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Section 1: 10-Q (10-Q)

10-Q

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 September 30, 2015
 
 
 
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 or other jurisdiction of incorporation or organization)
 
(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 latest practicable date:
 Title of each class
 
Outstanding at October 30, 2015
Class A Common Stock, without par value
 
24,769,873
Class B Common Stock, without par value
 
11,413


















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FBL FINANCIAL GROUP, INC.
FORM 10-Q FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2015
TABLE OF CONTENTS


PART I.
FINANCIAL INFORMATION
 
 
 
 
Item 1.
Financial Statements (Unaudited)
 
 
Consolidated Balance Sheets
 
Consolidated Statements of Operations
 
Consolidated Statements of Comprehensive Income (Loss)
 
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 1A.
Risk Factors
 
 
 
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)

 
September 30,
2015
 
December 31,
2014
Assets
 
 
 
Investments:
 
 
 
Fixed maturities - available for sale, at fair value (amortized cost: 2015 - $6,332,977; 2014 - $6,111,433)
$
6,720,128

 
$
6,700,698

Equity securities - available for sale, at fair value (cost: 2015 - $116,822; 2014 - $107,410)
120,543

 
112,623

Mortgage loans
694,069

 
629,296

Real estate
3,438

 
3,622

Policy loans
185,353

 
182,502

Short-term investments
17,314

 
48,585

Other investments
1,075

 
3,644

Total investments
7,741,920

 
7,680,970

 
 
 
 
Cash and cash equivalents
32,637

 
76,632

Securities and indebtedness of related parties
141,089

 
129,872

Accrued investment income
83,959

 
76,445

Amounts receivable from affiliates
5,436

 
2,666

Reinsurance recoverable
102,845

 
101,247

Deferred acquisition costs
292,450

 
220,760

Value of insurance in force acquired
21,053

 
22,497

Other assets
74,235

 
70,286

Assets held in separate accounts
617,172

 
683,033

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total assets
$
9,112,796

 
$
9,064,408


 


2




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

 
September 30,
2015
 
December 31,
2014
Liabilities and stockholders' equity
 
 
 
Liabilities:
 
 
 
Future policy benefits:
 
 
 
Interest sensitive products
$
4,722,977

 
$
4,543,980

Traditional life insurance and accident and health products
1,620,174

 
1,581,138

Other policy claims and benefits
39,645

 
34,895

Supplementary contracts without life contingencies
342,260

 
341,955

Advance premiums and other deposits
256,973

 
248,679

Amounts payable to affiliates
679

 
188

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

 
97,000

Current income taxes
13,514

 
2,764

Deferred income taxes
153,028

 
205,698

Other liabilities
82,065

 
72,196

Liabilities related to separate accounts
617,172

 
683,033

Total liabilities
7,945,487

 
7,811,526

 
 
 
 
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 24,766,512 shares in 2015 and 24,703,903 shares in 2014
148,016

 
144,625

Class B common stock, without par value - authorized 1,500,000 shares, issued and outstanding 11,413 shares in 2015 and 2014
72

 
72

Accumulated other comprehensive income
169,560

 
258,410

Retained earnings
846,630

 
846,737

Total FBL Financial Group, Inc. stockholders' equity
1,167,278

 
1,252,844

Noncontrolling interest
31

 
38

Total stockholders' equity
1,167,309

 
1,252,882

Total liabilities and stockholders' equity
$
9,112,796

 
$
9,064,408
















See accompanying notes.


3




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

 
Three months ended September 30,
 
Nine months ended September 30,
 
2015
 
2014
 
2015
 
2014
Revenues:
 
 
 
 
 
 
 
Interest sensitive product charges
$
29,856

 
$
27,633

 
$
86,250

 
$
82,085

Traditional life insurance premiums
46,719

 
45,020

 
142,758

 
137,956

Net investment income
95,882

 
95,744

 
292,144

 
283,590

Net realized capital gains (losses) on sales of investments
(93
)
 
1,273

 
7,509

 
3,539

 
 
 
 
 
 
 
 
Total other-than-temporary impairment losses
(559
)
 
(273
)
 
(719
)
 
(273
)
Non-credit portion in other comprehensive income (loss)
146

 

 
146

 

Net impairment losses recognized in earnings
(413
)
 
(273
)
 
(573
)
 
(273
)
Other income
3,543

 
4,023

 
12,097

 
10,895

Total revenues
175,494

 
173,420

 
540,185

 
517,792

 
 
 
 
 
 
 
 
Benefits and expenses:
 
 
 
 
 
 
 
Interest sensitive product benefits
53,940

 
53,002

 
163,121

 
158,145

Traditional life insurance benefits
41,604

 
38,375

 
131,967

 
121,863

Policyholder dividends
2,885

 
2,834

 
8,802

 
9,086

Underwriting, acquisition and insurance expenses
36,176

 
34,829

 
107,535

 
103,547

Interest expense
1,213

 
1,197

 
3,637

 
3,495

Other expenses
4,277

 
3,488

 
13,425

 
11,999

Total benefits and expenses
140,095

 
133,725

 
428,487

 
408,135

 
35,399

 
39,695

 
111,698

 
109,657

Income taxes
(11,520
)
 
(12,535
)
 
(36,057
)
 
(35,102
)
Equity income, net of related income taxes
2,761

 
2,992

 
6,932

 
7,171

Net income
26,640

 
30,152

 
82,573

 
81,726

Net loss attributable to noncontrolling interest
19

 
7

 
49

 
67

Net income attributable to FBL Financial Group, Inc.
$
26,659

 
$
30,159

 
$
82,622

 
$
81,793

 
 
 
 
 
 
 
 
Earnings per common share
$
1.07

 
$
1.21

 
$
3.31

 
$
3.28

Earnings per common share - assuming dilution
$
1.06

 
$
1.21

 
$
3.30

 
$
3.26

 
 
 
 
 
 
 
 
Cash dividends per common share
$
0.40

 
$
0.35

 
$
1.20

 
$
1.05

Special cash dividend per common share
$

 
$

 
$
2.00

 
$











See accompanying notes.


4




FBL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Unaudited)
(Dollars in thousands)
 
Three months ended September 30,
 
Nine months ended September 30,
 
2015
 
2014
 
2015
 
2014
Net income
$
26,640

 
$
30,152

 
$
82,573

 
$
81,726

Other comprehensive income (loss) (1)
 
 
 
 
 
 
 
Change in net unrealized investment gains/losses
(2,802
)
 
(8,154
)
 
(89,488
)
 
114,758

Non-credit impairment losses
(85
)
 

 
(85
)
 

Change in underfunded status of postretirement benefit plans
246

 
181

 
723

 
536

Total other comprehensive income (loss), net of tax
(2,641
)
 
(7,973
)
 
(88,850
)
 
115,294

Total comprehensive income (loss), net of tax
23,999

 
22,179

 
(6,277
)
 
197,020

Comprehensive loss attributable to noncontrolling interest
19

 
7

 
49

 
67

Total comprehensive income (loss) applicable to FBL Financial Group, Inc.
$
24,018

 
$
22,186

 
$
(6,228
)
 
$
197,087


(1)
Other comprehensive income (loss) is 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.


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, 2014
$
3,000

 
$
135,065

 
$
119,067

 
$
787,609

 
$
50

 
$
1,044,791

Net income - nine months ended September 30, 2014

 

 

 
81,793

 
(67
)
 
81,726

Other comprehensive income

 

 
115,294

 

 

 
115,294

Issuance of common stock under compensation plans

 
9,560

 

 

 

 
9,560

Purchase of common stock

 
(2,201
)
 

 
(14,741
)
 

 
(16,942
)
Dividends on preferred stock

 

 

 
(112
)
 

 
(112
)
Dividends on common stock

 

 

 
(25,948
)
 

 
(25,948
)
Receipts related to noncontrolling interest

 

 

 

 
93

 
93

Balance at September 30, 2014
$
3,000

 
$
142,424

 
$
234,361

 
$
828,601

 
$
76

 
$
1,208,462

 
 
 
 
 
 
 
 
 
 
 
 
Balance at January 1, 2015
$
3,000

 
$
144,697

 
$
258,410

 
$
846,737

 
$
38

 
$
1,252,882

Net income - nine months ended September 30, 2015

 

 

 
82,622

 
(49
)
 
82,573

Other comprehensive loss

 

 
(88,850
)
 

 

 
(88,850
)
Issuance of common stock under compensation plans

 
3,790

 

 

 

 
3,790

Purchase of common stock

 
(399
)
 

 
(3,343
)
 

 
(3,742
)
Dividends on preferred stock

 

 

 
(112
)
 

 
(112
)
Dividends on common stock

 

 

 
(79,274
)
 

 
(79,274
)
Receipts related to noncontrolling interest

 

 

 

 
42

 
42

Balance at September 30, 2015
$
3,000

 
$
148,088

 
$
169,560

 
$
846,630

 
$
31

 
$
1,167,309






See accompanying notes.


5




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

 
Nine months ended September 30,
 
2015
 
2014
Operating activities
 
 
 
Net income
$
82,573

 
$
81,726

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Interest credited to account balances
113,783

 
111,324

Charges for mortality, surrenders and administration
(81,011
)
 
(78,708
)
Net realized gains on investments
(6,936
)
 
(3,266
)
Change in fair value of derivatives
292

 
(777
)
Increase in traditional life and accident and health benefit liabilities
39,037

 
47,853

Deferral of acquisition costs
(30,682
)
 
(30,223
)
Amortization of deferred acquisition costs and value of insurance in force
28,617

 
25,546

Change in reinsurance recoverable
(1,598
)
 
140

Provision for deferred income taxes
(4,818
)
 
692

Other
4,126

 
(7,869
)
Net cash provided by operating activities
143,383

 
146,438

 
 
 
 
Investing activities
 
 
 
Sales, maturities or repayments:
 
 
 
Fixed maturities - available for sale
471,774

 
373,020

Equity securities - available for sale
13,620

 
1,360

Mortgage loans
32,841

 
34,733

Derivative instruments
3,078

 
696

Policy loans
26,615

 
24,802

Securities and indebtedness of related parties
18,091

 
2,972

Acquisitions:
 
 
 
Fixed maturities - available for sale
(680,727
)
 
(570,403
)
Equity securities - available for sale
(23,022
)
 
(17,025
)
Mortgage loans
(97,510
)
 
(88,023
)
Derivative instruments
(2,675
)
 
(1,584
)
Policy loans
(29,466
)
 
(29,154
)
Securities and indebtedness of related parties
(22,930
)
 
(15,886
)
Short-term investments, net change
31,271

 
64,489

Purchases and disposals of property and equipment, net
(8,330
)
 
(7,434
)
Net cash used in investing activities
(267,370
)
 
(227,437
)




6




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

 
Nine months ended September 30,
 
2015
 
2014
Financing activities
 
 
 
Contract holder account deposits
$
476,664

 
$
457,913

Contract holder account withdrawals
(316,925
)
 
(306,882
)
Receipts related to noncontrolling interests, net
42

 
93

Excess tax deductions on stock-based compensation
1,088

 
828

Issuance or repurchase of common stock, net
(1,491
)
 
(8,065
)
Dividends paid
(79,386
)
 
(26,060
)
Net cash provided by financing activities
79,992

 
117,827

Increase (decrease) in cash and cash equivalents
(43,995
)
 
36,828

Cash and cash equivalents at beginning of period
76,632

 
6,370

Cash and cash equivalents at end of period
$
32,637

 
$
43,198

 
 
 
 
Supplemental disclosures of cash flow information
 
 
 
Cash paid during the period for:
 
 
 
Interest
$
3,638

 
$
3,638

Income taxes
16,501

 
10,701































See accompanying notes.


7


FBL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
September 30, 2015

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 nine-month period ended September 30, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015. We encourage you to refer to our consolidated financial statements and notes for the year ended December 31, 2014 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.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (FASB) issued guidance that outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers, which supersedes most current revenue recognition guidance, including industry-specific guidance. Although insurance contracts are specifically excluded from the scope of this guidance, almost all entities will be affected to some extent by the significant increase in required disclosures. The new guidance is based on the principle that an entity should recognize revenue to reflect the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to fulfill a contract. Entities have the option of using either a full retrospective or a modified retrospective approach for the adoption of the new standard, which becomes effective for fiscal years beginning after December 15, 2017; early adoption is not permitted. We are currently evaluating the impact of this new guidance on our consolidated financial statements.

In February 2015, the FASB issued guidance that amends existing consolidation guidance. The new guidance modifies the consolidation framework for certain investment entities and all limited partnerships. It also eliminates certain criteria used to determine whether fees paid to a decision maker are a variable interest. The amendment allows for either a full retrospective or modified approach at adoption of the new standard, which becomes effective for fiscal years beginning after December 15, 2015. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. We are currently evaluating the impact of this new guidance on our consolidated financial statements.



8

Table of Contents

2. Investment Operations

Fixed Maturity and Equity Securities

Available-For-Sale Fixed Maturity and Equity Securities by Investment Category
 
 
 
 
 
 
 
September 30, 2015
 
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)
$
3,454,960

 
$
245,670

 
$
(84,290
)
 
$
3,616,340

 
$
415

Residential mortgage-backed
440,014

 
40,202

 
(4,731
)
 
475,485

 
(3,560
)
Commercial mortgage-backed
510,629

 
49,983

 
(1,452
)
 
559,160

 

Other asset-backed
568,039

 
15,655

 
(4,581
)
 
579,113

 
4,804

United States Government and agencies
40,648

 
4,057

 
(5
)
 
44,700

 

State, municipal and other governments
1,318,687

 
128,776

 
(2,133
)
 
1,445,330

 

Total fixed maturities
$
6,332,977

 
$
484,343

 
$
(97,192
)
 
$
6,720,128

 
$
1,659

 
 
 
 
 
 
 
 
 
 
Equity securities:
 
 
 
 
 
 
 
 
 
Non-redeemable preferred stocks
$
87,029

 
$
4,635

 
$
(1,301
)
 
$
90,363

 
 
Common stocks
29,793

 
454

 
(67
)
 
30,180

 
 
Total equity securities
$
116,822

 
$
5,089

 
$
(1,368
)
 
$
120,543

 
 
 
December 31, 2014
 
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)
$
3,335,535

 
$
348,937

 
$
(17,566
)
 
$
3,666,906

 
$
211

Residential mortgage-backed
453,607

 
42,510

 
(4,583
)
 
491,534

 
(3,694
)
Commercial mortgage-backed
485,934

 
45,573

 
(812
)
 
530,695

 

Other asset-backed
508,090

 
17,188

 
(4,017
)
 
521,261

 
5,223

United States Government and agencies
38,227

 
4,581

 
(4
)
 
42,804

 

State, municipal and other governments
1,290,040

 
157,571

 
(113
)
 
1,447,498

 

Total fixed maturities
$
6,111,433

 
$
616,360

 
$
(27,095
)
 
$
6,700,698

 
$
1,740

 
 
 
 
 
 
 
 
 
 
Equity securities:
 
 
 
 
 
 
 
 
 
Non-redeemable preferred stocks
$
80,566

 
$
5,135

 
$
(660
)
 
$
85,041

 
 
Common stocks
26,844

 
738

 

 
27,582

 
 
Total equity securities
$
107,410

 
$
5,873

 
$
(660
)
 
$
112,623

 
 

(1)
Non-credit losses, subsequent to the initial impairment measurement date, on other-than-temporary impairment (OTTI) losses are included in the gross unrealized gains and gross unrealized losses columns above. The non-credit loss component of OTTI losses for corporate and other asset-backed securities were in an unrealized gain position at September 30, 2015 and December 31, 2014 due to increases in estimated fair value subsequent to initial recognition of non-credit losses on such securities.
(2)
Corporate securities include hybrid preferred securities with a carrying value of $48.2 million at September 30, 2015 and $80.9 million at December 31, 2014. Corporate securities also include redeemable preferred stock with a carrying value of $24.9 million at September 30, 2015 and $29.9 million at December 31, 2014.


9

Table of Contents

Available-For-Sale Fixed Maturities by Maturity Date
 
 
 
 
 
 
 
 
September 30, 2015
 
Amortized
Cost
 
Estimated
Fair Value
 
(Dollars in thousands)
Due in one year or less
$
104,470

 
$
106,544

Due after one year through five years
720,973

 
784,894

Due after five years through ten years
830,380

 
875,297

Due after ten years
3,158,472

 
3,339,635

 
4,814,295

 
5,106,370

Mortgage-backed and other asset-backed
1,518,682

 
1,613,758

Total fixed maturities
$
6,332,977

 
$
6,720,128


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
 
 
 
 
 
September 30,
2015
 
December 31,
2014
 
(Dollars in thousands)
Net unrealized appreciation on:
 
 
 
Fixed maturities - available for sale
$
387,151

 
$
589,265

Equity securities - available for sale
3,721

 
5,213

 
390,872

 
594,478

Adjustments for assumed changes in amortization pattern of:
 
 
 
Deferred acquisition costs
(112,780
)
 
(179,544
)
Value of insurance in force acquired
(3,537
)
 
(3,939
)
Unearned revenue reserve
5,473

 
11,461

Adjustments for assumed changes in policyholder liabilities
(6,567
)
 
(11,182
)
Provision for deferred income taxes
(95,692
)
 
(143,932
)
Net unrealized investment gains
$
177,769

 
$
267,342


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 the fair value of securities for which a previous non-credit OTTI loss was recognized in accumulated other comprehensive income, are reported along with changes in fair value for which no OTTI losses were previously recognized.



10

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Fixed Maturity and Equity Securities with Unrealized Losses by Length of Time
 
 
 
 
 
 
 
 
 
September 30, 2015
 
 
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
 
$
802,548

 
$
(64,347
)
 
$
96,958

 
$
(19,943
)
 
$
899,506

 
$
(84,290
)
 
86.7
%
Residential mortgage-backed
 
22,564

 
(273
)
 
26,843

 
(4,458
)
 
49,407

 
(4,731
)
 
4.9

Commercial mortgage-backed
 
44,129

 
(881
)
 
7,626

 
(571
)
 
51,755

 
(1,452
)
 
1.5

Other asset-backed
 
71,000

 
(900
)
 
66,455

 
(3,681
)
 
137,455

 
(4,581
)
 
4.7

United States Government and agencies
 
2,010

 
(5
)
 

 

 
2,010

 
(5
)
 

State, municipal and other governments
 
86,915

 
(2,133
)
 

 

 
86,915

 
(2,133
)
 
2.2

Total fixed maturities
 
$
1,029,166

 
$
(68,539
)
 
$
197,882

 
$
(28,653
)
 
$
1,227,048

 
$
(97,192
)
 
100.0
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Equity securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-redeemable preferred stocks
 
$
33,034

 
$
(551
)
 
$
4,250

 
$
(750
)
 
$
37,284

 
$
(1,301
)
 
 
Common stocks
 
1,241

 
(67
)
 

 

 
1,241

 
(67
)
 
 
Total equity securities
 
$
34,275

 
$
(618
)
 
$
4,250

 
$
(750
)
 
$
38,525

 
$
(1,368
)
 
 

 
 
December 31, 2014
 
 
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
 
$
203,764

 
$
(9,756
)
 
$
142,600

 
$
(7,810
)
 
$
346,364

 
$
(17,566
)
 
64.8
%
Residential mortgage-backed
 
27,889

 
(315
)
 
19,084

 
(4,268
)
 
46,973

 
(4,583
)
 
16.9

Commercial mortgage-backed
 

 

 
20,900

 
(812
)
 
20,900

 
(812
)
 
3.0

Other asset-backed
 
128,516

 
(2,349
)
 
55,526

 
(1,668
)
 
184,042

 
(4,017
)
 
14.8

United States Government and agencies
 
500

 

 
470

 
(4
)
 
970

 
(4
)
 

State, municipal and other governments
 

 

 
12,472

 
(113
)
 
12,472

 
(113
)
 
0.5

Total fixed maturities
 
$
360,669

 
$
(12,420
)
 
$
251,052

 
$
(14,675
)
 
$
611,721

 
$
(27,095
)
 
100.0
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Equity securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-redeemable preferred stocks
 
$
14,838

 
$
(110
)
 
$
4,450

 
$
(550
)
 
$
19,288

 
$
(660
)
 
 
Total equity securities
 
$
14,838

 
$
(110
)
 
$
4,450

 
$
(550
)
 
$
19,288

 
$
(660
)
 
 

Fixed maturities in the above tables include 368 securities from 299 issuers at September 30, 2015 and 185 securities from 160 issuers at December 31, 2014. We do not have plans to sell or believe we will be required to sell any of our temporarily-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 September 30, 2015.

Corporate securities: The largest unrealized losses were in the energy sector ($142.3 million carrying value and $25.4 million unrealized loss) and the basic industrial sector ($126.6 million carrying value and $19.5 million unrealized loss). The largest unrealized losses in the energy sector were in the oil field services ($32.5 million carrying value and $12.8 million unrealized loss) and energy-independent ($54.7 million carrying value and $7.2 million unrealized loss) sub-sectors. The largest unrealized losses in the basic industrial sector were in the metal/mining ($62.3 million carrying value and $14.5 million unrealized loss) and the chemicals ($47.1 million carrying value and $4.6 million unrealized loss) sub-sectors. The majority of losses were primarily attributable to credit spread widening across the energy sector and metal/mining sub-sectors associated with sharp declines in commodity prices.



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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.

Other asset-backed securities: The unrealized losses on other asset-backed securities were primarily due to market 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 on equity securities 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 OTTIs similar to fixed maturities. The decline in fair value is primarily due to market concerns regarding the finance sector. We have evaluated the near-term prospects of our equity securities in relation to the severity and duration of their impairment as well as our intent and ability to hold these investments until recovery of fair value, and have concluded they are not other-than-temporarily impaired.

Excluding mortgage- and asset-backed securities, no securities from the same issuer had an aggregate unrealized loss in excess of $3.7 million at September 30, 2015, with the largest unrealized loss from an energy service provider. With respect to mortgage- and asset-backed securities not backed by the United States Government, our largest aggregate unrealized loss from the same issuer at September 30, 2015 was $3.7 million, consisting of two different securities that are backed by different pools of Alt-A residential mortgage loans. Both securities are rated non-investment grade and the largest unrealized loss totaled $2.2 million.

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 an OTTI 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 OTTI 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 an OTTI. In determining whether or not an unrealized loss is an OTTI, 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 OTTI 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 principal and interest payments and an estimated recovery value, generally based on a percentage return of the current fair value.



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After an OTTI write down of all equity securities and any fixed maturities with a credit-only impairment, the cost basis is not adjusted for subsequent recoveries in fair value. 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
 
 
 
 
 
Nine months ended September 30,
 
2015

2014
 
(Dollars in thousands)
Balance at beginning of period
$
(16,772
)
 
$
(21,592
)
Increases to previously impaired investments
(363
)
 

Reductions due to investments sold
757

 
4,468

Balance at end of period
$
(16,378
)
 
$
(17,124
)

The table above 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 OTTI was recognized in other comprehensive income (loss) and corresponding changes in such amounts.
Realized Gains (Losses) - Recorded in Income 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three months ended September 30,
 
Nine months ended September 30,
 
2015
 
2014
 
2015
 
2014
 
(Dollars in thousands)
 
 
 
 
Realized gains (losses) on sales of investments
 
 
 
 
 
 
 
Fixed maturities:
 
 
 
 
 
 
 
Gross gains
$
136

 
$
1,437

 
$
2,884

 
$
4,345

Gross losses
(229
)
 
(164
)
 
(1,832
)
 
(806
)
Securities and indebtedness of related parties

 

 
6,457

 

Net realized gains on investments recorded in income
$
(93
)
 
$
1,273

 
7,509

 
3,539

Impairment losses recognized in earnings:
 
 
 
 
 
 
 
Credit-related portion of fixed maturity losses (1)
(363
)
 

 
(363
)
 

Other credit-related (2)
(50
)
 
(273
)
 
(210
)
 
(273
)
Net realized gains (losses) on investments recorded in income
$
(506
)
 
$
1,000

 
$
6,936

 
$
3,266


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

Proceeds from sales of fixed maturities totaled $88.3 million during the nine months ended September 30, 2015 and $47.5 million during the nine months ended September 30, 2014.

The realized gain on securities and indebtedness of related parties relates to a partnership investment's underlying asset sold at a gain and the dissolution of the partnership during 2015.

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

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


13

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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, management maintains and regularly 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 estimated loss, if needed, for each impaired loan identified. An estimated loss is needed for loans for which we do not believe we will collect all amounts due according to the contractual terms of the respective loan agreements.

Any loan delinquent on contractual payments is considered non-performing. At September 30, 2015 and December 31, 2014, there were no non-performing loans over 90 days past due on contractual payments. 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 non-accrual 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 such that the collection of interest is considered likely.

Mortgage Loans by Collateral Type
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
September 30, 2015
 
December 31, 2014
Collateral Type
 
Carrying Value
 
Percent of Total
 
Carrying Value
 
Percent of Total
 
 
(Dollars in thousands)
Office
 
$
312,177

 
45.0
%
 
$
269,308

 
42.8
%
Retail
 
215,600

 
31.0

 
214,710

 
34.1

Industrial
 
124,673

 
18.0

 
125,425

 
19.9

Other
 
41,619

 
6.0

 
19,853

 
3.2

Total
 
$
694,069

 
100.0
%
 
$
629,296

 
100.0
%

Mortgage Loans by Geographic Location within the United States
 
 
 
 
 
 
 
 
 
 
 
 
 
September 30, 2015
 
December 31, 2014
Region of the United States
 
Carrying Value
 
Percent of Total
 
Carrying Value
 
Percent of Total
 
 
(Dollars in thousands)
South Atlantic
 
$
217,000

 
31.2
%
 
$
191,835

 
30.5
%
West North Central
 
103,723

 
14.9

 
85,664

 
13.6

Pacific
 
96,284

 
13.9

 
94,770

 
15.1

East North Central
 
76,854

 
11.1

 
80,999

 
12.9

Mountain
 
68,523

 
9.9

 
62,473

 
9.9

West South Central
 
64,662

 
9.3

 
50,010

 
7.9

Other
 
67,023

 
9.7

 
63,545

 
10.1

Total
 
$
694,069

 
100.0
%
 
$
629,296

 
100.0
%

Mortgage Loans by Loan-to-Value Ratio
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
September 30, 2015
 
December 31, 2014
Loan-to-Value Ratio
 

Carrying Value
 
Percent of Total
 
Carrying Value
 
Percent of Total
 
 
(Dollars in thousands)
0% - 50%
 
$
236,618

 
34.1
%
 
$
180,884

 
28.7
%
51% - 60%
 
178,501

 
25.7

 
189,210

 
30.1

61% - 70%
 
202,993

 
29.2

 
198,336

 
31.5

71% - 80%
 
67,152

 
9.7

 
53,480

 
8.5

81% - 90%
 
8,805

 
1.3

 
7,386

 
1.2

Total
 
$
694,069

 
100.0
%
 
$
629,296

 
100.0
%


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Table of Contents


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 there are loan modifications or refinance requests.

Mortgage Loans by Year of Origination
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
September 30, 2015
 
December 31, 2014
Year of Origination
 
Carrying Value
 
Percent of Total
 
Carrying Value
 
Percent of Total
 
 
(Dollars in thousands)
2015
 
$
96,592

 
13.9
%
 
$

 
%
2014
 
84,221

 
12.1

 
86,174

 
13.7

2013
 
79,694

 
11.5

 
81,802

 
13.0

2012
 
66,472

 
9.6

 
70,274

 
11.2

2011
 
45,730

 
6.6

 
46,813

 
7.4

2010 and prior
 
321,360

 
46.3

 
344,233

 
54.7

Total
 
$
694,069

 
100.0
%
 
$
629,296

 
100.0
%

 Impaired Mortgage Loans
 
 
 
September 30, 2015
 
December 31, 2014
 
(Dollars in thousands)
Unpaid principal balance
$
21,868

 
$
22,103

Less:
 
 
 
Related allowance
(851
)
 
(857
)
Discount
(132
)
 
(267
)
Carrying value of impaired mortgage loans
$
20,885

 
$
20,979

 Allowance on Mortgage Loans
 
Nine months ended September 30,
 
2015
 
2014
 
(Dollars in thousands)
Balance at beginning of period
$
857

 
$
888

Charge offs
(6
)
 
(24
)
Balance at end of period
$
851

 
$
864


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 troubled debt restructuring 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.

There were no loan modifications during the first three quarters of 2015 or of 2014.

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 would therefore be required to consolidate it for financial reporting purposes. None of our VIE investees were required to be consolidated for any reporting periods presented in this Form 10-Q. Our VIE investments are as follows:



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Table of Contents

 
September 30, 2015
 
December 31, 2014
 
Carrying Value
 
Maximum Exposure to Loss
 
Carrying Value
 
Maximum Exposure to Loss
 
(Dollars in thousands)
Real estate limited partnerships
$
15,486

 
$
15,486

 
$
17,046

 
$
17,046


We make commitments to fund partnership investments in the normal course of business. We did not have any commitments to investees designated as VIEs as of September 30, 2015 or December 31, 2014.

Other

At September 30, 2015, we had committed to provide $35.2 million of additional funds for limited partnerships and limited liability companies in which we invest.

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 $4.2 million at September 30, 2015 and $7.1 million at December 31, 2014. At September 30, 2015, we had master netting agreements with counterparties covering cash collateral payable totaling $0.4 million. This amount was invested and included in the consolidated balance sheets with corresponding amounts netted against the derivative instruments. We also received collateral of $0.5 million at September 30, 2015 which is held in a separate custodial account and not recorded on the balance sheet. Our derivative assets consist of derivatives embedded within our modified coinsurance agreements and call options which provide an economic hedge for our index annuity contracts. Derivative liabilities totaled $8.5 million at September 30, 2015 and $8.7 million at December 31, 2014 and include derivatives embedded within our index annuity contracts and derivatives embedded within our modified coinsurance agreements. The net gain recognized on these derivatives is included in net investment income and interest sensitive benefits.

Net gain (loss) recognized on these derivatives totaled $(2.0) million for the quarter ended September 30, 2015 and $(0.1) million for the same period in 2014 and totaled $(2.1) million for the nine months ended September 30, 2015 and $1.6 million for the same period in 2014.


3. Fair Values

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

Fair Values and Carrying Values
 
 
 
 
 
 
 
 
 
September 30, 2015
 
December 31, 2014
 
Carrying Value
 
Fair Value
 
Carrying Value
 
Fair Value
 
(Dollars in thousands)
Assets
 
 
 
 
 
 
 
Fixed maturities - available for sale
$
6,720,128

 
$
6,720,128

 
$
6,700,698

 
$
6,700,698

Equity securities - available for sale
120,543

 
120,543

 
112,623

 
112,623

Mortgage loans
694,069

 
739,554

 
629,296

 
667,913

Policy loans
185,353

 
234,651

 
182,502

 
230,070

Other investments
988

 
988

 
3,558

 
3,558

Cash, cash equivalents and short-term investments
49,951

 
49,951

 
125,217

 
125,217

Reinsurance recoverable
2,820

 
2,820

 
3,562

 
3,562

Assets held in separate accounts
617,172

 
617,172

 
683,033

 
683,033



16

Table of Contents

Fair Values and Carrying Values (continued)
 
 
 
 
 
 
 
 
 
September 30, 2015
 
December 31, 2014
 
Carrying Value
 
Fair Value
 
Carrying Value
 
Fair Value
 
(Dollars in thousands)
Liabilities
 
 
 
 
 
 
 
Future policy benefits
$
3,715,477

 
$
3,663,602

 
$
3,563,558

 
$
3,666,960

Supplemental contracts without life contingencies
342,260

 
305,842

 
341,955

 
329,651

Advance premiums and other deposits
247,887

 
247,887

 
239,700

 
239,700

Long-term debt
97,000

 
69,394

 
97,000

 
69,772

Other liabilities
60

 
60

 
173

 
173

Liabilities related to separate accounts
617,172

 
612,301

 
683,033

 
677,040


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 market data and where observable market 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 from which we obtain the information. Transfers into 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:

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 asset-backed, United States Government agencies, state and municipal and private placement corporate 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 private placement 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


17

Table of Contents

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 corporate, mortgage- and asset-backed, United States Government agencies and private placement corporate securities for which there is little or no current market data available. We use external pricing sources, or if prices are not available we will estimate fair value internally. Fair values of private corporate investments in Level 3 are determined by reference to the 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 the 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:

We 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 corporate bonds 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.

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

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

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

We compare prices between different pricing sources for unusual disparity.

We meet at least quarterly 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 of Des Moines (FHLB), with estimated fair value based on the current redemption value of the shares and non-redeemable preferred stock. Estimated fair value is obtained from external pricing sources using a matrix pricing approach.

Level 3 equity securities consist of non-redeemable preferred stock for which no active market exists, and fair value estimates for these securities is based on the values of comparable securities which are actively traded. Increases in spreads used in our


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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.

In the case where external pricing services are used for certain Level 1 and Level 2 equity securities, our review process is consistent with the process used to determine the fair value of fixed maturities discussed above.

Mortgage loans:

Mortgage loans are not measured at fair value on a recurring basis. Mortgage loans are a Level 3 measurement as there is no current market for the loans. The fair value of our mortgage loans is estimated internally using a matrix pricing approach. Along with specific loan terms, two key management assumptions are required including the risk rating of the loan (our current rating system is A-highest quality, B-moderate quality, C-low quality, W-watch or F-foreclosure) and estimated spreads for new loans over the U.S. Treasury yield curve. Spreads are updated quarterly and loans are reviewed and rated annually with quarterly adjustments should significant changes occur. Our determination of each loan's risk rating as well as selection of the credit spread requires significant judgment. A higher risk rating, as well as an increase in spreads, would result in a decrease in discounted cash flows used, and accordingly the fair value of the loan.

Policy loans:

Policy loans are not measured at fair value on a recurring basis. Policy loans are a Level 3 measurement as there is no current market since they are specifically tied to the underlying insurance policy. The loans are relatively risk free as they cannot exceed the cash surrender value of the insurance policy. Fair values are estimated by discounting expected cash flows using a risk-free interest rate based on the U.S. Treasury curve. An increase in the risk-free interest rate would result in a decrease in discounted cash flows used, and accordingly the fair value of the loan.

Other investments:

Level 2 other investments include call options with fair values based on counterparty market prices adjusted for a credit component of the counterparty, net of collateral received.

Cash, cash equivalents and short-term investments:

Level 1 cash, cash equivalents and short-term investments are highly liquid instruments for which historical cost approximates fair value.

Reinsurance recoverable:

Level 2 reinsurance recoverable includes embedded derivatives in our modified coinsurance contracts under which we cede or assume business. Fair values of these embedded derivatives are based on the difference between the fair value and the cost basis of the underlying fixed maturities, which are valued consistent with the discussion of fixed maturities above.

Assets held in separate accounts:

Level 1 assets held in separate accounts consist of mutual funds that are actively traded, allowing us to use current market prices as an estimate of their fair value.



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Future policy benefits, supplemental contracts without life contingencies and advance premiums and other deposits:

Level 3 policy-related financial instruments of investment-type contracts are those not involving significant mortality or morbidity risks. No active market exists for these contracts and they are not measured at fair value on a recurring basis. Fair values for our insurance contracts, other than investment-type contracts, are not required to be disclosed. Fair values for our investment-type contracts with expected maturities, including deferred annuities, funding agreements and supplementary contracts, are determined using discounted cash flow valuation techniques based on current interest rates adjusted to reflect our credit risk and an additional provision for adverse deviation. For certain deposit liabilities with no defined maturities and no surrender charges, including pension-related deposit administration funds, advance premiums and other deposits, fair value is the account value or amount payable on demand. Significant judgment is required in selecting the assumptions used to estimate the fair values of these financial instruments. For contracts with known maturities, increases in current rates will result in a decrease in discounted cash flows and a decrease in the estimated fair value of the policy obligation.

Certain annuity contracts include embedded derivatives and are measured at fair value on a recurring basis. These embedded derivatives are a Level 3 measurement. The fair value of the embedded derivatives is based on the discounted excess of projected account values (including a risk margin) over projected guaranteed account values. The key unobservable inputs required in the projection of future values which require management judgment include the risk margin as well as the credit risk of our company. Should the risk margin increase or the credit risk decrease, the discounted cash flows and the estimated fair value of the obligation will increase.

Long-term debt:

Long-term debt is not measured at fair value on a recurring basis. Long-term debt is a Level 3 measurement. The fair value of our outstanding debt is estimated using a discounted cash flow method based on the market's assessment or our current incremental borrowing rate for similar types of borrowing arrangements adjusted, as needed, to reflect our credit risk. Our selection of the credit spread requires significant judgment. A decrease in the spread will increase the estimated fair value of the outstanding debt.

Other liabilities:

Level 2 other liabilities include the embedded derivatives in our modified coinsurance contracts under which we cede business. Fair values for the embedded derivatives are based on the difference between the fair value and the cost basis of the underlying fixed maturities.

Liabilities related to separate accounts:

Separate account liabilities are not measured at fair value on a recurring basis. Level 3 separate account liabilities' fair value is based on the cash surrender value of the underlying contract, which is the cost we would incur to extinguish the liability.



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Valuation of our Financial Instruments Measured on a Recurring Basis by Hierarchy Levels
 
 
 
September 30, 2015
 
Quoted prices in active markets
for identical assets (Level 1)
 
Significant other observable inputs
(Level 2)
 
Significant unobservable inputs
(Level 3)
 
Total
 
(Dollars in thousands)
Assets
 
 
 
 
 
 
 
Corporate securities
$

 
$
3,565,630