Fair Value of Financial Instruments (Notes)

9 Months Ended

Sep. 30, 2012

Fair Value Disclosures [Abstract]

Financial Instruments

Fair Value of Financial Instruments

Fair value is the price that would be received upon the sale of an asset in an orderly transaction between market participants at the measurement date. Fair value measurements are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our view of market assumptions in the absence of observable market information. We classify and disclose all invested assets carried at fair value in one of the following three categories:

• Level 1. Quoted prices for identical instruments in active markets. Level 1 primarily consists of financial instruments whose value is based on quoted market prices in active markets, such as exchange-traded common stocks and actively traded mutual fund investments;

• Level 2. Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets. Level 2 includes those financial instruments that are valued using industry-standard pricing methodologies, models or other valuation methodologies. Various inputs are considered in deriving the fair value of the underlying financial instrument, including interest rate, credit spread, and foreign exchange rates. All significant inputs are observable, or derived from observable information in the marketplace or are supported by observable levels at which transactions are executed in the marketplace. Financial instruments in this category primarily include: certain public and private corporate fixed-maturity and equity securities; government or agency securities; certain mortgage- and asset-backed securities and certain non-exchange-traded derivatives, such as currency swaps and forwards; and

• Level 3. Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable. Level 3 consists of financial instruments whose fair value is estimated based on industry-standard pricing methodologies and models using significant inputs not based on, nor corroborated by, readily available market information. Valuations for this category primarily consist of non-binding broker quotes. Financial instruments in this category primarily include less liquid fixed-maturity corporate securities.

As of each reporting period, all assets and liabilities recorded at fair value are classified in their entirety based on the lowest level of input (Level 3 being the lowest). Significant levels of estimation and judgment are required to determine the fair value of certain of our investments. The factors influencing these estimations and judgments are subject to change in subsequent reporting periods.

The estimated fair value and hierarchy classifications for assets and liabilities that are measured at fair value on a recurring basis were as follows: 

	September 30, 2012
	Level 1		Level 2		Level 3		Total
	(In thousands)
Fair value assets:
Fixed-maturity securities:
U.S. government and agencies	$	—	$	7,628	$	—	$	7,628
Foreign government	—		119,637		—		119,637
States and political subdivisions	—		34,545		—		34,545
Corporates	1,266		1,382,438		4,246		1,387,950
Mortgage- and asset-backed securities	—		360,148		2,548		362,696
Total fixed-maturity securities	1,266		1,904,396		6,794		1,912,456
Equity securities	27,219		9,426		48		36,693
Trading securities	—		17,081		—		17,081
Separate accounts	—		2,630,630		—		2,630,630
Total fair value assets	$	28,485	$	4,561,533	$	6,842	$	4,596,860
Fair value liabilities:
Currency swaps	$	—	$	1,893	$	—	$	1,893
Separate accounts	—		2,630,630		—		2,630,630
Total fair value liabilities	$	—	$	2,632,523	$	—	$	2,632,523

	December 31, 2011
	Level 1		Level 2		Level 3		Total
	(In thousands)
Fair value assets:
Fixed-maturity securities:
U.S. government and agencies	$	—	$	10,985	$	—	$	10,985
Foreign government	—		111,845		—		111,845
States and political subdivisions	—		30,935		—		30,935
Corporates	256		1,349,021		4,924		1,354,201
Mortgage- and asset-backed securities	—		449,228		1,962		451,190
Total fixed-maturity securities	256		1,952,014		6,886		1,959,156
Equity securities	18,069		8,592		51		26,712
Trading securities	—		9,640		—		9,640
Separate accounts	—		2,408,598		—		2,408,598
Total fair value assets	$	18,325	$	4,378,844	$	6,937	$	4,404,106
Fair value liabilities:
Currency swaps	$	—	$	2,032	$	—	$	2,032
Separate accounts	—		2,408,598		—		2,408,598
Total fair value liabilities	$	—	$	2,410,630	$	—	$	2,410,630

In assessing fair value of our investments, we use a third-party pricing service for approximately 94% of our securities. The remaining securities are primarily thinly traded securities valued using models based on observable inputs on public corporate spreads having similar tenors (e.g., sector, average life and quality rating) and liquidity and yield based on quality rating, average life and treasury yields. All observable data inputs are corroborated by independent third-party data. In the absence of sufficient observable inputs, we utilize non-binding broker quotes, which are reflected in our Level 3 classification as we are unable to evaluate the valuation technique(s) or significant inputs used to develop the quotes. Therefore, we do not internally develop the quantitative unobservable inputs used in measuring the fair value of Level 3 investments. However, we do corroborate pricing information provided by our third-party pricing servicing by performing a review of selected securities. Our review activities include obtaining detailed information about the assumptions, inputs and methodologies used in pricing the security; documenting this information; and corroborating it by comparison to independently obtained prices and or independently developed pricing methodologies.

Furthermore, we perform internal reasonableness assessments on fair value determinations within our portfolio throughout the quarter and at quarter-end, including pricing variance analyses and comparisons to alternative pricing sources and benchmark returns. If a fair value appears unusual relative to these assessments, we will re-examine the inputs and may challenge a fair value assessment made by the pricing service. If there is a known pricing error, we will request a reassessment by the pricing service. If the pricing service is unable to perform the reassessment on a timely basis, we will determine the appropriate price by requesting a reassessment from an alternative pricing service or other qualified source as necessary. We do not adjust quotes or prices except in a rare circumstance to resolve a known error.

Because many fixed-maturity securities do not trade on a daily basis, fair value is determined using industry-standard methodologies by applying available market information through processes such as U.S. Treasury curves, benchmarking of similar securities, sector groupings, quotes from market participants and matrix pricing. Observable information is compiled and integrates relevant credit information, perceived market movements and sector news. Additionally, security prices are periodically back-tested to validate and/or refine models as conditions warrant. Market indicators and industry and economic events are also monitored as triggers to obtain additional data. For certain structured securities with limited trading activity, industry-standard pricing methodologies use adjusted market information, such as index prices or discounting expected future cash flows, to estimate fair value. If these measures are not deemed observable for a particular security, the security will be classified as Level 3 in the fair value hierarchy.

Where specific market information is unavailable for certain securities, pricing models produce estimates of fair value primarily using Level 2 inputs along with certain Level 3 inputs. These models include matrix pricing. The pricing matrix uses current treasury rates and credit spreads received from third-party sources to estimate fair value. The credit spreads incorporate the issuer’s industry- or issuer-specific credit characteristics and the security’s time to maturity, if warranted. Remaining un-priced securities are valued using an estimate of fair value based on indicative market prices that include significant unobservable inputs not based on, nor corroborated by, market information, including the utilization of non-binding broker quotes.

The roll-forward of the Level 3 assets measured at fair value on a recurring basis was as follows:

	Three months ended September 30,						Nine months ended September 30,
	2012			2011			2012			2011
	(In thousands)
Level 3 assets, beginning of period	$	10,131		$	12,265		$	6,937		$	24,998
Net unrealized gains (losses) included in other comprehensive income	206			(454		)	(130		)	(735		)
Net realized gains (losses) included in realized investment gains, including other-than-temporary impairment losses	50			158			10			1,624
Purchases	757			13,609			3,173			17,609
Sales	—			—			—			(3,823		)
Settlements	(3,162		)	(193		)	(3,900		)	(1,655		)
Transfers into Level 3	—			488			2,951			4,991
Transfers out of Level 3	(1,140		)	(4,815		)	(2,199		)	(21,951		)
Level 3 assets, end of period	$	6,842		$	21,058		$	6,842		$	21,058

We obtain independent pricing quotes based on observable inputs as of the end of the reporting period for all securities in Level 2. Those inputs include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, market bids/offers, quoted prices for similar instruments in markets that are not active, and other relevant data. We monitor these inputs for market indicators, industry and economic events. We recognize transfers into new levels and out of previous levels as of the end of the reporting period, including interim reporting periods, as applicable. There were no transfers between Level 1 and Level 2 during the nine months ended September 30, 2012 and 2011. In addition, there were no transfers between Level 1 and Level 3 during the nine months ended September 30, 2012 and 2011.

Invested assets included in the transfer from Level 2 to Level 3 during the three months ended September 30, 2011 and the nine months ended September 30, 2012 and 2011 primarily were fixed-maturity investments for which we were unable to corroborate independent broker quotes with observable market data. Invested assets included in the transfer from Level 3 to Level 2 during the nine months ended September 30, 2011 primarily were fixed-maturity securities and fixed-maturity securities with embedded conversion options for which we were able to obtain independent pricing quotes based on observable inputs.

The table below is a summary of the estimated fair value for financial instruments.

	September 30, 2012				December 31, 2011
	Carrying value		Estimated fair value		Carrying value		Estimated fair value
	(In thousands)
Assets:
Fixed-maturity securities	$	1,912,456	$	1,912,456	$	1,959,156	$	1,959,156
Equity securities	36,693		36,693		26,712		26,712
Trading securities	17,081		17,081		9,640		9,640
Policy loans	24,669		24,699		25,996		25,996
Deposit asset underlying 10% reinsurance agreement	83,850		83,850		59,975		59,975
Separate accounts	2,630,630		2,630,630		2,408,598		2,408,598
Liabilities:
Notes payable	$	374,421	$	397,745	$	300,000	$	329,779
Currency swaps	1,893		1,893		2,032		2,032
Separate accounts	2,630,630		2,630,630		2,408,598		2,408,598

The fair values of financial instruments presented above are estimates of the fair values at a specific point in time using various sources and methods, including market quotations and a complex matrix system that takes into account issuer sector, quality, and spreads in the current marketplace.

Recurring fair value measurements. Estimated fair values of investments in fixed-maturity securities are principally a function of current spreads and interest rates that are corroborated by independent third-party data. Therefore, the fair values presented are indicative of amounts we could realize or settle at the respective balance sheet date. We do not necessarily intend to dispose of or liquidate such instruments prior to maturity. Trading securities, which primarily consist of fixed-maturity securities, are carried at fair value. Equity securities, including common and non-redeemable preferred stocks, are carried at fair value. Currency swaps are stated at fair value. Segregated funds in separate accounts are carried at the underlying value of the variable insurance contracts, which is fair value.

Nonrecurring fair value measurements. Policy loans are carried at unpaid principal balances, which approximate fair value and are categorized as Level 3 fair value measurements. The deposit asset underlying the 10% reinsurance agreement represents the value of the assets backing the economic reserves held in support of a reinsurance agreement. The carrying value of this deposit asset approximates fair value, which is categorized as Level 3 in the fair value hierarchy. As of September 30, 2012, notes payable were comprised of our publicly-traded senior notes and valued as a Level 2 fair value measurement using the quoted market price for our notes. As of December 31, 2011, notes payable consisted of a note issued to Citi for which the fair value was obtained by using a Level 2 fair value measurement involving market spreads and interest rates that were corroborated by independent third-party data.

The carrying amounts for cash and cash equivalents, receivables, accrued investment income, accounts payable, cash collateral and payables for security transactions approximate their fair values due to the short-term nature of these instruments. Consequently, such financial instruments are not included in the above table.