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Investing Activities
9 Months Ended
Sep. 30, 2011
Notes to Financial Statements 
Investing Activities

 

Debt securities

 

We invest in a variety of debt securities for the general account portfolio. We classify these investments into various sectors using industry conventions; however, our classifications may differ from similarly titled classifications of other companies. We classify debt securities into investment grade and below-investment-grade securities based on ratings prescribed by the National Association of Insurance Commissioners (“NAIC”). In a majority of cases, these classifications will coincide with ratings assigned by one or more Nationally Recognized Standard Ratings Organizations (“NRSROs”); however, for certain structured securities, the NAIC designations may differ from NRSRO designations based on the amortized cost or the securities in our portfolio.

 

Fair Value and Cost of General Account Securities: September  30, 2011   December  31, 2010
($ in thousands) Fair Value   Cost   Fair Value   Cost
                       
U.S. government and agency $ 220,795     $ 208,402     $ 98,283     $ 96,137  
State and political subdivision   38,850       35,152       32,509       33,092  
Foreign government   28,021       26,864       16,086       14,683  
Corporate   1,002,620       974,063       693,777       692,780  
CMBS   271,689       269,065       173,955       172,850  
RMBS   502,550       510,234       333,605       350,729  
CDO/CLO   55,350       66,035       63,184       72,603  
Other asset-backed   138,644       136,768       108,999       108,632  
Available-for-sale debt securities $ 2,258,519     $ 2,226,583     $ 1,520,398     $ 1,541,506  

 

Gross Unrealized Gains (Losses) from September  30, 2011   December  31, 2010
General Account Securities: Gains   Losses   Gains   Losses
($ in thousands)                      
U.S. government and agency $ 12,796     $ (403)   $ 2,483     $ (337)
State and political subdivision   4,067       (369)     216       (799)
Foreign government   1,422       (265)     1,463       (60)
Corporate   70,785       (42,228)     39,804       (38,807)
CMBS   8,005       (5,381)     5,673       (4,568)
RMBS   14,702       (22,386)     4,429       (21,553)
CDO/CLO   681       (11,366)     1,940       (11,359)
Other asset-backed   2,657       (781)     1,320       (953)
Debt securities unrealized gains (losses) $ 115,115     $ (83,179)   $ 57,328     $ (78,436)
Debt securities net unrealized gains (losses) $ 31,936                 $ (21,108)

 

Net unrealized investment gains and losses on securities classified as available-for-sale and certain other assets are included in the balance sheet as a component of AOCI. The table below presents the special category of AOCI for debt securities that are other-than-temporarily impaired when the impairment loss has been split between the credit loss component (in earnings) and the non-credit component (separate category of AOCI).

 

Fixed Maturity Non-Credit OTTI Losses in AOCI, by Security Type: Sept  30,   Dec  31,
($ in thousands) 2011(1)   2010(1)
           
U.S. government and agency $ --     $ --  
State and political subdivision   --       --  
Foreign government   --       --  
Corporate   (1,505)     (1,512)
CMBS   (4,519)     (4,519)
RMBS   (19,873)     (15,263)
CDO/CLO   (5,432)     (6,279)
Other asset-backed   --       --  
Total fixed maturity non-credit OTTI losses in AOCI $ (31,329)   $ (27,573)

———————

(1) Represents the amount of non-credit OTTI losses recognized in AOCI excluding net unrealized gains or losses subsequent to the date of impairment.

 

Aging of Temporarily Impaired As of September 30, 2011
General Account Debt Securities: Less than 12 months   Greater than 12 months   Total
($ in thousands) Fair   Unrealized   Fair   Unrealized   Fair   Unrealized
  Value   Losses   Value   Losses   Value   Losses
Debt securities                                  
   U.S. government and agency $ --     $ --     $ 3,539     $ (403)   $ 3,539     $ (403)
   State and political subdivision   --       --       960       (369)     960       (369)
   Foreign government   7,389       (265)     --       --       7,389       (265)
   Corporate   102,816       (4,550)     79,352       (37,678)     182,168       (42,228)
   CMBS   62,604       (2,550)     7,962       (2,831)     70,566       (5,381)
   RMBS   112,007       (4,184)     75,033       (18,202)     187,040       (22,386)
   CDO/CLO   5,639       (150)     40,417       (11,216)     46,056       (11,366)
   Other asset-backed   33,346       (608)     7,135       (173)     40,481       (781)
Total temporarily impaired securities $ 323,801     $ (12,307)   $ 214,398     $ (70,872)   $ 538,199     $ (83,179)
                                   
Below investment grade $ 24,087     $ (1,101)   $ 71,353     $ (45,106)   $ 95,440     $ (46,207)
Below investment grade after offsets
  for deferred policy acquisition cost
  adjustment and taxes
      $ (467)         $ (4,073)         $ (4,540)
                                   
Number of securities         212             150             362  

 

Unrealized losses on below-investment-grade debt securities with a fair value of less than 80% of amortized cost totaled $40,566 thousand at September 30, 2011, of which $36,475 thousand was below 80% of amortized cost for more than 12 months.

 

These securities were considered to be temporarily impaired at September 30, 2011 because each of these securities had performed, and was expected to perform, in accordance with its original contractual terms. In addition, management does not have the intention to sell nor does it expect to be required to sell these securities prior to their recovery.

 

Aging of Temporarily Impaired As of December 31, 2010
General Account Debt Securities: Less than 12 months   Greater than 12 months   Total
($ in thousands) Fair   Unrealized   Fair   Unrealized   Fair   Unrealized
  Value   Losses   Value   Losses   Value   Losses
Debt securities                                  
   U.S. government and agency $ 592     $ (8)   $ 3,613     $ (329)   $ 4,205     $ (337)
   State and political subdivision   20,184       (381)     910       (418)     21,094       (799)
   Foreign government   968       (60)     --       --       968       (60)
   Corporate   38,680       (1,833)     89,756       (36,974)     128,436       (38,807)
   CMBS   22,577       (401)     12,851       (4,167)     35,428       (4,568)
   RMBS   61,907       (2,296)     96,254       (19,257)     158,161       (21,553)
   CDO/CLO   88       --       43,920       (11,359)     44,008       (11,359)
   Other asset-backed   35,346       (355)     7,456       (598)     42,802       (953)
Total temporarily impaired securities $ 180,342     $ (5,334)   $ 254,760     $ (73,102)   $ 435,102     $ (78,436)
                                   
Below investment grade $ 3,946     $ (276)   $ 88,564     $ (43,094)   $ 92,510     $ (43,370)
Below investment grade after offsets
  for deferred policy acquisition cost
  adjustment and taxes
      $ (35)         $ (3,310)         $ (3,345)
                                   
Number of securities         142             174             316  

 

Unrealized losses on below-investment-grade debt securities with a fair value of less than 80% of amortized cost totaled $37,304 thousand at December 31, 2010, of which $36,499 thousand was below 80% of amortized cost for more than 12 months.

 

These securities were considered to be temporarily impaired at December 31, 2010 because each of these securities had performed, and was expected to perform, in accordance with its original contractual terms. In addition, management does not have the intention to sell nor does it expect to be required to sell these securities prior to their recovery.

 

Maturities of General Account Debt Securities: As of September 30, 2011
($ in thousands) Fair   Amortized
  Value   Cost
           
Due in one year or less $ 161,484     $ 161,232  
Due after one year through five years   246,905       233,740  
Due after five years through ten years   446,477       420,200  
Due after ten years   435,420       429,309  
CMBS/RMBS/ABS/CDO/CLO   968,233       982,102  
Total $ 2,258,519     $ 2,226,583  

 

The maturities of general account debt securities, as of September 30, 2011, are summarized in the table above by contractual maturity. Actual maturities will differ from contractual maturities as certain borrowers have the right to call or prepay obligations with or without call or prepayment penalties, and we have the right to put or sell certain obligations back to the issuers.

 

Other-than-temporary impairments

 

A portion of certain other-than-temporary impairment (“OTTI”) losses on fixed maturity securities are recognized in OCI. For these securities the net amount recognized in earnings represents the difference between the amortized cost of the security and the net present value of its projected future cash flows discounted at the effective interest rate implicit in the debt security prior to impairment. Any remaining difference between the fair value and amortized cost is recognized in OCI. The following table sets forth the amount of pre-tax credit loss impairments on fixed maturity securities held by the Company as of the dates indicated, for which a portion of the OTTI loss was recognized in OCI, and the corresponding changes in such amounts.

 

Management exercised significant judgment with respect to certain securities in determining whether impairments are temporary or other than temporary. At September 30, 2011, this included debt securities with $27,383 thousand of gross unrealized losses of 50% or more for which no OTTI was ultimately indicated. In reaching its conclusions, management used a number of issuer-specific quantitative indicators and qualitative judgments to assess the probability of receiving a given security’s contractual cash flows. This included the issue’s implied yield to maturity, cumulative default rate based on rating, comparisons of issue-specific spreads to industry or sector spreads, specific trading activity in the issue, and other market data such as recent debt tenders and upcoming refinancing requirements. Management also reviewed fundamentals such as issuer credit and liquidity metrics, business outlook and industry conditions. Management does not have the intention to sell nor does it expect to be required to sell these securities prior to their recovery. Management maintains a watch list of securities that is reviewed for impairments. Each security on the watch list was evaluated, analyzed and discussed, with the positive and negative factors weighed in the ultimate determination of whether or not the security was other-than-temporarily impaired.

 

In periods subsequent to the recognition of an OTTI, the impaired security is accounted for as if it had been purchased on the measurement date of impairment at an amortized cost basis equal to the previous amortized cost basis less the OTTI recognized in earnings. We will continue to estimate the present value of future expected cash flows and if significantly greater than the new cost basis, we will accrete the difference as investment income on a prospective basis.

 

Fixed income OTTIs recorded in the first nine months of 2011 were primarily concentrated in structured securities and corporate bonds. These impairments were driven primarily by increased collateral default rates and rating downgrades. In our judgment, these credit events or other adverse conditions of the issuers have caused, or will most likely lead to, a deficiency in the contractual cash flows related to the investment. Therefore, based upon these credit events, we have determined that OTTIs exist. Total debt impairments recognized through earnings related to such credit-related circumstances were $682 thousand in the third quarter of 2011 and $1,973 thousand in the third quarter of 2010 and $1,612 thousand in the first nine months of 2011 and $8,514 thousand in the first nine months of 2010.

 

In addition to these credit-related impairments recognized through earnings, we impaired securities to fair value through other comprehensive loss for any impairments related to non-credit related factors. These types of impairments were driven primarily by market or sector credit spread widening or by a lack of liquidity in the securities. The amount of impairments recognized as an adjustment to other comprehensive loss due to these factors was $3,853 thousand in the third quarter of 2011 and $3,230 thousand in the third quarter of 2010 and $4,585 thousand in the first nine months of 2011 and $6,429 thousand in the first nine months of 2010.

 

The following table rolls forward the amount of credit losses recognized in earnings on debt securities held at the beginning of the period, for which a portion of the OTTI was recognized in OCI.

 

Credit Losses Recognized in Earnings on Debt Securities for Three Months Ended   Nine Months Ended
which a Portion of the OTTI Loss was Recognized in OCI: September  30,   September  30,
($ in thousands) 2011   2010   2011   2010
                       
Balance, beginning of period $ (17,248)   $ (18,983)   $ (17,335)   $ (12,442)
  Add: Credit losses on securities not previously impaired(1)   --       (546)     (527)     (2,193)
  Add: Credit losses on securities previously impaired(1)   (681)     (1,305)     (1,025)     (6,199)
   Less: Credit losses on securities impaired due to intent to sell   --       --       --       --  
   Less: Credit losses on securities sold   250       --       1,208       --  
   Less: Increases in cash flows expected on
    previously impaired securities
  --       --       --       --  
Balance, end of period $ (17,679)   $ (20,834)   $ (17,679)   $ (20,834)

———————

(1) Additional credit losses on securities for which a portion of the OTTI loss was recognized in AOCI are included within net OTTI losses recognized in earnings on the statements of income and comprehensive income.

 

Venture capital partnerships

 

The following table presents investments in limited partnerships interests. We make contributions to partnerships under existing or new funding commitments.

 

Investment Activity in Venture Capital Partnerships: Three Months Ended   Nine Months Ended
($ in thousands) September  30,   September  30,
  2011   2010   2011   2010
                       
Contributions $ 314     $ 726     $ 852     $ 1,282  
Equity in earnings (loss) of partnerships   298       (125)     352       41  
Distributions   (51)     --       (54)     (91)
Change in venture capital partnerships   561       601       1,150       1,232  
Venture capital partnership investments, beginning of period   3,815       2,068       3,226       1,437  
Venture capital partnership investments, end of period $ 4,376     $ 2,669     $ 4,376     $ 2,669  

 

Net investment income

 

Sources of Net Investment Income: Three Months Ended   Nine Months Ended
($ in thousands) September  30,   September  30,
  2011   2010   2011   2010
                       
Debt securities $ 25,309     $ 17,380     $ 69,141     $ 51,364  
Policy loans   786       783       2,279       2,287  
Venture capital   298       (125)     352       41  
Other investments   44       123       578       1,198  
Fair value option investments   (201)     (381)     219       (277)
Cash and cash equivalents   --       7       5       20  
Total investment income   26,236       17,787       72,574       54,633  
Less: Investment expenses   504       334       1,213       1,016  
Net investment income $ 25,732     $ 17,453     $ 71,361     $ 53,617  

 

Net realized investment gains (losses)

 

Sources and Types of Three Months Ended   Nine Months Ended
Net Realized Investment Gains (Losses): September  30,   September  30,
($ in thousands) 2011   2010   2011   2010
                       
Total other-than temporary debt impairment losses $ (4,535)   $ (5,203)   $ (6,197)   $ (14,943)
Portion of loss recognized in OCI   3,853       3,230       4,585       6,429  
Net debt impairment losses recognized in earnings $ (682)   $ (1,973)   $ (1,612)   $ (8,514)
                       
Debt security impairments:                      
   U.S. government and agency $ --     $ --     $ --     $ --  
   State and political subdivision   --       --       --       --  
   Foreign government   --       --       --       --  
   Corporate   (163)     (546)     (413)     (756)
   CMBS   --       (390)           (1,260)
   RMBS   (519)     (267)     (1,140)     (3,680)
   CDO/CLO   --       (648)     --       (2,696)
   Other asset-backed   --       (122)     (59)     (122)
Net debt security impairments   (682)     (1,973)     (1,612)     (8,514)
Other investments impairments   --       --       --       --  
Impairment losses   (682)     (1,973)     (1,612)     (8,514)
Debt security transaction gains   149       1,910       2,376       3,064  
Debt security transaction losses   (8)     (75)     (593)     (1,807)
Other investments transaction gains (losses)   --       104       --       265  
Net transaction gains   141       1,939       1,783       1,522  
Realized gains (losses) on derivative assets and liabilities   (5,536)     (7,373)     (12,899)     1,279  
Net realized investment gains (losses),
  excluding impairment losses
  (5,395)     (5,434)     (11,116)     2,801  
Net realized investment (losses),
  including impairment losses
$ (6,077)   $ (7,407)   $ (12,728)   $ (5,713)

 

Unrealized investment gains (losses)

 

Sources of Changes in Three Months Ended   Nine Months Ended
Net Unrealized Investment Gains (Losses): September  30,   September  30,
($ in thousands) 2011   2010   2011   2010
                       
Debt securities $ 22,628     $ 36,535     $ 53,044     $ 98,348  
Other investments   (192)     53       78       146  
Net unrealized investment gains $ 22,436     $ 36,588     $ 53,122     $ 98,494  
                       
Net unrealized investment gains $ 22,436     $ 36,588     $ 53,122     $ 98,494  
Applicable deferred policy acquisition cost   12,883       26,822       31,543       100,605  
Applicable deferred income tax expense (benefit)   8,994       4,019       7,553       (10,738)
Offsets to net unrealized investment losses   21,877       30,841       39,096       89,867  
Net unrealized investment gains included in OCI $ 559     $ 5,747     $ 14,026     $ 8,627  

 

Non-consolidated variable interest entities

 

Entities which do not have sufficient equity at risk to allow the entity to finance its activities without additional financial support or in which the equity investors, as a group, do not have the characteristic of a controlling financial interest are referred to as VIEs. We perform ongoing assessments of our investments in VIEs to determine whether we have a controlling financial interest in the VIE and therefore would be considered to be the primary beneficiary. An entity would be considered a primary beneficiary and be required to consolidate a VIE when the entity has both the power to direct the activities of a VIE that most significantly impact the entity’s economic performance and the obligation to absorb losses, or right to receive benefits, that could potentially be significant to the VIE. We reassess our VIE determination with respect to an entity on an ongoing basis.

 

We are involved with various entities that are deemed to be VIEs primarily as a passive investor in private equity limited partnerships and through direct investments, in which we are not related to the general partner. These investments are accounted for under the equity method of accounting and are included in venture capital partnerships on the balance sheet. The carrying value of assets and liabilities, as well as the maximum exposure to loss, relating to significant VIEs for which we are not the primary beneficiary was $4,376 thousand and $3,226 thousand as of September 30, 2011 and December 31, 2010, respectively. The asset value of our investments in VIEs for which we are not the primary beneficiary is based upon sponsor values and financial statements of the individual entities. Our maximum exposure to loss related to these non-consolidated VIEs is limited to the amount of our investment.

 

Issuer and counterparty credit exposure

 

Credit exposure related to issuers and derivatives counterparties is inherent in investments and derivative contracts with positive fair value or asset balances. We manage credit risk through the analysis of the underlying obligors, issuers and transaction structures. We review our debt security portfolio regularly to monitor the performance of obligors and assess the stability of their credit ratings. We also manage credit risk through industry and issuer diversification and asset allocation. Maximum exposure to an issuer or derivative counterparty is defined by quality ratings, with higher quality issuers having larger exposure limits. As of September 30, 2011, we were not exposed to any credit concentration risk of a single issuer greater than 10% of stockholder’s equity other than U.S. government and government agencies backed by the faith and credit of the U.S. government. We have an overall limit on below-investment-grade-rated issuer exposure. To further mitigate the risk of loss on derivatives, we only enter into contracts in which the counterparty is a financial institution with a rating of A or higher.

 

As of September 30, 2011, we held derivative assets, net of liabilities, with a fair value of $97,259 thousand. Derivative credit exposure was diversified with eight different counterparties. We also had debt securities of these issuers with a carrying value of $13,771 thousand. Our maximum amount of loss due to credit risk with these issuers was $111,030 thousand. See Note 6 to these financial statements for more information regarding derivatives.