Benefits. We offer medical stop-loss insurance, limited benefit medical plans, group life insurance, accidental death and dismemberment insurance and disability income insurance mainly to employer groups of 50 to 5,000 individuals. In addition to our insurance products, we offer MGU services.
Acquired the renewal rights to a $120.0 block of medical stop-loss policies;
Further, we expect this ASU will decrease 2012 net income and adjusted operating income by an amount comparable to the 2011 reduction in restated net income.
Adjusted operating income consists of net income, less after-tax net realized investment gains (losses), plus after-tax net investment gains (losses) on our fixed indexed annuity (FIA) options. Net income is the most directly comparable GAAP measure to adjusted operating income. Net income for any period presents the results of our insurance operations, as well as our net realized investment gains (losses). We consider investment income generated by our invested assets to be part of the results of our insurance operations because they are acquired and generally held to maturity to generate income that we use to meet our obligations. Conversely, we do not consider the activities reported through net realized investment gains (losses), with the exception of our FIA options, to be reflective of the performance of our insurance operations, as discussed below.
Adjusted book value, as converted consists of adjusted book value, plus the assumed proceeds from the exercise of outstanding warrants. This measure is used to calculate adjusted book value per common share, as converted which gives effect to the exercise of our outstanding warrants. Adjusted book value per common share, as converted, is calculated as adjusted book value plus the assumed proceeds from the warrants, divided by the sum of outstanding common shares and shares subject to outstanding warrants. It assumes a full cash exercise of the warrants, regardless of the stock price. Book value per common share is the most directly comparable GAAP measure and is calculated as stockholders’ equity divided by the sum of our common shares outstanding and shares issuable pursuant to outstanding warrants.
Net realized investment gains decreased $32.8. This was driven by net equity losses related to fair value declines, partially offset by lower impairments of $6.8. Net equity losses were $(9.1) in 2011, compared to net gains of $32.6 for the same period in 2010. For further discussion of our investment results and portfolio, including a discussion of our impairment losses, refer to “- Investments” below.
Policyholder benefits and claims increased $34.8 primarily driven by the AUL transaction. Overall, the loss ratio decreased from 2010, which reflects a lower frequency and severity of claims as well as our pricing discipline during our 2010 and 2011 policy year renewals.
(3) Base interest spread is the interest spread adjusted to exclude items that can vary significantly from period to period due to a number of factors and, therefore, may contribute to yields that are not indicative of the underlying trends. This is primarily the impact of asset prepayments, such as bond make whole premiums and the MBS prepayment speed adjustment.
Premiums increased $1.9 driven by an increase in premium from our term products. This increase is primarily the result of a change in reinsurance coverage obtained on new terms sales, which lowered our ceded premiums.
(1) Public fixed maturities includes publicly traded securities and highly marketable private placements for which there is an actively traded market.
In our RMBS portfolio, certain vintage years have overall higher interest rates than current market rates. Certain agency RMBS collateralized mortgage obligations (CMOs) with a 2003 vintage year have caused the most volatility in our net investment income. During the second quarter of 2011, we strategically sold $177.0 of these CMOs to reduce the volatility in net investment income related to prepayment speed adjustments. The securities we sold had an associated gross discount of $14.0. We plan to continue monitoring the remaining CMOs within our RMBS portfolio in order to reduce the income volatility related to prepayment speed adjustments.
Traditional individual life insurance products, including term and whole life insurance products, are long-duration contracts, and the associated premiums and benefits are fixed and guaranteed. Premiums from these products are considered earned and recognized as revenue when due. As premiums are earned, the Company establishes a reserve for future policy benefits associated with those premiums, resulting in the recognition of profits over the life of the policy.
As of December 31, 2011 and 2010, the Company had $936.4, or 4.1%, and $892.9, or 4.2%, respectively, of its fixed maturities invested in private placement securities. The valuation model requires the use of inputs that are not market-observable and involves significant judgment. The discount rate is based on the current Treasury curve adjusted for credit and liquidity factors. The appropriate illiquidity adjustment is estimated based on illiquidity spreads observed in transactions involving other similar securities. The use of such significant unobservable inputs in determining the fair value of the Company’s investments in private placement securities resulted in the classification of $853.3, or 91.1%, and $815.4, or 91.3%, as Level 3 measurements as of December 31, 2011 and 2010, respectively.
Cash and cash equivalents consist of demand bank deposits and short-term highly liquid investments with original maturities of three months or less at the time of purchase. Cash equivalents are reported at cost, which approximates fair value, and were $234.0 and $261.0 as of December 31, 2011 and 2010, respectively. As of December 31, 2011 and 2010, cash equivalents of $231.5 and $257.9, respectively, were held at a single highly rated financial institution.
The Company uses estimates in determining its liability for policy and contract claims. These estimates are based on historical claim payment patterns and expected loss ratios to provide for the inherent variability in claim patterns and severity. For the year ended December 31, 2011, the change in prior year incurred claims was primarily due to unfavorable changes in liability estimates for medical stop-loss claims and higher than expected claims in our Life segment. For the year ended December 31, 2010, the change in prior year incurred claims was primarily due to unfavorable changes in liability estimates for medical stop-loss claims, offset by lower than expected individual life claims. For the year ended December 31, 2009, the change in prior year incurred claims was primarily due to favorable changes in liability estimates for medical stop-loss claims partially offset by higher than expected paid claims for individual life.
The Company includes penalties and interest accrued related to unrecognized tax benefits in the calculation of income tax expense. As of December 31, 2011, the Company has no unrecognized tax benefits and does not expect significant changes within the next twelve months.