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Investments
 3 Months Ended
Mar. 31, 2012
Investments  
Investments

Note 8 — Investments

 

Total Realized Investment Gains and Losses

 

The following total realized gains and losses on investments include other-than-temporary impairments on debt securities but exclude amounts required to adjust future policy benefits for the run-off settlement annuity business:

 

 Three Months Ended
 March 31,
(In millions)20122011
Fixed maturities$ 12$ 21
Equity securities  4  3
Commercial mortgage loans  (3)  -
Real estate  (1)  -
Other investments, including derivatives  1  2
Realized investment gains before income taxes  13  26
Less income taxes   1  9
Net realized investment gains $ 12$ 17

Included in pre-tax realized investment gains (losses) above were changes in valuation reserves, asset write-downs and other-than-temporary impairments on fixed maturities as follows:

 

 Three Months Ended
 March 31,
(In millions)20122011
Credit-related (1)$ 5$ -
Other   1  -
Total $ 6$ -
     
(1) Credit related losses include other-than-temporary declines in fair value of fixed maturities and changes in valuation reserves related to commercial mortgage loans.

Fixed Maturities and Equity Securities

 

Securities in the following table are included in fixed maturities and equity securities on the Company's Consolidated Balance Sheets. These securities are carried at fair value with changes in fair value reported in other realized investment gains (losses) and interest and dividends reported in net investment income. The Company's hybrid investments include preferred stock or debt securities with call or conversion features.

 As of March 31,As of December 31,
(In millions)20122011
Included in fixed maturities:    
Trading securities (amortized cost: $2; $2)$ 2$ 2
Hybrid securities (amortized cost: $27; $26)  29  28
Total$ 31$ 30
Included in equity securities:    
Hybrid securities (amortized cost: $92; $90)$ 72$ 65

Fixed maturities included $58 million at March 31, 2012, which were pledged as collateral to brokers as required under certain futures contracts. These fixed maturities were primarily federal government securities.

 

The following information about fixed maturities excludes trading and hybrid securities. The amortized cost and fair value by contractual maturity periods for fixed maturities were as follows at March 31, 2012:

 

  Amortized Fair
(In millions) Cost Value
Due in one year or less$ 966$ 977
Due after one year through five years  5,177  5,540
Due after five years through ten years  5,204  5,809
Due after ten years  2,756  3,499
Mortgage and other asset-backed securities  1,038  1,193
Total$ 15,141$ 17,018

Actual maturities could differ from contractual maturities because issuers may have the right to call or prepay obligations, with or without penalties. Also, in some cases the Company may extend maturity dates.

 

Gross unrealized appreciation (depreciation) on fixed maturities (excluding trading securities and hybrid securities with a fair value of $31 million at March 31, 2012 and $30 million at December 31, 2011) by type of issuer is shown below.

 

         
 March 31, 2012
    Unrealized Unrealized  
  Amortized Appre- Depre- Fair
(In millions) Cost ciation ciation Value
Federal government and agency$ 509$ 339$ -$ 848
State and local government  2,267  261  (4)  2,524
Foreign government  1,182  95  (2)  1,275
Corporate  10,145  1,064  (31)  11,178
Federal agency mortgage-backed  157  1  -  158
Other mortgage-backed  84  10  (5)  89
Other asset-backed  797  158  (9)  946
Total$ 15,141$ 1,928$ (51)$ 17,018
(In millions)December 31, 2011
Federal government and agency$ 552$ 406$ -$ 958
State and local government  2,185  274  (3)  2,456
Foreign government  1,173  103  (2)  1,274
Corporate  9,460  1,070  (45)  10,485
Federal agency mortgage-backed  9  -  -  9
Other mortgage-backed  73  10  (4)  79
Other asset-backed  777  160  (11)  926
Total$ 14,229$ 2,023$ (65)$ 16,187

The above table includes investments with a fair value of $2.9 billion supporting the Company's run-off settlement annuity business, with gross unrealized appreciation of $734 million and gross unrealized depreciation of $22 million at March 31, 2012. Such unrealized amounts are required to support future policy benefit liabilities of this business and, as such, are not included in accumulated other comprehensive income. At December 31, 2011, investments supporting this business had a fair value of $3 billion, gross unrealized appreciation of $851 million and gross unrealized depreciation of $25 million.

 

Sales information for available-for-sale fixed maturities and equity securities were as follows:

 

 Three Months Ended
 March 31,
(In millions)20122011
Proceeds from sales$ 221$ 155
Gross gains on sales$ 15$ 14
Gross losses on sales$ -$ -

Review of declines in fair value. Management reviews fixed maturities with a decline in fair value from cost for impairment based on criteria that include:

 

  • length of time and severity of decline;

  • financial health and specific near term prospects of the issuer;
  • changes in the regulatory, economic or general market environment of the issuer's industry or geographic region; and
  • the Company's intent to sell or the likelihood of a required sale prior to recovery.

 

Excluding trading and hybrid securities, as of March 31, 2012, fixed maturities with a decline in fair value from amortized cost (which were primarily investment grade corporate bonds) were as follows, including the length of time of such decline:

 Fair Amortized UnrealizedNumber
(In millions)ValueCostDepreciationof Issues
Fixed maturities:       
One year or less:       
Investment grade$ 963$ 974$ (11)470
Below investment grade$ 87$ 90$ (3)44
More than one year:       
Investment grade$ 245$ 275$ (30)49
Below investment grade$ 11$ 18$ (7)12

The unrealized depreciation of investment grade fixed maturities is primarily due to increases in market yields since purchase. There were no equity securities with a fair value significantly lower than cost as of March 31, 2012.

 

Commercial Mortgage Loans

 

Mortgage loans held by the Company are collateralized exclusively by commercial real estate and are diversified by property type, location and borrower. Loans are secured by high quality, primarily completed and substantially leased operating properties, generally carried at unpaid principal balances and issued at a fixed rate of interest.

 

Credit quality. The Company applies a consistent and disciplined approach to evaluating and monitoring credit risk, beginning with the initial underwriting of a mortgage loan and continuing throughout the investment holding period. Mortgage origination professionals employ an internal rating system developed from the Company's experience in real estate investing and mortgage lending. A quality rating, designed to evaluate the relative risk of the transaction, is assigned at each loan's origination and is updated each year as part of the annual portfolio loan review. The Company monitors credit quality on an ongoing basis, classifying each loan as a loan in good standing, potential problem loan or problem loan.

 

Quality ratings are based on internal evaluations of each loan's specific characteristics considering a number of key inputs, including real estate market-related factors such as rental rates and vacancies, and property-specific inputs such as growth rate assumptions and lease rollover statistics. However, the two most significant contributors to the credit quality rating are the debt service coverage and loan-to-value ratios. The debt service coverage ratio measures the amount of property cash flow available to meet annual interest and principal payments on debt. A debt service coverage ratio below 1.0 indicates that there is not enough cash flow to cover the loan payments. The loan-to-value ratio, commonly expressed as a percentage, compares the amount of the loan to the fair value of the underlying property collateralizing the loan.

 

The following tables summarize the credit risk profile of the Company's commercial mortgage loan portfolio based on loan-to-value and debt service coverage ratios, as of March 31, 2012 and December 31, 2011:

(In millions)    March 31, 2012     
  Debt Service Coverage Ratio  
  1.30x or 1.20x to 1.10x to 1.00x to Less than  
Loan-to-Value Ratios Greater 1.29x 1.19x 1.09x 1.00x Total
Below 50%$ 223$ 55$ 3$ 50$ 9$ 340
50% to 59%  562  47  26  -  53  688
60% to 69%  633  159  41  -  77  910
70% to 79%  98  132  88  136  33  487
80% to 89%  99  81  78  94  100  452
90% to 99%  36  34  30  69  107  276
100% or above  -  10  50  24  22  106
Total$ 1,651$ 518$ 316$ 373$ 401$ 3,259
             
             
(In millions)    December 31, 2011     
  Debt Service Coverage Ratio  
  1.30x or 1.20x to 1.10x to 1.00x to Less than  
Loan-to-Value Ratios Greater 1.29x 1.19x 1.09x 1.00x Total
Below 50%$ 225 $ 55 $ 3 $ 50 $ 9$ 342
50% to 59%  444  47  26  -  53  570
60% to 69%  646  140  42  -  77  905
70% to 79%  117  132  120  159  33  561
80% to 89%  99  81  79  72  71  402
90% to 99%  36  35  30  58  116  275
100% or above  -  10  50  51  135  246
Total$ 1,567$ 500$ 350$ 390$ 494$ 3,301

The Company's annual in-depth review of its commercial mortgage loan investments is the primary mechanism for identifying emerging risks in the portfolio. The most recent review was completed by the Company's investment professionals in the second quarter of 2011 and included an analysis of each underlying property's most recent annual financial statements, rent rolls, operating plans, budgets, a physical inspection of the property and other pertinent factors. Based on historical results, current leases, lease expirations and rental conditions in each market, the Company estimates the current year and future stabilized property income and fair value, and categorizes the investments as loans in good standing, potential problem loans or problem loans. Based on property valuations and cash flows estimated as part of this review, and considering updates for loans where material changes were subsequently identified, the portfolio's average loan-to-value ratio improved to 68% at March 31, 2012, decreasing from 70% as of December 31, 2011. The portfolio's average debt service coverage ratio was estimated to be 1.41 at March 31, 2012, a slight increase from 1.40 at December 31, 2011.

Quality ratings are adjusted between annual reviews if new property information is received or events such as delinquency or a borrower's request for restructure cause management to believe that the Company's estimate of financial performance, fair value or the risk profile of the underlying property has been impacted.

 

During the three months ended March 31, 2012, the Company restructured a $119 million problem mortgage loan, net of a valuation reserve, into two notes carried at $100 million and $19 million. The $100 million note was reclassified to impaired commercial mortgage loans with no valuation reserves and the $19 million note is now classified as an other long-term investment. During the twelve months ended December 31, 2011, the Company restructured a $65 million potential problem loan into two notes carried at $55 million and $10 million. Each of these modifications was considered a troubled debt restructuring because each borrower was experiencing financial difficulties and interest rate concessions were granted. No valuation reserves were required because the fair value of each underlying property equaled or exceeded the carrying value of the outstanding loan. As a part of these restructurings, the borrowers and the Company have committed to fund additional capital for leasing and capital requirements.

 

 

 

 

Other loans were modified during the three months ended March 31, 2012 and the twelve months ended December 31, 2011, but were not considered troubled debt restructures. The impact of modifications to these loans was not material to the Company's results of operations, financial condition or liquidity.

 

       Potential problem mortgage loans are considered current (no payment more than 59 days past due), but exhibit certain characteristics that increase the likelihood of future default. The characteristics management considers include, but are not limited to, the deterioration of debt service coverage below 1.0, estimated loan-to-value ratios increasing to 100% or more, downgrade in quality rating and request from the borrower for restructuring. In addition, loans are considered potential problems if principal or interest payments are past due by more than 30 but less than 60 days. Problem mortgage loans are either in default by 60 days or more or have been restructured as to terms, which could include concessions on interest rate, principal payment or maturity date. The Company monitors each problem and potential problem mortgage loan on an ongoing basis, and updates the loan categorization and quality rating when warranted.

 

Problem and potential problem mortgage loans, net of valuation reserves, totaled $345 million at March 31, 2012 and $336 million at December 31, 2011. At March 31, 2012 and December 31, 2011, mortgage loans collateralized by industrial properties represent the most significant component of problem and potential problem mortgage loans, with no significant concentration by geographic region.

 

Impaired commercial mortgage loans. A commercial mortgage loan is considered impaired when it is probable that the Company will not collect all amounts due (principal and interest) according to the terms of the original loan agreement. The Company assesses each loan individually for impairment, using the information obtained from the quality review process discussed above. Impaired loans are carried at the lower of unpaid principal balance or the fair value of the underlying real estate. Certain commercial mortgage loans without valuation reserves are considered impaired because the Company will not collect all interest due according to the terms of the original agreements; however, the Company does expect to recover their remaining carrying value primarily because it is less than the fair value of the underlying real estate.

The carrying value of the Company's impaired commercial mortgage loans and related valuation reserves were as follows:

 

(In millions) March 31, 2012 December 31, 2011
  Gross  Reserves Net  Gross  Reserves Net
Impaired commercial mortgage loans with valuation reserves$ 28$ (6)$ 22 $ 154$ (19)$ 135
Impaired commercial mortgage loans with no valuation reserves  160  -  160   60  -  60
Total $ 188$ (6)$ 182 $ 214$ (19)$ 195

During the three months ended March 31, 2012, the Company recorded a $3 million pre-tax ($2 million after-tax) increase in valuation reserves on an impaired commercial mortgage loan collateralized by industrial properties. The average recorded investment in impaired loans was $201 million at March 31, 2012 and $102 million at March 31, 2011. The Company recognizes interest income on problem mortgage loans only when payment is actually received because of the risk profile of the underlying investment. Interest income that would have been reflected in net income if interest on non-accrual commercial mortgage loans had been received in accordance with the original terms was not significant for the three months ended March 31, 2012 or 2011. Interest income on impaired commercial mortgage loans was not significant for the three months ended March 31, 2012 or 2011.

 

The following table summarizes the changes in valuation reserves for commercial mortgage loans:

 

(In millions)20122011
Reserve balance, January 1,$ 19$ 12
Increase in valuation reserves  3  -
Charge-offs upon sales and repayments, net of recoveries  -  (1)
Transfers to Other long-term investments  (16)  -
     
Reserve balance, March 31,$ 6$ 11

Short-term investments and cash equivalents. Short-term investments and cash equivalents includes corporate securities of $736 million, federal government securities of $172 million and money market funds of $79 million as of March 31, 2012. The Company's short-term investments and cash equivalents as of December 31, 2011 included corporate securities of $4.1 billion, federal government securities of $164 million and money market funds of $40 million.