Low interest rates are also challenging for property and casualty insurers. Investment income is an important element in earning an acceptable return on capital. Lower interest rates resulting in lower investment income require us to achieve better underwriting results. We have adjusted policy prices to help mitigate the adverse impact of low interest rates on our property and casualty business.
Effective management of invested assets and associated liabilities using crediting rates and, where applicable, financial hedging instruments (which we use as economic hedges of equity-indexed life and annuity products), is important to the success of our life and annuity segments. Asset “disintermediation”, the risk of large outflows of cash at times when it is disadvantageous to us to dispose of invested assets, is a risk associated with these segments.
We believe we are well positioned to address the Baby Boomers’ increasing need for savings tools and income protection. We believe that our overall financial strength and broad distribution channels position us to respond with a variety of products for individuals approaching retirement age, who seek information to plan for and manage their retirement needs. We believe our products that offer guaranteed income flows for life, including single premium immediate annuities, are well positioned to serve this market.
Competitive Pressures: In recent years, the competitive landscape of the U.S. life insurance industry has shifted. Established insurers are competing against each other and also against new market entrants that are developing products to attract the interest of the growing number of retirees. Competition exists in terms of retaining and acquiring consumers’ business and also in terms of access to producers and distributors. Consolidation among distributors coupled with the aging sales force remains a challenge among insurers. In addition, the increased technological sophistication of consumers necessitates that insurers and distributors invest significant resources in technology to adapt to consumer expectations. We believe we possess sufficient scale, financial strength, resources and flexibility to compete effectively.
The preparation of financial statements in accordance with GAAP requires estimates and assumptions that often involve a significant degree of judgment. These estimates and judgments include expectations of current and future mortality, morbidity, persistency, claims and claim adjustment expenses, recoverability of receivables, investment returns and interest rates which extend well into the future. In developing these estimates, there is inherent uncertainty and material changes to facts and circumstances may develop. Although variability is inherent in these estimates, we believe the amounts as reported are appropriate, based upon the facts available upon compilation of the consolidated financial statements.
Reserves for fixed deferred annuities are established equivalent to the account value held on behalf of the policyholder. Reserves for indexed annuities are calculated in accordance with derivative accounting guidance which defines a host liability for return of principal and guaranteed interest, and an embedded derivative liability for funded benefits in excess of the host guarantee. Additional reserves for benefits that can exceed contract fund value, such as lifetime income riders, are determined as needed in accordance with the applicable accounting guidance. The profit recognition on deferred annuity contracts is gradual over the expected life of the contract. No immediate profit is recognized on the sale of the contract.
Loss or Expense Development (Chain Ladder)-This method uses actual loss or defense and cost containment expense data and the historical development profiles on older accident periods to project more recent, less developed periods to their ultimate total. This method is appropriate when there is a relatively stable pattern of loss and expense emergence and a relatively large number of reported claims.
For non-credit lines of business, future inflation rates could vary from our assumption of relatively stable rates. Unexpected changes in future inflation rates could impact our financial position and liquidity, and we measure the sensitivity of our reserve levels to unexpected changes in inflation. The impacts of future inflation for a 1.0% decrease and 3.0% increase over the implied inflation rate in the December 31, 2017 gross loss reserve balance are as follows (amounts in thousands):
We believe the estimates used in our DAC calculations provide an example of how variations in assumptions and estimates would affect our business. The following table displays the sensitivity of reasonably likely changes in assumptions in the DAC amortization for our long-tail business at December 31, 2017 (in thousands):
A decline in the fair value of investment securities below their cost basis is evaluated on an ongoing basis to determine if the decline is other-than-temporary. A number of assumptions and estimates inherent in evaluating impairments are used to determine if they are other-than-temporary, which include 1) our ability and intent to hold the investment securities for a period of time sufficient to allow for an anticipated recovery in value; 2) the expected recoverability of principal and interest; 3) the length of time and extent to which the fair value has been less than cost basis; 4) the financial condition, near-term and long-term prospects of the issue or issuer, including relevant industry conditions and trends and implications of rating agency actions and offering prices; and 5) the specific reasons that a security is in a significant unrealized loss position, including market conditions, which could affect liquidity.
Consolidated earnings increased during 2017 compared to 2016 primarily due to an increase in net investment income and realized investment gains. The increase in net investment income is attributable to higher realized investment earnings and increased investment income on mortgage loans. The increase in realized investment gains is attributable to an increase in the sale of bonds, equity securities, and certain real estate holdings. Consolidated earnings decreased during 2016 compared to 2015 primarily due to a decrease in property and casualty earnings and lower realized capital gains.
The company converted the valuation of its universal life business from a home grown valuation system to a more robust vendor based system in 2016 resulting in a change in estimate. This change in estimate affected the other policy revenues, policyholder benefits, and change in deferred policy acquisition costs. The impact of this change in estimate on 2016 net income was not material.
Other policy revenues include mortality charges, earned policy service fees and surrender charges on interest-sensitive life insurance policies. The decrease in other policy revenue during 2017 compared to 2016 and the increase during 2016 compared to 2015 is due to the change in estimate.
Life insurance sales increased for all major lines during 2017 compared to 2016. Life insurance sales increased during 2016 compared to 2015 primarily driven by an increase in universal life policy sales.
Policyholder benefits decreased during 2017 compared to 2016 and increased during 2016 compared to 2015 primarily due to the change in estimate.
The increase in DAC during 2017 compared to 2016 and the decrease during 2016 compared to 2015 was primarily due to the change in estimate.
Total life insurance in-force increased during 2017 compared to 2016 and 2016 compared to 2015, due to increased sales, despite a reduction of policies in-force. The reduction in policies in-force reflects termination of lower face amount policies.
We use reinsurance to mitigate risk to the Life segment. During 2017, our retention limits were $1.5 million for issue ages 65 and under, and $700,000 for issue ages 66 and older for traditional and universal life. In our life segment, we currently retain 100% of newly developed permanent and term products up to our retention limit and cede the excess. We also engage in facultative reinsurance through several reinsurers. Accidental death and premium waiver benefits are mostly retained on new business. Increases in reserves and premium amounts ceded primarily reflect increased use of reinsurance in conjunction with treaties related to universal life products.
(1) A.M. Best rating as of the most current information available February 06, 2018.
The company converted the valuation of its single premium immediate annuity business from a mainframe valuation system to a more robust vendor based system in 2017 resulting in a change in estimate affecting policyholder benefits.
Earnings increased during 2017 compared to 2016 primarily due to this change in estimate combined with a decrease in operating expenses. Earnings increased during 2016 compared to 2015 primarily due to increased assets, as measured by account value and reserves, leading to an increase in margins earned on net investment income and a favorable decrease in DAC related to lower surrenders.
Sales strengthened during 2017 compared to 2016 led by the fixed deferred and equity indexed products. These are deposit type contracts and do not contribute to earned premiums. Earned premiums are reflective of single premium immediate annuity sales which decreased during the year ended December 31, 2017 compared to 2016.
Other operating expenses decreased during 2017 compared to 2016 due to the impact of higher expenses incurred relating to premium tax in the third quarter of 2016 which did not impact 2017 to the same extent. Other operating expenses were relatively flat during 2016 compared to 2015 despite the increase in annuity volume.
The change in DAC increased during 2017 compared to 2016, and 2016 compared to 2015, due to an increase in the capitalization of acquisition costs which is primarily driven by an increase in sales which generated an increase in commissions.
Single premium immediate annuities margin on interest and mortality increased $8.9 million in 2017 compared to 2016 primarily due to a methodology change in accounting for these contracts. 2016 experienced a more favorable mortality experience when compared to 2015.
The following table summarizes the interest margin due to the impact of the investment performance, interest credited to policyholder’s account balances, and the end of period assets measured by account balance (in thousands):
Earnings increased during 2017 compared to 2016, primarily due to a change in estimate which decreased the amount of ceded MGU claim reserves during the third quarter of 2016. Earnings also increased due to the absence of a group health plan that was not renewed effective January 1, 2017 and an improvement in results for the closed medical expense block. Earnings remained relatively constant during 2016 compared to 2015.
Health earned premiums for the periods indicated were as follows (in thousands, except percentages):
Other operating expenses decreased during 2017 compared to 2016 in correlation to the absence of a non-renewed group health plan.
(1) A.M. Best rating as of the most current information available February 09, 2018.
A positive net change indicates less expense was deferred than amortized and represents an increase to expenses in the period indicated.
Claims incurred increased during 2017 compared to 2016, as a result of increases in catastrophe losses and premium growth. Claims incurred increased during 2016 compared to 2015 as a result of increases in catastrophe losses as well as an increase in frequency and severity of claims related to the personal automobile line of business.
Commissions for acquiring and servicing policies increased during 2017 compared to 2016, primarily as a result of the premium growth as well as the mix of products. Commissions for acquiring and servicing policies increased during 2016 compared to 2015, primarily as a result of the growth of the collateral protection (CPI) and mortgage security insurance lines of business.
Our Property and Casualty segment consists of: (i) Personal products, marketed primarily to individuals, representing 57.4% of net premiums written; (ii) Commercial products, focused primarily on agricultural and other business related markets, representing 31.3% of net premiums written; and (iii) Credit-related property insurance products, marketed to and through financial institutions and retailers, representing 11.3% of net premiums written.
Automobile: Net premiums written and earned increased in our personal automobile line during 2017 compared to 2016 due to rate increases and an increase in policies in force. The loss and combined ratios decreased during 2017 compared to 2016 primarily due to an improvement in rate adequacy somewhat offset by an increase in catastrophe losses. Net premiums written and earned increased during 2016 compared to 2015, due to an increase of policies in force and rate increases. The loss and combined ratio increased during 2016 compared to 2015, primarily due to an increase in the frequency and severity of claims and catastrophe losses compared to the prior year.
Other Commercial: Net premiums written and earned increased during 2017 compared to 2016 primarily due to increased sales of mortgage fire insurance and workers’ compensation. The decrease in the loss and combined ratios for 2017 compared to 2016 is primarily due to decreased claim activity on business owners’ lines of business and lower than anticipated prior year claim emergence on workers’ compensation. Net premiums written and earned increased during 2016 compared to 2015 primarily due to increased sales of mortgage security insurance. This increase was partially offset by an increase in reinsurance premium ceded for the workers compensation and commercial umbrella lines of business.
Agricultural Business: Our agricultural business product allows policyholders to customize and cover their agriculture exposure using a package policy, which includes coverage for residences and household contents, farm buildings and building contents, personal and commercial liability and personal property. Net premiums written and earned increased during 2017 compared to 2016 primarily as a result of an increase in policies in force. The loss and combined ratios were relatively constant during 2017 compared to 2016. Net premiums written and earned increased during 2016 compared to 2015, primarily as a result of improved rate adequacy. The loss ratio decreased during 2016 compared to 2015 primarily due to a decrease in catastrophe losses.
Credit-related property product results for the periods indicated were as follows (in thousands, except percentages):
Net written and earned premiums increased during 2017 compared to 2016 primarily due to an increase in debt cancellation business. The loss and combined ratios increased during 2017 compared to 2016 primarily due to an increase in claims in the Guaranteed Auto Protection (GAP) business, partially resulting from catastrophes that caused flooding to automobiles. Net written and earned premiums increased during 2016 compared to 2015, primarily due to increases in our collateral protection business. The loss ratio increased during 2016 compared to 2015 primarily due to an increase in claims in our GAP business.
100% of multiple peril losses covered by Corporate Program(1) (all perils)
While we believe that our claims reserves at December 31, 2017 are adequate, new information, events or circumstances, unknown at the original valuation date, may lead to future developments in ultimate losses in amounts significantly greater or less than the reserves currently recorded. The actual final cost of settling both claims outstanding at December 31, 2017 and claims expected to arise from unexpired periods of risk is uncertain. There are many other possible changes that would cause losses to increase or decrease, which include but are not limited to: claim severity; the expected level of reported claims; judicial action changing the scope or liability of coverage; the regulatory, social and economic environment; and unexpected changes in loss inflation. For additional information regarding prior year development of our claims and CAE reserves, refer to Note 12, Liability for Unpaid Claims and Claim Adjustment Expenses, of the Notes to the Consolidated Financial Statements.
Earnings increased during 2017 compared to 2016 primarily due to an increase in realized investment gains. The increase in realized investment gains is primarily attributable to an increase in the sale of equity securities and certain real estate holdings. These increases were partially offset during 2017 by an increase in other operating expenses which included a pension cost of $12.5 million relating to the completion of the one-time pension payment window that occurred in 2017. Earnings decreased during 2016 compared to 2015 primarily due to a decrease in realized investment gains. The decrease in realized investment gains is primarily attributable to a decrease in the sale of certain real estate holdings compared to 2015.
The increase in our total investments at December 31, 2017 compared to 2016 was primarily a result of an increase in bonds, mortgage loans, short-term investments, and equity securities.
Bonds-We allocate most of our fixed maturity securities to support our insurance business. At December 31, 2017, our fixed maturity securities had an estimated fair value of $13.9 billion, which was $0.4 billion, or 3.0%, above amortized cost. At December 31, 2016, our fixed maturity securities had an estimated fair value of $13.3 billion, which was $0.4 billion, or 2.9%, above amortized cost. The estimated fair value for securities due in one year or less decreased from $0.7 billion as of December 31, 2016 to $0.5 billion as of December 31, 2017. For additional information regarding total bonds by credit quality rating refer to Note 4, Investments in Securities, of the Notes to the Consolidated Financial Statements.
Policy Loans-For certain life insurance products, policyholders may borrow funds using the policy’s cash value as collateral. The maximum amount of the policy loan depends upon the policy’s surrender value. As of December 31, 2017, we had $377.1 million in policy loans with a loan to surrender value of 62.8%, and at December 31, 2016, we had $384.4 million in policy loans with a loan to surrender value of 64.6%. Interest rates on policy loans primarily range from 3.0% to 12.0% per annum. Policy loans may be repaid at any time by the policyholder and have priority to any claims on the policy. If the policyholder fails to repay the policy loan, funds are withdrawn from the policy’s benefits.
Net realized gains increased $58.0 million during 2017 compared to 2016 primarily due to an increase in the sale of bonds, equity securities and certain real estate holdings. Other-than-temporary impairment on investment securities decreased $4.3 million during 2017 compared to 2016.
The unrealized gains and losses of our fixed maturity and equity securities investment portfolio are shown below (in thousands):
The net unrealized gains of our equity securities were $1.0 billion and $809.2 million at December 31, 2017 and 2016, respectively. The increase is attributable to favorable market conditions.
Our liquidity requirements have been and are expected to continue to be met by funds from operations, comprised of premiums received from our customers, collateral for derivative transactions, and investment income. The primary use of cash has been and is expected to continue to be payment of policyholder benefits and claims incurred. Current and expected patterns of claim frequency and severity may change from period to period but continue to be within historical norms. Management considers our current liquidity position to be sufficient to meet anticipated demands over the next twelve months. Our contractual obligations are not expected to have a significant negative impact to cash flow from operations.
Changes in interest rates during 2017 and market expectations for potentially higher rates through 2018, may lead to an increase in the volume of annuity contracts, which may be partially offset by increases in surrenders. Our defined benefit plans are frozen and currently adequately funded; however, low interest rates, increased longevity of participants, and rising Pension Benefit Guaranty Corporation (“PBGC”) premiums may cause us to increase our funding of the plans. Future contributions to our defined benefit plans are not expected to significantly impact cash flow and are expected to enhance overall funded status of plans. No unusually large capital expenditures are expected in the next 12-24 months. We have paid dividends to stockholders for over 110 consecutive years and expect to continue this trend. There are no other known trends or uncertainties regarding product pricing, changes in product lines or rising costs that are expected to have a significant impact to cash flows from operations.
Funds received as premium payments and deposits, that are not used for liquidity requirements are generally invested in bonds and commercial mortgages. Funds are invested with the intent that income from the investments and proceeds from the maturities will meet our ongoing cash flow needs. We historically have not had to liquidate invested assets in order to cover cash flow needs. We believe our portfolio of highly liquid available-for-sale investment securities, including equity securities, is sufficient to meet future liquidity needs as necessary.
Our cash and cash equivalents and short-term investment position increased from $481.6 million at December 31, 2016 to $1.0 billion at December 31, 2017. The increase primarily relates to an increase in commercial paper to fund additional investments.
The following summarizes our contractual obligations as of December 31, 2017 (in thousands):
(1) Life and annuity obligations include undiscounted estimated claim, benefit, surrender and commission obligations offset by expected future premiums and deposits on in-force insurance policies and annuity contracts. All amounts are gross of any reinsurance recoverable. Estimated claim, benefit and surrender obligations are based on mortality and lapse assumptions comparable with historical experience. Estimated payments on interest-sensitive life and annuity obligations include interest credited to those products. The interest crediting rates are derived by deducting current product spreads from a constant investment yield. As a result, the estimated obligations for insurance liabilities included in the table exceed the liabilities recorded in the liability for future policy benefits and policy and contract claims. Due to the significance of the assumptions used, the amounts presented could materially differ from actual payments. Separate account obligations have not been included in the table since those obligations are not part of the general account obligations and will be funded by cash flows from separate account assets. The general account obligations for insurance liabilities will be funded by cash flows from general account assets and future premiums and deposits. Participating policyholder dividends payable consists of liabilities related to dividends payable in the following calendar year and are presented in the less than one-year category. All estimated cash payments are net of estimated future premiums on policies currently in-force net of future policyholder dividends payable. The participating policyholders’ share obligation included in other policyholder funds and the timing and amount of the ultimate participating policyholder obligation is subject to significant uncertainty and the amount of the participating policyholder obligation is based upon a long-term projection of the performance of the participating policy block.
(2) Includes undiscounted case reserves for reported claims and reserves for IBNR with the timing of future payments based on our historical payment patterns. The timing of these payments may vary significantly from the pattern shown in the preceding table. The ultimate losses may vary materially from the recorded amounts, which are our best estimates.
(3) Reflects estimated future claim payments for claims incurred based on mortality and morbidity assumptions that are consistent with historical claims experience. These are not discounted with interest and will exceed the liabilities recorded in reserves for future claim payment, which are discounted with interest. Due to the significance of the assumptions used, the amounts presented could materially differ from actual payments.
Consolidated Statements of Changes in Equity for the years ended December 31, 2017, 2016, and 2015
We have audited American National Insurance Company and subsidiaries’ (the “Company”) internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Investment real estate including related improvements, are stated at cost less accumulated depreciation. Depreciation is provided on a straight-line basis over the estimated useful life of the asset (typically 15 to 50 years). Rental income is recognized on a straight-line basis over the term of the respective lease. American National classifies a property as held-for-sale if it commits to a plan to sell a property within one year and actively markets the property in its current condition for a price that is reasonable in comparison to its estimated fair value. Real estate held-for-sale is stated at the lower of depreciated cost or estimated fair value less expected disposition costs, and is not depreciated while it is classified as held-for-sale. American National periodically reviews its investment real estate for impairment and tests properties for recoverability whenever events or changes in circumstances indicate the carrying amount of the asset may not be recoverable and the carrying value of the property exceeds its estimated fair value. Properties whose carrying values are greater than their undiscounted cash flows are written down to their estimated fair value, with the impairment loss included as an adjustment to “Net realized investment gains” in the consolidated statements of operations. Impairment losses are based upon the estimated fair value of real estate, which is generally computed using the present value of expected future cash flows from the real estate discounted at a rate commensurate with the underlying risks as well as other appraisal methods. Real estate acquired upon foreclosure is recorded at the lower of its cost, or its estimated fair value at the date of foreclosure.
Other invested assets comprised primarily of equity-indexed options are carried at fair value and may be collateralized by counterparties; such collateral is restricted to the Company’s use. Other invested assets also include tax credit partnerships, Certified Capital Companies (“CAPCO”) investments, mineral rights and limited liability interests, are carried at cost, less allowance for depletion, where applicable.
After the recognition of an OTTI, fixed maturity securities are accounted for as if they had been purchased on the OTTI measurement date, with a cost basis equal to their previous amortized cost less the related OTTI losses recognized in earnings. The new cost basis of an other-than-temporarily impaired security is not adjusted for subsequent increases in estimated fair value. Should there be a significant increase in the estimate of cash flows expected to be collected from previously impaired securities, the increase would be accounted for prospectively by accreting it as interest income over its remaining life.
Property and equipment consist of buildings occupied by American National, data processing equipment, software, furniture and equipment, and automobiles which are carried at cost, less accumulated depreciation. Depreciation is calculated using straight-line and accelerated methods over the estimated useful lives of the assets (typically 3 to 50 years).
DAC on traditional life and health products is amortized with interest over the anticipated premium-paying period of the related policies, in proportion to the ratio of annual premium revenue expected to be received over the life of the policies. Expected premium revenue is estimated by using the same mortality, morbidity and withdrawal assumptions used in computing liabilities for future policy benefits. DAC is reduced by a provision for possible inflation of maintenance and settlement expenses determined by means of grading interest rates.
Universal life and single premium whole life revenues represent amounts assessed to policyholders including mortality charges, surrender charges actually paid and earned policy service fees. Amounts included in expenses are benefits in excess of account balances returned to policyholders.
Restricted Stock Units (“RSU”) provides the recipients of the awards the option to settle vested RSUs in cash, American National common stock, or a combination of both. The settlement provision within the outstanding restricted stock units results in classifying RSUs as a liability award. The liability is remeasured each reporting period through the vesting date and is adjusted for changes in fair value. The compensation liability related to the RSUs is included in “Other Liabilities” in the consolidated statements of financial position.
In May 2014, the FASB issued guidance that will supersede most existing revenue recognition requirements in GAAP. Insurance contracts generally are excluded from the scope of the guidance. For those contracts which are impacted, the transaction price is attributed to the underlying performance obligations in the contract and revenue is recognized as the entity satisfies the performance obligations and transfers control of a good or service to the customer. The standard is effective for annual periods and interim periods within those annual periods beginning after December 15, 2017. The Company will adopt the standard effective January 1, 2018 using a modified retrospective approach. Our evaluation process was done with a top-down approach and included, but was not limited to, identifying contracts in scope of the guidance through a disaggregated analysis of consolidated revenues, reviewing and documenting the accounting for these contracts and identifying and determining the accounting for any related contract costs. Since the majority of our revenue sources are insurance related and, accordingly, not in the scope of the standard, the results of adoption are immaterial to opening equity and will not have a material impact on financial statement line items.
In January 2016, the FASB issued guidance that will change certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The new guidance requires that equity investments, other than those accounted for under the equity method or those that result in consolidation of the investee, be measured at fair value and the changes in fair value are recognized through earnings. When the fair value option has been elected for financial liabilities, changes in fair value due to instrument-specific credit risk will be recognized separately in other comprehensive income. The guidance also simplifies the impairment assessment of equity investments and eliminates the disclosure requirements for methods and significant assumptions used to estimate fair value of financial instruments that are measured at amortized cost on the statement of financial position. The standard is effective for annual periods and interim periods within those annual periods beginning after December 15, 2017. The impact, if the guidance were effective in 2017, would be an increase of $217 million in net investment income from the change in unrealized gains and losses on securities in the equity portfolio. Cumulative unrealized gains and losses of $811 million at adoption will be reclassified from accumulated other comprehensive income to retained earnings at January 1, 2018.
In February 2016, the FASB issued guidance that will require significant changes to the statement of financial position of lessees. With certain limited exceptions, lessees will need to recognize virtually all of their leases on the statement of financial position, by recording a right-of-use asset and a lease liability. Lessor accounting is less affected by the standard, but has been updated to align with certain changes in the lessee model and the new revenue recognition standard. The standard is effective for annual periods and interim periods within those annual periods beginning after December 15, 2018. We are currently quantifying the expected gross up of our balance sheet for a right of use asset and a lease liability as required. Since the majority of our lease activity is as a lessor, we do not expect the adoption of the standard to be material to the Company’s results of operations or financial position.
In June 2016, the FASB issued guidance that will significantly change how entities measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. The guidance will replace the current “incurred loss” approach with an “expected loss” model for instruments measured at amortized cost. For available-for-sale debt securities, entities will be required to record allowances rather than reduce the carrying amount, as they do under the current other-than-temporary impairment model. The standard is effective for annual periods and interim periods within those annual periods beginning after December 15, 2019. The Company must develop appropriate models to measure expected credit losses to begin determining the impact of adopting the standard on our results of operations or financial position.
The cost or amortized cost and fair value of investments in securities are shown below (in thousands):
Gains and losses are determined using specific identification of the securities sold. During 2017 and 2016, bonds with a carrying value of $25,266,000 and $22,848,000, respectively were transferred from held-to-maturity to available-for-sale after a significant deterioration in the issuers’ credit worthiness became evident. A realized loss of $6,000,000 was recorded in 2017 on a bond that was transferred due to an other-than-temporary impairment. An unrealized loss of $723,000 was recorded in 2016 following the transfer at fair value.
In accordance with various regulations, American National had bonds on deposit with regulating authorities with a carrying value of $47,556,000 and $52,349,000 at December 31, 2017 and 2016, respectively. In addition, American National has pledged bonds in connection with agreements and transactions, such as financing and reinsurance agreements. The carrying value of bonds pledged was $63,386,000 and $76,558,000 at December 31, 2017 and 2016, respectively
As of December 31, 2017, the securities with unrealized losses including those exceeding one year were not deemed to be other-than-temporarily impaired. American National has the ability and intent to hold those securities until a market price recovery or maturity. It is not more-likely-than-not that American National will be required to sell them prior to recovery, and recovery is expected in a reasonable period of time. It is possible an issuer’s financial circumstances may be different in the future, which may lead to a different impairment conclusion in future periods.
During 2017, American National foreclosed on one loan with a recorded investment of $2,285,000, and four loans with a total recorded investment of $17,263,000 were in the process of foreclosure. For the year ended December 31, 2016, American National did not foreclose on any loans, and one loan with a recorded investment of $1,940,000, was in the process of foreclosure. American National did not sell any loans during 2017 or 2016.
A loan is considered impaired when it is probable that all amounts due will not be collected according to the contractual terms of the loan agreement. Mortgage loans with temporary difficulties are not considered impaired when the borrower has the financial capacity to fund revenue shortfalls from the properties for the foreseeable future. Individual valuation allowances are established for impaired loans to reduce the carrying value to the fair value of the collateral. Loans not evaluated individually for collectability are segregated by property-type and location, and allowance factors are applied. These factors are developed based on our historical loss experience adjusted for the expected trend in the rate of foreclosure losses. Allowance factors are higher for loans of certain property types and in certain regions based on loss experience or a blended historical loss factor.
Troubled debt restructuring mortgage loan information is as follows (in thousands, except number of loans):
Investment real estate by property-type and geographic distribution are as follows:
American National regularly invests in real estate partnerships and joint ventures. American National frequently participates in the design of these entities with the sponsor, but in most cases, its involvement is limited to financing. Through analysis performed by American National, some of these partnerships and joint ventures have been determined to be variable interest entities (“VIEs”). In certain instances, in addition to an economic interest in the entity, American National holds the power to direct the most significant activities of the entity and is deemed the primary beneficiary or consolidator of the entity. The assets of the consolidated VIEs are restricted and must first be used to settle their liabilities. Creditors or beneficial interest holders of these VIEs have no recourse to the general credit of American National, as American National’s obligation is limited to the amount of its committed investment. American National has not provided financial or other support to the VIEs in the form of liquidity arrangements, guarantees, or other commitments to third parties that may affect the fair value or risk of its variable interest in the VIEs in 2017 or 2016.
The notes payable in the consolidated statements of financial position pertain to the borrowings of the consolidated VIEs. The liability of American National relating to notes payable of the consolidated VIEs is limited to the amount of its direct or indirect investment in the respective ventures, which totaled $28,377,000 and $31,795,000 at December 31, 2017 and 2016, respectively.
The total long-term notes payable of the consolidated VIE’s consists of the following (in thousands):
For other VIEs in which American National is a partner, it is not the primary beneficiary, and these entities are not consolidated, as the major decisions that most significantly impact the economic activities of the VIE require consent of all partners. The carrying amount and maximum exposure to loss relating to unconsolidated VIEs follows (in thousands):
As of December 31, 2017, no real estate investments were classified as held for sale.
The Company’s equity in earnings of unconsolidated affiliates is the Company’s share of operating earnings and realized gains from investments in real estate joint ventures and other limited partnership interests (“joint ventures”) using the equity method of accounting. In 2017 and 2016 certain joint ventures took advantage of market opportunities to generate realized gains on the sale of real estate held or developed by the venture.
Note 8 - Net Investment Income and Realized Investment Gains (Losses)
Unadjusted quoted prices in active markets for identical assets or liabilities.
Lapse rate assumptions are determined by company experience. Lapse rates are generally assumed to be lower during a contract’s surrender charge period and then higher once the surrender charge period has ended. Decreases to the assumed lapse rates generally increase the fair value of the liability as more policyholders persist to collect the crediting interest pertaining to the indexed product. Increases to the lapse rate assumption will have the inverse effect decreasing the fair value.
Within the net gain (loss) for derivatives included in net investment income were unrealized gains of $50,805,000, and $44,615,000, and unrealized losses of $50,114,000 relating to assets still held at December 31, 2017, 2016, and 2015, respectively.
There were no transfers between Level 1 and Level 2 fair value hierarchies during the periods presented. The transfers into Level 3 during the years ended December 31, 2017, 2016, and 2015 were the result of existing securities no longer being priced by the third-party pricing service at the end of the period. Unless information is obtained from the brokers that indicate observable inputs were used in their pricing, there are not enough observable inputs to enable American National to classify the securities priced by the brokers as other than Level 3. American National’s valuation of these securities involves judgment regarding assumptions market participants would use including quotes from independent brokers. The inputs used by the brokers include recent transactions in the security, similar bonds with same name, ratings, maturity and structure, external dealer quotes in the security, Bloomberg evaluated pricing and prior months pricing. None of them are observable to American National as of December 31, 2017. The transfers out of Level 3 during the year end December 31, 2017, 2016, and 2015, were securities being priced by the third-party service at the end of the period, using inputs that are observable or derived from market data, which resulted in classification of these assets as Level 2.
Policyholder account balances relate to investment-type contracts and universal life-type policies. Investment-type contracts principally include traditional individual fixed annuities in the accumulation phase and non-variable group annuity contracts. Policyholder account balances are equal to (i) policy account values, which consist of an accumulation of gross premium payments; (ii) credited interest, ranging from 1.0% to 8.0% (some annuities have enhanced first year crediting rates ranging from 1.0% to 7.0%), less expenses, mortality charges, and withdrawals; and (ii) fair value adjustment.
The following contains information about incurred and paid claims development as of December 31, 2017, net of reinsurance, as well as cumulative claim frequency and the total of incurred-but-not-reported liabilities plus expected development on reported claims included within the net incurred claims amounts. The information about incurred and paid claims development for the years ended December 31, 2008, to 2016, is presented as supplementary information.
Homeowners- Consists of homeowners and renters business. Claims and claim adjustment expenses are shown below (in thousands):
American National reinsures portions of certain life insurance policies to provide a greater diversification of risk and manage exposure on larger risks. For the issue ages zero to 65, the maximum amount that would be retained by one life insurance company (American National) would be $1.5 million individual life, $250,000 individual accidental death, $100,000 group life, and $125,000 credit life. If individual, group and credit insurance were all in force at the same time, the maximum risk on any one life aged zero to 65 could be $1.975 million. For the issue ages 66 and over, the maximum amount that would be retained by one life insurance company (American National) would be $700,000 individual life, $250,000 individual accidental death, $100,000 group life, and $125,000 credit life. If individual, group and credit insurance were all in force at the same time, the maximum risk on any one life aged over 65 could be $1.175 million.
American National remains primarily liable with respect to any reinsurance ceded, and would bear the entire loss if the reinsurer does not meet their obligations under any reinsurance treaties. American National had amounts recoverable from reinsurers of $418,589,000 and $401,709,000 at December 31, 2017 and 2016, respectively. None of the amount outstanding at December 31, 2017 is the subject of litigation or is in dispute with the reinsurers involved. Management believes the unfavorable resolution of any dispute that may arise would not have a material impact on American National’s consolidated financial statements.
The SARs give the holder the right to cash compensation based on the difference between the stock price on the grant date and the stock price on the exercise date. The SARs vest at a rate of 20% per year for five years and expire five years after vesting.
RS awards entitle the participant to full dividend and voting rights. Each RS share awarded has the value of one share of restricted stock and vests 10 years from the grant date. Unvested shares are restricted as to disposition, and are subject to forfeiture under certain circumstances. Compensation expense is recognized over the vesting period. The restrictions on these awards lapse after 10 years and most of these awards feature a graded vesting schedule in the case of the retirement, death or disability of an award holder. Restricted stock awards for 350,334 shares have been granted at an exercise price of zero, of which 74,000 shares are unvested.
American National Insurance Company’s payment of dividends to stockholders is restricted by insurance law. The restrictions require life insurance companies to maintain minimum amounts of capital and surplus, and in the absence of special approval, limit the payment of dividends to the greater of the prior year’s statutory net income from operations, or 10% of prior year statutory surplus. American National Insurance Company is permitted without prior approval of the Texas Department of Insurance to pay total dividends of $329,347,000 during 2018. Similar restrictions on amounts that can transfer in the form of dividends, loans, or advances to American National Insurance Company apply to its insurance subsidiaries.
American National sponsors a qualified defined contribution (401(k) plan) for all employees, and non-qualified defined contribution plans for certain employees whose otherwise eligible earnings exceed the statutory limits under the qualified plans. The total expense associated with these plans was $13,466,000, $13,658,000, and $12,146,000 for 2017, 2016, and 2015, respectively.
American National sponsors qualified and non-qualified defined benefit pension plans each of which have been frozen. As such, no additional benefits are accrued through these plans for additional years of service credit or future salary increase credit, and no new participants are added to the plans. Benefits earned by eligible employees prior to the plans being frozen have not been affected. In 2017, the Company commenced a one- time window offering to terminated, vested participants of our qualified defined benefit pension plans. The offer allowed participants to take a lump sum or annuity payout funded from pension plan assets. A $7.2 million pension expense was recognized in the second quarter of 2017 for this de-risking. There was an additional pension settlement expense of $5.3 million recognized in the fourth quarter of 2017. This was part of the normal year-end actuarial valuation process of the defined pension plans and is primarily the result of higher lump sum payouts in 2017 due to plan amendments to make this option available.
American National’s funding policy for the qualified pension plans is to make annual contributions to meet the minimum funding standards of ERISA. American National contributed $25,023,000, $40,090,000, and $18,630,000 to the qualified pension plans in 2017, 2016 and 2015, respectively. American National and its affiliates expect to contribute $20,000,000 to its qualified plans in 2018. The benefits paid from the non-qualified plans were $12,287,000, $12,319,000 and $10,082,000 in 2017, 2016 and 2015, respectively. Future payments from the non-qualified pension benefit plans will be funded out of general corporate assets.
The following table shows pension benefit payments, expected to be paid (in thousands).
The accrued postretirement benefit obligation, included in the liability for retirement benefits, was $6,424,000 and $6,197,000 at December 31, 2017 and 2016, respectively. These amounts were approximately equal to the unfunded accumulated postretirement benefit obligation.