Competitive pressures: We operate in a highly competitive marketplace for customers and distributors from insurance and other non-insurance financial services companies, such as banks, broker-dealers and asset managers, in each of our businesses. Refer to Item 1 - “Business - competition” in this report for further discussion of the competitive environment. Current trends that we are experiencing include:
The preparation of financial statements in conformity with GAAP requires management to adopt accounting policies and make estimates and assumptions that affect amounts reported and disclosed in the consolidated financial statements. The Company's accounting policies discussed in this section are those that we consider to be particularly critical to understanding our consolidated financial statements, because their application places the most significant demands on management's ability to make subjective and complex judgments that frequently require estimates about matters that are inherently uncertain. Many of these policies, estimates and related judgments are common in the insurance and financial services industries; others are specific to the Company’s businesses and operations. For all of these policies, we caution that future events rarely develop exactly as forecasted, and our best estimates may require adjustment.
We analyze the prices received from the pricing services to ensure they represent a reasonable estimate of fair value, including analytical reviews of prices between reporting periods. As appropriate, we engage our pricing services in discussion regarding the valuation of a security; however, it has not been our practice to adjust their prices. We also perform procedures to gain assurance on the overall reasonableness and consistent use of inputs, valuation methodologies and compliance with fair value accounting standards. This includes an annual review of pricing methodologies and inputs by asset class and performing periodic due diligence procedures, including quarterly deep-dive analyses, monthly price fluctuation analyses, and corroboration of prices by obtaining secondary pricing quotes for selected securities. Based upon our procedures, we believe that the values provided by our pricing services are appropriate measurements of fair value and determined in accordance with GAAP.
If we do not intend to sell a security, but believe we will not recover all the security’s contractual cash flows, the amortized cost is written down to our estimated recovery value. This amount is determined to be a credit loss and is recorded as a realized loss in our consolidated statements of income. The remainder of the difference between amortized cost and fair value is recorded in OCI as OTTI on fixed maturities not related to credit losses, as this is determined to be a noncredit or recoverable loss.
Income Annuities. The DAC amortization period for SPIAs, including structured settlement annuities, is the benefit payment period. The benefit payment periods vary by policy; however, approximately 80% of the benefits will be paid over the next 45 years and nearly all benefits are paid within 80 years of contract issue.
Interest credited decreased $7.0, driven by favorable mortality experience and decreased crediting rates on slightly lower reserves, offset by decreased funding services activity due to a decline in case volume.
Sales of individual life products decreased to $9.1 for the year ended December 31, 2012, compared to $11.7 for the same period in 2011, due to lower sales of SPL polices. This was partially offset by growth in sales of our Classic UL product.
For the year ended December 31, 2013, net investment income increased slightly compared to the same period in 2012, driven by an increase in prepayment income and an increase in average invested assets, partially offset by lower portfolio yields. We continue to experience prepayment activity and receive prepayment-related income, which has mainly affected our fixed maturities. Prepayment-related activities generated income of $50.0, or 19 bps of yield, in the year ended December 31, 2013, compared to $24.7, or 10 bps of yield, in the same period in 2012. These prepayment-related activities were on securities with an amortized cost of $537.9 and $256.0 for the year ended December 31, 2013 and 2012, respectively. Prepayment-related income includes make-whole payments and consent fees on early calls or tenders of fixed maturities, prepayment speed adjustments on structured securities, and prepayment fees on our commercial mortgage loans. Prepayment activity usually stems from higher-yielding investments, resulting in cash inflows which are then typically reinvested into lower-yielding new assets, placing downward pressure on our future investment income and interest spreads. We believe investment income in 2013 has been impacted by reinvesting prepayment proceeds in 2012 at lower rates.
We regularly monitor our investments for indicators of impairment. When evaluating a security for possible impairment, we consider several factors, which are described in more detail in Note 4 to the accompanying consolidated financial statements. Impairments for the years ended December 31, 2013 and 2012 were $18.3 and $29.0, respectively, driven by reductions in both credit-related impairments and write-downs of securities we intend to sell. Credit impairments for the year ended December 31, 2012 were higher than in 2013 due to three large impairments. For those issuers for which we recorded a credit-related impairment during 2013, we had remaining holdings with an amortized cost of $38.4 and a fair value of $37.7 as of December 31, 2013. We believe the amortized cost of these securities is recoverable, based on our estimated recovery values.
Impairments for the years ended December 31, 2012 and 2011 were $29.0 and $14.1, respectively. The increase in impairments was driven by $12.4 in write-downs of two underwater securities in 2012 that we had the intent to sell. Credit-related impairments also increased over 2011, driven by a $6.9 impairment of one holding in the utilities sector in 2012.
Our fixed maturities holdings are diversified by industry and issuer, and the portfolio does not have significant exposure to any single issuer. As of December 31, 2013 and 2012, the fair value of our ten largest issuers of corporate securities was $1,373.5 and $1,555.0, or 7.9% and 9.0%, respectively, of total corporate securities. The fair value of our largest exposure to a single issuer of corporate securities was $152.1, or 0.9% of total corporate securities, as of December 31, 2013. All of the securities related to this issuer have an NAIC rating of 2. As of December 31, 2012, the fair value of our largest exposure to a single issuer of corporate securities was $240.6, or 1.4% of total corporate securities, all of which had an NAIC rating of 1.
The following table sets forth the total fair value, and amortized cost of our non-agency RMBS by year of origination (vintage) and credit quality, based on the highest rating by Moody’s, S&P, or Fitch. There was one security with a total amortized cost and fair value of $9.9 and $9.5, respectively, that was rated below investment grade by either Moody’s, S&P or Fitch, while at least one other agency rated it investment grade.
As of December 31, 2013 and 2012, 59.8% and 63.4%, respectively, of the fair value of our non-agency RMBS had super senior subordination. The super senior class has priority over all principal and interest cash flows and will not experience any loss of principal until lower levels are written down to zero. Therefore, the majority of our RMBS investments have less exposure to defaults and delinquencies in the underlying collateral than if we held the more subordinated classes.
The following table presents information about the composition of our mortgage loan portfolio:
The following table sets forth the impact of these investments on net income:
The Company utilizes reinsurance agreements to manage its exposure to potential losses. The Company reinsures a portion of its risk to reinsurers for certain types of directly written business. In addition, the Company reinsures through pools to cover catastrophic losses. See Note 10 for further discussion of the Company's reinsurance agreements.
On June 20, 2013, the Company issued 5,297,758 common shares to settle all of its outstanding warrants with wholly-owned subsidiaries of White Mountains Insurance Group, Ltd. and Berkshire Hathaway, Inc., both related parties. The number of shares issued in the cashless exercise was determined based on the fair value of the warrants on the settlement date. These warrants were exercisable for 18,975,744 common shares, and were considered participating securities because the terms of the agreements entitled the holders to receive any dividends declared on the common stock concurrently with the holders of outstanding shares of common stock, on a one-to-one basis. As a result, for the portion of the period the warrants were outstanding, they were included in weighted-average common shares outstanding for basic and diluted earnings per share, using the two-class method.
This includes net gains (losses) on calls and redemptions, and changes in the fair value of the Company’s convertible securities held as of period end totaling $1.9, $0.2 and $(10.2) for the years ended December 31, 2013, 2012 and 2011, respectively. As of December 31, 2013 and 2012, the Company’s convertible securities totaled $50.0 and $75.2, respectively.
The Company transacts in call options that are correlated to the portfolio allocation decisions of the contract holders, such that the Company is economically hedged with respect to equity returns for the current interest term. These derivatives are not designated for hedge accounting.
The Company originates and manages a portfolio of mortgage loans which are secured by first-mortgage liens on income-producing commercial real estate, primarily in the retail, industrial and office building sectors. Loans are underwritten based on loan-to-value (LTV) ratios and debt-service coverage ratios (DSCR) as well as detailed market, property and borrower analyses. The Company’s mortgage loan portfolio is considered a single portfolio segment and class of financing receivables, which is consistent with how the Company assesses and monitors the risk and performance of the portfolio. A large majority of these loans have personal guarantees, and all mortgaged properties are inspected annually. The Company’s mortgage loan portfolio is generally diversified by geographic region, loan size and scheduled maturity. As of December 31, 2013, the three states with the largest concentrations of the Company’s commercial mortgage loans were California, primarily the Los Angeles area, Texas and Washington. Loans in these states comprised 29.4%, 11.6% and 9.0% of the total portfolio, respectively.
As of December 31, 2013, the Company had $653.7 or 2.8%, of its fixed maturities invested in private placement securities. The use of significant observable inputs in determining the fair value of the Company’s investments in private placement securities resulted in the classification of $635.6, or 97.2%, as Level 2 measurements as of December 31, 2013. As of December 31, 2012, the Company had $819.6, or 3.5%, of its fixed maturities invested in private placement securities, of which $787.3, or 96.1%, were classified as Level 2 measurements.
Restricted shares are valued based on the number of shares granted and the Company’s closing stock price on the grant date. The Company recognizes such compensation cost as expense over the service period (generally three years), net of estimated forfeitures, using the straight-line method. Many factors are considered when estimating forfeitures, including types of awards, employee class and historical experience. The estimation of equity awards that will ultimately vest requires judgment, and to the extent actual results or future estimates differ from current estimates, the Company records a cumulative adjustment in the period that the estimates are revised.
The Company is required to pay facility fees ranging from 0.10% to 0.30%, depending on the Company’s rating with Moody’s or S&P, on the daily amount of the commitment. Under the terms of the agreement, the Company is required to maintain a debt-to-capitalization ratio, excluding AOCI, below 35%, and each of the Company’s material insurance company subsidiaries must maintain a risk-based capital ratio of at least 225%, as well as other customary affirmative covenants.
Individual Life. Individual Life offers insurance products such as term and universal life insurance. Individual Life also offers institutional products including BOLI and variable COLI.