Fair Value of Assets and Liabilities

12 Months Ended

Dec. 31, 2011

Fair Value of Assets and Liabilities [Abstract]

Fair Value of Assets and Liabilities

5. Fair Value of Assets and Liabilities

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The hierarchy for inputs used in determining fair value maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that observable inputs be used when available. Assets and liabilities recorded on the Statements of Financial Position at fair value are categorized in the fair value hierarchy based on the observability of inputs to the valuation techniques as follows:

Level 1: Assets and liabilities whose values are based on unadjusted quoted prices for identical assets or liabilities in an active market that the Company can access.

Level 2: Assets and liabilities whose values are based on the following:

(a) Quoted prices for similar assets or liabilities in active markets;

(b) Quoted prices for identical or similar assets or liabilities in markets that are not active; or

(c) Valuation models whose inputs are observable, directly or indirectly, for substantially the full term of the asset or liability.

Level 3: Assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. Unobservable inputs reflect the Company’s estimates of the assumptions that market participants would use in valuing the assets and liabilities.

The availability of observable inputs varies by instrument. In situations where fair value is based on internally developed pricing models or inputs that are unobservable in the market, the determination of fair value requires more judgment. The degree of judgment exercised by the Company in determining fair value is typically greatest for instruments categorized in Level 3. In many instances, valuation inputs used to measure fair value fall into different levels of the fair value hierarchy. The category level in the fair value hierarchy is determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company uses prices and inputs that are current as of the measurement date, including during periods of market disruption. In periods of market disruption, the ability to observe prices and inputs may be reduced for many instruments.

The Company has two types of situations where investments are classified as Level 3 in the fair value hierarchy. The first is where quotes continue to be received from independent third-party valuation service providers and all significant inputs are market observable; however, there has been a significant decrease in the volume and level of activity for the asset when compared to normal market activity such that the degree of market observability has declined to a point where categorization as a Level 3 measurement is considered appropriate. The indicators considered in determining whether a significant decrease in the volume and level of activity for a specific asset has occurred include the level of new issuances in the primary market, trading volume in the secondary market, the level of credit spreads over historical levels, applicable bid-ask spreads, and price consensus among market participants and other pricing sources.

The second situation where the Company classifies securities in Level 3 is where specific inputs significant to the fair value estimation models are not market observable. This relates to the Company’s use of broker quotes to value certain securities where the inputs have not been corroborated to be market observable.

In determining fair value, the Company principally uses the market approach which generally utilizes market transaction data for the same or similar instruments. To a lesser extent, the Company uses the income approach which involves determining fair values from discounted cash flow methodologies. For the majority of Level 2 and Level 3 valuations, a combination of the market and income approaches is used.

Summary of significant valuation techniques for assets and liabilities measured at fair value on a recurring basis

Level 1 measurements

• Fixed income securities: Comprise U.S. Treasuries. Valuation is based on unadjusted quoted prices for identical assets in active markets that the Company can access.

• Short-term: Comprise actively traded money market funds that have daily quoted net asset values for identical assets that the Company can access.

• Separate account assets: Comprise actively traded mutual funds that have daily quoted net asset values for identical assets that the Company can access. Net asset values for the actively traded mutual funds in which the separate account assets are invested are obtained daily from the fund managers.

Level 2 measurements

• Fixed income securities:

U.S. government and agencies: The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields and credit spreads.

Municipal: The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields and credit spreads.

Corporate, including privately placed: The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields and credit spreads. Also included are privately placed securities valued using a discounted cash flow model that is widely accepted in the financial services industry and uses market observable inputs and inputs derived principally from, or corroborated by, observable market data. The primary inputs to the discounted cash flow model include an interest rate yield curve, as well as published credit spreads for similar assets in markets that are not active that incorporate the credit quality and industry sector of the issuer.

Foreign government: The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields and credit spreads.

RMBS and ABS: The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields, prepayment speeds, collateral performance and credit spreads.

CMBS: The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields, collateral performance and credit spreads.

• Short-term: The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields and credit spreads. For certain short-term investments, amortized cost is used as the best estimate of fair value.

Level 3 measurements

• Fixed income securities:

Corporate: Valued based on models that are widely accepted in the financial services industry with certain inputs to the valuation model that are significant to the valuation, but are not market observable.

RMBS: Valued based on non-binding broker quotes received from brokers who are familiar with the investments and where the inputs have not been corroborated to be market observable.

Contractholder funds: Derivatives embedded in certain life and annuity contracts are valued internally using models widely accepted in the financial services industry that determine a single best estimate of fair value for the embedded derivatives within a block of contractholder liabilities. The models primarily use stochastically determined cash flows based on the contractual elements of embedded derivatives, projected option cost and applicable market data, such as interest rate yield curves and equity index volatility assumptions. These are categorized as Level 3 as a result of the significance of non-market observable inputs.

The following table summarizes the Company’s assets and liabilities measured at fair value on a recurring and non-recurring basis as of December 31, 2011:

($ in thousands)	Quoted prices in active markets for identical assets (Level 1)			Significant other observable inputs (Level 2)			Significant unobservable inputs (Level 3)			Balance as of December 31, 2011
Assets:
Fixed income securities:
U.S. government and agencies	$	36,883		$	53,119		$	—		$	90,002
Municipal		—			2,898			—			2,898
Corporate		—			181,228			598			181,826
Foreign government		—			5,237			—			5,237
RMBS		—			40,186			2,321			42,507
CMBS		—			8,356			—			8,356
ABS		—			2,814			—			2,814
Total fixed income securities		36,883			293,838			2,919			333,640
Short-term investments		1,925			11,049			—			12,974
Separate account assets		1,682,128			—			—			1,682,128
Total recurring basis assets		1,720,936			304,887			2,919			2,028,742
Total assets at fair value	$	1,720,936		$	304,887		$	2,919		$	2,028,742
% of total assets at fair value		84.8	%		15.0	%		0.2	%		100.0	%
Liabilities:
Contractholder funds:
Derivatives embedded in life and annuity contracts	$	—		$	—		$	(506,678	)	$	(506,678	)
Total liabilities at fair value	$	—		$	—		$	(506,678	)	$	(506,678	)
% of total liabilities at fair value		—	%		—	%		100.0	%		100.0	%

The following table summarizes the Company’s assets and liabilities measured at fair value on a recurring and non-recurring basis as of December 31, 2010:

($ in thousands)	Quoted prices in active markets for identical assets (Level 1)			Significant other observable inputs (Level 2)			Significant unobservable inputs (Level 3)			Balance as of December 31, 2010
Assets:
Fixed income securities:
U.S. government and agencies	$	31,007		$	42,549		$	—		$	73,556
Municipal		—			3,176			—			3,176
Corporate		—			162,735			852			163,587
Foreign government		—			5,090			—			5,090
RMBS		—			50,922			6,880			57,802
CMBS		—			6,947			1,916			8,863
ABS		—			8,382			—			8,382
Total fixed income securities		31,007			279,801			9,648			320,456
Short-term investments		11,543			50			—			11,593
Separate account assets		2,017,185			—			—			2,017,185
Total recurring basis assets		2,059,735			279,851			9,648			2,349,234
Total assets at fair value	$	2,059,735		$	279,851		$	9,648		$	2,349,234
% of total assets at fair value		87.7	%		11.9	%		0.4	%		100.0	%
Liabilities:
Contractholder funds:
Derivatives embedded in life and annuity contracts	$	—		$	—		$	(494,149	)	$	(494,149	)
Total liabilities at fair value	$	—		$	—		$	(494,149	)	$	(494,149	)
% of total liabilities at fair value		—	%		—	%		100.0	%		100.0	%

The following table presents the rollforward of Level 3 assets and liabilities held at fair value on a recurring basis during the year ended December 31, 2011.

($ in thousands)				Total realized and unrealized gains (losses) included in:
	Balance as of December 31, 2010			Net income(1)			OCI on Statement of Financial Position			Transfers into Level 3			Transfers out of Level 3
Assets
Fixed income securities:
Corporate	$	852		$	—		$	199		$	—		$	(10,199	)
RMBS		6,880			(4	)		(108	)		—			(3,577	)
CMBS		1,916			—			(49	)		—			(1,867	)
Total recurring Level 3 assets	$	9,648		$	(4	)	$	42		$	—		$	(15,643	)
Liabilities
Contractholder funds:
Derivatives embedded in life and annuity contracts	$	(494,149	)	$	(110,951	)	$	—		$	—		$	—
Total recurring Level 3 liabilities	$	(494,149	)	$	(110,951	)	$	—		$	—		$	—
	Purchases			Sales			Issuances			Settlements			Balance as of December 31, 2011
Assets
Fixed income securities:
Corporate	$	10,000		$	—		$	—		$	(254	)	$	598
RMBS		—			—			—			(870	)		2,321
CMBS		—			—			—			—			—
Total recurring Level 3 assets	$	10,000		$	—		$	—		$	(1,124	)	$	2,919
Liabilities
Contractholder funds:
Derivatives embedded in life and annuity contracts	$	—		$	—		$	(55,559	)	$	153,981		$	(506,678	)
Total recurring Level 3 liabilities	$	—		$	—		$	(55,559	)	$	153,981		$	(506,678	)

⁽¹⁾ The amount above attributable to fixed income securities is reported in the Statements of Operations and Comprehensive Income as net investment income. The amount above attributable to derivatives embedded in life and annuity contracts is reported as follows: $(106.6) million in interest credited to contractholder funds and $(4.3) million in contract benefits. These amounts are ceded in accordance with the Company’s reinsurance agreements.

The following table presents the rollforward of Level 3 assets and liabilities held at fair value on a recurring basis during the year ended December 31, 2010.

($ in thousands)				Total realized and unrealized gains (losses) included in:					Purchases, sales, issuances and settlements, net		Transfers into Level 3			Transfers out of Level 3			Balance as of December 31, 2010
	Balance as of December 31, 2009			Net income(1)			OCI on Statement of Financial Position
Assets
Fixed income securities:
Corporate	$	1,089		$	(1	)	$	—	$	7,740	$	—		$	(7,976	)	$	852
RMBS		—			(17	)		131		9,459		—			(2,693	)		6,880
CMBS		1,158			—			758		—		—			—			1,916
Total recurring Level 3 assets	$	2,247		$	(18	)	$	889	$	17,199	$	—		$	(10,669	)	$	9,648
Liabilities
Contractholder funds:
Derivatives embedded in life and annuity contracts	$	(15,526	)	$	(4,877	)	$	—	$	—	$	(473,746	)	$	—		$	(494,149	)
Total recurring Level 3 liabilities	$	(15,526	)	$	(4,877	)	$	—	$	—	$	(473,746	)	$	—		$	(494,149	)

⁽¹⁾ The amount above attributable to fixed income securities is reported in the Statements of Operations and Comprehensive Income as net investment income. The amount above attributable to derivatives embedded in life and annuity contracts is reported as a component of contract benefits and is ceded in accordance with the Company’s reinsurance agreements.

Transfers between level categorizations may occur due to changes in the availability of market observable inputs, which generally are caused by changes in market conditions such as liquidity, trading volume or bid-ask spreads. Transfers between level categorizations may also occur due to changes in the valuation source. For example, in situations where a fair value quote is not provided by the Company’s independent third-party valuation service provider and as a result the price is stale or has been replaced with a broker quote whose inputs have not been corroborated to be market observable, the security is transferred into Level 3. Transfers in and out of level categorizations are reported as having occurred at the beginning of the quarter in which the transfer occurred. Therefore, for all transfers into Level 3, all realized and changes in unrealized gains and losses in the quarter of transfer are reflected in the Level 3 rollforward table.

There were no transfers between Level 1 and Level 2 during 2011 or 2010.

During 2011, certain RMBS and CMBS were transferred into Level 2 from Level 3 as a result of increased liquidity in the market and a sustained increase in market activity for these assets. When transferring these securities into Level 2, the Company did not change the source of fair value estimates or modify the estimates received from independent third-party valuation service providers or the internal valuation approach. Accordingly, for securities included within this group, there was no change in fair value in conjunction with the transfer resulting in a realized or unrealized gain or loss.

During 2011, a corporate fixed income security was transferred into Level 2 from Level 3 due to a change in the valuation model to use primarily market observable inputs. Transfers out of Level 3 during 2011 and 2010 also included situations where a broker quote was used in the prior period and a fair value quote became available from the Company’s independent third-party valuation service provider in the current period. A quote utilizing the new pricing source was not available as of the prior period, and any gains or losses related to the change in valuation source for individual securities were not significant.

Transfers into Level 3 during 2010 also included derivatives embedded in equity-indexed life and annuity contracts due to refinements in the valuation modeling resulting in an increase in significance of non-market observable inputs.

The following table provides the total gains and (losses) included in net income for Level 3 assets and liabilities still held as of December 31.

($ in thousands)	2011			2010
Assets
Fixed income securities:
Corporate	$	(2	)	$	(2	)
RMBS		(5	)		(11	)
CMBS		—			(1	)
Total recurring Level 3 assets	$	(7	)	$	(14	)
Liabilities
Contractholder funds:
Derivatives embedded in life and annuity contracts	$	(110,951	)	$	(4,877	)
Total recurring Level 3 liabilities	$	(110,951	)	$	(4,877	)

The amounts in the table above represent losses included in net income during 2011 and 2010 for the period of time that the asset or liability was determined to be in Level 3. The amounts attributable to fixed income securities are reported in net investment income. The amount attributable to derivatives embedded in life and annuity contracts is reported as follows: $(106.6) million in interest credited to contractholder funds and $(4.3) million in contract benefits. These amounts are ceded in accordance with the Company’s reinsurance agreements.

The following table presents the rollforward of Level 3 assets and liabilities held at fair value on a recurring basis during the year ended December 31, 2009.

	Balance as of December 31, 2008			Total realized and unrealized gains (losses) included in:						Purchases, sales, issuances and settlements, net			Net transfers in and/ or (out) of Level 3			Balance as of December 31, 2009			Total gains (losses) included in net income for financial instruments still held as of December 31, 2009(2)
($ in thousands)				Net income (1)			OCI on Statement of Financial Position
Assets
Fixed income securities:
Corporate	$	1,307		$	(2	)	$	96		$	(216	)	$	(96	)	$	1,089		$	(2	)
CMBS		—			—			535			—			623			1,158			—
ABS		6,002			288			(19	)		(6,271	)		—			—			—
Total recurring Level 3 assets	$	7,309		$	286		$	612		$	(6,487	)	$	527		$	2,247		$	(2	)
Liabilities
Contractholder funds:
Derivatives embedded in life and annuity contracts	$	(36,544	)	$	19,984		$	—		$	1,034		$	—		$	(15,526	)	$	19,984
Total recurring Level 3 liabilities	$	(36,544	)	$	19,984		$	—		$	1,034		$	—		$	(15,526	)	$	19,984

⁽¹⁾ The amount above attributable to fixed income securities is reported in the Statements of Operations and Comprehensive Income as follows: $288 thousand in realized capital gains and losses and $(2) thousand in net investment income. The amount above attributable to derivatives embedded in life and annuity contracts is reported as a component of contract benefits and is ceded in accordance with the Company’s reinsurance agreements.

⁽²⁾  The amount above attributable to fixed income securities is reported as a component of net investment income in the Statements of Operations and Comprehensive Income. The amount above attributable to derivatives embedded in life and annuity contracts is reported as a component of contract benefits and is ceded in accordance with the Company’s reinsurance agreements.

As of December 31, 2011 and 2010, financial instruments not carried at fair value included contractholder funds on investment contracts. The carrying value and fair value of contractholder funds on investment contracts were $10.66 billion and $10.33 billion, respectively, as of December 31, 2011 and were $12.69 billion and $11.66 billion, respectively, as of December 31, 2010.

The fair value of contractholder funds on investment contracts is based on the terms of the underlying contracts utilizing prevailing market rates for similar contracts adjusted for the Company’s own credit risk. Deferred annuities included in contractholder funds are valued using discounted cash flow models which incorporate market value margins, which are based on the cost of holding economic capital, and the Company’s own credit risk. Immediate annuities without life contingencies are valued at the present value of future benefits using market implied interest rates which include the Company’s own credit risk.