We lease 222,000 square feet in Bellevue, Washington which serves as our corporate headquarters and the primary operations location for our divisions. We also lease 29,000 square feet in Enfield, Connecticut and 14,000 square feet in Waltham, Massachusetts, where we have strategic operations supporting our Benefits and Individual Life divisions. In addition to these locations, we lease 19 other properties throughout the U.S. which comprise a total of 80,000 square feet.
This discussion contains forward-looking statements that involve risk and uncertainties. Our actual results may differ materially from those discussed in or implied by any of the forward-looking statements as a result of various factors, including but not limited to those listed under "Forward-Looking Statements" and Item 1A - "Risk Factors." You should read the following discussion in conjunction with the consolidated financial statements in Item 8 - "Financial Statements and Supplementary Data" and the discussion under Item 6 - "Selected Financial Data" included in this Form 10-K, as well as our current reports on Form 8-K and other publicly available information.
Management considers certain non-GAAP financial measures to be useful to investors in evaluating our financial performance and condition. These have been reconciled to their most comparable GAAP financial measures, see Item 6 - "Selected Financial Data." For a definition and further discussion of these non-GAAP measures, see - "Use of non-GAAP Financial Measures."
We manage our business through three divisions composed of four business segments:
Benefits. We are a multi-line carrier offering medical stop-loss, limited benefit medical and group life and DI products and services to employers, unions, and public agencies.
In addition, we have a fifth segment, referred to as the Other segment, which reflects our operations that are not directly related to the operating segments. This includes small, non-insurance businesses that are managed outside our divisions; investment income related to unallocated surplus, alternative investments and tax credit investments; unallocated corporate expenses; interest expense on debt; and inter-segment elimination entries.
See Note 18 to the accompanying consolidated financial statements for the financial results of our segments.
Retirement Division: Higher FIA account values delivered significant earnings contributions. FIA account values grew to $3.31 billion from $1.71 billion in the prior year, driven by strong sales. Total account values in our Deferred Annuities segment grew to $15.17 billion from $13.42 billion in the prior year.
Senior notes: In the third quarter of 2014, the Company issued $250.0 of 4.25% senior notes due on July 15, 2024. Interest on the notes is payable semi-annually, commencing on January 15, 2015.
Profitably grow premiums in our Benefits division, while expanding our reputation as a multi-line carrier that can provide comprehensive solutions to meet our customers' needs;
Generate strong sales of annuities through banks and broker-dealers and enhance our FIA product offerings; and
Increase sales of UL products through deeper penetration in existing BGA relationships and the launch of additional UL riders.
Return capital to shareholders, in the form of dividends or share repurchases.
Interest rates: The level of and movement in interest rates can significantly affect the profitability of our in-force business, as well as our ability to generate sales of new business. For further discussion on how interest rates affect our business, refer to Item 1A - "Risk Factors."
Interest rates remain at historically low levels, which has challenged sales of our annuity and life insurance products. However, we are pleased with the growth that we experienced in 2014, including sales of our FIA product which we believe offers our customers more attractive investment options in a low interest rate environment. We believe that our product portfolio and disciplined asset liability management will help us maintain profitability, as well as position us well for moderate changes in interest rates.
investments in high-quality privately placed and foreign corporate securities. For further discussion of our investment portfolio and results, refer to "- Investments."
Merger and acquisition activity in recent years has introduced new competitors for fixed annuities sold through banks and broker-dealers. Some of the newer entrants may have more aggressive views on investment strategy and profitability goals, and we are monitoring how this affects our ability to remain competitive.
This discussion should be read in conjunction with our consolidated financial statements and the related notes. The results of operations and selected operating metrics for our five segments (Benefits, Deferred Annuities, Income Annuities, Individual Life and Other) for the years ended December 31, 2014, 2013 and 2012 are discussed in their respective sections.
The following table sets forth detail of our other underwriting and operating expenses allocated among the segments:
Net income increased $33.7 as a result of higher pre-tax adjusted operating income, discussed further below, an increase in net realized gains, and a lower provision for income taxes due to a lower effective tax rate. Most net realized gains (losses) are excluded from pre-tax adjusted operating income. Refer to - "Investments" for further discussion of realized gains (losses).
Our other underwriting and operating expenses increased $1.9. This reflects higher expenses to support business growth including an increased number of employees, a $4.3 charge primarily for prior years' state sales and use tax expense, increases in rent and occupancy costs, and expenses associated with our national brand campaign. Partially offsetting these were expense savings of $18.3 related to a broker-dealer subsidiary sold in the fourth quarter of 2013.
Pre-tax earnings contributions from our Deferred Annuities, Individual Life, and Other segments improved, partially offset by a decline in earnings in our Benefits and Income Annuities segments. Excluding non-deferrable incentive compensation and other expenses related to higher sales, we held our underwriting and operating expenses flat with 2012 levels.
Loss ratio represents policyholder benefits and claims incurred divided by premiums earned.
Medical stop-loss - loss ratio represents medical stop-loss policyholder benefits and claims incurred divided by medical stop-loss premiums earned.
Total sales represents annualized first-year premiums net of first year policy lapses.
The $6.6 increase in other underwriting and operating expenses was mainly driven by increased employee-related expenses, commissions due to growth in our group life & DI business, and expenses associated with our national brand campaign.
Sales for the year ended December 31, 2014 totaled $166.7, compared to sales of $130.9 for the same period in 2013. Sales increased across all business lines in 2014.
Policyholder benefits and claims increased $23.1 driven by growth in our medical stop-loss business and higher claims frequency. Also contributing to the increase were higher group life and DI claims due to growth in this line of business.
The following table sets forth selected historical operating metrics relating to our Deferred Annuities segment as of, or for the years ended:
Interest spread excludes FIA and is the difference between the net investment yield and the credited rate to policyholders. The net investment yield is the approximate yield on invested assets. The credited rate is the approximate rate credited on policyholder fixed account value. Interest credited is subject to contractual terms, including minimum guarantees.
Base interest spread excludes FIA and 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 results that are not indicative of the underlying trends. This is primarily the impact of asset prepayments, such as bond make-whole premiums net of related deferred sales inducement amortization and the MBS prepayment speed adjustment.
FIA interest spread is the difference between the net investment yield and the credited rate to policyholders. The net investment yield is the approximate yield on invested assets, excluding derivative assets. The credited rate represents amounts recorded in interest credited related to FIA contracts.
Net investment income increased $54.4 driven by an increase in invested assets due to higher account values. Prepayments also generated net investment income of $40.4 compared to $34.7 in 2013. This increase was partially offset by lower yields on invested assets. The decline in yields was mainly due to earned rates on recent purchases of fixed maturities and originations of commercial mortgage loans, which were below our overall portfolio yields. Also contributing to the decline in yields was the reinvestment of proceeds from prepayments in 2013 and 2014 at lower yields.
The $17.2 increase in interest credited was driven by higher FIA interest, primarily from growth in account values. This was partially offset by lower interest credited on traditional deferred annuities due to lower crediting rates.
Other underwriting and operating expenses increased $5.0, primarily due to higher employee-related expenses to support business growth and a $1.5 charge primarily for prior years' state sales and use tax expense, as well as expenses associated with our national brand campaign.
Certain realized gains increased $5.0, as a result of gains on S&P 500 options during 2013. These gains are offset by higher interest credited on the related policies.
The $7.0 increase in interest credited was driven by higher FIA interest, primarily from growth in account values, and DSI amortization related to the unlocking impact from higher prepayment-related income. These were partially offset by lower interest credited on traditional fixed annuities, reflecting management of renewal crediting rates on existing business.
Deferred Annuities’ sales nearly doubled, reaching $2,243.5 for 2013 compared to $1,146.6 for 2012. This was primarily the result of higher FIA sales, which totaled $1,298.0 in 2013 compared with $292.6 in 2012. FIA sales benefited from a more favorable interest rate environment and ongoing expansion of our retirement products on bank distribution platforms. Expanded bank distribution also helped to diversify our sales among more key partners.
The following table sets forth selected historical operating metrics relating to our Income Annuities segment as of, or for the years ended:
Interest spread is the difference between the net investment yield and the implied credited rate to policyholder reserves. The net investment yield is the approximate yield on invested assets, excluding equities, attributed to the segment. The credited rate is the approximate rate credited on policyholder reserves.
Mortality gains (losses) represent the difference between actual and expected reserves released from mortality on our life contingent annuities.
The following table sets forth selected historical information relating to our equity investments and an estimate of the long-duration reserves and related interest credited for the years ended:
Net investment income decreased $15.9, primarily due to lower investment yields and lower assets invested in fixed maturities. The decline in yields was driven by earned rates on recent fixed maturity purchases and commercial mortgage loan originations, which were below overall portfolio yields. Proceeds from prepayments of higher yielding assets were also reinvested at lower yields. Additionally, we experienced a $4.8 mark-to-market loss on alternative investments.
Interest credited decreased $0.9 primarily driven by lower crediting rates on newer SPIA reserves. The impact of lower overall crediting rates was largely offset by a $4.8 decrease in mortality gains. Mortality experience is expected to fluctuate from period to period.
Interest credited decreased $3.0, driven by lower crediting rates on lower reserves, which was partially offset by lower mortality gains.
Sales decreased $47.7, primarily due to lower structured settlement annuity sales, which were discontinued in late 2012. Sales of SPIAs increased 17%, to $203.0 in 2013 compared to $173.5 in 2012. The increase was primarily due to increased sales during the fourth quarter of 2013 as a result of a more favorable interest rate environment and the success of our sales strategies to help customers maximize retirement income.
Individual sales represents annualized first year premiums for recurring premium products and 10% of new single premium deposits, net of first year policy lapses and/or surrenders.
Policy fees, contract charges, and other increased $12.7, primarily due to increased COI charges and policy fees related to our BOLI and UL businesses.
Segment pre-tax adjusted operating income increased $8.3, driven by lower individual claims, a favorable impact of annual unlocking, and higher prepayment-related income. These sources of earnings were partially offset by a lower BOLI base ROA, due to higher BOLI claims, and lower earnings contributions from our declining block of term life business.
The decrease in other underwriting and operating expenses was primarily due to 2013 commissions and other operating expenses associated with our broker-dealer subsidiary that was sold in the fourth quarter of 2013, which was offset by a related decline in fee revenue. We also incurred expenses in 2013 related to the exploration of acquisition opportunities. We expect losses in this segment to continue due to interest expense on debt outpacing revenues.
Alternative investments are carried at fair value, and our tax credit investments are carried at amortized cost.
Return on invested assets is an important element of our financial results. The following table sets forth the income yield and net investment income, excluding realized gains (losses), for each major investment category:
Yields are determined based on monthly averages calculated using beginning and end-of-period balances. Yields for fixed maturities are based on amortized cost. Yields for equity securities are based on cost. Yields for all other asset types are based on carrying values.
Yields were negatively impacted by the low interest rate environment. Excluding the impact of prepayments, which are discussed below, yields on our investment portfolio decreased to 4.50% for the year ended December 31, 2014 from 4.75% for the same period in 2013. This reduction is a result of earned rates on new purchases, which are significantly below overall portfolio yields, as well as maturities of assets purchased in a higher interest rate environment. We have experienced significant growth in the volume of new investment purchases on cash inflows from strong sales and the proceeds from prepayment activity, pay-downs, and maturities of invested assets. The interest rates on new investment purchases associated with these cash flows are putting downward pressure on our overall portfolio yield.
We also continued to see elevated levels of prepayment-related income as a result of the low interest rate environment. Prepayment-related activities generated income of $55.1, or 19bps of yield, in the year ended December 31, 2014, compared to $50.0, or 19bps of yield, in the same period in 2013. These prepayment-related activities were on securities with an amortized cost of $596.7 and $627.3 for the year ended December 31, 2014 and 2013, 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.
In an attempt to mitigate the impact of low interest rates, we continued to focus on our underwriting of commercial mortgage loans and increased our investments in high-quality privately placed and foreign corporate securities. For further discussion of our foreign securities, see "- Exposure to Foreign Fixed Maturity Securities." We believe our yields on commercial mortgage loans are more attractive than those available on fixed maturity securities. For the year ended December 31, 2014 and 2013, we originated commercial mortgage loans at a spread over U.S. Treasuries of approximately 235bps and 290bps, respectively. Spreads tightened throughout 2014, primarily due to increased competition for loans that meet our size, duration and underwriting standards. Additionally, U.S. Treasury rates remained low throughout 2014, which has led to a decline in our overall mortgage loan portfolio yield.
Excluding the impacts from prepayment-related income, yields on our entire investment portfolio decreased to 4.75% for the year ended December 31, 2013 from 4.98% for the same period in 2012. In an attempt to mitigate this impact, we continued to focus on our underwriting of commercial mortgage loans, which generally provide higher yields than fixed maturities and increasing our investments in high-quality foreign corporate securities.
For the year ended December 31, 2014, our equity portfolio produced net realized gains of $55.7, compared to gains of $66.0 for the same period in 2013. For further discussion, see "- Return on Equity Investments."
Impairments for the year ended December 31, 2014 decreased $4.2 from the same period in 2013. For those issuers for which we recorded a credit-related impairment during 2014, we had remaining holdings with an amortized cost of $6.7 and a fair value of $4.5 as of December 31, 2014. Based on our analysis, including cash flow analysis where appropriate, we believe the amortized cost of these securities is recoverable.
The Securities Valuation Office (SVO) of the National Association of Insurance Commissioners (NAIC) evaluates the investments of insurers for regulatory reporting purposes and assigns fixed maturities to one of the six categories called "NAIC Designations." NAIC designations of "1" or "2" include fixed maturities considered investment grade, which generally include securities rated BBB- or higher by Standard & Poor’s (S&P). NAIC designations of "3" through "6" are referred to as below investment grade, which generally include securities rated BB+ or lower by S&P. In recent years, the SVO adopted a modeling approach to determine the NAIC designation for non-agency RMBS and CMBS securities. As a result, the NAIC designation for such securities may not correspond to the S&P designations.
Below investment grade securities comprised 4.4% and 5.5% of our fixed maturities portfolio as of December 31, 2014 and 2013, respectively. As of December 31, 2014, our NAIC 5 and 6 designated securities had gross unrealized losses of $9.4. Our analysis of these securities, including management’s estimates of future cash flows, where appropriate, supports the recoverability of amortized cost.
Our fixed maturity holdings are diversified by industry and issuer. As of December 31, 2014 and 2013, the fair value of our ten largest issuers of corporate securities was $1,435.5 and $1,373.5, or 7.5% and 7.9%, respectively, of total corporate securities. The fair value of our largest exposure to a single issuer of corporate securities was $152.5, or 0.8% of total corporate securities, as of December 31, 2014. Of this, $123.3 were rated investment grade and $29.2 were rated below investment grade, NAIC ratings of 4 or higher. As of December 31, 2013, the fair value of our largest exposure to a single issuer of corporate securities was $152.1, or 0.9% of total corporate securities, all of which had an NAIC rating of 2.
As of December 31, 2014 and 2013, the fair value of our state and political subdivision securities included $36.1 and $34.2 of municipal general obligation bonds and $793.1 and $717.3 of municipal revenue bonds, respectively. We have municipal holdings of $5.6 and $5.4 in Illinois as of December 31, 2014 and 2013, respectively, and no exposure to holdings in Michigan or Puerto Rico.
As of December 31, 2014 and 2013, we held $725.1 and $530.6, respectively, of fixed maturities denominated in a foreign currency and reported in U.S. dollars based on period-end exchange rates. As part of our strategy to improve portfolio yields, we invest in high-quality foreign corporate securities. We utilize foreign currency swaps and forwards to hedge our exposure to foreign currency.
The following tables summarize our exposure to foreign fixed maturity holdings separated between sovereign debt, financial industry and other corporate debt exposures. The country designation is based on the issuer’s country of incorporation. The majority of these holdings are denominated in U.S. dollars.
Non-agency mortgage-backed securities issued in the 2006 through 2008 vintage years were generally the most affected by the financial crisis, due to weaker underwriting standards and an issuance date closest to the market peak in real estate prices. As of December 31, 2014, our non-agency mortgage-backed securities with vintage years 2006 through 2008, which are primarily non-agency commercial mortgage-backed securities, had an amortized cost of $552.1 and a fair value of $615.8.
Our mortgage-backed securities may have prepayment options. Accounting standards require us to make estimates regarding prepayments when recognizing interest income on these securities. Prepayments that vary from our estimates in amount or timing cause fluctuations in our yields due to an acceleration or deceleration of unamortized premiums or discounts associated with the securities in our portfolio. These adjustments, which relate primarily to residential mortgage-backed securities (RMBS), are recorded in net investment income in our results of operations and can create volatility between periods.
We classify our investments in RMBS as agency, prime, Alt-A, and subprime. Agency RMBS are guaranteed or otherwise supported by the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, or the Government National Mortgage Association. Prime RMBS have underlying loans to customers with good quality credit profiles, and subprime RMBS have underlying loans to customers with a greater risk of default. Alt-A RMBS have overall credit quality between prime and subprime, based on a review of their underlying mortgage loans and factors such as credit scores and financial ratios. The Company had no exposure to subprime loans as of December 31, 2014 or 2013.
As of December 31, 2014, our CMBS portfolio was highly concentrated in the most senior tranches, with 99.8% of our AAA-rated securities in the most senior tranche, based on amortized cost. The senior class has priority over the mezzanine and junior classes to all principal and interest cash flows and will not experience any loss of principal until both the entire mezzanine and junior tranches are written down to zero. As of December 31, 2014, our CMBS had total gross unamortized discount and premium of $10.1 and $11.5, respectively.
The weighted-average credit enhancement of our CMBS was 32.8% as of December 31, 2014. We believe this additional credit enhancement is significant, especially in the event of a deep real estate downturn during which losses would be expected to increase substantially.
Our equity investments consist primarily of publicly traded common stock and, in late 2014, we liquidated a portion of our common stock holdings and invested the proceeds in index ETFs, primarily related to the S&P 500 and Russell 1000 indexes. We believe that these equity investments are suitable for funding certain long duration liabilities in our Income Annuities segment. We also invest in equities on a limited basis in our surplus portfolio, reported in our Other segment.
The majority of these securities are included in trading marketable equity securities on our consolidated balance sheets and are recorded at fair value, with changes in fair value recorded in net realized gains (losses). A small amount of these securities are classified as available for sale. Available-for-sale securities are carried at fair value on our consolidated balance sheets, with changes in fair value recorded in other comprehensive income.
The following table compares our total gross return on our equity securities to the S&P 500. The gross return includes both the impact of changes in fair value and dividend income.
Our mortgage loan department originates commercial mortgages and manages our existing commercial mortgage loan portfolio. We specialize in originating loans of $1.0 to $5.0, which are secured by first-mortgage liens on income-producing commercial real estate. All loans are underwritten consistently to our standards based on loan-to-value (LTV) ratios and debt service coverage ratios (DSCR). LTV ratios and DSCRs are based on income and detailed market, property and borrower analyses using our long-term experience in commercial mortgage lending. A large majority of our loans have personal guarantees and all loans are inspected and evaluated annually. We diversify our mortgage loans by geographic region, loan size and scheduled maturity.
We continue to increase our investments in mortgage loans, as this strategy has resulted in increased net investment yields when compared to fixed maturity investments. We believe a disciplined increase in commercial mortgage loan investments will help maintain the overall quality of our investment portfolio and obtain appropriate yields to match our policyholder liabilities. We originated $896.6 of mortgage loans during the year ended December 31, 2014, and expect to continue similar originations during 2015.
The LTV ratio compares the outstanding principal of the loan to the estimated fair value of the underlying property collateralizing the loan. In the year of funding, LTV ratios are calculated using independent appraisals performed by Member of the Appraisal Institute (MAI) designated appraisers. Subsequent to the year of funding, LTV ratios are updated annually using internal valuations based on property income and estimated market capitalization rates. Property income estimates are typically updated during the third quarter of each year. Market capitalization rates are updated during the first quarter based on geographic region, property type and economic climate. LTV ratios greater than 100% indicate that the loan amount is greater than the collateral value. A smaller LTV ratio generally indicates a higher quality loan.
The DSCR compares the amount of rental income a property is generating to the amount of the mortgage payments due on the property. DSCRs are calculated using the most current annual operating history for the collateral, which are typically updated during the third quarter. The following table sets forth the DSCRs for our mortgage loan portfolio:
The following table sets forth our investments in mortgage loans by state:
The shopping centers and retail portfolio is diversified among several sub-categories including anchored shopping centers, restaurants, and car care centers.
The majority of our investments in limited partnerships relate to affordable housing. The tax credits from these partnerships are generally delivered in the first 10 years of the investment, with the largest portions provided in the middle years. We amortize these investments over the period during which partnership losses are expected to be recognized. The amortization schedule for each investment is updated periodically as new information related to the amount and timing of losses is received. Other tax credit investments generally provide benefits during the first year of the investment.
Symetra conducts its operations through its operating subsidiaries, and our liquidity requirements primarily have been and will continue to be met by funds from such subsidiaries. Dividends from its subsidiaries are Symetra’s principal source of cash to pay dividends to stockholders, fund its stock repurchase program and meet its obligations, including payments of principal and interest on notes payable. Payments of dividends from our insurance subsidiaries are subject to restrictions under state insurance regulations.
The liquidity requirements of Symetra’s insurance company subsidiaries principally relate to the liabilities associated with their insurance and investment products, operating costs, the payment of dividends to the holding company, and payment of income taxes. Liabilities arising from insurance and investment products include the payment of benefits, as well as cash payments in connection with policy and contract surrenders and withdrawals and policy loans. Historically, Symetra’s insurance company subsidiaries have used cash flows from operations, cash flows from invested assets and sales of investment securities to fund their liquidity requirements.
In managing the liquidity of our insurance operations, we consider the risk of policyholder and contract holder withdrawals of funds earlier than assumed when selecting assets to support these contractual obligations. We use surrender charges and other contract provisions to mitigate the extent, timing and profitability impact of such withdrawals. While certain policy lapses and surrenders occur in the normal course of business, the current low interest rate environment generally has resulted in lower than expected lapses of our fixed annuities, as policyholders have limited alternatives to seek a higher return on their funds. If interest rates rise significantly, we will likely experience an increase in lapses.
Our asset liability management process takes into account the expected cash flows on investments and expected policyholder payments as well as the specific nature and risk profile of the liabilities. Considering the size and liquidity profile of our investment portfolio, we believe that we have appropriately mitigated the risk of policyholder behavior varying from our projections. We also consider attributes of the various categories of liquid assets, for example, type of asset and credit quality, in evaluating the adequacy of our insurance operations’ liquidity under a variety of stress scenarios. We believe that the liquidity profile of our assets is sufficient to satisfy our liquidity requirements, including under foreseeable stress scenarios.
The liabilities presented above have been aggregated based on contractual surrender charge schedules without adjustment for free partial withdrawals and guaranteed return of premium provisions, if applicable. The following footnotes may also be useful in evaluating the withdrawal characteristics of our liabilities:
The MVA adjusts the value of the contract at surrender based on current interest rates, subject to a guaranteed minimum account value specified in the contract.
The MVA adjusts the value of the contract at surrender based on current interest rates, subject to a guaranteed minimum account value specified in the contract. In a liquidity crisis situation, we could invoke the five-year payout provision so that the contract value with interest is paid out ratably over five years.
Represents the sum of funds held under deposit contracts, future policy benefits and policy and contract claims in the consolidated balance sheets, excluding other policyholder related liabilities and reinsurance recoverables of $253.0 and $231.5 as of December 31, 2014 and 2013, respectively.
We are seeing a relative increase in our somewhat liquid liabilities, primarily as a result of strong sales of our FIA product during 2014. We ended the year with positive net cash flows of $1,336.6 on deferred annuities, as deposits increased from strong sales in 2014. Our liquid liabilities also increased, as account values related to strong sales in 2009 move closer to the end of their surrender charge period, where surrender charges are lower, and we expect this trend to continue over the next few years.
Our capitalization increased $666.4 from the prior year primarily due to an increase in our AOCI, reported in stockholders' equity, driven by higher net unrealized gains on available-for-sale securities, as well as our net income for the year. Unrealized gains on available-for-sale securities increased by $374.8, net of taxes and the related adjustment for DAC and DSI. The increase in notes payable of $247.7 was due to the issuance of our senior notes in August 2014, which was offset by $237.6 of stockholder distributions, discussed further below, including a special dividend totaling $150.7 funded by the proceeds from the notes.
We believe our capital level provides us flexibility to execute our capital management strategies, which are focused on organic growth. We may pursue acquisition opportunities and prudent capital actions, including our stock repurchase program or dividends to stockholders.
We declared and paid a quarterly dividend of $0.10 per common share during each of the first three quarters of 2014 and $1.40 per common share during the fourth quarter of 2014 for a total payout of $196.4. This includes a special dividend of $1.30 per common share declared on October 24, 2014, for a total payout of $150.7. The special dividend was funded by the proceeds from issuance of our senior notes in August 2014.
As of December 31, 2014 our primary life insurance company subsidiary, Symetra Life Insurance Company, had a risk-based capital ratio of 474%. We believe this provides adequate capital levels for growth of our business.
In the fourth quarter of 2014, Symetra Life Insurance Company, and its newly formed, directly wholly owned captive reinsurance company, Symetra Reinsurance Corporation (SRC), entered into an inter-company reinsurance arrangement, which provided a mechanism for financing up to $107.2 of non-economic reserves related to certain universal life insurance products in a more efficient manner. Our transaction is limited to statutory reserves related to UL products with secondary guarantees subject to Actuarial Guideline 38, commonly referred to as AXXX reserves. The transaction helps us manage risk, more effectively manage insurance subsidiary capital, and allows products to be priced competitively. In connection with the transaction, we expect to pay an average annual financing fee of approximately $0.5.
during the year, to reflect the level of prepayment income in 2014. This increase in statutory reserves decreased statutory capital by $26.7 and reduced our risk-based capital ratio by approximately six points. In 2013, we increased these temporary reserves by $32.0, reflecting prepayment income received during that year. Our total temporary statutory reserves as of December 31, 2014 were $98.0, including our cash flow testing reserves, and they do not impact our consolidated GAAP financial statements.
Risks of a low interest rate environment mainly impact our structured settlement annuity and BOLI blocks of business, which represent long-duration liabilities that are interest rate sensitive. Our testing was run over various interest rate scenarios, and we believe that the resulting statutory reserves are adequate under moderately adverse scenarios.
On August 28, 2014, we entered into a $400.0 senior unsecured revolving credit facility with a syndicate of lending institutions. The facility also provides access to up to $100.0 of additional financing, subject to the availability of additional commitments from lenders. The facility is set to mature on August 28, 2019. As of December 31, 2014, we have not made any borrowings under the facility.
Concurrently with entry into the unsecured revolving credit agreement referenced above, we terminated our prior $300.0 credit agreement, dated December 14, 2011, which was set to mature on December 14, 2015.
On December 12, 2014, our insurance subsidiary issued a surplus note with no initial outstanding principal balance, associated with our reserve financing transaction. For additional discussion about the transaction, refer to - "Capital Management of Insurance Subsidiaries" above.
Cash flows from our investing activities are primarily driven by the amount and timing of cash received from maturities and calls of fixed maturity securities, sales of investments and maturities of mortgage loans, as well as the amount and timing of cash disbursed for purchases of investments and funding of mortgage loan originations. Generally, the amount and timing of our purchases of investments correlate to sales of annuity and life insurance policies, which are recorded as cash inflows from financing activities. The amount and timing of cash inflows from investments generally correlate to amounts needed to fund policyholder obligations. The following discussion highlights key drivers in the level of cash flows used in our investing activities:
Years Ended December 31, 2014 compared with 2013. Net cash used in investing activities for the year ended December 31, 2014 increased $350.3 over 2013. This increase was primarily due to an increase in purchases of fixed maturities and originations of mortgage loans, both a result of strong annuity sales. These were partially offset by increased proceeds from sales of fixed maturities as well as proceeds from investment prepayments.
Years Ended December 31, 2014 compared with 2013. Net cash provided by financing activities for the year ended December 31, 2014 increased $529.2 over 2013. This change was driven by higher net policyholder deposits, mainly
from higher annuity sales, and net proceeds from the issuance of debt in the third quarter of 2014. These were partially offset by an increase in dividends paid on our common stock, primarily driven by a special dividend paid during fourth quarter 2014.
Years Ended December 31, 2013 compared with 2012. Net cash provided by financing activities for the year ended December 31, 2013 was $596.6, in comparison to cash used in financing activities of $253.4 in 2013. This change was driven by higher policyholder deposits, mainly from higher FIA sales, offset by shares repurchased as part of the Company’s common stock repurchase program.
Includes capital efficient notes (CENts), which are redeemable at the Company’s option beginning October 15, 2017, with a final maturity date of October 15, 2067. Since the timing of repayment is at the Company’s option after October 15, 2017, subject to the terms of the replacement capital covenant, the outstanding principal balance of the CENts has been included in payments due 2016-2017. For more information about our notes payable, see Note 12 to the consolidated financial statements.
Includes contractual commitments for a service agreement to outsource the majority of our information technology infrastructure. For more information, see Note 14 to the consolidated financial statements.
Primarily comprised of unfunded mortgage loan commitments of $50.7 as of December 31, 2014 and financing fees related to the surplus note.
Our Level 2 assets measured at fair value on a recurring basis primarily include fixed maturities. We carry substantial investments in high-quality fixed maturities to provide for the funding of our future policy obligations. These securities, which include bonds, mortgage-backed securities and redeemable preferred stock, are classified as available for sale. Net unrealized gains and losses are calculated as the difference between fair value and amortized cost, and these are reported in AOCI in stockholders’ equity. Realized gains and losses are reported in the consolidated statements of income.
As of December 31, 2014 and 2013, $929.0, or 3.7%, and $653.7, or 2.8%, respectively, of our fixed maturities portfolio was invested in private placement securities. The fair values of these assets are determined internally, typically using a matrix pricing approach. The significant inputs are observable, including the base credit spread, treasury yield and expected future cash flows of the security. The measurement also uses an illiquidity spread, which ranges from 0 to 60 basis points and is based on the credit quality of the security. The illiquidity spread is an unobservable input, but generally does not significantly impact the resulting valuation. As a result, we classified 93.7% and 97.2% as of December 31, 2014 and 2013, respectively, of our private placement securities as Level 2.
We defer as assets certain policy acquisition costs, including commissions, distribution costs, new business processing costs, and other underwriting costs related to the production of new and renewal business. Our DAC asset is amortized over the life of the related policies and results in a reduction of income. We also defer as assets certain sales inducements, including bonus interest, which are included within other assets on our consolidated balance sheets. Our DSI asset is amortized over the life of the related policies and results in an increase to interest credited, which reduces income.
The identification of internal costs related to the successful acquisition or renewal of a contract involves judgment and estimates. We estimate deferrable costs using time studies, internal surveys, and system-generated data about policy applications and issuances. Only costs that are directly related to the successful acquisition or renewal of insurance contracts are deferred. These include:
DAC and DSI are amortized over the premium paying period or the expected lifetime of policies proportionate to estimated gross profits (EGPs). EGPs reflect actual experience to date and projections of future profits. Estimating future gross profits is a complex process requiring considerable judgment and forecasting of events well into the future. To determine the EGPs, we make assumptions as to lapse and withdrawal rates, expenses, interest margins, mortality experience, long-term equity market returns and investment performance.
Deferred Annuities. The DAC amortization period is typically 20 years, although most occurs within the first 10 years because the EGPs are highest during that period. DSI amortization follows the same methodology, assumptions and period as DAC amortization.
In periods of rising interest rates, the fair value of our fixed maturities would generally decrease, and this may result in net unrealized investment losses. In such circumstances, the DAC and DSI adjustments would increase our DAC and DSI balances and increase AOCI. For DAC, this adjustment is limited to cumulative capitalized acquisition costs plus interest. As of December 31, 2014, the maximum DAC adjustment would be $176.7, net of taxes of $95.2, in our Deferred Annuities segment and $23.8, net of taxes of $12.8, in our Individual Life segment. For DSI, this adjustment is limited to cumulative capitalized
We review estimates for reported but unpaid claims and IBNR quarterly. Any necessary adjustments are recorded in the consolidated statements of income in the period in which the change occurs. If expected loss ratios increase or expected claims paying completion patterns extend, the IBNR amount increases. While we make a best estimate at each reporting period, we may still experience volatility due to uncertainty inherent in the underlying estimates. For example, in 2014, our incurred claims related to previous years developed favorably by $24.5, or 14.8% of net reserves at December 31, 2013. This favorable experience related to management's assumptions as of December 31, 2013 primarily related to completion rates, which were faster than assumed in our reserve estimates. See Note 11 for a rollforward of our liabilities related to unpaid claims, which primarily consists of liabilities for policy and contract claims.
Each of our four business segments maintains its own portfolio of invested assets, which are managed in accordance with specific guidelines. The net investment income and realized gains (losses) are reported in the segment in which they occur. We also allocate net investment income generated by our surplus portfolio to each segment using a risk-based capital formula. The unallocated portion of net investment income is reported in the Other segment. Investment expenses, which are recorded as a reduction of net investment income, are allocated to each segment based on its portfolio of invested assets. We allocate shared service operating expenses to each segment using multiple factors, including employee headcount and time study results.
Net realized gains (losses) mainly consists of realized gains (losses) from sales of our investments, realized losses from investment impairments, changes in fair value of our marked-to-market investments and changes in fair value of our FIA embedded derivative. It also includes the portion of DAC and DSI amortization due to changes in EGPs related to these items.
Policyholder benefits and claims consist of benefits paid, net of reinsurance recoveries, and reserve changes on group insurance, individual life and BOLI products.
We defer as assets certain commissions, distribution costs, new business processing costs, and other underwriting costs that are directly related to the successful acquisition of new and renewal business. Amortization of previously capitalized DAC is recorded as an expense.
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 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 many of the activities reported through net realized gains (losses) as part of the results of our insurance operations. The timing and amount of these gains (losses) are driven by investment decisions and external economic developments unrelated to our management of the insurance and underwriting aspects of our business.
Certain realized gains (losses) that are included in adjusted operating income reflect the gains (losses) on S&P 500 options supporting FIA policies primarily sold in the late 1990s. These policyholders earn interest based on equity market performance, and we purchase S&P 500 options to hedge market fluctuations. Interest earned by these policyholders is reported in interest credited in the consolidated statements of income. Each year, we use any realized gains from the S&P 500 options to meet obligations associated with this block, similar to the way we use investment income to meet obligations associated with other fixed deferred annuities. Therefore, we include these realized gains (losses) in adjusted operating income.
We believe investors find it useful to review a per share measure of the results of our insurance operations separate from the gain and loss activity attributable to most of our investment portfolio, in order to evaluate their proportionate stake in the earnings of the insurance operations.
Return on stockholders’ equity, or ROE, is the most directly comparable GAAP measure. Return on stockholders’ equity for the most recent four quarters is calculated as net income for such period divided by the average ending stockholders’ equity for the most recent five quarters.
Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2014, 2013 and 2012
We have audited the accompanying consolidated balance sheets of Symetra Financial Corporation as of December 31, 2014 and 2013, and the related consolidated statements of income, comprehensive income (loss), changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2014. Our audits also included the financial statement schedules listed in the Index at Item 15(a). These financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Symetra Financial Corporation at December 31, 2014 and 2013, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2014, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
Symetra Financial Corporation is a Delaware corporation that, through its subsidiaries, offers products and services that serve the retirement, employment-based benefits and life insurance markets. These products and services are marketed through financial institutions, broker-dealers, benefits consultants, and independent agents and advisors in all states and the District of Columbia. The Company’s principal products include fixed, fixed indexed and variable deferred annuities, single premium immediate annuities, medical stop-loss insurance, limited benefit medical insurance, group life and disability income (DI) insurance, individual life insurance and institutional life insurance including bank-owned life insurance (BOLI) and variable corporate owned life insurance (COLI). The Company also services its block of structured settlement annuities. The accompanying consolidated financial statements include, on a consolidated basis, the accounts of Symetra Financial Corporation and its subsidiaries, which are wholly-owned and collectively referred to as "Symetra" or "the Company."
The Company has 750,000,000 authorized shares of common stock, $0.01 par value per share, and 10,000,000 authorized shares of preferred stock, $0.01 par value per share. The Company’s board of directors has the authority to designate the preferred stock into series and to designate the voting powers, preferences and other rights of the shares of each series without further stockholder approval, as limited by New York Stock Exchange and other regulatory rules.
Traditional individual life insurance products, including term and whole life insurance products, are long-duration contracts, and the associated premiums and benefits are fixed. Premiums from these products are considered earned and recognized as revenue when due. The Company establishes a reserve for future policy benefits associated with earned premiums, resulting in the recognition of profits over the life of the policy.
Deposits related to universal life (UL) insurance products and investment-type products are credited to policyholder account balances and reflected as liabilities, rather than as premium income, when received. These UL insurance products include BOLI and single-premium life (SPL) insurance. Investment-type products include fixed deferred annuities, single premium immediate annuities (SPIA), and structured settlements.
Fees for variable products, including variable annuity, variable life, and variable COLI products, include mortality and expense, policy administration and surrender charges. These fees are charged to policyholders’ accounts based upon the daily
net assets of the policyholders’ account values and are recognized in policy fees, contract charges, and other in the consolidated statements of income when assessed.
Liabilities for fixed annuity contracts and universal life policies, including BOLI, are computed as deposits net of withdrawals made by the policyholder, plus interest amounts credited based on contract specifications, less contract fees and charges assessed.
The Company estimates liabilities for future policy benefits for its traditional individual life policies as the present value of expected future policy benefits less future net premiums. The Company selects the net premiums so that the actuarial present value of future benefits equals the actuarial present value of future premiums. The Company sets the interest, mortality, and persistency assumptions in the year of issue and includes a provision for adverse deviation. The provision for adverse deviation is intended to provide coverage for the risk that actual experience may be worse than locked-in best-estimate assumptions. The Company derives mortality assumptions from both company-specific and industry statistics. Future benefits are discounted at interest rates that vary by year of policy issue. These rates are initially set to be consistent with investment rates at the time of issue, and are graded to a lower rate over time. Assumptions are set at the time each product is introduced and are not updated for actual experience unless the total product liability amount is determined to be inadequate to cover future policy benefits.
The Company estimates liabilities for future policy benefits for certain group long-term disability policies as the present value of future benefit payments, net of terminations and recoveries, and discounted at interest rates based on investment rates at the time of disability.
The Company invests in limited partnerships that generate tax benefits. These partnerships are established to invest in low-income housing and other qualifying purposes, where the primary return on investment is in the form of income tax credits (collectively referred to as "tax credit investments"). The Company's investments are primarily accounted for under the equity
Investments in limited partnerships also include alternative investments (private equity and hedge funds) recorded at fair value. The impact of changes in the fair value of alternative investments is recorded in net investment income. The Company elected the fair value option for these investments, regardless of ownership percentage, to standardize the related accounting and reporting.
The Company performs an ongoing qualitative assessment of its involvement with variable interest entities (VIEs). A VIE is an entity that does not have sufficient equity to finance its own activities without additional financial support, or where investors lack certain characteristics of a controlling financial interest. The Company assesses its contractual, ownership or other interests in a VIE to determine whether it has a variable interest in the entity, and if so, to determine whether the Company has a controlling financial interest and would therefore be considered the primary beneficiary of the VIE. If it is determined the Company is the primary beneficiary of a VIE, the Company includes the assets and liabilities of the VIE in the consolidated financial statements.
In the normal course of business, the Company also makes passive investments in structured securities issued by VIEs. These structured securities primarily include residential and commercial mortgage-backed securities. Because the Company lacks the ability to direct the activities that most significantly impact the economic performance of the VIEs, it is not considered the primary beneficiary and therefore does not consolidate them. The Company’s maximum exposure to loss with respect to these investments is limited to the amortized cost of the Company’s investment, which was $4,569.4 and $4,571.5 as of December 31, 2014 and 2013, respectively.
For the years ended December 31, 2014, 2013 and 2012, 2,650,000 of stock options were excluded from the computation of diluted earnings per share, based on the application of the treasury stock method, because they were anti-dilutive.
The Company classifies its investments in fixed maturities and certain marketable equity securities as available-for-sale and carries them at fair value. Fixed maturities primarily include bonds, mortgage-backed securities and redeemable preferred stock. See Note 7 for information on the valuation of these securities and additional disclosures regarding fair value measurements.
The Company reports net unrealized gains (losses) related to its available-for-sale securities in accumulated other comprehensive income (AOCI) in stockholders’ equity, net of related DAC and DSI adjustments and deferred income taxes. The cost of securities sold is determined using the specific-identification method.
When the collectibility of interest income for fixed maturities is considered doubtful, any accrued but uncollectible interest is deducted from investment income in the current period. The Company then places the securities on nonaccrual status, and they are not restored to accrual status until all delinquent interest and principal are paid.
The Company maintains a diversified portfolio of corporate fixed maturity securities across industries. The following table presents the composition of the Company’s corporate securities portfolio by sector:
The following tables summarize gross unrealized losses and fair values of the Company’s available-for-sale investments. The tables are aggregated by investment category and present separately those securities that have been in a continuous unrealized loss position for less than twelve months and for twelve months or more.
The following table summarizes the amortized cost and fair value of fixed maturities as of December 31, 2014, by contractual years to maturity. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties.
This includes net gains (losses) on changes in the fair value of trading securities held as of period end totaling $32.3, $41.1 and $37.7 for the years ended December 31, 2014, 2013 and 2012, respectively.
The Company’s review of available-for-sale investment securities for OTTI includes both quantitative and qualitative criteria. Quantitative criteria include the length of time and amount that each security is in an unrealized loss position (i.e., is underwater) and, for fixed maturities, whether expected future cash flows indicate that a credit loss exists.
The financial condition and near-term prospects of the issuer of the security, including any specific events that may affect its operations, earnings potential or compliance with terms and covenants of the security;
For fixed maturities, the Company concludes that an OTTI has occurred if a security is underwater and there is an intent to sell the security or if the present value of expected cash flows is less than the amortized cost of the security (i.e., a credit loss exists). Where a credit loss exists, the Company isolates the portion of the total unrealized loss related to a credit loss, which is recognized in realized gains (losses) on the consolidated statements of income, and the remainder is recorded as a non-credit OTTI through other comprehensive income.
In order to determine the amount of the credit loss, the Company calculates the recovery value by discounting its estimate of future cash flows from the security. The discount rate is the original effective yield for corporate securities or current effective yield for mortgage-backed and other structured securities.
To determine the recovery value for a corporate security, the Company performs an analysis including, but not limited to, the following:
Fundamentals of the issuer to determine what the Company would recover if the issuer were to file for bankruptcy or restructure its debt outside of bankruptcy;
Delinquency ratios, debt-service coverage, and loan-to-value ratios on the underlying collateral;
The following table presents the severity and duration of the gross unrealized losses on the Company’s underwater available-for-sale fixed maturities, after the recognition of OTTI:
Changes in the amount of credit-related OTTI recognized in net income where the portion related to other factors was recognized in other comprehensive income (OCI) were as follows:
The Company’s mortgage loan portfolio is generally diversified by geographic region, loan size and scheduled maturity. As of December 31, 2014, 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 29.1%, 10.8% and 8.4% of the total portfolio, respectively.
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 allowance for losses on mortgage loans provides for the risk of credit loss inherent in the lending process. The allowance includes a portfolio reserve for probable losses incurred but not specifically identified and, as needed, specific reserves for impaired loans. The allowance for losses on mortgage loans is evaluated at each reporting period and adjustments are recorded when appropriate. To assist in its evaluation of the allowance for loan losses, the Company utilizes the following credit quality indicators to categorize its loans as lower, medium or higher risk:
Lower Risk Loans - Loans with an LTV ratio of less than 65%, and a DSCR of greater than 1.50.
As of December 31, 2014 and 2013, reserve amounts of $0.2 and $0.2, respectively, were held for loans specifically evaluated for impairment.
In developing its portfolio reserve for incurred but not specifically identified losses, the Company evaluates loans by risk category and considers its past loan experience, commercial real estate market conditions, and third party data for expected losses on loans with similar LTV ratios and DSCRs. Each loan’s LTV ratio and DSCR is updated annually, primarily during the third quarter. In developing its provision for specifically identified loans, a market valuation on the collateral is performed to determine if a reserve is necessary.
Non-performing loans, defined generally as those in default, close to being in default or more than 90 days past due, are placed on non-accrual status. As of December 31, 2014, one loan with an outstanding balance of $1.5 was considered non-performing. There were no such loans as of December 31, 2013.
The accounting for changes in the fair value of derivative instruments depends on whether it qualifies and has been designated for hedge accounting. To qualify for hedge accounting treatment, a derivative must be highly effective in mitigating the designated risk of the hedged item. Effectiveness of the hedge is formally assessed at inception and throughout the life of the hedging relationship.
The Company prospectively discontinues hedge accounting when: (1) the criteria to qualify for hedge accounting is no longer met (e.g., the derivative is no longer highly effective in offsetting the change in cash flows of a hedged item); (2) the derivative expires, is sold, terminated or exercised; or (3) the derivative is de-designated as a hedging instrument. If it is determined that a derivative no longer qualifies as an effective hedge, the derivative continues to be carried in the consolidated balance sheets at its fair value, with changes in fair value recognized prospectively in income.
The following table sets forth the fair value of the Company’s derivative instruments. In the consolidated balance sheets, derivative contracts in an asset position are included in other invested assets, derivative contracts in a liability position are included in other liabilities, and embedded derivative liabilities are included in funds held under deposit contracts.
The Company’s derivative contracts are typically governed by an International Swaps and Derivatives Association (ISDA) Master Agreement, except for foreign currency forwards which do not require an ISDA. For each ISDA, the Company and the counterparty have also entered into a credit support annex (CSA) to reduce the risk of counterparty default in derivative transactions by requiring the posting of cash collateral or other financial assets. The CSA requires either party to post collateral when net exposures from all derivative contracts between the parties exceed pre-determined contractual thresholds, which vary by counterparty. The amount of net exposure is the difference between the derivative contract’s fair value and the fair value of the collateral held for such agreements with each counterparty. Collateral amounts required to be posted or received are determined daily based on the net exposure with each counterparty under a master netting agreement. The Company does not offset recognized collateral amounts pledged or received against the fair value amounts recognized for derivative contracts.
The following table presents the amount of gain (loss) recognized in OCI on derivatives that qualify as cash flow hedges:
As of December 31, 2014, the maximum term over which the Company is hedging its exposure to the variability in future cash flows is approximately fifteen years. The Company recorded no ineffectiveness for cash flow hedging relationships for the years ended December 31, 2014, 2013 or 2012.
Level 1 - Unadjusted quoted prices in active markets for identical instruments. This category primarily consists of exchange-traded marketable equity securities and mutual fund investments.
The carrying value of this balance excludes $6,111.6 of liabilities related to insurance contracts and embedded derivatives.
As of December 31, 2014, the Company had $929.0 or 3.7%, 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 $870.7, or 93.7%, as Level 2 measurements as of December 31, 2014. As of December 31, 2013, the Company had $653.7, or 2.8%, of its fixed maturities invested in private placement securities, of which $635.6, or 97.2%, were classified as Level 2 measurements.
Agency securities comprised 87.9% and 89.2% of the Company’s Level 2 RMBS as of December 31, 2014 and 2013, respectively. The following table presents additional information about the composition of the Level 2 non-agency RMBS securities:
As of December 31, 2014 and 2013, the Company’s non-agency Level 2 RMBS had a weighted-average credit enhancement of 9.0% and 8.8%, respectively. As of December 31, 2014 and 2013, $72.8 and $110.3, or 20.6% and 37.0%, respectively, of the Company’s non-agency Level 2 RMBS had an origination or vintage year of 2004 and prior. The underlying collateral in years prior to 2005 is considered higher quality as underwriting standards were more stringent.
As of December 31, 2014 and 2013, the fair value of the Company’s commercial mortgage-backed securities (CMBS) classified as Level 2 measurements was $1,331.4 and $1,512.6, respectively. The weighted-average coupon rate on these securities was 4.65% and 4.82% as of December 31, 2014 and 2013, respectively.
Equity index options consist primarily of S&P 500 options. As of December 31, 2014, the fair values of these index options were determined using option pricing models. Significant inputs include index implied volatilities, index dividend yields, index prices, a risk-free rate, option term and option strike price. As these inputs are observable, the equity index options are classified as a Level 2 measurement.
Separate account assets are primarily invested in mutual funds with published NAVs, which are classified as a Level 1 measurement.
Foreign currency swaps are valued using an income approach. These swaps are priced utilizing a discounted cash flow model. The significant inputs include the projected cash flows, currency spot rates, swap yield curve and cross currency basis curve. As these inputs are observable, the foreign currency swaps are classified as a Level 2 measurement.
The fair value of the Company’s investments in limited partnerships associated with tax credit investments are estimated based on the discounted cash flows over the remaining life of the tax credits, using the original internal rate of return for each investment. As these inputs are considered observable, investments in limited partnerships are classified as a Level 2 measurement.
Transfers into and/or out of Level 3 are reported at the value as of the beginning of the period in which the transfer occurs. Gross transfers into Level 3 were $27.4 and $6.9 for the years ended December 31, 2014 and 2013. Gross transfers out of Level 3 were $(138.7) and $(34.2) for the years ended December 31, 2014 and 2013, respectively, related to fixed maturities for which observable inputs became available. Additionally, transfers out included a change in valuation methodology for equity index options during the first quarter of 2014 to a method that uses significant observable inputs. Such securities are now classified as Level 2.
Realized and unrealized gains and losses for investments in limited partnerships are included in net investment income. All other realized and unrealized gains and losses recognized in net income are included in net realized gains (losses). Amounts shown for financial liabilities are (gains) losses in net income.
The Company adjusts the unamortized DAC balance for the effect of net unrealized gains and losses on securities and embedded derivatives as if they had been realized as of the balance sheet date. The Company includes the impact of this adjustment, net of tax, in AOCI. The Company also adjusts its unamortized DAC balance for the effect of realized gains and losses including changes in fair value of the embedded derivatives for the Company's FIA policy assets. These adjustments are recognized in net realized gains (losses) in the consolidated statements of income.
For some products, policyholders can elect to modify product benefits, features, rights or coverage by exchanging a contract for a new contract; by amendment, endorsement or rider to a contract; or by election of a feature or coverage within a contract. These transactions are known as internal replacements. If the modification substantially changes the original contract, the remaining DAC balance is immediately written off through earnings and any eligible costs associated with the replacement contract are deferred. If the modification does not substantially change the contract, the DAC is retained and amortized over the life of the modified contract and any acquisition costs associated with the related modification are expensed as incurred.
The Company offers sales inducements on certain deferred annuity contracts and universal life policies. For certain deferred annuity contracts, the inducement entitles the contract holder to an incremental amount of interest that is credited to the account value over a 12- to 60-month period following the initial deposit, depending on the product. The incremental interest causes the initial credited rate to be higher than the contract’s expected ongoing crediting rates for periods after the inducement. For certain universal life policies, the inducement provides an immediate increment to the policyholder’s account value at the issue date or time of deposit. Deferred sales inducements are included in receivables and other assets and amortized into interest credited using the same methodology and assumptions used to amortize DAC.
Similar to DAC, the Company amortizes deferred sales inducements for deferred annuity contracts and universal life insurance policies over the lives of the contracts or policies in proportion to the estimated future gross profits. The Company makes assumptions as to lapse rates, mortality experience, maintenance expenses, crediting rates, and investment performance. Actual profits can vary from the estimates and can thereby result in increases or decreases to DSI amortization. The Company regularly evaluates its assumptions and, when necessary, revises the estimated gross profits of these contracts, resulting in assumption and experience unlocking adjustments to DSI amortization. When such estimates are revised, the impact is recorded in the consolidated statements of income. Deferred sales inducement balances are subject to regular recoverability testing to ensure that capitalized amounts do not exceed the present value of estimated gross profits. As of December 31, 2014 and 2013, all of the deferred sales inducement balances were considered recoverable.
The Company adjusts the unamortized DSI balance for the effect of net unrealized gains and losses on securities as if they had been realized as of the balance sheet date. The Company includes the impact of this adjustment, net of tax, in AOCI. The Company also adjusts its unamortized DSI balance for the effect of realized gains and losses. These adjustments are recognized in net realized gains (losses) in the consolidated statements of income.
Reclassification adjustments of OTTI on fixed maturities not related to credit losses are included in changes in unrealized gains and losses on available-for-sale securities within the consolidated statements of comprehensive income (loss).
The 2013 activity includes 5,297,758 shares of common stock issued from the settlement of warrants.
Represents shares of common stock repurchased pursuant to the Company’s stock repurchase program that began in 2013, which are held in treasury, as well as shares repurchased and subsequently retired to satisfy employee income tax withholding pursuant to the Company’s Equity Plan.
As of December 31, 2014, the Company had two stock-based compensation plans: the Symetra Financial Corporation Equity Plan, amended and restated on March 5, 2014, (the "Equity Plan") and the Symetra Financial Corporation Employee Stock Purchase Plan, amended and restated on May 11, 2010, (the "Stock Purchase Plan").
The Equity Plan authorizes the Company to issue various types of awards, including restricted stock, stock options, stock appreciation rights, restricted stock units, performance shares, performance units and other types of awards to employees, directors and consultants. A total of 7,830,000 shares are authorized for issuance under the Equity Plan, and 4,074,216 shares are available for future issuance as of December 31, 2014.
Stock-based compensation expense for restricted shares, recognized in other underwriting and operating expenses in the consolidated statements of income, was $3.6, $3.5, and $3.5 for the years ended December 31, 2014, 2013 and 2012, respectively. The related income tax benefit for the years ended December 31, 2014, 2013 and 2012 was $1.3, $1.2 and $1.2, respectively.
The following table summarizes the Company’s restricted share activity for the year ended December 31, 2014:
The Company issued 2,950,000 options during the year ended December 31, 2010, that have an exercise price of $26.70. The price reflects a non-discretionary equitable adjustment made, in accordance with the terms of the Company’s Equity Plan, for the special $1.30 cash dividend paid to stockholders during the fourth quarter of 2014. There was no incremental compensation cost recognized as a result of this adjustment. These options vest on June 30, 2017 and expire one year thereafter. The weighted average grant-date fair value of the awards was $2.73 per share. No options have been granted after December 31, 2010. As of December 31, 2014 and 2013, 2,650,000 options were outstanding, none of which were exercisable.
Outstanding options have a remaining contractual term of 3.5 years and no intrinsic value as of December 31, 2014. As of December 31, 2014, unrecognized compensation cost for stock options was $2.4 and is expected to be recognized over the next 2.5 years.
The Company reinsures portions of its insurance risk, primarily in the Individual Life and Benefits segments, in order to spread risk, limit losses and minimize exposure to significant risks. Beginning in 2014, we also utilize inter-company reinsurance agreements to manage our statutory capital position.
In the Benefits segment, the Company reinsures portions of risk associated with its group life and DI and medical stop-loss businesses. The Company typically reinsures its group life mortality risk in excess of $0.25 per individual, per line of coverage. For policies issued on or after August 1, 2014, the Company fully retains its short-term disability risk, and for policies issued on or after April 1, 2014, the Company reinsures 75% of its long-term disability risk. The Company reinsures its exposure to medical stop-loss in excess of $1.0 for aggregate policy claims and $1.5 for specific policy claims. The Company also has catastrophic coverage for its group life policies.
In the Individual Life segment, the Company reinsures portions of its risk associated with its universal life, term life, BOLI and variable COLI products. Coverage under these reinsurance agreements varies by product, policy issue year and issue age of the insured. For policies issued during 2014, the Company retained face values to $3.0 per policy. For policies issued after November 11, 2014, most of the Company's newly issued fully underwritten term life was 50% reinsured.
(All amounts in millions, except share, per share and percentage data, unless otherwise stated)
On October 10, 2007, the Company issued $150.0 aggregate principal amount CENts with a scheduled maturity date of October 15, 2037, subject to certain limitations, with a final maturity date of October 15, 2067. The Company issued the CENts at a discount, yielding $149.8. For the initial 10-year period following the original issuance date, to, but not including October 15, 2017, the CENts carry a fixed interest rate of 8.3% payable semi-annually. From October 15, 2017, until the final maturity date of October 15, 2067, interest on the CENts will accrue at a variable annual rate equal to the three-month LIBOR plus 4.18%, payable quarterly. The effective interest rate on the CENts is 9.39%, including the impact of a related terminated cash flow hedge.
Borrowings under the facility will bear interest at a variable annual rate based on adjusted LIBOR or the alternate base rate plus, in each case, an applicable margin. The terms of the facility call for the Company to maintain a debt-to-capitalization ratio, excluding AOCI, not to exceed 35%, and risk-based capital ratios of at least 225% for each material insurance company subsidiary, as well as other customary affirmative covenants. The Company is required to pay facility fees ranging from 0.1% to 0.3%, depending on the Company's ratings from Moody's and S&P, on the daily amount of the commitment. The Company did not borrow under this facility and was in compliance with all covenants as of December 31, 2014.
balance and a maximum capacity of $107.2. As of December 31, 2014, there were no borrowings outstanding under the surplus note.
Income taxes have been determined using the liability method. The provision for income taxes has two components: amounts currently payable or receivable and deferred income taxes. The deferred income taxes are calculated as the difference between the book and tax bases of the appropriate assets and liabilities and are measured using enacted tax rates.
The Company files income tax returns in the U.S. federal and various state jurisdictions. The Company’s federal income tax returns have been examined and closing agreements have been executed with the Internal Revenue Service, or the statute of limitations has expired for all tax periods through December 31, 2009. The Company is not currently subject to any state income tax exams.
The tax effects of temporary differences that gave rise to the deferred income tax assets and liabilities were as follows:
As of December 31, 2014, the Company's non-insurance entities have gross federal net operating loss carry-forwards of $81.1, which are reflected in its deferred tax assets. These are due to expire under current law during 2028 through 2034.
The Company includes penalties and interest accrued related to unrecognized tax benefits in the calculation of income tax expense. As of December 31, 2014, the Company has no unrecognized tax benefits and does not expect significant changes within the next year.
The Company has a service agreement with a third party service provider to outsource the majority of its information technology infrastructure. Under the original terms of the service agreement, the Company agreed to pay an annual fixed service fee ranging from $10.6 to $11.4 for five years, and the original term of the service agreement expired in July 2014. The Company exercised its extension options in the service agreement for another two years, extending the term through July 2016. During the two-year extension period, the Company agreed to pay an annual fixed service fee of $10.8. The Company incurred service fee expenses of $10.9, $13.4 and $13.6 for the years ended December 31, 2014, 2013 and 2012, respectively, which included the fixed fee as well as a variable fee based on usage.
The Company’s insurance company subsidiaries are required to prepare statutory financial statements in accordance with statutory accounting practices prescribed or permitted by the insurance department of the state of domicile. Statutory accounting practices primarily differ from GAAP by charging policy acquisition costs to expense as incurred and establishing future policy benefit liabilities using different actuarial assumptions, as well as accounting for investments, certain assets and deferred taxes on a different basis. Permitted statutory accounting practices encompass all accounting practices not prescribed and adopted by the NAIC, but which have been specifically allowed by state insurance authorities. The Company’s insurance company subsidiaries have no material permitted accounting practices.
The statutory net income and statutory capital and surplus for the Company’s insurance company subsidiaries are as follows:
Effective January 1, 2015, the Company and WMA entered into a new investment management agreement. Pursuant to the revised agreement, WMA remains the investment advisor on the majority of the Company's investments, including its investment grade fixed maturity portfolio, and certain portfolio management services moved from WMA to the Company.
The primary profitability measure that management uses to manage business segment results is pre-tax adjusted operating income (loss). Pre-tax adjusted operating income is defined as income from operations, excluding net realized gains (losses) that are not reflective of the performance of the Company's insurance operations. Excluded gains (losses) are associated with investment sales or disposal, other-than-temporary investment impairments, changes in the fair value of mark-to-market investments and derivative investments (except for certain S&P 500 options discussed below) and changes in the fair value of embedded derivatives related to the Company's FIA product.
In the Deferred Annuities segment, certain net gains (losses) related to FIA products sold in the late 1990s are considered related to the performance of insurance operations and included in the pre-tax adjusted operating income. These products credit interest to policyholder accounts based on equity market performance, which is recorded in interest credited. The Company purchases S&P 500 options to economically hedge exposure to this block of business, which are not designated for hedge accounting. Any realized gains from these options are used to meet policyholder obligations.
Benefits. As a multi-line carrier, Benefits offers products and services related to medical stop-loss insurance, limited benefit medical insurance, group life insurance, accidental death and dismemberment insurance and DI insurance, mainly to employer groups.
Individual Life. Individual Life offers insurance products such as universal and term life insurance. Individual Life also offers institutional products including BOLI and variable COLI.
The accounting policies of the segments are the same as those described for the Company, except for the method of capital allocation. The Company has an internally developed risk-based capital model, the purpose of which is to measure the risk in the business and to provide a basis upon which capital is deployed. This model accounts for the unique and specific nature of the risks inherent in the Company’s segments, and a portion of net investment income on surplus investments, but not the invested assets, is allocated to the segments based on the level of allocated capital.
The following tables present selected financial information by segment and reconcile segment pre-tax adjusted operating income (loss) to amounts reported in the consolidated statements of income:
Quarterly earnings per share amounts may not add up to the full year amounts due to share weighting and rounding.