2013-03-31-AEL-10Q


FORM 10-Q
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

(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, 2013
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 of Incorporation)
 
(I.R.S. Employer Identification No.)
 
 
 
6000 Westown Parkway
West Des Moines, Iowa
 
50266
(Address of principal executive offices)
 
(Zip Code)
 
 
 
Registrant's telephone number, including area code
 
(515) 221-0002
 
 
(Telephone)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Name of each exchange on which registered
Common Stock, par value $1
 
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $1
Indicate by check mark whether the registrant (1) has filed all documents and reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or 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 or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o
 
Accelerated filer x
Non-accelerated filer o
 
Smaller reporting company o
(Do not check if a smaller reporting company)
 
 
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:
Shares of common stock outstanding at April 30, 2013: 64,019,160



TABLE OF CONTENTS
 
Page
 
 
 
 
 
 





PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
 
March 31, 2013
 
December 31, 2012
 
(Unaudited)
 
 
Assets
 
 
 
Investments:
 
 
 
Fixed maturity securities:
 
 
 
Available for sale, at fair value (amortized cost: 2013 - $23,513,179; 2012 - $21,957,027)
$
25,609,218

 
$
24,172,136

Held for investment, at amortized cost (fair value: 2013 - $62,173; 2012 - $61,521)
76,129

 
76,088

Equity securities, available for sale, at fair value (cost: 2013 - $44,172; 2012 - $44,598)
55,215

 
53,422

Mortgage loans on real estate
2,591,897

 
2,623,940

Derivative instruments
719,683

 
415,258

Other investments
193,714

 
196,366

Total investments
29,245,856

 
27,537,210

 
 
 
 
Cash and cash equivalents
882,097

 
1,268,545

Coinsurance deposits
2,941,816

 
2,910,701

Accrued investment income
298,341

 
261,833

Deferred policy acquisition costs
1,803,498

 
1,709,799

Deferred sales inducements
1,370,285

 
1,292,341

Other assets
311,076

 
153,049

Total assets
$
36,852,969

 
$
35,133,478

 
 
 
 
Liabilities and Stockholders' Equity
 
 
 
Liabilities:
 
 
 
Policy benefit reserves
$
32,937,308

 
$
31,773,988

Other policy funds and contract claims
447,301

 
455,752

Notes payable
313,043

 
309,869

Subordinated debentures
245,913

 
245,869

Deferred income taxes
33,313

 
49,303

Income taxes payable
10,194

 
4,756

Other liabilities
1,135,668

 
573,704

Total liabilities
35,122,740

 
33,413,241

 
 
 
 
Stockholders' equity:
 
 
 
Preferred stock, par value $1 per share, 2,000,000 shares authorized,
  2013 and 2012 no shares issued and outstanding
—

 
—

Common stock, par value $1 per share, 200,000,000 shares authorized; issued and outstanding:
   2013 - 62,783,971 shares (excluding 4,779,535 treasury shares);
   2012 - 61,750,601 shares (excluding 5,127,379 treasury shares)
62,784

 
61,751

Additional paid-in capital
504,470

 
496,715

Unallocated common stock held by ESOP; 2013 - 239,799 shares; 2012 - 239,799 shares
(2,266
)
 
(2,583
)
Accumulated other comprehensive income
661,663

 
686,807

Retained earnings
503,578

 
477,547

Total stockholders' equity
1,730,229

 
1,720,237

Total liabilities and stockholders' equity
$
36,852,969

 
$
35,133,478

See accompanying notes to unaudited consolidated financial statements.

2


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,
 
2013
 
2012
Revenues:
 
 
 
Traditional life insurance premiums
$
2,698

 
$
3,222

Annuity product charges
21,481

 
19,393

Net investment income
329,690

 
326,910

Change in fair value of derivatives
373,962

 
259,161

Net realized gains (losses) on investments, excluding other than temporary impairment ("OTTI") losses
10,585

 
(6,076
)
OTTI losses on investments:
 
 
 
Total OTTI losses
(2,189
)
 
(1,781
)
Portion of OTTI losses recognized from other comprehensive income
(1,048
)
 
(1,100
)
Net OTTI losses recognized in operations
(3,237
)
 
(2,881
)
Total revenues
735,179

 
599,729

 
 
 
 
Benefits and expenses:
 
 
 
Insurance policy benefits and change in future policy benefits
1,735

 
2,117

Interest sensitive and index product benefits
225,809

 
139,123

Amortization of deferred sales inducements
28,831

 
16,710

Change in fair value of embedded derivatives
363,272

 
359,066

Interest expense on notes payable
7,248

 
6,995

Interest expense on subordinated debentures
3,009

 
3,586

Amortization of deferred policy acquisition costs
46,230

 
34,284

Other operating costs and expenses
19,520

 
21,713

Total benefits and expenses
695,654

 
583,594

Income before income taxes
39,525

 
16,135

Income tax expense
13,494

 
5,664

Net income
$
26,031

 
$
10,471

 
 
 
 
Earnings per common share
$
0.41

 
$
0.18

Earnings per common share - assuming dilution
$
0.38

 
$
0.16

Weighted average common shares outstanding (in thousands):
 
 
 
Earnings per common share
63,314

 
59,701

Earnings per common share - assuming dilution
68,706

 
65,930

See accompanying notes to unaudited consolidated financial statements.

3


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

 
Three Months Ended
March 31,
 
2013
 
2012
 
 
 
 
Net income
26,031

 
10,471

Other comprehensive loss:
 
 
 
Change in net unrealized investment gains/losses (1)
(35,183
)
 
(74,975
)
Noncredit component of OTTI losses (1)
347

 
389

Reclassification of unrealized investment gains/losses to net income (1)
(3,847
)
 
—

Other comprehensive loss before income tax
(38,683
)
 
(74,586
)
Income tax effect related to other comprehensive income
13,539

 
26,104

Other comprehensive loss
(25,144
)
 
(48,482
)
Comprehensive income (loss)
$
887

 
$
(38,011
)
(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


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

 
Common
Stock
 
Additional
Paid-in
Capital
 
Unallocated
Common
Stock Held
by ESOP
 
Accumulated
Other
Comprehensive
Income
 
Retained
Earnings
 
Total
Stockholders'
Equity
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2012
$
61,751

 
$
496,715

 
$
(2,583
)
 
$
686,807

 
$
477,547

 
$
1,720,237

Net income for period
—

 
—

 
—

 
—

 
26,031

 
26,031

Other comprehensive loss
—

 
—

 
—

 
(25,144
)
 
—

 
(25,144
)
Allocation of 29,430 shares of common stock by ESOP, including excess income tax benefits
—

 
58

 
317

 
—

 
—

 
375

Share-based compensation, including excess income tax benefits
—

 
1,488

 
—

 
—

 
—

 
1,488

Issuance of 1,033,370 shares of common stock under compensation plans, including excess income tax benefits
1,033

 
6,209

 
—

 
—

 
—

 
7,242

Balance at March 31, 2013
$
62,784

 
$
504,470

 
$
(2,266
)
 
$
661,663

 
$
503,578

 
$
1,730,229

 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2011
$
57,837

 
$
468,281

 
$
(3,620
)
 
$
457,229

 
$
428,952

 
$
1,408,679

Net income for period
—

 
—

 
—

 
—

 
10,471

 
10,471

Other comprehensive loss
—

 
—

 
—

 
(48,482
)
 
—

 
(48,482
)
Conversion of $60 of subordinated debentures
7

 
49

 
—

 
—

 
—

 
56

Allocation of 30,903 shares of common stock by ESOP, including excess income tax benefits
—

 
22

 
333

 
—

 
—

 
355

Share-based compensation, including excess income tax benefits
—

 
1,774

 
—

 
—

 
—

 
1,774

Issuance of 777,690 shares of common stock under compensation plans, including excess income tax benefits
778

 
(47
)
 
—

 
—

 
—

 
731

Balance at March 31, 2012
$
58,622

 
$
470,079

 
$
(3,287
)
 
$
408,747

 
$
439,423

 
$
1,373,584

See accompanying notes to unaudited consolidated financial statements.

5


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

 
Three Months Ended
March 31,
 
2013
 
2012
Operating activities
 
 
 
Net income
$
26,031

 
$
10,471

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Interest sensitive and index product benefits
225,809

 
139,123

Amortization of deferred sales inducements
28,831

 
16,710

Annuity product charges
(21,481
)
 
(19,393
)
Change in fair value of embedded derivatives
363,272

 
359,066

Increase in traditional life and accident and health insurance reserves
402

 
6,032

Policy acquisition costs deferred
(94,638
)
 
(91,177
)
Amortization of deferred policy acquisition costs
46,230

 
34,284

Provision for depreciation and other amortization
4,607

 
4,547

Amortization of discounts and premiums on investments
(6,296
)
 
(39,738
)
Realized gains/losses on investments and net OTTI losses recognized in operations
(7,348
)
 
8,957

Change in fair value of derivatives
(373,962
)
 
(259,161
)
Deferred income taxes
(2,451
)
 
(12,443
)
Share-based compensation
1,290

 
1,106

Change in accrued investment income
(36,508
)
 
(7,685
)
Change in income taxes payable
5,438

 
17,441

Change in other assets
1,315

 
(682
)
Change in other policy funds and contract claims
(8,451
)
 
18,224

Change in collateral held for derivatives
224,755

 
292,043

Change in other liabilities
(6,215
)
 
(19,523
)
Other
(1,014
)
 
(482
)
Net cash provided by operating activities
369,616

 
457,720

 
 
 
 
Investing activities
 
 
 
Sales, maturities, or repayments of investments:
 
 
 
Fixed maturity securities - available for sale
937,343

 
965,283

Fixed maturity securities - held for investment
—

 
1,140,816

Equity securities - available for sale
—

 
2,605

Mortgage loans on real estate
125,998

 
99,199

Derivative instruments
146,918

 
57,015

Other investments
5,371

 
4,568

Acquisition of investments:
 
 
 
Fixed maturity securities - available for sale
(2,308,052
)
 
(988,547
)
Mortgage loans on real estate
(95,147
)
 
(43,678
)
Derivative instruments
(82,448
)
 
(83,201
)
Other investments
(199
)
 
(17
)
Purchases of property, furniture and equipment
(78
)
 
(191
)
Net cash provided by (used in) investing activities
(1,270,294
)
 
1,153,852


6


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

 
Three Months Ended
March 31,
 
2013
 
2012
Financing activities
 
 
 
Receipts credited to annuity and single premium universal life policyholder account balances
$
914,936

 
$
933,632

Coinsurance deposits
5,641

 
(49,478
)
Return of annuity policyholder account balances
(402,185
)
 
(368,708
)
Excess tax benefits realized from share-based compensation plans
305

 
665

Proceeds from issuance of common stock
7,103

 
721

Change in checks in excess of cash balance
(11,570
)
 
(6,243
)
Net cash provided by financing activities
514,230

 
510,589

Increase (decrease) in cash and cash equivalents
(386,448
)
 
2,122,161

Cash and cash equivalents at beginning of period
1,268,545

 
404,952

Cash and cash equivalents at end of period
$
882,097

 
$
2,527,113

 
 
 
 
Supplemental disclosures of cash flow information
 
 
 
Cash paid during period for:
 
 
 
Interest expense
$
6,470

 
$
7,014

Income taxes
10,200

 
—

Non-cash operating activity:
 
 
 
Deferral of sales inducements
73,898

 
70,019

Non-cash investing activity:
 
 
 
Real estate acquired in satisfaction of mortgage loans
844

 
3,303

Non-cash financing activities:
 
 
 
Conversion of subordinated debentures
—

 
60

See accompanying notes to unaudited consolidated financial statements.
 

7


AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2013
(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, 2013 are not necessarily indicative of the results that may be expected for the year ended December 31, 2013. 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, 2012.
As previously reported in the notes to consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2012, we identified certain classification errors related to amounts reported in the financing activities section of our consolidated statements of cash flows. Consistent with that presentation, we have revised the consolidated statement of cash flows for the three months ended March 31, 2012 resulting in decreases of $45.8 million to receipts credited to annuity and single premium universal life policyholder account balances and return of annuity policyholder account balances. These revisions had no net impact on net cash provided by financing activities, and no impact on our consolidated balance sheets, statements of operations, statements of comprehensive income or statements of changes in stockholders' equity.
Adopted Accounting Pronouncements
In February 2013, the Financial Accounting Standards Board ("FASB") issued an accounting standards update ("ASU") that expands the disclosure requirements related to other comprehensive income (loss). A reporting entity is now required to provide information about the amounts reclassified out of accumulated other comprehensive income (loss) by component. In addition, a reporting entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required to be reclassified to net income in its entirety in the same reporting period. This ASU became effective for interim and annual periods beginning after December 15, 2012. We adopted this ASU on January 1, 2013.
New Accounting Pronouncements
There are no accounting standards updates finalized to become effective in the future that will significantly affect our consolidated financial statements.

8


2. Fair Values of Financial Instruments
The following sets forth a comparison of the fair values and carrying amounts of our financial instruments:
 
March 31, 2013
 
December 31, 2012
 
Carrying
Amount
 
Fair Value
 
Carrying
Amount
 
Fair Value
 
(Dollars in thousands)
Assets
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Available for sale
$
25,609,218

 
$
25,609,218

 
$
24,172,136

 
$
24,172,136

Held for investment
76,129

 
62,173

 
76,088

 
61,521

Equity securities, available for sale
55,215

 
55,215

 
53,422

 
53,422

Mortgage loans on real estate
2,591,897

 
2,831,426

 
2,623,940

 
2,848,235

Derivative instruments
719,683

 
719,683

 
415,258

 
415,258

Other investments
164,950

 
164,725

 
163,193

 
163,517

Cash and cash equivalents
882,097

 
882,097

 
1,268,545

 
1,268,545

Coinsurance deposits
2,941,816

 
2,699,973

 
2,910,701

 
2,678,232

Interest rate caps
3,724

 
3,724

 
3,247

 
3,247

2015 notes hedges
71,203

 
71,203

 
43,105

 
43,105

 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
Policy benefit reserves
32,610,449

 
26,941,764

 
31,452,496

 
26,264,831

Single premium immediate annuity (SPIA) benefit reserves
446,967

 
461,429

 
455,167

 
469,768

Notes payable
313,043

 
476,786

 
309,869

 
422,175

Subordinated debentures
245,913

 
224,659

 
245,869

 
218,283

2015 notes embedded derivatives
71,203

 
71,203

 
43,105

 
43,105

Interest rate swap
3,528

 
3,528

 
4,261

 
4,261

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 the three months ended March 31, 2013.

9


Our assets and liabilities which are measured at fair value on a recurring basis as of March 31, 2013 and December 31, 2012 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, 2013
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
United States Government full faith and credit
$
4,616

 
$
4,616

 
$
—

 
$
—

United States Government sponsored agencies
1,857,377

 
—

 
1,857,377

 
—

United States municipalities, states and territories
3,657,164

 
—

 
3,657,164

 
—

Foreign government obligations
100,460

 
—

 
100,460

 
—

Corporate securities
15,550,966

 
25,814

 
15,525,152

 
—

Residential mortgage backed securities
2,668,454

 
—

 
2,666,730

 
1,724

Commercial mortgage backed securities
748,601

 
—

 
748,601

 
—

Other asset backed securities
1,021,580

 
380

 
1,021,200

 
—

Equity securities, available for sale: finance, insurance and real estate
55,215

 
37,744

 
17,471

 
—

Derivative instruments
719,683

 
—

 
719,683

 
—

Cash and cash equivalents
882,097

 
882,097

 
—

 
—

Interest rate caps
3,724

 
—

 
3,724

 
—

2015 notes hedges
71,203

 
—

 
71,203

 
—

 
$
27,341,140

 
$
950,651

 
$
26,388,765

 
$
1,724

Liabilities
 
 
 
 
 
 
 
2015 notes embedded derivatives
$
71,203

 
$
—

 
$
71,203

 
$
—

Interest rate swap
3,528

 
—

 
3,528

 
—

Fixed index annuities - embedded derivatives
3,848,902

 
—

 
—

 
3,848,902

 
$
3,923,633

 
$
—

 
$
74,731

 
$
3,848,902

 
 
 
 
 
 
 
 
December 31, 2012
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
United States Government full faith and credit
$
5,154

 
$
5,154

 
$
—

 
$
—

United States Government sponsored agencies
1,772,025

 
—

 
1,772,025

 
—

United States municipalities, states and territories
3,578,323

 
—

 
3,578,323

 
—

Foreign government obligations
105,259

 
—

 
105,259

 
—

Corporate securities
14,466,772

 
33,131

 
14,433,641

 
—

Residential mortgage backed securities
2,888,113

 
—

 
2,886,301

 
1,812

Commercial mortgage backed securities
357,982

 
—

 
357,982

 
—

Other asset backed securities
998,508

 
378

 
998,130

 
—

Equity securities, available for sale: finance, insurance and real estate
53,422

 
36,928

 
16,494

 
—

Derivative instruments
415,258

 
—

 
415,258

 
—

Cash and cash equivalents
1,268,545

 
1,268,545

 
—

 
—

Interest rate caps
3,247

 
—

 
3,247

 
—

2015 notes hedges
43,105

 
—

 
43,105

 
—

 
$
25,955,713

 
$
1,344,136

 
$
24,609,765

 
$
1,812

Liabilities
 
 
 
 
 
 
 
2015 notes embedded derivatives
$
43,105

 
$
—

 
$
43,105

 
$
—

Interest rate swap
4,261

 
—

 
4,261

 
—

Fixed index annuities - embedded derivatives
3,337,556

 
—

 
—

 
3,337,556

 
$
3,384,922

 
$
—

 
$
47,366

 
$
3,337,556


10


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 further quotes or prices from additional parties as needed. In addition, for our callable United States Government sponsored agencies we obtain two broker quotes and take the average of two broker prices received. 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 of 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, 2013 and December 31, 2012.
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 current 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 and appraised property values); 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
None of the financial instruments included in other investments are measured at fair value on a recurring basis. Financial instruments included in other investments are policy loans, an equity method investment 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 value 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 value of our equity method investment qualifies as a Level 3 fair value and was determined by calculating the present value of future cash flows discounted by a risk free rate, a risk spread and a liquidity discount. The risk spread and liquidity discount are rates determined by our investment professionals and are unobservable market inputs. The fair value of our COLI approximates the cash surrender value of the policies and whose fair values fall within Level 2 of the fair value hierarchy.

11


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.
2015 notes hedges
The fair value of these call options is determined by a third party who applies market observable data such as our common stock price, its dividend yield and its volatility, as well as the time to expiration of the call options to determine a fair value of the buy side of these options.
Interest rate swap and caps
The fair values of our pay fixed/receive variable interest rate swap and interest rate caps are obtained from third parties and are determined by discounting expected future cash flows using projected LIBOR rates for the term of the swap and caps.
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 purchased 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 value of the convertible senior notes is 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.
2015 notes embedded derivatives
The fair value of this embedded derivative is determined by pricing the call options that hedge this potential liability. The terms of the conversion premium are identical to the 2015 notes hedges and the method of determining fair value of the call options is based upon observable market data.
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.

12


The following tables provide a reconciliation of the beginning and ending balances for our Level 3 assets and liabilities, which are measured at fair value on a recurring basis using significant unobservable inputs for the three months ended March 31, 2013 and 2012:
 
Three Months Ended
March 31,
 
2013
 
2012
 
(Dollars in thousands)
Available for sale securities
 
 
 
Beginning balance
$
1,812

 
$
2,098

Principal returned
(368
)
 
(41
)
Accretion of discount
129

 
26

Total gains (losses) (realized/unrealized):
 
 
 
Included in other comprehensive income (loss)
151

 
102

Included in operations
—

 
(158
)
Ending balance
$
1,724

 
$
2,027

The Level 3 assets included in the table above are not material to our financial position, results of operations or cash flows, and it is management's opinion that the sensitivity of the inputs used in determining the fair value of these assets is not material as well.
 
Three Months Ended
March 31,
 
2013
 
2012
 
(Dollars in thousands)
Fixed index annuities - embedded derivatives
 
 
 
Beginning balance
$
3,337,556

 
$
2,530,496

Premiums less benefits
246,722

 
84,226

Change in unrealized gains, net
264,624

 
306,315

Ending balance
$
3,848,902

 
$
2,921,037

Change in unrealized gains, net for each period in our embedded derivatives are 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, 2013, were to increase by 100 basis points, the fair value of the embedded derivatives would decrease by $261.8 million recorded through operations as a decrease in the change in fair value of embedded derivatives and there would be a corresponding decrease of $158.3 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 $291.9 million recorded through operations as an increase in the change in fair value of embedded derivatives and increase our combined balance for deferred policy acquisition costs and deferred sales inducements by $177.0 million recorded through operations as a decrease in amortization of deferred policy acquisition costs and deferred sales inducements.

13


3. Investments
At March 31, 2013 and December 31, 2012, the amortized cost and fair value of fixed maturity securities and equity securities were as follows:
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
 
(Dollars in thousands)
March 31, 2013
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
United States Government full faith and credit
$
4,091

 
$
525

 
$
—

 
$
4,616

United States Government sponsored agencies
1,853,618

 
7,646

 
(3,887
)
 
1,857,377

United States municipalities, states and territories
3,191,793

 
466,207

 
(836
)
 
3,657,164

Foreign government obligations
86,102

 
14,574

 
(216
)
 
100,460

Corporate securities
14,167,049

 
1,434,504

 
(50,587
)
 
15,550,966

Residential mortgage backed securities
2,488,435

 
186,029

 
(6,010
)
 
2,668,454

Commercial mortgage backed securities
742,965

 
8,772

 
(3,136
)
 
748,601

Other asset backed securities
979,126

 
48,252

 
(5,798
)
 
1,021,580

 
$
23,513,179

 
$
2,166,509

 
$
(70,470
)
 
$
25,609,218

Held for investment:
 
 
 
 
 
 
 
Corporate security
$
76,129

 
$
—

 
$
(13,956
)
 
$
62,173

 
 
 
 
 
 
 
 
Equity securities, available for sale:
 
 
 
 
 
 
 
Finance, insurance, and real estate
$
44,172

 
$
11,043

 
$
—

 
$
55,215

 
 
 
 
 
 
 
 
December 31, 2012
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
United States Government full faith and credit
$
4,590

 
$
564

 
$
—

 
$
5,154

United States Government sponsored agencies
1,763,789

 
11,704

 
(3,468
)
 
1,772,025

United States municipalities, states and territories
3,116,678

 
461,770

 
(125
)
 
3,578,323

Foreign government obligations
86,099

 
19,160

 
—

 
105,259

Corporate securities
12,930,173

 
1,568,223

 
(31,624
)
 
14,466,772

Residential mortgage backed securities
2,743,537

 
172,304

 
(27,728
)
 
2,888,113

Commercial mortgage backed securities
354,870

 
5,095

 
(1,983
)
 
357,982

Other asset backed securities
957,291

 
44,190

 
(2,973
)
 
998,508

 
$
21,957,027

 
$
2,283,010

 
$
(67,901
)
 
$
24,172,136

Held for investment:
 
 
 
 
 
 
 
Corporate security
76,088

 
—

 
(14,567
)
 
61,521

 
 
 
 
 
 
 
 
Equity securities, available for sale:
 
 
 
 
 
 
 
Finance, insurance, and real estate
$
44,598

 
$
10,227

 
$
(1,403
)
 
$
53,422

During the three months ended March 31, 2013 and 2012, we received $0.3 billion and $1.9 billion, respectively, in redemption proceeds related to calls of our callable United States Government sponsored agency securities and public and private corporate bonds, of which $1.1 billion for the three months ended March 31, 2012, were classified as held for investment. The proceeds from these redemptions that have been reinvested have primarily been in United States government sponsored agencies, corporate securities, commercial mortgage backed securities and other asset backed securities. At March 31, 2013, 31% of our fixed income securities have call features and 0.3% ($0.1 billion) were subject to call redemption. Another 8% ($1.8 billion) will become subject to call redemption during the next twelve months, of which $522.3 million are short-term U.S. Government agency securities with a book yield of 0.76%.

14


The amortized cost and fair value of fixed maturity securities at March 31, 2013, 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
$
100,860

 
$
105,574

 
$
—

 
$
—

Due after one year through five years
737,142

 
833,797

 
—

 
—

Due after five years through ten years
5,706,584

 
6,093,251

 
—

 
—

Due after ten years through twenty years
5,804,473

 
6,322,926

 
—

 
—

Due after twenty years
6,953,594

 
7,815,035

 
76,129

 
62,173

 
19,302,653

 
21,170,583

 
76,129

 
62,173

Residential mortgage backed securities
2,488,435

 
2,668,454

 
—

 
—

Commercial mortgage backed securities
742,965

 
748,601

 
—

 
—

Other asset backed securities
979,126

 
1,021,580

 
—

 
—

 
$
23,513,179

 
$
25,609,218

 
$
76,129

 
$
62,173

Net unrealized gains on available for sale fixed maturity securities and equity securities reported as a separate component of stockholders' equity were comprised of the following:
 
March 31,
2013
 
December 31,
2012
 
(Dollars in thousands)
Net unrealized gains on available for sale fixed maturity securities and equity securities
$
2,107,082

 
$
2,223,933

Adjustments for assumed changes in amortization of deferred policy acquisition costs and deferred sales inducements
(1,123,806
)
 
(1,201,974
)
Deferred income tax valuation allowance reversal
22,534

 
22,534

Deferred income tax benefit
(344,147
)
 
(357,686
)
Net unrealized gains reported as accumulated other comprehensive income
$
661,663

 
$
686,807

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 98% and of our fixed maturity portfolio rated investment grade at March 31, 2013 and December 31, 2012.
The following table summarizes the credit quality, as determined by NAIC designation, of our fixed maturity portfolio as of the dates indicated:
 
 
March 31, 2013
 
December 31, 2012
NAIC
Designation
 
Amortized Cost

 
Fair Value
 
Amortized Cost
 
Fair Value
 
 
(Dollars in thousands)
1
 
$
14,659,495

 
$
16,121,041

 
$
13,737,381

 
$
15,250,560

2
 
8,457,623

 
9,087,432

 
7,838,186

 
8,533,121

3
 
419,163

 
408,178

 
398,294

 
387,222

4
 
50,789

 
53,006

 
53,879

 
56,151

5
 
—

 
—

 
—

 
—

6
 
2,238

 
1,734

 
5,375

 
6,603

 
 
$
23,589,308

 
$
25,671,391

 
$
22,033,115

 
$
24,233,657


15


The following tables show our investments' gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities (consisting of 211 and 198 securities, respectively) have been in a continuous unrealized loss position, at March 31, 2013 and December 31, 2012:
 
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, 2013
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
 
 
 
 
United States Government sponsored agencies
$
874,724

 
$
(3,887
)
 
$
—

 
$
—

 
$
874,724

 
$
(3,887
)
United States municipalities, states and territories
62,810

 
(836
)
 
—

 
—

 
62,810

 
(836
)
Foreign government obligations
14,270

 
(216
)
 
—

 
—

 
14,270

 
(216
)
Corporate securities:
 
 
 
 
 
 
 
 
 
 
 
Finance, insurance and real estate
379,876

 
(7,483
)
 
68,378

 
(6,127
)
 
448,254

 
(13,610
)
Manufacturing, construction and mining
622,394

 
(13,677
)
 
11,980

 
(1,896
)
 
634,374

 
(15,573
)
Utilities and related sectors
362,337

 
(10,870
)
 
39,887

 
(3,533
)
 
402,224

 
(14,403
)
Wholesale/retail trade
95,328

 
(1,586
)
 
10,263

 
(193
)
 
105,591

 
(1,779
)
Services, media and other
370,926

 
(5,222
)
 
—

 
—

 
370,926

 
(5,222
)
Residential mortgage backed securities
62,181

 
(2,251
)
 
92,736

 
(3,759
)
 
154,917

 
(6,010
)
Commercial mortgage backed securities
216,149

 
(3,136
)
 
—

 
—

 
216,149

 
(3,136
)
Other asset backed securities
167,487

 
(3,598
)
 
24,008

 
(2,200
)
 
191,495

 
(5,798
)
 
$
3,228,482

 
$
(52,762
)
 
$
247,252

 
$
(17,708
)
 
$
3,475,734

 
$
(70,470
)
Held for investment:
 
 
 
 
 
 
 
 
 
 
 
Corporate security:
 
 
 
 
 
 
 
 
 
 
 
Insurance
$
—

 
$
—

 
$
62,173

 
$
(13,956
)
 
$
62,173

 
$
(13,956
)
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2012
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
 
 
 
 
United States Government sponsored agencies
$
973,728

 
$
(3,468
)
 
$
—

 
$
—

 
$
973,728

 
$
(3,468
)
United States municipalities, states and territories
24,393

 
(125
)
 
—

 
—

 
24,393

 
(125
)
Corporate securities:
 
 
 
 
 
 
 
 
 
 
 
Finance, insurance and real estate
177,962

 
(4,126
)
 
85,709

 
(8,438
)
 
263,671

 
(12,564
)
Manufacturing, construction and mining
426,120

 
(4,303
)
 
21,975

 
(1,281
)
 
448,095

 
(5,584
)
Utilities and related sectors
221,044

 
(5,187
)
 
39,224

 
(4,212
)
 
260,268

 
(9,399
)
Wholesale/retail trade
101,790

 
(784
)
 
10,250

 
(208
)
 
112,040

 
(992
)
Services, media and other
264,421

 
(3,085
)
 
—

 
—

 
264,421

 
(3,085
)
Residential mortgage backed securities
220,622

 
(8,679
)
 
260,226

 
(19,049
)
 
480,848

 
(27,728
)
Commercial mortgage backed securities
161,582

 
(1,983
)
 
—

 
—

 
161,582

 
(1,983
)
Other asset backed securities
145,238

 
(2,242
)
 
26,131

 
(731
)
 
171,369

 
(2,973
)
 
$
2,716,900

 
$
(33,982
)
 
$
443,515

 
$
(33,919
)
 
$
3,160,415

 
$
(67,901
)
Held for investment:
 
 
 
 
 
 
 
 
 
 
 
Corporate security:
 
 
 
 
 
 
 
 
 
 
 
Insurance
$
—

 
$
—

 
$
61,521

 
$
(14,567
)
 
$
61,521

 
$
(14,567
)
 


 


 


 


 


 


Equity security, available for sale:
 
 
 
 
 
 
 
 
 
 
 
Services
$
—

 
$
—

 
$
8,722

 
$
(1,403
)
 
$
8,722

 
$
(1,403
)
The following is a description of the factors causing the temporary unrealized losses by investment category as of March 31, 2013:
United States Government sponsored agencies: These securities are relatively long in duration; however, they are callable in less than 12 months making the value of such securities sensitive to changes in market interest rates. The timing of when some of these securities were purchased gave rise to unrealized losses at March 31, 2013.
United States municipalities, states and territories: These securities are relatively long in duration whose fair values are sensitive to changes in market interest rates. The timing of the purchase of these securities have resulted in unrealized losses at this point in time.
Foreign government obligations: The unrealized losses on these securities is due to wider spreads on the announcement of increased capital expenditures with resulting higher leverage and greater supply.

16


Corporate securities: The unrealized losses in these securities are due partially to the timing of purchases in 2012 and 2013. These securities carry yields less than those available at December 31, 2012 as the result of rising interest rates in the first quarter of 2013. In addition, a small number of securities seeing their credit spreads remain wide due to issuer or industry specific news while some financial and industrial sector credit spreads remain wide due to continued economic uncertainty and concerns of economic instability in the European Union.
Residential mortgage backed securities: At March 31, 2013, we had no exposure to sub-prime residential mortgage backed securities. All of our residential mortgage backed securities are pools of first-lien residential mortgage loans. Substantially all of the securities that we own are in the most senior tranche of the securitization in which they are structured and are not subordinated to any other tranche. Our "Alt-A" residential mortgage backed securities are comprised of 36 securities with a total amortized cost basis of $358.3 million and a fair value of $378.6 million. Despite recent improvements in the capital markets, the fair values of RMBS with weaker borrower characteristics continue at prices below amortized cost. These RMBS prices will likely remain below our cost basis until the housing market is able to absorb current and future foreclosures.
Commercial mortgage backed securities: The unrealized losses in these securities are due partially to the timing of purchases in 2012 and 2013. A number of purchases made in the middle of the fourth quarter 2012 were at yields lower than what could be executed at the end of this quarter due to the increase in the treasury yield since the time of purchase. Yield spreads for commercial mortgage backed securities have narrowed but remain attractive.
Other asset backed securities: The unrealized losses in these securities are predominantly assigned to financial sector capital trust securities which have longer maturity dates and have declined in price due to prolonged stress in the financial sector. Only one security in an unrealized loss position is rated below investment grade.
Approximately 76% and 75% of the unrealized losses on fixed maturity securities shown in the above table for March 31, 2013 and December 31, 2012, respectively, are on securities that are rated investment grade, defined as being the highest two NAIC designations. All of the 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, 2013 and 2012 are as follows:
 
Three Months Ended
March 31,
 
2013
 
2012
 
(Dollars in thousands)
Fixed maturity securities held for investment carried at amortized cost
$
611

 
$
10,189

Investments carried at fair value:
 
 
 
Fixed maturity securities, available for sale
$
(119,070
)
 
$
(215,088
)
Equity securities, available for sale
2,219

 
4,424

 
(116,851
)
 
(210,664
)
Adjustment for effect on other balance sheet accounts:
 
 
 
Deferred policy acquisition costs and deferred sales inducements
78,168

 
136,078

Deferred income tax asset/liability
13,539

 
26,104

 
91,707

 
162,182

Change in net unrealized gains on investments carried at fair value
$
(25,144
)
 
$
(48,482
)
Proceeds from sales of available for sale securities for the three months ended March 31, 2013 and 2012 were $380.4 million and $51.7 million, respectively. Scheduled principal repayments, calls and tenders for available for sale securities for the three months ended March 31, 2013 and 2012 were $556.9 million and $919.1 million, respectively.

17


Realized gains and losses on sales are determined on the basis of specific identification of investments based on the trade date. Net realized gains (losses) on investments, excluding net OTTI losses for the three months ended March 31, 2013 and 2012 are as follows:
 
Three Months Ended
March 31,
 
2013
 
2012
 
(Dollars in thousands)
Available for sale fixed maturity securities:
 
 
 
Gross realized gains
$
13,015

 
$
1,018

Gross realized losses
(2,187
)
 
(296
)
 
10,828

 
722

Equity securities:
 
 
 
Gross realized gains
—

 
562

Other investments:
 
 
 
Gain on sale of real estate
589

 
1,445

Loss on sale of real estate
(466
)
 
—

Impairment losses on real estate
—

 
(974
)
 
123

 
471

Mortgage loans on real estate:
 
 
 
Increase in allowance for credit losses
(366
)
 
(7,831
)
 
$
10,585

 
$
(6,076
)
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 in place 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;
•
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;
•
our assessment in the case of equity securities including perpetual preferred stocks with credit deterioration that the security cannot recover to cost in a reasonable period of time;
•
our intent and ability to retain equity securities for a period of time sufficient to allow for recovery;
•
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 and equity securities by assessing all facts and circumstances surrounding each security. Where the decline in market 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. For equity securities, we recognize an impairment charge in the period in which we do not have the intent and ability to hold the securities until recovery of cost or we determine that the security will not recover to book value within a reasonable period of time. We determine what constitutes a reasonable period of time on a security-by-security basis by considering all the evidence available to us, including the magnitude of any unrealized loss and its duration. In any event, this period does not exceed 18 months from the date of impairment for perpetual preferred securities for which there is evidence of deterioration in credit of the issuer and common equity securities. For perpetual preferred securities absent evidence of a deterioration in credit of the issuer we apply an impairment model, including an anticipated recovery period, similar to a debt security.
Other than temporary impairment losses on equity securities are recognized in operations. 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

18


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.
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, 2013 and 2012, 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, 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Prime
 
2003
 
5.1
%
 
5.1
%
 
2
%
 
2
%
 
30
%
 
30
%
 
 
2005
 
6.5
%
 
7.7
%
 
8
%
 
17
%
 
50
%
 
50
%
 
 
2006
 
6.0
%
 
6.9
%
 
9
%
 
16
%
 
50
%
 
50
%
 
 
2007
 
6.5
%
 
6.7
%
 
14
%
 
25
%
 
40
%
 
60
%
 
 
2008
 
6.6
%
 
6.6
%
 
16
%
 
16
%
 
45
%
 
45
%
Alt-A
 
2005
 
5.6
%
 
8.7
%
 
15
%
 
25
%
 
5
%
 
65
%
 
 
2007
 
6.2
%
 
6.9
%
 
38
%
 
52
%
 
60
%
 
65
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three months ended March 31, 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Prime
 
2005
 
7.5
%
 
7.5
%
 
13
%
 
13
%
 
50
%
 
50
%
 
 
2006
 
6.9
%
 
7.4
%
 
19
%
 
19
%
 
50
%
 
55
%
 
 
2007
 
6.4
%
 
7.3
%
 
15
%
 
38
%
 
50
%
 
60
%
Alt-A
 
2005
 
6.4
%
 
7.4
%
 
14
%
 
27
%
 
5
%
 
50
%
 
 
2006
 
6.0
%
 
6.0
%
 
46
%
 
46
%
 
55