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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 June 30, 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
394491824_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 July 31, 2018
Class A Common Stock, without par value
 
24,806,796
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 JUNE 30, 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)

 
June 30,
2018
 
December 31,
2017
Assets
 
 
 
Investments:
 
 
 
Fixed maturities - available for sale, at fair value (amortized cost: 2018 - $6,922,505; 2017 - $6,757,250)
$
7,173,415

 
$
7,291,967

Equity securities at fair value (cost: 2018 - $99,279; 2017 - $96,715)
104,026

 
104,145

Mortgage loans
982,987

 
971,812

Real estate
1,543

 
1,543

Policy loans
194,838

 
191,398

Short-term investments
15,141

 
17,007

Other investments
44,724

 
42,371

Total investments
8,516,674

 
8,620,243

 
 
 
 
Cash and cash equivalents
23,705

 
52,696

Securities and indebtedness of related parties
127,876

 
130,240

Accrued investment income
75,044

 
76,468

Amounts receivable from affiliates
8,200

 
3,561

Reinsurance recoverable
103,032

 
108,948

Deferred acquisition costs
387,527

 
302,611

Value of insurance in force acquired
8,880

 
4,560

Current income taxes recoverable

 
3,269

Other assets
106,722

 
112,054

Assets held in separate accounts
638,061

 
651,963

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total assets
$
9,995,721

 
$
10,066,613


 


2




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

 
June 30,
2018
 
December 31,
2017
Liabilities and stockholders’ equity
 
 
 
Liabilities:
 
 
 
Future policy benefits:
 
 
 
Interest sensitive products
$
5,417,955

 
$
5,299,961

Traditional life insurance and accident and health products
1,775,968

 
1,750,504

Other policy claims and benefits
46,681

 
44,475

Supplementary contracts without life contingencies
312,399

 
322,630

Advance premiums and other deposits
265,763

 
267,023

Amounts payable to affiliates
1,299

 
1,164

Short-term debt payable to non-affiliates
27,000

 

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

 
97,000

Current income taxes payable
2,984

 

Deferred income taxes
88,993

 
131,912

Other liabilities
93,930

 
111,131

Liabilities related to separate accounts
638,061

 
651,963

Total liabilities
8,768,033

 
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 24,806,796 shares in 2018 and 24,919,113 shares in 2017
153,114

 
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
131,081

 
284,983

Retained earnings
940,389

 
947,148

Total FBL Financial Group, Inc. stockholders’ equity
1,227,656

 
1,388,792

Noncontrolling interest
32

 
58

Total stockholders’ equity
1,227,688

 
1,388,850

Total liabilities and stockholders’ equity
$
9,995,721

 
$
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 June 30,
 
Six months ended June 30,
 
2018
 
2017
 
2018
 
2017
Revenues:
 
 
 
 
 
 
 
Interest sensitive product charges
$
30,906

 
$
29,456

 
$
61,004

 
$
58,657

Traditional life insurance premiums
51,091

 
50,262

 
100,588

 
98,696

Net investment income
103,974

 
103,908

 
204,996

 
204,902

Net realized capital gains (losses)
841

 
921

 
(906
)
 
518

Net other-than-temporary impairment losses recognized in earnings
(504
)
 

 
(1,799
)
 
(66
)
Other income
3,637

 
4,450

 
8,237

 
8,210

Total revenues
189,945

 
188,997

 
372,120

 
370,917

 
 
 
 
 
 
 
 
Benefits and expenses:
 
 
 
 
 
 
 
Interest sensitive product benefits
62,637

 
58,251

 
123,982

 
121,011

Traditional life insurance benefits
43,725

 
42,610

 
89,181

 
85,564

Policyholder dividends
2,560

 
2,557

 
5,111

 
5,110

Underwriting, acquisition and insurance expenses
37,210

 
36,341

 
76,787

 
70,694

Interest expense
1,213

 
1,213

 
2,426

 
2,425

Other expenses
5,627

 
4,740

 
11,220

 
8,891

Total benefits and expenses
152,972

 
145,712

 
308,707

 
293,695

 
36,973

 
43,285

 
63,413

 
77,222

Income taxes
(6,650
)
 
(13,891
)
 
(11,337
)
 
(24,624
)
Equity income, net of related income taxes
2,087

 
2,924

 
3,942

 
6,155

Net income
32,410

 
32,318

 
56,018

 
58,753

Net loss (income) attributable to noncontrolling interest
18

 
(27
)
 
41

 
(29
)
Net income attributable to FBL Financial Group, Inc.
$
32,428

 
$
32,291

 
$
56,059

 
$
58,724

 
 
 
 
 
 
 
 
Earnings per common share
$
1.30

 
$
1.29

 
$
2.24

 
$
2.34

Earnings per common share - assuming dilution
$
1.30

 
$
1.29

 
$
2.24

 
$
2.34

 
 
 
 
 
 
 
 
Cash dividend per common share
$
0.46

 
$
0.44

 
$
0.92

 
$
0.88

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 June 30,
 
Six months ended June 30,
 
2018
 
2017
 
2018
 
2017
Net income
$
32,410

 
$
32,318

 
$
56,018

 
$
58,753

Other comprehensive income (loss) (1)
 
 
 
 
 
 
 
Change in net unrealized investment gains/losses
(55,797
)
 
46,570

 
(148,951
)
 
62,431

Change in underfunded status of postretirement benefit plans
267

 
189

 
529

 
371

Total other comprehensive income (loss), net of tax
(55,530
)
 
46,759

 
(148,422
)
 
62,802

Total comprehensive income (loss), net of tax
(23,120
)
 
79,077

 
(92,404
)
 
121,555

Comprehensive (income) loss attributable to noncontrolling interest
18

 
(27
)
 
41

 
(29
)
Total comprehensive income (loss) applicable to FBL Financial Group, Inc.
$
(23,102
)
 
$
79,050

 
$
(92,363
)
 
$
121,526


(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 - six months ended June 30, 2017

 

 

 
58,724

 
29

 
58,753

Other comprehensive income

 

 
62,802

 

 

 
62,802

Issuance of common stock under compensation plans

 
440

 

 

 

 
440

Dividends on preferred stock

 

 

 
(75
)
 

 
(75
)
Dividends on common stock

 

 

 
(59,309
)
 

 
(59,309
)
Balance at June 30, 2017
$
3,000

 
$
153,415

 
$
212,357

 
$
882,012

 
$
85

 
$
1,250,869

 
 
 
 
 
 
 
 
 
 
 
 
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

 

 
(5,480
)
 
5,480

 

 

Net income - six months ended June 30, 2018

 

 

 
56,059

 
(41
)
 
56,018

Other comprehensive loss

 

 
(148,422
)
 

 

 
(148,422
)
Issuance of common stock under compensation plans

 
320

 

 

 

 
320

Purchase of common stock

 
(795
)
 

 
(8,054
)
 

 
(8,849
)
Dividends on preferred stock

 

 

 
(75
)
 

 
(75
)
Dividends on common stock

 

 

 
(60,169
)
 

 
(60,169
)
Receipts related to noncontrolling interest

 

 

 

 
15

 
15

Balance at June 30, 2018
$
3,000

 
$
153,186

 
$
131,081

 
$
940,389

 
$
32

 
$
1,227,688


See accompanying notes.


5




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

 
Six months ended June 30,
 
2018
 
2017
Operating activities
 
 
 
Net income
$
56,018

 
$
58,753

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Interest credited to account balances
82,699

 
79,938

Charges for mortality, surrenders and administration
(60,081
)
 
(58,037
)
Net realized (gains) losses on investments
2,705

 
(452
)
Change in fair value of derivatives
(3,089
)
 
(2,466
)
Increase in liabilities for life insurance and other future policy benefits
38,308

 
43,282

Deferral of acquisition costs
(22,244
)
 
(21,908
)
Amortization of deferred acquisition costs and value of insurance in force
20,318

 
16,565

Change in reinsurance recoverable
5,097

 
(2,728
)
Provision for deferred income taxes
(3,466
)
 
1,054

Other
10,971

 
6,787

Net cash provided by operating activities
127,236

 
120,788

 
 
 
 
Investing activities
 
 
 
Sales, maturities or repayments:
 
 
 
Fixed maturities - available for sale
352,051

 
293,162

Equity securities - available for sale

 
8,928

Mortgage loans
36,861

 
28,584

Derivative instruments
8,912

 
5,892

Policy loans
19,030

 
19,410

Securities and indebtedness of related parties
3,064

 
3,859

Real estate

 
717

Other long-term investments
3,524

 
14

Acquisitions:
 
 
 
Fixed maturities - available for sale
(529,344
)
 
(294,258
)
Equity securities - available for sale
(2,283
)
 
(1,102
)
Mortgage loans
(47,936
)
 
(90,450
)
Derivative instruments
(7,049
)
 
(4,557
)
Policy loans
(22,470
)
 
(19,786
)
Securities and indebtedness of related parties
(8,476
)
 
(6,859
)
Other long-term investments
(6,531
)
 

Short-term investments, net change
1,866

 
(13,273
)
Purchases and disposals of property and equipment, net
(6,067
)
 
(5,954
)
Net cash used in investing activities
(204,848
)
 
(75,673
)




6




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

 
Six months ended June 30,
 
2018
 
2017
Financing activities
 
 
 
Contract holder account deposits
$
402,751

 
$
263,551

Contract holder account withdrawals
(311,878
)
 
(239,237
)
Dividends paid
(60,244
)
 
(59,384
)
Proceeds from issuance of short-term debt
27,000

 

Issuance or repurchase of common stock, net
(9,023
)
 
181

Other financing activities
15

 

Net cash provided by (used in) financing activities
48,621

 
(34,889
)
Increase (decrease) in cash and cash equivalents
(28,991
)
 
10,226

Cash and cash equivalents at beginning of period
52,696

 
33,583

Cash and cash equivalents at end of period
$
23,705

 
$
43,809

 
 
 
 
Supplemental disclosures of cash flow information
 
 
 
Cash (paid) received during the period for:
 
 
 
Interest
$
(2,425
)
 
$
(2,425
)
Income taxes
(20
)
 
(3,602
)

See accompanying notes.


7


FBL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
June 30, 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 three- and six-month periods ended June 30, 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 associated with components of AOCI during 2018 would result in additional reclassification. There have been no such adjustments during the six months ended June 30, 2018.

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 $5.5 million of net unrealized investment gains, net of adjustments to deferred acquisition costs, interest sensitive policy reserves and income taxes, on our equity securities from AOCI to retained earnings as a cumulative effect adjustment. Adoption resulted in a decrease to net income of $1.9 million ($0.08 per basic and diluted earnings per share) during the six months ended June 30, 2018 and $0.6 million ($0.02 per basic and diluted earnings per share) during the second 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

During the first quarter of 2018, we began reporting 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, as other investments rather than equity securities 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
 
 
 
June 30, 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)
$
3,259,368

 
$
169,981

 
$
(56,088
)
 
$
3,373,261

 
$

Residential mortgage-backed
577,566

 
29,353

 
(7,450
)
 
599,469

 
1,788

Commercial mortgage-backed
863,195

 
19,067

 
(21,289
)
 
860,973

 

Other asset-backed
770,178

 
17,452

 
(3,606
)
 
784,024

 
1,573

United States Government and agencies
20,491

 
1,099

 
(230
)
 
21,360

 

States and political subdivisions
1,431,707

 
106,026

 
(3,405
)
 
1,534,328

 

Total fixed maturities
$
6,922,505

 
$
342,978

 
$
(92,068
)
 
$
7,173,415

 
$
3,361

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 residential mortgage-backed and other asset-backed securities at June 30, 2018 and 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 $13.7 million at June 30, 2018 and $17.5 million at December 31, 2017. Corporate securities also include redeemable preferred stock with a fair value of $20.6 million at June 30, 2018 and $21.7 million at December 31, 2017.



10

Table of Contents

Available-For-Sale Fixed Maturities by Maturity Date
 
 
 
 
June 30, 2018
 
Amortized
Cost
 

Fair Value
 
(Dollars in thousands)
Due in one year or less
$
129,205

 
$
132,022

Due after one year through five years
547,317

 
566,723

Due after five years through ten years
713,103

 
727,046

Due after ten years
3,321,941

 
3,503,158

 
4,711,566

 
4,928,949

Mortgage-backed and other asset-backed
2,210,939

 
2,244,466

Total fixed maturities
$
6,922,505

 
$
7,173,415


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
 
June 30,
2018
 
December 31,
2017
 
(Dollars in thousands)
Net unrealized appreciation on:
 
 
 
Fixed maturities - available for sale
$
250,910

 
$
534,718

Equity securities - available for sale

 
7,430

 
250,910

 
542,148

Adjustments for assumed changes in amortization pattern of:
 
 
 
Deferred acquisition costs
(65,530
)
 
(147,173
)
Value of insurance in force acquired
(9,459
)
 
(14,870
)
Unearned revenue reserve
7,108

 
12,705

Adjustments for assumed changes in policyholder liabilities
(4,199
)
 
(18,499
)
Provision for deferred income taxes
(37,555
)
 
(78,605
)
Net unrealized investment gains
$
141,275

 
$
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
 
 
 
 
June 30, 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
 
$
927,826

 
$
(36,269
)
 
$
164,984

 
$
(19,819
)
 
$
1,092,810

 
$
(56,088
)
 
60.9
%
Residential mortgage-backed
 
245,127

 
(6,475
)
 
27,229

 
(975
)
 
272,356

 
(7,450
)
 
8.1

Commercial mortgage-backed
 
442,114

 
(18,046
)
 
29,415

 
(3,243
)
 
471,529

 
(21,289
)
 
23.1

Other asset-backed
 
299,747

 
(2,234
)
 
67,874

 
(1,372
)
 
367,621

 
(3,606
)
 
3.9

United States Government and agencies
 
5,010

 
(180
)
 
1,846

 
(50
)
 
6,856

 
(230
)
 
0.3

States and political subdivisions
 
103,189

 
(1,829
)
 
17,393

 
(1,576
)
 
120,582

 
(3,405
)
 
3.7

Total fixed maturities
 
$
2,023,013

 
$
(65,033
)
 
$
308,741

 
$
(27,035
)
 
$
2,331,754

 
$
(92,068
)
 
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 642 securities from 406 issuers at June 30, 2018 and 247 securities from 154 issuers at December 31, 2017.

Unrealized losses increased during the six months ended June 30, 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 June 30, 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 an oil field service provider and totaled $2.0 million at June 30, 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
 
Six months ended June 30,
 
2018

2017
 
(Dollars in thousands)
Balance at beginning of period
$
(12,392
)
 
$
(14,500
)
Reductions due to investments sold or paid down
3,369

 
829

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
$
(6,494
)
 
$
(13,084
)



12

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 June 30,
 
Six months ended June 30,
 
2018
 
2017
 
2018
 
2017
 
(Dollars in thousands)
Realized gains (losses) on sales of investments
 
 
 
 
 
 
 
Fixed maturities:
 
 
 
 
 
 
 
Gross gains
$
1,713

 
$
1,081

 
$
1,796

 
$
1,205

Gross losses
(1
)
 
(414
)
 
(1
)
 
(941
)
Equity securities

 
(90
)
 

 
(90
)
Other long-term investments
(5
)
 
40

 
(18
)
 
40

Real estate

 
304

 

 
304

 
1,707

 
921

 
1,777

 
518

Net unrealized losses recognized during the period on equity securities held at the end of the period (1)
(866
)
 

 
(2,683
)
 

Net realized gains (losses)
841

 
921

 
(906
)
 
518

 
 
 
 
 
 
 
 
Impairment losses recognized in earnings:
 
 
 
 
 
 
 
Other credit-related (2)
(504
)
 

 
(1,799
)
 
(66
)
Net realized gains (losses) on investments recorded in income
$
337

 
$
921

 
$
(2,705
)
 
$
452


(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 $56.3 million during the six months ended June 30, 2018 and $85.1 million during the six months ended June 30, 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 June 30, 2018 and December 31, 2017, there were no non-performing loans over 90 days past due on contractual payments. At June 30, 2018, we had committed to provide additional funding for mortgage loans totaling $16.2 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
 
 
 
 
 
 
 
 
 
 
June 30, 2018
 
December 31, 2017
Collateral Type
 
Carrying Value
 
Percent of Total
 
Carrying Value
 
Percent of Total
 
 
(Dollars in thousands)
Office
 
$
415,920

 
42.3
%
 
$
410,090

 
42.2
%
Retail
 
295,997

 
30.1

 
292,257

 
30.1

Industrial
 
208,815

 
21.2

 
207,180

 
21.3

Other
 
62,255

 
6.4

 
62,285

 
6.4

Total
 
$
982,987

 
100.0
%
 
$
971,812

 
100.0
%

Mortgage Loans by Geographic Location within the United States
 
 
 
 
June 30, 2018
 
December 31, 2017
Region of the United States
 
Carrying Value
 
Percent of Total
 
Carrying Value
 
Percent of Total
 
 
(Dollars in thousands)
South Atlantic
 
$
278,061

 
28.3
%
 
$
296,947

 
30.5
%
Pacific
 
155,917

 
15.9

 
146,320

 
15.0

West North Central
 
124,177

 
12.6

 
127,096

 
13.1

Mountain
 
103,331

 
10.5

 
105,627

 
10.9

East North Central
 
102,597

 
10.4

 
91,971

 
9.5

West South Central
 
92,322

 
9.4

 
85,566

 
8.8

East South Central
 
66,063

 
6.7

 
67,228

 
6.9

New England
 
34,286

 
3.5

 
35,005

 
3.6

Middle Atlantic
 
26,233

 
2.7

 
16,052

 
1.7

Total
 
$
982,987

 
100.0
%
 
$
971,812

 
100.0
%

Mortgage Loans by Loan-to-Value Ratio
 
 
 
 
 
 
 
 
 
 
June 30, 2018
 
December 31, 2017
Loan-to-Value Ratio
 

Carrying Value
 
Percent of Total
 
Carrying Value
 
Percent of Total
 
 
(Dollars in thousands)
0% - 50%
 
$
381,586

 
38.8
%
 
$
334,037

 
34.4
%
51% - 60%
 
250,732

 
25.5

 
258,359

 
26.6

61% - 70%
 
310,805

 
31.6

 
297,404

 
30.6

71% - 80%
 
21,212

 
2.2

 
63,116

 
6.5

81% - 90%
 
18,652

 
1.9

 
18,896

 
1.9

Total
 
$
982,987

 
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
 
 
 
 
 
 
 
 
 
 
June 30, 2018
 
December 31, 2017
Year of Origination
 
Carrying Value
 
Percent of Total
 
Carrying Value
 
Percent of Total
 
 
(Dollars in thousands)
2018
 
$
46,500

 
4.6
%
 
$

 
%
2017
 
211,055

 
21.5

 
214,365

 
22.1

2016
 
151,923

 
15.5

 
154,359

 
15.9

2015
 
135,616

 
13.8

 
144,890

 
14.9

2014
 
76,363

 
7.8

 
77,866

 
8.0

2013 and prior
 
361,530

 
36.8

 
380,332

 
39.1

Total
 
$
982,987

 
100.0
%
 
$
971,812

 
100.0
%


14

Table of Contents


 Impaired Mortgage Loans
 
June 30, 2018
 
December 31, 2017
 
(Dollars in thousands)
Unpaid principal balance
$
18,826

 
$
19,027

Less:
 
 
 
Related allowance
(397
)
 
(497
)
Carrying value of impaired mortgage loans
$
18,429

 
$
18,530

 Allowance on Mortgage Loans
 
Six months ended June 30,
 
2018
 
2017
 
(Dollars in thousands)
Balance at beginning of period
$
497

 
$
713

Recoveries
(100
)
 
(98
)
Balance at end of period
$
397

 
$
615


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 six months ended June 30, 2018 or June 30, 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 depreciation 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 $0.8 million of impairment losses on these investments during the first six 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 lower as a result of the Tax Act by $0.9 million during the second quarter 2018, and $2.3 million for the six months ended June 30, 2018 due to impairment losses recorded by the underlying partnerships in their fourth quarter earnings. Equity income from LIHTC is generally recorded one quarter in arrears as financial information becomes available from the investee. The carrying value of our LIHTC totaled $75.4 million at June 30, 2018 and $82.4 million at December 31, 2017.

LIHTC Equity Income (Loss), Net of Related Income Taxes
 
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2018
 
2017
 
2018
 
2017
 
 
(Dollars in thousands)
Equity losses from LIHTC
 
$
(3,304
)
 
$
(2,938
)
 
$
(6,309
)
 
$
(4,743
)
Income tax benefits:
 
 
 
 
 
 
 
 
Tax benefits from equity losses
 
694

 
1,028

 
1,325

 
1,660

Investment tax credits
 
3,558

 
3,568

 
7,127

 
7,097

Equity income from LIHTC, net of related income tax benefits
 
$
948

 
$
1,658

 
$
2,143

 
$
4,014




15

Table of Contents

At June 30, 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 $43.4 million, including $1.6 million for LIHTC commitments, which are summarized by year in the following table.

LIHTC Commitments by Year
 
 
June 30, 2018
 
(Dollars in thousands)
2018
$
472

2019
248

2020-2025
884

Total
$
1,604


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 June 30, 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
 
 
 
 
 
 
 
 
June 30, 2018
 
December 31, 2017
 
Carrying Value
 
Maximum Exposure to Loss
 
Carrying Value
 
Maximum Exposure to Loss
 
(Dollars in thousands)
LIHTC
$
75,374

 
$
76,978

 
$
82,417

 
$
84,103

Investment companies
31,300

 
62,706

 
25,335

 
62,372

Real estate limited partnerships
9,317

 
19,463

 
8,589

 
20,590

Other
724

 
918

 
1,182

 
1,488

Total
$
116,715

 
$
160,065

 
$
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
 
 
June 30, 2018
 
December 31, 2017
 
(Dollars in thousands)
Assets
 
 
 
Freestanding derivatives:
 
 
 
Call options (reported in other investments)
$
14,002

 
$
14,824

Embedded derivatives:
 
 
 
Modified coinsurance (reported in reinsurance recoverable)
1,145

 
2,125

Interest-only security (reported in fixed maturities)
1,624

 
2,096

Total assets
$
16,771

 
$
19,045

 
 
 
 
Liabilities
 
 
 
Embedded derivatives:
 
 
 
Indexed annuity and universal life products (reported in liability for future policy benefits)
$
32,969

 
$
27,774

Modified coinsurance agreements (reported in other liabilities)
106

 
268

Total liabilities
$
33,075

 
$
28,042


Derivative Income (Loss)
 
 
 
 
 
 
 
 
Three months ended June 30,
 
Six months ended June 30,
 
2018
 
2017
 
2018
 
2017
 
(Dollars in thousands)
Change in fair value of free standing derivatives:
 
 
 
 
 
 
 
Call options
$
2,193

 
$
1,400

 
$
1,041

 
$
3,765

Change in fair value of embedded derivatives:
 
 
 
 
 
 
 
Modified coinsurance agreements
125

 
(12
)
 
(818
)
 
(1,422
)
Interest-only security
(44
)
 
(174
)
 
(79
)
 
(195
)
Indexed annuity and universal life products
281

 
(91
)
 
2,945

 
318

Total income from derivatives
$
2,555

 
$
1,123

 
$
3,089

 
$
2,466


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 $9.5 million at June 30, 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 June 30, 2018, none of the collateral had been sold or re-pledged. As of June 30, 2018, our net derivative exposure was $4.8 million.



17

Table of Contents

3. Fair Values

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 measured at fair value on a recurring basis:

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


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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.

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.

Other investments:

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



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Cash, cash equivalents and short-term investments:

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

Reinsurance recoverable:

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

Assets held in separate accounts:

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

Future policy benefits-indexed product embedded derivatives:

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.

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.




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Valuation of our Financial Instruments Measured on a Recurring Basis by Hierarchy Levels
 
June 30, 2018
 
Quoted prices in active markets
for identical assets (Level 1)
 
Significant other observable inputs
(Level 2)
 
Significant unobservable inputs
(Level 3)
 
Fair Value
 
(Dollars in thousands)
Assets
 
 
 
 
 
 
 
Fixed maturities:
 
 
 
 
 
 
 
Corporate securities
$

 
$
3,342,791

 
$
30,470

 
$
3,373,261

Residential mortgage-backed securities

 
575,529

 
23,940

 
599,469

Commercial mortgage-backed securities

 
773,606

 
87,367

 
860,973

Other asset-backed securities

 
767,725

 
16,299

 
784,024

United States Government and agencies
8,403

 
12,957

 

 
21,360

States and political subdivisions

 
1,534,328

 

 
1,534,328

Total fixed maturities
8,403

 
7,006,936

 
158,076

 
7,173,415

Non-redeemable preferred stocks

 
90,269

 
7,056

 
97,325

Common stocks (1)
5,395

 

 

 
5,395

Other investments

 
14,002

 

 
14,002

Cash, cash equivalents and short-term investments
38,846