Fair Value Measurements
 9 Months Ended
Sep. 30, 2012
Fair Value Measurements

5. Fair Value Measurements

Under GAAP, fair value represents the price that would be received to sell an asset (exit price) or paid to transfer a liability in an orderly transaction between market participants at the measurement date. It is the Company’s policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements.

 

The Company categorizes its financial assets and liabilities measured at fair value in three levels, based on the inputs and assumptions used to determine the fair value. These levels are as follows:

Level 1 – Valuations are based upon quoted prices for identical instruments traded in active markets.

Level 2 – Valuations are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. Valuations are obtained from third-party pricing services or inputs that are observable or derived principally from or corroborated by observable market data.

Level 3 – Valuations are generated from techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect the Company’s assumptions that market participants would use in pricing the asset or liability. Valuation techniques include the use of discounted cash flow models, spread-based models, and similar techniques, using the best information available in the circumstances.

Following is a description of valuation methodologies used for assets and liabilities recorded at fair value and for estimating fair value for financial instruments not recorded at fair value but for which fair value is disclosed.

Assets

Securities Available for Sale

Fixed maturity and equity securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon unadjusted quoted prices, if available, except as described in the subsequent paragraphs.

Short-Term Financial Assets

Short-term financial assets include cash and other short-term assets. Cash is categorized as Level 1. Other short-term assets are invested in institutional money market funds. These assets are categorized as Level 2, as the valuation is based upon the net asset value (NAV) of the fund.

Loans

The Company does not record loans at fair value. As such, valuation techniques discussed herein for loans are primarily for estimating fair value for purpose of disclosure.

Fair values of mortgage loans on real estate properties are calculated by discounting contractual cash flows, using discount rates based on current industry pricing or the Company’s estimate of an appropriate risk-adjusted discount rate for loans of similar size, type, remaining maturity, likelihood of prepayment, and repricing characteristics. Mortgage loans are categorized as Level 3 in the fair value hierarchy.

The Company also has loans made to policyholders. These loans cannot exceed the cash surrender value of the policy. Carrying value of policy loans approximates fair value. Policy loans are categorized as Level 3.

Separate Accounts

The separate account assets and liabilities, which are equal, are recorded at fair value based upon NAV. They are categorized as Level 2 in the fair value hierarchy, as the Company receives independent prices from external pricing sources to determine the fair value.

Liabilities

Investment-Type Liabilities Included in Policyholder Account Balances and Other Policyholder Funds

Fair values for liabilities under investment-type insurance contracts are based upon account value. The fair values of investment-type insurance contracts included with policyholder account balances for fixed deferred annuities are estimated to be their cash surrender values. The fair values of supplementary contracts without life contingencies are estimated to be the present value of payments using a market yield. The fair values of deposits with no stated maturity are estimated to be the amount payable on demand at the measurement date. These liabilities are categorized as Level 3.

Guaranteed Minimum Withdrawal Benefits (GMWB)

The Company offers a GMWB rider that can be added to new or existing variable annuity contracts. The rider provides an enhanced withdrawal benefit that guarantees a stream of income payments to an owner or annuitant, regardless of the contract account value. Fair value for GMWB rider contracts is a Level 3 valuation, as it is based on models which utilize significant unobservable inputs. These models require actuarial and financial market assumptions, which reflect the assumptions market participants would use in pricing the contract, including adjustments for volatility, risk, and issuer non-performance.

 

Notes Payable

Fair values for short-term notes payable approximate their carrying value. The carrying amount is a reasonable estimate of the fair value because of the relatively short time between the origination of the loan and its expected repayment.

Determination of Fair Value

The determination of the fair value of the Company’s fixed maturity and equity securities is the responsibility of the Company’s investment accounting group, which reports to the Principal Accounting Officer. This group manages and creates the policies and processes used to determine the fair value for these assets. This group employs third-party pricing services and obtains selected support from the Company’s portfolio managers in order to achieve results for this multi-tiered process. All prices are reviewed by the investment accounting group. The financial reporting group, the Principal Accounting Officer, and the Chief Financial Officer also review the fair value methodologies and the fair values that are obtained each quarter. The results of those reviews are made known to the Company’s Disclosure Committee and to the Company’s Audit Committee. In addition, any significant policy or process changes made during the quarter are also discussed with the Company’s Audit Committee.

The Company utilizes external independent third-party pricing services to determine the majority of its fair values on investment securities available for sale. At September 30, 2012, 96% of the carrying value of these investments was from external pricing services, 1% was from brokers, and 3% was derived from internal matrices and calculations, unchanged from December 31, 2011. In the event that the primary pricing service does not provide a price, the Company utilizes the price provided by a second pricing service. The Company reviews prices received from service providers for reasonableness and unusual fluctuations but generally accepts the price identified from the primary pricing service. In the event that a price is not available from either third-party pricing service, the Company pursues external pricing from brokers. Generally, the Company pursues and utilizes only one broker quote per security. In doing so, the Company solicits only brokers which have previously demonstrated knowledge and experience of the subject security. If a broker price is not available, the Company determines a fair value through various valuation techniques that may include discounted cash flows, spread-based models, or similar techniques, depending upon the specific security to be priced. These techniques are primarily applied to private placement securities. The Company utilizes available market information, wherever possible, to identify inputs into the fair value determination, primarily including prices and spreads on comparable securities. At September 30, 2012, the Company obtained prices for six securities from brokers and internally determined the prices for 18 securities. At December 31, 2011, the Company obtained prices for five securities from brokers and internally determined the prices for 15 securities.

Each quarter, the Company evaluates the prices received from third-party security pricing services and independent brokers to ensure that the prices represent a reasonable estimate of the fair value within the macro-economic environment, sector factors, and overall pricing trends and expectations. The Company corroborates and validates the primary pricing sources through a variety of procedures that include but are not limited to comparison to additional independent third-party pricing services or brokers, where possible; a review of third-party pricing service methodologies; back testing; and comparison of prices to actual trades for specific securities where observable data exists. In addition, the Company analyzes the primary third-party pricing service’s methodologies and related inputs and also evaluates the various types of securities in its investment portfolio to determine an appropriate fair value hierarchy. Finally, the Company also performs additional evaluations when individual prices fall outside tolerance levels for prices received from third-party pricing services.

Fair value measurements for assets and liabilities where there exists limited or no observable market data are calculated using the Company’s own estimates and are categorized as Level 3. These estimates are based on current interest rates, credit spreads, liquidity premium or discount, the economic and competitive environment, unique characteristics of the asset or liability, and other pertinent factors. Therefore, these estimates cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the asset or liability. Additionally, there may be inherent weaknesses in any valuation technique. Further, changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results of current or future values.

The Company’s own estimates of fair value of fixed maturity and equity securities are derived in a number of ways, including but not limited to: 1) pricing provided by brokers, where the price indicates reliability as to value; 2) fair values of comparable securities, incorporating a spread adjustment for maturity differences, collateralization, credit quality, liquidity, and other items, if applicable; 3) discounted cash flow models and margin spreads; 4) bond yield curves; 5) observable market prices and exchange transaction information not provided by external pricing services; and 6) statement values provided to the Company by fund managers.

 

The determination of the value of the Company’s liabilities that are reported at fair value in the financial statements is the responsibility of the Company’s valuation actuary group, which reports to the Company’s Senior Vice President and Actuary. This group manages and creates the policies and processes used to determine the fair value for these liabilities. This methodology uses internal assumptions and directed third-party inputs to derive a value including a risk-neutral option pricing model that incorporates a third-party-developed index that is consistent with the attributes of the product and provides for an approximate match of the volatility measure with the expected life of the underlying contracts. The fair value methodologies and the fair values are reviewed by the Senior Vice President and Actuary, the Principal Accounting Officer, and the Chief Financial Officer. The results of those reviews are made known to the Company’s Disclosure Committee and to the Company’s Audit Committee. In addition, any significant policy or process changes made during the quarter are also discussed with the Company’s Audit Committee.

Categories Reported at Fair Value

The following tables present categories reported at fair value on a recurring basis.

 

     September 30, 2012  
         Level 1              Level 2              Level 3               Total        

Assets:

           

U.S. Treasury securities and obligations of U.S. Government

    $ 12,790       $ 122,692       $ 3,029      $ 138,511   

Federal agencies 1

      -         26,250         -        26,250   

Federal agency issued residential mortgage-backed securities 1

      -         101,235         -        101,235   
  

 

 

     

 

 

     

 

 

    

 

 

  

Subtotal

      12,790         250,177         3,029        265,996   

Corporate obligations:

           

Industrial

      2,900         549,206         2,444        554,550   

Energy

      2,500         201,853         2,359        206,712   

Communications and technology

      -         225,310         -        225,310   

Financial

      2,000         315,303         11,534        328,837   

Consumer

      4,070         530,605         25,869        560,544   

Public utilities

      3,000         293,452         -        296,452   
  

 

 

     

 

 

     

 

 

    

 

 

  

Subtotal

      14,470         2,115,729         42,206        2,172,405   

Corporate private-labeled residential mortgage-backed securities

      -         154,567         -        154,567   

Municipal securities

      -         170,003         4,363        174,366   

Other

      -         99,886         2,194        102,080   

Redeemable preferred stocks

      9,211         -         -        9,211   
  

 

 

     

 

 

     

 

 

    

 

 

  

Fixed maturity securities

      36,471         2,790,362         51,792        2,878,625   
  

 

 

     

 

 

     

 

 

    

 

 

  

Equity securities

      2,172         34,072         1,209        37,453   
  

 

 

     

 

 

     

 

 

    

 

 

  

Total

    $ 38,643       $ 2,824,434       $ 53,001      $ 2,916,078   
  

 

 

     

 

 

     

 

 

    

 

 

  

Percent of total

      1%         97%         2%        100%   
  

 

 

     

 

 

     

 

 

    

 

 

  

Liabilities:

           

Other policyholder funds

           

GMWB

    $ -       $ -       $ (409 )    $ (409 ) 
  

 

 

     

 

 

     

 

 

    

 

 

  

Total

    $ -       $ -       $ (409 )    $ (409 ) 
  

 

 

     

 

 

     

 

 

    

 

 

  

 

1

Federal agency securities are not backed by the full faith and credit of the U.S. Government.

 

     December 31, 2011  
         Level 1              Level 2              Level 3               Total        

Assets:

           

U.S. Treasury securities and obligations of U.S. Government

    $ 12,876       $ 118,130       $ 3,431      $ 134,437   

Federal agencies 1

      -         25,881         -        25,881   

Federal agency issued residential mortgage-backed securities 1

      -         119,637         -        119,637   
  

 

 

     

 

 

     

 

 

    

 

 

  

Subtotal

      12,876         263,648         3,431        279,955   

Corporate obligations:

           

Industrial

      -         486,380         500        486,880   

Energy

      -         169,342         2,369        171,711   

Communications and technology

      -         201,393         -        201,393   

Financial

      -         307,464         10,614        318,078   

Consumer

      -         474,553         21,934        496,487   

Public utilities

      -         296,337         -        296,337   
  

 

 

     

 

 

     

 

 

    

 

 

  

Subtotal

      -         1,935,469         35,417        1,970,886   

Corporate private-labeled residential mortgage-backed securities

      -         156,902         -        156,902   

Municipal securities

      -         163,611         4,911        168,522   

Other

      -         94,656         -        94,656   

Redeemable preferred stocks

      11,221         -         -        11,221   
  

 

 

     

 

 

     

 

 

    

 

 

  

Fixed maturity securities

      24,097         2,614,286         43,759        2,682,142   
  

 

 

     

 

 

     

 

 

    

 

 

  

Equity securities

      2,216         33,350         1,123        36,689   
  

 

 

     

 

 

     

 

 

    

 

 

  

Total

    $ 26,313       $ 2,647,636       $ 44,882      $ 2,718,831   
  

 

 

     

 

 

     

 

 

    

 

 

  

Percent of total

      1%         97%         2%        100%   
  

 

 

     

 

 

     

 

 

    

 

 

  

Liabilities:

           

Other policyholder funds

           

GMWB

    $ -       $ -       $ (187 )    $ (187 ) 
  

 

 

     

 

 

     

 

 

    

 

 

  

Total

    $ -       $ -       $ (187 )    $ (187 ) 
  

 

 

     

 

 

     

 

 

    

 

 

  

 

1

Federal agency securities are not backed by the full faith and credit of the U.S. Government.

 

The following tables present the fair value of fixed maturity and equity securities available for sale by pricing source and fair value hierarchy level.

 

     September 30, 2012  
         Level 1              Level 2              Level 3                Total        

Fixed maturity securities available for sale:

            

Priced from external pricing services

    $ 36,471       $ 2,751,815       $ -       $ 2,788,286   

Priced from independent broker quotations

      -         38,547         -         38,547   

Priced from internal matrices and calculations

      -         -         51,792         51,792   
  

 

 

     

 

 

     

 

 

     

 

 

  

Subtotal

      36,471         2,790,362         51,792         2,878,625   
  

 

 

     

 

 

     

 

 

     

 

 

  

Equity securities available for sale:

            

Priced from external pricing services

      2,172         7,273         -         9,445   

Priced from independent broker quotations

      -         -         -         -   

Priced from internal matrices and calculations

      -         26,799         1,209         28,008   
  

 

 

     

 

 

     

 

 

     

 

 

  

Subtotal

      2,172         34,072         1,209         37,453   
  

 

 

     

 

 

     

 

 

     

 

 

  

Total

    $ 38,643       $ 2,824,434       $ 53,001       $ 2,916,078   
  

 

 

     

 

 

     

 

 

     

 

 

  

Percent of total

      1%         97%         2%         100%   
  

 

 

     

 

 

     

 

 

     

 

 

  
     December 31, 2011  
         Level 1              Level 2              Level 3                Total        

Fixed maturity securities available for sale:

            

Priced from external pricing services

    $ 24,097       $ 2,582,617       $ -       $ 2,606,714   

Priced from independent broker quotations

      -         31,669         -         31,669   

Priced from internal matrices and calculations

      -         -         43,759         43,759   
  

 

 

     

 

 

     

 

 

     

 

 

  

Subtotal

      24,097         2,614,286         43,759         2,682,142   
  

 

 

     

 

 

     

 

 

     

 

 

  

Equity securities available for sale:

            

Priced from external pricing services

      2,216         7,444         -         9,660   

Priced from independent broker quotations

      -         -         -         -   

Priced from internal matrices and calculations

      -         25,906         1,123         27,029   
  

 

 

     

 

 

     

 

 

     

 

 

  

Subtotal

      2,216         33,350         1,123         36,689   
  

 

 

     

 

 

     

 

 

     

 

 

  

Total

    $ 26,313       $ 2,647,636       $ 44,882       $ 2,718,831   
  

 

 

     

 

 

     

 

 

     

 

 

  

Percent of total

      1%         97%         2%         100%   
  

 

 

     

 

 

     

 

 

     

 

 

  

 

The changes in Level 3 assets and liabilities measured at fair value on a recurring basis for the third quarter and nine months ended September 30, 2012 and year ended December 31, 2011 are summarized below:

 

     Quarter Ended September 30, 2012  
     Assets         Liabilities      
     Fixed maturity
securities  available
for sale		     Equity securities
available
for sale		            Total           GMWB  

Beginning balance

    $ 44,999      $ 1,149       $ 46,148      $ 278   

Included in earnings

      (340 )      -         (340 )      (978 ) 

Included in other comprehensive income

      (107 )      60         (47 )      -   

Purchases, issuances, sales and other dispositions:

          

Purchases

      -        -         -        -   

Issuances

      -        -         -        807   

Sales

      -        -         -        -   

Other dispositions

      (697 )      -         (697 )      (516 ) 

Transfers into Level 3

      7,990        -         7,990        -   

Transfers out of Level 3

      (53 )      -         (53 )      -   
  

 

 

    

 

 

     

 

 

    

 

 

  

Ending balance

    $ 51,792      $ 1,209       $ 53,001      $ (409 ) 
  

 

 

    

 

 

     

 

 

    

 

 

  

Net unrealized losses

    $ (406 )    $ 30       $ (376 )   
  

 

 

    

 

 

     

 

 

    
     Nine Months Ended September 30, 2012  
     Assets     Liabilities  
     Fixed maturity
securities  available
for sale		     Equity securities
available
for sale		      Total     GMWB  

Beginning balance

    $ 43,759      $ 1,123       $ 44,882      $ (187 ) 

Included in earnings

      (333 )      -         (333 )      (295 ) 

Included in other comprehensive income

      (146 )      86         (60 )      -   

Purchases, issuances, sales and other dispositions:

          

Purchases

      -        -         -        -   

Issuances

      -        -         -        1,003   

Sales

      -        -         -        -   

Other dispositions

      (3,239 )      -         (3,239 )      (930 ) 

Transfers into Level 3

      11,804        -         11,804        -   

Transfers out of Level 3

      (53 )      -         (53 )      -   
  

 

 

    

 

 

     

 

 

    

 

 

  

Ending balance

    $ 51,792      $ 1,209       $ 53,001      $ (409 ) 
  

 

 

    

 

 

     

 

 

    

 

 

  

Net unrealized losses

    $ (158 )    $ 86       $ (72 )   
  

 

 

    

 

 

     

 

 

    
     Year Ended December 31, 2011  
     Assets         Liabilities      
     Fixed maturity
securities  available
for sale		     Equity securities
available
for sale		           Total           GMWB  

Beginning balance

    $ 55,801      $ 1,180      $ 56,981      $ (2,799 ) 

Included in earnings

      11        92        103        2,500   

Included in other comprehensive income

      1,385        51        1,436        -   

Purchases, issuances, sales and other dispositions:

         

Purchases

      -        -        -        -   

Issuances

      -        -        -        163   

Sales

      -        -        -        -   

Other dispositions

      (2,977 )      (200 )      (3,177 )      (51 ) 

Transfers into Level 3

      8,640        -        8,640        -   

Transfers out of Level 3

      (19,101 )      -        (19,101 )      -   
  

 

 

    

 

 

    

 

 

    

 

 

  

Ending balance

    $ 43,759      $ 1,123      $ 44,882      $ (187 ) 
  

 

 

    

 

 

    

 

 

    

 

 

  

Net unrealized gains

    $ 1,401      $ 105      $ 1,506     
  

 

 

    

 

 

    

 

 

    

The Company did not exclude any realized or unrealized gains or losses on items transferred into Level 3 in any of the periods presented. Depending upon the availability of Level 1 or Level 2 pricing, specific securities may transfer into or out of Level 3. The Company transferred five securities from Level 2 to Level 1 during the third quarter ended September 30, 2012. These securities were approaching maturity and the price was known.

The following table presents quantitative information about material Level 3 fair value measurements as of September 30, 2012.

 

                                 Weighted  
            Valuation      Unobservable      Range      Average  
     Fair Value      Technique      Inputs      (in basis points)      of Range  

Fixed maturity securities

    $ 51,792         Market comparable         Spread adjustment         69 -353         204   

The Company’s primary category of Level 3 fair values is fixed maturity securities, totaling $51.8 million as of September 30, 2012. These assets are valued using comparable security valuations through the unobservable input of estimated discount spreads. Specifically, the Company reviews the values and discount spreads on similar securities for which such information is observable in the market. Estimates of increased discount spreads are then determined based upon the characteristics of the securities being evaluated. The Company estimates that an increased spread of 10 basis points on each of the Level 3 securities would reduce the reported fair value by $0.2 million as of September 30, 2012.

Other assets and liabilities categorized as Level 3 for purposes of fair value determination are not material to the Company’s financial statements, and the sensitivities of such valuations to unobservable inputs are also believed to not be material.

 

The table below is a summary of fair value estimates at September 30, 2012 and December 31, 2011 for financial instruments. The Company has not included assets and liabilities that are not financial instruments in this disclosure. The total of the fair value calculations presented do not represent, and should not be construed to represent, the underlying value of the Company.

 

     September 30, 2012     December 31, 2011  
     Carrying     Fair     Carrying     Fair  
     Value     Value     Value     Value  

Assets:

         

Investments:

         

Fixed maturity securities available for sale

    $ 2,878,625      $ 2,878,625      $ 2,682,142      $ 2,682,142   

Equity securities available for sale

      37,453        37,453        36,689        36,689   

Mortgage loans

      560,772        602,559        601,923        642,905   

Policy loans

      78,172        78,172        80,375        80,375   

Cash and short-term investments

      34,212        34,212        59,752        59,752   

Separate account assets

      343,721        343,721        316,609        316,609   

Liabilities:

         

Individual and group annuities

      1,125,833        1,105,053        1,082,324        1,062,407   

Supplementary contracts without life contingencies

      54,694        53,869        56,193        54,824   

Separate account liabilities

      343,721        343,721        316,609        316,609   

Other policyholder funds - GMWB

      (409 )      (409 )      (187 )      (187 )