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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
 
FORM 10-Q

(Mark one)
 
 
[X]
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
 
 
 
For the quarterly period ended June 30, 2014
 
 
 
or
 
 
 
[ ]
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
 
 
 
For the transition period from____________________ to____________________
 
 
 
Commission File Number: 1-11917
(Exact name of registrant as specified in its charter)
 
 
 
Iowa
 
42-1411715
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
5400 University Avenue, West Des Moines, Iowa
 
50266-5997
(Address of principal executive offices)
 
(Zip Code)
 
 
 
(515) 225-5400
(Registrant's telephone number, including area code)
 
 
 
 
(Former name, former address and former fiscal year, if changed since last report)
 
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [ ] No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). [X] Yes [ ] No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [ ]
Accelerated filer [X]
Non-accelerated filer [ ]
Smaller reporting company [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). [ ] Yes [X] No
 
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:
 Title of each class
 
Outstanding at July 30, 2014
Class A Common Stock, without par value
 
24,707,998
Class B Common Stock, without par value
 
11,413


















(This page has been intentionally left blank.)




FBL FINANCIAL GROUP, INC.
FORM 10-Q FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2014
TABLE OF CONTENTS


PART I.
FINANCIAL INFORMATION
 
 
 
 
Item 1.
Financial Statements (Unaudited)
 
 
Consolidated Balance Sheets
 
Consolidated Statements of Operations
 
Consolidated Statements of Comprehensive Income
 
Consolidated Statements of Changes in Stockholders' Equity
 
Consolidated Statements of Cash Flows
 
Notes to Consolidated Financial Statements
 
 
 
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
 
 
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
 
 
 
Item 4.
Controls and Procedures
 
 
 
PART II.
OTHER INFORMATION
 
 
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
 
 
 
Item 6.
Exhibits
 
 
 
SIGNATURES
 
    



1


ITEM 1. FINANCIAL STATEMENTS

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

 
June 30,
2014
 
December 31,
2013
Assets
 
 
 
Investments:
 
 
 
Fixed maturities - available for sale, at fair value (amortized cost: 2014 - $6,029,051; 2013 - $5,828,539)
$
6,559,738

 
$
6,081,753

Equity securities - available for sale, at fair value (cost: 2014 - $105,368; 2013 - $90,071)
111,402

 
91,555

Mortgage loans
597,416

 
575,861

Real estate
4,066

 
4,084

Policy loans
181,048

 
176,993

Short-term investments
48,987

 
108,677

Other investments
2,444

 
1,079

Total investments
7,505,101

 
7,040,002

 
 
 
 
Cash and cash equivalents
31,672

 
6,370

Securities and indebtedness of related parties
122,899

 
116,305

Accrued investment income
75,987

 
75,186

Amounts receivable from affiliates
3,004

 
3,145

Reinsurance recoverable
99,484

 
100,001

Deferred acquisition costs
255,182

 
335,514

Value of insurance in force acquired
15,973

 
23,579

Other assets
74,131

 
67,266

Assets held in separate accounts
712,533

 
693,955

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total assets
$
8,895,966

 
$
8,461,323


 


2




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

 
June 30,
2014
 
December 31,
2013
Liabilities and stockholders' equity
 
 
 
Liabilities:
 
 
 
Future policy benefits:
 
 
 
Interest sensitive products
$
4,415,108

 
$
4,278,871

Traditional life insurance and accident and health products
1,545,388

 
1,515,139

Other policy claims and benefits
36,122

 
45,530

Supplementary contracts without life contingencies
344,310

 
349,761

Advance premiums and other deposits
251,680

 
240,441

Amounts payable to affiliates
1,106

 
408

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

 
97,000

Current income taxes
3,530

 
1,499

Deferred income taxes
192,751

 
122,839

Other liabilities
99,310

 
71,089

Liabilities related to separate accounts
712,533

 
693,955

Total liabilities
7,698,838

 
7,416,532

 
 
 
 
Stockholders' equity:
 
 
 
FBL Financial Group, Inc. stockholders' equity:
 
 
 
Preferred stock, without par value, at liquidation value - authorized 10,000,000 shares, issued and outstanding 5,000,000 Series B shares
3,000

 
3,000

Class A common stock, without par value - authorized 88,500,000 shares, issued and outstanding 24,702,093 shares in 2014 and 24,742,942 shares in 2013
142,127

 
134,993

Class B common stock, without par value - authorized 1,500,000 shares, issued and outstanding 11,413 shares in 2014 and 2013
72

 
72

Accumulated other comprehensive income
242,334

 
119,067

Retained earnings
809,528

 
787,609

Total FBL Financial Group, Inc. stockholders' equity
1,197,061

 
1,044,741

Noncontrolling interest
67

 
50

Total stockholders' equity
1,197,128

 
1,044,791

Total liabilities and stockholders' equity
$
8,895,966

 
$
8,461,323
















See accompanying notes.


3


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

 
Three months ended June 30,
 
Six months ended June 30,
 
2014
 
2013
 
2014
 
2013
Revenues:
 
 
 
 
 
 
 
Interest sensitive product charges
$
27,361

 
$
26,795

 
$
54,452

 
$
52,099

Traditional life insurance premiums
47,444

 
46,058

 
92,936

 
90,992

Net investment income
95,215

 
92,898

 
187,846

 
183,708

Net realized capital gains on sales of investments
2,806

 
7,435

 
2,266

 
11,367

 
 
 
 
 
 
 
 
Total other-than-temporary impairment losses

 
(199
)
 

 
(845
)
Non-credit portion in other comprehensive income

 

 

 

Net impairment losses recognized in earnings

 
(199
)
 

 
(845
)
Other income
3,011

 
3,696

 
6,872

 
7,410

Total revenues
175,837

 
176,683

 
344,372

 
344,731

 
 
 
 
 
 
 
 
Benefits and expenses:
 
 
 
 
 
 
 
Interest sensitive product benefits
51,763

 
48,631

 
105,143

 
96,923

Traditional life insurance benefits
41,991

 
40,263

 
83,488

 
80,069

Policyholder dividends
2,907

 
3,395

 
6,252

 
6,753

Underwriting, acquisition and insurance expenses
35,274

 
37,335

 
68,718

 
72,359

Interest expense
1,086

 
1,838

 
2,298

 
3,813

Other expenses
4,383

 
4,818

 
8,511

 
9,202

Total benefits and expenses
137,404

 
136,280

 
274,410

 
269,119

 
38,433

 
40,403

 
69,962

 
75,612

Income taxes
(12,339
)
 
(13,378
)
 
(22,567
)
 
(24,961
)
Equity income, net of related income taxes
2,531

 
2,528

 
4,179

 
3,840

Net income
28,625

 
29,553

 
51,574

 
54,491

Net loss attributable to noncontrolling interest
17

 
34

 
60

 
62

Net income attributable to FBL Financial Group, Inc.
$
28,642

 
$
29,587

 
$
51,634

 
$
54,553

 
 
 
 
 
 
 
 
Earnings per common share
$
1.15

 
$
1.14

 
$
2.07

 
$
2.12

Earnings per common share - assuming dilution
$
1.14

 
$
1.13

 
$
2.06

 
$
2.10

 
 
 
 
 
 
 
 
Cash dividends per common share
$
0.35

 
$
0.11

 
$
0.70

 
$
0.22

















See accompanying notes.


4


FBL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Unaudited)
(Dollars in thousands)
 
Three months ended June 30,
 
Six months ended June 30,
 
2014
 
2013
 
2014
 
2013
Net income
$
28,625

 
$
29,553

 
$
51,574

 
$
54,491

Other comprehensive income (1)
 
 
 
 
 
 
 
Change in net unrealized investment gains/losses
53,604

 
(131,175
)
 
122,912

 
(125,498
)
Non-credit impairment losses

 
1

 

 
(35
)
Change in underfunded status of postretirement benefit plans
183

 
205

 
355

 
468

Total other comprehensive income, net of tax
53,787

 
(130,969
)
 
123,267

 
(125,065
)
Total comprehensive income, net of tax
82,412

 
(101,416
)
 
174,841

 
(70,574
)
Comprehensive loss attributable to noncontrolling interest
17

 
34

 
60

 
62

Total comprehensive income (loss) applicable to FBL Financial Group, Inc.
$
82,429

 
$
(101,382
)
 
$
174,901

 
$
(70,512
)

(1)
Other comprehensive income is recorded net of deferred income taxes and other adjustments for assumed changes in deferred acquisition costs, value of insurance in force acquired, unearned revenue reserve and policyholder liabilities.


FBL FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Unaudited)
(Dollars in thousands)
 
FBL Financial Group, Inc. Stockholders' Equity
 
 
 
 
 
Preferred Stock
 
Common Stock
 
Accumulated Other Comprehensive Income
 
Retained Earnings
 
Non-
controlling Interest
 
Total Stockholders' Equity
Balance at January 1, 2013
$
3,000

 
$
123,228

 
$
289,853

 
$
796,110

 
$
56

 
$
1,212,247

Net income - six months ended June 30, 2013

 

 

 
54,553

 
(62
)
 
54,491

Other comprehensive loss

 

 
(125,065
)
 

 

 
(125,065
)
Issuance of common stock under compensation plans

 
14,275

 

 

 

 
14,275

Purchase of common stock

 
(1,799
)
 

 
(12,206
)
 

 
(14,005
)
Dividends on preferred stock

 

 

 
(75
)
 

 
(75
)
Dividends on common stock

 

 

 
(5,645
)
 

 
(5,645
)
Receipts related to noncontrolling interest

 

 

 

 
57

 
57

Balance at June 30, 2013
$
3,000

 
$
135,704

 
$
164,788

 
$
832,737

 
$
51

 
$
1,136,280

 
 
 
 
 
 
 
 
 
 
 
 
Balance at January 1, 2014
$
3,000

 
$
135,065

 
$
119,067

 
$
787,609

 
$
50

 
$
1,044,791

Net income - six months ended June 30, 2014

 

 

 
51,634

 
(60
)
 
51,574

Other comprehensive income

 

 
123,267

 

 

 
123,267

Issuance of common stock under compensation plans

 
8,976

 

 

 

 
8,976

Purchase of common stock

 
(1,842
)
 

 
(12,339
)
 

 
(14,181
)
Dividends on preferred stock

 

 

 
(75
)
 

 
(75
)
Dividends on common stock

 

 

 
(17,301
)
 

 
(17,301
)
Receipts related to noncontrolling interest

 

 

 

 
77

 
77

Balance at June 30, 2014
$
3,000

 
$
142,199

 
$
242,334

 
$
809,528

 
$
67

 
$
1,197,128








See accompanying notes.


5


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

 
Six months ended June 30,
 
2014
 
2013
Operating activities
 
 
 
Net income
$
51,574

 
$
54,491

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Interest credited to account balances
73,890

 
71,327

Charges for mortality, surrenders and administration
(52,479
)
 
(50,062
)
Net realized gains on investments
(2,266
)
 
(10,522
)
Change in fair value of derivatives
(932
)
 
(553
)
Increase in traditional life and accident and health benefit liabilities
30,249

 
29,991

Deferral of acquisition costs
(20,418
)
 
(22,807
)
Amortization of deferred acquisition costs and value of insurance in force
16,309

 
17,772

Change in reinsurance recoverable
517

 
(1,257
)
Provision for deferred income taxes
3,480

 
1,944

Other
(14,909
)
 
(12,750
)
Net cash provided by operating activities
85,015

 
77,574

 
 
 
 
Investing activities
 
 
 
Sales, maturities or repayments:
 
 
 
Fixed maturities - available for sale
202,166

 
401,421

Equity securities - available for sale
1,080

 
8,135

Mortgage loans
17,844

 
22,889

Derivative instruments
431

 
263

Policy loans
16,313

 
18,355

Securities and indebtedness of related parties
1,207

 
2,191

Real estate

 
1,957

Other long-term investments

 
30

Acquisitions:
 
 
 
Fixed maturities - available for sale
(354,061
)
 
(596,148
)
Equity securities - available for sale
(16,377
)
 
(6,108
)
Mortgage loans
(39,027
)
 
(41,140
)
Derivative instruments
(1,021
)
 
(222
)
Policy loans
(20,368
)
 
(18,587
)
Securities and indebtedness of related parties
(10,872
)
 
(15,847
)
Short-term investments, net change
59,690

 
13,128

Purchases and disposals of property and equipment, net
(6,149
)
 
(5,566
)
Net cash used in investing activities
(149,144
)
 
(215,249
)




6


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

 
Six months ended June 30,
 
2014
 
2013
Financing activities
 
 
 
Contract holder account deposits
$
323,800

 
$
325,672

Contract holder account withdrawals
(211,604
)
 
(198,212
)
Receipts related to noncontrolling interests, net
77

 
57

Excess tax deductions on stock-based compensation
717

 
1,622

Repurchase of common stock, net
(6,183
)
 
(1,747
)
Dividends paid
(17,376
)
 
(5,720
)
Net cash provided by financing activities
89,431

 
121,672

Increase (decrease) in cash and cash equivalents
25,302

 
(16,003
)
Cash and cash equivalents at beginning of period
6,370

 
78,074

Cash and cash equivalents at end of period
$
31,672

 
$
62,071

 
 
 
 
Supplemental disclosures of cash flow information
 
 
 
Cash paid during the period for:
 
 
 
Interest
$
2,425

 
$
3,950

Income taxes
9,001

 
7,001

































See accompanying notes.


7


FBL FINANCIAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
June 30, 2014

1. Significant Accounting Policies

Basis of Presentation

The accompanying unaudited consolidated financial statements of FBL Financial Group, Inc. (we or the Company) have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. Our financial statements include all adjustments (consisting of normal recurring accruals) necessary for a fair presentation of our financial position and results of operations.

Operating results for the three- and six-month periods ended June 30, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014. We encourage you to refer to our consolidated financial statements and notes for the year ended December 31, 2013 included in our Annual Report on Form 10-K for a complete description of our material accounting policies. Also included in the Form 10-K is a description of areas of judgments and estimates and other information necessary to understand our financial position and results of operations.

Future Adoption of Recent Accounting Pronouncements

In January 2014, the Financial Accounting Standards Board (FASB) issued guidance related to accounting for investments in low income housing tax credit limited partnerships. Our low income housing tax credit investments totaled $81.5 million at June 30, 2014 and $76.2 million at December 31, 2013. Presently, we account for these investments under the equity method and include related tax benefits as a component of equity income. The new guidance allows us to account for these partnerships using the proportional amortization method, which amortizes the acquisition cost of the partnership in proportion to the recognition of the tax credits associated with these projects. The tax credits, net of the amortization of the partnership interest, would be recognized as a component of income taxes. This guidance will be effective for fiscal years beginning after December 15, 2014 and must be applied retrospectively, if we elect to change our accounting practice. We are currently evaluating the impact of this new guidance on our consolidated financial statements.

In May 2014, the FASB issued guidance that outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers, which supersedes most current revenue recognition guidance, including industry-specific guidance. Although insurance contracts are specifically excluded from the scope of this guidance, almost all entities will be affected to some extent by the significant increase in required disclosures. The new guidance is based on the principle that an entity should recognize revenue to reflect the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to fulfill a contract. Entities have the option of using either a full retrospective or a modified retrospective approach for the adoption of the new standard, which becomes effective for fiscal years beginning after December 15, 2016; early adoption is not permitted. We are currently evaluating the impact of this new guidance on our consolidated financial statements.



8


2. Investment Operations

Fixed Maturity and Equity Securities

Available-For-Sale Fixed Maturity and Equity Securities by Investment Category
 
 
 
 
 
 
 
June 30, 2014
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
 
Non-credit losses on other-than-temporary impairments (1)
 
(Dollars in thousands)
Fixed maturities:
 
 
 
 
 
 
 
 
 
Corporate (2)
$
3,229,642

 
$
344,923

 
$
(11,910
)
 
$
3,562,655

 
$
526

Residential mortgage-backed
495,292

 
43,299

 
(4,969
)
 
533,622

 
(3,424
)
Commercial mortgage-backed
465,075

 
31,636

 
(2,557
)
 
494,154

 

Other asset-backed
471,648

 
19,054

 
(6,081
)
 
484,621

 
2,041

United States Government and agencies
38,768

 
4,158

 
(29
)
 
42,897

 

State, municipal and other governments
1,328,626

 
116,518

 
(3,355
)
 
1,441,789

 

Total fixed maturities
$
6,029,051

 
$
559,588

 
$
(28,901
)
 
$
6,559,738

 
$
(857
)
 
 
 
 
 
 
 
 
 
 
Equity securities:
 
 
 
 
 
 
 
 
 
Non-redeemable preferred stocks
$
80,566

 
$
5,609

 
$
(468
)
 
$
85,707

 
$

Common stocks
24,802

 
893

 

 
25,695

 

Total equity securities
$
105,368

 
$
6,502

 
$
(468
)
 
$
111,402

 
$

 
December 31, 2013
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
 
Non-credit losses on other-than-temporary impairments (1)
 
(Dollars in thousands)
Fixed maturities:
 
 
 
 
 
 
 
 
 
Corporate (2)
$
3,142,476

 
$
229,151

 
$
(64,848
)
 
$
3,306,779

 
$
329

Residential mortgage-backed
492,990

 
35,676

 
(7,938
)
 
520,728

 
(4,155
)
Commercial mortgage-backed
391,845

 
20,014

 
(7,192
)
 
404,667

 

Other asset-backed
444,047

 
19,169

 
(6,673
)
 
456,543

 
1,725

United States Government and agencies
39,261

 
4,218

 
(198
)
 
43,281

 

State, municipal and other governments
1,317,920

 
60,869

 
(29,034
)
 
1,349,755

 

Total fixed maturities
$
5,828,539

 
$
369,097

 
$
(115,883
)
 
$
6,081,753

 
$
(2,101
)
 
 
 
 
 
 
 
 
 
 
Equity securities:
 
 
 
 
 
 
 
 
 
Non-redeemable preferred stocks
$
65,692

 
$
3,141

 
$
(2,383
)
 
$
66,450

 
$

Common stocks
24,379

 
726

 

 
25,105

 

Total equity securities
$
90,071

 
$
3,867

 
$
(2,383
)
 
$
91,555

 
$


(1)
Non-credit losses, subsequent to the initial impairment measurement date, on other-than-temporary impairment (OTTI) losses are included in the gross unrealized gains and losses columns above. The non-credit loss component of OTTI losses for corporate and other asset-backed securities were in an unrealized gain position at June 30, 2014 and December 31, 2013 due to increases in estimated fair value subsequent to initial recognition of non-credit losses on such securities.
(2)
Corporate securities include hybrid preferred securities with a carrying value of $82.8 million at June 30, 2014 and $76.3 million at December 31, 2013. Corporate securities also include redeemable preferred stock with a carrying value of $19.7 million at June 30, 2014 and $17.1 million at December 31, 2013.


9



Short-term investments have been excluded from the above schedules as amortized cost approximates fair value for these securities.

Available-For-Sale Fixed Maturities by Maturity Date
 
 
 
 
 
 
 
 
June 30, 2014
 
Amortized
Cost
 
Estimated
Fair Value
 
(Dollars in thousands)
Due in one year or less
$
96,164

 
$
98,443

Due after one year through five years
772,820

 
875,150

Due after five years through ten years
910,895

 
996,046

Due after ten years
2,817,157

 
3,077,702

 
4,597,036

 
5,047,341

Mortgage-backed and other asset-backed
1,432,015

 
1,512,397

Total fixed maturities
$
6,029,051

 
$
6,559,738


Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Fixed maturities not due at a single maturity date have been included in the above table in the year of final contractual maturity.

Net Unrealized Gains (Losses) on Investments in Accumulated Other Comprehensive Income
 
 
 
 
 
June 30,
2014
 
December 31,
2013
 
(Dollars in thousands)
Net unrealized appreciation on:
 
 
 
Fixed maturities - available for sale
$
530,687

 
$
253,214

Equity securities - available for sale
6,034

 
1,484

 
536,721

 
254,698

Adjustments for assumed changes in amortization pattern of:
 
 
 
Deferred acquisition costs
(141,844
)
 
(55,550
)
Value of insurance in force acquired
(12,812
)
 
(6,356
)
Unearned revenue reserve
8,722

 
2,790

Adjustments for assumed changes in policyholder liabilities
(9,067
)
 
(2,957
)
Provision for deferred income taxes
(133,587
)
 
(67,404
)
Net unrealized investment gains
$
248,133

 
$
125,221


Net unrealized investment gains and losses are recorded net of deferred income taxes and other adjustments for assumed changes in deferred acquisition costs, value of insurance in force acquired, unearned revenue reserve and policyholder liabilities. Subsequent changes in fair value of securities for which a previous non-credit OTTI loss was recognized in accumulated other comprehensive income, are reported along with changes in fair value for which no OTTI losses were previously recognized.



10


Fixed Maturity and Equity Securities with Unrealized Losses by Length of Time
 
 
 
 
 
 
 
 
 
June 30, 2014
 
 
Less than one year
 
One year or more
 
Total
 
 
Description of Securities
 
Estimated
Fair Value
 
Unrealized Losses
 
Estimated
Fair Value
 
Unrealized Losses
 
Estimated Fair Value
 
Unrealized Losses
 
Percent of Total
 
 
(Dollars in thousands)
 
 
Fixed maturities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate
 
$
69,193

 
$
(1,091
)
 
$
299,090

 
$
(10,819
)
 
$
368,283

 
$
(11,910
)
 
41.2
%
Residential mortgage-backed
 
53,495

 
(697
)
 
29,675

 
(4,272
)
 
83,170

 
(4,969
)
 
17.2

Commercial mortgage-backed
 

 

 
36,494

 
(2,557
)
 
36,494

 
(2,557
)
 
8.9

Other asset-backed
 
80,114

 
(1,535
)
 
36,237

 
(4,546
)
 
116,351

 
(6,081
)
 
21.0

United States Government and agencies
 
3,556

 
(24
)
 
470

 
(5
)
 
4,026

 
(29
)
 
0.1

State, municipal and other governments
 
19,752

 
(202
)
 
90,207

 
(3,153
)
 
109,959

 
(3,355
)
 
11.6

Total fixed maturities
 
$
226,110

 
$
(3,549
)
 
$
492,173

 
$
(25,352
)
 
$
718,283

 
$
(28,901
)
 
100.0
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Equity securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-redeemable preferred stocks
 
$
7,826

 
$
(68
)
 
$
4,600

 
$
(400
)
 
$
12,426

 
$
(468
)
 
 
Total equity securities
 
$
7,826

 
$
(68
)
 
$
4,600

 
$
(400
)
 
$
12,426

 
$
(468
)
 
 

 
 
December 31, 2013
 
 
Less than one year
 
One year or more
 
Total
 
 
Description of Securities
 
Estimated
Fair Value
 
Unrealized Losses
 
Estimated
Fair Value
 
Unrealized Losses
 
Estimated Fair Value
 
Unrealized Losses
 
Percent of Total
 
 
(Dollars in thousands)
 
 
Fixed maturities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate
 
$
802,161

 
$
(60,138
)
 
$
43,500

 
$
(4,710
)
 
$
845,661

 
$
(64,848
)
 
56.0
%
Residential mortgage-backed
 
92,020

 
(3,548
)
 
20,948

 
(4,390
)
 
112,968

 
(7,938
)
 
6.8

Commercial mortgage-backed
 
53,647

 
(4,454
)
 
28,054

 
(2,738
)
 
81,701

 
(7,192
)
 
6.2

Other asset-backed
 
101,961

 
(1,109
)
 
33,170

 
(5,564
)
 
135,131

 
(6,673
)
 
5.8

United States Government and agencies
 
4,407

 
(198
)
 

 

 
4,407

 
(198
)
 
0.2

State, municipal and other governments
 
353,120

 
(25,700
)
 
19,165

 
(3,334
)
 
372,285

 
(29,034
)
 
25.0

Total fixed maturities
 
$
1,407,316

 
$
(95,147
)
 
$
144,837

 
$
(20,736
)
 
$
1,552,153

 
$
(115,883
)
 
100.0
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Equity securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-redeemable preferred stocks
 
$
31,639

 
$
(1,756
)
 
$
4,373

 
$
(627
)
 
$
36,012

 
$
(2,383
)
 
 
Total equity securities
 
$
31,639

 
$
(1,756
)
 
$
4,373

 
$
(627
)
 
$
36,012

 
$
(2,383
)
 
 

Fixed maturities in the above tables include 206 securities from 178 issuers at June 30, 2014 and 440 securities from 366 issuers at December 31, 2013. The unrealized losses in fixed maturities were generally due to an increase in risk free rates relative to the risk free rates when the securities were purchased. We do not intend to sell or believe we will be required to sell any of our impaired fixed maturities before recovery of their amortized cost basis. The following summarizes the more significant unrealized losses of fixed maturities and equity securities by investment category as of June 30, 2014.

Corporate securities: The largest unrealized losses were in the consumer noncyclical sector ($102.5 million carrying value and $3.4 million unrealized loss). The largest unrealized losses in the consumer noncyclical sector were in the food processing ($28.4 million carrying value and $1.3 million unrealized loss) and the beverage ($11.4 million carrying value and $0.7 million unrealized loss) sub-sectors. The majority of losses in the sector were primarily attributable to general changes in market interest rates for corporate securities.

Residential mortgage-backed securities: The unrealized losses on residential mortgage-backed securities were primarily due to continued uncertainty regarding mortgage defaults on Alt-A loans. We purchased most of these investments at a discount to


11


their face amount and the contractual cash flows of these investments are based on mortgages and other assets backing the securities.

Commercial mortgage-backed securities: The unrealized losses on commercial mortgage-backed securities were primarily due to spread widening and concerns regarding the potential for future defaults. The contractual cash flows of these investments are based on mortgages backing the securities. Unrealized losses on military housing bonds were mainly attributable to spread widening relative to spreads at which we acquired the bonds. Insured military housing bonds have also been impacted by the removal of their ratings following downgrades of the insurance providers.

Other asset-backed securities: The unrealized losses on other asset-backed securities were primarily due to market concerns regarding defaults on subprime mortgages and home equity loans. We purchased most of these investments at a discount to their face amount and the contractual cash flows of these investments are based on mortgages and other assets backing the securities.

State, municipal and other governments: The unrealized losses on state, municipal and other governments were primarily due to general spread widening relative to spreads at which we acquired the bonds.

Equity securities: Our gross unrealized losses were on investment grade non-redeemable perpetual preferred securities within the finance sector. These securities provide periodic cash flows, contain call features and are similarly rated and priced like other long-term callable bonds and are evaluated for OTTIs similar to fixed maturities. The decline in fair value is primarily due to market concerns regarding the sector. We have evaluated the near-term prospects of our equity securities in relation to the severity and duration of their impairment as well as our intent and ability to hold these investments until recovery of fair value, and have concluded they are not other than temporarily impaired.

Excluding mortgage and asset-backed securities, no securities from the same issuer had an aggregate unrealized loss in excess of $0.8 million at June 30, 2014, with the largest unrealized loss from an oil and gas company. With respect to mortgage and asset-backed securities not backed by the United States Government, no securities from the same issuer had an aggregate unrealized loss in excess of $3.5 million at June 30, 2014, which consists of two different securities from the same issuer that are backed by different pools of Alt-A residential mortgage loans. Both securities are rated non-investment grade and the largest unrealized loss totaled $1.8 million.

The carrying values of all our investments are reviewed on an ongoing basis for credit deterioration. When our review indicates a decline in fair value for a fixed maturity security is an OTTI and we do not intend to sell or believe we will be required to sell the security before recovery of our amortized cost, a specific write down is charged to earnings for the credit loss and a specific charge is recognized in accumulated other comprehensive income for the non-credit loss component. If we intend to sell or believe we will be required to sell a fixed maturity security before its recovery, the full amount of the impairment write down to fair value is charged to earnings. For all equity securities, the full amount of an OTTI write down is recognized as a realized loss on investments in the consolidated statements of operations and the new cost basis for the security is equal to its fair value.

We monitor the financial condition and operations of the issuers of fixed maturities and equity securities that could potentially have a credit impairment that is an OTTI. In determining whether or not an unrealized loss is an OTTI, we review factors such as:

historical operating trends;
business prospects;
status of the industry in which the company operates;
analyst ratings on the issuer and sector;
quality of management;
size of unrealized loss;
level of current market interest rates compared to market interest rates when the security was purchased; and
length of time the security has been in an unrealized loss position.

In order to determine the credit and non-credit impairment loss for fixed maturities, every quarter we estimate the future cash flows we expect to receive over the remaining life of the instrument as well as review our plans to hold or sell the instrument. Significant assumptions regarding the present value of expected cash flows for each security are used when an OTTI occurs and there is a non-credit portion of the unrealized loss that won't be recognized in earnings. Our assumptions for residential mortgage-backed securities, commercial mortgage-backed securities and other asset-backed securities include collateral pledged, guarantees, vintage, anticipated principal and interest payments, prepayments, default levels, severity assumptions, delinquency rates and the level of nonperforming assets for the remainder of the investments' expected term. We use a single


12


best estimate of cash flows approach and use the effective yield prior to the date of impairment to calculate the present value of cash flows. Our assumptions for corporate and other fixed maturities include anticipated principal and interest payments and an estimated recovery value, generally based on a percentage return of the current fair value.

After an OTTI write down of all equity securities and any fixed maturities with a credit-only impairment, the cost basis is not adjusted for subsequent recoveries in fair value. For fixed maturities for which we can reasonably estimate future cash flows after a write down, the discount or reduced premium recorded, based on the new cost basis, is amortized over the remaining life of the security. Amortization in this instance is computed using the prospective method and the current estimate of the amount and timing of future cash flows.

Credit Loss Component of Other-Than-Temporary Impairments on Fixed Maturities
 
 
 
 
 
Six months ended June 30,
 
2014

2013
 
(Dollars in thousands)
Balance at beginning of period
$
(21,592
)
 
$
(27,712
)
Reductions due to investments sold
4,362

 
5,729

Balance at end of period
$
(17,230
)
 
$
(21,983
)

The table above sets forth the amount of credit loss impairments on fixed maturities held by the Company as of the dates indicated for which a portion of the OTTI was recognized in other comprehensive income (loss) and corresponding changes in such amounts.

Realized Gains (Losses) - Recorded in Income 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three months ended June 30,
 
Six months ended June 30,
 
2014
 
2013
 
2014
 
2013
 
(Dollars in thousands)
Realized gains (losses) on sales of investments
 
 
 
 
 
 
 
Fixed maturities:
 
 
 
 
 
 
 
Gross gains
$
2,811

 
$
8,086

 
$
2,908

 
$
13,726

Gross losses
(5
)
 
(657
)
 
(642
)
 
(2,365
)
Real estate

 
12

 

 
12

Other

 
(6
)
 

 
(6
)
 
2,806

 
7,435

 
2,266

 
11,367

Impairment losses recognized in earnings:
 
 
 
 
 
 
 
Other credit-related (1)

 
(199
)
 

 
(845
)
Net realized gains on investments recorded in income
$
2,806

 
$
7,236

 
$
2,266

 
$
10,522


(1)
Amount represents credit-related losses for mortgage loans, real estate and fixed maturities written down to fair value through income.

Proceeds from sales of fixed maturities totaled $30.9 million during the six months ended June 30, 2014 and $79.3 million during the six months ended June 30, 2013.

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

Mortgage Loans

Our mortgage loan portfolio consists principally of commercial mortgage loans that we have originated. Our lending policies require that the loans be collateralized by the value of the related property, establish limits on the amount that can be loaned to one borrower and require diversification by geographic location and collateral type. We originate loans with an initial loan-to-value ratio that provides sufficient excess collateral to absorb losses should we be required to foreclose and take possession of the collateral. In order to identify impairment losses timely, management maintains and reviews a watch list of mortgage loans


13


that have heightened risk. These loans may include those with borrowers delinquent on contractual payments, borrowers experiencing financial difficulty, increases in rental real estate vacancies and significant declines in collateral value. We evaluate each of our mortgage loans individually and establish an estimated loss, if any, for each impaired loan identified. An estimated loss is needed for loans in which we do not believe we will collect all amounts due according to the contractual terms of the respective loan agreements.

Any loan delinquent on contractual payments is considered non-performing. At June 30, 2014, and December 31, 2013, there were no non-performing loans over 90 days past due on contractual payments. Interest income is accrued on impaired loans to the extent it is deemed collectible (delinquent less than 90 days) and the loan continues to perform under its original or restructured contractual terms. Interest income on non-performing loans is generally recognized on a cash basis. Once mortgage loans are classified as nonaccrual loans, the resumption of the interest accrual would commence only after all past due interest has been collected or the mortgage loan has been restructured to where the collection of interest is considered likely.

Mortgage Loans by Collateral Type
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
June 30, 2014
 
December 31, 2013
Collateral Type
 
Carrying Value
 
Percent of Total
 
Carrying Value
 
Percent of Total
 
 
(Dollars in thousands)
Office
 
$
253,433

 
42.5
%
 
$
241,951

 
42.0
%
Retail
 
198,508

 
33.2

 
194,053

 
33.7

Industrial
 
127,345

 
21.3

 
126,151

 
21.9

Other
 
18,130

 
3.0

 
13,706

 
2.4

Total
 
$
597,416

 
100.0
%
 
$
575,861

 
100.0
%

Mortgage Loans by Geographic Location within the United States
 
 
 
 
 
 
 
 
 
 
 
 
 
June 30, 2014
 
December 31, 2013
Region of the United States
 
Carrying Value
 
Percent of Total
 
Carrying Value
 
Percent of Total
 
 
(Dollars in thousands)
South Atlantic
 
$
169,700

 
28.4
%
 
$
170,529

 
29.6
%
Pacific
 
97,696

 
16.4

 
92,538

 
16.1

West North Central
 
87,506

 
14.6

 
85,629

 
14.9

East North Central
 
85,749

 
14.3

 
79,128

 
13.7

Mountain
 
51,872

 
8.7

 
53,460

 
9.3

West South Central
 
39,859

 
6.7

 
39,780

 
6.9

Other
 
65,034

 
10.9

 
54,797

 
9.5

Total
 
$
597,416

 
100.0
%
 
$
575,861

 
100.0
%

Mortgage Loans by Loan-to-Value Ratio
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
June 30, 2014
 
December 31, 2013
 

Carrying Value
 
Percent of Total
 
Carrying Value
 
Percent of Total
 
(Dollars in thousands)
0% - 50%
$
166,893

 
27.9
%
 
$
149,719

 
26.0
%
51% - 60%
216,280

 
36.2

 
202,025

 
35.1

61% - 70%
179,986

 
30.2

 
204,460

 
35.5

71% - 80%
34,257

 
5.7

 
15,559

 
2.7

81% - 90%

 

 
4,098

 
0.7

Total
$
597,416

 
100.0
%
 
$
575,861

 
100.0
%

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


14



Mortgage Loans by Year of Origination
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
June 30, 2014
 
December 31, 2013
 
Carrying Value
 
Percent of Total
 
Carrying Value
 
Percent of Total
 
(Dollars in thousands)
2014
$
33,429

 
5.6
%
 
$

 
%
2013
83,192

 
13.9

 
84,478

 
14.7

2012
71,547

 
12.0

 
72,792

 
12.6

2011
47,511

 
7.9

 
48,190

 
8.4

2010
25,494

 
4.3

 
26,173

 
4.5

2009 and prior
336,243

 
56.3

 
344,228

 
59.8

Total
$
597,416

 
100.0
%
 
$
575,861

 
100.0
%

 Impaired Mortgage Loans
 
 
 
June 30, 2014
 
December 31, 2013
 
(Dollars in thousands)
Unpaid principal balance
$
22,255

 
$
22,100

Less:
 
 
 
Related allowance
871

 
888

Discount
351

 
429

Carrying value of impaired mortgage loans
$
21,033

 
$
20,783

 Allowance on Mortgage Loans
 
Six months ended June 30,
 
2014
 
2013
 
(Dollars in thousands)
Balance at beginning of period
$
888

 
$
1,694

Allowances established

 
475

Charge offs

 
(1,610
)
Recoveries of amounts previously charged off
(17
)
 

Balance at end of period
$
871

 
$
559


Mortgage Loan Modifications

Our commercial mortgage loan portfolio includes loans that have been modified. We assess loan modifications on a loan-by-loan basis to evaluate whether a troubled debt restructuring (TDR) has occurred. Generally, the types of concessions include: reduction of the contractual interest rate to a below market rate, extension of the maturity date, and/or a reduction of accrued interest. The amount, timing and extent of the concession granted is considered in determining if an impairment loss is needed for the restructuring.

There were no loan modifications during the first two quarters of 2014. During the first quarter of 2013 we modified one commercial mortgage loan that met the criteria of a TDR with a carrying value after the restructuring of $14.4 million and recognized an impairment loss of $0.5 million.



15


Variable Interest Entities

We evaluate our variable interest entity (VIE) investees to determine whether the level of our direct ownership interest, our rights to manage operations or our obligation to provide ongoing financial support are such that we are the primary beneficiary of the entity, and are then required to consolidate it for financial reporting purposes. None of our VIE investees were required to be consolidated for any reporting periods presented in this Form 10-Q. Our VIE investments are as follows:

 
June 30, 2014
 
December 31, 2013
 
Carrying Value
 
Maximum Exposure to Loss
 
Carrying Value
 
Maximum Exposure to Loss
 
(Dollars in thousands)
Real estate limited partnerships
$
17,359

 
$
17,359

 
$
17,646

 
$
17,646


We make commitments to fund partnership investments in the normal course of business. We did not have any other commitments to investees designated as VIEs as of June 30, 2014 or December 31, 2013.

Other

At June 30, 2014, we had committed to provide $29.3 million of additional funds for our limited partnerships and our limited liability companies.

Derivative Instruments

We are not significantly involved in hedging activities and have limited exposure to derivatives. We do not apply hedge accounting to any of our derivative positions. Derivative assets, which are primarily reported in reinsurance recoverable and other investments, totaled $6.0 million at June 30, 2014 and $3.7 million at December 31, 2013. Our derivative assets consist of derivatives embedded within our modified coinsurance agreements and call options which provide an economic hedge for a small block of index annuity contracts. Derivative liabilities totaled $0.4 million at June 30, 2014 and $0.3 million at December 31, 2013 and include derivatives embedded within our index annuity contracts and derivatives embedded within our modified coinsurance agreements. The net gain (loss) recognized on these derivatives is included in net investment income and interest sensitive benefits and, for the three-month period ended June 30, totaled $1.3 million for 2014 and ($0.6) million for 2013.

3. Fair Values

The carrying and estimated fair values of our financial instruments are as follows:

Fair Values and Carrying Values
 
 
 
 
 
 
 
 
 
June 30, 2014
 
December 31, 2013
 
Carrying Value
 
Fair Value
 
Carrying Value
 
Fair Value
 
(Dollars in thousands)
Assets
 
 
 
 
 
 
 
Fixed maturities - available for sale
$
6,559,738

 
$
6,559,738

 
$
6,081,753

 
$
6,081,753

Equity securities - available for sale
111,402

 
111,402

 
91,555

 
91,555

Mortgage loans
597,416

 
627,053

 
575,861

 
594,451

Policy loans
181,048

 
221,381

 
176,993

 
210,401

Other investments
2,358

 
2,358

 
993

 
993

Cash, cash equivalents and short-term investments
80,659

 
80,659

 
115,047

 
115,047

Reinsurance recoverable
3,671

 
3,671

 
2,678

 
2,678

Assets held in separate accounts
712,533

 
712,533

 
693,955

 
693,955

 


16


Fair Values and Carrying Values (continued)
 
 
 
 
 
 
 
 
 
June 30, 2014
 
December 31, 2013
 
Carrying Value
 
Fair Value
 
Carrying Value
 
Fair Value
 
(Dollars in thousands)
Liabilities
 
 
 
 
 
 
 
Future policy benefits
$
3,460,941

 
$
3,587,849

 
$
3,360,519

 
$
3,371,706

Supplemental contracts without life contingencies
344,310

 
317,835

 
349,761

 
320,195

Advance premiums and other deposits
242,707

 
242,707

 
230,819

 
230,819

Long-term debt
97,000

 
70,597

 
97,000

 
63,343

Other liabilities
142

 
142

 

 

Liabilities related to separate accounts
712,533

 
705,751

 
693,955

 
686,387


Fair value is based on an exit price, which is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. As not all financial instruments are actively traded, various valuation methods may be used to estimate fair value. These methods rely on observable market data and where observable market data is not available, the best information available. Significant judgment may be required to interpret the data and select the assumptions used in the valuation estimates, particularly when observable market data is not available.

In the discussion that follows, we have ranked our financial instruments by the level of judgment used in the determination of the fair values presented above. The levels are defined as follows:

Level 1 - Fair values are based on unadjusted quoted prices in active markets for identical assets or liabilities.

Level 2 - Fair values are based on inputs, other than quoted prices from active markets, that are observable for the asset or liability, either directly or indirectly.

Level 3 - Fair values are based on significant unobservable inputs for the asset or liability.

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, a financial instrument's level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the financial instrument. From time to time there may be movements between levels as inputs become more or less observable, which may depend on several factors including the activity of the market for the specific security, the activity of the market for similar securities, the level of risk spreads and the source of the information from which we obtain the information. Transfers in or out of any level are measured as of the beginning of the period.

The following methods and assumptions were used in estimating the fair value of our financial instruments:

Fixed maturities:

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

Level 2 fixed maturities consist of corporate, mortgage and other asset-backed, United States Government agencies and private placement securities with observable market data, and in some circumstances recent trade activity. When quoted prices of identical assets in active markets are not available, our first priority is to obtain prices from third party pricing vendors. We have regular interaction with these vendors to ensure we understand their pricing methodologies and to confirm they are utilizing observable market information. Their methodologies vary by asset class and include inputs such as estimated cash flows, benchmark yields, reported trades, credit quality, industry events and economic events. Fixed maturities with validated prices from pricing services, which includes the majority of our public fixed maturities in all asset classes, are generally reflected in Level 2.

Also included in Level 2 are corporate bonds where quoted market prices are not available, for which an internal model using substantially all observable inputs or a matrix pricing valuation approach is used. In the matrix approach, securities


17


are grouped into pricing categories that vary by sector, rating and average life. Each pricing category is assigned a risk spread based on studies of observable public market data. The expected cash flows of the security are then discounted back at the current Treasury curve plus the appropriate risk spread.

Level 3 fixed maturities include private placements as well as corporate, mortgage and other asset-backed and state and municipal securities for which there is little or no current market data available. We use external pricing sources, or if prices are not available we will estimate fair value internally. Fair values of private investments in Level 3 are determined by reference to public market, private transactions or valuations for comparable companies or assets in the relevant asset class when such amounts are available. For other securities where an exit price based on relevant observable inputs is not obtained, the fair value is determined using a matrix calculation. Fair values estimated through use of matrix pricing methods rely on an estimate of credit spreads to a risk free U.S. Treasury yield. Selecting the credit spread requires judgment based on an understanding of the security and may include a market liquidity premium. Our selection of comparable companies as well as the level of spread requires significant judgment. Increases in spreads used in our matrix models, or those used to value comparable companies, will result in a decrease in discounted cash flows used, and accordingly in the estimated fair value of the security.

We obtain fixed maturity fair values from a variety of external independent pricing services, including brokers, with access to observable data including recent trade information, if available. In certain circumstances in which an external price is not available for a Level 3 security, we will internally estimate its fair value. Our process for evaluation and selection of the fair values includes:

We follow a “pricing waterfall” policy, which establishes the pricing source preference for a particular security or security type. The order of preference is based on our evaluation of the valuation methods used, the source's knowledge of the instrument and the reliability of the prices we have received from the source in the past. Our valuation policy dictates that fair values are initially sought from third party pricing services. If our review of the prices received from our preferred source indicates an inaccurate price, we will use an alternative source within the waterfall and document the decision. In the event that fair values are not available from one of our external pricing services or upon review of the fair values provided it is determined that they may not be reflective of market conditions, those securities are submitted to brokers familiar with the security to obtain non-binding price quotes. Broker quotes tend to be used in limited circumstances such as for newly issued, private placement and other instruments that are not widely traded. For those securities for which an externally provided fair value is not available, we use cash flow modeling techniques to estimate fair value.

We evaluate third party pricing source estimation methodologies to assess whether they will provide a fair value which approximates a market exit price.

We perform an overall analysis of portfolio fair value movement against general movements in interest rates and spreads.

We compare month-to-month price trends to detect unexpected price fluctuation based on our knowledge of the market and the particular instrument. As fluctuations are noted, we will perform further research which may include discussions with the original pricing source or other external sources to ensure we are in agreement with the valuation.

We compare prices between different pricing sources for unusual disparity.

We meet at least quarterly with our Investment Committee, the group that oversees our valuation process, to discuss valuation practices and observations during the pricing process.

Equity securities:

Level 1 equity securities consist of listed common stocks and mutual funds that are actively traded, allowing us to use current market prices as an estimate of their fair value.

Level 2 equity securities consist of common stock issued by the Federal Home Loan Bank (FHLB), with estimated fair value based on the current redemption value of the shares and non-redeemable preferred stock with estimated fair value obtained from external pricing sources using a matrix pricing approach.


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Level 3 equity securities consist of a non-redeemable preferred stock for which no active market exists, and fair value estimates for these securities is based on the values of comparable securities which are actively traded. Increases in spreads used in our matrix models, or those used to value comparable companies, will result in a decrease in discounted cash flows used, and accordingly in the estimated fair value of the security.

In the case where external pricing services are used for certain Level 1 and Level 2 equity securities, our review process is consistent with the process used to determine the fair value of fixed maturities discussed above.

Mortgage loans:

Mortgage loans are not measured at fair value on a recurring basis. Mortgage loans are a Level 3 measurement as there is no current market for the loans. The fair value of our mortgage loans is estimated internally using a matrix pricing approach. Along with specific loan terms, two key management assumptions are required including the risk rating of the loan (our current rating system is A-highest quality, B-moderate quality, C-low quality, W-watch or F-foreclosure) and estimated spreads for new loans over the U.S. Treasury yield curve. Spreads are updated quarterly and loans are reviewed and rated annually with quarterly adjustments should significant changes occur. Our determination of each loan's risk rating as well as selection of the credit spread requires significant judgment. A higher risk rating, as well as an increase in spreads, would result in a decrease in discounted cash flows used, and accordingly the fair value of the loan.

Policy loans:

Policy loans are not measured at fair value on a recurring basis. Policy loans are a Level 3 measurement as there is no current market since they are specifically tied to the underlying insurance policy. The loans are relatively risk free as they cannot exceed the cash surrender value of the insurance policy. Fair values are estimated by discounting expected cash flows using a risk-free interest rate based on the U.S. Treasury curve. An increase in the risk-free interest rate would result in a decrease in discounted cash flows used, and accordingly the fair value of the loan.

Other investments:

Level 2 other investments include call options with fair values based on counterparty market prices adjusted for a credit component of the counterparty.

Cash, cash equivalents and short-term investments:

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

Reinsurance recoverable:

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

Assets held in separate accounts:

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

Future policy benefits, supplemental contracts without life contingencies and advance premiums and other deposits:

Level 3 policy-related financial instruments of investment-type contracts are those not involving significant mortality or morbidity risks. No active market exists for these contracts and they are not measured at fair value on a recurring basis. Fair values for our insurance contracts, other than investment-type contracts, are not required to be disclosed. Fair values for our investment-type contracts with expected maturities, including deferred annuities, funding agreements and supplementary contracts, are determined using discounted cash flow valuation techniques based on current interest rates adjusted to reflect our credit risk and an additional provision for adverse deviation. For certain deposit liabilities with no


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defined maturities and no surrender charges, including pension-related deposit administration funds, advance premiums and other deposits, fair value is the account value or amount payable on demand. Significant judgment is required in selecting the assumptions used to estimate the fair values of these financial instruments. For contracts with known maturities, increases in current rates will result in a decrease in discounted cash flows and a decrease in the estimated fair value of the policy obligation.

Certain annuity contracts include embedded derivatives and are measured at fair value on a recurring basis. These embedded derivatives are a Level 3 measurement. The fair value of the embedded derivatives is based on the discounted excess of projected account values (including a risk margin) over projected guaranteed account values. The key unobservable inputs required in the projection of future values which require management judgment include the risk margin as well as the credit risk of our company. Should the risk margin increase or the credit risk decrease, the discounted cash flows and the estimated fair value of the obligation will increase.