4. Investing Activities

6 Months Ended

Jun. 30, 2012

Notes to Financial Statements

Investing Activities

4. Investing Activities

Debt securities

We invest in a variety of debt securities. We classify these investments into various sectors using industry conventions; however, our classifications may differ from similarly titled classifications of other companies.

Net unrealized investment gains and losses on securities classified as available-for-sale and certain other assets are included in our balance sheet as a component of AOCI.

Fair Value and Cost of Securities:	June 30, 2012
($ in thousands)			Gross		Gross				OTTI
	Amortized		Unrealized		Unrealized		Fair		Recognized
	Cost		Gains		Losses		Value		in AOCI(1)
U.S. government and agency	$	203,205	$	13,686	$	(373)	$	216,518	$	--
State and political subdivision		99,773		11,351		(487)		110,637		--
Foreign government		44,423		4,255		(62)		48,616		--
Corporate		1,462,223		114,901		(39,180)		1,537,944		(1,505)
Commercial mortgage-backed (“CMBS”)		261,834		18,862		(2,556)		278,140		(650)
Residential mortgage-backed (“RMBS”)		525,183		18,718		(18,013)		525,888		(21,660)
CDO/CLO		71,211		1,398		(10,088)		62,521		(6,132)
Other asset-backed		129,549		3,959		(570)		132,938		--
Available-for-sale debt securities	$	2,797,401	$	187,130	$	(71,329)	$	2,913,202	$	(29,947)

———————

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

Fair Value and Cost of Securities:	December 31, 2011
($ in thousands)			Gross		Gross				OTTI
	Amortized		Unrealized		Unrealized		Fair		Recognized
	Cost		Gains		Losses		Value		in AOCI(1)
U.S. government and agency	$	163,132	$	12,653	$	(457)	$	175,328	$	--
State and political subdivision		77,323		5,518		(444)		82,397		--
Foreign government		30,473		1,825		(421)		31,877		--
Corporate		1,169,209		83,310		(44,142)		1,208,377		(1,505)
CMBS		281,616		12,283		(3,944)		289,955		(5,131)
RMBS		562,186		14,106		(22,773)		553,519		(20,396)
CDO/CLO		77,456		1,240		(10,680)		68,016		(6,220)
Other asset-backed		135,435		2,333		(845)		136,923		--
Available-for-sale debt securities	$	2,496,830	$	133,268	$	(83,706)	$	2,546,392	$	(33,252)

———————

⁽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 June 30, 2012
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	$	--	$	--	$	3,569	$	(373)	$	3,569	$	(373)
State and political subdivision		6,691		(88)		930		(399)		7,621		(487)
Foreign government		1,647		(62)		--		--		1,647		(62)
Corporate		83,037		(3,276)		70,481		(35,904)		153,518		(39,180)
CMBS		5,927		(79)		18,061		(2,477)		23,988		(2,556)
RMBS		20,125		(1,467)		111,135		(16,546)		131,260		(18,013)
CDO/CLO		6,475		(185)		35,962		(9,903)		42,437		(10,088)
Other asset-backed		8,714		(123)		6,469		(447)		15,183		(570)
Total temporarily impaired securities	$	132,616	$	(5,280)	$	246,607	$	(66,049)	$	379,223	$	(71,329)
Below investment grade	$	32,903	$	(1,993)	$	64,113	$	(44,034)	$	97.016	$	(46,027)
Number of securities				81				168				249

Unrealized losses on below-investment-grade debt securities with a fair value of less than 80% of amortized cost totaled $41,177 thousand at June 30, 2012, of which $39,010 thousand was below 80% of amortized cost for more than 12 months.

These securities were considered to be temporarily impaired at June 30, 2012 because each of these securities had performed, and is expected to perform, in accordance with 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, 2011
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	$	--	$	--	$	3,485	$	(457)	$	3,485	$	(457)
State and political subdivision		15,419		(28)		913		(416)		16,332		(444)
Foreign government		7,231		(421)		--		--		7,231		(421)
Corporate		113,623		(3,707)		74,192		(40,435)		187,815		(44,142)
CMBS		59,478		(1,240)		6,924		(2,704)		66,402		(3,944)
RMBS		74,575		(2,809)		106,890		(19,964)		181,465		(22,773)
CDO/CLO		3,735		(110)		40,638		(10,570)		44,373		(10,680)
Other asset-backed		22,944		(190)		15,194		(655)		38,138		(845)
Total temporarily impaired securities	$	297,005	$	(8,505)	$	248,236	$	(75,201)	$	545,241	$	(83,706)
Below investment grade	$	26,187	$	(1,515)	$	76,237	$	(49,711)	$	102,424	$	(51,226)
Number of securities				193				180				373

Unrealized losses on below-investment-grade debt securities with a fair value of less than 80% of amortized cost totaled $44,536 thousand at December 31, 2011, of which $40,125 thousand was below 80% of amortized cost for more than 12 months.

These securities were considered to be temporarily impaired at December 31, 2011 because each of these securities had performed, and is expected to perform, in accordance with 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 Debt Securities:	June 30, 2012				December 31, 2011
($ in thousands)	Amortized		Fair		Amortized		Fair
	Cost		Value		Cost		Value
Due in one year or less	$	173,875	$	174,512	$	111,027	$	111,279
Due after one year through five years		304,940		323,357		268,596		284,081
Due after five years through ten years		761,612		814,554		572,731		604,800
Due after ten years		569,197		601,292		487,783		497,819
CMBS/RMBS/ABS/CDO/CLO		987,777		999,487		1,056,693		1,048,413
Total	$	2,797,401	$	2,913,202	$	2,496,830	$	2,546,392

The maturities of debt securities, as of June 30, 2012, are summarized in the table above by contractual maturity. Actual maturities may 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

Management assessed all securities in an unrealized loss position in determining whether impairments were temporary or other than temporary. In reaching its conclusions, management exercised significant judgment and 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 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. For securities for which no OTTI was ultimately indicated at June 30, 2012, management does not have the intention to sell, nor does it expect to be required to sell, these securities prior to their recovery.

Fixed income OTTIs recorded in the first half of 2012 were primarily concentrated in structured securities. These impairments were driven primarily by increased collateral default rates. 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 $613 thousand for the second quarter of 2012 and $436 thousand for the second quarter of 2011 and $1,272 thousand for the first half of 2012 and $930 thousand for the first half of 2011. There were no limited partnership and other investment OTTIs for the three and six months ended June 30, 2012 and 2011.

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 $2,390 thousand for the first quarter of 2012 and $346 thousand for the first quarter of 2011 and $2,817 thousand for the first half of 2012 and $732 thousand for the first half of 2011.

The following table presents a roll-forward of pre-tax credit losses recognized in earnings related to debt securities for which a portion of the OTTI was recognized in OCI.

Credit Losses Recognized in Earnings on Debt Securities for	Three Months Ended				Six Months Ended
which a Portion of the OTTI Loss was Recognized in OCI:	June 30,				June 30,
($ in thousands)	2012		2011		2012		2011
Balance, beginning of period	$	(19,223)	$	(16,871)	$	(18,614)	$	(17,335)
Add: Credit losses on securities not previously impaired(1)		--		(277)		(374)		(527)
Add: Credit losses on securities previously impaired(1)		(549)		(100)		(784)		(344)
Less: Credit losses on securities impaired due to intent to sell		--		--		--		--
Less: Credit losses on securities sold		88		--		88		958
Less: Increases in cash flows expected on previously     impaired securities		--		--		--		--
Balance, end of period	$	(19,684)	$	(17,248)	$	(19,684)	$	(17,248)

———————

⁽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 comprehensive income.

Limited partnerships and other investments

Limited partnerships and other investments consist of private equity investments of $5,404 thousand and $4,620 thousand as of June 30, 2012 and December 31, 2011, respectively, and common stock of $350 thousand and $345 thousand as of June 30, 2012 and December 31, 2011, respectively.

Net investment income

Sources of Net Investment Income:	Three Months Ended				Six Months Ended
($ in thousands)	June 30,				June 30,
	2012		2011		2012		2011
Debt securities	$	31,471	$	23,390	$	61,066	$	43,832
Policy loans		805		773		1,587		1,493
Limited partnerships and other investments		759		388		923		588
Fair value option investments		(48)		146		48		420
Cash and cash equivalents		--		1		--		5
Total investment income		32,987		24,698		63,624		46,338
Less: Investment expenses		189		467		564		709
Net investment income	$	32,798	$	24,231	$	63,060	$	45,629

Net realized investment gains (losses)

Sources and Types of	Three Months Ended				Six Months Ended
Net Realized Investment Gains (Losses):	June 30,				June 30,
($ in thousands)	2012		2011		2012		2011
Total other-than temporary debt impairment losses	$	(3,003)	$	(782)	$	(4,089)	$	(1,662)
Portion of loss recognized in OCI		2,390		346		2,817		732
Net debt impairment losses recognized in earnings	$	(613)	$	(436)	$	(1,272)	$	(930)
Debt security impairments:
U.S. government and agency	$	--	$	--	$	--	$	--
State and political subdivision		--		--		--		--
Foreign government		--		--		--		--
Corporate		--		--		--		(250)
CMBS		--		--		(88)		--
RMBS		(549)		(377)		(1,070)		(621)
CDO/CLO		(26)		--		(26)		--
Other asset-backed		(38)		(59)		(88)		(59)
Net debt security impairments		(613)		(436)		(1,272)		(930)
Limited partnerships and other investment impairments		--		--		--		--
Impairment losses		(613)		(436)		(1,272)		(930)
Debt security transaction gains(1)		151		1,596		258		2,227
Debt security transaction losses(1)		(36)		(260)		(84)		(585)
Limited partnerships and other investment transaction gains		--		--		--		--
Limited partnerships and other investment transaction losses		--		--		--		--
Net transaction gains		115		1,336		174		1,642
Derivative instruments		5,848		1,470		(17,680)		(11,871)
Embedded derivatives(2)		(12,394)		(4,559)		3,962		4,508
Net realized investment losses, excluding impairment losses		(6,431)		(1,753)		(13,544)		(5,721)
Net realized investment losses, including impairment losses	$	(7,044)	$	(2,189)	$	(14,816)	$	(6,651)

———————

⁽¹⁾ Proceeds from the sale of available-for-sale debt securities were $79,105 thousand and $104,410 thousand for the three months ended June 30, 2012 and 2011, respectively. Proceeds from the sale of available-for-sale debt securities were $80,796 thousand and $202,691 thousand for the six months ended June 30, 2012 and 2011, respectively.

⁽²⁾ Includes the change in fair value of embedded derivatives associated with variable annuity GMWB, GMAB, GPAF and COMBO riders. See Note 5 to these financial statements for additional disclosures.

Unrealized investment gains (losses)

Sources of Changes in	Three Months Ended				Six Months Ended
Net Unrealized Investment Gains (Losses):	June 30,				June 30,
($ in thousands)	2012		2011		2012		2011
Debt securities	$	45,860	$	16,845	$	66,239	$	30,416
Other investments		(48)		163		(8)		270
Net unrealized investment gains	$	45,812	$	17,008	$	66,231	$	30,686
Net unrealized investment gains	$	45,812	$	17,008	$	66,231	$	30,686
Applicable deferred policy acquisition cost		18,445		11,436		27,183		16,113
Applicable deferred income tax expense (benefit)		9,578		(6,299)		13,666		(549)
Offsets to net unrealized investment gains		28,023		5,137		40,849		15,564
Net unrealized investment gains included in OCI	$	17,789	$	11,871	$	25,382	$	15,122

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 affect 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 limited partnerships and other investments on our 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 $5,404 thousand and $4,620 thousand as of June 30, 2012 and December 31, 2011, 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 June 30, 2012, 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 enter into contracts in which the counterparty is a financial institution with a rating of A or higher from at least one rating agency.

As of June 30, 2012, we held derivative assets, net of liabilities, with a fair value of $90,169 thousand. Derivative credit exposure was diversified with nine different counterparties. We also had debt securities of these issuers with a fair value of $20,865 thousand as of June 30, 2012. Our maximum amount of loss due to credit risk with these issuers was $111,034 thousand as of June 30, 2012. See Note 6 to these financial statements for more information regarding derivatives.