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Section 1: 10-Q (10-Q)

Document
 
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 December 31, 2016
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: 001-36227
 
 
 
FIDELITY & GUARANTY LIFE
(Exact name of registrant as specified in its charter)
 
 
 

Delaware
46-3489149
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
Two Ruan Center
601 Locust Street, 14th Floor
Des Moines, Iowa
50309
(Address of principal executive offices)
(Zip Code)
(800) 445-6758
(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.    Yes x    or    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).    Yes x    or    No ¨.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer
¨
 
Accelerated Filer
x
Non-accelerated Filer
¨
(Do not check if a smaller reporting company)
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes ¨    or    No x
There were 58,984,637 shares of the registrant’s common stock outstanding as of February 2, 2017.
 



FIDELITY & GUARANTY LIFE AND SUBSIDIARIES
TABLE OF CONTENTS
 
 
Page
PART I. FINANCIAL INFORMATION & FORWARD LOOKING STATEMENTS
 
 
PART II. OTHER INFORMATION

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PART I: FINANCIAL INFORMATION
Item 1.
Financial Statements
FIDELITY & GUARANTY LIFE AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In millions, except share data)
 
December 31,
2016
 
September 30,
2016
 
(Unaudited)
 
 
ASSETS
 
 
 
Investments:

 
 
Fixed maturity securities, available-for-sale, at fair value (amortized cost: December 31, 2016 - $19,173; September 30, 2016 - $18,521)
$
19,437

 
$
19,411

Equity securities, available-for-sale, at fair value (amortized cost: December 31, 2016 - $691; September 30, 2016 - $640)
696

 
683

Derivative investments
314

 
276

Commercial mortgage loans
582

 
595

Other invested assets
47

 
60

Total investments
21,076

 
21,025

Related party loans
71

 
71

Cash and cash equivalents
632

 
864

Accrued investment income
201

 
214

Reinsurance recoverable
3,444

 
3,464

Intangibles, net
1,228

 
1,026

Deferred tax assets
68

 

Other assets
232

 
371

Total assets
$
26,952

 
$
27,035

 
 
 
 
LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
 
 
 
 
Contractholder funds
$
19,486

 
$
19,251

Future policy benefits
3,453

 
3,467

Funds withheld for reinsurance liabilities
1,142

 
1,172

Liability for policy and contract claims
53

 
55

Debt
300

 
300

Revolving credit facility
100

 
100

Deferred tax liability

 
10

Other liabilities
666

 
746

Total liabilities
25,200

 
25,101

 
 
 
 
Commitments and contingencies ("Note 12")

 

 
 
 
 
Shareholders' equity:
 
 
 
Preferred stock ($.01 par value, 50,000,000 shares authorized, no shares issued at December 31, 2016 and September 30, 2016)
$

 
$

Common stock ($.01 par value, 500,000,000 shares authorized, 58,984,034 issued and outstanding at December 31, 2016; 58,956,127 shares issued and outstanding at September 30, 2016)
1

 
1

Additional paid-in capital
715

 
714

Retained earnings
896

 
792

Accumulated other comprehensive income
153

 
439

Treasury stock, at cost (565,723 shares at December 31, 2016; 537,613 shares at September 30, 2016)
(13
)
 
(12
)
Total shareholders' equity
1,752

 
1,934

Total liabilities and shareholders' equity
$
26,952

 
$
27,035

 
 
 
 

See accompanying notes to unaudited condensed consolidated financial statements.

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FIDELITY & GUARANTY LIFE AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In millions, except share data)

 
Three months ended
 
December 31,
2016
 
December 31,
2015
 
(Unaudited)
Revenues:
 
 
 
Premiums
$
11

 
$
15

Net investment income
240

 
222

Net investment gains
51

 
63

Insurance and investment product fees and other
38

 
29

Total revenues
340

 
329

Benefits and expenses:
 
 
 
Benefits and other changes in policy reserves
20

 
181

Acquisition and operating expenses, net of deferrals
28

 
28

Amortization of intangibles
123

 
41

        Total benefits and expenses
171

 
250

Operating income
169

 
79

Interest expense
(6
)
 
(6
)
Income before income taxes
163

 
73

Income tax expense
(55
)
 
(25
)
        Net income
$
108

 
$
48

 
 
 
 
Net income per common share:
 
 
 
 
 
 
 
Basic
$
1.85

 
$
0.82

Diluted
$
1.85

 
$
0.82

Weighted average common shares used in computing net income per common share:
 
 
 
Basic
58,280,532

 
58,219,260

Diluted
58,366,009

 
58,542,588

 
 
 
 
Cash dividend per common share
$
0.065

 
$
0.065

 
 
 
 
 
 
 
 
Supplemental disclosures:
 
 
 
Total other-than-temporary impairments
$
(1
)
 
$
(10
)
Portion of other-than-temporary impairments included in other comprehensive income

 

Net other-than-temporary impairments
(1
)
 
(10
)
(Losses) Gains on derivative and embedded derivatives
51

 
70

Other realized investment gains
1

 
3

        Total net investment (losses) gains
$
51

 
$
63



See accompanying notes to unaudited condensed consolidated financial statements.

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FIDELITY & GUARANTY LIFE AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In millions)
 
Three months ended
 
December 31,
2016
 
December 31,
2015
 
(Unaudited)
Net income
$
108

 
$
48

 
 
 
 
Other comprehensive (loss) income:
 
 
 
Unrealized investment gains/(losses):
 
 
 
Change in unrealized investment gains/losses before reclassification adjustment
(663
)
 
(373
)
Net reclassification adjustment for (gains) losses included in net income
(2
)
 
7

Changes in unrealized investment gains/losses after reclassification adjustment
(665
)
 
(366
)
Adjustments to intangible assets
225

 
135

Changes in deferred income tax asset/liability
154

 
81

Net changes to derive comprehensive (loss) income for the period
(286
)
 
(150
)
Comprehensive (loss) income, net of tax
$
(178
)
 
$
(102
)

See accompanying notes to unaudited condensed consolidated financial statements.


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FIDELITY & GUARANTY LIFE AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(Unaudited) (In millions)

 
Preferred Stock
 
Common Stock
 
Additional Paid-in Capital
 
Retained Earnings
 
Accumulated Other Comprehensive Income
 
Treasury Stock
 
Total Shareholders' Equity
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, September 30, 2016
$

 
$
1

 
$
714

 
$
792

 
$
439

 
$
(12
)
 
$
1,934

Treasury shares purchased

 

 

 

 

 
(1
)
 
(1
)
Dividends

 

 

 
(4
)
 

 

 
(4
)
Net income

 

 

 
108

 

 

 
108

Unrealized investment losses, net

 

 

 

 
(286
)
 

 
(286
)
Stock compensation

 

 
1

 

 

 

 
1

Balance, December 31, 2016
$

 
$
1

 
$
715

 
$
896

 
$
153

 
$
(13
)
 
$
1,752

 
 
 
 
 
 
 
 
 
 
 
 
 
 

See accompanying notes to unaudited condensed consolidated financial statements.


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FIDELITY & GUARANTY LIFE AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
 
Three months ended
 
December 31,
2016
 
December 31,
2015
 
(Unaudited)
Cash flows from operating activities:
 
 
 
Net income
$
108

 
$
48

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Stock based compensation
1

 
4

Amortization
(6
)
 
(15
)
Deferred income taxes
76

 
23

Interest credited/index credit to contractholder account balances
(13
)
 
136

Net recognized (gains) on investments and derivatives
(51
)
 
(63
)
Charges assessed to contractholders for mortality and administration
(32
)
 
(24
)
Deferred policy acquisition costs, net of related amortization
23

 
(39
)
Changes in operating assets and liabilities:
 
 
 
     Reinsurance recoverable
(8
)
 
(9
)
     Future policy benefits
(14
)
 
5

  Funds withheld from reinsurers
(26
)
 
(16
)
  Collateral posted
40

 
66

     Other assets and other liabilities
(26
)
 
24

Net cash provided by operating activities
72

 
140

Cash flows from investing activities:
 
 
 
Proceeds from available-for-sale investments sold, matured or repaid
733

 
896

Proceeds from derivatives instruments and other invested assets
71

 
89

Proceeds from commercial mortgage loans
13

 
2

Cost of available-for-sale investments acquired
(1,355
)
 
(1,021
)
Costs of derivatives instruments and other invested assets
(54
)
 
(78
)
Costs of commercial mortgage loans

 
(87
)
Related party loans

 
(3
)
Capital expenditures
(2
)
 
(2
)
Net cash (used in) investing activities
(594
)
 
(204
)
Cash flows from financing activities:
 
 
 
Treasury stock
(1
)
 
(1
)
Common stock issued under employee plans

 
2

Dividends paid
(4
)
 
(4
)
Contractholder account deposits
698

 
569

Contractholder account withdrawals
(403
)
 
(436
)
Net cash provided by financing activities
290

 
130

Change in cash & cash equivalents
(232
)
 
66

Cash & cash equivalents, beginning of period
864

 
502

Cash & cash equivalents, end of period
$
632

 
$
568

 
 
 
 
Supplemental disclosures of cash flow information
 
 
 
Interest paid
$
10

 
$
10

Taxes paid
$

 
$
1

Deferred sales inducements
$

 
$
6


See accompanying notes to unaudited condensed consolidated financial statements.

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FIDELITY & GUARANTY LIFE AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(1) Basis of Presentation
Fidelity & Guaranty Life (“FGL” and, collectively with its subsidiaries, the “Company”) is a subsidiary of HRG Group, Inc. (formerly, Harbinger Group Inc. (“HRG”)). The accompanying unaudited consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions for the Securities and Exchange Commission (“SEC”) Quarterly Report on Form 10-Q, including Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements.  Therefore, the information contained in the Notes to Consolidated Financial Statements included in Fidelity & Guaranty Life and Subsidiaries' Annual Report on Form 10-K, for the year ended September 30, 2016 (“2016 Form 10-K”), should be read in connection with the reading of these interim unaudited condensed consolidated financial statements. Dollar amounts in the accompanying sections are presented in millions, unless otherwise noted.
FGL markets products through its wholly-owned insurance subsidiaries, Fidelity & Guaranty Life Insurance Company (“FGL Insurance”) and Fidelity & Guaranty Life Insurance Company of New York (“FGL NY Insurance”), which together is licensed in all fifty states and the District of Columbia.
On November 8, 2015, FGL entered into an Agreement and Plan of Merger (as amended “Merger Agreement” and the merger contemplated thereby, the "Merger"), by and among FGL, Anbang Insurance Group Co., Ltd., a joint-stock insurance company established in the People’s Republic of China (“Anbang”), AB Infinity Holding, Inc., a Delaware corporation and a wholly-owned subsidiary of Anbang (“AB Infinity”), and AB Merger Sub, Inc., a Delaware corporation and a newly formed, wholly-owned subsidiary of AB Infinity (“Merger Sub”), which was amended on November 3, 2016, to extend the outside termination date for the completion of the Merger from November 7, 2016 to February 8, 2017. Accordingly, either party may terminate the merger agreement if the closing of the merger does not occur prior to February 8, 2017. As of the date of this report, the parties were in discussions regarding an extension of the outside termination date beyond February 8, 2017. The Company expects to make an announcement on or about February 9, 2017 regarding the outcome of their discussions.
Pursuant to the Merger Agreement, at the effective time of the Merger, each issued and outstanding share of FGL common stock will be canceled and converted automatically into the right to receive $26.80 in cash, without interest, other than any shares of common stock owned by FGL as treasury stock or otherwise or owned by Anbang, AB Infinity or Merger Sub (which will be canceled and no payment will be made with respect thereto), shares of common stock granted pursuant to FGL’s employee equity award plan and those shares of common stock with respect to which appraisal rights under Delaware law are properly exercised and not withdrawn.
At the effective time of the Merger, each, vested and unvested, FGL option to purchase shares of common stock and restricted shares of common stock will become fully vested and automatically converted into the right to receive a cash payment in an amount pursuant to the Merger Agreement.  In addition, at such time, each, vested and unvested, stock option and restricted stock unit relating to shares of Fidelity & Guaranty Life Holdings, Inc., a subsidiary of FGL (“FGLH”) will become fully vested and automatically converted into the right to receive a cash payment in an amount pursuant to the Merger Agreement, and each dividend equivalent right held in respect of a share of FGLH stock (a “DER”), whether vested or unvested, will become fully vested and automatically converted into the right to receive a cash payment equal to the amount accrued with respect to such DER. All DER were vested as of March 31, 2016 and were paid out in April 2016.
The Merger is subject to closing conditions, including the receipt of regulatory approvals from the Iowa Insurance Division, New York Department of Financial Services, Vermont Department of Financial Regulation, China Insurance Regulatory Commission, and the Committee on Foreign Investment in the United States ("CFIUS"). In the event that the Merger Agreement is terminated, FGL may be required to pay a termination fee to Anbang and its subsidiaries of $51.
On November 8, 2015, FS Holdco II Ltd., a wholly-owned subsidiary of HRG Group, Inc. and direct holder of 47,000 thousand shares of FGL’s common stock representing approximately 81% of the outstanding shares of FGL’s common stock, delivered a written consent adopting, authorizing, accepting and approving in all respects the Merger Agreement and the transactions contemplated thereby, including the Merger. On November 25, 2015,

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FGL obtained the requisite approval for the Merger from the Vermont Department of Financial Regulation. On March 14, 2016, FGL received notification from CFIUS that it had concluded all action under Section 721 of the Defense Production Act of 1950, as amended, and determined that there are no unresolved national security concerns with respect to the merger. The parties are not required to file a notification of the Merger under the Hart-Scott Rodino Antitrust Improvements Act of 1976, as amended, due to an available exemption. The adoption of the Merger Agreement by FGL’s shareholders required the affirmative vote or written consent of holders of at least a majority of the outstanding shares of FGL’s common stock.
In the opinion of management, these statements include all normal recurring adjustments necessary for a fair presentation of the Company’s results.  Operating results for the three months ended December 31, 2016, are not necessarily indicative of the results that may be expected for the full year ending September 30, 2017.  Amounts reclassified out of other comprehensive income are reflected in net investment gains in the unaudited Condensed Consolidated Statements of Operations.
(2) Significant Accounting Policies and Practices
Principles of Consolidation
The accompanying unaudited condensed consolidated financial statements include the accounts of the Company and all other entities in which FGL has a controlling financial interest. All intercompany accounts and transactions have been eliminated in consolidation.
We are involved in certain entities that are considered variable interest entities ("VIEs") as defined under GAAP. Our involvement with VIEs is primarily to invest in assets that allow us to gain exposure to a broadly diversified portfolio of asset classes. A VIE is an entity that does not have sufficient equity to finance its own activities without additional financial support or where investors lack certain characteristics of a controlling financial interest. We assess our relationships to determine if we have the ability to direct the activities, or otherwise exert control to evaluate if we are the primary beneficiary of the VIE. See "Note 4. Investments" to the Company’s unaudited Condensed Consolidated Financial Statements for additional information on the Company’s investments in unconsolidated VIEs.
Adoption of New Accounting Pronouncements
Share-Based Payments When a Performance Target is Achieved after the Requisite Service Period
In June 2014, the FASB issued new guidance on Stock Compensation (ASU 2014-12, Accounting for Share-Based Payments When the Term of an Award Provide that a Performance Target Could Be Achieved after the Requisite Service Period), effective for fiscal years beginning after December 15, 2015 and interim periods within those years. The new guidance requires performance targets that affect vesting and that could be achieved after the requisite service period to be treated as performance conditions. Such performance targets will not be included in the grant-date fair value calculation of the award, rather compensation cost will be recorded when it is probable the performance target will be reached and should represent the compensation cost attributable to period(s) for which the requisite service has already been rendered. The Company adopted this guidance effective October 1, 2016, as required. The adoption of ASU 2014-12 will not impact the Company's consolidated financial statements or related disclosures, as the Company has historically treated the performance targets for its share-based payment awards as a performance condition that affects vesting and has not reflected the targets in the grant-date fair value calculation of the awards.
Amendments to the Consolidation Analysis
In February 2015, the FASB issued amended consolidation guidance (ASU 2015-02, Amendments to the Consolidation Analysis), effective for fiscal years beginning after December 15, 2015. The amended guidance changes the consolidation analysis of reporting entities with variable interest entity ("VIE") relationships by i) modifying the criteria used to evaluate whether limited partnerships and similar legal entities are VIEs or voting interest entities and revising the primary beneficiary determination of a VIE, ii) eliminating the specialized consolidation model and guidance for limited partnerships thereby removing the presumption that a general partner should consolidate a limited partnership, iii) reducing the criteria in the variable interest model contained in Accounting Standards Codification Topic 810, Consolidation, that is used to evaluate whether the fees paid to a decision maker or service provider represents a variable interest, and iv) exempting reporting entities from consolidating money market funds that operate in accordance with Rule 2a-7 of the Investment Company Act of

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1940. The Company adopted ASU 2015-02 effective October 1, 2016, as required. The adoption of ASU 2015-02 will not impact the Company's consolidated financial statements or related disclosure as the Company determined that this new guidance does not change its conclusions regarding consolidation of its VIEs.
Presentation of Debt Issuance Costs
In April 2015, the FASB issued amended guidance (ASU 2015-03, Interest-Imputation of Interest (Subtopic 835-30), Simplifying the Presentation of Debt Issuance Costs), effective for fiscal years beginning after December 15, 2015 and interim periods within those years. The amended guidance requires debt issuance costs related to a recognized debt liability to be presented on the balance sheet as a direct deduction from the debt liability, similar to the presentation of debt discounts or premiums. The cost of issuing debt will no longer be recorded as a separate asset, except when incurred before the receipt of the funding from the associated debt liability. Instead, debt issuance costs will be presented on the balance sheet as a direct deduction from the carrying amount of the related debt liability, and the costs will be amortized to interest expense using the effective interest method. The Company adopted ASU 2015-03 effective October 1, 2016, as required. The Company retrospectively considered adjustments to adjust its historical balance sheets to present deferred debt issuance costs related to the Company's debt as a reduction of the debt liability. As the Company's debt issuance costs were fully amortized as of the period ended September 30, 2016, there is no impact to the current period financial statements.
Accounting for Fees Paid in Cloud Computing Arrangements
In April 2015, the FASB issued amended guidance (ASU 2015-05, Customer's Accounting for Fees Paid in a Cloud Computing Arrangement), effective for fiscal years beginning after December 15, 2015 and interim periods within those years. Previous GAAP did not include explicit guidance regarding a customer's accounting for fees paid in a cloud computing arrangement, which may include software as a service, platform as a service, infrastructure as a service, and other similar hosting arrangements. The adopted guidance addresses whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If the cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The Company prospectively adopted ASU 2015-05 effective as of October 1, 2016, as required, for all new or materially modified cloud computing arrangements that contain a software license component.
Investments That Calculate Net Asset Value per Share
In May 2015, the FASB issued amended guidance (ASU 2015-07, Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent)), effective for fiscal years beginning after December 15, 2015 and interim periods within those years. Previous GAAP required that investments for which fair value is measured at net asset value (or its equivalent) using the practical expedient in Topic 820 be categorized within the fair value hierarchy using criteria that differ from the criteria used to categorize other fair value measurements within the hierarchy. Previously, investments valued using the practical expedient were categorized within the fair value hierarchy on the basis of whether the investment is redeemable with the investee at net asset value on the measurement date, never redeemable with the investee at net asset value, or redeemable with the investee at net asset value at a future date. For investments that are redeemable with the investee at a future date, a reporting entity will take into account the length of time until those investments become redeemable to determine the classification within the fair value hierarchy. There is diversity in practice related to how certain investments measured at net asset value with redemption dates in the future (including periodic redemption dates) are categorized within the fair value hierarchy. Under the amendments in this Update, investments for which fair value will be measured at net asset value per share (or its equivalent) using the practical expedient should not be categorized in the fair value hierarchy. Removing those investments from the fair value hierarchy not only eliminates the diversity in practice resulting from the way in which investments measured at net asset value per share (or its equivalent) with future redemption dates are classified, but also ensures that all investments categorized in the fair value hierarchy are classified using a consistent approach. Investments that calculate net asset value per share (or its equivalent), but for which the practical expedient is not applied will continue to be included in the fair value hierarchy. The Company adopted ASU 2015-07 effective October 1, 2016, as required, and has updated the fair value disclosures to reflect the amended guidance. Refer to "Note 6. Fair Value of Financial Instruments" for further details.

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Future Adoption of Accounting Pronouncements
Presentation of Changes in Restricted Cash on the Cash Flow Statement
In November 2016, the FASB issued amended guidance (ASU 2016-18, Statement of Cash Flows (Topic 230), Restricted Cash), effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years. The ASU will require amounts generally described as changes in restricted cash and restricted cash equivalents to be included with cash and cash equivalents on the statement of cash flows. The amendments in this ASU may be early adopted during any period or interim period, however, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. The amendments should be applied using a retrospective transition method to each period presented. The Company will not early adopt this standard and is currently evaluating the impact of this new accounting guidance on its consolidated financial statements.

Technical Corrections and Improvements
In December 2016, the FASB issued new guidance on the Simplification of Topics Within Insurance and Debt Restructuring (ASU 2016-19, Technical Corrections and Improvements), effective upon issuance for most amendments in the Update. For several items requiring transition guidance, the ASU identifies adoption dates specific to those items. The amendments cover a wide range of topics in the Accounting Standards Codification ("ASC") and will correct differences between original guidance and the ASC, clarify guidance through updated wording or corrected references, and simplify guidance through minor editing. The amendments in this ASU that do not require transition guidance were effective upon issuance, however, those that require transition guidance may be early adopted. The Company adopted the amendments that do not require transition guidance upon issuance of ASU 2016-19 with no impact on its financial statements. The Company will not early adopt the guidance in this standard that require transition guidance and is currently evaluating the impact of this new accounting guidance on its consolidated financial statements.

(3) Significant Risks and Uncertainties

Federal Regulation    

In April 2016, the Department of Labor (“DOL”) released its final “fiduciary” rule which could have a material impact on the Company, its products, distribution, and business model. The final rule treats persons who provide investment advice for a fee or other compensation with respect to assets of an employer plan or individual retirement account ("IRA") as fiduciaries of that plan or IRA. Significantly, the rule expands the definition of fiduciary to apply to persons, including insurance agents, who advise and sell products to IRA owners. As a practical matter, this means commissioned insurance agents selling the Company’s IRA products must qualify for a prohibited transaction exemption which requires the agent and financial institution to meet various conditions including that an annuity sale be in the “best interest” of the client without regard for the agent’s, financial institution’s or other party’s financial or other interests, and that any compensation paid to the agent and financial institution be reasonable. The final rule was effective June 2016 and generally applicable in April 2017. The rule has generated considerable controversy and is the subject of industry efforts to block implementation both in Congress and through court actions. The success or failure of these efforts cannot be predicted. Assuming the rule is not blocked, the precise impact of the rule on the financial services industry more generally, and the impact on the Company and its business in particular, is difficult to assess. We believe however it could have an adverse effect on sales of annuity products to IRA owners particularly in the independent agent distribution channel. A significant portion of our annuity sales are to IRAs. Compliance with the prohibited transaction exemptions would likely require additional supervision of agents, cause changes to compensation practices and product offerings, and increase litigation risk, all of which could adversely impact our business, results of operations and/or financial condition. Regardless of the outcome of the court and political challenges, FGL Insurance is prepared to execute on its implementation plans on the applicability date.
Use of Estimates and Assumptions
The preparation of the Company’s unaudited Condensed Consolidated Financial Statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets

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and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates and assumptions used.
Concentrations of Financial Instruments
As of December 31, 2016 and September 30, 2016, the Company’s most significant investment in one industry, excluding United States ("U.S.") Government securities, was its investment securities in the banking industry with a fair value of $2,570 or 12% and $2,448 or 12%, respectively, of the invested assets portfolio, and an amortized cost of $2,552 and $2,352, respectively. As of December 31, 2016, the Company’s holdings in this industry include investments in 106 different issuers with the top ten investments accounting for 32% of the total holdings in this industry. As of December 31, 2016 and September 30, 2016, the Company had no investments in issuers that exceeded 10% of shareholders' equity. The Company's largest concentration in any single issuer as of December 31, 2016 and September 30, 2016 was Wells Fargo & Company with a total fair value of $166 or 1% and $171 or 1% of the invested assets portfolio, respectively.

Concentrations of Financial and Capital Markets Risk
The Company is exposed to financial and capital markets risk, including changes in interest rates and credit spreads which can have an adverse effect on the Company’s results of operations, financial condition and liquidity. The Company expects to continue to face challenges and uncertainties that could adversely affect its results of operations and financial condition. The Company attempts to mitigate the risk, including changes in interest rates by investing in less rate-sensitive investments, including senior tranches of collateralized loan obligations, non-agency residential mortgage-backed securities, and various types of asset backed securities.
The Company’s exposure to such financial and capital markets risk relates primarily to the market price and cash flow variability associated with changes in interest rates. A rise in interest rates, in the absence of other countervailing changes, will decrease the net unrealized gain position of the Company’s investment portfolio and, if long-term interest rates rise dramatically within a six to twelve month time period, certain of the Company’s products may be exposed to disintermediation risk. Disintermediation risk refers to the risk that policyholders may surrender their contracts in a rising interest rate environment, requiring the Company to liquidate assets in an unrealized loss position. Management believes this risk is mitigated to some extent by surrender charge protection provided by the Company’s products.
Concentration of Reinsurance Risk
The Company has a significant concentration of reinsurance with Wilton Reassurance Company (“Wilton Re”) and Front Street Re (Cayman) Ltd. ("FSRCI"), an affiliate, that could have a material impact on the Company’s financial position in the event that Wilton Re or FSRCI fail to perform their obligations under the various reinsurance treaties. Wilton Re is a wholly owned subsidiary of Canada Pension Plan Investment Board ("CPPIB"). CPPIB has an AAA issuer credit rating from Standard & Poor's Ratings Services ("S&P") as of December 31, 2016. As of December 31, 2016, the net amount recoverable from Wilton Re was $1,528 and the net amount recoverable from FSRCI was $1,087. The coinsurance agreement with FSRCI is on a funds withheld basis. The Company monitors both the financial condition of individual reinsurers and risk concentration arising from similar geographic regions, activities and economic characteristics of reinsurers to attempt to reduce the risk of default by such reinsurers.


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Table of Contents

(4) Investments
The Company’s fixed maturity and equity securities investments have been designated as available-for-sale and are carried at fair value with unrealized gains and losses included in accumulated other comprehensive income (loss) (“AOCI”) net of associated adjustments for deferred acquisition costs (“DAC”), value of business acquired (“VOBA”), and deferred income taxes. The Company’s consolidated investments at December 31, 2016 and September 30, 2016 are summarized as follows:
 
December 31, 2016
 
 Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
 
Carrying Value
 
 
 
 
 
 
 
 
 
 
Available-for sale securities
 
 
 
 
 
 
 
 
 
Asset-backed securities
$
2,629

 
$
17

 
$
(38
)
 
$
2,608

 
$
2,608

Commercial mortgage-backed securities
852

 
7

 
(22
)
 
837

 
837

Corporates
11,294

 
412

 
(227
)
 
11,479

 
11,479

Equities
691

 
17

 
(12
)
 
696

 
696

Hybrids
1,352

 
45

 
(64
)
 
1,333

 
1,333

Municipals
1,553

 
113

 
(25
)
 
1,641

 
1,641

Residential mortgage-backed securities
1,269

 
65

 
(25
)
 
1,309

 
1,309

U.S. Government
224

 
6

 

 
230

 
230

Total available-for-sale securities
19,864

 
682

 
(413
)
 
20,133

 
20,133

Derivative investments
218

 
104

 
(8
)
 
314

 
314

Commercial mortgage loans
582

 

 

 
574

 
582

Other invested assets
47

 

 

 
43

 
47

Total investments
$
20,711

 
$
786

 
$
(421
)
 
$
21,064

 
$
21,076


 
September 30, 2016
 
 Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
 Fair Value
 
Carrying Value
 
 
 
 
 
 
 
 
 
 
Available-for-sale securities
 
 
 
 
 
 
 
 
 
Asset-backed securities
$
2,528

 
$
16

 
$
(45
)
 
$
2,499

 
$
2,499

Commercial mortgage-backed securities
850

 
23

 
(9
)
 
864

 
864

Corporates
10,712

 
760

 
(132
)
 
11,340

 
11,340

Equities
640

 
47

 
(4
)
 
683

 
683

Hybrids
1,356

 
77

 
(47
)
 
1,386

 
1,386

Municipals
1,515

 
206

 
(4
)
 
1,717

 
1,717

Residential mortgage-backed securities
1,327

 
63

 
(28
)
 
1,362

 
1,362

U.S. Government
233

 
10

 

 
243

 
243

Total available-for-sale securities
19,161

 
1,202

 
(269
)
 
20,094

 
20,094

Derivative investments
221

 
78

 
(23
)
 
276

 
276

Commercial mortgage loans
595

 

 

 
614

 
595

Other invested assets
60

 

 

 
58

 
60

Total investments
$
20,037

 
$
1,280

 
$
(292
)
 
$
21,042

 
$
21,025

Included in AOCI were cumulative gross unrealized gains of $1 and gross unrealized losses of $3 related to the non-credit portion of other-than-temporary impairments ("OTTI") on non-agency residential mortgage-backed securities ("RMBS") at December 31, 2016 and gross unrealized gains of $1 and gross unrealized losses of $3 related to the non-credit portion of OTTI on RMBS at September 30, 2016.
Securities held on deposit with various state regulatory authorities had a fair value of $18,155 and $18,075 at December 31, 2016 and September 30, 2016, respectively. Under Iowa regulations, insurance companies are required to hold securities on deposit in an amount no less than the Company's legal reserve as prescribed by Iowa regulations.

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Table of Contents

At December 31, 2016 and September 30, 2016, the company held investments that were non-income producing for a period greater than twelve months with fair values of $0 and $2, respectively.
In accordance with the Company's Federal Home Loan Bank of Atlanta (“FHLB”) agreements, the investments supporting the funding agreement liabilities are pledged as collateral to secure the FHLB funding agreement liabilities. The collateral investments had a fair value of $622 and $649 at December 31, 2016 and September 30, 2016, respectively.
The amortized cost and fair value of fixed maturity available-for-sale securities by contractual maturities, as applicable, are shown below. Actual maturities may differ from contractual maturities because issuers may have the right to call or pre-pay obligations.
 
December 31, 2016
 
Amortized Cost
 
 Fair Value
Corporates, Non-structured Hybrids, Municipal and U.S. Government securities:
 
 
 
Due in one year or less
$
290

 
$
294

Due after one year through five years
1,940

 
1,978

Due after five years through ten years
3,189

 
3,261

Due after ten years
8,256

 
8,433

Subtotal
13,675

 
13,966

Other securities which provide for periodic payments:
 
 
 
Asset-backed securities
2,629

 
2,608

Commercial mortgage-backed securities
852

 
837

Structured hybrids
748

 
717

Residential mortgage-backed securities
1,269

 
1,309

Subtotal
5,498

 
5,471

Total fixed maturity available-for-sale securities
$
19,173

 
$
19,437

The Company's available-for-sale securities with unrealized losses are reviewed for potential OTTI. In evaluating whether a decline in value is other-than-temporary, the Company considers several factors including, but not limited to the following: (1) the extent and the duration of the decline; (2) the reasons for the decline in value (credit event, currency or interest-rate related, including general credit spread widening); and (3) the financial condition of and near-term prospects of the issuer. The Company also considers the ability and intent to hold the investment for a period of time to allow for a recovery of value.
The Company analyzes its ability to recover the amortized cost by comparing the net present value of cash flows expected to be collected with the amortized cost of the security. For mortgage-backed and asset-backed securities, cash flow estimates consider the payment terms of the underlying assets backing a particular security, including interest rate and prepayment assumptions, based on data from widely accepted third-party data sources or internal estimates. In addition to interest rate and prepayment assumptions, cash flow estimates also include other assumptions regarding the underlying collateral including default rates and recoveries, which vary based on the asset type and geographic location, as well as the vintage year of the security. For structured securities, the payment priority within the tranche structure is also considered. For all other fixed maturity securities, cash flow estimates are driven by assumptions regarding probability of default and estimates regarding timing and amount of recoveries associated with a default. If the net present value is less than the amortized cost of the investment, an OTTI is recognized.
Based on the results of our process for evaluating available-for-sale securities in unrealized loss positions for OTTI discussed above, the Company determined that the unrealized losses as of December 31, 2016 increased due to upward movement in the U.S. Treasury rates. Bond prices in most sectors moved lower based on these higher Treasury yields. Based on an assessment of all securities in the portfolio in unrealized loss positions, the Company determined that the unrealized losses on the securities presented in the table below were not other-than-temporarily impaired as of December 31, 2016.

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Table of Contents

The fair value and gross unrealized losses of available-for-sale securities, aggregated by investment category and duration of fair value below amortized cost, were as follows:
 
December 31, 2016
 
Less than 12 months
 
12 months or longer
 
Total
 
Fair Value
 
Gross Unrealized
Losses
 
Fair Value
 
Gross Unrealized
Losses
 
Fair Value
 
Gross Unrealized
Losses
Available-for-sale securities
 
 
 
 
 
 
 
 
 
 
 
Asset-backed securities
$
439

 
$
(2
)
 
$
1,348

 
$
(36
)
 
$
1,787

 
$
(38
)
Commercial mortgage-backed securities
327

 
(8
)
 
188

 
(14
)
 
515

 
(22
)
Corporates
2,716

 
(88
)
 
1,191

 
(139
)
 
3,907

 
(227
)
Equities
232

 
(9
)
 
64

 
(3
)
 
296

 
(12
)
Hybrids
246

 
(15
)
 
476

 
(49
)
 
722

 
(64
)
Municipals
440

 
(21
)
 
36

 
(4
)
 
476

 
(25
)
Residential mortgage-backed securities
49

 
(1
)
 
486

 
(24
)
 
535

 
(25
)
U.S. Government
51

 

 

 

 
51

 

Total available-for-sale securities
$
4,500

 
$
(144
)
 
$
3,789

 
$
(269
)
 
$
8,289

 
$
(413
)
Total number of available-for-sale securities in an unrealized loss position less than twelve months
 
 
 
 
 
 
 
 
 
 
620

Total number of available-for-sale securities in an unrealized loss position twelve months or longer
 
 
 
 
 
 
 
 
 
 
527

Total number of available-for-sale securities in an unrealized loss position
 
 
 
 
 
 
 
 
 
 
1,147


 
September 30, 2016
 
Less than 12 months
 
12 months or longer
 
Total
 
Fair Value
 
Gross Unrealized
Losses
 
Fair Value
 
Gross Unrealized
Losses
 
Fair Value
 
Gross Unrealized
Losses
Available-for-sale securities
 
 
 
 
 
 
 
 
 
 
 
Asset-backed securities
$
352

 
$
(4
)
 
$
1,368

 
$
(41
)
 
$
1,720

 
$
(45
)
Commercial mortgage-backed securities
44

 
(1
)
 
182

 
(8
)
 
226

 
(9
)
Corporates
413

 
(9
)
 
1,031

 
(123
)
 
1,444

 
(132
)
Equities
51

 
(1
)
 
75

 
(3
)
 
126

 
(4
)
Hybrids
41

 
(2
)
 
412

 
(45
)
 
453

 
(47
)
Municipals
69

 
(2
)
 
38

 
(2
)
 
107

 
(4
)
Residential mortgage-backed securities
70

 
(1
)
 
544

 
(27
)
 
614

 
(28
)
Total available-for-sale securities
$
1,040

 
$
(20
)
 
$
3,650

 
$
(249
)
 
$
4,690

 
$
(269
)
Total number of available-for-sale securities in an unrealized loss position less than twelve months
 
 
 
 
 
 
 
 
 
 
193

Total number of available-for-sale securities in an unrealized loss position twelve months or longer
 
 
 
 
 
 
 
 
 
 
543

Total number of available-for-sale securities in an unrealized loss position
 
 
 
 
 
 
 
 
 
 
736

At December 31, 2016 and September 30, 2016, securities in an unrealized loss position were primarily concentrated in investment grade, corporate debt, asset-backed, and hybrid instruments.
At December 31, 2016 and September 30, 2016, securities with a fair value of $131 and $183, respectively, had an unrealized loss greater than 20% of amortized cost (excluding U.S. Government and U.S. Government sponsored agency securities), which represented less than 1% of the carrying value of all investments in both reporting periods.

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Table of Contents

The following table provides a reconciliation of the beginning and ending balances of the credit loss portion of OTTI on fixed maturity available-for-sale securities held by the Company for the three months ended December 31, 2016 and 2015, for which a portion of the OTTI was recognized in AOCI:
 
Three months ended
 
December 31, 2016
 
December 31, 2015
Beginning balance
$
3

 
$
3

Increases attributable to credit losses on securities:
 
 
 
OTTI was previously recognized

 

OTTI was not previously recognized

 

Ending balance
$
3

 
$
3

The Company recognized $1 of credit impairment losses in operations during the three months ended December 31, 2016 and $0 of change of intent impairment losses in operations during the three months ended December 31, 2016, related to fixed maturity securities with an amortized cost of $115 and a fair value of $114 at December 31, 2016. During the three months ended December 31, 2015, the Company recognized $10 of credit impairment losses in operations related to fixed maturity securities and other invested assets with an amortized cost of $64 and a fair value of $54 at December 31, 2015.
Details underlying write-downs taken as a result of OTTI that were recognized in "Net income" and included in net realized gains on securities were as follows:
 
Three months ended
 
December 31, 2016
 
December 31, 2015
OTTI Recognized in Net Income:
 
 
 
Asset-backed securities
$
1

 
$
4

Corporates

 
6

Total
$
1

 
$
10

The portion of OTTI recognized in AOCI is disclosed in the unaudited Condensed Consolidated Statements of Comprehensive Income (Loss).



16

Table of Contents

Commercial Mortgage Loans
Commercial mortgage loans ("CMLs") represented approximately 3% of the Company’s total investments as of December 31, 2016 and September 30, 2016. The Company primarily makes mortgage loans on income producing properties including hotels, industrial properties, retail buildings, multifamily properties and office buildings. The Company diversifies its CML portfolio by geographic region and property type to attempt to reduce concentration risk. Subsequent to origination, the Company continuously evaluates CMLs based on relevant current information to ensure properties are performing at a consistent and acceptable level to secure the related debt. The distribution of CMLs, gross of valuation allowances, by property type and geographic region is reflected in the following tables:
 
December 31, 2016
 
September 30, 2016
 
Gross Carrying Value
 
% of Total
 
Gross Carrying Value
 
% of Total
Property Type:
 
 
 
 
 
 
 
Funeral Home
$
1

 
%
 
$
1

 
%
Hotel
23

 
4
%
 
23

 
4
%
Industrial - General
46

 
8
%
 
58

 
10
%
Industrial - Warehouse
65

 
11
%
 
64

 
11
%
Multifamily
70

 
12
%
 
70

 
11
%
Office
159

 
27
%
 
160

 
27
%
Retail
219

 
38
%
 
220

 
37
%
Total commercial mortgage loans, gross of valuation allowance
$
583

 
100
%
 
$
596

 
100
%
Allowance for loan loss
(1
)
 
 
 
(1
)
 
 
Total commercial mortgage loans
$
582

 
 
 
$
595

 
 
 
 
 
 
 
 
 
 
U.S. Region:
 
 
 
 
 
 
 
East North Central
$
136

 
23
%
 
$
137

 
23
%
East South Central
20

 
4
%
 
21

 
4
%
Middle Atlantic
86

 
15
%
 
97

 
16
%
Mountain
68

 
12
%
 
67

 
12
%
New England
14

 
2
%
 
14

 
2
%
Pacific
136

 
23
%
 
136

 
23
%
South Atlantic
67

 
12
%
 
67

 
11
%
West North Central
14

 
2
%
 
14

 
2
%
West South Central
42

 
7
%
 
43

 
7
%
Total commercial mortgage loans, gross of valuation allowance
$
583

 
100
%
 
$
596

 
100
%
Allowance for loan loss
(1
)
 
 
 
(1
)
 
 
Total commercial mortgage loans
$
582

 
 
 
$
595

 
 
Within the Company's CML portfolio, 100% of all CMLs had a loan-to-value (“LTV”) ratio of less than 75% at inception at December 31, 2016 and September 30, 2016. As of December 31, 2016, all CMLs are current and have not experienced credit or other events which would require the recording of an impairment loss.
LTV and debt service coverage (“DSC”) ratios are measures commonly used to assess the risk and quality of mortgage loans. The LTV ratio, calculated at time of origination, is expressed as a percentage of the amount of the loan relative to the value of the underlying property. A LTV ratio in excess of 100% indicates the unpaid loan amount exceeds the underlying collateral. The DSC ratio, based upon the most recently received financial statements, is expressed as a percentage of the amount of a property’s net income to its debt service payments. A DSC ratio of less than 1.00 indicates that a property’s operations do not generate sufficient income to cover debt payments.

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Table of Contents

The following table presents the recorded investment in CMLs by LTV and DSC ratio categories and estimated fair value by the indicated loan-to-value ratios at December 31, 2016 and September 30, 2016:
 
Debt Service Coverage Ratios
 
Total Amount
 
% of Total
 
Estimated Fair Value
 
% of Total
 
>1.25
 
1.00 - 1.25
 
< 1.00
 
N/A(a)
 
 
 
 
December 31, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
LTV Ratios:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Less than 50%
$
195

 
$

 
$
18

 
$
1

 
$
214

 
37
%
 
$
210

 
37
%
50% to 60%
234

 

 

 

 
234

 
40
%
 
230

 
40
%
60% to 75%
112

 
7

 
16

 

 
135

 
23
%
 
134

 
23
%
Commercial mortgage loans
$
541

 
$
7

 
$
34

 
$
1

 
$
583

 
100
%
 
$
574

 
100
%
September 30, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
LTV Ratios:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Less than 50%
$
158

 
$
18

 
$

 
$
1

 
$
177

 
29
%
 
$
181

 
29
%
50% to 60%
189

 

 

 

 
189

 
32
%
 
194

 
32
%
60% to 75%
230

 

 

 

 
230

 
39
%
 
239

 
39
%
Commercial mortgage loans
$
577

 
$
18

 
$

 
$
1

 
$
596

 
100
%
 
$
614

 
100
%
(a) N/A - Current DSC ratio not available.

We establish a general mortgage loan allowance based upon the underlying risk and quality of the mortgage loan portfolio using DSC ratio and LTV ratio. A higher LTV ratio will result in a higher allowance. A higher DSC ratio will result in a lower allowance. We believe that the DSC ratio is an indicator of default risk on loans. We believe that the LTV ratio is an indicator of the principal recovery risk for loans that default.
 
December 31, 2016
 
September 30, 2016
Gross balance commercial mortgage loans
$
583

 
$
596

Allowance for loan loss
(1
)
 
(1
)
Net balance commercial mortgage loans
$
582

 
$
595

The Company recognizes a mortgage loan as delinquent when payments on the loan are greater than 30 days past due. At December 31, 2016 and September 30, 2016, we had no CMLs that were delinquent in principal or interest payments. The following provides the current and past due composition of our CMLs:
 
December 31, 2016
 
September 30, 2016
Current to 30 days
$
583

 
$
596

Past due

 

Total carrying value
$
583

 
$
596

A Troubled Debt Restructuring ("TDR") is a situation where we have granted a concession to a borrower for economic or legal reasons related to the borrower's financial difficulties that we would not otherwise consider. A mortgage loan that has been granted new terms, including workout terms as described previously, would be considered a TDR if it meets conditions that would indicate a borrower is experiencing financial difficulty and the new terms constitute a concession on our part. We analyze all loans where we have agreed to workout terms and all loans that we have refinanced to determine if they meet the definition of a TDR. We consider the following factors in determining whether or not a borrower is experiencing financial difficulty:
borrower is in default,
borrower has declared bankruptcy,
there is growing concern about the borrower's ability to continue as a going concern,
borrower has insufficient cash flows to service debt,
borrower's inability to obtain funds from other sources, and
there is a breach of financial covenants by the borrower.

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Table of Contents

If the borrower is determined to be in financial difficulty, we consider the following conditions to determine if the borrower will be granted a concession:
assets used to satisfy debt are less than our recorded investment,
interest rate is modified,
maturity date extension at an interest rate less than market rate,
capitalization of interest,
delaying principal and/or interest for a period of three months or more, and
partial forgiveness of the balance or charge-off.
Mortgage loan workouts, refinances or restructures that are classified as TDRs are individually evaluated and measured for impairment. As of December 31, 2016, our CML portfolio had no impairments, modifications or troubled debt restructuring.
Net investment income
The major sources of “Net investment income” on the accompanying unaudited Condensed Consolidated Statements of Operations were as follows:
 
Three months ended
 
December 31, 2016
 
December 31, 2015
Fixed maturity securities, available-for-sale
$
228

 
$
210

Equity securities, available-for-sale
10

 
8

Commercial mortgage loans
6

 
6

Related party loans

 
1

Invested cash and short-term investments

 

Other investments
1

 
1

Gross investment income
245

 
226

Investment expense
(5
)
 
(4
)
Net investment income
$
240

 
$
222

During the fiscal quarter ended June 30, 2015, the Company received notice that we are entitled to receive a settlement as a result of our ownership of certain RMBS that were issued by Countrywide Financial Corp. ("Countrywide"), an entity which was later acquired by Bank of America Corporation. An $18 cash settlement was received in the fiscal quarter ended June 30, 2016 for a majority of the Countrywide securities, and another $2 is expected to be paid in the third fiscal quarter of 2017. In compliance with the Company's accounting policy described in "Note 2. Significant Accounting Policies and Practices" of the 2016 Form 10-K, the Company updated its cash flow projections for its best estimate of the recovery as of May 31, 2016 and determined the new effective yield, with the resulting immaterial impact recognized in “Net Investment Income”.

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Table of Contents

Net investment Gains (Losses)
Details underlying “Net investment gains (losses)” reported on the accompanying unaudited Condensed Consolidated Statements of Operations were as follows:
 
Three months ended
 
December 31, 2016
 
December 31, 2015
Net realized gains (losses) on fixed maturity available-for-sale securities
$
2

 
$
(5
)
Realized gains (losses) on equity securities

 

Change in fair value of other derivatives and embedded derivatives

 
2

Realized losses on other invested assets
(2
)
 
(2
)
Net realized (losses) gains on available-for-sale securities

 
(5
)
Realized gains (losses) on certain derivative instruments
1

 
(12
)
Unrealized gains (losses) on certain derivative instruments
38

 
53

Change in fair value of reinsurance related embedded derivative
12

 
27

Realized (losses) gains on hedging derivatives and reinsurance-related embedded derivatives
51

 
68

Net investment (losses) gains
$
51

 
$
63

For the three months ended December 31, 2016, proceeds from the sale of fixed maturity available-for-sale securities totaled $97, gross gains on such sales totaled $2, and gross losses totaled $2.
For the three months ended December 31, 2015, proceeds from the sale of fixed maturity available-for-sale securities, totaled $564, gross gains on such sales totaled $13, and gross losses totaled $9, respectively.
Unconsolidated Variable Interest Entities
The Company owns investments in VIEs that are not consolidated within the Company’s financial statements. VIEs do not have sufficient equity to finance their own activities without additional financial support and certain of its investors lack certain characteristics of a controlling financial interest.  These VIEs are not consolidated in the Company’s financial statements for the following reasons: 1)  FGL Insurance does not have any voting rights or notice rights; 2)  the Company does not have any rights to remove the investment manager; and 3)  the Company was not involved in the design of the investment.  These characteristics indicate that FGL Insurance lacks the ability to direct the activities, or otherwise exert control, of the VIEs and is not considered the primary beneficiary of them. 
FGL Insurance participates in loans to third parties originated by Salus. Salus is an affiliated, limited liability company indirectly owned by HRG that originates senior secured asset-based loans to unaffiliated third-party borrowers. FGL Insurance also participates in CLOs managed by Salus and owns preferred equity in Salus within the funds withheld portfolio of the FSRCI treaty. The Company’s maximum exposure to loss as a result of its investments in or with Salus is limited to the carrying value of its investments in Salus which totaled $14 and $22 as of December 31, 2016 and September 30, 2016, respectively. FGL’s investments in or with Salus are detailed in “Note 14. Related Party Transactions” to the Company’s unaudited Condensed Consolidated Financial Statements.
During the fiscal quarter ended June 30, 2015, FGL invested in Boardwalk, an unaffiliated limited partnership fund that will invest in consumer whole loans, asset-backed investments, high yield, private investments, bank portfolio liquidations, bridge financing and other investments. The initial funding occurred March 20, 2015 with the remaining commitment expected to fund over the course of the next 3 years. FGL has funded $13 of a $35 commitment as of December 31, 2016.
FGL also executed a commitment of $75 to purchase common shares in an unaffiliated private business development company ("BDC"). The BDC invests in secured and unsecured fixed maturity and equity securities of middle market companies in the United States. Due to the voting structure of the transaction, FGL does not have voting power.  The initial capital call occurred June 30, 2015, with the remaining commitment expected to fund through 2017. FGL has funded $42 as of December 31, 2016.
During the fiscal quarter ended December 31, 2016, FGL executed a commitment to invest in two limited partnerships, Golub Capital Partners 10, L.P. and Golub Capital Partners 11, L.P, which invest in United States middle market, senior secured, floating rate loans and broadly syndicated loans primarily acquired from unaffiliated third parties. FGL has executed $20 and $40 commitments in Golub Capital Partners 10, L.P. and Golub Capital Partners 11, L.P, respectively, none of which was funded as of December 31, 2016.


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(5) Derivative Financial Instruments
The carrying amounts of derivative instruments, including derivative instruments embedded in fixed indexed annuity (“FIA”) contracts, is as follows:
 
December 31, 2016
 
September 30, 2016
Assets:
 
 
 
Derivative investments:
 
 
 
Call options
$
314

 
$
276

Futures contracts

 

Other invested assets:
 
 
 
Other derivatives and embedded derivatives
13

 
13

Other assets:
 
 
 
Reinsurance related embedded derivative
131

 
119

 
$
458

 
$
408

Liabilities:
 
 
 
Contractholder funds:
 
 
 
FIA embedded derivative
$
2,250

 
$
2,383

Funds withheld for reinsurance liabilities:
 
 
 
Call options payable to FSRCI
12

 
11

Other liabilities:
 
 
 
Futures contracts

 

 
$
2,262

 
$
2,394

 
The change in fair value of derivative instruments included in the accompanying unaudited Condensed Consolidated Statements of Operations is as follows:
 
Three months ended
 
December 31, 2016
 
December 31, 2015
Revenues:
 
 
 
Net investment (losses) gains:
 
 
 
Call options
$
39

 
$
36

Futures contracts

 
5

Other derivatives and embedded derivatives

 
2

Reinsurance related embedded derivative
12

 
27

 
$
51

 
$
70

Benefits and other changes in policy reserves
 
 
 
FIA embedded derivatives
$
(133
)
 
$
51

Additional Disclosures
Other Derivatives and Embedded Derivatives
On June 16, 2014, FGL Insurance invested in a $35 fund-linked note issued by Nomura International Funding Pte. Ltd. The note provides for an additional payment at maturity based on the value of an embedded derivative in AnchorPath Dedicated Return Fund (the "AnchorPath Fund") of $11 which was based on the actual return of the fund. At December 31, 2016 the fair value of the fund-linked note and embedded derivative were $24 and $13, respectively. At maturity of the fund-linked note, FGL Insurance will receive the $35 face value of the note plus the value of the embedded derivative in the AnchorPath Fund. The additional payment at maturity is an embedded derivative reported in "Other invested assets", while the host is an available-for-sale security reported in "Fixed maturities, available-for-sale".

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FGL Insurance participates in loans to third parties originated by Salus, an affiliated VIE, indirectly owned by HRG that provides asset-based financing. These participating loans are denominated in Canadian ("CAD") currency which is different from FGL Insurance's functional currency. At September 30, 2015, four loan participations were denominated in CAD currency. Three of the four loans denominated in CAD currency were settled prior to June 30, 2016. Therefore, as of both September 30, 2016 and December 31, 2016 only one loan denominated in CAD currency remains.
Two of the loan participations included a provision for reimbursement from the borrower to FGL Insurance for any net foreign exchange losses realized by FGL Insurance under the loan agreements. FGL Insurance's ability to recover the foreign exchange losses under these loan participations was such that the Company established embedded derivatives equal to FGL Insurance's cumulative net foreign exchange loss on these loan participations. The value of the embedded derivatives, which is equal to the cumulative net foreign exchange loss recognized on these loan participations, net of an allowance for counterparty credit risk, was reflected in "Other invested assets" as of the balance sheet date with changes in fair value reflected in the Company's Condensed Consolidated Statements of Operations. As of September 30, 2016, all of the loan participations were settled in full and the related embedded derivative balance was reduced to zero. The Company had realized losses of $0 for the three months ended December 31, 2015, related to these foreign exchange embedded derivatives included in "Net investment gains (losses)".
FGL Insurance also had two participating loans denominated in CAD currency which also required reimbursement from the borrower in CAD currency, but did not include a provision for reimbursement for any net foreign exchange losses from the borrower. Salus executed CAD swap agreements with FGL Insurance to convert the CAD cash flows into United States dollar ("USD") cash flows. Under these swap agreements, Salus reimbursed the Company for certain realized foreign exchange losses related to cash flows on these loan participations from origination date through the earlier of the maturity date of the loan or expiration of the swap agreement. Reimbursement under the swap agreements was reduced in the event the counterparties on the underlying loan participations were unable to fully repay amounts due on those loan participations. FGL Insurance's ability to recover the foreign exchange losses under these swap agreements was such that the Company established derivatives equal to FGL Insurance's cumulative net foreign exchange losses on these loan participations. During the year ended September 30, 2016, one of the loan participations was repaid in full and FGL Insurance recovered the full amount due under the related swap agreement. The other loan participation remains outstanding at December 31, 2016. The Company recognized an OTTI loss on the loan during the quarter ended September 30, 2016 and also recorded a reduction in the amount recoverable under the swap agreement. The related swap agreement with Salus expired in July 2016 and FGL Insurance recovered the amount due under the swap agreement. The value of these derivatives was reflected in “Other invested assets” with the changes in the fair value reflected in the Company’s Condensed Consolidated Statements of Operations. The value of these derivatives was $0 and $0 at December 31, 2016 and September 30, 2016, respectively, which is equal to the cumulative net realized foreign exchange loss recognized on these loan participations, net of allowance for counterparty credit risk. The Company had realized losses of $0 for the three months ended December 31, 2016; and $2 realized gains for the three months ended December 31, 2015 related to these foreign exchange derivatives included in "Net investment gains (losses)". Additionally, a subsidiary of HRG, HGI Funding LLC, executed an agreement with the Company to guarantee, subject to the terms of the agreement, the fulfillment of the accumulated foreign exchange loss recoverable from Salus. The guarantee was terminated in the quarter ended September 30, 2016 concurrent with the settlement of the Salus swap agreement.
FGL Insurance has entered into two CAD currency forward contracts since August 2016 to economically hedge against unfavorable movements in CAD on the one CAD-denominated loan participation which remains outstanding at December 31, 2016. Under the forward contracts, FGL Insurance sold CAD equal to the estimated recovery amounts on the loan participation and will receive USD. The forward contracts will be settled in cash. No cash was exchanged upon execution of the forward contracts. The value of these derivatives at each balance sheet date is equal to the cumulative unrealized value and is reflected in “Other invested assets” with the changes in the fair value reflected in the Company’s Consolidated Statements of Operations. The value of the forward contracts as of December 31, 2016 was not material. The Company had realized gains of $0 for the three months ended December 31, 2016 related to the forward contracts included in "Net investment gains".

Credit Risk
The Company is exposed to credit loss in the event of non-performance by its counterparties on the call options and reflects assumptions regarding this non-performance risk in the fair value of the call options. The non-performance risk is the net counterparty exposure based on the fair value of the open contracts less collateral held. The Company maintains a policy of requiring all derivative contracts to be governed by an International Swaps and Derivatives Association (“ISDA”) Master Agreement.

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Information regarding the Company’s exposure to credit loss on the call options it holds is presented in the following table:
 
 
 
 
December 31, 2016
 
September 30, 2016
Counterparty
 
Credit Rating
(Fitch/Moody's/S&P) (a)
 
Notional
Amount
 
Fair Value
 
Collateral
 
Net Credit Risk
 
Notional
Amount
 
Fair Value
 
Collateral
 
Net Credit Risk
Merrill Lynch
 
 A/*/A+
 
$
2,860

 
$
77

 
$
40

 
$
37

 
$
2,302

 
$
55

 
$
10

 
$
45

Deutsche Bank
 
 A-/Baa2/BBB+
 
468

 
24

 

 
24

 
1,620

 
46

 
12

 
34

Morgan Stanley
 
 */A1/A+
 
2,530

 
84

 
68

 
16

 
2,952

 
87

 
58

 
29

Barclay's Bank
 
 A/A1/A-
 
1,898

 
57

 
17

 
40

 
1,389

 
39

 

 
39

Canadian Imperial Bank of Commerce
 
 AA-/Aa3/A+
 
2,254

 
72

 
73

 
(1
)
 
1,623

 
49

 
48

 
1

 Total
 
 
 
$
10,010

 
$
314

 
$
198

 
$
116

 
$
9,886

 
$
276

 
$
128

 
$
148

(a) An * represents credit ratings that were not available.
Collateral Agreements
The Company is required to maintain minimum ratings as a matter of routine practice as part of its over-the-counter derivative agreements on ISDA forms. Under some ISDA agreements, the Company has agreed to maintain certain financial strength ratings. A downgrade below these levels provides the counterparty under the agreement the right to terminate the open derivative contracts between the parties, at which time any amounts payable by the Company or the counterparty would be dependent on the market value of the underlying derivative contracts. The Company’s current rating allows multiple counterparties the right to terminate ISDA agreements. No ISDA agreements have been terminated, although the counterparties have reserved the right to terminate the ISDA agreements at any time. In certain transactions, the Company and the counterparty have entered into a collateral support agreement requiring either party to post collateral when the net exposures exceed pre-determined thresholds. These thresholds vary by counterparty and credit rating. As of December 31, 2016 and September 30, 2016, counterparties posted $198 and $128 of collateral, respectively, of which $158 and $118 is included in "Cash and cash equivalents" with an associated payable for this collateral included in "Other liabilities" on the unaudited Condensed Consolidated Balance Sheets. The remaining $40 and $10 of non-cash collateral was held by a third-party custodian and is not included in the Company's unaudited Condensed Consolidated Balance Sheets at December 31, 2016 and September 30, 2016, respectively. Accordingly, the maximum amount of loss due to credit risk that the Company would incur if parties to the call options failed completely to perform according to the terms of the contracts was $116 and $148 at December 31, 2016 and September 30, 2016, respectively.
The Company held 540 and 559 futures contracts at December 31, 2016 and September 30, 2016, respectively. The fair value of the futures contracts represents the cumulative unsettled variation margin (open trade equity, net of cash settlements). The Company provides cash collateral to the counterparties for the initial and variation margin on the futures contracts which is included in "Cash and cash equivalents " in the accompanying unaudited Condensed Consolidated Balance Sheets. The amount of cash collateral held by the counterparties for such contracts was $3 and $3 at December 31, 2016 and September 30, 2016, respectively.



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Table of Contents

(6) Fair Value of Financial Instruments
The Company’s measurement of fair value is based on assumptions used by market participants in pricing the asset or liability, which may include inherent risk, restrictions on the sale or use of an asset, or non-performance risk, which may include the Company’s own credit risk. The Company’s estimate of an exchange price is the price in an orderly transaction between market participants to sell the asset or transfer the liability (“exit price”) in the principal market, or the most advantageous market in the absence of a principal market, for that asset or liability, as opposed to the price that would be paid to acquire the asset or receive a liability (“entry price”). The Company categorizes financial instruments carried at fair value into a three-level fair value hierarchy, based on the priority of inputs to the respective valuation technique. The three-level hierarchy for fair value measurement is defined as follows:
Level 1 - Values are unadjusted quoted prices for identical assets and liabilities in active markets accessible at the measurement date.
Level 2 - Inputs include quoted prices for similar assets or liabilities in active markets, quoted prices from those willing to trade in markets that are not active, or other inputs that are observable or can be corroborated by market data for the term of the instrument. Such inputs include market interest rates and volatilities, spreads, and yield curves.
Level 3 - Certain inputs are unobservable (supported by little or no market activity) and significant to the fair value measurement. Unobservable inputs reflect the Company’s best estimate of what hypothetical market participants would use to determine a transaction price for the asset or liability at the reporting date based on the best information available in the circumstances.
In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an investment’s level within the fair value hierarchy is based on the lower level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the investment.
When a determination is made to classify an asset or liability within Level 3 of the fair value hierarchy, the determination is based upon the significance of the unobservable inputs to the overall fair value measurement. Because certain securities trade in less liquid or illiquid markets with limited or no pricing information, the determination of fair value for these securities is inherently more difficult. However, Level 3 fair value investments may include, in addition to the unobservable or Level 3 inputs, observable components, which are components that are actively quoted or can be validated to market-based sources.
 

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Table of Contents

The carrying amounts and estimated fair values of the Company’s financial instruments for which the disclosure of fair values is required, including financial assets and liabilities measured and carried at fair value on a recurring basis, with the exception of investment contracts, related party loans, portions of other invested assets and debt which are disclosed later within this footnote, are summarized according to the hierarchy previously described, as follows:
 
December 31, 2016
 
Level 1
 
Level 2
 
Level 3
 
Fair Value
 
Carrying Amount
Assets
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
632

 
$

 
$

 
$
632

 
$
632

Fixed maturity securities, available-for-sale:
 
 
 
 
 
 
 
 
 
Asset-backed securities

 
2,411

 
197

 
2,608

 
2,608

Commercial mortgage-backed securities

 
752

 
85

 
837

 
837

Corporates

 
10,401

 
1,078

 
11,479

 
11,479

Hybrids

 
1,323

 
10

 
1,333

 
1,333

Municipals

 
1,604

 
37

 
1,641

 
1,641

Residential mortgage-backed securities

 
1,309

 

 
1,309

 
1,309

U.S. Government
54

 
176

 

 
230

 
230

Equity securities, available-for-sale
17

 
636

 
1

 
654

 
654

Derivative financial instruments

 
314

 

 
314

 
314

Reinsurance related embedded derivative, included in other assets

 
131

 

 
131

 
131

Other invested assets

 

 
19

 
19

 
19

Total financial assets at fair value
$
703

 
$
19,057

 
$
1,427

 
$
21,187

 
$
21,187

Liabilities
 
 
 
 
 
 
 
 
 
Derivatives:
 
 
 
 
 
 
 
 
 
FIA embedded derivatives, included in contractholder funds
$

 
$

 
$
2,250

 
$
2,250

 
$
2,250

Call options payable for FSRCI, included in funds withheld for reinsurance liabilities

 
12

 

 
12

 
12

Total financial liabilities at fair value
$

 
$
12

 
$
2,250

 
$
2,262

 
$
2,262



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Table of Contents

 
September 30, 2016
 
Level 1
 
Level 2
 
Level 3
 
Fair Value
 
Carrying Amount
Assets
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
864

 
$

 
$

 
$
864

 
$
864

Fixed maturity securities, available-for-sale:
 
 
 
 
 
 
 
 
 
Asset-backed securities

 
2,327

 
172

 
2,499

 
2,499

Commercial mortgage-backed securities

 
785

 
79

 
864

 
864

Corporates

 
10,219

 
1,121

 
11,340

 
11,340

Hybrids

 
1,386

 

 
1,386

 
1,386

Municipals

 
1,676

 
41

 
1,717

 
1,717

Residential mortgage-backed securities

 
1,362

 

 
1,362

 
1,362

U.S. Government
61

 
182