We lease 280,000 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 7,000 square feet in Waltham, Massachusetts, where we have strategic operations supporting our Benefits and Individual Life divisions. In addition to these locations, we lease 14 other properties throughout the U.S. which comprise a total of 73,000 square feet.
The following selected financial data, except for non-GAAP financial measures, have been derived from our consolidated financial statements. The consolidated income statement data for the years ended December 31, 2013, 2012 and 2011 and the consolidated balance sheet data as of December 31, 2013 and 2012, except for the non-GAAP financial measures, have been derived from our consolidated financial statements included elsewhere herein. The consolidated income statement data for the years ended December 31, 2010 and 2009 and the consolidated balance sheet data as of December 31, 2011, 2010 and 2009, except for the non-GAAP financial measures, have been derived from the consolidated financial statements not included herein.
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.
All dollar and share amounts, except per share data, are in millions unless otherwise stated.
We are a financial services company in the life insurance industry providing employee benefits, annuities and life insurance through a national network of benefits consultants, financial institutions and independent agents and advisers. Our operations date back to 1957 and many of our distribution relationships have been in place for decades.
Benefits. We offer medical stop-loss, limited benefit medical and group life and DI insurance products and services to employers, unions, and public agencies.
Deferred Annuities. We offer fixed deferred annuities, including FIA, and variable deferred annuities to consumers who want to accumulate tax-deferred assets for retirement.
Benefits division: Our loss ratio was 66.5% for the year, exceeding our target range, mainly due to higher than expected claims frequency in our medical stop-loss business. We have priced January 2014 medical stop-loss business to improve the loss ratio, which may limit our top-line growth.
by related non-deferrable sales expenses. We expect this significant growth in account value to contribute to earnings in 2014.
Individual Life division: We expanded our distribution relationships in the BGA market, which generated increased sales in the second half of the year, primarily of our universal life product, and we received $45.0 of deposits for our new variable COLI product. We expect these trends to continue in 2014.
Capital actions: We deployed a total of $136.6 in share buybacks and dividends during the year, in addition to settling all of our outstanding warrants in a cashless exercise in June 2013.
Generate strong sales of annuities and SPL through banks and broker-dealers, and enhance our FIA product offerings; and
We also plan to continue to take modest capital actions in 2014, through share repurchases and dividends. We may repurchase approximately half of the remaining 9.0 million shares authorized under our current program in 2014. We also remain open to acquisition opportunities that complement our existing lines of business, but do not expect to be active in this area.
Our results and ability to execute on our strategies are influenced by a range of economic and other factors. Economic factors include consumer spending, business investment, government spending, the volatility and strength of capital markets, investor and consumer confidence, and levels of inflation. We continually monitor developments that affect our business, including:
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” in this report.
Investment yields, however, continue to be challenged by the low interest rate environment of recent years. We are mitigating these effects by investing in commercial mortgage loans that we originate, and by making modest investments in high-quality foreign securities. For further discussion of our investment portfolio and results, refer to "- Investments."
In response to lower investment yields, we continue to manage new and renewal crediting rates to customers on our fixed deferred annuities and universal life policies. However, the crediting rates that we set are influenced by periodic guarantees, contractual minimums, and competitive pressures, among other factors.
We believe that PPACA is affecting the competitive landscape in our Benefits division. We are seeing increased competition in our medical stop-loss line of business. We believe employers are exploring self-funding options, which is attracting attention from market participants, including major health insurers. In the group life & DI marketplace, we are seeing less movement of business between providers, which slows our pace of growth in this business.
We are working to increase our brand recognition among our distributors and customers. To achieve this goal, we have invested in a nationwide campaign aligned with major sporting events across multiple media platforms.
We are facing increased competition from other lenders in the origination of commercial mortgage loans. This puts downward pressure on new loan origination yields. We expect to originate loans with a smaller average principal amount in 2014 that meet our quality standards and provide attractive yields relative to other investments.
We carry certain assets on our consolidated balance sheets at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants (an “exit price”). GAAP establishes a fair value hierarchy that distinguishes between inputs based on market data from independent sources (“observable inputs”) and a reporting entity’s internal assumptions based upon the best information available when external market data is limited or unavailable (“unobservable inputs”). The fair value hierarchy prioritizes fair value measurements into three levels based on the nature of the inputs. The level in the fair value hierarchy within which the fair value measurement falls is determined based on the lowest level input that is significant to the fair value measurement. For further discussion of the levels of the fair value hierarchy, see Note 6 to the consolidated financial statements.
We use our judgment in assigning our fixed maturities to a level within the fair value hierarchy by determining whether significant pricing inputs are observable and if the market for a given security is active. When we have significant observable market inputs, which is the case when the security is priced by our pricing services, it is classified as a Level 2 measurement. If
our pricing services determine that they do not have sufficient objectively verifiable information about a security, they will not provide a valuation for that security, and its fair value is determined internally. We use observable information for pricing when available, however, 0.8% of our fixed maturities are classified as Level 3 measurements.
As of December 31, 2013 and 2012, $653.7, or 2.8%, and $819.6, or 3.5%, 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 25 basis points and is based on the credit quality of the security. The illiquidity spread is an unobservable input, but it does not significantly impact the resulting valuation. As a result, we classified 97.2% and 96.1% as of December 31, 2013 and 2012, respectively, of our private placement securities as Level 2.
Making the determinations as to whether these conditions exist requires judgment. As part of this process, we analyze investments in an unrealized loss position to determine whether the decline in value is other-than-temporary. While all securities are monitored for impairment, our experience indicates that securities for which the cost or amortized cost exceeds the fair value by less than 20% do not typically represent a significant risk of impairment and, often, fair values recover over time as the factors that caused the declines improve. If the estimated fair value has declined and remained below cost or amortized cost by 20% or more for at least six months, we further analyzes the decrease in fair value to determine whether it is an other-than-temporary decline.
The impairment review involves the investment management team, including internal management and our third-party asset portfolio managers. To make this determination, we consider both quantitative and qualitative criteria including:
For securities we intend to sell or for which it is more likely than not that we will be required to sell before recovery, the impairment charge is equal to the difference between the fair value and the amortized cost basis of the security. This amount is recorded as a realized loss in our consolidated statements of income. In determining our intent to sell a security or whether it is more likely than not that we will be required to sell a security, we evaluate facts and circumstances such as decisions to reposition our security portfolio, sales of securities to meet cash flow needs and sales of securities to capitalize on favorable pricing. During 2013, we purchased U.S. Treasury securities for cash management purposes, which declined in value due to changes in interest rates. We recorded impairment losses on these securities, as we concluded that we were more likely than not to sell them prior to recovery of amortized cost.
We determine the estimated recovery values based on our best estimate of expected future cash flows, which requires significant judgment. Our models reflect the probability of issuer default and estimates regarding timing and amount of expected principal and interest payments or recoveries under current and expected future economic conditions. Assumptions used to develop the best estimate of future cash flows include various performance indicators, such as historical default and recovery rates, credit ratings, current delinquency rates and the structure of the issuer/security. The discount rate is based on the security’s effective yield prior to impairment.
Projections of expected future cash flows may change based upon new information regarding the performance of the issuer and/or the underlying collateral of the security. Future impairments may develop if actual results underperform current cash flow modeling assumptions, which may be the result of macroeconomic factors, changes in assumptions used, specific deterioration in certain industry sectors or company failures.
We defer as assets certain policy acquisition costs, including commissions, distribution costs and other underwriting costs related to the production of new and renewal business. When our DAC asset is amortized, it reduces income. We also defer as assets certain sales inducements, including bonus interest, which are included within other assets on our consolidated balance sheets. When our DSI asset is amortized it increases interest credited and reduces income.
The portion of the salaries and benefits related to employee time spent directly on acquisition-related activities for successfully acquired new or renewal contracts
We offer sales inducements mainly on certain deferred annuity contracts, which entitles the contract holder to an incremental amount of interest to be credited to the account value over a specified 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. The incremental interest is deferred and amortized into interest credited in the consolidated statements of income over the life of the contract.
Additionally, DAC and DSI balances are adjusted to reflect the impact of realized gains (losses) during the period. These adjustments are recognized in net realized investment gains (losses) in the consolidated statements of income.
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. Estimating future gross profits is a complex process requiring considerable judgment and forecasting of events well into the future. Changes to assumptions can have a significant impact on DAC and DSI amortization. In the event actual experience differs from our assumptions or our future assumptions are revised, we adjust our EGPs, which could result in a significant change in amortization expense.
The following would generally cause an increase in amortization or adjustments of DAC and DSI balances:
decreases in expected future interest margins due to increases in expected renewal crediting rates and/or decreases to expected investment yields;
significant investment prepayment activity, which results in decreased future interest margins;
For future assumptions, we complete a study and refine our estimates of future gross profits annually during the third quarter. We also revise future assumptions as needed throughout the year if a significant transaction or trend is identified that would warrant a change in those assumptions. Upon completion of an assumption study, we revise our assumptions to reflect our current best estimate, thereby changing our estimate of projected EGPs used in the DAC and DSI asset amortization models. This is often referred to as “unlocking” the amortization models. For the years ended December 31, 2013 and 2012, we recorded net pre-tax adjustments that increased amortization by $2.6 and $2.6, respectively, related to annual DAC unlocking, and $0.7 and $1.0, respectively, related to annual DSI unlocking.
Additionally, we recorded incremental amortization expense related to prepayment-related income received, primarily from make-whole provisions on fixed maturities that were prepaid in the historically low interest rate environment. The expected future impact of these prepayments was also analyzed and, where applicable, DAC and DSI amortization due to unlocking was recorded in the period the prepayment occurred. For the years ended December 31, 2013 and 2012, we recorded additional amortization from prepayment-related income totaling $8.3 and $1.4, respectively, for DAC and $6.8 and $1.1, respectively, for DSI.
We regularly conduct DAC and DSI recoverability analyses, where we compare the current asset balances with the estimated present value of future profitability of the underlying business. The DAC and DSI asset balances are considered recoverable if the present value of future profits is greater than the current asset balances.
if we increased our future expense assumptions by a factor of 10%, the DAC asset balance would decrease approximately $0.4.
if we decreased our future investment yield assumptions by a factor of 100 bps, the DAC asset balance would decrease approximately $1.1.
We compute liabilities for future policy benefits under traditional individual life and group life insurance policies on the level premium method, which uses a level premium assumption to fund reserves. We select the level of premiums at issuance so that the actuarial present value of future benefits equals the actuarial present value of future premiums. We set the interest, mortality and persistency assumptions in the year of issue and include provisions for adverse deviations. The provisions for adverse deviations are intended to provide coverage for the risk that actual experience may be worse than locked-in best-estimate assumptions.
These liabilities are contingent upon the death of the insured while the policy is in force. We derive mortality assumptions from both company-specific and industry statistics. We discount future benefits at interest rates that vary by year of policy issue. These interest rates are set initially at a rate consistent with portfolio rates at the time of issue, and grade to a lower rate, such as the statutory valuation interest rate, over time. Assumptions are made at the time each policy is issued, and do not change over time unless the liability amount is determined to be inadequate to cover expected future policy benefits. No revisions to assumptions within the future policy benefits liabilities have been necessary, and therefore we have not experienced any significant impact in our financial results due to changes in assumptions.
Liabilities for policy and contract claims primarily represent liabilities for claims under our group and individual life insurance policies and are established on the basis of reported losses. We also provide for claims incurred but not reported (IBNR) based on expected loss ratios, claims paying completion patterns and historical experience. For our medical stop-loss policies, IBNR reserves are estimated based on the development method, which uses historical claims paying patterns to determine appropriate reserves. 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 variance 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 2013, our incurred claims related to previous years developed favorably by $10.4, or 6.3% of net reserves at December 31, 2012.
balances, DAC amortization, and general business and operating expenses, net of DAC deferrals. These items are discussed in further detail below.
Net realized investment 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.
Other underwriting and operating expenses represent non-deferrable costs related to the acquisition and the ongoing maintenance of insurance and investment contracts, including certain non-deferrable commissions, policy issuance expenses and other business and administrative operating costs.
In the following paragraphs, we provide definitions of our non-GAAP measures. For a reconciliation of these non-GAAP measures to their most directly comparable GAAP measures, see Item 6 - “Selected Financial Data.”
Adjusted operating income consists of net income, excluding certain net realized gains (losses). Excluded realized gains (losses) are associated with investment sales or disposals, 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, described below), and changes in the fair value of embedded derivatives related to our FIA product.
We do not exclude all realized gains (losses) from adjusted operating income. For example, we include the gain (loss) on S&P 500 options supporting FIA policies we 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 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 do not remove these realized gains (losses) from adjusted operating income.
We believe investors find it useful to review a measure of the results of our insurance operations separate from the gain and loss activity attributable to most of our investment portfolio because it assists an investor in determining whether our insurance-related revenues, composed primarily of premiums, net investment income and policy fees, contract charges and other, have been sufficient to generate operating earnings after meeting our insurance-related obligations, composed primarily of claims paid to policyholders, investment returns credited to policyholder accounts, and other operating costs.
Pre-tax adjusted operating income is adjusted operating income on a pre-tax basis. It also represents the cumulative total of segment pre-tax adjusted operating income, which at the segment level is a GAAP measure. Income from operations before income taxes is the most directly comparable GAAP measure to pre-tax adjusted operating income. In presenting pre-tax adjusted operating income, we are excluding certain pre-tax net realized investment gains (losses) as described above.
We purchase fixed maturities with durations and cash flows that match our estimate of when our insurance liabilities and other obligations will come due. We typically expect to hold our fixed maturities to maturity, using the principal and interest cash flows to pay our obligations over time. Since we expect to collect the contractual cash flows on these fixed maturities, we do not expect to realize the unrealized gains (losses) that are included in our AOCI balance as of any particular date. AOCI primarily fluctuates based on changes in the fair value of our fixed maturities, which is driven by factors outside of our control, including the movement of interest rates, credit spreads and the impact of credit market conditions.
We believe investors find it useful if we present them with a comparative measure of adjusted book value per common share, as converted, to remove AOCI from stockholders’ equity and give effect to the exercise of our outstanding warrants. This allows the investor to assess its proportionate stake in our adjusted book value, while understanding the effect of the exercise of outstanding warrants, as of the dates presented, and the change in such measures over time, based on our practice of holding our fixed maturities to maturity.
The following discussion should be read in conjunction with our consolidated financial statements and the related notes.
Basic net income and adjusted operating income per common share include all participating securities using the two-class method. Diluted net income and adjusted operating income per common share include the dilutive impact of non-participating securities, based on the application of the treasury stock method. Antidilutive awards were excluded from the computation of diluted earnings per share. Historically, our outstanding warrants were considered participating securities and included in basic and diluted weighted-average common shares outstanding. For the years ended December 31, 2013, these measures reflect the net-share settlement of the warrants on June 20, 2013, resulting in the issuance of 5,297,758 common shares. Shares included in these calculations were weighted for the portion of the period they were outstanding.
The following table sets forth additional detail of our other underwriting and operating expenses:
The provision for income taxes decreased by $11.3 from 2012. The effective tax rate declined to 19.5% for the year ended December 31, 2013 from 24.0% for the same period in 2012 due primarily to an increase in benefits from our tax credit investments.
Net income increased $9.6 as a result of higher net realized investment gains on our investment portfolio and a lower provision for income taxes, partially offset by a decline in pre-tax adjusted operating income.
Net realized investment gains increased $23.9, driven by mark-to-market net gains on our equity securities, partially offset by higher impairments. For further discussion of our investment results and portfolio refer to - “Investments.”
The following table sets forth selected historical operating metrics relating to our Benefits segment for the years ended:
Sales for the year ended December 31, 2013 totaled $130.9, compared to sales of $159.3 for the same period in 2012. Medical stop-loss sales declined $36.4, reflecting our pricing discipline in a competitive market. This was partially offset by an $12.1 increase in group life and DI sales as we focused on expanding our presence in this market.
Premiums increased $67.7, driven by organic growth from strong 2012 sales, as well as the medical stop-loss block of business acquired in July 2011.
Policyholder benefits and claims increased $54.2, driven by growth in our medical stop-loss business, including the block of business acquired in July 2011. Also contributing to the increase was higher limited benefit medical claims for 2012, compared to 2011.
Sales for the year ended December 31, 2012 totaled $159.3, compared to $118.7 in 2011. This increase was primarily driven by competitive medical stop-loss pricing and strong producer relationships.
The following table sets forth the results of operations relating to our Deferred Annuities segment:
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 values. 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.
The $7.0 increase in interest credited was driven by higher FIA interest, primarily from growth in account value, 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.
Segment pre-tax adjusted operating income increased $6.9, primarily driven by earnings from higher fixed account values and a stable interest spread, as well as lower DAC amortization. Our base earned yield continued to decline as a result of the low interest rate environment; however, base interest spreads were slightly higher year-over-year, reflecting disciplined pricing on new business and management of renewal crediting rates on existing business. These results were partially offset by higher operating expenses related to our True VA product.
Interest credited increased $8.2, primarily due to a $0.83 billion increase in average fixed annuities account values. Typically DAC amortization increases as account values increase; however, we experienced a $5.0 decrease in DAC amortization primarily as a result of lower lapses than assumed in our DAC models.
Deferred Annuities’ sales decreased 37% in 2012, compared to 2011. This was primarily the result of the low interest rate environment, which we believe has driven a decline in overall industry sales of deferred annuities and increased competition for customers.
Mortality gains (losses) represent the difference between actual and expected reserves released on our life contingent annuities.
Net investment income decreased $12.0, primarily due to lower yields and lower average invested assets. The decline in yields was driven by lower yields on recent fixed maturity purchases and commercial mortgage loan originations, and prepayments of higher yielding assets.
Segment pre-tax adjusted operating income increased $9.9, primarily due to favorable mortality experience. Mortality gains increased to $12.9 for 2012, compared to gains of $0.3 for 2011. In addition, fee revenue earned on sales of third-party structured settlements increased $4.3, compared to 2011, due to significantly higher sales. These increases were partially offset by decreased funding services activity and lower reserves.
UL interest spread excludes SPL 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 in the general account attributed to UL policies. The credited rate is the approximate rate credited on UL policyholder account values. Interest credited is subject to contractual terms, including minimum guarantees.
BOLI base ROA is BOLI ROA adjusted to exclude items that can vary significantly from period to period due to a number of factors and, therefore, may contribute to yields that are not indicative of the underlying trends. This is primarily the impact of asset prepayments, such as bond make-whole premiums, the MBS prepayment speed adjustment.
Net investment income decreased $4.0, due primarily to lower yields on asset purchases over the past year. This was partially offset by an increase in average invested assets, mainly due to growth in BOLI account value, and an increase in prepayment-related income. Prepayment-related income totaled $6.3 in 2013, compared to $3.5 in 2012.
Segment pre-tax adjusted operating income decreased $18.3 primarily driven by higher individual claims experience, a lower BOLI ROA due to higher BOLI claims and lower investment yields, and higher expenses related to the expansion of our sales organization.
Premiums decreased $3.2, driven by lower revenue on a smaller block of our term life business and decreased sales of term life.
Policy fees, contract charges, and other increased $5.5 due to higher COI and administrative fees on our BOLI and UL business.
Benefit-related expenses increased $8.8, primarily due to higher individual claims as well as an increase in interest credited on higher BOLI account values, which offset the increased BOLI COI revenue charges noted above. Individual life claims increased $6.7 million over 2011, though mortality was generally in line with our expectations. These increases were partially offset by lower claims on our BOLI business and reserve modifications in 2011, which increased 2011 benefit-related expenses by $1.9.
Other underwriting and operating expenses increased $6.1 due to higher employee-related expenses, primarily associated with our strategic growth initiatives.
The Other segment reported pre-tax adjusted operating losses of $15.5 for 2013, compared with losses of $26.1 in 2012. This improvement was due to higher net investment income, primarily from higher average invested assets, and decreased operating expenses, including lower costs associated with the exploration of acquisition opportunities. In addition, we sold a broker-dealer subsidiary during the fourth quarter of 2013, which decreased operating revenues and other underwriting and operating expenses. Accordingly, we expect Other segment losses to decrease in the future, although results can be volatile from period to period based on assets in the segment and the returns of our private equity fund investments.
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, including investments in limited partnerships, are based on cost. Yields for all other asset types are based on carrying values.
The negative impact from the tax credit investments is offset by U.S. federal income tax benefits. The total impact to net income was $23.5, $17.0 and $6.2 for the years ended December 31, 2013, 2012 and 2011, respectively. For further discussion, see - “Investments in Limited Partnerships - Tax Credit Investments.”
primarily due to increased competition for loans that meet our size, duration and underwriting standards. Additionally, U.S. Treasury rates were low throughout 2012 and 2013, which has led to a decline in our overall mortgage loan portfolio yield.
Represents the changes in fair value of embedded derivative liabilities associated with our FIA product launched in 2011, netted with changes in fair value of index options purchased to economically hedge this business.
For the year ended December 31, 2013, our equity portfolio produced net realized gains of $66.0, compared to gains of $36.7 for the same period in 2012. For further discussion, see “- Return on Equity Investments.”
For the year ended December 31, 2012, our portfolio produced net realized gains of $31.1, as compared to $7.2 for the same period in 2011, primarily due to mark-to-market gains on our equity investments. Our equity investments had gains of $36.7 in 2012, compared to losses of $9.1 in 2011. The improvement in our equity investments was partially offset by a $14.9 increase in impairments on fixed maturities.
As of December 31, 2013 and 2012, 36.8% and 61.0%, respectively, of the gross unrealized losses on our investment portfolio, after the recognition of OTTI, related to securities due after ten years, which we consider to be longer duration assets. The fair value of these securities fluctuate more significantly with changes in interest rates and credit spreads, and we believe they will recover over time as the factors that caused the declines improve. Refer to Note 4 to the accompanying consolidated financial statements for a table summarizing the amortized cost and fair value of fixed maturities by contractual years to maturity as of December 31, 2013.
Fixed maturities represented approximately 84% and 85% of invested assets as of December 31, 2013 and 2012, respectively. The majority of our fixed maturities are invested in highly marketable or publicly traded securities. We invest in a small amount of privately placed fixed maturities to enhance the overall value of the portfolio and obtain higher yields than can ordinarily be obtained with comparable public market securities. As of December 31, 2013 and 2012, privately placed fixed maturities represented 2.8% and 3.5%, respectively, of our total fixed maturity portfolio at fair value.
As of December 31, 2013 and 2012, the fair value of our exposure to European fixed maturities was 9.0% and 7.0%, respectively, of our total fixed maturities portfolio. Our gross unrealized losses on these securities increased to $33.0 as of December 31, 2013, compared to $4.1 as of 2012, primarily due to rising interest rates. The fair value of our total exposure to Ireland, Italy, Portugal, and Spain was $37.6 and $18.8 as of December 31, 2013 and 2012, respectively. We have no exposure to any issuers in Greece, Hungary, Cyprus or Slovenia.
As of December 31, 2013, our fixed maturity securities portfolio included $4.27 billion of residential and commercial mortgage-backed securities at fair value. The residential and commercial real estate markets were significantly impacted by the financial crisis and recession, but have since shown signs of improvement. 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.
Our mortgage-backed securities are primarily agency securities, which account for 63.5% of the portfolio. Additionally, 28.6% of our mortgage-backed securities are AAA-rated non-agency securities in the most senior tranche of the structure type.
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 premium or discount associated with the securities in our portfolio. These adjustments, which relate primarily to RMBS, are recorded in net investment income in our results of operations and create volatility between periods.
The following table provides additional information on our RMBS prepayment exposure, by type and vintage:
There are various U.S. government initiatives through the Making Home Affordable program that may result in higher than expected prepayments on our RMBS portfolio, such as the Home Affordable Refinance Program that was extended to 2015. We continually monitor the underlying collateral in our RMBS to manage our prepayment exposure.
The following table sets forth the total fair value, and amortized cost of our non-agency CMBS by credit quality and vintage. There were 13 securities having a fair value of $318.3 and an amortized cost of $285.7 that were rated AAA by either S&P, Moody’s or Fitch, that were given a lower rating by at least one other agency. None of these securities were rated below investment grade by any of the three agencies.
The following table sets forth the LTV ratios for our mortgage loan portfolio:
The following table sets forth our investments in mortgage loans by property type:
Prior to their contractual maturity, some of our mortgage loans have one or more specified rate resetting windows during which the loan typically can be prepaid without a fee. During these windows, we expect that a portion of these loans will either be reset or refinanced at market terms, given the current interest rate environment. These loan features are considered in our asset-liability management, and we align our expected mortgage loan cash inflows and duration with the amount and timing of liability cash outflows. Additionally, our loan terms usually allow borrowers to prepay their mortgage loan prior to the stated maturity or outside specified rate resetting windows. Prepayments are driven by factors specific to the activities of our borrowers as well as the interest rate environment. However, the vast majority of our mortgage loans contain yield maintenance prepayment provisions that we believe mitigate such prepayments.
We invest in limited partnership interests related to tax credit investments. Although these investments decrease our net investment income on a pre-tax basis, they provide us with significant tax benefits, which decrease our effective tax rate. As of December 31, 2013 and 2012, our tax credit investments had a carrying value of $265.1 and $210.7, respectively. We expect to increase our investments in these partnerships in 2014.
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. We continue to evaluate opportunities for these investments.
We actively manage our liquidity in light of changing market, economic and business conditions, and we believe that our liquidity levels are more than adequate to cover our exposures, as evidenced by the following:
As of December 31, 2013 we had $23.37 billion of liquid assets, which includes cash, cash equivalents, short-term investments, publicly traded fixed maturities and equity securities.
While certain policy lapses and surrenders occur in the normal course of business, the current 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. As interest rates rise, we may experience an increase in lapses.
As of December 31, 2013, we had the ability to borrow, on an unsecured basis, up to a maximum principal amount of $300.0 under a revolving line of credit arrangement.
As of December 31, 2013 our primary life insurance company subsidiary, Symetra Life Insurance Company, had a risk-based capital ratio of 461%. This provides adequate capital levels for growth of our business.
During the second half of 2013, we completed our cash flow testing to assess statutory reserve adequacy. As a result of our analysis and to address risks related to low interest rates, we increased our cash flow testing reserve by $32.0 to a total of $57.0 as of December 31, 2013. The risk is mainly related to our structured settlement annuity and BOLI blocks of business, which represent long-duration liabilities that are interest rate sensitive. The testing was run over a set of deterministic and stochastic interest rate scenarios, and we believe that the statutory reserves are adequate under a set of moderately adverse scenarios. This $32.0 increase in statutory reserves decreased statutory capital by $20.8 and reduced our risk-based capital ratio by approximately four points. The cash flow testing statutory reserve does not impact our consolidated GAAP financial statements.
Historically, we have paid quarterly cash dividends to holders of our common stock and outstanding warrants. During 2013, we declared and paid a cash dividends of $0.34 per common share, which included payments to holders of outstanding warrants prior to their net-share settlement. On June 20, 2013, we issued 5,297,758 common shares to net-share settle all of the outstanding warrants. We intend to continue to pay quarterly cash dividends to our stockholders, and the declaration and payment of future dividends to holders of our common stock will be at the discretion of our board of directors. See “- Dividends” below for further discussion.
In February 2013, we began a stock repurchase program, authorized for up to 10,000,000 shares of Symetra’s outstanding common stock. In May 2013, the authorization was increased to 16,000,000 shares. As of December 31, 2013, we had repurchased 6,952,266 shares for a total of $93.4. Symetra has funded and plans to continue to fund this program mainly through dividends from its subsidiaries. Refer to Item 5 - “Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” for further information about the repurchase program.
The liquidity requirements of Symetra’s insurance company subsidiaries principally relate to the liabilities associated with their insurance and investment products, operating costs and expenses, 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.
The benefits are specified in the contracts as fixed amounts, primarily to be paid over the next several decades. Certain single premium immediate annuity contracts contain a liquidity feature that permits contract owners to make partial withdrawals once every 36 months within the life expectancy period. The withdrawals are based on prevailing market rates which limits our exposure to liquidity and interest rate risk.
We are seeing an increase in our somewhat liquid liabilities, primarily as a result of strong sales of our deferred FIA product during 2013.
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. 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.
Our capitalization decreased $688.1 from the prior year due to lower stockholders' equity primarily from decreased AOCI and our stock repurchase program, partially offset by increased net income. Our balance of AOCI in stockholders' equity decreased by $777.6, primarily driven by a reduction in net unrealized gains on available-for-sale securities due to increases in interest rates during the year. We believe our capital level provides us flexibility to execute our capital management strategies, which are focused on organic growth. We also may pursue acquisition opportunities and continue prudent capital actions, including our stock repurchase program.
On October 10, 2007, we issued $150.0 aggregate principal amount CENts with a scheduled maturity date of October 15, 2037 and, subject to certain limitations, with a final maturity date of October 15, 2067. We issued the CENts at a discount yielding $149.8. For the initial ten-year period following the original issuance date, to but not including October 15, 2017, the CENts carry a fixed interest rate of 8.300% 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 4.177%, payable quarterly. In connection with the offering of the CENts, we entered into a replacement capital covenant for the benefit of the holders of the senior notes, which may limit our ability to redeem or repay the CENts. The CENts do not contain any other significant restrictions or covenants.
On December 14, 2011, we entered into a $300.0 senior unsecured revolving credit agreement with a syndicate of lending institutions led by JPMorgan Chase Bank, N.A. The credit facility also provides access up to an additional $100.0 of financing, subject to the availability of additional commitments. The credit facility matures on December 14, 2015, and loans under this facility bear interest at a variable annual rate based on adjusted LIBOR or the alternate base rate (“ABR”) plus an applicable margin. This facility requires us to maintain specified financial ratios, and includes other customary restrictive and affirmative covenants. This revolving credit facility is available to provide support for working capital, capital expenditures and other general corporate purposes as needed.
The payment of dividends and other distributions to Symetra by its insurance company subsidiaries is controlled by insurance laws and regulations. In general, dividends in excess of prescribed limits are deemed “extraordinary” and require insurance regulatory approval. During the years ended December 31, 2013, 2012 and 2011, Symetra received dividends of $195.0, $80.0, and $52.0, respectively, from its insurance company subsidiaries. In January 2014, Symetra received a $45.0 dividend that was declared in December 2013. Based on our statutory results, as of December 31, 2013, Symetra’s insurance company subsidiaries may pay it dividends of up to $187.0 during 2014 without needing to obtain regulatory approval.
Years Ended December 31, 2013 compared with 2012. Net cash provided by operating activities for the year ended December 31, 2013 increased $8.4 over the same period in 2012. This increase was primarily the result of timing differences in the settlement of federal income tax liabilities, and higher net investment income, including bond make-whole premiums from asset prepayments. The increased cash inflows were partially offset by higher commission and distribution-related payments associated with the strong fixed deferred annuity sales.
Years Ended December 31, 2012 compared with 2011. Net cash provided by operating activities for 2012 increased $23.7 over the same period in 2011. This was primarily the result of the increase in premiums from our growing book of medical stop-loss business outpacing the increase in medical stop-loss paid claims, an increase in net investment income driven by higher average assets and a lower commission expense due to lower sales of fixed annuities. The increase was partially offset by higher operating expenses related to our strategic growth initiatives.
Years Ended December 31, 2012 compared with 2011. Net cash used in investing activities decreased $778.6 compared to 2011. This decrease was primarily the result of higher sales of fixed maturities, related to active management of our portfolio to increase investment yields, and lower originations of mortgage loans.
Cash flows from our financing activities are primarily driven by the amount and timing of cash received from deposits into certain life insurance and annuity policies, as well as the amount and timing of cash disbursed to fund withdrawals from certain life insurance and annuity policies, dividend distributions to our common stockholders and stock repurchase activity. The following discussion highlights key drivers in the level of cash flows from our financing activities:
Years Ended December 31, 2012 compared with 2011. Net cash used in financing activities for 2012 was $253.4, in comparison to cash provided by financing activities of $628.1 in 2011. This change was primarily driven by lower policyholder deposits, mainly related to fixed annuities. In addition, there were higher deferred annuity policyholder withdrawals in 2012 compared to 2011 as policies move out of the surrender charge period.
We enter into obligations with third parties in the ordinary course of our operations. The estimated cash payments related to these obligations as of December 31, 2013 are set forth in the table below. The estimated payments reflected in this table are based on management’s estimates and assumptions, which are necessarily subjective. Actual cash out flows in future periods will vary, possibly materially. Further, we do not believe that our cash flow requirements can be assessed based upon an analysis of these obligations as the funding of these future cash obligations will be from future cash flows from maturities of invested assets, premiums, deposits, fees and investment income that are not reflected in the table below. In addition, our operations involve significant expenditures that are not based upon commitments, including expenditures for payroll and income taxes.
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 2017-2018. For more information, see Note 12 to the consolidated financial statements.
Includes minimum rental commitments on leases for office space and certain equipment. For more information, see Note 14 to the consolidated financial statements.
Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2013, 2012 and 2011
Consolidated Statements of Cash Flows for the years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements for the years ended December 31, 2013, 2012 and 2011
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, 2013 and 2012, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2013, 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, employee benefits and life insurance markets. These products and services are marketed through financial institutions, benefits consultants, and independent agents and advisors in all states and the District of Columbia. The Company’s principal products include fixed and variable deferred annuities, single premium immediate annuities, medical stop-loss insurance, group life and disability income 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’s group insurance policies, which include medical stop-loss, limited benefit medical, group life and disability income, are short duration contracts. Premiums from these products are recognized as revenue when earned over the life of the policy. Policyholder claims are charged to operations as incurred.
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.
An impairment is recorded on an available-for-sale security when a decline in fair value below a security’s amortized cost is judged to be other-than-temporary. The Company’s review of securities includes both quantitative and qualitative criteria. See Note 4 for additional discussion regarding the Company’s process for identifying and recording OTTI.
The Company invests in limited partnerships that generate tax benefits. These 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, “tax credit investments”). The Company's investments are accounted for under the equity method and recorded at amortized cost, with amortization recorded as a reduction to net investment income. When the carrying value of an investment exceeds the amount of remaining tax benefits, the Company records an impairment loss, which is included in other net realized investment gains (losses) in the consolidated statements of income. The present value of any unfunded commitments related to these investments is recorded in other liabilities.
The Company uses derivative financial instruments to hedge certain portions of its exposure to equity market risk, interest rate risk and foreign currency exchange risk. Derivative financial instruments currently held consist primarily of Standard & Poor’s 500 Index® (“S&P 500”) options, interest rate swaps, foreign currency swaps and foreign currency forwards. Derivative instruments may be exchange-traded or contracted in the over-the-counter (“OTC”) market. The Company does not offset the fair value amounts recognized for derivatives executed with the same counterparty under the a master netting agreement. All of the Company’s derivative financial instruments are individually recognized as either assets within other invested assets, or liabilities within other liabilities in the consolidated balance sheets at fair value. The Company also issues fixed indexed annuity contracts that contain embedded derivative, which are recorded at fair value in funds held under deposit contracts in the consolidated balance sheets.
When a derivative is designated as a cash flow hedge and is determined to be highly effective, changes in its fair value are recorded as a component of other comprehensive income (loss) (OCI) and reclassified into net income in the same period during which the hedged transaction affects net income. Any hedge ineffectiveness is recorded in the consolidated statements of income within net realized investment gains (losses). If a derivative instrument does not qualify, or is not designated for hedge accounting, the changes in its fair value are recorded in the consolidated statements of income within net realized investment gains (losses).
The Company remains liable to its policyholders to the extent that counterparties to reinsurance contracts do not meet their contractual obligations. Accordingly, the future policy benefit reserves and policy and contract claims liabilities are reported gross of any related reinsurance recoverables, which are reported as assets. The Company reports premiums, benefits, and settlement expenses net of reinsurance in the consolidated statements of income. The Company accounts for reinsurance premiums, commissions, expense reimbursements, benefits and reserves related to reinsured business on bases consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts.
The Company defers costs that are directly related to the successful acquisition or renewal of insurance contracts. These primarily include commissions, distribution costs directly related to production, third-party underwriting costs and the portion of salaries and benefits directly related to processing successful new and renewal contracts. All other acquisition-related costs, including costs incurred for soliciting potential customers, managing the distribution and underwriting functions, training, administration, unsuccessful acquisition or renewal efforts, market research and product development are not deferrable and are expensed in the period incurred.
The Company amortizes deferred acquisition costs 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 surrender 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 DAC amortization. The Company regularly evaluates its assumptions and, when necessary, revises the estimated gross profits of these contracts, resulting in adjustments to DAC amortization. When such estimates are revised, the impact is recorded in the consolidated statements of income.
The Company amortizes acquisition costs for traditional individual life insurance policies over the premium paying period of the related policies, using assumptions consistent with those used in computing policy reserves. The Company amortizes acquisition costs for immediate annuities using a constant yield approach.
The Company conducts regular recoverability analyses for its DAC asset balances associated with deferred and immediate annuity contracts, universal life contracts, and traditional life contracts. The Company compares the current DAC asset balances with the estimated present value of future profitability of the underlying business. The DAC asset balances are considered recoverable if the present value of future profits is greater than the current DAC asset balance. As of December 31, 2013 and 2012, all of the DAC asset balances were considered recoverable.
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, 2013 and 2012, 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 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 DSI balance for the effect of realized gains and losses. These adjustments are recognized in net realized investment gains (losses) in the consolidated statements of income.
Liabilities for fixed annuity contracts, and universal life policies, including BOLI and variable COLI, 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.
For single premium immediate annuities (SPIAs), including structured settlements, liabilities are based on discounted amounts of estimated future benefits. Future benefits are either fully guaranteed or are contingent on the survivorship of the annuitant. Contingent future benefits are discounted with pricing mortality assumptions, which include provisions for longer life spans over time. The interest rate pattern used to calculate the reserves for SPIAs is set at issue. The interest rates within the pattern vary over time and start with interest rates that prevailed at contract issue. As of December 31, 2013, the weighted-average implied interest rate on the existing book of business was 5.71% and is expected to grade to 6.37% during the next 20 years.
Funds held under deposit contracts also include liabilities for the embedded derivative related to our FIA policies, which is recorded at fair value. See Note 6 for further discussion of the valuation of the embedded derivative.
Liabilities for policy and contract claims, which primarily represent liabilities for claims under medical stop-loss and individual life policies, are established on the basis of reported losses. The Company also provides for claims incurred but not
ASU 2011-11, Disclosures about Offsetting Assets and Liabilities and ASU 2013-01, Scope Clarification of Disclosures about Offsetting Assets and Liabilities
In January 2013, the FASB issued ASU 2013-01, Balance Sheet (Topic 210) - Scope Clarification of Disclosures about Offsetting Assets and Liabilities. This ASU limits the scope requirements of ASU 2011-11 to derivatives, repurchase agreements, reverse repurchase agreements, and securities borrowing and lending transactions. The Company prospectively adopted ASU 2011-11 and 2013-01 on January 1, 2013 and included the disclosures in Note 4.
In January 2014, the FASB issued ASU 2014-01, Investments (Topic 323) - Equity Method and Joint Ventures: Accounting for Investments in Qualified Affordable Housing (AFH) Projects. This ASU provides companies with the option to elect the proportional method of amortization for AFH investments if certain criteria are met. Under this method, a company would amortize the cost of its investment in proportion to the tax credits and other tax benefits received. Amortization would be presented as a component of income tax expense. The standard is effective for annual and interim periods beginning on or after January 1, 2015, with retrospective application required. The standard does not apply to other types of tax credit investments. The Company is currently evaluating whether it will elect the proportional amortization method for its AFH investments and the impact that it may have on the consolidated financial statements.
Basic earnings per share represents the amount of earnings for the period available to each share of common stock outstanding during the reporting period. Diluted earnings per share represents the amount of earnings for the period available to each share of common stock outstanding during the reporting period, adjusted for the potential issuance of common stock, if dilutive.
Based on National Association of Insurance Commissioners (NAIC) ratings as of December 31, 2013 and December 31, 2012, the Company held below-investment-grade fixed maturities with fair values of $1,267.5 and $1,279.2, respectively, and amortized costs of $1,229.7 and $1,241.3, respectively. These holdings amounted to 5.5% and 5.4% of the Company’s investments in fixed maturities at fair value as of December 31, 2013 and December 31, 2012, respectively.
The following table summarizes the amortized cost and fair value of fixed maturities as of December 31, 2013, 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.
The Company’s review of 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.
To determine the recovery value for a structured security, including residential mortgage-, commercial mortgage- and other asset-backed securities, the Company performs an analysis including, but not limited to, the following:
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 does not offset recognized collateral amounts pledged or received against the fair value amounts recognized for derivative contracts.
The Company is invested in foreign currency forwards to hedge exposure related to purchases of foreign denominated equities and fixed maturities. The Company invests in foreign currency forwards to economically hedge its exposure related to foreign currency-denominated fixed maturity purchases until a foreign currency swap is executed. In a foreign currency forward transaction, the Company agrees with other parties to deliver a specified amount of an identified currency at a specified future date. The price is agreed upon at the time of the contract and payment for such a contract is made at the specified future date. In general, the Company is selling a foreign currency and receiving U.S. dollars to protect against fluctuations in exchange rates over a short period of time. These derivatives are not designated for hedge accounting.
The Company uses interest rate swaps as part of its interest rate risk management strategy. In an interest rate swap, the Company agrees with other parties to exchange, at specified intervals, the difference between floating-rate and fixed-rate interest amounts calculated by reference to an agreed upon notional principal amount. The Company primarily uses interest rate swaps to synthetically convert variable rate fixed maturities to fixed rate securities. These derivatives qualify and are designated as cash flow hedges.
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.
In the consolidated balance sheets, the Company recognizes cash collateral received in cash and cash equivalents, and the obligation to return cash collateral in other liabilities. Non-cash collateral received is not recognized in the consolidated balance sheets. In the event of default, the counterparty relinquishes claim to the assets pledged as collateral, and the Company recognizes the collateral as its own asset recorded at fair value, or, in the case of cash collateral, derecognizes its obligation to return collateral.
See Note 8 for amounts reclassified out of AOCI into net income for the years ended December 31, 2013 and 2012. The Company expects to reclassify net gains of $1.5 from AOCI into net income in the next 12 months, which includes both discontinued hedges and periodic settlements of active hedges. Actual amounts may vary from this estimate as a result of market conditions.
Higher Risk Loans - Loans with an LTV ratio greater than 80%, or loans which have an LTV ratio between 65% and 80%, and a DSCR of less than 1.50.
Loans are specifically evaluated for impairment if the Company considers it probable that amounts due according to the terms of the loan agreement will not be collected, or the loan is modified in a troubled debt restructuring. The Company establishes specific reserves for these loans when the fair value is less than its carrying value.
Includes the allowance for loan losses and deferred fees and costs.
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, 2013, no loans were considered non-performing. As of December 31, 2012, one loan with an outstanding principal balance of $3.7 was considered non-performing and included in the assessment of the provision for specific loans.
The carrying value of this balance excludes $5,899.1 of liabilities related to insurance contracts and embedded derivatives.
The vast majority of the Company’s fixed maturities have been classified as Level 2 measurements. To make this assessment, the Company determines whether the market for a security is active and if significant pricing inputs are observable. The Company predominantly utilizes third party independent pricing services to assist management in determining the fair value of its fixed maturity securities. As of December 31, 2013 and December 31, 2012, respectively, pricing services provided prices for 96.6% and 96.2% of the Company’s fixed maturities.
The Company analyzes 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. The Company also performs 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 its analyses, the Company has not adjusted prices obtained from the pricing services.
As of December 31, 2013 and 2012, $523.5, or 3.0%, and $675.1, or 3.9%, respectively, of Level 2 corporate securities were privately placed. These securities were valued using a matrix pricing approach. The significant inputs to the measurement are the base credit spread, treasury yield and expected future cash flows of the security, which are all observable inputs. The base spread is determined based on trades of similar publicly-traded securities, and the expected future cash flows are based on the contractual terms of the security. The valuation approach also incorporates an illiquidity spread, determined based on premiums demanded by investors for privately placed securities. The illiquidity spread is an unobservable input, which ranges from 0 to 25 basis points and is based on the credit quality of the security. The illiquidity spread does not significantly impact the resulting valuation.
As of December 31, 2013 and 2012, the fair value of the Company’s residential mortgage-backed securities (RMBS) classified as Level 2 measurements was $2,755.8 and $3,007.8, respectively. These securities were primarily fixed-rate, with a weighted-average coupon rate of 4.39% and 4.67% as of December 31, 2013 and 2012, respectively.
Agency securities comprised 89.2% and 89.4% of the Company’s Level 2 RMBS as of December 31, 2013 and 2012, respectively. The following table presents additional information about the composition of the Level 2 non-agency RMBS securities:
As of December 31, 2013 and 2012, the Company’s non-agency Level 2 RMBS had a weighted-average credit enhancement of 8.8% and 8.4%, respectively. As of December 31, 2013 and 2012, $110.3 and $127.7, or 37.0% and 40.0%, 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.
The Company’s Level 2 CMBS securities were primarily non-agency securities, which comprised 83.3% and 78.4% of Level 2 CMBS as of December 31, 2013 and 2012, respectively. The non-agency Level 2 CMBS had an estimated weighted-average credit enhancement of 31.4% and 29.9% as of December 31, 2013 and 2012, respectively, and 98.7% and 96.6% were in the most senior tranche as of December 31, 2013 and 2012, respectively.
Marketable equity securities are investments in common stock and certain nonredeemable preferred stocks. The securities primarily consist of investments in publicly traded companies. When the fair values of the Company’s marketable equity securities are based on quoted market prices in active markets for identical assets, they are classified as Level 1 measurements. The fair values of nonredeemable preferred stocks are valued by pricing services utilizing evaluated pricing models and are classified as Level 2 measurements. These valuations are created based on benchmark curves using industry standard inputs and exchange prices of underlying securities and common stock of the same issuer.
Embedded derivatives relate to the Company’s FIA product, which credits interest to the policyholder’s account balance based on increases in equity or commodity indexes. See Note 4 for further discussion. The fair value of the embedded derivative reflects the excess of the projected benefits based on the indexed fund value over the projected benefits based on the guaranteed fund value. The excess benefits are projected using best estimates for surrenders, mortality and indexed fund interest, and discounted at a risk-free rate plus a spread for nonperformance risk. Because the estimates utilize significant unobservable inputs, the Company classifies the embedded derivative as a Level 3 measurement.
Cash and cash equivalents consist of demand bank deposits and short-term highly liquid investments with original maturities of three months or less at the time of purchase. Cash equivalents are reported at cost, which approximates fair value, and were $37.8 and $121.9 as of December 31, 2013 and 2012, respectively.
The fair value of the Company’s mortgage loans are measured by discounting the projected future cash flows using the current rate at which the loans would be made to borrowers with similar credit ratings and for the same maturities.
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.
The following tables present additional information about financial instruments measured at fair value on a recurring basis and for which the Company has utilized significant unobservable inputs (Level 3) to determine fair value for the years ended December 31, 2013 and 2012:
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 $6.9 and $50.9 for the years ended December 31, 2013 and 2012. Gross transfers out of Level 3 were $34.2 and $69.7 for the years ended December 31, 2013 and 2012. For the year ended December 31, 2012, transfers out included certain privately placed fixed maturities for which there was a change in valuation methodology during the first quarter 2012 to a method that uses significant observable inputs.
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 investment gains (losses). Amount shown for financial liabilities are (gains) losses in net income.
The following tables summarize the components of AOCI and the adjustments to OCI for amounts reclassified from AOCI into net income for the years ended December 31, 2013, 2012 and 2011:
See Note 7 for the adjustment for the accumulated effect of net unrealized investment gains separately presented for DAC and DSI.
Includes 5,297,758 shares of common stock issued from the settlement of warrants. See Note 3 for further discussion.
The following table summarizes the Company’s restricted share activity for the year ended December 31, 2013:
The weighted-average fair value of restricted shares granted during the years ended December 31, 2013, 2012 and 2011 was $13.45, $10.09, and $13.78 per share, respectively, and the total fair value of restricted shares vested was $3.5, $2.6 and $0.2, respectively.
As of December 31, 2013, unrecognized compensation cost for restricted shares was $3.7 and is expected to be recognized over the weighted average of 1.4 years.
The Company issued 2,950,000 options for the year ended December 31, 2010, with an exercise price of $28.00. 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 were granted in 2013, 2012 or 2011. As of December 31, 2013 and 2012, 2,650,000 and 2,650,000 options were outstanding, none of which were exercisable.
The Company measures compensation cost for stock awards at fair value on the grant date and recognizes such cost, net of estimated forfeitures, over the requisite service period (generally seven years). Stock options are valued using the Black-Scholes valuation model. Stock-based compensation expense for stock options was $0.9, $0.5 and $1.0 for the years ended December 31, 2013, 2012 and 2011 respectively, and the related tax benefit was $0.3, $0.2 and $0.4.
Outstanding options have a remaining contractual term of 4.5 years and no intrinsic value as of December 31, 2013. As of December 31, 2013, unrecognized compensation cost for stock options was $3.1 and is expected to be recognized over the next 3.5 years.
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 through the first quarter of 2013, the Company retained face values of $0.5 to $1.0 on individual policies. In March 2013, the Company increased its retention to $3.0 for certain polices issued thereafter. As of December 31, 2013, most of the Company's fully underwritten term life was 50% to 90% reinsured.
Total policy fees and contract charges represents amounts charged to policyholders other than premiums and recorded in policy fees, contract charges and other in the consolidated statements of income. This primarily consists of costs of insurance charges.
The Company uses estimates in determining its liability for unpaid claims and claim adjustment expenses. These estimates are based on historical claim payment patterns and expected loss ratios to provide for the inherent variability in claim patterns and severity. For the year ended December 31, 2013, the change in prior year incurred claims was primarily due to favorable claims experience for medical stop-loss, offset by higher than expected claims on the Company's BOLI product. For the year ended December 31, 2012, the change in prior year incurred claims was primarily due to favorable claims experience for medical stop-loss, primarily related the business we assumed in July 2011. For the year ended December 31, 2011, the change in prior year incurred claims was primarily due to favorable claims experience for medical stop-loss, offset by higher than expected individual life claims.
Subject to certain conditions, the Company has the right, on one or more occasions, to defer the payment of interest on the CENts during any period up to 10 years without giving rise to an event of default. Deferred interest will accumulate additional interest at an annual rate equal to the annual interest rate then applicable to the CENts.
On March 30, 2006, the Company issued $300.0 of 6.125% senior notes due on April 1, 2016, which were issued at a discount yielding $298.7. Interest on the senior notes is payable semi-annually in arrears. The effective interest rate on the senior notes is 6.11%, including the impact of a related terminated cash flow hedge.
The Company has not made any borrowings under its revolving credit facility. As of December 31, 2013 and 2012, the Company was in compliance with all covenants.
As of December 31, 2013, the Company's non-insurance entities have gross federal net operating loss carry-forwards of $74.1, which are reflected in its deferred tax assets. These are due to expire under current law during 2028 through 2033.
The Company is required to establish a valuation allowance for any portion of the deferred tax assets that management believes will not be realized. Based on an analysis of the Company’s tax position, management believes that it is more likely than not that the results of future operations will generate sufficient taxable income to enable the Company to utilize all of its deferred tax assets. Accordingly, no valuation allowance for deferred tax assets has been established as of December 31, 2013 and 2012.
Because of the nature of its business, the Company is subject to legal actions filed or threatened in the ordinary course of its business operations. The Company does not expect that any such litigation, pending or threatened, as of December 31, 2013, will have a material adverse effect on its consolidated financial condition, future operating results or liquidity.
The Company sponsors a defined contribution 401(k) plan for all eligible employees that includes matching a participant’s contributions up to 6% of eligible compensation. The expense for the matching contributions was $6.6, $6.2 and $5.4 for the years ended December 31, 2013, 2012 and 2011, respectively.
The Company’s insurance company subsidiaries are restricted by state regulations as to the aggregate amount of dividends they may pay to their parent company in any consecutive 12-month period without regulatory approval. The aggregate amount of dividends for the current year is determined based on prior year’s statutory limits. Accordingly, Symetra Financial Corporation was eligible to receive dividends from its directly owned insurance company subsidiary, Symetra Life Insurance Company, during 2013 without obtaining regulatory approval, as long as the aggregate dividends paid over twelve months did not exceed $282.2. The total amount of dividends received by Symetra Financial Corporation from Symetra Life Insurance Company during 2013 was $195.0. Based on state regulations as of December 31, 2013, Symetra Financial Corporation is eligible to receive dividends from Symetra Life Insurance Company during 2014 without obtaining regulatory approval as long as the aggregate dividends paid over the 12 months preceding any dividend payment date in 2014 do not exceed $187.0. In January 2014, Symetra Financial Corporation received a $45.0 dividend that was declared in December 2013. More information about the capital requirements of the Company’s insurance company subsidiaries can be found in Note 17.
There are no regulatory restrictions on the ability of Symetra Financial Corporation to pay dividends. The declaration and payment of future dividends on common stock will be at the discretion of the Company’s board of directors and will be dependent on, and may be limited by, many factors including the receipt of dividends from the Company’s insurance company subsidiaries, the capital requirements of the Company’s insurance company subsidiaries, the Company’s financial conditions and operating results, compliance with covenants of the Company’s revolving credit facility, the Company’s credit and financial strength ratings, and such other factors as the board of directors deems relevant. More information about the covenants of the Company’s revolving credit facility can be found in Note 12.
Symetra Life Insurance Company’s surplus includes the surplus of its two wholly owned subsidiaries, First Symetra National Life Insurance Company of New York and Symetra National Life Insurance Company
Each of the insurance company subsidiaries’ state of domicile imposes minimum risk-based capital (RBC) requirements that were developed by the NAIC. The formulas for determining the amount of RBC specify various weighting factors that are applied to the financial balances or various levels of activity based on the perceived degree of risk. Regulatory compliance is determined by a ratio of total adjusted capital, as defined by the NAIC, to authorized control level RBC, as defined by the NAIC. Companies below specific trigger points or ratios are classified within certain levels, each of which requires specified correction action. As of December 31, 2013 and 2012 each of the Company’s insurance company subsidiaries exceeded the minimum RBC requirements of 200%, and maintained risk-based capital ratios in excess of 460%. The Company’s insurance company subsidiaries’ minimum statutory capital and surplus necessary to satisfy regulatory requirements in the aggregate was $472.4 at December 31, 2013, of which 96.7% was attributable to Symetra Life Insurance Company.
The Company’s insurance company subsidiaries are subject to certain insurance department regulatory restrictions as to the payment of dividends to their parent company. More information on the restrictions on the payment of dividends can be found in Note 16.
The Company offers a broad range of products and services that include retirement, group health and employee benefits and life insurance products. These operations are managed separately as three divisions, consisting of four business segments based on product groupings, and a fifth reportable segment consisting primarily of unallocated corporate items and surplus investment income. The five segments are Benefits, Deferred Annuities, Income Annuities, Individual Life and Other, described further below.
Other. This segment consists of unallocated corporate income, which primarily includes investment income on unallocated surplus, unallocated corporate expenses, interest expense on debt, earnings related to limited partnership interests, the results of small, non-insurance businesses that are managed outside of our divisions, and inter-segment elimination entries.
The accounting policies of the segments are the same as those described in Note 2, 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 are allocated to the segments based on the level of allocated capital.
Includes funds held under deposit contracts, future policy benefits and policy and contract claims.
The unaudited quarterly results of operations for years ended December 31, 2013 and 2012 are summarized in the table below.