The financial position of the issuer, including the current and future impact of any specific events;
The Company’s ability and intent to hold the security to maturity or until it recovers in value.
The risk that fraudulent information could be provided to the Company’s investment professionals who determine the fair value estimates;
Risk that fraudulent information could be provided to the Company’s credit, investment and accounting professionals who determine the fair value estimates and accounting treatment for securities;
The following table summarizes the fixed maturity securities with unrealized losses as of December 31, 2008 and December 31, 2007 by ratio of unrealized loss to amortized cost.
Following is a description of the securities that were written down during the second quarter of 2008: 1) Three of the securities were written down by a total of $3.0 million, primarily as a result of declines in price and rating agency downgrades on debt issues from issuers that have recently completed LBO transactions. These LBO transactions greatly increased the debt level of each issuer. One of these securities had been written down previously. 2) Two securities were collateralized debt obligations (CDOs) and were written down by $2.6 million, primarily due to price declines that had persisted for periods longer than the Company considered temporary. 3) One security was written down by $3.3 million due to combination of a decline in price that had persisted for a period longer than the Company considered temporary, rating agency downgrades and a debt restructuring during the quarter. 4) The final security was written down by $0.8 million due to a combination of a decline in price that had persisted for a period longer than the Company considered temporary and a further deterioration in fair value during the second quarter of 2008.
The Company had no securities that it identified as other-than-temporarily impaired during the first, second and third quarters of 2007 for this segment. The Company’s analysis of fixed maturity securities at year-end 2007 resulted in the determination that two securities had other-than-temporary declines which were written down by $3.5 million. One of the two securities was below cost by 20% or more for more than six consecutive months and was the subject of a recent leveraged buyout that was finalized during the fourth quarter of 2007, which greatly increased the debt level of the company. Accordingly, the Company wrote down this security $2.8 million at year-end 2007. The second security filed for Chapter 11 protection and indicated that it would not be able to fully meet all of the obligations of its borrowings. The Company recognized an other-than-temporary impairment on this security at year-end 2006 of $1.1 million. As a result of this new action, the Company recognized an additional $0.7 million impairment in 2007. At December 31, 2006, this security was below cost by 20% or more for more than twelve consecutive months. It was in a highly competitive and cyclical industry that was experiencing weakened demand and overcapacity. Capital expenditures for equipment upgrades were exceeding cash generation.
Interest is credited to policyholder account balances for universal life, fixed deferred annuities and other investment-type products. The amount of interest credited is a function of the crediting rate and account balances. Account balances are impacted by deposits, benefits, surrenders and contract charges. Interest credited to policyholder account balances decreased $4.3 million in 2008 and $3.4 million in 2007 compared with 2006. The declines in both years were primarily due to a combination of lower policyholder account balances and reduced crediting rates.
Policyholder benefits consist of death benefits (mortality), accident and health benefits and the associated increase or decrease in reserves for future policy benefits. Policyholder benefits increased $2.9 million or 10% in 2008, reflecting increased dental benefits. The increase in benefits in the dental product line reflects, in part, the increase in new dental business over the past year. It is typical for new dental business to report an increase in benefits in the first policy year. As the business ages, the benefit ratio falls more in line with renewal expectations. Management monitors this ratio on an ongoing basis and adjusts future renewal premiums, as necessary, in order to achieve profitability expectations on individual groups. Policyholder benefits increased $1.5 million or 5% in 2007, reflecting an increase in stop loss and dental benefits.
Net cash provided by investing activities was $48.9 million in 2008, $84.1 million in 2007 and $68.1 million in 2006. The Company’s new investments in fixed maturity and equity securities were $259.4 million in 2008, down from $328.3 million during 2007 and $285.4 million during 2006. New investments in mortgage loans were $49.3 million in 2008, $54.8 million in 2007, and $72.6 million in 2006. During 2008, the Company increased its purchases of real estate investments to $30.1 million, up from $4.5 million in 2007, but down from $45.0 million in 2006. Approximately 11% of the securities portfolio was sold, called or matured in 2008, compared with 13% in 2007 and 2006. The Company had $54.0 million in mortgage loan maturities and principal paydowns in 2008, compared with $58.4 million in 2007 and $59.1 million in 2006. During 2008, the Company had sales of real estate investments of $30.6 million, compared with $22.5 million in 2007 and $18.8 million in 2006. During these three years, the Company sold several real estate properties which resulted in realized gains.
At December 31, 2008, the Company had $258.6 million in separate account assets. This was a decrease of $161.8 million from $420.4 million at December 31, 2007. The significant decline in the market directly contributed to the decrease in these assets. This decline affected both the investment performance of existing contract holders but also contributed to a decline in new sales. Nearly 19% of the policyholder withdrawals were transferred to the general account, which credits interest on the balance invested. Negative investment performance decreased separate accounts by $135.3 million in 2008 versus an increase of $33.8 million in 2007. Deposits in separate accounts decreased in 2008 to $49.0 million versus $57.8 million in 2007. Policyholder withdrawals also contributed to the decline in assets, increasing to $61.3 million in 2008 from $57.1 million in 2007. In addition, contract charges were $14.2 million and $14.8 million in 2008 and 2007, respectively.
(1) Borrowings include short-term debt as described in the previous section - Debt and Short-Term Borrowing.
Mortgage loans are stated at cost, adjusted for amortization of premium and accrual of discount, less a valuation reserve for probable losses. A loan is considered impaired if it is probable that contractual amounts due will not be collected. The valuation reserve is determined based upon historical impairment experience and insurance industry studies. Such estimates are based upon the value of the expected cash flows and the underlying collateral on a net realizable basis. Loans in foreclosure and loans considered to be impaired are placed on a non-accrual status.
Any of these situations could result in a charge to income in a future period.
In accordance with SFAS 157, the Company groups its financial assets and liabilities measured at fair value in three levels, based on the inputs and assumptions used to determine the fair value. These levels are as follows:
The table below summarizes the fixed maturity securities with unrealized losses as of December 31, 2008 by ratio of unrealized loss to amortized cost.
The following table provides information for notes payable as of December 31.
The Company adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes”, on January 1, 2007. The Company did not change the liability for unrecognized tax benefits as of January 1, 2007 as a result of implementing Interpretation No. 48. A reconciliation of the beginning and ending amount of unrecognized tax benefits for the years ended December 31 is as follows: