AEL / American Equity Investment Life Holding Co. 10-Q (Quarterly Report)

SecurityAEL / American Equity Investment Life Holding Co.
Form Type10-Q
File Date2018-05-08

Document List

AEL / American Equity Investment Life Holding Co. 10-Q (Quarterly Report)
AEL / American Equity Investment Life Holding Co. EXHIBIT 10.1
AEL / American Equity Investment Life Holding Co. EXHIBIT 10.2
AEL / American Equity Investment Life Holding Co. EXHIBIT 10.3
AEL / American Equity Investment Life Holding Co. EXHIBIT 10.4
AEL / American Equity Investment Life Holding Co. EXHIBIT 10.5
AEL / American Equity Investment Life Holding Co. EXHIBIT 12.1
AEL / American Equity Investment Life Holding Co. EXHIBIT 31.1
AEL / American Equity Investment Life Holding Co. EXHIBIT 31.2
AEL / American Equity Investment Life Holding Co. EXHIBIT 32.1
AEL / American Equity Investment Life Holding Co. EXHIBIT 32.2
Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2018
OR
o 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission File Number : 001-31911
American Equity Investment Life Holding Company
(Exact name of registrant as specified in its charter)
Iowa
 
42-1447959
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
6000 Westown Parkway
West Des Moines, Iowa 50266
(Address of principal executive offices, including zip code)
(515) 221-0002
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x
Accelerated filer o
Non-accelerated filer o
Smaller reporting company o
Emerging growth company o
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
APPLICABLE TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:
As of May 2, 2018, there were 90,095,990 shares of the registrant's common stock, $1 par value, outstanding.



TABLE OF CONTENTS
 
Page
PART I — FINANCIAL INFORMATION
 
Item 1: Financial Statements:
2
Consolidated Balance Sheets
2
Consolidated Statements of Operations
3
Consolidated Statements of Comprehensive Income (Loss)
4
Consolidated Statements of Changes in Stockholders’ Equity
5
Consolidated Statements of Cash Flows
6
Notes to Consolidated Financial Statements
8
Note 1. Significant Accounting Policies
8
Note 2. Fair Values of Financial Instruments
10
Note 3. Investments
15
Note 4. Mortgage Loans on Real Estate
21
Note 5. Derivative Instruments
25
Note 6. Notes Payable and Amounts Due Under Repurchase Agreements
27
Note 7. Commitments and Contingencies
27
Note 8. Earnings Per Share
28
Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations
29
Item 3: Quantitative and Qualitative Disclosures about Market Risk
47
Item 4: Controls and Procedures
49
 
 
PART II — OTHER INFORMATION
 
Item 1: Legal Proceedings
49
Item 1A: Risk Factors
49
Item 2: Unregistered Sales of Equity Securities and Use of Proceeds
49
Item 6: Exhibits
50
 
 
Signatures
51




Table of Contents

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share and per share data)
 
March 31, 2018
 
December 31, 2017
 
(Unaudited)
 
 
Assets
 
 
 
Investments:
 
 
 
Fixed maturity securities:
 
 
 
Available for sale, at fair value (amortized cost: 2018 - $44,510,813; 2017 - $43,116,759)
$
45,551,348

 
$
45,372,989

Held for investment, at amortized cost (fair value: 2018 - $69,441; 2017 - $76,460)
77,043

 
77,041

Mortgage loans on real estate
2,699,637

 
2,665,531

Derivative instruments
847,741

 
1,568,380

Other investments
481,825

 
616,764

Total investments
49,657,594

 
50,300,705

 
 
 
 
Cash and cash equivalents
723,784

 
1,434,045

Coinsurance deposits
4,871,912

 
4,858,289

Accrued investment income
454,519

 
429,008

Deferred policy acquisition costs
3,039,311

 
2,714,523

Deferred sales inducements
2,219,597

 
2,001,892

Deferred income taxes
159,601

 
38,147

Other assets
175,006

 
254,127

Total assets
$
61,301,324

 
$
62,030,736

 
 
 
 
Liabilities and Stockholders' Equity
 
 
 
Liabilities:
 
 
 
Policy benefit reserves
$
56,072,140

 
$
56,142,673

Other policy funds and contract claims
280,072

 
282,884

Notes payable
494,215

 
494,093

Subordinated debentures
242,667

 
242,565

Amounts due under repurchase agreements
137,223

 

Income taxes payable
72,191

 
34,285

Other liabilities
1,455,826

 
1,984,079

Total liabilities
58,754,334

 
59,180,579

 
 
 
 
Stockholders' equity:
 
 
 
Preferred stock, par value $1 per share, 2,000,000 shares authorized,
  2018 and 2017 - no shares issued and outstanding

 

Common stock, par value $1 per share, 200,000,000 shares authorized; issued and outstanding:
   2018 - 89,983,823 shares (excluding 1,814,460 treasury shares);
   2017 - 89,331,087 shares (excluding 2,064,727 treasury shares)
89,984

 
89,331

Additional paid-in capital
798,835

 
791,446

Accumulated other comprehensive income
399,982

 
724,599

Retained earnings
1,258,189

 
1,244,781

Total stockholders' equity
2,546,990

 
2,850,157

Total liabilities and stockholders' equity
$
61,301,324

 
$
62,030,736

See accompanying notes to unaudited consolidated financial statements.

2

Table of Contents

AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except per share data)
(Unaudited)

 
Three Months Ended 
 March 31,
 
2018
 
2017
Revenues:
 
 
 
Premiums and other considerations
$
9,053

 
$
9,402

Annuity product charges
50,723

 
43,572

Net investment income
510,784

 
485,597

Change in fair value of derivatives
(451,083
)
 
386,533

Net realized gains on investments, excluding other than temporary impairment ("OTTI") losses
302

 
2,338

OTTI losses on investments:
 
 
 
Total OTTI losses
(907
)
 

Portion of OTTI losses recognized in (from) other comprehensive income

 
(141
)
Net OTTI losses recognized in operations
(907
)
 
(141
)
Total revenues
118,872

 
927,301

 
 
 
 
Benefits and expenses:
 
 
 
Insurance policy benefits and change in future policy benefits
12,094

 
11,875

Interest sensitive and index product benefits
514,095

 
419,139

Amortization of deferred sales inducements
100,423

 
62,325

Change in fair value of embedded derivatives
(867,232
)
 
224,170

Interest expense on notes and loan payable
6,372

 
7,722

Interest expense on subordinated debentures
3,630

 
3,336

Amortization of deferred policy acquisition costs
140,639

 
89,678

Other operating costs and expenses
31,240

 
27,579

Total benefits and expenses
(58,739
)
 
845,824

Income before income taxes
177,611

 
81,477

Income tax expense
36,649

 
27,538

Net income
$
140,962

 
$
53,939

 
 
 
 
Earnings per common share
$
1.57

 
$
0.61

Earnings per common share - assuming dilution
$
1.55

 
$
0.60

 
 
 
 
Weighted average common shares outstanding (in thousands):
 
 
 
Earnings per common share
90,017

 
88,647

Earnings per common share - assuming dilution
91,139

 
89,976

See accompanying notes to unaudited consolidated financial statements.

3

Table of Contents

AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Dollars in thousands)
(Unaudited)

 
Three Months Ended 
 March 31,
 
2018
 
2017
 
 
 
 
Net income
$
140,962

 
$
53,939

Other comprehensive income (loss):
 
 
 
Change in net unrealized investment gains/losses (1)
(572,033
)
 
129,124

Noncredit component of OTTI losses (1)

 
65

Reclassification of unrealized investment gains/losses to net income (1)
(339
)
 
930

Other comprehensive income (loss) before income tax
(572,372
)
 
130,119

Income tax effect related to other comprehensive income (loss)
120,201

 
(45,542
)
Other comprehensive income (loss)
(452,171
)
 
84,577

Comprehensive income (loss)
$
(311,209
)
 
$
138,516

(1)
Net of related adjustments to amortization of deferred sales inducements and deferred policy acquisition costs.
See accompanying notes to unaudited consolidated financial statements.

4

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AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Dollars in thousands, except share data)
(Unaudited)

 
Common
Stock
 
Additional
Paid-in
Capital
 
Accumulated
Other
Comprehensive
Income
 
Retained
Earnings
 
Total
Stockholders'
Equity
Balance at December 31, 2016
$
88,001

 
$
770,344

 
$
339,966

 
$
1,093,284

 
$
2,291,595

Net income for period

 

 

 
53,939

 
53,939

Other comprehensive income

 

 
84,577

 

 
84,577

Share-based compensation

 
2,403

 

 

 
2,403

Issuance of 629,553 shares of common stock under compensation plans
630

 
3,087

 

 

 
3,717

Balance at March 31, 2017
$
88,631

 
$
775,834

 
$
424,543

 
$
1,147,223

 
$
2,436,231

 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2017
$
89,331

 
$
791,446

 
$
724,599

 
$
1,244,781

 
$
2,850,157

Net income for period

 

 

 
140,962

 
140,962

Other comprehensive loss

 

 
(452,171
)
 

 
(452,171
)
Implementation of accounting standard related to the reclassification of certain tax effects

 

 
127,554

 
(127,554
)
 

Share-based compensation

 
3,526

 

 

 
3,526

Issuance of 652,736 shares of common stock under compensation plans
653

 
3,863

 

 

 
4,516

Balance at March 31, 2018
$
89,984

 
$
798,835

 
$
399,982

 
$
1,258,189

 
$
2,546,990

See accompanying notes to unaudited consolidated financial statements.

5

Table of Contents

AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)

 
Three Months Ended 
 March 31,
 
2018
 
2017
Operating activities
 
 
 
Net income
$
140,962

 
$
53,939

Adjustments to reconcile net income to net cash provided by (used in) operating activities:
 
 
 
Interest sensitive and index product benefits
514,095

 
419,139

Amortization of deferred sales inducements
100,423

 
62,325

Annuity product charges
(50,723
)
 
(43,572
)
Change in fair value of embedded derivatives
(867,232
)
 
224,170

Change in traditional life and accident and health insurance reserves
2,049

 
726

Policy acquisition costs deferred
(96,562
)
 
(110,574
)
Amortization of deferred policy acquisition costs
140,639

 
89,678

Provision for depreciation and other amortization
900

 
957

Amortization of discounts and premiums on investments
6,002

 
2,800

Realized gains (losses) on investments and net OTTI losses recognized in operations
605

 
(2,197
)
Distributions from equity method investments
66

 
122

Change in fair value of derivatives
450,906

 
(386,842
)
Deferred income taxes
(1,253
)
 
(3,670
)
Share-based compensation
3,526

 
2,403

Change in accrued investment income
(25,511
)
 
(26,371
)
Change in income taxes recoverable/payable
37,906

 
31,161

Change in other assets
(470
)
 
33

Change in other policy funds and contract claims
(4,343
)
 
(6,985
)
Change in collateral held for derivatives
(784,932
)
 
233,992

Change in other liabilities
(6,472
)
 
(38,754
)
Other
(3,757
)
 
(4,431
)
Net cash provided by (used in) operating activities
(443,176
)
 
498,049

 
 
 
 
Investing activities
 
 
 
Sales, maturities, or repayments of investments:
 
 
 
Fixed maturity securities - available for sale
265,837

 
517,301

Mortgage loans on real estate
68,017

 
75,110

Derivative instruments
479,675

 
349,732

Other investments
153,936

 
4,868

Acquisitions of investments:
 
 
 
Fixed maturity securities - available for sale
(1,310,985
)
 
(1,216,014
)
Mortgage loans on real estate
(101,037
)
 
(100,797
)
Derivative instruments
(200,542
)
 
(147,283
)
Other investments
(15,131
)
 
(1,550
)
Purchases of property, furniture and equipment
(1,099
)
 
(1,402
)
Net cash used in investing activities
(661,329
)
 
(520,035
)

6

Table of Contents

AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Dollars in thousands)
(Unaudited)

 
Three Months Ended 
 March 31,
 
2018
 
2017
Financing activities
 
 
 
Receipts credited to annuity and single premium universal life policyholder account balances
$
1,020,429

 
$
1,073,583

Coinsurance deposits
(6,867
)
 
63,746

Return of annuity policyholder account balances
(738,219
)
 
(727,494
)
Net proceeds from amounts due under repurchase agreements
137,223

 

Proceeds from issuance of common stock
4,516

 
3,717

Change in checks in excess of cash balance
(22,838
)
 
(10,084
)
Net cash provided by financing activities
394,244

 
403,468

Increase (decrease) in cash and cash equivalents
(710,261
)
 
381,482

Cash and cash equivalents at beginning of period
1,434,045

 
791,266

Cash and cash equivalents at end of period
$
723,784

 
$
1,172,748

 
 
 
 
Supplemental disclosures of cash flow information
 
 
 
Cash paid during period for:
 
 
 
Interest expense
$
3,488

 
$
18,682

Income taxes

 
47

Non-cash operating activity:
 
 
 
Deferral of sales inducements
43,670

 
65,245

See accompanying notes to unaudited consolidated financial statements.




 

7

Table of Contents

AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2018
(Unaudited)


1. Significant Accounting Policies
Consolidation and Basis of Presentation
The accompanying consolidated financial statements of American Equity Investment Life Holding Company ("we", "us" or "our") have been prepared in accordance with U.S. generally accepted accounting principles ("GAAP") for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and notes required by GAAP for complete financial statements. The consolidated financial statements reflect all adjustments, consisting only of normal recurring items, which are necessary to present fairly our financial position and results of operations on a basis consistent with the prior audited consolidated financial statements. Operating results for the three month period ended March 31, 2018 are not necessarily indicative of the results that may be expected for the year ended December 31, 2018. All significant intercompany accounts and transactions have been eliminated. The preparation of financial statements requires the use of management estimates. For further information related to a description of areas of judgment and estimates and other information necessary to understand our financial position and results of operations, refer to the audited consolidated financial statements and notes included in our Annual Report on Form 10-K for the year ended December 31, 2017.
Adopted Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board ("FASB") issued an accounting standards update ("ASU") related to revenue arising from contracts with customers. This ASU, which replaces most current revenue recognition guidance, including industry specific guidance, prescribes that an entity should recognize revenue to reflect the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. We adopted this ASU on January 1, 2018. The adoption of this ASU had no impact on our consolidated financial statements as revenues related to insurance contracts and investment contracts are excluded from its scope.
In January 2016, the FASB issued an ASU that, among other aspects of recognition, measurement, presentation and disclosure of financial instruments, primarily requires equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. However, an entity may choose to measure equity investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Additionally, it changes the accounting for financial liabilities measured at fair value under the fair value option and eliminates some disclosures regarding fair value of financial assets and liabilities measured at amortized cost. We adopted this ASU on January 1, 2018. The adoption of this ASU had no impact on our consolidated financial statements.
In August 2016, the FASB issued an ASU that clarifies how certain cash receipts and cash payments are to be presented and classified in the statement of cash flows. We adopted this ASU on January 1, 2018. The adoption of this ASU resulted in a reclassification of certain cash flows related to equity method investment distributions from investing activities to operating activities within our consolidated statements of cash flows.
In February 2018, the FASB issued an ASU that allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act of 2017 ("Tax Reform"). We adopted this ASU on January 1, 2018. The adoption of this ASU resulted in a reclassification of $128 million between accumulated other comprehensive income and retained earnings within our consolidated balance sheet.
New Accounting Pronouncements
In February 2016, the FASB issued an ASU that will require recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. This ASU affects accounting and disclosure more dramatically for lessees as accounting for lessors is mainly unchanged. This ASU will be effective for us on January 1, 2019, with early adoption permitted. We are in the process of evaluating the impact this guidance may have on our consolidated financial statements.
In June 2016, the FASB issued an ASU that significantly changes the impairment model for most financial assets that are measured at amortized cost and certain other instruments from an incurred loss model to an expected loss model that requires these assets be presented at the net amount expected to be collected. In addition, credit losses on available for sale debt securities should be recorded through an allowance account.  This ASU will be effective for us on January 1, 2020, with early adoption permitted. While we are still in the process of evaluating the impact this guidance will have on our consolidated financial statements, we believe the new impairment model will lead to earlier recognition of credit losses for our commercial mortgage loans.

8

Table of Contents

In March 2017, the FASB issued an ASU that applies to certain callable debt securities where the amortized cost basis is at a premium to the price repayable by the issuer at the earliest call date. Under this guidance, the premium will be amortized to the first call date. This ASU will be effective for us on January 1, 2019, with early adoption permitted. We are in the process of evaluating the impact this guidance may have on our consolidated financial statements.
Income Tax Reform
As a result of Tax Reform, the federal corporate tax rate was reduced from 35% to 21% effective January 1, 2018.

9

Table of Contents

2. Fair Values of Financial Instruments
The following sets forth a comparison of the carrying amounts and fair values of our financial instruments:
 
March 31, 2018
 
December 31, 2017
 
Carrying
Amount
 
Fair Value
 
Carrying
Amount
 
Fair Value
 
(Dollars in thousands)
Assets
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Available for sale
$
45,551,348

 
$
45,551,348

 
$
45,372,989

 
$
45,372,989

Held for investment
77,043

 
69,441

 
77,041

 
76,460

Mortgage loans on real estate
2,699,637

 
2,684,976

 
2,665,531

 
2,670,037

Derivative instruments
847,741

 
847,741

 
1,568,380

 
1,568,380

Other investments
481,825

 
472,642

 
616,764

 
605,894

Cash and cash equivalents
723,784

 
723,784

 
1,434,045

 
1,434,045

Coinsurance deposits
4,871,912

 
4,402,849

 
4,858,289

 
4,347,990

Interest rate caps
890

 
890

 
415

 
415

Interest rate swap
427

 
427

 

 

Counterparty collateral
124,778

 
124,778

 
186,108

 
186,108

 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
Policy benefit reserves
55,713,429

 
47,137,678

 
55,786,011

 
46,344,931

Single premium immediate annuity (SPIA) benefit reserves
279,678

 
288,991

 
282,563

 
292,153

Notes payable
494,215

 
506,345

 
494,093

 
521,800

Subordinated debentures
242,667

 
229,588

 
242,565

 
244,117

Amounts due under repurchase agreements
137,223

 
137,223

 

 

Interest rate swap

 

 
789

 
789

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. There were no transfers between levels during any period presented.

10

Table of Contents

Our assets and liabilities which are measured at fair value on a recurring basis as of March 31, 2018 and December 31, 2017 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, 2018
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
United States Government full faith and credit
$
11,433

 
$
5,541

 
$
5,892

 
$

United States Government sponsored agencies
1,270,106

 

 
1,270,106

 

United States municipalities, states and territories
4,137,005

 

 
4,137,005

 

Foreign government obligations
231,671

 

 
231,671

 

Corporate securities
29,584,128

 
375

 
29,583,753

 

Residential mortgage backed securities
1,102,609

 

 
1,102,609

 

Commercial mortgage backed securities
5,596,882

 

 
5,596,882

 

Other asset backed securities
3,617,514

 

 
3,617,514

 

Other investments: equity securities
157,431

 
150,000

 
7,431

 

Derivative instruments
847,741

 

 
847,741

 

Cash and cash equivalents
723,784

 
723,784

 

 

Interest rate caps
890

 

 
890

 

Interest rate swap
427

 

 
427

 

Counterparty collateral
124,778

 

 
124,778

 

 
$
47,406,399

 
$
879,700

 
$
46,526,699

 
$

Liabilities
 
 
 
 
 
 
 
Fixed index annuities - embedded derivatives
$
8,233,557

 
$

 
$

 
$
8,233,557

 
$
8,233,557

 
$

 
$

 
$
8,233,557

 
 
 
 
 
 
 
 
December 31, 2017
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
United States Government full faith and credit
$
11,876

 
$
5,640

 
$
6,236

 
$

United States Government sponsored agencies
1,305,017

 

 
1,305,017

 

United States municipalities, states and territories
4,166,812

 

 
4,166,812

 

Foreign government obligations
239,360

 

 
239,360

 

Corporate securities
29,878,971

 
5

 
29,878,966

 

Residential mortgage backed securities
1,105,567

 

 
1,105,567

 

Commercial mortgage backed securities
5,544,850

 

 
5,544,850

 

Other asset backed securities
3,120,536

 

 
3,120,536

 

Other investments: equity securities, available for sale
292,429

 
285,000

 
7,429

 

Derivative instruments
1,568,380

 

 
1,568,380

 

Cash and cash equivalents
1,434,045

 
1,434,045

 

 

Interest rate caps
415

 

 
415

 

Counterparty collateral
186,108

 

 
186,108

 

 
$
48,854,366

 
$
1,724,690

 
$
47,129,676

 
$

Liabilities
 
 
 
 
 
 
 
Interest rate swap
$
789

 
$

 
$
789

 
$

Fixed index annuities - embedded derivatives
8,790,427

 

 

 
8,790,427

 
$
8,791,216

 
$

 
$
789

 
$
8,790,427


11

Table of Contents

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 and equity securities
The fair values of fixed maturity securities and equity 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, 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, 2018 and December 31, 2017.
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.
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 (see determination of fair value above). Financial instruments included in other investments that are not measured at fair value on a recurring basis are policy loans, equity method investments and company owned life insurance ("COLI"). We have not attempted to determine the fair values associated with our policy loans, as we believe any differences between carrying values and the fair values afforded these instruments are immaterial to our consolidated financial position and, accordingly, the cost to provide such disclosure does not justify the benefit to be derived. The fair values of our equity method investments are obtained from third parties and determined by calculating the present value of future cash flows discounted by a risk free rate, a risk spread and a liquidity discount. 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 of our COLI approximates the cash surrender value of the policies and falls within Level 2 of the fair value hierarchy.

12

Table of Contents

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.
Interest rate swap and caps
The fair values of our pay fixed/receive variable interest rate swap and our interest rate caps are obtained from third parties and are determined by discounting expected future cash flows using a projected London Interbank Offered Rate ("LIBOR") for the term of the swap and caps.
Counterparty collateral
Amounts reported in other assets 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.
Notes payable
The fair values of our senior unsecured notes are based upon pricing matrices developed by a third party pricing service when quoted market prices are not available 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.
Amounts due under repurchase agreements
The amounts reported in the consolidated balance sheets for short term indebtedness under repurchase agreements with variable interest rates approximate their fair values.
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 March 31, 2018 and December 31, 2017, we utilized an estimate of 3.10% 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.

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Table of Contents

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 revised as our experience develops and/or as future expectations change. Our mortality rate assumptions are based on 65% of the 1983 Basic Annuity Mortality Tables. 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, 2018
 
December 31, 2017
 
March 31, 2018
 
December 31, 2017
1 - 5
 
2.11%
 
1.83%
 
3.33%
 
3.32%
6 - 10
 
7.30%
 
7.01%
 
3.33%
 
3.32%
11 - 15
 
11.33%
 
11.31%
 
3.34%
 
3.34%
16 - 20
 
11.91%
 
11.96%
 
3.24%
 
3.20%
20+
 
11.58%
 
11.62%
 
3.21%
 
3.20%
Lapse rates are generally expected to increase as surrender charge percentages decrease. 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 liabilities, which are measured at fair value on a recurring basis using significant unobservable inputs for the three months ended March 31, 2018 and 2017:
 
Three Months Ended 
 March 31,
 
2018
 
2017
 
(Dollars in thousands)
Fixed index annuities - embedded derivatives
 
 
 
Beginning balance
$
8,790,427

 
$
6,563,288

Premiums less benefits
549,153

 
411,502

Change in fair value, net
(1,106,023
)
 
76,210

Ending balance
$
8,233,557

 
$
7,051,000

The fair value of our fixed index annuities embedded derivatives is net of coinsurance ceded of $529.6 million and $539.7 million as of March 31, 2018 and December 31, 2017, 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, 2018, were to increase by 100 basis points, the fair value of the embedded derivatives would decrease by $529.0 million recorded through operations as a decrease in the change in fair value of embedded derivatives and there would be a corresponding decrease of $321.0 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 rate used to discount the excess projected contract values would increase the fair value of the embedded derivatives by $588.5 million recorded through operations as an increase in the change in fair value of embedded derivatives and there would be a corresponding increase of $340.9 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.

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Table of Contents

3. Investments
At March 31, 2018 and December 31, 2017, the amortized cost and fair value of fixed maturity securities were as follows:
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
 
(Dollars in thousands)
March 31, 2018
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
United States Government full faith and credit
$
11,696

 
$
110

 
$
(373
)
 
$
11,433

United States Government sponsored agencies
1,308,312

 
21,134

 
(59,340
)
 
1,270,106

United States municipalities, states and territories
3,853,098

 
296,762

 
(12,855
)
 
4,137,005

Foreign government obligations
227,617

 
8,502

 
(4,448
)
 
231,671

Corporate securities
28,801,351

 
1,186,607

 
(403,830
)
 
29,584,128

Residential mortgage backed securities
1,044,032

 
65,581

 
(7,004
)
 
1,102,609

Commercial mortgage backed securities
5,685,290

 
33,098

 
(121,506
)
 
5,596,882

Other asset backed securities
3,579,417

 
52,730

 
(14,633
)
 
3,617,514

 
$
44,510,813

 
$
1,664,524

 
$
(623,989
)
 
$
45,551,348

Held for investment:
 
 
 
 
 
 
 
Corporate security
$
77,043

 
$

 
$
(7,602
)
 
$
69,441

 
 
 
 
 
 
 
 
December 31, 2017
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
United States Government full faith and credit
$
11,861

 
$
162

 
$
(147
)
 
$
11,876

United States Government sponsored agencies
1,308,290

 
28,457

 
(31,730
)
 
1,305,017

United States municipalities, states and territories
3,804,360

 
366,048

 
(3,596
)
 
4,166,812

Foreign government obligations
228,214

 
13,171

 
(2,025
)
 
239,360

Corporate securities
28,127,653

 
1,897,005

 
(145,687
)
 
29,878,971

Residential mortgage backed securities
1,028,484

 
79,554

 
(2,471
)
 
1,105,567

Commercial mortgage backed securities
5,531,922

 
82,768

 
(69,840
)
 
5,544,850

Other asset backed securities
3,075,975

 
57,966

 
(13,405
)
 
3,120,536

 
$
43,116,759

 
$
2,525,131

 
$
(268,901
)
 
$
45,372,989

Held for investment:
 
 
 
 
 
 
 
Corporate security
$
77,041

 
$

 
$
(581
)
 
$
76,460

 
 
 
 
 
 
 
 
Other investments: equity securities, available for sale:
 
 
 
 
 
 
 
Finance, insurance, and real estate
$
292,429

 
$

 
$

 
$
292,429

At March 31, 2018, 37% of our fixed income securities have call features, of which 2.7% ($1.2 billion) were subject to call redemption and another 0.2% ($111.2 million) will become subject to call redemption during the next twelve months. Approximately 74% of our fixed income securities that have call features are not callable until within six months of their stated maturities.

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Table of Contents

The amortized cost and fair value of fixed maturity securities at March 31, 2018, by contractual maturity, are shown below. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. All of our mortgage and other asset backed securities provide for periodic payments throughout their lives and are shown below as separate lines.
 
Available for sale
 
Held for investment
 
Amortized
Cost
 
Fair Value
 
Amortized
Cost
 
Fair Value
 
(Dollars in thousands)
Due in one year or less
$
218,825

 
$
223,487

 
$

 
$

Due after one year through five years
5,615,360

 
5,673,765

 

 

Due after five years through ten years
10,439,109

 
10,428,466

 

 

Due after ten years through twenty years
9,188,746

 
9,774,966

 

 

Due after twenty years
8,740,034

 
9,133,659

 
77,043

 
69,441

 
34,202,074

 
35,234,343

 
77,043

 
69,441

Residential mortgage backed securities
1,044,032

 
1,102,609

 

 

Commercial mortgage backed securities
5,685,290

 
5,596,882

 

 

Other asset backed securities
3,579,417

 
3,617,514

 

 

 
$
44,510,813

 
$
45,551,348

 
$
77,043

 
$
69,441

Net unrealized gains on available for sale fixed maturity securities reported as a separate component of stockholders' equity were comprised of the following:
 
March 31, 2018
 
December 31, 2017
 
(Dollars in thousands)
Net unrealized gains on available for sale fixed maturity securities
$
1,040,535

 
$
2,256,230

Adjustments for assumed changes in amortization of deferred policy acquisition costs and deferred sales inducements
(562,755
)
 
(1,206,078
)
Deferred income tax valuation allowance reversal
22,534

 
22,534

Deferred income tax expense (a)
(100,332
)
 
(348,087
)
Net unrealized gains reported as accumulated other comprehensive income
$
399,982

 
$
724,599

(a)
December 31, 2017 includes $128 million related to the impact of Tax Reform that was reclassified between accumulated other comprehensive income and retained earnings within our consolidated balance sheet during the first quarter of 2018. For more information regarding the reclassification, see Note 1 to our unaudited consolidated financial statements.
The National Association of Insurance Commissioners ("NAIC") assigns designations to fixed maturity securities. These designations range from Class 1 (highest quality) to Class 6 (lowest quality). In general, securities are assigned a designation based upon the ratings they are given by the Nationally Recognized Statistical Rating Organizations ("NRSRO’s"). The NAIC designations are utilized by insurers in preparing their annual statutory statements. NAIC Class 1 and 2 designations are considered "investment grade" while NAIC Class 3 through 6 designations are considered "non-investment grade." Based on the NAIC designations, we had 97% of our fixed maturity portfolio rated investment grade at both March 31, 2018 and December 31, 2017, respectively.
The following table summarizes the credit quality, as determined by NAIC designation, of our fixed maturity portfolio as of the dates indicated:
 
 
March 31, 2018
 
December 31, 2017
NAIC
Designation
 
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
 
 
(Dollars in thousands)
1
 
$
27,142,276

 
$
27,984,297

 
$
26,669,427

 
$
28,274,379

2
 
15,897,296

 
16,147,267

 
15,198,551

 
15,869,219

3
 
1,350,395

 
1,316,146

 
1,161,737

 
1,157,420

4
 
170,754

 
145,085

 
134,838

 
117,542

5
 
17,108

 
19,926

 
17,015

 
20,927

6
 
10,027

 
8,068

 
12,232

 
9,962

 
 
$
44,587,856

 
$
45,620,789

 
$
43,193,800

 
$
45,449,449


16

Table of Contents

The following table shows our investments' gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities (consisting of 1,902 and 955 securities, respectively) have been in a continuous unrealized loss position, at March 31, 2018 and December 31, 2017:
 
Less than 12 months
 
12 months or more
 
Total
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
(Dollars in thousands)
March 31, 2018
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
 
 
 
 
United States Government full faith and credit
$
3,193

 
$
(50
)
 
$
6,380

 
$
(323
)
 
$
9,573

 
$
(373
)
United States Government sponsored agencies
74,632

 
(1,513
)
 
932,691

 
(57,827
)
 
1,007,323

 
(59,340
)
United States municipalities, states and territories
224,928

 
(5,000
)
 
124,097

 
(7,855
)
 
349,025

 
(12,855
)
Foreign government obligations
127,620

 
(2,442
)
 
12,297

 
(2,006
)
 
139,917

 
(4,448
)
Corporate securities:
 
 
 
 
 
 
 
 
 
 
 
Finance, insurance and real estate
1,980,979

 
(46,008
)
 
599,683

 
(48,915
)
 
2,580,662

 
(94,923
)
Manufacturing, construction and mining
1,378,585

 
(29,518
)
 
229,805

 
(17,840
)
 
1,608,390

 
(47,358
)
Utilities and related sectors
1,830,012

 
(41,549
)
 
239,209

 
(18,121
)
 
2,069,221

 
(59,670
)
Wholesale/retail trade
755,307

 
(16,446
)
 
173,229

 
(16,809
)
 
928,536

 
(33,255
)
Services, media and other
3,498,221

 
(85,932
)
 
855,680

 
(82,692
)
 
4,353,901

 
(168,624
)
Residential mortgage backed securities
286,561

 
(4,535
)
 
24,870

 
(2,469
)
 
311,431

 
(7,004
)
Commercial mortgage backed securities
2,495,283

 
(43,167
)
 
1,310,142

 
(78,339
)
 
3,805,425

 
(121,506
)
Other asset backed securities
797,174

 
(6,376
)
 
187,857

 
(8,257
)
 
985,031

 
(14,633
)
 
$
13,452,495

 
$
(282,536
)
 
$
4,695,940

 
$
(341,453
)
 
$
18,148,435

 
$
(623,989
)
Held for investment:
 
 
 
 
 
 
 
 
 
 
 
Corporate security:
 
 
 
 
 
 
 
 
 
 
 
Insurance
$

 
$

 
$
69,441

 
$
(7,602
)
 
$
69,441

 
$
(7,602
)
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2017
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
 
 
 
 
United States Government full faith and credit
$
1,565

 
$
(10
)
 
$
6,731

 
$
(137
)
 
$
8,296

 
$
(147
)
United States Government sponsored agencies
44,794

 
(180
)
 
958,965

 
(31,550
)
 
1,003,759

 
(31,730
)
United States municipalities, states and territories
44,736

 
(128
)
 
128,499

 
(3,468
)
 
173,235

 
(3,596
)
Foreign government obligations
49,663

 
(337
)
 
12,625

 
(1,688
)
 
62,288

 
(2,025
)
Corporate securities:
 
 
 
 
 
 
 
 
 
 
 
Finance, insurance and real estate
456,244

 
(5,135
)
 
600,655

 
(28,043
)
 
1,056,899

 
(33,178
)
Manufacturing, construction and mining
222,985

 
(3,475
)
 
231,196

 
(10,849
)
 
454,181

 
(14,324
)
Utilities and related sectors
395,183

 
(4,099
)
 
249,416

 
(8,901
)
 
644,599

 
(13,000
)
Wholesale/retail trade
152,941

 
(1,249
)
 
178,635

 
(11,371
)
 
331,576

 
(12,620
)
Services, media and other
729,124

 
(19,000
)
 
891,654

 
(53,565
)
 
1,620,778

 
(72,565
)
Residential mortgage backed securities
39,771

 
(387
)
 
32,917

 
(2,084
)
 
72,688

 
(2,471
)
Commercial mortgage backed securities
1,096,757

 
(10,385
)
 
1,306,437

 
(59,455
)
 
2,403,194

 
(69,840
)
Other asset backed securities
765,531

 
(3,499
)
 
217,595

 
(9,906
)
 
983,126

 
(13,405
)
 
$
3,999,294

 
$
(47,884
)
 
$
4,815,325

 
$
(221,017
)
 
$
8,814,619

 
$
(268,901
)
Held for investment:
 
 
 
 
 
 
 
 
 
 
 
Corporate security:
 
 
 
 
 
 
 
 
 
 
 
Insurance
$

 
$

 
$
76,460

 
$
(581
)
 
$
76,460

 
$
(581
)
Based on the results of our process for evaluating available for sale securities in unrealized loss positions for other than temporary impairments, which is discussed in detail later in this footnote, we have determined that the unrealized losses on the securities in the preceding table are temporary. The unrealized losses at March 31, 2018 are principally related to timing of the purchases of these securities, which carry less yield than those available at March 31, 2018.

17

Table of Contents

Approximately 88% and 83% of the unrealized losses on fixed maturity securities shown in the above table for March 31, 2018 and December 31, 2017, respectively, are on securities that are rated investment grade, defined as being the highest two NAIC designations. All of the fixed maturity securities with unrealized losses are current with respect to the payment of principal and interest.
Changes in net unrealized gains on investments for the three months ended March 31, 2018 and 2017 are as follows:
 
Three Months Ended 
 March 31,
 
2018
 
2017
 
(Dollars in thousands)
Fixed maturity securities held for investment carried at amortized cost
$
(7,021
)
 
$
(1,976
)
Investments carried at fair value:
 
 
 
Fixed maturity securities, available for sale
$
(1,215,695
)
 
$
281,094

Equity securities, available for sale

 
(13
)
 
(1,215,695
)
 
281,081

Adjustment for effect on other balance sheet accounts:
 
 
 
Deferred policy acquisition costs and deferred sales inducements
643,323

 
(150,962
)
Deferred income tax asset/liability
120,201

 
(45,542
)
 
763,524

 
(196,504
)
Change in net unrealized gains on investments carried at fair value
$
(452,171
)
 
$
84,577

Proceeds from sales of available for sale securities for the three months ended March 31, 2018 and 2017 were $85.5 million and $186.5 million, respectively. Scheduled principal repayments, calls and tenders for available for sale fixed maturity securities for the three months ended March 31, 2018 and 2017 were $180.4 million and $330.8 million, respectively.
Realized gains and losses on sales are determined on the basis of specific identification of investments based on the trade date. Net realized gains on investments, excluding net OTTI losses for the three months ended March 31, 2018 and 2017, are as follows:
 
Three Months Ended 
 March 31,
 
2018
 
2017
 
(Dollars in thousands)
Available for sale fixed maturity securities:
 
 
 
Gross realized gains
$
1,382

 
$
5,572

Gross realized losses
(2,102
)
 
(3,563
)
 
(720
)
 
2,009

 
 
 
 
Other investments:
 
 
 
Gain on sale of real estate

 
29

 
 
 
 
Mortgage loans on real estate:
 
 
 
Decrease in allowance for credit losses
300

 
300

Recovery of specific allowance
722

 

 
1,022

 
300

 
$
302

 
$
2,338

Losses on available for sale fixed maturity securities were realized primarily due to strategies to reposition the fixed maturity security portfolio that result in improved net investment income, credit risk or duration profiles as they pertain to our asset liability management.
We review and analyze all investments on an ongoing basis for changes in market interest rates and credit deterioration. This review process includes analyzing our ability to recover the amortized cost basis of each investment that has a fair value that is materially lower than its amortized cost and requires a high degree of management judgment and involves uncertainty. The evaluation of securities for other than temporary impairments is a quantitative and qualitative process, which is subject to risks and uncertainties.
We have a policy and process to identify securities that could potentially have impairments that are other than temporary. This process involves monitoring market events and other items that could impact issuers. The evaluation includes but is not limited to such factors as:
the length of time and the extent to which the fair value has been less than amortized cost or cost;
whether the issuer is current on all payments and all contractual payments have been made as agreed;
the remaining payment terms and the financial condition and near-term prospects of the issuer;

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Table of Contents

the lack of ability to refinance due to liquidity problems in the credit market;
the fair value of any underlying collateral;
the existence of any credit protection available;
our intent to sell and whether it is more likely than not we would be required to sell prior to recovery for debt securities;
consideration of rating agency actions; and
changes in estimated cash flows of mortgage and asset backed securities.
We determine whether other than temporary impairment losses should be recognized for debt securities by assessing all facts and circumstances surrounding each security. Where the decline in fair value of debt securities is attributable to changes in market interest rates or to factors such as market volatility, liquidity and spread widening, and we anticipate recovery of all contractual or expected cash flows, we do not consider these investments to be other than temporarily impaired because we do not intend to sell these investments and it is not more likely than not we will be required to sell these investments before a recovery of amortized cost, which may be maturity.
If we intend to sell a debt security or if it is more likely than not that we will be required to sell a debt security before recovery of its amortized cost basis, other than temporary impairment has occurred and the difference between amortized cost and fair value will be recognized as a loss in operations.
If we do not intend to sell and it is not more likely than not we will be required to sell the debt security but also do not expect to recover the entire amortized cost basis of the security, an impairment loss would be recognized in operations in the amount of the expected credit loss. We determine the amount of expected credit loss by calculating the present value of the cash flows expected to be collected discounted at each security's acquisition yield based on our consideration of whether the security was of high credit quality at the time of acquisition. The difference between the present value of expected future cash flows and the amortized cost basis of the security is the amount of credit loss recognized in operations. The remaining amount of the other than temporary impairment is recognized in other comprehensive income (loss).
The determination of the credit loss component of a mortgage backed security is based on a number of factors. The primary consideration in this evaluation process is the issuer's ability to meet current and future interest and principal payments as contractually stated at time of purchase. Our review of these securities includes an analysis of the cash flow modeling under various default scenarios considering independent third party benchmarks, the seniority of the specific tranche within the structure of the security, the composition of the collateral and the actual default, loss severity and prepayment experience exhibited. With the input of third party assumptions for default projections, loss severity and prepayment expectations, we evaluate the cash flow projections to determine whether the security is performing in accordance with its contractual obligation.
We utilize the models from a leading structured product software specialist serving institutional investors. These models incorporate each security's seniority and cash flow structure. In circumstances where the analysis implies a potential for principal loss at some point in the future, we use the "best estimate" cash flow projection discounted at the security's effective yield at acquisition to determine the amount of our potential credit loss associated with this security. The discounted expected future cash flows equates to our expected recovery value. Any shortfall of the expected recovery when compared to the amortized cost of the security will be recorded as the credit loss component of other than temporary impairment.
The cash flow modeling is performed on a security-by-security basis and incorporates actual cash flows on the residential mortgage backed securities through the current period, as well as the projection of remaining cash flows using a number of assumptions including default rates, prepayment rates and loss severity rates. The default curves we use are tailored to the Prime or Alt-A residential mortgage backed securities that we own, which assume lower default rates and loss severity for Prime securities versus Alt-A securities. These default curves are scaled higher or lower depending on factors such as current underlying mortgage loan performance, rating agency loss projections, loan to value ratios, geographic diversity, as well as other appropriate considerations.
The following table presents the range of significant assumptions used to determine the credit loss component of other than temporary impairments we have recognized on residential mortgage backed securities for the three months ended March 31, 2017, which are all senior level tranches within the structure of the securities:
 
 
 
 
Discount Rate
 
Default Rate
 
Loss Severity
Sector
 
Vintage
 
Min
 
Max
 
Min
 
Max
 
Min
 
Max
Three months ended March 31, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Prime
 
2005
 
7.7
%
 
7.7
%
 
8
%
 
8
%
 
50
%
 
50
%
 
 
2007
 
6.2
%
 
6.3
%
 
15
%
 
18
%
 
50
%
 
60
%
The determination of the credit loss component of a corporate bond (including redeemable preferred stocks) is based on the underlying financial performance of the issuer and their ability to meet their contractual obligations. Considerations in our evaluation include, but are not limited to, credit rating changes, financial statement and ratio analysis, changes in management, significant changes in credit spreads, breaches of financial covenants and a review of the economic outlook for the industry and markets in which they trade. In circumstances where an issuer appears unlikely to meet its future obligation, or the security's price decline is deemed other than temporary, an estimate of credit loss is determined. Credit loss is calculated using default probabilities as derived from the credit default swaps markets in conjunction with recovery rates derived from independent third party analysis or a best estimate of credit loss. This credit loss rate is then incorporated into a present value calculation based on an expected principal loss in the future discounted at the yield at the date of purchase and compared to amortized cost to determine the amount of credit loss associated with the security.

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Table of Contents

In addition, for debt securities which we do not intend to sell and it is not more likely than not we will be required to sell, but our intent changes due to changes or events that could not have been reasonably anticipated, an other than temporary impairment charge is recognized. Once an impairment charge has been recorded, we then continue to review the other than temporarily impaired securities for appropriate valuation on an ongoing basis. Unrealized losses may be recognized in future periods through a charge to earnings should we later conclude that the decline in fair value below amortized cost is other than temporary pursuant to our accounting policy described above. The use of different methodologies and assumptions to determine the fair value of investments and the timing and amount of impairments may have a material effect on the amounts presented in our consolidated financial statements.
The following table summarizes other than temporary impairments for the three months ended March 31, 2018 and 2017, by asset type:
 
Number
of
Securities
 
Total OTTI
Losses
 
Portion of OTTI
Losses
Recognized
in (from) Other
Comprehensive
Income
 
Net OTTI
Losses
Recognized in
Operations
 
 
 
(Dollars in thousands)
Three months ended March 31, 2018
 
 
 
 
 
 
 
Fixed maturity securities, available for sale:
 
 
 
 
 
 
 
Corporate securities:
 
 
 
 
 
 
 
Consumer discretionary
1

 
$
(907
)
 
$

 
$
(907
)
 
 
 
 
 
 
 
 
Three months ended March 31, 2017
 
 
 
 
 
 
 
Fixed maturity securities, available for sale:
 
 
 
 
 
 
 
Residential mortgage backed securities
3

 
$

 
$
(141
)
 
$
(141
)
The cumulative portion of other than temporary impairments determined to be credit losses which have been recognized in operations for debt securities are summarized as follows:
 
Three Months Ended 
 March 31,
 
2018
 
2017
 
(Dollars in thousands)
Cumulative credit loss at beginning of period
$
(157,066
)
 
$
(166,375
)
Credit losses on securities for which OTTI has not previously been recognized
(907
)
 

Additional credit losses on securities for which OTTI has previously been recognized

 
(141
)
Accumulated losses on securities that were disposed of during the period
3,900

 
13,939

Cumulative credit loss at end of period
$
(154,073
)
 
$
(152,577
)
The following table summarizes the cumulative noncredit portion of OTTI and the change in fair value since recognition of OTTI, both of which were recognized in other comprehensive income, by major type of security, for securities that are part of our investment portfolio at March 31, 2018 and December 31, 2017:
 
Amortized Cost
 
OTTI
Recognized in
Other
Comprehensive
Income
 
Change in Fair
Value Since
OTTI was
Recognized
 
Fair Value
 
(Dollars in thousands)
March 31, 2018
 
 
 
 
 
 
 
Fixed maturity securities, available for sale:
 
 
 
 
 
 
 
Corporate securities
$
17,947

 
$
(3,700
)
 
$
10,012

 
$
24,259

Residential mortgage backed securities
282,835

 
(168,355
)
 
198,719

 
313,199

Other asset backed securities
4,567

 
(1,356
)
 
(1,631
)
 
1,580

 
$
305,349

 
$
(173,411
)
 
$
207,100

 
$
339,038

December 31, 2017
 
 
 
 
 
 
 
Fixed maturity securities, available for sale: