We lease our headquarters in Bellevue, Washington, which consists of 222,000 square feet in the Symetra Center building and 72,000 square feet in the adjacent Key Center building. Leases for both facilities expire in 2015 with multiple options to renew. Our headquarters in Bellevue serves as the primary location for operations of all of our divisions. In addition to our headquarters, we lease 20 other properties throughout the U.S. which comprise a total of 105,000 square feet.
The following selected financial data, except for non-GAAP financial measures, have been derived from our consolidated financial statements. The consolidated income statement data for the years ended December 31, 2012, 2011 and 2010 and the consolidated balance sheet data as of December 31, 2012 and 2011, except for the non-GAAP financial measures, have been derived from our consolidated financial statements included elsewhere herein. The consolidated income statement data for the years ended December 31, 2009 and 2008 and the consolidated balance sheet data as of December 31, 2010, 2009 and 2008, except for the non-GAAP financial measures, have been derived from the consolidated financial statements not included herein. Historical financial information has been restated to reflect the retrospective adoption of a new accounting standard for deferred acquisition costs on January 1, 2012. See Note 2 to the accompanying consolidated financial statements for discussion of adoption of new accounting pronouncements.
Historical financial information has been restated to reflect the retrospective adoption of a new accounting standard for deferred acquisition costs on January 1, 2012. See Note 2 to the accompanying consolidated financial statements for discussion of adoption of new accounting pronouncements.
We manage our business through three divisions composed of four business segments. See Note 19 to the consolidated financial statements for financial results of our segments.
Benefits. We offer medical stop-loss, limited benefit medical and group life and disability insurance products and services to employers, unions, and public agencies.
Income Annuities. We offer SPIAs to customers seeking a reliable source of retirement income or to protect against outliving their assets during retirement. In addition, through 2012, we offered structured settlement annuities to fund third party personal injury settlements. In the fourth quarter of 2012, we discontinued future sales of structured settlement annuities. We continue to service our block of structured settlement policies and offer funding services options to existing structured settlement clients.
Individual Life. We offer an array of insurance products such as term and universal life insurance, including BOLI. In 2012, we began to offer COLI, although no policies were sold.
In addition, we also have our Other segment which includes our operations that are not directly related to the operating segments. This includes small, non-insurance businesses that are managed outside our divisions, such as our broker-dealer entity, as well as investment income on unallocated surplus, unallocated corporate expenses, interest expense on debt, earnings related to our limited partnership interests and inter-segment elimination entries.
To manage our investment yield in this environment, we plan to continue investing in commercial mortgage loans we underwrite, as well as increase our investments in foreign securities. During 2012, we originated $825.7 in commercial mortgage loans and we expect to continue at least this pace of originations during 2013. While interest rates on recently written loans have decreased consistent with the overall level of interest rates, they continue to be an attractive investment opportunity. We also expect to modestly increase our investments in foreign securities, as we believe this asset class has quality investment opportunities that offer attractive yields. We purchased $156.1 of foreign fixed maturity securities in the fourth quarter of 2012
Our investment yield is impacted by investment prepayments and by normal reinvestment of cash flows from our investment portfolio. We believe the low interest rate environment makes it relatively attractive for bond issuers to prepay their bonds and refinance at lower market rates. We may receive fees related to these prepayments, which are recorded in net investment income. Such fees help maintain current period yields; however, reinvestment of the proceeds and other cash flows generated by our portfolios at current market rates will result in lower investment income in the future. We estimate that we will reinvest approximately $750.0 - $800.0 of cash flows from our current portfolio in 2013. In addition, we have been selling lower yielding, higher premium agency RMBS where the prepayment characteristics of the securities have deteriorated. During 2012, we sold $382.7 of these assets. In doing so, we were able to produce realized gains while reducing our future reinvestment risk. We will remain proactive in managing our prepayment and reinvestment risk in 2013.
In addition to investment strategies, we attempt to mitigate the negative impact of the low interest rate environment through disciplined pricing on new business and managing renewal crediting rates on existing business. For many of our products, we are able to decrease interest crediting rates. However, in a prolonged low interest rate environment, the following factors may cause our interest spread to decrease:
To manage our way through this uncertain environment and grow profitably, we will continue to focus on the strategies outlined in Item 1 - “Business - Our Business.” Our 2013 focus is on profitable growth of our core businesses and executing on our strategic initiatives. We believe we have adequate levels of capital to support our priorities - organic growth, transactional growth and capital actions. Opportunities for organic growth of our business and for strategic transactions have arisen as major players in the life insurance industry have exited or announced plans to exit the life and annuities marketplace. To provide us with greater flexibility to execute on our capital management plans, our board of directors recently authorized the repurchase of up to 10.0 shares of our outstanding common stock.
The preparation of financial statements in conformity with U.S. GAAP requires management to adopt accounting policies and make estimates and assumptions that affect amounts reported and disclosed in the consolidated financial statements. The accounting policies discussed in this section are those that we consider to be particularly critical to understanding our consolidated financial statements because their application places the most significant demands on our ability to judge the effect of inherently uncertain matters on our financial results and requires management to make subjective and complex judgments. Many of these policies, estimates and related judgments are common in the insurance and financial services industries; others are specific to the Company’s businesses and operations. For all of these policies, we caution that future events rarely develop exactly as forecast, and our best estimates may require adjustment.
Fixed maturities include bonds, mortgage-backed securities and redeemable preferred stock. We classify all fixed maturities as available-for-sale and carry them at fair value. Net unrealized gains and losses related to these securities are calculated as the difference between the fair value and amortized cost. We report these unrealized gains and losses in AOCI in stockholders’ equity. Realized investment gains and losses are reported in the consolidated statements of income.
We determine the fair value of fixed maturities primarily by obtaining prices from third-party independent pricing services, which as of December 31, 2012 and 2011, priced 96.2% and 95.9%, respectively, of our fixed maturities. The pricing services we use have policies and processes to ensure that they are using objectively verifiable, observable market data, including documentation by major security type on the observable market inputs used to determine the prices. Securities are priced using evaluated pricing models that vary by asset class.
We analyze the prices received from the pricing services to ensure they represent a reasonable estimate of fair value, including analytical reviews of prices between reporting periods. As appropriate, we engage our pricing services in discussion regarding the valuation of a security; however, it has not been our practice to adjust their prices. We also perform procedures to gain assurance on the overall reasonableness and consistent use of
inputs, valuation methodologies and compliance with fair value accounting standards. This includes an annual review of pricing methodologies and inputs by asset class and performing periodic due diligence procedures, including quarterly deep-dive analyses, monthly price fluctuation analyses, and corroboration of prices by obtaining secondary pricing quotes for selected securities. Based upon our procedures, we believe that the values provided by our pricing services are appropriate measurements of fair value and determined in accordance with U.S. GAAP.
One of the significant estimates related to available-for-sale securities is the evaluation of investments for OTTI. We record an OTTI on fixed maturity securities in an unrealized loss position when one of the following occurs:
Making the determinations as to whether these conditions exist requires judgment. As part of this process, we analyze investments in an unrealized loss position to determine whether the decline in value is other-than-temporary. The impairment review involves the investment management team, including internal management and our third-party asset portfolio managers. To make this determination, we consider both quantitative and qualitative criteria including:
any reduction or elimination of dividends or non-payment of scheduled interest;
for fixed maturities, our intent to sell or whether it is more likely than not we will be required to sell the fixed maturity prior to recovery of its amortized cost, considering any regulatory developments, prepayment or call notifications and our liquidity needs.
For securities we intend to sell or for which it is more likely than not that we will be required to sell before recovery, the impairment charge is equal to the difference between the fair value and the amortized cost basis of the security. This amount is recorded as a realized loss in our consolidated statements of income. In determining our intent to sell a security or whether it is more likely than not that we will be required to sell a security, we evaluate facts and circumstances such as decisions to reposition our security portfolio, sales of securities to meet cash flow needs and sales of securities to capitalize on favorable pricing.
If we do not intend to sell a security, but believe we will not recover all the security’s contractual cash flows, the amortized cost is written down to our estimated recovery value. This amount is determined to be a credit loss and is recorded as a realized loss in our consolidated statements of income. The remainder of the decline in fair value is recorded as OTTI on fixed maturities not related to credit losses in other comprehensive income (OCI), as this is determined to be a noncredit or recoverable loss.
We determine the estimated recovery values by using discounted cash flow models that consider estimated cash flows under current and expected future economic conditions with various assumptions regarding the timing and amount of principal and interest payments. The recovery value is based on our best estimate of expected future cash flows discounted at the security’s effective yield prior to impairment. Our best estimate of future cash flows is based on assumptions, including various performance indicators, such as historical default and recovery rates, credit ratings, current delinquency rates and the structure of the issuer/security. These assumptions require the use of significant judgment and include the probability of issuer default and estimates regarding timing and amount of expected recoveries. In addition, projections of expected future fixed maturity security cash flows may change based upon new information regarding the performance of the issuer and/or underlying collateral. Future impairments may develop if actual results underperform current cash flow modeling assumptions, which may be the result of macroeconomic factors, changes in assumptions used, specific deterioration in certain industry sectors or company failures.
As of December 31, 2012 and 2011, the fair value of our available-for-sale fixed maturity securities that were below cost or amortized cost by 20% or more was $69.6 and $260.0, respectively. Included in the gross unrealized losses are losses attributable to both movements in market interest rates as well as movements in credit spreads. Net income for the year ended December 31, 2012 would be reduced by approximately $27.0 on a pre-tax basis if all the securities in an unrealized loss position of more than 20% were deemed to be other than temporarily impaired, and all of the unrealized loss was credit related.
Individual Life. The DAC amortization period related to universal life policies is typically 25 years. DAC amortization related to our term life insurance policies is the premium paying period, which ranges from 10 to 30 years.
Changes to assumptions can have a significant impact on DAC and DSI amortization. In the event actual experience differs from our assumptions or our future assumptions are revised, we adjust our EGPs, which could result in a significant increase in amortization expense. EGPs are adjusted quarterly to reflect actual experience to date. For example, for our deferred annuity products, if renewal crediting rates are greater or lower than the renewal crediting rates we assumed in our DAC and DSI asset amortization models, we would record a change in amortization expense to reflect the change in our EGPs.
The following would generally cause an increase in DAC and DSI amortization expense:
In connection with our recoverability analyses, we perform sensitivity analyses on our most significant DAC and DSI asset balances, which currently relate to our deferred annuity, universal life, and BOLI products, to capture the effect that certain key assumptions have on DAC asset balances. The sensitivity tests are performed independently, without consideration for any correlation among the key assumptions. The following depicts the sensitivities for our deferred annuity, universal life and BOLI DAC asset balances as of December 31, 2012:
if we decreased our future investment yield assumptions by a factor of 100bps, the DAC asset balance would decrease approximately $2.1.
In addition, depending on the amount and the type of new business written in the future, we may determine that other assumptions may produce significant variations in our financial results.
We adjust the unamortized DAC and DSI balances for the accumulated effect of net unrealized gains or losses on investments, which is recorded net of taxes in AOCI. This adjustment reflects the impact on estimated future gross profits as if the unrealized investment gains and losses had been realized as of the balance sheet date. Currently, our available-for-sale portfolio is in a net unrealized gain position, primarily due to the low interest rate environment, and the corresponding adjustment decreases our DAC and DSI balances and AOCI. In periods of rising interest rates, the fair value of our fixed maturities would generally decrease, and this may result in net unrealized investment losses. In such circumstances, the DAC and DSI adjustments would increase our DAC and DSI balances and increase AOCI. However, this adjustment is limited to cumulative capitalized acquisition costs plus interest, which would be $175.0, net of taxes of $94.2, in our Deferred Annuities segment and $13.2, net of taxes of $7.1, in our Individual Life segment as of December 31, 2012. For DSI, this adjustment is limited to cumulative capitalized interest costs plus interest, which would be $83.3, net of taxes of $44.8.
Our primary sources of revenues from our insurance operations are premiums, net investment income and policy fees and contract charges. Our primary sources of expenses from our insurance operations are policyholder benefits and claims, interest credited to policyholder reserves and account balances, and general business and operating expenses, net of DAC. We allocate shared service operating expenses to each segment using multiple factors, including employee headcount, allocated investments, account values and time study results. We also generate net realized investment gains (losses) on sales or impairment of our investments and changes in fair value on our equity trading portfolio.
Premiums consist primarily of premiums from our group insurance products, primarily medical stop-loss and limited benefit medical, individual term and whole life insurance products.
We defer as assets certain commissions, distribution costs and other underwriting costs that are directly related to the successful acquisition of new and renewal business. Amortization of previously capitalized DAC is recorded as an expense.
Adjusted operating income consists of net income, less after-tax net realized investment gains (losses), plus after-tax net investment gains (losses) on FIA. Net income is the most directly comparable GAAP measure to adjusted operating income. Net income for any period presents the results of our insurance operations, as well as our net realized investment gains (losses). We consider investment income generated by our invested assets to be part of the results of our insurance operations because they are acquired and generally held to maturity to generate income that we use to meet our obligations. Conversely, we do not consider the activities reported through net realized investment gains (losses), with the exception of our FIA gains (losses), to be reflective of the performance of our insurance operations, as discussed below.
In presenting adjusted operating income, we are excluding after-tax net realized investment gains (losses). The timing and amount of these gains and losses are driven by investment decisions and external economic developments unrelated to our management of the insurance and underwriting aspects of our business. However, we do consider realized investment gains (losses) on FIA as part of adjusted operating income. Our FIA products credit interest to policyholder accounts based on equity market performance. Net realized gains (losses) on FIA includes changes in fair value of our FIA options and the related FIA embedded derivative, which represents our current period obligation to policyholders related to equity market performance. Each year, we use the realized gains from our FIA options similar to the way we use investment income to meet our obligations associated with our FIA product.
In addition to using adjusted operating income to evaluate our insurance operations, our management and board of directors have other uses for this measure, including assessing achievement of our financial plan and managing the crediting rates on our insurance liabilities.
The following discussion should be read in conjunction with our consolidated financial statements and related notes.
Net income increased $9.6 as a result of higher net realized investment gains on our investment portfolio compared to 2011, partially offset by a decline in pre-tax adjusted operating income. In addition, the provision for income taxes decreased $12.7 on lower pre-tax earnings and a lower effective tax rate, which was 24.0% for the year ended December 31, 2012 compared to 28.3% for the same period in 2011. The effective tax rate decreased due to an increase in tax credit investments and the related benefits.
Included in our 2012 segment results is $24.8 of net investment income, received mainly in the fourth quarter of 2012, related to investment prepayments (primarily bond make-whole premiums from investments in our Deferred Annuities segments, and our prepayment speed adjustment). This compares to $23.0 of prepayment-related income received in 2011. This income was partially offset by related DAC and DSI amortization expenses.
Our Individual Life segment’s profitability decreased $18.3, driven by higher individual claims, a lower BOLI ROA, and increased employee-related expenses, primarily related to the implementation of our Grow & Diversify initiatives.
Pre-tax adjusted operating income increased on higher profitability in three of our four business segments. Included in our 2011 segment results is $23.0 of net investment income, received mainly in the fourth quarter of 2011, related to investment prepayments (primarily bond make-whole premiums from investments in our Deferred Annuities and Life segments, and our prepayment speed adjustment), offset by related DAC and DSI amortization expenses. This compares to $14.5 of prepayment related income in 2010. In addition, other underwriting and operating expenses increased $38.0 over prior year levels, primarily due to higher employee-related expenses and professional services expenses, including costs related to our Grow & Diversify initiatives, as well as operational expenses related to the acquisition of a block of business in July 2011.
Our Benefits segment’s profitability increased $7.9 due to an improved stop-loss loss ratio on a larger block of medical stop-loss business. On July 1, 2011, we assumed medical stop-loss policies and acquired the renewal rights for a block of stop-loss business. The transaction accounts for the majority of the increase in premiums and policyholder benefits and claims. For the full year 2011, the loss ratio decreased to 63.1%, from 64.9%, in 2010.
Our Deferred Annuities segment’s profitability increased $23.5 as our account values grew to $10.6 billion, resulting in a $35.8 increase in the investment margin (net investment income less interest credited). Also contributing to the increase was $9.2 of investment prepayment related income, net of DAC and DSI amortization expenses. The increase in fixed account values also drove an offsetting $10.9 increase in DAC amortization.
Our Income Annuities segment’s profitability increased $1.9 on mortality gains and funding services activity that more than offset the impact of lower reserves and lower prepayment speed adjustment income on mortgage-backed securities (MBS).
Our Individual Life segment’s profitability decreased $7.9 primarily due to the favorable impact of a $7.4 reserve release in the first quarter of 2010 and a $3.6 increase in individual claims. These items were partially offset by increased income on higher BOLI account values and $5.0 of investment prepayment related income.
The results of operations and selected operating metrics for our five segments (Benefits, Deferred Annuities, Income Annuities, Individual Life and Other) for the years ended December 31, 2012, 2011 and 2010 are set forth in the following respective sections.
(1) Loss ratio represents policyholder benefits and claims incurred divided by premiums earned.
(3) Combined ratio is equal to the sum of the loss ratio and the expense ratio.
Premiums increased $67.7 driven by organic growth from strong 2012 sales, as well as the medical stop-loss block of business acquired in July 2011.
The $22.7 increase in other underwriting and operating expenses was driven by expenses related to the expansion of our group life and disability operations as part of our Grow & Diversify strategy, and higher commissions and incentive compensation due to growth in our business.
The increase in other underwriting and operating expenses of $27.0 was primarily related to the block of business acquired in July 2011. Also contributing to the increase were higher employee related costs, increased commissions and $3.0 of expenses related to the expansion of our group life and disability operations as part of the Grow & Diversify strategy.
(2) Base interest spread is the interest spread adjusted to exclude items that can vary significantly from period to period due to a number of factors and, therefore, may contribute to results that are not indicative of the underlying trends. This is primarily the impact of asset prepayments, such as bond make whole premiums net of related deferred sales inducement amortization, and the MBS prepayment speed adjustment.
Interest credited increased $8.2, primarily due to a $0.8 billion increase in average fixed annuities account values. Typically DAC amortization increases as account values increase; however, we experienced a $5.0 decrease in DAC amortization primarily as a result of lower lapses than assumed in our DAC models.
Segment pre-tax adjusted operating income increased $23.5 primarily driven by higher fixed annuities account values, which increased $1.4 billion to $10.6 billion. Also contributing to the increase in income was $9.2 of investment prepayment related income, net of related DAC and DSI amortization expense, the majority of which was received in the fourth quarter of 2011. As a result of the low interest rate environment, fixed maturity yields decreased; however, base interest spreads were slightly higher year-over-year, reflecting disciplined pricing on new business and management of renewal crediting rates on existing business.
Interest credited decreased $7.0 driven by favorable mortality experience and decreased crediting rates on slightly lower reserves, offset by decreased funding services activity due to a decline in case volume. Mortality experience is volatile and can fluctuate significantly from quarter to quarter.
(1) Individual claims represents incurred claims, net of reinsurance, on our term and universal life policies.
(3) UL interest spread excludes SPL and is the difference between the net investment yield and the credited rate to policyholders. The net investment yield is the approximate yield on invested assets in the general account attributed to UL policies. The credited rate is the approximate rate credited on UL policyholder fixed account values. Interest credited is subject to contractual terms, including minimum guarantees.
(6) BOLI ROA is a measure of the gross margin on our BOLI book of business. This metric is calculated as the difference between our BOLI revenue earnings rate and our BOLI policy benefits rate. The revenue earnings rate is calculated as revenues divided by average invested assets. The policy benefits rate is calculated as total policy benefits divided by average account value. The policy benefits used in this metric do not include expenses.
Net investment income decreased $4.1 due primarily to lower yields on asset purchases over the past twelve months. This was partially offset by an increase in average invested assets, primarily related to higher BOLI and UL account values.
Segment pre-tax adjusted operating income decreased $7.9 primarily due to a $7.4 reserve release in the first quarter of 2010 causing a reduction in benefits and expenses. In addition, year-over-year individual claims were higher and we recorded unfavorable reserve modifications in 2011. Also contributing to the decrease was an increase in other underwriting and operating expenses due primarily to expenses related to our Grow & Diversify initiative and employee-related expenses. These items were partially offset by increased income on higher BOLI account values and investment prepayment related income.
Amortization of tax credit investments, which is recorded as a reduction to net investment income, increased $7.4 over 2011 due to higher levels of investments in these assets. Tax credit investments reduce investment income, but provide tax benefits that help decrease our effective tax rate. See “Investments - Investments in Limited Partnerships - Tax Credit Investments” for further information.
Our investment portfolio is structured with the objective of supporting the expected cash flows of our liabilities and producing stable returns over the long term. The composition of our portfolio reflects our asset management philosophy of protecting principal and receiving appropriate reward for risk. Our investment portfolio mix as of December 31, 2012 consisted in large part of high quality fixed maturities and commercial mortgage loans we originated, as well as a smaller allocation of high yield fixed maturities, marketable equity securities, investments in limited partnerships (primarily tax credit investments and private equity funds) and other investments. Our portfolio of our equity and equity-like investments, is marked-to-market and mainly supports investment strategies including asset and liability matching strategies for certain long-duration insurance products. These equity and equity-like investments include common stock, REITs, and convertible bonds. We believe that prudent levels of equity and equity-like investments offer enhanced long term, after-tax total returns.
(1) Yields are determined based on monthly averages calculated using beginning and end-of-period balances. Yields for fixed maturities are based on amortized cost. Yields for equity securities, including investments in limited partnerships, are based on cost. Yields for all other asset types are based on carrying values.
In June 2012, U.S. banking regulators announced that, beginning in 2013, trust preferred securities (TruPS) issued by banks would be phased out as allowable Tier 1 Capital. Many TruPS have features that allow the issuer to call the security at par upon a regulatory event such as this. For the year ended December 31, 2012, $92.7 of these callable securities, on an amortized cost basis, have been redeemed. We have remaining holdings of $151.8, and we may experience additional calls of these securities as the new rules take effect. Generally, we do not expect to receive prepayment related income on these redemptions.
For the year ended December 31, 2011 net investment income increased 6.0% compared to 2010, driven by higher invested assets on strong sales of our fixed annuities in 2010 and 2011. The income increase driven by growth in invested assets was partially offset by a decrease in the total net investment yields, which decreased to 5.30% in 2011 from 5.49% in 2010 due to the prolonged low interest rate environment. Our yields would have been lower without the impact of prepayment-related income, which generated 10bps of yield in 2011 compared to 6bps in 2010.
(1) Public fixed maturities include publicly traded securities and highly marketable private placements for which there is an actively traded market.
Impairments for the years ended December 31, 2012 and 2011 were $29.0 and $14.1, respectively. The increase in impairments was driven by $12.4 in write-downs of two underwater securities in 2012 that we intend to sell. Credit-related impairments also increased over 2011, driven by a $6.9 impairment of one holding in the utilities sector in 2012. For those issuers for which we recorded a credit-related impairment during 2012, we had remaining holdings with an amortized cost of $86.9 and a fair value of $85.7 as of December 31, 2012. We believe the amortized cost of these securities is recoverable, based on our estimated recovery values.
Additionally, gross gains on sales increased $15.4, due to more favorable market conditions for sales, offset by an $18.9 increase in gross losses on sales due to sales of selected securities when credit concerns developed.
For the year ended December 31, 2011, our portfolio produced net realized gains of $7.2, compared to gains of $40.1 for the same period in 2010. We experienced a $41.7 mark-to-market decline in the performance of our equity investments, which generated losses of $9.1 in 2011 compared to gains of $32.6 in 2010, which was
Below investment grade securities comprised 5.4% and 6.6% of our fixed maturities portfolio as of December 31, 2012 and 2011, respectively. The decline in the relative amount of below investment grade fixed maturities is primarily due to securities that were upgraded to investment grade, or sold or otherwise redeemed during 2012. We held NAIC 5 and 6 designated securities with gross unrealized losses of $17.1 as of December 31, 2012, of which $12.8, or 74.9%, related to five issuers. Our analysis of these issuers, including management’s best estimates of future cash flows where appropriate, supports the recoverability of amortized cost.
Certain of our fixed maturities are supported by guarantees from monoline bond insurers, the majority of which are municipal bonds. As of December 31, 2012, fixed maturities with monoline guarantees had an amortized cost of $494.7 and a fair value of $531.0, with gross unrealized losses of $1.9, compared to an
During the year ended December 31, 2012, our investments in corporate securities increased relative to other fixed maturities due to attractive risk and reward characteristics and the availability of suitable securities. We have mainly purchased investment grade corporate securities, with a focus on obtaining appropriate yields and duration to match our policyholder liabilities while retaining quality.
As of December 31, 2012, approximately 20% of the fair value of our fixed maturity portfolio was held in mortgage-backed securities, and approximately 21% was held in securities due after ten years, which we consider to be longer duration assets. As of December 31, 2011, approximately 24% of the fair value of our fixed maturity portfolio was held in mortgage-backed securities, and approximately 23% was held in securities that are due after ten years.
As of December 31, 2012, our fixed maturity securities portfolio included $4.7 billion of residential and commercial mortgage-backed securities at fair value. The residential and commercial real estate markets were significantly impacted by the financial crisis and recession, but have since stabilized. Non-agency
mortgage-backed securities issued in the 2006 through 2008 vintage years were generally the most affected by the financial crisis, due to weaker underwriting standards and an issuance date closest to the market peak.
As of December 31, 2012, our Alt-A, prime and total non-agency RMBS had an estimated weighted-average credit enhancement of 13.2%, 6.8% and 8.5%, respectively. Credit enhancement refers to the weighted-average percentage of the outstanding capital structure that is subordinate in the priority of cash flows and absorbs losses first. We believe that our credit enhancement will help mitigate losses on these securities.
As of December 31, 2012 and 2011, 63.4% and 59.9%, respectively, of the fair value of our non-agency RMBS had super senior subordination. The super senior class has priority over all principal and interest cash flows and will not experience any loss of principal until lower levels are written down to zero. Therefore, the majority of our RMBS investments have less exposure to defaults and delinquencies in the underlying collateral than if we held the more subordinated classes.
The following tables set forth the amortized cost of our AAA non-agency CMBS by type and vintage:
The weighted-average credit enhancement of our CMBS, adjusted to remove defeased loans, as of December 31, 2012 was 30.6%. We believe this additional credit enhancement is significant, especially in the event of a deep real estate downturn during which losses would be expected to increase substantially.
The following table provides additional information on our CMBS prepayment exposure by type and vintage:
Prospector Partners, LLC, or Prospector, manages a portfolio of equity and equity-like investments, the majority of which are publicly traded common stock and convertible securities. We believe that these investments are suitable for funding certain long duration liabilities in our Income Annuities segment and, on a limited basis, in our surplus portfolio. These securities are recorded at fair value, with changes in fair value recorded in net realized investment gains (losses). The common stock securities are included in trading marketable equity securities and the convertible securities are included in fixed maturities on our consolidated balance sheets.
The following table compares our total gross return on common stock and convertible securities in the Prospector portfolio to the benchmark S&P 500 Total Return Index for the years ended December 31, 2012, 2011 and 2010.
Beginning in the second quarter of 2011, we implemented an investment strategy focusing on real estate-related investments to enhance funding of the long duration liabilities in our Income Annuities segment. The investments for this strategy primarily consist of investments in REITs, which are included in trading marketable equity securities on our consolidated balance sheets. As of December 31, 2012, the real estate-related investments had a fair value of $168.4. For the year ended December 31, 2012, the real estate-related investments had a total gross return of 13.6%, compared with the REIT Index (FTSE NAREIT All Equity REITS Index) result of 13.3%. For the year ended December 31, 2011, our real-estate related investments had a total gross return of 2.7% since inception in April, compared with the REIT Index result of 4.2% over the same period.
Our mortgage loan department originates commercial mortgages and manages our existing commercial mortgage loan portfolio. We focus on originating loans of $1.0 to $5.0, which are secured by first-mortgage liens on income-producing commercial real estate. All loans are underwritten consistently to our standards based on loan-to-value (LTV) ratios and debt service coverage ratios (DSCR) based on income and detailed market, property and borrower analysis using our long-term experience in commercial mortgage lending. A large majority of our loans have personal guarantees and all loans are inspected and evaluated annually. We diversify our mortgage loans by geographic region, loan size and scheduled maturities.
The following table presents selected information about the composition of our mortgage loan portfolio:
We continue to increase our investments in mortgage loans, as this strategy has resulted in increased net investment yields when compared to fixed maturity investments. We believe a disciplined increase in our mortgage loan portfolio will help maintain the overall quality of our investment portfolio and obtain appropriate yields to match our policyholder liabilities. We originated $825.7 of mortgage loans during the year ended December 31, 2012 and expect to continue this pace of originations during 2013.
The following table presents selected information about our mortgage loan originations:
We use the LTV and DSCR ratios as our primary metrics to assess mortgage loan quality. These factors are also considered in our evaluation of our allowance for mortgage loan losses. For more information and further discussion of our allowance for mortgage loan losses, see Note 5 to our consolidated financial statements. The following table sets forth the LTV ratios for our gross mortgage loan portfolio:
As we increase the volume of originations, we focus on maintaining our disciplined underwriting approach. The following table sets forth the carrying value and weighted-average LTV ratios for our mortgage loan portfolio by year of origination, as of December 31, 2012:
Prior to the maturity dates shown above, the majority of our mortgage loans have one or more specified rate resetting windows during which the loan typically can be prepaid without penalty. During these windows, we expect that a substantial portion of these loans will either be reset or refinanced at market terms given the current low interest rate environment. These loan features are considered in our asset-liability management and we align our expected mortgage loan cash flows and duration with the amount and timing of liability cash outflows. Additionally, our loan terms usually allow borrowers to prepay their mortgage loan prior to the stated maturity or outside specified rate resetting windows, subject to yield maintenance provisions. Prepayments are driven by
Although these investments decrease our net investment income over time on a pre-tax basis, they provide us with significant tax benefits, which decrease our effective tax rate. The following table sets forth the impact the amortization of our investments and related tax credits had on net income:
The tax credits from our investments in limited partnerships occur in the first 10 years, with the largest portions provided in the middle years. A significant amount of our investments are entering these middle years and we expect the impact to net income to continue to grow next year.
We actively manage our liquidity in light of changing market, economic and business conditions and we believe that our liquidity levels are more than adequate to cover our exposures, as evidenced by the following:
As of December 31, 2012, we had $23.4 billion of liquid assets, which includes cash, cash equivalents, short-term investments, publicly traded fixed maturities and equity securities.
While certain policy lapses and surrenders occur in the normal course of business, the current low interest rate environment has resulted in lower than expected lapses of our fixed annuities, as policyholders have limited alternatives to seek higher returns on their funds.
We continued to generate strong cash flows from operations, which were $1,011.2 for 2012, $987.5 for 2011 and $925.7 for 2010.
Although surrenders and withdrawals exceeded deposits in our Deferred Annuities segment during the second half of 2012, we were able to fund these withdrawals through readily available liquid assets.
(1) These contracts cannot be surrendered. The benefits are specified in the contracts as fixed amounts, primarily to be paid over the next several decades.
We define liquid assets to include cash, cash equivalents, short-term investments, publicly traded fixed maturities and public equity securities. As of December 31, 2012 and 2011, our insurance subsidiaries had liquid assets of $23.3 billion and $22.5 billion, respectively, and Symetra had liquid assets of $77.6 and $114.6, respectively. The portion of total company liquid assets comprised of cash and cash equivalents and short-term investments was $136.7 and $245.1 as of December 31, 2012 and 2011, respectively. The increase in our insurance subsidiaries’ liquid assets was primarily the result of sales of deferred annuities during 2012.
Our capitalization increased $515.4 as of December 31, 2012, as compared to December 31, 2011 due to an increase in stockholders’ equity from our net income of $205.4 and a $343.9 increase in AOCI, primarily driven by an increase in the fair value of our available-for-sale securities due mainly to declines in interest rates. We believe our capital level provides us flexibility to execute our capital management strategies. These include supporting our stock repurchase program and continuing to capitalize on organic growth, as well as pursuing acquisition opportunities.
On March 30, 2006, we issued $300.0 of 6.125% senior notes due April 1, 2016, which were issued at a discount yielding $298.7. Interest on the senior notes is payable semiannually in arrears, beginning on October 2, 2006. The senior notes do not contain any financial covenants or any provisions restricting us from purchasing or redeeming capital stock, paying dividends or entering into a highly leveraged transaction, reorganization, restructuring, merger or similar transaction. In addition, we are not required to repurchase, redeem or modify the terms of any of the senior notes upon a change of control or other event involving Symetra.
For a description of additional terms of our debt facilities, see Note 12 to the consolidated financial statements.
December 31, 2012, Symetra’s insurance subsidiaries may pay it dividends of up to $282.2 during 2013 without needing to obtain regulatory approval.
Years Ended December 31, 2012 and 2011. Net cash provided by operating activities for 2012 increased $23.7 over the same period in 2011. This was primarily the result of the increase in premiums from our growing book of medical stop-loss business outpacing the increase in medical stop-loss paid claims, an increase in net investment income driven by higher average assets and a lower commission expense due to lower sales of fixed annuities. The increase was partially offset by higher operating expenses related to our Grow & Diversify strategies.
Years Ended December 31, 2011 and 2010. Net cash provided by operating activities for 2011 increased $61.8 over 2010. This was primarily the result of increased net investment income driven by an increase in average assets. In addition, the increase in premiums from our medical stop-loss and limited benefits medical products outpaced the increase in paid claims.
Years Ended December 31, 2011 and 2010. Net cash used in investing activities for 2011 decreased $808.9 over 2010. This decrease was primarily the result of decreased purchases of fixed maturities, partially offset by increased mortgage loan originations. In addition, we strategically sold certain CMO securities during 2011 due to prepayment volatility and lower yielding fixed maturities, and increased our investments in mortgage loans to improve overall yields.
We enter into obligations with third parties in the ordinary course of our operations. The estimated cash payments related to these obligations as of December 31, 2012 are set forth in the table below. The estimated payments reflected in this table are based on management’s estimates and assumptions, which are necessarily subjective. Actual cash out flows in future periods will vary, possibly materially. Further, we do not believe that our cash flow requirements can be assessed based upon an analysis of these obligations as the funding of these future cash obligations will be from future cash flows from maturities of invested assets, premiums, deposits, fees and investment income that are not reflected in the table below. In addition, our operations involve significant expenditures that are not based upon commitments, including expenditures for payroll and income taxes.
(1) Includes estimated claim and benefit, policy surrender, reinsurance premiums and commission obligations on in force insurance policies and deposit contracts. Estimated claim and benefit obligations are based on mortality, morbidity and lapse assumptions comparable with our historical experience. In contrast to this table, our obligations recorded in our consolidated balance sheets generally represent the present value of these cash flows and do not incorporate future credited interest for annuity and BOLI contracts. Therefore, the estimated obligations for insurance liabilities presented in this table significantly exceed the liabilities recorded in reserves for future annuity and contract benefits and the liability for policy and contract claims. Due to the significance of the assumptions used, the amounts presented could materially differ from actual results. We
(2) Includes capital efficient notes (CENts), which are redeemable at the Company’s option beginning October 15, 2017, with a final maturity date of October 15, 2067. Since the timing of repayment is at the Company’s option after October 15, 2017, subject to the terms of the replacement capital covenant, the outstanding principal balance of the CENts has been included in payments due 2016-2017. For more information, see Note 12 to the consolidated financial statements.
(6) Includes minimum rental commitments on leases for office space and certain equipment. For more information, see Note 14 to the consolidated financial statements.
As discussed in Note 2 to the consolidated financial statements, the Company changed its method for accounting for deferred acquisition costs in 2012.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Symetra Financial Corporation’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 and our report dated February 26, 2013 expressed an unqualified opinion thereon.
Symetra Financial Corporation is a Delaware corporation that, through its subsidiaries, offers products and services that include retirement, group insurance products and life insurance products, marketed through benefits consultants, financial institutions and independent agents and advisors in all states and the District of Columbia. The Company’s principal products include medical stop-loss insurance, fixed and variable deferred annuities, single premium immediate annuities, structured settlement annuities, individual life insurance and bank-owned life insurance (BOLI). The accompanying financial statements include, on a consolidated basis, the accounts of Symetra Financial Corporation and its subsidiaries, which are wholly-owned and are collectively referred to as “Symetra” or “the Company.”
The Company has 750.000 authorized shares of common stock, $0.01 par value per share, and 10.000 authorized shares of preferred stock, $0.01 par value per share. The Company’s board of directors has the authority to designate the preferred stock into series and to designate the voting powers, preferences and other rights of the shares of each series without further stockholder approval, as limited by New York Stock Exchange and other regulatory rules. The Company also has warrants outstanding as of December 31, 2012, which are recorded in stockholders’ equity. The warrants are exercisable at any time until August 2, 2014, to acquire 18.976 shares of common stock at an exercise price of $11.49 per share and can be net-share settled at the option of the warrant holder.
Certain reclassifications have been made to prior year financial information for it to conform to the current period presentation. In addition, prior period financial information, including information for the years ended December 31, 2011 and 2010 and as of December 31, 2011 has been restated to reflect the retrospective adoption of the new accounting standard for DAC. More information on the restatement can be found in the “Adoption of New Accounting Pronouncements” section below and in Note 20. Restated information has been labeled “as adjusted” where applicable.
The Company’s group insurance policies, which include medical stop-loss, limited benefit medical, group life and short-term disability, are short duration contracts. Premiums from these products are recognized as revenue when earned over the life of the policy and a liability for the portion of premiums unearned is reported on the consolidated balance sheets. Benefit claims are charged to operations as incurred.
Deposits related to universal life (UL) insurance, including BOLI and single-premium life (SPL) insurance, and investment-type products, including fixed annuities, are credited to policyholder account balances and reflected as liabilities, rather than as premium income, when received. Revenues from these contracts consist of net investment income on the policyholders’ fund balances, and amounts assessed during the period for cost of insurance, policy administration, and surrender charges. The Company includes such amounts in policy fees, contract charges, and other in the consolidated statements of income. Expenses that are charged to operations for these products include interest credited and benefit claims incurred in excess of related policyholder account balances.
The Company classifies its investments in fixed maturities and certain marketable equity securities as available-for-sale and carries them at fair value. Fixed maturities primarily include bonds, mortgage-backed securities and redeemable preferred stock. Marketable equity securities classified as available-for-sale primarily include nonredeemable preferred stock. See Note 6 for information on the valuation of securities and additional disclosures regarding fair value measurements.
In the normal course of business the Company makes passive investments in structured securities issued by VIEs. These structured securities primarily include residential and commercial mortgage-backed securities. Because the Company lacks the ability to direct the activities that most significantly impact the economic performance of the VIEs, it is not considered the primary beneficiary and therefore does not consolidate them. The Company’s maximum exposure to loss with respect to these investments is limited to the amortized cost of the Company’s investment, which is $4,708.1 and $5,534.2 as of December 31, 2012 and 2011, respectively.
The Company is invested in common stock, including real estate investment trusts (REITs), and mutual funds that are classified as trading. The Company also has a portfolio of common stock for which it has elected fair value accounting. Changes in the fair value of the Company’s trading portfolio are recorded in net realized investment gains (losses) in the consolidated statements of income. The Company believes this presents its investment results for these securities on a basis that is consistent with management’s operating principles. Dividends earned on trading securities are reported in net investment income.
The Company invests in limited partnerships that operate affordable housing projects, state tax credit funds and other types of assets that provide tax benefits (collectively, “tax credit investments”). These investments are accounted for under the equity method and recorded at amortized cost, with amortization recorded as a reduction to net investment income. When the carrying value of an investment exceeds the amount of remaining tax benefits, the Company records an impairment loss, which is included in other net realized investment gains (losses) on the consolidated statements of income. The present value of any unfunded commitments related to these investments is recorded in other liabilities.
The limited partnerships that the Company invests in meet the definition of a VIE. Because the Company, as a limited partner, lacks the ability to direct the activities of any of these partnerships, it is not considered the primary beneficiary and therefore has not consolidated them. The maximum exposure to loss in these VIEs was $261.8 and $250.1 as of December 31, 2012 and 2011, respectively. The maximum exposure to loss includes commitments to provide future capital contributions as described in Note 14.
To qualify for hedge accounting treatment, a derivative must be highly effective in mitigating the designated risk of the hedged item. Effectiveness of the hedge is formally assessed at inception and throughout the life of the hedging relationship. When a derivative is designed as a cash flow hedge and is determined to be highly effective, changes in its fair value are recorded as a component of OCI. Even if a derivative qualifies for hedge accounting treatment, there may be an element of ineffectiveness in the hedge. Any hedge ineffectiveness is recorded in the consolidated statements of income within net realized investment gains (losses).
The Company prospectively discontinues hedge accounting when: (1) the criteria to qualify for hedge accounting is no longer met (e.g., the derivative is no longer highly effective in offsetting the change in cash flows of a hedged item); (2) the derivative expires, is sold, terminated or exercised; or (3) the derivative is de-designated as a hedging instrument.
On January 1, 2012, the Company retrospectively adopted a new accounting standard related to the deferral of policy acquisition costs. While DAC amortization has been restated to reflect the retrospective reduction in costs deferred, the Company’s policies and methodology for amortization have not changed.
The Company defers costs that are directly related to the successful acquisition of new or the renewal of insurance contracts. These primarily include commissions, distribution costs directly related to production, third-party underwriting costs and the portion of salaries and benefits related to employee time spent on processing successful new and renewal contracts. All other acquisition-related costs, including costs incurred for soliciting potential customers, managing distribution and underwriting functions, training, administration, unsuccessful acquisition or renewal efforts, market research and product development are not deferrable and are expensed in the period incurred.
The Company amortizes acquisition costs for traditional individual life insurance policies over the premium paying period of the related policies, using assumptions consistent with those used in computing policy benefit liabilities. The Company amortizes acquisition costs for immediate annuities using a constant yield approach.
The Company conducts regular recoverability analyses for DAC asset balances associated with deferred and immediate annuity contracts, universal life contracts, and traditional life contracts. The Company compares the current DAC asset balances with the estimated present value of future profitability of the underlying business. The DAC asset balances are considered recoverable if the present value of future profits is greater than the current DAC asset balance. As of December 31, 2012 and 2011, all of the DAC asset balances were considered recoverable.
For some products, policyholders can elect to modify product benefits, features, rights or coverage by exchanging a contract for a new contract; by amendment, endorsement or rider to a contract; or by election of a feature or coverage within a contract. These transactions are known as internal replacements. If the modification substantially changes the original contract, the DAC is immediately written off through earnings and any eligible costs associated with the replacement contract are deferred. If the modification does not substantially change the contract, the DAC is retained and amortized over the life of the modified contract and any acquisition costs associated with the related modification are expensed.
The Company offers sales inducements on certain deferred annuity contracts and universal life policies. For certain deferred annuity contracts, the inducement interest entitles the contract holder to an incremental amount of interest to be credited to the account value over a 12- to 60-month period following the initial deposit, depending on the product. The incremental interest causes the initial credited rate to be higher than the contract’s expected ongoing crediting rates for periods after the inducement. For certain universal life policies, the inducement provides an immediate increment to the policyholder’s account value at the issue date or time of deposit. Deferred sales inducements are reported as other assets and amortized into interest credited using the same methodology and assumptions used to amortize DAC. Deferred sales inducement balances are subject to regular recoverability testing to ensure that capitalized amounts do not exceed the present value of estimated gross profits. As of December 31, 2012 and 2011, all of the deferred sales inducement balances were considered recoverable.
segregated and are not subject to claims that arise out of the Company’s other business activities. Investment risks associated with market value changes are borne by the policyholder, except to the extent of guaranteed minimum death benefits (GMDB) made by the Company with respect to certain accounts. Net investment income and realized investment gains and losses accrue directly to the policyholders and are not included in the Company’s revenues. Separate account liabilities primarily represent the policyholder’s account balance in the separate account. Fees charged to policyholders include mortality, policy administration, and surrender charges and are included in policy fees, contract charges, and other on the consolidated statements of income.
For variable annuity contracts with GMDB, the Company contractually guarantees total deposits, less any partial withdrawals, in the event of death. The Company reinsures nearly all of the GMDB risk on its variable annuity contracts.
The Company estimates liabilities for future policy benefits under traditional individual life and group life and long-term disability insurance policies using the level premium method, which includes a level premium assumption to fund reserves. The Company selects the level premiums so that the actuarial present value of future benefits equals the actuarial present value of future premiums. The Company sets the interest, mortality, and persistency assumptions in the year of issue and includes a provision for adverse deviation. The provision for adverse deviation is intended to provide coverage for the risk that actual experience may be worse than locked-in best-estimate assumptions. These liabilities are contingent upon the death of the insured while the policy is in force. The Company derives mortality assumptions from both company-specific and industry statistics. The Company discounts future benefits at interest rates that vary by year of policy issue. These rates are initially set to be consistent with portfolio rates at the time of issue, and are graded to a lower rate, such as the statutory valuation interest rate, over time. Assumptions are set at the time each product is introduced and are not updated for actual experience unless the total product liability amount is determined to be inadequate to cover future policy benefits.
Income taxes have been determined using the liability method. The provision for income taxes has two components: amounts currently payable or receivable and deferred income taxes. The deferred income taxes are calculated as the difference between the book and tax bases of the appropriate assets and liabilities and are measured using enacted tax rates. Deferred tax assets are recognized only to the extent that it is more likely than not that future taxable profits will be available. A valuation allowance is established where deferred tax assets cannot be recognized. See Note 13 for further discussion.
In October 2010, the FASB issued Accounting Standards Update (ASU) 2010-26, Financial Services - Insurance (Topic 944) - Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts. This ASU limits the amount of deferrable acquisition costs to those directly related to the successful acquisition of an insurance contract and clarifies which costs are included in that definition. The Company’s adoption of this standard results in more distribution and new business processing and underwriting costs being expensed as incurred.
ASU 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure
ASU 2011-05, Presentation of Comprehensive Income and ASU 2011-12 Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05
In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220) - Presentation of Comprehensive Income. This ASU requires the components of net income and other comprehensive income (OCI) to be presented either in one continuous statement, referred to as the statement of comprehensive income, or in two separate but consecutive statements. While the new standard changes the presentation of comprehensive income, there are no changes to the components that are recognized in net income or OCI under current accounting standards.
ASU 2011-5 include certain requirements related to presentation of reclassifications, which were subsequently deferred indefinitely in December 2011, in ASU 2011-12, Comprehensive Income (Topic 220) - Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. The Company adopted both standards on January 1, 2012 and included the statements of comprehensive income as separate statements in the consolidated financial statements.
Basic earnings per share represents the amount of earnings for the period available to each share of common stock outstanding during the reporting period. Diluted earnings per share represents the amount of earnings for the period available to each share of common stock outstanding during the reporting period, adjusted for the potential issuance of common stock if dilutive.
The Company’s outstanding warrants, exercisable for 18.976 common shares, are considered participating securities because the terms of the agreements entitle the holders to receive any dividends declared on the common stock concurrently with the holders of outstanding shares of common stock, on a one-to-one basis. As a result, the warrants are potential common stock securities that are included in weighted-average common shares outstanding for purposes of computing basic and diluted earnings per share using the two-class method.
Based on National Association of Insurance Commissioners (NAIC) ratings, as of December 31, 2012 and 2011, the Company held below-investment-grade fixed maturities with fair values of $1,279.2 and $1,508.1, respectively, and amortized costs of $1,241.3 and $1,583.7, respectively. These holdings amounted to 5.4% and 6.6% of the Company’s investments in fixed maturities at fair value as of December 31, 2012 and 2011, respectively.
The following table summarizes the amortized cost and fair value of fixed maturities as of December 31, 2012, by contractual years to maturity. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties.
The Company records OTTI charges in earnings on fixed maturities. The largest write-downs were from investments in the following sectors:
Any reduction or elimination of dividends or nonpayment of scheduled interest;
To determine the recovery value for a corporate security, the Company performs an analysis related to the underlying issuer including, but not limited to, the following:
To determine the recovery value for a structured security, including residential mortgage-, commercial mortgage- and other asset-backed securities, the Company performs an analysis related to the underlying issuer including, but not limited to, the following:
(1) Represents circumstances where the Company determined in the period that it intended to sell the security prior to recovery of its amortized cost.
The Company offers a fixed indexed annuity contract that permits the contract holder to elect an interest rate return or an equity market component, where interest credited to the contract is linked to the performance of the S&P 500 or a commodities-based index. Contract holders may elect to rebalance index options at renewal dates annually. As of each renewal date, the Company has the opportunity to re-price the indexed component by
The following table presents the components of gain (loss) recognized into OCI on derivatives that qualify as cash flow hedges:
The Company enters into various collateral arrangements in connection with its derivative instruments, which require both the pledging and accepting of collateral. Based on the net position at the end of each day, the Company determines collateral amounts required to be posted or received with the same counterparty under the same master netting agreement.
As of December 31, 2012 and 2011, the Company had no pledged collateral. As of December 31, 2012 and 2011, the Company received collateral of $14.0 and $10.2, respectively, which was included in cash and cash equivalents in the consolidated balance sheets.
The Company originates and manages a portfolio of mortgage loans which are secured by first-mortgage liens on income-producing commercial real estate, primarily in the retail, industrial and office building sectors. All loans are underwritten consistently using standards based on loan-to-value (LTV) ratios and debt-service coverage ratios (DSCR) as well as detailed market, property and borrower analyses. The Company’s mortgage loan portfolio is considered a single portfolio segment and class of financing receivables, which is consistent with how the Company assesses and monitors the risk and performance of the portfolio. A large majority of these loans have personal guarantees, and all loans are inspected and evaluated annually. The Company’s mortgage loan portfolio is diversified by geographic region, loan size and scheduled maturities. As of December 31, 2012, 28.4% of our commercial mortgage loans were located in California, primarily in the Los Angeles area, 11.3% were located in Texas and 10.0% were located in Washington.
The allowance for losses on mortgage loans provides for the risk of credit loss inherent in the lending process. The allowance includes a portfolio reserve for probable incurred but not specifically identified losses and, as needed, specific reserves for impaired loans. The allowance for losses on mortgage loans is evaluated as of each reporting period and adjustments are recorded when appropriate. To assist in its evaluation of the allowance for loan losses, the Company utilizes the following credit quality indicators to categorize its loans as lower, medium or higher risk:
Non-performing loans, defined generally as those in default, close to being in default or more than 90 days past due, are placed on non-accrual status. As of December 31, 2012, one loan with an outstanding principal balance of $3.7 was considered in default and assessed in our provision for specific loans; no other loans were considered non-performing at December 31, 2012. As of December 31, 2011 and 2010, no loans were considered non-performing.
gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The level within which a fair value measurement falls is determined based on the lowest-level input that is significant to the fair value measurement. The Company’s financial assets recorded at fair value on the consolidated balance sheets and financial instruments not carried at fair value, but disclosed at fair value are categorized as follows:
The following tables present the fair value of the Company’s financial instruments classified by the valuation hierarchy described above. The financial instruments are separated between those accounted for at fair value on a recurring basis and those not carried at fair value but for which disclosure of fair value is required.
(1) The carrying value of this balance excludes $5,885.9 of liabilities related to insurance contracts as of December 31, 2012.
(1) These amounts include certain privately placed fixed maturities that are valued primarily using observable inputs. These securities, totaling $733.8, were included in Level 3 in the prior year financial statements. During the first quarter 2012, upon further evaluation and review of the valuation methodology, the Company determined that they are more appropriately reflected as Level 2 measurements as the unobservable inputs were not significant to the overall valuation. This evaluation did not result in a change to the fair value amounts reported.
The vast majority of the Company’s fixed maturities have been classified as Level 2 measurements. To make this assessment, the Company determines whether the market for a security is active and if significant pricing inputs are observable. The Company predominantly utilizes third party independent pricing services to assist management in determining the fair value of its fixed maturity securities. As of December 31, 2012 and 2011, respectively, pricing services provided prices for 96.2% and 95.9% of the Company’s fixed maturities.
investments in private placement securities resulted in the classification of $787.3, or 96.1%, as Level 2 measurements as of December 31, 2012. As of December 31, 2011, the Company had $936.4, or 4.1%, of its fixed maturities invested in private placement securities, of which $816.9, or 87.2%, were classified as Level 2 measurements.
The majority of corporate securities classified as Level 2 measurements are priced by independent pricing services utilizing evaluated pricing models. The significant inputs for security evaluations include benchmark yields, reported trades, broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and other reference data, including market research publications. Because many corporate securities do not trade on a daily basis, evaluated pricing applications apply available information through processes such as benchmark curves, benchmarking of like securities, sector groupings and matrix pricing to prepare valuations.
As of December 31, 2012, $675.1, or 3.9%, of Level 2 corporate securities were privately placed. These securities were valued using a matrix pricing approach. The significant inputs to the measurement are the base credit spread, treasury yield and expected future cash flows of the security, which are all observable inputs. The base spread is determined based on trades of similar publicly-traded securities, and the expected future cash flows are based on the contractual terms of the security. The valuation approach also incorporates an illiquidity spread, determined based on premiums demanded by investors for privately placed securities. The illiquidity spread is an unobservable input, which ranges from 0 to 25 basis points and is based on the credit quality of the security. The illiquidity spread does not significantly impact the resulting valuation.
As of December 31, 2012 and 2011, the fair value of the Company’s residential mortgage-backed securities (RMBS) classified as Level 2 measurements was $3,007.8 and $3,625.0, respectively. These securities were primarily fixed-rate, with a weighted-average coupon rate of 4.67% and 4.87% as of December 31, 2012 and 2011, respectively. Agency securities comprised 89.4% and 90.0% of the Company’s Level 2 RMBS as of December 31, 2012 and 2011, respectively.
The following table presents additional information about the composition of the Level 2 non-agency RMBS securities:
The Company’s Level 2 CMBS securities were primarily non-agency securities, which comprised 78.4% and 72.1% of Level 2 CMBS as of December 31, 2012 and 2011, respectively. The non-agency Level 2 CMBS
had an estimated weighted-average credit enhancement of 29.9% and 29.2% as of December 31, 2012 and 2011, respectively, and 96.6% and 94.9% were in the most senior tranche as of December 31, 2012 and 2011, respectively.
Marketable equity securities are investments in common stock, including real estate investment trusts (REITs), certain nonredeemable preferred stocks, and investments in mutual funds. The securities primarily consist of investments in publicly traded companies, and Symetra mutual funds with published net asset values (NAVs). When the fair values of the Company’s marketable equity securities are based on quoted market prices in active markets for identical assets, they are classified as Level 1 measurements. The fair values of nonredeemable preferred stocks are valued by our independent pricing services utilizing evaluated pricing models and are classified as Level 2 measurements. These valuations are created based on benchmark curves using industry standard inputs and exchange prices of underlying securities and common stock of the same issuer.
Investments in limited partnerships recorded at fair value are investments in private equity funds. The Company utilizes the fair value option for these investments, regardless of ownership percentage, to standardize the related accounting and reporting. The fair value is approximated based upon the Company’s proportionate interest in the underlying partnership or fund’s NAV. The Company is generally unable to liquidate these investments during the term of the partnership or fund, which range from five to twelve years. As such, the Company classifies these securities as Level 3 measurements.
The following table presents additional information about assets measured at fair value on a recurring basis and for which significant unobservable inputs (Level 3) were utilized to determine fair value for the year ended December 31, 2012:
The following table presents additional information about assets measured at fair value on a recurring basis and for which the Company has utilized significant unobservable inputs (Level 3) to determine fair value for the year ended December 31, 2011:
(1) Transfers into and/or out of Level 3 are reported at the value as of the beginning of the period in which the transfer occurs. Gross transfers into Level 3 were $1.6 for the year ended December 31, 2011. Gross transfers out of Level 3 were $14.8 for the year ended December 31, 2011.
The following table provides a reconciliation of the beginning and ending balance for DAC:
The following table provides a reconciliation of the beginning and ending balance for DSI, which are included in other assets on the consolidated balance sheets:
The consolidated statements of comprehensive income presents the changes in unrealized gains and losses on available-for-sale securities, net of reclassification adjustments. The following table summarizes the adjustments to OCI for amounts reclassified from AOCI to net income during the period.
As of December 31, 2012, unrecognized compensation cost for restricted stock was $3.9 and is expected to be recognized over the weighted average of 1.6 years.
The Company issued 2.950 options for the year ended December 31, 2010, with an exercise price of $28.00. These options vest on June 30, 2017 and expire one year thereafter. The weighted average fair value of awards granted during the year ended December 31, 2010 was $2.73 per share. No options were granted in 2012 or 2011. For the year ended December 31, 2012, 0.300 options were forfeited.
As of December 31, 2012 and 2011, 2.650 and 2.950 options were outstanding, none of which were exercisable. Stock-based compensation expense for stock options was $0.5 and $1.0 for the years ended December 31, 2012 and 2011, respectively, and the related tax benefit was $0.2 and $0.4.
Outstanding options have a remaining contractual term of 5.5 years and no intrinsic value as of December 31, 2012. As of December 31, 2012, unrecognized compensation cost for stock options was $3.7 and is expected to be recognized over the next 4.5 years.
(2) Total policy fees and contract charges represents amounts charged to policyholders other than premiums and recorded in policy fees, contract charges and other on the consolidated statements of income. This primarily consists of costs of insurance charges. Ceded reinsurance reduced policyholder benefits and claims by $63.9, $55.6 and $51.0 for the years ended December 31, 2012, 2011 and 2010, respectively.
(1) In 2012, the Company refined its methodology for identifying the incurred date of medical stop-loss claims. The information for 2011 and 2010 has been updated to reflect this refined methodology, and there was no impact to the total claims incurred or paid in either year.
The Company is required to use commercially reasonable efforts to sell enough qualifying capital securities to permit repayment of the CENts at the scheduled maturity date or on each interest payment date thereafter. Any remaining outstanding principal amount will be due on October 15, 2067.
In connection with the offering of the CENts, the Company entered into a “replacement capital covenant” for the benefit of the holders of the senior notes (see below). Under the terms of the replacement capital covenant, the Company may not redeem or repay the CENts prior to October 15, 2047 unless the redemption or repayment is financed from the offering of replacement capital securities, as specified in the covenant.
Effective December 14, 2011, concurrently with entry into the unsecured revolving line of credit agreement referenced above, the Company terminated its prior $200.0 credit agreement, dated August 16, 2007, which was set to mature on August 16, 2012. At termination, the Company had no borrowings outstanding under the credit agreement and was in compliance with all covenants.
The Company files income tax returns in the U.S. federal and various state jurisdictions. The Company’s federal income tax returns have been examined and closing agreements have been executed with the Internal Revenue Service, or the statute of limitations has expired for all tax periods through December 31, 2008. The Company is not currently subject to any state income tax exams.
Included in the 2012 deferred tax assets were gross federal net operating loss carry-forwards attributable to the non-life companies in the amount of $59.2, due to expire under current law during 2027 through 2032. The Company is required to establish a valuation allowance for any portion of the deferred tax assets that management believes will not be realized. Based on an analysis of the Company’s tax position, management believes that it is more likely than not that the results of future operations will generate sufficient taxable income to enable the Company to utilize all of its deferred tax assets. Accordingly, no valuation allowance for deferred tax assets has been established as of December 31, 2012 and 2011.
The Company includes penalties and interest accrued related to unrecognized tax benefits in the calculation of income tax expense. As of December 31, 2012, the Company has no unrecognized tax benefits and does not expect significant changes within the next year.
Rent expense was $8.4, $7.7, and $7.1 for the years ended December 31, 2012, 2011 and 2010, respectively.
During late 2012, the Company’s life insurance subsidiaries received notice of an audit on behalf of multiple states’ treasury and controllers’ offices for compliance with laws and regulations concerning the identification, reporting and escheatment of abandoned or unclaimed money or property. Also in late 2012, the Company received notice regarding a market conduct examination focused on its three insurance subsidiaries’ life insurance and annuity claims settlement practices, including practices related to handing of unclaimed property. The audit and examination have not yet started. The Company believes it is reasonably possible that the audit and examination activity could result in payments of interest, fines or penalties. The Company is not currently able to estimate the loss or range of loss of these matters.
Because of the nature of the business, the Company is subject to legal actions filed or threatened in the ordinary course of its business operations. The Company does not expect that any such litigation, pending or threatened, as of December 31, 2012, will have a material adverse effect on its consolidated financial condition, future operating results or liquidity.
The Company has a service agreement with a third party service provider to outsource the majority of its information technology infrastructure. The initial term of the service agreement expires in July 2014, subject to early termination in certain cases, with two one-year extensions at the Company’s election. Under the terms of the service agreement, the Company agreed to pay an annual fixed service fee ranging from $10.6 to $11.4 for five years. The Company incurred service fee expenses of $13.6, $12.3 and $12.0 for the years ended December 31, 2012, 2011 and 2010, respectively, which included the fixed fee as well as a variable fee based on usage.
As of December 31, 2012 and 2011, unfunded mortgage loan commitments were $64.4 and $105.1, respectively. The Company had no other material commitments or contingencies as of December 31, 2012 and 2011.
The Company’s insurance subsidiaries are restricted by state regulations as to the aggregate amount of dividends they may pay to their parent company in any consecutive 12-month period without regulatory approval. Accordingly, based on statutory limits as of December 31, 2011, the Company was eligible to receive dividends from its directly owned insurance subsidiary, Symetra Life Insurance Company, during 2012 without obtaining regulatory approval as long as the aggregate dividends paid over the twelve months preceding any dividend payment date in 2012 did not exceed $182.3. The total amount of dividends received by the Company from Symetra Life Insurance Company during 2012 was $80.0. Based on state regulations as of December 31, 2012, the Company is eligible to receive dividends from Symetra Life Insurance Company during 2013 without obtaining regulatory approval as long as the aggregate dividends paid over the 12 months preceding any dividend payment date in 2013 do not exceed $282.2. More information about the capital requirements of the Company’s insurance subsidiaries can be found in Note 17.
There are no regulatory restrictions on the ability of Symetra Financial Corporation to pay dividends. The declaration and payment of future dividends to common stock and warrant holders will be at the discretion of the Company’s board of directors and will be dependent on, and may be limited by many factors including the receipt of dividends from the Company’s insurance subsidiaries, the capital requirements of the Company’s insurance subsidiaries, the Company’s financial conditions and operating results, compliance with covenants of the Company’s revolving credit facility, the Company’s credit and financial strength ratings, and such other factors as the board of directors deems relevant. More information about the covenants of the Company’s revolving credit facility can be found in Note 12.
The Company’s insurance subsidiaries are required to prepare statutory financial statements in accordance with statutory accounting practices prescribed or permitted by the insurance department of the state of domicile. Statutory accounting practices primarily differ from GAAP by charging policy acquisition costs to expense as incurred and establishing future policy benefit liabilities using different actuarial assumptions, as well as accounting for investments, certain assets and deferred taxes on a different basis. Permitted statutory accounting practices encompass all accounting practices not so prescribed, which have been specifically allowed by state insurance authorities. The Company’s insurance subsidiaries have no material permitted accounting practices.
Each of the insurance subsidiaries’ state of domicile imposes minimum risk-based capital (RBC) requirements that were developed by the NAIC. The formulas for determining the amount of RBC specify various weighting factors that are applied to the financial balances or various levels of activity based on the perceived degree of risk. Regulatory compliance is determined by a ratio of total adjusted capital, as defined by the NAIC, to authorized control level RBC, as defined by the NAIC. Companies below specific trigger points or ratios are classified within certain levels, each of which requires specified correction action. As of December 31, 2012 and 2011 each of the Company’s insurance subsidiaries exceeded the minimum RBC requirements of 200%, and maintained risk-based capital ratios in excess of 485%. The Company’s insurance subsidiaries’ minimum statutory capital and surplus necessary to satisfy regulatory requirements in the aggregate was $461.3 at December 31, 2012, of which 97.0% was attributable to Symetra Life Insurance Company.
The Company’s insurance subsidiaries are subject to certain insurance department regulatory restrictions as to the payment of dividends to their parent company. More information on the restrictions on the payment of dividends can be found in Note 16.
The Company has an Investment Management Agreement, amended and restated on June 1, 2011, with White Mountains Advisors, LLC (WMA), a subsidiary of White Mountains Insurance Group, Ltd. White Mountains Insurance Group, Ltd. is a related party who beneficially owns 26.888 shares of the Company’s common stock, including warrants exercisable for 9.488 shares. This agreement, as amended, provides for investment advisory services related to the Company’s invested assets and portfolio management services. Expenses amounted to $16.0, $15.5, and $14.1 for the years ended December 31, 2012, 2011 and 2010, respectively. As of December 31, 2012 and 2011, amounts due to WMA were $3.9 and $4.0, respectively.
The Company offers a broad range of products and services that include retirement, group health and employee benefits products and life insurance. These operations are managed separately as three divisions, consisting of four business segments based on product groupings, and a fifth reportable segment consisting primarily of unallocated corporate items and surplus investment income. The five segments are: Benefits, Deferred Annuities, Income Annuities, Individual Life and Other.
Benefits. Benefits offers the following products and related services: medical stop-loss insurance, limited benefit medical insurance, group life insurance, accidental death and dismemberment insurance and disability income insurance mainly to employer groups.