Management considers certain non-GAAP financial measures, including adjusted operating income; adjusted operating income per common share; pre-tax adjusted operating income; adjusted book value; adjusted book value, as converted; adjusted book value per common share; adjusted book value per common share, as converted; average adjusted book value; and operating return on average equity (ROAE) to be useful to investors in evaluating our financial performance and condition. These measures have been reconciled to their most comparable GAAP financial measures. For a definition of these non-GAAP measures, see “- Use of non-GAAP Financial Measures.”
Our ability to lower interest crediting rates could be limited by competition, regulatory approval, or contractual guarantees of minimum rates, and may not match the timing or magnitude of changes in asset yields.
The availability of market observable information is the principal factor in determining the level that our investments are assigned in the fair value hierarchy. The following table summarizes our assets carried at fair value and the respective fair value hierarchy, based on input levels:
Our Deferred Annuities segment’s profitability increased $6.9 as the investment margin (net investment income less interest credited) increased $11.4, driven by a $0.8 billion increase in average fixed account value. The higher investment margin was partially offset by higher expenses primarily related to our True VA product.
(2) Expense ratio is equal to other underwriting and operating expenses of our insurance operations divided by premiums earned.
(4) Medical stop-loss - loss ratio represents medical stop-loss policyholder benefits and incurred claims divided by medical stop-loss premiums earned.
(1) Interest spread 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 the
Segment pre-tax adjusted operating income increased $6.9, primarily driven by higher fixed account values and a stable interest spread, as well as lower DAC amortization. Our base earned yield continued to decline as a result of the low interest rate environment; 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. These results were partially offset by higher operating expenses related to our True VA product.
Net investment income decreased $9.6 due to declines in average invested assets on lower reserves and lower year-over-year investment prepayment related income. In addition, we experienced lower investment yields on fixed maturity purchases and mortgage loan originations.
The increase in invested assets during the year ended December 31, 2012 is primarily due to a net increase in the fair value of our fixed maturities and portfolio growth generated by sales of fixed annuities. As of December 31, 2012, net unrealized gains on our fixed maturities increased to $2.4 billion, compared with $1.8 billion as of December 31, 2011. This was driven by a rise in market prices on previously purchased fixed maturities due to tighter credit spreads and the current lower yield environment. Our investments in commercial mortgage loans increased to $3.1 billion as of December 31, 2012, up from $2.5 billion as of December 31, 2011, as we sought investments providing relatively higher yields compared to new purchases of fixed maturities.
The Securities Valuation Office, or SVO, of the NAIC, evaluates the investments of insurers for regulatory reporting purposes and assigns fixed maturities to one of the six categories called “NAIC Designations.” NAIC designations of “1” or “2” include fixed maturities considered investment grade, which generally include securities rated BBB- or higher by Standard & Poor’s. NAIC designations of “3” through “6” are referred to as below investment grade, which generally include securities rated BB+ or lower by Standard & Poor’s. In recent years, the NAIC adopted a modeling approach to determine the NAIC designation for RMBS and CMBS securities. As a result, the NAIC designation for structured securities may not correspond to the Standards & Poor’s designations described.
Our primary insurance subsidiary is domiciled in Washington State and, effective July 1, 2012, Washington State law changed to increase the percentage of assets we are able to invest in foreign securities to 20%, from 10%, of statutory admitted assets. This opportunity provides us with additional flexibility to invest in high-quality foreign corporate securities with a focus on investment grade securities. During the fourth quarter of 2012, we purchased foreign fixed maturity securities of $156.1.
The DSCR compares the amount of rental income a property is generating to the amount of the mortgage payments due on the property. DSCRs are calculated using the most current annual operating history for the collateral. As of December 31, 2012, loans with an aggregate carrying value of $110.6 had a DSCR of less than 1.00. The average outstanding principal balance of these loans was $1.7. As of December 31, 2012, one loan with an outstanding principal balance of $3.7 was in default.
As of December 31, 2012, we had the ability to borrow, on an unsecured basis, up to a maximum principal amount of $300.0 under a revolving line of credit arrangement.
Given the size and liquidity profile of our investment portfolio, we believe that claim experience varying from our projections does not constitute a significant liquidity risk. Our asset/liability management process takes into account the expected cash flows on investments and expected claim payments as well as the specific nature and risk profile of the liabilities. Historically, there has been limited variation between the expected cash flows on our investments and the payment of claims.
We have audited the accompanying consolidated balance sheets of Symetra Financial Corporation as of December 31, 2012 and 2011, and the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2012. Our audits also included the financial statement schedules listed in the Index at Item 15(a). These financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
The Company adjusts the unamortized balance of DAC for the impact on estimated future gross profits as if net unrealized investment gains and losses on securities had been realized as of the balance sheet date. The Company includes the impact of this adjustment, net of tax, in AOCI.
Liabilities for fixed annuity contracts, and universal life policies, including BOLI, are computed as deposits net of withdrawals made by the policyholder, plus amounts credited based on contract specifications, less contract fees and charges assessed.
(2) This includes net gains (losses) on changes in the fair value of trading securities held as of period end totaling $37.7, $(7.5) and $34.5 for the years ended December 31, 2012, 2011 and 2010, respectively.
Derivatives are instruments whose values are derived from underlying instruments, indices or rates; have a notional amount; and can be net settled. This may include derivatives that are embedded in financial instruments or in certain existing assets or liabilities. The Company is exposed to various risks relating to its ongoing business operations, primarily equity market risk, interest rate risk, and foreign currency exchange risk. The Company uses a variety of strategies to manage these risks, including the use of derivative instruments, primarily options, interest rate swaps and foreign currency forwards. The Company has established policies for managing each of these risks, including prohibitions on derivatives market-making and other speculative derivatives activities. See Note 2 for a description of the Company’s accounting policies for derivative financial instruments.
Level 2 - Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-derived valuations whose inputs are observable or whose significant value drivers are observable. This level includes those financial instruments that are valued using industry-standard pricing methodologies or models. All significant inputs are observable or derived from observable information in the marketplace. Financial instruments in this category primarily include corporate fixed maturities, government or agency securities and mortgage-backed securities.
As of December 31, 2012, the Company had $819.6, or 3.5%, of its fixed maturities invested in private placement securities. The use of significant observable inputs in determining the fair value of the Company’s
The following table summarizes the Company’s restricted stock activity for the three years ended December 31, 2012:
(1) This includes funds held under deposit contracts, future policy benefits, and policy and contract claims.
The following tables present the effects of the Company’s retrospective adoption of a new accounting principle on previously reported quarterly financial information for 2011: