Fair Values of Financial Instruments

The following sets forth a comparison of the carrying amounts and fair values of our financial instruments:



	December 31,
	2015				2014
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
	(Dollars in thousands)
Assets
Fixed maturity securities:
Available for sale	$	36,421,839	$	36,421,839	$	32,445,202	$	32,445,202
Held for investment	76,622		65,377		76,432		75,838
Equity securities, available for sale	7,828		7,828		7,805		7,805
Mortgage loans on real estate	2,435,257		2,471,864		2,434,580		2,493,901
Derivative instruments	337,256		337,256		731,113		731,113
Other investments	285,044		290,075		266,488		273,004
Cash and cash equivalents	397,749		397,749		701,514		701,514
Coinsurance deposits	3,187,470		2,860,882		3,044,342		2,698,552
Interest rate caps	1,411		1,411		2,778		2,778
2015 notes hedges	—		—		30,291		30,291
Counterparty collateral	82,312		82,312		206,096		206,096

Liabilities
Policy benefit reserves	45,151,460		38,435,515		39,463,987		33,078,978
Single premium immediate annuity (SPIA) benefit reserves	324,264		336,066		365,440		377,654
Notes payable	400,000		417,752		421,679		503,349
Subordinated debentures	246,450		216,933		246,243		244,437
2015 notes embedded conversion derivative	—		—		30,291		30,291
Interest rate swap	3,139		3,139		2,644		2,644

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.

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. There were no transfers between levels during any period presented.

Our assets and liabilities which are measured at fair value on a recurring basis as of December 31, 2015 and 2014 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)
December 31, 2015
Assets
Fixed maturity securities:
Available for sale:
United States Government full faith and credit	$	471,256	$	438,598	$	32,658	$	—
United States Government sponsored agencies	1,398,611		—		1,398,611		—
United States municipalities, states and territories	3,755,367		—		3,755,367		—
Foreign government obligations	212,565		—		212,565		—
Corporate securities	23,802,394		121		23,802,273		—
Residential mortgage backed securities	1,462,072		—		1,462,072		—
Commercial mortgage backed securities	4,174,396		—		4,174,396		—
Other asset backed securities	1,145,178		—		1,145,178		—
Equity securities, available for sale: finance, insurance and real estate	7,828		—		7,828		—
Derivative instruments	337,256		—		337,256		—
Cash and cash equivalents	397,749		397,749		—		—
Interest rate caps	1,411		—		1,411		—
Counterparty collateral	82,312		—		82,312		—
	$	37,248,395	$	836,468	$	36,411,927	$	—
Liabilities
Interest rate swap	$	3,139	$	—	$	3,139	$	—
Fixed index annuities—embedded derivatives	5,983,622		—		—		5,983,622
	$	5,986,761	$	—	$	3,139	$	5,983,622
December 31, 2014
Assets
Fixed maturity securities:
Available for sale:
United States Government full faith and credit	$	138,460	$	4,255	$	134,205	$	—
United States Government sponsored agencies	1,393,890		—		1,393,890		—
United States municipalities, states and territories	3,723,309		—		3,723,309		—
Foreign government obligations	193,803		—		193,803		—
Corporate securities	21,490,292		11		21,490,281		—
Residential mortgage backed securities	1,751,345		—		1,750,970		375
Commercial mortgage backed securities	2,807,620		—		2,807,620		—
Other asset backed securities	946,483		—		946,483		—
Equity securities, available for sale: finance, insurance and real estate	7,805		—		7,805		—
Derivative instruments	731,113		—		731,113		—
Cash and cash equivalents	701,514		701,514		—		—
Interest rate caps	2,778		—		2,778		—
2015 notes hedges	30,291		—		30,291		—
Counterparty collateral	206,096		—		206,096		—
	$	34,124,799	$	705,780	$	33,418,644	$	375
Liabilities
2015 notes embedded conversion derivative	$	30,291	$	—	$	30,291	$	—
Interest rate swap	2,644		—		2,644		—
Fixed index annuities—embedded derivatives	5,574,653		—		—		5,574,653
	$	5,607,588	$	—	$	32,935	$	5,574,653

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 multiple broker quotes and take the average of the 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 using 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 December 31, 2015 and 2014.

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. 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 determined by our investment team 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, equity method investments 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 investments qualify as Level 3 fair values and were 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 the cash surrender value of the policies and whose fair values fall within Level 2 of the fair value hierarchy.

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.

Interest rate swap and caps

The fair values of our pay fixed/receive variable interest rate swap and interest rate caps are obtained from third parties and are determined by discounting expected future cash flows using projected LIBOR rates for the term of the swap and caps.

2015 notes hedges

The fair value of these call options has been 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.

Counterparty collateral

Amounts reported in other assets of 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.

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 values of our senior unsecured notes and convertible senior notes are 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 conversion derivative

The fair value of this embedded derivative was determined by pricing the call options that hedge this potential liability. The terms of the conversion option 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 benefit reserves 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.

Within this determination we have the following significant unobservable inputs: 1) the expected cost of annual call options we will purchase in the future to fund index credits beyond the next policy anniversary and 2) our best estimates for future policy decrements, primarily lapse, partial withdrawal and mortality rates. As of December 31, 2015 and 2014, we utilized an estimate of 3.10% and 3.10%, respectively, for the expected cost of annual call options, which are based on estimated account value growth and a historical review of our actual option costs.

Our best estimate assumptions for lapse, partial withdrawal and mortality rates are based on our actual experience and our outlook as to future expectations for such assumptions. These assumptions, which are consistent with the assumptions used in calculating deferred policy acquisition costs and deferred sales inducements, are reviewed on a quarterly basis and are revised as our experience develops and/or as future expectations change. Our mortality rate assumptions are based on 65% of the 1983 Basic Annuity Mortality Tables. The following table presents average lapse rate and partial withdrawal rate assumptions, by contract duration, used in estimating the fair value of the embedded derivative component of our fixed index annuity policy benefit reserves at each reporting date:



	Average Lapse Rates				Average Partial Withdrawal Rates
Contract Duration (Years)	Year Ended December 31, 2015		Year Ended December 31, 2014		Year Ended December 31, 2015		Year Ended December 31, 2014
1 - 5	1.58	%	1.60	%	3.08	%	3.07	%
6 - 10	8.55	%	8.14	%	3.55	%	3.54	%
11 - 15	12.01	%	11.58	%	3.59	%	3.56	%
16 - 20	12.99	%	12.25	%	3.22	%	3.31	%
20+	12.54	%	11.94	%	3.22	%	3.31	%

Lapse rates are generally expected to increase as surrender charge percentages decrease. Lapse expectations reflect a significant increase in the year in which the surrender charge period on a contract ends.

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 years ended December 31, 2015 and 2014:



	Year Ended December 31,
	2015			2014
	(Dollars in thousands)
Available for sale securities
Beginning balance	$	375		$	1,376
Principal returned	(23		)	(285		)
Amortization of premium/accretion of discount	(494		)	(262		)
Total gains (losses) (realized/unrealized):
Included in other comprehensive income (loss)	280			109
Included in operations	(138		)	(563		)
Ending balance	$	—		$	375

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.



	Year Ended December 31,
	2015			2014
	(Dollars in thousands)
Fixed index annuities—embedded derivatives
Beginning balance	$	5,574,653		$	4,406,163
Premiums less benefits	1,234,637			1,700,827
Change in fair value, net	(825,668		)	(532,337		)
Ending balance	$	5,983,622		$	5,574,653

Change in fair value, net for each period in our embedded derivatives are included in change in fair value of embedded derivatives in the 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 the method described above under fixed index annuities - embedded derivatives. 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 December 31, 2015, were to increase by 100 basis points, the fair value of the embedded derivatives would decrease by $400.3 million recorded through operations as a decrease in the change in fair value of embedded derivatives and there would be a corresponding decrease of $173.3 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 $447.5 million recorded through operations as an increase in the change in fair value of embedded derivatives and there would be a corresponding increase of $248.9 million to our combined balance for deferred policy acquisition costs and deferred sales inducements recorded through operations as a decrease in amortization of deferred policy acquisition costs and deferred sales inducements.