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, 2010, 2009 and 2008 and the consolidated balance sheet data as of December 31, 2010 and 2009, 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, 2007 and 2006 and the consolidated balance sheet data as of December 31, 2008, 2007 and 2006, except for the non-GAAP financial measures, have been derived from the our consolidated financial statements not included herein. The selected financial data presented below should be read in conjunction with
Average stockholders’ equity is derived by averaging ending stockholders’ equity for the most recent five quarters and average adjusted book value is derived by averaging ending adjusted book value for the most recent five quarters.
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.” You should read the following discussion in conjunction with the consolidated financial statements and accompanying condensed notes included in Item 8 - “Financial Statements and Supplementary Data” included in this Form 10-K, as well as the discussion under Item 6 - “Selected Financial Data.”
We are a financial services company in the life insurance industry focused on profitable growth in selected group health, retirement, life insurance and employee benefits markets. Our operations date back to 1957 and many of our agency and distribution relationships have been in place for decades. We are headquartered in Bellevue, Washington and employ approximately 1,100 people in 18 offices across the United States, serving approximately 1.7 million customers.
Income Annuities. We offer single premium immediate annuities, or SPIAs, to customers seeking a reliable source of retirement income or to protect against outliving their assets during retirement, and structured settlement annuities to fund third party personal injury settlements. In addition, we offer funding services options to existing structured settlement clients.
See Note 21 to the Consolidated Financial Statements for financial results of our segments, including our operating revenues, for each of the last three fiscal years.
To navigate our way through this environment and provide profitable growth and long-term ROE expansion to our shareholders, we intend to focus on the following strategies:
developing new products that capitalize on favorable demographic trends such as the need for retirement savings, life insurance and employers’ need to provide affordable health care to employees;
Making the determinations as to whether one or more of these conditions exist often 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. The impairment review involves the investment management team, including our portfolio asset managers. To make this determination for each security, we consider both quantitative and qualitative criteria including:
Prior to January 1, 2009, if the loss was determined to be other-than-temporary, we recorded an impairment charge equal to the difference between the fair value and the amortized cost basis of the security within net realized investment gains (losses) in our consolidated statements of income in the period that we made the determination. The fair value of the other-than-temporarily impaired investment became its new cost basis. We also recorded an impairment charge if we did not have the intent and/or the ability to hold the security until the fair value was expected to recover to amortized cost or until maturity, resulting in a charge recorded for a security that may not have had credit issues.
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”). The accounting guidance 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
The availability of market observable information is the principal factor in determining the level that our investments are assigned in the fair value hierarchy. The following tables summarize our assets carried at fair value and the respective fair value hierarchy, based on input levels:
Fixed maturities include bonds, mortgage-backed securities and redeemable preferred stock. We classify all fixed maturities as available-for-sale and carry them at fair value. We report net unrealized investment gains and losses related to our available-for-sale securities, which is equal to the difference between the fair value and the amortized cost, in AOCI in stockholders’ equity. We report net realized investment gains and losses in the consolidated statements of income.
Our pricing services routinely review the inputs for the securities they cover, including broker quotes, executed trades and credit information, as applicable. We perform analyses on the prices received from our pricing services to ensure that the prices represent a reasonable estimate of fair value. We gain assurance on the overall reasonableness and consistent application of input assumption valuation methodologies, as well as compliance with accounting standards for fair value determination through various processes, including:
evaluation of pricing methodologies and inputs; analytical reviews of changes in certain prices between reporting periods; and back-testing of selected sales activity to determine whether there are any significant differences between the market price used to value the security prior to sale and the actual sales price. Through our analysis, we have engaged our pricing services in discussion regarding the valuation of a security; however, it has not been our practice to adjust their prices.
As of December 31, 2010 and 2009, $892.9, or 4.2%, and $901.3, or 4.8%, respectively, of our fixed maturities portfolio was invested in private placement securities, which are not actively traded. The fair values of these assets are typically determined using a discounted cash flow approach. The valuation model requires the use of inputs that are not market-observable and involves significant judgment. The discount rate is based on the current Treasury curve adjusted for credit and liquidity factors. The appropriate illiquidity adjustment is estimated based on illiquidity spreads observed in transactions involving other similar securities. We consider this approach appropriate for this asset class, which comprises 88.0% of our Level 3 fixed maturities.
In our Deferred Annuities, Income Annuities and Life segments, we amortize acquisition costs over the premium paying period or over the lives of the policies in proportion to the future estimated gross profits, or EGPs, of each of these product lines, as follows:
Income Annuities. The DAC amortization period for SPIAs, including structured settlement annuities, is the benefit payment period. The benefit payment periods vary by policy; however, nearly all benefits are paid within 80 years of contract issue.
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 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 increase in amortization expense. EGPs are adjusted quarterly to reflect actual experience to date. For example, for our deferred annuity products, if renewal crediting rates are greater or lower than the renewal crediting rates we assumed in our DAC amortization models, we would record a change in amortization expense to reflect the change in our EGPs. For future assumptions we complete a study and refine our estimates of future gross profits annually during the third quarter. 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 asset amortization models. The following would generally cause an increase in DAC amortization expense: increases to lapse and withdrawal rates in the current period, increases to expected renewal crediting rates, which may decrease interest margins, increases to expected future lapse and withdrawal rates, increases to future expected expense levels, increases to interest margins in
In connection with our recoverability analyses, we perform sensitivity analyses on our most significant DAC asset balances, which currently relate to our deferred annuity, universal life, and BOLI products, to capture the effect that certain key assumptions have on DAC asset balances. The sensitivity tests are performed independently, without consideration for any correlation among the key assumptions. The following depicts the sensitivities for our deferred annuity, universal life and BOLI DAC asset balances: if we changed our future lapse and withdrawal rate assumptions by a factor of 10%, the effect on the DAC asset balance would be approximately $5.9; if we changed our future expense assumptions by a factor of 10%, the effect on the DAC asset balance would be $0.3. Also, 25% of our DAC balance relates to a block of recently issued deferred annuity products with either a three- or five-year guaranteed interest rate period. Given the recent rise in interest rates and other factors, we will likely change our renewal interest rate assumption in our DAC and DSI models. If we increased renewal interest rates on these contracts 100 basis points above the renewal interest rates currently assumed in our DAC amortization models during the surrender charge period, the effect would be an adjustment of $0.8 and $0.4 to reduce our DAC and DSI balances, respectively. In addition, during 2011 we would also anticipate an additional net impact on our DAC and DSI balances, and reduction of pre-tax earnings, of approximately $7.0.
We adjust the unamortized DAC balance for the accumulated effect of net unrealized gains or losses. This adjustment reflects the impact on estimated future gross profits as if the net unrealized investment gains and losses had been realized as of the balance sheet date. We record the impact of this adjustment, net of tax, in AOCI. In periods of rising interest rates, the fair value of our fixed maturities generally decreases, resulting in an increase in unrealized investment losses, which is recorded as a reduction of AOCI. In such a period, the DAC adjustment would increase our DAC balance and increase AOCI. However, this adjustment is limited to cumulative capitalized acquisition costs plus interest. As of December 31, 2010, this adjustment would have been limited to $86.0, net of taxes of $46.3, in our Deferred Annuities segment and $5.4, net of taxes of $2.9, in our Life segment. We expect the DAC asset balance to grow during 2011 as we continue to write new business, and as this occurs we would expect the sensitivities to grow accordingly. In addition, depending on the amount and the type of new business written in the future we may determine that other assumptions may produce significant variations in our financial results.
For a discussion of recently adopted and not yet adopted accounting pronouncements, see Note 2 to the Consolidated Financial Statements.
Our primary sources of revenues from our insurance operations are premiums and net investment income. Our primary sources of expenses from our insurance operations are policyholder benefits and claims, interest credited to policyholder reserves and account balances and general business and operating expenses, net of DAC. We allocate shared service operating expenses to each segment using multiple factors, including employee headcount, allocated investments, account values and time study results. We also generate net realized investment gains (losses) on sales or impairment of our investments and changes in fair value on our equity trading portfolio.
Net investment income represents the income earned on our investments, net of investment expenses, including gains or losses from changes in the fair value of our investments in private equity and hedge fund limited partnerships.
Policy fees, contract charges and other includes cost of insurance (COI) charges on our universal life insurance and BOLI policies, mortality expense, surrender and other administrative charges to policyholders, revenues from our non-insurance businesses, and reinsurance allowance fees.
Net realized investment gains (losses) mainly consists of realized gains (losses) from sales of our investments, realized losses from investment impairments and changes in fair value on our trading portfolio and FIA options.
Interest credited represents interest credited to policyholder reserves and contract holder general account balances.
Interest expense primarily includes interest on corporate debt, the impact of interest rate hedging activities and amortization of debt issuance costs.
Certain tables and related disclosures in this report include non-GAAP financial measures. We believe these measures provide useful information to investors in evaluating our financial performance or condition. The non-GAAP financial measures discussed below are not a substitute for their most directly comparable GAAP measures. The adjustments made to derive these non-GAAP measures are important to understanding our overall results of operations and financial position and, if evaluated without proper context, these non-GAAP measures possess material limitations. Therefore, our management and board of directors also separately review the items excluded from or added to the most directly comparable GAAP measures to arrive at these non-GAAP measures. In addition, management and our board of directors also analyze each of the comparable GAAP measures in connection with their review of our results of operations and financial position.
Adjusted Operating Income, Adjusted Operating Income per Common Share-Basic, and Adjusted Operating Income per Common Share-Diluted
In presenting adjusted operating income, we are excluding after-tax net realized investment gains (losses). The timing and amount of these gains and losses are driven by investment decisions and external
In addition to using adjusted operating income to evaluate our insurance operations, our management and board of directors have other uses for this measure, including managing our insurance liabilities and assessing achievement of our financial plan.
Adjusted operating income per common share-basic, and adjusted operating income per common share-diluted, consist of adjusted operating income, divided by the GAAP-basis weighted average basic and diluted shares outstanding, respectively.
In addition to using adjusted operating income per common share-basic, and adjusted operating income per common share-diluted, to evaluate our insurance operations, our management and board of directors have other uses for this measure, including assessing achievement of our financial plan.
Adjusted book value, as converted consists of adjusted book value, plus the assumed proceeds from the exercise of outstanding warrants. This measure is used to calculate adjusted book value per common share, as converted which gives effect to the exercise of our outstanding warrants. Adjusted book value per common share, as converted, is calculated as adjusted book value plus the assumed proceeds from the warrants, divided by the sum of outstanding common shares and shares subject to outstanding warrants.
We believe investors find it useful if we present them with 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.
In addition to using adjusted book value per common share, as converted to evaluate our financial condition on a per common share basis, our management and board of directors use this measure to assess our financial performance and to compare the value and the change in value over time of our common shares to that of our peer companies.
Operating return on average equity, or operating ROAE, consists of adjusted operating income for the most recent four quarters, divided by average adjusted book value, both of which are non-GAAP measures as described above. We measure average adjusted book value by averaging adjusted book value for the most recent five quarters.
Basic and diluted net income per common share includes all participating securities, such as warrants and unvested restricted shares, based on the application of the two-class method. Diluted net income per common share also includes the dilutive impact of non-participating securities, to the extent dilutive, such as stock options and shares estimated to be issued under the employee stock purchase plan, based on application of the treasury stock method. Antidilutive awards were excluded from the computation of dilutive net income per share.
Our Group segment’s loss ratio improved to 64.9% for the year ended December 31, 2010 from 68.3% for the same period in 2009. This improvement was driven by medical stop-loss pricing increases initiated in late 2009, and improved limited benefit medical underwriting results on increased premiums.
Net income increased $106.2 on an increase in adjusted operating income and a reduction in net realized investment losses. Adjusted operating income increased $25.0, which was driven primarily by an increase in the investment margin (net investment income less interest credited) in our Deferred Annuities segment, increased returns on our investments in limited partnerships, which produced gains of $8.9 in 2009, compared to losses of $24.4 in 2008, and a decrease in other underwriting and operating expenses. These favorable drivers were partially offset by a decrease in our Group segment’s underwriting margin (premiums less policyholder benefits and claims) and an increase in DAC amortization.
Net realized investment losses decreased $128.7 on improved performance of our equity portfolio, which yielded total returns of 34.0%, as compared to (30.6)% in 2008, and outpaced the 2009 S&P 500 total return index of 26.5%. For further discussion on our investment results and portfolio, including a discussion of our impairment charges, refer to “-Investments.”
Our Group segment’s underwriting margin decreased $17.1 driven by decreased premiums without a corresponding decrease in claims. We experienced reduced premium as a result of lower sales and renewals, which was primarily driven by pricing increases in the medical stop-loss line as we focused on pricing to achieve our target loss ratios. We also experienced an increase in larger dollar claims in 2009 as compared to 2008. Also in our Group segment, commission expense, which is not deferred, decreased $4.3, consistent with decreased premiums.
The following table sets forth the results of operations relating to our Group segment:
Group loss ratio represents policyholder benefits and claims divided by premiums earned.
Segment pre-tax adjusted operating income increased $16.2 as a result of an improved loss ratio, reflecting medical stop-loss pricing actions initiated in late 2009. In addition, we experienced an overall decrease in the number of medical stop-loss claims, as well as strong underwriting results on our limited benefit medical product.
2009 loss ratio increased to 68.3% from 65.8%, which exceeded our target, while the expense ratio remained flat on a smaller block of medical stop-loss business.
Other revenues decreased $4.1 primarily due to a reduction in revenue from our third party administrator, which was sold in the third quarter of 2009.
Interest spread is the difference between net investment yield earned and the credited interest rate to policyholders. The investment yield is the approximate yield on invested assets in the general account attributed to the segment. The credited interest rate is the approximate rate credited on policyholder fixed account values within the segment. Interest credited is subject to contractual terms, including minimum guarantees.
Segment pre-tax adjusted operating income increased $22.7 driven by an increase in the investment margin (net investment income less interest credited) from a higher interest spread on record high account values. This was partially offset by an increase in DAC amortization which is also related to an increase in account value driven by higher sales.
Interest credited increased $36.7 primarily due to a $1.6 billion increase in fixed account values driven by strong sales of fixed deferred annuity products over the past three years. In addition, the interest spread improved on a reduction in the new and renewal crediting rates, which were lowered in response to the lower interest rate environment.
Policy fees, contract charges, and other decreased primarily due to a $3.8 reduction in fees on average variable account values. Although variable annuities account values increased during 2009, the average account value in 2008 was higher as the equity markets declined during the second half of 2008, primarily in the fourth quarter.
Policyholder benefits and claims decreased $4.6 driven by a reduced benefit from amortization of the PGAAP reserve, which was fully amortized as of September 30, 2009, resulting in only nine months of amortization in 2009 compared to 12 months in 2008.
Interest credited increased $80.5 primarily due to a 34% increase in average account value as a result of increased sales of fixed deferred annuity products. In addition, due to the growth in the S&P 500 in 2009, compared to a loss in 2008, the interest credited to contract holders of our FIA product increased $5.9.
Segment pre-tax adjusted operating income decreased $9.2 primarily due to mortality losses of $2.6 for the year ended December 31, 2010 compared to mortality gains of $5.1 for the same period in 2009. In addition, we experienced a $3.9 decrease in the benefit from funding services activity. This was offset by improvement in the interest spread from increased originations of mortgage loans and a reduction in interested credited. Total 2010 sales increased over 2009 driven by sales of our structured settlement annuities as the low interest rate environment impacted sales of our SPIAs.
Interest credited decreased $6.6, which was primarily due to a $4.0 decrease in interest as a result of lower reserves in 2009, consistent with the decrease in investment income, and $3.0 due to an increase in mortality gains.
Individual insurance claims represents incurred claims on our term and universal life policies.
UL account value and BOLI account value represent our liabilities to our policyholders.
UL interest spread is the difference between net investment yield earned and the credited interest rate to policyholders. The investment yield is the approximate yield on invested assets in the general account attributed to the UL policies. The credited interest rate is the approximate rate credited on UL policyholder fixed account values. Interest credited to UL policyholders’ account values is subject to contractual terms, including minimum guarantees. Interest credited tends to move gradually over time to reflect actions by management to respond to competitive pressures and profit targets. The 2010 credited rate to policyholders has been adjusted to exclude a reserve adjustment related to a persistency bonus. Without this adjustment the 2010 UL interest spread of 1.50% would have been 2.50%.
BOLI ROA is a measure of the gross margin on our BOLI book of business. This metric is calculated as the difference between our BOLI revenue earnings rate and our BOLI policy benefits rate. The revenue earnings rate is calculated as revenues divided by average invested assets. The policy benefits rate is calculated as total policy benefits divided by average account value. The policy benefits used in this metric do not include expenses.
Twelve Months Ended December 31, 2010 Compared to the Twelve Months Ended December 31, 2009
Premiums increased $1.9 driven by an increase in premium from our term products. This increase is primarily the result of a change in reinsurance coverage obtained on new terms sales, which has lowered our ceded premiums.
Due to the continued low interest rate environment, the credited interest rate on a universal life product was adjusted downward beginning first quarter 2010 to the guaranteed minimum rate. For this product, bonus interest is not earned if the credited rate is equal to the guaranteed minimum. As a result, during the first quarter of 2010, we released bonus interest reserves of $6.0 recorded in policyholder benefits and claims, benefited from a $1.7 reduction in DAC amortization due to the unlocking of future assumptions and recorded a $(0.3) adjustment to policy fees, contract charges and other. In addition, policyholder benefits and claims decreased due to individual insurance claims, decreasing $2.8.
Twelve Months Ended December 31, 2009 Compared to the Twelve Months Ended December 31, 2008
Net investment income increased $10.6 of which $7.4 was related to an increase in average invested assets, which increased to $4.9 billion from $4.8 billion due mainly to increases in the BOLI account value. In addition, there was a positive rate variance of $3.2 as yields increased to 5.39% from 5.33%.
Police fees, contract charges, and other increased $2.0 driven by the annual increases in COI charges on the UL and BOLI blocks of business due to the aging of the covered lives.
Policyholder benefits and claims decreased $2.1 primarily due to strong underwriting results, and a refinement of reserve assumptions as a result of a conversion to a new actuarial reserve model. These decreases were partially offset by higher BOLI claims.
Our investment portfolio is structured with the objective of supporting the expected cash flows of our liabilities and to produce stable returns over the long term. The composition of our portfolio reflects our asset management philosophy of protecting principal and receiving appropriate reward for risk. Our investment portfolio mix as of December 31, 2010 consisted in large part of high quality fixed maturities and commercial
mortgage loans, as well as a smaller allocation of high yield fixed maturities, marketable equity securities, investments in limited partnerships (which includes tax credit investments, private equity and hedge funds) and other investments. We believe that prudent levels of investments in marketable equity securities within our investment portfolio offer enhanced long term, after-tax total returns to support a portion of our longest duration liabilities.
The increase in invested assets during 2010 is primarily due to portfolio growth generated by sales of fixed deferred annuities and BOLI, a net increase in the fair value of our fixed maturities, and the investment of the net proceeds from our IPO. As of December 31, 2010, we had $865.3 of net unrealized gains on our fixed maturities, an increase of $824.7 from $40.6 as of December 31, 2009. Contributing to the increase in fair value was an improvement in the markets during the latter part of 2010. In addition, U.S. Treasury yields declined in the middle half of the year before rising in the fourth quarter of 2010, while fixed income spreads ended the year modestly tighter.
Other income producing assets includes income from other invested assets and cash and cash equivalents.
The following table sets forth the detail of our net realized investment gains (losses) before taxes:
Public fixed maturities includes publicly traded securities and highly marketable private placements for which there is an actively traded market.
This primarily consists of changes in fair value on derivatives instruments, gains (losses) on calls and redemptions, and the impact of net realized investment gains (losses) on DAC and deferred sales inducements.
The Securities Valuation Office, or SVO, of the NAIC, evaluates the investments of insurers for regulatory reporting purposes and assigns fixed maturities to one of the six categories called “NAIC Designations.” NAIC designations of “1” or “2” include fixed maturities considered investment grade, which generally include securities rated BBB- or higher by Standard & Poor’s. NAIC designations of “3” through “6” are referred to as below investment grade, which generally include securities rated BB+ or lower by Standard & Poor’s.
As of December 31, 2010 and 2009, securities with an amortized cost of $847.3 and $898.2, and fair value of $891.9 and $925.8, respectively, had no rating from a nationally recognized securities rating agency. We derived the equivalent S&P credit quality rating for these securities based on the securities’ NAIC rating designation.
Below investment grade securities comprised 5.9% and 5.6% of our fixed maturities portfolio as of December 31, 2010 and 2009, respectively. We had NAIC 5 and 6 designated securities with gross unrealized losses of $27.0 as of December 31, 2010, of which $15.4, or 57.0%, related to two issuers. These issuers are current on their contractual payments and our analysis supports the recoverability of amortized cost.
All of our RMBS and CMBS securities have a prepayment option. Prepayments that vary in amount or timing from our estimates cause fluctuations in our yields due to an acceleration or deceleration of unamortized premium or discount associated with the securities in our portfolio. Such adjustment is recorded in net investment income in our results of operations. As of December 31, 2010, our RMBS had gross unamortized premiums and discounts of $76.9 and $68.9, respectively, and our CMBS had gross unamortized premiums and discounts of $36.7 and $44.3, respectively.
The following table sets forth the total fair value, and amortized cost of our non-agency RMBS by credit quality and year of origination (vintage). There were seven securities with a total amortized cost and fair value of $82.4 and $69.8, respectively, that were rated below investment grade by either Moody’s, S&P or Fitch, while at least one other rated them investment grade.
The following table sets forth the total fair value, and amortized cost of our non-agency CMBS by credit quality and year of origination (vintage). There were 12 securities having a fair value of $299.5 and an amortized cost of $279.0 that were rated A by S&P, while Moody’s and/or Fitch rated them AAA.
U.S. CMBS securities have historically utilized a senior/subordinate credit structure to allocate cash flows and losses. The structure was changed in late 2004 and was in transition into early 2005 when fully implemented to include super-senior, mezzanine, and junior AAA tranches. This change resulted in increasing the credit enhancement (subordination) on the most senior tranche (super-senior) to 30%. The mezzanine AAAs were structured to typically have 20% credit enhancement and the junior AAAs 14% credit enhancement. Credit enhancement refers to the weighted-average percentage of outstanding capital structure that is subordinate in the priority of cash flows and absorbs losses first. Credit enhancement does not include any equity interest or property value in excess of outstanding debt. The super senior class has priority over the mezzanine and junior classes to all principal and interest cash flows and will not experience any loss of principal until both the entire mezzanine and junior tranches are written down to zero.
The following tables set forth the amortized cost of our AAA non-agency CMBS by type and year of origination (vintage):
As of December 31, 2010 and 2009, 73.6% and 77.7%, respectively, of our mortgage loans were under $5.0 and our average loan balance was $2.2 and $1.9, respectively. As of December 31, 2010 and 2009, our largest loan balance was $13.0 and $13.4, respectively.
The loan-to-value ratio compares the amount of the loan to the estimated fair value of the underlying property collateralizing the loan. In the year of funding, LTV ratios are calculated using independent appraisals performed by Member of the Appraisal Institute, or MAI, designated appraisers. Subsequent to the year of funding, LTV ratios are updated annually between June 1st and September 30th using internal valuations based on property income and market capitalization rates. LTV ratios greater than 100% indicate that the loan amount is greater than the collateral value. A smaller LTV ratio generally indicates a higher quality loan.
As of December 31, 2010 and 2009, the mortgage loan portfolio had weighted-average LTV ratios of 57.0% and 53.5%, respectively. The slight increase in the LTV ratio is driven by a reduction in the market values of the underlying properties, which is the result of a distressed commercial real estate market. The weighted average LTV ratio was 55.2% and 49.4% for loans funded during 2010 and 2009, respectively. For loans originated during 2010, 31.7% had a LTV ratio of 50% or less, and no loans had a LTV ratio of more than 75%. For loans originated during 2009, 44.8% had a LTV ratio of 50% or less, and no loans had a LTV ratio of more than 70%. The following table sets forth the DSCR for our gross mortgage loan portfolio:
For more information and further discussion of our allowance of mortgage loans, see Note 6 to the Consolidated Financial Statements.
Although these investments decrease our net investment income over time on a pre-tax basis, they provide us with significant tax benefits, which decrease our effective tax rate. The following table sets forth the impact the amortization of our investments and related tax credits had on net income.
Symetra conducts all of its operations through its operating subsidiaries, and our liquidity requirements primarily have been and will continue to be met by funds from such subsidiaries. Dividends and permitted tax sharing payments from its subsidiaries are Symetra’s principal sources of cash to pay dividends and meet its obligations, including payments of principal and interest on notes payable and tax obligations. On January 27, 2010, Symetra completed an initial public offering of its common stock and received net proceeds of $282.5, which further enhanced our liquidity and capital resources.
We have and intend to pay quarterly cash dividends on our common stock and warrants. Our current rate is $0.05 per share. 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 and Regulatory Requirements” below for further discussion.
Over the past few years, the global financial markets experienced unprecedented disruption, adversely affecting the business environment in general, and financial services companies in particular. During the year ended December 31, 2010, the economy began to slowly recover. The credit markets remained tight, and we continued to experience a low interest rate environment through most of 2010, although interest rates began to rise in late 2010. In managing the challenging market conditions over the past couple of years, we benefited from the diversification of our business and strong financial fundamentals. 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:
We continued to generate strong cash flows from operations, which grew $127.3 to $925.7 for 2010, from $798.4 for 2009.
To support the sales of our products and maintain financial strength ratings, we target a risk-based capital level of at least 350% in our life insurance company, Symetra Life Insurance Company. As of December 31, 2010, Symetra Life Insurance Company had a risk-based capital ratio of approximately 480%. This capital level provides more than adequate capital levels for growth of our business.
In managing the liquidity of our insurance operations, we also consider the risk of policyholder and contract holder withdrawals of funds earlier than assumed when selecting assets to support these contractual obligations. We use surrender charges and other contract provisions to mitigate the extent, timing and profitability impact of withdrawals of funds by customers from annuity contracts and deposit liabilities. The following table sets forth withdrawal characteristics of our general account policyholder liabilities, composed of annuity reserves, deposit liabilities and policy and contract claim liabilities, net of reinsurance recoverables. The total represents the sum of funds held under deposit contracts, future policy benefits and policy and
contract claims on the consolidated balance sheets, excluding other policyholder related liabilities and reinsurance recoverables of $234.3 and $247.2 as of December 31, 2010 and 2009, respectively.
In a liquidity crisis situation, we could invoke the five-year payout provision so that the contract value with interest is paid out ratably over five years.
The surrender value on these contracts is generally zero. Represents incurred but not reported claim liabilities.
Represents BOLI, traditional insurance, and Group health and life reported claim liabilities.
We define liquid assets to include cash, cash equivalents, short-term investments, publicly traded fixed maturities and public equity securities. As of December 31, 2010 and 2009, our insurance subsidiaries had liquid assets of $20.8 billion and $18.1 billion, respectively, and Symetra had liquid assets of $89.7 and $33.3, respectively. The portion of total company liquid assets comprised of cash and cash equivalents and short-term investments was $277.1 and $259.9 as of December 31, 2010 and 2009, respectively. The increase in our insurance subsidiaries’ liquid assets was primarily the result of sales of deferred annuities during 2010.
Given the size and liquidity profile of our investment portfolio, we believe that claim experience varying from our projections does not constitute a significant liquidity risk. Our asset/liability management process takes into account the expected maturity of investments and expected claim payments as well as the specific nature and risk profile of the liabilities. Historically, there has been limited variation between the expected maturities of our investments and the payment of claims.
Our capitalization increased $947.4 as of December 31, 2010 compared to December 31, 2009 due to an increase in stockholders’ equity. This increase was driven by an increase in AOCI, the net proceeds received from our IPO, and the generation of net income of $200.9, offset partially by current year dividends. AOCI improved primarily due to improved valuation of available-for-sale fixed maturities, primarily corporate securities. We believe our capital levels position us well to capitalize on organic growth as well as pursue any potentially favorable acquisition opportunities.
On March 30, 2006, we issued $300.0 of 6.125% senior notes due April 1, 2016, which were issued at a discount yielding $298.7. Interest on the senior notes is payable semiannually in arrears, beginning on October 2, 2006.
Based on our statutory results, as of December 31, 2010, Symetra’s insurance subsidiaries may pay it dividends of up to $194.0 during 2011 without needing to obtain regulatory approval. A dividend of $20.0 was paid from our subsidiaries to us on March 4, 2011, leaving $174.0 available for our insurance subsidiaries to dividend to us during 2011 without having to seek approval.
Years ended December 31, 2010 and 2009. Net cash provided by operating activities for 2010 was $925.7, a $127.3 increase over 2009. This was primarily driven by increased net investment income driven by an increase in average assets, a decline in paid commissions related to our deferred annuity products on lower sales, and a decrease in group medical stop-loss paid claims.
Years ended December 31, 2009 and 2008. Net cash provided by operating activities for 2009 was $798.4, a $65.4 increase over 2008. This was primarily driven by an increase in our invested assets resulting in an increase in cash flows (interest receipts) on our investments and a reduction in operating expenses due to disciplined expense management and decreased federal income tax payments. Decreased premiums and increased claims related to our group medical stop-loss product partially offsets these increases.
Years ended December 31, 2010 and 2009. Net cash used in investing activities for the year ended December 31, 2010 was $2,456.8, a $314.5 increase over the same period in 2009. This increase was primarily the result of increased purchases of fixed maturities and higher originations of mortgage loans, as we deployed cash generated from sales of fixed deferred annuities and BOLI, as well as net proceeds from our IPO. These were partially offset by an increase in cash received from prepayments, maturities and calls on fixed maturities, and strategic sales of fixed maturities.
Years ended December 31, 2009 and 2008. Net cash used in investing activities for the year ended December 31, 2009 was $2,142.3, a $1,165.5 increase over the same period in 2008. This increase was primarily the result of higher purchases of fixed maturities, as we deployed cash generated on increased sales of fixed deferred annuities.
Years ended December 31, 2010 and 2009. Net cash provided by financing activities for the year ended December 31, 2010 was $1,547.9, a $414.2 increase over the same period in 2009. This was primarily due to net IPO proceeds of $282.5 received during the first quarter of 2010 and an increase in policyholder deposits, primarily related to increased BOLI deposits offset by decreased fixed annuity deposits.
Includes contractual commitments for a service agreement to outsource the majority of our information technology infrastructure. For more information, see Note 16 to the Consolidated Financial Statements.
Includes minimum rental commitments on leases for office space and certain equipment. For more information, see Note 16 to the Consolidated Financial Statements.
Notes to Consolidated Financial Statements for the years ended December 31, 2010, 2009 and 2008
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, 2010 and 2009, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2010, 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.
As discussed in Note 2 to the financial statements, in 2009, the Company changed its method of accounting for other-than-temporary impairments of fixed maturity securities.
On January 27, 2010, the Company completed the initial public offering (IPO) of its common stock at an offering price of $12.00 per share. The IPO included 25.260 newly issued shares of common stock sold by the Company and 9.700 existing shares of common stock sold by selling stockholders. The Company received net proceeds from the offering of approximately $282.5. The Company did not receive any proceeds from the sale of shares by the selling stockholders.
The most significant estimates include those used to determine the following: valuation of investments; the identification of other-than-temporary impairments (OTTI) of investments; the balance, recoverability and amortization of deferred policy acquisition costs (DAC); and the liabilities for funds held under deposit contracts, future policy benefits, and policy and contract claims. The recorded amounts reflect management’s best estimates, though actual results could differ from those estimates.
total revenues or amounts previously reported as other revenues that are now included in policy fees, contract charges and other.
Deposits related to universal life, bank-owned life insurance (BOLI), limited payment and investment-type products are credited to policyholder account balances and reflected as liabilities, rather than as premium income, when received. Revenues from these contracts consist of net investment income on the policyholders’ fund balances and amounts assessed during the period for cost of insurance, policy administration, and surrender charges. The Company includes such costs in policy fees, contract charges, and other in the consolidated statements of income. Expenses that are charged to operations for these products include interest credited and benefit claims incurred in excess of related policyholder account balances.
Fees for variable annuity and variable life products include mortality and expense charges, policy administration charges, 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 on the consolidated statements of income when charged.
The Company reports net unrealized investment gains (losses) related to its available-for-sale securities in accumulated other comprehensive income (loss) (AOCI) in stockholders’ equity, net of related DAC and deferred income taxes.
The Company reports interest and dividends earned in net investment income. Interest income for fixed maturities is recognized using the effective yield method. When the collectability of interest income for fixed maturities is considered doubtful, any accrued but uncollectible interest is excluded from investment income in the current period. The Company then places the securities on nonaccrual status, and they are not restored to accrual status until all delinquent interest and principal are paid. For mortgage-backed securities, the Company recognizes income using a constant effective yield based on anticipated prepayments and the estimated economic life of the securities. Quarterly, the Company compares actual prepayments to anticipated
The cost of securities sold is determined using the specific-identification method.
The Company’s investments in certain limited partnerships meet the definition of a variable interest entity (VIE). Based on the analyses of these interests, the Company is not considered the “primary beneficiary” of any of these partnerships and therefore has not consolidated them. The maximum exposure to loss as a result of the Company’s involvement in these VIEs was $208.0 and $147.3 as of December 31, 2010 and 2009, respectively. The maximum exposure to loss includes commitments to provide future capital contributions as described in Note 16.
The Company’s recognition of changes in fair value of a derivative depends on the intended use of the derivative and the extent to which it is effective as part of a hedging transaction. Derivative financial instruments currently held consist primarily of S&P 500 index options and are included in other invested assets at fair value on the Company’s consolidated balance sheets. See Note 5 for further discussion.
The Company utilizes reinsurance agreements to manage its exposure to potential losses. The Company reinsures all or a portion of its risk to reinsurers for certain types of directly written business. In addition, the Company reinsures through pools to cover catastrophic losses. 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 on 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 certain costs, principally commissions, distribution costs and other underwriting costs, that vary with and are primarily related to the production of business. The Company limits deferrals to the lesser of the acquisition costs contained in the Company’s product pricing assumptions or actual costs incurred.
Liabilities for fixed deferred annuity contracts and universal life policies, including BOLI, are computed as deposits net of withdrawals made by the policyholder, plus amounts credited based on contract specifications, less contract fees and charges assessed, plus any additional interest. For single premium immediate annuities (SPIAs), including structured settlements, future benefits are either fully guaranteed or are contingent on the survivorship of the annuitant. Liabilities are based on discounted amounts of estimated future benefits. 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, 2010, the weighted-average implied interest rate on the existing book of business was 5.9% and is expected to grade to 6.5% during the next 20 years.
Liabilities for policy and contract claims primarily represent liabilities for claims under group health insurance policies and are established on the basis of reported losses (case basis method). The Company also provides for claims incurred but not reported (IBNR), based on expected loss ratios, claims paying completion patterns and historical experience. The Company reviews estimates for reported but unpaid claims and IBNR quarterly. Any necessary adjustments are reflected in current operating results. If expected loss ratios increase or expected claims paying completion patterns extend, the IBNR claim liability increases.
The Company accounts for stock-based compensation based on the fair value of the awards on the grant date. Compensation expense for these awards is recognized over the requisite service period, using the straight-line method. See Note 15 for further discussion.
ASU 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses
In January 2010, the FASB issued ASU 2010-06, Fair Value Measurements and Disclosures (ASC Topic 820)-Improving Disclosures about Fair Value Measurement. The guidance in this ASU requires additional disclosures about an entity’s fair value measurements, including information about inputs to Level 2 measurements, gross transfers into and out of Levels 1 and 2, and information about activity for Level 3
measurements on a gross basis. It also clarifies the level of disaggregation required for existing fair value disclosures. The Company adopted this guidance on January 1, 2010, except for the provisions regarding activity for Level 3 measurements presented on a gross basis which, as permitted by the guidance, will be adopted on January 1, 2011. See Note 7 for the Company’s disclosures related to fair value measurements.
In April 2009, the FASB issued FASB Staff Position (FSP) SFAS 115-2 and SFAS 124-2 (ASC 320-10), Recognition and Presentation of Other-than-Temporary Impairments. This guidance amends OTTI guidance for fixed maturities and modifies the OTTI presentation and disclosure requirements for both fixed maturities and equity securities. Under this guidance, if a credit loss exists, it is recognized in earnings, whereas the portion due to other factors is recognized in other comprehensive income (loss). The Company elected to prospectively adopt the guidance effective January 1, 2009, which resulted in an increase of $15.7 (net of taxes of $8.4) to the opening balance of retained earnings with a corresponding decrease to AOCI.
On January 1, 2008, the Company prospectively adopted SFAS No. 159 (ASC 825-10), The Fair Value Option for Financial Assets and Financial Liabilities. The Statement allows companies to make an election, on an individual instrument basis, to report financial assets and liabilities at fair value. The election must be made at the inception of a transaction, or for existing financial assets and liabilities at the time of adoption, and may not be reversed. The Company elected the fair value option for certain of its investments in common stock, which are presented as trading securities, and its investments in private equity and hedge funds, regardless of ownership percentage, which are presented as investments in limited partnerships. The Company recorded an adjustment to increase retained earnings as of January 1, 2008 and increase accumulated other comprehensive loss by $29.4, or $19.1 net of taxes, to reclassify net unrealized gains as a result of adoption.
ASU 2010-15, How Investments Held through Separate Accounts Affect an Insurer’s Consolidation Analysis of Those Investments
In April 2010, the FASB issued ASU 2010-15, Financial Services-Insurance (Topic 944)-How Investments Held through Separate Accounts Affect an Insurer’s Consolidation Analysis of Those Investments. This guidance clarifies that an insurer should only consider its ownership interests held within its general account when determining if it holds a controlling interest in an investment, thus excluding interests held in a separate account from the analysis. It does not change the guidance for consolidating investments when the general account holds a controlling interest. The Company will adopt this guidance on January 1, 2011 when it becomes effective, which will not change the Company’s current practice of excluding ownership interests held in its separate account from its consolidation analysis.
under the employee stock purchase plan were included in diluted earnings per share based on the application of the treasury stock method.
For the year ended December 31, 2010, 2.950 stock options were excluded from the computation of diluted earnings per share, based on the application of the treasury stock method, because they were antidilutive. There were no antidilutive awards outstanding as of December 31, 2009 or 2008. Also, performance units granted during 2010 were also excluded from the computation of diluted earnings per share, because the Company has a historical practice of and intent to settle these awards in cash. Refer to Note 17 for discussion of the performance units.
Of the U.S. government and agencies securities, agencies comprised $13.9 and $23.7 of the fair value as of December 31, 2010 and 2009, respectively.
As of December 31, 2010, financial institutions, U.S. federal government, and industrials industries represented 19.0%, 18.6% and 12.4%, respectively, of the Company’s investments in fixed maturity and marketable equity securities at fair value.
The following tables summarize gross unrealized losses and fair values of the Company’s available-for-sale investments. For fixed maturities, gross unrealized losses include the portion of OTTI recorded in AOCI. The tables present separately those securities that have been in a continuous unrealized loss position for less than twelve months and for twelve months or more.
As of December 31, 2010 and 2009, $3,968.0, or 69.7%, and $3,458.3 or 64.9%, respectively, of the Company’s mortgage-backed securities were agency securities. The remaining $1,720.9 and $1,867.5, respectively, consisted of non-agency securities. Of these non-agency securities $1,240.1, or 72.1%, and $1,338.6, or 71.7%, respectively, were AAA-rated commercial mortgage-backed securities, and $329.7, or 19.2%, and $378.0, or 20.2%, were residential mortgage-backed securities classified as prime. Based on a review of the characteristics of their underlying mortgage loan pools, such as credit scores and financial ratios, the Company classified $111.3 and $125.5, of its non-agency residential mortgage-backed securities as Alt-A as of December 31, 2010 and 2009, respectively, as each has overall collateral credit quality between prime and subprime. Of the securities classified as Alt-A, 88.1% and 90.7% had an NAIC rating of 1 as of December 31, 2010 and 2009, respectively. As of December 31, 2010, the Company had no mortgage-backed securities classified as subprime, and as of December 31, 2009, $0.2 was classified as subprime.
The following table summarizes the Company’s net realized investment gains (losses):
This includes gains (losses) on calls and redemptions. Also included are changes in the fair value of the Company’s convertible securities held as of period end totaling $5.4, $10.1, and $(7.1) for the years ended December 31, 2010, 2009 and 2008, respectively.
During 2010, the Company recorded OTTI charges in earnings on fixed maturities totaling $20.9. The largest write-downs were from investments in the financial industry, totaling $8.3, or 39.7%; the industrial industry, totaling $6.7, or 32.1%; and the utilities industry, totaling $2.2, or 10.5%. During 2009, the Company
For fixed maturities, if the Company determines that the present value of the cash flows expected to be collected is less than the amortized cost of the security (i.e., a credit loss exists), the Company concludes that an OTTI has occurred. In order to determine the amount of the credit loss, the Company calculates the recovery value by discounting the current expectations of future cash flows it expects to recover. The discount rate is the effective interest rate implicit in the underlying fixed maturity. The effective interest rate is the original effective yield for corporate securities, or current effective yield for mortgage-backed securities.
(All amounts in millions, except per share data, unless otherwise stated)-Continued
As of December 31, 2010, $17.4, or 48.1%, of the unrealized losses on fixed maturities underwater by more than 20% for a period of six months or more related to investment-grade securities. Unrealized losses on investment-grade securities are principally related to changes in interest rates or changes in the issuer and the sector-related credit spreads since the securities were acquired.
Prior to January 1, 2009, when a loss was determined to be other-than-temporary, the Company recorded an impairment charge equal to the difference between the fair value and the amortized cost basis of the security within net realized investment gains (losses) in the Company’s consolidated statements of income. The fair value of the other-than-temporarily impaired investment became its new cost basis. The Company also recorded an impairment charge if it did not have the intent and/or the ability to hold the security until the fair value was expected to recover to amortized cost or until maturity, resulting in a charge recorded for a security that may not have had a credit risk.
Changes in the amount of credit-related OTTI recognized in net income where the portion related to other factors was recognized in other comprehensive income (loss) were as follows:
Derivatives are instruments whose values are derived from underlying instruments, indices or rates; have a notional amount; and can be net settled. This may include derivatives that are “embedded” in financial instruments or in certain existing assets or liabilities. The Company uses derivative financial instruments, including options, as a means of hedging exposure to equity price changes.
The Company has a closed block of fixed indexed annuity (FIA) product that credits policyholders’ accounts based on a percentage of the gain in the S&P 500 Index. In connection with this product, the Company has a hedging program with the objective to hedge the exposure to changes in the S&P 500 Index. This program consists of buying S&P 500 Index options. Although the Company uses index options to hedge the equity return component of the FIA, the options do not qualify as hedging instruments or for hedge accounting treatment. Accordingly, the options are recorded at fair value as free-standing derivative assets in other invested assets, with the impact of changes in the options’ fair value recorded in net realized investment gains (losses). The Company recognized pre-tax gains (losses) on these options of $0.3, $0.8 and $(2.9) for the years ended December 31, 2010, 2009 and 2008, respectively.
The allowance for losses on mortgage loans provides for the risk of credit loss inherent in the lending process. The allowance includes a portfolio reserve for probable incurred but not specifically identified losses and, as needed, specific reserves for non-performing loans. The allowance for losses on mortgage loans is evaluated as of each reporting period and adjustments are recorded when appropriate. To assist in its evaluation of the allowance for loan losses the Company utilizes the following credit quality indicators to categorize its loans as lower, medium or higher risk:
In developing its portfolio reserve for incurred but not specifically identified losses the Company evaluates loans by risk category as well as its past loan experience, commercial real estate market conditions,
As of December 31, 2010 all borrowers were current on loan payments. No loans were considered non-performing or were specifically evaluated and identified as impaired. As of December 31, 2009 one loan, with an unpaid principal balance of $3.9, was considered non-performing and specifically reserved for. As of December 31, 2008 no loans were considered non-performing or were specifically evaluated and identified as impaired.
The Company determines the fair value of its financial instruments based on the fair value hierarchy, which requires an entity to maximize its use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The Company has categorized its financial instruments, based on the priority of the inputs to the valuation technique, into the three-level hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). 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. The Company’s financial assets recorded at fair value on the consolidated balance sheets are categorized as follows:
Level 2-Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-derived valuations whose inputs are observable or whose significant value drivers are observable. This level includes those financial instruments that are valued using industry-standard pricing methodologies, models or other valuation methodologies. All significant inputs are observable, derived from observable information in the marketplace or are supported by observable levels at which transactions are executed in the market place. Financial instruments in this category primarily include certain public and private corporate fixed maturities, government or agency securities and certain mortgage-backed securities.
Level 3-Instruments whose significant value drivers are unobservable. This comprises financial instruments for which fair value is estimated based on industry-standard pricing methodologies and internally developed models utilizing significant inputs not based on or corroborated by readily available market information. In limited circumstances, this category may also utilize non-binding broker quotes. This category primarily consists of certain less liquid fixed maturities, including corporate private placement securities and investments in private equity and hedge funds.
The following tables present the financial instruments carried at fair value under the valuation hierarchy described above for assets accounted for at fair value on a recurring basis. The Company has no financial liabilities accounted for at fair value on a recurring basis:
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, 2010 and 2009, pricing services provided prices for 95.6% and 93.6% of the Company’s fixed maturities, respectively.
As of December 31, 2010 and 2009, the fair value of the Company’s corporate securities classified as Level 2 measurements was $13,786.8 and $11,552.9, respectively. The following table presents additional information about the composition of the Level 2 corporate securities:
As of December 31, 2009, 91.9% of the Level 3 corporate securities were privately placed securities. These securities were issued by entities primarily in the financial sector, 22.9%, the industrial sector, 20.7%, and the materials sector, 15.6%.
values of these securities were determined using a discounted cash flow approach. The discount rate was based on the current Treasury curve, adjusted for credit and liquidity factors. The credit factor adjustment, which is based on credit spreads to the Treasury curve for similar securities, varies for each security based on its quality and industry or sector. The illiquidity adjustment is estimated based on illiquidity spreads observed in transactions involving similar securities. As of December 31, 2010 and 2009, the range of illiquidity adjustments varied from 0 to 50 basis points.
The following table presents additional information about the quality of the Level 3 privately placed corporate securities:
Agency securities composed 88.4% and 84.7% of the Company’s Level 2 RMBS as of December 31, 2010 and 2009, respectively. The following table presents additional information about the composition of the Level 2 non-agency RMBS securities:
As of December 31, 2010 and 2009, the Company’s non-agency Level 2 RMBS had a weighted-average credit enhancement of 9.8%, and $181.8 and $191.3, or 41.2% and 38.0%, respectively, had an origination or vintage year of 2004 and prior.
The Company’s Level 2 CMBS had a weighted-average coupon rate of 5.50% and 5.55% as of December 31, 2010 and 2009, respectively. As of December 31, 2010, 18.2% of the underlying collateral for these securities was located in New York, 13.3% was located in California, and 7.1% was located in Texas. The underlying collateral primarily consisted of retail shopping centers and office buildings, comprising 33.7% and 30.5%, respectively, as of December 31, 2010.
Level 2 CMBS securities are priced by independent pricing services, who utilize evaluated pricing models. The significant inputs for security evaluations include benchmark yields, reported trades, broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, new issues, monthly payment information and other reference data, including market research publications. Because many CMBS do not trade on a daily basis, evaluated pricing applications apply available information through processes, such as benchmark curves, benchmarking of like securities, sector groupings and matrix pricing to prepare evaluations.
Marketable equity securities are investments in common stock and certain nonredeemable preferred stocks, which primarily consist of investments in publicly traded companies and actively traded mutual fund investments. The fair values of the Company’s marketable equity securities are based on quoted market prices in active markets for identical assets, which are classified as Level 1 measurements.
Investments in limited partnerships recorded at fair value are investments in private equity and hedge funds. The Company utilizes the fair value option for these investments, regardless of ownership percentage, to standardize the related accounting and reporting.
The fair value for the Company’s investments in private equity and hedge funds is based upon the Company’s proportionate interest in the underlying partnership or fund’s net asset value (NAV), which is deemed to approximate fair value. The Company is generally unable to liquidate these investments during the term of the partnership or fund, which range from five to twelve years. As such, the Company classifies these securities as Level 3 measurements.
The following table presents additional information about assets measured at fair value on a recurring basis and for which significant unobservable inputs (Level 3) were utilized to determine fair value between January 1, 2010 and December 31, 2010:
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 $14.9 for the year ended December 31, 2010. Gross transfers out of Level 3 were $257.3 for the year ended December 31, 2010, of which $250.5 were related to reverse mortgages that are now priced by the Company’s pricing services.
Other is comprised of transactions such as pay downs, calls, amortization, and redemptions, as well as reclassifications between categories.
The following table presents additional information about assets measured at fair value on a recurring basis and for which significant unobservable inputs (Level 3) were utilized to determine fair value between January 1, 2009 and December 31, 2009:
Investments in limited partnerships associated with tax credit investments are carried at amortized cost. Fair value was estimated based on the discounted cash flows over the remaining life of the tax credits. The discount rate used was the original internal rate of return for each investment.
The fair values of the Company’s notes payable were based on nonbinding quotes provided by third-parties. The fair value measurement assumes that liabilities were transferred to a market participant of equal credit standing and without consideration for any optional redemption features.
For the individual life business, the Company has reinsurance agreements that limit the maximum claim on a single individual to $0.5. The reinsurance agreements vary by product and policy issue year. Most of the reinsurance recoverable relates to future policy benefits and is covered by coinsurance agreements where the reinsurer reimburses the Company based on a percentage of claims, which ranges from 50% to 85%, as specified in the reinsurance contracts.
The Company reinsures 100% of its group long-term and short-term disability income business, except for short-term disability income insurance sold within the limited benefit medical plan, which is not reinsured. The reinsurer is responsible for paying all claims.
The Company evaluates the financial condition of its reinsurers to minimize its exposure to losses from reinsurer insolvencies. The Company is not aware of any of its major reinsurers currently experiencing material financial difficulties. The Company analyzes reinsurance recoverables according to the credit ratings of its reinsurers. Of the total amount due from reinsurers as of both December 31, 2010 and 2009, 99.6% was with reinsurers rated A- or higher by A.M. Best. The Company had no reserve for uncollectible reinsurance in 2010 or 2009.
Total policy fees and contract charges represents amounts charged to policyholders other than premiums and recorded in policy fees, contract charges, and other on the consolidated statements of income. This primarily consists of cost of insurance charges.
Ceded reinsurance reduced policyholder benefits and claims by $51.0, $54.1 and $54.3 for the years ended December 31, 2010, 2009 and 2008, respectively.
The CENts are unsecured junior subordinated obligations. The Company can redeem the CENts at its option, in whole or in part, on October 15, 2017, and on each interest payment date thereafter at a redemption price of 100% of the principal amount being redeemed plus accrued but unpaid interest. The Company can redeem the CENts at its option, prior to October 15, 2017, in whole or in part, at a redemption price of 100% of the principal amount being redeemed or, if greater, a make-whole price, plus accrued and unpaid interest.
In connection with the offering of the CENts, the Company entered into a “replacement capital covenant” for the benefit of the holders of the $300.0 senior notes due April 1, 2016 (see below). Under the terms of the replacement capital covenant, the Company may not redeem or repay the CENts prior to October 15, 2047 unless the redemption or repayment is financed from the offering of replacement capital securities, as specified in the covenant.
In 2010, the Company removed its balance of $0.5 in unrecognized tax benefits related to tax positions of prior years. The Company does not expect the total amount of unrecognized tax benefits for any tax position to change significantly within the next twelve months.
Net of taxes of $305.6, $599.5 and $(615.3) for the years ended December 31, 2010, 2009 and 2008, respectively.
Net of taxes of $(17.3), $13.4 and $55.5 for the years ended December 31, 2010, 2009 and 2008, respectively. For the years ended December 31, 2010 and 2009, $24.8 (net of taxes of $13.3), and $30.5 (net of taxes of $16.4), respectively, of the reclassification adjustment is related to losses previously classified as other-than-temporary impairments not related to credit losses.
Net of taxes of $(30.7), $(44.2) and $10.0 for the years ended December 31, 2010, 2009 and 2008, respectively.
Represents shares repurchased during the second quarter of 2010 and subsequently retired, pursuant to the Company’s Equity Plan.
As of December 31, 2010, the Company had two stock-based compensation plans: the Symetra Financial Corporation Equity Plan, amended and restated on August 11, 2010, (the “Equity Plan”) and the Symetra Financial Corporation Employee Stock Purchase Plan, amended and restated on May 11, 2010, (the “Stock Purchase Plan”). Under the Equity Plan, the Company is authorized to issue various types of stock-based compensation to employees, directors and consultants. A total of 7.830 shares are authorized for issuance under the Equity Plan, and 4.602 equity instruments are available for future issuance as of December 31, 2010. The Stock Purchase Plan allows eligible employees to purchase shares of the Company’s common stock at a 15% discount from the market price. A total of 0.870 shares are authorized for issuance under this plan. As of December 31, 2010, 0.837 shares are available for future issuance under the Stock Purchase Plan.
The Company issued 0.274 and 0.083 shares of restricted stock for the years ended December 31, 2010 and 2009, respectively. These awards vest over a weighted average period of 2.6 and 2.4 years. The weighted average fair value of restricted stock granted for the years ended December 31, 2010 and 2009 was $12.25 and $13.08 per share, respectively. The total fair value of restricted stock vested during the year ended December 31, 2010 was $1.6. No restricted stock vested during the year ended December 31, 2009. The Company did not issue restricted stock awards in 2008 or prior.
The Company issued 2.950 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 fair value of awards granted during the year ended December 31, 2010 was $2.73 per share.
The following table summarizes the weighted average assumptions used to value stock options issued:
As of December 31, 2010, the Company was invested in 16 limited partnership interests related to tax credit investments, five of which were entered into in 2010. The Company unconditionally committed to provide capital contributions totaling approximately $197.4, of which the remaining $66.0 is expected to be contributed over a period of three years. Capital contributions of $131.4 were paid as of December 31, 2010, with the remaining expected cash capital contributions as follows:
The Company has also committed to invest $47.5 in four private equity funds, of which $36.0 had been made through December 31, 2010. The Company will provide capital contributions to the partnerships up to the committed amount at the discretion of the general partners, subject to certain incremental contribution limits. The remaining term of the capital commitments range up to 3 years, ending in 2013.
The Company has office space and certain equipment under leases that expire at various dates through 2016. Certain of the leases include renewal options. The Company accounts for these leases as operating leases.
Rent expense was $7.1, $7.9, and $8.0 for the years ended December 31, 2010, 2009 and 2008, respectively.
The Company has a service agreement with a third party service provider to outsource the majority of its information technology infrastructure. The initial term of the service agreement expires in July 2014, subject to early termination in certain cases, with two one-year extensions at the Company’s election. Under the terms of the service agreement, the Company agreed to pay an annual service fee ranging from $10.6 to $11.4 for five years. The Company incurred service fee expenses of $10.7, $11.2 and $11.8 for the years ended December 31, 2010, 2009 and 2008, respectively.
As of December 31, 2010 the Performance Share Plan has one remaining active plan, which is scheduled to end on December 31, 2011. For the 2010 fiscal year incentives were provided as performance unit grants under the Equity Plan (see below).
The value of each performance unit is determined at the discretion of the Company’s Board of Directors based on the long-term success of the Company over a three-year period. These are accounted for as liability awards as the Company intends to settle such awards in cash. The Company recognized $1.5 in expense related to performance units granted during 2010.
The Company paid cash dividends totaling $20.6, or $0.05 per share, to its stockholders and warrant holders of record during the year ended December 31, 2010. No dividends were paid during the years ended December 31, 2009 and 2008.
The Company’s insurance 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. Accordingly, based on statutory limits as of December 31, 2009, the Company was eligible to receive dividends from its insurance subsidiaries during 2010 without obtaining regulatory approval as long as the aggregate dividends paid over the twelve months preceding any dividend payment date in 2010 did not exceed $141.5. The total amount of dividends received by the Company from its insurance subsidiaries during 2010 was $40.0. Based on state regulations as of December 31, 2010, the Company is eligible to receive dividends from its insurance subsidiaries during 2011 without obtaining regulatory approval as long as the aggregate dividends paid over the 12 months preceding any dividend payment date in 2011 do not exceed $194.0.
Life and health insurance companies are subject to certain risk-based capital requirements as specified by the NAIC. Under those requirements, the amount of capital and surplus maintained by a life and health insurance company is to be determined based on various risk factors related to it. At December 31, 2010 and 2009, Symetra Life Insurance Company and its subsidiaries met the minimum risk-based capital requirements.
Deferred Annuities. Deferred Annuities offers fixed and variable deferred annuities to consumers who want to accumulate tax-deferred assets for retirement.
The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies (see Note 2). The Company allocates capital and related investment income to each segment using a risk-based capital formula.
The unaudited quarterly results of operations for years ended December 31, 2010 and 2009 are summarized in the table below.
Quarterly earnings per share amounts may not add to the full year amounts due to share weighting and rounding.