The Company’s investments consist principally of fixed maturity and equity securities that are classified as available-for-sale (“AFS”) which are reported at estimated fair value. In addition, the Company held fixed maturity securities which contain a conversion to equity feature, which is considered an embedded derivative. These fixed maturity securities have been classified as trading and are reported at estimated fair value. During 2012, the last of these securities converted so the Company no longer holds any of these securities as of December 31, 2012. The fair values of fixed maturity and equity securities are determined by management after taking into consideration several sources of data. When available, the Company uses quoted market prices in active markets to determine the fair value of its investments. The Company’s valuation policy utilizes a pricing hierarchy which dictates that publicly available prices are initially sought from indices and third-party pricing services. In the event that pricing is not available from these sources, those securities are submitted to brokers to obtain quotes. If broker quotes are not available, then securities are priced using internal cash flow modeling techniques. These valuation methodologies commonly use reported trades, bids, offers, issuer spreads, benchmark yields, estimated prepayment speeds, and/or estimated cash flows.
At December 31, 2012 and 2011, there was $52.6 million and $55.7 million, respectively, in mortgage loans on real estate recorded on the Balance Sheets. The estimated fair value of the mortgage loans on real estate at December 31, 2012 and December 31, 2011 was $59.5 million and $61.8 million, respectively. There were no impaired mortgage loans at December 31, 2012 or 2011. The general reserve at December 31, 2012 and 2011 was less than $0.1 million. The change in the valuation allowance and the general reserve is reflected in net realized investment gains (losses), excluding OTTI losses on securities in the Statements of Income. At December 31, 2012 and 2011, there were no mortgage loans that were two or more payments delinquent. See Note 3 to the Financial Statements for further discussion.
The Company has entered into variance swaps to hedge the costs of the volatility of the Standard & Poor’s 500 Composite Stock Price Index (“S&P”) market. These variance swaps are similar to volatility options where the underlying index provides for the market value movements. Variance swaps do not accrue interest, and typically, no cash is exchanged at initiation.
ASC 350, Intangibles-Goodwill and Other - ASU 2011-08, Testing Goodwill for Impairment - gives entities the option of performing a qualitative assessment to determine whether it is necessary to perform the two-step goodwill impairment test - adopted January 1, 2012.
RMBS are securitizations of underlying pools of non-commercial mortgages on real estate. The underlying residential mortgages have varying credit ratings and are pooled together and sold in tranches. The Company’s RMBS includes government sponsored enterprise (“GSE”) guaranteed passthroughs, whole loan passthroughs and collateralized mortgage obligations (“CMO”), as well as negative amortization mortgage-backed securities.
Policy benefits decreased $163.7 million during 2012 as compared to 2011. The following table provides the changes in policy benefits by type:
(a) Asset-based policy charge revenue for 2011 was negatively impacted by the decrease in average variable account balances.