Edgar Filing: AMERICAN EQUITY INVESTMENT LIFE HOLDING CO

2013-09-30-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 September 30, 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 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)		(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:

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

Shares of common stock outstanding at October 31, 2013: 69,052,869

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
Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations	32
Item 3: Quantitative and Qualitative Disclosures about Market Risk	51
Item 4: Controls and Procedures	52

PART II — OTHER INFORMATION
Item 1: Legal Proceedings	53
Item 1A: Risk Factors	53
Item 2: Unregistered Sales of Equity Securities and Use of Proceeds	53
Item 6: Exhibits	54

Signatures	55

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)



	September 30, 2013			December 31, 2012
	(Unaudited)
Assets
Investments:
Fixed maturity securities:
Available for sale, at fair value (amortized cost: 2013 - $25,783,116; 2012 - $21,957,027)	$	26,262,878		$	24,172,136
Held for investment, at amortized cost (fair value: 2013 - $60,843; 2012 - $61,521)	76,212			76,088
Equity securities, available for sale, at fair value (cost: 2013 - $8,917; 2012 - $44,598)	9,708			53,422
Mortgage loans on real estate	2,593,851			2,623,940
Derivative instruments	625,236			415,258
Other investments	212,870			196,366
Total investments	29,780,755			27,537,210

Cash and cash equivalents	934,931			1,268,545
Coinsurance deposits	2,970,601			2,910,701
Accrued investment income	307,554			261,833
Deferred policy acquisition costs	2,291,996			1,709,799
Deferred sales inducements	1,763,137			1,292,341
Deferred income taxes	225,894			—
Other assets	438,279			153,049
Total assets	$	38,713,147		$	35,133,478

Liabilities and Stockholders' Equity
Liabilities:
Policy benefit reserves	$	34,652,479		$	31,773,988
Other policy funds and contract claims	431,425			455,752
Notes payable	691,452			309,869
Subordinated debentures	246,003			245,869
Amounts due under repurchase agreements	148,180			—
Deferred income taxes	—			49,303
Income taxes payable	29,878			4,756
Other liabilities	1,119,062			573,704
Total liabilities	37,318,479			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 - 64,722,600 shares (excluding 4,876,735 treasury shares); 2012 - 61,750,601 shares (excluding 5,127,379 treasury shares)	64,723			61,751
Additional paid-in capital	487,971			496,715
Unallocated common stock held by ESOP; 2013 - 186,485 shares; 2012 - 239,799 shares	(1,623		)	(2,583		)
Accumulated other comprehensive income	163,725			686,807
Retained earnings	679,872			477,547
Total stockholders' equity	1,394,668			1,720,237
Total liabilities and stockholders' equity	$	38,713,147		$	35,133,478

See accompanying notes to unaudited consolidated financial statements.

AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in thousands, except per share data)

(Unaudited)



	Three Months Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013			2012
Revenues:
Traditional life insurance premiums	$	2,493		$	3,300		$	8,104		$	9,770
Annuity product charges	26,451			23,875			71,443			65,176
Net investment income	354,147			318,594			1,019,980			965,763
Change in fair value of derivatives	193,028			161,090			631,030			269,404
Net realized gains (losses) on investments, excluding other than temporary impairment ("OTTI") losses	(2,077		)	(1,238		)	24,197			(7,925		)
OTTI losses on investments:
Total OTTI losses	—			—			(4,964		)	(2,156		)
Portion of OTTI losses recognized from other comprehensive income	(222		)	(1,686		)	(1,270		)	(3,389		)
Net OTTI losses recognized in operations	(222		)	(1,686		)	(6,234		)	(5,545		)
Loss on extinguishment of debt	(938		)	—			(1,527		)	—
Total revenues	572,882			503,935			1,746,993			1,296,643

Benefits and expenses:
Insurance policy benefits and change in future policy benefits	1,647			1,865			5,488			6,232
Interest sensitive and index product benefits	327,976			246,105			889,810			527,961
Amortization of deferred sales inducements	34,625			7,709			183,992			50,359
Change in fair value of embedded derivatives	36,224			188,201			(8,913		)	466,278
Interest expense on notes payable	12,957			7,141			26,985			21,208
Interest expense on subordinated debentures	3,034			3,235			9,061			10,384
Amortization of deferred policy acquisition costs	50,034			25,954			265,534			105,086
Other operating costs and expenses	20,658			36,170			65,029			76,785
Total benefits and expenses	487,155			516,380			1,436,986			1,264,293
Income (loss) before income taxes	85,727			(12,445		)	310,007			32,350
Income tax expense (benefit)	29,546			(4,616		)	107,682			10,949
Net income (loss)	$	56,181		$	(7,829	)	$	202,325		$	21,401

Earnings (loss) per common share	$	0.86		$	(0.13	)	$	3.15		$	0.35
Earnings (loss) per common share - assuming dilution	$	0.75		$	(0.13	)	$	2.79		$	0.34
Weighted average common shares outstanding (in thousands):
Earnings (loss) per common share	65,129			62,504			64,239			60,723
Earnings (loss) per common share - assuming dilution	74,560			65,262			72,459			65,232

See accompanying notes to unaudited consolidated financial statements.

AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Dollars in thousands)

(Unaudited)



	Three Months Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013			2012

Net income (loss)	$	56,181		$	(7,829	)	$	202,325		$	21,401
Other comprehensive income (loss):
Change in net unrealized investment gains/losses (1)	(123,269		)	202,184			(793,140		)	390,575
Noncredit component of OTTI losses (1)	239			1,377			586			1,667
Reclassification of unrealized investment gains/losses to net income (loss) (1)	(903		)	—			(12,189		)	—
Other comprehensive income (loss) before income tax	(123,933		)	203,561			(804,743		)	392,242
Income tax effect related to other comprehensive income (loss)	43,378			(71,247		)	281,661			(137,285		)
Other comprehensive income (loss)	(80,555		)	132,314			(523,082		)	254,957
Comprehensive income (loss)	$	(24,374	)	$	124,485		$	(320,757	)	$	276,358

(1) Net of related adjustments to amortization of deferred sales inducements and deferred policy acquisition costs.

See accompanying notes to unaudited consolidated financial statements.

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			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	—		—			—			—			202,325		202,325
Other comprehensive loss	—		—			—			(523,082		)	—		(523,082		)
Allocation of 89,150 shares of common stock by ESOP, including excess income tax benefits	—		432			960			—			—		1,392
Share-based compensation, including excess income tax benefits	—		7,492			—			—			—		7,492
Issuance of 2,755,270 shares of common stock under compensation plans, including excess income tax benefits	2,755		23,663			—			—			—		26,418
Extinguishment of convertible senior notes, net of tax, including 216,729 shares of common stock issued upon conversion	217		1,547			—			—			—		1,764
Warrants to be settled in cash	—		(41,878		)	—			—			—		(41,878		)
Balance at September 30, 2013	$	64,723	$	487,971		$	(1,623	)	$	163,725		$	679,872	$	1,394,668

Balance at December 31, 2011	$	57,837	$	468,281		$	(3,620	)	$	457,229		$	428,952	$	1,408,679
Net income for period	—		—			—			—			21,401		21,401
Other comprehensive income	—		—			—			254,957			—		254,957
Conversion of $20,770 of subordinated debentures	2,564		17,027			—			—			—		19,591
Allocation of 63,946 shares of common stock by ESOP, including excess income tax benefits	—		32			689			—			—		721
Share-based compensation, including excess income tax benefits	—		5,495			—			—			—		5,495
Issuance of 1,147,440 shares of common stock under compensation plans, including excess income tax benefits	1,147		2,962			—			—			—		4,109
Balance at September 30, 2012	$	61,548	$	493,797		$	(2,931	)	$	712,186		$	450,353	$	1,714,953

See accompanying notes to unaudited consolidated financial statements.

AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(Unaudited)



	Nine Months Ended September 30,
	2013			2012
Operating activities
Net income	$	202,325		$	21,401
Adjustments to reconcile net income to net cash provided by operating activities:
Interest sensitive and index product benefits	889,810			527,961
Amortization of deferred sales inducements	183,992			50,359
Annuity product charges	(71,443		)	(65,176		)
Change in fair value of embedded derivatives	(8,913		)	466,278
Change in traditional life and accident and health insurance reserves	(3,925		)	27,850
Policy acquisition costs deferred	(313,560		)	(287,285		)
Amortization of deferred policy acquisition costs	265,534			105,086
Provision for depreciation and other amortization	14,285			13,969
Amortization of discounts and premiums on investments	7,920			(75,596		)
Realized gains/losses on investments and net OTTI losses recognized in operations	(17,963		)	13,470
Change in fair value of derivatives	(631,030		)	(269,404		)
Deferred income taxes	9,965			(41,469		)
Share-based compensation	5,942			4,907
Change in accrued investment income	(45,721		)	(47,938		)
Change in income taxes payable	23,040			9,856
Change in other assets	(36		)	(5,354		)
Change in other policy funds and contract claims	(24,327		)	56,568
Change in collateral held for derivatives	115,666			324,596
Change in other liabilities	5,474			3,442
Other	(2,611		)	(3,873		)
Net cash provided by operating activities	604,424			829,648

Investing activities
Sales, maturities, or repayments of investments:
Fixed maturity securities - available for sale	2,955,734			1,942,533
Fixed maturity securities - held for investment	—			2,618,207
Equity securities - available for sale	44,829			7,604
Mortgage loans on real estate	402,233			341,771
Derivative instruments	662,336			276,227
Other investments	18,244			25,901
Acquisition of investments:
Fixed maturity securities - available for sale	(6,691,800		)	(4,987,848		)
Mortgage loans on real estate	(383,074		)	(280,749		)
Derivative instruments	(302,135		)	(280,407		)
Other investments	(24,302		)	(83,779		)
Purchases of property, furniture and equipment	(621		)	(378		)
Net cash used in investing activities	(3,318,556		)	(420,918		)

AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

(Dollars in thousands)

(Unaudited)



	Nine Months Ended September 30,
	2013			2012
Financing activities
Receipts credited to annuity policyholder account balances	$	3,073,490		$	2,738,553
Coinsurance deposits	20,355			(16,364		)
Return of annuity policyholder account balances	(1,226,967		)	(1,134,943		)
Financing fees incurred and deferred	(9,045		)	—
Proceeds from notes payable	415,000			—
Repayment of notes payable	(43,243		)	—
Repayment of subordinated debentures	—			(270		)
Proceeds from amounts due under repurchase agreements	148,180			—
Excess tax benefits realized from share-based compensation plans	1,993			624
Proceeds from issuance of common stock	25,900			4,055
Change in checks in excess of cash balance	(25,145		)	(7,903		)
Net cash provided by financing activities	2,380,518			1,583,752
Increase (decrease) in cash and cash equivalents	(333,614		)	1,992,482
Cash and cash equivalents at beginning of period	1,268,545			404,952
Cash and cash equivalents at end of period	$	934,931		$	2,397,434

Supplemental disclosures of cash flow information
Cash paid during period for:
Interest expense	$	19,136		$	20,858
Income taxes	72,900			41,938
Non-cash operating activity:
Deferral of sales inducements	(250,322		)	220,784
Non-cash investing activity:
Real estate acquired in satisfaction of mortgage loans	6,285			14,932
Non-cash financing activities:
Conversion of subordinated debentures	—			20,770
Common stock issued in extinguishment of debt	3,367			—
Warrants to be settled in cash	41,878			—

See accompanying notes to unaudited consolidated financial statements.

AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 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 and nine month periods ended September 30, 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 nine months ended September 30, 2012 resulting in decreases of $140.3 million to receipts credited to annuity 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 currently no accounting standards updates with effective dates after September 30, 2013 that will significantly affect our consolidated financial statements.

2. Fair Values of Financial Instruments

The following sets forth a comparison of the carrying amounts and fair values of our financial instruments:



	September 30, 2013				December 31, 2012
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
	(Dollars in thousands)
Assets
Fixed maturity securities:
Available for sale	$	26,262,878	$	26,262,878	$	24,172,136	$	24,172,136
Held for investment	76,212		60,843		76,088		61,521
Equity securities, available for sale	9,708		9,708		53,422		53,422
Mortgage loans on real estate	2,593,851		2,711,170		2,623,940		2,848,235
Derivative instruments	625,236		625,236		415,258		415,258
Other investments	187,437		187,655		163,193		163,517
Cash and cash equivalents	934,931		934,931		1,268,545		1,268,545
Coinsurance deposits	2,970,601		2,642,309		2,910,701		2,678,232
Interest rate caps	5,356		5,356		3,247		3,247
2015 notes hedges	144,904		144,904		43,105		43,105
Counterparty collateral	240,713		240,713		—		—

Liabilities
Policy benefit reserves	34,319,660		28,802,302		31,452,496		26,264,831
Single premium immediate annuity (SPIA) benefit reserves	430,908		444,512		455,167		469,768
Notes payable	691,452		1,023,962		309,869		422,175
Subordinated debentures	246,003		233,125		245,869		218,283
2015 notes embedded derivatives	147,150		147,150		43,105		43,105
2015 warrants	51,077		51,077		—		—
Interest rate swap	222		222		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 nine months ended September 30, 2013.

Our assets and liabilities which are measured at fair value on a recurring basis as of September 30, 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)
September 30, 2013
Assets
Fixed maturity securities:
Available for sale:
United States Government full faith and credit	$	4,907	$	4,907	$	—	$	—
United States Government sponsored agencies	1,239,603		—		1,239,603		—
United States municipalities, states and territories	3,461,131		—		3,461,131		—
Foreign government obligations	92,682		—		92,682		—
Corporate securities	16,741,581		8,794		16,732,787		—
Residential mortgage backed securities	2,118,827		—		2,117,513		1,314
Commercial mortgage backed securities	1,590,310		—		1,590,310		—
Other asset backed securities	1,013,837		362		1,013,475		—
Equity securities, available for sale: finance, insurance and real estate	9,708		1,908		7,800		—
Derivative instruments	625,236		—		625,236		—
Cash and cash equivalents	934,931		934,931		—		—
Interest rate caps	5,356		—		5,356		—
2015 notes hedges	144,904		—		144,904		—
Counterparty collateral	240,713		—		240,713		—
	$	28,223,726	$	950,902	$	27,271,510	$	1,314
Liabilities
2015 notes embedded derivatives	$	147,150	$	—	$	147,150	$	—
Interest rate swap	222		—		222		—
2015 warrants	51,077		—		51,077		—
Fixed index annuities - embedded derivatives	3,975,862		—		—		3,975,862
	$	4,174,311	$	—	$	198,449	$	3,975,862

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

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 multiple broker quotes and take the average of the 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 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 September 30, 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, 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 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 values of our equity method investments qualify as Level 3 fair values and were 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 falls within Level 2 of the fair value hierarchy.

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 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.

2015 notes hedges and warrants

The fair value of these call options has been 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. Since August 26, 2013, when 50% of these call options were committed to partial unwind agreements, fair value has been determined in accordance with the terms of the unwind agreement that relies on market data. Fair value of the warrants that were committed to the partial unwind agreements has been determined in a similar manner in accordance with terms of the unwind agreements.

Counterparty collateral

Amounts reported in other assets of 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 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 values of our senior unsecured notes and convertible senior 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.

2015 notes embedded derivatives

The fair value of this embedded derivative is determined by pricing the call options that remain outstanding after the partial unwind agreement that hedge this potential liability. The terms of the conversion premium are identical to the 2015 notes hedges that remain after the partial unwind agreement 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.

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 and nine months ended September 30, 2013 and 2012:



	Three Months Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013			2012
	(Dollars in thousands)
Available for sale securities
Beginning balance	$	1,541		$	2,005		$	1,812		$	2,098
Principal returned	(148		)	(101		)	(709		)	(194		)
Accretion of discount	(18		)	13			116			60
Total gains (losses) (realized/unrealized):
Included in other comprehensive income (loss)	(61		)	28			95			211
Included in operations	—			(73		)	—			(303		)
Ending balance	$	1,314		$	1,872		$	1,314		$	1,872

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 September 30,					Nine Months Ended September 30,
	2013			2012		2013			2012
	(Dollars in thousands)
Fixed index annuities - embedded derivatives
Beginning balance	$	3,747,052		$	2,914,948	$	3,337,556		$	2,530,496
Premiums less benefits	372,363			229,340		1,044,756			418,845
Change in unrealized gains, net	(143,553		)	122,494		(406,450		)	317,441
Ending balance	$	3,975,862		$	3,266,782	$	3,975,862		$	3,266,782

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 September 30, 2013, were to increase by 100 basis points, the fair value of the embedded derivatives would decrease by $255.4 million recorded through operations as a decrease in the change in fair value of embedded derivatives and there would be a corresponding decrease of $155.2 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 $283.6 million recorded through operations as an increase in the change in fair value of embedded derivatives and there would be a corresponding increase of $168.8 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.

3. Investments

At September 30, 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)
September 30, 2013
Fixed maturity securities:
Available for sale:
United States Government full faith and credit	$	4,608	$	342	$	(43	)	$	4,907
United States Government sponsored agencies	1,314,449		4,069		(78,915		)	1,239,603
United States municipalities, states and territories	3,278,749		212,975		(30,593		)	3,461,131
Foreign government obligations	86,109		9,365		(2,792		)	92,682
Corporate securities	16,420,869		720,010		(399,298		)	16,741,581
Residential mortgage backed securities	1,999,201		145,605		(25,979		)	2,118,827
Commercial mortgage backed securities	1,664,541		5,194		(79,425		)	1,590,310
Other asset backed securities	1,014,590		23,544		(24,297		)	1,013,837
	$	25,783,116	$	1,121,104	$	(641,342	)	$	26,262,878
Held for investment:
Corporate security	$	76,212	$	—	$	(15,369	)	$	60,843

Equity securities, available for sale:
Finance, insurance, and real estate	$	8,917	$	791	$	—		$	9,708

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 nine months ended September 30, 2013 and 2012, we received $1.1 billion and $3.8 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 $2.6 billion for the nine months ended September 30, 2012, were classified as held for investment. The proceeds from these redemptions have been reinvested primarily in United States government sponsored agencies, corporate securities, residential and commercial mortgage backed securities and other asset backed securities. At September 30, 2013, 31% of our fixed income securities have call features of which 5% ($1.3 billion) will become subject to call redemption during the next twelve months, of which $500.0 million are U.S. Government agency securities maturing in January 2028 with 3.75% coupons. These securities are callable quarterly and a modest decline in interest rates from current levels could result in the calls being exercised on their next call date in January of 2014.

The amortized cost and fair value of fixed maturity securities at September 30, 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	$	123,756	$	126,880	$	—	$	—
Due after one year through five years	853,588		958,053		—		—
Due after five years through ten years	7,379,238		7,364,750		—		—
Due after ten years through twenty years	6,226,753		6,341,286		—		—
Due after twenty years	6,521,449		6,748,935		76,212		60,843
	21,104,784		21,539,904		76,212		60,843
Residential mortgage backed securities	1,999,201		2,118,827		—		—
Commercial mortgage backed securities	1,664,541		1,590,310		—		—
Other asset backed securities	1,014,590		1,013,837		—		—
	$	25,783,116	$	26,262,878	$	76,212	$	60,843

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:



	September 30, 2013			December 31, 2012
	(Dollars in thousands)
Net unrealized gains on available for sale fixed maturity securities and equity securities	$	480,553		$	2,223,933
Adjustments for assumed changes in amortization of deferred policy acquisition costs and deferred sales inducements	(263,337		)	(1,201,974		)
Deferred income tax valuation allowance reversal	22,534			22,534
Deferred income tax benefit	(76,025		)	(357,686		)
Net unrealized gains reported as accumulated other comprehensive income	$	163,725		$	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% of our fixed maturity portfolio rated investment grade at September 30, 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:



	September 30, 2013				December 31, 2012
NAIC Designation	Amortized Cost		Fair Value		Amortized Cost		Fair Value
	(Dollars in thousands)
1	$	15,945,089	$	16,367,238	$	13,737,381	$	15,250,560
2	9,277,558		9,352,577		7,838,186		8,533,121
3	533,890		509,433		398,294		387,222
4	100,907		93,126		53,879		56,151
5	—		—		—		—
6	1,884		1,347		5,375		6,603
	$	25,859,328	$	26,323,721	$	22,033,115	$	24,233,657

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 885 and 198 securities, respectively) have been in a continuous unrealized loss position, at September 30, 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)
September 30, 2013
Fixed maturity securities:
Available for sale:
United States Government full faith and credit	$	977	$	(43	)	$	—	$	—		$	977	$	(43	)
United States Government sponsored agencies	1,130,979		(78,915		)	—		—			1,130,979		(78,915		)
United States municipalities, states and territories	488,260		(30,593		)	—		—			488,260		(30,593		)
Foreign government obligations	26,985		(2,792		)	—		—			26,985		(2,792		)
Corporate securities:
Finance, insurance and real estate	1,291,001		(71,692		)	119,734		(11,273		)	1,410,735		(82,965		)
Manufacturing, construction and mining	2,925,074		(161,188		)	16,494		(2,608		)	2,941,568		(163,796		)
Utilities and related sectors	1,568,088		(83,013		)	30,766		(2,673		)	1,598,854		(85,686		)
Wholesale/retail trade	336,683		(20,153		)	—		—			336,683		(20,153		)
Services, media and other	843,825		(44,173		)	30,939		(2,525		)	874,764		(46,698		)
Residential mortgage backed securities	296,361		(23,605		)	34,068		(2,374		)	330,429		(25,979		)
Commercial mortgage backed securities	1,268,293		(79,425		)	—		—			1,268,293		(79,425		)
Other asset backed securities	402,461		(17,914		)	44,726		(6,383		)	447,187		(24,297		)
	$	10,578,987	$	(613,506	)	$	276,727	$	(27,836	)	$	10,855,714	$	(641,342	)
Held for investment:
Corporate security:
Insurance	$	—	$	—		$	60,843	$	(15,369	)	$	60,843	$	(15,369	)

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 September 30, 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 September 30, 2013.

United States municipalities, states and territories: These securities are relatively long in duration and their 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 are due to wider spreads on the announcement of increased capital expenditures with resulting higher leverage and greater supply.

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 September 30, 2013 as the result of rising interest rates in the first nine months of 2013. In addition, a small number of securities have seen 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.

Residential mortgage backed securities: At September 30, 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 $323.4 million and a fair value of $340.7 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. No securities in an unrealized loss position are rated below investment grade.

Approximately 94% and 75% of the unrealized losses on fixed maturity securities shown in the above table for September 30, 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 and nine months ended September 30, 2013 and 2012 are as follows:



	Three Months Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013			2012
	(Dollars in thousands)
Fixed maturity securities held for investment carried at amortized cost	$	(449	)	$	(626	)	$	(802	)	$	(12,505	)
Investments carried at fair value: