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- Quarterly Report (10-Q)

Date : 05/07/2012 @ 12:09PM
Source : Edgar (US Regulatory)
Stock : American Equity Investment Life Holding (AEL)
Quote : 23.26  -0.07 (-0.30%) @ 11:43AM
American Equity Life share price Chart

- Quarterly Report (10-Q)



FORM 10-Q
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2012
o  
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission File Number : 001-31911
American Equity Investment Life Holding Company
(Exact name of registrant as specified in its charter)
Iowa
 
42-1447959
(State of Incorporation)
 
(I.R.S. Employer Identification No.)
 
 
 
6000 Westown Parkway
West Des Moines, Iowa
 
50266
(Address of principal executive offices)
 
(Zip Code)
 
 
 
Registrant's telephone number, including area code
 
(515) 221-0002
 
 
(Telephone)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Name of each exchange on which registered
Common Stock, par value $1
 
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $1
Indicate by check mark whether the registrant (1) has filed all documents and reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o
 
Accelerated filer x
Non-accelerated filer o
 
Smaller reporting company o
(Do not check if a smaller reporting company)
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.) Yes o No x
APPLICABLE TO CORPORATE ISSUERS:
Shares of common stock outstanding at April 30, 2012: 59,923,590




TABLE OF CONTENTS
 
Page
PART I — FINANCIAL INFORMATION
 
Item 1: Financial Statements:
2
Consolidated Balance Sheets
2
Consolidated Statements of Operations
3
Consolidated Statements of Comprehensive Income (Loss)
4
Consolidated Statements of Changes in Stockholders’ Equity
5
Consolidated Statements of Cash Flows
6
Notes to Consolidated Financial Statements
8
Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations
30
Item 3: Quantitative and Qualitative Disclosures about Market Risk
46
Item 4: Controls and Procedures
48
 
 
PART II — OTHER INFORMATION
 
Item 1: Legal Proceedings
48
Item 1A: Risk Factors
48
Item 2: Unregistered Sales of Equity Securities and Use of Proceeds
48
Item 6: Exhibits
49
 
 
Signatures
50







PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
 
March 31, 2012
 
December 31, 2011
 
(Unaudited)
 
 
Assets
 
 
 
Investments:
 
 
 
Fixed maturity securities:
 
 
 
Available for sale, at fair value (amortized cost: 2012 - $17,738,411; 2011 - $16,980,279)
$
19,007,153

 
$
18,464,109

Held for investment, at amortized cost (fair value: 2012 - $1,521,790; 2011 - $2,644,422)
1,531,763

 
2,644,206

Equity securities, available for sale, at fair value (cost: 2012 - $56,396; 2011 - $58,438)
65,227

 
62,845

Mortgage loans on real estate
2,756,392

 
2,823,047

Derivative instruments
558,610

 
273,314

Other investments
115,594

 
115,930

Total investments
24,034,739

 
24,383,451

 
 
 
 
Cash and cash equivalents
2,527,113

 
404,952

Coinsurance deposits
2,902,172

 
2,818,642

Accrued investment income
236,622

 
228,937

Deferred policy acquisition costs
1,820,153

 
1,683,857

Deferred sales inducements
1,352,771

 
1,242,787

Deferred income taxes
60,528

 
21,981

Income taxes recoverable

 
8,441

Other assets
104,435

 
81,671

Total assets
$
33,038,533

 
$
30,874,719

 
 
 
 
Liabilities and Stockholders' Equity
 
 
 
Liabilities:
 
 
 
Policy benefit reserves
$
29,255,621

 
$
28,118,716

Other policy funds and contract claims
418,818

 
400,594

Notes payable
300,567

 
297,608

Subordinated debentures
268,574

 
268,593

Income taxes payable
9,000

 

Other liabilities
1,412,369

 
380,529

Total liabilities
31,664,949

 
29,466,040

 
 
 
 
Stockholders' equity:
 
 
 
Preferred stock, no par value, 2,000,000 shares authorized, 2012 and 2011 no shares issued and outstanding

 

Common stock, par value $1 per share, 125,000,000 shares authorized; issued and outstanding:
   2012 - 58,621,637 shares (excluding 5,124,749 treasury shares);
   2011 - 57,836,540 shares (excluding 5,616,595 treasury shares)
58,622

 
57,837

Additional paid-in capital
470,079

 
468,281

Unallocated common stock held by ESOP; 2012 - 336,093 shares; 2011 - 336,093 shares
(3,287
)
 
(3,620
)
Accumulated other comprehensive income
408,747

 
457,229

Retained earnings
439,423

 
428,952

Total stockholders' equity
1,373,584

 
1,408,679

Total liabilities and stockholders' equity
$
33,038,533

 
$
30,874,719

See accompanying notes to unaudited consolidated financial statements.

2



AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except per share data)
(Unaudited)

 
Three Months Ended March 31,
 
2012
 
2011
Revenues:
 
 
 
Traditional life insurance premiums
$
3,222

 
$
2,916

Annuity product charges
19,393

 
16,962

Net investment income
326,910

 
292,128

Change in fair value of derivatives
259,161

 
148,653

Net realized losses on investments, excluding other than temporary impairment ("OTTI") losses
(6,076
)
 
(1,193
)
OTTI losses on investments:
 
 
 
Total OTTI losses
(1,781
)
 
(5,100
)
Portion of OTTI losses recognized from other comprehensive income
(1,100
)
 
(1,471
)
Net OTTI losses recognized in operations
(2,881
)
 
(6,571
)
Total revenues
599,729

 
452,895

 
 
 
 
Benefits and expenses:
 
 
 
Insurance policy benefits and change in future policy benefits
2,117

 
1,895

Interest sensitive and index product benefits
139,123

 
159,665

Amortization of deferred sales inducements
16,710

 
30,692

Change in fair value of embedded derivatives
359,066

 
128,303

Interest expense on notes payable
6,995

 
7,907

Interest expense on subordinated debentures
3,586

 
3,466

Interest expense on amounts due under repurchase agreements

 
4

Amortization of deferred policy acquisition costs
34,284

 
55,223

Other operating costs and expenses
21,713

 
17,474

Total benefits and expenses
583,594

 
404,629

Income before income taxes
16,135

 
48,266

Income tax expense
5,664

 
16,923

Net income
10,471

 
31,343

 
 
 
 
Earnings per common share
$
0.18

 
$
0.53

Earnings per common share - assuming dilution
$
0.16

 
$
0.48

Weighted average common shares outstanding (in thousands):
 
 
 
Earnings per common share
59,701

 
59,182

Earnings per common share - assuming dilution
65,930

 
65,711

See accompanying notes to unaudited consolidated financial statements.

3



AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Dollars in thousands)
(Unaudited)

 
Three Months Ended March 31,
 
2012
 
2011
 
 
 
 
Net income
$
10,471

 
$
31,343

Other comprehensive loss:
 
 
 
Change in net unrealized investment gains/losses (1)
(74,975
)
 
(22,553
)
Noncredit component of OTTI losses (1)
389

 
644

Other comprehensive loss before income tax
(74,586
)
 
(21,909
)
Income tax effect related to other comprehensive loss
26,104

 
7,668

Other comprehensive loss
(48,482
)
 
(14,241
)
Comprehensive income (loss)
$
(38,011
)
 
$
17,102

(1) Net of related adjustments to amortization of deferred sales inducements and deferred policy acquisition costs.
See accompanying notes to unaudited consolidated financial statements.

4



AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Dollars in thousands, except per share data)
(Unaudited)

 
Common
Stock
 
Additional
Paid-in
Capital
 
Unallocated
Common
Stock Held
by ESOP
 
Accumulated
Other
Comprehensive
Income
 
Retained
Earnings
 
Total
Stockholders'
Equity
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2011
$
57,837

 
$
468,281

 
$
(3,620
)
 
$
457,229

 
$
428,952

 
$
1,408,679

Net income for period

 

 

 

 
10,471

 
10,471

Other comprehensive loss

 

 

 
(48,482
)
 

 
(48,482
)
Conversion of $60 of subordinated debentures
7

 
49

 

 

 

 
56

Allocation of 30,903 shares of common stock by ESOP, including excess income tax benefits

 
22

 
333

 

 

 
355

Share-based compensation, including excess income tax benefits

 
1,774

 

 

 

 
1,774

Issuance of 777,690 shares of common stock under compensation plans, including excess income tax benefits
778

 
(47
)
 

 

 

 
731

Balance at March 31, 2012
$
58,622

 
$
470,079

 
$
(3,287
)
 
$
408,747

 
$
439,423

 
$
1,373,584

 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2010
$
56,968

 
$
454,454

 
$
(4,815
)
 
$
81,820

 
$
349,620

 
$
938,047

Net income for period

 

 

 

 
31,343

 
31,343

Other comprehensive loss

 

 

 
(14,241
)
 

 
(14,241
)
Allocation of 24,492 shares of common stock by ESOP, including excess income tax benefits

 
37

 
264

 

 

 
301

Share-based compensation, including excess income tax benefits

 
2,630

 

 

 

 
2,630

Issuance of 719,979 shares of common stock under compensation plans, including excess income tax benefits
720

 
2,377

 

 

 

 
3,097

Balance at March 31, 2011
$
57,688

 
$
459,498

 
$
(4,551
)
 
$
67,579

 
$
380,963

 
$
961,177

See accompanying notes to unaudited consolidated financial statements.

5



AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)

 
Three Months Ended March 31,
 
2012
 
2011
Operating activities
 
 
 
Net income
$
10,471

 
$
31,343

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Interest sensitive and index product benefits
139,123

 
159,665

Amortization of deferred sales inducements
16,710

 
30,692

Annuity product charges
(19,393
)
 
(16,962
)
Change in fair value of embedded derivatives
359,066

 
128,303

Increase in traditional life and accident and health insurance reserves
6,032

 
24,356

Policy acquisition costs deferred
(91,177
)
 
(117,501
)
Amortization of deferred policy acquisition costs
34,284

 
55,223

Provision for depreciation and other amortization
4,547

 
4,515

Amortization of discounts and premiums on investments
(39,738
)
 
(45,564
)
Realized gains/losses on investments and net OTTI losses recognized in operations
8,957

 
7,764

Change in fair value of derivatives
(259,161
)
 
(149,241
)
Deferred income taxes
(12,443
)
 
(41,597
)
Share-based compensation
1,106

 
1,719

Change in accrued investment income
(7,685
)
 
(30,003
)
Change in income taxes recoverable/payable
17,441

 
56,581

Change in other assets
(682
)
 
253

Change in other policy funds and contract claims
18,224

 
45,816

Change in collateral held for derivatives
292,043

 
122,437

Change in other liabilities
(19,523
)
 
(28,408
)
Other
(482
)
 
318

Net cash provided by operating activities
457,720

 
239,709

 
 
 
 
Investing activities
 
 
 
Sales, maturities, or repayments of investments:
 
 
 
Fixed maturity securities - available for sale
965,283

 
1,732,408

Fixed maturity securities - held for investment
1,140,816

 

Equity securities - available for sale
2,605

 

Mortgage loans on real estate
99,199

 
52,768

Derivative instruments
57,015

 
97,878

Other investments
4,568

 

Acquisition of investments:
 
 
 
Fixed maturity securities - available for sale
(988,547
)
 
(1,824,696
)
Fixed maturity securities - held for investment

 
(760,505
)
Equity securities - available for sale

 
(1,600
)
Mortgage loans on real estate
(43,678
)
 
(191,583
)
Derivative instruments
(83,201
)
 
(83,409
)
Other investments
(17
)
 
(33
)
Purchases of property, furniture and equipment
(191
)
 
(2,656
)
Net cash provided by (used in) investing activities
1,153,852

 
(981,428
)

6



AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Dollars in thousands)
(Unaudited)

 
Three Months Ended March 31,
 
2012
 
2011
Financing activities
 
 
 
Receipts credited to annuity and single premium universal life policyholder account balances
$
979,445

 
$
1,341,844

Coinsurance deposits
(49,478
)
 
(16,207
)
Return of annuity policyholder account balances
(414,521
)
 
(438,371
)
Financing fees incurred and deferred

 
(1,566
)
Excess tax benefits realized from share-based compensation plans
665

 
935

Proceeds from issuance of common stock
721

 
3,052

Change in checks in excess of cash balance
(6,243
)
 
1,003

Net cash provided by financing activities
510,589

 
890,690

Increase in cash and cash equivalents
2,122,161

 
148,971

Cash and cash equivalents at beginning of period
404,952

 
597,766

Cash and cash equivalents at end of period
$
2,527,113

 
$
746,737

 
 
 
 
Supplemental disclosures of cash flow information
 
 
 
Cash paid during period for:
 
 
 
Interest expense
$
7,014

 
$
6,792

Income taxes

 
1,000

Non-cash operating activity:
 
 
 
Deferral of sales inducements
70,019

 
106,249

Non-cash investing activity:
 
 
 
Real estate acquired in satisfaction of mortgage loans
3,303

 
3,781

Non-cash financing activities:
 
 
 
Conversion of subordinated debentures
60

 

See accompanying notes to unaudited consolidated financial statements.
 

7



AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2012
(Unaudited)

1. Significant Accounting Policies
Consolidation and Basis of Presentation
The accompanying consolidated financial statements of American Equity Investment Life Holding Company (“we”, “us” or “our”) have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and notes required by GAAP for complete financial statements. The consolidated financial statements reflect all adjustments, consisting only of normal recurring items, which are necessary to present fairly our financial position and results of operations on a basis consistent with the prior audited consolidated financial statements. Operating results for the three month period ended March 31, 2012 are not necessarily indicative of the results that may be expected for the year ended December 31, 2012 . All significant intercompany accounts and transactions have been eliminated. The preparation of financial statements requires the use of management estimates. For further information related to a description of areas of judgment and estimates and other information necessary to understand our financial position and results of operations, refer to the audited consolidated financial statements and notes included in our Annual Report on Form 10-K for the year ended December 31, 2011 .
During 2011, we discovered a prior period error related to policy benefit reserves for our single premium immediate annuity products. Accordingly, we made an adjustment in the first quarter of 2011 which resulted in a decrease of policy benefit reserves and a decrease in interest sensitive and index product benefits of $4.2 million. On an after-tax basis, the adjustment resulted in a $2.7 million increase in net income for the three months ended March 31, 2011.
Adopted Accounting Pronouncements
In October 2010, as a result of a consensus of the Financial Accounting Standards Board ("FASB") Emerging Issues Task Force (EITF), the FASB issued an accounting standards update (ASU) that modifies the definition of the types of costs incurred that can be capitalized in the acquisition of new and renewal insurance contracts. This guidance defines the costs that qualify for deferral as incremental direct costs that result directly from and are essential to successful contract transactions and would not have been incurred by the insurance entity had the contract transactions not occurred. In addition, it lists certain costs as deferrable as those that are directly related to underwriting, policy issuance and processing, medical and inspection, and sales force contract selling as deferrable, as well as the portion of an employee's total compensation related directly to time spent performing those activities for actual acquired contracts and other costs related directly to those activities that would not have been incurred if the contract had not been acquired. This amendment to current GAAP became effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011. Other operating costs and expenses for the three months ended March 31, 2012, increased $3.0 million due to the prospective adoption of this ASU effective January 1, 2012, which decreased net income $1.9 million and decreased diluted earnings per share $0.03.
In May 2011, the FASB issued an ASU that addresses fair value measurement and disclosure as part of its convergence efforts with the International Accounting Standards Board. The result is common fair value measurement and disclosure requirements in GAAP and International Financial Reporting Standards. This ASU changes the wording used to describe many of the requirements in GAAP for measuring fair value and for disclosing information about fair value measurements. Some changes clarify the FASB's intent about the application of existing fair value measurement requirements. Other amendments change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements. The disclosure requirements add information about transfers between Level 1 and Level 2 of the fair value hierarchy, information about the sensitivity of a fair value measurement categorized within Level 3 of the fair value hierarchy to changes in unobservable inputs and any interrelationships between those unobservable inputs and the categorization by level of the fair value hierarchy for items that are not measured at fair value in the statement of financial position, but for which the fair value of such items is required to be disclosed. This ASU became effective for interim and annual periods beginning after December 15, 2011. See note 2 for disclosures regarding fair value measurements.
In June 2011, the FASB issued an ASU that expands the disclosure requirements related to other comprehensive income (loss). A reporting entity is now required to present the total of comprehensive income (loss), the components of net income, and the components of other comprehensive income (loss) either in a single continuous statement of comprehensive income (loss) or in two separate but consecutive statements. Under both choices, the reporting entity is required to present each component of net income along with total net income, each component of other comprehensive income (loss) along with a total for other comprehensive income (loss) and a total amount for comprehensive income (loss). This ASU became effective for interim and annual periods beginning after December 15, 2011. We have adopted this ASU on January 1, 2012.
New Accounting Pronouncements
There are no accounting standards updates finalized to become effective in the future that will significantly effect our consolidated financial statements.

8



Significant Accounting Policy - Deferred Policy Acquisition Costs
Our accounting policy for deferred policy acquisition costs follows, which has been updated from out 10-K for the year ended December 31, 2011 to reflect the adoption of new accounting standards.
To the extent recoverable from future policy revenues and gross profits, certain incremental direct costs that vary with and are directly related to the production of successful new business are not expensed when incurred but instead are capitalized as deferred policy acquisition costs. Deferred policy acquisition costs are subject to loss recognition testing on a quarterly basis or when an event occurs that may warrant loss recognition. Deferred policy acquisition costs consist primarily of commissions and certain costs of policy issuance.
For annuity products, these capitalized costs are being amortized generally in proportion to expected gross profits from investment spreads, including the cost of hedging the fixed indexed annuity obligations, and, to a lesser extent, from product charges and mortality and expense margins. That amortization is adjusted retrospectively through an unlocking process when estimates of current or future gross profits/margins (including the impact of net realized gains on investments and net OTTI losses recognized in operations) to be realized from a group of products are revised. Deferred policy acquisition costs are also adjusted for the change in amortization that would have occurred if available for sale fixed maturity securities and equity securities had been sold at their aggregate fair value at the end of the reporting period and the proceeds reinvested at current yields. The impact of this adjustment is included in accumulated other comprehensive income (loss) within consolidated stockholders' equity, net of applicable taxes.

2. Fair Values of Financial Instruments
The following sets forth a comparison of the fair values and carrying amounts of our financial instruments:
 
March 31, 2012
 
December 31, 2011
 
Carrying
Amount
 
Fair Value
 
Carrying
Amount
 
Fair Value
 
(Dollars in thousands)
Assets
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Available for sale
$
19,007,153

 
$
19,007,153

 
$
18,464,109

 
$
18,464,109

Held for investment
1,531,763

 
1,521,790

 
2,644,206

 
2,644,422

Equity securities, available for sale
65,227

 
65,227

 
62,845

 
62,845

Mortgage loans on real estate
2,756,392

 
2,980,414

 
2,823,047

 
3,030,308

Derivative instruments
558,610

 
558,610

 
273,314

 
273,314

Other investments
79,769

 
77,297

 
79,109

 
76,648

Cash and cash equivalents
2,527,113

 
2,527,113

 
404,952

 
404,952

Coinsurance deposits
2,902,172

 
2,622,586

 
2,818,642

 
2,549,025

Interest rate swaps
890

 
890

 

 

2015 notes hedges
62,344

 
62,344

 
45,593

 
45,593

 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
Policy benefit reserves
28,969,453

 
24,077,557

 
27,842,770

 
23,407,540

Single premium immediate annuity (SPIA) benefit reserves
418,143

 
433,803

 
397,248

 
412,998

Notes payable
300,567

 
432,539

 
297,608

 
376,370

Subordinated debentures
268,574

 
245,648

 
268,593

 
233,809

2015 notes embedded derivatives
62,344

 
62,344

 
45,593

 
45,593

Fair value is the price that would be received to sell an asset or paid to transfer a liability (exit price) in an orderly transaction between market participants at the measurement date. The objective of a fair value measurement is to determine that price for each financial instrument at each measurement date. We meet this objective using various methods of valuation that include market, income and cost approaches.

9



We categorize our financial instruments into three levels of fair value hierarchy based on the priority of inputs used in determining fair value. The hierarchy defines the highest priority inputs (Level 1) as quoted prices in active markets for identical assets or liabilities. The lowest priority inputs (Level 3) are our own assumptions about what a market participant would use in determining fair value such as estimated future cash flows. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, a financial instrument's level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the financial instrument. We categorize financial assets and liabilities recorded at fair value in the consolidated balance sheets as follows:
Level 1—
Quoted prices are available in active markets for identical financial instruments as of the reporting date. We do not adjust the quoted price for these financial instruments, even in situations where we hold a large position and a sale could reasonably impact the quoted price.
Level 2—
Quoted prices in active markets for similar financial instruments, quoted prices for identical or similar financial instruments in markets that are not active; and models and other valuation methodologies using inputs other than quoted prices that are observable.
Level 3—
Models and other valuation methodologies using significant inputs that are unobservable for financial instruments and include situations where there is little, if any, market activity for the financial instrument. The inputs into the determination of fair value require significant management judgment or estimation. Financial instruments that are included in Level 3 are securities for which no market activity or data exists and for which we used discounted expected future cash flows with our own assumptions about what a market participant would use in determining fair value.
Transfers of securities among the levels occur at times and depend on the type of inputs used to determine fair value of each security, however there were no transfers between levels during the three months ended March 31, 2012 .

10



Our assets and liabilities which are measured at fair value on a recurring basis as of March 31, 2012 and December 31, 2011 are presented below based on the fair value hierarchy levels:
 
Total
Fair Value
 
Quoted
Prices in
Active
Markets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
(Dollars in thousands)
March 31, 2012
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
United States Government full faith and credit
$
4,586

 
$
4,586

 
$

 
$

United States Government sponsored agencies
1,680,889

 

 
1,680,889

 

United States municipalities, states and territories
3,331,165

 

 
3,331,165

 

Foreign government obligations
43,713

 

 
43,713

 

Corporate securities
10,852,808

 
59,446

 
10,793,362

 

Residential mortgage backed securities
2,583,699

 

 
2,581,672

 
2,027

Other asset backed securities
510,293

 
373

 
509,920

 

Equity securities, available for sale: finance, insurance and real estate
65,227

 
45,533

 
19,694

 

Derivative instruments
558,610

 

 
558,610

 

Cash and cash equivalents
2,527,113

 
2,527,113

 

 

Interest rate swaps
890

 

 
890

 

2015 notes hedges
62,334

 

 
62,334

 

 
$
22,158,993

 
$
2,637,051

 
$
19,519,915

 
$
2,027

Liabilities
 
 
 
 
 
 
 
2015 notes embedded derivatives
$
62,334

 
$

 
$
62,334

 
$

Fixed index annuities - embedded derivatives
2,921,037

 

 

 
2,921,037

 
$
2,983,371

 
$

 
$
62,334

 
$
2,921,037

 
 
 
 
 
 
 
 
December 31, 2011
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
United States Government full faith and credit
$
4,678

 
$
4,678

 
$

 
$

United States Government sponsored agencies
1,799,779

 

 
1,799,779

 

United States municipalities, states and territories
3,333,383

 

 
3,333,383

 

Foreign government obligations
43,228

 

 
43,228

 

Corporate securities
10,116,361

 
58,827

 
10,057,534

 

Residential mortgage backed securities
2,703,290

 

 
2,701,192

 
2,098

Other asset backed securities
463,390

 
370

 
463,020

 

Equity securities, available for sale: finance, insurance and real estate
62,845

 
44,229

 
18,616

 

Derivative instruments
273,314

 

 
273,314

 

Cash and cash equivalents
404,952

 
404,952

 

 

2015 notes hedges
45,593

 

 
45,593

 

 
$
19,250,813

 
$
513,056

 
$
18,735,659

 
$
2,098

Liabilities
 
 
 
 
 
 
 
2015 notes embedded derivatives
45,593

 

 
45,593

 

Fixed index annuities - embedded derivatives
2,530,496

 

 

 
2,530,496

 
$
2,576,089

 
$

 
$
45,593

 
$
2,530,496


11



The following methods and assumptions were used in estimating the fair values of financial instruments during the periods presented in these consolidated financial statements.
Fixed maturity securities and equity securities
The fair values of fixed maturity securities and equity securities in an active and orderly market are determined by utilizing independent pricing services. The independent pricing services incorporate a variety of observable market data in their valuation techniques, including:
reported trading prices,
benchmark yields
broker-dealer quotes,
benchmark securities,
bids and offers,
credit ratings,
relative credit information, and
other reference data.
The independent pricing services also take into account perceived market movements and sector news, as well as a security's terms and conditions, including any features specific to that issue that may influence risk and marketability. Depending on the security, the priority of the use of observable market inputs may change as some observable market inputs may not be relevant or additional inputs may be necessary.
The independent pricing services provide quoted market prices when available. Quoted prices are not always available due to market inactivity. When quoted market prices are not available, the third parties use yield data and other factors relating to instruments or securities with similar characteristics to determine fair value for securities that are not actively traded. We generally obtain one value from our primary external pricing service. In situations where a price is not available from this service, we may obtain further quotes or prices from additional parties as needed. In addition, for our callable United States Government sponsored agencies we obtain two broker quotes and take the average of two broker prices received. Market indices of similar rated asset class spreads are considered for valuations and broker indications of similar securities are compared. Inputs used by the broker include market information, such as yield data and other factors relating to instruments or securities with similar characteristics. Valuations and quotes obtained from third party commercial pricing services are non-binding and do not represent quotes on which one may execute the disposition of the assets.
We validate external valuations at least quarterly through a combination of procedures that include the evaluation of methodologies used by the pricing services, analytical reviews and performance analysis of the prices against trends, and maintenance of a securities watch list. Additionally, as needed we utilize discounted cash flow models or perform independent valuations on a case-by-case basis of inputs and assumptions similar to those used by the pricing services. Although we do identify differences from time to time as a result of these validation procedures, we did not make any significant adjustments as of March 31, 2012 and December 31, 2011 .
Mortgage loans on real estate
Mortgage loans on real estate are not measured at fair value on a recurring basis. The fair values of mortgage loans on real estate are calculated using discounted expected cash flows using current competitive market interest rates currently being offered for similar loans which are not fair value exit prices. The fair values of impaired mortgage loans on real estate that we have considered to be collateral dependent are based on the fair value of the real estate collateral (based on appraised values) less estimated costs to sell. The inputs utilized to determine fair value of all mortgage loans are unobservable market data (competitive market interest rates and appraised property values); therefore, fair value of mortgage loans falls into Level 3 in the fair value hierarchy.
Derivative instruments
The fair values of derivative instruments, primarily call options, are based upon the amount of cash that we will receive to settle each derivative instrument on the reporting date. These amounts are obtained from each of the counterparties using industry accepted valuation models and are adjusted for the nonperformance risk of each counterparty net of any collateral held. Inputs include market volatility and risk free interest rates and are used in income valuation techniques in arriving at a fair value for each option contract. The nonperformance risk for each counterparty is based upon its credit default swap rate. We have no performance obligations related to the call options purchased to fund our fixed index annuity policy liabilities.
Other investments
None of the financial instruments included in other investments are measured at fair value on a recurring basis. Financial instruments included in other investments are policy loans, an equity method investment and company owned life insurance (COLI). We have not attempted to determine the fair values associated with our policy loans, as we believe any differences between carrying value and the fair values afforded these instruments are immaterial to our consolidated financial position and, accordingly, the cost to provide such disclosure does not justify the benefit to be derived. The fair value of our equity method investment qualifies as a Level 3 fair value and was determined by calculating the present value of future cash flows discounted by a risk free rate, a risk spread and a liquidity discount. The risk spread and liquidity discount are rates determined by our investment professionals and are unobservable market inputs. The fair value of our COLI approximates its cash surrender value. Cash surrender of our COLI is based on the fair value of the underlying assets, whose fair values fall within Level 2 of the fair value hierarchy.

12



Cash and cash equivalents
Amounts reported in the consolidated balance sheets for these instruments are reported at their historical cost which approximates fair value due to the nature of the assets assigned to this category.
2015 notes hedges
The fair value of these call options is determined by a third party who applies market observable data such as our common stock price, its dividend yield and its volatility, as well as the time to expiration of the call options to determine a fair value of the buy side of these options.
Interest rate swaps
The fair values of our pay fixed/receive variable interest rate swaps are obtained from third parties and are determined by discounting expected future cash flows using projected LIBOR rates for the term of the swaps.
Policy benefit reserves, coinsurance deposits and SPIA benefit reserves
The fair values of the liabilities under contracts not involving significant mortality or morbidity risks (principally deferred annuities), are stated at the cost we would incur to extinguish the liability (i.e., the cash surrender value) as these contracts are generally issued without an annuitization date. The coinsurance deposits related to the annuity benefit reserves have fair values determined in a similar fashion. For period-certain annuity benefit contracts, the fair value is determined by discounting the benefits at the interest rates currently in effect for newly purchased immediate annuity contracts. We are not required to and have not estimated the fair value of the liabilities under contracts that involve significant mortality or morbidity risks, as these liabilities fall within the definition of insurance contracts that are exceptions from financial instruments that require disclosures of fair value. Policy benefit reserves, coinsurance deposits and SPIA benefit reserves are not measured at fair value on a recurring basis. All of the fair values presented within these categories fall within Level 3 of the fair value hierarchy as most of the inputs are unobservable market data.
Notes payable
The fair value of the convertible senior notes is based upon pricing matrices developed by a third party pricing service when quoted market prices are not available and are categorized as Level 2 within the fair value hierarchy. Notes payable are not remeasured at fair value on a recurring basis.
Subordinated debentures
Fair values for subordinated debentures are estimated using discounted cash flow calculations based principally on observable inputs including our incremental borrowing rates, which reflect our credit rating, for similar types of borrowings with maturities consistent with those remaining for the debt being valued. These fair values are categorized as Level 2 within the fair value hierarchy. Subordinated debentures are not measured at fair value on a recurring basis.
2015 notes embedded derivatives
The fair value of this embedded derivative is determined by pricing the call options that hedge this potential liability. The terms of the conversion premium are identical to the 2015 notes hedges and the method of determining fair value of the call options is based upon observable market data.
Fixed index annuities - embedded derivatives
We estimate the fair value of the embedded derivative component of our fixed index annuity policy liabilities at each valuation date by (i) projecting policy contract values and minimum guaranteed contract values over the expected lives of the contracts and (ii) discounting the excess of the projected contract value amounts at the applicable risk free interest rates adjusted for our nonperformance risk related to those liabilities. The projections of policy contract values are based on our best estimate assumptions for future policy growth and future policy decrements. Our best estimate assumptions for future policy growth include assumptions for the expected index credit on the next policy anniversary date which are derived from the fair values of the underlying call options purchased to fund such index credits and the expected costs of annual call options we will purchase in the future to fund index credits beyond the next policy anniversary. The projections of minimum guaranteed contract values include the same best estimate assumptions for policy decrements as were used to project policy contract values.

13



The following tables provide a reconciliation of the beginning and ending balances for our Level 3 assets and liabilities, which are measured at fair value on a recurring basis using significant unobservable inputs for the three months ended March 31, 2012 and 2011 :
 
Three Months Ended March 31,
 
2012
 
2011
 
(Dollars in thousands)
Available for sale securities
 
 
 
Beginning balance
$
2,098

 
$
2,702

Purchases

 
1,600

Principal returned
(41
)
 
(188
)
(Amortization)/accretion of premium/discount
26

 
12

Total gains (losses) (realized/unrealized):
 
 
 
Included in other comprehensive income (loss)
102

 
175

Included in operations
(158
)
 

Ending balance
$
2,027

 
$
4,301

The Level 3 assets included in the table above are not material to our financial position, results of operations or cash flows, and it is management's opinion that the sensitivity of the inputs used in determining the fair value of these assets is not material as well.
 
Three Months Ended March 31,
 
2012
 
2011
 
(Dollars in thousands)
Fixed index annuities - embedded derivatives
 
 
 
Beginning balance
$
2,530,496

 
$
1,971,383

Premiums less benefits
84,226

 
215,943

Change in unrealized gains, net
306,315

 
54,674

Ending balance
$
2,921,037

 
$
2,242,000

Change in unrealized gains, net for each period in our embedded derivatives are included in change in fair value of embedded derivatives in the unaudited consolidated statements of operations.
Certain derivatives embedded in our fixed index annuity contracts are our most significant financial instrument measured at fair value that are categorized as Level 3 in the fair value hierarchy. The contractual obligations for future annual index credits within our fixed index annuity contracts are treated as a "series of embedded derivatives" over the expected life of the applicable contracts. We estimate the fair value of these embedded derivatives at each valuation date by (i) projecting policy contract values and minimum guaranteed contract values over the expected lives of the contracts and (ii) discounting the excess of the projected contract value amounts at the applicable risk free interest rates adjusted for our nonperformance risk related to those liabilities. The projections of policy contract values are based on our best estimate assumptions for future policy growth and future policy decrements. Our best estimate assumptions for future policy growth include assumptions for the expected index credits on the next policy anniversary date which are derived from the fair values of the underlying call options purchased to fund such index credits and the expected costs of annual call options we will purchase in the future to fund index credits beyond the next policy anniversary. The projections of minimum guaranteed contract values include the same best estimate assumptions for policy decrements as were used to project policy contract values.
The most sensitive assumption in determining policy liabilities for fixed index annuities is the rates used to discount the excess projected contract values. As indicated above, the discount rate reflects our nonperformance risk. If the discount rates used to discount the excess projected contract values at March 31, 2012, were to increase by100 basis points, the fair value of the embedded derivatives would decrease by $195.1 million recorded through operations as a decrease in the change in fair value of embedded derivatives and there would be a corresponding decrease of $117.7 million to our combined balance for deferred policy acquisition costs and deferred sales inducements recorded through operations as an increase in amortization of deferred policy acquisition costs and deferred sales inducements. A decrease by 100 basis points in the discount rate used to discount the excess projected contract values would increase the fair value of the embedded derivatives by $217.5 million recorded through operations as an increase in the change in fair value of embedded derivatives and increase our combined balance for deferred policy acquisition costs and deferred sales inducements by $132.3 million recorded through operations as a decrease in amortization of deferred policy acquisition costs and deferred sales inducements.

14



3. Investments
At March 31, 2012 and December 31, 2011 , the amortized cost and fair value of fixed maturity securities and equity securities were as follows:
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
 
(Dollars in thousands)
March 31, 2012
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
United States Government full faith and credit
$
4,084

 
$
502

 
$

 
$
4,586

United States Government sponsored agencies
1,669,737

 
12,903

 
(1,751
)
 
1,680,889

United States municipalities, states and territories
3,015,682

 
316,645

 
(1,162
)
 
3,331,165

Foreign government obligations
36,387

 
7,326

 

 
43,713

Corporate securities
9,982,373

 
932,175

 
(61,740
)
 
10,852,808

Residential mortgage backed securities
2,529,727

 
131,170

 
(77,198
)
 
2,583,699

Other asset backed securities
500,421

 
17,352

 
(7,480
)
 
510,293

 
$
17,738,411

 
$
1,418,073

 
$
(149,331
)
 
$
19,007,153

Held for investment:
 
 
 
 
 
 
 
United States Government sponsored agencies
$
1,455,793

 
$
7,761

 
$

 
$
1,463,554

Corporate security
75,970

 

 
(17,734
)
 
58,236

 
$
1,531,763

 
$
7,761

 
$
(17,734
)
 
$
1,521,790

Equity securities, available for sale:
 
 
 
 
 
 
 
Finance, insurance, and real estate
$
56,396

 
$
9,900

 
$
(1,069
)
 
$
65,227

 
 
 
 
 
 
 
 
December 31, 2011
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
United States Government full faith and credit
$
4,084

 
$
594

 
$

 
$
4,678

United States Government sponsored agencies
1,780,401

 
19,378

 

 
1,799,779

United States municipalities, states and territories
2,981,699

 
351,694

 
(10
)
 
3,333,383

Foreign government obligations
36,373

 
6,855

 

 
43,228

Corporate securities
9,117,173

 
1,079,422

 
(80,234
)
 
10,116,361

Residential mortgage backed securities
2,618,040

 
157,331

 
(72,081
)
 
2,703,290

Other asset backed securities
442,509

 
26,492

 
(5,611
)
 
463,390

 
$
16,980,279

 
$
1,641,766

 
$
(157,936
)
 
$
18,464,109

Held for investment:
 
 
 
 
 
 
 
United States Government sponsored agencies
$
2,568,274

 
$
16,806

 
$

 
$
2,585,080

Corporate security
75,932

 

 
(16,590
)
 
59,342

 
$
2,644,206

 
$
16,806

 
$
(16,590
)
 
$
2,644,422

Equity securities, available for sale:
 
 
 
 
 
 
 
Finance, insurance, and real estate
$
58,438

 
$
8,752

 
$
(4,345
)
 
$
62,845

During the three months ended March 31, 2012 and 2011 , we received $1.9 billion and $1.5 billion , respectively, in redemption proceeds related to calls of our callable United States Government sponsored agency securities and public and private corporate bonds, of which $1.1 billion were c lassified as held for investment for the three months ended March 31, 2012 . There were no calls of held for investment securities during the three months ended March 31, 2011 . We reinvested the proceeds from these redemptions primarily in United States Government sponsored agencies, corporate securities and other asset backed securities . At March 31, 2012 , 34% of our fixed income securities have call features and 1% ($0.1 billion) were subject to call redemption. Another 13% ($2.5 billion) will become subject to call redemption during the next twelve months (principally the last three quarters of 2012).

15



The amortized cost and fair value of fixed maturity securities at March 31, 2012 , by contractual maturity, are shown below. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. All of our residential mortgage and other asset backed securities provide for periodic payments throughout their lives and are shown below as separate lines.
 
Available for sale
 
Held for investment
 
Amortized
Cost
 
Fair Value
 
Amortized
Cost
 
Fair Value
 
(Dollars in thousands)
Due in one year or less
$
54,155

 
$
56,064

 
$

 
$

Due after one year through five years
478,530

 
537,796

 

 

Due after five years through ten years
2,902,552

 
3,144,559

 

 

Due after ten years through twenty years
4,321,964

 
4,622,946

 

 

Due after twenty years
6,951,062

 
7,551,796

 
1,531,763

 
1,521,790

 
14,708,263

 
15,913,161

 
1,531,763

 
1,521,790

Residential mortgage backed securities
2,529,727

 
2,583,699

 

 

Other asset backed securities
500,421

 
510,293

 

 

 
$
17,738,411

 
$
19,007,153

 
$
1,531,763

 
$
1,521,790

Net unrealized gains on available for sale fixed maturity securities and equity securities reported as a separate component of stockholders' equity were comprised of the following:
 
March 31,
2012
 
December 31,
2011
 
(Dollars in thousands)
Net unrealized gains on available for sale fixed maturity securities and equity securities
$
1,277,573

 
$
1,488,237

Adjustments for assumed changes in amortization of deferred policy acquisition costs and deferred sales inducements
(683,398
)
 
(819,476
)
Deferred income tax valuation allowance reversal
22,534

 
22,534

Deferred income tax benefit
(207,962
)
 
(234,066
)
Net unrealized gains reported as accumulated other comprehensive income
$
408,747

 
$
457,229

The National Association of Insurance Commissioners (“NAIC”) assigns designations to fixed maturity securities. These designations range from Class 1 (highest quality) to Class 6 (lowest quality). In general, securities are assigned a designation based upon the ratings they are given by the Nationally Recognized Statistical Rating Organizations (“NRSRO’s”). The NAIC designations are utilized by insurers in preparing their annual statutory statements. NAIC Class 1 and 2 designations are considered “investment grade” while NAIC Class 3 through 6 designations are considered “non-investment grade.” Based on the NAIC designations, we had 98% of our fixed maturity portfolio rated investment grade at March 31, 2012 and December 31, 2011 .
The following table summarizes the credit quality, as determined by NAIC designation, of our fixed maturity portfolio as of the dates indicated:
 
 
March 31, 2012
 
December 31, 2011
NAIC
Designation
 
Amortized Cost

 
Fair Value
 
Amortized Cost
 
Fair Value
 
 
(Dollars in thousands)
1
 
$
13,459,266

 
$
14,395,046

 
$
14,359,272

 
$
15,486,571

2
 
5,477,252

 
5,821,823

 
4,894,739

 
5,272,759

3
 
302,139

 
280,833

 
335,642

 
315,406

4
 
22,851

 
21,137

 
26,674

 
23,989

5
 
5,613

 
5,872

 
4,932

 
5,756

6
 
3,053

 
4,232

 
3,226

 
4,050

 
 
$
19,270,174

 
$
20,528,943

 
$
19,624,485

 
$
21,108,531



16



The following tables show our investments' gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities (consisting of 302 and 246 securities, respectively) have been in a continuous unrealized loss position, at March 31, 2012 and December 31, 2011 :
 
Less than 12 months
 
12 months or more
 
Total
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
(Dollars in thousands)
March 31, 2012
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
 
 
 
 
United States Government sponsored agencies
$
607,349

 
$
(1,751
)
 
$

 
$

 
$
607,349

 
$
(1,751
)
United States municipalities, states and territories
47,597

 
(1,162
)
 

 

 
47,597

 
(1,162
)
Corporate securities:
 
 
 
 
 
 
 
 
 
 
 
Finance, insurance and real estate
393,955

 
(18,721
)
 
137,166

 
(12,238
)
 
531,121

 
(30,959
)
Manufacturing, construction and mining
312,333

 
(11,078
)
 
16,838

 
(1,543
)
 
329,171

 
(12,621
)
Utilities and related sectors
220,057

 
(7,749
)
 
40,567

 
(4,148
)
 
260,624

 
(11,897
)
Wholesale/retail trade
18,001

 
(605
)
 
9,575

 
(891
)
 
27,576

 
(1,496
)
Services, media and other
121,293

 
(1,219
)
 
16,452

 
(3,548
)
 
137,745

 
(4,767
)
Residential mortgage backed securities
445,892

 
(30,080
)
 
563,164

 
(47,118
)
 
1,009,056

 
(77,198
)
Other asset backed securities
174,011

 
(5,166
)
 
30,378

 
(2,314
)
 
204,389

 
(7,480
)
 
$
2,340,488

 
$
(77,531
)
 
$
814,140

 
$
(71,800
)
 
$
3,154,628

 
$
(149,331
)
Held for investment:
 
 
 
 
 
 
 
 
 
 
 
Corporate security:
 
 
 
 
 
 
 
 
 
 
 
Insurance
$

 
$

 
$
58,236

 
$
(17,734
)
 
$
58,236

 
$
(17,734
)
 
 
 
 
 
 
 
 
 
 
 
 
Equity securities, available for sale:
 
 
 
 
 
 
 
 
 
 
 
Finance, insurance and real estate
$
12,212

 
$
(913
)
 
$
4,844

 
$
(156
)
 
$
17,056

 
$
(1,069
)
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2011
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
 
 
 
 
United States municipalities, states and territories
$
3,535

 
$
(10
)
 
$

 
$

 
$
3,535

 
$
(10
)
Corporate securities:
 
 
 
 
 
 
 
 
 
 
 
Finance, insurance and real estate
363,909

 
(36,575
)
 
146,354

 
(15,611
)
 
510,263

 
(52,186
)
Manufacturing, construction and mining
201,762

 
(7,131
)
 
29,875

 
(1,869
)
 
231,637

 
(9,000
)
Utilities and related sectors
174,251

 
(7,576
)
 
37,778

 
(6,946
)
 
212,029

 
(14,522
)
Wholesale/retail trade
15,523

 
(188
)
 
9,275

 
(1,194
)
 
24,798

 
(1,382
)
Services, media and other
27,688

 
(249
)
 
17,105

 
(2,895
)
 
44,793

 
(3,144
)
Residential mortgage backed securities
295,352

 
(19,920
)
 
709,612

 
(52,161
)
 
1,004,964

 
(72,081
)
Other asset backed securities
115,542

 
(2,863
)
 
15,550

 
(2,748
)
 
131,092

 
(5,611
)
 
$
1,197,562

 
$
(74,512
)
 
$
965,549

 
$
(83,424
)
 
$
2,163,111

 
$
(157,936
)
Held for investment:
 
 
 
 
 
 
 
 
 
 
 
Corporate security:
 
 
 
 
 
 
 
 
 
 
 
Insurance
$

 
$

 
$
59,342

 
$
(16,590
)
 
$
59,342

 
$
(16,590
)
 


 


 


 


 


 


Equity securities, available for sale:
 
 
 
 
 
 
 
 
 
 
 
Finance, insurance and real estate
$
20,028

 
$
(3,095
)
 
$
3,750

 
$
(1,250
)
 
$
23,778

 
$
(4,345
)
The following is a description of the factors causing the temporary unrealized losses by investment category as of March 31, 2012 :
United States Government sponsored agencies ; and United States municipalities, states and territories : These securities are relatively long in duration, making the value of such securities sensitive to changes in market interest rates. We purchase these securities regularly over time at different interest rates available at time of purchase; thus, some securities carry yields less than those available at March 31, 2012 .
Corporate securities : The unrealized losses in these securities are due partially to the timing of purchases in 2011 and a small number of securities seeing their yield spreads widen due to issuer specific news. In addition, the financial sector credit spreads narrowed from year end 2011 but remain wide as the result of continued economic uncertainty and further concerns around the European Union.

17



Residential mortgage backed securities : At March 31, 2012 , we had no exposure to sub-prime residential mortgage backed securities. All of our residential mortgage backed securities are pools of first-lien residential mortgage loans. Substantially all of the securities that we own are in the most senior tranche of the securitization in which they are structured and are not subordinated to any other tranche. Our "Alt-A" residential mortgage backed securities are comprised of 36 securities with a total amortized cost basis of $418.3 million and a fair value of $383.5 million. Despite recent improvements in the capital markets, the fair values of RMBS continue at prices below amortized cost. RMBS prices will likely remain below our cost basis until the housing market is able to absorb current and future foreclosures.
Other asset backed securities : The unrealized losses in these securities are predominantly assigned to financial sector capital trust securities which have longer maturity dates and have declined in price due to prolonged stress in the financial sector. Only one security in an unrealized loss position is rated below investment grade.
Equity securities : Equity securities in an unrealized loss position are in the financial sector and have exposure to the economic uncertainty in the European Union and the United States. A majority of these securities have been in an unrealized loss position for 12 months or more and are investment grade perpetual preferred stocks that are absent credit deterioration. A continued difficult investment environment has raised concerns in regard to earnings and dividend stability in many companies which directly affect the values of these securities.
Approximately 83% of the unrealized losses on fixed maturity securities shown in the above table for March 31, 2012 and December 31, 2011 , are on securities that are rated investment grade, defined as being the highest two NAIC designations. All of the securities with unrealized losses are current with respect to the payment of principal and interest.
Changes in net unrealized gains on investments for the three months ended March 31, 2012 and 2011 are as follows:
 
Three Months Ended March 31,
 
2012
 
2011
 
 
 
 
Fixed maturity securities held for investment carried at amortized cost
$
10,189

 
$
(25,658
)
 
 
 
 
Investments carried at fair value:
 
 
 
Fixed maturity securities, available for sale
$
(215,088
)
 
$
(52,144
)
Equity securities, available for sale
4,424

 
2,081

 
(210,664
)
 
(50,063
)
Adjustment for effect on other balance sheet accounts:
 
 
 
Deferred policy acquisition costs and deferred sales inducements
136,078

 
28,154

Deferred income tax asset
26,104

 
7,668

 
162,182

 
35,822

Decrease in net unrealized gains on investments carried at fair value
$
(48,482
)
 
$
(14,241
)
Proceeds from sales of available for sale securities for the three months ended March 31, 2012 and 2011 were $51.7 million and $40.5 million , respectively. Scheduled principal repayments, calls and tenders for available for sale securities for the three months ended March 31, 2012 and 2011 were $0.9 billion and $1.7 billion , respectively.
Realized gains and losses on sales are determined on the basis of specific identification of investments based on the trade date. Net realized gains (losses) on investments, excluding net OTTI losses for the three months ended March 31, 2012 and 2011 are as follows:
 
Three Months Ended March 31,
 
2,012
 
2,011
 
(Dollars in thousands)
Available for sale fixed maturity securities:
 
 
 
Gross realized gains
$
1,018

 
$
1,641

Gross realized losses
(296
)
 

 
722

 
1,641

Equity securities:
 
 
 
Gross realized gains
562

 

Mortgage loans on real estate:
 
 
 
Increase in allowance for credit losses
(7,831
)
 
(2,834
)
Other investments:
 
 
 
Gain on sale of real estate
1,445

 

Impairment losses on real estate
(974
)
 

 
471

 

 
$
(6,076
)
 
$
(1,193
)


18



We review and analyze all investments on an ongoing basis for changes in market interest rates and credit deterioration. This review process includes analyzing our ability to recover the amortized cost basis of each investment that has a fair value that is materially lower than its amortized cost and requires a high degree of management judgment and involves uncertainty. The evaluation of securities for other than temporary impairments is a quantitative and qualitative process, which is subject to risks and uncertainties.
We have a policy and process in place to identify securities that could potentially have impairments that are other than temporary. This process involves monitoring market events and other items that could impact issuers. The evaluation includes but is not limited to such factors as:
the length of time and the extent to which the fair value has been less than amortized cost or cost;
whether the issuer is current on all payments and all contractual payments have been made as agreed;
the remaining payment terms and the financial condition and near-term prospects of the issuer;
the lack of ability to refinance due to liquidity problems in the credit market;
the fair value of any underlying collateral;
the existence of any credit protection available;
our intent to sell and whether it is more likely than not we would be required to sell prior to recovery for debt securities;
our assessment in the case of equity securities including perpetual preferred stocks with credit deterioration that the security cannot recover to cost in a reasonable period of time;
our intent and ability to retain equity securities for a period of time sufficient to allow for recovery;
consideration of rating agency actions; and
changes in estimated cash flows of residential mortgage and asset backed securities.
We determine whether other than temporary impairment losses should be recognized for debt and equity securities by assessing all facts and circumstances surrounding each security. Where the decline in market value of debt securities is attributable to changes in market interest rates or to factors such as market volatility, liquidity and spread widening, and we anticipate recovery of all contractual or expected cash flows, we do not consider these investments to be other than temporarily impaired because we do not intend to sell these investments and it is not more likely than not we will be required to sell these investments before a recovery of amortized cost, which may be maturity. For equity securities, we recognize an impairment charge in the period in which we do not have the intent and ability to hold the securities until recovery of cost or we determine that the security will not recover to book value within a reasonable period of time. We determine what constitutes a reasonable period of time on a security-by-security basis by considering all the evidence available to us, including the magnitude of any unrealized loss and its duration. In any event, this period does not exceed 18 months from the date of impairment for perpetual preferred securities for which there is evidence of deterioration in credit of the issuer and common equity securities. For perpetual preferred securities absent evidence of a deterioration in credit of the issuer we apply an impairment model, including an anticipated recovery period, similar to a debt security.
Other than temporary impairment losses on equity securities are recognized in operations. If we intend to sell a debt security or if it is more likely than not that we will be required to sell a debt security before recovery of its amortized cost basis, other than temporary impairment has occurred and the difference between amortized cost and fair value will be recognized as a loss in operations.
If we do not intend to sell and it is not more likely than not we will be required to sell the debt security but also do not expect to recover the entire amortized cost basis of the security, an impairment loss would be recognized in operations in the amount of the expected credit loss. We determine the amount of expected credit loss by calculating the present value of the cash flows expected to be collected discounted at each security's acquisition yield based on our consideration of whether the security was of high credit quality at the time of acquisition. The difference between the present value of expected future cash flows and the amortized cost basis of the security is the amount of credit loss recognized in operations. The remaining amount of the other than temporary impairment is recognized in other comprehensive income.
The determination of the credit loss component of a residential mortgage backed security is based on a number of factors. The primary consideration in this evaluation process is the issuer's ability to meet current and future interest and principal payments as contractually stated at time of purchase. Our review of these securities includes an analysis of the cash flow modeling under various default scenarios considering independent third party benchmarks, the seniority of the specific tranche within the structure of the security, the composition of the collateral and the actual default, loss severity and prepayment experience exhibited. With the input of third party assumptions for default projections, loss severity and prepayment expectations, we evaluate the cash flow projections to determine whether the security is performing in accordance with its contractual obligation.
We utilize the models from a leading structured product software specialist serving institutional investors. These models incorporate each security's seniority and cash flow structure. In circumstances where the analysis implies a potential for principal loss at some point in the future, we use the "best estimate" cash flow projection discounted at the security's effective yield at acquisition to determine the amount of our potential credit loss associated with this security. The discounted expected future cash flows equates to our expected recovery value. Any shortfall of the expected recovery when compared to the amortized cost of the security will be recorded as the credit loss component of other than temporary impairment.

19



The cash flow modeling is performed on a security-by-security basis and incorporates actual cash flows on the residential mortgage backed securities through the current period, as well as the projection of remaining cash flows using a number of assumptions including default rates, prepayment rates and loss severity rates. The default curves we use are tailored to the Prime or Alt-A residential mortgage backed securities that we own, which assume lower default rates and loss severity for Prime securities versus Alt-A securities. These default curves are scaled higher or lower depending on factors such as current underlying mortgage loan performance, rating agency loss projections, loan to value ratios, geographic diversity, as well as other appropriate considerations. The default curves generally assume lower loss levels for older vintage securities versus more recent vintage securities, which reflects the decline in underwriting standards over the years.
The following table presents the range of significant assumptions used to determine the credit loss component of other than temporary impairments we have recognized on residential mortgage backed securities for the three months ended March 31, 2012 and 2011 , which are all senior level tranches within the structure of the securities:
 
 
 
 
Discount Rate
 
Default Rate
 
Loss Severity
Sector
 
Vintage
 
Min
 
Max
 
Min
 
Max
 
Min
 
Max
Three months ended March 31, 2012
Prime
 
2005
 
7.5
%
 
7.5
%
 
13
%
 
13
%
 
50
%
 
50
%
 
 
2006
 
6.9
%
 
7.4
%
 
19
%
 
19
%
 
50
%
 
55
%
 
 
2007
 
6.4
%
 
7.3
%
 
15
%
 
38
%
 
50
%
 
60
%
Alt-A
 
2005
 
6.4
%
 
7.4
%
 
14
%
 
27
%
 
5
%
 
50
%
 
 
2006
 
6.0
%
 
6.0
%
 
46
%
 
46
%
 
55
%
 
55
%
 
 
2007
 
6.6
%
 
7.0
%
 
42
%
 
55
%
 
55
%
 
60
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three months ended March 31, 2011
Prime
 
2005
 
7.7
%
 
7.7
%
 
8
%
 
8
%
 
50
%
 
50
%
 
 
2006
 
7.3
%
 
7.6
%
 
9
%
 
11
%
 
50
%
 
55
%
 
 
2007
 
5.8
%
 
7.3
%
 
8
%
 
30
%
 
40
%
 
60
%
Alt-A
 
2005
 
6.0
%
 
7.7
%
 
18
%
 
18
%
 
50
%
 
50
%
 
 
2006
 
6.0
%
 
6.0
%
 
30
%
 
30
%
 
50
%
 
50
%
 
 
2007
 
6.2
%
 
7.4
%
 
29
%
 
41
%
 
50
%
 
60
%
The determination of the credit loss component of a corporate bond (including redeemable preferred stocks) is based on the underlying financial performance of the issuer and their ability to meet their contractual obligations. Considerations in our evaluation include, but are not limited to, credit rating changes, financial statement and ratio analysis, changes in management, significant changes in credit spreads, breaches of financial covenants and a review of the economic outlook for the industry and markets in which they trade. In circumstances where an issuer appears unlikely to meet its future obligation, or the security's price decline is deemed other than temporary, an estimate of credit loss is determined. Credit loss is calculated using default probabilities as derived from the credit default swaps markets in conjunction with recovery rates derived from independent third party analysis or a best estimate of credit loss. This credit loss rate is then incorporated into a present value calculation based on an expected principal loss in the future discounted at the yield at the date of purchase and compared to amortized cost to determine the amount of credit loss associated with the security.
In addition, for debt securities which we do not intend to sell and it is not more likely than not we will be required to sell, but our intent changes due to changes or events that could not have been reasonably anticipated, an other than temporary impairment charge is recognized. Once an impairment charge has been recorded, we then continue to review the other than temporarily impaired securities for appropriate valuation on an ongoing basis. Unrealized losses may be recognized in future periods through a charge to earnings, should we later conclude that the decline in fair value below amortized cost is other than temporary pursuant to our accounting policy described above. The use of different methodologies and assumptions to determine the fair value of investments and the timing and amount of impairments may have a material effect on the amounts presented in our consolidated financial statements.

20



The following table summarizes other than temporary impairments for the three months ended March 31, 2012 and 2011 , by asset type:
 
Number
of
Securities

 
Total OTTI
Losses

 
Portion of OTTI
Losses Recognized in (from) Other
Comprehensive
Income

 
Net OTTI Losses
Recognized in Operations

 
 
 
(Dollars in thousands)
Three months ended March 31, 2012
 
 
 
 
 
 
 
Fixed maturity securities, available for sale:
 
 
 
 
 
 
 
Residential mortgage backed securities
20

 
$
(1,781
)
 
$
(1,100
)
 
$
(2,881
)
 
 
 
 
 
 
 
 
Three months ended March 31, 2011
 
 
 
 
 
 
 
Fixed maturity securities, available for sale:
 
 
 
 
 
 
 
Residential mortgage backed securities
24

 
$
(5,100
)
 
$
(1,471
)
 
$
(6,571
)
The cumulative portion of other than temporary impairments determined to be credit losses which have been recognized in operations for debt securities are summarized as follows:
 
Three Months Ended March 31,
 
2012
 
2011
 
(Dollars in thousands)
Cumulative credit loss at beginning of period
$
(119,095
)
 
$
(96,893
)
Credit losses on securities for which OTTI has not previously been recognized

 
(789
)
Additional credit losses on securities for which OTTI has previously been recognized
(2,881
)
 
(5,782
)
Accumulated losses on securities that were disposed of during the period

 
1,213

Cumulative credit loss at end of period
$
(121,976
)
 
$
(102,251
)
The following table summarizes the cumulative noncredit portion of OTTI and the change in fair value since recognition of OTTI, both of which were recognized in other comprehensive income, by major type of security for securities that are part of our investment portfolio at March 31, 2012 and December 31, 2011 :
 
Amortized Cost
 
OTTI
Recognized in
Other
Comprehensive
Income
 
Change in Fair
Value Since
OTTI was
Recognized
 
Fair Value
 
(Dollars in thousands)
March 31, 2012
 
 
 
 
 
 
 
Fixed maturity securities, available for sale:
 
 
 
 
 
 
 
Corporate securities
$
3,401

 
$
(2,151
)
 
$
5,683

 
$
6,933

Residential mortgage backed securities
969,010

 
(186,026
)
 
126,626

 
909,610

Equity securities, available for sale:
 
 
 
 
 
 
 
Finance, insurance and real estate
9,976

 

 
8,512

 
18,488

 
$
982,387

 
$
(188,177
)
 
$
140,821

 
$
935,031

December 31, 2011
 
 
 
 
 
 
 
Fixed maturity securities, available for sale:
 
 
 
 
 
 
 
Corporate securities
$
3,347

 
$
(2,151
)
 
$
4,818

 
$
6,014

Residential mortgage backed securities
999,024

 
(187,126
)
 
125,502

 
937,400

Equity securities, available for sale:
 
 
 
 
 
 
 
Finance, insurance and real estate
12,019

 

 
8,110

 
20,129

 
$
1,014,390

 
$
(189,277
)
 
$
138,430

 
$
963,543


21



4. Mortgage Loans on Real Estate
Our mortgage loan portfolio totaled $2.8 billion at March 31, 2012 and December 31, 2011 with commitments outstanding of $55.2 million at March 31, 2012 .
 
March 31, 2012
 
December 31, 2011
 
(Dollars in thousands)
Principal outstanding
$
2,796,287

 
$
2,856,011

Loan loss allowance
(39,895
)
 
(32,964
)
Carrying value
$
2,756,392

 
$
2,823,047

The portfolio consists of commercial mortgage loans collateralized by the related properties and diversified as to property type, location and loan size. Our mortgage lending policies establish limits on the amount that can be loaned to one borrower and other criteria to attempt to reduce the risk of default. The mortgage loan portfolio is summarized by geographic region and property type as follows:
 
March 31, 2012
 
December 31, 2011
 
Principal Outstanding
 
Percent
 
Principal Outstanding
 
Percent
 
(Dollars in thousands)
Geographic distribution
 
 
 
 
 
 
 
East
$
717,953

 
25.7
%
 
$
719,231

 
25.2
%
Middle Atlantic
157,771

 
5.6
%
 
169,240

 
5.9
%
Mountain
407,010

 
14.5
%
 
411,054

 
14.4
%
New England
32,889

 
1.2
%
 
36,815

 
1.3
%
Pacific
306,721

 
11.0
%
 
309,693

 
10.8
%
South Atlantic
488,968

 
17.5
%
 
493,764

 
17.3
%
West North Central
458,915

 
16.4
%
 
487,693

 
17.1
%
West South Central
226,060

 
8.1
%
 
228,521

 
8.0
%
 
2,796,287

 
100.0
%
 
2,856,011

 
100.0
%
 
 
 
 
 
 
 
 
Property type distribution
 
 
 
 
 
 
 
Office
$
750,536

 
26.8
%
 
$
777,343

 
27.2
%
Medical Office
152,393

 
5.4
%
 
175,580

 
6.1
%
Retail
630,629

 
22.7
%
 
635,916

 
22.3
%
Industrial/Warehouse
699,303

 
25.0
%
 
710,426

 
24.9
%
Hotel
137,994

 
4.9
%
 
139,193

 
4.9
%
Apartment
190,159

 
6.8
%
 
187,548

 
6.6
%
Mixed use/other
235,273

 
8.4
%
 
230,005

 
8.0
%
 
2,796,287

 
100.0
%
 
2,856,011

 
100.0
%
We evaluate our mortgage loan portfolio for the establishment of a loan loss reserve by specific identification of impaired loans and the measurement of an estimated loss for each individual loan identified. A mortgage loan is i mpaired when it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. If we determine that the value of any specific mortgage loan is impaired, the carrying amount of the mortgage loan will be reduced to its fair value, based upon the present value of expected future cash flows from the loan discounted at the loan's effective interest rate, or the fair value of the underlying collateral less estimated costs to sell. In addition, we analyze the mortgage loan portfolio for the need of a general loan allowance for probable losses on all other loans. The amount of the general loan allowance is based upon management's evaluation of the collectability of the loan portfolio, historical loss experience, delinquencies, credit concentrations, underwriting standards and national and local economic conditions.
Our financing receivables currently consist of one portfolio segment which is our commercial mortgage loan portfolio. These are mortgage loans with collateral consisting of commercial real estate and borrowers consisting mostly of limited liability partnerships or limited liability corporations. Credit loss experience in our mortgage loan portfolio has been limited to the most recent fiscal years. We experienced our first credit loss from our mortgage loan portfolio in 2009.
Since 2008, we have had a population of mortgage loans that we have been carrying with workout terms (e.g. interest only periods, period of suspended payments, etc.) and a population of mortgage loans that have been in a delinquent status (i.e. more than 60 days past due). It is from this population that we have been recognizing some impairment loss due to nonpayment and eventual satisfaction of the loan by taking ownership of the collateral real estate. In most cases the fair value of the collateral less estimated costs to sell such collateral has been less than the outstanding principal amount of the mortgage loan.

22



Our general loan loss allowance as of March 31, 2011 was calculated on the cumulative outstanding principal on loans making up the group of loans currently in workout terms and loans currently more than 60 days past due. We applied a factor to the total outstanding principal of these loans that is calculated as the average specific impairment loss for the most recent 4 quarters divided by the sum of the average of the total outstanding principal of delinquent loans for the most recent 4 quarters and the average of the total outstanding principal of loans in workout for the most recent 4 quarters.
We modified the calculation for determining our general loan loss allowance during the year ended December 31, 2011. The group of loans that we are now analyzing collectively are those that have a debt service coverage ratio (DSCR) of less than 1.0. The DSCR is calculated by dividing the net operating income of the mortgaged property by the contractual principal and interest payment due for the corresponding period. We developed the loss rates to apply to this group of loans by dividing the specific impairment loss for the most recent 4 quarters by the principal outstanding of the loans with a DSCR of less than 1.0.
The following table presents a rollforward of our specific and general valuation allowances for commercial mortgage loans for the three months ended March 31, 2012 and 2011 :
 
Three Months Ended
March 31, 2012
 
Three Months Ended
March 31, 2011
 
Specific Allowance
 
General Allowance
 
Specific Allowance
 
General Allowance
 
(Dollars in thousands)
Beginning allowance balance
$
(23,664
)
 
$
(9,300
)
 
$
(13,224
)
 
$
(3,000
)
Charge-offs
900

 

 
2,116

 

Recoveries

 

 

 

Provision for credit losses
(6,831
)
 
(1,000
)
 
(2,734
)
 
(100
)
Ending allowance balance
$
(29,595
)
 
$
(10,300
)
 
$
(13,842
)
 
$
(3,100
)
The specific allowance is a total of credit loss allowances on loans which are individually evaluated for impairment. The general allowance is the group of loans discussed above which are collectively evaluated for impairment. The following table presents the total outstanding principal of loans evaluated for impairment by basis of impairment method:
 
March 31, 2012
 
December 31, 2011
 
(Dollars in thousands)
Individually evaluated for impairment
$
75,141

 
$
67,698

Collectively evaluated for impairment
173,296

 
176,681

Total loans evaluated for impairment
$
248,437

 
$
244,379

The amount of charge-offs include the amount of allowance that has been established for loans that were satisfied by taking ownership of the collateral. When the property is taken it is recorded at its fair value and the mortgage loan is recorded as fully paid, with any allowance for credit loss that has been established charged off. There could be other situations that develop where we have established a larger specific loan loss allowance than is needed based on increases in the fair value of collateral supporting collateral dependent loans, or improvements in the financial position of a borrower so that a loan would become reliant on cash flows from debt service instead of dependent upon sale of the collateral. Charge-offs of the allowance would be recognized in those situations as well. We define collateral dependent loans as those mortgage loans for which we will depend on the value of the collateral real estate to satisfy the outstanding principal of the loan. See note 2 for how we determine the value of the collateral real estate.
During the three months ended March 31, 2012 and 2011 , nine and one mortgage loans, respectively, were satisfied by taking ownership of the real estate serving as collateral. The following table summarizes the activity in the real estate owned which was obtained in satisfaction of mortgage loans on real estate:
 
Three Months Ended March 31,
 
2012
 
2011
 
(Dollars in thousands)
Real estate owned at beginning of period
$
36,821

 
$
19,122

Real estate acquired in satisfaction of mortgage loans
3,303

 
3,781

Additions

 
24

Sales
(3,083
)
 

Impairments
(974
)
 

Depreciation
(243
)
 
(137
)
Real estate owned at end of period
$
35,824

 
$
22,790


23



We analyze credit risk of our mortgage loans by analyzing all available evidence on loans that are delinquent and loans that are in a workout period.
 
March 31, 2012
 
December 31, 2011
 
(Dollars in thousands)
Credit Exposure--By Payment Activity
 
 
 
Performing
$
2,677,066

 
$
2,743,068

In workout
65,941

 
67,425

Delinquent
6,315

 
6,595

Collateral dependent
46,965

 
38,923

 
$
2,796,287

 
$
2,856,011

Mortgage loans are considered delinquent when they become 60 days past due. When loans become 90 days past due, become collateral dependent or enter a period with no debt service payments required we place them on non-accrual status and discontinue recognizing interest income. If payments are received on a delinquent loan, interest income is recognized to the extent it would have been recognized if normal principal and interest would have been received timely. If payments are received to bring a delinquent loan back to current we will resume accruing interest income on that loan. Outstanding principal of loans in a non-accrual status at March 31, 2012 and December 31, 2011 totaled $49.7 million and $45.5 million , respectively.
All of our commercial mortgage loans depend on the cash flow of the borrower to be at a sufficient level to service the principal and interest payments as they come due. In general, cash inflows of the borrowers are generated by collecting monthly rent from tenants occupying space within the borrowers' properties. Our borrowers face collateral risks such as tenants going out of business, tenants struggling to make rent payments as they become due, and tenants canceling leases and moving to other locations. We have a number of loans where the real estate is occupied by a single tenant. The current depressed and somewhat inactive commercial real estate market has resulted in some of our borrowers experiencing both a reduction in cash flow on their mortgage property as well as a reduction in the fair value of the real estate collateral. If these borrowers are unable to replace lost rent revenue and increases in the fair value of their property do not materialize we could potentially incur more losses than what we have allowed for in our specific and general loan loss allowances.
Aging of financing receivables with loans in a "workout" period as of the reporting date considered current if payments are current in accordance with agreed upon terms:
 
30 - 59 Days
 
60 - 89 Days
 
90 Days and Over
 
Total Past Due
 
Current
 
Collateral Dependent Receivables
 
Total Financing Receivables
 
(Dollars in thousands)
Commercial Mortgage Loans
 
 
 
 
 
 
 
 
 
 
 
 
 
March 31, 2012
$
2,318

 
$
3,579

 
$
2,736

 
$
8,633

 
$
2,740,689

 
$
46,965

 
$
2,796,287

December 31, 2011
$
3,378

 
$

 
$
6,595

 
$
9,973

 
$
2,807,115

 
$
38,923

 
$
2,856,011

Financing receivables summarized in the following table represent all loans that we are either not currently collecting or those we feel it is probable we will not collect all amounts due according to the contractual terms of the loan agreements (all loans that we have worked with the borrower to alleviate short-term cash flow issues, loans delinquent for more than 60 days at the reporting date, loans we have determined to be collateral dependent and loans that we have recorded specific impairments on that we feel may continue to have performance issues).
 
Recorded Investment
 
Unpaid Principal Balance
 
Related Allowance
 
Average Recorded Investment
 
Interest Income Recognized
 
(Dollars in thousands)
March 31, 2012
 
 
 
 
 
 
 
 
 
Mortgage loans with an allowance
$
45,546

 
$
75,141

 
$
(29,595
)
 
$
56,843

 
$
505

Mortgage loans with no related allowance
66,756

 
66,756

 

 
66,823

 
916

 
$
112,302

 
$
141,897

 
$
(29,595
)
 
$
123,666

 
$
1,421

December 31, 2011
 
 
 
 
 
 
 
 
 
Mortgage loans with an allowance
$
44,034

 
$
67,698

 
$
(23,664
)
 
$
53,617

 
$
3,284

Mortgage loans with no related allowance
63,023

 
63,023

 

 
60,974

 
3,509

 
$
107,057

 
$
130,721

 
$
(23,664
)
 
$
114,591

 
$
6,793

The loans that are categorized as "in workout" consist of loans that we have agreed to lower or no mortgage payments for a period of time while the borrowers address cash flow and/or operational issues. The key features of these workouts have been determined on a loan-by-loan basis. Most of these loans are in a period of low cash flow due to tenants vacating their space or tenants requesting rent relief during difficult economic periods. Generally, we have allowed the borrower a six month interest only period and in some cases a twelve month period of interest only.

24



Interest only workout loans are expected to return to their regular debt service payments after the interest only period. Interest only loans that are not fully amortizing will have a larger balance at their balloon date than originally contracted. Fully amortizing loans that are in interest only periods will have larger debt service payments for their remaining term due to lost principal payments during the interest only period. In limited circumstances we have allowed borrowers to pay the principal portion of their loan payment into an escrow account that can be used for capital and tenant improvements for a period of not more than 12 months. In these situations new loan amortization schedules are calculated based on the principal not collected during this 12 month workout period and larger payments are collected for the remaining term of each loan. In all cases, original interest rate and maturity date have not been modified and we have not forgiven any principal amounts.
A Troubled Debt Restructuring ("TDR") is a situation where we have granted a concession to a borrower for economic or legal reasons related to the borrower's financial difficulties that we would not otherwise consider. A mortgage loan that has been granted new terms, including workout terms as described previously, would be considered a TDR if it meets conditions that would indicate a borrower experiencing financial difficulty and the new terms constituting a concession on our part. We analyze all loans that we agree to workout terms and all loans that we have refinanced to determine if they meet the definition of a TDR. We consider the following factors in determining whether or not a borrower is experiencing financial difficulty:
borrower is in default,
borrower has declared bankruptcy,
there is growing concern about the borrower's ability to continue as a going concern,
borrower has insufficient cash flows to service debt,
borrower's inability to obtain funds from other sources, and
there is a breach of financial covenants by the borrower.
If the borrower is determined to be in financial difficulty, we consider the following conditions to determine if the borrower was granted a concession:

assets used to satisfy debt are less than our recorded investment,
interest rate is modified,
maturity date extension at an interest rate less than market rate,
capitalization of interest,
delaying principal and/or interest for a period of three months or more, and
partial forgiveness of the balance or charge-off.
Mortgage loan workouts, refinances or restructures that are classified as TDR are individually evaluated and measured for impairment. A summary of mortgage loans on commercial real estate with outstanding principal at March 31, 2012 and December 31, 2011 that we determined to be TDR's are as follows:
Geographic Region
 
Number of Workouts
 
Principal Balance Outstanding
 
Specific Loan Loss Allowance
 
Net Carrying Amount
 
 
 
 
(Dollars in thousands)
March 31, 2012
 
 
 
 
 
 
 
 
East
 
2
 
$
6,127

 
$
(1,964
)
 
$
4,163

Mountain
 
9
 
30,833

 
(1,260
)
 
29,573

South Atlantic
 
10
 
27,342

 
(5,213
)
 
22,129

East North Central
 
1
 
3,378

 
(894
)
 
2,484

West North Central
 
1
 
5,036

 
(1,300
)
 
3,736

 
 
23
 
$
72,716

 
$
(10,631
)
 
$
62,085

December 31, 2011
 
 
 
 
 
 
 
 
East
 
3
 
$
8,489

 
$
(2,115
)
 
$
6,374

Mountain
 
10
 
29,539

 
(1,637
)
 
27,902

South Atlantic
 
11
 
28,676

 
(6,339
)
 
22,337

West North Central
 
1
 
1,937

 
(269
)
 
1,668

 
 
25
 
$
68,641

 
$
(10,360
)
 
$
58,281



25



5. Derivative Instruments
We recognize all derivative instruments as assets or liabilities in the consolidated balance sheets at fair value. None of our derivatives qualify for hedge accounting, thus, any change in the fair value of the derivatives is recognized immediately in the consolidated statements of operations. The fair value of our derivative instruments, including derivative instruments embedded in fixed index annuity contracts, presented in the unaudited consolidated balance sheets are as follows:
 
 
March 31,
2012
 
December 31,
2011
 
 
(Dollars in thousands)
Assets
 
 
 
 
Derivative instruments
 
 
 
 
Call options
 
$
558,610

 
$
273,314

 
 
 
 
 
Other assets
 
 
 
 
2015 notes hedges
 
62,344

 
45,593

Interest rate swaps
 
890

 

 
 
$
621,844

 
$
318,907

Liabilities
 
 
 
 
Policy benefit reserves - annuity products
 
 
 
 
Fixed index annuities - embedded derivatives
 
$
2,921,037

 
$
2,530,496

Other liabilities
 
 
 
 
2015 notes embedded derivatives
 
62,344

 
45,593

 
 
$
2,983,381

 
$
2,576,089

The changes in fair value of derivatives included in the unaudited consolidated statements of operations are as follows:
 
 
Three Months Ended March 31,
 
 
2012
 
2011
 
 
(Dollars in thousands)
Change in fair value of derivatives:
 
 
 
 
Call options
 
$
241,520

 
$
143,452

2015 notes hedges
 
16,751

 
5,269

Interest rate swaps
 
890

 
(68
)
 
 
$
259,161

 
$
148,653

Change in fair value of embedded derivatives:
 
 
 
 
2015 notes embedded derivatives
 
$
16,751

 
$
5,269

Fixed index annuities
 
342,315

 
123,034

 
 
$
359,066

 
$
128,303

We have fixed index annuity products that guarantee the return of principal to the policyholder and credit interest based on a percentage of the gain in a specified market index. When fixed index annuity deposits are received, a portion of the deposit is used to purchase derivatives consisting of call options on the applicable market indices to fund the index credits due to fixed index annuity policyholders. Substantially all such call options are one year options purchased to match the funding requirements of the underlying policies. The call options are marked to fair value with the change in fair value included as a component of revenues. The change in fair value of derivatives includes the gains or losses recognized at the expiration of the option term or upon early termination and the changes in fair value for open positions. On the respective anniversary dates of the index policies, the index used to compute the annual index credit is reset and we purchase new one-year call options to fund the next annual index credit. We manage the cost of these purchases through the terms of our fixed index annuities, which permit us to change caps, participation rates, and/or asset fees, subject to guaranteed minimums on each policy's anniversary date. By adjusting caps, participation rates, or asset fees, we can generall