Separate Accounts, Death Benefits and Other Insurance Benefit Features and Embedded Product Derivatives

Separate accounts

Separate account products are those for which a separate investment and liability account is maintained on behalf of the policyholder. Investment objectives for these separate accounts vary by fund account type, as outlined in the applicable fund prospectus or separate account plan of operations. We have variable annuity and variable life insurance contracts that are classified as separate account products. The assets supporting these contracts are carried at fair value and are reported as separate account assets with an equivalent amount reported as separate account liabilities. Amounts assessed against the policyholder for mortality, administration and other services are included within revenue in fee income. For the three and nine months ended September 30, 2014 and 2013, there were no gains or losses on transfers of assets from the general account to a separate account.

Assets with fair value and carrying value of $2.4 billion and $2.0 billion at September 30, 2014 and December 31, 2013, respectively, supporting fixed indexed annuities are maintained in accounts that are legally segregated from the other assets of the Company, but policyholders do not direct the investment of those assets and the investment performance does not pass through to the policyholders. These assets supporting fixed indexed annuity contracts are reported within the respective investment line items on the balance sheets.



Separate Account Investments of Account Balances of Variable Annuity Contracts with Insurance Guarantees:	September 30,		December 31,
($ in millions)	2014		2013

Debt securities	$	296.0	$	322.1
Equity funds	1,339.1		1,538.7
Other	38.9		47.4
Total	$	1,674.0	$	1,908.2

Death benefits and other insurance benefit features

Variable annuity guaranteed benefits

We establish policy benefit liabilities for minimum death and income benefit guarantees relating to certain annuity policies as follows:

•

Liabilities associated with the guaranteed minimum death benefit (“GMDB”) are determined by estimating the expected value of death benefits in excess of the projected account balance and recognizing the excess ratably over the expected life of the contract based on total expected assessments. The assumptions used for calculating the liabilities are generally consistent with those used for amortizing DAC.

•

Liabilities associated with the guaranteed minimum income benefit (“GMIB”) are determined by estimating the expected value of the income benefits in excess of the projected account balance at the date of annuitization and recognizing the excess ratably over the accumulation period based on total expected assessments. The assumptions used for calculating such guaranteed income benefit liabilities are generally consistent with those used for amortizing DAC.

For variable annuities with GMDB and GMIB, reserves for these guarantees are calculated and recorded in policy liabilities and accruals on our balance sheets. Changes in the liability are recorded in policy benefits on our statements of income and comprehensive income. We regularly evaluate estimates used and adjust the additional liability balances, with a related charge or credit to benefit expense if actual experience or other evidence suggests that earlier assumptions should be revised.



Changes in Variable Annuity Guaranteed Insurance Benefit Liability Balances:	Three Months Ended September 30, 2014					Nine Months Ended September 30, 2014
($ in millions)	Annuity GMDB			Annuity GMIB		Annuity GMDB			Annuity GMIB

Balance, beginning of period	$	14.4		$	5.5	$	17.0		$	9.5
Incurred	1.5			0.5		(0.1		)	(3.4		)
Paid	(1.6		)	—		(2.6		)	—
Change due to net unrealized gains or losses included in AOCI	—			—		—			(0.1		)
Assumption unlocking	—			—		—			—
Balance, end of period	$	14.3		$	6.0	$	14.3		$	6.0



Changes in Variable Annuity Guaranteed Insurance Benefit Liability Balances:	Three Months Ended September 30, 2013						Nine Months Ended September 30, 2013
($ in millions)	Annuity GMDB			Annuity GMIB			Annuity GMDB			Annuity GMIB

Balance, beginning of period	$	10.4		$	20.8		$	10.8		$	20.9
Incurred	0.6			(2.2		)	1.8			(2.2		)
Paid	(0.8		)	—			(2.4		)	—
Change due to net unrealized gains or losses included in AOCI	—			—			—			(0.1		)
Assumption unlocking	—			—			—			—
Balance, end of period	$	10.2		$	18.6		$	10.2		$	18.6

For those guarantees of benefits that are payable in the event of death, the net amount at risk (“NAR”) is generally defined as the benefit payable in excess of the current account balance at our balance sheet date. We have entered into reinsurance agreements to reduce the net amount of risk on certain death benefits. Following are the major types of death benefits currently in force as defined in Note 7 to our financial statements in the 2013 Form 10-K:



GMDB and GMIB Benefits by Type:	September 30, 2014
($ in millions)	Account Value		NAR before Reinsurance		NAR after Reinsurance		Average Attained Age of Annuitant

GMDB return of premium	$	646.8	$	1.5	$	1.5	63
GMDB step up	1,241.7		70.1		12.8		64
GMDB earnings enhancement benefit (“EEB”)	30.9		—		—		64
GMDB greater of annual step up and roll up	24.8		5.0		5.0		68
Total GMDB at September 30, 2014	1,944.2		$	76.6	$	19.3
Less: General account value with GMDB	276.4
Subtotal separate account liabilities with GMDB	1,667.8
Separate account liabilities without GMDB	148.5
Total separate account liabilities	$	1,816.3
GMIB [1] at September 30, 2014	$	324.3					65

GMDB and GMIB Benefits by Type:	December 31, 2013
($ in millions)	Account Value		NAR before Reinsurance		NAR after Reinsurance		Average Attained Age of Annuitant

GMDB return of premium	$	728.8	$	1.8	$	1.8	63
GMDB step up	1,401.0		66.7		7.0		63
GMDB earnings enhancement benefit (“EEB”)	35.9		0.1		0.1		64
GMDB greater of annual step up and roll up	26.7		4.8		4.8		68
Total GMDB at December 31, 2013	2,192.4		$	73.4	$	13.7
Less: General account value with GMDB	294.7
Subtotal separate account liabilities with GMDB	1,897.7
Separate account liabilities without GMDB	155.0
Total separate account liabilities	$	2,052.7
GMIB [1] at December 31, 2013	$	385.7					64

———————


[1]	Policies with a GMIB also have a GMDB, however these benefits are not additive. When a policy terminates due to death, any NAR related to GMIB is released. Similarly, when a policy goes into benefit status on a GMIB, its GMDB NAR is released.

Fixed indexed annuity guaranteed benefits

Many of our fixed indexed annuities contain guaranteed benefits. We establish policy benefit liabilities for minimum death and minimum withdrawal benefit guarantees relating to these policies as follows:

•

Liabilities associated with the guaranteed minimum withdrawal benefit (“GMWB”) and Chronic Care guarantees are determined by estimating the value of the withdrawal benefits expected to be paid after the projected account value depletes and recognizing the value ratably over the accumulation period based on total expected assessments. Liabilities associated with the GMWB for the fixed indexed annuities differ from those contained on variable annuities in that the GMWB feature and the underlying contract, exclusive of the equity index crediting option, are fixed income instruments.


•	Liabilities associated with the GMDB are determined by estimating the expected value of death benefits in excess of the projected account balance and recognizing the excess ratably over the expected life of the contract based on total expected assessments.

The assumptions used for calculating GMWB, GMDB and Chronic Care guarantees are generally consistent with those used for amortizing DAC. We regularly evaluate estimates used and adjust the additional liability balances, with a related charge or credit to benefit expense if actual experience or other evidence suggests that earlier assumptions should be revised. The GMWB, GMDB and Chronic Care guarantees on fixed indexed annuities are recorded in policy liabilities and accruals on our balance sheets.



Changes in Fixed Indexed Annuity Guaranteed Liability Balances:	Fixed Indexed Annuity
($ in millions)	GMWB & GMDB
	Three Months Ended September 30,						Nine Months Ended September 30,
	2014			2013			2014			2013

Balance, beginning of period	$	141.2		$	89.4		$	90.0		$	103.6
Incurred	10.5			12.1			26.8			44.9
Paid	(0.1		)	—			(0.3		)	(0.2		)
Change due to net unrealized gains or losses included in AOCI	(6.1		)	(0.9		)	29.0			(47.7		)
Assumption unlocking	—			—			—			—
Balance, end of period	$	145.5		$	100.6		$	145.5		$	100.6

Universal life

Liabilities for universal life contracts in excess of the account balance, some of which contain secondary guarantees, are generally determined by estimating the expected value of benefits and expenses when claims are triggered and recognizing those benefits and expenses over the accumulation period based on total expected assessments. The assumptions used in estimating these liabilities are generally consistent with those used for amortizing DAC.



Changes in Universal Life Guaranteed Liability Balances:	Universal Life
($ in millions)	Secondary Guarantees
	Three Months Ended September 30,						Nine Months Ended September 30,
	2014			2013			2014			2013

Balance, beginning of period	$	164.1		$	131.6		$	153.2		$	115.8
Incurred	8.1			9.1			20.7			31.9
Paid	(2.1		)	(6.5		)	(5.3		)	(11.8		)
Change due to net unrealized gains or losses included in AOCI	(0.2		)	(0.1		)	1.3			(1.8		)
Assumption unlocking	—			—			—			—
Balance, end of period	$	169.9		$	134.1		$	169.9		$	134.1

In addition, the universal life block of business has experience which produces profits in earlier periods followed by losses in later periods for which additional reserves are required to be held above the account value liability. These reserves are accrued ratably over historical and anticipated positive income to offset the future anticipated losses. The assumptions used in estimating these liabilities are generally consistent with those used for amortizing DAC.



Changes in Universal Life Additional Liability Balances:	Universal Life
($ in millions)	Profits Followed by Losses
	Three Months Ended September 30,						Nine Months Ended September 30,
	2014			2013			2014		2013

Balance, beginning of period	$	318.2		$	326.0		$	273.4	$	300.4
Expenses	16.6			13.3			54.6		45.3
Change due to net unrealized gains or losses included in AOCI	(4.0		)	(10.6		)	2.8		(17.0		)
Assumption unlocking	—			—			—		—
Balance, end of period	$	330.8		$	328.7		$	330.8	$	328.7

Embedded derivatives

Variable annuity embedded derivatives

Certain separate account variable products may contain a GMWB, guaranteed minimum accumulation benefit (“GMAB”) and/or combination (“COMBO”) rider as defined in Note 7 to our financial statements in the 2013 Form 10-K. These features are accounted for as embedded derivatives as described below.



Variable Annuity Embedded Derivatives Non-Insurance Guaranteed Product Features:	September 30, 2014
($ in millions)	Account Value		Average Attained Age of Annuitant

GMWB	$	491.3	64
GMAB	318.2		59
COMBO	6.9		64
Balance, end of period	$	816.4

Variable Annuity Embedded Derivatives Non-Insurance Guaranteed Product Features:	December 31, 2013
($ in millions)	Account Value		Average Attained Age of Annuitant

GMWB	$	551.1	64
GMAB	370.9		59
COMBO	7.0		63
Balance, end of period	$	929.0

The GMWB, GMAB and COMBO features represent embedded derivative liabilities in the variable annuity contracts that are required to be reported separately from the host variable annuity contract. These liabilities are recorded at fair value within policyholder deposit funds on the balance sheets with changes in fair value recorded in realized investment gains on the statements of income and comprehensive income. The fair value of the GMWB, GMAB and COMBO obligation is calculated based on actuarial and capital market assumptions related to the projected cash flows, including benefits and related contract charges, over the lives of the contracts, incorporating expectations concerning policyholder behavior. As markets change, contracts mature and actual policyholder behavior emerges, these assumptions are continually evaluated and may from time to time be adjusted. Embedded derivative liabilities for GMWB, GMAB and COMBO are shown in the table below.



Variable Annuity Embedded Derivative Liabilities:	September 30,			December 31,
($ in millions)	2014			2013

GMWB	$	1.2		$	(5.1	)
GMAB	0.5			1.4
COMBO	(0.3		)	(0.4		)
Total variable annuity embedded derivative liabilities	$	1.4		$	(4.1	)

There were no benefit payments made for the GMWB and GMAB in the nine months ended September 30, 2014 and 2013. We have established a risk management strategy under which we hedge our GMAB, GMWB and COMBO exposure using equity index options, equity index futures, equity index variance swaps, interest rate swaps and swaptions.

Fixed indexed annuity embedded derivatives

Fixed indexed annuities may also contain a variety of index-crediting options: policy credits that are calculated based on the performance of an outside equity market or other index over a specified term. These index options are embedded derivative liabilities that are required to be reported separately from the host contract. These index options are accounted for at fair value and recorded in policyholder deposits within the balance sheets with changes in fair value recorded in realized investment gains, in the statements of income and comprehensive income. The fair value of these index options is calculated using the budget method. See Note 9 to these interim financial statements for additional information. Several additional inputs reflect our internally developed assumptions related to lapse rates and other policyholder behavior. The fair value of these embedded derivatives was $115.0 million and $78.9 million as of September 30, 2014 and December 31, 2013, respectively. In order to manage the risk associated with these equity indexed-crediting features, we hedge using equity index options. See Note 8 to these interim unaudited financial statements for additional information.

Embedded derivatives realized gains and losses

Changes in the fair value of embedded derivatives associated with variable annuity and fixed indexed annuity contracts are recorded as realized investment gains and losses within the statements of income and comprehensive income. Embedded derivatives gains and (losses) recognized in earnings for the three and nine months ended September 30, 2014 are $(5.6) million and $(17.7) million, respectively. Embedded derivatives gains and (losses) recognized in earnings for the three and nine months ended September 30, 2013 are $8.4 million and $13.7 million, respectively.