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Fair Values of Financial Instruments

3 Months Ended

Mar. 31, 2022

The following sets forth a comparison of the carrying amounts and fair values of our financial instruments:


	March 31, 2022				December 31, 2021
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
	(Dollars in thousands)
Assets
Fixed maturity securities, available for sale	$	49,662,120	$	49,662,120	$	51,305,943	$	51,305,943
Mortgage loans on real estate	5,734,872		5,792,356		5,687,998		5,867,227
Real estate investments	510,188		510,188		337,939		337,939
Derivative instruments	642,413		642,413		1,277,480		1,277,480
Other investments	1,999,113		2,057,113		1,767,144		1,767,144
Cash and cash equivalents	1,933,899		1,933,899		4,508,982		4,508,982
Coinsurance deposits	8,713,069		8,002,548		8,850,608		7,938,292


Liabilities
Policy benefit reserves	63,342,037		56,478,030		65,076,041		56,375,076
Single premium immediate annuity (SPIA) benefit reserves	224,618		234,189		226,207		235,891
Other policy funds - FHLB	200,000		200,000		—		—
Notes payable	496,425		523,085		496,250		569,485
Subordinated debentures	78,502		80,126		78,421		93,721

Fair value is the price that would be received to sell an asset or paid to transfer a liability (exit price) in an orderly transaction between market participants at the measurement date. The objective of a fair value measurement is to determine that price for each financial instrument at each measurement date. We meet this objective using various methods of valuation that include market, income and cost approaches.

We categorize our financial instruments into three levels of fair value hierarchy based on the priority of inputs used in determining fair value. The hierarchy defines the highest priority inputs (Level 1) as quoted prices in active markets for identical assets or liabilities. The lowest priority inputs (Level 3) are our own assumptions about what a market participant would use in determining fair value such as estimated future cash flows. 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. We categorize financial assets and liabilities recorded at fair value in the consolidated balance sheets as follows:

Level 1 - Quoted prices are available in active markets for identical financial instruments as of the reporting date. We do not adjust the quoted price for these financial instruments, even in situations where we hold a large position and a sale could reasonably impact the quoted price.

Level 2 - Quoted prices in active markets for similar financial instruments, quoted prices for identical or similar financial instruments in markets that are not active; and models and other valuation methodologies using inputs other than quoted prices that are observable.

Level 3 - Models and other valuation methodologies using significant inputs that are unobservable for financial instruments and include situations where there is little, if any, market activity for the financial instrument. The inputs into the determination of fair value require significant management judgment or estimation. Financial instruments that are included in Level 3 are securities for which no market activity or data exists and for which we used discounted expected future cash flows with our own assumptions about what a market participant would use in determining fair value.

Transfers of securities among the levels occur at times and depend on the type of inputs used to determine fair value of each security.

Our assets and liabilities which are measured at fair value on a recurring basis as of March 31, 2022 and December 31, 2021 are presented below based on the fair value hierarchy levels:


	Total Fair Value		Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(Dollars in thousands)
March 31, 2022
Assets
Fixed maturity securities, available for sale:
United States Government full faith and credit	$	38,666	$	33,850	$	4,816	$	—
United States Government sponsored agencies	174,845		—		174,845		—
United States municipalities, states and territories	3,812,510		—		3,812,510		—
Foreign government obligations	405,166		—		405,166		—
Corporate securities	33,873,527		31,499		33,842,028		—
Residential mortgage backed securities	1,210,559		—		1,210,559		—
Commercial mortgage backed securities	4,769,867		—		4,769,867		—
Other asset backed securities	5,376,980		—		5,376,980		—
Other investments: equity securities	29,303		—		25,436		3,867
Real estate investments	510,188		—		—		510,188
Derivative instruments	642,413		—		642,413		—
Cash and cash equivalents	1,933,899		1,933,899		—		—

	$	52,777,923	$	1,999,248	$	50,264,620	$	514,055
Liabilities
Funds withheld liability - embedded derivative	$	(204,806)	$	—	$	(204,806)	$	—
Fixed index annuities - embedded derivatives	6,770,915		—		—		6,770,915
	$	6,566,109	$	—	$	(204,806)	$	6,770,915

December 31, 2021
Assets
Fixed maturity securities, available for sale:
United States Government full faith and credit	$	37,793	$	32,737	$	5,056	$	—
United States Government sponsored agencies	1,040,953		—		1,040,953		—
United States municipalities, states and territories	3,927,201		—		3,927,201		—
Foreign government obligations	402,545		—		402,545		—
Corporate securities	34,660,234		32,700		34,627,534		—
Residential mortgage backed securities	1,125,049		—		1,125,049		—
Commercial mortgage backed securities	4,840,311		—		4,840,311		—
Other asset backed securities	5,271,857		—		5,271,857		—
Other investments: equity securities	12,226		—		5,877		6,349
Real estate investments	337,939		—		—		337,939
Derivative instruments	1,277,480		—		1,277,480		—
Cash and cash equivalents	4,508,982		4,508,982		—		—

	$	57,442,570	$	4,574,419	$	52,523,863	$	344,288
Liabilities
Funds withheld liability - embedded derivative	$	(2,362)	$	—	$	(2,362)	$	—
Fixed index annuities - embedded derivatives	7,964,961		—		—		7,964,961
	$	7,962,599	$	—	$	(2,362)	$	7,964,961

The following methods and assumptions were used in estimating the fair values of financial instruments during the periods presented in these consolidated financial statements.

Fixed maturity securities

The fair values of fixed maturity securities in an active and orderly market are determined by utilizing independent pricing services. The independent pricing services incorporate a variety of observable market data in their valuation techniques, including:

•reported trading prices,

•benchmark yields,

•broker-dealer quotes,

•benchmark securities,

•bids and offers,

•credit ratings,

•relative credit information, and

•other reference data.

The independent pricing services also take into account perceived market movements and sector news, as well as a security's terms and conditions, including any features specific to that issue that may influence risk and marketability. Depending on the security, the priority of the use of observable market inputs may change as some observable market inputs may not be relevant or additional inputs may be necessary.

The independent pricing services provide quoted market prices when available. Quoted prices are not always available due to market inactivity. When quoted market prices are not available, the third parties use yield data and other factors relating to instruments or securities with similar characteristics to determine fair value for securities that are not actively traded. We generally obtain one value from our primary external pricing service. In situations where a price is not available from this service, we may obtain quotes or prices from additional parties as needed. Market indices of similar rated asset class spreads are considered for valuations and broker indications of similar securities are compared. Inputs used by the broker include market information, such as yield data and other factors relating to instruments or securities with similar characteristics. Valuations and quotes obtained from third party commercial pricing services are non-binding and do not represent quotes on which one may execute the disposition of the assets.

We validate external valuations at least quarterly through a combination of procedures that include the evaluation of methodologies used by the pricing services, comparison of the prices to a secondary pricing source, analytical reviews and performance analysis of the prices against trends, and maintenance of a securities watch list. Additionally, as needed we utilize discounted cash flow models or perform independent valuations on a case-by-case basis using inputs and assumptions similar to those used by the pricing services. Although we do identify differences from time to time as a result of these validation procedures, we did not make any significant adjustments as of March 31, 2022 and December 31, 2021.

Mortgage loans on real estate

Mortgage loans on real estate are not measured at fair value on a recurring basis. The fair values of mortgage loans on real estate are calculated using discounted expected cash flows using competitive market interest rates currently being offered for similar loans. The fair values of impaired mortgage loans on real estate that we have considered to be collateral dependent are based on the fair value of the real estate collateral (based on appraised values) less estimated costs to sell. The inputs utilized to determine fair value of all mortgage loans are unobservable market data (competitive market interest rates); therefore, fair value of mortgage loans falls into Level 3 in the fair value hierarchy.

Real estate investments

The fair values of residential real estate investments are initially calculated based on the cost to purchase the properties and subsequently calculated based on a discounted cash flow methodology. Under the discounted cash flow method, net operating income is forecasted assuming a 10-year hold period commencing as of the valuation date. An additional year is forecast in order to determine the residual sale price at the end of the hold period, using a residual (terminal) capitalization rate. The significant inputs into the fair value calculation under the discounted cash flow method include the residual capitalization rate and discount rate. These inputs are unobservable market data; therefore, fair value of residential real estate investments falls into Level 3 in the fair value hierarchy. At March 31, 2022, the residual capitalization rates used in the fair value calculations ranged from 4.75% to 6.50% with an average rate of 5.47%. At March 31, 2022, the discount rates used in the fair value calculations ranged from 6.00% to 7.75% with an average rate of 6.72%.

Derivative instruments

The fair values of derivative instruments, primarily call options, are based upon the amount of cash that we will receive to settle each derivative instrument on the reporting date. These amounts are determined by our investment team using industry accepted valuation models and are adjusted for the nonperformance risk of each counterparty net of any collateral held. Inputs include market volatility and risk free interest rates and are used in income valuation techniques in arriving at a fair value for each option contract. The nonperformance risk for each counterparty is based upon its credit default swap rate. We have no performance obligations related to the call options purchased to fund our fixed index annuity policy liabilities.

Other investments

Equity securities are the only financial instruments included in other investments that are measured at fair value on a recurring basis. The fair value for these securities are determined using the same methods discussed above for fixed maturity securities. Financial instruments included in other investments that are not measured at fair value on a recurring basis are FHLB common stock, equity method investments, short-term loans and company owned life insurance ("COLI"). FHLB common stock is carried at cost which approximates fair value. FHLB common stock was $18.0 million as of March 31, 2022 and falls within Level 2 of the fair value hierarchy. The fair values for most of our equity method investments are obtained from third parties and are determined using a variety of valuation techniques, including discounted cash flow analysis, valuation multiples analysis for comparable investments and appraisal values. As the risk spread and liquidity discount are unobservable market inputs, the fair value of our equity method investments falls within Level 3 of the fair value hierarchy. The fair value for one of our equity method investments is based on earnings multiples derived by comparing valuations of similar entities relative to earnings data. The fair value of this equity method investment falls within Level 3 of the fair value hierarchy. The fair value of equity method investments was $717.9 million and $520.1 million as of March 31, 2022 and December 31, 2021, respectively. Due to the short-term nature of the investment, the fair value of our short-term loans approximates the carrying value. The fair value of short-term loans was $320.0 million and $320.0 million as of March 31, 2022 and December 31, 2021, respectively. Our short-term loans fall within Level 2 of the fair value hierarchy. The fair value of our COLI approximates the cash surrender value of the policies and falls within Level 2 of the fair value hierarchy. The fair value of COLI was $387.7 million and $384.3 million as of March 31, 2022 and December 31, 2021, respectively.

Cash and cash equivalents

Amounts reported in the consolidated balance sheets for these instruments are reported at their historical cost which approximates fair value due to the nature of the assets assigned to this category.

Policy benefit reserves, coinsurance deposits and SPIA benefit reserves

The fair values of the liabilities under contracts not involving significant mortality or morbidity risks (principally deferred annuities), are stated at the cost we would incur to extinguish the liability (i.e., the cash surrender value) as these contracts are generally issued without an annuitization date. The coinsurance deposits related to the annuity benefit reserves have fair values determined in a similar fashion. For period-certain annuity benefit contracts, the fair value is determined by discounting the benefits at the interest rates currently in effect for newly issued immediate annuity contracts. We are not required to and have not estimated the fair value of the liabilities under contracts that involve significant mortality or morbidity risks, as these liabilities fall within the definition of insurance contracts that are exceptions from financial instruments that require disclosures of fair value. Policy benefit reserves, coinsurance deposits and SPIA benefit reserves are not measured at fair value on a recurring basis. All of the fair values presented within these categories fall within Level 3 of the fair value hierarchy as most of the inputs are unobservable market data.

Other policy funds - FHLB

The fair values of the Company's funding agreements with the FHLB are estimated using discounted cash flow calculations based on interest rates currently being offered for similar agreements with similar maturities.

Notes payable

The fair values of our senior unsecured notes are based upon quoted market prices and are categorized as Level 2 within the fair value hierarchy. Notes payable are not remeasured at fair value on a recurring basis.

Subordinated debentures

Fair values for subordinated debentures are estimated using discounted cash flow calculations based principally on observable inputs including our incremental borrowing rates, which reflect our credit rating, for similar types of borrowings with maturities consistent with those remaining for the debt being valued. These fair values are categorized as Level 2 within the fair value hierarchy. Subordinated debentures are not measured at fair value on a recurring basis.

Funds withheld liability - embedded derivative

We estimate the fair value of the embedded derivative based on the fair value of the assets supporting the funds withheld payable under modified coinsurance reinsurance agreements. The fair value of the embedded derivative is classified as Level 2 based on valuation methods used for the assets held supporting the reinsurance agreements.

Fixed index annuities - embedded derivatives

We estimate the fair value of the embedded derivative component of our fixed index annuity policy benefit reserves at each valuation date by (i) projecting policy contract values and minimum guaranteed contract values over the expected lives of the contracts and (ii) discounting the excess of the projected contract value amounts at the applicable risk free interest rates adjusted for our nonperformance risk related to those liabilities. The projections of policy contract values are based on our best estimate assumptions for future policy growth and future policy decrements. Our best estimate assumptions for future policy growth include assumptions for the expected index credit on the next policy anniversary date which are derived from the fair values of the underlying call options purchased to fund such index credits and the expected costs of annual call options we will purchase in the future to fund index credits beyond the next policy anniversary. The projections of minimum guaranteed contract values include the same best estimate assumptions for policy decrements as were used to project policy contract values.

Within this determination we have the following significant unobservable inputs: 1) the expected cost of annual call options we will purchase in the future to fund index credits beyond the next policy anniversary and 2) our best estimates for future policy decrements, primarily lapse, partial withdrawal and mortality rates. As of both March 31, 2022 and December 31, 2021, we utilized an estimate of 2.10% for the expected cost of annual call options, which is based on estimated long-term account value growth and a historical review of our actual option costs.

Our best estimate assumptions for lapse, partial withdrawal and mortality rates are based on our actual experience and our outlook as to future expectations for such assumptions. These assumptions, which are consistent with the assumptions used in calculating deferred policy acquisition costs and deferred sales inducements, are reviewed on a quarterly basis and are updated as our experience develops and/or as future expectations change. The following table presents average lapse rate and partial withdrawal rate assumptions, by contract duration, used in estimating the fair value of the embedded derivative component of our fixed index annuity policy benefit reserves at each reporting date:


	Average Lapse Rates		Average Partial Withdrawal Rates
Contract Duration (Years)	March 31, 2022	December 31, 2021	March 31, 2022	December 31, 2021
1 - 5	3.13%	3.04%	2.20%	2.19%
6 - 10	2.91%	2.84%	2.27%	2.26%
11 - 15	4.32%	4.47%	2.11%	2.14%
16 - 20	9.30%	8.93%	1.30%	1.33%
20+	4.97%	4.93%	—%	—%

Lapse rates are generally expected to increase as surrender charge percentages decrease for policies without a lifetime income benefit rider. Lapse expectations reflect a significant increase in the year in which the surrender charge period on a contract ends.

The following table provides a reconciliation of the beginning and ending balances for our Level 3 assets and liabilities, which are measured at fair value on a recurring basis using significant unobservable inputs for the three months ended March 31, 2022 and 2021:


	Three Months Ended March 31,
		2022		2021
		(Dollars in thousands)
Other investments: equity securities
Beginning balance		$	6,349	$	—
Transfers in		—		—
Total realized/unrealized gains (losses):
Included in net income		(2,482)		—
Included in other comprehensive income (loss)		—		—
Ending balance		$	3,867	$	—

Real estate investments
Beginning balance		$	337,939	$	—
Purchases and sales, net		168,088		—
Change in fair value		4,161		—
Ending balance		$	510,188	$	—

Fixed index annuities - embedded derivatives
Beginning balance		$	7,964,961	$	7,938,281
Premiums less benefits		114,077		119,791
Change in fair value, net		(1,308,123)		(377,121)

Ending balance		$	6,770,915	$	7,680,951

The fair value of our fixed index annuities embedded derivatives is net of coinsurance ceded of $1,048.7 million and $1,245.0 million as of March 31, 2022 and December 31, 2021, respectively. Change in fair value, net for each period in our embedded derivatives is included in change in fair value of embedded derivatives in the unaudited consolidated statements of operations.

Certain derivatives embedded in our fixed index annuity contracts are our most significant financial instrument measured at fair value that are categorized as Level 3 in the fair value hierarchy. The contractual obligations for future annual index credits within our fixed index annuity contracts are treated as a "series of embedded derivatives" over the expected life of the applicable contracts. We estimate the fair value of these embedded derivatives at each valuation date by the method described above under fixed index annuities - embedded derivatives. The projections of minimum guaranteed contract values include the same best estimate assumptions for policy decrements as were used to project policy contract values.

The most sensitive assumption in determining policy liabilities for fixed index annuities is the rates used to discount the excess projected contract values. As indicated above, the discount rate reflects our nonperformance risk. If the discount rates used to discount the excess projected contract values at March 31, 2022, were to increase by 100 basis points, the fair value of the embedded derivatives would decrease by $499.4 million recorded through operations as a decrease in the change in fair value of embedded derivatives and there would be a corresponding decrease of $193.5 million to our combined balance for deferred policy acquisition costs and deferred sales inducements recorded through operations as an increase in amortization of deferred policy acquisition costs and deferred sales inducements. A decrease by 100 basis points in the discount rates used to discount the excess projected contract values would increase the fair value of the embedded derivatives by $578.3 million recorded through operations as an increase in the change in fair value of embedded derivatives and there would be a corresponding increase of $229.0 million to our combined balance for deferred policy acquisition costs and deferred sales inducements recorded through operations as a decrease in amortization of deferred policy acquisition costs and deferred sales inducements.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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