2014-03-31_AEL 10Q

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, 2014
OR
o 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission File Number : 001-31911
American Equity Investment Life Holding Company
(Exact name of registrant as specified in its charter)
Iowa
 
42-1447959
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
6000 Westown Parkway
West Des Moines, Iowa 50266
(Address of principal executive offices, including zip code)
(515) 221-0002
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
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 (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer," “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x
 
Accelerated filer o
Non-accelerated filer o
 
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
APPLICABLE TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:
As of April 30, 2014, there were 74,330,895 shares of the registrant's common stock, $1 par value, outstanding.



TABLE OF CONTENTS
 
Page
 
 
 
 
 
 




Table of Contents

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share and per share data)
 
March 31, 2014
 
December 31, 2013
 
(Unaudited)
 
 
Assets
 
 
 
Investments:
 
 
 
Fixed maturity securities:
 
 
 
Available for sale, at fair value (amortized cost: 2014 - $27,255,625; 2013 - $26,527,730)
$
28,315,473

 
$
26,610,447

Held for investment, at amortized cost (fair value: 2014 - $64,920; 2013 - $60,840)
76,298

 
76,255

Equity securities, available for sale, at fair value (cost: 2014 - $7,505; 2013 - $7,503)
7,767

 
7,778

Mortgage loans on real estate
2,584,583

 
2,581,082

Derivative instruments
790,396

 
856,050

Other investments
213,706

 
215,042

Total investments
31,988,223

 
30,346,654

 
 
 
 
Cash and cash equivalents
679,172

 
897,529

Coinsurance deposits
3,028,367

 
2,999,618

Accrued investment income
322,818

 
301,641

Deferred policy acquisition costs
2,210,694

 
2,426,652

Deferred sales inducements
1,713,246

 
1,875,880

Deferred income taxes
189,956

 
301,856

Other assets
412,020

 
471,669

Total assets
$
40,544,496

 
$
39,621,499

 
 
 
 
Liabilities and Stockholders' Equity
 
 
 
Liabilities:
 
 
 
Policy benefit reserves
$
36,731,438

 
$
35,789,655

Other policy funds and contract claims
402,895

 
418,033

Notes payable
521,758

 
549,958

Subordinated debentures
246,097

 
246,050

Income taxes payable
18,062

 
10,153

Other liabilities
969,297

 
1,222,963

Total liabilities
38,889,547

 
38,236,812

 
 
 
 
Stockholders' equity:
 
 
 
Preferred stock, par value $1 per share, 2,000,000 shares authorized,
  2014 and 2013 - no shares issued and outstanding

 

Common stock, par value $1 per share, 200,000,000 shares authorized; issued and outstanding:
   2014 - 72,390,229 shares (excluding 4,527,167 treasury shares);
   2013 - 70,535,404 shares (excluding 4,876,735 treasury shares)
72,390

 
70,535

Additional paid-in capital
542,003

 
550,400

Unallocated common stock held by ESOP; 2014 - 58,618 shares; 2013 - 58,618 shares
(313
)
 
(631
)
Accumulated other comprehensive income
332,435

 
46,196

Retained earnings
708,434

 
718,187

Total stockholders' equity
1,654,949

 
1,384,687

Total liabilities and stockholders' equity
$
40,544,496

 
$
39,621,499

See accompanying notes to unaudited consolidated financial statements.

2

Table of Contents

AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except per share data)
(Unaudited)

 
Three Months Ended
March 31,
 
2014
 
2013
Revenues:
 
 
 
Premiums and other considerations
$
7,331

 
$
13,084

Annuity product charges
25,272

 
21,481

Net investment income
370,005

 
329,690

Change in fair value of derivatives
48,493

 
373,962

Net realized gains (losses) on investments, excluding other than temporary impairment ("OTTI") losses
(714
)
 
10,585

OTTI losses on investments:
 
 
 
Total OTTI losses

 
(2,189
)
Portion of OTTI losses recognized from other comprehensive income
(905
)
 
(1,048
)
Net OTTI losses recognized in operations
(905
)
 
(3,237
)
Loss on extinguishment of debt
(3,977
)
 

Total revenues
445,505

 
745,565

 
 
 
 
Benefits and expenses:
 
 
 
Insurance policy benefits and change in future policy benefits
10,095

 
14,760

Interest sensitive and index product benefits
317,192

 
223,170

Amortization of deferred sales inducements
666

 
28,831

Change in fair value of embedded derivatives
92,619

 
363,272

Interest expense on notes payable
10,264

 
7,248

Interest expense on subordinated debentures
3,008

 
3,009

Amortization of deferred policy acquisition costs
7,194

 
46,230

Other operating costs and expenses
19,085

 
19,520

Total benefits and expenses
460,123

 
706,040

Income (loss) before income taxes
(14,618
)
 
39,525

Income tax expense (benefit)
(4,865
)
 
13,494

Net income (loss)
$
(9,753
)
 
$
26,031

 
 
 
 
Earnings (loss) per common share
$
(0.13
)
 
$
0.41

Earnings (loss) per common share - assuming dilution
$
(0.13
)
 
$
0.38

Weighted average common shares outstanding (in thousands):
 
 
 
Earnings (loss) per common share
72,519

 
63,314

Earnings (loss) per common share - assuming dilution
79,616

 
68,706

See accompanying notes to unaudited consolidated financial statements.

3

Table of Contents

AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in thousands)
(Unaudited)

 
Three Months Ended
March 31,
 
2014
 
2013
 
 
 
 
Net income (loss)
$
(9,753
)
 
$
26,031

Other comprehensive income (loss):
 
 
 
Change in net unrealized investment gains/losses (1)
440,688

 
(41,463
)
Noncredit component of OTTI losses (1)
408

 
347

Reclassification of unrealized investment gains/losses to net income (1)
(730
)
 
2,433

Other comprehensive income (loss) before income tax
440,366

 
(38,683
)
Income tax effect related to other comprehensive income (loss)
(154,127
)
 
13,539

Other comprehensive income (loss)
286,239

 
(25,144
)
Comprehensive income
$
276,486

 
$
887

(1)
Net of related adjustments to amortization of deferred sales inducements and deferred policy acquisition costs.
See accompanying notes to unaudited consolidated financial statements.

4

Table of Contents

AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Dollars in thousands, except share data)
(Unaudited)

 
Common
Stock
 
Additional
Paid-in
Capital
 
Unallocated
Common
Stock Held
by ESOP
 
Accumulated
Other
Comprehensive
Income
 
Retained
Earnings
 
Total
Stockholders'
Equity
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2013
$
70,535

 
$
550,400

 
$
(631
)
 
$
46,196

 
$
718,187

 
$
1,384,687

Net loss for period

 

 

 

 
(9,753
)
 
(9,753
)
Other comprehensive income

 

 

 
286,239

 

 
286,239

Allocation of 29,309 shares of common stock by ESOP, including excess income tax benefits

 
364

 
318

 

 

 
682

Share-based compensation, including excess income tax benefits

 
2,578

 

 

 

 
2,578

Issuance of 908,032 shares of common stock under compensation plans, including excess income tax benefits
908

 
5,731

 

 

 

 
6,639

Extinguishment of convertible senior notes, net of tax, including 946,793 shares of common stock issued upon conversion
947

 
(17,070
)
 

 

 

 
(16,123
)
Balance at March 31, 2014
$
72,390

 
$
542,003

 
$
(313
)
 
$
332,435

 
$
708,434

 
$
1,654,949

 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2012
$
61,751

 
$
496,715

 
$
(2,583
)
 
$
686,807

 
$
477,547

 
$
1,720,237

Net income for period

 

 

 

 
26,031

 
26,031

Other comprehensive loss

 

 

 
(25,144
)
 

 
(25,144
)
Allocation of 29,430 shares of common stock by ESOP, including excess income tax benefits

 
58

 
317

 

 

 
375

Share-based compensation, including excess income tax benefits

 
1,488

 

 

 

 
1,488

Issuance of 1,033,370 shares of common stock under compensation plans, including excess income tax benefits
1,033

 
6,209

 

 

 

 
7,242

Balance at March 31, 2013
$
62,784

 
$
504,470

 
$
(2,266
)
 
$
661,663

 
$
503,578

 
$
1,730,229

See accompanying notes to unaudited consolidated financial statements.

5

Table of Contents

AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)

 
Three Months Ended
March 31,
 
2014
 
2013
Operating activities
 
 
 
Net income (loss)
$
(9,753
)
 
$
26,031

Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
Interest sensitive and index product benefits
317,192

 
223,170

Amortization of deferred sales inducements
666

 
28,831

Annuity product charges
(25,272
)
 
(21,481
)
Change in fair value of embedded derivatives
92,619

 
363,272

Change in traditional life and accident and health insurance reserves
(91
)
 
3,041

Policy acquisition costs deferred
(93,333
)
 
(94,638
)
Amortization of deferred policy acquisition costs
7,194

 
46,230

Provision for depreciation and other amortization
3,000

 
4,607

Amortization of discounts and premiums on investments
(2,829
)
 
(6,296
)
Realized gains/losses on investments and net OTTI losses recognized in operations
1,619

 
(7,348
)
Change in fair value of derivatives
(48,493
)
 
(373,962
)
Deferred income taxes
(37,360
)
 
(2,451
)
Loss on extinguishment of debt, net of tax
3,977

 

Share-based compensation
37

 
1,290

Change in accrued investment income
(21,177
)
 
(36,508
)
Change in income taxes payable
7,909

 
5,438

Change in other assets
(339
)
 
1,315

Change in other policy funds and contract claims
(17,288
)
 
(8,451
)
Change in collateral held for derivatives
(98,351
)
 
224,755

Change in other liabilities
(30,056
)
 
(6,215
)
Other
(1,708
)
 
(1,014
)
Net cash provided by operating activities
48,163

 
369,616

 
 
 
 
Investing activities
 
 
 
Sales, maturities, or repayments of investments:
 
 
 
Fixed maturity securities - available for sale
208,747

 
937,343

Mortgage loans on real estate
84,735

 
125,998

Derivative instruments
241,098

 
146,918

Other investments
8,942

 
5,371

Acquisition of investments:
 
 
 
Fixed maturity securities - available for sale
(974,244
)
 
(2,308,052
)
Mortgage loans on real estate
(90,056
)
 
(95,147
)
Derivative instruments
(103,330
)
 
(82,448
)
Other investments
(2,259
)
 
(199
)
Purchases of property, furniture and equipment
(200
)
 
(78
)
Net cash used in investing activities
(626,567
)
 
(1,270,294
)

6

Table of Contents

AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Dollars in thousands)
(Unaudited)

 
Three Months Ended
March 31,
 
2014
 
2013
Financing activities
 
 
 
Receipts credited to annuity and single premium universal life policyholder account balances
$
915,631

 
$
914,936

Coinsurance deposits
(2,609
)
 
5,641

Return of annuity policyholder account balances
(475,280
)
 
(402,185
)
Financing fees incurred and deferred
(100
)
 

Repayment of notes payable
(54,583
)
 

Excess tax benefits realized from share-based compensation plans
3,087

 
305

Proceeds from issuance of common stock
6,093

 
7,103

Change in checks in excess of cash balance
(32,192
)
 
(11,570
)
Net cash provided by financing activities
360,047

 
514,230

Decrease in cash and cash equivalents
(218,357
)
 
(386,448
)
Cash and cash equivalents at beginning of period
897,529

 
1,268,545

Cash and cash equivalents at end of period
$
679,172

 
$
882,097

 
 
 
 
Supplemental disclosures of cash flow information
 
 
 
Cash paid during period for:
 
 
 
Interest expense
$
17,993

 
$
6,470

Income taxes
21,500

 
10,200

Non-cash operating activity:
 
 
 
Deferral of sales inducements
72,687

 
73,898

Non-cash investing activity:
 
 
 
Real estate acquired in satisfaction of mortgage loans
1,713

 
844

Non-cash financing activities:
 
 
 
Common stock issued in extinguishment of debt
23,177

 

See accompanying notes to unaudited consolidated financial statements.




 

7


AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2014
(Unaudited)

1. Significant Accounting Policies
Consolidation and Basis of Presentation
The accompanying consolidated financial statements of American Equity Investment Life Holding Company (“we”, “us” or “our”) 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 the information and notes required by GAAP for complete financial statements. The consolidated financial statements reflect all adjustments, consisting only of normal recurring items, which are necessary to present fairly our financial position and results of operations on a basis consistent with the prior audited consolidated financial statements. Operating results for the three month period ended March 31, 2014 are not necessarily indicative of the results that may be expected for the year ended December 31, 2014. All significant intercompany accounts and transactions have been eliminated. The preparation of financial statements requires the use of management estimates. For further information related to a description of areas of judgment and estimates and other information necessary to understand our financial position and results of operations, refer to the audited consolidated financial statements and notes included in our Annual Report on Form 10-K for the year ended December 31, 2013.
As previously reported in the notes to audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2013, we identified certain classification errors related to the presentation of premiums and other considerations, insurance policy benefits and change in future policy benefits and interest sensitive and index product benefits related to life contingent immediate annuities in our audited consolidated statements of operations. Consistent with that presentation, we have revised the unaudited consolidated statements of operations for the three months ended March 31, 2013. The changes resulted in increases to premiums and other considerations of $10.4 million and insurance policy benefits and change in future policy benefits of $13.0 million, as well as decreases to interest sensitive and index product benefits of $2.6 million for the three months ended March 31, 2013. These changes had no impact on the consolidated balance sheets, net income or stockholders' equity.
Reclassifications have been made to prior period unaudited consolidated financial statements to conform to the March 31, 2014 presentation.
Adopted Accounting Pronouncements
There were no accounting pronouncements that were adopted during the current period.
New Accounting Pronouncements
There are currently no accounting standards updates with effective dates after March 31, 2014 that will significantly affect our consolidated financial statements.

8

Table of Contents

2. Fair Values of Financial Instruments
The following sets forth a comparison of the carrying amounts and fair values of our financial instruments:
 
March 31, 2014
 
December 31, 2013
 
Carrying
Amount
 
Fair Value
 
Carrying
Amount
 
Fair Value
 
(Dollars in thousands)
Assets
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Available for sale
$
28,315,473

 
$
28,315,473

 
$
26,610,447

 
$
26,610,447

Held for investment
76,298

 
64,920

 
76,255

 
60,840

Equity securities, available for sale
7,767

 
7,767

 
7,778

 
7,778

Mortgage loans on real estate
2,584,583

 
2,616,777

 
2,581,082

 
2,615,410

Derivative instruments
790,396

 
790,396

 
856,050

 
856,050

Other investments
193,114

 
195,888

 
192,198

 
193,343

Cash and cash equivalents
679,172

 
679,172

 
897,529

 
897,529

Coinsurance deposits
3,028,367

 
2,707,325

 
2,999,618

 
2,669,432

Interest rate caps
4,926

 
4,926

 
6,103

 
6,103

Interest rate swap

 

 
712

 
712

2015 notes hedges
86,640

 
86,640

 
107,041

 
107,041

Counterparty collateral
275,558

 
275,558

 
315,824

 
315,824

 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
Policy benefit reserves
36,395,040

 
30,382,940

 
35,453,166

 
29,670,827

Single premium immediate annuity (SPIA) benefit reserves
402,549

 
415,757

 
417,625

 
430,835

Notes payable
521,758

 
611,384

 
549,958

 
699,435

Subordinated debentures
246,097

 
239,126

 
246,050

 
234,959

2015 notes embedded conversion derivative
86,640

 
86,640

 
107,041

 
107,041

Interest rate swap
690

 
690

 

 

Fair value is the price that would be received to sell an asset or paid to transfer a liability (exit price) in an orderly transaction between market participants at the measurement date. The objective of a fair value measurement is to determine that price for each financial instrument at each measurement date. We meet this objective using various methods of valuation that include market, income and cost approaches.
We categorize our financial instruments into three levels of fair value hierarchy based on the priority of inputs used in determining fair value. The hierarchy defines the highest priority inputs (Level 1) as quoted prices in active markets for identical assets or liabilities. The lowest priority inputs (Level 3) are our own assumptions about what a market participant would use in determining fair value such as estimated future cash flows. 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. We categorize financial assets and liabilities recorded at fair value in the consolidated balance sheets as follows:
Level 1—
Quoted prices are available in active markets for identical financial instruments as of the reporting date. We do not adjust the quoted price for these financial instruments, even in situations where we hold a large position and a sale could reasonably impact the quoted price.
Level 2—
Quoted prices in active markets for similar financial instruments, quoted prices for identical or similar financial instruments in markets that are not active; and models and other valuation methodologies using inputs other than quoted prices that are observable.
Level 3—
Models and other valuation methodologies using significant inputs that are unobservable for financial instruments and include situations where there is little, if any, market activity for the financial instrument. The inputs into the determination of fair value require significant management judgment or estimation. Financial instruments that are included in Level 3 are securities for which no market activity or data exists and for which we used discounted expected future cash flows with our own assumptions about what a market participant would use in determining fair value.
Transfers of securities among the levels occur at times and depend on the type of inputs used to determine fair value of each security. There were no transfers between levels during any period presented.

9

Table of Contents

Our assets and liabilities which are measured at fair value on a recurring basis as of March 31, 2014 and December 31, 2013 are presented below based on the fair value hierarchy levels:
 
Total
Fair Value
 
Quoted
Prices in
Active
Markets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
(Dollars in thousands)
March 31, 2014
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
United States Government full faith and credit
$
43,300

 
$
4,841

 
$
38,459

 
$

United States Government sponsored agencies
1,299,454

 

 
1,299,454

 

United States municipalities, states and territories
3,437,313

 

 
3,437,313

 

Foreign government obligations
144,023

 

 
144,023

 

Corporate securities
18,441,187

 
37

 
18,441,150

 

Residential mortgage backed securities
1,928,555

 

 
1,927,475

 
1,080

Commercial mortgage backed securities
1,976,589

 

 
1,976,589

 

Other asset backed securities
1,045,052

 
369

 
1,044,683

 

Equity securities, available for sale: finance, insurance and real estate
7,767

 

 
7,767

 

Derivative instruments
790,396

 

 
790,396

 

Cash and cash equivalents
679,172

 
679,172

 

 

Interest rate caps
4,926

 

 
4,926

 

2015 notes hedges
86,640

 

 
86,640

 

Counterparty collateral
275,558

 

 
275,558

 

 
$
30,159,932

 
$
684,419

 
$
29,474,433

 
$
1,080

Liabilities
 
 
 
 
 
 
 
2015 notes embedded conversion derivative
$
86,640

 
$

 
$
86,640

 
$

Interest rate swap
690

 

 
690

 

Fixed index annuities - embedded derivatives
4,755,913

 

 

 
4,755,913

 
$
4,843,243

 
$

 
$
87,330

 
$
4,755,913

 
 
 
 
 
 
 
 
December 31, 2013
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
United States Government full faith and credit
$
42,925

 
$
4,805

 
$
38,120

 
$

United States Government sponsored agencies
1,194,289

 

 
1,194,289

 

United States municipalities, states and territories
3,306,743

 

 
3,306,743

 

Foreign government obligations
91,557

 

 
91,557

 

Corporate securities
17,233,037

 
20

 
17,233,017

 

Residential mortgage backed securities
1,971,960

 

 
1,970,584

 
1,376

Commercial mortgage backed securities
1,735,460

 

 
1,735,460

 

Other asset backed securities
1,034,476

 
359

 
1,034,117

 

Equity securities, available for sale: finance, insurance and real estate
7,778

 

 
7,778

 

Derivative instruments
856,050

 

 
856,050

 

Cash and cash equivalents
897,529

 
897,529

 

 

Interest rate caps
6,103

 

 
6,103

 

Interest rate swap
712

 

 
712

 

2015 notes hedges
107,041

 

 
107,041

 

Counterparty collateral
315,824

 

 
315,824

 

 
$
28,801,484

 
$
902,713

 
$
27,897,395

 
$
1,376

Liabilities
 
 
 
 
 
 
 
2015 notes embedded conversion derivative
$
107,041

 
$

 
$
107,041

 
$

Fixed index annuities - embedded derivatives
4,406,163

 

 

 
4,406,163

 
$
4,513,204

 
$

 
$
107,041

 
$
4,406,163


10

Table of Contents

The following methods and assumptions were used in estimating the fair values of financial instruments during the periods presented in these consolidated financial statements.
Fixed maturity securities and equity securities
The fair values of fixed maturity securities and equity securities in an active and orderly market are determined by utilizing independent pricing services. The independent pricing services incorporate a variety of observable market data in their valuation techniques, including:
reported trading prices,
benchmark yields,
broker-dealer quotes,
benchmark securities,
bids and offers,
credit ratings,
relative credit information, and
other reference data.
The independent pricing services also take into account perceived market movements and sector news, as well as a security's terms and conditions, including any features specific to that issue that may influence risk and marketability. Depending on the security, the priority of the use of observable market inputs may change as some observable market inputs may not be relevant or additional inputs may be necessary.
The independent pricing services provide quoted market prices when available. Quoted prices are not always available due to market inactivity. When quoted market prices are not available, the third parties use yield data and other factors relating to instruments or securities with similar characteristics to determine fair value for securities that are not actively traded. We generally obtain one value from our primary external pricing service. In situations where a price is not available from this service, we may obtain further quotes or prices from additional parties as needed. In addition, for our callable United States Government sponsored agencies, we obtain multiple broker quotes and take the average of the broker prices received. Market indices of similar rated asset class spreads are considered for valuations and broker indications of similar securities are compared. Inputs used by the broker include market information, such as yield data and other factors relating to instruments or securities with similar characteristics. Valuations and quotes obtained from third party commercial pricing services are non-binding and do not represent quotes on which one may execute the disposition of the assets.
We validate external valuations at least quarterly through a combination of procedures that include the evaluation of methodologies used by the pricing services, analytical reviews and performance analysis of the prices against trends, and maintenance of a securities watch list. Additionally, as needed we utilize discounted cash flow models or perform independent valuations on a case-by-case basis using inputs and assumptions similar to those used by the pricing services. Although we do identify differences from time to time as a result of these validation procedures, we did not make any significant adjustments as of March 31, 2014 and December 31, 2013.
Mortgage loans on real estate
Mortgage loans on real estate are not measured at fair value on a recurring basis. The fair values of mortgage loans on real estate are calculated using discounted expected cash flows using current competitive market interest rates currently being offered for similar loans. The fair values of impaired mortgage loans on real estate that we have considered to be collateral dependent are based on the fair value of the real estate collateral (based on appraised values) less estimated costs to sell. The inputs utilized to determine fair value of all mortgage loans are unobservable market data (competitive market interest rates and appraised property values); therefore, fair value of mortgage loans falls into Level 3 in the fair value hierarchy.
Derivative instruments
The fair values of derivative instruments, primarily call options, are based upon the amount of cash that we will receive to settle each derivative instrument on the reporting date. These amounts are determined by our investment team using industry accepted valuation models and are adjusted for the nonperformance risk of each counterparty net of any collateral held. Inputs include market volatility and risk free interest rates and are used in income valuation techniques in arriving at a fair value for each option contract. The nonperformance risk for each counterparty is based upon its credit default swap rate. We have no performance obligations related to the call options purchased to fund our fixed index annuity policy liabilities.
Other investments
None of the financial instruments included in other investments are measured at fair value on a recurring basis. Financial instruments included in other investments are policy loans, equity method investments and company owned life insurance (COLI). We have not attempted to determine the fair values associated with our policy loans, as we believe any differences between carrying value and the fair values afforded these instruments are immaterial to our consolidated financial position and, accordingly, the cost to provide such disclosure does not justify the benefit to be derived. The fair values of our equity method investments qualify as Level 3 fair values and were determined by calculating the present value of future cash flows discounted by a risk free rate, a risk spread and a liquidity discount. The risk spread and liquidity discount are rates determined by our investment professionals and are unobservable market inputs. The fair value of our COLI approximates the cash surrender value of the policies and falls within Level 2 of the fair value hierarchy.

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Table of Contents

Cash and cash equivalents
Amounts reported in the consolidated balance sheets for these instruments are reported at their historical cost which approximates fair value due to the nature of the assets assigned to this category.
Interest rate caps and swap
The fair values of our pay fixed/receive variable interest rate caps and interest rate swap are obtained from third parties and are determined by discounting expected future cash flows using projected LIBOR rates for the term of the caps and swap.
2015 notes hedges
The fair value of these call options has been determined by a third party who applies market observable data such as our common stock price, its dividend yield and its volatility, as well as the time to expiration of the call options to determine a fair value of the buy side of these options.
Counterparty collateral
Amounts reported in other assets of the consolidated balance sheets for these instruments are reported at their historical cost which approximates fair value due to the nature of the assets assigned to this category.
Policy benefit reserves, coinsurance deposits and SPIA benefit reserves
The fair values of the liabilities under contracts not involving significant mortality or morbidity risks (principally deferred annuities), are stated at the cost we would incur to extinguish the liability (i.e., the cash surrender value) as these contracts are generally issued without an annuitization date. The coinsurance deposits related to the annuity benefit reserves have fair values determined in a similar fashion. For period-certain annuity benefit contracts, the fair value is determined by discounting the benefits at the interest rates currently in effect for newly purchased immediate annuity contracts. We are not required to and have not estimated the fair value of the liabilities under contracts that involve significant mortality or morbidity risks, as these liabilities fall within the definition of insurance contracts that are exceptions from financial instruments that require disclosures of fair value. Policy benefit reserves, coinsurance deposits and SPIA benefit reserves are not measured at fair value on a recurring basis. All of the fair values presented within these categories fall within Level 3 of the fair value hierarchy as most of the inputs are unobservable market data.
Notes payable
The fair values of our senior unsecured notes and convertible senior notes are based upon pricing matrices developed by a third party pricing service when quoted market prices are not available and are categorized as Level 2 within the fair value hierarchy. Notes payable are not remeasured at fair value on a recurring basis.
Subordinated debentures
Fair values for subordinated debentures are estimated using discounted cash flow calculations based principally on observable inputs including our incremental borrowing rates, which reflect our credit rating, for similar types of borrowings with maturities consistent with those remaining for the debt being valued. These fair values are categorized as Level 2 within the fair value hierarchy. Subordinated debentures are not measured at fair value on a recurring basis.
2015 notes embedded conversion derivative
The fair value of this embedded derivative is determined by pricing the call options that hedge this potential liability. The terms of the conversion option are identical to the 2015 notes hedges and the method of determining fair value of the call options is based upon observable market data.
Fixed index annuities - embedded derivatives
We estimate the fair value of the embedded derivative component of our fixed index annuity policy benefit reserves at each valuation date by (i) projecting policy contract values and minimum guaranteed contract values over the expected lives of the contracts and (ii) discounting the excess of the projected contract value amounts at the applicable risk free interest rates adjusted for our nonperformance risk related to those liabilities. The projections of policy contract values are based on our best estimate assumptions for future policy growth and future policy decrements. Our best estimate assumptions for future policy growth include assumptions for the expected index credit on the next policy anniversary date which are derived from the fair values of the underlying call options purchased to fund such index credits and the expected costs of annual call options we will purchase in the future to fund index credits beyond the next policy anniversary. The projections of minimum guaranteed contract values include the same best estimate assumptions for policy decrements as were used to project policy contract values.

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Table of Contents

The following tables provide a reconciliation of the beginning and ending balances for our Level 3 assets and liabilities, which are measured at fair value on a recurring basis using significant unobservable inputs for the three months ended March 31, 2014 and 2013:
 
Three Months Ended
March 31,
 
2014
 
2013
 
(Dollars in thousands)
Available for sale securities
 
 
 
Beginning balance
$
1,376

 
$
1,812

Principal returned
(78
)
 
(368
)
Accretion of discount
(27
)
 
129

Total gains (losses) (realized/unrealized):
 
 
 
Included in other comprehensive income (loss)
(191
)
 
151

Included in operations

 

Ending balance
$
1,080

 
$
1,724

The Level 3 assets included in the table above are not material to our financial position, results of operations or cash flows, and it is management's opinion that the sensitivity of the inputs used in determining the fair value of these assets is not material as well.
 
Three Months Ended
March 31,
 
2014
 
2013
 
(Dollars in thousands)
Fixed index annuities - embedded derivatives
 
 
 
Beginning balance
$
4,406,163

 
$
3,337,556

Premiums less benefits
371,953

 
246,722

Change in fair value, net
(22,203
)
 
264,624

Ending balance
$
4,755,913

 
$
3,848,902

Change in unrealized gains (losses), net for each period in our embedded derivatives are included in change in fair value of embedded derivatives in the unaudited consolidated statements of operations.
Certain derivatives embedded in our fixed index annuity contracts are our most significant financial instrument measured at fair value that are categorized as Level 3 in the fair value hierarchy. The contractual obligations for future annual index credits within our fixed index annuity contracts are treated as a "series of embedded derivatives" over the expected life of the applicable contracts. We estimate the fair value of these embedded derivatives at each valuation date by the method described above under fixed index annuities - embedded derivatives. The projections of minimum guaranteed contract values include the same best estimate assumptions for policy decrements as were used to project policy contract values.
The most sensitive assumption in determining policy liabilities for fixed index annuities is the rates used to discount the excess projected contract values. As indicated above, the discount rate reflects our nonperformance risk. If the discount rates used to discount the excess projected contract values at March 31, 2014, were to increase by 100 basis points, the fair value of the embedded derivatives would decrease by $316.1 million recorded through operations as a decrease in the change in fair value of embedded derivatives and there would be a corresponding decrease of $192.0 million to our combined balance for deferred policy acquisition costs and deferred sales inducements recorded through operations as an increase in amortization of deferred policy acquisition costs and deferred sales inducements. A decrease by 100 basis points in the discount rate used to discount the excess projected contract values would increase the fair value of the embedded derivatives by $351.6 million recorded through operations as an increase in the change in fair value of embedded derivatives and there would be a corresponding increase of $208.7 million to our combined balance for deferred policy acquisition costs and deferred sales inducements recorded through operations as a decrease in amortization of deferred policy acquisition costs and deferred sales inducements.

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Table of Contents

3. Investments
At March 31, 2014 and December 31, 2013, the amortized cost and fair value of fixed maturity securities and equity securities were as follows:
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
 
(Dollars in thousands)
March 31, 2014
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
United States Government full faith and credit
$
44,185

 
$
325

 
$
(1,210
)
 
$
43,300

United States Government sponsored agencies
1,358,426

 
8,276

 
(67,248
)
 
1,299,454

United States municipalities, states and territories
3,186,473

 
265,511

 
(14,671
)
 
3,437,313

Foreign government obligations
136,116

 
10,379

 
(2,472
)
 
144,023

Corporate securities
17,662,806

 
1,006,794

 
(228,413
)
 
18,441,187

Residential mortgage backed securities
1,831,161

 
120,106

 
(22,712
)
 
1,928,555

Commercial mortgage backed securities
2,003,425

 
17,671

 
(44,507
)
 
1,976,589

Other asset backed securities
1,033,033

 
30,254

 
(18,235
)
 
1,045,052

 
$
27,255,625

 
$
1,459,316

 
$
(399,468
)
 
$
28,315,473

Held for investment:
 
 
 
 
 
 
 
Corporate security
$
76,298

 
$

 
$
(11,378
)
 
$
64,920

 
 
 
 
 
 
 
 
Equity securities, available for sale:
 
 
 
 
 
 
 
Finance, insurance, and real estate
$
7,505

 
$
262

 
$

 
$
7,767

 
 
 
 
 
 
 
 
December 31, 2013
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
United States Government full faith and credit
$
44,852

 
$
367

 
$
(2,294
)
 
$
42,925

United States Government sponsored agencies
1,313,776

 
1,875

 
(121,362
)
 
1,194,289

United States municipalities, states and territories
3,181,032

 
164,785

 
(39,074
)
 
3,306,743

Foreign government obligations
86,112

 
8,907

 
(3,462
)
 
91,557

Corporate securities
17,142,118

 
606,948

 
(516,029
)
 
17,233,037

Residential mortgage backed securities
1,895,913

 
119,230

 
(43,183
)
 
1,971,960

Commercial mortgage backed securities
1,821,988

 
3,287

 
(89,815
)
 
1,735,460

Other asset backed securities
1,041,939

 
23,300

 
(30,763
)
 
1,034,476

 
$
26,527,730

 
$
928,699

 
$
(845,982
)
 
$
26,610,447

Held for investment:
 
 
 
 
 
 
 
Corporate security
$
76,255

 
$

 
$
(15,415
)
 
$
60,840

 
 
 
 
 
 
 
 
Equity securities, available for sale:
 
 
 
 
 
 
 
Finance, insurance, and real estate
$
7,503

 
$
275

 
$

 
$
7,778

At March 31, 2014, 31% of our fixed income securities have call features, of which 0.5% ($0.1 billion) were subject to call redemption and another 5% ($1.2 billion) will become subject to call redemption during the next twelve months. Of the $1.2 billion subject to call redemption during the next twelve months, $0.5 billion of U.S. Government agency securities were called during April 2014.

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Table of Contents

The amortized cost and fair value of fixed maturity securities at March 31, 2014, by contractual maturity, are shown below. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. All of our mortgage and other asset backed securities provide for periodic payments throughout their lives and are shown below as separate lines.
 
Available for sale
 
Held for investment
 
Amortized
Cost
 
Fair Value
 
Amortized
Cost
 
Fair Value
 
(Dollars in thousands)
Due in one year or less
$
38,837

 
$
39,547

 
$

 
$

Due after one year through five years
985,636

 
1,113,705

 

 

Due after five years through ten years
8,171,938

 
8,264,244

 

 

Due after ten years through twenty years
6,588,518

 
6,838,801

 

 

Due after twenty years
6,603,077

 
7,108,980

 
76,298

 
64,920

 
22,388,006

 
23,365,277

 
76,298

 
64,920

Residential mortgage backed securities
1,831,161

 
1,928,555

 

 

Commercial mortgage backed securities
2,003,425

 
1,976,589

 

 

Other asset backed securities
1,033,033

 
1,045,052

 

 

 
$
27,255,625

 
$
28,315,473

 
$
76,298

 
$
64,920

Net unrealized gains on available for sale fixed maturity securities and equity securities reported as a separate component of stockholders' equity were comprised of the following:
 
March 31,
2014
 
December 31,
2013
 
(Dollars in thousands)
Net unrealized gains on available for sale fixed maturity securities and equity securities
$
1,060,110

 
$
82,992

Adjustments for assumed changes in amortization of deferred policy acquisition costs and deferred sales inducements
(583,340
)
 
(46,588
)
Deferred income tax valuation allowance reversal
22,534

 
22,534

Deferred income tax benefit
(166,869
)
 
(12,742
)
Net unrealized gains reported as accumulated other comprehensive income
$
332,435

 
$
46,196

The National Association of Insurance Commissioners (“NAIC”) assigns designations to fixed maturity securities. These designations range from Class 1 (highest quality) to Class 6 (lowest quality). In general, securities are assigned a designation based upon the ratings they are given by the Nationally Recognized Statistical Rating Organizations (“NRSRO’s”). The NAIC designations are utilized by insurers in preparing their annual statutory statements. NAIC Class 1 and 2 designations are considered “investment grade” while NAIC Class 3 through 6 designations are considered “non-investment grade.” Based on the NAIC designations, we had 98% of our fixed maturity portfolio rated investment grade at March 31, 2014 and December 31, 2013.
The following table summarizes the credit quality, as determined by NAIC designation, of our fixed maturity portfolio as of the dates indicated:
 
 
March 31, 2014
 
December 31, 2013
NAIC
Designation
 
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
 
 
(Dollars in thousands)
1
 
$
16,990,834

 
$
17,755,174

 
$
16,394,654

 
$
16,531,250

2
 
9,755,720

 
10,059,679

 
9,630,251

 
9,598,399

3
 
519,452

 
505,434

 
502,822

 
474,165

4
 
64,256

 
58,988

 
74,493

 
66,078

5
 

 

 

 

6
 
1,661

 
1,118

 
1,765

 
1,395

 
 
$
27,331,923

 
$
28,380,393

 
$
26,603,985

 
$
26,671,287


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Table of Contents

The following table shows our investments' gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities (consisting of 665 and 1,047 securities, respectively) have been in a continuous unrealized loss position, at March 31, 2014 and December 31, 2013:
 
Less than 12 months
 
12 months or more
 
Total
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
(Dollars in thousands)
March 31, 2014
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
 
 
 
 
United States Government full faith and credit
$
33,386

 
$
(1,210
)
 
$

 
$

 
$
33,386

 
$
(1,210
)
United States Government sponsored agencies
618,888

 
(58,157
)
 
340,909

 
(9,091
)
 
959,797

 
(67,248
)
United States municipalities, states and territories
288,578

 
(14,671
)
 

 

 
288,578

 
(14,671
)
Foreign government obligations
77,271

 
(2,472
)
 

 

 
77,271

 
(2,472
)
Corporate securities:
 
 
 
 
 
 
 
 
 
 
 
Finance, insurance and real estate
1,126,695

 
(40,893
)
 
139,455

 
(9,454
)
 
1,266,150

 
(50,347
)
Manufacturing, construction and mining
2,267,589

 
(76,780
)
 
131,419

 
(14,578
)
 
2,399,008

 
(91,358
)
Utilities and related sectors
933,917

 
(40,959
)
 
101,402

 
(9,215
)
 
1,035,319

 
(50,174
)
Wholesale/retail trade
204,346

 
(11,286
)
 
13,850

 
(840
)
 
218,196

 
(12,126
)
Services, media and other
566,481

 
(17,716
)
 
97,230

 
(6,692
)
 
663,711

 
(24,408
)
Residential mortgage backed securities
385,500

 
(22,132
)
 
1,080

 
(580
)
 
386,580

 
(22,712
)
Commercial mortgage backed securities
1,169,178

 
(43,622
)
 
27,135

 
(885
)
 
1,196,313

 
(44,507
)
Other asset backed securities
318,187

 
(14,745
)
 
45,652

 
(3,490
)
 
363,839

 
(18,235
)
 
$
7,990,016

 
$
(344,643
)
 
$
898,132

 
$
(54,825
)
 
$
8,888,148

 
$
(399,468
)
Held for investment:
 
 
 
 
 
 
 
 
 
 
 
Corporate security:
 
 
 
 
 
 
 
 
 
 
 
Insurance
$

 
$

 
$
64,920

 
$
(11,378
)
 
$
64,920

 
$
(11,378
)
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2013
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
 
 
 
 
United States Government full faith and credit
$
32,969

 
$
(2,294
)
 
$

 
$

 
$
32,969

 
$
(2,294
)
United States Government sponsored agencies
692,320

 
(88,671
)
 
467,309

 
(32,691
)
 
1,159,629

 
(121,362
)
United States municipalities, states and territories
614,056

 
(39,074
)
 

 

 
614,056

 
(39,074
)
Foreign government obligations
26,298

 
(3,462
)
 

 

 
26,298

 
(3,462
)
Corporate securities:
 
 
 
 
 
 
 
 
 
 
 
Finance, insurance and real estate
1,690,846

 
(92,426
)
 
153,037

 
(12,873
)
 
1,843,883

 
(105,299
)
Manufacturing, construction and mining
3,370,775

 
(191,245
)
 
93,608

 
(16,088
)
 
3,464,383

 
(207,333
)
Utilities and related sectors
1,829,868

 
(102,758
)
 
83,550

 
(11,547
)
 
1,913,418

 
(114,305
)
Wholesale/retail trade
428,407

 
(25,189
)
 
17,687

 
(1,992
)
 
446,094

 
(27,181
)
Services, media and other
834,699

 
(51,508
)
 
107,242

 
(10,403
)
 
941,941

 
(61,911
)
Residential mortgage backed securities
309,599

 
(41,080
)
 
31,739

 
(2,103
)
 
341,338

 
(43,183
)
Commercial mortgage backed securities
1,450,143

 
(83,814
)
 
51,099

 
(6,001
)
 
1,501,242

 
(89,815
)
Other asset backed securities
356,018

 
(20,426
)
 
92,372

 
(10,337
)
 
448,390

 
(30,763
)
 
$
11,635,998

 
$
(741,947
)
 
$
1,097,643

 
$
(104,035
)
 
$
12,733,641

 
$
(845,982
)
Held for investment:
 
 
 
 
 
 
 
 
 
 
 
Corporate security:
 
 
 
 
 
 
 
 
 
 
 
Insurance
$

 
$

 
$
60,840

 
$
(15,415
)
 
$
60,840

 
$
(15,415
)
The following is a description of the factors causing the temporary unrealized losses by investment category as of March 31, 2014:
United States Government full faith and credit and sponsored agencies: These securities are relatively long in duration; however, they are callable in less than 12 months making the value of such securities sensitive to changes in market interest rates. The timing of when some of these securities were purchased gave rise to unrealized losses at March 31, 2014.
United States municipalities, states and territories: These securities are relatively long in duration and their fair values are sensitive to changes in market interest rates. The timing of the purchase of these securities have resulted in unrealized losses.
Foreign government obligations: The unrealized losses on these securities are due to wider spreads on the announcement of increased capital expenditures with resulting higher leverage and greater supply.

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Table of Contents

Corporate securities: The unrealized losses in these securities are due partially to the timing of purchases. These securities carry yields less than those available at March 31, 2014. In addition, a small number of securities have seen their credit spreads remain wide due to issuer or industry specific news while some financial and industrial sector credit spreads remain wide due to continued economic uncertainty and concerns of economic instability.
Residential mortgage backed securities: At March 31, 2014, we had no exposure to sub-prime residential mortgage backed securities. All of our residential mortgage backed securities are pools of first-lien residential mortgage loans. Substantially all of the securities that we own are in the most senior tranche of the securitization in which they are structured and are not subordinated to any other tranche. Our "Alt-A" residential mortgage backed securities are comprised of 36 securities with a total amortized cost basis of $301.1 million and a fair value of $324.2 million. Despite recent improvements in the capital markets, the fair values of RMBS with weaker borrower characteristics continue at prices below amortized cost. These RMBS prices will likely remain below our cost basis until the housing market is able to absorb current and future foreclosures.
Commercial mortgage backed securities: The unrealized losses in these securities are due partially to the timing of purchases. A number of purchases were at yields lower than what could be executed at the end of this quarter due to the increase in the treasury yield since the time of purchase. Yield spreads for commercial mortgage backed securities have narrowed but remain attractive.
Other asset backed securities: The unrealized losses in these securities are predominantly assigned to financial sector capital trust securities which have longer maturity dates and have declined in price due to prolonged stress in the financial sector. No securities in an unrealized loss position are rated below investment grade.
Approximately 93% and 95% of the unrealized losses on fixed maturity securities shown in the above table for March 31, 2014 and December 31, 2013, respectively, are on securities that are rated investment grade, defined as being the highest two NAIC designations. All of the securities with unrealized losses are current with respect to the payment of principal and interest.
Changes in net unrealized gains on investments for the three months ended March 31, 2014 and 2013 are as follows:
 
Three Months Ended
March 31,
 
2014
 
2013
 
(Dollars in thousands)
Fixed maturity securities held for investment carried at amortized cost
$
4,037

 
$
611

Investments carried at fair value:
 
 
 
Fixed maturity securities, available for sale
$
977,131

 
$
(119,070
)
Equity securities, available for sale
(13
)
 
2,219

 
977,118

 
(116,851
)
Adjustment for effect on other balance sheet accounts:
 
 
 
Deferred policy acquisition costs and deferred sales inducements
(536,752
)
 
78,168

Deferred income tax asset/liability
(154,127
)
 
13,539

 
(690,879
)
 
91,707

Change in net unrealized gains on investments carried at fair value
$
286,239

 
$
(25,144
)
Proceeds from sales of available for sale securities for the three months ended March 31, 2014 and 2013 were $56.1 million and $380.4 million, respectively. Scheduled principal repayments, calls and tenders for available for sale securities for the three months ended March 31, 2014 and 2013 were $152.7 million and $556.9 million, respectively.

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Table of Contents

Realized gains and losses on sales are determined on the basis of specific identification of investments based on the trade date. Net realized gains (losses) on investments, excluding net OTTI losses for the three months ended March 31, 2014 and 2013, are as follows:
 
Three Months Ended
March 31,
 
2014
 
2013
 
(Dollars in thousands)
Available for sale fixed maturity securities:
 
 
 
Gross realized gains
$
184

 
$
13,015

Gross realized losses
(691
)
 
(2,187
)
 
(507
)
 
10,828

Other investments:
 
 
 
Gain on sale of real estate
756

 
589

Loss on sale of real estate

 
(466
)
Impairment losses on real estate
(799
)
 

 
(43
)
 
123

Mortgage loans on real estate:
 
 
 
Increase in allowance for credit losses
(164
)
 
(366
)
 
$
(714
)
 
$
10,585

Losses on available for sale fixed maturity securities were realized primarily due to strategies in place to reposition the fixed maturity security portfolio that result in improved net investment income, risk or duration profiles as they pertain to our asset liability management.
We review and analyze all investments on an ongoing basis for changes in market interest rates and credit deterioration. This review process includes analyzing our ability to recover the amortized cost basis of each investment that has a fair value that is materially lower than its amortized cost and requires a high degree of management judgment and involves uncertainty. The evaluation of securities for other than temporary impairments is a quantitative and qualitative process, which is subject to risks and uncertainties.
We have a policy and process in place to identify securities that could potentially have impairments that are other than temporary. This process involves monitoring market events and other items that could impact issuers. The evaluation includes but is not limited to such factors as:
the length of time and the extent to which the fair value has been less than amortized cost or cost;
whether the issuer is current on all payments and all contractual payments have been made as agreed;
the remaining payment terms and the financial condition and near-term prospects of the issuer;
the lack of ability to refinance due to liquidity problems in the credit market;
the fair value of any underlying collateral;
the existence of any credit protection available;
our intent to sell and whether it is more likely than not we would be required to sell prior to recovery for debt securities;
our assessment in the case of equity securities including perpetual preferred stocks with credit deterioration that the security cannot recover to cost in a reasonable period of time;
our intent and ability to retain equity securities for a period of time sufficient to allow for recovery;
consideration of rating agency actions; and
changes in estimated cash flows of mortgage and asset backed securities.
We determine whether other than temporary impairment losses should be recognized for debt and equity securities by assessing all facts and circumstances surrounding each security. Where the decline in fair value of debt securities is attributable to changes in market interest rates or to factors such as market volatility, liquidity and spread widening, and we anticipate recovery of all contractual or expected cash flows, we do not consider these investments to be other than temporarily impaired because we do not intend to sell these investments and it is not more likely than not we will be required to sell these investments before a recovery of amortized cost, which may be maturity. For equity securities, we recognize an impairment charge in the period in which we do not have the intent and ability to hold the securities until recovery of cost or we determine that the security will not recover to book value within a reasonable period of time. We determine what constitutes a reasonable period of time on a security-by-security basis by considering all the evidence available to us, including the magnitude of any unrealized loss and its duration. In any event, this period does not exceed 18 months from the date of impairment for perpetual preferred securities for which there is evidence of deterioration in credit of the issuer and common equity securities. For perpetual preferred securities absent evidence of a deterioration in credit of the issuer we apply an impairment model, including an anticipated recovery period, similar to a debt security.
Other than temporary impairment losses on equity securities are recognized in operations. If we intend to sell a debt security or if it is more likely than not that we will be required to sell a debt security before recovery of its amortized cost basis, other than temporary impairment has occurred and the difference between amortized cost and fair value will be recognized as a loss in operations.

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Table of Contents

If we do not intend to sell and it is not more likely than not we will be required to sell the debt security but also do not expect to recover the entire amortized cost basis of the security, an impairment loss would be recognized in operations in the amount of the expected credit loss. We determine the amount of expected credit loss by calculating the present value of the cash flows expected to be collected discounted at each security's acquisition yield based on our consideration of whether the security was of high credit quality at the time of acquisition. The difference between the present value of expected future cash flows and the amortized cost basis of the security is the amount of credit loss recognized in operations. The remaining amount of the other than temporary impairment is recognized in other comprehensive income (loss).
The determination of the credit loss component of a mortgage backed security is based on a number of factors. The primary consideration in this evaluation process is the issuer's ability to meet current and future interest and principal payments as contractually stated at time of purchase. Our review of these securities includes an analysis of the cash flow modeling under various default scenarios considering independent third party benchmarks, the seniority of the specific tranche within the structure of the security, the composition of the collateral and the actual default, loss severity and prepayment experience exhibited. With the input of third party assumptions for default projections, loss severity and prepayment expectations, we evaluate the cash flow projections to determine whether the security is performing in accordance with its contractual obligation.
We utilize the models from a leading structured product software specialist serving institutional investors. These models incorporate each security's seniority and cash flow structure. In circumstances where the analysis implies a potential for principal loss at some point in the future, we use the "best estimate" cash flow projection discounted at the security's effective yield at acquisition to determine the amount of our potential credit loss associated with this security. The discounted expected future cash flows equates to our expected recovery value. Any shortfall of the expected recovery when compared to the amortized cost of the security will be recorded as the credit loss component of other than temporary impairment.
The cash flow modeling is performed on a security-by-security basis and incorporates actual cash flows on the residential mortgage backed securities through the current period, as well as the projection of remaining cash flows using a number of assumptions including default rates, prepayment rates and loss severity rates. The default curves we use are tailored to the Prime or Alt-A residential mortgage backed securities that we own, which assume lower default rates and loss severity for Prime securities versus Alt-A securities. These default curves are scaled higher or lower depending on factors such as current underlying mortgage loan performance, rating agency loss projections, loan to value ratios, geographic diversity, as well as other appropriate considerations.
The following table presents the range of significant assumptions used to determine the credit loss component of other than temporary impairments we have recognized on residential mortgage backed securities for the three months ended March 31, 2014 and 2013, which are all senior level tranches within the structure of the securities:
 
 
 
 
Discount Rate
 
Default Rate
 
Loss Severity
Sector
 
Vintage
 
Min
 
Max
 
Min
 
Max
 
Min
 
Max
Three months ended March 31, 2014
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Prime
 
2006
 
6.5
%
 
7.4
%
 
11
%
 
12
%
 
50
%
 
50
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three months ended March 31, 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Prime
 
2003
 
5.1
%
 
5.1
%
 
2
%
 
2
%
 
30
%
 
30
%
 
 
2005
 
6.5
%
 
7.7
%
 
8
%
 
17
%
 
50
%
 
50
%
 
 
2006
 
6.0
%
 
6.9
%
 
9
%
 
16
%
 
50
%
 
50
%
 
 
2007
 
6.5
%
 
6.7
%
 
14
%
 
25
%
 
40
%
 
60
%
 
 
2008
 
6.6
%
 
6.6
%
 
16
%
 
16
%
 
45
%
 
45
%
Alt-A
 
2005
 
5.6
%
 
8.7
%
 
15
%
 
25
%
 
5
%
 
65
%
 
 
2007
 
6.2
%
 
6.9
%
 
38
%
 
52
%
 
60
%
 
65
%
The determination of the credit loss component of a corporate bond (including redeemable preferred stocks) is based on the underlying financial performance of the issuer and their ability to meet their contractual obligations. Considerations in our evaluation include, but are not limited to, credit rating changes, financial statement and ratio analysis, changes in management, significant changes in credit spreads, breaches of financial covenants and a review of the economic outlook for the industry and markets in which they trade. In circumstances where an issuer appears unlikely to meet its future obligation, or the security's price decline is deemed other than temporary, an estimate of credit loss is determined. Credit loss is calculated using default probabilities as derived from the credit default swaps markets in conjunction with recovery rates derived from independent third party analysis or a best estimate of credit loss. This credit loss rate is then incorporated into a present value calculation based on an expected principal loss in the future discounted at the yield at the date of purchase and compared to amortized cost to determine the amount of credit loss associated with the security.
In addition, for debt securities which we do not intend to sell and it is not more likely than not we will be required to sell, but our intent changes due to changes or events that could not have been reasonably anticipated, an other than temporary impairment charge is recognized. Once an impairment charge has been recorded, we then continue to review the other than temporarily impaired securities for appropriate valuation on an ongoing basis. Unrealized losses may be recognized in future periods through a charge to earnings, should we later conclude that the decline in fair value below amortized cost is other than temporary pursuant to our accounting policy described above. The use of different methodologies and assumptions to determine the fair value of investments and the timing and amount of impairments may have a material effect on the amounts presented in our consolidated financial statements.

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Table of Contents

The following table summarizes other than temporary impairments for the three months ended March 31, 2014 and 2013, by asset type:
 
Number
of
Securities
 
Total OTTI
Losses
 
Portion of OTTI
Losses
Recognized
from Other
Comprehensive
Income
 
Net OTTI
Losses
Recognized in
Operations