`

 

FORM 10-Q

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

(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, 2009

 

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 of Incorporation)

 

(I.R.S. Employer Identification No.)

 

 

 

5000 Westown Parkway, Suite 440

 

 

West Des Moines, Iowa

 

50266

(Address of principal executive offices)

 

(Zip Code)

 

 

 

Registrant’s telephone number, including area code

 

(515) 221-0002

 

 

(Telephone)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

Common Stock, par value $1

 

New York Stock Exchange

 

Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $1

 

Indicate by check mark whether the registrant (1) has filed all documents and reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or 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 o No o

 

Indicate by check mark whether the registrant is a large accelerated filed, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer o

 

Accelerated filer x

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.)  Yeso No x

 

APPLICABLE TO CORPORATE ISSUERS:

 

Shares of common stock outstanding at April 30, 2009: 53,162,259

 

 

 



 

PART I — FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except per share data)

(Unaudited)

 

 

 

March 31,
2009

 

December 31,
2008

 

 

 

 

 

(As Adjusted)

 

Assets

 

 

 

 

 

Investments:

 

 

 

 

 

Fixed maturity securities:

 

 

 

 

 

Available for sale, at fair value (amortized cost: 2009 - $8,278,636; 2008 - $7,159,286)

 

$

7,573,330

 

$

6,629,046

 

Held for investment, at amortized cost (fair value: 2009 - $3,039,243; 2008 - $3,588,114)

 

3,050,505

 

3,604,149

 

Equity securities, available for sale, at fair value (cost: 2009 - $104,483; 2008 - $125,157)

 

73,378

 

99,552

 

Mortgage loans on real estate

 

2,351,405

 

2,329,824

 

Derivative instruments

 

57,492

 

56,588

 

Policy loans

 

459

 

446

 

Total investments

 

13,106,569

 

12,719,605

 

 

 

 

 

 

 

Cash and cash equivalents

 

108,032

 

214,862

 

Coinsurance deposits

 

1,491,558

 

1,528,981

 

Accrued investment income

 

104,821

 

91,756

 

Deferred policy acquisition costs

 

1,661,764

 

1,579,871

 

Deferred sales inducements

 

917,902

 

843,377

 

Deferred income taxes

 

93,454

 

82,409

 

Other assets

 

24,522

 

20,879

 

Total assets

 

$

17,508,622

 

$

17,081,740

 

 

2



 

AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
CONSOLIDATED BALANCE SHEETS (Continued)
(Dollars in thousands, except per share data)

(Unaudited)

 

 

 

March 31,
2009

 

December 31,
2008

 

 

 

 

 

(As Adjusted)

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

Liabilities:

 

 

 

 

 

Policy benefit reserves:

 

 

 

 

 

Traditional life and accident and health insurance products

 

$

125,826

 

$

121,914

 

Annuity products

 

16,120,559

 

15,687,625

 

Other policy funds and contract claims

 

110,046

 

111,205

 

Notes payable

 

272,732

 

247,750

 

Subordinated debentures

 

268,243

 

268,209

 

Income taxes payable

 

9,880

 

14,133

 

Other liabilities

 

93,635

 

134,060

 

Total liabilities

 

17,000,921

 

16,584,896

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Common stock, par value $1 per share, 125,000,000 shares authorized; issued and outstanding: 2009 - 51,066,008 shares (excluding 5,941,547 treasury shares); 2008 - 50,739,355 shares (excluding 6,263,700 treasury shares)

 

51,066

 

50,739

 

Additional paid-in capital

 

376,432

 

376,782

 

Unallocated common stock held by ESOP; 2009 - 588,312 shares; 2008 - 588,312 shares

 

(6,229

)

(6,336

)

Accumulated other comprehensive loss

 

(188,318

)

(147,376

)

Retained earnings

 

274,750

 

223,035

 

Total stockholders’ equity

 

507,701

 

496,844

 

Total liabilities and stockholders’ equity

 

$

17,508,622

 

$

17,081,740

 

 

See accompanying notes to unaudited consolidated financial statements.

 

3



 

AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY

CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in thousands, except per share data)

(Unaudited)

 

 

 

Three Months Ended
March 31,

 

 

 

2009

 

2008

 

 

 

 

 

(As Adjusted)

 

Revenues:

 

 

 

 

 

Traditional life and accident and health insurance premiums

 

$

3,486

 

$

3,316

 

Annuity product charges

 

15,051

 

12,098

 

Net investment income

 

220,654

 

195,488

 

Change in fair value of derivatives

 

(43,823

)

(157,365

)

Realized gains (losses) on investments, excluding impairment losses

 

760

 

830

 

Impairment losses on investments:

 

 

 

 

 

Total other than temporary impairment losses

 

(55,391

)

(3,249

)

Portion of impairment losses recognized in other comprehensive loss

 

41,953

 

 

Net impairment losses recognized in operations

 

(13,438

)

(3,249

)

Total revenues

 

182,690

 

51,118

 

 

 

 

 

 

 

Benefits and expenses:

 

 

 

 

 

Insurance policy benefits and change in future policy benefits

 

2,199

 

2,609

 

Interest credited to account balances

 

59,763

 

54,176

 

Amortization of deferred sales inducements

 

13,711

 

31,912

 

Change in fair value of embedded derivatives

 

14,183

 

(218,614

)

Interest expense on notes payable

 

4,276

 

5,132

 

Interest expense on subordinated debentures

 

4,208

 

5,231

 

Interest expense on amounts due under repurchase agreements

 

242

 

2,972

 

Amortization of deferred policy acquisition costs

 

34,644

 

80,690

 

Other operating costs and expenses

 

14,464

 

13,583

 

Total benefits and expenses

 

147,690

 

(22,309

)

Income before income taxes

 

35,000

 

73,427

 

Income tax expense

 

8,525

 

25,367

 

Net income

 

$

26,475

 

$

48,060

 

 

 

 

 

 

 

Earnings per common share

 

$

0.50

 

$

0.87

 

Earnings per common share - assuming dilution

 

$

0.48

 

$

0.83

 

 

See accompanying notes to unaudited consolidated financial statements.

 

4



 

AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(Dollars in thousands, except per share data)

(Unaudited)

 

 

 

Common
Stock

 

Additional
Paid-in
Capital

 

Unallocated
Common
Stock Held
by ESOP

 

Accumulated
Other
Comprehensive
Loss

 

Retained
Earnings

 

Total
Stockholders’
Equity

 

 

 

 

 

 

 

 

 

 

 

(As Adjusted)

 

(As Adjusted)

 

Balance at December 31, 2007

 

$

53,556

 

$

387,302

 

$

(6,781

)

$

(38,929

)

$

216,487

 

$

611,635

 

Retrospective application of FSP APB 14-1

 

 

15,355

 

 

 

(5,888

)

9,467

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income for period, as adjusted

 

 

 

 

 

48,060

 

48,060

 

Change in net unrealized investment gains/losses

 

 

 

 

(20,182

)

 

(20,182

)

Total comprehensive income, as adjusted

 

 

 

 

 

 

 

 

 

 

 

27,878

 

Acquisition of 1,946,406 shares of common stock

 

(1,946

)

(14,681

)

 

 

 

(16,627

)

Allocation of 10,263 shares of common stock by ESOP, including excess income tax benefits

 

 

(15

)

111

 

 

 

96

 

Share-based compensation, including excess income tax benefits

 

 

761

 

 

 

 

761

 

Issuance of 59,244 shares of common stock under compensation plans, including excess income tax benefits

 

59

 

(2

)

 

 

 

57

 

Conversion of $10 of subordinated debentures

 

1

 

9

 

 

 

 

10

 

Balance at March 31, 2008, as adjusted

 

$

51,670

 

$

388,729

 

$

(6,670

)

$

(59,111

)

$

258,659

 

$

633,277

 

 

5



 

AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (Continued)

(Dollars in thousands, except per share data)

(Unaudited)

 

 

 

Common
Stock

 

Additional
Paid-in
Capital

 

Unallocated
Common
Stock Held
by ESOP

 

Accumulated
Other
Comprehensive
Loss

 

Retained
Earnings

 

Total
Stockholders’
Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2008, as adjusted

 

$

50,739

 

$

376,782

 

$

(6,336

)

$

(147,376

)

$

223,035

 

$

496,844

 

Cumulative effect of FSP FAS 115-2, net

 

 

 

 

(20,094

)

25,240

 

5,146

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income for period

 

 

 

 

 

26,475

 

26,475

 

Change in net unrealized investment gains/losses

 

 

 

 

6,422

 

 

6,422

 

Noncredit component of other than temporary impairment losses, available for sale securities, net

 

 

 

 

(27,270

)

 

(27,270

)

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

5,627

 

Acquisition of 12,362 shares of common stock

 

(12

)

(40

)

 

 

 

(52

)

Allocation of 9,994 shares of common stock by ESOP, including excess income tax benefits

 

 

(35

)

107

 

 

 

72

 

Share-based compensation, including excess income tax benefits

 

 

64

 

 

 

 

64

 

Issuance of 339,015 shares of common stock under compensation plans, including excess income tax benefits

 

339

 

(339

)

 

 

 

 

Balance at March 31, 2009

 

$

51,066

 

$

376,432

 

$

(6,229

)

$

(188,318

)

$

274,750

 

$

507,701

 

 

See accompanying notes to unaudited consolidated financial statements.

 

6



 

AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(Unaudited)

 

 

 

Three Months Ended
March 31,

 

 

 

2009

 

2008

 

 

 

 

 

(As Adjusted)

 

Operating activities

 

 

 

 

 

Net income

 

$

26,475

 

$

48,060

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Adjustments related to interest sensitive products:

 

 

 

 

 

Interest credited to account balances

 

59,763

 

54,176

 

Amortization of deferred sales inducements

 

13,711

 

31,912

 

Annuity product charges

 

(15,051

)

(12,098

)

Change in fair value of embedded derivatives

 

14,183

 

(218,614

)

Increase in traditional life and accident and health insurance reserves

 

1,708

 

1,622

 

Policy acquisition costs deferred

 

(73,200

)

(57,855

)

Amortization of deferred policy acquisition costs

 

34,644

 

80,690

 

Provision for depreciation and other amortization

 

1,519

 

1,661

 

Amortization of discount and premiums on investments

 

(56,721

)

(62,250

)

Net realized gains on investments

 

(760

)

(830

)

Net impairment losses recognized in operations

 

13,438

 

3,249

 

Change in fair value of derivatives

 

43,531

 

157,362

 

Deferred income taxes

 

(2,854

)

36,073

 

Loss on retirement of debt

 

 

1,132

 

Share-based compensation

 

433

 

761

 

Change in accrued investment income

 

(13,065

)

(9,296

)

Change in income taxes payable

 

(4,253

)

(10,829

)

Change in other assets

 

(778

)

299

 

Change in other policy funds and contract claims

 

(1,159

)

(1,932

)

Change in other liabilities

 

17,975

 

11,488

 

Other

 

27

 

88

 

Net cash provided by operating activities

 

59,566

 

54,869

 

 

 

 

 

 

 

Investing activities

 

 

 

 

 

Sales, maturities, or repayments of investments:

 

 

 

 

 

Fixed maturity securities - available for sale

 

650,765

 

623,318

 

Fixed maturity securities - held for investment

 

588,601

 

150,474

 

Equity securities - available for sale

 

200

 

1,065

 

Mortgage loans on real estate

 

25,353

 

36,473

 

Derivative instruments

 

2,539

 

15,299

 

Acquisition of investments:

 

 

 

 

 

Fixed maturity securities - available for sale

 

(1,683,183

)

(1,007,828

)

Equity securities - available for sale

 

 

(51,695

)

Mortgage loans on real estate

 

(46,936

)

(129,415

)

Derivative instruments

 

(50,418

)

(65,769

)

Policy loans

 

(13

)

(19

)

Purchases of property, furniture and equipment

 

(233

)

(61

)

Net cash used in investing activities

 

(513,325

)

(428,158

)

 

7



 

AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

(Dollars in thousands)

 (Unaudited)

 

 

 

Three Months Ended
March 31,

 

 

 

2009

 

2008

 

 

 

 

 

(As Adjusted)

 

Financing activities

 

 

 

 

 

Receipts credited to annuity and single premium universal life policyholder account balances

 

$

653,133

 

$

515,160

 

Coinsurance deposits

 

44,066

 

43,393

 

Return of annuity and single premium universal life policyholder account balances

 

(342,312

)

(332,050

)

Proceeds from notes payable

 

25,000

 

15,000

 

Repayments of notes payable

 

(1,028

)

(20,766

)

Increase in amounts due under repurchase agreements

 

 

182,389

 

Acquisition of common stock

 

(34

)

(16,627

)

Excess tax benefits realized from share-based compensation plans

 

20

 

21

 

Proceeds from issuance of common stock

 

 

44

 

Change in checks in excess of cash balance

 

(31,916

)

(12,516

)

Net cash provided by financing activities

 

346,929

 

374,048

 

Increase (decrease) in cash and cash equivalents

 

(106,830

)

759

 

 

 

 

 

 

 

Cash and cash equivalents at beginning of period

 

214,862

 

18,888

 

Cash and cash equivalents at end of period

 

$

108,032

 

$

19,647

 

 

 

 

 

 

 

Supplemental disclosures of cash flow information:

 

 

 

 

 

Cash paid during period for:

 

 

 

 

 

Interest expense

 

$

5,868

 

$

8,941

 

Income taxes

 

15,800

 

 

Non-cash operating activity:

 

 

 

 

 

Deferral of sales inducements

 

58,788

 

42,139

 

Non-cash financing activity:

 

 

 

 

 

Conversion of subordinated debentures

 

 

10

 

 

See accompanying notes to unaudited consolidated financial statements.

 

8



 

AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2009

(Unaudited)

 

1. Organization and Significant Accounting Policies

 

Consolidation and Basis of Presentation

 

The accompanying unaudited consolidated financial statements of American Equity Investment Life Holding Company (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 the information and notes required by GAAP for complete financial statements.  The unaudited consolidated financial statements reflect all adjustments, consisting only of normal recurring items, which are necessary to present fairly the Company’s financial position and results of operations on a basis consistent with the prior audited consolidated financial statements.  Operating results for the three months ended March 31, 2009 are not necessarily indicative of the results that may be expected for the year ended December 31, 2009.  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 the Company’s financial position and results of operations, refer to the audited consolidated financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.

 

Reclassifications have been made to prior period financial statements to conform with the March 31, 2009 presentation. See Adopted Accounting Pronouncements for impact of new accounting guidance on prior period financial statements.

 

Adopted Accounting Pronouncements

 

On January 1, 2009, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 161, Disclosures about Derivative Instruments and Hedging Activities - an Amendment of FASB Statement 133 (“SFAS 161”).  SFAS 161 enhances required disclosures regarding derivatives and hedging activities, including enhanced disclosures regarding how an entity uses derivative instruments and how derivative instruments and related hedged items are accounted for and affect an entity’s financial position, financial performance and cash flows.  The adoption of SFAS 161 did not have a material impact on the Company’s financial position or results of operations as it impacts financial statement disclosure only.

 

In April 2009, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) No. FAS 115-2 and FAS 124-2, Recognition and Presentation of Other Than Temporary Impairments (“FSP FAS 115-2”).  FSP FAS 115-2 amends the other than temporary impairment guidance in GAAP for debt securities only to make the guidance more operational and to expand the presentation and disclosure of other than temporary impairments on debt and equity securities in the financial statements.  FSP FAS 115-2 requires that other than temporary impairments on debt securities be allocated between credit and noncredit components with the noncredit portion of the other than temporary impairments recognized as a component of other comprehensive income and the credit loss portion included in operations.  FSP FAS 115-2 also requires a cumulative effect adjustment to the opening balance of retained earnings and accumulated other comprehensive income (loss) in the period of adoption for other than temporary impairments on debt securities recognized in prior periods which are still held as investments at the date of adoption.  FSP FAS 115-2 is effective for interim and annual reporting periods ending after June 15, 2009; however, early application is permitted.  The Company elected to adopt FSP FAS 115-2 effective January 1, 2009.  The cumulative effect adjustment as of January 1, 2009 increased retained earnings by $25.2 million and increased accumulated other comprehensive loss by $20.1 million.

 

In April 2009, the FASB issued FSP No. FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly (“FSP FAS 157-4”).  FSP FAS 157-4 provides additional guidance for estimating fair value when the volume and level of activity for the asset or liability have significantly decreased, as well as guidance on identifying circumstances that indicate a transaction is not orderly.  FSP FAS 157-4 becomes effective for interim and annual reporting periods ending after June 15, 2009, and shall be applied prospectively, with early adoption permitted for periods ending after March 15, 2009.  The Company elected to adopt FSP FAS 157-4 as of January 1, 2009, and it did not have a material impact on the Company’s unaudited consolidated financial statements.

 

On January 1, 2009, the Company adopted FSP No. APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement) (“FSP APB 14-1”) and applied it retrospectively to all periods presented as required.  FSP APB 14-1 clarifies that convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement) do not fall within the scope of paragraph 12 of Accounting Principles Board Opinion No. 14, Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants, and specifies that issuers of such instruments should separately account for the liability component and the equity component represented by the embedded conversion option in a manner that will reflect the entity’s nonconvertible debt borrowing rate when interest

 

9



 

cost is recognized in subsequent periods.  Upon settlement, the entity shall allocate consideration transferred and transaction costs incurred to the extinguishment of the liability component and the reacquisition of the equity component.

 

In December 2004, the Company issued $260 million of contingent convertible senior notes with a fixed rate of 5.25% and a maturity date of December 6, 2024.  FSP APB 14-1 requires on the date of issuance bifurcation of these notes into a debt component and an equity component.  The difference between the fair value of the debt component at the date of issuance and the initial proceeds at the date of issuance is recorded as a component of equity.  The fair value of the notes without the embedded conversion option (liability component) at the date of issuance was $221.4 million.  The fair value of the embedded conversion option (equity component) at the date of issuance was $39.1 million.  The fair value of the equity component has been recorded as a debt discount to the notes, with a corresponding increase to additional paid-in capital, net of income tax.  The debt discount is being amortized over the expected life of the debt.

 

The following summarizes the effects of the retrospective adoption of FSP APB 14-1 on the balance sheet, statement of operations and earnings per share:

 

 

 

December 31, 2008

 

 

 

As Adjusted

 

As Originally Reported

 

 

 

(Dollars in thousands)

 

Deferred income taxes

 

$

82,409

 

$

85,700

 

Other assets

 

20,879

 

23,661

 

Total assets

 

17,081,740

 

17,087,813

 

 

 

 

 

 

 

Notes payable

 

247,750

 

258,462

 

Total liabilities

 

16,584,896

 

16,595,608

 

 

 

 

 

 

 

Additional paid-in capital

 

376,782

 

361,427

 

Retained earnings

 

223,035

 

233,751

 

Total stockholders’ equity

 

496,844

 

492,205

 

 

 

 

Three Months Ended
March 31, 2008

 

 

 

As Adjusted

 

As Originally Reported

 

 

 

(Dollars in thousands, except
per share data)

 

Interest expense on notes payable

 

$

5,132

 

$

4,129

 

Other operating costs and expenses

 

13,583

 

12,718

 

Income tax expense

 

25,367

 

26,143

 

 

 

 

 

 

 

Net income

 

48,060

 

49,152

 

 

 

 

 

 

 

Earnings per common share

 

$

0.87

 

$

0.89

 

Earnings per common share - assuming dilution

 

$

0.83

 

$

0.85

 

 

New Accounting Pronouncements

 

In April 2009, the FASB issued FSP No. FAS 107-1 and Accounting Principles Board Opinion (“APB”) 28-1, Interim Disclosures about Fair Value of Financial Instruments (“FSP FAS 107-1”).  FSP FAS 107-1 amends SFAS No. 107, Disclosures about Fair Value of Financial Instruments, to require disclosures about fair value of financial instruments for interim reporting periods as well as in annual financial statements.  FSP FAS 107-1 also requires entities to disclose the methods and significant assumptions used to estimate the fair value of financial instruments in financial statements on an interim and annual basis and to highlight any changes from prior periods.  FSP FAS 107-1 is effective for financial statements issued for interim and annual periods ending after June 15, 2009.  The adoption of FSP FAS 107-1 as of April 1, 2009 will not have a material impact on the Company’s financial position or results of operations as it impacts financial statement disclosure only.

 

10



 

2. Fair Values of Financial Instruments

 

SFAS No. 157, Fair Value Measurements (“SFAS 157”) requires companies to expand disclosures associated with fair value measurements and to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  SFAS 157 provides a hierarchy for valuation inputs in which assets and liabilities measured at fair value must be disclosed.  Accordingly, the Company groups financial assets and financial liabilities measured at fair value in the following categories:

 

Level 1 -  Quoted prices are available in active markets for identical financial instruments as of the reporting date.  The types of financial instruments included in Level 1 are listed equities and non-interest bearing cash.  As required by SFAS 157, the Company does not adjust the quoted price for these financial instruments, even in situations where it holds 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.  The types of financial instruments included in Level 2 are U.S. Government sponsored agency securities, corporate preferred securities, corporate bonds and mortgage and asset-backed securities.

 

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 the Company used discounted expected future cash flows with unobservable inputs using market participant assumptions to determine fair value.

 

The following valuation techniques were used by the Company in estimating the fair values of financial instruments:

 

1.                                       Fair values of fixed maturity securities are obtained primarily from a broker who starts by obtaining a price from an independent pricing source and adjusts for observable data.  These prices from the independent broker undergo evaluation by the Company’s internal investment professionals.  The Company generally obtains one price per security, which is compared to relevant credit information, perceived market movements and sector news.  Market indices of similar rated asset class spreads are considered for valuations and broker indications of similar securities are compared.  If the issuer has had trades in similar debt outstanding but not necessarily the same rank in the capital structure, spread information is used to support fair value.  If discrepancies are identified, additional quotes are obtained and the quote that best reflects a fair value exit price at the reporting date is selected.

 

2.                                      Amounts reported as fair value of embedded derivatives are estimated by projecting policy contract values and minimum guaranteed contract values over the expected lives of the contracts and discounting the excess of the projected contract value amounts.  The projections of the policy contract values are based on best estimate assumptions for future policy growth and future policy decrements.  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 that will be purchased 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.  Increases or decreases in the fair value of embedded derivatives generally correspond to increases or decreases in the fair values of call options purchased to fund the annual index credits and changes in the discount rates used to discount the excess of the projected policy contract values over the projected minimum guaranteed contract values.  The fair value of the embedded derivatives includes an adjustment for the non performance risk of the Company.

 

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.  The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the financial instrument.

 

11



 

The Company’s assets and liabilities which are measured at fair value on a recurring basis as of March 31, 2009 and December 31, 2008 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, 2009

 

 

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

 

Fixed maturity securities:

 

 

 

 

 

 

 

 

 

Available for sale:

 

 

 

 

 

 

 

 

 

United States Government full faith and credit

 

$

21,861

 

$

2,683

 

$

19,178

 

$

 

United States Government sponsored agencies

 

2,932,137

 

 

2,932,137

 

 

U.S. states, territories and political subdivisions

 

15,916

 

 

15,916

 

 

Corporate securities

 

2,414,058

 

68,483

 

2,328,187

 

17,388

 

Mortgage and asset-backed securities

 

2,189,358

 

 

2,187,158

 

2,200

 

Equity securities - available for sale

 

73,378

 

65,090

 

8,288

 

 

Derivative instruments

 

57,492

 

 

57,492

 

 

Cash and cash equivalents

 

108,032

 

108,032

 

 

 

 

 

$

7,812,232

 

$

244,288

 

$

7,548,356

 

$

19,588

 

Liabilities

 

 

 

 

 

 

 

 

 

Embedded derivatives

 

$

943,386

 

$

 

$

 

$

943,386

 

 

 

 

 

 

 

 

 

 

 

December 31, 2008

 

 

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

 

Fixed maturity securities:

 

 

 

 

 

 

 

 

 

Available for sale:

 

 

 

 

 

 

 

 

 

United States Government full faith and credit

 

$

22,050

 

$

3,404

 

$

18,646

 

$

 

United States Government sponsored agencies

 

3,104,853

 

 

3,104,853

 

 

Corporate securities

 

1,688,869

 

84,946

 

1,586,174

 

17,749

 

Mortgage and asset-backed securities

 

1,813,274

 

 

1,810,941

 

2,333

 

Equity securities - available for sale

 

99,552

 

84,554

 

14,998

 

 

Derivative instruments

 

56,588

 

 

56,588

 

 

Cash and cash equivalents

 

214,862

 

214,862

 

 

 

 

 

$

7,000,048

 

$

387,766

 

$

6,592,200

 

$

20,082

 

Liabilities

 

 

 

 

 

 

 

 

 

Embedded derivatives

 

$

998,015

 

$

 

$

 

$

998,015

 

 

The following tables provide a reconciliation of the beginning and ending balances for the Company’s 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, 2009 and 2008.

 

 

 

Three Months
Ended
March 31,

 

 

 

2009

 

2008

 

 

 

(Dollars in thousands)

 

Available for sale securities

 

 

 

 

 

Beginning balance

 

$

20,082

 

$

 

Transfers in to or out of Level 3

 

 

 

Disposals

 

(37

)

 

Total gains (losses) (realized/unrealized):

 

 

 

 

 

Included in other comprehensive income (loss)

 

81

 

 

Included in operations

 

(538

)

 

 

 

$

19,588

 

$

 

 

Realized losses of $0.5 million for the three months ended March 31, 2009 are included in net impairment losses recognized in operations in the consolidated statements of operations.

 

 

 

Three Months
Ended
March 31,

 

 

 

2009

 

2008

 

 

 

(Dollars in thousands)

 

Embedded Derivatives

 

 

 

 

 

Beginning balance

 

$

998,015

 

$

1,432,746

 

Premiums less benefits

 

(16,664

)

42,913

 

Change in unrealized gains, net

 

(37,965

)

(284,724

)

 

 

$

943,386

 

$

1,190,935

 

 

Change in unrealized gains, net of $38.0 million and $284.7 million for the three months ended March 31, 2009 and 2008, respectively, are included in change in fair value of embedded derivatives in the unaudited consolidated statement of operations.

 

12



 

3.  Investments

 

At March 31, 2009 and December 31, 2008, the amortized cost and fair value of fixed maturity securities and equity securities were as follows:

 

 

 

Amortized
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Other Than
Temporary
Impairments in
Accumulated
Other
Comprehensive
Loss

 

Fair Value

 

 

 

(Dollars in thousands)

 

March 31, 2009

 

 

 

 

 

 

 

 

 

 

 

Fixed maturity securities:

 

 

 

 

 

 

 

 

 

 

 

Available for sale:

 

 

 

 

 

 

 

 

 

 

 

United States Government full faith and credit

 

$

21,439

 

$

422

 

$

 

$

 

$

21,861

 

United States Government sponsored agencies

 

2,919,945

 

12,206

 

(14

)

 

2,932,137

 

U.S. states, territories and political subdivisions

 

17,037

 

48

 

(1,169

)

 

15,916

 

Corporate securities, including redeemable preferred stocks

 

2,685,892

 

35,079

 

(291,875

)

(15,038

)

2,414,058

 

Mortgage and asset-backed securities

 

2,634,323

 

9,435

 

(344,264

)

(110,136

)

2,189,358

 

 

 

$

8,278,636

 

$

57,190

 

$

(637,322

)

$

(125,174

)

$

7,573,330

 

 

 

 

 

 

 

 

 

 

 

 

 

Held for investment:

 

 

 

 

 

 

 

 

 

 

 

United States Government sponsored agencies

 

$

2,974,953

 

$

11,254

 

$

(293

)

$

 

$

2,985,914

 

Redeemable preferred stock

 

75,552

 

 

(22,223

)

 

53,329

 

 

 

$

3,050,505

 

$

11,254

 

$

(22,516

)

$

 

$

3,039,243

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity securities, available for sale:

 

 

 

 

 

 

 

 

 

 

 

Non-redeemable preferred stocks

 

$

75,454

 

$

55

 

$

(23,644

)

$

 

$

51,865

 

Common stocks

 

29,029

 

39

 

(7,555

)

 

21,513

 

 

 

$

104,483

 

$

94

 

$

(31,199

)

$

 

$

73,378

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2008

 

 

 

 

 

 

 

 

 

 

 

Fixed maturity securities:

 

 

 

 

 

 

 

 

 

 

 

Available for sale:

 

 

 

 

 

 

 

 

 

 

 

United States Government full faith and credit

 

$

21,664

 

$

515

 

$

(129

)

$

 

$

22,050

 

United States Government sponsored agencies

 

3,090,458

 

15,528

 

(1,133

)

 

3,104,853

 

Corporate securities, including redeemable preferred stocks

 

1,951,308

 

14,939

 

(277,378

)

 

1,688,869

 

Mortgage and asset-backed securities

 

2,095,856

 

6,055

 

(288,637

)

 

1,813,274

 

 

 

$

7,159,286

 

$

37,037

 

$

(567,277

)

$

 

$

6,629,046

 

 

 

 

 

 

 

 

 

 

 

 

 

Held for investment:

 

 

 

 

 

 

 

 

 

 

 

United States Government sponsored agencies

 

$

3,528,628

 

$

6,421

 

$

(4,984

)

$

 

$

3,530,065

 

Redeemable preferred stock

 

75,521

 

 

(17,472

)

 

58,049

 

 

 

$

3,604,149

 

$

6,421

 

$

(22,456

)

$

 

$

3,588,114

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity securities, available for sale:

 

 

 

 

 

 

 

 

 

 

 

Non-redeemable preferred stocks

 

$

95,939

 

$

 

$

(25,624

)

$

 

$

70,315

 

Common stocks

 

29,218

 

373

 

(354

)

 

29,237

 

 

 

$

125,157

 

$

373

 

$

(25,978

)

$

 

$

99,552

 

 

During the three months ended March 31, 2009 and 2008, the Company received $1.0 billion and $330.7 million, respectively, in net redemption proceeds related to calls of its callable United States Government sponsored agency securities, of which $588.6 million and $150.5 million, respectively, were classified as held for investment.  The Company reinvested the proceeds from these redemptions primarily in corporate securities and mortgage-backed securities classified as available for sale.  At March 31, 2009, 58% of the Company’s fixed income securities have call features and 13% were subject to call redemption.  Another 41% will become

 

13



 

subject to call redemption through December 31, 2009.

 

The amortized cost and fair value of fixed maturity securities at March 31, 2009, 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 the Company’s mortgage-backed and asset-backed securities provide for periodic payments throughout their lives and are shown below as a separate line.

 

 

 

Available-for-sale

 

Held for investment

 

 

 

Amortized
Cost

 

Fair Value

 

Amortized
Cost

 

Fair Value

 

 

 

(Dollars in thousands)

 

Due after one year through five years

 

$

425,210

 

$

397,988

 

$

 

$

 

Due after five years through ten years

 

1,067,540

 

1,022,366

 

 

 

Due after ten years through twenty years

 

2,036,431

 

1,997,241

 

790,000

 

793,792

 

Due after twenty years

 

2,115,132

 

1,966,377

 

2,260,505

 

2,245,451

 

 

 

5,644,313

 

5,383,972

 

3,050,505

 

3,039,243

 

Mortgage-backed and asset-backed securities

 

2,634,323

 

2,189,358

 

 

 

 

 

$

8,278,636

 

$

7,573,330

 

$

3,050,505

 

$

3,039,243

 

 

Net unrealized losses 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,
2009

 

December 31,
2008

 

 

 

(Dollars in thousands)

 

Net unrealized losses on available for sale fixed maturity securities
and equity securities

 

$

(611,237

)

$

(555,845

)

Noncredit component of other than temporary impairment losses
on available for sale fixed maturity securities

 

(125,174

)

 

Adjustments for assumed changes in amortization of deferred policy acquisition costs and deferred sales inducements

 

446,691

 

329,113

 

Deferred income tax benefit

 

101,402

 

79,356

 

Net unrealized losses reported as accumulated other comprehensive loss

 

$

(188,318

)

$

(147,376

)

 

14



 

The following tables show the Company’s investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities (consisting of 440 and 394 securities, respectively) have been in a continuous unrealized loss position, at March 31, 2009 and December 31, 2008:

 

 

 

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, 2009

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturity securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Available for sale:

 

 

 

 

 

 

 

 

 

 

 

 

 

United States Government sponsored agencies

 

$

101,871

 

$

(14

)

$

 

$

 

$

101,871

 

$

(14

)

U.S. states, territories and political subdivisions

 

5,000

 

(90

)

7,731

 

(1,079

)

12,731

 

(1,169

)

Corporate securities, including redeemable preferred stocks:

 

 

 

 

 

 

 

 

 

 

 

 

 

Finance, insurance and real estate

 

119,140

 

(40,164

)

219,043

 

(106,252

)

338,183

 

(146,416

)

Manufacturing, construction and mining

 

317,066

 

(30,698

)

132,764

 

(33,462

)

449,830

 

(64,160

)

Utilities and related sectors

 

235,297

 

(16,042

)

152,500

 

(33,779

)

387,797

 

(49,821

)

Wholesale/retail trade

 

133,013

 

(8,837

)

55,092

 

(11,541

)

188,105

 

(20,378

)

Services, media and other

 

68,448

 

(5,693

)

97,655

 

(20,445

)

166,103

 

(26,138

)

Mortgage and asset-backed securities

 

1,350,541

 

(218,707

)

637,995

 

(235,693

)

1,988,536

 

(454,400

)

 

 

$

2,330,376

 

$

(320,245

)

$

1,302,780

 

$

(442,251

)

$

3,633,156

 

$

(762,496

)

Held for investment:

 

 

 

 

 

 

 

 

 

 

 

 

 

United States Government sponsored agencies

 

$

 

$

 

$

299,707

 

$

(293

)

$

299,707

 

$

(293

)

Redeemable preferred stock:

 

 

 

 

 

 

 

 

 

 

 

 

 

Finance, insurance and real estate

 

 

 

53,329

 

(22,223

)

53,329

 

(22,223

)

 

 

$

 

$

 

$

353,036

 

$

(22,516

)

$

353,036

 

$

(22,516

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity securities, available for sale

 

$

40,473

 

$

(17,030

)

$

15,832

 

$

(14,169

)

$

56,305

 

$

(31,199

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2008

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturity securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Available for sale:

 

 

 

 

 

 

 

 

 

 

 

 

 

United States Government full faith and credit

 

$

 

$

 

$

18,645

 

$

(129

)

$

18,645

 

$

(129

)

United States Government sponsored agencies

 

60,475

 

(57

)

298,925

 

(1,076

)

359,400

 

(1,133

)

Corporate securities, including redeemable preferred stocks:

 

 

 

 

 

 

 

 

 

 

 

 

 

Finance, insurance and real estate

 

205,148

 

(44,478

)

146,226

 

(46,761

)

351,374

 

(91,239

)

Manufacturing, construction and mining

 

294,428

 

(37,589

)

65,578

 

(27,978

)

360,006

 

(65,567

)

Utilities and related sectors

 

192,110

 

(22,816

)

116,173

 

(32,307

)

308,283

 

(55,123

)

Wholesale/retail trade

 

120,056

 

(16,557

)

11,825

 

(9,680

)

131,881

 

(26,237

)

Services, media and other

 

119,297

 

(22,425

)

79,664

 

(16,787

)

198,961

 

(39,212

)

Mortgage and asset-backed securities

 

1,117,973

 

(221,480

)

297,442

 

(67,157

)

1,415,415

 

(288,637

)

 

 

$

2,109,487

 

$

(365,402

)

$

1,034,478

 

$

(201,875

)

$

3,143,965

 

$

(567,277

)

Held for investment:

 

 

 

 

 

 

 

 

 

 

 

 

 

United States Government sponsored agencies

 

$

 

$

 

$

360,016

 

$

(4,984

)

$

360,016

 

$

(4,984

)

Redeemable preferred stock:

 

 

 

 

 

 

 

 

 

 

 

 

 

Finance, insurance and real estate

 

 

 

58,049

 

(17,472

)

58,049

 

(17,472

)

 

 

$

 

$

 

$

418,065

 

$

(22,456

)

$

418,065

 

$

(22,456

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity securities, available for sale

 

$

30,093

 

$

(14,360

)

$

20,358

 

$

(11,618

)

$

50,451

 

$

(25,978

)

 

15



 

The following is a description of the factors causing the temporary unrealized losses by investment category as of March 31, 2009:

 

United States Government full faith and credit; United States Government sponsored agencies; and U.S. states, territories and political subdivisions: These securities are relatively long in duration, making the value of such securities sensitive to changes in market interest rates.  While the decline in risk-free interest rates have provided benefit to these securities, current spreads on agency securities compared to U.S. Treasury securities continue to remain wide from a historic perspective.  The continued uncertainty surrounding economic conditions has resulted in an extended period of wider agency spreads relative to U.S. Treasury securities.

 

Corporate securities, including redeemable preferred stocks:  The unrealized losses in these securities are due to a dramatic widening in credit spreads as the result of diminished liquidity and instability in the financial credit markets.  Credit spreads at March 31, 2009 are wider than the Company would expect given current default rates and are likely more reflective of supply and demand imbalances.  Risk aversion remains high because of the financial crisis and global recession fears, despite continued government action to calm the markets.

 

Mortgage and asset-backed securities: At March 31, 2009, the Company had no exposure to subprime mortgage-backed securities.  Substantially all of the securities that the Company owns are in the highest rated tranche of the pool in which they are structured and are not subordinated to any other tranche.  The Company’s “Alt-A” mortgage-backed securities are comprised of 34 securities with a total amortized cost basis of $562.3 million and a fair value of $377.9 million.  Unrealized losses in residential mortgage-backed securities have increased as mortgage spreads have widened as Fannie Mae and Freddie Mac slipped into government receivership in 2008 due to increased capital concerns.  Despite government efforts, increased foreclosures and bankruptcies during the first quarter of 2009 have caused additional spread widening.

 

Equity securities: The unrealized loss on equity securities, which includes exposure to REITS, investment banks and finance companies, is due to the instability in the financial markets and a further deterioration in the economy.  A deepening recession due to tight credit markets and a difficult housing market have raised concerns in regard to earnings and dividend stability in many companies which directly affect the values of these securities.

 

Where the decline in market value of debt securities is attributable to changes in market interest rates or to factors such as market volatility, liquidity and spread widening, and the Company anticipates recovery of amortized cost, it does not consider these investments to be other than temporarily impaired because the Company does not intend to sell these securities and it is more likely than not the Company will not have to sell the securities before recovery of their amortized cost.  Where there is a decline in the fair value of equity securities, other than temporary impairment is not recognized when the Company anticipates a recovery of cost within a reasonable period of time.

 

Approximately 67% of the unrealized losses on fixed maturity securities shown in the above table for March 31, 2009 are on securities that are rated investment grade, defined as being the highest two National Association of Insurance Commissioners (“NAIC”) designations.  Approximately 33% of the unrealized losses on fixed maturity securities shown in the above table for March 31, 2009 are on securities rated below investment grade.  All of the securities with unrealized losses are current with respect to the payment of principal and interest.

 

16



 

Changes in net unrealized losses on investments for the three months ended March 31, 2009 and 2008 are as follows:

 

 

 

March 31,
2009

 

March 31,
2008

 

 

 

(Dollars in thousands)

 

Fixed maturity securities held for investment carried at amortized cost

 

$

4,773

 

$

(99,113

)

 

 

 

 

 

 

Investments carried at fair value:

 

 

 

 

 

Fixed maturity securities, available for sale

 

$

(175,066

)

$

(66,839

)

Equity securities, available for sale

 

(5,500

)

(2,345

)

 

 

(180,566

)

(69,184

)

Adjustment for effect on other balance sheet accounts:

 

 

 

 

 

Deferred policy acquisition costs and deferred sales inducements

 

117,578

 

38,135

 

Deferred income tax asset

 

22,046

 

10,867

 

 

 

139,624

 

49,002

 

Increase in net unrealized losses on investments carried at fair value

 

$

(40,942

)

$

(20,182

)

 

Realized gains and losses on sales are determined on the basis of specific identification of investments based on the trade date.  Realized gains (losses) on investments, excluding impairment losses for the three months ended March 31, 2009 and 2008 are as follows:

 

 

 

Three Months Ended
March 31,

 

 

 

2009

 

2008

 

 

 

(Dollars in thousands)

 

Available for sale fixed maturity securities:

 

 

 

 

 

Gross realized gains

 

$

810

 

$

943

 

Gross realized losses

 

(53

)

(113

)

 

 

757

 

830

 

Equity securities:

 

 

 

 

 

Gross realized gains

 

3

 

 

 

 

3

 

 

 

 

$

760

 

$

830

 

 

The Company reviews and analyzes all investments on an ongoing basis for changes in market interest rates and credit deterioration.  This review process includes analyzing the Company’s 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.

 

The Company has a policy and process in place to identify securities that could potentially have an impairment that is 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 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;

·                  the Company’s intent and ability to retain equity securities for a period of time sufficient to allow for recovery;

·                  the Company’s intent to sell and whether it is more likely than not the Company would be required to sell prior to recovery for debt securities;

·                  consideration of rating agency actions;

·                  changes in estimated cash flows of asset-backed and mortgage-backed securities; and

·                  the Company’s 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.

 

17



 

The Company determines whether other than temporary impairment losses should be recognized for debt and equity securities by assessing all facts and circumstances surrounding the security. Other than temporary impairment losses on equity securities are recognized in operations.  If the Company intends to sell a debt security, or if it is more likely than not that the Company 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.

 

If the Company does not intend to sell the debt security but also does 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 amortized cost basis that would not be collected (credit loss).  The Company calculates the present value of the cash flows expected to be collected.  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.  The Company’s review of these securities includes an analysis of the cash flow modeling under various default scenarios as compared to independent third party contributors, 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, the Company evaluates the cash flow projections to determine whether the security is performing in accordance with its contractual obligation.  In circumstances where the analysis implies a potential for principal loss at some point in the future, the cash flow projection is discounted at the security’s current effective yield and compared to amortized cost to determine the amount of credit loss associated with the security.

 

The determination of the credit loss component of a corporate bond is based on the underlying financial performance of the issuer and their ability to meet their contractual obligations.  Considerations in the Company’s evaluation include, but are not limited to credit rating changes, financial statement and ratio analysis, changes in management, large 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.  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.

 

The following table summarizes other than temporary impairments by asset type:

 

 

 

Three Months Ended March 31, 2009

 

 

 

Total Other
Than
Temporary
Losses

 

Included in
Other
Comprehensive
Loss

 

Net
Impairment
Losses in
Operations

 

 

 

(Dollars in thousands)

 

Fixed maturity securities:

 

 

 

 

 

 

 

Available for sale:

 

 

 

 

 

 

 

United States Government full faith and credit