We own and occupy approximately 420,000 square feet at our corporate headquarters located in Galveston, Texas. We also own the following properties that are materially important to our operations:
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.
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. These forward-looking statements are not a guarantee of future performance and involve risks and uncertainties. There are certain important factors that could cause actual results to differ, possibly materially, from expectations or estimates reflected in such forward-looking statements, including without limitations risks, uncertainties and other factors discussed in Item 1A, Risk Factors and elsewhere in this report.
The insurance segments do not directly own assets. Rather, assets are allocated to support the liabilities and capital allocated to each segment. The mix of assets allocated to each of the insurance segments is intended to support the characteristics of the insurance liabilities within each segment including expected 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.
The continued low interest rate environment also affects our estimated future profit projections, which could impact the amortization of our DAC assets and the estimates of our policyholder liabilities. Significantly lower future profits may cause us to accelerate the amortization of DAC or require us to establish additional policyholder liabilities, thereby reducing our earnings. We periodically review our assumptions with respect to future earnings to make sure that they remain appropriate considering the current interest rate environment.
Changing Regulatory Environment: The insurance industry is primarily regulated at the state level and some life and annuity products and services are also subject to U.S. federal regulation. We are regularly subjected to additional or changing regulation that requires us to update systems, change product structure, increase the amount of reporting or adopt changes to distribution. 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.
Importance of Operating Efficiencies: The challenging economic environment creates a further need for operating cost reductions and efficiencies. We manage our cost base while maintaining our commitment to provide superior customer service to agents and policyholders. Investments in technology 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.
Increased Role of Advanced Technology: Over the past several years, the use of mobile technology has changed the way consumers want to conduct their business, including real-time access to information. Many of today’s customers also expect to complete transactions in a digital format instead of traditional methods that require a phone call or submission of paper forms. Social media and other customer-facing technologies are also reshaping the way companies communicate and collaborate with key stakeholders, and new tools exist to better collect and analyze information for potential business opportunities and better manage risks. For example, American National has mobile-enabled all of its Internet-based access and leverages social media channels to reach out to potential customers to promote awareness of the company, including the products and services offered. We expect that technology will continue to evolve, offering new and more effective ways to reach out to and service our shareholders and customers. American National continually evaluates available and evolving technologies and incorporates those that offer appropriate benefits to the company and its customers into the organization.
Life insurance and annuity are our mainstay segments, as they have been during our long history. We believe that the combination of predictable and decreasing mortality rates, positive cash flow generation for many years after policy issue and favorable persistency characteristics suggest a viable and profitable future for this lines of business. We continue to use a wide variety of marketing channels and plan to expand our traditional distribution models with additional agents.
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’s 2012 Current Population Survey, the median age is 37.3 years. 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 and an ongoing transition from defined benefit pension plans to 401(k) type retirement plans, 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.
Most of the major provisions of the Patient Protection and Affordable Care Act, and a reconciliation measure, the Health Care and Education Reconciliation Act of 2010 (collectively, “the Healthcare Acts”), phased in effective January 1, 2014. The Healthcare Acts mandate broad changes in the delivery of health care benefits that have impacted our current business model, including our relationship with current and future customers, producers and health care providers, products, services, processes and technology. As a result, the Healthcare Acts generated new opportunities in the limited benefit and supplemental product markets. In recent years, we built a portfolio of such products, which were sold in the worksite market as well as to individuals. We also established new distribution channels and sales strategies and are experiencing continued increase in sales of our new worksite products.
We expect our Managing General Underwriter (“MGU”) line to continue to grow during 2014. We retain only 10% of the MGU premium and risk. The majority of the revenue generated from this line is fee income included in “Other income” of the Health segment’s operating results.
Our operating results improved significantly in 2013. The improvement was driven by decreases in catastrophe losses, underwriting and risk mitigation actions and improved pricing.
We remain committed to offering our personal and commercial property and casualty lines of business primarily through exclusive agents. We are taking a balanced, focused and collaborative approach to both growth and profitability through the development of successful agencies. We have launched a new Agent Career Program to enhance how we recruit, select, on-board and train new agent candidates. We are pleased with the initial results of the program and are experiencing growth in our agency force.
Our primary focus is to acquire and retain profitable business. To accomplish this objective, we use sophisticated pricing models and risk segmentation, along with focused distribution force. We believe this approach allows us to make product enhancements and offer programs that are tailored to our target markets while charging the right premium for the risk.
Demand for property and casualty credit-related insurance products continues to increase. Credit markets have improved from the 2008 credit crisis, which is leading to 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 while, at the same time, looking for efficiencies to reduce administrative costs.
Life Reserving Methodology-Determining the reserves for future amounts payable under life insurance policies requires the use of assumptions. Principal assumptions used in the determination of the reserves 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 calculated using historical claims information. Reserves for interest-sensitive and variable universal life insurance policies are equal to the current account value calculated for the policyholder. Some of our universal life policies contain secondary guarantees, for which additional reserves are recorded based on the term of the policy.
Tabular Claims Reserves-This method is used to calculate the reserves for disability income and long-term care blocks of business. These reserves rely on published valuation continuance tables created using industry experience regarding assumptions of continued morbidity and subsequent recovery. Reserves are calculated by applying these continuance tables, along with appropriate company experience adjustments, to the stream of contractual benefit payments. These expected benefit payments are discounted at the required interest rate.
Case Reserves-Reserves for reported losses are determined 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 determine the claims and CAE reserves involves the collaboration of underwriting, claims and internal actuarial departments. The process also includes consultation with independent actuarial firms as part of our process of gaining reassurance that claims and CAE reserves estimate sufficiently, all obligations arising from all losses incurred as of year-end. The independent actuarial firm completes the Statements of Actuarial Opinion required by individual state insurance regulations at each year-end, opining that the recorded statutory claims and CAE reserves are reasonable.
Premium Deficiency Reserve-Deficiency reserves are recorded when the expected claims payments and policy maintenance costs 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, CAE, 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, 2013 and 2012.
Bornhuetter-Ferguson-This method uses as a starting point an assumed initial expected loss ratio method and blends in the loss ratio implied by the claims experience to date by using loss development patterns based on our own historical experience. This method is generally appropriate where there are few reported claims and a relatively less stable pattern of reported losses.
The selected loss ratio used in the initial expected loss ratio method and Bornhuetter-Ferguson method for each accident year;
The loss ratio selections and development profiles are developed primarily using our own historical claims and loss experience. These development patterns reflect prior inflation rates and could be impacted by future changes in inflation rates particularly those relating to medical care costs, automobile repair parts and building or home material costs. These assumptions have not been modified from the preceding periods and are consistent with historical loss reserve development patterns.
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, 2013. 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 $5.6 million.
It is not appropriate to aggregate the impacts shown in our sensitivity analysis, as our lines of business are not directly correlated. The variations are not meant to be a “best-case” or “worst-case” scenario, and it is possible that future variations will be more or less than the amounts in our sensitivity analysis. While we believe these are possible scenarios based on the information available to us at this time, we do not believe the reader should consider our sensitivity analysis an actual reserve range.
Our accounting policy requires that a decline in the fair value of investment securities below their cost basis be evaluated on an ongoing basis to determine if the decline is other-than-temporary. A number of assumptions and estimates inherent in evaluating impairments are used to determine if they are other-than-temporary, which include 1) our ability and intent to hold the investment securities for a period of time sufficient to allow for an anticipated recovery in value; 2) the expected recoverability of principal and interest; 3) the length of time and extent to which the fair value has been less than cost basis; 4) the financial condition, near-term and long-term prospects of the issue or issuer, including relevant industry conditions and trends and implications of rating agency actions and offering prices; and 5) the specific reasons that a security is in a significant unrealized loss position, including market conditions, which could affect liquidity.
Consolidated earnings increased during 2013 compared to 2012 as a result of a decrease in claims primarily in our property and casualty segment and an increase in realized investment gains. Consolidated earnings increased during 2012 compared to 2011 primarily as a result of improved earnings in our annuity and property and casualty segments, partially offset by decreases in realized investment gains.
Earnings decreased during 2013 compared to 2012 primarily due to increases in operating expenses and policyholder benefits, partially offset by increases in premiums and other policy revenues. Earnings increased in 2012 compared to 2011 primarily due to an increase in other policy revenues, partially offset by an increase in other operating expenses.
Premiums from traditional life insurance products increased during 2013 compared to 2012 primarily as a result of increased sales following the introduction of a new portfolio of term products in 2012. Premiums increased during 2012 compared to 2011 primarily due to improved persistency and sales of term products.
The following table presents life insurance sales as measured by annualized premium, a non-GAAP measure used by the insurance industry, which allows a comparison of new policies written by an insurance company during the period (in thousands):
Life insurance sales increased during 2013 compared to 2012, and during 2012 compared to 2011 due to a continued focus on life production and expansion of product offerings. Term life sales increased as a result of a new term portfolio introduced in 2012. Equity-indexed universal life products were the primary driver of the increase in universal life sales.
In the fourth quarter of 2011, we modified our claims settlement procedures in response to the emerging regulation of claim processes from the long-standing practice of waiting for a beneficiary to file a claim to a view that insurers should actively seek possible beneficiaries. This led to an increase in our policyholder benefits of $2.4 million in 2013, $22.1 million in 2012 and $31.5 million in 2011.
Commissions increased during 2013 compared to 2012, and during 2012 compared to 2011 primarily due to increased sales of our term and equity-indexed universal life products.
Other operating expenses increased during 2013 compared to 2012 as a result of increases in costs associated with the growth in our life insurance in-force during 2013 including increases in costs allocated among our segments based on related activity as well as sales bonuses paid to independent contractors. Substantially all independent contractor bonuses are capitalized as DAC, therefore, they have minimal impact on earnings. Other operating costs and expenses increased during 2012 compared to 2011 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.
Total life insurance in-force increased during 2013 compared to 2012, and during 2012 compared to 2011, while the total number of policies decreased for the same periods. The increases in traditional life in-force amounts are believed to be attributed to the attractiveness of our portfolio of products and the ease of doing business. The decrease in our policy count for all periods is attributable to new business activity, which is generally comprised of fewer but larger face-value policies, being outpaced by terminations relating to claims, surrenders and lapses.
Reinsurance is used in the credit life business primarily to provide producers of credit-related insurance products the opportunity to participate in the underwriting risk through offshore producer-owned captive reinsurance companies. A majority of the treaties entered into by our Credit Insurance Division are written on a 100% coinsurance basis with benefit limits of $100,000 on credit life. We have entered into funds withheld reinsurance treaties, which are ceded to the reinsurer on a written basis.
For 2013, 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 Febraury 4, 2014.
During 2012, we discontinued marketing annuities through one of our third-party marketing organizations. Termination of this relationship is not expected to have a significant impact on our annuity volume or our ability to generate annuity sales, and is not expected to materially impact earnings. The total business written by this organization represented less than 1% and 13.3% of total annuity premium and deposits in 2013 and 2012, respectively, and was primarily comprised of fixed deferred annuities.
Single premium immediate annuity (“SPIA”) premiums increased during 2013 compared to 2012, and decreased during 2012 compared to 2011, driven primarily by the changing priorities of potential customers entering the market for guaranteed monthly payouts on a portion of their retirement dollars.
Policyholder benefits consist of annuity payments and reserve increases for SPIA contracts. Benefits are highly correlated to the sales volume of SPIA contracts and increased for 2013 compared to 2012, and 2012 compared to 2011 commensurate with increases in SPIA premium during these periods.
Commissions decreased for 2013 compared to 2012, and 2012 compared to 2011 primarily due to reduced deposits as well as decreases in commission rates on certain annuities.
Other operating expenses were higher in 2013 compared to 2012 due to higher technology cost and a benefit in 2012 relating to final resolution of certain litigation.
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.
Acquisition costs capitalized decreased during 2013 compared to 2012 and 2012 compared to 2011 primarily due to decreases in commissions on the lower deferred annuity contract sales.
An important measure of the Annuity segment is amortization of DAC as a percentage of gross profits. The amortization of DAC as a percentage of gross profits for the years ended December 31, 2013, 2012, and 2011 was 35.8%, 41.5%, and 41.9%, respectively. The 2013 ratio decreased primarily due to an increase in gross profits resulting from higher option return and favorable surrender experience compared to surrender assumptions.
Shown below is the incremental impact of option return to net investment income, and the impact of the equity-indexed annuity embedded derivative to interest credited to policyholder’s account balances (in thousands):
The option return, as well as the related equity-indexed annuity embedded derivative, increased significantly during 2013 compared to 2012, and in 2012 compared to 2011, primarily due to the change in the S&P 500 Index during the respective periods. These option returns correlate to the 29.6%, 13.4%, and 0.0% change in the S&P 500 Index during 2013, 2012, and 2011, respectively. In addition, the nominal value of options held during 2013 was larger than in 2012, which also contributed to the increase in option return.
Health earned premiums for the periods indicated are as follows (in thousands, except percentages):
Earned premiums decreased during 2013 compared to 2012, and 2012 compared to 2011 primarily resulting from the run-off of our closed block of medical expense insurance plans, which will continue to decrease. In addition, Medicare Supplement premiums declined due to policy lapses outpacing new sales along with a lower average premium per policy on those new sales.
Total in-force policies increased during 2013 compared to 2012 primarily due to an increase in the MGU line partially offset by a decrease in credit accident and health business. The MGU line increased as a result of our continued expansion in the MGU market as we believe an increasing number of employers will use the stop loss market to manage the cost of providing health insurance for employees. Credit accident and health decreased due to the contraction in that market.
Our total in-force policies decreased during 2012 compared to 2011 primarily due to increases in the MGU line being offset by decreases in credit accident and health and all other lines. The MGU line increased due to increased production by existing MGUs and the addition of new MGUs.
Claims incurred decreased during 2013 compared to 2012 primarily as a result of the continued decline in the closed medical expense block and a decrease in group claim submissions. Claims incurred during 2012 compared to 2011 were relatively unchanged. Benefit ratios were 65.6% in 2013, 69.6% in 2012, and 68.7% in 2011. Commissions were relatively unchanged during all periods.
Other operating expenses increased during 2013 compared to 2012 due primarily to an accrual on the MGU line for an anticipated payment to a state insurance guaranty pool. Other operating expenses decreased during 2012 compared to 2011 as a result of managing expenses as the aggregate health block of business decreased.
The amortization of DAC had a smaller impact on expenses during 2013 compared to 2012 and in 2012 compared to 2011 due to the declining aggregate health block of business.
For 2013, the companies to which we have ceded reinsurance for the Health segment are shown below (in thousands, except percentages):
Property and Casualty results improved during 2013 compared to 2012, and during 2012 compared to 2011 due to continued improvement in the loss ratio. The loss ratio improved as a result of decreases in catastrophe losses, underwriting and risk mitigation actions and improved price adequacy. Results also improved during 2012 compared to 2011 due to a decline in commissions resulting from a shift to non-commission products from commission products in our credit business.
Commissions decreased during 2013 compared to 2012, and during 2012 compared to 2011, primarily due to a shift from Guaranteed Auto Protection (“GAP”) commissioned products to non-commission products, which also have lower premiums.
Other operating expenses increased in 2013 compared to 2012, primarily due to increases in agent recruitment and marketing expenses. Other operating expenses remained relatively unchanged during 2012 compared to 2011.
Other Commercial: Net premiums written and earned increased during 2013 compared to 2012, primarily due to rate increases in the workers’ compensation line. In addition, net premiums written and earned increased during 2012 compared to 2011 as a result of premiums assumed from involuntary pools.
Net premiums written increased during 2013 compared to 2012 primarily due to an increase in our Collateral Protection business, while net premiums earned decreased as premiums shifted from Guaranteed Auto Protection (“GAP”) Insurance to GAP Waiver, a lower premium debt protection product. Net premiums written and earned decreased during 2012 compared to 2011. The primary driver for the decrease in premiums was a shift from GAP Insurance to GAP Waiver.
The loss and combined ratios increased during 2013 compared to 2012 primarily due to an increase in claims in our collateral protection business.
We retain the first $1.0 million of loss per risk, which will remain the same for 2014. Our catastrophe reinsurance retention covering property and casualty companies in total has been $40.0 million in recent years and will remain the same in 2014. The following table summarizes the Company’s catastrophe reinsurance coverage effective during 2014.
95% of multiple peril losses covered by Corporate Program(1) (all perils).
100% of multiple peril losses covered by Corporate Program(1) (all perils).
(1) The Corporate Program covers all non-credit property and casualty business, subject to certain limits, and is not specific to the Company or any of its subsidiaries, or any state or region.
Each per event coverage above includes one automatic reinstatement except for a 15% portion of the Corporate Program (15% of $40 million to $500 million). In 2013, this reinsurance coverage was placed at 95% and included one automatic reinstatement. 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 15% placement of non-reinstateable coverage reduces the amount of reinstatement premium we are obligated to pay.
We purchase a Catastrophe Aggregate reinsurance coverage that provides for $30 million of limit excess of $90 million of aggregated catastrophe losses. Qualifying losses include amounts of retained losses below the $10 million retention of the catastrophe program. The Catastrophe Aggregate reinsurance coverage has been placed at 95% for 2014 and does not include a reinstatement.
We use multiple reinsurers with each reinsurer absorbing part of the overall risk ceded. The primary reinsurers in the 2014 programs and the coverage each provides are shown in the following table:
Our credit-related property insurance products do not employ reinsurance to manage catastrophe loss exposure, and their reinsurers for risks other than catastrophes are not deemed significant to our business.
The top line shows our original reserves, net of reinsurance recoverable, for each of the indicated years. The table then shows the cumulative net paid claims and CAE as of successive years. The table below also shows the re-estimated amount of previously recorded reserves based on experience as of the end of each succeeding year. The cumulative deficiency or redundancy represents the aggregate change in the estimates over all prior years. Conditions and trends that affected development of liabilities in the past may not occur in the future. Accordingly, it is inappropriate to anticipate future redundancies or deficiencies based on historical experience.
The current year loss ratio is a blend of the current accident year loss ratio and the impact of favorable or adverse development on prior accident years during the current calendar year. Excluding the 3.6 point impact of favorable prior year loss development for accident years 2012 and prior, the 2013 loss ratio would have been 73.1%. Excluding the 4.4 point impact of favorable prior year loss development for accident years 2011 and prior, the 2012 loss ratio would have been 77.7%.
The Corporate and Other business segment recorded other-than-temporary impairments of $4.6 million, $22.5 million, and $9.5 million in 2013, 2012 and 2011, 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 primarily by the state insurance departments where we or our insurance subsidiaries are domiciled. Investment activities, including the setting 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.
Our insurance and annuity products are primarily supported by investment-grade bonds, and to a lesser extent collateralized mortgage obligations and commercial mortgage loans. We purchase fixed maturity securities and designate them as either held-to-maturity or available-for-sale considering our estimated future cash flow needs. We also monitor the composition of our fixed maturity securities classified as held-to-maturity and available-for-sale and adjust the mix within the portfolio as investments mature or new investments are purchased.
The increase in our total investments at December 31, 2013 as compared to 2012 was primarily a result of an increase in equity securities, due to market appreciation, as well as increases in short-term investments and mortgage loans. These increases were partially offset by decreases in bonds due to maturities.
Each component of our invested assets and its related revenues are described further in the Notes to the Consolidated Financial Statements within Item 8, Financial Statements and Supplementary Data.
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.
Realized gains increased $33.4 million during 2013 compared to 2012 primarily as a result of realized gains on sales of investment real estate. Realized gains decreased $9.6 million during 2012 compared to 2011 primarily due to a decrease in realized gains from sales of equity securities. Other-than-temporary impairment on investment securities decreased $17.9 million during 2013 compared to 2012 and increased $13.0 million during 2012 compared to 2011 primarily due to the $12.7 million bond impairment during 2012.
The gross unrealized gains of held-to-maturity securities decreased $387.7 million to $451.8 million and gross unrealized losses increased from $8.0 million in 2012 to $120.1 million in 2013, which was primarily attributable to corporate debt securities and the impact changes in interest rates have on fixed income securities.
Our cash and cash equivalents and short-term investment position was $613.3 million compared to $616.1 million at December 31, 2013 and 2012, respectively. The slight decrease relates primarily to a reduction in cash and cash equivalents.
(4) Estimated payments through continuing operations for pension benefit obligations for the non-qualified defined benefit pension plan. A liability has been established for the full amount of benefits accrued.
We have various agency, consulting and service arrangements with individuals and corporations considered to be related parties. Each of these arrangements has been reviewed and approved by our Audit Committee, which retains final decision-making authority for these transactions. The amounts involved, both individually and in the aggregate, with these arrangements are not material to any segment or to our overall operations. For additional details see Note 20, Related Party Transactions, of the Notes to the Consolidated Financial Statements.
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, 2013 and 2012, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2013, 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.
In our opinion, American National Insurance Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control - Integrated Framework issued by the COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statements of financial position of American National Insurance Company and subsidiaries as of December 31, 2013 and 2012, and the related consolidated statements of operations, comprehensive income (loss), changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2013, and our report dated February 28, 2014 expressed an unqualified opinion on those consolidated financial statements.
American National Insurance Company and its consolidated subsidiaries (collectively “American National”) offer a broad spectrum of insurance products, including individual and group life insurance, annuities, health insurance, and property and casualty insurance. Business is conducted in 50 states, the District of Columbia, Puerto Rico, Guam and American Samoa.
Investment securities - Bonds classified as held-to-maturity are carried at amortized cost. Bonds classified as available-for-sale are carried at fair value. Equity securities are classified as available-for-sale and carried at fair value. After-tax net unrealized gains or losses on available-for-sale securities are reflected in stockholders’ equity as a component of “Accumulated Other Comprehensive Income (Loss)” (“AOCI”).
Other invested assets comprised primarily of tax credit partnerships, CAPCO investments and mineral rights, are carried at cost, less allowance for depletion, where applicable. Other invested assets also include equity-indexed options which are carried at fair value. Impairments for other invested assets are considered on an individual basis.
Impairments-American National evaluates all fixed maturity securities with unrealized losses on a quarterly basis to determine if the creditworthiness of any of those securities has deteriorated to a point where its carrying value will not be realized at maturity. For fixed maturity securities where management believes that the carrying value will not be realized, an other-than-temporary impairment (“OTTI”) loss is recorded. At December 31, 2013, the unrealized losses on fixed maturity securities that were not other-than-temporarily impaired were the result of credit spread widening. There were no delinquent coupon payments attributed to these securities at December 31, 2013.
Cash and cash equivalents include cash on-hand and in banks plus amounts invested in money market funds and are reported as “Cash and cash equivalents” in the consolidated statements of financial position.
Traditional ordinary life and health-Life and accident and health premiums are recognized as revenue when due. Benefits and expenses are associated with earned premiums to result in recognition of profits over the term of the insurance contracts.
Annuities-Premiums received on limited-pay and supplemental annuity contracts involving a significant life contingency are recognized as revenue when due. Deferred annuity premiums are recorded as deposits rather than recognized as revenue. Revenues from deferred annuity contracts are principally surrender charges and, in the case of variable annuities, administrative fees assessed to contractholders.
Property and casualty premiums are recognized as revenue proportionately over the contract period, net of reinsurance ceded. Claims incurred consist of actual claims and CAE paid and the change in reserves, net of reinsurance received and recoverable.
Participating business comprised approximately 8.1% of the life insurance in-force at December 31, 2013 and 11.7% of life premiums in 2013. Of the total participating business, 78.1% 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.
The pension and postretirement benefit obligations and costs are calculated using 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 compensation.
Restricted Stock-The measurement of the equity and compensation cost of restricted stock (“RS”) is based on the fair value of the underlying stock at grant date. The compensation cost accrued is included in “Additional paid-in capital” in the consolidated statements of financial position.
American National reviews existing litigation matters and potential litigation items with counsel quarterly to determine if any adjustments to liabilities for possible losses are necessary. Reserves for losses are established whenever they are probable and estimable based on the best estimate of the probable loss. If no one estimate within the range of possible losses is more probable than any other, a reserve is recorded based on the lowest amount of the range.
Amended guidance on presentation of AOCI. The amendments require disclosures 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 GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under GAAP that provide additional detail about those amounts.
Future Adoption of New Accounting Standards-The FASB issued the following significant accounting guidance relevant to American National. Each became effective for American National on January 1, 2014 and unless stated otherwise, did not have a material effect on the consolidated financial statements:
Amended guidance for the recognition, measurement, and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of the guidance is fixed at the reporting date. The amended guidance requires the entity to measure obligations resulting from joint and several liability arrangements as the sum of the amount the reporting entity agreed with co-obligors to pay and any additional amounts it expects to pay on behalf of one or more co-obligors.
Guidance that allows investors to elect the use of proportional amortization method to account for investments in qualified affordable housing projects, if certain conditions are met. The new guidance replaces the effective yield method and allows an investor to amortize the cost of its investment, in proportion to the tax credits and other tax benefits it receives, to income tax expense. The guidance requires new disclosure for all investors for all investments in qualified affordable housing projects, regardless of the accounting method used for those investments.
All gains and losses for securities sold throughout the year were determined using specific identification of the securities sold. During 2013 and 2012, bonds with a carrying value of $13,492,000 and $62,500,000, respectively, were transferred from held-to-maturity to available-for-sale after a significant deterioration in the issuers’ creditworthiness became evident. An unrealized loss of $236,000 was established at the time of the transfer in 2013, while an other-than-temporary impairment of $11,358,000 was recorded in 2012 following the transfers at fair value.
In accordance with various regulations, American National had bonds on deposit with regulating authorities with a carrying value of $50,471,000 and $50,027,000 at December 31, 2013 and 2012, respectively. In addition, American National has pledged bonds in connection with agreements and transactions, such as financing and reinsurance agreements. The carrying value of bonds pledged was $68,125,000 and $73,176,000 at December 31, 2013 and 2012, respectively.
As of December 31, 2013, 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 an issuer’s financial circumstances may be different in the future, which may lead to a different impairment conclusion in future periods.
Bonds distributed by credit quality rating, using both S&P and Moody’s ratings, are shown below:
During 2013, American National foreclosed one loan with a recorded investment of $5,600,000, and during 2012, four loans with a recorded investment of $34,562,000. American National also sold one commercial loan with a recorded investment of $23,304,000 resulting in a gain of $115,000 in 2013, and one commercial loan with a recorded investment of $19,665,000 resulting in a realized gain of $2,607,000 in 2012.
There were no non-cash transactions during 2013. However, during 2012, mortgage loans with carrying value of $15,865,000 were transferred to investments in unconsolidated affiliates.
The age analysis of past due commercial mortgage loans is shown below (in thousands):
At December 31, 2013 and 2012, the recorded investment for loans collectively evaluated for impairment was $3,294,235,000 and $3,045,486,000, respectively, and the recorded investment for loans individually evaluated for impairment was $17,188,000 and $109,537,000, respectively.
There are no commitments to lend additional funds to debtors whose loans have been modified in troubled debt restructuring, and there have been no defaults on modified loans during the period.
The pricing service evaluates each asset class based on relevant market information, credit information, perceived market movements and sector news. The market inputs utilized in the pricing evaluation, listed in the approximate order of priority, include: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, and economic events. The extent of the use of each market input depends on the asset class and the market conditions. Depending on the security, the priority of the use of inputs may change or some market inputs may not be relevant. For some securities, additional inputs may be necessary.
American National holds a small amount of private placement debt and fixed maturity securities that have characteristics that make them unsuitable for matrix pricing. For these securities, a quote from an independent broker (typically a market maker) is obtained. Due to the disclaimers on the quotes that indicate that the price is indicative only, American National includes these fair value estimates in Level 3.
The significant unobservable input used to calculate the fair value of the embedded derivatives is equity option implied volatility. An increase in implied volatility will result in an increase in the value of the equity-indexed embedded derivatives, all other things being equal. At December 31, 2013 and 2012, the one year implied volatility used to estimate embedded derivative value was 15.0% and 18.1%, respectively.
There were no transfers between Level 1 and Level 2 fair value hierarchies. The transfers into Level 3 were the result of existing securities no longer being priced by the third-party pricing service at the end of the period. American National’s valuation of these securities involves judgment regarding assumptions market participants would use including quotes from independent brokers. The transfers out of Level 3 were securities being priced by a third-party service at the end of the period, using inputs that are observable or derived from market data, which resulted in classification of these assets as Level 2.
Effective January 1, 2012, American National retrospectively adopted a new accounting guidance for deferring costs associated with acquiring or renewing insurance contracts. The amended accounting guidance 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. 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.
Future policy benefit liabilities for disabled lives are estimated using the present value of benefits method and experience assumptions as to claim terminations, expenses and interest. Interest rates used in establishing such liabilities range from 3.0% to 4.5%.
The liability for unpaid claims and claim adjustment expenses (“claims”) for accident and health, and property and casualty insurance is included in the “Policy and contract claims” in the consolidated statements of financial position and represents the amount estimated for claims that have been reported but not settled and IBNR claims. Liability for unpaid claims are estimated based upon American National’s historical experience and actuarial assumptions that consider the effects of current developments, anticipated trends and risk management programs, reduced for anticipated salvage and subrogation. The effects of the changes are included in the consolidated results of operations in the period in which the changes occur.
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 2013 was placed at 100%.
American National remains primarily liable with respect to any reinsurance ceded, and would bear the entire loss if the reinsurer were to be unable to meet their obligations under any reinsurance treaties. American National had amounts recoverable from reinsurers of $414,743,000 and $418,743,000 at December 31, 2013 and 2012, respectively. None of the amount outstanding at December 31, 2013 is the subject of litigation or is in dispute with the reinsurers involved. Management believes the unfavorable resolution of any dispute that may arise would not have a material impact on American National’s consolidated financial statements.
American National made payments of $73,993,000, $46,939,000 and $54,620,000 during 2013, 2012, and 2011, respectively.
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, 2013 and 2012. However, if not utilized beforehand, approximately $10,843,000 in ordinary loss tax carryforwards will expire on December 31, 2033.
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 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.
RS Awards entitle the participant to full dividend and voting rights. Each award has the value of one share of restricted stock and vests 10 years from the grant date. Unvested shares are restricted as to disposition, and are subject to forfeiture under certain circumstances. Compensation expense is recognized over the vesting period. The restrictions on these awards lapse after 10 years, and these awards feature a graded vesting schedule in the case of the retirement of an award holder. Restricted stock for 350,334 shares has been granted at an exercise price of zero, of which 190,667 shares are unvested.
Basic earnings per share were calculated using a weighted average number of shares outstanding. The Restricted Stock awards and units resulted in diluted earnings per share as follows (in thousands, except share-related data):
Risk Based Capital (“RBC”) requirements are measures insurance regulators use to evaluate the capital adequacy of American National Insurance Company and its insurance subsidiaries. RBC is calculated using formulas applied to certain financial balances and activities that consider, among other things, risks related to the type and quality of the invested assets, insurance risks associated with an insurer’s products and liabilities, interest rate risks and general business risks. Insurance companies that do not maintain capital and surplus at a level at least 200% of the authorized control level RBC are required to take certain actions. At December 31, 2013 and 2012, American National Insurance Company’s statutory capital and surplus was $2,667,589,000 and $2,260,268,000, respectively. Additionally, each of the insurance subsidiaries had statutory capital and surplus at December 31, 2013 and 2012, substantially above each individual subsidiary’s authorized control level RBC.
American National’s insurance subsidiaries prepare statutory-basis financial statements in accordance with statutory accounting practices prescribed or permitted by the insurance department of the state of domicile which include certain components of the National Association of Insurance Commissioners’ Codification of Statutory Accounting Principles (“NAIC Codification”). NAIC Codification is intended to standardize regulatory accounting and reporting to state insurance departments. However, statutory accounting practices continue to be established by individual state laws and permitted practices. Modifications by the various state insurance departments may impact the statutory capital and surplus of American National Insurance Company and its insurance subsidiaries.
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 other partners in the consolidated joint ventures are shown as noncontrolling interests of $6,007,000 and $4,741,000 at December 31, 2013 and 2012, respectively.
During 2012 and 2011, American National increased its ownership interest with a consolidated joint venture. The effect of the change in ownership interest of American National is shown below (in thousands):
On October 31, 2013, American National adopted certain amendments to freeze all of its remaining unfrozen defined benefit pension plans as of December 31, 2013. Prior to the plan amendments, American National had a qualified defined benefit pension plan covering virtually all employees and two non-qualified defined benefit pension plans covering executives. Effective December 31, 2013, benefits accrued through these plans will no longer include additional years of service credit or future salary increase credit, and no new participants will be added to the plans. Benefits earned by eligible employees prior to the effective date of the plan amendments will not be affected. The plan amendments did not result in any curtailment gain or loss.
The estimated actuarial loss for the plan that will be amortized out of AOCI into the net periodic benefit cost over the next fiscal year is $7,532,000. Amounts recognized as a component of AOCI that have not been recognized as a component of the combined net periodic benefit cost of the defined benefit pension plans, are shown below (in thousands):
American National’s funding policy for the qualified pension plans is to make annual contributions to meet the minimum funding standards of ERISA. The unfunded plans will be funded out of general corporate assets when necessary. American National contributed $10,065,000, $48,531,000, and $34,547,000 to the qualified pension plan in 2013, 2012 and 2011, respectively. American National and its affiliates expect to contribute $10,700,000 to its qualified pension plan in 2014.
The investment policy for the retirement plan assets is designed to provide the highest return possible commensurate with sound and prudent underwriting practices. The investment diversification goals are to have investments in cash and cash equivalents as necessary for liquidity, debt securities up to 100% and equity securities up to 60% of the total invested plan assets. The amount invested in any particular investment is limited based on credit quality, and no single investment may at the time of purchase be more than 5% of the total invested assets.
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.
Equity portfolio managers have discretion to choose the degree of concentration in various issues and industry sectors for the equity securities. Permitted securities are those for which there is an active market providing liquidity for the specific security.
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. Prior to January 1, 2014, American National did 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 $1,900,000 for 2013, $1,700,000 for 2012, and $1,810,000 for 2011. Beginning in 2014, American National will provide retirement benefits for eligible employees using contributory defined contribution plans and will make company contribution as a percent of eligible employees’ pay and a matching contribution of each employees elected contribution.
American National and its subsidiaries lease insurance sales office space in various cities. The remaining long-term lease commitments at December 31, 2013, were approximately $1,760,000.
American National had aggregate commitments at December 31, 2013, to purchase, expand or improve real estate, to fund fixed interest rate mortgage loans, and to purchase other invested assets of $513,773,000 of which $409,017,000 is expected to be funded in 2014. The remaining $104,756,000 will be funded in 2015 and beyond.
In September 2013, American National renewed an existing $100,000,000 short-term variable rate borrowing facility containing a $55,000,000 sub-feature for the issuance of letters of credit. Borrowings under the facility are at the discretion of the lender and would be used only for funding working capital requirements. The combination of borrowings and outstanding letters of credit cannot exceed $100,000,000 at any time. As of December 31, 2013 and 2012, the outstanding letters of credit were $15,560,000 and $33,696,000, respectively, and there were no borrowings on this facility to meet liquidity requirements. This facility expires on September 30, 2014. American National expects it will be renewed on substantially equivalent terms upon expiration.