• We own and occupy four buildings in League City, Texas, totaling approximately 346,000 square feet. Our Life, Health, and Corporate and Other business segments use approximately 60% of such space.
(1) Amounts were adjusted to reflect the effect of the retrospective adoption of a new accounting standard on deferred policy acquisition costs.
Management’s discussion and analysis (“MD&A”) of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included herein.
Certain statements made in this report include forward-looking statements, within the meaning of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements may be identified by words such as “expects,” “plans,” “believes,” “estimates,” “will” or words of similar meaning; and include, but are not limited to, statements regarding the outlook of our business and financial performance. These forward-looking statements are subject to changes and uncertainties, which are, in many instances, beyond our control and have been made based upon our assumptions, expectations and beliefs concerning future developments and their potential effect upon us. There can be no assurance that future developments will be in accordance with our expectations, or that the effect of future developments on us will be as anticipated. It is not a matter of corporate policy for us to make specific projections relating to future earnings, and we do not endorse any projections regarding future performance made by others. Additionally, we do not publicly update or revise forward-looking statements based on the outcome of various foreseeable or unforeseeable events.
We are a diversified insurance and financial services company, offering a broad spectrum of insurance products. Chartered in 1905, we are headquartered in Galveston, Texas. We operate in all 50 states, the District of Columbia, Guam, American Samoa and Puerto Rico.
The insurance segments do not directly own assets. Rather, assets are allocated to support the liabilities and surplus of each segment. The mix of assets allocated to each of the insurance segments is managed to support the characteristics of the insurance liabilities including cash flows and pricing assumptions, and is considered sufficient to support each segment’s business activities. We have utilized this methodology consistently over all periods presented.
This report contains many forward-looking statements, particularly relating to our future financial performance. Actual results are likely to differ materially from those forecasts, depending on the outcome of various factors.
Low Interest Rates: Low interest rate environments are typically challenging for life and annuity companies as the spreads on deposit-type funds and contracts narrow and policies approach their minimum crediting rates. Low market interest rates may reduce the spreads between the amounts we credit to fixed annuity and individual life policyholders and the amounts we earn on the investments that support these obligations. We have an ALM Committee that actively manages the profitability of our in-force insurance and annuity contracts. We believe we were an early adopter of lower guaranteed minimum crediting rates on new fixed annuity contracts, which has afforded us the flexibility to respond to the unusually low interest rates in recent years . Additionally, we have reduced crediting rates on in-force contracts, where permitted to do so. These actions have helped mitigate the adverse impact of low interest rates on our spreads and profitability of these products, although sales volume has and could further diminish as a result. Additionally, we maintain assets with various maturities to support product liabilities and ensure liquidity. A gradual increase in longer-term interest rates relative to short-term rates generally will have a favorable effect on the profitability of these products. Rapidly rising interest rates, however, could result in reduced persistency of our spread-based products, as contract holders shift assets into higher yielding investments. We believe our ability to react quickly to the changing marketplace will help us manage this risk.
Low interest rates are also challenging for property and casualty companies. Investment income is generally a substantial element in earning an acceptable return on capital. Lower interest rates resulting in lower investment income require us to achieve better underwriting results. We have taken pricing actions to help mitigate the adverse impact of low interest rates on our property and casualty business.
Importance of Operating Efficiencies: The challenging economic environment creates a further need for operating cost reductions and efficiencies. We aggressively manage our cost base while maintaining our commitment to provide superior customer service to agents and policyholders. Investments in technology are aligned with activities and are coordinated through a disciplined project management process. We anticipate continually improving our use of technology to enhance our policyholders’ and agents’ experience and increase efficiency of our employees.
Changing Regulatory Environment: The insurance industry is regulated at the state level and some life and annuity products and services are subject to U.S. federal regulation. We are regularly subjected to additional or changing regulation that requires us to update systems, change product structure or increase the amount of reporting. These changes may increase the capital requirements for us and the industry, increase operating costs, change our operating practices and change our ability to provide products with pricing attractive to the marketplace.
Demographics: We believe a key driver shaping the actions of the life insurance industry is the rising income protection, wealth accumulation, and insurance needs of retiring Baby Boomers (those born between 1946 and 1964). According to the US Census Bureau Brief entitled “Age and Sex Composition: 2010”, the median age of the population, increased from 35.3 years in 2000 to 37.2 years in 2010. The aging of the Baby Boom population is a major contributor to the increase, along with stable birth rates and improving mortality. While the total population grew at a rate of 9.7% over the 10-year period from 2000 to 2010, the increase in the number aged 45 to 64 years and those 65 years and over grew at rates of 31.5% and 15.1%, respectively. As a result of increasing longevity and uncertainty regarding the Social Security System, retirees will need to accumulate sufficient savings to support retirement income requirements.
We are well positioned to address the Baby Boomers’ increasing need for savings tools and income protection. We believe our overall financial strength and broad distribution channels position us to respond with a variety of products to individuals approaching retirement age who seek information to plan for and manage their retirement needs. We believe our products that offer guaranteed income flows for life, including single premium immediate annuities, are well positioned to serve this market.
We believe we will continue to be competitive in the life and annuity markets through our broad line of products, diverse distribution channels, and consistent high level of customer service. We modify our products to meet customer needs and to expand our reach where we believe we can obtain profitable growth. Some highlights of recent activities include:
Sales of traditional life insurance products increased in 2012 primarily resulting from a new portfolio of term products. This, coupled with our focus on policy persistency and expense management, allowed us to continue to maintain a stable and profitable block of in-force business.
“U.S. Property/Casualty - Review and Preview” published by A.M. Best on February 4, 2013 noted that the U.S. property and casualty insurance industry has continued to experience above average catastrophe losses. While Sandy was certainly the most significant U.S. catastrophe of 2012, it was not the only weather event to cause losses. Through the first six months of 2012, in fact, the industry’s weather-related losses were significantly above industry’s average. Tornadoes, wildfires, hailstorms, Tropical Storms Beryl and Debby, and an outbreak of severe storms that caused damage from the Midwest to the mid-Atlantic, brought total industry losses through June 30 to more than $13 billion, an unusually high mid-year industry total. Hurricane Isaac - the only storm to make U.S. landfall classified as a hurricane in 2012 - cause an estimated $2 billion in total economic damage. Without Sandy, expected to be the second costliest catastrophe on record, at $25 billion, the United States would have experienced an “average” catastrophe year, with approximately 4 points of industry losses attributable to catastrophe events.
Demand for P&C credit-related insurance products continues to increase. Credit markets have improved from the previous recessionary years, which resulted in increasing sales in the auto dealer market and, in turn, demand for our GAP products. We continue to update credit-related insurance product offerings and pricing to meet changing market needs, as well as adding new agents to expand market share in the credit-related insurance market. We are reviewing and implementing procedures to enhance customer service and, at the same time, looking for efficiencies to reduce administrative costs.
The preparation of financial statements in accordance with GAAP requires us to make estimates and assumptions that often involve a significant degree of judgment, in particular, expectations of current and future mortality, morbidity, persistency, claims and claim adjustment expenses, recoverability of receivables, investment returns and interest rates. In developing these estimates, we make subjective and complex judgments that are inherently uncertain and subject to material changes as facts and circumstances develop. Although variability is inherent in these estimates, we believe that the amounts as reported are appropriate, based upon the facts available upon compilation of the consolidated financial statements.
Management reviews the estimates and assumptions used in the preparation of our financial statements on an ongoing basis. If management determines that modifications in estimates and assumptions are appropriate given current facts and circumstances, our financial position and results of operations as reported in the consolidated financial statements could change significantly.
Life Reserving Methodology- Establishing an adequate liability for amounts payable under life insurance policies requires the use of assumptions. (Principal assumptions used in the establishment of liabilities for future policy benefits are mortality, policy lapse rates, investment return, inflation, expenses and other contingent events as appropriate to the respective product type). Reserves for incurred but not reported (“IBNR”) claims on life policies are also established using historical claims information. Liabilities for interest-sensitive and variable universal life insurance policies are equal to the current account value established for the policyholder. Some of our universal life policies contain secondary guarantees, for which an additional liability is established.
Recoverability-At least annually, we test the adequacy of the net benefit reserves (policy benefit reserves less DAC) established for life insurance and annuity products. This testing is referred to as “Loss Recognition” for traditional products and “Unlocking” for interest-sensitive products. The assumptions used to perform the tests are our current best estimate assumptions as to policyholder mortality, persistency, maintenance expenses and invested asset returns.
Overview-We establish future policy benefit reserves in order to match income and benefit expenses by accounting period. Policy and contract claim reserves are established in order to associate future benefit payments, both known and unknown, with the period in which they were incurred. As of year-end 2012, the total Health net reserves were $154.6 million versus $164.3 million at year-end 2011. The following methods are employed to establish the Health reserves:
Future Policy Benefits-Liabilities for future policy benefits are equal to the aggregate of the present value of expected future benefit payments, less the present value of expected future premiums. Morbidity and termination assumptions are based on our experience or published valuation tables when available and appropriate.
Premium Deficiency Reserves-Deficiency reserves are established when the expected future claim payments and expenses for a classification of policies having homogenous characteristics are in excess of the expected premiums for these policies. The determination of a deficiency reserve takes into consideration the likelihood of premium rate increases, the timing of these increases, and the expected benefit utilization patterns. We have established premium deficiency reserves for portions of the major medical business and the long-term care business that are in run-off. The assumptions and methods used to determine the deficiency reserves are reviewed periodically for reasonableness, and the reserve amount is monitored against emerging losses.
Case Reserves-Reserves for reported losses are established on either a judgment or a formula basis, depending on the timing and type of the loss. The formula reserve is a fixed amount for each claim of a given type based on historical paid loss data for similar claims with provisions for trend changes, such as those caused by inflation. Judgment reserve amounts generally replace initial formula reserves and are set on a per case basis based on facts and circumstances of each case and the expectation of damages. We regularly monitor the adequacy of reserves on a case-by-case basis and change the amount of such reserves as necessary.
The evaluation process to establish the claims and CAE reserves involves the collaboration of underwriting, claims and internal actuarial departments. The process also includes consultation with independent actuarial firms on a regular basis. Work performed by independent actuarial firms is an important part of our process of gaining reassurance that the claims and CAE reserves determined by our internal actuarial department sufficiently meet all obligations arising from all claims incurred as of year-end. Additionally, the independent actuarial firms complete the Statements of Actuarial Opinion at each year-end, certifying that the recorded claims and CAE reserves appear reasonable.
Premium Deficiency Reserve-Deficiency reserves are established when the expected claims payments and a maintenance component for a product line is in excess of the expected premiums for that product line. The determination of a deficiency reserve takes into consideration the current profitability of a product line using anticipated claims, claims expense, and policy maintenance costs. The assumptions and methods used to determine the deficiency reserves are reviewed periodically for reasonableness and the reserve amount is monitored against emerging losses. There were no reserves of this type at December 31, 2012.
Implicit in the actuarial methodologies are the following assumptions, which may impact our property and casualty reserves:
The impacts of a future 1.6% decrease and 2.4% increase over the implied inflation rate in our year-end gross loss reserve balance are as follows (amounts in thousands):
The analysis of our credit insurance line of business quantifies the estimated impact on gross loss reserves of a reasonably likely scenario of varying the ratio applied to the earned premium to determine the IBNR reserves at December 31, 2012. IBNR reserving methodology for this line of business focuses primarily on the use of a ratio applied to the unearned premium for each credit insurance product. The selected ratios are based on historical loss and claim data. In our analysis, we varied this ratio by +/- 5% across all credit insurance products combined. The results of our analysis show an increase or decrease in gross reserves across all accident years combined of approximately $6.9 million.
Short-tail business-The emergence of paid losses and case reserves for short-tail business is credible and likely indicator of ultimate losses; therefore, more reliance is placed on the Loss or Expense Development methods. Large catastrophe and weather-related events are analyzed separately using information available to our claims staff, loss development profiles from similar events and our own historical experience.
We had a total DAC asset of approximately $1.25 billion and $1.32 billion at December 31, 2012 and 2011, respectively. Effective January 1, 2012, we retrospectively adopted new accounting guidance and implemented a new DAC capitalization policy. See Note 3, Recently Issued Accounting Pronouncements, of the Notes to the Consolidated Financial Statements for a detailed discussion regarding the impact of this pronouncement on us.
We believe that the estimates used in our DAC calculations provide a representative example of how variations in assumptions and estimates would affect our business. The following table displays the sensitivity of reasonably likely changes in assumptions included in the amortization of the DAC balance of our long-tail business for the year ended December 31, 2012 (in thousands):
The fair value of available-for-sale securities (equity and fixed maturity securities) is determined by management using one of the three primary sources of information: the quoted prices in active markets; third-party pricing services; or independent broker quotations. Estimated fair value of securities based on quoted prices in active markets are readily and regularly available; therefore, valuation of these securities generally does not involve management judgment.
For securities priced using third-party pricing services, fair value measurements are determined using the third-party pricing services’ proprietary pricing applications. The typical inputs used by the models are relevant market information, benchmark curves, benchmark pricing of like securities, sector groupings and matrix pricing. Any securities remaining unpriced after utilizing the first two pricing methods are submitted to the independent brokers for prices. We have analyzed the third-party pricing services and independent brokers’ valuation methodologies and related inputs, and have evaluated the various types of securities in our investment portfolio to determine an appropriate fair value hierarchy level based upon trading activity and the observability of market inputs. Management does complete certain tests throughout the year and at year-end to determine that prices provided by our pricing services are reasonable.
Consolidated earnings increased during 2012 compared to 2011 primarily as a result of
Consolidated earnings increased during 2011 compared to 2010 primarily as a result of
In the Consolidated Results of Operations above and in the segment discussions that follow, certain amounts in the prior year have been reclassified to conform to the current year presentation. Additionally, certain prior year amounts were adjusted to reflect the effect of the retrospective adoption of a new accounting standard relating to DAC, which impacted reported income before other items and federal income taxes by a decrease of $2.3 million and an increase of $0.5 million during 2011 and 2010, respectively.
Revenues from traditional life insurance products include scheduled premium payments from policyholders on whole life and term life products. The change in these premiums is impacted primarily by policy persistency and new sales during the period. Premiums increased during 2012 compared to 2011 primarily due to improved persistency and new sales. The decrease in 2011 compared to 2010 was primarily driven by higher reinsurance premiums due to increasing policy face values, and a decrease in the credit-related life products as a result of lower sales.
Benefits decreased slightly during 2012 compared to 2011, and increased in 2011 compared to 2010, primarily as the result of an increase in the estimate of claims incurred but not reported. During 2011, there was an emerging shift of view regarding claim processes from the long-standing practice that a claim must be filed by a beneficiary to a view that an insurer should actively seek possible beneficiaries by monitoring information of a policyholder’s death. This type of information might be ascertainable using the U.S. Social Security Death Master File (“SSA Master File”). We modified our claims settlement procedures in the fourth quarter of 2011 to apply this perspective on a nationwide basis. This led to an increase in our policy benefits of $22.1 million and $31.5 million during 2012 and 2011, respectively.
Commissions increased during 2012 compared to 2011 primarily due to increased sales. The decrease during 2011 compared to 2010 primarily resulted from the decrease in premiums of traditional products.
Other operating costs and expenses increased during 2012 compared to 2011, and decreased for 2011 compared to 2010, as a result of 2011 benefitting from a reduction of an accrual for litigation contingencies in addition to an increase in allocated costs to this segment during 2012.
(1) A positive amount of net change indicates more expense was deferred than amortized and represents a decrease to expenses in the periods indicated.
We use reinsurance to mitigate excessive risk to the Life segment. During 2012 our retention limits were $2,350,000 for issue ages 65 and under, and $1,550,000 for issue ages 66 and older for traditional and universal life, unchanged from 2011, as compared to a single limit of $1,550,000 during 2010. Accidental death and premium waiver benefits are mostly retained on new business. Increases in reserves and premium amounts ceded primarily reflect increased use of reinsurance in conjunction with treaties related to universal life products. Decreases in assumed reserves and premium were primarily due to the cancellation of our reinsurance agreement with two credit life reinsurers. Those blocks of business are now in run-off, and the new business retained is currently written by us on a direct basis.
Consistent with our corporate risk management strategy we periodically adjust our reinsurance program and retention limits as market conditions warrant. While, in the past, we have reinsured up to 90% of new business, we are currently reinsuring newly developed permanent products on a modified excess retention basis, in which we reinsure mortality risk on a yearly renewable term basis, ceding a 75% quota share of policies with a face value of at least $500,000 up to our retention and then 100% in excess of retention. Current traditionally marketed term products are reinsured on a modified excess retention basis, in which we reinsure mortality risk on a yearly renewable term basis, ceding 50% quota share of face amounts in excess of $250,000 up to our retention and then 100% in excess of retention. Current direct marketed products are coinsured on a 60% basis, up to our retention, and then 100% in excess of retention.
For 2012, the companies to whom we have ceded reinsurance for the Life segment are shown below (in thousands, except percentages):
(1) A.M. Best rating as of the most current information available February 14, 2013.
An equity-indexed annuity allows a policyholder to participate in equity returns while also having certain downside protection from the guaranteed minimum returns defined in the product. Net inflows for this product decreased during 2012 compared to 2011, and during 2011 compared to 2010. These decreases were primarily attributed to lower indexed crediting terms resulting from lower fixed investment yields.
Other operating expenses decreased during 2012 compared to 2011 primarily as a result of an accrual during 2011 related to the settlement of certain litigation, as well as a decrease in allocated costs to this segment during 2012. Additionally, a decrease in producer compensation linked to annuity production further reduced other operating expenses. Other operating expenses were unchanged during 2011 compared to 2010.
(1) A positive amount of net change indicates more expense was deferred than amortized and is a decrease to expense in the periods indicated.
The decrease in acquisition costs capitalized during 2012 compared to 2011 was the result of lower commissions incurred with the decrease in fixed deferred annuity production. The increase in the amortization of DAC during 2011 as compared to 2010 was primarily as a result of surrender activity.
Shown below is the analysis of the impact to net investment income of the option return, along with the impact to interest credited of the equity-indexed annuity embedded derivative (in thousands):
The Health segment’s earned premiums decreased during the year ended December 31, 2011 as compared to 2010 primarily due to the discontinuation of sales of our medical expense insurance plans effective June 30, 2010. In-force policies continue to lapse and this produced the reduction in premiums. Due to the competitive nature of the market, sales of our Medicare Supplement product also decreased. Additionally, our credit accident and health premiums decreased primarily due to a decrease in new business related to short-term financing.
Our total in-force policies decreased during 2012 compared to 2011, and in 2011 compared to 2010. Increases in the MGU line were more than offset by decreases in the credit accident and health and other lines. The MGU line increased due to increased production by existing MGU’s, and the addition of new MGUs. The “all other” line is mostly composed of closed blocks of business, and has few new sales. The MGU and Group in-force policies include a block of 100% reinsured certificates, which is a rapidly growing block of business. The increases in these 100% reinsured certificates will not translate into corresponding increases in premiums.
Claims incurred were relatively unchanged during 2012, and decreased during 2011 compared to 2010 primarily as the result of a decline in sales of our medical expense insurance plans and Medicare Supplement products. The decline in claims incurred was consistent with lower premiums and lower commissions. Additionally, the medical expense benefit ratio, measured as the ratio of claims and other benefits to premiums, increased to 69.6% in 2012, from 68.7% in 2011, but decreased from 70.1% in 2010. The 2011 decrease in the benefit ratio compared to 2010 was driven primarily by a significant decrease in claims.
(1) A negative amount of net change indicates less expense was deferred than amortized and represents an increase to expenses in the periods indicated.
Acquisition cost capitalized decreased during 2012 compared to 2011 primarily due to the decreases in amortization outpacing costs capitalized due to the aggregate decrease in the health block of business. Acquisition cost capitalized decreased during 2011 compared to 2010 primarily resulting from the decrease in sales and resulting decrease in commissions.
For the medical expense business, we use reinsurance on an excess of loss basis. Our retention limit is $500,000 per claim on these types of policies. We cede or retrocede the majority of the risk associated with our stop loss and other catastrophic health reinsurance programs. We maintain reinsurance on a quota share basis for our long-term care and disability income business.
(1) A.M.Best rating as of the most current information available February 14, 2013.
Gross catastrophes for the year ended December 31, 2012 were $135.6 million, compared to $217.9 million for the same period in 2011. We experienced a significant decrease in catastrophe losses due primarily to a decrease in frequency of catastrophes in 2012 as compared to 2011, as well as the severity of the catastrophe events in 2011. In 2012 there were 26 catastrophe events compared to 31 in 2011 and 33 in 2010. Hurricane Sandy accounted for $46.6 million in gross catastrophe losses and $11.1 million in net catastrophe losses in 2012. 2011 catastrophe activity included a record number of tornados, including two events which impacted primarily Alabama in late April 2011 and Joplin, Missouri in May 2011.
The combined ratio, excluding net catastrophe impact, remained relatively flat during 2012 compared to 2011 and improved during 2011 compared to 2010. This was driven by an improvement in rate adequacy. Inherent to our fundamental risk management practices, we continue to evaluate and manage our aggregate catastrophe risk exposure with risk selection and reinsurance coverage.
The change in DAC during 2012 increased total expenses compared to 2011. The higher amortization is attributable to Credit business written in prior years being earned while recently introduced products with lower revenue and without commissions are a larger portion of the current Credit business. The decrease during 2011 compared to 2010 is attributable to a shift in our credit-related property products from shorter duration products to longer duration products. We regularly review the recoverability of DAC, and if the actual emergence of future profitability were to be substantially lower than estimated, we would accelerate DAC amortization to account for any recoverability issues or premium deficiency. We have not historically experienced these issues with our DAC balances.
Our Property and Casualty segment consists of: (i) Personal, which we market primarily to individuals, represent 63.1% of net premiums written, (ii) Commercial, which focus primarily on agricultural and other commercial markets, represent 29.3% of net premiums written, and (iii) Credit-related property insurance products, which are marketed to and through financial institutions and retailers represent 7.6% of net premiums written.
Personal Automobile: Net premiums written and earned decreased in our personal automobile line during 2012 compared to 2011 primarily due to a decline in policies in-force resulting from a combination of the decreases in homeowner policies in-force, which decreased cross-sell opportunities. Net premiums written and earned decreased during 2011 compared to 2010, due to a decline in policies in-force resulting from a competitive marketplace and lower new business sales. The loss and combined ratios increased slightly during 2012 compared to 2011 consistent with our expectations. The loss and combined ratios decreased during 2011 compared to 2010 due to improved rate adequacy as well as an increase in commissions in 2010 that was not incurred in 2011.
The combined industry ratios per A.M. Best’s “U.S. Property/Casualty-Review and Preview” for 2012 (estimated), 2011 and 2010 are 99.6%, 101.9 and 101.0%, respectively.
Homeowners: Net premiums written and earned decreased during 2012 compared to 2011 primarily due to fewer policies in-force. The decrease in homeowner policies in-force was primarily driven by improved rate adequacy and our catastrophe risk mitigation actions, which are tailored to the local market conditions in the states where we write policies. Net premiums written decreased during 2011 compared to 2010 attributable to increased catastrophe reinsurance reinstatement premiums as a result of higher catastrophe reinsurance losses ceded and a decline in policies in-force. Net premiums earned remained relatively flat during 2011 compared to 2010.
Other Personal: These products include watercraft, rental-owner and umbrella coverages for individuals seeking to protect their personal property and liability not covered within their homeowner and auto policies. Net premiums written and earned remained substantially unchanged during 2012 compared to 2011, and decreased during 2011 compared to 2010 due to a decline in policies in-force. Premiums for these products generally trend with the homeowners and personal automobile lines as policies are typically sold in conjunction with one another.
Agribusiness Product: Our agribusiness product allows policyholders to customize and cover their agriculture exposure via a package policy which includes coverage for residences and household contents, farm buildings and building contents, personal and commercial liability and personal property. Net premiums written were substantially unchanged in 2012 as compared to 2011, and net premiums earned increased during 2012 as compared to 2011, primarily as a result of a decrease in reinsurance reinstatement premiums. Net premiums written and earned decreased during 2011 compared to the same period in 2010 primarily as a result of a decrease in policies in-force as the result of non-renewing certain policies in unprofitable segments and catastrophe reinsurance reinstatement premiums that were not incurred in 2010.
Commercial Automobile: Net premiums written and earned decreased during 2012 compared to 2011 primarily as a result of lower new business writings in our small commercial business as well as selective underwriting intended to improve risk selection. Net premiums written and earned increased during 2011 compared to 2010 primarily as the result of a vehicle reclassification adjustment that resulted in refunds to policyholders in 2010 that did not occur in 2011. The increase was offset by a reduction in polices in-force from our primary lines and improved selective underwriting.
Credit-related property insurance products are offered on automobiles, furniture and appliances in connection with the financing of those items. These policies pay an amount if the insured property is lost or damaged and is not directly related to an event affecting the consumer’s ability to pay the debt. The primary distribution channel for credit-related property insurance is general agents who market to sellers of covered products and financial institutions.
Net premiums written and earned decreased during 2012 compared to 2011. The primary driver for the decrease in premiums is a shift from Guaranteed Auto Protection (“GAP”) Insurance to GAP Waiver, a lower premium debt protection product. Net premiums written increased during 2011 compared to 2010. This increase was primarily driven by the reduction of reinsurance placed with producer-owned reinsurance companies. Net premiums earned decreased during 2011 due to our credit business continuing to shift from the shorter duration collateral protection products, to the longer duration GAP products.
The loss ratios remained substantially unchanged during 2012 compared to 2011. The decrease in the loss ratio during 2011 compared to 2010 was attributable to an overall decline in claims incurred as a result of lower frequency and severity of claims. Specifically, the GAP line of business experienced a positive trend in claims incurred as the result of used automobile market values rebounding from the recent financial crisis.
The combined ratios remained substantially unchanged during 2012 compared to 2011. The combined ratios decrease during 2011 compared to 2010 primarily as a result of the decrease in the loss ratio, which was partially offset by higher underwriting expenses from rising commission expenses as a result of the change in our product mix.
We reinsure a portion of the risks that we underwrite to manage our loss exposure and protect capital resources. In return for a premium, reinsurers assume a portion of the claims incurred.
In addition to our reinsurance coverage, we are partially protected by the Terrorism Risk Insurance Act of 2002, which was modified and extended through December 31, 2014 by the Terrorism Risk Insurance Program Reauthorization Act of 2007.
We retain the first $1.0 million of loss per risk, which will remain the same for 2013. Our catastrophe reinsurance retention covering all our property and casualty companies in total has been $40.0 million in recent years and will remain the same in 2013. The following table summarizes the Company’s catastrophe reinsurance coverage effective January 1, 2013 to December 31, 2013.
• 90% of multiple peril losses in Texas, Oklahoma, and Arkansas
All per event covers above include one automatic reinstatement and were placed at 97.5% in 2012. The automatic reinstatement requires us to pay additional reinsurance premium for any losses into each reinsurance layer. The reinstatement premium is prorated by the percentage of actual loss to the coverage.
The loss development table included herein shows the development of our claims and CAE reserves. The table does not present individual accident or policy year development data.
While we believe that our claims reserves at December 31, 2012 are adequate, new information, events or circumstances, unknown at the original valuation date, may lead to future developments in our ultimate losses in amounts significantly greater or less than the reserves currently provided. The actual final cost of settling both claims outstanding at December 31, 2012 and claims expected to arise from unexpired periods of risk is uncertain. There are many other factors that would cause our losses to increase or decrease, which include but are not limited to: changes in claim severity; changes in the expected level of reported claims; judicial action changing the scope or liability of coverage; changes in the regulatory, social and economic environment; and unexpected changes in loss inflation. The deficiency or redundancy for different reporting dates is cumulative and should not be added together.
For 2012, the net favorable prior year claims and CAE development was $47.6 million, compared to approximately $68.1 million of net favorable prior year development in 2011, as a result of better than expected paid and incurred loss emergence across several lines of business.
Earnings during 2012 decreased substantially due to the lower realized gains, primarily as a result of other-than-temporary impairments related to bond and equity investments of $22.5 million during 2012. Other operating costs increased during 2012 as a result of an increase in expenses for share-based compensation under the stock and incentive plan as well as an increase in allocated costs to this segment during 2012.
Earnings during 2011 increased compared to 2010 primarily due to the increase in realized gains from investments as a result of improved financial markets. The 2011 increase was also driven by the increase in net investment income as a result of our growing portfolio of bonds and mortgage loans.
The Corporate and Other business segment recorded other-than-temporary impairments of $22.5 million, $9.5 million and $5.7 million in 2012, 2011 and 2010, respectively, which are included in “Realized investments gains, net.”
We manage our investment portfolio to optimize the rate of return commensurate with sound and prudent asset selection and to maintain a well-diversified portfolio. Our investment operations are regulated by various regulatory authorities, primarily the state insurance departments where we or our insurance subsidiaries are domiciled. Investment activities, including the setting of investment policies and defining acceptable risk levels, are subject to review and approval by our Board of Directors, which is assisted by our Finance Committee and Management Risk Committee.
Bonds-We allocate most of our fixed maturity securities to support our insurance business. At December 31, 2012, our fixed maturity securities had an estimated fair market value of $14.5 billion, which was $1.2 billion, or 8.9%, above amortized cost. At December 31, 2011, our fixed maturity securities had an estimated fair value of $14.2 billion, which was $851.7 million, or 6.4%, above amortized cost.
Fixed maturity securities’ estimated fair value, due in one year or less, increased to $1.7 billion as of December 31, 2012 from $961.2 million as of December 31, 2011, primarily as a result of approaching maturity dates of long-term bonds.
The following table identifies the total bonds by credit quality rating, using both Standard & Poor’s and Moody’s ratings (in thousands, except percentages):
The slight shifts in our credit quality diversification, including below investment grade securities, at December 31, 2012 compared to December 31, 2011, was primarily the result of purchases of AAA through BBB bonds, and maturities of bonds rated AAA through BB and below. We expect the exposure to below investment grade securities to decrease as these bonds approach maturity. We do not own direct investments in sovereign debt issued by Greece, Ireland, Italy, Portugal or Spain.
Mortgage Loans-We invest in commercial mortgage loans that are diversified by property-type and geography to support our insurance business. Generally, mortgage loans are secured by first liens on income-producing real estate with a loan-to-value ratio of up to 75%. Mortgage loans held-for-investment are carried at outstanding principal balances, adjusted for any unamortized premium or discount, deferred fees or expenses, and net of allowances.
Equity Securities-Our equity portfolio is in companies publicly traded on a national U.S. stock exchange; the cost and estimated value of the equity securities are as follows (in thousands):
Net investment income from bonds and mortgage loans decreased $1.4 million during 2012, compared to an increase of $64.5 million during 2011. The slight decrease during 2012 was the result of lower interest bonds making up a larger percentage of our bond portfolio as older bonds mature. The increase during 2011 resulted from the growth of our bond portfolio during the period. Net investment income in other asset classes (equities, real estate, options and other) increased $18.6 million during 2012, compared to a decrease of $7.2 million during 2011, primarily resulting from marking our option portfolio to fair value at December 31, 2012 and 2011.
The net unrealized gains on available-for-sale securities at December 31, 2012 and 2011 were $736.0 million and $541.4 million, respectively; a net gain of $194.6 million for the year ended December 31, 2012. Unrealized gains or losses on available-for-sale securities have no impact on earnings rather, they are recognized as other comprehensive income or loss, which directly impact equity. The gross unrealized gains of available-for-sale securities increased $165.1 million to $757.3 million during 2012 primarily resulting from increases in corporate debt securities. The gross unrealized losses of available-for-sale securities decreased to $21.4 million from $50.8 million. The $29.4 million decrease in gross unrealized losses during 2012 primarily resulted from other-than-temporary impairments.
We have notes payable that are not part of our capital resources relating to amounts borrowed by real estate joint ventures that we consolidate into our financial statements. During 2012, one real estate joint venture, which the company consolidates, borrowed $100.0 million from a third party using the real estate owned by the joint venture as collateral. The debt service on the ten year loan is intended to be met by the earnings and cash flow of the joint venture. The lenders for the notes payable have no recourse against us in the event of default by the joint ventures. Therefore, the only amount of liability we have for these notes payable is limited to our investment in the respective ventures, which totaled $9.7 million and $18.0 million at December 31, 2012 and 2011, respectively.
We have off-balance sheet arrangements relating to third-party marketing operation bank loans discussed Note 19, Commitments and Contingencies, of the Notes to the Consolidated Financial Statements. We could be exposed to a liability for these loans, which are supported by the cash value of the underlying insurance contracts. The cash value of the life insurance policies is designed to always equal or exceed the balance of the loans, accordingly management does not foresee any loss related to these arrangements.
Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2012, 2011, and 2010
Consolidated Statements of Changes in Equity for the years ended December 31, 2012, 2011, and 2010
Consolidated Statements of Cash Flows for the years ended December 31, 2012, 2011, and 2010
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of American National Insurance Company and subsidiaries as of December 31, 2012 and 2011, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2012, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 8, 2013 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
We have audited American National Insurance Company’s (the Company) internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
In our opinion, American National Insurance Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control - Integrated Framework issued by the COSO.
American National Insurance Company and its consolidated subsidiaries (collectively “American National”) offers a broad spectrum of insurance products, including individual and group life insurance, health insurance, annuities, and property and casualty insurance. Through non-insurance subsidiaries, American National invests in stocks and real estate. Business is conducted in all 50 states, the District of Columbia, Puerto Rico, Guam and American Samoa.
Investment real estate including related improvements, are stated at cost less accumulated depreciation. Depreciation is provided on a straight-line basis over the estimated useful life of the asset (typically 15 to 50 years). Rental income is recognized on a straight-line basis over the term of the respective lease. American National classifies a property as held-for-sale if it commits to a plan to sell a property within one year and actively markets the property in its current condition for a price that is reasonable in comparison to its estimated fair value. Real estate held-for-sale is stated at the lower of depreciated cost or estimated fair value less expected disposition costs, and is not depreciated while it is classified as held-for-sale. American National periodically reviews its investment real estate for impairment and tests properties for recoverability whenever events or changes in circumstances indicate the carrying amount of the asset may not be recoverable and the carrying value of the property exceeds its estimated fair value. Properties whose carrying values are greater than their undiscounted cash flows are written down to their estimated fair value, with the impairment loss included in “Realized investment gains (losses)” in the consolidated statements of operations. Impairment losses are based upon the estimated fair value of real estate, which is generally computed using the present value of expected future cash flows from the real estate discounted at a rate commensurate with the underlying risks as well as other appraisal methods. Real estate acquired upon foreclosure is recorded at the lower of estimated fair value or the carrying value of the mortgage loan at the date of foreclosure.
Real Estate Joint Ventures and Other Limited Partnership Interests-American National uses the equity method of accounting for its investments in real estate joint ventures and other limited partnership interests in which it has more than a minor interest or influence over the investee’s operations, but it does not have a controlling interest and is not the primary beneficiary. These investments are reported as “Investments in unconsolidated affiliates” in the consolidated statements of financial position. For certain joint ventures, American National records its share of earnings using a three-month lag methodology for all instances where the timely financial information is not available and the contractual right does not exist to receive such financial information. In addition to the investees regular impairment analysis of its underlying investments, American National routinely evaluates its investments in those investees for impairments. American National considers financial and other information provided by the investee, other known information and inherent risks in the underlying investments, as well as future capital commitments, in determining whether impairment has occurred. When an impairment is deemed to have occurred at the joint venture level, American National recognizes its share on impairment losses within “Equity in earnings (losses) of unconsolidated affiliates” to record the investment at its estimated fair value. When an impairment resulted from American National’s separate account analysis, an adjustment is made through “Realized investment gains (losses)” to record the investment at its fair value.
Short-term investments comprised of commercial paper, are carried at amortized cost, which approximates fair value.
Derivative instruments are purchased as hedges of a recognized asset or liability, which are recorded on the consolidated statements of financial position at fair value. The change in fair value of derivative assets and liabilities is reported in the consolidated statements of operations as “Net investment income” and “Interest credited to policyholder account balances,” respectively. Derivative instruments held at December 31, 2012 and 2011 had an immaterial impact on the consolidated financial statements. American National does not apply hedge accounting treatment to its derivative instruments.
Cash on-hand and in banks plus amounts invested in money market funds are reported as “Cash and cash equivalents” in the consolidated statements of financial position.
These assets consist of buildings occupied by American National, data processing equipment, and furniture and equipment, which are carried at cost, less accumulated depreciation. Depreciation is calculated using straight-line and accelerated methods over the estimated useful lives of the assets (3 to 50 years).
DAC on universal life, limited-pay and investment-type contracts is amortized as a level percentage of the present value of anticipated gross profits from investment yields, mortality, and surrender charges. The effect on DAC that would result from realization of unrealized gains (losses) is recognized with an offset to “Accumulated other comprehensive income (loss)” in the consolidated statements of financial position as of the reporting date. It is possible a change in interest rates could have a significant impact on DAC calculated for these contracts.
Reserves for claims and claim adjustment expenses-American National establishes reserves for claims and claim adjustment expense (“CAE”) to provide for the estimated costs of paying claims. These reserves include estimates for both case reserves and reserves for incurred but not reported (“IBNR”) claims. Case reserves include the liability for reported but unpaid claims. IBNR reserves include a provision for potential development on case reserves, losses on claims currently closed which may reopen in the future as well as incurred but not reported claims. These reserves also include an estimate of the expense associated with settling claims, including legal and other fees and the general expenses of administering the claims adjustment process.
Participating business comprised approximately 9.2% of the life insurance in-force at December 31, 2012 and 12.5% of life premiums in 2012. Of the total participating business, 78.2% was written by Farm Family Life Insurance Company (“Farm Family Life”). For the participating business excluding Farm Family Life, the allocation of dividends to participating policyowners is based upon a comparison of experienced rates of mortality, interest and expenses, as determined periodically for representative plans of insurance, issue ages and policy durations, with the corresponding rates assumed in the calculation of premiums.
Deferred federal income tax assets and liabilities have been recognized to reflect the future tax consequences attributable to differences between the financial statement amounts of assets and liabilities and their respective tax bases. Deferred taxes are measured using enacted tax rates expected to apply in the years in which those temporary differences are expected to be recovered or settled.
The pension and postretirement benefit obligations and costs are calculated using actuarial concepts in accordance with GAAP. The discount rate and the expected return on plan assets, are important elements of expense and/or liability measurement and these key assumptions are evaluated annually. Other assumptions involve demographic factors such as retirement age, mortality, turnover and rate of compensation increases.
American National uses a discount rate to determine the present value of future benefits on the measurement date. The guideline for setting this rate is a high-quality long-term corporate bond rate. To determine the expected long-term rate of return on plan assets, a building-block method is used. The expected rate of return on each asset is broken down into three components: (1) inflation, (2) the real risk-free rate of return (i.e., the long-term estimate of future returns on default-free U.S. government securities), and (3) the risk premium for each asset class (i.e., the expected return in excess of the risk-free rate). Using this approach, the calculated return will fluctuate from year to year; however, it is American National’s policy to hold this long-term assumption relatively constant. For further information, refer to Note 18.
In October 2010, the FASB issued amended accounting guidance for costs associated with acquiring or renewing insurance contracts. The amendment limits the deferrable cost to those incremental direct costs associated with the successful acquisition or renewal of insurance contracts. It also specifies that advertising costs should be deferred only if the capitalization criteria for direct-response advertising are met. American National applied the retrospective method of adoption to all prior periods presented in the consolidated financial statements. Accordingly, upon adoption, the DAC asset was reduced by $34,260,000 as a result of acquisition costs previously deferred that are no longer eligible for deferral under the new guidance. The after-tax cumulative effect adjustment to the opening balance of stockholders’ equity at January 1, 2012 was approximately $19,745,000.
In May 2011, the FASB issued amended guidance on fair value measurement and disclosures. The amendment clarifies the application of existing fair value measurement and disclosure requirements. Other amendments change a particular element for measuring or disclosing information about fair value measurements. In addition, the amendment expands the qualitative and quantitative disclosures on Level 3 measurements.
Future Adoption of New Accounting Standards- During 2011 and 2012 the FASB issued the following significant accounting guidance relevant to American National including technical amendments and corrections to make the codification easier to understand and fair value measurement guidance easier to apply. Each became effective for American National on January 1, 2013 unless stated otherwise, and did not have, or is not expected to have, a material effect on the consolidated financial statements.
In July 2011, the FASB issued guidance to address questions about how health insurers should recognize and classify fees mandated by the Patient Protection and Affordable Care Act in their income statements. The new guidance is effective for calendar years beginning after December 31, 2013. The guidance specifies that the liability for the fee should be recorded in full once the entity provides qualifying health insurance in the applicable calendar year. The corresponding deferred cost is then amortized to expense using a straight-line method of allocation unless another method better allocates the fee over the calendar year that it is payable.
In February 2013, the FASB issued amended guidance on presentation of accumulated other comprehensive income (“AOCI”). The amendments require an entity to provide information about the amounts reclassified out of AOCI by component. In addition, an entity is required to present, either on the face of the statement of operations or in the notes, significant amounts reclassified out of AOCI by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under U.S. GAAP that provide additional detail about those amounts.
The cost or amortized cost and estimated fair value of investments are shown below (in thousands):
All gains and losses for securities sold throughout the year were determined using specific identification of the securities sold. Proceeds from the sales of these securities, with the realized gains and losses, are shown below (in thousands):
As of December 31, 2012, the securities with unrealized losses were not deemed to be other-than-temporarily impaired, including those with the duration of the unrealized losses exceeding one year. American National has the ability and intent to hold those securities until a market price recovery or maturity. Further, it is not more-likely-than-not that American National will be required to sell them prior to recovery, and recovery is expected in a reasonable period of time. It is possible the investee’s financial circumstances may be different in the future, which may lead to a different impairment conclusion in future periods.
Generally, commercial mortgage loans are secured by first liens on income-producing real estate. American National attempts to maintain a diversified portfolio by considering the property-type and property location of the underlying mortgage collateral. Mortgage loans by property-type and geographic distribution are as follows:
During 2012, American National sold one office loan with a recorded investment of $19,665,000 and a realized gain of $2,607,000. During 2011, American National sold one industrial loan with a recorded investment of $27,532,000 and a realized gain of $4,968,000. During 2012, American National foreclosed on four loans with a recorded investment of $34,562,000. There were no foreclosures during 2011.
Non-cash transactions during 2012 were a $15,865,000 transfer from mortgage loans to investment in unconsolidated affiliates. During 2011, American National exchanged $25,500,000 in mortgage loans for an additional ownership interest in a real estate joint venture. After the exchange transaction, the joint venture was included in American National’s consolidated financial statement. Upon consolidation, American National’s investment real estate had a noncash-related increase of $28,500,000.
The allowance for credit losses and unpaid principal balance in commercial mortgage loans are shown below (in thousands):
A small portion of the mortgage loan portfolio for which American National has granted concessions related to the borrowers’ ability to pay the loans is classified as troubled debt restructurings. Concessions are generally one of, or a combination of, a delay in payment of principal or interest, a reduction of the contractual interest rate or an extension of the maturity date. American National considers the amount, timing and extent of concessions in determining any impairment or changes in the specific allowance for loan losses recorded in connection with a troubled debt restructuring. The carrying value after specific allowance, before and after modification in a troubled debt restructuring, may not change significantly, or may increase if the expected recovery is higher than the pre-modification recovery assessment.
Mortgage Loans-The fair value of mortgage loans is estimated using discounted cash flow analyses on a loan by loan basis by applying a discount rate to expected cash flows from future installment and balloon payments. The discount rate takes into account general market trends and specific credit risk trends for the individual loan. Factors used to arrive at the discount rate include inputs from spreads based on U.S. Treasury notes and the loan’s credit rating, region, property type, lien number, payment type and current status.
Embedded Derivative-The embedded derivative liability for equity-indexed annuities is measured at fair value and is recalculated each reporting period using equity option pricing models. To validate the assumptions used to price the embedded derivative liability, American National measures and compares embedded derivative returns against the returns of equity options held to hedge the liability cash flows.
The significant unobservable input used to calculate the fair value of the embedded derivatives is equity option implied volatility. This volatility assumption is the range of implied volatilities that American National has determined market participants would use to price equity options that match the current derivative characteristics of our in-force equity-indexed annuities. Implied volatility can vary by term and strike price. An increase in implied volatility will result in an increase in the value of the equity-indexed annuity embedded derivatives, all other things being equal. At December 31, 2012, the implied volatility used to estimate embedded derivative value ranges from 15.9% to 30.1%.
Investment contracts liability-The carrying value of investment contracts liability is equivalent to the accrued account balance. The accrued account balance consists of deposits, net of withdrawals, plus or minus interest credited, fees and charges assessed and other adjustments. American National believes that the carrying value of investment contracts liability approximates fair value because the majority of these contracts’ interest rates reset to current rates offered at anniversary.
Commissions comprise the majority of the additions to deferred policy acquisition costs for each year. Effective January 1, 2012, American National retrospectively adopted a new guidance that modified the accounting for DAC. Refer to Note 3 for additional discussion.
For the Property and Casualty segment, American National retains the first $1,000,000 of loss per risk. Reinsurance then covers the next $5,000,000 of property and liability losses per risk. Additional excess property per risk coverage is purchased to cover risks up to $15,000,000, and excess casualty clash coverage is maintained to cover losses up to $50,000,000. Excess casualty clash covers losses incurred as a result of one casualty event involving multiple policies, excess policy limits, and excess contractual obligations. Facultative reinsurance cover is purchased for individual risks attaching at $15,000,000, as needed. Corporate catastrophe coverage is also in place for losses up to a $500,000,000 event. Catastrophe aggregate reinsurance coverage is also purchased. This cover provides for $30,000,000 of coverage after $90,000,000 of aggregated catastrophe losses has been reached. The first $10,000,000 of each catastrophe loss contributes to the $90,000,000 aggregation of losses. The catastrophe aggregate reinsurance coverage for 2012 was placed at 100%.
Management believes that a sufficient level of taxable income will be achieved over time to utilize the deferred tax assets in the consolidated federal tax return; therefore, no valuation allowance was recorded as of December 31, 2012 and 2011. If not utilized beforehand, approximately $23,041,000 in ordinary loss tax carryforwards will expire at the end of tax year 2032.
The statute of limitations for the examination of federal income tax returns by the Internal Revenue Service (“IRS”) for years 2006 to 2011 either has been extended or has not expired. In the opinion of management, all prior year deficiencies have been paid or adequate provisions have been made for any tax deficiencies that may be upheld. No provision for penalties was established, and no interest expense was incurred for 2012, 2011 or 2010, relating to uncertain tax positions. Management does not believe that there are any uncertain tax benefits that could be recognized within the next twelve months that would decrease American National’s effective tax rate.
The components of and changes in the accumulated other comprehensive income (loss) (“AOCI”), and the related tax effects, are shown below (in thousands):
American National has one stock-based compensation plan, which allows for grants of Non-Qualified Stock Options, Stock Appreciation Rights (“SAR”), Restricted Stock (“RS”) Awards, Restricted Stock Units (“RSU”), Performance Awards, Incentive Awards or any combination thereof. This plan is administered by the American National Board Compensation Committee. The Board Compensation Committee makes incentive awards under this plan to our executives after meeting established performance objectives. All awards are subject to review and approval by the committee and the Board of Directors, both at the time of setting applicable performance objectives and at the same time of payment of the awards. The number of shares available for grants under the plan cannot exceed 2,900,000 shares, and no more than 200,000 shares may be granted to any one individual in any calendar year. Grants are made to certain officers and directors as compensation and to align their interests with those of other shareholders.
Effective December 31, 2012, the settlement provision within outstanding RSU awards was modified to allow the recipient of the awards to settle the vested RSUs in either cash or American National’s common stock. Prior to the modification, vested RSUs were converted to American National’s common stock on a one-for-one basis. This modification changes the award classification from equity to liability award. At the date of modification, American National recorded a liability of $7,974,000 with a corresponding reduction in additional paid-in capital. The liability will be remeasured and adjusted for changes in the fair value each reporting period through the vesting date. RSUs generally vest after a three-year graded vesting requirement. Certain awards vest over a shorter period as a result of retirement provisions. Compensation expense of $7,752,000, $1,873,000 and $520,000 was recorded in 2012, 2011 and 2010, respectively. The modification, which was applied consistently to all participants added an incremental cost of $0.
Basic earnings (losses) per share were calculated using a weighted-average number of shares outstanding. The Restricted Stock resulted in diluted earnings per share as follows (in thousands, except share related data):
American National Insurance Company and its subsidiaries exercise significant control or ownership of various joint ventures, resulting in their consolidation into American National’s consolidated financial statements. The interests of the joint ventures other partners are shown as Noncontrolling Interests, which were a net liability of $4,741,000 and $6,197,000 at December 31, 2012 and 2011, respectively.
During 2012 and 2011, American National increased its ownership interest with a consolidated joint venture. The effect of the change in ownership interest on American National is as shown below (in thousands):
Life-markets whole, term, universal, indexed and variable life insurance on a national basis primarily through career and multiple-line agents, as well as through independent agents and direct marketing channels.
Health-primary lines of business are Medicare Supplement, stop loss, other supplemental health products and credit disability insurance. Health products are typically distributed through independent agents and managing general underwriters.
Property and Casualty-writes personal, commercial and credit-related property insurance. These products are primarily sold through multiple-line agents and independent agents.
Expenses are allocated based upon various factors, including premium and commission ratios within the respective operating segments.
American National utilizes third-party pricing services to estimate fair value measurements of its pension plan assets. Refer to Note 9 for further information concerning the valuation methodologies and related inputs utilized by the third-party pricing services. The pension plans have no level 3 assets. The fair values of the pension plan assets by asset category are shown below (in thousands):
The Corporate debt securities category are investment grade bonds of U.S and foreign issuers denominated and payable in U.S. dollars from diverse industries, with a maturity of 1 to 30 years. Foreign bonds in the aggregate shall not exceed 20% of the bond portfolio. Residential mortgage-backed securities represents asset-backed securities with a maturity date 1 to 30 years with a rating of NAIC 1 or 2.
The accrued postretirement benefit obligation, included in the liability for retirement benefits, was $6,018,000 and $6,135,000 at December 31, 2012 and 2011, respectively. These amounts were approximately equal to the unfunded accumulated postretirement benefit obligation. Since American National’s contributions to the cost of the retiree benefit plans are fixed, the health care cost trend rate will have no effect on the future expense or the accumulated postretirement benefit obligation. Under American National’s various group benefit plans for active employees, life insurance benefits are provided upon retirement for eligible participants who meet certain age and length of service requirements.
In addition to the defined benefit pension plans, American National sponsors one defined contribution plan for all employees excluding those of the Farm Family companies, and an incentive savings plan for employees of the Farm Family companies. The defined contribution plan (401(k) plan) allows employees to contribute up to the maximum allowable amount as determined by the IRS. American National does not contribute to the defined contribution plan. Company contributions are made under the incentive savings plan for the Farm Family companies, with a discretionary portion based on the profits earned by the Farm Family companies. The expense associated with this plan was $1,700,000 for 2012, $1,800,000 for 2011, and $1,588,000 for 2010.
American National has entered into recurring transactions and agreements with certain related parties. These include mortgage loans, management contracts, agency commission contracts, marketing agreements, accident and health insurance contracts and legal services. The impact on the consolidated financial statements of the significant related party transactions for the periods indicated is shown below (in thousands):
Mortgage Loans to Gal-Tex Hotel Corporation (“Gal-Tex”): American National held a first mortgage loan issued to Gal-Tex collateralized by hotel property in San Antonio, Texas. This loan was originated in 1999, had a balance of $8,890,000 as of December 31, 2012, has a current interest rate of 7.30%, and has a final maturity date of April 1, 2019. This loan is current as to principal and interest payments.
Cash flows from discontinued operations in 2010 are immaterial and have been combined with cash flows from continuing operations within each category of the consolidated statements of cash flows.
The unaudited selected quarterly financial data is shown below (in thousands, except per share data):