The Company leases administrative and marketing office space in various cities with most leases being for periods of two to twenty-five years. The aggregate annualized rent is $4.1 million.
The Company has applied the amendment to Regulation S-K Item 301 which became effective on February 10, 2021.
We are a wholly owned subsidiary of Protective Life Corporation (“PLC”). Founded in 1907, we are the largest operating subsidiary of PLC. On February 1, 2015, PLC became a wholly owned subsidiary of The Dai-ichi Life Insurance Company, Limited, a kabushiki kaisha organized under the laws of Japan (now known as Dai-ichi Life Holdings, Inc., “Dai-ichi Life”), when DL Investment (Delaware), Inc., a wholly owned subsidiary of Dai-ichi Life, merged with and into PLC (the “Merger”). We provide financial services through the production, distribution, and administration of insurance and investment products. Unless the context otherwise requires, the “Company,” “we,” “us,” or “our” refers to the consolidated group of Protective Life Insurance Company and our subsidiaries.
In 2020, as a result of changes in the way the chief operating decision maker makes decisions about the allocation of resources and assesses the performance of the business, the Company combined two of its former six segments into one segment, Retail Life and Annuity. These changes enable the Company to better serve the needs of its customers and to help achieve the goals of the organization.
Prior-period amounts were adjusted retrospectively to reflect the change to our reportable segments.
Our operating segments are Retail Life & Annuity, Acquisitions, Stable Value Products, and Asset Protection. We have an additional reporting segment referred to as Corporate and Other.
•Acquisitions-We focus on acquiring, converting, and/or servicing policies and contracts from other companies. This segment’s primary focus is on life insurance policies and annuity products that were sold to individuals. The level of the segment’s acquisition activity is predicated upon many factors, including available capital, operating capacity, potential return on capital, and market dynamics. Policies acquired through the Acquisitions segment are typically blocks of business where no new policies are being marketed, however, some recent acquisitions have included ongoing new business activities. Ongoing new product sales written by the Company from these acquisitions are included in the Retail Life and Annuity segment. As a result, earnings and account values are expected to decline as the result of lapses, deaths, and other terminations of coverage unless new acquisitions are made.
•Asset Protection-We market extended service contracts, guaranteed asset protection (“GAP”) products, credit life and disability insurance, and other specialized ancillary products to protect consumers’ investments in automobiles and recreational vehicles. GAP products are designed to cover the difference between the scheduled loan pay-off amount and an asset’s actual cash value in the case of a total loss. Each type of specialized ancillary product protects against damage or other loss to a particular aspect of the underlying asset.
Asset Protection segment. The primary impacts from COVID-19 on the Asset Protection segment during 2020 included a negative impact on sales due to lower sales in the auto industry, a reduction in vehicle service and GAP claims as a result of the effect of less miles driven and lower general and administrative expenses, especially with respect to travel costs. While current trends remain positive, there remains uncertainty around the potential effect of the COVID-19 pandemic on the segment’s 2021 results, including a potential negative impact on sales if increased COVID-19 cases result in increased shut downs of economic activity.
Corporate Securities. The overall deterioration in the macroeconomic environment as a result of the impact of COVID-19 as well as the continued pressure on commodity prices has negatively affected the values of certain of our investments. The largest impacts have been in the oil & gas, real estate, and consumer and retail industries. For the year ended December 31, 2020, we have recognized $125.5 million of impairments primarily reflecting declines in the value of certain oil and gas securities.
•credit market volatility or disruption could adversely impact our financial condition or results from operations;
•our use of derivative financial instruments within our risk management strategy may not be effective or sufficient;
•our securities lending program may subject us to liquidity and other risks;
•our financial condition or results of operations could be adversely impacted if our assumptions regarding the fair value and future performance of our investments differ from actual experience;
•the National Association of Insurance Commissioners (“NAIC”) actions, pronouncements and initiatives may affect our product profitability, reserve and capital requirements, financial condition or results of operations;
•laws, regulations and initiatives related to unreported deaths and unclaimed property and death benefits may result in operational burdens, fines, unexpected payments or escheatments;
•we are subject to insurable interest laws, rules and regulations that could adversely affect our financial condition or results of operations;
•changes to tax law, or interpretations of existing tax law could adversely affect our ability to compete with non-insurance products or reduce the demand for certain insurance products;
•if our business does not perform well, we may be required to recognize an impairment of our goodwill and indefinite lived intangible assets which could adversely affect our results of operations or financial condition;
•our policy claims fluctuate from period to period resulting in earnings volatility;
•confidential information maintained in the systems of the Company or other parties upon which the Company relies could be compromised or misappropriated as a result of security breaches or other related lapses or incidents, damaging the Company’s business and reputation and adversely affecting its financial condition and results of operations;
•compliance with existing and emerging privacy regulations could result in increased compliance costs and/or lead to changes in business practices and policies, and any failure to protect the confidentiality of consumer information could adversely affect our reputation and have a material adverse effect on our business, financial condition and results of operations;
•we operate as a holding company and depend on the ability of our subsidiaries to transfer funds to us to meet our obligations;
•our use of affiliate and captive reinsurance companies to finance statutory reserves related to our fixed annuity and term and universal life products and to reduce volatility affecting our variable annuity products may be limited or adversely affected by regulatory action, pronouncements, and interpretations;
•exposure to risks related to natural and man-made disasters and catastrophes, such as diseases, epidemics, pandemics (including the novel coronavirus, COVID-19), malicious acts, cyberattacks, terrorist acts, and climate change, which could adversely affect our operations and results;
•we may not be able to protect our intellectual property and may be subject to infringement claims;
•we may be required to establish a valuation allowance against our deferred tax assets, which could have a material adverse effect on our results of operations, financial condition, and capital position; and
Fair Value of Financial Instruments - The Financial Accounting Standards Board (“FASB”) guidance defines fair value for accounting principles generally accepted in the United States of America (“GAAP”) and establishes a framework for measuring fair value as well as a fair value hierarchy based on the quality of inputs used to measure fair value and enhances disclosure requirements for fair value measurements. The term “fair value” in this document is defined in accordance with GAAP. The standard describes three levels of inputs that may be used to measure fair value. For more information, refer to
Available-for-sale securities and trading securities are recorded at fair value, which is primarily based on actively traded markets where prices are based on either direct market quotes or observed transactions. Liquidity is a significant factor in the determination of the fair value for these securities. Market price quotes may not be readily available for some positions or for some positions within a market sector where trading activity has slowed significantly or ceased. These situations are generally triggered by the market’s perception of credit uncertainty regarding a single company or a specific market sector. In these instances, fair value is determined based on limited available market information and other factors, principally from reviewing the issuer’s financial position, changes in credit ratings, and cash flows on the investments. As of December 31, 2020, $2.1 billion of available-for-sale and trading securities, excluding other long-term investments, were classified as Level 3 fair value assets.
For securities that are priced via non-binding independent broker quotations, we assess whether prices received from independent brokers represent a reasonable estimate of fair value through an analysis using internal and external cash flow models developed based on spreads and, when available, market indices. We use a market-based cash flow analysis to validate the reasonableness of prices received from independent brokers. These analytics, which are updated daily, incorporate various metrics (yield curves, credit spreads, prepayment rates, etc.) to determine the valuation of such holdings. As a result of this analysis, if we determine that there is a more appropriate fair value based upon the analytics, the price received from the independent broker is adjusted accordingly. As of December 31, 2020, we did not adjust any prices received from independent brokers.
Derivatives - We utilize a risk management strategy that incorporates the use of derivative financial instruments to reduce exposure to certain risks, including but not limited to, interest rate risk, inflation risk, currency exchange risk, volatility risk, and equity market risk. Assessing the effectiveness of the hedging programs and evaluating the carrying values of the related derivatives often involve a variety of assumptions and estimates. Derivative financial instruments are valued using exchange prices, independent broker quotations, or pricing valuation models, which utilize market data inputs. The fair values of most of our derivatives are determined using exchange prices or independent broker quotes, but certain derivatives, including embedded derivatives, are valued based upon industry standard models which calculate the present-value of the projected cash flows of the derivatives using current and implied future market conditions. These models include market-observable estimates of volatility and interest rates in the determination of fair value. The use of different assumptions may have a material effect on the estimated fair value amounts, as well as the amount of reported net income. In addition, measurements of ineffectiveness of hedging relationships are subject to interpretations and estimations, and any differences may result in material changes to our results of operations. The fair values of derivative assets and liabilities include adjustments for market liquidity, counterparty credit quality, and other deal specific factors, where appropriate. The fair values of derivative assets and liabilities traded in the over-the-counter market are determined using quantitative models that require the use of multiple market inputs including interest rates, prices, and indices to generate continuous yield or pricing curves and volatility factors. The predominance of market inputs are actively quoted and can be validated through external sources. Estimation risk is greater for derivative financial instruments that are either option-based or have longer maturity dates where observable market inputs are less readily available or are unobservable, in which case quantitative based extrapolations of rate, price, or index scenarios are used in determining fair values. As of December 31, 2020, the fair value of derivatives reported on our balance sheet in “other long-term investments” and “other liabilities” was $1.6 billion and $2.7 billion, respectively. Of those derivative assets and liabilities, $222.0 million and $1.7 billion, respectively, were Level 3 fair values determined by quantitative models.
information. The Company considers contractual cash flows and all known market data related to cash flows when developing its estimates of expected cash flows. The Company uses the effective interest rate implicit in the security at the date of acquisition to discount expected cash flows. For floating rate securities, the Company’s policy is to lock in the interest rate at the first instance of an impairment. Estimates of expected cash flows are not probability-weighted but reflect the Company’s best estimate based on past events, current conditions, and reasonable and supportable forecasts of future events. Debt securities that the Company intends to sell or expects to be required to sell before recovery are written down to fair value with the change recognized in realized gains (losses).
Prior to January 1, 2020, on quarterly basis, the Company reviewed investments with unrealized losses for indications of other than temporary impairments. In addition to the factors noted above that are analyzed to determine if impairments are the result of credit losses, the Company also previously considered the duration that the security had been in an unrealized loss position in evaluating the need for any other-than-temporary impairments. Although no set formula was used in this process, the investment performance, collateral position, and continued viability of the issuer were significant measures considered, and in some cases, an analysis regarding the Company’s expectations for recovery of the security’s entire amortized cost basis through the receipt of future cash flows was performed. Once a determination had been made that a specific other-than-temporary impairment existed, the security’s basis was adjusted and an other-than-temporary impairment was recognized. Other-than-temporary impairments to debt securities that the Company did not intend to sell and did not expect to be required to sell before recovering the security’s amortized cost were written down to discounted expected future cash flows (“post impairment cost”) and credit losses were recorded in realized gains (losses). The difference between the securities’ discounted expected future cash flows and the fair value of the securities on the impairment date was recognized in other comprehensive income (loss) as a non-credit portion impairment. When calculating the post impairment cost for residential mortgage-backed securities (“RMBS”), commercial mortgage-backed securities (“CMBS”), and other asset-backed securities (collectively referred to as asset-backed securities or “ABS”), the Company considered all known market data related to cash flows to estimate future cash flows. When calculating the post impairment cost for corporate debt securities, the Company considered all contractual cash flows to estimate expected future cash flows. To calculate the post impairment cost, the expected future cash flows are discounted at the original purchase yield basis.
Our specific accounting policies related to our invested assets are discussed in Note 2, Summary of Significant Accounting Policies, and Note 4, Investment Operations, to the consolidated financial statements. As of December 31, 2020, we held $69.8 billion of available-for-sale investments, including $3.2 billion in investments with a gross unrealized loss of $130.5 million.
Our reinsurance is ceded to a diverse group of reinsurers. The collectability of reinsurance is largely a function of the solvency of the individual reinsurers. We perform periodic credit reviews on our reinsurers, focusing on, among other things, financial capacity, stability, trends, and commitment to the reinsurance business. We also require assets in trust, letters of credit, or other acceptable collateral to support balances due from reinsurers not authorized to transact business in the applicable jurisdictions. Despite these measures, a reinsurer’s insolvency, inability, or unwillingness to make payments under the terms of a reinsurance contract could have a material adverse effect on our results of operations and financial condition. As of December 31, 2020, our third party reinsurance receivables amounted to $4.6 billion. These amounts include ceded reserve balances and ceded benefit payments.
We account for reinsurance as required by FASB guidance under the Accounting Standards Codification (“ASC” or “Codification”) Financial Services Topic as applicable. In accordance with this guidance, costs for reinsurance are amortized as a level percentage of premiums for traditional life products and a level percentage of estimated gross profits for universal life products. Accordingly, ceded reserve and deferred acquisition cost balances are established using methodologies consistent with those used in establishing direct policyholder reserves and deferred acquisition costs. Establishing these balances requires the use of various assumptions including investment returns, mortality, persistency, and expenses. The assumptions made for
DAC and VOBA - The estimated present value of future cash flows used in the calculation of the VOBA is based on certain assumptions, including mortality, persistency, expenses, and interest rates that the Company expects to experience in future years. The Company amortizes VOBA in proportion to gross premiums for traditional life products, or estimated gross margins (“EGMs”) for participating traditional life products within the MONY block. For interest sensitive products, the Company uses various amortization bases including expected gross profits (“EGPs”), revenues, or insurance in-force. VOBA amortization included accrued interest credited to account balances of up to approximately 6.85%. VOBA is subject to annual recoverability testing.
We incur significant costs in connection with acquiring new insurance business. Portions of these costs, which are determined to be incremental direct costs associated with successfully acquired policies and coinsurance of blocks of policies, are deferred and amortized over future periods. Some examples of acquisition costs that are subject to deferral include commissions, underwriting testing fees, certain direct underwriting costs, and premium taxes. The determination of which costs are deferrable must be made on a contract-level basis. (All other acquisition-related costs, including market research, administration, management of distribution and underwriting functions, and product development, are considered non-deferrable acquisition costs and must be expensed in the period incurred.) The recovery of the deferred costs is dependent on the future profitability of the related policies. The amount of future profit is dependent principally on investment returns, mortality, morbidity, persistency, and expenses to administer the business and certain economic variables, such as inflation. These costs are amortized over the expected lives of the contracts, based on the level and timing of either gross profits or gross premiums, depending on the type of contract. Revisions to estimates result in changes to the amounts expensed in the reporting period in which the revisions are made and could result in the impairment of the asset and a charge to income if estimated future profits are less than the unamortized deferred amounts. As of December 31, 2020, we had a DAC and VOBA asset of $3.4 billion.
If it is determined that it is more likely than not that impairment exists, the Company performs a quantitative assessment and compares its estimate of the fair value of the reporting unit to which the goodwill is assigned to the reporting unit’s carrying amount, including goodwill. The Company utilizes a fair value measurement (which includes a discounted cash flows analysis) to assess the carrying value of the reporting unit in consideration of the recoverability of the goodwill balance assigned to each reporting unit as of the measurement date. The cash flows used to determine the fair value of the Company’s reporting units are dependent on a number of significant assumptions. The Company’s estimates, which consider a market participant view of fair value, are subject to change given the inherent uncertainty in predicting future results and cash flows, which are impacted by such things as policyholder behavior, competitor pricing, capital limitations, new product introductions, and specific industry and market conditions.
After-tax adjusted operating income (loss) is derived from pre-tax adjusted operating income (loss) with the inclusion of income tax expense or benefits associated with pre-tax adjusted operating income. Income tax expense or benefits is allocated to the items excluded from pre-tax adjusted operating income (loss) at the statutory federal income tax rate for the associated period. Income tax expense or benefits allocated to after-tax adjusted operating income (loss) can vary period to period based on changes in our effective income tax rate.
We periodically review and update as appropriate our key assumptions used to measure certain balances related to insurance products, including future mortality, expenses, lapses, premium persistency, benefit utilization, investment yields, interest rates, and separate account fund returns. Changes to these assumptions result in adjustments which increase or decrease DAC and VOBA amortization and/or benefits and expenses. Assumptions may be updated as part of our annual assumption review process, as well as during our quarterly update of historical business activity. This periodic review and updating of
assumptions is collectively referred to as “unlocking.” When referring to unlocking the reference is to changes in all balance sheet components associated with these changes. The adjustments associated with unlocking can create significant variability from period to period in the profitability of certain of the Company’s operating segments.
(1)Sales data for traditional life insurance, other than Single Premium Whole Life (“SPWL”) insurance, is based on annualized premiums. SPWL insurance sales are based on total single premium dollars received in the period. Universal life sales are based on annualized planned premiums, or “target” premiums if lesser, plus 6% of amounts received in excess of target premium and 10% of single premiums. “Target” premiums for universal life are those premiums upon which full first year commissions are paid.
(2)Sales are measured based on the amount of purchase payments received less first year surrenders.
Net premiums and policy fees increased by $301.0 million, or 25.7%, for the year ended December 31, 2020, as compared to the year ended December 31, 2019, due to post level activity in the traditional life block, offset in party by lower universal life net policy fees and variable annuity fee income.
Net investment income in the segment increased $68.7 million, or 7.3%, driven by higher liability balances in the annuity and life blocks.
Other income increased $0.8 million due to higher fixed annuity fee income, partially offset by lower VA fee income.
Benefits and settlement expenses increased by $413.2 million, or 23.6%, due to a $295.7 million unfavorable change in reserves in the traditional life block due to post level impacts, higher traditional life and universal life claims, and higher annuity credited interest and fixed annuity change in guaranteed benefit reserves and unfavorable unlocking in the universal life block, offset in part by favorable changes in universal life reserves and favorable annuity mortality. Segment results were negatively impacted by $42.4 million of unfavorable unlocking for 2020, as compared to $23.1 million of unfavorable unlocking for the prior year.
DAC/VOBA amortization increased $21.9 million, or 14.4%, due to an unfavorable change in unlocking on the annuity block, and net unfavorable changes in amortization for the traditional life block, offset in part by a favorable change in unlocking on the universal life block. Segment results were negatively impacted by $18.5 million of unfavorable unlocking in 2020, as compared to $11.5 million of unfavorable unlocking in the prior year.
Other operating expenses decreased $11.3 million primarily due to higher ceding allowances, lower commission expense, offset by an increase in acquisition expense, increases in maintenance and overhead expenses, and higher interest expense on reinsurance ceded.
Sales for the segment increased $573.7 million primarily due to an increase in fixed annuity and variable annuity sales.
The lower ceded premium and policy fees was caused primarily by lower ceded traditional life premiums of $466.8 million, primarily due to fluctuations in the number of policies entering their post level period during the fourth quarter of 2019. This is partially offset by increases in ceded universal life policy fees.
Ceded other operating expenses increased due to higher ceding allowances on the universal life block. Ceded other operating expenses reflect the impact of reinsurance allowances, net of amounts deferred.
(2)Includes general account balances held within variable annuity products and is net of coinsurance ceded. Excludes structured annuity products.
Total benefits and expenses increased $322.0 million primarily due to GWL&A which added $819.8 million of benefits and expenses for 2020, an increase of $378.8 million as compared to the prior year. This was partly offset by the expected runoff of the in-force blocks of business.
The segment’s reinsurance programs do not materially impact the other income line of the income statement. In addition, net investment income generally has no direct impact on reinsurance cost. However, by ceding business to the assuming companies, we forgo investment income on the reserves ceded to the assuming companies. Conversely, the assuming companies will receive investment income on the reserves assumed which will increase the assuming companies’ profitability on business assumed from the Company. For business ceded under modified coinsurance arrangements, the amount of investment income attributable to the assuming company is included as part of the overall change in policy reserves and, as such, is reflected in benefit and settlement expenses. The net investment income impact to us and the assuming companies has not been quantified as it is not fully reflected in our consolidated financial statements.
The net impact of reinsurance was more favorable by $6.3 million primarily due to lower ceded revenue partly offset by lower ceded benefits and expenses. For the year ended December 31, 2020, ceded revenues decreased by $65.2 million, while ceded benefits and expenses decreased by $54.8 million primarily due to lower benefit and settlement expenses.
spread, which excludes participation commercial mortgage loan income, decreased by 3 basis points for 2020, from the prior year, due primarily to a decrease in yields, partially offset by a decrease in credited interest.
(1)Sales are based on the amount of single premiums and fees received
Pre-tax adjusted operating income increased $4.6 million, or 12.5%, due to an increase in service contract earnings of $3.4 million, primarily due to favorable loss ratios and lower expenses, somewhat offset by lower investment income. Income from the GAP product line increased $2.3 million primarily resulting from lower loss ratios somewhat offset by higher expenses and credit insurance product lines decreased $1.1 million primarily due to lower volume.
Other income increased $2.4 million, or 1.7%, primarily due to an increase of $3.3 million in the service contract product line due to higher sales in previous years and was partly offset by a decrease of $0.8 million from the GAP product line.
Benefits and settlement expenses decreased $17.2 million, or 18.5%, due to a decrease of $11.1 million and $6.1 million, respectively, of GAP and service contract claims due to lower volumes as a result of discontinuing the relationship with a significant distribution partner and lower loss ratios.
The majority of the Asset Protection segment’s reinsurance activity relates to the cession of single premium credit life and credit accident and health insurance, vehicle service contracts, and guaranteed asset protection insurance to wholly owned subsidiaries of PLC. The business ceded to PLC’s subsidiaries is then retroceded to producer affiliated reinsurance companies (“PARCs”). These arrangements are coinsurance contracts ceding the business on a first dollar quota share basis generally at 100% to limit the segment’s exposure and allow the PARCs to share in the underwriting income of the product. Reinsurance contracts do not relieve the Asset Protection segment from obligations to policyholders. The Asset Protection segment also carries a catastrophic reinsurance policy for the GAP program. A more detailed discussion of the components of reinsurance can be found in the Reinsurance section of Note 2, Summary of Significant Accounting Policies to our consolidated financial statements included in this report.
Net investment income for the segment decreased $101.6 million for the year ended December 31, 2020, as compared to the year ended December 31, 2019, primarily due to the Captive Merger, causing a decrease in held-to-maturity income due to the acceleration of the amortization of premiums recorded against the held-to-maturity securities as well as a decrease in interest received from these securities, and an increase in investment expenses.
Total benefits and expenses decreased $20.0 million for the year ended December 31, 2020, as compared to the year ended December 31, 2019. Other operating expenses were lower due to reduced interest expense as the non-recourse funding obligations were redeemed October 1, 2020. This reduction in interest expense was partially offset by an increase in corporate overhead expenses primarily due to restructuring fees associated with the Captive Merger.
A portion of our bond portfolio is invested in RMBS, CMBS, and ABS. ABS are securities that are backed by a pool of assets. These holdings as of December 31, 2020, were $11.3 billion. Mortgage-backed securities (“MBS”) are constructed from pools of mortgages and may have cash flow volatility as a result of changes in the rate at which prepayments of principal occur with respect to the underlying loans. Excluding limitations on access to lending and other extraordinary economic
conditions, prepayments of principal on the underlying loans can be expected to accelerate with decreases in market interest rates and diminish with increases in interest rates.
The majority of our RMBS holdings as of December 31, 2020 were super senior or senior bonds in the capital structure. Our total non-agency portfolio has a weighted-average life of approximately 1.48 years. The following table categorizes the approximate weighted-average life for our non-agency portfolio, by category of material holdings, as of December 31, 2020.
Certain of the commercial mortgage loans have call options that occur within the next 9 years. However, if interest rates were to significantly increase, we may be unable to exercise the call options on our existing commercial mortgage loans commensurate with the significantly increased market rates. As of December 31, 2020, assuming the loans are called at their next call dates, $270.4 million will be due in 2021, $541.9 million in 2022 through 2026, and $10.2 million in 2027 through 2029.
We offer a type of commercial mortgage loan under which we will permit a loan-to-value ratio of up to 85% in exchange for a participating interest in the cash flows from the underlying real estate. As of December 31, 2020 and December 31, 2019, $805.9 million and $717.0 million, respectively, of our total commercial mortgage loans principal balance have this participation feature. Cash flows received as a result of this participation feature are recorded as interest income when received. During the years ended December 31, 2020, 2019, and 2018, we recognized, $26.3 million, $23.4 million, and $29.4 million, respectively, of participation commercial mortgage loan income.
We record commercial mortgage loans net of an allowance for credit losses. This allowance is calculated through analysis of specific loans that have indicators of potential impairment based on current information and events. As of December 31, 2020 and 2019, there were allowances for funded commercial mortgage loans and unfunded commitment credit losses of $244.6 million and $4.9 million, respectively.
As of December 31, 2020, $2.6 million of invested assets consisted of nonperforming commercial mortgage loans, restructured commercial mortgage loans, or commercial mortgage loans that were foreclosed and were converted to real estate properties. We do not expect these investments to adversely affect our liquidity or ability to maintain proper matching of assets and liabilities. During the year ended December 31, 2020, certain commercial mortgage loan transactions occurred that would have been accounted for as troubled debt restructurings. For all commercial mortgage loans, the impact of troubled debt restructurings is reflected in our investment balance and in the allowance for mortgage loan credit losses. During the year ended December 31, 2020, we recognized four troubled debt restructurings as a result of granting concessions to borrowers which included loan terms unavailable from other lenders. These concessions were the result of agreements between the creditor and the debtor. We identified one loan whose principal was permanently impaired during the year ended December 31, 2020.
The information presented below relates to investments at a certain point in time and is not necessarily indicative of the status of the portfolio at any time after December 31, 2020. Information about unrealized gains and losses is subject to rapidly changing conditions, including volatility of financial markets and changes in interest rates. Management considers a number of factors in determining if an unrealized loss is credit-related, including the expected cash to be collected and the intent, likelihood, and/or ability to hold the security until recovery. Consistent with our long-standing practice, we do not utilize a “bright line test” to determine credit losses. On a quarterly basis, we perform an analysis on every security with an unrealized loss to determine if a credit loss has occurred. This analysis includes reviewing several metrics including collateral, expected cash flows, ratings, and liquidity. Furthermore, since the timing of recognizing realized gains and losses is largely based on management’s decisions as to the timing and selection of investments to be sold, the tables and information provided below should be considered within the context of the overall unrealized gain/(loss) position of the portfolio. We had an overall net unrealized gain of $6.9 billion, prior to income tax and the related impact of certain insurance assets and liabilities offsets, as of December 31, 2020, and an overall net unrealized gain of $2.8 billion as of December 31, 2019.
As of December 31, 2020, the Barclays Investment Grade Index was priced at 91.0 basis points versus a 10 year average of 132.0 basis points. Similarly, the Barclays High Yield Index was priced at 387.0 basis points versus a 10 year average of 506.0 basis points. As of December 31, 2020, the five, ten, and thirty-year U.S. Treasury obligations were trading at levels of 0.4%, 0.9%, and 1.6%, as compared to 10 year averages of 1.5%, 2.2%, and 2.9%, respectively.
The following table includes the fair value, amortized cost, unrealized loss, and total time period that the security has been in an unrealized loss position for all below investment grade securities as of December 31, 2020:
We have no material concentrations of issuers or guarantors of fixed maturity securities. The industry segment composition of all securities in an unrealized loss position held as of December 31, 2020 is presented in the following table:
We monitor the overall credit quality of our portfolio within established guidelines. The following table includes our available-for-sale fixed maturities by credit rating as of December 31, 2020:
Not included in the table above are $2.7 billion of investment grade and $140.4 million of below investment grade fixed maturities classified as trading securities.
Limiting bond exposure to any creditor group is another way we manage credit risk. We held no credit default swaps on the positions listed below as of December 31, 2020. The following table summarizes our ten largest maturity exposures to an individual creditor group as of December 31, 2020:
Determining whether a decline in the current fair value of invested assets is a credit loss in value is both objective and subjective, and can involve a variety of assumptions and estimates, particularly for investments that are not actively traded in established markets. We review our positions on a monthly basis for possible credit concerns and review our current exposure, credit enhancement, and delinquency experience.
flows since the last revised estimate, considering both timing and amount, a credit loss is recognized. Estimating future cash flows is a quantitative and qualitative process that incorporates information received from third party sources along with certain internal assumptions and judgments regarding the future performance of the underlying collateral. Projections of expected future cash flows may change based upon new information regarding the performance of the underlying collateral. In addition, we consider our intent and ability to retain a temporarily depressed security until recovery.
For securities which the Company has the intent and ability to hold the security until the recovery of the amortized cost basis, analysis of expected cash flows is used to measure the amount of the credit loss, if any, and the Company uses the effective interest rate implicit in the security at the date of acquisition to discount expected cash flows. For floating rate securities, the Company’s policy is to lock in the interest rate at the first instance of an impairment. Estimates of expected cash flows are not probability-weighted, but will reflect the Company’s best estimate based on past events, current conditions, and reasonable and supportable forecasts of future events. To the extent the amortized cost basis of the security exceeds the present value of future cash flows expected to be collected, this difference represents a credit loss. Credit losses are recorded in current earnings with a corresponding adjustment to the allowance for credit losses, except that the credit loss recognized cannot exceed the difference between the book value and fair value of the security as of the date of the analysis. In future periods, recoveries in the present value of expected cash flows are recorded in current earnings as a reversal of the previously recognized allowance for credit losses. Based on our analysis, for the year ended December 31, 2020, we recognized $125.5 million of credit losses in earnings.
As previously discussed, management considers several factors when determining whether a credit loss has occurred. Although we purchase securities with the intent to hold them until maturity, we may change our position as a result of a change in circumstances. Any such decision is consistent with our classification of all but a specific portion of our investment portfolio as available-for-sale. For the year ended December 31, 2020, we sold securities in an unrealized loss position with a fair value of $33.8 million. For such securities, the proceeds, realized loss, and total time period that the security had been in an unrealized loss position are presented in the table below:
For the year ended December 31, 2020, we sold securities in an unrealized loss position with a fair value (proceeds) of $33.8 million. The loss realized on the sale of these securities was $4.9 million. We made the decision to exit these holdings in conjunction with our overall asset liability management process.
For the year ended December 31, 2020, net gains of $182.6 million related to changes in fair value on our Modco trading portfolios were included in realized gains and losses. Of this amount, $49.3 million of gains were realized through the sale of certain securities, which will be recovered by our reinsurance partners over time through the reinsurance settlement process for this block of business. The Modco embedded derivative associated with the trading portfolios had realized pre-tax losses of $97.9 million during the year ended December 31, 2020. The losses on the embedded derivative were due treasury yields decreasing.
the GLWB rider associated with the variable annuity, fixed indexed annuity products, structured annuity products, and indexed universal life products. During the year ended December 31, 2020, we experienced net realized gains on derivatives related to VA contracts of $95.5 million. These net gains on derivatives related to VA contracts were affected by capital market impacts, changes in our non-performance risk, variations in actual sub-account fund performance compared to the indices included in our hedging program, as well as updates to certain policyholder assumptions during the year ended December 31, 2020.
The Funds Withheld derivative associated with Shades Creek had pre-tax realized gains of $17.1 million for the year ended December 31, 2020. The Funds Withheld derivative associated with Protective Re had pre-tax realized losses of $10.0 million for the year ended December 31, 2020.
In conjunction with the Captives merger into Golden Gate Captive Insurance Company (“Golden Gate”), a Vermont special purpose financial insurance company and a wholly owned subsidiary of the Company, certain of the Company’s affiliates terminated interest support, YRT premium support, and portfolio maintenance agreements with PLC. The Company recognized gains of $23.5 million related to these agreements for the year ended December 31, 2020.
As part of the Captives Merger into Golden Gate, Golden Gate entered into a new portfolio maintenance agreement with PLC. The Company recognized no gains or losses on this agreement for the year ended December 31, 2020.
Under a revolving line of credit arrangement (the “Credit Facility”), we have the ability to borrow on an unsecured basis up to an aggregated principal amount of $1.0 billion. We have the right in certain circumstances to request that the commitment under the Credit Facility be increased up to a maximum principal amount of $1.5 billion. We are not aware of any non-compliance with the financial debt covenants of the Credit Facility as of December 31, 2020. PLC had an outstanding balance under the Credit Facility of $190.0 million as of December 31, 2020.
We maintain investment strategies intended to provide adequate funds to pay benefits and expected surrenders, withdrawals, loans, and redemption obligations without forced sales of investments. In addition, we hold highly liquid, high-quality short-term investment securities and other liquid investment grade fixed maturity securities to fund our expected operating expenses, surrenders, and withdrawals. We were committed as of December 31, 2020, to fund commercial mortgage loans in the amount of $801.1 million.
Our cash flows from operations are used to fund an investment portfolio that provides for future benefit payments. We employ a formal asset/liability program to manage the cash flows of our investment portfolio relative to our long-term benefit obligations. As of December 31, 2020, we held cash and short-term investments of $1.0 billion.
Net cash (used in) provided by operating activities - Cash flows from operating activities are affected by the timing of premiums received, fees received, investment income, and expenses paid. Principal sources of cash include sales of our products and services. Due to the nature of our business and the fact that many of the products we sell produce financing and investing cash flows it is important to consider cash flows generated by investing and financing activities in conjunction with those generated by operating activities.
Net cash used in investing activities - Changes in cash from investing activities primarily related to our investment portfolio. We had payments for business acquisition of $815.6 million, net of cash acquired, for the GWL&A acquisition for the year ended December 31, 2019.
Net cash provided by financing activities - Changes in cash from financing activities included $160.2 million of inflows from secured financing liabilities for the year ended December 31, 2020, as compared to $159.8 million of outflows for the year ended December 31, 2019 and $2.5 billion inflows of investment product and universal life net activity as compared to $1.3 billion in the prior year. Net repayment of non-recourse funding obligations equaled $329.9 million during the year ended December 31, 2020 which was due to the Captive Merger. Refer to Note 3, Significant Transactions for additional information. In addition, the Company received a capital contribution from its parent of $850.0 million during the year ended December 31, 2019.
The Company and certain of our subsidiaries, are members of the FHLB of Cincinnati, the FHLB of New York and the FHLB of Atlanta. FHLB advances provide an attractive funding source for short-term borrowing and for the sale of funding agreements. Membership in the FHLB requires that we purchase FHLB capital stock based on a minimum requirement and a percentage of the dollar amount of advances outstanding. Our borrowing capacity is determined by criteria established by each respective bank. In addition, our obligations under the advances must be collateralized. We maintain control over any such pledged assets, including the right of substitution. As of December 31, 2020, we had $1.6 billion of funding agreement-related advances and accrued interest outstanding under the FHLB program.
We participate in securities lending, primarily as an investment yield enhancement, whereby securities that are held as investments are loaned out to third parties for short periods of time. We require collateral at least equal to 102% of the fair value of the loaned securities to be separately maintained. The loaned securities’ fair value is monitored on a daily basis and collateral is adjusted accordingly. We maintain ownership of the securities at all times and are entitled to receive from the borrower any payments for interest received on such securities during the loan term. Securities lending transactions are accounted for as secured borrowings. As of December 31, 2020, securities with a fair value of $56.6 million were loaned under this program. As collateral for the loaned securities, we receive cash, which is primarily reinvested in short-term repurchase agreements, which are also collateralized by U.S. Government or U.S. Government Agency securities, and government money market funds. These investments are recorded in “short-term investments” with a corresponding liability recorded in “secured financing liabilities” to account for its obligation to return the collateral. As of December 31, 2020 and 2019, the fair value of the collateral related to this program was $58.7 million and $65.5 million and we had an obligation to return $58.7 million and $65.5 million, respectively, of collateral to the securities borrowers.
State insurance regulators and the NAIC have adopted risk-based capital (“RBC”) requirements for life insurance companies to evaluate the adequacy of statutory capital and surplus in relation to investment and insurance risks. The requirements provide a means of measuring the minimum amount of statutory surplus appropriate for an insurance company to support its overall business operations based on its size and risk profile. A company’s risk-based statutory surplus is calculated by applying factors and performing calculations relating to various asset, premium, claim, expense, and reserve items. Regulators can then measure the adequacy of a company’s statutory surplus by comparing it to RBC. We manage our capital consumption by using the ratio of our total adjusted capital, as defined by the insurance regulators, to our company action level RBC (known as the RBC ratio), also as defined by insurance regulators. As of December 31, 2020, our total adjusted capital and company action level RBC were $5.6 billion and $1.1 billion, respectively, providing an RBC ratio of approximately 490%.
Our statutory surplus is impacted by credit spreads as a result of accounting for the assets and liabilities on our fixed MVA annuities. Statutory separate account assets supporting the fixed MVA annuities are recorded at fair value. In determining the statutory reserve for the fixed MVA annuities, we are required to use current crediting rates based on U.S. Treasuries. In
In conjunction with the Captive Merger, Golden Gate and Steel City, LLC (“Steel City”), a wholly owned subsidiary of the Company, terminated the financing facility into which Golden Gate and Steel City had entered in 2016. This termination included redeeming the fixed maturity securities issued by Steel City to Golden Gate and the non-recourse funding obligation issued by Golden Gate to Steel City. This non-cash transaction resulted in a reduction to the carrying value of fixed maturities, at amortized cost on the balance sheet as well as a reduction to the carrying value of non-recourse funding obligations on the balance sheet of $1,858.0 million. These redemptions did not have an impact on income before taxes.
Our captive reinsurance company assumes business from affiliates only. Our captive is capitalized to a level we believe is sufficient to support the contractual risks and other general obligations of the captive entity. Our captive reinsurance company is a wholly owned subsidiary and is located domestically. The captive insurance company is subject to regulations in the state of domicile.
NAIC and state adoption of Actuarial Guideline XLVIII and the Term and Universal Life Insurance Reserve Financing Model Regulation may make the use of new captive structures in the future less capital efficient and/or lead to lower product terms and could impact the Company’s ability to engage in certain reinsurance transactions with non-affiliates.
Various Nationally Recognized Statistical Rating Organizations (“rating organizations”) review the financial performance and condition of insurers, including us and our subsidiaries, and publish their financial strength ratings as indicators of an insurer’s ability to meet policyholder and contract holder obligations. These ratings are important to maintaining public confidence in an insurer’s products, its ability to market its products and its competitive position. The following table summarizes the current financial strength ratings of the Company and our significant member companies from the major independent rating organizations:
Rating organizations also publish credit ratings for the issuers of debt securities, including PLC. Credit ratings are indicators of a debt issuer’s ability to meet the terms of debt obligations in a timely manner. PLC is an important source of funding for the Company, so its credit ratings may affect the Company’s liquidity. These ratings are important in the debt issuer’s overall ability to access credit markets and other types of liquidity. Ratings are not recommendations to buy our securities or products. A downgrade or other negative action by a rating organization with respect to PLC’s credit rating could limit its access to capital markets, increase the cost of issuing debt, and a downgrade of sufficient magnitude, combined with other negative factors, could require PLC to post collateral. The rating agencies may take various actions, positive or negative, with respect to PLC’s debt ratings, including as a result of its status as a subsidiary of Dai-ichi Life.
(1)Non-recourse funding obligations include all undiscounted principal amounts owed and expected future interest payments due over the term of the notes. The non-recourse funding obligations are associated with obligations assumed with the acquisition of MONY Life Insurance Company.
(5)Estimated contractual policyholder obligations are based on mortality, morbidity, and lapse assumptions comparable to our historical experience, modified for recent observed trends. These obligations are based on current balance sheet values and include expected interest crediting, but do not incorporate an expectation of future market growth, or future deposits. Due to the significance of the assumptions used, the amounts presented could materially differ from actual results. As variable separate account obligations are legally insulated from general account obligations, the variable separate account obligations will be fully funded by cash flows from variable separate account assets. We expect to fully fund the general account obligations from cash flows from general account investments.
The Company uses the same methodology and assumptions to estimate the allowance for credit losses for unfunded loan commitments as for funded commercial mortgage loan receivables. As of December 31, 2020 the allowance for credit losses for unfunded commitments was $22.4 million. As of January 1, 2020, the Company established an allowance for credit losses for unfunded loan commitments of $10.6 million upon adoption of ASU No. 2016-13. During the year ended December 31, 2020, the Company established an additional allowance for credit losses of $11.8 million. Refer to Note 8, Commercial Mortgage Loans, of the consolidated financial statements for more information.
We utilize a risk management strategy that incorporates the use of derivative financial instruments to reduce exposure to certain risks, including but not limited to, interest rate risk, currency exchange risk, volatility risk, and equity market risk. These strategies are developed through our analysis of data from financial simulation models and other internal and industry sources, and are then incorporated into our risk management program. Refer to Note 6, Derivative Financial Instruments, to the consolidated financial statements included in this report for additional information on our financial instruments.
Estimated fair values from the hypothetical increase in rates were derived from the durations of our fixed maturities and commercial mortgage loans. Duration measures the change in fair value resulting from a change in interest rates. While these estimated fair values provide an indication of how sensitive the fair values of our fixed maturities and commercial mortgage loans are to changes in interest rates, they do not represent management’s view of future fair value changes or the potential impact of fluctuations in credit spreads. Actual results may differ from these estimates.
The estimated fair values from the hypothetical increase in rates were derived from the durations of our outstanding mortgage loan commitments. While these estimated fair values provide an indication of how sensitive the fair value of our
outstanding commitments are to changes in interest rates, they do not represent management’s view of future market changes, and actual market results may differ from these estimates.
Our stable value contract and annuity products tend to be more sensitive to market risks than our non-annuity products. As such, many of these products contain surrender charges and other features that reward persistency and penalize the early withdrawal of funds. Certain stable value and annuity contracts have market-value adjustments that protect us against investment losses if interest rates are higher at the time of surrender than at the time of issue. Additionally, as of December 31, 2020, $5.7 billion of our stable value contracts have no early termination rights.
The tables below present account values by range of current minimum guaranteed interest rates and current crediting rates for our universal life and deferred fixed annuity products:
The higher interest rates that have traditionally accompanied inflation could also affect our operations. Policy loans increase as policy loan interest rates become relatively more attractive. As interest rates increase, disintermediation of stable value and annuity account balances and individual life policy cash values may increase. The fair value of our fixed-rate, long-term investments may decrease, we may be unable to implement fully the interest rate reset and call provisions of our commercial mortgage loans, and our ability to make attractive commercial mortgage loans, including participating commercial mortgage loans, may decrease. In addition, participating mortgage loan income may decrease. The difference between the interest rate earned on investments and the interest rate credited to life insurance and investment products may also be adversely affected by rising interest rates. During the periods covered by this report, we believe inflation has not had a material impact on our business.
During 2020, the Company identified $63.2 million of certain reclassifications needed to appropriately present amounts related to reinsured vehicle service contracts. Also during 2020, the Company identified $195.0 million of certain cash flows presented in its investing and financing activities that were determined to be non-cash items. The Company determined that the reclassifications were not material to the financial statements for any period. These amounts have been corrected in the consolidated balance sheets, statements of income, and statements of cash flows for the year ended December 31, 2019.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The most significant estimates include those used in determining deferred policy acquisition
Further, certain estimates and assumptions include the direct and indirect impact of the COVID-19 pandemic on the Company’s business, financial condition and results of operations. The economic impact of the pandemic on the Company’s business depends on its severity and duration, which in turn depend on highly uncertain factors such as the nature and extent of containment efforts and the timing and efficacy of vaccines. The high level of uncertainty regarding this economic impact means that management’s estimates and assumptions, specifically those related to investments and certain derivatives fair values, the allowance for credit losses, and future policy benefits are subject to change - perhaps substantial change - as the situation develops and new information becomes available.
Investment income is recognized when earned, net of applicable management or other fees. Investment income on fixed maturity securities includes coupon interest, amortization of any premium and accretion of any discount. Investment income on equity securities includes dividend income and preferred coupons interest.
Each quarter the Company reviews investments with unrealized losses to determine whether such impairments are the result of credit losses. The Company analyzes various factors to make such determination including, but are not limited to: 1) actions taken by rating agencies, 2) default by the issuer, 3) the significance of the decline, 4) an assessment of the Company’s intent to sell the security (including a more likely than not assessment of whether the Company will be required to sell the security) before recovering the security’s amortized cost, 5) an economic analysis of the issuer’s industry, and 6) the financial strength, liquidity, and recoverability of the issuer. Management performs a security by security review each quarter to evaluate whether a credit loss has occurred.
For securities which the Company does not intend to sell and does not expect to be required to sell before recovering the security’s amortized cost basis, analysis of expected cash flows is used to measure the amount of the credit loss. To the extent the amortized cost basis of the security exceeds the present value of future cash flows expected to be collected, this difference represents a credit loss. Beginning on January 1, 2020, credit losses are recorded in realized gains (losses) with a corresponding adjustment to the allowance for credit losses, except that the credit loss recognized cannot exceed the difference between the book value and fair value of the security as of the date of the analysis. In future periods, recoveries in the present value of expected cash flows are recorded as a reversal of the previously recognized allowance for credit losses with an offsetting adjustment to realized gains (losses). See, “Accounting Pronouncements Recently Adopted” below for additional information. The Company considers contractual cash flows and all known market data related to cash flows when developing its estimates of expected cash flows. The Company uses the effective interest rate implicit in the security at the date of acquisition to discount expected cash flows. For floating rate securities, the Company’s policy is to lock in the interest rate at the first instance of an impairment. Estimates of expected cash flows are not probability-weighted but reflect the Company’s best estimate based on past events, current conditions, and reasonable and supportable forecasts of future events. Debt securities that the Company intends to sell or expects to be required to sell before recovery are written down to fair value with the change recognized in realized gains (losses).
The Company presents accrued interest receivable separately from other components of the amortized cost basis of its fixed maturity and structured investments and has made an accounting policy election not to measure an allowance for credit losses for accrued interest receivable. The Company’s policy is to write off uncollectible accrued interest receivables through a reversal of interest income in the period in which a credit loss is identified.
The Company held certain investments in entities in which its ownership interests could possibly be considered variable interests under Topic 810 of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) (excluding debt and equity securities held as trading, available-for-sale, or held-to-maturity). The Company reviewed the characteristics of each of these applicable entities and compares those characteristics to applicable criteria to determine whether the entity is a Variable Interest Entity (“VIE”). If the entity is determined to be a VIE, the Company then performed a detailed review to determine whether the interest would be considered a variable interest under the guidance. The Company then performed a qualitative review of all variable interests with the entity and determines whether the Company is the primary beneficiary. ASC 810 provides that an entity is the primary beneficiary of a VIE if the entity has 1) the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance, and 2) the obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the entity that could potentially be significant to the VIE, which was recorded on the balance sheet as of December 31, 2019 as fixed maturities at amortized cost.
The Company records its derivative financial instruments at fair value in the consolidated balance sheet in other long-term investments and other liabilities. The Company designates derivatives as either a cash flow hedge which hedges the variability of cash flows specific to a recognized asset or liability or forecasted transaction; a fair value hedge, which hedges the fair value of a recognized asset or liability or unrecognized firm commitment; or a derivative that does not qualify for hedge accounting. The Company assesses the effectiveness of a hedge at its inception and subsequently on a quarterly basis. For cash flow hedges, the effective portion of their gain or loss is reported as a component of other comprehensive income (loss) and reclassified into earnings in the period during which the hedged item impacts earnings. Any remaining gain or loss, the ineffective portion, is recognized in realized gains (losses). For fair value hedges, their gain or loss as well as the offsetting loss or gain on the hedged item attributable to the hedged risk are recognized in realized gains (losses). The Company reports changes in fair values of derivatives that are not part of a qualifying hedge relationship in realized gains (losses). For additional information, refer to Note 6, Derivative Financial Instruments.
PDs and LGDs are forecasted over a reasonable and supportable forecast period, which is reassessed on a quarterly basis. After the reasonable and supportable forecast period, the CML Model reverts to the Company’s own historical loss history at a portfolio segment level. The historical loss data used for reversion will be assessed annually in the third quarter, along with certain other model inputs and assumptions.
All or a portion of a loan may be written off at such point that a) the Company no longer expects to receive cash payments, b) the present value of future expected payments of a renegotiated loan is less than the current principal balance, or c) at such time that the Company is party to foreclosure or bankruptcy proceedings associated with the borrower and does not expect to recover the principal balance of the loan. A write-off is recorded by eliminating the allowance against the commercial mortgage loan and recording the renegotiated loan or the collateral property related to the loan as investment real estate on the balance sheet, which is carried at the lower of the appraised fair value of the property or the unpaid principal balance of the loan, less estimated selling costs associated with the property.
Prior to January 1, 2020, the Company calculated a valuation allowance based on the analysis of specific loans that were believed to have a higher risk of credit impairment consistent with the applicable guidance for loan impairments in ASC Subtopic 310. Due to the Company’s loss experience and nature of the loan portfolio, the Company believed that a collectively evaluated allowance would be inappropriate. Since the Company used the specific identification method for calculating the allowance, it was necessary to review the economic situation of each borrower to determine those that had higher risk of credit impairment. The Company has a team of professionals that monitors borrower conditions such as payment practices, borrower credit, operating performance, and property conditions, as well as ensuring the timely payment of property taxes and insurance. Through this monitoring process, the Company assessed the risk of each loan. When issues were identified, the severity of the issues was assessed and reviewed for possible credit impairment. If a loss was deemed probable, an expected loss calculation was performed and an allowance was established for that loan based on the expected loss. The expected loss was calculated as the excess carrying value of a loan over either the present value of expected future cash flows discounted at the loan’s original effective interest rate, or the current estimated fair value of the loan’s underlying collateral. A loan could be subsequently charged off at such point that the Company no longer expected to receive cash payments, the present value of future expected payments of the renegotiated loan was less than the current principal balance, or at such time that the Company was party to foreclosure or bankruptcy proceedings associated with the borrower and did not expect to recover the principal balance of the loan.
Short-term investments primarily consist of highly liquid securities and other investments with remaining maturities of one year or less, but greater than three months, at the time of purchase. These securities and investments are generally carried at fair value or amortized cost that approximates fair value.
Cash includes all demand deposits reduced by the amount of outstanding checks and drafts. As a result of the Company’s cash management system, checks issued from a particular bank but not yet presented for payment may create negative book cash balances with the bank at certain reporting dates. Such negative balances are included in other liabilities and were $184.7 million and $183.7 million as of December 31, 2020 and 2019, respectively. The Company has deposits with certain financial institutions which exceed federally insured limits. The Company has reviewed the creditworthiness of these financial institutions and believes there is minimal risk of a material loss.
In conjunction with the Merger and the acquisition of insurance policies or investment contracts, a portion of the purchase price is allocated to the right to receive future gross profits from cash flows and earnings of associated insurance policies and investment contracts. This intangible asset, called VOBA, is based on the actuarially estimated present value of future cash flows from associated insurance policies and investment contracts acquired. The estimated present value of future cash flows used in the calculation of the VOBA is based on certain assumptions, including mortality, persistency, expenses, and interest rates that the Company believes to be those of a market participant. The Company amortizes VOBA in proportion to gross premiums for traditional life products, or estimated gross margins (“EGMs”) for participating traditional life products within the MONY Life Insurance Company (“MONY”) block. For interest sensitive products, the Company uses various amortization bases including EGPs, revenues, account values, or insurance in-force. VOBA is subject to annual recoverability testing.
Other intangible assets with definite lives are amortized over the estimated useful life of the asset and reviewed for impairment whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. Amortizable intangible assets primarily consist of distribution relationships, trade names, technology, and software. Intangible assets with indefinite lives, primarily insurance licenses, are not amortized, but are reviewed for impairment on an annual basis or whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. Software is generally amortized over a three - five year useful life.
The separate account assets represent funds for which the Company does not bear the investment risk. These assets are carried at fair value and are equal to the separate account liabilities, which represent the policyholder’s equity in those assets. The investment income and investment gains and losses on the separate account assets accrue directly to the policyholder. These amounts are reported separately as assets and liabilities related to separate accounts in the accompanying consolidated financial statements. Amounts assessed against policy account balances for the costs of insurance, policy administration, and other services are included in premiums and policy fees in the accompanying consolidated statements of income. Fees are generally based on the daily net assets of the policyholder’s account value and recognized as revenue when assessed. Assets and liabilities related to separate accounts include balances related to separate accounts assumed through reinsurance. These balances relate to variable annuity and variable life policies that we have reinsured on a modified coinsurance basis.
The Company also establishes reserves for guaranteed living withdrawal benefits (“GLWB”) on its variable annuity (“VA”) products. The GLWB is valued in accordance with FASB guidance under the ASC Derivatives and Hedging Topic which utilizes the valuation technique prescribed by the ASC Fair Value Measurements and Disclosures Topic, which requires the embedded derivative to be recorded at fair value using current interest rates and implied volatilities for the equity indices. The fair value of the GLWB is impacted by equity market conditions and can result in the GLWB embedded derivative being in an overall net asset or net liability position. In times of favorable equity market conditions the likelihood and severity of claims is reduced and expected fee income increases. Since claims are generally expected later than fees, these favorable equity market conditions can result in the present value of fees being greater than the present value of claims, which results in a net GLWB embedded derivative asset. In times of unfavorable equity market conditions the likelihood and severity of claims is increased and expected fee income decreases and can result in the present value of claims exceeding the present value of fees resulting in a net GLWB embedded derivative liability. The methods used to estimate the embedded derivative employ assumptions about mortality, lapses, policyholder behavior, equity market returns, interest rates, and market volatility. The Company assumes age-based mortality from the Ruark 2015 ALB table adjusted for company experience. Differences between the actual experience and the assumptions used result in variances in profit and could result in losses. The Company reinsures certain risks associated with the GLWB to Shades Creek Captive Insurance (“Shades Creek”), a direct wholly owned insurance subsidiary of PLC. As of December 31, 2020 and 2019, the Company’s net GLWB liability held, including the impact of reinsurance, was $403.7 million and $186.0 million, respectively.
The balance recognized as goodwill is not amortized, but is reviewed for impairment on an annual basis, or more frequently as events or circumstances may warrant, including those circumstances which would more likely than not reduce the fair value of the Company’s reporting units below its carrying amount. Accounting for goodwill requires an estimate of the future profitability of the associated lines of business within the Company’s reporting units to assess the recoverability of the capitalized goodwill. The Company’s material goodwill balances are attributable to certain of its reportable segments. Each of the Company’s reportable segments are considered separate reporting units, with the exception of the Retail Life and Annuity segment. This reportable segment contains the Protection and Retirement divisions which are considered separate reporting units. The Company evaluates the carrying value of goodwill at the reporting units level at least annually and between annual evaluations if events occur or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Such circumstances could include, but are not limited to: 1) a significant adverse change in legal factors or in business climate, 2) unanticipated competition, or 3) an adverse action or assessment by a regulator. When evaluating whether goodwill is impaired, the Company first determines through qualitative analysis whether relevant events and circumstances indicate that it is more likely than not that a reporting unit’s goodwill balances is impaired as of the testing date. If the qualitative analysis does not indicate that an impairment of a reporting unit’s goodwill is more likely than not then no other specific quantitative impairment testing is required.
The Company evaluates the recoverability of the Company’s deferred tax assets and establish a valuation allowance, if necessary, to reduce the Company’s deferred tax assets to an amount that is more likely than not to be realized. Considerable judgment is required in determining whether a valuation allowance is necessary, and if so, the amount of such valuation allowance. In evaluating the need for a valuation allowance the Company may consider many factors, including: (1) the nature of the deferred tax assets and liabilities; (2) whether they are ordinary or capital; (3) in which tax jurisdictions they were generated and the timing of their reversal; (4) taxable income in prior carryback years as well as projected taxable earnings exclusive of reversing temporary differences and carryforwards; (5) the length of time that carryovers can be utilized in the various taxing jurisdictions; (6) any unique tax rules that would impact the utilization of the deferred tax assets; and (7) any tax planning strategies that the Company would employ to avoid a tax benefit from expiring unused. Although realization is not assured, management believes it is more likely than not that the deferred tax assets, net of valuation allowances, will be realized.
GAAP prescribes a comprehensive model for how a company should recognize, measure, present, and disclose in its financial statements uncertain tax positions that a company has taken or expects to take on tax returns. The application of this guidance is a two-step process, the first step being recognition. The Company determines whether it is more likely than not, based on the technical merits, that the tax position will be sustained upon examination. If a tax position does not meet the more likely than not recognition threshold, the benefit of that position is not recognized in the financial statements. The second step for the tax positions that meet the more likely than not criteria is measurement. The Company measures the tax position as the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate resolution with a taxing authority that has full knowledge of all relevant information. This measurement considers the amounts and probabilities of the outcomes that could be realized upon ultimate settlement using the facts, circumstances, and information available at the reporting date.
The Company’s liability for income taxes includes the liability for unrecognized tax benefits, interest and penalties which relate to tax years still subject to review by the Internal Revenue Service (“IRS”) or other taxing jurisdictions. Audit periods remain open for review until the statute of limitations expires. Generally, for tax years which produce net operating losses, capital losses or tax credit carryforwards, the statute of limitations does not close until the expiration of the statute of limitations for the tax year in which they are fully utilized. The completion of review or the expiration of the statute of limitations for a given audit period could result in an adjustment to the liability for income taxes. The Company classifies all interest and penalties related to tax uncertainties as income tax expense. Refer to Note 18, Income Taxes, for additional information regarding income taxes.
Traditional life insurance products consist principally of those products with fixed and guaranteed premiums and benefits, and they include whole life insurance policies, term and term-like life insurance policies, limited payment life insurance policies, and certain annuities with life contingencies. In accordance with ASC 805, the liabilities for future policy benefits on traditional life insurance products, when combined with the associated VOBA, were recorded at fair value on the date of the Merger. These values, subsequent to the Merger, are computed using assumptions that include interest rates, mortality, lapse rates, expense estimates, and other assumptions based on the Company’s experience, modified as necessary to reflect anticipated trends and to include provisions for possible adverse deviation.
Liabilities for future policy benefits on traditional life insurance products have been computed using a net level method including assumptions as to investment yields, mortality, persistency, and other assumptions based on the Company’s experience, modified as necessary to reflect anticipated trends and to include provisions for possible adverse deviation. Reserve investment yield assumptions on December 31, 2020, range from approximately 2.50% to 5.50%. The liability for future policy benefits and claims on traditional life, health, and credit insurance products includes estimated unpaid claims that have been reported to us and claims incurred but not yet reported. Policy claims are charged to expense in the period in which the claims are incurred.
The Company establishes liabilities for fixed indexed annuity (“FIA”) products. These products are deferred fixed annuities with a guaranteed minimum interest rate plus a contingent return based on equity market performance. The FIA product is considered a hybrid financial instrument under FASB ASC Topic 815 - Derivatives and Hedging which allows the Company to make the election to value the liabilities of these FIA products at fair value. This election was made for the FIA products issued through 2009. These products are no longer being marketed. The future changes in the fair value of the liability for these FIA products are recorded in Benefit and settlement expenses with the liability being recorded in Annuity account balances. For more information regarding the determination of fair value of annuity account balances please refer to Note 5, Fair Value of Financial Instruments. Premiums and policy fees for these FIA products consist of fees that have been assessed against the policy account balances for surrenders. Such fees are recognized when assessed and earned.
The Company markets universal life products with a guaranteed minimum interest rate plus a contingent return based on equity market performance and the products are considered hybrid financial instruments under the FASB’s ASC Topic 815 - Derivatives and Hedging. The Company has not elected to value these indexed universal life (“IUL”) products at fair value prior to the Merger date. As a result, the Company accounts for the provision that provides for a contingent return based on equity market performance as an embedded derivative. The embedded derivative is bifurcated from the host contract and recorded at fair value in Other liabilities. Changes in the fair value of the embedded derivative are recorded in realized gains (losses). For more information regarding the determination of fair value of the IUL embedded derivative refer to Note 5, Fair Value of Financial Instruments. The host contract is accounted for as a debt instrument in accordance with ASC Topic 944 - Financial Services - Insurance and is recorded in Future policy benefits and claims with any discount to the minimum account value being accreted using the effective yield method. Benefits and settlement expenses include accrued interest and benefit claims incurred during the period.
The Company establishes liabilities for guaranteed minimum death benefits (“GMDB”) on its VA products. The methods used to estimate the liabilities employ assumptions about mortality and the performance of equity markets. The Company assumes age-based mortality from the Ruark 2015 ALB table adjusted for company experience. Future declines in the equity market would increase the Company’s GMDB liability. Differences between the actual experience and the assumptions used result in variances in profit and could result in losses. A portion of the Company’s GMDB is subject to a dollar-for-dollar reduction upon withdrawal of related annuity deposits on contracts issued prior to January 1, 2003. The Company reinsures certain risks associated with the GMDB to Shades Creek. As of December 31, 2020 and 2019, the GMDB reserve, including the impact of reinsurance, was $34.1 million and $37.7 million.
Property and casualty insurance products include service contract business, surety bonds, and guaranteed asset protection (“GAP”). Premiums and fees associated with service contracts and GAP products are recognized based on expected claim patterns. For all other products, premiums are generally recognized over the terms of the contract on a pro-rata basis. Commissions and fee income associated with other products are recognized as earned when the related services are provided to the customer. Unearned premium reserves are maintained for the portion of the premiums that is related to the unexpired period of the policy. Such reserves are computed by pro rata methods or methods related to anticipated claims. Benefit reserves are recorded when insured events occur. Benefit reserves include case basis reserves for known but unpaid claims as of the balance sheet date as well as incurred but not reported (“IBNR”) reserves for claims where the insured event has occurred but has not been reported to the Company as of the balance sheet date. The case basis reserves and IBNR are calculated based on historical experience and on assumptions relating to claim severity and frequency, the level of used vehicle prices, and other factors. These assumptions are modified as necessary to reflect anticipated trends.
Reinsurance Accounting Methodology-Ceded premiums of the Company’s traditional life insurance products are treated as an offset to direct premium and policy fee revenue and are recognized when due to the assuming company. Ceded claims are treated as an offset to direct benefits and settlement expenses and are recognized when the claim is incurred on a direct basis. Ceded policy reserve changes are also treated as an offset to benefits and settlement expenses and are recognized
during the applicable financial reporting period. Expense allowances paid by the assuming companies which are allocable to the current period are treated as an offset to other operating expenses. Since reinsurance treaties typically provide for allowance percentages that decrease over the lifetime of a policy, allowances in excess of the “ultimate” or final level allowance are capitalized. Amortization of capitalized reinsurance expense allowances representing recovery of acquisition costs is treated as an offset to direct amortization of DAC or VOBA. Amortization of deferred expense allowances is calculated as a level percentage of expected premiums in all durations given expected future lapses and mortality and accretion due to interest.
underlying reinsured contracts would be recognized. In some cases reinsurance allowances allocable to the current period may exceed non-deferred direct costs, which may cause net other operating expenses (related to specific contracts) to be negative.
Liabilities for unpaid reinsurance claims are produced from claims and reinsurance system records, which contain the relevant terms of the individual reinsurance contracts. The Company monitors claims due from reinsurers to ensure that balances are settled on a timely basis. Incurred but not reported claims are reviewed to ensure that appropriate amounts are ceded.
The Company had total reinsurance receivables of $4.6 billion as of December 31, 2020, which includes both ceded policy benefit reserves and receivables for claims. Receivables for claims represented approximately 10% of total reinsurance receivables as of December 31, 2020. Receivables for claims are short-term in nature, and generally carry minimal credit risk. Of reserves ceded as of December 31, 2020, 71% were receivables from reinsurers rated by A.M. Best Company. Of the total rated by A.M. Best, 76% were rated A+ or better, 14% were rated A, and 10% were rated A- or lower. The Company monitors the concentration of credit risk the Company has with any reinsurer, as well as the financial condition of its reinsurers, on an ongoing basis. Certain of the Company’s reinsurance receivables are supported by letters of credit, funds held or trust agreements.
ASU No. 2016-13 - Financial Instruments-Credit Losses: Measurement of Credit Losses on Financial Instruments. The amendments in this Update introduce a new current expected credit loss (“CECL”) model for certain financial assets, including commercial mortgage loans and reinsurance receivables. For assets within the scope of the new model, an entity will recognize as an allowance against earnings its estimate of the contractual cash flows not expected to be collected on day one of the asset’s acquisition. The allowance may be reversed through earnings if a security recovers in value. This differs from the current impairment model, which requires recognition of credit losses when they have been incurred and recognizes a security’s subsequent recovery in value in other comprehensive income. The Update also makes targeted changes to the current impairment model for available-for-sale (“AFS”) debt securities, which comprise the majority of the Company’s invested assets. Similar to the CECL model, credit loss impairments will be recorded in an allowance against earnings that may be reversed for subsequent recoveries in value. The amendments in this Update, along with related amendments in ASU No. 2018-19, ASU No. 2019-04, and ASU No. 2019-11 - Codification Improvements to Topic 326, Financial Instruments-Credit Losses, collectively ASC Topic 326, were effective for annual and interim periods beginning after December 15, 2019 on a modified retrospective basis. A vendor-provided credit loss model is utilized to measure the allowance for the majority of the Company’s commercial mortgage loans and unfunded commercial mortgage loan commitments, and the Company utilizes an internally-developed model to measure the allowance for amounts recoverable from reinsurers. The Company applied the revisions in the Update through a cumulative effect adjustment to retained earnings as of January 1, 2020. The cumulative effect adjustment resulted in a decrease in retained earnings of $138.1 million, net of the impact to deferred taxes, DAC, VOBA and other items. The Company continues to apply the previous guidance to 2019 and prior periods.
ASU No. 2018-12 - Financial Services - Insurance (Topic 944): Targeted Improvements to Accounting for Long-Duration Contracts. The amendments in this Update are designed to make improvements to the existing recognition, measurement, presentation, and disclosure requirements for certain long-duration contracts issued by an insurance company. The new amendments require insurance entities to provide a more current measure of the liability for future policy benefits for traditional and limited-payment contracts by regularly refining the liability for actual past experience and updated future assumptions. This differs from current requirements where assumptions are locked-in at contract issuance for these contract types. In addition, the updated liability will be discounted using an upper-medium grade (low-credit-risk) fixed income instrument yield that reflects the characteristics of the liability which differs from currently used rates based on the invested assets supporting the liability. In addition, the amendments introduce new requirements to assess market-based insurance contract options and guarantees for Market Risk Benefits and measure them at fair value. This Update also requires insurance entities to amortize deferred acquisition costs on a constant-level basis over the expected life of the contract. Finally, this Update requires new disclosures including liability rollforwards and information about significant inputs, judgments, assumptions, and methods used in the measurement. In November 2020, FASB issued ASU No. 2020-11 - Financial Services - Insurance (Topic 944); Effective Date and Early Application which deferred the effective date to periods beginning after December 15, 2023. The Company is currently reviewing its policies, processes, and applicable systems to determine the impact this standard will have on its operations and financial results.
In conjunction with the Captive Merger, Golden Gate II redeemed the full outstanding principal amount of floating rate non-recourse funding obligations due July 15, 2052. These non-recourse funding obligations were previously marked to fair value in conjunction with the Merger. The redemption required the acceleration of the accretion of the discount associated with the non-recourse funding obligation. The impact of this non-cash acceleration was a $54.1 million reduction to income before taxes for the year ended December 31, 2020. Additionally, this redemption required a $329.9 million cash payment, of which $20.6 million was held by external parties and $309.3 million was held by nonconsolidated affiliates, to third parties in order to settle the outstanding principal associated with the non-recourse funding obligation. Refer to Note 14, Debt and Other Obligations, for additional detail around the impacted balances.
Also in conjunction with the Captive Merger, the interest support and YRT premium support agreements that were entered into with PLC by certain of the Company’s affiliates were terminated. As discussed in Note 5, Fair Value of Financial Instruments, these agreements met the definition of a derivative financial instrument and were accounted for at fair value in the consolidated financial statements. PLC settled its obligation under these agreements during the fourth quarter of 2020 and made a payment of $134.8 million to Golden Gate.
The GWL&A Master Transaction Agreement and other transaction documents contain certain customary representations and warranties made by each of the parties, and certain customary covenants regarding the Sellers and the Individual Life Business, and provide for indemnification, among other things, for breaches of those representations, warranties, and covenants. The terms of the GWL&A Reinsurance Agreements resulted in an acquisition of the Individual Life Business by PLC in accordance with ASC Topic 805, Business Combinations.
The following table details the final allocation of assets acquired and liabilities assumed from the Individual Life Business reinsurance transaction as of the date of the GWL&A Closing.
The following chart is a rollforward of the available-for-sale credit losses on fixed maturities held by the Company for which a portion of an other-than-temporary impairment was recognized in other comprehensive income:
As of December 31, 2020, the Company had a total of 429 positions that were in an unrealized loss position, including 7 positions for which an allowance for expected credit losses was established. For unrealized losses for which an allowance for credit losses was not established, the Company does not consider these unrealized loss positions to be credit related. This is based on the aggregate factors discussed previously and because the Company has the ability and intent to hold these investments until the fair values recover, and the Company does not intend to sell or expect to be required to sell the securities before recovering the Company’s amortized cost of the securities.
As of December 31, 2020, the Company had securities in its available-for-sale portfolio which were rated below investment grade with a fair value of $2.6 billion and had an amortized cost of $2.5 billion. In addition, included in the Company’s trading portfolio, the Company held $140.4 million of securities which were rated below investment grade. The Company held $493.2 million of the below investment grade securities that were not publicly traded.
The change in unrealized gains (losses), excluding the allowance for expected credit losses, net of income tax, on fixed maturities classified as available-for-sale is summarized as follows:
The Company’s held-to-maturity securities were issued by affiliates of the Company which were considered VIEs. The Company is not the primary beneficiary of these entities and thus the securities were not eliminated in consolidation. These securities were collateralized by non-recourse funding obligations issued by captive insurance companies that were affiliates of the Company. As of December 31, 2020, the Company no longer held any held-to-maturity securities. Refer to Note 3, Significant Transactions for additional information on Red Mountain, LLC and Steel City, LLC.
For securities that are priced via non-binding independent broker quotations, the Company assesses whether prices received from independent brokers represent a reasonable estimate of fair value. The Company’s assessment incorporates various metrics (yield curves, credit spreads, prepayment rates, etc.) along with other information available to the Company from both internal and external sources to determine the valuation of such holdings. As a result of this analysis, if the Company determines there is a more appropriate fair value based upon the analytics, the price received from the independent broker is adjusted accordingly. The Company did not adjust any quotes or prices received from brokers during the years ended December 31, 2020 and 2019.
As of December 31, 2020, the Company held $538.5 million of Level 3 ABS, which included $467.1 million of other asset-backed securities classified as available-for-sale and $71.4 million of other asset-backed securities classified as trading. These securities are predominantly ARS whose underlying collateral is at least 97% guaranteed by the FFELP. As a result of the ARS market collapse during 2008, the Company prices its ARS using an income approach valuation model. As part of the valuation process the Company reviews the following characteristics of the ARS in determining the relevant inputs: 1) weighted-average coupon rate, 2) weighted-average years to maturity, 3) types of underlying assets, 4) weighted-average coupon rate of the underlying assets, 5) weighted-average years to maturity of the underlying assets, 6) seniority level of the tranches owned, 7) credit ratings of the securities, 8) liquidity premium, and 9) paydown rate. In periods where market activity increases and there are transactions at a price that is not the result of a distressed or forced sale we consider those prices as part of our valuation. If the market activity during a period is solely the result of the issuer redeeming positions we consider those transactions in our valuation, but still consider them to be level three measurements due to the nature of the transaction.
As of December 31, 2020, the Company classified $1.4 billion of securities as Level 3 valuations. Level 3 securities primarily represent investments in illiquid bonds for which no price is readily available. To determine a price, the Company uses a discounted cash flow model with both observable and unobservable inputs. These inputs are entered into an industry standard pricing model to determine the final price of the security. These inputs include: 1) principal and interest payments, 2) coupon rate, 3) sector and issuer level spread over treasury, 4) underlying collateral, 5) credit ratings, 6) maturity, 7) embedded options, 8) recent new issuance, 9) comparative bond analysis, and 10) an illiquidity premium.
The fair value of the GLWB embedded derivative is derived through the income method of valuation using a valuation model that projects future cash flows using multiple risk neutral stochastic equity scenarios and policyholder behavior assumptions. The risk neutral scenarios are generated using the current swap curve and projected equity volatilities and correlations. The projected equity volatilities are based on a blend of historical volatility and near- term equity market implied volatilities. The equity correlations are based on historical price observations. For policyholder behavior assumptions, expected lapse and utilization assumptions are used and updated for actual experience, as necessary. The Company assumes age-based mortality from the Ruark 2015 ALB table with attained age factors varying from 88% - 100% based on company experience. The present value of the cash flows is determined using the discount rate curve, which is based upon LIBOR plus a credit spread (to represent the Company’s non-performance risk). For expected lapse and utilization, assumptions are used and updated for actual experience, as necessary, using an internal predictive model developed by the Company. As a result of using significant unobservable inputs, the GLWB embedded derivative is categorized as Level 3. Policyholder assumptions are reviewed on an annual basis.
The balance of the indexed universal life (“IUL”) embedded derivative is impacted by policyholder cash flows associated with the IUL product that are allocated to the embedded derivative in addition to changes in the fair value of the embedded derivative during the reporting period. The fair value of the IUL embedded derivative is derived through the income method of valuation using a valuation model that projects future cash flows using current index values and volatility, the hedge budget used to price the product, and policyholder assumptions (both elective and non-elective). For policyholder behavior assumptions, expected lapse and withdrawal assumptions are used and updated for actual experience, as necessary. The Company assumes age-based mortality from the SOA 2015 VBT Primary Tables, with attained age factors varying from 36% - 161% based on company experience. The present value of the cash flows is determined using the discount rate curve, which is based upon LIBOR up to one year and constant maturity treasury rates plus a credit spread (to represent the Company’s non-performance risk) thereafter. Policyholder assumptions are reviewed on an annual basis. As a result of using significant unobservable inputs, the IUL embedded derivative is categorized as Level 3.
The Company has assumed and ceded certain blocks of policies under modified coinsurance agreements in which the investment results of the underlying portfolios inure directly to the reinsurers. Funds withheld arrangements related to such agreements contain embedded derivatives that are reported at fair value. Changes in their fair value are reported in realized gains (losses). The fair value of embedded derivatives related to funds withheld under modified coinsurance agreements are a function of the unrealized gains or losses on the underlying assets and are calculated in a manner consistent with the terms of
the agreements. The investments supporting certain of these agreements are designated as “trading securities”; therefore changes in their fair value are also reported in realized gains (losses). The fair value of embedded derivatives is estimated based on market standard valuation methodology and is considered a Level 3 valuation.
The Funds Withheld derivative results from reinsurance agreements with Shades Creek and Protective Life Reinsurance Bermuda LTD, a wholly owned subsidiary of PLC (“Protective Re”) where the economic performance of certain hedging instruments held by the Company are ceded to Shades Creek and Protective Re. The value of the Funds Withheld derivative is directly tied to the value of the hedging instruments held in the funds withheld accounts. The hedging instruments consist of derivative instruments, the fair values of which are classified as a Level 2 measurement; as such, the fair value of the Funds Withheld derivative has been classified as a Level 2 measurement. The fair value of the Funds Withheld derivative as of December 31, 2020, was a liability of $66.3 million.
The Company records a certain legacy block of FIA reserves at fair value. Based on the characteristics of these reserves, the Company believes that the fund value approximates fair value. The fair value measurement of these reserves is considered a Level 3 valuation due to the unobservable nature of the fund values.
The following table presents the valuation method for material financial instruments included in Level 3 as of December 31, 2020, as well as the unobservable inputs used in the valuation of those financial instruments:
The chart above excludes Level 3 financial instruments that are valued using broker quotes and those for which book value approximates fair value. Unobservable inputs were weighted by the relative fair value of instruments, except for other asset-backed securities which were weighted by the relative par amounts.
In certain cases the Company has determined that book value materially approximates fair value. As of December 31, 2020, the Company held $89.9 million of financial instruments where book value approximates fair value which are predominantly FHLB stock.
The following table presents the valuation method for material financial instruments included in Level 3, as of December 31, 2019, as well as the unobservable inputs used in the valuation of those financial instruments:
The chart above excludes Level 3 financial instruments that are valued using broker quotes and those for which book value approximates fair value.
The Company has considered all reasonably available quantitative inputs as of December 31, 2019, but the valuation techniques and inputs used by some brokers in pricing certain financial instruments are not shared with the Company. This resulted in $76.8 million of financial instruments being classified as Level 3 as of December 31, 2019. Of the $76.8 million, $65.4 million are other asset backed securities, and $11.4 million are corporate securities.
The asset-backed securities classified as Level 3 are predominantly ARS. A change in the paydown rate (the projected annual rate of principal reduction) of the ARS can significantly impact the fair value of these securities. A decrease in the paydown rate would increase the projected weighted average life of the ARS and increase the sensitivity of the ARS’ fair value to changes in interest rates. An increase in the liquidity premium would result in a decrease in the fair value of the securities, while a decrease in the liquidity premium would increase the fair value of these securities. The liquidation value for these
For the year ended December 31, 2020, there were $184.0 million of securities transferred into Level 3 from Level 2. These transfers resulted from securities that were priced by independent pricing services or brokers in previous periods but were priced internally using significant unobservable inputs where market observable inputs were not available as of December 31, 2020.
For the year ended December 31, 2020, there were $1.2 million of securities transferred into Level 2 from Level 3.
(7)As of December 31, 2019, carrying amount of $2.8 billion and fair value of $3.0 billion related to non-recourse funding obligations issued by Golden Gate and Golden Gate V.
The Company estimates the fair value of commercial mortgage loans using an internally developed model. This model includes inputs derived by the Company based on assumed discount rates relative to the Company’s current commercial mortgage loan lending rate and an expected cash flow analysis based on a review of the commercial mortgage loan terms. The model also contains the Company’s determined representative risk adjustment assumptions related to credit and liquidity risks.
The Company estimates the fair value of its fixed maturity, held-to-maturity securities using internal discounted cash flow models. The discount rates used in the model are based on a current market yield for similar financial instruments. As of December 31, 2020, the Company did not hold any held-to-maturity securities.
The Company has funds withheld accounts that consists of various derivative instruments held by us that are used to hedge certain GLWB and GMDB riders, as well as certain fixed indexed annuity products. The economic performance of derivatives in the funds withheld accounts are ceded to Shades Creek and Protective Re. The funds withheld accounts are accounted for as a derivative financial instrument.
It is the Company's policy not to offset assets and liabilities associated with open derivative contracts. However, the Chicago Mercantile Exchange (“CME”) rules characterize variation margin transfers as settlement payments, as opposed to adjustments to collateral. As a result, derivative assets and liabilities associated with centrally cleared derivatives for which the CME serves as the central clearing party are presented as if these derivatives had been settled as of the reporting date.
(1)The Company and certain of its subsidiaries had an interest support agreement, YRT premium support agreements, and portfolio maintenance agreements with PLC through October 1, 2020. These agreements were terminated as part of the Captive Merger and a new portfolio maintenance agreement was entered into with PLC on that date.
Based on expected cash flows of the underlying hedged items, the Company expects to reclassify $0.8 million out of accumulated other comprehensive income (loss) into realized gains (losses) during the next twelve months.
The tables below present the derivative instruments by assets and liabilities for the Company as of December 31, 2020:
The tables below present the derivative instruments by assets and liabilities for the Company as of December 31, 2019.
(1)Borrowings under repurchase agreements are for a term less than 90 days.
During the year ended December 31, 2020, the Company funded $1.4 billion of new loans, with an average loan size of $7.7 million. The average size commercial mortgage loan in the portfolio as of December 31, 2020, was $5.6 million and the weighted-average interest rate was 4.3%. The largest single commercial mortgage loan at December 31, 2020 was $78.0 million.
The Company offers a type of commercial mortgage loan under which the Company will permit a loan-to-value ratio of up to 85% in exchange for a participating interest in the cash flows from the underlying real estate. As of December 31, 2020 and 2019, $805.9 million and $717.0 million, respectively, of the Company’s total commercial mortgage loans principal balance have this participation feature. Cash flows received as a result of this participation feature are recorded as interest income. During the years ended December 31, 2020, 2019, and 2018, the Company recognized $26.3 million, $23.4 million, and $29.4 million of participation commercial mortgage loan income, respectively.
As of December 31, 2019, the Company had allowances for commercial mortgage loan credit losses of $4.9 million which is shown in the chart below.
An analysis of delinquent loans is shown in the following chart:
The Company’s commercial mortgage loan portfolio consists of commercial mortgage loans that are collateralized by real estate. Due to the collateralized nature of the loans, any assessment of impairment and ultimate loss given a default on the loans is based upon a consideration of the estimated fair value of the real estate.
The Company limits accrued interest income on loans to ninety days of interest. For loans in nonaccrual status, interest income is recognized on a cash basis. For the twelve months ended December 31, 2020, an immaterial amount of accrued interest was excluded from the amortized cost basis pursuant to the Company’s nonaccrual policy.
Based on the balance recorded as of December 31, 2020, the expected amortization of VOBA for the next five years is as follows:
During the fourth quarter of 2020, the Company performed its annual qualitative evaluation of goodwill based on the circumstances that existed as of October 1, 2020 and determined that there was no indication that its goodwill was more likely than not impaired and no adjustment to impair goodwill was necessary. The Company has assessed whether events have occurred subsequent to October 1, 2020 that would impact the Company’s conclusion and no such events were identified. After consideration of applicable factors and circumstances noted as part of the annual assessment, the Company determined that no triggering events had occurred and it was more likely than not that the fair value of the reporting units exceeded the carrying value of the reporting units.
The GMDB reserve is calculated by applying a benefit ratio, equal to the present value of total expected GMDB claims divided by the present value of total expected contract assessments, to cumulative contract assessments. This amount is then adjusted by the amount of cumulative GMDB claims paid and accrued interest. Assumptions used in the calculation of the GMDB reserve were as follows: mean investment performance of 6.2%, age-based mortality from the Ruark 2015 ALB table adjusted for company and industry experience, lapse rates determined by a dynamic formula, and an average discount rate of 4.5%. Changes in the GMDB reserve are included in benefits and settlement expenses in the accompanying consolidated statements of income.
These amounts exclude certain VA business which has been 100% reinsured to Commonwealth Annuity and Life Insurance Company (formerly known as Allmerica Financial Life Insurance and Annuity Company) (“CALIC”) under a Modco agreement. The guaranteed amount payable associated with the annuities reinsured to CALIC was $6.4 million and $7.1 million, as of December 31, 2020 and 2019, respectively. The average attained age of contract holders as of December 31, 2020 and 2019, was 69 and 68.
Activity relating to GMDB reserves (excluding those 100% ceded under the Modco agreement) is as follows:
The excess of Closed Block liabilities over Closed Block assets (adjusted to exclude the impact of related amounts in AOCI) at the acquisition date of October 1, 2013, represented the estimated maximum future post-tax earnings from the Closed Block that would be recognized in income from continuing operations over the period the policies and contracts in the Closed Block remain in force. In connection with the acquisition of MONY, the Company developed an actuarial calculation of the expected timing of MONY’s Closed Block’s earnings as of October 1, 2013. Pursuant to the Merger, this actuarial calculation of the expected timing of MONY’s Closed Block earnings was recalculated and reset as February 1, 2015, along with the establishment of a policyholder dividend obligation as of such date.
The Company’s third party reinsurance receivables amounted to $4.6 billion and $4.4 billion as of December 31, 2020 and 2019, respectively. These amounts include ceded reserve balances and ceded benefit payments. The ceded benefit payments are recoverable from reinsurers. The following table sets forth the receivables attributable to our more significant reinsurance partners:
On January 15, 2016, Golden Gate and Steel City entered into an 18-year transaction to finance $2.188 billion of “XXX” reserves related to the acquired GLAIC Block and the other term life insurance business reinsured to Golden Gate by the Company and WCL, a direct wholly owned subsidiary of the Company. Steel City issued notes (the “2016 Steel City Notes”) with an aggregate initial principal amount of $2.188 billion to Golden Gate in exchange for a surplus note issued by Golden Gate (the “2016 Surplus Notes”) with an initial principal amount of $2.188 billion. This structure was subsequently amended effective December 31, 2019, to accommodate financing of “XXX” reserves related to a specified portion of term life business the Company acquired from Liberty Life Assurance Company of Boston. Through the structure, Hannover Life Reassurance Company of America (Bermuda) Ltd., The Canada Life Assurance Company (Barbados Branch) and Nomura Americas Re Ltd. (collectively, the “Risk-Takers”) provide credit enhancement to the 2016 Steel City Notes in exchange for credit enhancement fees. The transaction is “non-recourse” to PLC, WCL, and the Company, meaning that none of these companies, other than Golden Gate, are liable to reimburse the Risk-Takers for any credit enhancement payments required to be made. As of September 30, 2020, the aggregate principal balance of the 2016 Steel City Notes was $1.858 billion. In connection with this transaction, PLC had entered into certain support agreements under which it guaranteed or otherwise supported certain obligations of Golden Gate or Steel City. During 2020 and 2019, no payments were made under these agreements. In connection with the Captive Merger, the Steel City Notes and the Golden Gate Note were redeemed and cancelled and the related support agreements were terminated effective October 1, 2020.
On October 10, 2012, Golden Gate V and Red Mountain entered into a 20-year transaction to finance up to $945 million of “AXXX” reserves related to a block of universal life insurance policies with secondary guarantees issued by the Company and WCL. Golden Gate V issued non-recourse funding obligations to Red Mountain, and Red Mountain issued a note with an initial principal amount of $275 million, increasing to a maximum of $945 million in 2027, to Golden Gate V for deposit to a reinsurance trust supporting Golden Gate V’s obligations under a reinsurance agreement with WCL, pursuant to which WCL cedes liabilities relating to the policies of WCL and retrocedes liabilities relating to the policies of the Company. Through the structure, Hannover Life Reassurance Company of America (“Hannover Re”), the ultimate risk taker in the transaction, provides credit enhancement to the Red Mountain note for the 20-year term in exchange for a fee. The transaction is “non-recourse” to Golden Gate V, Red Mountain, WCL, PLC, and the Company, meaning that none of these companies are liable for the reimbursement of any credit enhancement payments required to be made. As of September 30, 2020, the principal balance of the Red Mountain note was $750 million. In connection with the transaction, PLC had entered into certain support agreements under which it guaranteed or otherwise supports certain obligations of Golden Gate V or Red Mountain. During 2020 and 2019, no payments were made under these agreements. In connection with the Captive Merger discussed above, the Red Mountain Note and the Golden Gate V Note were redeemed and cancelled, and the related support and guaranteed agreements were terminated effective October 1, 2020.
On April 23, 2010, Golden Gate III entered into a Reimbursement Agreement (the “GGIII Reimbursement Agreement”) with UBS AG, Stamford Branch (“UBS”), as issuing lender. Under the Reimbursement Agreement, UBS issued a letter of credit (the “LOC)”) to a trust for the benefit of WCL. The GGIII Reimbursement Agreement has undergone three separate amendments and restatements, most recently effective June 25, 2014, to finance up to of $935.0 million of “XXX reserves related to term life blocks issued or acquired by the Company and WCL and reinsured by Golden Gate III. As of September 30, 2020, the LOC balance was $750.0 million. The term of the LOC was expected to be approximately 15 years from the original issuance date. This transaction is “non-recourse” to WCL, PLC, and the Company, meaning that none of these companies other than Golden Gate III are liable for reimbursement on a draw of the LOC. In connection with the Captive Merger discussed above, Golden Gate III paid an early termination fee of $11 million to UBS, the LOC was cancelled effective October 1, 2020.
On December 10, 2010, Golden Gate IV entered into a Reimbursement Agreement (the “GGIV Reimbursement Agreement”) with UBS AG, Stamford Branch, as issuing lender. Under the GGIV Reimbursement Agreement, UBS issued a LOC to a trust for the benefit of WCL to finance up to $790 million of “XXX” reserves related to term life blocks issued by the Company and WCL. As of September 30, 2020, the LOC balance was $740 million. The term of the LOC was expected to be 12 years from the original issuance date (stated maturity of December 30, 2022). This transaction was a “non-recourse” to WCL, PLC, and the Company, meaning that none of these companies other than Golden Gate IV are liable for reimbursement on a draw of the LOC. In connection with the Captive Merger discussed above, Golden Gate IV paid an early termination fee of $3.7 million to UBS, the LOC was cancelled effective October 1, 2020.
The following table provides the fair value of collateral pledged for repurchase agreements, grouped by asset class, as of December 31, 2020 and 2019:
The Company had rental expense of $4.1 million, and $6.3 million, and $11.3 million for the years ended December 31, 2020, 2019, and 2018, respectively. The following is a schedule by year of future minimum rental payments required under these leases:
As of December 31, 2020 and 2019, the Company had outstanding commercial mortgage loan commitments of $801.1 million at an average rate of 3.91% and $757.4 million at an average rate of 3.99%, respectively.
The Company and certain of its insurance subsidiaries, as well as certain other insurance companies for which the Company has coinsured blocks of life insurance and annuity policies, are under audit for compliance with the unclaimed property laws of a number of states. The audits are being conducted on behalf of the treasury departments or unclaimed property administrators in such states. The focus of the audits is on whether there have been unreported deaths, maturities, or policies that have exceeded limiting age with respect to which death benefits or other payments under life insurance or annuity
policies should be treated as unclaimed property that should be escheated to the state. The Company is presently unable to estimate the reasonably possible loss or range of loss that may result from the audits due to a number of factors, including the early stages of the audits being conducted, and uncertainty as to whether the Company or other companies are responsible for the liabilities, if any, arising in connection with certain co-insured policies. The Company will continue to monitor the matter for any developments that would make the loss contingency associated with the audits reasonably estimable.
A proposed Rehabilitation Plan (“Rehabilitation Plan”) was filed by the Receiver on June 30, 2020. The Rehabilitation Plan presents the following two options to each cedent: (1) remain in business with SRUS and be governed by the Rehabilitation Plan, or (2) recapture business ceded to SRUS. Due to SRUS’s financial status, neither option pays 100% of outstanding claims. Certain financial terms and conditions will be imposed on the cedents based on the election made, the type of business ceded, the manner in which the business is collateralized, and the amount of losses sustained by a cedent. On October 9, 2020, the Receiver filed a proposed order setting forth a schedule to present the Rehabilitation Plan for Court approval, which order contemplated possible modifications to the Rehabilitation Plan to be filed with the Court by March 16, 2021. On January 15, 2021, the Receiver filed a draft Amended Rehabilitation Plan (“Amended Plan”) with the Court. The majority of the substance and form of the original Rehabilitation Plan, including its two option structure described above, remained in place. On March 16, 2021, the Receiver filed a draft Amended Plan, which contains the same proposed revisions as the draft he previously circulated on January 15, 2021. Later on March 19, 2021, the Receiver filed a proposed order asking the Court to revise the schedule to push back dates, including the deadline that the Receiver must file any modifications to the Amended Plan to May 3, 2021. A group of interested parties separately filed a Motion to Appoint a Special Master, and at the hearing on the Motion, held on March 26, 2021, the Court suspended all deadlines in the case to allow the Receiver and interested parties to meet and confer on a number of topics for 30 days. It is expected that the parties will report back to the Court on or around April 30, 2021 at which time it is likely a new scheduling order will be entered.
The following table summarizes the changes in the accumulated balances for each component of AOCI as of December 31, 2020, 2019, and 2018.
(2)As of December 31, 2018, 2019 and 2020, net unrealized losses reported in AOCI were offset by $613.4 million, $(776.9) million and $(2.0) billion, respectively, due to the impact those net unrealized losses would have had on certain of the Company’s insurance assets and liabilities if the net unrealized losses had been recognized in net income.
The following tables summarize the reclassifications amounts out of AOCI for the years ended December 31, 2020, 2019, and 2018.
Included in the deferred income tax assets above are $9.1 million in state net operating loss carryforwards attributable to certain jurisdictions, which are available to offset future taxable income in the respective state jurisdictions, expiring between 2021 and 2040.
Any accrued interest related to the unrecognized tax benefits and other accrued income taxes have been included in income tax expense. There were no amounts included in any period ending in 2020, 2019, or 2018, as PLC maintains responsibility for the interest on unrecognized tax benefits.
Certain corporations with which PLC’s directors were affiliated paid us premiums and policy fees or other amounts for various types of insurance and investment products, interest on bonds we own and commissions on securities underwritings in which our affiliates participated. Such amounts were immaterial for the year ended December 31, 2020 and $6.4 million and $6.8 million for the years ended December 31, 2019 and 2018, respectively. The Company and/or PLC paid commissions, interest on debt and investment products, and fees to these same corporations totaling $1.9 million and $2.3 million for the years ended December 31, 2019 and 2018, respectively. The Company did not make any payments for the year ended December 31, 2020.
The Company has joint venture interests in real estate for which the Company holds the underlying real estate’s loan. During 2020, 2019, and 2018, the Company received $4.5 million, $23.2 million, and $6.8 million, respectively, in mortgage loan payments corresponding to the joint venture interests and $15.6 million in principal was collected on loans that paid off in December 2019.
During the periods ending December 31, 2020, 2019, and 2018, PLC paid a management fee to Dai-ichi Life of $11.8 million, $11.1 million, and $12.2 million, respectively, for certain services provided to the company.
PLC has guaranteed the Company’s obligations for borrowings or letters of credit under the revolving line of credit arrangement to which PLC is also a party. PLC has also issued guarantees, entered into support agreements and/or assumed a duty to indemnify its indirect wholly owned captive insurance companies in certain respects. In connection with the Captive Merger on October 1, 2020, certain captive related guarantees, support agreements and indemnification obligations were terminated, amended or replaced. Refer to Note 3, Significant Transactions, for additional information.
The Company has reinsured certain riders related to its fixed and deferred annuity business to Protective Re, a wholly owned subsidiary of PLC. PLC owns all of the shares of common stock issued by Protective Re.
are that statutory financial statements do not reflect 1) deferred acquisition costs and VOBA, 2) benefit liabilities that are calculated using Company estimates of expected mortality, interest, and withdrawals, 3) deferred income taxes that are not subject to statutory limits, 4) recognition of realized gains and losses on the sale of securities in the period they are sold, and 5) fixed maturities recorded at fair values, but instead at amortized cost.
State insurance regulators and the NAIC have adopted risk-based capital (“RBC”) requirements for life insurance companies to evaluate the adequacy of statutory capital and surplus in relation to investment and insurance risks. The requirements provide a means of measuring the minimum amount of statutory surplus appropriate for an insurance company to support its overall business operations based on its size and risk profile. A company’s risk-based statutory surplus is calculated by applying factors and performing calculations relating to various asset, premium, claim, expense, and reserve items. Regulators can then measure the adequacy of a company’s statutory surplus by comparing it to RBC. The Company manages its capital consumption by using the ratio of its total adjusted capital, as defined by the insurance regulators, to the Company’s action level RBC (known as the RBC ratio), also defined by insurance regulators. As of December 31, 2020 and 2019, the Company and its insurance subsidiaries all exceeded the minimum RBC requirements.
Additionally, the Company has certain assets that are on deposit with state regulatory authorities and restricted from use. As of December 31, 2020, the Company and its insurance subsidiaries had on deposit with regulatory authorities, fixed maturity and short-term investments with a fair value of $44.7 million.
The favorable (unfavorable) effects of the Company and its statutory surplus, compared to NAIC statutory surplus, from the use of this prescribed practice was as follows:
The favorable (unfavorable) effects on the statutory surplus of the Company and its insurance subsidiaries, compared to NAIC statutory surplus, from the use of these permitted practices were as follows:
•The Retail Life and Annuity segment primarily markets fixed UL, IUL, VUL, level premium term insurance (“traditional”), fixed annuity, and VA products on a national basis primarily through networks of independent insurance agents and brokers, broker-dealers, financial institutions, independent distribution organizations, and affinity groups.
•The Asset Protection segment markets extended service contracts, GAP products, credit life and disability insurance, and other specialized ancillary products to protect consumers’ investments in automobiles and recreational vehicles. GAP products are designed to cover the difference between the scheduled loan pay-off amount and an asset’s actual cash value in the case of a total loss. Each type of specialized ancillary product protects against damage or other loss to a particular aspect of the underlying asset.
After-tax adjusted operating income (loss) is derived from pre-tax adjusted operating income (loss) with the inclusion of income tax expense or benefits associated with pre-tax adjusted operating income. Income tax expense or benefits is allocated to the items excluded from pre-tax adjusted operating income (loss) at the statutory federal income tax rate for the associated period. Income tax expense or benefits allocated to after-tax adjusted operating income (loss) can vary period to period based on changes in the Company’s effective income tax rate.
In determining the components of the pre-tax adjusted operating income (loss) for each segment, premiums and policy fees, other income, benefits and settlement expenses, and amortization of DAC and VOBA are attributed directly to each operating segment. Net investment income is allocated based on directly related assets required for transacting the business of that segment. Realized gains (losses) and other operating expenses are allocated to the segments in a manner that most appropriately reflects the operations of that segment. Investments and other assets are allocated based on statutory policy liabilities net of associated statutory policy assets, while DAC/VOBA and goodwill are shown in the segments to which they are attributable.
As of April 1, 2020, the Company refined its method of allocating the realized gains and losses associated with its derivative portfolios to the Acquisitions and Retail Life and Annuity operating segments. The impact of the change in allocation was not considered material to the operating segment results for the year ended December 31, 2020.
There were no significant intersegment transactions during the years ended December 31, 2020, 2019, and 2018.
The Company’s unaudited consolidated quarterly operating data for the years ended December 31, 2020 and 2019 is presented below. In the opinion of management, all adjustments (consisting only of normal recurring items) necessary for a fair statement of quarterly results have been reflected in the following data. It is also management’s opinion, however, that quarterly operating data for insurance enterprises are not necessarily indicative of results that may be expected in succeeding quarters or years. In order to obtain a more accurate indication of performance, there should be a review of operating results, changes in shareowner’s equity, and cash flows for a period of several quarters.
As discussed in Note 2 to the consolidated financial statements, the Company has changed its method of accounting for the recognition and measurement of credit losses as of January 1, 2020 due to the adoption of Accounting Standards Codification (ASC) Topic 326, Financial Instruments - Credit Losses.
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
Fair value measurement for embedded derivatives associated with the guaranteed living withdrawal benefit riders and fixed indexed annuity contracts
As discussed in Notes 5 and 6 to the consolidated financial statements, the Company has established policies and procedures for determining the fair value of embedded derivatives associated with guaranteed living withdrawal benefit (GLWB) riders on variable annuity contracts and guaranteed minimum interest rate features on fixed indexed annuity (FIA) contracts. As of December 31, 2020, the recorded balance of the GLWB and FIA embedded derivatives was $403.7 million and $633.4 million, respectively, both of which are classified as Level 3 fair value measurements.
We identified the evaluation of the fair value measurement for embedded derivatives associated with GLWB riders and FIA contracts as a critical audit matter. Specifically, the evaluation of the benefit utilization (GLWB) and lapse (GLWB and FIA) assumptions used in the fair value estimates required complex auditor judgment due to the high degree of estimation uncertainty. Specialized skills were needed to evaluate the benefit utilization and lapse assumptions and the impact of those assumptions on the fair values of the GLWB and FIA embedded derivatives.
• evaluating the Company’s methodology to produce a fair value estimate compliant with U.S. generally accepted accounting principles
• comparing the benefit utilization and lapse assumptions used in developing the estimate to the Company’s actual historical experience
• evaluating the Company’s decisions to change or not to change the benefit utilization and lapse assumptions based on management’s historical experience and the experience of similar companies
• developing an estimate of the fair value of the FIA embedded derivative for a select policy based on the assumptions used by the Company and comparing the estimate to the Company’s estimate
We have audited the consolidated statement of income, comprehensive income (loss), shareowner’s equity and cash flows of Protective Life Insurance Company and its subsidiaries (the “Company”) for the year ended December 31, 2018, including the related notes and financial statement schedules as of and for the year ended December 31, 2018 listed in the index appearing under Item 15(2) (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the results of operations and cash flows of the Company for the year ended December 31, 2018 in conformity with accounting principles generally accepted in the United States of America.
We conducted our audit of these consolidated financial statements in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud.