756
|
|
34,110
|
|
(45.0
|
)
|
Amortization of deferred policy acquisition costs
|
|
12,775
|
|
13,683
|
|
(6.6
|
)
|
Other operating expenses
|
|
21,907
|
|
12,782
|
|
71.4
|
|
Total benefits and expenses
|
|
53,438
|
|
60,575
|
|
(11.8
|
)
|
INCOME BEFORE INCOME TAX
|
|
12,993
|
|
6,280
|
|
n/m
|
|
Less: noncontrolling interests
|
|
(74
|
)
|
|
|
n/m
|
|
OPERATING INCOME
|
|
$
|
13,067
|
|
$
|
6,280
|
|
n/m
|
|
The following table
summarizes key data for the Asset Protection segment:
|
|
For
The
|
|
|
|
|
|
Three
Months Ended
|
|
|
|
|
|
March 31,
|
|
|
|
|
|
2010
|
|
2009
|
|
Change
|
|
|
|
(Dollars In Thousands)
|
|
|
|
Sales
|
|
|
|
|
|
|
|
Credit insurance
|
|
$
|
7,692
|
|
$
|
8,483
|
|
(9.3
|
)%
|
Service contracts
|
|
52,539
|
|
48,089
|
|
9.3
|
|
Other products
|
|
11,459
|
|
11,768
|
|
(2.6
|
)
|
|
|
$
|
71,690
|
|
$
|
68,340
|
|
4.9
|
|
Loss Ratios
(1)
|
|
|
|
|
|
|
|
Credit insurance
|
|
43.9
|
%
|
32.1
|
%
|
|
|
Service contracts
|
|
78.4
|
|
74.6
|
|
|
|
Other products
|
|
(34.7
|
)
|
97.3
|
|
|
|
(1)
Incurred
claims as a percentage of earned premiums
For
The Three Months Ended March 31, 2010 compared to The Three Months Ended March 31,
2009
Segment
operating income
Operating income was
$13.1 million, representing an increase of $6.8 million for the three months ended
March 31, 2010, compared to the three months ended March 31, 2009.
First quarter income was comprised of $5.5 million of income from core
operations and $7.6 million of income from runoff lines.
Credit
insurance earnings decreased $1.5 million compared to the prior year,
primarily due to unfavorable loss experience and higher expenses. Service
contract earnings declined $0.5 million, or 9.6%, compared to the prior year,
primarily due to higher loss ratios and higher expenses in certain product
lines. Earnings from other products increased $8.8 million for the three months
ended March 31, 2010 compared to the prior year. The increase in other
products was primarily
56
Table of
Contents
from
a $7.8 million reserve release in the first quarter of 2010 related to the
final settlement in the runoff Lenders Indemnity line of business. Favorable
loss experience in the GAP product line also contributed to the increase.
Net
premiums
and policy fees
Net premiums and policy
fees decreased $1.8 million, or 4.1%, for the three months ended March 31,
2010, compared to the three months ended March 31, 2009. Credit insurance
premiums decreased $0.8 million, or 12.8%, due to the impact of lower auto
sales. Within the other product lines, net premiums decreased $0.8 million, or
6.2%, compared to the prior year mainly due to a decrease in the GAP product
line as a result of lower auto sales and the discontinuation of the inventory
protection product (IPP) product line
.
Other
income
Other income increased
$2.9 million, or 22.9%, for the three months ended March 31, 2010,
compared to the three months ended March 31, 2009, primarily due to the
impact of taking over the administration of a block of service contract business in the fourth
quarter of 2009.
Benefits
and settlement expenses
Benefits and settlement expenses decreased $15.4
million, or 45.0%, for the three months ended March 31, 2010, compared to
the three months ended March 31, 2009. Credit insurance claims for the
three months ended March 31, 2010, compared to the prior year, increased
$0.4 million, or 19.3%, due to higher loss ratios. Service contract claims
increased $0.8 million, or 4.2%, due to higher loss ratios in some product
lines. Other products claims decreased $16.6 million for the three months ended
March 31, 2010, compared to the three months ended March 31, 2009.
The decrease included a $7.8 million decrease in reserves related to the final
settlement in the runoff Lenders Indemnity line of business. In addition, the
first quarter of 2009 included a $6.3 million increase in the runoff Lenders
indemnity product lines loss reserve related to the commutation of a
reinsurance agreement which was offset by a reduction in other expenses.
Improved loss ratios in the GAP product line also contributed to the decrease.
Amortization
of DAC
and Other operating expenses
Amortization of DAC was
$0.9 million, or 6.6%, lower for the three months ended March 31, 2010,
compared to the three months ended March 31, 2009, primarily due to lower
premiums in the dealer credit insurance line. Other operating expenses
increased $9.1 million, or 71.4%, for the three months ended March 31,
2010, due to a $6.3 million bad debt recovery in the runoff Lenders Indemnity
product line due to the commutation of a reinsurance agreement in the first
quarter of 2009, which was offset by an increase in benefits and settlement
expenses. Higher commission expense resulting from an increase in sales in
certain service contract lines also contributed to the increase.
Sales
Total segment sales
increased $3.4 million, or 4.9%, for the three months ended March 31,
2010, compared to the three months ended March 31, 2009. Credit insurance
sales decreased $0.8 million, or 9.3%. Service contract sales increased $4.5
million, or 9.3%, compared to the prior year. The decline in the other products
line was primarily the result of the discontinuation of the IPP product line
.
Reinsurance
The majority of the Asset
Protection segments reinsurance activity relates to the cession of single
premium credit life and credit accident and health insurance, credit property,
vehicle service contracts, and guaranteed asset protection insurance to
producer affiliated reinsurance companies (PARCs). These arrangements are
coinsurance contracts ceding the business on a first dollar quota share basis
at levels ranging from 50% to 100% to limit our exposure and allow the PARCs
to share in the underwriting income of the product. Reinsurance contracts do
not relieve us from our obligations to our policyholders.
57
Table of
Contents
Reinsurance
impacted the Asset
Protection segment line items as shown in the following table:
Asset Protection Segment
Line Item Impact of Reinsurance
|
|
For
The
|
|
|
|
Three
Months Ended
|
|
|
|
March 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
(Dollars In Thousands)
|
|
REVENUES
|
|
|
|
|
|
Reinsurance ceded
|
|
$
|
(35,906
|
)
|
$
|
(41,485
|
)
|
BENEFITS AND EXPENSES
|
|
|
|
|
|
Benefit and settlement expenses
|
|
(19,275
|
)
|
(21,378
|
)
|
Amortization of deferred policy acquisition costs
|
|
(3,584
|
)
|
(5,494
|
)
|
Other operating expenses
|
|
(934
|
)
|
(8,484
|
)
|
Total benefits and expenses
|
|
(23,793
|
)
|
(35,356
|
)
|
|
|
|
|
|
|
NET IMPACT OF REINSURANCE
|
|
$
|
(12,113
|
)
|
$
|
(6,129
|
)
|
For
The Three Months Ended March 31, 2010 compared to The Three Months Ended March 31,
2009
Reinsurance premiums
ceded decreased $5.6 million, or 13.4%, for the three months ended March 31,
2010, compared to the three months ended March 31, 2009. The decrease was
primarily due to a decline in ceded dealer credit insurance premiums and GAP
premiums due to lower auto sales. Ceded unearned premium reserves and claim
reserves with PARCs are generally secured by trust accounts, letters of
credit, or on a funds withheld basis.
Benefits and settlement
expenses ceded decreased $2.1 million, or 9.8%, for the three months ended March 31,
2010, compared to the three months ended March 31, 2009. The decrease was
primarily due to lower losses in the service contract and GAP lines.
Amortization of DAC ceded
decreased $1.9 million, or 34.8%, for the three months ended March 31,
2010, compared to the three months ended March 31, 2009, primarily as the
result of the decreases in the ceded dealer credit and GAP product lines. Other
operating expenses ceded decreased $7.6 million, 89.0%, for the three months
ended March 31, 2010, compared to the three months ended March 31,
2009. The fluctuation was primarily attributable to $6.3 million bad debt
recovery in the runoff Lenders Indemnity product line as a result of the
commutation of a reinsurance agreement in the first quarter of 2009.
Net investment income has
no direct impact on reinsurance cost. However, by ceding business to the
assuming companies, we forgo investment income on the reserves ceded.
Conversely, the assuming companies will receive investment income on the
reserves assumed which will increase the assuming companies profitability on
business we cede. The net investment income impact to us and the assuming
companies has not been quantified as it is not reflected in our consolidated
condensed financial statements.
58
Table of
Contents
Corporate and Other
Segment
results of operations
Segment results were as
follows:
|
|
For
The
|
|
|
|
|
|
Three
Months Ended
|
|
|
|
|
|
March 31,
|
|
|
|
|
|
2010
|
|
2009
|
|
Change
|
|
|
|
(Dollars In Thousands)
|
|
|
|
REVENUES
|
|
|
|
|
|
|
|
Gross premiums and policy fees
|
|
$
|
6,371
|
|
$
|
6,898
|
|
(7.6
|
)%
|
Reinsurance ceded
|
|
|
|
(1
|
)
|
(100.0
|
)
|
Net premiums and policy fees
|
|
6,371
|
|
6,897
|
|
(7.6
|
)
|
Net investment income
|
|
35,338
|
|
29,527
|
|
19.7
|
|
Realized gains (losses) - derivatives
|
|
42
|
|
2,238
|
|
|
|
Other income
|
|
58
|
|
51
|
|
13.7
|
|
Total operating revenues
|
|
41,809
|
|
38,713
|
|
8.0
|
|
Realized gains (losses) - investments
|
|
(9,767
|
)
|
(73,913
|
)
|
|
|
Realized gains (losses) - derivatives
|
|
(2,960
|
)
|
12,716
|
|
|
|
Total revenues
|
|
29,082
|
|
(22,484
|
)
|
n/m
|
|
BENEFITS AND EXPENSES
|
|
|
|
|
|
|
|
Benefits and settlement expenses
|
|
6,537
|
|
7,715
|
|
(15.3
|
)
|
Amortization of deferred policy acquisition costs
|
|
448
|
|
484
|
|
(7.4
|
)
|
Other operating expenses
|
|
50,955
|
|
39,761
|
|
28.2
|
|
Total benefits and expenses
|
|
57,940
|
|
47,960
|
|
20.8
|
|
INCOME (LOSS) BEFORE INCOME TAX
|
|
(28,858
|
)
|
(70,444
|
)
|
(59.0
|
)
|
Less: realized gains (losses) - investments
|
|
(9,767
|
)
|
(73,913
|
)
|
|
|
Less: realized gains (losses) - derivatives
|
|
(2,960
|
)
|
12,716
|
|
|
|
Less: noncontrolling interests
|
|
1
|
|
|
|
n/m
|
|
OPERATING INCOME (LOSS)
|
|
$
|
(16,132
|
)
|
$
|
(9,247
|
)
|
74.5
|
|
For
The Three Months Ended March 31, 2010 compared to The Three Months Ended March 31,
2009
Segment
operating income (loss)
Corporate and Other
segment operating loss was $16.1 million for the three months ended March 31,
2010, compared to a loss of $9.2 million for the three months ended March 31,
2009. The variance was primarily due to an increase of interest expense of
$11.9 million. Partially offsetting this decrease to earnings was an
improvement of $5.8 million in investment income, and a $0.7 million
improvement in the trading portfolio, compared to the three months ended March 31,
2009.
Operating revenues
Net investment income for
the segment increased $5.8 million, or 19.7%, for the three months ended March 31,
2010, compared to the three months ended March 31, 2009, and net premiums
and policy fees decreased $0.5 million, or 7.6%. The increase in net
investment income was primarily the result of investing amounts that were previously
being held as cash and short-term investments, as well as an improvement of
$0.7 million related to the trading portfolio.
Benefits and expenses
Benefits and expenses
increased $10.0 million, or 20.8%, for the three months ended March 31,
2010, compared to the three months ended March 31, 2009, primarily due to
an increase in interest expense of $11.9 million, partially offset by a
reduction in policy benefits on non-core lines of business.
59
Table of
Contents
CONSOLIDATED INVESTMENTS
Certain
reclassifications have been made in the previously reported financial
statements and accompanying tables to make the prior year amounts comparable to
those of the current year. Such reclassifications had no effect on previously
reported net income, shareowners equity, or the totals reflected in the
accompanying tables.
Portfolio
Description
As
of March 31, 2010, our investment portfolio was approximately $30.0
billion.
The types of
assets in which we may invest are influenced by various state laws which
prescribe qualified investment assets. Within the parameters of these laws, we
invest in assets giving consideration to such factors as liquidity and capital
needs, investment quality, investment return, matching of assets and
liabilities, and the overall composition of the investment portfolio by asset
type and credit exposure.
The
following table includes the reported values of our invested assets:
|
|
As
of
|
|
|
|
March 31,
2010
|
|
December 31,
2009
|
|
|
|
(Dollars In Thousands)
|
|
Publicly issued bonds (amortized cost: 2010 -
$18,884,619; 2009 - $18,376,802)
|
|
$
|
18,936,117
|
|
63.1
|
%
|
$
|
18,100,141
|
|
62.3
|
%
|
Privately issued bonds (amortized cost: 2010 -
$4,257,734; 2009 - $4,851,515)
|
|
4,266,909
|
|
14.2
|
|
4,730,286
|
|
16.3
|
|
Fixed maturities
|
|
23,203,026
|
|
77.3
|
|
22,830,427
|
|
78.6
|
|
Equity securities (cost: 2010 - $281,726; 2009 -
$280,615)
|
|
280,703
|
|
0.9
|
|
275,497
|
|
0.9
|
|
Mortgage loans
|
|
4,861,699
|
|
16.2
|
|
3,877,087
|
|
13.3
|
|
Investment real estate
|
|
25,068
|
|
0.1
|
|
25,188
|
|
0.1
|
|
Policy loans
|
|
783,580
|
|
2.6
|
|
794,276
|
|
2.7
|
|
Other long-term investments
|
|
198,014
|
|
0.7
|
|
204,754
|
|
0.7
|
|
Short-term investments
|
|
647,952
|
|
2.2
|
|
1,049,609
|
|
3.7
|
|
Total investments
|
|
$
|
30,000,042
|
|
100.0
|
%
|
$
|
29,056,838
|
|
100.0
|
%
|
Included
in the preceding table are $3.0 billion and $2.9 billion of fixed
maturities and $236.5 million and $250.8 million of short-term investments
classified as trading securities as of March 31, 2010 and December 31,
2009, respectively. The trading portfolio includes invested assets of $2.7
billion as of March 31, 2010 and December 31, 2009, held pursuant to
Modco arrangements under which the economic risks and benefits of the
investments are passed to third-party reinsurers.
Fixed
Maturity Investments
As of March 31,
2010, our fixed maturity investment holdings were approximately $23.2 billion.
The approximate percentage distribution of our fixed maturity investments by
quality rating is as follows:
|
|
As
of
|
|
Rating
|
|
March 31,
2010
|
|
December 31,
2009
|
|
AAA
|
|
14.7
|
%
|
19.9
|
%
|
AA
|
|
4.0
|
|
4.9
|
|
A
|
|
21.9
|
|
18.7
|
|
BBB
|
|
45.6
|
|
42.9
|
|
Below investment grade
|
|
13.8
|
|
13.6
|
|
|
|
100.0
|
%
|
100.0
|
%
|
The
increase in BBB securities reflected in the table above is a result of negative
ratings migration on securities owned by the Company. During the first quarter
of 2010 and full year of 2009, we did not actively purchase securities below
the BBB level.
We do
not have material exposure to financial guarantee insurance companies with respect
to our investment portfolio. As of March 31, 2010, based upon amortized
cost, $96.0 million of our securities were guaranteed either directly or
indirectly by third parties out of a total of $23.0 billion fixed maturity
securities held by us (0.42% of total fixed maturity securities).
60
Table of
Contents
Declines
in fair value for our available-for-sale portfolio, net of related DAC and
VOBA, are charged or credited directly to shareowners equity. Declines in fair
value that are other-than-temporary are recorded as realized losses in the
consolidated condensed statements of income, net of any applicable non-credit
component of the loss, which is recorded as an adjustment to other
comprehensive income. The increase in BBB and below investment grade assets, as
shown in the preceding table, is primarily a result of ratings downgrades
related to our corporate credit and residential mortgage-backed securities
holdings.
The distribution of our fixed maturity
investments by type is as follows:
|
|
As
of
|
|
Type
|
|
March 31,
2010
|
|
December 31,
2009
|
|
|
|
(Dollars In Millions)
|
|
Corporate bonds
|
|
$
|
15,724.6
|
|
$
|
14,847.8
|
|
Residential mortgage-backed securities
|
|
3,720.4
|
|
3,917.5
|
|
Commercial mortgage-backed securities
|
|
270.9
|
|
1,124.3
|
|
Other asset-backed securities
|
|
959.2
|
|
1,120.8
|
|
U.S. government-related securities
|
|
1,579.4
|
|
811.3
|
|
Other government-related securities
|
|
307.1
|
|
608.5
|
|
States, municipals and political subdivisions
|
|
641.4
|
|
400.2
|
|
Total Fixed Income Portfolio
|
|
$
|
23,203.0
|
|
$
|
22,830.4
|
|
Within
our fixed maturity securities, we maintain portfolios classified as available-for-sale
and trading. We purchase our investments with the intent to hold to maturity
by purchasing investments that match future cash flow needs. However, we may
sell any of our investments to maintain proper matching of assets and
liabilities. Accordingly, we classified $20.2 billion or 87.3% of our fixed
maturities as available-for-sale as of March 31, 2010. These securities
are carried at fair value on our consolidated condensed balance sheets.
Trading securities are
carried at fair value and changes in fair value are recorded on the income
statement as they occur. Our trading portfolio accounts for $3.0 billion,
or 12.7%, of our fixed maturities as of March 31, 2010. Of this balance,
fixed maturities with a market value of $2.7 billion and short-term investments
with a market value of $236.5 million were added as part of the Chase
Insurance Group acquisition. Investment results for the Chase Insurance Group
portfolios, including gains and losses from sales, are passed to the reinsurers
through the contractual terms of the reinsurance arrangements. Partially
offsetting these amounts are corresponding changes in the fair value of the
embedded derivative associated with the underlying reinsurance arrangement. The
total Modco trading portfolio fixed maturities by rating is as follows:
|
|
As
of
|
|
Rating
|
|
March 31,
2010
|
|
December 31,
2009
|
|
|
|
(Dollars In Thousands)
|
|
AAA
|
|
$
|
711,910
|
|
$
|
834,733
|
|
AA
|
|
117,216
|
|
73,210
|
|
A
|
|
642,756
|
|
544,135
|
|
BBB
|
|
969,894
|
|
950,252
|
|
Below investment grade
|
|
291,646
|
|
281,487
|
|
Total Modco trading fixed maturities
|
|
$
|
2,733,422
|
|
$
|
2,683,817
|
|
A portion of our bond
portfolio is invested in residential mortgage-backed securities (RMBS),
commercial mortgage-backed securities (CMBS), and other asset-backed
securities. These holdings as of March 31, 2010, were approximately $5.0
billion. Mortgage-backed securities (MBS) are constructed from pools of
mortgages and may have cash flow volatility as a result of changes in the rate
at which prepayments of principal occur with respect to the underlying loans.
Excluding limitations on access to lending and other extraordinary economic
conditions, prepayments of principal on the underlying loans can be expected to
accelerate with decreases in market interest rates and diminish with increases
in interest rates. In addition, we have entered into derivative contracts at
times to partially offset the volatility in the market value of these securities.
61
Table of
Contents
Residential mortgage-backed
securities -
The
tables below include a breakdown of our RMBS portfolio by type and rating as of
March 31, 2010. As of March 31, 2010, these holdings were
approximately $3.7 billion. Sequential securities receive payments in order
until each class is paid off. Planned amortization class securities (PACs)
pay down according to a schedule. Pass through securities receive principal as
principal of the underlying mortgages is received.
|
|
Percentage of
|
|
|
|
Residential
|
|
|
|
Mortgage-Backed
|
|
Type
|
|
Securities
|
|
Sequential
|
|
64.9
|
%
|
PAC
|
|
15.7
|
|
Pass Through
|
|
3.6
|
|
Other
|
|
15.8
|
|
|
|
100.0
|
%
|
|
|
Percentage of
|
|
|
|
Residential
|
|
|
|
Mortgage-Backed
|
|
Rating
|
|
Securities
|
|
AAA
|
|
34.5
|
%
|
AA
|
|
5.6
|
|
A
|
|
6.8
|
|
BBB
|
|
11.5
|
|
Below investment grade
|
|
41.6
|
|
|
|
100.0
|
%
|
62
Table of
Contents
As of March 31,
2010, we held $445.6 million, or 1.5% of invested assets, of securities
supported by collateral classified as Alt-A. As of December 31, 2009, we
held securities with a market value of $466.6 million of securities supported
by collateral classified as Alt-A.
The following table includes the percentage
of our collateral classified as Alt-A grouped by rating category as of March 31,
2010
:
|
|
Percentage of
|
|
|
|
Alt-A
|
|
Rating
|
|
Securities
|
|
AAA
|
|
1.3
|
%
|
A
|
|
1.0
|
|
BBB
|
|
4.1
|
|
Below investment grade
|
|
93.6
|
|
|
|
100.0
|
%
|
The following tables categorize the estimated fair
value and unrealized gain/(loss) of our mortgage-backed securities
collateralized by Alt-A mortgage loans by rating as of March 31, 2010:
Alt-A Collateralized Holdings
|
|
Estimated
Fair Value of Security by Year of Security Origination
|
|
|
|
2006
and
|
|
|
|
|
|
|
|
|
|
|
|
Rating
|
|
Prior
|
|
2007
|
|
2008
|
|
2009
|
|
2010
|
|
Total
|
|
|
|
(Dollars In Millions)
|
|
AAA
|
|
$
|
5.9
|
|
$
|
|
|
$
|
|
|
$
|
|
|
$
|
|
|
$
|
5.9
|
|
A
|
|
4.3
|
|
|
|
|
|
|
|
|
|
4.3
|
|
BBB
|
|
18.2
|
|
|
|
|
|
|
|
|
|
18.2
|
|
Below investment grade
|
|
237.2
|
|
180.0
|
|
|
|
|
|
|
|
417.2
|
|
Total mortgage-backed securities collateralized by
Alt-A mortgage loans
|
|
$
|
265.6
|
|
$
|
180.0
|
|
$
|
|
|
$
|
|
|
$
|
|
|
$
|
445.6
|
|
|
|
Estimated
Unrealized Gain (Loss) of Security by Year of Security
Origination
|
|
|
|
2006
and
|
|
|
|
|
|
|
|
|
|
|
|
Rating
|
|
Prior
|
|
2007
|
|
2008
|
|
2009
|
|
2010
|
|
Total
|
|
|
|
(Dollars In Millions)
|
|
AAA
|
|
$
|
(0.5
|
)
|
$
|
|
|
$
|
|
|
$
|
|
|
$
|
|
|
$
|
(0.5
|
)
|
A
|
|
0.7
|
|
|
|
|
|
|
|
|
|
0.7
|
|
BBB
|
|
(0.2
|
)
|
|
|
|
|
|
|
|
|
(0.2
|
)
|
Below investment grade
|
|
(46.9
|
)
|
(29.4
|
)
|
|
|
|
|
|
|
(76.3
|
)
|
Total mortgage-backed securities collateralized by
Alt-A mortgage loans
|
|
$
|
(46.9
|
)
|
$
|
(29.4
|
)
|
$
|
|
|
$
|
|
|
$
|
|
|
$
|
(76.3
|
)
|
63
Table of
Contents
The following table
includes the percentage of our collateral classified as sub-prime grouped by
rating category as of March 31, 2010:
|
|
Percentage of
|
|
|
|
Sub-prime
|
|
Rating
|
|
Securities
|
|
AAA
|
|
0.6
|
%
|
AA
|
|
3.1
|
|
A
|
|
6.9
|
|
BBB
|
|
2.0
|
|
Below
investment grade
|
|
87.4
|
|
|
|
100.0
|
%
|
As of March 31,
2010, we had RMBS with a total fair value of $39.5 million, or 0.1%, of total
invested assets, that were supported by collateral classified as sub-prime. As
of December 31, 2009, we held securities with a fair value of $35.2
million of securities supported by collateral classified as sub-prime. The
following tables categorize the estimated fair value and unrealized gain/(loss)
of our mortgage-backed securities collateralized by sub-prime mortgage loans by
rating as of March 31, 2010:
Sub-prime Collateralized Holdings
|
|
Estimated
Fair Value of Security by Year of Security Origination
|
|
|
|
2006
and
|
|
|
|
|
|
|
|
|
|
|
|
Rating
|
|
Prior
|
|
2007
|
|
2008
|
|
2009
|
|
2010
|
|
Total
|
|
|
|
(Dollars In Millions)
|
|
AAA
|
|
$
|
0.3
|
|
$
|
|
|
$
|
|
|
$
|
|
|
$
|
|
|
$
|
0.3
|
|
AA
|
|
1.2
|
|
|
|
|
|
|
|
|
|
1.2
|
|
A
|
|
2.7
|
|
|
|
|
|
|
|
|
|
2.7
|
|
BBB
|
|
0.8
|
|
|
|
|
|
|
|
|
|
0.8
|
|
Below investment grade
|
|
19.6
|
|
14.9
|
|
|
|
|
|
|
|
34.5
|
|
Total mortgage-backed securities collateralized by
sub-prime mortgage loans
|
|
$
|
24.6
|
|
$
|
14.9
|
|
$
|
|
|
$
|
|
|
$
|
|
|
$
|
39.5
|
|
|
|
Estimated
Unrealized Gain (Loss) of Security by Year of Security
Origination
|
|
|
|
2006
and
|
|
|
|
|
|
|
|
|
|
|
|
Rating
|
|
Prior
|
|
2007
|
|
2008
|
|
2009
|
|
2010
|
|
Total
|
|
|
|
(Dollars In Millions)
|
|
AAA
|
|
$
|
|
|
$
|
|
|
$
|
|
|
$
|
|
|
$
|
|
|
$
|
|
|
AA
|
|
(0.1
|
)
|
|
|
|
|
|
|
|
|
(0.1
|
)
|
A
|
|
(0.4
|
)
|
|
|
|
|
|
|
|
|
(0.4
|
)
|
BBB
|
|
(0.5
|
)
|
|
|
|
|
|
|
|
|
(0.5
|
)
|
Below investment grade
|
|
(7.5
|
)
|
(19.7
|
)
|
|
|
|
|
|
|
(27.2
|
)
|
Total mortgage-backed securities collateralized by
sub-prime mortgage loans
|
|
$
|
(8.5
|
)
|
$
|
(19.7
|
)
|
$
|
|
|
$
|
|
|
$
|
|
|
$
|
(28.2
|
)
|
64
Table of
Contents
The following table
includes the percentage of our collateral classified as prime grouped by rating
category as of March 31, 2010:
|
|
Percentage of
|
|
|
|
Prime
|
|
Rating
|
|
Securities
|
|
AAA
|
|
39.5
|
%
|
AA
|
|
6.4
|
|
A
|
|
7.6
|
|
BBB
|
|
12.6
|
|
Below
investment grade
|
|
33.9
|
|
|
|
100.0
|
%
|
As of March 31,
2010, we had RMBS collateralized by prime mortgage loans (including agency
mortgages) with a total fair value of $3.2 billion, or 10.8%, of total invested
assets. As of December 31, 2009, we held securities with a fair value of
$3.4 billion of residential mortgage-backed securities collateralized by prime
mortgage loans (including agency mortgages). The following tables categorize
the estimated fair value and unrealized gain/(loss) of our mortgage-backed
securities collateralized by prime mortgage loans (including agency mortgages)
by rating as of March 31, 2010:
Prime Collateralized Holdings
|
|
Estimated
Fair Value of Security by Year of Security Origination
|
|
|
|
2006
and
|
|
|
|
|
|
|
|
|
|
|
|
Rating
|
|
Prior
|
|
2007
|
|
2008
|
|
2009
|
|
2010
|
|
Total
|
|
|
|
(Dollars In Millions)
|
|
AAA
|
|
$
|
1,266.5
|
|
$
|
10.2
|
|
$
|
|
|
$
|
|
|
$
|
|
|
$
|
1,276.7
|
|
AA
|
|
208.3
|
|
|
|
|
|
|
|
|
|
208.3
|
|
A
|
|
237.4
|
|
8.0
|
|
|
|
|
|
|
|
245.4
|
|
BBB
|
|
385.1
|
|
24.0
|
|
|
|
|
|
|
|
409.1
|
|
Below investment grade
|
|
844.4
|
|
251.4
|
|
|
|
|
|
|
|
1,095.8
|
|
Total mortgage-backed securities collateralized by
prime mortgage loans
|
|
$
|
2,941.7
|
|
$
|
293.6
|
|
$
|
|
|
$
|
|
|
$
|
|
|
$
|
3,235.3
|
|
|
|
Estimated
Unrealized Gain (Loss) of Security by Year of Security
Origination
|
|
|
|
2006
and
|
|
|
|
|
|
|
|
|
|
|
|
Rating
|
|
Prior
|
|
2007
|
|
2008
|
|
2009
|
|
2010
|
|
Total
|
|
|
|
(Dollars In Millions)
|
|
AAA
|
|
$
|
40.1
|
|
$
|
0.6
|
|
$
|
|
|
$
|
|
|
$
|
|
|
$
|
40.7
|
|
AA
|
|
(5.3
|
)
|
|
|
|
|
|
|
|
|
(5.3
|
)
|
A
|
|
(0.3
|
)
|
0.5
|
|
|
|
|
|
|
|
0.2
|
|
BBB
|
|
(46.5
|
)
|
(0.7
|
)
|
|
|
|
|
|
|
(47.2
|
)
|
Below investment grade
|
|
(134.5
|
)
|
(48.2
|
)
|
|
|
|
|
|
|
(182.7
|
)
|
Total mortgage-backed securities collateralized by
prime mortgage loans
|
|
$
|
(146.5
|
)
|
$
|
(47.8
|
)
|
$
|
|
|
$
|
|
|
$
|
|
|
$
|
(194.3
|
)
|
65
Table of Contents
Commercial
mortgage-backed securities
- Our CMBS portfolio consists of commercial
mortgage-backed securities issued in securitization transactions. As of March 31,
2010, the CMBS holdings were approximately $270.9 million. The following table
includes the percentages of our CMBS holdings grouped by rating category as of March 31,
2010:
|
|
Percentage of
|
|
|
|
Commercial
|
|
|
|
Mortgage-Backed
|
|
Rating
|
|
Securities
|
|
AAA
|
|
97.7
|
%
|
AA
|
|
0.0
|
|
A
|
|
0.0
|
|
BBB
|
|
2.3
|
|
Below investment grade
|
|
0.0
|
|
|
|
100.0
|
%
|
The following tables include external commercial
mortgage-backed securities as of March 31, 2010:
External Commercial Mortgage-Backed Securities
|
|
Estimated
Fair Value of Security by Year of Security Origination
|
|
|
|
2006
and
|
|
|
|
|
|
|
|
|
|
|
|
Rating
|
|
Prior
|
|
2007
|
|
2008
|
|
2009
|
|
2010
|
|
Total
|
|
|
|
(Dollars In Millions)
|
|
AAA
|
|
$
|
218.2
|
|
$
|
|
|
$
|
46.4
|
|
$
|
|
|
$
|
|
|
$
|
264.6
|
|
BBB
|
|
6.3
|
|
|
|
|
|
|
|
|
|
6.3
|
|
Total external commercial mortgage-backed securities
|
|
$
|
224.5
|
|
$
|
|
|
$
|
46.4
|
|
$
|
|
|
$
|
|
|
$
|
270.9
|
|
|
|
Estimated
Unrealized Gain (Loss) of Security by Year of Security
Origination
|
|
|
|
2006
and
|
|
|
|
|
|
|
|
|
|
|
|
Rating
|
|
Prior
|
|
2007
|
|
2008
|
|
2009
|
|
2010
|
|
Total
|
|
|
|
(Dollars In Millions)
|
|
AAA
|
|
$
|
10.1
|
|
$
|
|
|
$
|
2.2
|
|
$
|
|
|
$
|
|
|
$
|
12.3
|
|
BBB
|
|
(0.7
|
)
|
|
|
|
|
|
|
|
|
(0.7
|
)
|
Total external commercial mortgage-backed securities
|
|
$
|
9.4
|
|
$
|
|
|
$
|
2.2
|
|
$
|
|
|
$
|
|
|
$
|
11.6
|
|
66
Table of Contents
Other
asset-backed securities
Other asset-backed securities pay down based on cash
flows received from the underlying pool of assets, such as receivables on auto
loans, student loans, credit cards, etc. As of March 31, 2010, these
holdings were approximately $959.2 million. The following table includes the
percentages of our other asset-backed securities holdings grouped by rating
category as of March 31, 2010:
|
|
Percentage of
|
|
|
|
Other Asset-Backed
|
|
Rating
|
|
Securities
|
|
AAA
|
|
93.6
|
%
|
AA
|
|
3.3
|
|
A
|
|
0.7
|
|
BBB
|
|
1.4
|
|
Below investment grade
|
|
1.0
|
|
|
|
100.0
|
%
|
The
following tables include our other asset-backed securities as of March 31,
2010:
Other Asset-Backed Securities
|
|
Estimated
Fair Value of Security by Year of Security Origination
|
|
|
|
2006
and
|
|
|
|
|
|
|
|
|
|
|
|
Rating
|
|
Prior
|
|
2007
|
|
2008
|
|
2009
|
|
2010
|
|
Total
|
|
|
|
(Dollars In Millions)
|
|
AAA
|
|
$
|
649.4
|
|
$
|
213.0
|
|
$
|
35.8
|
|
$
|
|
|
$
|
|
|
$
|
898.2
|
|
AA
|
|
32.0
|
|
|
|
|
|
|
|
|
|
32.0
|
|
A
|
|
6.9
|
|
|
|
|
|
|
|
|
|
6.9
|
|
BBB
|
|
6.6
|
|
7.3
|
|
|
|
|
|
|
|
13.9
|
|
Below investment grade
|
|
0.7
|
|
7.5
|
|
|
|
|
|
|
|
8.2
|
|
Total asset-backed securities
|
|
$
|
695.6
|
|
$
|
227.8
|
|
$
|
35.8
|
|
$
|
|
|
$
|
|
|
$
|
959.2
|
|
|
|
Estimated
Unrealized Gain (Loss) of Security by Year of Security
Origination
|
|
|
|
2006
and
|
|
|
|
|
|
|
|
|
|
|
|
Rating
|
|
Prior
|
|
2007
|
|
2008
|
|
2009
|
|
2010
|
|
Total
|
|
|
|
(Dollars In Millions)
|
|
AAA
|
|
$
|
(36.8
|
)
|
$
|
(21.0
|
)
|
$
|
0.3
|
|
$
|
|
|
$
|
|
|
$
|
(57.5
|
)
|
AA
|
|
3.0
|
|
|
|
|
|
|
|
|
|
3.0
|
|
A
|
|
0.4
|
|
|
|
|
|
|
|
|
|
0.4
|
|
BBB
|
|
(1.5
|
)
|
|
|
|
|
|
|
|
|
(1.5
|
)
|
Below investment grade
|
|
(0.3
|
)
|
(15.3
|
)
|
|
|
|
|
|
|
(15.6
|
)
|
Total asset-backed securities
|
|
$
|
(35.2
|
)
|
$
|
(36.3
|
)
|
$
|
0.3
|
|
$
|
|
|
$
|
|
|
$
|
(71.2
|
)
|
We obtained ratings of
our fixed maturities from Moodys Investors Service, Inc. (Moodys),
Standard & Poors Corporation (S&P) and/or Fitch
Ratings (Fitch). If a bond is not rated by Moodys, S&P, or Fitch,
we use ratings from the National Association of Insurance Commissioners (NAIC),
or we rate the bond based upon a comparison of the unrated issue to rated
issues of the same issuer or rated issues of other issuers with similar risk
characteristics. As of March 31, 2010 over 99.0% of our bonds were rated
by Moodys, S&P, Fitch, and/or the NAIC.
67
Table of Contents
The industry segment composition of our fixed maturity
securities is presented in the following table:
|
|
As of
|
|
% Fair
|
|
As of
|
|
% Fair
|
|
|
|
March 31,
2010
|
|
Value
|
|
December 31,
2009
|
|
Value
|
|
|
|
(Dollars In Thousands)
|
|
Banking
|
|
$
|
2,037,489
|
|
8.8
|
%
|
$
|
1,955,544
|
|
8.5
|
%
|
Other finance
|
|
158,546
|
|
0.7
|
|
82,694
|
|
0.4
|
|
Electric
|
|
2,894,863
|
|
12.5
|
|
2,650,003
|
|
11.6
|
|
Natural gas
|
|
1,964,965
|
|
8.5
|
|
1,789,164
|
|
7.8
|
|
Insurance
|
|
1,651,312
|
|
7.1
|
|
1,529,248
|
|
6.7
|
|
Energy
|
|
1,422,688
|
|
6.1
|
|
1,369,370
|
|
6.0
|
|
Communications
|
|
1,036,813
|
|
4.5
|
|
1,079,497
|
|
4.7
|
|
Basic industrial
|
|
976,207
|
|
4.2
|
|
936,575
|
|
4.1
|
|
Consumer noncyclical
|
|
995,890
|
|
4.3
|
|
958,688
|
|
4.2
|
|
Consumer cyclical
|
|
434,861
|
|
1.9
|
|
491,594
|
|
2.1
|
|
Finance companies
|
|
234,685
|
|
1.0
|
|
231,312
|
|
1.0
|
|
Capital goods
|
|
597,583
|
|
2.6
|
|
532,778
|
|
2.3
|
|
Transportation
|
|
469,679
|
|
2.0
|
|
426,860
|
|
1.9
|
|
Other industrial
|
|
123,856
|
|
0.5
|
|
91,237
|
|
0.4
|
|
Brokerage
|
|
414,882
|
|
1.8
|
|
375,650
|
|
1.6
|
|
Technology
|
|
259,750
|
|
1.1
|
|
289,029
|
|
1.3
|
|
Real estate
|
|
45,508
|
|
0.2
|
|
53,517
|
|
0.2
|
|
Other utility
|
|
5,006
|
|
0.0
|
|
5,049
|
|
0.0
|
|
Commercial mortgage-backed securities
|
|
270,925
|
|
1.2
|
|
1,124,325
|
|
4.9
|
|
Other asset-backed securities
|
|
959,226
|
|
4.1
|
|
1,120,761
|
|
4.8
|
|
Residential mortgage-backed non-agency securities
|
|
2,841,412
|
|
12.2
|
|
3,000,142
|
|
13.1
|
|
Residential mortgage-backed agency securities
|
|
878,959
|
|
3.8
|
|
917,312
|
|
4.0
|
|
U.S. government-related securities
|
|
1,579,370
|
|
6.8
|
|
811,323
|
|
3.5
|
|
Other government-related securities
|
|
307,114
|
|
1.3
|
|
608,530
|
|
2.7
|
|
States, municipals, and political divisions
|
|
641,437
|
|
2.8
|
|
400,225
|
|
2.2
|
|
Total
|
|
$
|
23,203,026
|
|
100.0
|
%
|
$
|
22,830,427
|
|
100.0
|
%
|
Our investments in debt and equity securities are
reported at fair value, and investments in mortgage loans are reported at
amortized cost. As of March 31, 2010, our fixed maturity investments
(bonds and redeemable preferred stocks) had a market value of $23.2 billion,
which was 0.9% above amortized cost of $23.0 billion. These assets are
invested for terms approximately corresponding to anticipated future benefit
payments. Thus, market fluctuations are not expected to adversely affect
liquidity.
Market values for private, non-traded securities are
determined as follows: 1) we obtain estimates from independent pricing
services and 2) we estimate market value based upon a comparison to quoted
issues of the same issuer or issues of other issuers with similar terms and
risk characteristics. We analyze the independent pricing services valuation
methodologies and related inputs, including an assessment of the observability
of market inputs. Upon obtaining this information related to market value,
management makes a determination as to the appropriate valuation amount.
68
Table
of Contents
Mortgage Loans
We invest a portion of
our investment portfolio in commercial mortgage loans. As of March 31,
2010, our mortgage loan holdings were approximately $4.9 billion. We have
specialized in making loans on either credit-oriented commercial properties or
credit-anchored strip shopping centers and apartments. Our underwriting
procedures relative to our commercial loan portfolio are based, in our view, on
a conservative and disciplined approach. We concentrate on a small number of
commercial real estate asset types associated with the necessities of life
(retail, multi-family, professional office buildings, and warehouses). We
believe these asset types tend to weather economic downturns better than other
commercial asset classes in which we have chosen not to participate. We believe
this disciplined approach has helped to maintain a relatively low delinquency
and foreclosure rate throughout our history.
We record mortgage loans
net of an allowance for credit losses. This allowance is calculated through
analysis of specific loans that have indicators of potential impairment based
on current information and events. As of March 31, 2010 and 2009, our
allowance for mortgage loan credit losses was $5.7 million and
$2.3 million, respectively. While our mortgage loans do not have quoted
market values, as of March 31, 2010, we estimated the fair value of our
mortgage loans to be $ 5.2 billion (using discounted cash flows from the
next call date), which was 6.1% greater than the amortized cost, less any
related loan loss reserve.
At the time of
origination, our mortgage lending criteria targets that the loan-to-value ratio
on each mortgage is 75% or less. We target projected rental payments from
credit anchors (i.e., excluding rental payments from smaller local tenants)
of 70% of the propertys projected operating expenses and debt service. We also
offer a commercial loan product under which we will permit a loan-to-value
ratio of up to 85% in exchange for a participating interest in the cash flows
from the underlying real estate. As of March 31, 2010, approximately
$812.5 million of our mortgage loans had this participation feature.
Exceptions to these loan-to-value measures may be made if we believe the
mortgage has an acceptable risk profile.
Many of our mortgage
loans have call or interest rate reset provisions between 3 and
10 years. However, if interest rates were to significantly increase, we
may be unable to call the loans or increase the interest rates on our existing
mortgage loans commensurate with the significantly increased market rates.
As of March 31,
2010, delinquent mortgage loans and foreclosed properties were less than 0.16%
of invested assets. We do not expect these investments to adversely affect our
liquidity or ability to maintain proper matching of assets and liabilities. Our
mortgage loan portfolio consists of two categories of loans: (1) those not
subject to a pooling and servicing agreement and (2) those previously a
part of variable interest entity securitizations and thus subject to a contractual
pooling and servicing agreement. The loans subject to a pooling and servicing
agreement have been included on our consolidated condensed balance sheet (balance
sheet) in the first quarter of 2010 in accordance with ASU 2009-17. For loans
not subject to a pooling and servicing agreement, as of March 31, 2010,
$29.1 million of the mortgage loan portfolio was nonperforming. In addition, as
of March 31, 2010, $16.1 million of the mortgage loan portfolio that is
subject to a pooling and servicing agreement was being restructured under the
terms and conditions of the pooling and service agreement.
It is our policy to cease
to carry accrued interest on loans that are over 90 days delinquent. For
loans less than 90 days delinquent, interest is accrued unless it is
determined that the accrued interest is not collectible. If a loan becomes over
90 days delinquent, it is our general policy to initiate foreclosure
proceedings unless a workout arrangement to bring the loan current is in place.
For loans subject to a pooling and servicing agreement, there are certain
additional restrictions and/or requirements related to workout proceedings, and
as such, these loans may have different attributes and/or circumstances
affecting the status of delinquency or categorization of those in nonperforming
status.
Securities Lending
We participate in
securities lending, primarily as an investment yield enhancement, whereby
securities that are held as investments are loaned to third parties for short
periods of time. We require initial collateral of 102% of the market value of
the loaned securities to be separately maintained. The loaned securities
market value is monitored on a daily basis. As of March 31, 2010,
securities with a market value of $96.2 million were loaned under this program.
As collateral for the loaned securities, we receive short-term investments,
which are recorded in short-term investments with a corresponding liability
recorded in other liabilities to account for our obligation to return the
collateral. As of March 31, 2010, the fair value of the collateral related
to this program was $94.8 million and we have an obligation to return $98.6
million of collateral to the securities borrowers.
69
Table
of Contents
Risk Management and Impairment Review
We monitor the overall credit quality of our portfolio
within established guidelines. The following table includes our available-for-sale
fixed maturities by credit rating as of March 31, 2010:
|
|
|
|
Percent
of
|
|
S&P
or Equivalent Designation
|
|
Market
Value
|
|
Market
Value
|
|
|
|
(Dollars In Thousands)
|
|
|
|
AAA
|
|
$
|
2,673,191
|
|
13.2
|
%
|
AA
|
|
815,597
|
|
4.0
|
|
A
|
|
4,406,928
|
|
21.8
|
|
BBB
|
|
9,538,112
|
|
47.1
|
|
Investment grade
|
|
17,433,828
|
|
86.1
|
|
BB
|
|
1,088,735
|
|
5.4
|
|
B
|
|
566,246
|
|
2.8
|
|
CCC or lower
|
|
1,163,455
|
|
5.7
|
|
In or near default
|
|
|
|
0.0
|
|
Below investment grade
|
|
2,818,436
|
|
13.9
|
|
Total
|
|
$
|
20,252,264
|
|
100.0
|
%
|
Not included in the table
above are $2.6 billion of investment grade and $376.5 million of below
investment grade fixed maturities classified as trading securities.
Limiting bond exposure to
any creditor group is another way we manage credit risk. The following table
includes securities held in our Modco portfolio and summarizes our ten largest
fixed maturity exposures to an individual creditor group as of March 31,
2010:
Creditor
|
|
Market
Value
|
|
|
|
(Dollars In Millions)
|
|
Federal Home Loan Mortgage Corporation
|
|
$
|
214.7
|
|
Bershire Hathaway Inc.
|
|
178.5
|
|
Verizon Communications Inc.
|
|
176.8
|
|
Federal National Mortgage Association
|
|
173.1
|
|
Wells Fargo & Company
|
|
169.1
|
|
Bank of America Corp
|
|
156.0
|
|
PNC Financial Services Group
|
|
144.8
|
|
Prudential Financial Inc.
|
|
139.7
|
|
Metlife Inc.
|
|
136.3
|
|
AT&T Corporation
|
|
133.6
|
|
|
|
|
|
|
Determining whether a
decline in the current fair value of invested assets is an other-than-temporary
decline in value is both objective and subjective, and can involve a variety of
assumptions and estimates, particularly for investments that are not actively
traded in established markets.
We review our positions on a monthly basis for
possible credit concerns and review our current exposure, credit enhancement,
and delinquency experience.
Management considers a number of factors when determining
the impairment status of individual securities. These include the economic
condition of various industry segments and geographic locations and other areas
of identified risks. Since it is possible for the impairment of one investment
to affect other investments, we engage in ongoing risk management to safeguard
against and limit any further risk to our investment portfolio. Special
attention is given to correlative risks within specific industries, related
parties, and business markets.
For certain securitized
financial assets with contractual cash flows, including ABS, GAAP requires us
to periodically update our best estimate of cash flows over the life of the
security. If the fair value of a securitized financial asset is less than its
cost or amortized cost and there has been a decrease in the present value of
the expected cash flows since the last revised estimate, considering both
timing and amount, an other-than-temporary impairment charge is recognized.
Estimating future cash flows is a quantitative and qualitative process that
incorporates information received from third party sources along with certain
internal assumptions and judgments regarding the future performance of the
underlying collateral. Projections of expected future cash flows may change
based upon new information regarding the performance of the underlying
collateral. In addition, we consider our intent and ability to retain a
temporarily depressed security until recovery.
70
Table of
Contents
In April of 2009, the FASB issued guidance to
amend the other-than-temporary impairment guidance in GAAP for debt securities
to make the guidance more operational and to improve the presentation and
disclosure of other-than-temporary impairments of debt and equity securities in
the financial statements. This guidance addresses the timing of impairment
recognition and provides greater clarity to investors about the credit and
noncredit components of impaired debt securities that are not expected to be
sold. Impairments will continue to be measured at fair value with credit losses
recognized in earnings and non-credit losses recognized in other comprehensive
income. This guidance also requires increased and more frequent disclosures
regarding measurement techniques, credit losses, and an aging of securities
with unrealized losses. We elected to early adopt the guidance in the first
quarter of 2009. For the three months ended March 31, 2010, we recorded
total other-than-temporary impairments of approximately $21.9 million with $10.0
million of this amount recorded in other comprehensive income (loss).
Securities in an
unrealized loss position are reviewed at least quarterly to determine if an
other-than-temporary impairment is present based on certain quantitative and
qualitative factors. We consider a number of factors in determining whether the
impairment is other-than-temporary. These include, but are not limited to: 1) actions
taken by rating agencies, 2) default by the issuer, 3) the
significance of the decline, 4) an assessment of the Companys intent to
sell the security (including a more likely than not assessment of whether the
Company will be required to sell the security) before recovering the securitys
amortized cost, 5) the time period during which the decline has occurred,
6) an economic analysis of the issuers industry, and 7) the
financial strength, liquidity, and recoverability of the issuer. Management performs
a security-by-security review each quarter in evaluating the need for any
other-than-temporary impairments. Although no set formula is used in this
process, the investment performance, collateral position, and continued
viability of the issuer are significant measures considered, along with
an analysis
regarding the Companys expectations for recovery of the securitys entire
amortized cost basis through the receipt of future cash flows
. Based on our analysis, for the three
months ended March 31, 2010, we concluded that approximately $11.9 million
of investment securities in an unrealized loss position was
other-than-temporarily impaired, due to credit-related factors, resulting in a
charge to earnings. Additionally, we recognized $10.0 million of non-credit
losses in other comprehensive income for the securities where an
other-than-temporary impairment was recorded.
There
are certain risks and uncertainties associated with determining whether
declines in market values are other-than-temporary. These include significant
changes in general economic conditions and business markets, trends in certain
industry segments, interest rate fluctuations, rating agency actions, changes
in significant accounting estimates and assumptions, commission of fraud, and
legislative actions. We continuously monitor these factors as they relate to
the investment portfolio in determining the status of each investment.
We
have deposits with certain financial institutions which exceed federally
insured limits. We have reviewed the creditworthiness of these financial
institutions and believe there is minimal risk of a material loss.
71
Table of Contents
Realized Gains and Losses
The following table sets
forth realized investment gains and losses for the periods shown:
|
|
For
The
|
|
|
|
|
|
Three
Months Ended
|
|
|
|
|
|
March 31,
|
|
|
|
|
|
2010
|
|
2009
|
|
Change
|
|
|
|
(Dollars In Thousands)
|
|
|
|
Fixed maturity gains - sales
|
|
$
|
8,232
|
|
$
|
5,579
|
|
$
|
2,653
|
|
Fixed maturity losses - sales
|
|
(1,506
|
)
|
(26
|
)
|
(1,480
|
)
|
Equity gains - sales
|
|
|
|
|
|
|
|
Equity losses - sales
|
|
|
|
|
|
|
|
Impairments on fixed maturity securities
|
|
(11,869
|
)
|
(70,386
|
)
|
58,517
|
|
Impairments on equity securities
|
|
|
|
(19,440
|
)
|
19,440
|
|
Modco trading portfolio trading activity
|
|
44,093
|
|
(45,878
|
)
|
89,971
|
|
Other
|
|
(2,920
|
)
|
(1,518
|
)
|
(1,402
|
)
|
Total realized gains (losses) - investments
|
|
$
|
36,030
|
|
$
|
(131,669
|
)
|
$
|
167,699
|
|
|
|
|
|
|
|
|
|
Derivatives related to mortgage loan commitments
|
|
$
|
|
|
$
|
2,296
|
|
$
|
(2,296
|
)
|
Embedded derivatives related to reinsurance
|
|
(31,094
|
)
|
60,632
|
|
(91,726
|
)
|
Derivatives related to corporate debt
|
|
|
|
(125
|
)
|
125
|
|
Other interest rate swaps
|
|
(2,392
|
)
|
14,148
|
|
(16,540
|
)
|
Credit default swaps
|
|
505
|
|
(4,337
|
)
|
4,842
|
|
GMWB embedded derivatives
|
|
9,124
|
|
19,801
|
|
(10,677
|
)
|
Other derivatives
|
|
785
|
|
18
|
|
767
|
|
Total realized gains (losses) - derivatives
|
|
$
|
(23,072
|
)
|
$
|
92,433
|
|
$
|
(115,505
|
)
|
Realized
gains and losses on investments reflect portfolio management activities
designed to maintain proper matching of assets and liabilities and to enhance
long-term investment portfolio performance. The change in net realized
investment gains (losses), excluding impairments, Modco trading portfolio
activity, and related embedded derivatives related to corporate debt, during
the three months ended March 31, 2010, primarily reflects the normal
operation of our asset/liability program within the context of the changing
interest rate and spread environment.
Realized losses are comprised of both write-downs on
other-than-temporary impairments and actual sales of investments. For the three
months ended March 31, 2010, we recognized pre-tax other-than-temporary
impairments of $11.9 million, due to credit-related factors, resulting in a charge
to earnings. Additionally, we recognized $10.0 million of non-credit losses in
other comprehensive income for the securities where an other-than-temporary
impairment was recorded. Other-than-temporary impairments totaled $89.8 million
for the three months ended March 31, 2009. These other-than-temporary
impairments resulted from our analysis of circumstances and our belief that
credit events, loss severity, changes in credit enhancement, and/or other
adverse conditions of the respective issuers have caused, or will lead to, a
deficiency in the contractual cash flows related to these investments. These
other-than-temporary impairments, net of Modco recoveries, are presented in the
chart below:
|
|
For
The
|
|
|
|
Three
Months Ended
|
|
|
|
March 31,
2010
|
|
|
|
(Dollars In Millions)
|
|
Alt-A MBS
|
|
$
|
9.3
|
|
Other MBS
|
|
1.1
|
|
Other Corporate Bonds
|
|
1.4
|
|
Sub-prime Bonds
|
|
0.1
|
|
Total
|
|
$
|
11.9
|
|
72
Table of Contents
As previously discussed, management considers several
factors when determining other-than-temporary impairments. Although we purchase
securities with the intent to hold securities until maturity, we may change our
position as a result of a change in circumstances. Any such decision is
consistent with our classification of all but a specific portion of our
investment portfolio as available-for-sale. For the three months ended March 31,
2010, we sold securities in an unrealized loss position with a fair value of
$102.7 million. For such securities, the proceeds, realized loss, and
total time period that the security had been in an unrealized loss position are
presented in the table below:
|
|
Proceeds
|
|
%
Proceeds
|
|
Realized
Loss
|
|
%
Realized Loss
|
|
|
|
(Dollars In Thousands)
|
|
<= 90 days
|
|
$
|
77,900
|
|
75.9
|
%
|
$
|
(1,265
|
)
|
84.0
|
%
|
>90 days but <= 180 days
|
|
14,500
|
|
14.1
|
|
(195
|
)
|
13.0
|
|
>180 days but <= 270 days
|
|
|
|
0.0
|
|
|
|
0.0
|
|
>270 days but <= 1 year
|
|
233
|
|
0.2
|
|
(10
|
)
|
0.6
|
|
>1 year
|
|
10,067
|
|
9.8
|
|
(36
|
)
|
2.4
|
|
Total
|
|
$
|
102,700
|
|
100.0
|
%
|
$
|
(1,506
|
)
|
100.0
|
%
|
For the three months ended March 31,
2010, the Company sold securities in an unrealized loss position with a fair
value (proceeds) of $102.7 million. For the three months ended March 31,
2010, we sold securities in an unrealized gain position with a fair value of
$951.0 million. The gain realized on the sale of these securities was $8.2
million.
The $2.9 million of other realized losses
recognized for the three months ended March 31, 2010, consists of the change
in the mortgage loan loss reserves.
As of March 31,
2010, net gains of $44.1 million primarily related to mark-to-market changes on
our Modco trading portfolios associated with the Chase Insurance Group
acquisition were also included in realized gains and losses. Of this amount,
approximately $13.3 million of gains were realized through the sale of certain
securities, which will be reimbursed to our reinsurance partners over time
through the reinsurance settlement process for this block of business. Additional
details on our investment performance and evaluation are provided in the
sections below.
Realized investment gains
and losses related to derivatives represent changes in the fair value of
derivative financial instruments and gains/(losses) on derivative contracts
closed during the period.
From time to time, we
have taken short positions in U.S. Treasury futures to mitigate interest
rate risk related to our mortgage loan commitments. There were no outstanding
positions for the three months ended March 31, 2010.
We also have in place
various modified coinsurance and funds withheld arrangements that contain
embedded derivatives. The $31.1 million of losses on these embedded derivatives
for the three months ended March 31, 2010, was the result of spread
tightening. For the three months ended March 31, 2010, the investment
portfolios that support the related modified coinsurance reserves and funds
withheld arrangements had mark-to-market gains that offset the losses on these
embedded derivatives.
We use certain interest
rate swaps to mitigate interest rate risk related to certain Senior Notes,
Medium-Term Notes, and subordinated debt securities. As of March 31, 2010,
we did not hold any positions in these swaps.
We use certain interest
rate swaps to mitigate the price volatility of assets. These positions resulted
in net losses of $2.4 million for the three months ended March 31, 2010.
The net losses were primarily the result of $1.6 million in mark-to-market
losses during the period.
We reported net gains of
$0.5 million related to credit default swaps for the three months ended March 31,
2010. The net gains for the three months ended March 31, 2010, were
primarily the result of $0.4 million of mark-to-market gains during the period.
The GMWB rider embedded
derivatives on certain variable deferred annuities had net unrealized gains of
$9.1 million for the three months ended March 31, 2010.
73
Table of Contents
We also use various swaps and
options to mitigate risk related to other exposures. These contracts generated
net gains of $0.8 million for the three months ended March 31, 2010.
Unrealized Gains and Losses Available-for-Sale Securities
The information presented below relates to investments
at a certain point in time and is not necessarily indicative of the status of
the portfolio at any time after March 31, 2010, the balance sheet date.
Information about unrealized gains and losses is subject to rapidly changing
conditions, including volatility of financial markets and changes in interest
rates. Management considers a number of factors in determining if an unrealized
loss is other-than-temporary, including the expected cash to be collected and
the intent, likelihood, and/or ability to hold the security until recovery.
Consistent with our long-standing practice, we do not utilize a bright line
test to determine other-than-temporary impairments. On a quarterly basis, we
perform an analysis on every security with an unrealized loss to determine if
an other-than-temporary impairment has occurred. This analysis includes
reviewing several metrics including collateral, expected cash flows, ratings,
and liquidity. Furthermore, since the timing of recognizing realized gains and
losses is largely based on managements decisions as to the timing and
selection of investments to be sold, the tables and information provided below
should be considered within the context of the overall unrealized gain/(loss)
position of the portfolio. As of March 31, 2010, we had an overall net
unrealized gain of $61.3 million, prior to tax and DAC offsets, compared to a
$403.0 million loss as of December 31, 2009.
Credit and RMBS markets
have experienced volatility across numerous asset classes over the past two
years, primarily as a result of marketplace uncertainty arising from the
failure or near failure of a number of large financial service companies
resulting in intervention by the United States Federal Government, downgrades
in ratings, interest rate changes, higher defaults in sub-prime and Alt-A
residential mortgage loans, and a weakening of the overall economy. In
connection with this uncertainty, we believe investors have departed from many
investments in other asset-backed securities, including those associated with
sub-prime and Alt-A residential mortgage loans, as well as types of debt
investments with fewer lender protections or those with reduced transparency
and/or complex features which may hinder investor understanding. We believe
these factors have contributed to the level of our net unrealized investment
losses through declines in market values over the past two years.
For fixed maturity and
equity securities held that are in an unrealized loss position as of March 31,
2010, the estimated market value, amortized cost, unrealized loss, and total
time period that the security has been in an unrealized loss position are
presented in the table below:
|
|
Estimated
|
|
%
Market
|
|
Amortized
|
|
%
Amortized
|
|
Unrealized
|
|
%
Unrealized
|
|
|
|
Market
Value
|
|
Value
|
|
Cost
|
|
Cost
|
|
Loss
|
|
Loss
|
|
|
|
(Dollars In Thousands)
|
|
<= 90 days
|
|
$
|
2,613,203
|
|
32.8
|
%
|
$
|
2,670,195
|
|
30.9
|
%
|
$
|
(56,992
|
)
|
8.2
|
%
|
>90 days but <= 180 days
|
|
549,881
|
|
6.9
|
|
565,248
|
|
6.5
|
|
(15,367
|
)
|
2.2
|
|
>180 days but <= 270 days
|
|
82,979
|
|
1.0
|
|
88,524
|
|
1.0
|
|
(5,545
|
)
|
0.8
|
|
>270 days but <= 1 year
|
|
28,171
|
|
0.4
|
|
28,784
|
|
0.3
|
|
(613
|
)
|
0.1
|
|
>1 year but <= 2 years
|
|
986,405
|
|
12.4
|
|
1,106,586
|
|
12.8
|
|
(120,181
|
)
|
17.2
|
|
>2 years but <= 3 years
|
|
2,822,576
|
|
35.5
|
|
3,205,273
|
|
37.0
|
|
(382,697
|
)
|
54.8
|
|
>3 years but <= 4 years
|
|
380,354
|
|
4.8
|
|
426,619
|
|
4.9
|
|
(46,265
|
)
|
6.6
|
|
>4 years but <= 5 years
|
|
448,264
|
|
5.6
|
|
511,975
|
|
5.9
|
|
(63,711
|
)
|
9.1
|
|
>5 years
|
|
44,187
|
|
0.6
|
|
50,865
|
|
0.7
|
|
(6,678
|
)
|
1.0
|
|
Total
|
|
$
|
7,956,020
|
|
100.0
|
%
|
$
|
8,654,069
|
|
100.0
|
%
|
$
|
(698,049
|
)
|
100.0
|
%
|
The majority of the
unrealized loss as of March 31, 2010, for both investment grade and below
investment grade securities, is attributable to a widening in credit and
mortgage spreads for certain securities. The negative impact of spread levels
for certain securities was partially offset by lower treasury yield levels and
their associated positive effect on security prices. Spread levels have
improved since December 31, 2009. However, certain types of securities,
including tranches of RMBS and ABS continue to be priced at a level which has
caused the unrealized losses noted above.
74
Table of Contents
As of March 31, 2010, the Barclays Investment
Grade Index was priced at 136 bps versus a 10 year average of 160 bps.
Similarly, the Barclays High Yield Index was priced at 570 bps versus a 10 year
average of 617 bps. As of March 31, 2010, the five, ten, and thirty-year
U.S. Treasury obligations were trading at levels of 2.54%, 3.82%, and 4.71%,
compared to 10 year averages of 3.78%, 4.36%, and 4.87%, respectively.
As of March 31, 2010, 38.1% of the unrealized
loss was associated with securities that were rated investment grade. We have
examined the performance of the underlying collateral and cash flows and expect
that our investments will continue to perform in accordance with their
contractual terms. Factors such as credit enhancements within the deal
structures and the underlying collateral performance/characteristics support
the recoverability of the investments. Based on the factors discussed, we do
not consider these unrealized loss positions to be other-than-temporary.
However, from time to time, we may sell securities in the ordinary course of
managing our portfolio to meet diversification, credit quality, yield
enhancement, asset-liability management, and liquidity requirements.
Expectations that
investments in mortgage-backed and asset-backed securities will continue to
perform in accordance with their contractual terms are based on assumptions a
market participant would use in determining the current fair value. It is
reasonably possible that the underlying collateral of these investments will
perform worse than current market expectations and that such event may lead to
adverse changes in the cash flows on our holdings of these types of securities.
This could lead to potential future write-downs within our portfolio of
mortgage-backed and asset-backed securities. Expectations that our investments
in corporate securities and/or debt obligations will continue to perform in
accordance with their contractual terms are based on evidence gathered through
our normal credit surveillance process. Although we do not anticipate such
events, it is reasonably possible that issuers of our investments in corporate
securities will perform worse than current expectations. Such events may lead
us to recognize potential future write-downs within our portfolio of corporate
securities. It is also possible that such unanticipated events would lead
us to dispose of those certain holdings and recognize the effects of any market
movements in our financial statements.
As of March 31,
2010, there were estimated gross unrealized losses of $86.8 million and $26.6
million, related to our mortgage-backed securities collateralized by Alt-A
mortgage loans and sub-prime mortgage loans, respectively. Gross unrealized
losses in our securities collateralized by sub-prime and Alt-A residential mortgage
loans as of March 31, 2010, were primarily the result of continued
widening spreads, representing marketplace uncertainty arising from higher
defaults in sub-prime and Alt-A residential mortgage loans and rating agency
downgrades of securities collateralized by sub-prime and Alt-A residential
mortgage loans.
For the three months
ended March 31, 2010, we recorded $11.9 million of pre-tax
other-than-temporary impairments related to estimated credit losses. These
other-than-temporary impairments resulted from our analysis of circumstances
and our belief that credit events, loss severity, changes in credit
enhancement, and/or other adverse conditions of the respective issuers have
caused, or will lead to, a deficiency in the contractual cash flows related to
these investments. Excluding the securities on which other-than-temporary
impairments were recorded, we expect these investments to continue to perform
in accordance with their original contractual terms. We have the ability and
intent to hold these investments until maturity or until the fair values of the
investments have recovered, which may be at maturity. Additionally, we do not
expect these investments to adversely affect our liquidity or ability to
maintain proper matching of assets and liabilities.
75
Table of
Contents
We have no material concentrations of issuers or
guarantors of fixed maturity securities. The industry segment composition of
all securities in an unrealized loss position held as of March 31, 2010,
is presented in the following table:
|
|
Estimated
|
|
%
Market
|
|
Amortized
|
|
%
Amortized
|
|
Unrealized
|
|
%
Unrealized
|
|
|
|
Market
Value
|
|
Value
|
|
Cost
|
|
Cost
|
|
Loss
|
|
Loss
|
|
|
|
(Dollars In Thousands)
|
|
Banking
|
|
$
|
941,287
|
|
11.8
|
%
|
$
|
1,035,271
|
|
12.0
|
%
|
$
|
(93,984
|
)
|
13.5
|
%
|
Other finance
|
|
62,280
|
|
0.8
|
|
62,758
|
|
0.7
|
|
(478
|
)
|
0.1
|
|
Electric
|
|
633,506
|
|
8.0
|
|
664,285
|
|
7.7
|
|
(30,779
|
)
|
4.4
|
|
Natural gas
|
|
360,066
|
|
4.5
|
|
377,008
|
|
4.4
|
|
(16,942
|
)
|
2.4
|
|
Insurance
|
|
625,317
|
|
7.9
|
|
674,634
|
|
7.8
|
|
(49,317
|
)
|
7.1
|
|
Energy
|
|
121,068
|
|
1.5
|
|
123,378
|
|
1.4
|
|
(2,310
|
)
|
0.3
|
|
Communications
|
|
173,712
|
|
2.2
|
|
191,629
|
|
2.2
|
|
(17,917
|
)
|
2.6
|
|
Basic industrial
|
|
144,729
|
|
1.8
|
|
154,840
|
|
1.8
|
|
(10,111
|
)
|
1.4
|
|
Consumer noncyclical
|
|
156,488
|
|
2.0
|
|
161,311
|
|
1.9
|
|
(4,823
|
)
|
0.7
|
|
Consumer cyclical
|
|
159,906
|
|
2.0
|
|
170,842
|
|
2.0
|
|
(10,936
|
)
|
1.6
|
|
Finance companies
|
|
119,301
|
|
1.5
|
|
127,422
|
|
1.5
|
|
(8,121
|
)
|
1.2
|
|
Capital goods
|
|
138,156
|
|
1.7
|
|
145,559
|
|
1.7
|
|
(7,403
|
)
|
1.1
|
|
Transportation
|
|
51,551
|
|
0.6
|
|
55,774
|
|
0.6
|
|
(4,223
|
)
|
0.6
|
|
Other industrial
|
|
67,475
|
|
0.8
|
|
69,431
|
|
0.8
|
|
(1,956
|
)
|
0.3
|
|
Brokerage
|
|
128,119
|
|
1.6
|
|
138,548
|
|
1.6
|
|
(10,429
|
)
|
1.5
|
|
Technology
|
|
50,326
|
|
0.6
|
|
54,074
|
|
0.6
|
|
(3,748
|
)
|
0.5
|
|
Real estate
|
|
19,079
|
|
0.2
|
|
19,360
|
|
0.2
|
|
(281
|
)
|
0.0
|
|
Other utility
|
|
21
|
|
0.0
|
|
44
|
|
0.0
|
|
(23
|
)
|
0.0
|
|
Commercial mortgage-backed securities
|
|
6,365
|
|
0.1
|
|
7,009
|
|
0.1
|
|
(644
|
)
|
0.1
|
|
Other asset-backed securities
|
|
665,603
|
|
8.4
|
|
743,264
|
|
8.6
|
|
(77,661
|
)
|
11.1
|
|
Residential mortgage-backed non-agency securities
|
|
2,091,048
|
|
26.3
|
|
2,424,807
|
|
28.0
|
|
(333,759
|
)
|
47.8
|
|
Residential mortgage-backed agency securities
|
|
174,835
|
|
2.2
|
|
176,868
|
|
2.0
|
|
(2,033
|
)
|
0.3
|
|
U.S. government-related securities
|
|
837,635
|
|
10.5
|
|
844,124
|
|
9.8
|
|
(6,489
|
)
|
0.9
|
|
Other government-related securities
|
|
61,182
|
|
0.8
|
|
61,810
|
|
0.7
|
|
(628
|
)
|
0.1
|
|
States, municipals, and political divisions
|
|
166,965
|
|
2.2
|
|
170,019
|
|
1.9
|
|
(3,054
|
)
|
0.4
|
|
Total
|
|
$
|
7,956,020
|
|
100.0
|
%
|
$
|
8,654,069
|
|
100.0
|
%
|
$
|
(698,049
|
)
|
100.0
|
%
|
76
Table of
Contents
The percentage of our
unrealized loss positions, segregated by industry segment, is presented in the
following table:
|
|
As
of
|
|
|
|
March 31,
2010
|
|
December 31,
2009
|
|
|
|
|
|
|
|
Banking
|
|
13.5
|
%
|
14.0
|
%
|
Other finance
|
|
0.1
|
|
0.0
|
|
Electric
|
|
4.4
|
|
3.9
|
|
Natural gas
|
|
2.4
|
|
2.0
|
|
Insurance
|
|
7.1
|
|
8.2
|
|
Energy
|
|
0.3
|
|
0.4
|
|
Communications
|
|
2.6
|
|
1.9
|
|
Basic industrial
|
|
1.4
|
|
1.6
|
|
Consumer noncyclical
|
|
0.7
|
|
0.8
|
|
Consumer cyclical
|
|
1.6
|
|
1.7
|
|
Finance companies
|
|
1.2
|
|
1.7
|
|
Capital goods
|
|
1.1
|
|
1.2
|
|
Transportation
|
|
0.6
|
|
0.8
|
|
Other industrial
|
|
0.3
|
|
0.4
|
|
Brokerage
|
|
1.5
|
|
1.6
|
|
Technology
|
|
0.5
|
|
0.4
|
|
Real estate
|
|
0.0
|
|
0.1
|
|
Other utility
|
|
0.0
|
|
0.0
|
|
Commercial mortgage-backed securities
|
|
0.1
|
|
8.8
|
|
Other asset-backed securities
|
|
11.1
|
|
8.3
|
|
Residential mortgage-backed non-agency securities
|
|
47.8
|
|
40.7
|
|
Residential mortgage-backed agency securities
|
|
0.3
|
|
0.3
|
|
U.S. government-related securities
|
|
0.9
|
|
0.4
|
|
Other government-related securities
|
|
0.1
|
|
0.1
|
|
States, municipals, and political divisions
|
|
0.4
|
|
0.7
|
|
Total
|
|
100.0
|
%
|
100.0
|
%
|
The range of maturity
dates for securities in an unrealized loss position as of March 31, 2010,
varies, with 31.4% maturing in less than 5 years, 22.2% maturing between 5 and
10 years, and 46.4% maturing after 10 years. The following table shows the
credit rating of securities in an unrealized loss position as of March 31,
2010:
S&P
or Equivalent
|
|
Estimated
|
|
%
Market
|
|
Amortized
|
|
%
Amortized
|
|
Unrealized
|
|
%
Unrealized
|
|
Designation
|
|
Market
Value
|
|
Value
|
|
Cost
|
|
Cost
|
|
Loss
|
|
Loss
|
|
|
|
(Dollars In Thousands)
|
|
AAA/AA/A
|
|
$
|
3,331,378
|
|
41.9
|
%
|
$
|
3,454,741
|
|
39.9
|
%
|
$
|
(123,363
|
)
|
17.7
|
%
|
BBB
|
|
2,371,562
|
|
29.8
|
|
2,514,197
|
|
29.1
|
|
(142,635
|
)
|
20.4
|
|
Investment grade
|
|
5,702,940
|
|
71.7
|
|
5,968,938
|
|
69.0
|
|
(265,998
|
)
|
38.1
|
|
BB
|
|
703,790
|
|
8.8
|
|
776,888
|
|
9.0
|
|
(73,098
|
)
|
10.5
|
|
B
|
|
479,339
|
|
6.0
|
|
557,121
|
|
6.4
|
|
(77,782
|
)
|
11.1
|
|
CCC or lower
|
|
1,069,951
|
|
13.5
|
|
1,351,122
|
|
15.6
|
|
(281,171
|
)
|
40.3
|
|
Below investment grade
|
|
2,253,080
|
|
28.3
|
|
2,685,131
|
|
31.0
|
|
(432,051
|
)
|
61.9
|
|
Total
|
|
$
|
7,956,020
|
|
100.0
|
%
|
$
|
8,654,069
|
|
100.0
|
%
|
$
|
(698,049
|
)
|
100.0
|
%
|
As of March 31,
2010, we held 260 positions of below investment grade securities totaling $2.3
billion that were in an unrealized loss position. Total unrealized losses
related to below investment grade securities were $432.1 million, of which
$426.2 million had been in an unrealized loss position for more than twelve
months. Below investment grade securities in an unrealized loss position were
7.5% of invested assets. As of March 31, 2010,
securities in an unrealized loss position that were
rated as below investment grade represented 28.3% of the total market value and
61.9% of the total unrealized loss. We have the ability and intent to hold
these securities to maturity. After a review of each security and its expected
cash flows, we believe the decline in market value to be temporary. Total
unrealized losses for all securities in an unrealized loss position for more
than twelve months were $619.5 million. A widening of credit spreads is
estimated to account for unrealized losses of $773.9 million, with changes in
treasury rates offsetting this loss by an estimated $154.4 million
.
77
Table
of Contents
In addition,
market disruptions in the RMBS market negatively affected the market values of
our non-agency RMBS securities. The majority of our RMBS holdings as of March 31,
2010, were super senior or senior bonds in the capital structure. Our
non-agency portfolio has a weighted-average life of 2.59 years.
The following
table includes the fair value, amortized cost, unrealized loss, and total time
period that the security has been in an unrealized loss position for all below
investment grade securities as of March 31, 2010:
|
|
Fair
|
|
%
Fair
|
|
Amortized
|
|
%
Amortized
|
|
Unrealized
|
|
%
Unrealized
|
|
|
|
Value
|
|
Value
|
|
Cost
|
|
Cost
|
|
Loss
|
|
Loss
|
|
|
|
(Dollars In Thousands)
|
|
<= 90 days
|
|
$
|
88,653
|
|
3.9
|
%
|
$
|
89,675
|
|
3.3
|
%
|
$
|
(1,022
|
)
|
0.2
|
%
|
>90 days but <= 180 days
|
|
7,084
|
|
0.3
|
|
7,386
|
|
0.3
|
|
(302
|
)
|
0.1
|
|
>180 days but <= 270 days
|
|
22,168
|
|
1.0
|
|
26,447
|
|
1.0
|
|
(4,279
|
)
|
1.0
|
|
>270 days but <= 1 year
|
|
7,860
|
|
0.3
|
|
8,131
|
|
0.3
|
|
(271
|
)
|
0.1
|
|
>1 year but <= 2 years
|
|
458,161
|
|
20.3
|
|
548,180
|
|
20.4
|
|
(90,019
|
)
|
20.8
|
|
>2 years but <= 3 years
|
|
1,369,163
|
|
60.8
|
|
1,638,922
|
|
61.0
|
|
(269,759
|
)
|
62.4
|
|
>3 years but <= 4 years
|
|
95,773
|
|
4.3
|
|
121,964
|
|
4.5
|
|
(26,191
|
)
|
6.1
|
|
>4 years but <= 5 years
|
|
177,372
|
|
7.9
|
|
213,462
|
|
7.9
|
|
(36,090
|
)
|
8.4
|
|
>5 years
|
|
26,846
|
|
1.2
|
|
30,964
|
|
1.3
|
|
(4,118
|
)
|
0.9
|
|
Total
|
|
$
|
2,253,080
|
|
100.0
|
%
|
$
|
2,685,131
|
|
100.0
|
%
|
$
|
(432,051
|
)
|
100.0
|
%
|
LIQUIDITY
AND CAPITAL RESOURCES
2009
was a year of tremendous challenge in the financial services industry. The
banking and financial services industry continued to experience deterioration
and a significant amount of multiple notch ratings downgrades of securities
held as investments, including downgrades to below investment grade status. In
response to these events and to be prepared for potential policy and contract
holder surrenders and negative market perception, management made a strategic
decision to carry large amounts of cash and short-term investments during the
year. Carrying an elevated level of cash and short-term liquid assets, while significantly
reducing our liquidity risk, negatively impacts our earnings results as the
yield on such assets is much lower than the yields on longer-dated assets.
While we have made progress during the first quarter of 2010 in investing
portions of this high balance of cash and short-term liquid assets, we
continue to work towards reducing our cash and short-term investments to a more
normalized level.
Liquidity
Liquidity
refers to a companys ability to generate adequate amounts of cash to meet its
needs. We meet our liquidity requirements primarily through positive cash flows
from our operating subsidiaries. Primary sources of cash from the operating
subsidiaries are premiums, deposits for policyholder accounts, investment sales
and maturities, and investment income. Primary uses of cash for the operating
subsidiaries include benefit payments, withdrawals from policyholder accounts,
investment purchases, policy acquisition costs, and other operating expenses.
We believe that we have sufficient liquidity to fund our cash needs under
normal operating scenarios.
In the event of significant unanticipated cash
requirements beyond our normal liquidity requirements, we have additional
sources of liquidity available depending on market conditions and the amount
and timing of the liquidity need. These additional sources of liquidity include
cash flows from operations, the sale of liquid assets, accessing our credit
facility, and other sources described herein.
Our decision to sell investment assets could be impacted
by accounting rules, including rules relating to the likelihood of a
requirement to sell securities before recovery of our cost basis. Under
stressful market and economic conditions, liquidity may broadly deteriorate
which could negatively impact our ability to sell investment assets. If we
require on short notice significant amounts of cash in excess of normal
requirements, we may have difficulty selling investment assets in a timely
manner, be forced to sell them for less than we otherwise would have been able
to realize, or both.
While we anticipate that
the cash flows of our operating subsidiaries will be sufficient to meet our
investment commitments and operating cash needs in a normal credit market
environment, we recognize that investment commitments scheduled to be funded
may, from time to time, exceed the funds then available. Therefore, we have
established repurchase agreement programs for certain of our insurance
subsidiaries to provide liquidity when needed. We expect that the rate received
on our investments will equal or exceed our borrowing rate.
78
Table
of Contents
As of March 31,
2010, we had no outstanding balance related to such borrowings. During the
three months ended March 31, 2010, we had a maximum balance outstanding of
$300 million related to these programs. The average daily balance was $113.3
million, during the three months ended March 31, 2010.
Additionally, we may,
from time to time, sell short-duration stable value products to complement our
cash management practices. Depending on market conditions, we may also use
securitization transactions involving our commercial mortgage loans to increase
liquidity for the operating subsidiaries.
Credit
Facility
Under a revolving line of
credit arrangement, we have the ability to borrow on an unsecured basis up to
an aggregate principal amount of $500 million (the Credit Facility). We have
the right in certain circumstances to request that the commitment under the
Credit Facility be increased up to a maximum principal amount of $600 million.
Balances outstanding under the Credit Facility accrue interest at a rate equal
to (i) either the prime rate or the London Interbank Offered Rate
(LIBOR), plus (ii) a spread based on the ratings of our senior unsecured
long-term debt. The Credit Agreement provides that we are liable for the full
amount of any obligations for borrowings or letters of credit, including those
of PLICO, under the Credit Facility. The maturity date on the Credit Facility
is April 16, 2013. There was an outstanding balance of $260.0 million at
an interest rate of LIBOR plus 0.40% under the Credit Facility as of March 31,
2010. Of this amount, $180.0 million was used to purchase non-recourse funding
obligations issued by an indirect, wholly owned special-purpose financial
captive insurance company. For additional information related to special
purpose financial captives, see Capital Resources. We were not aware of any
non-compliance with the financial debt covenants of the Credit Facility as of March 31,
2010.
Sources
and Use of Cash
Our primary sources of
funding are dividends from our operating subsidiaries; revenues from
investment, data processing, legal, and management services rendered to
subsidiaries; investment income; and external financing. These sources of cash
support our general corporate needs including our common stock dividends and
debt service. The states in which our insurance subsidiaries are domiciled
impose certain restrictions on the insurance subsidiaries ability to pay us
dividends. These restrictions are based in part on the prior years statutory
income and surplus. Generally, these restrictions pose no short-term liquidity
concerns. We plan to retain substantial portions of the earnings of our
insurance subsidiaries in those companies primarily to support their future
growth.
During the second quarter
of 2008, we joined the Federal Home Loan Bank (FHLB) of Cincinnati. FHLB
advances provide an attractive funding source for short-term borrowing and for
the sale of funding agreements. Membership in the FHLB requires that we
purchase FHLB capital stock based on a minimum requirement and a percentage of
the dollar amount of advances outstanding. We held $58.9 million of common
stock as of March 31, 2010, which is included in equity securities. In
addition, our obligations under the advances must be collateralized. We
maintain control over any such pledged assets, including the right of
substitution. As of March 31, 2010, we had $751.0 million of funding
agreement-related advances and accrued interest outstanding under the FHLB
program.
As of March 31,
2010, we reported approximately $599.1 million (fair value) of Auction Rate
Securities (ARS), which were all rated AAA. While the auction rate market has
experienced liquidity constraints, we believe that based on our current
liquidity position and our operating cash flows, any lack of liquidity in the
ARS market will not have a material impact on our liquidity, financial
condition, or cash flows.
All
of the auction rate securities held by us as of December 31, 2009, were
student loan-backed auction rate securities, for which the underlying
collateral is at least 97% guaranteed by the Federal Family Education Loan
Program (FFELP). As there is no current active market for these auction rate
securities, we believe the best available source for current valuation
information is from actively-traded asset-backed securities with comparable
underlying assets (i.e. FFELP-backed student loans) and vintage.
We
use an internal valuation model to determine the fair value of our student
loan-backed auction rate securities. The model uses the discount margin and
projected average life of a comparable actively-traded FFELP student
loan-backed floating-rate asset-backed security, along with a discount related
to the current illiquidity of the auction rate securities. This comparable
security is selected based on its underlying assets (i.e. FFELP-backed student
loans) and vintage.
79
Table of Contents
The
auction rate securities are classified as a Level 3 valuation. An unrealized
loss of $58.3 million was recorded as of March 31, 2010, and an unrealized
loss of $45.0 million was recorded as of March 31, 2009, and we have not
recorded any other-than-temporary impairment because the underlying collateral
for each of the auction rate securities is at least 97% guaranteed by the FFELP
and there are subordinate tranches within each of these auction rate security
issuances that would support the senior tranches in the event of default. In
the event of a complete and total default by all underlying student loans, the
principal shortfall, in excess of the 97% FFELP guarantee, would be absorbed by
the subordinate tranches. Our non-performance exposure is to the FFELP
guarantee, not the underlying student loans. At this time, we have no reason to
believe that the U.S. Department of Education would not honor the FFELP
guarantee, if it were necessary. In addition, we have the ability and intent to
hold these securities until their values recover or maturity. Therefore, we
believe that no other-than-temporary impairment has been experienced.
The liquidity
requirements of our regulated insurance subsidiaries primarily relate to the
liabilities associated with their various insurance and investment products,
operating expenses, and income taxes. Liabilities arising from insurance and
investment products include the payment of policyholder benefits, as well as
cash payments in connection with policy surrenders and withdrawals, policy
loans, and obligations to redeem funding agreements.
Our insurance
subsidiaries have used cash flows from operations and investment activities as
a primary source to fund their liquidity requirements. Our insurance
subsidiaries primary cash inflows from operating activities are derived from
premiums, annuity deposits, stable value contract deposits, and insurance and
investment product fees and other income, including cost of insurance and
surrender charges, contract underwriting fees, and intercompany dividends or
distributions. The principal cash inflows from investment activities result
from repayments of principal, investment income, and as necessary, sales of
invested assets.
Our insurance
subsidiaries maintain investment strategies intended to provide adequate funds
to pay benefits and expected surrenders, withdrawals, loans, and redemption
obligations without forced sales of investments. In addition, our insurance
subsidiaries hold highly liquid, high-quality short-term investment securities
and other liquid investment grade fixed maturity securities to fund our
expected operating expenses, surrenders, and withdrawals. As of March 31,
2010, our total cash, cash equivalents, and invested assets were $30.2 billion.
The life insurance subsidiaries were committed as of March 31, 2010, to
fund mortgage loans in the amount of $247.3 million.
Our positive cash flows
from operations are used to fund an investment portfolio that provides for
future benefit payments. We employ a formal asset/liability program to manage
the cash flows of our investment portfolio relative to our long-term benefit
obligations.
In response to the
volatility and disruption in the credit markets, we have maintained a high
balance of cash and short-term investments to provide liquidity for cash
outflows projected for the coming months. Our subsidiaries held approximately
$782.3 million in cash and short-term investments as of March 31,
2010, and we held an additional $9.2 million in cash and short-term
investments available for general corporate purposes.
80
Table of Contents
The following chart includes the cash flows provided
by or used in operating, investing, and financing activities for the following
periods
:
|
|
For
The
|
|
|
|
Three
Months Ended
|
|
|
|
March 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
(Dollars In Thousands)
|
|
|
|
|
|
|
|
Net cash provided by operating activities
|
|
$
|
385,382
|
|
$
|
207,868
|
|
Net cash (used in) provided by investing activities
|
|
(335,586
|
)
|
488,561
|
|
Net cash used in financing activites
|
|
(52,187
|
)
|
(665,139
|
)
|
Total
|
|
$
|
(2,391
|
)
|
$
|
31,290
|
|
For The Three Months Ended March 31,
2010 compared to The Three Months Ended March 31, 2009
Net cash provided by operating
activities
-
Cash flows from operating activities are affected by the
timing of premiums received, fees received, investment income, and expenses
paid. Principal sources of cash include sales of our products and services. As
an insurance business, we typically generate positive cash flows from operating
activities, as premiums and deposits collected from our insurance and
investment products exceed benefits paid and redemptions, and we invest the
excess. Accordingly, in analyzing our cash flows we focus on the change in the
amount of cash available and used in investing activities.
Net
cash (used in) provided by investing activities
-
Changes in
cash from investing activities primarily related to the activity in our
investment portfolio
.
The change in
net cash (used in) provided by investing activities was primarily due to investing
amounts that were previously being held for liquidity purposes, as well as
portfolio rebalancing activities.
Net cash used in financing
activities
-
Changes in cash from financing activities primarily relate
to the issuance and repayment of borrowings, dividends to our stockholders, and
other capital transactions, as well as the issuance of, and redemptions and
benefit payments on, investment contracts. The variance for three months ended March 31,
2010 compared to the three months ended March 31, 2009, was primarily the
result of investment product and universal life withdrawal activity, as well as
fluctuations in line of credit balances.
Capital
Resources
To give us flexibility in connection with future
acquisitions and other funding needs, we have debt securities, preferred and
common stock, and additional preferred securities of special purpose finance
subsidiaries registered under the Securities Act of 1933 on a delayed (or
shelf) basis.
As of March 31, 2010, our capital structure consisted
of Medium-Term Notes, Senior Notes, Subordinated Debentures, and shareowners
equity. We also have a $500 million revolving line of credit (the Credit
Facility), under which we could borrow funds with balances due April 16,
2013. The line of credit arrangement contains, among other provisions,
requirements for maintaining certain financial ratios and restrictions on the
indebtedness that we and our subsidiaries can incur. Additionally, the line of
credit arrangement precludes us, on a consolidated basis, from incurring debt
in excess of 40% of our total capital. Pursuant to an amendment, this
calculation excludes the $800.0 million of senior notes we issued in 2009. As
of March 31, 2010, there was a $260.0 million outstanding balance under
the Credit Facility at an interest rate of LIBOR plus 0.40%. Of this amount,
$180.0 million was utilized to purchase non-recourse funding obligations issued
by Golden Gate Captive Insurance Company (Golden Gate), an indirect wholly
owned special-purpose financial captive insurance company. As discussed in Note
16,
Subsequent Events
, subsequent to March 31,
2010, Golden Gate redeemed $180 million of Series B Surplus Notes held by
Protective Life Corporation (PLC). PLC used the proceeds of this
redemption to repay $180 million of the outstanding balance on the Credit
Facility, resulting in an outstanding balance of $80 million under the Credit
Facility on such date. As the need arises, we may utilize the Credit Facility
to fund reserve financing in future periods.
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Table of Contents
Golden Gate II
Captive Insurance Company (Golden Gate II), a special-purpose
financial captive insurance company wholly owned by PLICO, had
$575.0 million of non-recourse funding obligations outstanding as of March 31,
2010. These non-recourse funding obligations mature in 2052. We do not
anticipate having to pursue additional funding related to this block of business;
however, we have contingent approval to issue an additional $100 million
of obligations if necessary. $275 million of this amount is currently accruing
interest at a rate of LIBOR plus 30 basis points. We have experienced higher
proportional borrowing costs associated with $300 million of our non-recourse
funding obligations supporting the business reinsured to Golden Gate II. These
higher costs are the result of a higher spread component interest costs
associated with the illiquidity of the current market for auction rate
securities, as well as a rating downgrade of our guarantor by certain rating
agencies. The current rate associated with these obligations is LIBOR plus 200
basis points, which is the maximum rate we can be required to pay under these
obligations.
These non-recourse
funding obligations are direct financial obligations of Golden Gate II and are
not guaranteed by us or PLICO. These non-recourse obligations are represented
by surplus notes that were issued to fund a portion of the statutory reserves
required by Regulation XXX. Under the terms of the surplus notes, the
holders of the surplus notes cannot require repayment from us or any of our
subsidiaries, other than Golden Gate II, the direct issuers of the surplus
notes, although we have agreed to indemnify Golden Gate II for certain
costs and obligations (which obligations do not include payment of principal
and interest on the surplus notes). In addition, we have entered into certain
support agreements with Golden Gate II obligating us to make capital
contributions or provide support related to certain of Golden Gate IIs
expenses and in certain circumstances, to collateralize certain of our
obligations to Golden Gate II.
On May
7,
2007, our Board of Directors extended our
previously authorized $100 million share repurchase program. The current
authorization extends through May 6, 2010. In light of recent credit
market disruption, extraordinary events and developments affecting financial
markets, and a specific focus on capital preservation and liquidity, we have
not repurchased any of our common stock under the existing share repurchase
program during the first quarter of 2010. Future activity will be dependent
upon many factors, including capital levels, liquidity needs, rating agency
expectations, and the relative attractiveness of alternative uses for capital.
A life insurance
companys statutory capital is computed according to rules prescribed by
NAIC, as modified by state law. Generally speaking, other states in which a
company does business defer to the interpretation of the domiciliary state with
respect to NAIC rules, unless inconsistent with the other states regulations.
Statutory accounting rules are different from GAAP and are intended to
reflect a more conservative view, for example, requiring immediate expensing of
policy acquisition costs. The NAICs risk-based capital requirements require
insurance companies to calculate and report information under a risk-based
capital formula. The achievement of long-term growth will require growth in the
statutory capital of our insurance subsidiaries. The subsidiaries may secure
additional statutory capital through various sources, such as retained
statutory earnings or our equity contributions. In general, dividends up to
specified levels are considered ordinary and may be paid thirty days after
written notice to the insurance commissioner of the state of domicile unless
such commissioner objects to the dividend prior to the expiration of such
period. Dividends in larger amounts are considered
extraordinary and are subject to affirmative prior approval by such
commissioner. The maximum amount that
would qualify as ordinary dividends to us from our insurance subsidiaries in
2010 is estimated to be $704.8 million.
State insurance regulators
and the NAIC have adopted risk-based capital (RBC) requirements for life
insurance companies to evaluate the adequacy of statutory capital and surplus
in relation to investment and insurance risks. The requirements provide a means
of measuring the minimum amount of statutory surplus appropriate for an
insurance company to support its overall business operations based on its size
and risk profile.
A companys risk-based
statutory surplus is calculated by applying factors and performing calculations
relating to various asset, premium, claim, expense, and reserve items.
Regulators can then measure the adequacy of a companys statutory surplus by
comparing it to the RBC. Under RBC requirements, regulatory compliance is
determined by the ratio of a companys total adjusted capital, as defined by
the insurance regulators, to its company action level of RBC (known as the RBC
ratio), also as defined by insurance regulators.
We cede material amounts
of insurance and transfer related assets to other insurance companies through
reinsurance. However, notwithstanding the transfer of related assets, we remain
liable with respect to ceded insurance should any reinsurer fail to meet the
obligations that such reinsurer assumed. We evaluate the financial condition of
our reinsurers and monitor the associated concentration of credit risk. For the
three months ended March 31, 2010, we ceded premiums to third-party
reinsurers amounting to $305.8 million. In addition, we had
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Table
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receivables from
reinsurers amounting to $5.4 billion as of March 31, 2010. We review
reinsurance receivable amounts for collectability and establish bad debt
reserves if deemed appropriate.
During 2008, Scottish Re
US (SRUS) received a statutory accounting permitted practice from the
Delaware Department of Insurance (the Department) that, in light of decreases
in the fair value of the securities in SRUSs qualifying reserve credit trust
accounts on business ceded to certain securitization companies, relieved SRUS
of the need to receive additional capital contributions. On January 5,
2009, the Department issued an order of supervision (the Order of Supervision)
against SRUS, in accordance with Delaware law, which, among other things,
requires the Departments consent to any transaction outside the ordinary
course of business, and which, in large part, formalized certain reporting and
processes already informally in place between SRUS and the Department. On April 3,
2009, the Department issued an Extended and Amended Order of Supervision
against SRUS which, among other things, clarified that payments made by SRUS to
its ceding insurers in satisfaction of claims or other obligations are not
subject to the Departments approval, but that any amendments to its
reinsurance agreements must be disclosed to and approved by the Department.
SRUS continues to promptly pay claims and satisfy its other obligations to our
insurance subsidiaries. We cannot predict what these or other changes in the
status of SRUSs financial condition may have on our ability to take reserve
credit for the business ceded to SRUS. If we were unable to take reserve credit
for the business ceded to SRUS, it could have a material adverse impact on both
our GAAP and statutory financial condition and results of operations. As of March 31,
2010, we had approximately $185.8 million of GAAP recoverables from SRUS, and
$503.3 million of ceded statutory reserves related to SRUS.
Ratings
Various Nationally Recognized Statistical Rating
Organizations (rating organizations) review the financial performance and
condition of insurers, including our insurance subsidiaries, and publish their
financial strength ratings as indicators of an insurers ability to meet
policyholder and contract holder obligations. These ratings are important to
maintaining public confidence in an insurers products, its ability to market
its products and its competitive position. Rating organizations also publish
credit ratings for the issuers of debt securities, including the Company.
Credit ratings are indicators of a debt issuers ability to meet the terms of
debt obligations in a timely manner. These ratings are important in the debt
issuers overall ability to access credit markets and other types of liquidity.
Ratings are not recommendations to buy our securities. The following table
summarizes the ratings of our significant member companies from the major
independent rating organizations as of March 31, 2010:
|
|
|
|
|
|
Standard &
|
|
|
|
Ratings
|
|
A.M. Best
|
|
Fitch
|
|
Poors
|
|
Moodys
|
|
|
|
|
|
|
|
|
|
|
|
Insurance companies financial strength ratings:
|
|
|
|
|
|
|
|
|
|
Protective Life Insurance Company
|
|
A+
|
|
A
|
|
AA-
|
|
A2
|
|
West Coast Life Insurance Company
|
|
A+
|
|
A
|
|
AA-
|
|
A2
|
|
Protective Life and Annuity Insurance Company
|
|
A+
|
|
A
|
|
AA-
|
|
|
|
Lyndon Property Insurance Company
|
|
A-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other ratings:
|
|
|
|
|
|
|
|
|
|
Issuer Credit/Default Rating - Protective Life
Corporation
|
|
a-
|
|
BBB+
|
|
A-
|
|
|
|
Senior Debt Rating - Protective Life Corporation
|
|
|
|
BBB
|
|
|
|
Baa2
|
|
Issuer Credit/Default Rating - Protective Life Ins.
Co.
|
|
aa-
|
|
|
|
AA-
|
|
|
|
Our ratings are subject
to review and change by the rating organizations at any time and without
notice. A downgrade or other negative action by a ratings organization with
respect to the financial strength ratings of our insurance subsidiaries could
adversely affect sales, relationships with distributors, the level of policy
surrenders and withdrawals, competitive position in the marketplace, and the
cost or availability of reinsurance. A downgrade or other negative action by a
ratings organization with respect to our credit rating could limit our access
to capital markets, increase the cost of issuing debt, and a downgrade of
sufficient magnitude, combined with other negative factors, could require us to
post collateral.
LIABILITIES
Many of our products
contain surrender charges and other features that are designed to reward
persistency and penalize the early withdrawal of funds. Certain stable value
and annuity contracts have market-value adjustments that are designed to
protect us against investment losses if interest rates are higher at the time
of surrender than at the time of issue.
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Table of Contents
As of March 31, 2010,
we had policy liabilities and accruals of approximately $18.7 billion. Our
interest-sensitive life insurance policies have a weighted-average minimum
credited interest rate of approximately 3.71%.
Contractual Obligations
The table below sets forth future maturities of debt,
non-recourse funding obligations, subordinated debt securities, stable value
products, notes payable, operating lease obligations, other property lease
obligations, mortgage loan commitments, and policyholder obligations.
We enter into various
obligations to third parties in the ordinary course of our operations. However,
we do not believe that our cash flow requirements can be assessed based upon an
analysis of these obligations. The most significant factor affecting our future
cash flows is our ability to earn and collect cash from our customers. Future
cash outflows, whether they are contractual obligations or not, will also vary
based upon our future needs. Although some outflows are fixed, others depend on
future events. Examples of fixed obligations include our obligations to pay
principal and interest on fixed-rate borrowings. Examples of obligations that
will vary include obligations to pay interest on variable-rate borrowings and
insurance liabilities that depend on future interest rates, market performance,
or surrender provisions. Many of our obligations are linked to cash-generating
contracts. In addition, our operations involve significant expenditures that
are not based upon commitments. These include expenditures for income taxes and
payroll.
As of March 31, 2010, we carried a
$21.4 million liability for uncertain tax positions, including interest on
unrecognized tax benefits. These amounts are not included in the long-term
contractual obligations table because of the difficulty in making reasonably
reliable estimates of the occurrence or timing of cash settlements with the
respective taxing authorities.
|
|
|
|
Payments
due by period
|
|
|
|
|
|
Less
than
|
|
|
|
|
|
More
than
|
|
|
|
Total
|
|
1
year
|
|
1-3
years
|
|
3-5
years
|
|
5
years
|
|
|
|
(Dollars In Thousands)
|
|
Long-term debt
(1)
|
|
$
|
2,936,684
|
|
$
|
92,810
|
|
$
|
194,249
|
|
$
|
843,400
|
|
$
|
1,806,225
|
|
Non-recourse funding obligations
(2)
|
|
924,499
|
|
8,207
|
|
16,415
|
|
16,415
|
|
883,462
|
|
Subordinated debt securities
(3)
|
|
1,856,016
|
|
37,147
|
|
74,294
|
|
74,294
|
|
1,670,281
|
|
Stable value products
(4)
|
|
3,953,108
|
|
1,156,529
|
|
1,472,434
|
|
726,164
|
|
597,981
|
|
Operating leases
(5)
|
|
33,091
|
|
6,925
|
|
11,541
|
|
9,314
|
|
5,311
|
|
Home office lease
(6)
|
|
77,667
|
|
712
|
|
1,415
|
|
75,540
|
|
|
|
Mortgage loan commitments
|
|
247,271
|
|
247,271
|
|
|
|
|
|
|
|
Policyholder obligations
(7)
|
|
24,202,528
|
|
2,320,007
|
|
3,364,115
|
|
3,040,951
|
|
15,477,455
|
|
Total
(8)
|
|
$
|
34,230,864
|
|
$
|
3,869,608
|
|
$
|
5,134,463
|
|
$
|
4,786,078
|
|
$
|
20,440,715
|
|
(1)
|
Long-term
debt includes all principal amounts owed on note agreements and expected
interest payments due over the term of the notes.
|
(2)
|
Non-recourse
funding obligations include all principal amounts owed on note agreements and
expected interest payments due over the term of the notes.
|
(3)
|
Subordinated
debt securities includes all principal amounts owed to our non-consolidated
special purpose finance subsidiaries and interest payments due over the term
of the obligations.
|
(4)
|
Anticipated
stable value products cash flows including interest.
|
(5)
|
Includes
all lease payments required under operating lease agreements.
|
(6)
|
The
lease payments shown assume we exercise our option to purchase the building
at the end of the lease term. Additionally, the payments due by the periods
above were computed based on the terms of the renegotiated lease agreement,
which was entered in January 2007.
|
(7)
|
Estimated
contractual policyholder obligations are based on mortality, morbidity, and
lapse assumptions comparable to our historical experience, modified for
recent observed trends. These obligations are based on current balance sheet
values and include expected interest crediting, but do not incorporate an
expectation of future market growth, or future deposits. Due to the
significance of the assumptions used, the amounts presented could materially
differ from actual results. As variable separate account obligations are
legally insulated from general account obligations, the variable separate account
obligations will be fully funded by cash flows from variable separate account
assets. We expect to fully fund the general account obligations from cash
flows from general account investments.
|
(8)
|
This
total does not take into account estimated payments related to our qualified
or unfunded excess benefit plans in future periods.
|
84
Table of
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FAIR VALUE OF FINANCIAL INSTRUMENTS
On January 1, 2008,
we adopted FASB guidance on fair value measurements and disclosures. This
guidance defines fair value for GAAP and establishes a framework for measuring
fair value as well as a fair value hierarchy based on the quality of inputs
used to measure fair value and enhances disclosure requirements for fair value
measurements. The term fair value in this document is defined in accordance
with GAAP. The standard describes three
levels of inputs that may be used to measure fair value. For more information,
see Note 1
, Basis of Presentation
and Note 13,
Fair Value of Financial Instruments.
Available-for-sale
securities and trading account securities are recorded at fair value, which is
primarily based on actively-traded markets where prices are based on either
direct market quotes or observed transactions. Liquidity is a significant
factor in the determination of the fair value for these securities. Market
price quotes may not be readily available for some positions or for some positions
within a market sector where trading activity has slowed significantly or
ceased. These situations are generally triggered by the markets perception of
credit uncertainty regarding a single company or a specific market sector. In
these instances, fair value is determined based on limited available market
information and other factors, principally from reviewing the issuers
financial position, changes in credit ratings, and cash flows on the
investments. As of March 31, 2010, $863.4 million of available-for-sale
and trading account assets, excluding other long-term investments, were
classified as Level 3 fair value assets.
The
fair values of derivative assets and liabilities include adjustments for market
liquidity, counterparty credit quality, and other deal specific factors, where
appropriate. The fair values of derivative assets and liabilities traded in the
over-the-counter market are determined using quantitative models that require
the use of multiple market inputs including interest rates, prices, and indices
to generate continuous yield or pricing curves and volatility factors, which
are used to value the position. The predominance of market inputs are actively
quoted and can be validated through external sources. Estimation risk is
greater for derivative asset and liability positions that are either
option-based or have longer maturity dates where observable market inputs are
less readily available or are unobservable, in which case quantitative based
extrapolations of rate, price, or index scenarios are used in determining fair
values. As of March 31, 2010, the Level 3 fair values of derivative assets
and liabilities determined by these quantitative models were $17.0 million and
$128.2 million, respectively.
The
liabilities of certain of our annuity account balances are calculated at fair
value using actuarial valuation models. These models use various observable and
unobservable inputs including projected future cash flows, policyholder
behavior, our credit rating, and other market conditions. As of March 31,
2010, the Level 3 fair value of these liabilities was $150.6 million.
For securities that are
priced via non-binding independent broker quotations, we assess whether prices
received from independent brokers represent a reasonable estimate of fair value
through an analysis using internal and external cash flow models developed
based on spreads and, when available, market indices. We use a market-based
cash flow analysis to validate the reasonableness prices received from
independent brokers. These analytics, which are updated daily, incorporate
various metrics (yield curves, credit spreads, prepayment rates, etc.) to
determine the valuation of such holdings. As a result of this analysis, if we
determine there is a more appropriate fair value based upon the analytics, the
price received from the independent broker is adjusted accordingly.
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Table of
Contents
Of our $880.4 million of
total assets (measured at fair value on a recurring basis) classified as Level
3 assets, $651.2 million were ABS. Of this amount, $610.1 million were student
loan related ABS, $37.5 million were non-student loan related ABS, and $3.6
million were other mortgage-backed securities. The years of issuance of the ABS
are as follows:
Year
of Issuance
|
|
Amount
|
|
|
|
(In Millions)
|
|
|
|
|
|
2002
|
|
$
|
298
|
|
2003
|
|
110
|
|
2004
|
|
114
|
|
2005
|
|
16
|
|
2006
|
|
30
|
|
2007
|
|
83
|
|
Total
|
|
$
|
651
|
|
The ABS was rated as
follows: $618.3 million were AAA rated, $26.0 million were AA rated, and $6.9
million were A rated. We do not expect any downgrade in the ratings of the
securities related to student loans since the underlying collateral of the
student loan asset-backed securities is guaranteed by the U.S. Department of
Education.
MARKET
RISK EXPOSURES AND OFF-BALANCE SHEET ARRANGEMENTS
Our financial position and earnings are subject to
various market risks including changes in interest rates, changes in the yield
curve, changes in spreads between risk-adjusted and risk-free interest rates,
changes in foreign currency rates, changes in used vehicle prices, and equity
price risks and issuer defaults. We analyze and manage the risks arising from
market exposures of
financial
instruments, as well as other risks, through an
integrated asset/liability management process. Our asset/liability management
programs and procedures involve the monitoring of asset and liability durations
for various product lines; cash flow testing under various interest rate
scenarios; and the continuous rebalancing of assets and liabilities with
respect to yield, risk, and cash flow characteristics. These programs also
incorporate the use of derivative financial instruments primarily to reduce our
exposure to interest rate risk, inflation risk, currency exchange risk, and
equity market risk.
The primary focus of our
asset/liability program is the management of interest rate risk within the
insurance operations. This includes monitoring the duration of both investments
and insurance liabilities to maintain an appropriate balance between risk and
profitability for each product category, and for us as a whole. It is our
policy to maintain asset and liability durations within one-half year of one
another, although, from time to time, a broader interval may be allowed.
We
are exposed to credit risk within our investment portfolio and through
derivative counterparties. Credit risk relates to the uncertainty of an
obligors continued ability to make timely payments in accordance with the
contractual terms of the instrument or contract. We manage credit risk through
established investment policies which attempt to address quality of obligors
and counterparties, credit concentration limits, diversification requirements, and
acceptable risk levels under expected and stressed scenarios. Derivative
counterparty credit risk is measured as the amount owed to us based upon
current market conditions and potential payment obligations between us and our
counterparties. We minimize the credit risk in derivative instruments by
entering into transactions with high quality counterparties, (A-rated or higher
at the time we enter into the contract) and we typically maintain collateral
support agreements with those counterparties.
Derivative instruments
that are used as part of our interest rate risk management strategy include
interest rate swaps, interest rate futures, interest rate options, and interest
rate swaptions. Our inflation risk management strategy involves the use of
swaps that require us to pay a fixed rate and receive a floating rate that is
based on changes in the Consumer Price Index (CPI). We use foreign
currency swaps to manage our exposure to changes in the value of foreign
currency denominated stable value contracts. No foreign currency swaps remain
outstanding. We also use S&P 500® options to mitigate our exposure to
the value of equity indexed annuity contracts.
We have sold credit
default protection on liquid traded indices to enhance the return on our
investment portfolio. These credit default swaps create credit exposure similar
to an investment in publicly-issued fixed maturity cash investments.
Outstanding credit default swaps related to the Investment Grade Series 9
Index and have terms to December 2017. Defaults within the Investment
Grade Series 9 Index that exceeded the 10% attachment
86
Table
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point would require us to
perform under the credit default swaps, up to the 15% exhaustion point. The
maximum potential amount of future payments (undiscounted) that we could be
required to make under the credit derivatives is $25.0 million. As of March 31,
2010, the fair value of the credit derivatives was a liability of $1.7 million.
As a result of the
ongoing disruption in the credit markets, the fair value of these derivatives
is expected to fluctuate in response to changing market conditions. We believe
that the unrealized loss recorded on the $25.0 million notional of credit
default swaps is not indicative of the economic value of the investment. We
expect the unrealized loss to reverse over the remaining life of the credit
default swap portfolio.
Derivative
instruments expose us to credit and market risk and could result in material
changes from quarter-to-quarter. We minimize our credit risk by entering into
transactions with highly rated counterparties. We manage the market risk
associated with interest rate and foreign exchange contracts by establishing
and monitoring limits as to the types and degrees of risk that may be
undertaken. We monitor our use of derivatives in connection with our overall
asset/liability management programs and procedures.
In the ordinary course of
our commercial mortgage lending operations, we will commit to provide a
mortgage loan before the property to be mortgaged has been built or acquired.
The mortgage loan commitment is a contractual obligation to fund a mortgage
loan when called upon by the borrower. The commitment is not recognized in our
financial statements until the commitment is actually funded. The mortgage loan
commitment contains terms, including the rate of interest, which may be
different than prevailing interest rates. As of March 31, 2010, we had
outstanding mortgage loan commitments of $247.3 million at an average rate of
6.31%.
We believe our
asset/liability management programs and procedures and certain product features
provide protection against the effects of changes in interest rates under
various scenarios. Additionally, we believe our asset/liability
management
programs and procedures provide
sufficient liquidity to enable us to fulfill our obligation to pay benefits
under our various insurance and deposit contracts. However, our asset/liability
management programs and procedures incorporate assumptions about the
relationship between short-term and long-term interest rates (i.e., the
slope of the yield curve), relationships between risk-adjusted and risk-free
interest rates, market liquidity, spread movements and other factors, and the
effectiveness of our asset/liability management programs and procedures may be
negatively affected whenever actual results differ from those assumptions.
RECENTLY
ISSUED ACCOUNTING STANDARDS
See
Note 2,
Summary of Significant Accounting Policies
, t
o the
consolidated condensed financial statements for information regarding recently
issued accounting standards.
RECENT
DEVELOPMENTS
In 2009, the NAIC
approved regulatory changes that impacted our insurance subsidiaries and their
competitors. The NAIC approved an initiative to create a new modeling and
assessment process for non-agency residential mortgage-backed securities for
calendar year 2009. The NAICs Valuation of Securities Task Force
indicated that this modeling and assessment process would continue for future
periods until a more comprehensive solution for the valuation of all
loan-backed and structured securities is fully developed and implemented. The
NAIC also approved changes to the measurements used to determine the amount of
deferred tax assets (DTAs) an insurance company may claim as admitted assets
on its statutory financial statements. These changes are predicted to have the
effect of increasing the amount of DTAs an insurance company may claim as an
admitted asset for purposes of insurance company statutory financial statements
filed for calendar years 2009 and 2010. In addition, the NAIC has adopted a
temporary modification to the Mortgage Experience Adjustment Factor for
calendar year 2009 that will reduce the factors volatility, and is currently
working on a permanent modification. However, the NAIC is also considering
proposed changes to the capital factors to be applied to commercial mortgages
held by insurance companies, including the Companys insurance subsidiaries.
Such changes, if adopted as proposed, could result in our insurance
subsidiaries being required to hold additional capital in support of their
respective commercial mortgage portfolios. The NAIC also adopted
modifications to the model regulation permitting the recognition of the
preferred mortality table and amendments to the model regulation regarding the
valuation of life insurance policies. In some states, changes to state
regulation will be required to implement these NAIC amendments to model
regulations.
The
NAIC has also adopted a revised version of its Model Standard Valuation Law
(the SVL) that would implement a new principles-based reserving method to
life insurance and annuity reserves. The SVL will need to be
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enacted
by state legislatures and a reserving valuation manual will need to be
completed before principles-based reserving will be in effect. We cannot
provide any assurance as to what impact the adopting of principles-based reserving,
if it occurs, will have on our reserve requirements.
IMPACT OF INFLATION
Inflation increases the
need for life insurance. Many policyholders who once had adequate insurance
programs may increase their life insurance coverage to provide the same relative
financial benefit and protection. Higher interest rates may result in higher
sales of certain of our investment products.
The higher interest rates
that have traditionally accompanied inflation could also affect our operations.
Policy loans increase as policy loan interest rates become relatively more
attractive. As interest rates increase, disintermediation of stable value and
annuity account balances and individual life policy cash values may increase.
The market value of our fixed-rate, long-term investments may decrease, we may
be unable to implement fully the interest rate reset and call provisions of our
mortgage loans, and our ability to make attractive mortgage loans, including
participating mortgage loans, may decrease. In addition, participating mortgage
loan income may decrease. The difference between the interest rate earned on
investments and the interest rate credited to life insurance and investment
products may also be adversely affected by rising interest rates.
Item 3.
Quantitative
and Qualitative Disclosures about Market Risk
See
Part I, Item 2,
Managements Discussion
and Analysis of Financial Condition and Results of Operations
, Executive
Summary and Liquidity and Capital Resources, and Part II, Item 1A,
Risk Factors
of this Report for market risk disclosures in
light of the current difficult conditions in the financial and credit markets,
and the economy generally.
Item 4. Controls
and Procedures
(a) Disclosure controls
and procedures
In order to ensure that
the information the Company must disclose in its filings with the Securities
and Exchange Commission is recorded, processed, summarized and reported on a
timely basis, the Companys management, with the participation of its Chief
Executive Officer and Chief Financial Officer, evaluated the effectiveness of
the design and operation of its disclosure controls and procedures (as such
term is defined in Rules 13a-15(e) and 15d- 15(e) under the
Securities Exchange Act of 1934, as amended (the Exchange Act)). Based on
their evaluation as of the end of the period covered by this Form 10-Q,
the Companys Chief Executive Officer and Chief Financial Officer have
concluded that the Companys disclosure controls and procedures were effective.
It should be noted that any system of controls, no matter how well designed and
operated, can provide only reasonable, not absolute, assurance that the control
systems objectives will be met. Further, the design of any control system is
based in part upon certain judgments, including the costs and benefits of
controls and the likelihood of future events. Because of these and other
inherent limitations of control systems, no evaluation of controls can provide
absolute assurance that all control issues, if any, within the Company have
been detected
.
(b) Changes in internal
control over financial reporting
There have been no changes in the Companys internal
control over financial reporting during the period ended March 31, 2010,
that have materially affected, or are reasonably likely to materially affect,
the Companys internal control over financial reporting. The Companys internal
controls exist within a dynamic environment and the Company continually strives
to improve its internal controls and procedures to enhance the quality of its
financial reporting.
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PART II
Item 1A.
Risk Factors and Cautionary Factors that may Affect Future Results
The operating results of
companies in the insurance industry have historically been subject to
significant fluctuations. The factors which could affect the Companys future
results include, but are not limited to, general economic conditions and known
trends and uncertainties. In addition to other information set forth in this
report, you should carefully consider the factors discussed in Part I,
Item 1A,
Risk Factors and Cautionary Factors that may Affect
Future Results
in the Companys Annual Report on Form 10-K for
the year ended December 31, 2009, which could materially affect the
Companys business, financial condition, or future results of operations.
Insurance companies are highly regulated and subject to
numerous legal restrictions and regulations.
The Company and its
subsidiaries are subject to government regulation in each of the states in
which they conduct business. Such regulation is vested in state agencies having
broad administrative and in some instances discretionary power dealing with
many aspects of the Companys business, which may include, among other things,
premium rates and increases thereto, underwriting practices, reserve
requirements, marketing practices, advertising, privacy, policy forms,
reinsurance reserve requirements, acquisitions, mergers, and capital adequacy,
and is concerned primarily with the protection of policyholders and other
customers rather than shareowners. In addition, some state insurance
departments may enact rules or regulations with extra-territorial
application, effectively extending their jurisdiction to areas such as
permitted insurance company investments that are normally the province of an
insurance companys domiciliary state regulator. At any given time, a
number of financial and/or market conduct examinations of the Companys
subsidiaries may be ongoing. From time to time, regulators raise issues during
examinations or audits of the Companys subsidiaries that could, if determined
adverse, have a material impact on the Company. The Companys insurance
subsidiaries are required to obtain state regulatory approval for rate
increases for certain health insurance products, and the Companys profits may
be adversely affected if the requested rate increases are not approved in full
by regulators in a timely fashion.
Under insurance guaranty
fund laws in most states, insurance companies doing business therein can be
assessed up to prescribed limits for policyholder losses incurred by insolvent
companies. The Company cannot predict the amount or timing of any future assessments.
The purchase of life
insurance products is limited by state insurable interest laws, which in most
jurisdictions require that the purchaser of life insurance name a beneficiary
that has some interest in the sustained life of the insured. To some extent,
the insurable interest laws present a barrier to the life settlement, or stranger-owned
industry, in which a financial entity acquires an interest in life insurance
proceeds, and efforts have been made in some states to liberalize the insurable
interest laws. To the extent these laws are relaxed, the Companys lapse
assumptions may prove to be incorrect.
Although the Company and
its subsidiaries are subject to state regulation, in many instances the state
regulatory models emanate from the National Association of Insurance
Commissioners (NAIC). State insurance regulators and the NAIC regularly
re-examine existing laws and regulations applicable to insurance companies and
their products. Changes in these laws and regulations, or in interpretations
thereof, are often made for the benefit of the consumer and at the expense of
the insurer and, thus, could have a material adverse effect on the Companys
financial condition and results of operations. The Company is also subject to
the risk that compliance with any particular regulators interpretation of a
legal or accounting issue may not result in compliance with another regulators
interpretation of the same issue, particularly when compliance is judged in
hindsight. There is an additional risk that any particular regulators
interpretation of a legal or accounting issue may change over time to the
Companys detriment, or that changes to the overall legal or market
environment, even absent any change of interpretation by a particular
regulator, may cause the Company to change its views regarding the actions it
needs to take from a legal risk management perspective, which could necessitate
changes to the Companys practices that may, in some cases, limit its ability
to grow and improve profitability.
Some of the NAIC
pronouncements, particularly as they affect accounting issues, take effect
automatically in the various states without affirmative action by the states.
Statutes, regulations, and interpretations may be applied with retroactive
impact, particularly in areas such as accounting and reserve requirements.
Also, regulatory actions with prospective impact can potentially have a
significant impact on currently sold products. As an example of both
retroactive and prospective impacts, in late 2005, the NAIC approved an
amendment to Actuarial Guideline 38
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Table of Contents
(AG38), commonly known
as AXXX, which interprets the reserve requirements for universal life insurance
with
secondary
guarantees. This amendment retroactively increased the reserve requirements for
universal life insurance with secondary guarantee products issued after July 1,
2005. This change to AG38 also affected the profitability of universal life
products sold after the adoption date. The NAIC is continuing to study
reserving methodology and has issued additional changes to AXXX and
Regulation XXX, which have had the effect of modestly decreasing the reserves
required for certain traditional and universal life policies that were issued
on January 1, 2007 and later. In addition, accounting and actuarial groups
within the NAIC have studied whether to change the accounting standards that
relate to certain reinsurance credits, and if changes were made, whether they
should be applied retrospectively, prospectively only, or in a phased-in
manner. A requirement to reduce the reserve credits on ceded business, if
applied retroactively, would have a negative impact on the statutory capital of
the Company. The NAIC continues to work to reform state regulation in various
areas, including comprehensive reforms relating to life insurance reserves.
At the
federal level, bills are routinely introduced in both chambers of the United
States Congress which could affect life insurers. In the past, Congress has
considered legislation that would impact insurance companies in numerous ways,
such as providing for an optional federal charter or federal presence for
insurance, pre-empting state law in certain respects regarding the regulation
of reinsurance, increasing federal oversight in areas such as consumer
protection and solvency regulation, and other matters. The Company cannot
predict whether or in what form reforms will be enacted and, if so, whether the
enacted reforms will positively or negatively affect the Company or whether any
effects will be material. In addition, on March 23, 2010, President
Obama signed the Patient Protection and Affordable Care Act of 2010 (the Act)
into law. The Act makes sweeping changes to regulation of health
insurance, imposing various conditions and requirements on the
Company. The Company cannot predict the effect that the Act will have on
its results of operations or financial condition.
In 2009, the Obama
Administration released a set of proposed reforms with respect to financial
services entities. As part of a larger effort to strengthen the regulation of
the financial services market, the proposal outlines certain reforms applicable
to the insurance industry. Although no legislation has been enacted or
regulations promulgated with respect to the proposal, there is currently
legislation pending before Congress which would require changes to law or
regulation applicable to the Company, including but not limited to: the
establishment of federal regulatory authority over derivatives, the
establishment of consolidated federal regulation and resolution authority over
systemically important financial services firms, changes to the regulation of
broker dealers and investment advisors, changes to the regulation of
reinsurance, the imposition of additional regulation over credit rating
agencies, and the imposition of concentration limits on financial institutions,
including FHLBs, limiting the amount of credit that may be extended to a single
person or entity. Any additional legislation or regulatory requirements
applicable to the Company or those entities with which it does business
promulgated in connection with the proposal may make it more expensive for the
Company to conduct its business and subject the Company to an additional layer
of regulatory oversight. Such actions by Congress could have a material adverse
effect on the overall business climate as well as the Companys financial
condition and results of operations.
The proposal as well as
legislation pending before Congress also calls for the creation of a Consumer
Financial Protection Agency (CFPA) with jurisdiction over credit, savings,
payment, and other consumer financial products and services, other than
investment products already regulated by the United States Securities and
Exchange Commission (the SEC) or the U.S. Commodity Futures Trading
Commission. Certain of the Companys subsidiaries sell products that could be
regulated by the CFPA. Any such regulation by the CFPA could make it more
difficult or costly for the Companys subsidiaries to sell certain products and
have a material adverse effect on its financial condition and results of
operations.
The Companys
subsidiaries may also be subject to regulation by the United States Department
of Labor when providing a variety of products and services to employee benefit
plans governed by the Employee Retirement Income Security Act (ERISA). Severe
penalties are imposed for breach of duties under ERISA. In addition, the
Company may be subject to regulation by governments of the countries in which
it currently, or may in the future, do business, as well as regulation by the
U.S. Government with respect to its operations in foreign countries, such as
the Foreign Corrupt Practices Act.
Certain policies,
contracts, and annuities offered by the Companys subsidiaries are subject to
regulation under the federal securities laws administered by the SEC. The
federal securities laws contain regulatory restrictions and criminal,
administrative, and private remedial provisions.
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Other types of regulation
that could affect the Company and its subsidiaries include insurance company
investment laws and regulations, state statutory accounting practices,
anti-trust laws, minimum solvency requirements, state securities laws, federal
privacy laws, insurable interest laws, federal anti-money laundering and
anti-terrorism laws, and because the Company owns and operates real property,
state, federal, and local environmental laws. The Company cannot predict what
form any future changes in these or other areas of regulation affecting the
insurance industry might take or what effect, if any, such proposals might have
on the Company if enacted into law.
Item 2. Unregistered Sales of
Equity Securities and Use of Proceeds
During
the quarter ended March 31, 2010, the Company issued no securities in
transactions which were not registered under the Securities Act of 1933, as
amended (the Act).
Issuer Purchases of Equity Securities
On
May 7, 2007, the Companys Board of Directors extended the Companys
previously authorized $100 million share repurchase program. The Company
announced on February 12, 2008, that it had commenced execution of this
repurchase plan. The current authorization extends through May 6, 2010.
Future activity will be dependent upon many factors, including capital levels,
rating agency expectations, and the relative attractiveness of alternative uses
for capital. There were no shares repurchased during the three months ended March 31,
2010. The remaining capacity, expressed in aggregate value of shares, which may
be repurchased under the existing program, is approximately $82.9 million.
Item 6. Exhibits
Exhibit 31(a)
|
-
|
Certification Pursuant
to §302 of the Sarbanes Oxley Act of 2002.
|
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Exhibit 31(b)
|
-
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Certification Pursuant
to §302 of the Sarbanes Oxley Act of 2002.
|
|
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Exhibit 32(a)
|
-
|
Certification Pursuant
to 18 U.S.C. §1350, as Adopted Pursuant to Section 906 of the Sarbanes
Oxley Act of 2002.
|
|
|
|
Exhibit 32(b)
|
-
|
Certification Pursuant
to 18 U.S.C. §1350, as Adopted Pursuant to Section 906 of the Sarbanes
Oxley Act of 2002.
|
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SIGNATURE
Pursuant
to the requirements of Section 13
or 15(d) of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
|
PROTECTIVE LIFE
CORPORATION
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|
|
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|
Date:
May 7, 2010
|
By:
|
/s/ Steven G. Walker
|
|
|
Steven G. Walker
|
|
|
Senior Vice President,
Controller
and Chief Accounting Officer
|
92
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