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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 March 31, 2018
 
 
 
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
393331088_ffglogoa02.jpg
(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, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one)
Large accelerated filer [ ]
Accelerated filer [X]
Non-accelerated filer [ ]
Smaller reporting company [ ]
Emerging growth company [ ]
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]
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 May 1, 2018
Class A Common Stock, without par value
 
24,797,899
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 MARCH 31, 2018
TABLE OF CONTENTS


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

 
March 31,
2018
 
December 31,
2017
Assets
 
 
 
Investments:
 
 
 
Fixed maturities - available for sale, at fair value (amortized cost: 2018 - $6,891,191; 2017 - $6,757,250)
$
7,246,912

 
$
7,291,967

Equity securities at fair value (cost: 2018 - $98,307; 2017 - $96,715)
103,920

 
104,145

Mortgage loans
968,664

 
971,812

Real estate
1,543

 
1,543

Policy loans
193,413

 
191,398

Short-term investments
30,075

 
17,007

Other investments
44,973

 
42,371

Total investments
8,589,500

 
8,620,243

 
 
 
 
Cash and cash equivalents
13,653

 
52,696

Securities and indebtedness of related parties
130,451

 
130,240

Accrued investment income
82,403

 
76,468

Amounts receivable from affiliates
5,117

 
3,561

Reinsurance recoverable
105,551

 
108,948

Deferred acquisition costs
357,861

 
302,611

Value of insurance in force acquired
7,169

 
4,560

Current income taxes recoverable
44

 
3,269

Other assets
108,293

 
112,054

Assets held in separate accounts
638,751

 
651,963

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total assets
$
10,038,793

 
$
10,066,613


 


2




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

 
March 31,
2018
 
December 31,
2017
Liabilities and stockholders’ equity
 
 
 
Liabilities:
 
 
 
Future policy benefits:
 
 
 
Interest sensitive products
$
5,446,094

 
$
5,299,961

Traditional life insurance and accident and health products
1,762,416

 
1,750,504

Other policy claims and benefits
47,250

 
44,475

Supplementary contracts without life contingencies
317,541

 
322,630

Advance premiums and other deposits
269,378

 
267,023

Amounts payable to affiliates
1,272

 
1,164

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

 
97,000

Deferred income taxes
104,372

 
131,912

Other liabilities
90,532

 
111,131

Liabilities related to separate accounts
638,751

 
651,963

Total liabilities
8,774,606

 
8,677,763

 
 
 
 
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 24,826,563 shares in 2018 and 24,919,113 shares in 2017
153,195

 
153,589

Class B common stock, without par value - authorized 1,500,000 shares, issued and outstanding 11,413 shares in 2018 and 2017
72

 
72

Accumulated other comprehensive income
186,222

 
284,983

Retained earnings
921,663

 
947,148

Total FBL Financial Group, Inc. stockholders’ equity
1,264,152

 
1,388,792

Noncontrolling interest
35

 
58

Total stockholders’ equity
1,264,187

 
1,388,850

Total liabilities and stockholders’ equity
$
10,038,793

 
$
10,066,613


See accompanying notes.


3




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

 
Three months ended March 31,
 
2018
 
2017
Revenues:
 
 
 
Interest sensitive product charges
$
30,098

 
$
29,201

Traditional life insurance premiums
49,497

 
48,434

Net investment income
101,022

 
100,994

Net realized capital losses
(1,747
)
 
(403
)
Net other-than-temporary impairment losses recognized in earnings
(1,295
)
 
(66
)
Other income
4,600

 
3,760

Total revenues
182,175

 
181,920

 
 
 
 
Benefits and expenses:
 
 
 
Interest sensitive product benefits
61,345

 
62,760

Traditional life insurance benefits
45,456

 
42,954

Policyholder dividends
2,551

 
2,553

Underwriting, acquisition and insurance expenses
39,577

 
34,353

Interest expense
1,213

 
1,212

Other expenses
5,593

 
4,151

Total benefits and expenses
155,735

 
147,983

 
26,440

 
33,937

Income taxes
(4,687
)
 
(10,733
)
Equity income, net of related income taxes
1,855

 
3,231

Net income
23,608

 
26,435

Net loss (income) attributable to noncontrolling interest
23

 
(2
)
Net income attributable to FBL Financial Group, Inc.
$
23,631

 
$
26,433

 
 
 
 
Earnings per common share
$
0.94

 
$
1.05

Earnings per common share - assuming dilution
$
0.94

 
$
1.05

 
 
 
 
Cash dividend per common share
$
0.46

 
$
0.44

Special cash dividend per common share
$
1.50

 
$
1.50


See accompanying notes.


4




FBL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
(Dollars in thousands)
 
Three months ended March 31,
 
2018
 
2017
Net income
$
23,608

 
$
26,435

Other comprehensive income (loss) (1)
 
 
 
Change in net unrealized investment gains/losses
(93,154
)
 
15,861

Change in underfunded status of postretirement benefit plans
262

 
182

Total other comprehensive income (loss), net of tax
(92,892
)
 
16,043

Total comprehensive income (loss), net of tax
(69,284
)
 
42,478

Comprehensive (income) loss attributable to noncontrolling interest
23

 
(2
)
Total comprehensive income (loss) applicable to FBL Financial Group, Inc.
$
(69,261
)
 
$
42,476


(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
 
 
 
 
 
Series B Preferred Stock
 
Class A and Class B Common Stock
 
Accumulated Other Comprehensive Income
 
Retained Earnings
 
Non-
controlling Interest
 
Total Stockholders’ Equity
Balance at January 1, 2017
$
3,000

 
$
152,975

 
$
149,555

 
$
882,672

 
$
56

 
$
1,188,258

Net income - three months ended March 31, 2017

 

 

 
26,433

 
2

 
26,435

Other comprehensive income

 

 
16,043

 

 

 
16,043

Issuance of common stock under compensation plans

 
339

 

 

 

 
339

Dividends on preferred stock

 

 

 
(38
)
 

 
(38
)
Dividends on common stock

 

 

 
(48,341
)
 

 
(48,341
)
Balance at March 31, 2017
$
3,000

 
$
153,314

 
$
165,598

 
$
860,726

 
$
58

 
$
1,182,696

 
 
 
 
 
 
 
 
 
 
 
 
Balance at January 1, 2018
$
3,000

 
$
153,661

 
$
284,983

 
$
947,148

 
$
58

 
$
1,388,850

Cumulative effect of change in accounting principle related to net unrealized gains on equity securities

 

 
(5,869
)
 
5,869

 

 

Net income - three months ended March 31, 2018

 

 

 
23,631

 
(23
)
 
23,608

Other comprehensive loss

 

 
(92,892
)
 

 

 
(92,892
)
Issuance of common stock under compensation plans

 
218

 

 

 

 
218

Purchase of common stock

 
(612
)
 

 
(6,194
)
 

 
(6,806
)
Dividends on preferred stock

 

 

 
(38
)
 

 
(38
)
Dividends on common stock

 

 

 
(48,753
)
 

 
(48,753
)
Balance at March 31, 2018
$
3,000

 
$
153,267

 
$
186,222

 
$
921,663

 
$
35

 
$
1,264,187


See accompanying notes.


5




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

 
Three months ended March 31,
 
2018
 
2017
Operating activities
 
 
 
Net income
$
23,608

 
$
26,435

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Interest credited to account balances
40,650

 
40,256

Charges for mortality, surrenders and administration
(29,827
)
 
(28,887
)
Net realized losses on investments
3,042

 
469

Change in fair value of derivatives
(534
)
 
(2,753
)
Increase in liabilities for life insurance and other future policy benefits
18,264

 
17,993

Deferral of acquisition costs
(11,293
)
 
(10,604
)
Amortization of deferred acquisition costs and value of insurance in force
10,314

 
7,598

Change in reinsurance recoverable
2,454

 
(841
)
Provision for deferred income taxes
(2,847
)
 
542

Other
(2,211
)
 
4,590

Net cash provided by operating activities
51,620

 
54,798

 
 
 
 
Investing activities
 
 
 
Sales, maturities or repayments:
 
 
 
Fixed maturities - available for sale
138,254

 
106,257

Equity securities - available for sale

 
744

Mortgage loans
10,383

 
11,024

Derivative instruments
4,131

 
3,052

Policy loans
9,133

 
10,266

Securities and indebtedness of related parties
1,596

 
2,391

Other long-term investments
938

 
7

Acquisitions:
 
 
 
Fixed maturities - available for sale
(288,677
)
 
(118,948
)
Equity securities - available for sale
(1,389
)
 
(1,102
)
Mortgage loans
(7,186
)
 
(50,000
)
Derivative instruments
(3,219
)
 
(1,988
)
Policy loans
(11,148
)
 
(9,993
)
Securities and indebtedness of related parties
(4,652
)
 
(3,712
)
Other long-term investments
(5,531
)
 

Short-term investments, net change
(13,068
)
 
2,084

Purchases and disposals of property and equipment, net
(1,859
)
 
(2,270
)
Net cash used in investing activities
(172,294
)
 
(52,188
)




6




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

 
Three months ended March 31,
 
2018
 
2017
Financing activities
 
 
 
Contract holder account deposits
$
261,240

 
$
116,760

Contract holder account withdrawals
(124,978
)
 
(87,929
)
Dividends paid
(48,791
)
 
(48,379
)
Issuance or repurchase of common stock, net
(5,840
)
 
128

Net cash provided by (used in) financing activities
81,631

 
(19,420
)
Decrease in cash and cash equivalents
(39,043
)
 
(16,810
)
Cash and cash equivalents at beginning of period
52,696

 
33,583

Cash and cash equivalents at end of period
$
13,653

 
$
16,773

 
 
 
 
Supplemental disclosures of cash flow information
 
 
 
Cash (paid) received during the period for:
 
 
 
Interest
$
(1,213
)
 
$
(1,213
)
Income taxes
(5
)
 
2


See accompanying notes.


7


FBL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
March 31, 2018

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 quarter ended March 31, 2018 are not necessarily indicative of the results that may be expected for the year ending December 31, 2018. We encourage you to refer to the notes to our consolidated financial statements included in Item 8 of our Form 10-K for the year ended December 31, 2017 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.

New Accounting Pronouncements

Description
Date of adoption
Effect on our consolidated financial statements or other significant matters
Standards adopted:
Stockholders' Equity
In February 2018, the Financial Accounting Standards Board (FASB) issued guidance allowing a reclassification from accumulated other comprehensive income (AOCI) to retained earnings for stranded tax effects resulting from changes in the federal income tax rate due to enactment of the Tax Cuts and Jobs Act of 2017 on December 22, 2017 (Tax Act). Accounting guidance requires that deferred tax assets and liabilities, including those associated with components of AOCI, be remeasured during the period new tax laws are enacted, with any changes reflected as a component of income tax expense (benefit). Under the previous guidance, retained earnings would reflect the full amount of the change and AOCI would not be adjusted for the portion of the change related to its components, leaving the unadjusted change “stranded” in AOCI. The new guidance allows AOCI to be adjusted to reclassify these stranded tax effects to retained earnings.
October 1, 2017
The new guidance was effective for 2018, with early adoption permitted. We adopted the new guidance in 2017 by reporting the reclassification in our Consolidated Statement of Stockholders’ Equity. We consider the remeasurement of deferred tax assets and liabilities a provisional estimate, so any adjustments to this estimate during 2018 would result in additional reclassification.

Financial instruments - recognition and measurement
In January 2016, the FASB issued guidance that amended certain aspects of the recognition and measurement of financial instruments. The new guidance primarily affected the accounting for equity securities, which are now carried at fair value with valuation changes recognized in the statement of operations rather than as other comprehensive income. The presentation and disclosure requirements for financial instruments and the methodology for assessing the need for a valuation allowance on deferred tax assets resulting from unrealized losses on available-for-sale fixed maturity securities were also revised under the new guidance. The new standard required the use of a modified retrospective method at adoption.
January 1, 2018
Upon adoption, we reclassified $5.9 million of net unrealized investment gains, net of tax, on our equity securities from accumulated other comprehensive income to retained earnings as a cumulative effect adjustment. Adoption resulted in a decrease to net income of $1.3 million ($0.05 per basic and diluted earnings per share) during the first quarter of 2018.


8

Table of Contents

Revenue recognition
In May 2014, the FASB issued guidance that outlined a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers. Insurance contract and investment related revenue, which make up the majority of our earnings, were specifically excluded from the scope of this guidance. The new guidance was 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 required 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. We had the option of using either a full retrospective or a modified retrospective approach for the adoption of the new standard.
January 1, 2018
Our revenues that fall under the scope of the new guidance primarily consist of the net commissions on insurance and investment products we broker for others. We have evaluated those contracts and concluded that there was no change in timing or measurement of revenues, as the historical accounting is consistent with the new guidance. Accordingly, there was no impact from adoption.
Standards not yet adopted:
Leases
In February 2016, the FASB issued a new lease accounting standard, which, for most lessees, will result in a gross-up of the balance sheet. Under the new standard, lessees will recognize the leased assets on the balance sheet and will recognize a corresponding liability for the present value of lease payments over the lease term. The new standard requires the application of judgment and estimates. Also, there are accounting policy elections that may be taken both at transition and for the accounting post-transition, including whether to adopt a short-term lease recognition exemption.
January 1, 2019
We are currently evaluating the impact of this guidance on our consolidated financial statements. Our most significant lease is for our home office building. See Note 10 of Item 8 of our 2017 Form 10-K for a further description of this lease, including future commitments. Our other leases are primarily shorter term in nature, relating to equipment. Upon adoption we will be required to recognize and measure leases at the beginning of the earliest period presented using the modified retrospective approach.
Financial Instruments - credit impairment
In June 2016, the FASB issued guidance amending the accounting for the credit impairment of financial instruments. Under the new guidance, impairment losses are required to be estimated using an expected loss model under which a valuation allowance is established and adjusted over time. The valuation allowance will be based on the probability of loss over the life of the instrument, considering historical, current and forecasted information. The new guidance differs significantly from the incurred loss model used today, and will result in the earlier recognition of impairment losses. The new guidance may also increase the volatility of earnings to the extent actual results differ from the assumptions used in the establishment of the valuation allowance. The financial instruments for which we will be required to use the new model include but are not limited to, mortgage loans, lease receivables and reinsurance recoverables. Our available-for-sale fixed maturities will continue to apply the incurred loss model. However, rather than impairment losses resulting in a permanent reduction of carrying value as they do today, such losses will be in the form of a valuation allowance, which can be increased in the case of future credit losses or decreased should conditions improve. 
January 1, 2020
We are currently evaluating the impact of this new guidance on our consolidated financial statements. We believe the most significant impact upon adoption will be the establishment of an additional valuation allowance for our mortgage loan investments. This guidance will be applied using a modified retrospective approach by recording a cumulative effect adjustment to retained earnings as of the beginning of the year of adoption.

Reclassifications

We have reclassified our holdings of Federal Home Loan Bank of Des Moines (FHLB) common stock, which we are required to hold as a member of the FHLB system, from equity securities to other investments as the stock is restricted in nature. The 2017 consolidated financial statements have been reclassified to conform to the current financial statement presentation.



9

Table of Contents

2. Investment Operations

Fixed Maturity and Equity Securities

Available-For-Sale Fixed Maturity Securities by Investment Category
 
 
 
March 31, 2018
 
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)
$
3,353,388

 
$
224,254

 
$
(31,961
)
 
$
3,545,681

 
$
290

Residential mortgage-backed
527,971

 
31,012

 
(5,439
)
 
553,544

 
594

Commercial mortgage-backed
784,999

 
22,428

 
(14,151
)
 
793,276

 

Other asset-backed
796,977

 
20,347

 
(3,032
)
 
814,292

 
3,350

United States Government and agencies
22,009

 
1,333

 
(130
)
 
23,212

 

States and political subdivisions
1,405,847

 
113,842

 
(2,782
)
 
1,516,907

 

Total fixed maturities
$
6,891,191

 
$
413,216

 
$
(57,495
)
 
$
7,246,912

 
$
4,234

Available-For-Sale Fixed Maturity and Equity Securities by Investment Category
 
 
 
December 31, 2017
 
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)
$
3,374,927

 
$
329,299

 
$
(15,955
)
 
$
3,688,271

 
$
(504
)
Residential mortgage-backed
483,671

 
35,890

 
(3,280
)
 
516,281

 
339

Commercial mortgage-backed
674,076

 
34,464

 
(3,233
)
 
705,307

 

Other asset-backed
818,071

 
18,645

 
(3,214
)
 
833,502

 
845

United States Government and agencies
23,378

 
1,606

 
(79
)
 
24,905

 

States and political subdivisions
1,383,127

 
141,813

 
(1,239
)
 
1,523,701

 

Total fixed maturities
$
6,757,250

 
$
561,717

 
$
(27,000
)
 
$
7,291,967

 
$
680

 
 
 
 
 
 
 
 
 
 
Equity securities:
 
 
 
 
 
 
 
 
 
Non-redeemable preferred stocks
$
92,951

 
$
7,146

 
$
(265
)
 
$
99,832

 
 
Common stocks
3,764

 
549

 

 
4,313

 
 
Total equity securities
$
96,715

 
$
7,695

 
$
(265
)
 
$
104,145

 
 

(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, residential mortgage-backed, and other asset-backed securities at March 31, 2018 and residential mortgage-backed and other asset-backed securities at December 31, 2017 were in an unrealized gain position 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 fair value of $16.8 million at March 31, 2018 and $17.5 million at December 31, 2017. Corporate securities also include redeemable preferred stock with a fair value of $22.0 million at March 31, 2018 and $21.7 million at December 31, 2017.



10

Table of Contents

Available-For-Sale Fixed Maturities by Maturity Date
 
 
 
 
March 31, 2018
 
Amortized
Cost
 

Fair Value
 
(Dollars in thousands)
Due in one year or less
$
165,210

 
$
167,953

Due after one year through five years
588,250

 
614,089

Due after five years through ten years
730,313

 
754,274

Due after ten years
3,297,471

 
3,549,484

 
4,781,244

 
5,085,800

Mortgage-backed and other asset-backed
2,109,947

 
2,161,112

Total fixed maturities
$
6,891,191

 
$
7,246,912


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 on Investments in Accumulated Other Comprehensive Income
 
March 31,
2018
 
December 31,
2017
 
(Dollars in thousands)
Net unrealized appreciation on:
 
 
 
Fixed maturities - available for sale
$
355,721

 
$
534,718

Equity securities - available for sale

 
7,430

 
355,721

 
542,148

Adjustments for assumed changes in amortization pattern of:
 
 
 
Deferred acquisition costs
(93,953
)
 
(147,173
)
Value of insurance in force acquired
(11,716
)
 
(14,870
)
Unearned revenue reserve
8,318

 
12,705

Adjustments for assumed changes in policyholder liabilities
(9,407
)
 
(18,499
)
Provision for deferred income taxes
(52,280
)
 
(78,605
)
Net unrealized investment gains
$
196,683

 
$
295,706


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.

Fixed Maturity Securities with Unrealized Losses by Length of Time
 
 
 
 
March 31, 2018
 
 
Less than one year
 
One year or more
 
Total
 
 
Description of Securities
 

Fair Value
 
Unrealized Losses
 

Fair Value
 
Unrealized Losses
 
 Fair Value
 
Unrealized Losses
 
Percent of Total
 
 
(Dollars in thousands)
 
 
Fixed maturities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate
 
$
516,564

 
$
(13,180
)
 
$
162,871

 
$
(18,781
)
 
$
679,435

 
$
(31,961
)
 
55.6
%
Residential mortgage-backed
 
170,226

 
(4,091
)
 
31,038

 
(1,348
)
 
201,264

 
(5,439
)
 
9.5

Commercial mortgage-backed
 
346,486

 
(12,199
)
 
18,419

 
(1,952
)
 
364,905

 
(14,151
)
 
24.6

Other asset-backed
 
251,682

 
(1,633
)
 
64,222

 
(1,399
)
 
315,904

 
(3,032
)
 
5.3

United States Government and agencies
 
5,106

 
(83
)
 
2,324

 
(47
)
 
7,430

 
(130
)
 
0.2

States and political subdivisions
 
78,770

 
(1,276
)
 
17,463

 
(1,506
)
 
96,233

 
(2,782
)
 
4.8

Total fixed maturities
 
$
1,368,834

 
$
(32,462
)
 
$
296,337

 
$
(25,033
)
 
$
1,665,171

 
$
(57,495
)
 
100.0
%


11

Table of Contents


Fixed Maturity and Equity Securities with Unrealized Losses by Length of Time
 
 
 
 
December 31, 2017
 
 
Less than one year
 
One year or more
 
Total
 
 
Description of Securities
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
 
Percent of Total
 
 
(Dollars in thousands)
 
 
Fixed maturities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate
 
$
85,019

 
$
(1,261
)
 
$
183,820

 
$
(14,694
)
 
$
268,839

 
$
(15,955
)
 
59.1
%
Residential mortgage-backed
 
76,393

 
(1,757
)
 
31,779

 
(1,523
)
 
108,172

 
(3,280
)
 
12.1

Commercial mortgage-backed
 
151,158

 
(2,078
)
 
16,398

 
(1,155
)
 
167,556

 
(3,233
)
 
12.0

Other asset-backed
 
159,111

 
(2,006
)
 
71,064

 
(1,208
)
 
230,175

 
(3,214
)
 
11.9

United States Government and agencies
 
5,698

 
(47
)
 
1,864

 
(32
)
 
7,562

 
(79
)
 
0.3

States and political subdivisions
 
5,904

 
(96
)
 
20,505

 
(1,143
)
 
26,409

 
(1,239
)
 
4.6

Total fixed maturities
 
$
483,283

 
$
(7,245
)
 
$
325,430

 
$
(19,755
)
 
$
808,713

 
$
(27,000
)
 
100.0
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Equity securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-redeemable preferred stocks
 
$
2,819

 
$
(71
)
 
$
4,807

 
$
(194
)
 
$
7,626

 
$
(265
)
 
 
Total equity securities
 
$
2,819

 
$
(71
)
 
$
4,807

 
$
(194
)
 
$
7,626

 
$
(265
)
 
 

Fixed maturities in the above tables include 475 securities from 301 issuers at March 31, 2018 and 247 securities from 154 issuers at December 31, 2017.

Unrealized losses increased during the three months ended March 31, 2018 due to higher Treasury rates and wider credit spreads. We do not consider securities to be OTTI when the market decline is attributable to factors such as interest rate movements, market volatility, liquidity, spread widening and credit quality when recovery of all amounts due under the contractual terms of the security is anticipated. Based on our intent not to sell or our belief that we will not be required to sell these securities before recovery of their amortized cost basis, we do not consider these investments to be OTTI at March 31, 2018. We will continue to monitor the investment portfolio for future changes in issuer facts and circumstances that could result in future impairments beyond those currently identified.

Our largest unrealized loss was from a retailer and totaled $2.9 million at March 31, 2018.

As described more fully in Note 1 to our consolidated financial statements included in Item 8 of our Form 10-K for the year ended December 31, 2017, we perform a regular evaluation of all investment classes for impairment, including fixed maturity securities and equity securities, in order to evaluate whether such investments are OTTI.

Credit Loss Component of Other-Than-Temporary Impairments on Fixed Maturities
 
Three months ended March 31,
 
2018

2017
 
(Dollars in thousands)
Balance at beginning of period
$
(12,392
)
 
$
(14,500
)
Reductions due to investments sold or paid down
271

 
349

Reduction for credit loss that no longer has a portion of the OTTI loss recognized in other comprehensive income
2,529

 
587

Balance at end of period
$
(9,592
)
 
$
(13,564
)



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Table of Contents

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 the non-credit portion of the OTTI was recognized in other comprehensive income and corresponding changes in such amounts. Credit loss impairments with no portion of the loss recognized in other comprehensive income, such as securities for which OTTI was measured at fair value, are excluded from the table.
Realized Gains (Losses) - Recorded in Income 
 
 
 
 
Three months ended March 31,
 
2018
 
2017
 
(Dollars in thousands)
Realized gains (losses) on sales of investments
 
 
 
Fixed maturities:
 
 
 
Gross gains
$
83

 
$
124

Gross losses

 
(527
)
Other long-term investments
(13
)
 

 
70

 
(403
)
Net unrealized losses recognized during the period on equity securities held at the end of the period (1)
(1,817
)
 

Net realized losses
(1,747
)
 
(403
)
 
 
 
 
Impairment losses recognized in earnings:
 
 
 
Other credit-related (2)
(1,295
)
 
(66
)
Net realized losses on investments recorded in income
$
(3,042
)
 
$
(469
)

(1)
See Note 1 to our consolidated financial statements for discussion of change in accounting policy for equity securities during the quarter.
(2)
Amount represents credit-related losses for fixed maturities written down to fair value through income and impairment losses related to investments accounted for under the equity method of accounting, which are included in securities and indebtedness of related parties within our consolidated balance sheets.

Proceeds from sales of fixed maturities totaled $5.2 million during the three months ended March 31, 2018 and $9.4 million during the three months ended March 31, 2017.

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

Mortgage Loans

Our mortgage loan portfolio consists of commercial mortgage loans that we have originated. Our lending policies require that the loans be collateralized by the value of the related property, establish limits on the amount that can be loaned to one borrower and require diversification by geographic location and collateral type. We originate loans with an initial loan-to-value ratio that provides sufficient 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. Mortgage loans are placed on non-accrual status if we have concerns regarding the collectability of future payments. 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. At March 31, 2018 and December 31, 2017, there were no non-performing loans over 90 days past due on contractual payments. At March 31, 2018, we had committed to provide additional funding for mortgage loans totaling $21.3 million. These commitments arose in the normal course of business at terms that are comparable to similar investments.



13

Table of Contents

Mortgage Loans by Collateral Type
 
 
 
 
 
 
 
 
 
 
March 31, 2018
 
December 31, 2017
Collateral Type
 
Carrying Value
 
Percent of Total
 
Carrying Value
 
Percent of Total
 
 
(Dollars in thousands)
Office
 
$
413,120

 
42.6
%
 
$
410,090

 
42.2
%
Retail
 
288,683

 
29.8

 
292,257

 
30.1

Industrial
 
205,107

 
21.2

 
207,180

 
21.3

Other
 
61,754

 
6.4

 
62,285

 
6.4

Total
 
$
968,664

 
100.0
%
 
$
971,812

 
100.0
%

Mortgage Loans by Geographic Location within the United States
 
 
 
 
March 31, 2018
 
December 31, 2017
Region of the United States
 
Carrying Value
 
Percent of Total
 
Carrying Value
 
Percent of Total
 
 
(Dollars in thousands)
South Atlantic
 
$
295,318

 
30.5
%
 
$
296,947

 
30.5
%
Pacific
 
144,935

 
14.9

 
146,320

 
15.0

West North Central
 
125,609

 
13.0

 
127,096

 
13.1

Mountain
 
104,298

 
10.8

 
105,627

 
10.9

East North Central
 
90,764

 
9.4

 
91,971

 
9.5

West South Central
 
90,511

 
9.3

 
85,566

 
8.8

East South Central
 
66,661

 
6.9

 
67,228

 
6.9

New England
 
34,665

 
3.6

 
35,005

 
3.6

Middle Atlantic
 
15,903

 
1.6

 
16,052

 
1.7

Total
 
$
968,664

 
100.0
%
 
$
971,812

 
100.0
%

Mortgage Loans by Loan-to-Value Ratio
 
 
 
 
 
 
 
 
 
 
March 31, 2018
 
December 31, 2017
Loan-to-Value Ratio
 

Carrying Value
 
Percent of Total
 
Carrying Value
 
Percent of Total
 
 
(Dollars in thousands)
0% - 50%
 
$
360,416

 
37.2
%
 
$
334,037

 
34.4
%
51% - 60%
 
236,382

 
24.5

 
258,359

 
26.6

61% - 70%
 
301,469

 
31.1

 
297,404

 
30.6

71% - 80%
 
51,621

 
5.3

 
63,116

 
6.5

81% - 90%
 
18,776

 
1.9

 
18,896

 
1.9

Total
 
$
968,664

 
100.0
%
 
$
971,812

 
100.0
%

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

Mortgage Loans by Year of Origination
 
 
 
 
 
 
 
 
 
 
March 31, 2018
 
December 31, 2017
Year of Origination
 
Carrying Value
 
Percent of Total
 
Carrying Value
 
Percent of Total
 
 
(Dollars in thousands)
2018
 
$
5,800

 
0.5
%
 
$

 
%
2017
 
212,785

 
22.0

 
214,365

 
22.1

2016
 
153,147

 
15.8

 
154,359

 
15.9

2015
 
143,457

 
14.8

 
144,890

 
14.9

2014
 
77,119

 
8.0

 
77,866

 
8.0

2013 and prior
 
376,356

 
38.9

 
380,332

 
39.1

Total
 
$
968,664

 
100.0
%
 
$
971,812

 
100.0
%


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Table of Contents


 Impaired Mortgage Loans
 
March 31, 2018
 
December 31, 2017
 
(Dollars in thousands)
Unpaid principal balance
$
18,927

 
$
19,027

Less:
 
 
 
Related allowance
(447
)
 
(497
)
Carrying value of impaired mortgage loans
$
18,480

 
$
18,530

 Allowance on Mortgage Loans
 
Three months ended March 31,
 
2018
 
2017
 
(Dollars in thousands)
Balance at beginning of period
$
497

 
$
713

Recoveries
(50
)
 
(50
)
Balance at end of period
$
447

 
$
663


Mortgage Loan Modifications

Our commercial mortgage loan portfolio can include 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 three months ended March 31, 2018 or March 31, 2017.

Low Income Housing Tax Credit Investments (LIHTC)

We invest in non-guaranteed federal LIHTC that are included in securities and indebtedness of related parties in the consolidated balance sheets. These investments take the form of limited partnerships, which in turn invest in a number of low income housing projects. We use the equity method of accounting for these investments. The limited partnerships generate pre-tax operating losses primarily from the deprecation of the underlying properties, but after-tax gains as the related tax credits are realized and the operating losses are deducted. The timing of the realization of tax credits is subject to fluctuation from period to period due to the timing of housing project completions and the approval of tax credits. Impairment losses may occur when the carrying value of the limited partnership exceeds the future tax benefits. We recognized $0.3 million of impairment losses on these investments during the first three months of 2018, which is reported as other-than-temporary impairment losses in the consolidated statement of operations. The Tax Act did not impact the tax credits we expect to receive from these investments. Equity income, however, was impacted by the Tax Act as the underlying limited partnerships reported aggregate fourth quarter 2017 losses of $1.4 million related to our ownership interest due to lower anticipated tax benefits from future operating loss deductions. These equity losses are reflected in our first quarter 2018 earnings as we record the results of operations from these limited partnerships a quarter in arrears. The carrying value of these investments totaled $79.2 million at March 31, 2018 and $82.4 million at December 31, 2017. Equity income from these investments as reported in our consolidated statement of operations is as follows:

LIHTC Equity Income (Loss), Net of Related Income Taxes
 
 
Three months ended March 31,
 
 
2018
 
2017
 
 
(Dollars in thousands)
Equity losses from LIHTC
 
$
(3,005
)
 
$
(1,805
)
Income tax benefits:
 
 
 
 
Tax benefits from equity losses
 
631

 
632

Investment tax credits
 
3,569

 
3,529

Equity income from LIHTC, net of related income tax benefits
 
$
1,195

 
$
2,356



15

Table of Contents

At March 31, 2018, we had committed to provide additional funds for limited partnerships and limited liability companies in which we invest. The amounts of these unfunded commitments totaled $47.5 million, including $1.7 million for LIHTC commitments, which are summarized by year in the following table.

LIHTC Commitments by Year
 
 
March 31, 2018
 
(Dollars in thousands)
2018
$
810

2019
46

2020-2025
811

Total
$
1,667


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. After determining that VIE status exists, we review our involvement in the VIE to determine whether we have both the power to direct activities that most significantly impact the economic performance of the VIE, and the obligation to absorb losses or the rights to receive benefits that could be potentially significant to the VIE. This analysis includes a review of the purpose and design of the VIE as well as the role that we played in the formation of the entity and how that role could impact our ability to control the VIE. We also review the activities and decisions considered significant to the economic performance of the VIE and assess what power we have in directing those activities and decisions. Finally, we review the agreements in place to determine if there are any guarantees that would affect our maximum exposure to loss.

We have reviewed the circumstances surrounding our investments in VIEs, which are classified as securities and indebtedness of related parties and consist of LIHTC, limited partnerships or limited liability companies accounted for under the equity method. In addition, we have reviewed the ownership interests in our VIEs and determined that we do not hold direct majority ownership or have other contractual rights (such as kick out rights) that give us effective control over these entities resulting in us having both the power to direct activities that most significantly impact the economic performance of the VIE and the obligation to absorb losses or the right to receive benefits that could be potentially significant to the VIE. The maximum loss exposure relative to our VIEs is limited to the carrying value and any unfunded commitments that exist for each particular VIE. We also have not provided additional support or other guarantees that was not previously contractually required (financial or otherwise) to any of the VIEs as of March 31, 2018 or December 31, 2017. Based on this analysis, none of our VIEs were required to be consolidated for any reporting periods presented in this Form 10-Q.

VIE Investments by Category
 
 
 
 
 
 
 
 
March 31, 2018
 
December 31, 2017
 
Carrying Value
 
Maximum Exposure to Loss
 
Carrying Value
 
Maximum Exposure to Loss
 
(Dollars in thousands)
LIHTC
$
79,176

 
$
80,843

 
$
82,417

 
$
84,103

Investment companies
28,418

 
63,054

 
25,335

 
62,372

Real estate limited partnerships
9,151

 
20,129

 
8,589

 
20,590

Other
728

 
955

 
1,182

 
1,488

Total
$
117,473

 
$
164,981

 
$
117,523

 
$
168,553


In addition, we make passive investments in the normal course of business in structured securities issued by VIEs for which we are not the investment manager. These structured securities include all of the residential mortgage-backed securities, commercial mortgage-backed securities and other asset-backed securities included in our fixed maturities. Our maximum exposure to loss on these securities is limited to our carrying value of the investment. We have determined that we are not the primary beneficiary of these structured securities because we do not have the power to direct the activities that most significantly impact the entities’ economic performance.



16

Table of Contents

Derivative Instruments

Our primary derivative exposure relates to purchased call options, which provide an economic hedge against the embedded derivatives in our indexed annuity and universal life insurance products. We also have embedded derivatives within our modified coinsurance agreements as well as an interest-only fixed maturity investment. We do not apply hedge accounting to any of our derivative positions, and they are held at fair value.

Derivatives Instruments by Type
 
 
March 31, 2018
 
December 31, 2017
 
(Dollars in thousands)
Assets
 
 
 
Freestanding derivatives:
 
 
 
Call options (reported in other investments)
$
12,760

 
$
14,824

Embedded derivatives:
 
 
 
Modified coinsurance (reported in reinsurance recoverable)
1,069

 
2,125

Interest-only security (reported in fixed maturities)
1,852

 
2,096

Total assets
$
15,681

 
$
19,045

 
 
 
 
Liabilities
 
 
 
Embedded derivatives:
 
 
 
Indexed annuity and universal life products (reported in liability for future policy benefits)
$
28,720

 
$
27,774

Modified coinsurance agreements (reported in other liabilities)
154

 
268

Total liabilities
$
28,874

 
$
28,042


Derivative Income (Loss)
 
 
 
 
Three months ended March 31,
 
2018
 
2017
 
(Dollars in thousands)
Change in fair value of free standing derivatives:
 
 
 
Call options
$
(1,152
)
 
$
2,365

Change in fair value of embedded derivatives:
 
 
 
Modified coinsurance agreements
(943
)
 
(1,410
)
Interest-only security
(35
)
 
(21
)
Indexed annuity and universal life products
2,664

 
409

Total income from derivatives
$
534

 
$
1,343


Derivative income is reported in net investment income except for the change in fair value of the embedded derivatives on our indexed annuity and universal life products, which is reported in interest sensitive product benefits.

We are exposed to credit losses in the event of nonperformance of the derivative counterparties. This credit risk is minimized by purchasing such agreements from financial institutions with high credit ratings (currently rated A or better by nationally recognized statistical rating organizations). We have also entered into credit support agreements with the counterparties requiring them to post collateral when net exposures exceed pre-determined thresholds that vary by counterparty. The net amount of such exposure is essentially the market value less collateral held for such agreements with each counterparty. The call options are supported by securities collateral received of $7.5 million at March 31, 2018, which is held in a separate custodial account. Subject to certain constraints, we are permitted to sell or re-pledge this collateral, but do not have legal rights to the collateral; accordingly, it has not been recorded on our balance sheet. At March 31, 2018, none of the collateral had been sold or re-pledged. As of March 31, 2018, our net derivative exposure was $5.3 million.



17

Table of Contents

3. Fair Values

The carrying and estimated fair values of our financial instruments are as follows:
Fair Values and Carrying Values
 
March 31, 2018
 
December 31, 2017
 
Carrying Value
 
Fair Value
 
Carrying Value
 
Fair Value
 
(Dollars in thousands)
Assets
 
 
 
 
 
 
 
Fixed maturities - available for sale
$
7,246,912

 
$
7,246,912

 
$
7,291,967

 
$
7,291,967

Equity securities
103,920

 
103,920

 
104,145

 
104,145

Mortgage loans
968,664

 
972,107

 
971,812

 
989,503

Policy loans
193,413

 
232,674

 
191,398

 
236,223

Other investments
44,950

 
46,040

 
42,318

 
43,443

Cash, cash equivalents and short-term investments
43,728

 
43,728

 
69,703

 
69,703

Reinsurance recoverable
1,069

 
1,069

 
2,125

 
2,125

Assets held in separate accounts
638,751

 
638,751

 
651,963

 
651,963


Liabilities
 
 
 
 
 
 
 
Future policy benefits
$
4,332,983

 
$
4,142,254

 
$
4,192,367

 
$
4,147,654

Supplementary contracts without life contingencies
317,541

 
315,625

 
322,630

 
327,151

Advance premiums and other deposits
260,967

 
260,967

 
259,099

 
259,099

Long-term debt
97,000

 
76,388

 
97,000

 
78,628

Other liabilities
154

 
154

 
268

 
268

Liabilities related to separate accounts
638,751

 
636,666

 
651,963

 
649,610


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, or, if 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:



18

Table of Contents

Fixed maturities:

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

Level 2 fixed maturities consist of corporate, mortgage- and asset-backed, United States Government agencies, state and political subdivisions 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 with no quoted market prices available, for which an internal model using substantially all observable inputs or a matrix pricing valuation approach is used. In the matrix approach, securities are grouped into pricing categories that vary by sector, rating and average life. Each pricing category is assigned a risk spread based on studies of observable public market data. The expected cash flows of the security are then discounted back at the current Treasury curve plus the appropriate risk spread.

Level 3 fixed maturities include corporate, mortgage- and asset-backed 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 for which 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 that 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 that may include discussions with the original pricing source or other external sources to ensure we are in agreement with the valuation.



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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 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 non-redeemable preferred stock. Estimated fair value for the non-redeemable preferred stock is obtained from external pricing sources using a matrix pricing approach.

Level 3 equity securities consist of non-redeemable preferred stock for which fair value estimates are based on the value of comparable securities that are actively traded. Increases in spreads 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 that 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 measured at fair value on a recurring basis include call options with fair values based on counterparty market prices adjusted for a credit component of the counterparty, net of collateral received. Level 3 other investments, which are not measured at fair value on a recurring basis, include common stock issued by the FHLB, with estimated fair value based on the current redemption value of the stock, and a promissory note that is priced internally using a discounted cash flow based on our assessment of the credit risk of the borrower.

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.



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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.

Future policy benefits, supplementary 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 that 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 that 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
 
March 31, 2018
 
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
 
 
 
 
 
 
 
Fixed maturities:
 
 
 
 
 
 
 
Corporate securities
$

 
$
3,515,151

 
$
30,530

 
$
3,545,681

Residential mortgage-backed securities

 
553,544

 

 
553,544

Commercial mortgage-backed securities

 
701,263

 
92,013

 
793,276

Other asset-backed securities

 
801,654

 
12,638

 
814,292

United States Government and agencies
8,961

 
14,251

 

 
23,212

States and political subdivisions

 
1,516,907

 

 
1,516,907

Total fixed maturities
8,961

 
7,102,770

 
135,181

 
7,246,912

Non-redeemable preferred stocks

 
90,877

 
7,325

 
98,202

Common stocks (1)
5,218

 

 

 
5,218

Other investments

 
12,760

 

 
12,760

Cash, cash equivalents and short-term investments
43,728

 

 

 
43,728

Reinsurance recoverable

 
1,069

 

 
1,069

Assets held in separate accounts
638,751

 

 

 
638,751

Total assets
$
696,658

 
$
7,207,476

 
$
142,506

 
$
8,046,640

 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
Future policy benefits - indexed product embedded derivatives
$

 
$

 
$
28,720

 
$
28,720

Other liabilities

 
154

 

 
154

Total liabilities
$

 
$
154

 
$
28,720

 
$
28,874


(1)
During 2018, we invested in a private equity fund totaling $0.5 million measured at fair value using net asset value (NAV) per share as a practical expedient, which have not been classified in the fair value hierarchy above per fair value reporting guidance. This fund invests in senior secured middle market loans and has unfunded commitments totaling $9.5 million at March 31, 2018. The investment is not currently eligible for redemption.


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Valuation of our Financial Instruments Measured on a Recurring Basis by Hierarchy Levels
 
December 31, 2017
 
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
 
 
 
 
 
 
 
Fixed maturities:
 
 
 
 
 
 
 
Corporate securities
$

 
$
3,654,671

 
$
33,600

 
$
3,688,271

Residential mortgage-backed securities

 
507,157

 
9,124

 
516,281

Commercial mortgage-backed securities

 
619,606

 
85,701

 
705,307

Other asset-backed securities

 
780,022

 
53,480

 
833,502

United States Government and agencies
9,078

 
15,827

 

 
24,905

States and political subdivisions

 
1,523,701

 

 
1,523,701

Total fixed maturities
9,078

 
7,100,984

 
181,905

 
7,291,967

Non-redeemable preferred stocks

 
92,425