2015-03-31_AEL 10Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2015
OR
o 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission File Number : 001-31911
American Equity Investment Life Holding Company
(Exact name of registrant as specified in its charter)
Iowa
 
42-1447959
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
6000 Westown Parkway
West Des Moines, Iowa 50266
(Address of principal executive offices, including zip code)
(515) 221-0002
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer," “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x
 
Accelerated filer o
Non-accelerated filer o
 
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
APPLICABLE TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:
As of April 30, 2015, there were 77,057,850 shares of the registrant's common stock, $1 par value, outstanding.


TABLE OF CONTENTS
 
Page
 
 
 
 
 
 



Table of Contents

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share and per share data)
 
March 31, 2015
 
December 31, 2014
 
(Unaudited)
 
 
Assets
 
 
 
Investments:
 
 
 
Fixed maturity securities:
 
 
 
Available for sale, at fair value (amortized cost: 2015 - $31,443,319; 2014 - $30,205,046)
$
34,203,641

 
$
32,445,202

Held for investment, at amortized cost (fair value: 2015 - $82,984; 2014 - $75,838)
76,479

 
76,432

Equity securities, available for sale, at fair value (cost: 2015 - $7,511; 2014 - $7,509)
7,849

 
7,805

Mortgage loans on real estate
2,433,757

 
2,434,580

Derivative instruments
610,764

 
731,113

Other investments
285,177

 
286,726

Total investments
37,617,667

 
35,981,858

 
 
 
 
Cash and cash equivalents
293,764

 
701,514

Coinsurance deposits
3,101,783

 
3,044,342

Accrued investment income
358,241

 
326,559

Deferred policy acquisition costs
2,021,990

 
2,058,556

Deferred sales inducements
1,558,921

 
1,587,257

Income taxes recoverable
—

 
9,252

Other assets
436,349

 
280,396

Total assets
$
45,388,715

 
$
43,989,734

 
 
 
 
Liabilities and Stockholders' Equity
 
 
 
Liabilities:
 
 
 
Policy benefit reserves
$
41,037,401

 
$
39,802,861

Other policy funds and contract claims
353,741

 
365,819

Notes payable
421,919

 
421,679

Subordinated debentures
246,293

 
246,243

Amounts due under repurchase agreements
15,075

 
—

Deferred income taxes
74,149

 
3,895

Income taxes payable
13,290

 
—

Other liabilities
900,127

 
1,009,361

Total liabilities
43,061,995

 
41,849,858

 
 
 
 
Stockholders' equity:
 
 
 
Preferred stock, par value $1 per share, 2,000,000 shares authorized,
  2014 and 2013 - no shares issued and outstanding
—

 
—

Common stock, par value $1 per share, 200,000,000 shares authorized; issued and outstanding:
   2015 - 76,681,287 shares (excluding 3,685,784 treasury shares);
   2014 - 76,062,407 shares (excluding 4,126,167 treasury shares)
76,681

 
76,062

Additional paid-in capital
521,203

 
513,218

Accumulated other comprehensive income
893,738

 
721,401

Retained earnings
835,098

 
829,195

Total stockholders' equity
2,326,720

 
2,139,876

Total liabilities and stockholders' equity
$
45,388,715

 
$
43,989,734

See accompanying notes to unaudited consolidated financial statements.

2
Table of Contents

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

 
Three Months Ended
March 31,
 
2015
 
2014
Revenues:
 
 
 
Premiums and other considerations
$
6,997

 
$
7,331

Annuity product charges
28,682

 
25,272

Net investment income
399,669

 
370,005

Change in fair value of derivatives
(31,100
)
 
48,493

Net realized gains (losses) on investments, excluding other than temporary impairment ("OTTI") losses
4,879

 
(714
)
OTTI losses on investments:
 
 
 
Total OTTI losses
(132
)
 
—

Portion of OTTI losses recognized from other comprehensive income
—

 
(905
)
Net OTTI losses recognized in operations
(132
)
 
(905
)
Loss on extinguishment of debt
—

 
(3,977
)
Total revenues
408,995

 
445,505

 
 
 
 
Benefits and expenses:
 
 
 
Insurance policy benefits and change in future policy benefits
9,220

 
10,095

Interest sensitive and index product benefits
282,825

 
317,192

Amortization of deferred sales inducements
10,953

 
666

Change in fair value of embedded derivatives
51,213

 
92,619

Interest expense on notes payable
7,339

 
10,264

Interest expense on subordinated debentures
3,016

 
3,008

Amortization of deferred policy acquisition costs
14,286

 
7,194

Other operating costs and expenses
21,122

 
19,085

Total benefits and expenses
399,974

 
460,123

Income (loss) before income taxes
9,021

 
(14,618
)
Income tax expense (benefit)
3,118

 
(4,865
)
Net income (loss)
$
5,903

 
$
(9,753
)
 
 
 
 
Earnings (loss) per common share
$
0.08

 
$
(0.13
)
Earnings (loss) per common share - assuming dilution
$
0.07

 
$
(0.13
)
Weighted average common shares outstanding (in thousands):
 
 
 
Earnings (loss) per common share
77,042

 
72,519

Earnings (loss) per common share - assuming dilution
79,118

 
79,616

See accompanying notes to unaudited consolidated financial statements.

3
Table of Contents

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

 
Three Months Ended
March 31,
 
2015
 
2014
 
 
 
 
Net income (loss)
$
5,903

 
$
(9,753
)
Other comprehensive income:
 
 
 
Change in net unrealized investment gains/losses (1)
264,113

 
440,688

Noncredit component of OTTI losses (1)
—

 
408

Reclassification of unrealized investment gains/losses to net income (1)
1,019

 
(730
)
Other comprehensive income before income tax
265,132

 
440,366

Income tax effect related to other comprehensive income
(92,795
)
 
(154,127
)
Other comprehensive income
172,337

 
286,239

Comprehensive income
$
178,240

 
$
276,486

(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
Table of Contents

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, 2014
$
76,062

 
$
513,218

 
$
—

 
$
721,401

 
$
829,195

 
$
2,139,876

Net income for period
—

 
—

 
—

 
—

 
5,903

 
5,903

Other comprehensive income
—

 
—

 
—

 
172,337

 
—

 
172,337

Share-based compensation, including excess income tax benefits
—

 
4,515

 
—

 
—

 
—

 
4,515

Issuance of 618,880 shares of common stock under compensation plans, including excess income tax benefits
619

 
3,470

 
—

 
—

 
—

 
4,089

Balance at March 31, 2015
$
76,681

 
$
521,203

 
$
—

 
$
893,738

 
$
835,098

 
$
2,326,720

 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2013
$
70,535

 
$
550,400

 
$
(631
)
 
$
46,196

 
$
718,187

 
$
1,384,687

Net loss for period
—

 
—

 
—

 
—

 
(9,753
)
 
(9,753
)
Other comprehensive income
—

 
—

 
—

 
286,239

 
—

 
286,239

Allocation of 29,309 shares of common stock by ESOP, including excess income tax benefits
—

 
364

 
318

 
—

 
—

 
682

Share-based compensation, including excess income tax benefits
—

 
2,578

 
—

 
—

 
—

 
2,578

Issuance of 908,032 shares of common stock under compensation plans, including excess income tax benefits
908

 
5,731

 
—

 
—

 
—

 
6,639

Extinguishment of convertible senior notes, net of tax, including 946,793 shares of common stock issued upon conversion
947

 
(17,070
)
 
—

 
—

 
—

 
(16,123
)
Balance at March 31, 2014
$
72,390

 
$
542,003

 
$
(313
)
 
$
332,435

 
$
708,434

 
$
1,654,949

See accompanying notes to unaudited consolidated financial statements.

5
Table of Contents

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

 
Three Months Ended
March 31,
 
2015
 
2014
Operating activities
 
 
 
Net income (loss)
$
5,903

 
$
(9,753
)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
 
 
 
Interest sensitive and index product benefits
282,825

 
317,192

Amortization of deferred sales inducements
10,953

 
666

Annuity product charges
(28,682
)
 
(25,272
)
Change in fair value of embedded derivatives
51,213

 
92,619

Decrease in traditional life and accident and health insurance reserves
(868
)
 
(91
)
Policy acquisition costs deferred
(121,822
)
 
(93,333
)
Amortization of deferred policy acquisition costs
14,286

 
7,194

Provision for depreciation and other amortization
1,267

 
3,000

Amortization of discounts and premiums on investments
(1,428
)
 
(2,829
)
Realized gains/losses on investments and net OTTI losses recognized in operations
(4,747
)
 
1,619

Change in fair value of derivatives
30,636

 
(48,493
)
Deferred income taxes
(22,541
)
 
(37,360
)
Loss on extinguishment of debt
—

 
3,977

Share-based compensation
1,687

 
37

Change in accrued investment income
(31,682
)
 
(21,177
)
Change in income taxes recoverable/payable
22,542

 
7,909

Change in other assets
(918
)
 
(339
)
Change in other policy funds and contract claims
(14,171
)
 
(17,288
)
Change in collateral held for derivatives
(326,248
)
 
(98,351
)
Change in other liabilities
(7,113
)
 
(30,056
)
Other
(1,307
)
 
(1,708
)
Net cash provided by (used in) operating activities
(140,215
)
 
48,163

 
 
 
 
Investing activities
 
 
 
Sales, maturities, or repayments of investments:
 
 
 
Fixed maturity securities - available for sale
276,734

 
208,747

Mortgage loans on real estate
109,846

 
84,735

Derivative instruments
214,667

 
241,098

Other investments
7,218

 
8,942

Acquisition of investments:
 
 
 
Fixed maturity securities - available for sale
(1,434,934
)
 
(974,244
)
Mortgage loans on real estate
(104,793
)
 
(90,056
)
Derivative instruments
(124,948
)
 
(103,330
)
Other investments
(3,385
)
 
(2,259
)
Purchases of property, furniture and equipment
(295
)
 
(200
)
Net cash used in investing activities
(1,059,890
)
 
(626,567
)

6
Table of Contents

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

 
Three Months Ended
March 31,
 
2015
 
2014
Financing activities
 
 
 
Receipts credited to annuity and single premium universal life policyholder account balances
$
1,307,792

 
$
915,631

Coinsurance deposits
(33,061
)
 
(2,609
)
Return of annuity policyholder account balances
(492,242
)
 
(475,280
)
Financing fees incurred and deferred
—

 
(100
)
Repayment of notes payable
—

 
(54,583
)
Proceeds from amounts due under repurchase agreements
15,075

 
—

Excess tax benefits realized from share-based compensation plans
2,828

 
3,087

Proceeds from issuance of common stock
4,089

 
6,093

Change in checks in excess of cash balance
(12,126
)
 
(32,192
)
Net cash provided by financing activities
792,355

 
360,047

Decrease in cash and cash equivalents
(407,750
)
 
(218,357
)
Cash and cash equivalents at beginning of period
701,514

 
897,529

Cash and cash equivalents at end of period
$
293,764

 
$
679,172

 
 
 
 
Supplemental disclosures of cash flow information
 
 
 
Cash paid during period for:
 
 
 
Interest expense
$
16,580

 
$
17,993

Income taxes
114

 
21,500

Non-cash operating activity:
 
 
 
Deferral of sales inducements
93,591

 
72,687

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

 
1,713

Non-cash financing activities:
 
 
 
Common stock issued in extinguishment of debt
—

 
23,177

See accompanying notes to unaudited consolidated financial statements.




 

7
Table of Contents

AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2015
(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, 2015 are not necessarily indicative of the results that may be expected for the year ended December 31, 2015. 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, 2014.
Adopted Accounting Pronouncements
There were no accounting pronouncements that were adopted during the current period.
New Accounting Pronouncements
In April 2015, the Financial Accounting Standards Board ("FASB") issued an accounting standards update ("ASU") which requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. This ASU will be effective for us on January 1, 2016, and retroactive application is required. It is not expected to have a material impact on our consolidated financial statements.
In June 2014, the FASB issued an ASU that requires that a performance target in a share-based payment arrangement that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. The requisite service period ends when the employee can cease rendering service and still be eligible to vest in the award if the performance target is achieved. This ASU will be effective for us on January 1, 2016, and early adoption is permitted, but it is not expected to have a material impact on our consolidated financial statements.

8
Table of Contents

2. Fair Values of Financial Instruments
The following sets forth a comparison of the carrying amounts and fair values of our financial instruments:
 
March 31, 2015
 
December 31, 2014
 
Carrying
Amount
 
Fair Value
 
Carrying
Amount
 
Fair Value
 
(Dollars in thousands)
Assets
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Available for sale
$
34,203,641

 
$
34,203,641

 
$
32,445,202

 
$
32,445,202

Held for investment
76,479

 
82,984

 
76,432

 
75,838

Equity securities, available for sale
7,849

 
7,849

 
7,805

 
7,805

Mortgage loans on real estate
2,433,757

 
2,484,775

 
2,434,580

 
2,493,901

Derivative instruments
610,764

 
610,764

 
731,113

 
731,113

Other investments
270,566

 
277,786

 
266,488

 
273,004

Cash and cash equivalents
293,764

 
293,764

 
701,514

 
701,514

Coinsurance deposits
3,101,783

 
2,755,386

 
3,044,342

 
2,698,552

Interest rate caps
2,092

 
2,092

 
2,778

 
2,778

2015 notes hedges
30,858

 
30,858

 
30,291

 
30,291

Counterparty collateral
331,035

 
331,035

 
206,096

 
206,096

 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
Policy benefit reserves
40,699,395

 
34,108,047

 
39,463,987

 
33,078,978

Single premium immediate annuity (SPIA) benefit reserves
353,420

 
365,835

 
365,440

 
377,654

Notes payable
421,919

 
452,950

 
421,679

 
503,349

Subordinated debentures
246,293

 
255,160

 
246,243

 
244,437

Amounts due under repurchase agreements
15,075

 
15,075

 
—

 
—

2015 notes embedded conversion derivative
30,858

 
30,858

 
30,291

 
30,291

Interest rate swap
3,940

 
3,940

 
2,644

 
2,644

Fair value is the price that would be received to sell an asset or paid to transfer a liability (exit price) in an orderly transaction between market participants at the measurement date. The objective of a fair value measurement is to determine that price for each financial instrument at each measurement date. We meet this objective using various methods of valuation that include market, income and cost approaches.
We categorize our financial instruments into three levels of fair value hierarchy based on the priority of inputs used in determining fair value. The hierarchy defines the highest priority inputs (Level 1) as quoted prices in active markets for identical assets or liabilities. The lowest priority inputs (Level 3) are our own assumptions about what a market participant would use in determining fair value such as estimated future cash flows. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, a financial instrument's level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the financial instrument. We categorize financial assets and liabilities recorded at fair value in the consolidated balance sheets as follows:
Level 1—
Quoted prices are available in active markets for identical financial instruments as of the reporting date. We do not adjust the quoted price for these financial instruments, even in situations where we hold a large position and a sale could reasonably impact the quoted price.
Level 2—
Quoted prices in active markets for similar financial instruments, quoted prices for identical or similar financial instruments in markets that are not active; and models and other valuation methodologies using inputs other than quoted prices that are observable.
Level 3—
Models and other valuation methodologies using significant inputs that are unobservable for financial instruments and include situations where there is little, if any, market activity for the financial instrument. The inputs into the determination of fair value require significant management judgment or estimation. Financial instruments that are included in Level 3 are securities for which no market activity or data exists and for which we used discounted expected future cash flows with our own assumptions about what a market participant would use in determining fair value.
Transfers of securities among the levels occur at times and depend on the type of inputs used to determine fair value of each security. There were no transfers between levels during any period presented.

9
Table of Contents

Our assets and liabilities which are measured at fair value on a recurring basis as of March 31, 2015 and December 31, 2014 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, 2015
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
United States Government full faith and credit
$
38,527

 
$
4,300

 
$
34,227

 
$
—

United States Government sponsored agencies
1,421,364

 
—

 
1,421,364

 
—

United States municipalities, states and territories
3,809,862

 
—

 
3,809,862

 
—

Foreign government obligations
227,541

 
—

 
227,541

 
—

Corporate securities
22,751,894

 
12

 
22,751,882

 
—

Residential mortgage backed securities
1,729,315

 
—

 
1,728,973

 
342

Commercial mortgage backed securities
3,165,829

 
—

 
3,165,829

 
—

Other asset backed securities
1,059,309

 
—

 
1,059,309

 
—

Equity securities, available for sale: finance, insurance and real estate
7,849

 
—

 
7,849

 
—

Derivative instruments
610,764

 
—

 
610,764

 
—

Cash and cash equivalents
293,764

 
293,764

 
—

 
—

Interest rate caps
2,092

 
—

 
2,092

 
—

2015 notes hedges
30,858

 
—

 
30,858

 
—

Counterparty collateral
331,035

 
—

 
331,035

 
—

 
$
35,480,003

 
$
298,076

 
$
35,181,585

 
$
342

Liabilities
 
 
 
 
 
 
 
2015 notes embedded conversion derivative
$
30,858

 
$
—

 
$
30,858

 
$
—

Interest rate swap
3,940

 
—

 
3,940

 
—

Fixed index annuities - embedded derivatives
5,865,171

 
—

 
—

 
5,865,171

 
$
5,899,969

 
$
—

 
$
34,798

 
$
5,865,171

 
 
 
 
 
 
 
 
December 31, 2014
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
United States Government full faith and credit
$
138,460

 
$
4,255

 
$
134,205

 
$
—

United States Government sponsored agencies
1,393,890

 
—

 
1,393,890

 
—

United States municipalities, states and territories
3,723,309

 
—

 
3,723,309

 
—

Foreign government obligations
193,803

 
—

 
193,803

 
—

Corporate securities
21,490,292

 
11

 
21,490,281

 
—

Residential mortgage backed securities
1,751,345

 
—

 
1,750,970

 
375

Commercial mortgage backed securities
2,807,620

 
—

 
2,807,620

 
—

Other asset backed securities
946,483

 
—

 
946,483

 
—

Equity securities, available for sale: finance, insurance and real estate
7,805

 
—

 
7,805

 
—

Derivative instruments
731,113

 
—

 
731,113

 
—

Cash and cash equivalents
701,514

 
701,514

 
—

 
—

Interest rate caps
2,778

 
—

 
2,778

 
—

2015 notes hedges
30,291

 
—

 
30,291

 
—

Counterparty collateral
206,096

 
—

 
206,096

 
—

 
$
34,124,799

 
$
705,780

 
$
33,418,644

 
$
375

Liabilities
 
 
 
 
 
 
 
2015 notes embedded conversion derivative
$
30,291

 
$
—

 
$
30,291

 
$
—

Interest rate swap
2,644

 
—

 
2,644

 
—

Fixed index annuities - embedded derivatives
5,574,653

 
—

 
—

 
5,574,653

 
$
5,607,588

 
$
—

 
$
32,935

 
$
5,574,653


10
Table of Contents

The following methods and assumptions were used in estimating the fair values of financial instruments during the periods presented in these consolidated financial statements.
Fixed maturity securities and equity securities
The fair values of fixed maturity securities and equity securities in an active and orderly market are determined by utilizing independent pricing services. The independent pricing services incorporate a variety of observable market data in their valuation techniques, including:
•
reported trading prices,
•
benchmark yields,
•
broker-dealer quotes,
•
benchmark securities,
•
bids and offers,
•
credit ratings,
•
relative credit information, and
•
other reference data.
The independent pricing services also take into account perceived market movements and sector news, as well as a security's terms and conditions, including any features specific to that issue that may influence risk and marketability. Depending on the security, the priority of the use of observable market inputs may change as some observable market inputs may not be relevant or additional inputs may be necessary.
The independent pricing services provide quoted market prices when available. Quoted prices are not always available due to market inactivity. When quoted market prices are not available, the third parties use yield data and other factors relating to instruments or securities with similar characteristics to determine fair value for securities that are not actively traded. We generally obtain one value from our primary external pricing service. In situations where a price is not available from this service, we may obtain 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 March 31, 2015 and December 31, 2014.
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 value 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 whose fair values fall within Level 2 of the fair value hierarchy.

11
Table of Contents

Cash and cash equivalents
Amounts reported in the consolidated balance sheets for these instruments are reported at their historical cost which approximates fair value due to the nature of the assets assigned to this category.
Interest rate swap and caps
The fair values of our pay fixed/receive variable interest rate swap and our interest rate caps are obtained from third parties and are determined by discounting expected future cash flows using projected LIBOR rates for the term of the swap and caps.
2015 notes hedges
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.
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.
Amounts due under repurchase agreements
The amounts reported in the consolidated balance sheets for short term indebtedness under repurchase agreements with variable interest rates approximate their fair values.
2015 notes embedded conversion derivative
The fair value of this embedded derivative is determined by pricing the call options that hedge this potential liability. The terms of the conversion option 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
Table of Contents

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, 2015 and 2014:
 
Three Months Ended
March 31,
 
2015
 
2014
 
(Dollars in thousands)
Available for sale securities
 
 
 
Beginning balance
$
375

 
$
1,376

Principal returned
(12
)
 
(78
)
Amortization of premium/accretion of discount
(57
)
 
(27
)
Total gains (losses) (realized/unrealized):
 
 
 
Included in other comprehensive income
36

 
(191
)
Included in operations
—

 
—

Ending balance
$
342

 
$
1,080

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,
 
2015
 
2014
 
(Dollars in thousands)
Fixed index annuities - embedded derivatives
 
 
 
Beginning balance
$
5,574,653

 
$
4,406,163

Premiums less benefits
360,395

 
371,953

Change in fair value, net
(69,877
)
 
(22,203
)
Ending balance
$
5,865,171

 
$
4,755,913

Change in fair value, 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, 2015, were to increase by 100 basis points, the fair value of the embedded derivatives would decrease by $405.6 million recorded through operations as a decrease in the change in fair value of embedded derivatives and there would be a corresponding decrease of $238.0 million to our combined balance for deferred policy acquisition costs and deferred sales inducements recorded through operations as an increase in amortization of deferred policy acquisition costs and deferred sales inducements. A decrease by 100 basis points in the discount rate used to discount the excess projected contract values would increase the fair value of the embedded derivatives by $454.2 million recorded through operations as an increase in the change in fair value of embedded derivatives and there would be a corresponding increase of $261.0 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.

13
Table of Contents

3. Investments
At March 31, 2015 and December 31, 2014, 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, 2015
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
United States Government full faith and credit
$
37,114

 
$
1,417

 
$
(4
)
 
$
38,527

United States Government sponsored agencies
1,384,476

 
45,559

 
(8,671
)
 
1,421,364

United States municipalities, states and territories
3,345,258

 
464,981

 
(377
)
 
3,809,862

Foreign government obligations
210,918

 
21,023

 
(4,400
)
 
227,541

Corporate securities
20,864,311

 
1,973,728

 
(86,145
)
 
22,751,894

Residential mortgage backed securities
1,571,548

 
159,281

 
(1,514
)
 
1,729,315

Commercial mortgage backed securities
3,017,014

 
149,269

 
(454
)
 
3,165,829

Other asset backed securities
1,012,680

 
54,766

 
(8,137
)
 
1,059,309

 
$
31,443,319

 
$
2,870,024

 
$
(109,702
)
 
$
34,203,641

Held for investment:
 
 
 
 
 
 
 
Corporate security
$
76,479

 
$
6,505

 
$
—

 
$
82,984

 
 
 
 
 
 
 
 
Equity securities, available for sale:
 
 
 
 
 
 
 
Finance, insurance, and real estate
$
7,511

 
$
338

 
$
—

 
$
7,849

 
 
 
 
 
 
 
 
December 31, 2014
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
United States Government full faith and credit
$
137,710

 
$
765

 
$
(15
)
 
$
138,460

United States Government sponsored agencies
1,364,424

 
43,399

 
(13,933
)
 
1,393,890

United States municipalities, states and territories
3,293,551

 
430,469

 
(711
)
 
3,723,309

Foreign government obligations
181,128

 
16,628

 
(3,953
)
 
193,803

Corporate securities
19,984,747

 
1,628,941

 
(123,396
)
 
21,490,292

Residential mortgage backed securities
1,616,846

 
136,704

 
(2,205
)
 
1,751,345

Commercial mortgage backed securities
2,720,294

 
90,649

 
(3,323
)
 
2,807,620

Other asset backed securities
906,346

 
48,022

 
(7,885
)
 
946,483

 
$
30,205,046

 
$
2,395,577

 
$
(155,421
)
 
$
32,445,202

Held for investment:
 
 
 
 
 
 
 
Corporate security
$
76,432

 
$
—

 
$
(594
)
 
$
75,838

 
 
 
 
 
 
 
 
Equity securities, available for sale:
 
 
 
 
 
 
 
Finance, insurance, and real estate
$
7,509

 
$
296

 
$
—

 
$
7,805

At March 31, 2015, 34% of our fixed income securities have call features, of which 0.6% ($0.2 billion) were subject to call redemption and another 4% ($1.2 billion) will become subject to call redemption during the next twelve months. Approximately 60% of our fixed income securities that have call features are not callable until within six months of their stated maturities.

14
Table of Contents

The amortized cost and fair value of fixed maturity securities at March 31, 2015, 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
$
79,405

 
$
81,179

 
$
—

 
$
—

Due after one year through five years
1,537,898

 
1,706,024

 
—

 
—

Due after five years through ten years
8,936,938

 
9,293,120

 
—

 
—

Due after ten years through twenty years
7,579,323

 
8,366,229

 
—

 
—

Due after twenty years
7,708,513

 
8,802,636

 
76,479

 
82,984

 
25,842,077

 
28,249,188

 
76,479

 
82,984

Residential mortgage backed securities
1,571,548

 
1,729,315

 
—

 
—

Commercial mortgage backed securities
3,017,014

 
3,165,829

 
—

 
—

Other asset backed securities
1,012,680

 
1,059,309

 
—

 
—

 
$
31,443,319

 
$
34,203,641

 
$
76,479

 
$
82,984

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, 2015
 
December 31, 2014
 
(Dollars in thousands)
Net unrealized gains on available for sale fixed maturity securities and equity securities
$
2,760,660

 
$
2,240,452

Adjustments for assumed changes in amortization of deferred policy acquisition costs and deferred sales inducements
(1,420,347
)
 
(1,165,271
)
Deferred income tax valuation allowance reversal
22,534

 
22,534

Deferred income tax expense
(469,109
)
 
(376,314
)
Net unrealized gains reported as accumulated other comprehensive income
$
893,738

 
$
721,401

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 both March 31, 2015 and December 31, 2014.
The following table summarizes the credit quality, as determined by NAIC designation, of our fixed maturity portfolio as of the dates indicated:
 
 
March 31, 2015
 
December 31, 2014
NAIC
Designation
 
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
 
 
(Dollars in thousands)
1
 
$
19,969,022

 
$
22,027,864

 
$
19,223,151

 
$
20,941,634

2
 
10,833,446

 
11,565,940

 
10,432,593

 
10,981,618

3
 
681,662

 
671,393

 
602,191

 
583,313

4
 
35,082

 
21,074

 
22,888

 
14,089

5
 
—

 
—

 
—

 
—

6
 
586

 
354

 
655

 
386

 
 
$
31,519,798

 
$
34,286,625

 
$
30,281,478

 
$
32,521,040


15
Table of Contents

The following table shows our investments' gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities (consisting of 213 and 402 securities, respectively) have been in a continuous unrealized loss position, at March 31, 2015 and December 31, 2014:
 
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, 2015
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
 
 
 
 
United States Government full faith and credit
$
508

 
$
(4
)
 
$
—

 
$
—

 
$
508

 
$
(4
)
United States Government sponsored agencies
585,574

 
(8,671
)
 
—

 
—

 
585,574

 
(8,671
)
United States municipalities, states and territories
50,040

 
(322
)
 
2,945

 
(55
)
 
52,985

 
(377
)
Foreign government obligations
9,044

 
(1,232
)
 
11,251

 
(3,168
)
 
20,295

 
(4,400
)
Corporate securities:
 
 
 
 
 
 
 
 
 
 
 
Finance, insurance and real estate
182,005

 
(1,464
)
 
79,738

 
(10,022
)
 
261,743

 
(11,486
)
Manufacturing, construction and mining
703,225

 
(30,909
)
 
235,075

 
(24,455
)
 
938,300

 
(55,364
)
Utilities and related sectors
339,510

 
(10,650
)
 
64,467

 
(2,500
)
 
403,977

 
(13,150
)
Wholesale/retail trade
71,296

 
(1,058
)
 
23,733

 
(2,727
)
 
95,029

 
(3,785
)
Services, media and other
149,762

 
(1,234
)
 
37,022

 
(1,126
)
 
186,784

 
(2,360
)
Residential mortgage backed securities
13,147

 
(149
)
 
7,292

 
(1,365
)
 
20,439

 
(1,514
)
Commercial mortgage backed securities
110,898

 
(454
)
 
—

 
—

 
110,898

 
(454
)
Other asset backed securities
125,651

 
(1,533
)
 
25,371

 
(6,604
)
 
151,022

 
(8,137
)
 
$
2,340,660

 
$
(57,680
)
 
$
486,894

 
$
(52,022
)
 
$
2,827,554

 
$
(109,702
)
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2014
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
 
 
 
 
United States Government full faith and credit
$
—

 
$
—

 
$
498

 
$
(15
)
 
$
498

 
$
(15
)
United States Government sponsored agencies
—

 
—

 
610,339

 
(13,933
)
 
610,339

 
(13,933
)
United States municipalities, states and territories
—

 
—

 
27,947

 
(711
)
 
27,947

 
(711
)
Foreign government obligations
14,194

 
(1,068
)
 
11,542

 
(2,885
)
 
25,736

 
(3,953
)
Corporate securities:
 
 
 
 
 
 
 
 
 
 
 
Finance, insurance and real estate
253,439

 
(2,586
)
 
399,874

 
(16,277
)
 
653,313

 
(18,863
)
Manufacturing, construction and mining
1,078,089

 
(35,151
)
 
694,088

 
(35,926
)
 
1,772,177

 
(71,077
)
Utilities and related sectors
373,952

 
(8,185
)
 
344,313

 
(10,153
)
 
718,265

 
(18,338
)
Wholesale/retail trade
88,766

 
(2,290
)
 
99,427

 
(3,122
)
 
188,193

 
(5,412
)
Services, media and other
131,940

 
(1,567
)
 
277,296

 
(8,139
)
 
409,236

 
(9,706
)
Residential mortgage backed securities
22,115

 
(1,219
)
 
20,427

 
(986
)
 
42,542

 
(2,205
)
Commercial mortgage backed securities
241,637

 
(1,344
)
 
187,241

 
(1,979
)
 
428,878

 
(3,323
)
Other asset backed securities
142,094

 
(3,519
)
 
58,958

 
(4,366
)
 
201,052

 
(7,885
)
 
$
2,346,226

 
$
(56,929
)
 
$
2,731,950

 
$
(98,492
)
 
$
5,078,176

 
$
(155,421
)
Held for investment:
 
 
 
 
 
 
 
 
 
 
 
Corporate security:
 
 
 
 
 
 
 
 
 
 
 
Insurance
$
—

 
$
—

 
$
75,838

 
$
(594
)
 
$
75,838

 
$
(594
)
Based on the results of our process for evaluating available for sale securities in unrealized loss positions for other-than-temporary-impairments, which is discussed in detail later in this footnote, we have determined that the unrealized losses on the securities in the preceding table are temporary. The unrealized losses at March 31, 2015 are principally related to timing of the purchases of these securities, which carry less yield than those available at March 31, 2015. In addition, a 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.

16
Table of Contents

At March 31, 2015, 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 34 securities with a total amortized cost basis of $235.8 million and a fair value of $264.6 million.
Approximately 64% and 78% of the unrealized losses on fixed maturity securities shown in the above table for March 31, 2015 and December 31, 2014, respectively, are on securities that are rated investment grade, defined as being the highest two NAIC designations. All of the fixed maturity securities with unrealized losses are current with respect to the payment of principal and interest.
Changes in net unrealized gains on investments for the three months ended March 31, 2015 and 2014 are as follows:
 
Three Months Ended
March 31,
 
2015
 
2014
 
(Dollars in thousands)
Fixed maturity securities held for investment carried at amortized cost
$
7,099

 
$
4,037

Investments carried at fair value:
 
 
 
Fixed maturity securities, available for sale
$
520,166

 
$
977,131

Equity securities, available for sale
42

 
(13
)
 
520,208

 
977,118

Adjustment for effect on other balance sheet accounts:
 
 
 
Deferred policy acquisition costs and deferred sales inducements
(255,076
)
 
(536,752
)
Deferred income tax asset/liability
(92,795
)
 
(154,127
)
 
(347,871
)
 
(690,879
)
Change in net unrealized gains on investments carried at fair value
$
172,337

 
$
286,239

Proceeds from sales of available for sale securities for the three months ended March 31, 2015 and 2014 were $169.4 million and $56.1 million, respectively. Scheduled principal repayments, calls and tenders for available for sale securities for the three months ended March 31, 2015 and 2014 were $107.3 million and $152.7 million, respectively.
Realized gains and losses on sales are determined on the basis of specific identification of investments based on the trade date. Net realized gains (losses) on investments, excluding net OTTI losses for the three months ended March 31, 2015 and 2014, are as follows:
 
Three Months Ended
March 31,
 
2015
 
2014
 
(Dollars in thousands)
Available for sale fixed maturity securities:
 
 
 
Gross realized gains
$
2,288

 
$
184

Gross realized losses
(289
)
 
(691
)
 
1,999

 
(507
)
Other investments:
 
 
 
Gain on sale of real estate
838

 
756

Loss on sale of real estate
(382
)
 
—

Impairment losses on real estate
(629
)
 
(799
)
 
(173
)
 
(43
)
Mortgage loans on real estate:
 
 
 
Decrease (increase) in allowance for credit losses
1,798

 
(164
)
Recovery of specific allowance
1,255

 
—

 
3,053

 
(164
)
 
$
4,879

 
$
(714
)
Losses on available for sale fixed maturity securities were realized primarily due to strategies to reposition the fixed maturity security portfolio that result in improved net investment income, risk or duration profiles as they pertain to our asset liability management.
We review and analyze all investments on an ongoing basis for changes in market interest rates and credit deterioration. This review process includes analyzing our ability to recover the amortized cost basis of each investment that has a fair value that is materially lower than its amortized cost and requires a high degree of management judgment and involves uncertainty. The evaluation of securities for other than temporary impairments is a quantitative and qualitative process, which is subject to risks and uncertainties.

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We have a policy and process to identify securities that could potentially have impairments that are other than temporary. This process involves monitoring market events and other items that could impact issuers. The evaluation includes but is not limited to such factors as:
•
the length of time and the extent to which the fair value has been less than amortized cost or cost;
•
whether the issuer is current on all payments and all contractual payments have been made as agreed;
•
the remaining payment terms and the financial condition and near-term prospects of the issuer;
•
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 fair value of debt securities is attributable to changes in market interest rates or to factors such as market volatility, liquidity and spread widening, and we anticipate recovery of all contractual or expected cash flows, we do not consider these investments to be other than temporarily impaired because we do not intend to sell these investments and it is not more likely than not we will be required to sell these investments before a recovery of amortized cost, which may be maturity. 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.
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 determine the amount of expected credit loss by calculating the present value of the cash flows expected to be collected discounted at each security's acquisition yield based on our consideration of whether the security was of high credit quality at the time of acquisition. The difference between the present value of expected future cash flows and the amortized cost basis of the security is the amount of credit loss recognized in operations. The remaining amount of the other than temporary impairment is recognized in other comprehensive income (loss).
The determination of the credit loss component of a mortgage backed security is based on a number of factors. The primary consideration in this evaluation process is the issuer's ability to meet current and future interest and principal payments as contractually stated at time of purchase. Our review of these securities includes an analysis of the cash flow modeling under various default scenarios considering independent third party benchmarks, the seniority of the specific tranche within the structure of the security, the composition of the collateral and the actual default, loss severity and prepayment experience exhibited. With the input of third party assumptions for default projections, loss severity and prepayment expectations, we evaluate the cash flow projections to determine whether the security is performing in accordance with its contractual obligation.
We utilize the models from a leading structured product software specialist serving institutional investors. These models incorporate each security's seniority and cash flow structure. In circumstances where the analysis implies a potential for principal loss at some point in the future, we use the "best estimate" cash flow projection discounted at the security's effective yield at acquisition to determine the amount of our potential credit loss associated with this security. The discounted expected future cash flows equates to our expected recovery value. Any shortfall of the expected recovery when compared to the amortized cost of the security will be recorded as the credit loss component of other than temporary impairment.
The cash flow modeling is performed on a security-by-security basis and incorporates actual cash flows on the residential mortgage backed securities through the current period, as well as the projection of remaining cash flows using a number of assumptions including default rates, prepayment rates and loss severity rates. The default curves we use are tailored to the Prime or Alt-A residential mortgage backed securities that we own, which assume lower default rates and loss severity for Prime securities versus Alt-A securities. These default curves are scaled higher or lower depending on factors such as current underlying mortgage loan performance, rating agency loss projections, loan to value ratios, geographic diversity, as well as other appropriate considerations.

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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, 2015 and 2014, 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, 2015
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Prime
 
2006
 
6.5
%
 
6.5
%
 
14
%
 
14
%
 
40
%
 
40
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three months ended March 31, 2014
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Prime
 
2006
 
6.5
%
 
7.4
%
 
11
%
 
12
%
 
50
%
 
50
%
The determination of the credit loss component of a corporate bond (including redeemable preferred stocks) is based on the underlying financial performance of the issuer and their ability to meet their contractual obligations. Considerations in our evaluation include, but are not limited to, credit rating changes, financial statement and ratio analysis, changes in management, significant changes in credit spreads, breaches of financial covenants and a review of the economic outlook for the industry and markets in which they trade. In circumstances where an issuer appears unlikely to meet its future obligation, or the security's price decline is deemed other than temporary, an estimate of credit loss is determined. Credit loss is calculated using default probabilities as derived from the credit default swaps markets in conjunction with recovery rates derived from independent third party analysis or a best estimate of credit loss. This credit loss rate is then incorporated into a present value calculation based on an expected principal loss in the future discounted at the yield at the date of purchase and compared to amortized cost to determine the amount of credit loss associated with the security.
In addition, for debt securities which we do not intend to sell and it is not more likely than not we will be required to sell, but our intent changes due to changes or events that could not have been reasonably anticipated, an other than temporary impairment charge is recognized. Once an impairment charge has been recorded, we then continue to review the other than temporarily impaired securities for appropriate valuation on an ongoing basis. Unrealized losses may be recognized in future periods through a charge to earnings, should we later conclude that the decline in fair value below amortized cost is other than temporary pursuant to our accounting policy described above. The use of different methodologies and assumptions to determine the fair value of investments and the timing and amount of impairments may have a material effect on the amounts presented in our consolidated financial statements.
The following table summarizes other than temporary impairments for the three months ended March 31, 2015 and 2014, by asset type:
 
Number
of
Securities
 
Total OTTI
Losses
 
Portion of OTTI
Losses
Recognized
from Other
Comprehensive
Income
 
Net OTTI
Losses
Recognized in
Operations
 
 
 
(Dollars in thousands)
Three months ended March 31, 2015
 
 
 
 
 
 
 
Fixed maturity securities, available for sale:
 
 
 
 
 
 
 
Residential mortgage backed securities
1
 
$
(132
)
 
$
—

 
$
(132
)
 
 
 
 
 
 
 
 
Three months ended March 31, 2014
 
 
 
 
 
 
 
Fixed maturity securities, available for sale:
 
 
 
 
 
 
 
Residential mortgage backed securities
2
 
—

 
(905
)
 
(905
)
The cumulative portion of other than temporary impairments determined to be credit losses which have been recognized in operations for debt securities are summarized as follows:
 
Three Months Ended
March 31,
 
2015
 
2014
 
(Dollars in thousands)
Cumulative credit loss at beginning of period
$
(127,050
)
 
$
(125,960
)
Credit losses on securities for which OTTI has not previously been recognized
(132
)
 
—

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

 
(905
)
Accumulated losses on securities that were disposed of during the period
—

 
—

Cumulative credit loss at end of period
$
(127,182
)
 
$
(126,865
)

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Table of Contents

The following table summarizes the cumulative noncredit portion of OTTI and the change in fair value since recognition of OTTI, both of which were recognized in other comprehensive income (loss), by major type of security, for securities that are part of our investment portfolio at March 31, 2015 and December 31, 2014:
 
Amortized Cost
 
OTTI
Recognized in
Other
Comprehensive
Income
 
Change in Fair
Value Since
OTTI was
Recognized
 
Fair Value
 
(Dollars in thousands)
March 31, 2015
 
 
 
 
 
 
 
Fixed maturity securities, available for sale:
 
 
 
 
 
 
 
Corporate securities
$
—

 
$
—

 
$
12

 
$
12

Residential mortgage backed securities