Note 3 - Fair Value of Financial Instruments

The Company is required under GAAP to disclose estimated fair values for certain financial and nonfinancial assets and liabilities. Fair values of the Company’s insurance contracts other than annuity contracts are not required to be disclosed. However, the estimated fair values of liabilities under all insurance contracts are taken into consideration in the Company’s overall management of interest rate risk through the matching of investment maturities with amounts due under insurance contracts.

Information regarding the three-level hierarchy presented below and the valuation methodologies utilized by the Company to estimate fair values at a point in time is included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013, specifically in “Note 3 — Fair Value of Financial Instruments”. Transactions subsequent to December 31, 2013 have resulted in additional components which are described below.

Short-term and Other Investments

Short-term and other investments are comprised of short-term fixed income securities, derivative instruments (all call options), policy loans, mortgage loans, and restricted FHLB membership and activity stocks, as well as certain alternative investments which are accounted for as equity method investments and therefore excluded from the fair value tabular disclosures.

In summary, the following investments in this caption are carried at fair value:

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Short-term fixed income securities — Because of the nature of these assets, carrying amounts generally approximate fair values.

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Derivative instruments, all call options — Fair values are based on the amount of cash expected to be received to settle each derivative instrument on the reporting date. These amounts are obtained from each of the counterparties using industry accepted valuation models and observable inputs. Significant inputs include contractual terms, underlying index prices, market volatilities, interest rates and dividend yields.

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FHLB membership and activity stocks — Fair value is based on redemption value, which is equal to par value.

The following investments in this caption are not carried at fair value; disclosure is provided:

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Policy loans — Fair value is based on estimates using discounted cash flow analysis and current interest rates being offered for new loans.

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Mortgage loans — Fair value is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and the same remaining maturities.

Other Policyholder Funds

Other policyholder funds are liabilities related to supplementary contracts without life contingencies and dividend accumulations, both of which represent deposits that do not have defined maturities, as well as balances outstanding under funding agreements with the FHLB and embedded derivatives. Except for embedded derivatives, each of these components is carried at cost, which management believes is a reasonable estimate of fair value due to the relatively short duration of these items, based on the Company’s past experience.

The fair value of the embedded derivatives, all related to the Company’s FIA products, is estimated at each valuation date by (1) projecting policy contract values and minimum guaranteed contract values over the expected lives of the contracts and (2) discounting the excess of the projected contract value amounts at the applicable risk free interest rates adjusted for the Company’s nonperformance risk related to those liabilities. The projections of policy contract values are based on the Company’s best estimate assumptions for future contract growth and decrements. The assumptions for future contract growth include the expected index credits 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 that will be purchased in the future to fund index credits beyond the next contract anniversary. Projections of minimum guaranteed contract values include the same best estimate assumptions for contract decrements used to project policy contract values.

Financial Instruments Measured and Carried at Fair Value

The following table presents the Company’s fair value hierarchy for those assets and liabilities measured and carried at fair value on a recurring basis. At September 30, 2014, Level 3 invested assets comprised approximately 2.3% of the Company’s total investment portfolio fair value.

					Fair Value Measurements at
	Carrying		Fair		Reporting Date Using
	Amount		Value		Level 1		Level 2		Level 3
September 30, 2014
Financial Assets
Investments
Fixed maturities
U.S. Government and federally sponsored agency obligations:
Mortgage-backed securities	$	534,513	$	534,513	$	-	$	534,513	$	-
Other, including
U.S. Treasury securities		503,712		503,712		17,697		486,015		-
Municipal bonds		1,617,105		1,617,105		-		1,603,962		13,143
Foreign government bonds		58,779		58,779		-		58,779		-
Corporate bonds		2,855,768		2,855,768		10,441		2,779,670		65,657
Other mortgage-backed securities		1,223,592		1,223,592		-		1,136,351		87,241
Total fixed maturities		6,793,469		6,793,469		28,138		6,599,290		166,041
Equity securities		106,837		106,837		88,640		18,191		6
Short-term investments		162,217		162,217		162,217		-		-
Other investments		11,276		11,276		-		11,276		-
Totals		7,073,799		7,073,799		278,995		6,628,757		166,047
Separate Account (variable annuity) assets (1)		1,786,363		1,786,363		1,786,363		-		-
Financial Liabilities
Other policyholder funds, embedded derivatives		13,082		13,082		-		-		13,082

December 31, 2013
Financial Assets
Investments
Fixed maturities
U.S. Government and federally sponsored agency obligations:
Mortgage-backed securities	$	569,725	$	569,725	$	-	$	569,725	$	-
Other, including
U.S. Treasury securities		435,574		435,574		17,757		417,817		-
Municipal bonds		1,471,527		1,471,527		-		1,468,833		2,694
Foreign government bonds		54,951		54,951		-		54,951		-
Corporate bonds		2,614,409		2,614,409		10,181		2,543,402		60,826
Other mortgage-backed securities		863,387		863,387		-		817,378		46,009
Total fixed maturities		6,009,573		6,009,573		27,938		5,872,106		109,529
Equity securities		91,858		91,858		74,279		17,573		6
Short-term investments		206,758		206,758		206,354		404		-
Other investments		5,000		5,000		-		5,000		-
Totals		6,313,189		6,313,189		308,571		5,895,083		109,535
Separate Account (variable annuity) assets (1)		1,747,995		1,747,995		1,747,995		-		-
Financial Liabilities
Other policyholder funds, embedded derivatives		-		-		-		-		-

(1)

Separate Account (variable annuity) liabilities are set equal to Separate Account (variable annuity) assets.

The Company transferred one equity security from Level 2 to Level 1 during the nine months ended September 30, 2014. The following tables present reconciliations for the periods indicated for all Level 3 assets and liabilities measured at fair value on a recurring basis.

	Financial Assets												Financial Liabilities(1)
	Municipal Bonds		Corporate Bonds		Other Mortgage- Backed Securities		Total Fixed Maturities		Equity Securities		Total

Beginning balance July 1, 2014	$	13,054	$	73,926	$	52,522	$	139,502	$	6	$	139,508	$	6,915
Transfers into Level 3 (2)		-		-		35,000		35,000		-		35,000		-
Transfers out of Level 3 (2)		-		(3,510)		-		(3,510)		-		(3,510)		-
Total gains or losses
Net realized gains (losses) included in net income		-		-		-		-		-		-		70
Net unrealized gains (losses) included in other comprehensive income		212		(180)		(137)		(105)		-		(105)		-
Purchases		-		-		-		-		-		-		-
Issuances		-		-		-		-		-		-		6,179
Sales		-		-		-		-		-		-		-
Settlements		-		-		-		-		-		-		-
Paydowns, maturities and distributions		(123)		(4,580)		(143)		(4,846)		-		(4,846)		(82)
Ending balance, September 30, 2014	$	13,143	$	65,656	$	87,242	$	166,041	$	6	$	166,047	$	13,082

Beginning balance, January 1, 2014	$	2,694	$	60,826	$	46,009	$	109,529	$	6	$	109,535	$	-
Transfers into Level 3 (2)		10,056		12,452		42,109		64,617		-		64,617		-
Transfers out of Level 3 (2)		-		(3,510)		(519)		(4,029)		-		(4,029)		-
Total gains or losses
Net realized gains (losses) included in net income		-		-		(26)		(26)		-		(26)		139
Net unrealized gains (losses) included in other comprehensive income		646		2,380		155		3,181		-		3,181		-
Purchases		-		-		-		-		-		-		-
Issuances		-		-		-		-		-		-		13,035
Sales		-		-		-		-		-		-		-
Settlements		-		-		-		-		-		-		-
Paydowns, maturities and distributions		(253)		(6,492)		(486)		(7,231)		-		(7,231)		(92)
Ending balance, September 30, 2014	$	13,143	$	65,656	$	87,242	$	166,041	$	6	$	166,047	$	13,082

(1)

Represents embedded derivatives, all related to the Company’s FIA products, reported in Other Policyholder Funds in the Company’s Consolidated Balance Sheets.

(2)

Transfers into and out of Level 3 during the three and nine months ended September 30, 2014 were attributable to changes in the availability of observable market information for individual fixed maturity securities. The Company’s policy is to recognize transfers into and transfers out of the levels as having occurred at the end of the reporting period in which the transfers were determined.

	Financial Assets
	Municipal Bonds		Corporate Bonds		Other Mortgage- Backed Securities		Total Fixed Maturities		Equity Securities		Total

Beginning balance July 1, 2013	$	3,764	$	56,590	$	49,343	$	109,697	$	6	$	109,703
Transfers into Level 3 (1)		5,546		9,315		23,828		38,689		-		38,689
Transfers out of Level 3 (1)		(800)		-		(1,881)		(2,681)		-		(2,681)
Total gains or losses
Net realized gains (losses) included in net income		-		-		-		-		-		-
Net unrealized gains (losses) included in other comprehensive income		(123)		104		(20)		(39)		-		(39)
Purchases		-		-		-		-		-		-
Issuances		-		-		-		-		-		-
Sales		-		-		-		-		-		-
Settlements		-		-		-		-		-		-
Paydowns, maturities and distributions		(72)		(1,718)		(8,260)		(10,050)		-		(10,050)
Ending balance, September 30, 2013	$	8,315	$	64,291	$	63,010	$	135,616	$	6	$	135,622

Beginning balance, January 1, 2013	$	12,275	$	85,722	$	33,172	$	131,169	$	340	$	131,509
Transfers into Level 3 (1)		9,453		32,754		67,827		110,034		-		110,034
Transfers out of Level 3 (1)		(800)		(50,341)		(20,284)		(71,425)		-		(71,425)
Total gains or losses
Net realized gains (losses) included in net income		-		-		-		-		-		-
Net unrealized gains (losses) included in other comprehensive income		(474)		(1,605)		(438)		(2,517)		-		(2,517)
Purchases		-		-		-		-		-		-
Issuances		-		-		-		-		-		-
Sales		-		-		-		-		(334)		(334)
Settlements		-		-		-		-		-		-
Paydowns, maturities and distributions		(12,139)		(2,239)		(17,267)		(31,645)		-		(31,645)
Ending balance, September 30, 2013	$	8,315	$	64,291	$	63,010	$	135,616	$	6	$	135,622

(1)

Transfers into and out of Level 3 during the three and nine months ended September 30, 2013 were attributable to changes in the availability of observable market information for individual fixed maturity securities. The Company’s policy is to recognize transfers into and transfers out of the levels as having occurred at the end of the reporting period in which the transfers were determined.

At September 30, 2014 and 2013, there were no realized gains or losses included in earnings that were attributable to changes in the fair value of Level 3 assets still held. For the three and nine months ended September 30, 2014, realized gains/(losses) of $70 and $139, respectively, were included in earnings that were attributable to the changes in the fair value of Level 3 liabilities (embedded derivatives) still held.

The valuation techniques and significant unobservable inputs used in the fair value measurement for financial assets classified as Level 3 are subject to the control processes as described in “Note 3 — Fair Value of Financial Instruments — Investments” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013. Generally, valuation for fixed maturity securities include spread pricing, matrix pricing and discounted cash flow methodologies; include inputs such as quoted prices for identical or similar securities that are less liquid; and are based on lower levels of trading activity than securities classified as Level 2. The valuation techniques and significant unobservable inputs used in the fair value measurement for equity securities classified as Level 3 use similar valuation techniques and significant unobservable inputs as fixed maturities.

The sensitivity of the estimated fair values to changes in the significant unobservable inputs for fixed maturities and equity securities included in Level 3 generally relate to interest rate spreads, illiquidity premiums and default rates. Significant spread widening in isolation will adversely impact the overall valuation, while significant spread tightening will lead to substantial valuation increases. Significant increases (decreases) in illiquidity premiums in isolation will result in substantially lower (higher) valuations. Significant increases (decreases) in expected default rates in isolation will result in substantially lower (higher) valuations.

Financial Instruments Not Carried at Fair Value; Disclosure Required

The Company has various other financial assets and financial liabilities used in the normal course of business that are not carried at fair value, but for which fair value disclosure is required. The following table presents the carrying value, fair value and fair value hierarchy of these financial assets and financial liabilities.

					Fair Value Measurements at
	Carrying		Fair		Reporting Date Using
	Amount		Value		Level 1		Level 2		Level 3
September 30, 2014
Financial Assets
Investments
Other investments	$	143,751	$	148,081	$	-	$	-	$	148,081
Financial Liabilities
Fixed annuity contract liabilities		3,717,277		3,491,512		-		-		3,491,512
Policyholder account balances on interest-sensitive life contracts		77,639		78,706		-		-		78,706
Other policyholder funds		588,479		588,479		-		500,055		88,424
Short-term debt		38,000		38,000		-		38,000		-
Long-term debt		199,923		212,432		212,432		-		-
Other liabilities, repurchase agreement obligations		-		-		-		-		-

December 31, 2013
Financial Assets
Investments
Other investments	$	140,685	$	144,921	$	-	$	-	$	144,921
Financial Liabilities
Fixed annuity contract liabilities		3,515,865		3,302,333		-		-		3,302,333
Policyholder account balances on interest-sensitive life contracts		78,598		79,678		-		-		79,678
Other policyholder funds		346,292		346,292		-		250,000		96,292
Short-term debt		38,000		38,000		-		38,000		-
Long-term debt		199,874		218,565		218,565		-		-
Other liabilities, repurchase agreement obligations		25,864		25,864		-		25,864		-