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Section 1: 10-Q (10-Q)

FBL 10Q 2013 Q2
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
 
FORM 10-Q

(Mark one)
 
 
[X]
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
 
 
 
For the quarterly period ended June 30, 2013
 
 
 
or
 
 
 
[ ]
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
 
 
 
For the transition period from____________________ to____________________
 
 
 
Commission File Number: 1-11917
(Exact name of registrant as specified in its charter)
 
 
 
Iowa
 
42-1411715
(State of incorporation)
 
(I.R.S. Employer Identification No.)
 
 
 
5400 University Avenue, West Des Moines, Iowa
 
50266-5997
(Address of principal executive offices)
 
(Zip Code)
 
 
 
(515) 225-5400
(Registrant's telephone number, including area code)
 
 
 
 
(Former name, former address and former fiscal year, if changed since last report)
 
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [ ] No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 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). [X] Yes [ ] No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [ ]
Accelerated filer [X]
Non-accelerated filer [ ]
Smaller reporting company [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). [ ] Yes [X] No
 
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the last practicable date:
 Title of each class
 
Outstanding at July 30, 2013
Class A Common Stock, without par value
 
24,504,327
Class B Common Stock, without par value
 
1,141,291



FBL FINANCIAL GROUP, INC.
FORM 10-Q FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2013
TABLE OF CONTENTS


PART I.
FINANCIAL INFORMATION
 
 
 
 
Item 1.
Financial Statements (Unaudited)
 
 
Consolidated Balance Sheets
 
Consolidated Statements of Operations
 
Consolidated Statements of Comprehensive Income
 
Consolidated Statements of Changes in Stockholders' Equity
 
Consolidated Statements of Cash Flows
 
Notes to Consolidated Financial Statements
 
 
 
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
 
 
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
 
 
 
Item 4.
Controls and Procedures
 
 
 
PART II.
OTHER INFORMATION
 
 
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
 
 
 
Item 6.
Exhibits
 
 
 
SIGNATURES
 
    


1


ITEM 1. FINANCIAL STATEMENTS

FBL FINANCIAL GROUP, INC.
CONSOLIDATED BALANCE SHEETS (Unaudited)
(Dollars in thousands)

 
June 30,
2013
 
December 31,
2012
Assets
 
 
 
Investments:
 
 
 
Fixed maturities - available for sale, at fair value (amortized cost: 2013 - $5,854,711; 2012 - $5,637,608)
$
6,198,400

 
$
6,265,745

Equity securities - available for sale, at fair value (cost: 2013 - $74,113; 2012 - $82,140)
77,439

 
86,253

Mortgage loans
571,017

 
554,843

Real estate
4,102

 
4,668

Policy loans
174,486

 
174,254

Short-term investments
61,388

 
74,516

Other investments
548

 
371

Total investments
7,087,380

 
7,160,650

 
 
 
 
Cash and cash equivalents
62,071

 
78,074

Securities and indebtedness of related parties
113,201

 
100,606

Accrued investment income
73,815

 
69,965

Amounts receivable from affiliates
3,192

 
3,931

Reinsurance recoverable
99,495

 
98,238

Deferred acquisition costs
300,464

 
204,326

Value of insurance in force acquired
22,185

 
17,154

Current income taxes recoverable

 
6,735

Other assets
72,694

 
59,238

Assets held in separate accounts
641,248

 
618,809

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total assets
$
8,475,745

 
$
8,417,726


 

2




FBL FINANCIAL GROUP, INC.
CONSOLIDATED BALANCE SHEETS (Continued)
(Dollars in thousands)

 
June 30,
2013
 
December 31,
2012
Liabilities and stockholders' equity
 
 
 
Liabilities:
 
 
 
Future policy benefits:
 
 
 
Interest sensitive products
$
4,194,976

 
$
4,050,846

Traditional life insurance and accident and health products
1,487,066

 
1,457,075

Other policy claims and benefits
44,624

 
39,072

Supplementary contracts without life contingencies
355,698

 
361,273

Advance premiums and other deposits
232,457

 
226,485

Amounts payable to affiliates
281

 
1,658

Long-term debt payable to affiliates
50,000

 
50,000

Long-term debt payable to non-affiliates
97,000

 
97,000

Current income taxes
2,413

 

Deferred income taxes
143,292

 
208,433

Other liabilities
90,410

 
94,828

Liabilities related to separate accounts
641,248

 
618,809

Total liabilities
7,339,465

 
7,205,479

 
 
 
 
Stockholders' equity:
 
 
 
FBL Financial Group, Inc. stockholders' equity:
 
 
 
Preferred stock, without par value, at liquidation value - authorized 10,000,000 shares, issued and outstanding 5,000,000 Series B shares
3,000

 
3,000

Class A common stock, without par value - authorized 88,500,000 shares, issued and outstanding 24,472,905 shares in 2013 and 24,282,184 shares in 2012
128,507

 
115,706

Class B common stock, without par value - authorized 1,500,000 shares, issued and outstanding 1,141,291 shares in 2013 and 1,192,890 shares in 2012
7,197

 
7,522

Accumulated other comprehensive income
164,788

 
289,853

Retained earnings
832,737

 
796,110

Total FBL Financial Group, Inc. stockholders' equity
1,136,229

 
1,212,191

Noncontrolling interest
51

 
56

Total stockholders' equity
1,136,280

 
1,212,247

Total liabilities and stockholders' equity
$
8,475,745

 
$
8,417,726















See accompanying notes.

3


FBL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(Dollars in thousands, except per share data)

 
Three months ended June 30,
 
Six months ended June 30,
 
2013
 
2012
 
2013
 
2012
Revenues:
 
 
 
 
 
 
 
Interest sensitive product charges
$
26,795

 
$
24,190

 
$
52,099

 
$
49,422

Traditional life insurance premiums
46,058

 
45,908

 
90,992

 
89,031

Net investment income
92,898

 
89,423

 
183,708

 
176,311

Net realized capital gains on sales of investments
7,435

 
4,411

 
11,367

 
5,290

 
 
 
 
 
 
 
 
Total other-than-temporary impairment losses
(199
)
 
(3,679
)
 
(845
)
 
(14,980
)
Non-credit portion in other comprehensive income

 

 

 
9,779

Net impairment losses recognized in earnings
(199
)
 
(3,679
)
 
(845
)
 
(5,201
)
Other income
3,696

 
5,729

 
7,410

 
10,734

Total revenues
176,683

 
165,982

 
344,731

 
325,587

 
 
 
 
 
 
 
 
Benefits and expenses:
 
 
 
 
 
 
 
Interest sensitive product benefits
48,631

 
49,328

 
96,923

 
98,410

Traditional life insurance benefits
40,263

 
40,341

 
80,069

 
79,452

Policyholder dividends
3,395

 
3,370

 
6,753

 
7,614

Underwriting, acquisition and insurance expenses
37,335

 
34,374

 
72,359

 
67,101

Interest expense
1,838

 
1,983

 
3,813

 
3,965

Other expenses
4,818

 
6,683

 
9,202

 
12,506

Total benefits and expenses
136,280

 
136,079

 
269,119

 
269,048

 
40,403

 
29,903

 
75,612

 
56,539

Income taxes
(13,378
)
 
(10,256
)
 
(24,961
)
 
(19,014
)
Equity income, net of related income taxes
2,528

 
630

 
3,840

 
2,251

Net income from continuing operations
29,553

 
20,277

 
54,491

 
39,776

Discontinued operations:
 
 
 
 
 
 
 
Loss on sale of subsidiary

 

 

 
(2,252
)
Loss from discontinued operations, net of tax

 
(84
)
 

 
(764
)
Total loss from discontinued operations

 
(84
)
 

 
(3,016
)
Net income
29,553

 
20,193

 
54,491

 
36,760

Net loss attributable to noncontrolling interest
34

 
98

 
62

 
118

Net income attributable to FBL Financial Group, Inc.
$
29,587

 
$
20,291

 
$
54,553

 
$
36,878

 
 
 
 
 
 
 
 
Earnings per common share:
 
 
 
 
 
 
 
Income from continuing operations
$
1.14

 
$
0.74

 
$
2.12

 
$
1.37

Loss from discontinued operations

 

 

 
(0.10
)
Earnings per common share
$
1.14

 
$
0.74

 
$
2.12

 
$
1.27

Earnings per common share - assuming dilution:
 
 
 
 
 
 
 
Income from continuing operations
$
1.13

 
$
0.73

 
$
2.10

 
$
1.35

Loss from discontinued operations

 

 

 
(0.10
)
Earnings per common share - assuming dilution
$
1.13

 
$
0.73

 
$
2.10

 
$
1.25

 
 
 
 
 
 
 
 
Cash dividends per common share
$
0.11

 
$
0.10

 
$
0.22

 
$
0.20





See accompanying notes.

4


FBL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
(Dollars in thousands)
 
Three months ended June 30,
 
Six months ended June 30,
 
2013
 
2012
 
2013
 
2012
Net income
$
29,553

 
$
20,193

 
$
54,491

 
$
36,760

Other comprehensive income (loss), net of tax
 
 
 
 
 
 
 
Change in net unrealized investment gains/losses
(131,175
)
 
52,271

 
(125,498
)
 
61,717

Non-credit impairment losses
1

 

 
(35
)
 
(6,356
)
Change in underfunded status of postretirement benefit plans
205

 

 
468

 
(96
)
Total other comprehensive income (loss), net of tax
(130,969
)
 
52,271

 
(125,065
)
 
55,265

Total comprehensive income (loss), net of tax
(101,416
)
 
72,464

 
(70,574
)
 
92,025

Comprehensive loss attributable to noncontrolling interest
34

 
98

 
62

 
118

Total comprehensive income (loss) applicable to FBL Financial Group, Inc.
$
(101,382
)
 
$
72,562

 
$
(70,512
)
 
$
92,143



FBL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Unaudited)
(Dollars in thousands)
 
FBL Financial Group, Inc. Stockholders' Equity
 
 
 
 
 
Preferred Stock
 
Common Stock
 
Accumulated Other Comprehensive Income
 
Retained Earnings
 
Non-
controlling Interest
 
Total Stockholders' Equity
Balance at January 1, 2012
$
3,000

 
$
137,206

 
$
177,845

 
$
884,263

 
$
115

 
$
1,202,429

Net income - six months ended June 30, 2012

 

 

 
36,878

 
(118
)
 
36,760

Other comprehensive income

 

 
55,265

 

 

 
55,265

Issuance of common stock under compensation plans

 
6,627

 

 

 

 
6,627

Purchase of common stock

 
(18,251
)
 

 
(118,215
)
 

 
(136,466
)
Dividends on preferred stock

 

 

 
(75
)
 

 
(75
)
Dividends on common stock

 

 

 
(5,751
)
 

 
(5,751
)
Balance at June 30, 2012
$
3,000

 
$
125,582

 
$
233,110

 
$
797,100

 
$
(3
)
 
$
1,158,789

 
 
 
 
 
 
 
 
 
 
 
 
Balance at January 1, 2013
$
3,000

 
$
123,228

 
$
289,853

 
$
796,110

 
$
56

 
$
1,212,247

Net income - six months ended June 30, 2013

 

 

 
54,553

 
(62
)
 
54,491

Other comprehensive loss

 

 
(125,065
)
 

 

 
(125,065
)
Issuance of common stock under compensation plans

 
14,275

 

 

 

 
14,275

Purchase of common stock

 
(1,799
)
 

 
(12,206
)
 

 
(14,005
)
Dividends on preferred stock

 

 

 
(75
)
 

 
(75
)
Dividends on common stock

 

 

 
(5,645
)
 

 
(5,645
)
Receipts related to noncontrolling interest

 

 

 

 
57

 
57

Balance at June 30, 2013
$
3,000

 
$
135,704

 
$
164,788

 
$
832,737

 
$
51

 
$
1,136,280











See accompanying notes.

5


FBL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Dollars in thousands)

 
Six months ended June 30,
 
2013
 
2012
Operating activities
 
 
 
Net income
$
54,491

 
$
36,760

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Interest credited to account balances
71,327

 
70,323

Charges for mortality, surrenders and administration
(50,062
)
 
(47,420
)
Net realized gains on investments
(10,522
)
 
(89
)
Change in fair value of derivatives
(553
)
 
274

Increase in traditional life and accident and health benefit liabilities
29,991

 
30,995

Deferral of acquisition costs
(22,807
)
 
(25,985
)
Amortization of deferred acquisition costs and value of insurance in force
17,772

 
18,144

Change in reinsurance recoverable
(1,257
)
 
(1,302
)
Provision for deferred income taxes
1,944

 
3,420

Loss on sale of subsidiary

 
2,252

Other
(12,750
)
 
(40,540
)
Net cash provided by operating activities
77,574

 
46,832

 
 
 
 
Investing activities
 
 
 
Sales, maturities or repayments:
 
 
 
Fixed maturities - available for sale
401,421

 
306,850

Equity securities - available for sale
8,135

 
7,079

Mortgage loans
22,889

 
28,878

Derivative instruments
263

 

Policy loans
18,355

 
16,941

Securities and indebtedness of related parties
2,191

 

Other long-term investments
30

 

Real estate
1,957

 

Acquisitions:
 
 
 
Fixed maturities - available for sale
(596,148
)
 
(595,177
)
Equity securities - available for sale
(6,108
)
 
(18,510
)
Mortgage loans
(41,140
)
 
(23,880
)
Derivative instruments
(222
)
 
(120
)
Policy loans
(18,587
)
 
(19,773
)
Securities and indebtedness of related parties
(15,847
)
 
(17,899
)
Short-term investments, net change
13,128

 
13,059

Purchases and disposals of property and equipment, net
(5,566
)
 
(855
)
Net cash used in investing activities
(215,249
)
 
(303,407
)



6


FBL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Dollars in thousands)

 
Six months ended June 30,
 
2013
 
2012
Financing activities
 
 
 
Contract holder account deposits
$
325,672

 
$
422,809

Contract holder account withdrawals
(198,212
)
 
(197,375
)
Transfer from restricted debt defeasance trusts

 
211,627

Repayments of debt

 
(174,258
)
Receipts related to noncontrolling interests, net
57

 

Excess tax deductions on stock-based compensation
1,622

 
2,251

Repurchase of common stock, net
(1,747
)
 
(130,304
)
Dividends paid
(5,720
)
 
(5,826
)
Net cash provided by financing activities
121,672

 
128,924

Decrease in cash and cash equivalents
(16,003
)
 
(127,651
)
Cash and cash equivalents at beginning of period
78,074

 
296,339

Cash and cash equivalents at end of period
$
62,071

 
$
168,688

 
 
 
 
Supplemental disclosures of cash flow information
 
 
 
Cash paid (received) during the period for:
 
 
 
Interest
$
3,950

 
$
7,433

Income taxes
7,001

 
(1,556
)






























See accompanying notes.

7


FBL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
June 30, 2013

1. Significant Accounting Policies

Basis of Presentation

The accompanying unaudited consolidated financial statements of FBL Financial Group, Inc. (we or the Company) have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. Our financial statements include all adjustments (consisting of normal recurring accruals) necessary for a fair presentation of our financial position and results of operations.

Operating results for the three and six-month periods ended June 30, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013. We encourage you to refer to our consolidated financial statements and notes for the year ended December 31, 2012 included in our Annual Report on Form 10-K for a complete description of our material accounting policies. Also included in the Form 10-K is a description of areas of judgments and estimates and other information necessary to understand our financial position and results of operations.

2. Discontinued Operations

On December 30, 2011, we sold our wholly-owned subsidiary, EquiTrust Life Insurance Company (EquiTrust Life). We recognized an additional loss on the sale of subsidiary of $2.3 million, net of tax, during the first quarter of 2012 as a result of post-closing sales price adjustments. As a result of the sale, our consolidated financial statements are presented to reflect the operations of the component sold as discontinued operations. A summary of loss from discontinued operations is as follows:

Condensed Statement of Loss from Discontinued Operations
 
 
 
 
 
 
 
 
Three months ended June 30, 2012
 
Six months ended June 30, 2012
 
(Dollars in thousands)
Benefits and expenses
$
(129
)
 
$
(320
)
Interest expense allocation

 
(855
)
Income taxes
45

 
411

Income (loss) from discontinued operations
$
(84
)
 
$
(764
)

Notes Redemptions
 
In connection with the EquiTrust Life sale discussed above, during the first quarter of 2012, we completed the required redemption of $175.0 million of our long-term debt in accordance with the mandatory redemption provisions of the underlying notes. The make-whole redemption price of $210.9 million, which included repayment of principal, accrued interest and a make-whole premium, was funded from assets held in two irrevocable debt defeasance trusts. The make-whole redemption premium was based on U.S. Treasury yields and considered an embedded derivative with a fair value of $33.1 million at December 31, 2011. The change in fair value during 2012 was offset by the write off of deferred debt issuance costs and reported with other expenses in the consolidated statements of operations.


8

Table of Contents

3. Investment Operations

Fixed Maturity and Equity Securities

Available-For-Sale Fixed Maturity and Equity Securities by Investment Category
 
 
 
 
 
 
 
June 30, 2013
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
 
Non-credit losses on other-than-temporary impairments (1)
 
(Dollars in thousands)
Fixed maturities:
 
 
 
 
 
 
 
 
 
Corporate (2)
$
3,155,674

 
$
260,267

 
$
(55,079
)
 
$
3,360,862

 
$
(3,301
)
Residential mortgage-backed
563,132

 
39,794

 
(6,236
)
 
596,690

 
(4,879
)
Commercial mortgage-backed
429,086

 
27,720

 
(5,548
)
 
451,258

 

Other asset-backed
450,067

 
19,118

 
(11,328
)
 
457,857

 
(1,981
)
United States Government and agencies
40,614

 
5,118

 
(7
)
 
45,725

 

State, municipal and other governments
1,216,138

 
89,013

 
(19,143
)
 
1,286,008

 

Total fixed maturities
$
5,854,711

 
$
441,030

 
$
(97,341
)
 
$
6,198,400

 
$
(10,161
)
 
 
 
 
 
 
 
 
 
 
Equity securities:
 
 
 
 
 
 
 
 
 
Non-redeemable preferred stocks
$
47,691

 
$
3,529

 
$
(706
)
 
$
50,514

 
$

Common stocks
26,422

 
503

 

 
26,925

 

Total equity securities
$
74,113

 
$
4,032

 
$
(706
)
 
$
77,439

 
$

 
December 31, 2012
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
 
Non-credit losses on other-than-temporary impairments (1)
 
(Dollars in thousands)
Fixed maturities:
 
 
 
 
 
 
 
 
 
Corporate (2)
$
2,906,622

 
$
399,144

 
$
(10,183
)
 
$
3,295,583

 
$
(2,913
)
Residential mortgage-backed
632,955

 
47,459

 
(6,232
)
 
674,182

 
(5,164
)
Commercial mortgage-backed
463,504

 
49,173

 
(1,858
)
 
510,819

 

Other asset-backed
485,796

 
16,981

 
(13,064
)
 
489,713

 
(4,788
)
United States Government and agencies
42,079

 
6,930

 

 
49,009

 

State, municipal and other governments
1,106,652

 
142,704

 
(2,917
)
 
1,246,439

 

Total fixed maturities
$
5,637,608

 
$
662,391

 
$
(34,254
)
 
$
6,265,745

 
$
(12,865
)
 
 
 
 
 
 
 
 
 
 
Equity securities:
 
 
 
 
 
 
 
 
 
Non-redeemable preferred stocks
$
56,909

 
$
4,251

 
$
(668
)
 
$
60,492

 
$

Common stocks
25,231

 
530

 

 
25,761

 

Total equity securities
$
82,140

 
$
4,781

 
$
(668
)
 
$
86,253

 
$


(1)
Non-credit losses, subsequent to the initial impairment measurement date, on other-than-temporary impairments are included in the gross unrealized gains and losses columns above.
(2)
Corporate securities include hybrid preferred securities with a carrying value of $73.2 million at June 30, 2013 and $99.6 million at December 31, 2012. Corporate securities also include redeemable preferred stock with a carrying value of $18.2 million at June 30, 2013 and $5.6 million at December 31, 2012.



9

Table of Contents

Short-term investments have been excluded from the above schedules as amortized cost approximates fair value for these securities.

Available-For-Sale Fixed Maturities by Maturity Date
 
 
 
 
 
 
 
 
June 30, 2013
 
Amortized
Cost
 
Estimated
Fair Value
 
(Dollars in thousands)
Due in one year or less
$
102,394

 
$
107,404

Due after one year through five years
646,250

 
707,272

Due after five years through ten years
1,085,134

 
1,176,020

Due after ten years
2,578,648

 
2,701,899

 
4,412,426

 
4,692,595

Mortgage-backed and other asset-backed
1,442,285

 
1,505,805

Total fixed maturities
$
5,854,711

 
$
6,198,400


Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Fixed maturities not due at a single maturity date have been included in the above table in the year of final contractual maturity.

Net Unrealized Gains (Losses) on Investments in Accumulated Other Comprehensive Income
 
 
 
 
 
June 30,
2013
 
December 31,
2012
 
(Dollars in thousands)
Net unrealized appreciation on:
 
 
 
Fixed maturities - available for sale
$
343,689

 
$
628,137

Equity securities - available for sale
3,326

 
4,113

 
347,015

 
632,250

Adjustments for assumed changes in amortization pattern of:
 
 
 
Deferred acquisition costs
(83,327
)
 
(172,320
)
Value of insurance in force acquired
(8,933
)
 
(15,346
)
Unearned revenue reserve
6,082

 
13,554

Adjustments for assumed changes in policyholder liabilities
4,175

 

Provision for deferred income taxes
(92,740
)
 
(160,333
)
Net unrealized investment gains
$
172,272

 
$
297,805


Net unrealized investment gains and losses are recorded net of deferred income taxes and other adjustments for assumed changes in deferred acquisition costs, value of insurance in force acquired, unearned revenue reserve and policyholder liabilities. Subsequent changes in fair value of securities for which a previous non-credit other-than-temporary impairment loss was recognized in accumulated other comprehensive income, are reported along with changes in fair value for which no other-than-temporary impairment losses were previously recognized.


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Fixed Maturity and Equity Securities with Unrealized Losses by Length of Time
 
 
 
 
 
 
 
 
 
June 30, 2013
 
 
Less than one year
 
One year or more
 
Total
 
 
Description of Securities
 
Estimated
Fair Value
 
Unrealized Losses
 
Estimated
Fair Value
 
Unrealized Losses
 
Estimated Fair Value
 
Unrealized Losses
 
Percent of Total
 
 
(Dollars in thousands)
 
 
Fixed maturities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate
 
$
752,347

 
$
(48,329
)
 
$
33,170

 
$
(6,750
)
 
$
785,517

 
$
(55,079
)
 
56.6
%
Residential mortgage-backed
 
44,900

 
(1,198
)
 
22,090

 
(5,038
)
 
66,990

 
(6,236
)
 
6.4

Commercial mortgage-backed
 
42,806

 
(3,118
)
 
22,784

 
(2,430
)
 
65,590

 
(5,548
)
 
5.7

Other asset-backed
 
96,930

 
(1,220
)
 
29,624

 
(10,108
)
 
126,554

 
(11,328
)
 
11.6

United States Government and agencies
 
967

 
(7
)
 

 

 
967

 
(7
)
 

State, municipal and other governments
 
252,880

 
(18,285
)
 
11,635

 
(858
)
 
264,515

 
(19,143
)
 
19.7

Total fixed maturities
 
$
1,190,830

 
$
(72,157
)
 
$
119,303

 
$
(25,184
)
 
$
1,310,133

 
$
(97,341
)
 
100.0
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Equity securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-redeemable preferred stocks
 
$
14,101

 
$
(293
)
 
$
4,588

 
$
(413
)
 
$
18,689

 
$
(706
)
 
 
Total equity securities
 
$
14,101

 
$
(293
)
 
$
4,588

 
$
(413
)
 
$
18,689

 
$
(706
)
 
 

 
 
December 31, 2012
 
 
Less than one year
 
One year or more
 
Total
 
 
Description of Securities
 
Estimated
Fair Value
 
Unrealized Losses
 
Estimated
Fair Value
 
Unrealized Losses
 
Estimated Fair Value
 
Unrealized Losses
 
Percent of Total
 
 
(Dollars in thousands)
 
 
Fixed maturities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate
 
$
123,610

 
$
(2,120
)
 
$
87,176

 
$
(8,063
)
 
$
210,786

 
$
(10,183
)
 
29.7
%
Residential mortgage-backed
 
10,560

 
(85
)
 
32,884

 
(6,147
)
 
43,444

 
(6,232
)
 
18.2

Commercial mortgage-backed
 
27,073

 
(380
)
 
32,697

 
(1,478
)
 
59,770

 
(1,858
)
 
5.4

Other asset-backed
 
31,749

 
(512
)
 
50,468

 
(12,552
)
 
82,217

 
(13,064
)
 
38.1

State, municipal and other governments
 
33,228

 
(542
)
 
15,932

 
(2,375
)
 
49,160

 
(2,917
)
 
8.6

Total fixed maturities
 
$
226,220

 
$
(3,639
)
 
$
219,157

 
$
(30,615
)
 
$
445,377

 
$
(34,254
)
 
100.0
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Equity securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-redeemable preferred stocks
 
$
3,858

 
$
(32
)
 
$
7,364

 
$
(636
)
 
$
11,222

 
$
(668
)
 
 
Total equity securities
 
$
3,858

 
$
(32
)
 
$
7,364

 
$
(636
)
 
$
11,222

 
$
(668
)
 
 

Included in fixed maturities in the above tables are 374 securities from 317 issuers at June 30, 2013 and 140 securities from 116 issuers at December 31, 2012. The unrealized losses in fixed maturities are generally due to wider spreads between the risk-free and corporate and other bond yields relative to the spreads when the securities were purchased. We do not intend to sell or believe we will be required to sell any of our impaired fixed maturities before recovery of their amortized cost basis. The following summarizes the more significant unrealized losses of fixed maturities and equity securities by investment category as of June 30, 2013.

Corporate securities: The largest unrealized losses are in the utilities sector ($199.2 million carrying value and $13.9 million unrealized loss). The largest unrealized losses in the utilities sector were in the electric ($137.4 million carrying value and $9.7 million unrealized loss) and the gas-pipeline ($44.8 million carrying value and $3.2 million unrealized loss) sub-sectors. The majority of losses in the sector are primarily attributable to general changes in market interest rates for corporate securities.

Residential mortgage-backed securities: The unrealized losses on residential mortgage-backed securities were primarily due to continued uncertainty regarding mortgage defaults on Alt-A loans. We purchased most of these investments at a discount to their face amount and the contractual cash flows of these investments are based on mortgages and other assets backing the securities.


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Commercial mortgage-backed securities: The unrealized losses on commercial mortgage-backed securities were primarily due to spread widening and concerns regarding the potential for future defaults. The contractual cash flows of these investments are based on mortgages backing the securities. Unrealized losses on military housing bonds were mainly attributed to negative publicity around this sector. Insured military housing bonds have also been impacted by the removal of their ratings following downgrades of the insurance providers.

Other asset-backed securities: The unrealized losses on other asset-backed securities were primarily due to concerns regarding defaults on subprime mortgages and home equity loans. We purchased most of these investments at a discount to their face amount and the contractual cash flows of these investments are based on mortgages and other assets backing the securities.

State, municipal and other governments: The unrealized losses on state, municipal and other governments were primarily due to general spread widening relative to spreads at which we acquired the bonds.

Equity securities: Our gross unrealized losses were on investment grade non-redeemable perpetual preferred securities within the finance sector. These securities provide periodic cash flows, contain call features and are similarly rated and priced like other long-term callable bonds and are evaluated for other-than-temporary impairment similar to fixed maturities. The decline in fair value is primarily due to market concerns regarding the sector. We have evaluated the near-term prospects of our equity securities in relation to the severity and duration of their impairment and based on that evaluation have the intent and ability to hold these investments until recovery of fair value.

Excluding mortgage and asset-backed securities, no securities from the same issuer had an aggregate unrealized loss in excess of $2.9 million at June 30, 2013, with the largest unrealized loss from hybrid Tier 1 capital bonds in the financial sector. With respect to mortgage and asset-backed securities not backed by the United States Government, no securities from the same issuer had an aggregate unrealized loss in excess of $5.2 million at June 30, 2013, with the largest unrealized loss from a collateralized bond obligation of bank and thrift holding companies, which is rated non-investment grade.

The carrying values of all our investments are reviewed on an ongoing basis for credit deterioration. When our review indicates a decline in fair value for a fixed maturity security is other-than-temporary and we do not intend to sell or believe we will be required to sell the security before recovery of our amortized cost, a specific write down is charged to earnings for the credit loss and a specific charge is recognized in accumulated other comprehensive income for the non-credit loss component. If we intend to sell or believe we will be required to sell a fixed maturity security before its recovery, the full amount of the impairment write down to fair value is charged to earnings. For all equity securities, the full amount of an other-than-temporary impairment write down is recognized as a realized loss on investments in the consolidated statements of operations and the new cost basis for the security is equal to its fair value.

We monitor the financial condition and operations of the issuers of fixed maturities and equity securities that could potentially have a credit impairment that is other-than-temporary. In determining whether or not an unrealized loss is other-than-temporary, we review factors such as:

historical operating trends;
business prospects;
status of the industry in which the company operates;
analyst ratings on the issuer and sector;
quality of management;
size of unrealized loss;
level of current market interest rates compared to market interest rates when the security was purchased; and
length of time the security has been in an unrealized loss position.

In order to determine the credit and non-credit impairment loss for fixed maturities, every quarter we estimate the future cash flows we expect to receive over the remaining life of the instrument as well as review our plans to hold or sell the instrument. Significant assumptions regarding the present value of expected cash flows for each security are used when an other-than-temporary impairment occurs and there is a non-credit portion of the unrealized loss that won't be recognized in earnings. Our assumptions for residential mortgage-backed securities, commercial mortgage-backed securities and other asset-backed securities include collateral pledged, guarantees, vintage, anticipated principal and interest payments, prepayments, default levels, severity assumptions, delinquency rates and the level of nonperforming assets for the remainder of the investments' expected term. We use a single best estimate of cash flows approach and use the effective yield prior to the date of impairment to calculate the present value of cash flows. Our assumptions for corporate and other fixed maturities include anticipated

12

Table of Contents

principal and interest payments and an estimated recovery value, generally based on a percentage return of the current fair value.

After an other-than-temporary write down of all equity securities and any fixed maturities with a credit-only impairment, the cost basis is generally not adjusted for subsequent recoveries in fair value. However, for fixed maturities for which we can reasonably estimate future cash flows after a write down, the discount or reduced premium recorded, based on the new cost basis, is amortized over the remaining life of the security. Amortization in this instance is computed using the prospective method and the current estimate of the amount and timing of future cash flows.

Credit Loss Component of Other-Than-Temporary Impairments on Fixed Maturities

The following table sets forth the amount of credit loss impairments on fixed maturities held by the Company as of the dates indicated for which a portion of the other-than-temporary impairment was recognized in other comprehensive income and corresponding changes in such amounts.

 
Six months ended June 30,
 
2013

2012
 
(Dollars in thousands)
Balance at beginning of period
$
(27,712
)
 
$
(22,746
)
Increases for which an impairment was not previously recognized

 
(847
)
Reductions due to investments sold
5,729

 
85

Reductions due to change of intent to not hold investments

 
40

Balance at end of period
$
(21,983
)
 
$
(23,468
)

Realized Gains (Losses) - Recorded in Income 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three months ended June 30,
 
Six months ended June 30,
 
2013
 
2012
 
2013
 
2012
 
(Dollars in thousands)
Realized gains (losses) on sales of investments
 
 
 
 
 
 
 
Fixed maturities:
 
 
 
 
 
 
 
Gross gains
$
8,086

 
$
4,227

 
$
13,726

 
$
4,648

Gross losses
(657
)
 
(21
)
 
(2,365
)
 
(435
)
Equity securities

 
205

 

 
310

Mortgage loans

 

 

 
767

Real estate
12

 

 
12

 

Other
(6
)
 

 
(6
)
 

 
7,435

 
4,411

 
11,367

 
5,290

Impairment losses recognized in earnings:
 
 
 
 
 
 
 
Credit-related portion of fixed maturity losses (1)

 

 

 
(847
)
Other credit-related (2)
(199
)
 
(3,679
)
 
(845
)
 
(4,354
)
Realized gains on investments recorded in income
$
7,236

 
$
732

 
$
10,522

 
$
89


(1)
Amount represents the credit-related losses recognized for fixed maturities which were not written down to fair value. As discussed above the non-credit portion of the losses have been recognized in other comprehensive income.
(2)
Amount represents credit-related losses for mortgage loans, real estate and fixed maturities written down to fair value.

Proceeds from sales of fixed maturities totaled $79.3 million at June 30, 2013 and $68.0 million at June 30, 2012.

Realized gains and losses on sales of investments are determined on the basis of specific identification.


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Table of Contents

Mortgage Loans

Our mortgage loan portfolio consists principally of commercial mortgage loans that we have originated. Our lending policies require that the loans be collateralized by the value of the related property, establish limits on the amount that can be loaned to one borrower and require diversification by geographic location and collateral type. We originate loans with an initial loan-to-value ratio that provides sufficient excess collateral to absorb losses should we be required to foreclose and take possession of the collateral. In order to identify impairment losses timely, management maintains and reviews a watch list of mortgage loans that have heightened risk. These loans may include those with borrowers delinquent on contractual payments, borrowers experiencing financial difficulty, increases in rental real estate vacancies and significant declines in collateral value. We evaluate each of our mortgage loans individually and establish an allowance as needed for possible losses against our mortgage loan portfolio. An allowance is needed for loans in which we do not believe we will collect all amounts due according to the contractual terms of the respective loan agreements or a modification which has been classified as a troubled debt restructuring (TDR).

Any loan delinquent on contractual payments is considered non-performing. At June 30, 2013, there was one non-performing loan over 90 days past due on contractual payments with a carrying value of $14.4 million. At December 31, 2012, there were two non-performing loans over 90 days past due on contractual payments with a carrying value of $16.4 million. During the first quarter of 2013, we foreclosed on one non-performing loan with a book value of $1.6 million and took possession of the real estate with an appraised value of $1.8 million. During the first quarter of 2012, we foreclosed on one non-performing loan with a book value of $2.1 million at December 31, 2011 and took possession of the real estate with an appraised value of $2.4 million. Interest income is accrued on impaired loans to the extent it is deemed collectible (delinquent less than 90 days) and the loan continues to perform under its original or restructured contractual terms. Interest income on non-performing loans is generally recognized on a cash basis. Once mortgage loans are classified as nonaccrual loans, the resumption of the interest accrual would commence only after all past due interest has been collected or the mortgage loan has been restructured to where the collection of interest is considered likely. We discontinued the accrual of interest on the one loan at June 30, 2013 and on the two loans at December 31, 2012.

Mortgage Loans by Collateral Type
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
June 30, 2013
 
December 31, 2012
Collateral Type
 
Carrying Value
 
Percent of Total
 
Carrying Value
 
Percent of Total
 
 
(Dollars in thousands)
Office
 
$
230,207

 
40.3
%
 
$
218,837

 
39.4
%
Retail
 
183,661

 
32.2

 
184,135

 
33.2

Industrial
 
123,244

 
21.6

 
133,149

 
24.0

Other
 
33,905

 
5.9

 
18,722

 
3.4

Total
 
$
571,017

 
100.0
%
 
$
554,843

 
100.0
%

Mortgage Loans by Geographic Location within the United States
 
 
 
 
 
 
 
 
 
 
 
 
 
June 30, 2013
 
December 31, 2012
Region of the United States
 
Carrying Value
 
Percent of Total
 
Carrying Value
 
Percent of Total
 
 
(Dollars in thousands)
South Atlantic
 
$
166,636

 
29.2
%
 
$
164,294

 
29.6
%
Pacific
 
98,290

 
17.2

 
81,333

 
14.7

West North Central
 
83,081

 
14.5

 
77,798

 
14.0

East North Central
 
78,757

 
13.8

 
81,015

 
14.6

Mountain
 
47,352

 
8.3

 
48,881

 
8.8

West South Central
 
40,912

 
7.2

 
42,141

 
7.6

Other
 
55,989

 
9.8

 
59,381

 
10.7

Total
 
$
571,017

 
100.0
%
 
$
554,843

 
100.0
%


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Table of Contents

Mortgage Loans by Loan-to-Value Ratio
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
June 30, 2013
 
December 31, 2012
 

Carrying Value
 
Percent of Total
 
Carrying Value
 
Percent of Total
 
(Dollars in thousands)
0% - 50%
$
150,311

 
26.3
%
 
$
173,040

 
31.2
%
51% - 60%
177,193

 
31.0

 
156,633

 
28.2

61% - 70%
219,906

 
38.5

 
186,738

 
33.7

71% - 80%
23,607

 
4.2

 
36,857

 
6.6

81% - 90%

 

 
1,575

 
0.3

Total
$
571,017

 
100.0
%
 
$
554,843

 
100.0
%

The loan-to-value ratio is determined using the most recent appraised value. Appraisals are updated periodically including when there is indication of a possible significant collateral decline or loan modification and refinance requests.

Mortgage Loans by Year of Origination
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
June 30, 2013
 
December 31, 2012
 
Carrying Value
 
Percent of Total
 
Carrying Value
 
Percent of Total
 
(Dollars in thousands)
2013
$
41,066

 
7.2
%
 
$

 
%
2012
74,010

 
13.0

 
75,173

 
13.6

2011
46,793

 
8.2

 
47,405

 
8.5

2010
26,816

 
4.7

 
27,422

 
4.9

2008
69,350

 
12.1

 
70,346

 
12.7

2007 and prior
312,982

 
54.8

 
334,497

 
60.3

Total
$
571,017

 
100.0
%
 
$
554,843

 
100.0
%

 Impaired Mortgage Loans
 
 
 
June 30, 2013
 
December 31, 2012
 
(Dollars in thousands)
Unpaid principal balance
$
21,714

 
$
10,046

Less:
 
 
 
Related allowance
559

 
1,694

Carrying value of impaired mortgage loans
$
21,155

 
$
8,352

 Allowance on Mortgage Loans
 
Six months ended June 30,
 
2013
 
2012
 
(Dollars in thousands)
Balance at beginning of period
$
1,694

 
$
1,759

Allowances established
475

 
20

Charge offs
(1,610
)
 
(400
)
Balance at end of period
$
559

 
$
1,379



15

Table of Contents

Mortgage Loan Modifications

Our commercial mortgage loan portfolio includes loans that have been modified. We assess loan modifications on a loan-by-loan basis to evaluate whether a TDR has occurred. Generally, the types of concessions include: reduction of the contractual interest rate to a below market rate, extension of the maturity date, and/or a reduction of accrued interest. The amount, timing and extent of the concession granted is considered in determining if an impairment loss is needed for the restructuring.

During the first quarter of 2013 we modified one commercial mortgage loan that met the criteria of a TDR with a carrying value after the restructuring of $14.4 million and recognized an impairment loss of $0.5 million. TDR modifications during the first two quarters of 2012 resulted in losses of less than $0.1 million.

Variable Interest Entities

We evaluate our variable interest entity (VIE) investees to determine whether the level of our direct ownership interest, our rights to manage operations or our obligation to provide ongoing financial support are such that we are the primary beneficiary of the entity, and are then required to consolidate it for financial reporting purposes. None of our VIE investees were required to be consolidated during 2013 or 2012. Our VIE investments are as follows:

 
June 30, 2013
 
December 31, 2012
 
Carrying Value
 
Maximum Exposure to Loss
 
Carrying Value
 
Maximum Exposure to Loss
 
(Dollars in thousands)
Real estate limited partnerships
$
15,906

 
$
15,906

 
$
16,914

 
$
16,914


We make commitments to fund partnership investments in the normal course of business. We did not have any other commitments to investees designated as VIEs as of June 30, 2013 or December 31, 2012.

Derivative Instruments

We are not significantly involved in hedging activities and have limited exposure to derivatives. We do not apply hedge accounting to any of our derivative positions. Derivative assets, which are primarily reported in reinsurance recoverable and other investments, totaled $4.3 million at June 30, 2013 and $5.6 million at December 31, 2012. Our derivative assets consist of derivatives embedded within our modified coinsurance agreements and call options which provide an economic hedge for a small block of index annuity contracts. Derivative liabilities totaled $0.4 million at June 30, 2013 and $0.5 million December 31, 2012 and include derivatives embedded within our index annuity contracts and derivatives embedded within our modified coinsurance agreements. The net gain (loss) recognized on these derivatives is included in net investment income and interest sensitive benefits and, for the three month period, totaled ($0.6) million for 2013 and ($0.1) million for 2012 and for the six-month period, totaled ($0.9) million for 2013 and $0.3 million for 2012.

Other

At June 30, 2013, we had committed to provide $50.0 million of additional funds for our investments in low income housing tax credit limited partnerships.


16

Table of Contents

4. Fair Values

The carrying and estimated fair values of our financial instruments are as follows:

Fair Values and Carrying Values
 
 
 
 
 
 
 
 
 
June 30, 2013
 
December 31, 2012
 
Carrying Value
 
Fair Value
 
Carrying Value
 
Fair Value
 
(Dollars in thousands)
Assets
 
 
 
 
 
 
 
Fixed maturities - available for sale
$
6,198,400

 
$
6,198,400

 
$
6,265,745

 
$
6,265,745

Equity securities - available for sale
77,439

 
77,439

 
86,253

 
86,253

Mortgage loans
571,017

 
605,911

 
554,843

 
600,448

Policy loans
174,486

 
215,229

 
174,254

 
227,161

Other investments
462

 
462

 
247

 
247

Cash, cash equivalents and short-term investments
123,459

 
123,459

 
152,590

 
152,590

Reinsurance recoverable
3,867

 
3,867

 
5,326

 
5,326

Assets held in separate accounts
641,248

 
641,248

 
618,809

 
618,809

 
Liabilities
 
 
 
 
 
 
 
Future policy benefits
$
3,306,074

 
$
3,377,415

 
$
3,226,765

 
$
3,352,252

Supplemental contracts without life contingencies
355,698

 
339,792

 
361,273

 
350,187

Advance premiums and other deposits
223,126

 
223,126

 
216,857

 
216,857

Long-term debt
147,000

 
119,628

 
147,000

 
116,359

Other liabilities
90

 
90

 
131

 
131

Liabilities related to separate accounts
641,248

 
632,959

 
618,809

 
609,704


Fair value is based on an exit price, which is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. As not all financial instruments are actively traded, various valuation methods may be used to estimate fair value. These methods rely on observable data and where observable data is not available, the best information available. Significant judgment may be required to interpret the data and select the assumptions used in the valuation estimates, particularly when observable market data is not available.

In the discussion that follows, we have ranked our financial instruments by the level of judgment used in the determination of the fair values presented above. The levels are defined as follows:

Level 1 - Fair values are based on unadjusted quoted prices in active markets for identical assets or liabilities.

Level 2 - Fair values are based on inputs, other than quoted prices from active markets, that are observable for the asset or liability, either directly or indirectly.

Level 3 - Fair values are based on significant unobservable inputs for the asset or liability.

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, a financial instrument's level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the financial instrument. From time to time there may be movements between levels as inputs become more or less observable, which may depend on several factors including the activity of the market for the specific security, the activity of the market for similar securities, the level of risk spreads and the source of the information from which we obtain the information. Transfers in or out of any level are measured as of the beginning of the period.

The following methods and assumptions were used in estimating the fair value of our financial instruments:


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Table of Contents

Fixed maturities:

Level 1 fixed maturities consist of U.S. Treasury issues that are actively traded, allowing us to use current market prices as an estimate of their fair value.

Level 2 fixed maturities consist of corporate, mortgage and other asset-backed, United States Government agencies and private placement securities with observable market data, and in some circumstances recent trade activity. When quoted prices of identical assets in active markets are not available, our first priority is to obtain prices from third party pricing vendors. We have regular interaction with these vendors to ensure we understand their pricing methodologies and to confirm they are utilizing observable market information. Their methodologies vary by asset class and include inputs such as estimated cash flows, benchmark yields, reported trades, credit quality, industry events and economic events. Fixed maturities with validated prices from pricing services, which includes the majority of our public fixed maturities in all asset classes, are generally reflected in Level 2.

Also included in Level 2 are corporate bonds where quoted market prices are not available, for which an internal model using substantially all observable inputs or a matrix pricing valuation approach is used. In the matrix approach, securities are grouped into pricing categories that vary by sector, rating and average life. Each pricing category is assigned a risk spread based on studies of observable public market data. The expected cash flows of the security are then discounted back at the current Treasury curve plus the appropriate risk spread.

Level 3 fixed maturities include private placements as well as corporate, mortgage and other asset-backed and state and municipal securities for which there is little or no current market data available. We use external pricing sources, or if prices are not available will estimate fair value internally. Fair values of private investments in Level 3 are determined by reference to public market, private transactions or valuations for comparable companies or assets in the relevant asset class when such amounts are available. For other securities where an exit price based on relevant observable inputs is not obtained, the fair value is determined using a matrix calculation. Fair values estimated through use of matrix pricing methods rely on an estimate of credit spreads to a risk free U.S. Treasury yield. Selecting the credit spread requires judgment based on an understanding of the security and may include a market liquidity premium. Our selection of comparable companies as well as the level of spread requires significant judgment. Increases in spreads used in our matrix models, or those used to value comparable companies, will result in a decrease in discounted cash flows used, and accordingly in the estimated fair value of the security.

We obtain fixed maturity fair values from a variety of external independent pricing services, including brokers, with access to observable data including recent trade information, if available. In certain circumstances in which an external price is not available for a Level 3 security, we will internally estimate its fair value. Our process for evaluation and selection of the fair values includes:

Follow a “pricing waterfall” policy, which establishes the pricing source preference for a particular security or security type. The order of preference is based on our evaluation of the valuation methods used, the source's knowledge of the instrument and the reliability of the prices we have received from the source in the past. Our valuation policy dictates that fair values are initially sought from third party pricing services. If our review of the prices received from our preferred source indicates an inaccurate price, we will use an alternative source within the waterfall and document the decision. In the event that fair values are not available from one of our external pricing services or upon review of the fair values provided it is determined that they may not be reflective of market conditions, those securities are submitted to brokers familiar with the security to obtain non-binding price quotes. Broker quotes tend to be used in limited circumstances such as for newly issued, private placement and other instruments that are not widely traded. For those securities for which an externally provided fair value is not available we use cash flow modeling techniques to estimate fair value.

Evaluate third party pricing source estimation methodologies to assess whether they will provide a fair value which approximates a market exit price.

Perform an overall analysis of portfolio fair value movement against general movements in interest rates and spreads.

Compare month-to-month price trends to detect unexpected price fluctuation based on our knowledge of the market and the particular instrument. As fluctuations are noted, we will perform further research which may

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include discussions with the original pricing source or other external sources to ensure we are in agreement with the valuation.

Compare prices between different pricing sources for unusual disparity.

Meet monthly with our Investment Committee, the group that oversees our valuation process, to discuss valuation practices and observations during the pricing process.

Equity securities:

Level 1 equity securities consist of listed common stocks and mutual funds that are actively traded, allowing us to use current market prices as an estimate of their fair value.

Level 2 equity securities consist of common stock issued by the Federal Home Loan Bank, with estimated fair value based on the current redemption value of the shares and non-redeemable preferred stock with estimated fair value obtained from external pricing sources using a matrix pricing approach.