We are a financial services company in the life insurance industry providing employee benefits, annuities and life insurance through a national network of benefits consultants, financial institutions and independent agents and advisers. Our operations date back to 1957, and many of our distribution relationships have been in place for decades.
The level and movement of interest rates are among the most important economic factors that we must consider in the management of the Company and establishment of future strategic direction. We continue to be impacted by the low interest rate environment in the U.S. Interest rates have been held to historically low levels by the Federal Reserve in an effort to drive a stronger economic recovery. In December 2012, the Federal Reserve announced plans to purchase longer-term U.S. Treasury securities outright, at a pace of $45 billion per month. Furthermore, they reaffirmed plans to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month. This announcement followed the conclusion of “Operation Twist”, which involved buying longer-term U.S. Treasury securities and simultaneously selling shorter-dated issues in order to bring down interest rates. These programs place downward pressure on interest rates, and the Federal Reserve intends to keep rates low until certain economic indicators are met, including a reduction in the unemployment rate. Although we have seen slight increases in interest rates in early 2013, as the ten-year Treasury rate reached 2.0%, we expect interest rates to remain low throughout 2013 and into 2014.
The low interest rate environment compresses margins on our annuity and life insurance businesses and slows our pace of growth. Our fixed annuity, SPIA, universal life and BOLI products expose us to the risk that declines in interest rates will reduce our interest spread, or the difference between the investment yield we earn and the interest rate we credit to policyholders on our products. Low interest rates have also had, and will continue to have, a negative impact on sales of these products, and may cause us to suspend sales of certain products. We experienced a nearly 40% decrease in sales in our Deferred Annuities segment in 2012 compared to 2011, which we believe was primarily driven by the low interest rate environment.
We have certain older in-force business that offers higher guaranteed interest rates, and we anticipate policyholder lapses on these contracts may be lower than expected.
We are unable to reduce the benefit payments on our immediate annuities.
The success of our business and the successful execution of our strategies may be affected by the factors discussed in Item 1A - “Risk Factors” and other factors as discussed herein.
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”). U.S. GAAP establishes a fair value hierarchy that distinguishes between inputs based on market data from independent sources (“observable inputs”) and a reporting entity’s internal assumptions based upon the best information available when external market data is limited or unavailable (“unobservable inputs”). The fair value hierarchy prioritizes fair value measurements into three levels based on the nature of the inputs. The level in the fair value hierarchy within which the fair value measurement falls is determined based on the lowest level input that is significant to the fair value measurement. For further discussion of the levels of the fair value hierarchy, see Note 6 to the consolidated financial statements.
We use our judgment in assigning our fixed maturities to a level within the fair value hierarchy by determining whether significant pricing inputs are observable and if the market for a given security is active. When we have significant observable market inputs, which is the case when the security is priced by our pricing services, it is classified as a Level 2 measurement. If our pricing services determine that they do not have sufficient objectively verifiable information about a security, they will not provide a valuation for that security, and the security’s fair value is determined internally.
As of December 31, 2012 and 2011, $819.6, or 3.5%, and $936.4, or 4.1%, respectively, of our fixed maturities portfolio was invested in private placement securities. The fair values of these assets are determined internally, typically using a matrix pricing approach. The significant inputs are observable, including the base credit spread, treasury yield and expected future cash flows of the security. The measurement also uses an illiquidity spread, which ranges from 0 to 25 basis points and is based on the credit quality of the security. The illiquidity spread is an unobservable input, but it does not significantly impact the resulting valuation. As a result, we classify these measurements as Level 2. In limited situations, private placement securities are valued through the use of a single broker quote and, in such situations, we consider the fair value a Level 3 measurement.
Fixed maturities categorized as Level 3 investments were $130.7 and $187.2 as of December 31, 2012 and 2011, respectively. As of December 31, 2012 and 2011, we had net unrealized gains of $18.0 and $15.8, respectively, on our Level 3 fixed maturities. For the year ended December 31, 2012 and 2011, we reported net realized losses of $1.6 and $4.5, respectively, on our Level 3 fixed maturities.
we do not expect to recover the amortized cost basis of the security, based on our estimate of cash flows expected to be collected; or
We defer as assets certain policy acquisition costs, including commissions, distribution costs and other underwriting costs related to the production of new and renewal business. When our DAC asset is amortized, it reduces income. We also defer as assets certain sales inducements, including inducement interest, which are included within other assets on our consolidated balance sheets. When our DSI asset is amortized it increases interest credited and reduces income.
On January 1, 2012, we retrospectively adopted a new accounting standard related to the deferral of policy acquisition costs. While we have restated DAC amortization to reflect the retrospective reduction in costs deferred, our policies and methodology have not changed. For more information on the impact of adoption, see Note 2 to the consolidated financial statements. This new accounting standard did not impact the accounting for deferred sales inducements.
Under the new standard, we defer only costs that are directly related to the successful acquisition or renewal of insurance contracts, including:
The portion of the salaries and benefits related to employee time spent on the processing of successfully acquired new and renewal contracts.
The identification of internal costs directly related to the successful acquisition or renewal of a contract involved significant judgment and estimates. All other acquisition-related costs, including costs incurred for soliciting potential customers, managing distribution and underwriting functions, training, administration, unsuccessful acquisition or renewal efforts, market research and product development are not deferrable and are expensed in the period incurred. Additionally, upon adoption, policy acquisition costs in our Benefits segment are no longer being deferred, as the application of the new standard to the short-duration contracts in this segment resulted in an immaterial net impact of deferral of acquisition costs on the consolidated financial statements.
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 and DSI asset amortization models. This is often referred to as “unlocking” the amortization models. For the year ended December 31, 2012, we recorded net pre-tax adjustments totaling $(2.6) and $(1.0) related to DAC and DSI unlocking, respectively. We also revise future assumptions as needed throughout the year if a significant transaction or trend is identified that would warrant a change in those assumptions.
if we increased our future lapse and withdrawal rate assumptions by a factor of 10%, the DAC asset balance would decrease approximately $6.0;
if we increased our future expense assumptions by a factor of 10%, the DAC asset balance would decrease approximately $0.5.
We periodically compare our actual experience with our estimates of actuarial liabilities for future policy benefits. To the extent that actual policy benefits differ from the reserves established for future policy benefits, such differences are recorded in the consolidated statements of income in the period in which the variances occur, which could result in a decrease in profits, or possibly losses. No revisions to assumptions within the future policy benefits liabilities have been necessary and therefore we have not experienced any significant impact in our financial results due to changes in assumptions.
Liabilities for policy and contract claims primarily represent liabilities for claims under group medical stop-loss coverages and are established on the basis of reported losses. We also provide for claims incurred but not reported (IBNR) based on expected loss ratios, claims paying completion patterns and historical experience. We continually review estimates for reported but unpaid claims and IBNR. Any necessary adjustments are recorded in the consolidated statements of income in the period in which the variance occurs. If expected loss ratios increase or expected claims paying completion patterns extend, the IBNR amount increases. While we make a best estimate at each reporting period, we may still experience volatility due to uncertainty inherent in the underlying estimates. For example, in 2012, our incurred claims related to previous years developed favorably by $9.5, or 5.9% of net reserves at December 31, 2011.
For a discussion of recently adopted and not yet adopted accounting pronouncements, see Note 2 to the accompanying consolidated financial statements.
Policy fees, contract charges and other includes cost of insurance (COI) charges on our UL 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, changes in fair value on our trading portfolio and changes in fair value of our FIA options and related FIA embedded derivative.
Pre-tax adjusted operating income is adjusted operating income on a pre-tax basis. It also represents the cumulative total of segment pre-tax adjusted operating income, which at the segment level is a GAAP measure. Income from operations before income taxes is the most directly comparable GAAP measure to pre-tax adjusted operating income. In presenting pre-tax adjusted operating income, we are excluding pre-tax net realized investment gains (losses), except pre-tax net realized investment gains (losses) on FIA.
We believe investors find it useful if we present them with a financial measure that removes from stockholders’ equity these temporary and unrealized changes in the fair values of our investments, and the related effects on AOCI. By evaluating our adjusted book value, an investor can assess our financial condition based on our general practice of holding our fixed investments to maturity. Additionally, by translating this measure into adjusted book value per common share, we allow the investor to assess its proportionate stake in our adjusted book value as of the dates presented, and the change in such measures over time.
In addition to using adjusted book value and adjusted book value per common share to evaluate our financial condition, our management and board of directors have other uses for these measures, including reviewing debt levels as a percentage of adjusted book value to monitor compliance with revolving credit facility covenants and to evaluate and review our ratings from rating agencies. Finally, our board of directors uses adjusted book value as a basis to measure the success of our Company over historical periods and reviews management’s financial plans based on the projected growth in adjusted book value.
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 as one of the key measures 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.
(1) Basic net income and adjusted operating income per common share include all participating securities using the two-class method. Diluted net income and adjusted operating income per common share include the dilutive impact of non-participating securities, based on the application of the treasury stock method. Shares included in these calculations are weighted for the portion of the period they were outstanding. Antidilutive awards were excluded from the computation of diluted earnings per share.
Net realized investment gains increased $23.9, driven by mark-to-market net gains on our equity securities. Net equity gains were $36.7 for the year ended December 31, 2012 compared to losses of $9.1 for the same period in 2011. This was partially offset by a $14.9 increase in impairments, which were $29.0 for the year ended December 31, 2012, compared to $14.1 for the same period in 2011. For further discussion of our investment results and portfolio refer to - “Investments.”
Pre-tax adjusted operating income declined $25.5 from 2011. We experienced lower earnings in two of our four business segments and higher losses in our Other segment. Our earnings results reflect a $42.6 increase in other underwriting and operating expenses over 2011 expense levels. This is primarily due to higher employee-related and professional services expenses related to our Grow & Diversify initiatives.
Our Benefits segment’s profitability decreased $8.6 for the year ended December 31, 2012, compared to the same period in 2011. This was driven by operating expenses related to our group life and disability income business, a Grow & Diversify initiative. Also contributing to the decline was a higher loss ratio on a larger block of medical stop-loss business.
Our Income Annuities segment’s profitability increased $9.9 on mortality gains of $12.9 in 2012, compared to $0.3 for 2011, which was partially offset by the impact of decreased funding services activity.
Our Other segment’s losses increased $15.4 primarily due to lower net investment income related to our tax credit investments and higher operating expenses. Tax credit investments reduce investment income, but provide tax benefits that help decrease our effective tax rate.
Net income increased $2.0 as a result of higher pre-tax adjusted operating income, offset by lower net realized investment gains. In addition, the provision for income taxes decreased $7.1 primarily due to lower pre-tax income and an increase in tax credits, which drove a lower effective tax rate, 28.3% for the year ended December 31, 2011 compared to 30.4% for 2010.
Net realized investment gains decreased $32.9. This was driven by net equity losses related to fair value declines, partially offset by lower impairments of $6.8. Net equity losses were $9.1 in 2011, compared to net gains of $32.6 for the same period in 2010. For further discussion of our investment results and portfolio, including a discussion of our impairment losses, refer to “- Investments” below.
Segment pre-tax adjusted operating income decreased $8.6, primarily the result of increased operating expenses related to the expansion of our group life and disability operations. Also contributing to the decline was a higher loss ratio on a larger block of medical stop-loss business. The loss ratio, which was in line with our long-term target range, increased to 65.1% for the year ended December 31, 2012, compared to 63.1% for the same period in 2011. Growth in our block of medical stop-loss business was a result of strong sales and premium related to the block of business acquired in July 2011.
Policyholder benefits and claims increased $54.2 driven by growth in our medical stop-loss business, including the block of business acquired in July 2011. Also contributing to the increase was higher limited benefit medical claims for 2012, compared to 2011.
Segment pre-tax adjusted operating income increased $7.9, primarily the result of an improved loss ratio and the block of business acquired in July 2011. For the year ended December 31, 2011, the loss ratio improved to 63.1%, compared to 64.9% for the same period in 2010, which was driven by a focus on pricing discipline during our 2010 and 2011 policy year renewals.
Premiums increased $67.9 driven by the block of business acquired in July 2011 and a $9.2 increase in limited benefit medical premiums, a result of higher sales.
Policyholder benefits and claims increased $34.8 primarily driven by the block of business acquired in July 2011. Overall, the loss ratio decreased from 2010, which reflects a lower frequency and severity of claims as well as our pricing discipline during our 2010 and 2011 policy year renewals.
segment. The credited rate is the approximate rate credited on policyholder fixed account values. Interest credited is subject to contractual terms, including minimum guarantees.
(3) Total sales represent deposits for new policies net of first year policy lapses and/or surrenders.
Deferred Annuities’ sales decreased 37% in 2012 compared to 2011. This was primarily the result of the low interest rate environment, which we believe has driven a decline in overall industry sales of deferred annuities and increased competition for customers.
Net investment income increased $19.6, driven by a $0.9 billion increase in average invested assets due to higher fixed annuities account values. This growth was partially offset by lower portfolio yields, which was the result of lower yields on recent fixed maturity purchases and commercial mortgage loan originations, and prepayments of higher yielding assets. We received prepayment-related income of $11.9, net of related DAC and DSI amortization, compared to $9.2 in 2011.
Other underwriting and operating expenses increased $11.6, primarily related to expenses associated with our True VA product.
Net investment income increased $64.7, driven by a $1.5 billion increase in average invested assets from increased fixed annuities account values. In addition, we received $14.0 of investment prepayment related income, primarily in the fourth quarter of 2011. The growth in average invested assets was partially offset by lower yields on fixed maturity purchases.
Interest credited increased $28.9, primarily due to a $1.4 billion increase in fixed annuities account values. The higher account values also drove a $10.9 increase in DAC amortization. Additionally, DAC and DSI amortization related to investment prepayment income received in the fourth quarter of 2011 increased interest credited and DAC amortization.
(2) Interest spread is the difference between the net investment yield and the credited rate to policyholders. The net investment yield is the approximate yield on invested assets in the general account attributed to the segment. The credited rate is the approximate rate credited on policyholder reserves.
(5) Mortality gains (losses) represent the difference between actual and expected reserves released on our life contingent annuities.
(6) Total sales represent deposits for new policies net of first year policy lapses and/or surrenders.
Segment pre-tax adjusted operating income increased $9.9 primarily due favorable mortality experience. Mortality gains increased to $12.9 for 2012, compared to gains of $0.3 for 2011. In addition, fee revenue earned on sales of third-party structured settlements increased $4.3 compared to 2011, due to significantly higher sales. These increases were partially offset by decreased funding services activity and lower reserves.
In addition to the drivers discussed above, we consider the following information regarding benefits and expenses useful in understanding our results.
Net investment income decreased $3.2 due to lower average invested assets and lower yields. Policy fees, contract charges, and other increased $5.0 primarily from fee revenue earned on increased sales of third-party structured settlements. The sales agreement with the third party was terminated in early 2013.
(4) UL base interest spread excludes SPL and is UL interest spread adjusted to exclude items that can vary significantly from period to period due to a number of factors and, therefore, may contribute to results that are not indicative of underlying trends. This is primarily the impact of asset prepayments, such as bond make whole premiums net of related bonus interest amortization, the MBS prepayment speed adjustment and reserve adjustments.
(5) Individual sales represents annualized first year premiums for recurring premium products, and 10% of new single premium deposits net of first year policy lapses and/or surrenders.
(7) BOLI base ROA is BOLI ROA adjusted to exclude items that can vary significantly from period to period due to a number of factors and, therefore, may contribute to yields that are not indicative of the underlying trends. This is primarily the impact of asset prepayments, such as bond make whole premiums, the MBS prepayment speed adjustment, and reserve adjustments.
Segment pre-tax adjusted operating income decreased $18.3 primarily driven by higher individual claims experience, a lower BOLI ROA due to higher BOLI claims and lower investment yields, and higher expenses related to our Grow & Diversify initiatives.
Premiums decreased $3.2 due to lapses on our older term business and decreased term sales.
Policy fees, contract charges, and other increased $5.5 due to higher COI and administrative fees on larger blocks of business for our BOLI and UL products.
Benefit-related expenses (policyholder benefits and claims, and interest credited) increased $8.8, which was primarily driven by higher individual claims as well as an increase in interest credited on higher BOLI account values, which offsets the increased BOLI COI revenue charges noted above. Individual life claims, which fluctuate from period to period, increased $6.7 million over 2011, though mortality was in line with expectations. These increases were partially offset by lower claims on our BOLI general account block of business and reserve modifications in 2011, which increased 2011 benefit-related expenses by $1.9.
Other underwriting and operating expenses increased $6.1 due to higher employee-related expenses, primarily associated with our Grow & Diversify initiatives.
Benefits and expenses increased $30.5 partially due to a bonus reserve decrease in 2010, which reduced total benefits and expenses by $7.4, which included the impact on DAC amortization.
Excluding the effects of the bonus reserve decrease, interest credited and policyholder benefits and claims increased $15.7. This was primarily due to an increase in BOLI account value, which also contributed to an increase in DAC amortization. Reserve modifications reduced policyholder benefits and claims by $2.1 and increased interest credited $4.0, for a net impact of $1.9. In addition, other underwriting and operating expenses increased $5.5 due primarily to employee-related expenses.
Our Other segment reported pre-tax adjusted operating losses of $26.1 for the year ended December 31, 2012 compared with losses of $10.7 for 2011. This decline in results was due to lower net investment income, mainly related to tax credit and private equity fund investments, and higher operating expenses primarily related to our exploration of acquisition opportunities that did not come to fruition.
Our Other segment’s pre-tax adjusted operating loss of $10.7 for the year ended December 31, 2011 improved $0.7 from a loss of $11.4 for 2011. Policy fees, contract charges, and other increased $4.2 due to higher broker-dealer concession revenue and advisory fees, which were partially offset by a $3.2 increase in related commissions.
(3) Investments in private equity funds are carried at fair value, and our tax credit investments are carried at amortized cost.
(2) The negative impact from the tax credit investments is offset by U.S. federal income tax benefits. The total impact to net income was $17.0, $6.2 and $4.6 for the years ended December 31, 2012, 2011 and 2010, respectively. For further discussion, see - “Investments in Limited Partnerships - Tax Credit Investments.”
(3) Other income producing assets includes other invested assets, short-term investments and cash and cash equivalents.
We also continue to experience prepayment activity and related prepayment income as a result of the low interest rate environment. Prepayment-related income includes make-whole premiums and consent fees on early calls or tenders of fixed maturities, prepayment speed adjustments on structured securities, and prepayment fees on our commercial mortgage loans. This income generated approximately 10bps of yield in both 2012 and 2011. Prepayment activity usually stems from higher-yielding investments, resulting in cash inflows which are then typically reinvested into lower-yielding new assets, placing downward pressure on our investment income and yields.
partially offset by a $6.8 improvement in impairments. The decline in impairments from 2011 to 2010 was primarily attributable to improved economic conditions and reduced credit concerns, as credit-related impairments decreased $9.8.
Fixed maturities represented approximately 85% and 88% of invested assets as of December 31, 2012 and 2011, respectively. The majority of our fixed maturities are invested in highly marketable or publicly traded securities. We also invest in privately placed fixed maturities to enhance the overall value of the portfolio and obtain higher yields than can ordinarily be obtained with comparable public market securities. As of December 31, 2012, privately placed fixed maturities represented 3.5% of our total fixed maturity portfolio at fair value.
amortized cost of $513.4 and a fair value of $543.4, with gross unrealized losses of $4.2 as of December 31, 2011. As of December 31, 2012, $508.1, or 95.7%, of the fair value of fixed maturities supported by guarantees from monoline bond insurers had investment grade credit ratings both with the monoline insurance and on a standalone basis. The credit ratings of our fixed maturities set forth in the table above reflect, where applicable, the guarantees provided by monoline bond insurers.
Our fixed maturities holdings are diversified by industry and issuer, and the portfolio does not have significant exposure to any single issuer. As of December 31, 2012 and 2011, the fair value of our ten largest corporate securities holdings was $1,555.0 and $1,505.0, or 9.0% and 9.3% of the portfolio, respectively. As of December 31, 2012, the fair value of our largest exposure to a single issuer of corporate securities was $240.6, or 1.4% of total corporate securities. All of the securities related to this issuer have an NAIC rating of 1. As of December 31, 2011, the fair value of our largest exposure to a single issuer of corporate securities was $221.5, or 1.4%, all of which had an NAIC rating of 2 or higher.
Additionally, as of December 31, 2012, our investments in U.S. government and agency securities increased $224.3, to $311.5 from $87.2 as of December 31, 2011. The increase is due to higher holdings of U.S. treasury securities, which were purchased with excess cash to obtain higher yields until suitable investments are found. Our investments in agency RMBS decreased $574.5, to $2,688.3 as of December 31, 2012 compared to $3,262.8 as of December 31, 2011. During 2012, we executed our investment strategy of selling lower yielding, higher premium agency RMBS to manage our prepayment risk exposure, which reduced RMBS holdings.
As of December 31, 2012 and 2011, the fair value of our fixed maturities in European countries was 7.0% and 6.1% of our total fixed maturities portfolio, respectively. Our gross unrealized losses on these securities decreased to $4.1 as of December 31, 2012, compared to $32.9 as of December 31, 2011, due to decreased concerns over the European debt crises and sales and tender activity in 2012. The fair value of our ten largest European security holdings was $920.7, or 3.9% of the fixed maturities portfolio as of December 31, 2012, and $836.1, or 3.7%, as of December 31, 2011. The fair value of our largest single issuer exposure to a European country was $125.0 and $116.0 as of December 31, 2012 and 2011, respectively, or 0.5% of the portfolio for both years.
As of December 31, 2012 and 2011, approximately 61% and 78%, respectively, of the gross unrealized losses on our investment portfolio related to these longer duration assets, which fluctuate more significantly with changes in interest rates and credit spreads. Refer to Note 4 to the accompanying consolidated financial statements for a table summarizing the amortized cost and fair value of fixed maturities by contractual years to maturity as of December 31, 2012.
Our mortgage-backed securities are primarily agency securities, which account for approximately 65% of the portfolio. Additionally, approximately 27% of our mortgage-backed securities are AAA-rated non-agency securities in the most senior tranche of the structure type.
All of our RMBS and CMBS have prepayment options. Prepayments that vary from our estimates in amount or timing cause fluctuations in our yields due to an acceleration or deceleration of unamortized premium or discount associated with the securities in our portfolio. These adjustments, which relate primarily to RMBS, are recorded in net investment income in our results of operations and create volatility between periods. Refer to the RMBS section below for additional discussion.
We classify our investments in RMBS as agency, prime, Alt-A, and subprime. Agency RMBS are guaranteed or otherwise supported by the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, or the Government National Mortgage Association. Prime RMBS have underlying loans to customers with good quality credit profiles. Alt-A RMBS have overall credit quality between prime and subprime, based on a review of their underlying mortgage loans and factors such as credit scores and financial ratios.
The following table sets forth the total fair value and amortized cost of our non-agency RMBS by year of origination (vintage) and credit quality, based on the highest rating by Moody’s, S&P, or Fitch. There were two securities with a total amortized cost and fair value of $21.2 and $21.1, respectively, that were rated below investment grade by either Moody’s, S&P or Fitch, while at least one other agency rated them investment grade.
As of December 31, 2012, our RMBS had gross unamortized premiums and discounts of $53.4 and $62.3, respectively. Changes in prepayment speeds, which are based on prepayment activity of the underlying mortgages, create volatility in our net investment income because they accelerate or decelerate our amortization of the unamortized premiums and discounts. The impact to net investment income is dependent on whether the securities are at a discount or premium and whether the prepayment speeds increase or decrease.
There are various U.S. government initiatives through the Making Home Affordable program that may result in higher than expected prepayments on our RMBS portfolio. For example, changes to HARP (Home Affordable Refinance Program) that went into effect in late 2011, have been effective in increasing refinancing for certain borrowers. Additionally, the extension of HAMP (Home Affordable Modification Program) through 2013 may impact prepayments.
During the year ended December 31, 2012, we strategically sold $382.7 of lower yielding, higher premium agency RMBS securities for gains totaling $21.3 while reducing future reinvestment risk. We continually monitor the underlying collateral in our RMBS to manage our prepayment exposure.
The following table sets forth the fair value of our investment in CMBS and the percentage of total invested assets they represent:
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 15 securities having a fair value of $337.4 and an amortized cost of $288.2 that were rated AAA by either S&P, Moody’s or Fitch, that were given a lower rating by at least one other agency. None of these securities were rated below investment grade by any of the three agencies.
As of December 31, 2012, our CMBS portfolio was highly concentrated in the most senior tranches, with 97.2% of our AAA-rated securities in the most senior tranche, based on amortized cost, and had significant credit enhancement. The senior class has priority over the mezzanine and junior classes to all principal and interest cash flows and will not experience any loss of principal until both the entire mezzanine and junior tranches are written down to zero.
Further, as of December 31, 2012 and 2011, 70.5% and 71.6%, respectively, of our mortgage loans had an outstanding balance under $5.0.
Further, for loans originated in the year ended December 31, 2012, 31.1% had an LTV ratio of 50% or less, and 71.6% had a DSCR of 1.60 or more. For loans originated in the year ended December 31, 2011, 23.2% had an LTV ratio of 50% or less, and 56.0% had a DSCR of 1.60 or more. The DSCR on loans funded in 2012 generally increased over loans funded in 2011. Lower interest rates on 2012 originations reduced the amount required for debt service and resulted in a higher weighted-average DSCR.
The following sections provide more information on the composition of our mortgage loan portfolio. On our consolidated balance sheets, mortgage loans are reported net of an allowance for losses, deferred loan origination costs, and unearned mortgage loan fees; however, the following tables exclude these items.
The LTV 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 (MAI) designated appraisers. Subsequent to the year of funding, LTV ratios are updated annually using internal valuations based on property income and estimated market capitalization rates. Property income estimates are typically updated during the third quarter of each year. Market capitalization rates are updated during the first quarter based on geographic region, property type and economic climate. LTV ratios greater than 100% indicate that the loan amount is greater than the collateral value. A smaller LTV ratio generally indicates a higher quality loan.
The following table sets forth the DSCRs for our gross mortgage loan portfolio:
factors specific to the activities of our borrowers as well as the interest rate environment. However, we believe our yield maintenance provisions mitigate prepayments in a low interest rate environment.
We invest in limited partnership interests related to tax credit investments, which are typically 15-year investments that provide tax credits in the first ten years. We amortize these investments over the period in which partnership losses are expected to be recognized. The amortization schedule for each investment is updated periodically as new information related to the amount and timing of losses is received.
On February 1, 2013, the board of directors authorized the repurchase of up to 10.0 shares of Symetra’s outstanding common stock. Symetra plans to fund this program mainly through dividends from its subsidiaries. Refer to Item 5 - “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” for further information about the repurchase program.
As of December 31, 2012, our primary life insurance company, Symetra Life Insurance Company, had a risk-based capital ratio of 486%. This provides adequate capital levels for growth of our business.
During the fourth quarter 2012 we completed our cash flow testing to assess statutory reserve adequacy. As a result of our analysis, we established a $25.0 statutory reserve as of December 31, 2012, to address the risk related to low interest rates. The risk is mainly related to our structured settlement annuity and SPIA blocks of business, which represent long-duration liabilities that are interest rate sensitive. The testing was run over a set of deterministic and stochastic scenarios. The Company believes that the statutory reserves are adequate under a set of moderately adverse scenarios. This level of statutory reserve decreased statutory capital by $16.3 and reduced our risk-based capital ratio by four points. The $60.0 statutory reserve established as of December 31, 2011 was released in the first quarter of 2012, when a permanent valuation reserve of $60.0 was established. In the third quarter of 2012, this reserve was increased by $29.3. Neither the statutory reserve nor the permanent valuation reserve impacts our consolidated GAAP financial statements.
(3) Represents incurred but not reported claim liabilities, mainly related to our medical stop-loss business. The surrender value on these contracts is generally zero but these liabilities are considered illiquid as the claims have not been reported to us and the precise timing and amount of the payment is unknown.
(6) Represents BOLI, traditional insurance, medical stop-loss and group life reported claim liabilities.
(7) 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 $206.0 and $232.9 as of December 31, 2012 and 2011, respectively.
On October 10, 2007, we issued $150.0 aggregate principal amount CENts with a scheduled maturity date of October 15, 2037 and, subject to certain limitations, with a final maturity date of October 15, 2067. We issued the CENts at a discount yielding $149.8. For the initial ten-year period following the original issuance date, to but not including October 15, 2017, the CENts carry a fixed interest rate of 8.300% payable semi-annually. From October 15, 2017 until the final maturity date of October 15, 2067, interest on the CENts will accrue at a variable annual rate equal to the three-month LIBOR plus 4.177%, payable quarterly.
On December 14, 2011, we entered into a $300.0 senior unsecured revolving credit agreement with a syndicate of lending institutions led by JPMorgan Chase Bank, N.A. The credit facility, which replaced a previous $200.0 facility, also provides access up to an additional $100.0 of financing, subject to the availability of additional commitments. The credit facility matures on December 14, 2015, and loans under this facility bear interest at a variable annual rate based on adjusted LIBOR or the alternate base rate (“ABR”) plus an applicable margin. This facility requires us to maintain specified financial ratios, and includes other customary restrictive and affirmative covenants. This revolving credit facility is available to provide support for working capital, capital expenditures and other general corporate purposes as needed.
The payment of dividends and other distributions to Symetra by its insurance subsidiaries is controlled by insurance laws and regulations. In general, dividends in excess of prescribed limits are deemed “extraordinary” and require insurance regulatory approval. During the years ended December 31, 2012, 2011 and 2010, Symetra received dividends of $80.0, $52.0, and $40.0, respectively, from its insurance subsidiaries. We expect dividends to increase in the future to support the stock repurchase program. Based on our statutory results, as of
We declared and paid a quarterly dividend of $0.07 per common share to shareholders and warrant holders during each quarter of 2012, for a total payout of $38.8.
Cash flows from our operating activities are primarily driven by the amounts and timing of cash received for income on our investments, including dividends and interest, and premiums on our group insurance and term life insurance products, as well as the amounts and timing of cash disbursed for our payment of policyholder benefits and claims, underwriting and operating expenses and income taxes. The following discussion highlights key drivers in the level of cash flows generated from our operating activities:
Years Ended December 31, 2012 and 2011. Net cash used in investing activities decreased $778.6 compared to 2011. This decrease was primarily the result of higher sales of fixed maturities, related to active management of our portfolio to increase investment yields, and lower originations of mortgage loans.
Cash flows from our financing activities are primarily driven by the amounts and timing of cash received from deposits into certain life insurance and annuity policies and proceeds from our issuances of common stock, as well as the amounts and timing of cash disbursed to fund withdrawals from certain life insurance and annuity policies, and dividend distributions to our stock and warrant holders. The following discussion highlights key drivers in the level of cash flows from our financing activities:
Years Ended December 31, 2012 and 2011. Net cash used in financing activities for 2012 was $253.4, in comparison to cash provided by financing activities of $628.1 in 2011. This change was primarily driven by lower policyholder deposits, mainly related to fixed annuities. In addition, there were higher deferred annuity policyholder withdrawals in 2012 compared to 2011 as policies move out of the surrender charge period.
Years Ended December 31, 2011 and 2010. Net cash provided by financing activities for 2011 decreased $919.8 over 2010. This was primarily driven by lower policyholder deposits as there were no BOLI deposits in 2011, compared to $461.0 in 2010, and higher deferred annuity policyholder withdrawals, which we anticipate as polices on a growing block of business move out of the surrender charge period. In addition, we received net IPO proceeds of $282.5 during the first quarter of 2010.
have not included the variable separate account obligations as these obligations are legally insulated from general account obligations and will be fully funded by cash flows from separate account assets.
(3) We have investments in limited partnership interests related to tax credit investments and private equity partnerships. We will provide capital contributions to our private equity partnerships through 2016 with a remaining committed amount of $16.4 at the discretion of the general partner, subject to certain contribution limits. Since the timing of payment is uncertain, the unfunded amount has been included in the payment due in less than one year. For more information, see Note 14 to the consolidated financial statements. Amounts recorded on the balance sheets are included in “other liabilities.”
(4) Includes contractual commitments for a service agreement to outsource the majority of our information technology infrastructure. For more information, see Note 14 to the consolidated financial statements.
(5) Primarily comprised of unfunded mortgage loan commitments of $64.4, as of December 31, 2012.
We have derivative instruments with off-balance-sheet risks whose notional or contractual amounts exceed their fair value. For further information on our derivative instruments, see Note 4 in the accompanying notes to the consolidated financial statements. We do not have any off-balance sheet arrangements that are reasonably likely to have a material effect on our financial condition, results of operations, liquidity, or capital resources.
Consolidated Statements of Comprehensive Income for the years ended December 31, 2012, 2011 and
Consolidated Statements of Cash Flows for the years ended December 31, 2012, 2011 and
Notes to Consolidated Financial Statements for the years ended December 31, 2012, 2011 and
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, 2012 and 2011, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2012, 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.
On February 1, 2013, the board of directors authorized the repurchase, at management’s discretion, of up to 10.000 shares of the Company’s outstanding common stock. The timing and amount of any stock repurchases will be determined by management based upon market conditions, regulatory considerations and other factors. No time limit was placed on the duration of the program, which may be modified, extended or terminated by the board of directors at any time. Repurchases may be effected in the open market, accelerated repurchase arrangements, privately negotiated transactions, or otherwise.
The consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles (GAAP), including the rules and regulations of the Securities and Exchange Commission (SEC). The preparation of financial statements in conformity with GAAP requires the Company to make estimates and assumptions that may affect the amounts reported in the consolidated financial statements. All significant intercompany transactions and balances have been eliminated.
The Company reports net unrealized investment gains (losses) related to its available-for-sale securities in accumulated other comprehensive income (AOCI) in stockholders’ equity, net of related DAC, DSI and deferred income taxes. The cost of securities sold is determined using the specific-identification method.
An impairment is recorded on an available-for-sale security when a decline in fair value below a security’s amortized cost is judged to be other-than-temporary. The Company’s review of investment securities includes both quantitative and qualitative criteria. See Note 4 for additional discussion about the Company’s process for identifying and recording OTTI.
The Company carries its mortgage loans at outstanding principal balances, adjusted for unamortized deferred fees and costs, net of an allowance for loan losses. Loan origination fees and costs are deferred and amortized over the life of the loan. Interest income, including amortization of deferred fees and expenses, is recorded in net investment income. See Note 5 for discussion of the Company’s allowance for loan losses.
The Company uses derivative financial instruments to hedge certain portions of its exposure to equity market risk, interest rate risk and foreign currency exchange risk. Derivative financial instruments currently held consist primarily of S&P 500 index options, interest rate swaps, foreign currency swaps and foreign currency forwards. Derivatives instruments may be exchange-traded or contracted in over-the-counter (“OTC”) market. All of the Company’s derivative financial instruments are recognized as either assets within other invested assets or liabilities within other liabilities on the consolidated balance sheets at fair value. The Company also issues fixed indexed annuity contracts that contain embedded derivative instruments that are recorded at fair value with the associated host contract in funds held under deposit contracts on the consolidated balances sheets. The Company does not offset the fair value amounts recognized for derivatives executed with the same counterparty under the same master netting agreement.
The accounting for changes in the fair value of derivative instruments depends on whether it has been designated and qualifies for hedge accounting. If a derivative instrument does not qualify, or is not designated for hedge accounting, the changes in its fair value are recorded in the consolidated statements of income within net realized investment gains (losses).
If it is determined that a derivative no longer qualifies as an effective hedge, the derivative continues to be carried in the consolidated balance sheets at its fair value, with changes in fair value recognized prospectively in income. See Note 4 for further discussion of the Company’s derivative instruments.
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 amortizes acquisition costs for deferred annuity contracts and universal life insurance policies over the lives of the contracts or policies in proportion to the estimated future gross profits. The Company makes assumptions as to surrender rates, mortality experience, maintenance expenses, and investment performance. Actual profits can vary from the estimates and can thereby result in increases or decreases to DAC amortization rates. The Company regularly evaluates its assumptions and, when necessary, revises the estimated gross profits of these contracts, resulting in adjustments to DAC amortization. When such estimates are revised, the impact is recorded in the consolidated statements of income.
Intangible assets, net of accumulated amortization, and goodwill are reported as other assets on the consolidated balance sheets. Intangible assets are reviewed at least annually for indicators of impairment and are tested for impairment when events or circumstances indicate the carrying amount may not be recoverable. Goodwill is not amortized but is tested for impairment at least annually. No impairment was recorded for goodwill or intangible assets for the years ended December 31, 2012, 2011 or 2010.
On July 1, 2011, the Company entered into an indemnity reinsurance agreement and acquired the renewal rights for medical stop-loss insurance policies issued by American United Life Insurance Company (AUL) for $26.0 and received $34.7, in cash, representing the value of the assumed net liabilities. Intangible assets acquired totaled $26.0 and are to be amortized over a weighted-average life of 7.7 years. This transaction expanded the customer and broker base for the medical stop-loss insurance in the Benefits segment.
Certain operating leases of the Company provide for minimum annual payments that change over the life of the lease. The aggregate minimum annual payments are expensed on the straight-line basis over the lease term. Rent holidays, rent incentives, and tenant improvement allowances are amortized on the straight-line basis over the initial term of the lease and any renewal option period that is reasonably assured.
Separate account assets are reported at fair value and represent funds that are invested on behalf of the Company’s variable annuity, life, and universal life policyholders. The assets of each separate account are legally
For single premium immediate annuities (SPIAs), including structured settlements, liabilities are based on discounted amounts of estimated future benefits. Future benefits are either fully guaranteed or are contingent on the survivorship of the annuitant. Contingent future benefits are discounted with pricing mortality assumptions, which include provisions for longer life spans over time. The interest rate pattern used to calculate the reserves for SPIAs is set at issue. The interest rates within the pattern vary over time and start with interest rates that prevailed at contract issue. As of December 31, 2012, the weighted-average implied interest rate on the existing book of business was 5.75% and is expected to grade to 6.39% during the next 20 years.
Under the new standard, the Company defers costs that are directly related to the successful acquisition of new or the renewal of insurance contracts. These costs primarily include commissions, premium taxes and premium based assessments, the portion of wholesaler distribution costs directly related to contract acquisition, third-party underwriting costs related to contracts that are successfully acquired, and a portion of the salaries and benefits related to employee time spent on the processing of successfully acquired new or renewal contracts. While the Company has restated DAC amortization to reflect the retrospective reduction in costs deferred, its policies and methodology for amortization have not changed.
The Company retrospectively adopted this standard on January 1, 2012. The Company believes retrospective adoption provides users the most useful financial information because it is comparable between financial periods. The Company has restated its financial information as of December 31, 2011 and for the years ended December 31, 2011 and 2010 in these financial statements, as shown below:
In May 2011, the FASB issued ASU 2011-04, Fair Value Measurements (Topic 820) - Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in US GAAP and IFRSs. This ASU establishes common definitions of fair value and requirements for measurement and disclosure between GAAP and International Financial Reporting Standards (IFRS). The measurement principles are generally consistent with current GAAP and the changes did not have a material impact on our condensed financial statements. Enhanced disclosures include quantitative information about unobservable inputs to Level 3 measurements, when available; qualitative information about the sensitivity of Level 3 measurements to alternative inputs; and classification within the fair value hierarchy of all fair value measurements disclosed. The Company adopted this standard on January 1, 2012. See Note 6 for the Company’s disclosures related to fair value measurements. The Company did not have material Level 3 measurements as of December 31, 2012 or 2011.
In January 2013, the FASB issued ASU 2013-02, Comprehensive Income (Topic 220) - Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. This standard requires entities to report the effect of significant reclassifications out of AOCI on the respective line items in net income. The standard is effective prospectively for periods beginning after December 15, 2012, with early adoption permitted. The Company will adopt this standard on January 1, 2013 and, effective with the first quarter of 2013, will provide the additional disclosures.
In December 2011, the FASB issued ASU 2011-11, Balance Sheet (Topic 210) - Disclosures about Offsetting Assets and Liabilities. This ASU requires the Company to disclose information about offsetting and related arrangements to enable users to understand the effect of those arrangements on its financial position. The new disclosure requirements are effective for annual and interim periods beginning on or after January 1, 2013, with retrospective application required. Effective with the first quarter 2013, the Company will provide the additional disclosures.
In January 2013, the FASB issued ASU 2013-01, Balance Sheet (Topic 210) - Scope Clarification of Disclosures about Offsetting Assets and Liabilities. This ASU limits the scope requirements to derivatives,
repurchase agreements and reverse repurchase agreements, and securities borrowing and lending transactions. Similar to ASU 2011-11, the scope limitation is effective for annual and interim periods beginning on or after January 1, 2013, with retrospective application required.
The Company has issued equity instruments to employees that are included in the computation of earnings per share, including restricted stock, stock options and shares issued under the employee stock purchase plan. Refer to Note 9 for discussion of these plans. The restricted shares are considered participating securities because the holders are entitled to receive any dividends declared on the common stock concurrently with the holders of outstanding shares of common stock, on a one-to-one basis. Participating restricted stock is included in basic and diluted earnings per share based on the application of the two-class method. Estimated shares to be issued under the employee stock purchase plan are included in diluted earnings per share based on the application of the treasury stock method.
For the years ended December 31, 2012, 2011 and 2010, 2.650, 2.950 and 2.950 of stock options, respectively, were excluded from the computation of diluted earnings per share, based on the application of the treasury stock method, because they were antidilutive. Also, performance units granted during 2011 had the option to settle in cash or shares at the Company’s discretion. These units were 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. Beginning in 2012, performance units granted are required to be settled in cash. Refer to Note 15 for discussion of the performance units.
Of the non-agency RMBS classified as Alt-A, 87.5% and 59.1% had an NAIC rating of 1 as of December 31, 2012 and 2011, respectively. As of December 31, 2012 and 2011, the Company had no mortgage-backed securities classified as subprime.
(1) This includes net gains on calls and redemptions and changes in the fair value of the Company’s convertible securities held as of period end totaling $0.2, $(10.2), and $5.4 for the years ended December 31, 2012, 2011 and 2010, respectively. As of December 31, 2012 and 2011, the Company’s convertible securities totaled $75.2 and $85.4, respectively.
For fixed maturities, the Company concludes that an OTTI has occurred if the present value of expected cash flows is less than the amortized cost of the security (i.e., a credit loss exists). 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 will recover. The discount rate is the effective interest rate implicit in the underlying fixed maturity, which is the original effective yield for corporate securities or current effective yield for mortgage-backed securities.
Expected cash flows from the security, including potential variability of prepayments;
Average cumulative collateral values, vintage year and level of subordination; and
Susceptibility to fair value fluctuations due to changes in the interest rate environment.
There were no marketable equity securities recorded as available-for-sale underwater by 20% or more as of December 31, 2012 and 2011.
Changes in the amount of credit-related OTTI recognized in net income where the portion related to other factors was recognized in OCI were as follows:
The Company uses call options based on the S&P 500® or a commodities-based index as part of our equity market risk management strategy. The Company offers a fixed indexed annuity contract that permits the holder to elect an interest rate return or an equity market component, where interest credited to the contract is linked to the performance of the S&P 500 or a commodities-based index. The Company purchases call options that are correlated to the portfolio allocation decisions of the contract holders, such that the Company is economically hedged with respect to equity returns for the current reset period. These derivatives do not qualify for hedge accounting.
The Company uses interest rate swaps as part of its interest rate risk management strategy. In an interest rate swap, the Company agrees with other parties to exchange, at specified intervals, the difference between floating-rate and fixed-rate interest amounts calculated by reference to an agreed upon notional principal amount. The Company primarily uses interest rate swaps to synthetically convert variable rate fixed maturities to fixed rate securities. These derivatives are designated and qualify as cash flow hedges.
The Company uses foreign currency swaps to reduce risks from changes in currency exchange rates with respect to investments denominated in foreign currencies that the Company holds. The Company agrees with other parties to exchange, at specified intervals, the difference between one currency and another at an exchange rate and calculated by reference to an agreed upon principal amount. Generally, the principal amount of each currency is exchanged at the maturity of the currency swap by each party. These derivatives are designated and qualify as cash flow hedges.
The Company uses foreign currency forwards as part of its foreign currency risk management strategy. The Company is invested in foreign currency denominated REITs and fixed maturities. In a foreign currency forward transaction, the Company agrees with other parties to deliver a specified amount of an identified currency at a specified future date. The price is agreed upon at the time of the contract and payment for such a contract is made at the specified future date. In general, the Company is selling a foreign currency and receiving U.S. dollars. These derivatives are not designated for hedge accounting.
establishing participation rates, subject to minimum guarantees. These contracts contain an embedded derivative instrument that is bifurcated from the host contract for measurement purposes because it possesses economic characteristics that are not clearly and closely related to the economic characteristics of the host contract. The embedded derivative, which is reported with the host instrument in the consolidated balance sheets, is carried at fair value with changes in fair value recognized in net income.
The Company’s risk of loss is typically limited to the fair value of our derivative instruments and not to the notional or contractual amounts of these derivatives. The following table sets forth the Company’s positions in derivative instruments:
Amounts reclassified into net income were recorded in net investment income on the consolidated statements of income. The Company had no gain (loss) from the ineffective portion of cash flow hedging relationships for the years ended December 31, 2012, 2011 and 2010.
The Company expects to reclassify net gains of $2.2 from AOCI into net income in the next 12 months, which includes net deferrals on both discontinued hedges and on periodic settlements of active hedges. Actual amounts may vary from this amount as a result of market conditions.
The following table shows the effect of derivatives not designated as hedges on the consolidated income statements:
(1) As of December 31, 2012 and 2011, reserve amounts of $0.0 and $0.3, respectively, were established for loans specifically evaluated for impairment.
(2) Includes the allowance for loan losses and deferred fees and costs.
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, and third party data for expected losses on loans with similar LTV ratios and DSCRs. Each loan’s LTV ratio and DSCR is updated annually, primarily during the third quarter.
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 into the three-level hierarchy, which
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 funds held under deposit contracts and mortgage loans.
(2) The carrying value of this balance excludes $5,685.8 of liabilities related to insurance contracts as of December 31, 2011.
As of December 31, 2012 and 2011, the fair value of the Company’s corporate securities classified as Level 2 measurements was $17,162.7 and $16,089.8, respectively. The following table presents additional information about the composition of the Level 2 corporate securities:
As of December 31, 2012 and 2011, the Company’s non-agency Level 2 RMBS had a weighted-average credit enhancement of 8.4% and 9.4%, respectively. As of December 31, 2012 and 2011, $127.7 and $152.3, or 40.0% and 42.0%, respectively, of the Company’s non-agency Level 2 RMBS had an origination or vintage year of 2004 and prior. The underlying collateral in years prior to 2005 is considered higher quality as underwriting standards were more stringent.
As of December 31, 2012 and 2011, the fair value of the Company’s commercial mortgage-backed securities (CMBS) classified as Level 2 measurements was $1,688.9 and $1,821.1, respectively. The weighted-average coupon rate on these securities was 5.03% and 5.23% as of December 31, 2012 and 2011. The following table presents additional information about the composition of the underlying collateral of Level 2 CMBS securities:
(1) 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 $50.9 for the year ended December 31, 2012. Gross transfers out of Level 3 were $69.7 for the year ended December 31, 2012.
(2) Other is comprised of transactions such as pay downs, calls, amortization and redemptions.
Cash and cash equivalents consist of demand bank deposits and short-term highly liquid investments with original maturities of three months or less at the time of purchase. Cash equivalents are reported at cost, which approximates fair value, and were $121.9 and $234.0 as of December 31, 2012 and 2011, respectively. As of December 31, 2012 and 2011, cash equivalents of $120.4 and $231.5, respectively, were held at a single highly-rated financial institution.
The fair values of funds held under deposit contracts related to investment-type contracts are estimated using an income approach, based on the present value of the discounted cash flows. Cash flows were projected using best estimates for lapses, mortality and expenses, and discounted at a risk-free rate plus a nonperformance risk spread.
(1) The restated accumulated effect of net unrealized investment gains as of January 1, 2010 was $(72.0).
As of December 31, 2012, the Company had two stock-based compensation plans: the Symetra Financial Corporation Equity Plan, amended and restated on March 4, 2011, (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 4.296 equity instruments are available for future issuance as of December 31, 2012. 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, 2012, 0.572 shares are available for future issuance under the Stock Purchase Plan.
Stock-based compensation expense for restricted shares, recognized in other underwriting and operating expenses on the consolidated statements of income, was $3.5, $2.1, and $2.0 for the years ended December 31, 2012, 2011 and 2010, respectively. The related income tax benefit for the years ended December 31, 2012, 2011 and 2010 was $1.2, $0.7 and $0.7, respectively.
The total fair value of restricted stock vested during the years ended December 31, 2012, 2011 and 2010 was $2.6, $0.2 and $1.6, respectively.
The Company measures compensation cost for stock awards at fair value on the grant date and recognizes such cost, net of estimated forfeitures, over the requisite service period (generally seven years). Stock options are valued using the Black-Scholes valuation model. The following table summarizes the weighted average assumptions used to value stock options issued:
Under the Company’s Stock Purchase Plan, eligible employees may purchase shares of the Company’s stock on quarterly purchase dates at an amount equal to 85% of the closing market price of the common stock. Compensation cost for employees is recognized for each three-month period between purchase dates, and is equal to the fair value of the discount received on the purchase of shares. Compensation cost recognized for employees under the Company’s Stock Purchase Plan for the years ended December 31, 2012, 2011 and 2010 was $0.2, $0.2 and $0.1, respectively.
The Company participates in the industry practice of reinsuring portions of our insurance risk with reinsurance companies in order to diversify risk and manage loss exposure primarily in the Individual Life and Benefits segments.
For the individual life business, the Company has reinsurance agreements that limit the maximum claim on a single individual to $0.5 prior to 2012, and $1.0 for policies issued in 2012. 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 90%, as specified in the reinsurance contracts.
The Company reinsures 40% of its group life risk and capped its liability at $0.5 per individual, per line of coverage. The Company reinsures 40% and 90%, respectively, of its short-term and long-term disability risk. The Company reinsures all of its exposure to medical stop loss claims in excess of $1.1.
The Company evaluates the financial condition of its reinsurers to minimize its exposure to losses from reinsurer insolvencies. As of December 31, 2012, $119.6, or 40.0%, of the reinsurance recoverable was related to one reinsurer. The Company analyzes reinsurance recoverables according to the credit ratings of its reinsurers and is not aware of any major reinsurers currently experiencing financial difficulties. Of the total amount due from reinsurers as of both December 31, 2012 and 2011, 99.6% were with reinsurers rated A- or higher by A.M. Best. The Company had no write-offs or reserve for uncollectible reinsurance in 2012, 2011 or 2010.
(1) The increase in assumed accident and health premiums and the percentage of assumed to total premiums and other amounts assessed to policyholders in 2011 is related to the reinsurance agreement executed with American United Life Insurance Company (AUL) during 2011.
The Company uses estimates in determining its liability for policy and contract claims. These estimates are based on historical claim payment patterns and expected loss ratios to provide for the inherent variability in claim patterns and severity. For the year ended December 31, 2012, the change in prior year incurred claims was primarily due to favorable claims experience for medical stop-loss, primarily related to the favorable experience related to the business we assumed in July 2011. For the year ended December 31, 2011, the change in prior year incurred claims was primarily due to favorable claims experience for medical stop-loss, offset by higher than expected individual life claims. For the year ended December 31, 2010, the change in prior year incurred claims was primarily due to slightly lower than expected individual life and medical stop-loss claims.
On October 10, 2007, the Company issued $150.0 aggregate principal amount CENts with a scheduled maturity date of October 15, 2037, subject to certain limitations, with a final maturity date of October 15, 2067. The Company issued the CENts at a discount, yielding $149.8. For the initial 10-year period following the original issuance date, to, but not including October 15, 2017, the CENts carry a fixed interest rate of 8.300% payable semi-annually. From October 15, 2017, until the final maturity date of October 15, 2067, interest on the CENts will accrue at a variable annual rate equal to the three-month LIBOR plus 4.177%, payable quarterly. The effective interest rate on the CENts is 9.39%, including the impact of a related terminated cash flow hedge.
Subject to certain conditions, the Company has the right, on one or more occasions, to defer the payment of interest on the CENts during any period up to ten years without giving rise to an event of default. Deferred interest will accumulate additional interest at an annual rate equal to the annual interest rate then applicable to the CENts.
The senior notes are unsecured senior obligations and are equal in right of payment to all existing and future unsecured senior indebtedness. These notes are redeemable, in whole or in part, at the option of the Company at any time or from time to time at a redemption price equal to the greater of: (1) 100% of the aggregate principal amount of the notes to be redeemed or (2) the sum of the present value of the remaining scheduled payments of principal and interest on the senior notes, discounted to the redemption date on a semi-annual basis at a prevailing U.S. Treasury rate plus 25 basis points, together in each case with accrued interest payments to the redemption date.
On December 14, 2011, the Company entered into a $300.0 senior unsecured revolving credit agreement with a syndicate of lending institutions led by JPMorgan Chase Bank, N.A. The credit facility also provides access to up to an additional $100.0 of financing, subject to the availability of additional commitments. The credit facility is set to mature on December 14, 2015. The revolving credit facility is available to provide support for working capital, capital expenditures, and other general corporate purposes.
As of December 31, 2012 and 2011, and during the years ended December 31, 2012, 2011 and 2010, the Company had no borrowings outstanding under its revolving credit facilities and was in compliance with all covenants.
The Company invests in limited partnership interests related to tax credit investments. The Company unconditionally committed to provide capital contributions for these investments of $296.8, of which $34.0 was related to partnerships entered into during the year ended December 31, 2012. Capital contributions of $256.2 were paid as of December 31, 2012, with the remaining expected cash capital contributions as follows:
The Company has also committed to invest up to $62.5 in private equity funds, of which the Company has remaining commitments of $16.4 as of December 31, 2012. The remaining term of these commitments ends in 2016. The Company will provide capital contributions to the partnerships, up to the committed amount, at the discretion of the general partners, subject to certain contribution limits.
The Company has office space and certain equipment under leases that expire at various dates through 2022, subject to certain renewal options. The Company accounts for these leases as operating leases.
The Company sponsors a defined contribution 401(k) plan for all eligible employees that includes matching a participant’s contributions up to 6% of eligible compensation. The expense for the matching contributions was $6.2, $5.4 and $4.8 for the years ended December 31, 2012, 2011 and 2010, respectively.
During 2012, 2011 and 2010, the Company granted 0.076, 0.065 and 0.072 performance units, respectively, to various members of management under the Equity Plan. The value of each performance unit is determined at the discretion of the Company’s board of directors based on the success of the Company over a three-year period. These are accounted for as liability awards, as the Company intends or is required to settle such awards in cash. The Company recognized $4.7, $2.5 and $1.5 in expense related to performance units granted under the Equity
Plan for the years ended December 31, 2012, 2011 and 2010, respectively. The Company also granted restricted stock and stock options under the Equity Plan, as discussed in Note 9.
The statutory net income (loss) and statutory capital and surplus for the Company’s insurance subsidiaries are as follows:
The primary segment profitability measure that management uses is segment pre-tax adjusted operating income (loss), which is calculated by adjusting income (loss) from operations before federal income taxes to exclude net realized investment gains (losses), and for the Deferred Annuities’ segment, to include the net investment gains (losses) on the fixed indexed annuity (FIA) product.
When evaluating segment pre-tax adjusted operating income (loss) in the Deferred Annuities’ segment, management includes the net investment gains (losses) from the FIA hedging program and changes in the fair value of the related FIA embedded derivative. The FIA hedging program consists of buying S&P 500 Index call options to hedge the equity return component of FIA products. These options do not qualify for hedge accounting treatment, and net gains (losses) from the options are recorded in net realized investment gains (losses). Because the interest earned on the Company’s FIA product is included as a component of interest credited, it is more meaningful to evaluate results inclusive of the results of this hedging program.
Income Annuities. Income Annuities offers single premium immediate annuities, or SPIAs, to customers seeking a reliable source of retirement income or to protect against outliving their assets during retirement. In addition, Income Annuities services our block of structured settlement policies sold to fund third party personal injury settlements. The Company discontinued structured settlement sales in December 2012. In addition, Income Annuities offers funding services options to existing structured settlement clients.
Individual Life. Individual Life offers a wide array of insurance products such as universal life insurance, including BOLI, and term life insurance.
Other. This segment consists of unallocated corporate income, composed primarily of investment income on unallocated surplus, unallocated corporate expenses, interest expense on debt, earnings related to limited partnership interests, the results of small, non-insurance businesses that are managed outside of our divisions, and inter-segment elimination entries.
The unaudited quarterly results of operations for years ended December 31, 2012 and 2011 are summarized in the table below.
(1) Quarterly earnings per share amounts may not add up to the full year amounts due to share weighting and rounding.