13. Fair Value of Financial Instruments

9 Months Ended

Sep. 30, 2012

Notes to Financial Statements

Note 13 - Fair Value of Financial Instruments

ASC 820-10 defines and establishes the framework for measuring fair value. The framework is based on inputs that are used in the valuation and a fair value hierarchy based on the quality of those inputs. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The input levels are defined as follows:

● Level 1 – inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets. Level 1 securities include highly liquid government bonds and exchange-traded equities.

● Level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. Examples of such instruments include government-backed mortgage products, certain collateralized mortgage and debt obligations and certain high-yield debt securities.

● Level 3 – inputs to the valuation methodology are unobservable and significant to the fair value measurement. Unobservable inputs reflect management’s own assumptions about inputs in which market participants would use in pricing these types of assets or liabilities. Level 3 financial instruments include values which are determined using pricing models and third-party evaluation. Additionally, the determination of some fair value estimates utilizes significant management judgments or best estimates.

The following tables present the financial instruments carried at fair value on a recurring basis by ASC 820-10 valuation hierarchy (as described above). There were no financial instruments carried at fair value on a non-recurring basis as of September 30, 2012 and December 31, 2011.

Fair Values of Financial Instruments by Level:	As of September 30, 2012
($ in millions)	Level 1		Level 2		Level 3			Total
Assets
Available-for-sale debt securities
U.S. government and agency	$	499.7	$	112.4	$	320.6	(1)	$	932.7
State and political subdivision		—		151.6		192.9			344.5
Foreign government		—		159.6		55.0			214.6
Corporate		—		3,673.2		3,733.2			7,406.4
CMBS		—		899.6		73.7			973.3
RMBS		—		1,048.8		832.8			1,881.6
CDO/CLO		—		—		216.5			216.5
Other asset-backed		—		146.1		321.0			467.1
Available-for-sale equity securities		1.6		—		29.3			30.9
Derivative assets		19.8		175.3		—			195.1
Fair value investments(2)		31.8		17.9		164.1			213.8
Separate account assets		3,395.4		—		—			3,395.4
Total assets	$	3,948.3	$	6,384.5	$	5,939.1		$	16,271.9
Liabilities
Derivative liabilities	$	—	$	60.0	$	—		$	60.0
Embedded derivatives		—		—		84.4			84.4
Total liabilities	$	—	$	60.0	$	84.4		$	144.4

———————

(1)

Includes securities whose underlying collateral is an obligation of a U.S. government entity.

(2)

Fair value investments at September 30, 2012 include $144.3 million of debt securities recorded at fair value. In addition, we have also elected the fair value option for equity securities backing our deferred compensation liabilities at $22.8 million as of September 30, 2012. Changes in the fair value of these assets are recorded through net investment income. Additionally, $46.7 million of assets relate to investment holdings of consolidated VIEs held at fair value, $8.7 million of which are Level 1 securities.

There were no transfers of assets between Level 1 and Level 2 during the nine months ended September 30, 2012.

Fair Values of Financial Instruments by Level:	As of December 31, 2011
($ in millions)	As restated and amended
	Level 1		Level 2		Level 3			Total
Assets
Available-for-sale debt securities
U.S. government and agency	$	268.2	$	137.4	$	336.2	(1)	$	741.8
State and political subdivision		—		165.2		116.6			281.8
Foreign government		—		153.4		51.8			205.2
Corporate		—		3,056.7		3,501.5			6,558.2
CMBS		—		1,028.7		100.6			1,129.3
RMBS		—		1,162.8		944.2			2,107.0
CDO/CLO		—		–		232.4			232.4
Other asset-backed		—		205.8		335.5			541.3
Available-for-sale equity securities		1.5		4.8		29.4			35.7
Derivative assets		18.9		143.3		—			162.2
Fair value investments(2)		23.7		15.5		144.8			184.0
Separate account assets		3,738.6		78.3		—			3,816.9
Total assets	$	4,050.9	$	6,151.9	$	5,793.0		$	15,995.8
Liabilities
Derivative liabilities	$	—	$	24.2	$	—		$	24.2
Embedded derivatives		—		—		84.5			84.5
Total liabilities	$	—	$	24.2	$	84.5		$	108.7

———————

(1)

Includes securities whose underlying collateral is an obligation of a U.S. government entity.

(2)

Fair value investments at December 31, 2011 include $117.9 million of debt securities recorded at fair value. In addition, we have also elected the fair value option for equity securities backing our deferred compensation liabilities at $22.1 million as of December 31, 2011. Changes in the fair value of these assets are recorded through net investment income. Additionally, $44.0 million of assets relate to investment holdings of consolidated VIEs held at fair value, $1.6 million of which are Level 1 securities.

There were no transfers of assets between Level 1 and Level 2 during the year ended December 31, 2011.

Available-for-sale debt securities as of September 30, 2012 and December 31, 2011, respectively are reported net of $33.9 million and $62.0 million of Level 2 investments included in discontinued assets on the consolidated balance sheets related to discontinued reinsurance operations.

The following tables present corporates carried at fair value and on a recurring basis by sector.

Fair Values of Corporates by Level and Sector:	As of September 30, 2012
($ in millions)	Level 1		Level 2		Level 3		Total
Corporates
Consumer	$	—	$	1,056.5	$	1,837.2	$	2,893.7
Energy		—		245.8		144.3		390.1
Financial services		—		1,421.9		760.9		2,182.8
Technical/communications		—		149.9		35.8		185.7
Transportation		—		72.8		149.2		222.0
Utilities		—		519.5		623.9		1,143.4
Other		—		206.8		181.9		388.7
Total corporates	$	—	$	3,673.2	$	3,733.2	$	7,406.4

Fair Values of Corporates by Level and Sector:	As of December 31, 2011
($ in millions)	As restated and amended
	Level 1		Level 2		Level 3		Total
Corporates
Consumer	$	—	$	898.4	$	1,662.4	$	2,560.8
Energy		—		171.7		131.4		303.1
Financial services		—		1,221.3		721.9		1,943.2
Technical/communications		—		130.9		23.8		154.7
Transportation		—		60.2		187.4		247.6
Utilities		—		467.4		619.2		1,086.6
Other		—		106.8		155.4		262.2
Total corporates	$	—	$	3,056.7	$	3,501.5	$	6,558.2

Level 3 financial assets and liabilities

The following tables set forth a summary of changes in the fair value of our Level 3 financial assets and liabilities. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The securities which were transferred as of the end of each reporting period into Level 3 were due to decreased market observability of similar assets and/or significant inputs and transfers out of Level 3 were due to increased market activity on comparable assets or observability of inputs.

Level 3 Financial Assets:	Three months ended September 30, 2012
($ in millions)													Realized &
													unrealized			Unrealized
													gains			gains
	Balance,							Transfers		Transfers			(losses)			(losses)
	beginning							into		out of			included			included
	of period		Purchases		Sales			Level 3		Level 3			in income(1)			in OCI			Total
Assets
Available-for-sale debt securities
U.S. government and agency(2)	$	322.9	$	0.6	$	(2.3	)	$	—	$	—		$	0.2		$	(0.8	)	$	320.6
State and political subdivision		181.7		10.2		(0.4	)		—		—			—			1.4			192.9
Foreign government		52.9		—		—			—		—			—			2.1			55.0
Corporate		3,702.2		88.4		(10.2	)		—		(18.8	)		—			(28.4	)		3,733.2
CMBS		99.2		—		—			—		—			—			(25.5	)		73.7
RMBS		857.5		3.8		(9.1	)		—		—			(0.4	)		(19.0	)		832.8
CDO/CLO		207.6		—		(5.5	)		—		—			0.5			13.9			216.5
Other asset-backed		297.5		3.5		(5.9	)		32.5		—			(0.5	)		(6.1	)		321.0
Available-for-sale equity securities		36.0		—		—			—		—			(1.5	)		(5.2	)		29.3
Fair value investments		159.3		1.8		(10.2	)		—		(1.4	)		14.6			—			164.1
Total assets	$	5,916.8	$	108.3	$	(43.6	)	$	32.5	$	(20.2	)	$	12.9		$	(67.6	)	$	5,939.1

———————

(1)	Reflected in realized investment gains and losses for all assets except limited partnerships and other investments and fair value investments.
(2)	Includes securities whose underlying collateral is an obligation of a U.S. government entity.

Level 3 Financial Assets:	Three months ended September 30, 2011
($ in millions)	As restated and amended
													Realized &
													unrealized			Unrealized
													gains			gains
	Balance,							Transfers		Transfers			(losses)			(losses)
	beginning							into		out of			included			included
	of period		Purchases		Sales			Level 3		Level 3			in income(1)			in OCI			Total
Assets
A      Available-for-sale debt securities
U.S. government and agency(2)	$	331.7	$	—	$	(2.1	)	$	—	$	—		$	—		$	22.5		$	352.1
State and political subdivision		74.1		—		(0.7	)		2.5		—			—			16.9			92.8
Foreign government		46.0		—		—			—		—			—			(7.1	)		38.9
Corporate		3,276.7		26.9		(16.4	)		175.0		(7.2	)		(2.6	)		(1.6	)		3,450.8
CMBS		89.2		8.9		(2.0	)		—		—			(2.5	)		(9.8	)		83.8
RMBS		1,022.9		44.0		(38.9	)		—		—			(1.7	)		(46.4	)		979.9
CDO/CLO		230.5		10.1		(3.7	)		—		—			(1.2	)		(20.3	)		215.4
Other asset-backed		357.1		7.8		(10.0	)		—		—			(0.3	)		(10.4	)		344.2
A v Available-for-sale equity securities		39.9		—		—			1.1		—			—			(3.4	)		37.6
Fair value investments		143.4		—		(1.0	)		—		—			(5.6	)		—			136.8
Total assets	$	5,611.5	$	97.7	$	(74.8	)	$	178.6	$	(7.2	)	$	(13.9	)	$	(59.6	)	$	5,732.3

———————

(1)	Reflected in realized investment gains and losses for all assets except limited partnerships and other investments and fair value investments.
(2)	Includes securities whose underlying collateral is an obligation of a U.S. government entity.

Level 3 Financial Assets:	Nine months ended September 30, 2012
($ in millions)													Realized &
													unrealized			Unrealized
													gains			gains
	Balance,							Transfers		Transfers			(losses)			(losses)
	beginning							into		out of			included			included
	of period		Purchases		Sales			Level 3		Level 3			in income(1)			in OCI			Total
Assets
Available-for-sale debt securities
U.S. government and agency(2)	$	336.2	$	2.6	$	(13.9	)	$	—	$	—		$	0.2		$	(4.5	)	$	320.6
State and political subdivision		116.6		40.5		(2.5	)		22.2		(8.3	)		—			24.4			192.9
Foreign government		51.8		5.0		(0.1	)		—		—			—			(1.7	)		55.0
Corporate		3,501.5		457.6		(65.8	)		56.3		(122.4	)		(0.5	)		(93.5	)		3,733.2
CMBS		100.6		—		(8.2	)		12.1		(37.1	)		(4.2	)		10.5			73.7
RMBS		944.2		2.9		(94.6	)		—		—			(6.7	)		(13.0	)		832.8
CDO/CLO		232.4		9.9		(18.6	)		—		—			1.3			(8.5	)		216.5
Other asset-backed		335.5		17.2		(26.4	)		0.1		(11.4	)		(1.5	)		7.5			321.0
Available-for-sale equity securities		29.4		5.6		—			4.8		—			(1.5	)		(9.0	)		29.3
Fair value investments		144.8		26.3		(9.0	)		—		—			2.0			—			164.1
Total assets	$	5,793.0	$	567.6	$	(239.1	)	$	95.5	$	(179.2	)	$	(10.9	)	$	(87.8	)	$	5,939.1

———————

(1)	Reflected in realized investment gains and losses for all assets except limited partnerships and other investments and fair value investments.
(2)	Includes securities whose underlying collateral is an obligation of a U.S. government entity.

Level 3 Financial Assets:	Nine months ended September 30, 2011
($ in millions)	As restated and amended
													Realized &
													unrealized			Unrealized
													gains			gains
	Balance,							Transfers		Transfers			(losses)			(losses)
	beginning							into		out of			included			included
	of period		Purchases		Sales			Level 3		Level 3			in income(1)			in OCI			Total
Assets
Available-for-sale debt securities
U.S. government and agency(2)	$	341.4	$	5.2	$	(7.9	)	$	6.9	$	—		$	—		$	6.5		$	352.1
State and political subdivision		67.1		10.0		(1.4	)		—		—			—			17.1			92.8
Foreign government		47.1		—		—			—		(7.0	)		—			(1.2	)		38.9
Corporate		3,278.3		308.1		(51.7	)		149.0		(95.9	)		(7.0	)		(130.0	)		3,450.8
CMBS		91.7		5.0		(5.0	)		8.4		(17.8	)		(1.9	)		3.4			83.8
RMBS		919.1		184.4		(77.2	)		—		—			(3.1	)		(43.3	)		979.9
CDO/CLO		238.0		0.3		(6.2	)		—		—			(0.8	)		(15.9	)		215.4
Other asset-backed		252.8		102.9		(30.9	)		3.2		(6.0	)		0.5			21.7			344.2
Available-for-sale equity securities		36.2		4.0		—			0.6		—			—			(3.2	)		37.6
Fair value investments		126.0		13.6		(10.5	)		—		—			7.7			—			136.8
Total assets	$	5,397.7	$	633.5	$	(190.8	)	$	168.1	$	(126.7	)	$	(14.6	)	$	(144.9	)	$	5,432.3

———————

(1)	Reflected in realized investment gains and losses for all assets except limited partnerships and other investments and fair value investments.
(2)	Includes securities whose underlying collateral is an obligation of a U.S. government entity.

Level 3 Financial Liabilities:	Embedded Derivative Liabilities
($ in millions)	Three Months Ended							Nine Months Ended
	September 30,							September 30,
	2012			2011				2012			2011
				As restated and amended							As restated and amended
Balance, beginning of period	$	89.3			$	46.2		$	84.5			$	30.4
Net purchases/(sales)		2.2				(9.0	)		6.8				14.5
Transfers into Level 3		—				—			—				—
Transfers out of Level 3		—				—			—				—
Realized (gains) losses(1)		(7.1	)			50.5			(6.9	)			42.9
Balance, end of period	$	84.4			$	87.8		$	84.4			$	87.8

———————

(1) Realized gains and losses are included in net realized investment gains on the consolidated statements of comprehensive income.

Significant unobservable inputs used in the fair value measurement of Level 3 assets are yield, prepayment rate, default rate, recovery rate, and reinvestment spread. Keeping other inputs unchanged, an increase in yield or default rate would decrease the fair value of the asset while an increase in prepayment rate, recovery rate, or reinvestment spread would result in an increase to the fair value of the asset. Yields are a function of the underlying treasury rates and asset spreads, and changes in default and recovery rates are dependent on overall market conditions.

The following table presents quantitative estimates about unobservable inputs used in the fair value measurement of significant categories of internally priced assets.

Level 3 Assets: (1)	As of September 30, 2012
($ in millions)
	Fair		Valuation	Unobservable
	Value		Technique(s)	Input	Range (Weighted Average)
U.S. government and agency	$	282.8	Spread matrix	Yield	1.54% - 5.21% (2.98%)
State and political subdivision	$	85.7	Discounted cash flow	Yield	1.80% - 3.41% (2.71%)
Foreign Government	$	10.1	Spread matrix	Yield	2.11%
Corporate	$	2,825.9	Spread matrix	Yield	1.53% - 6.86% (2.78%)
			Discounted cash flow	Yield	1.51% - 8.24% (3.16%)
CDO/CLO	$	18.0	Discounted cash flow	Prepayment rate	20% (CLOs)
				Default rate	2.5% (CLOs)
				Recovery rate	65% (Loans), 35% (High yield bonds), 45% (Investment grade bonds)
				Reinvestment spread	3 mo LIBOR + 400bps (CLOs)
Other asset-backed	$	41.9	Discounted cash flow	Yield	2.41% - 5.38% (2.66%)
			Discounted cash flow	Prepayment rate	5%
				Default rate	2.53% for 48 mos then .33% thereafter
				Recovery rate	10% (TRUPS)
Fair value option investments	$	4.8	Discounted cash flow	Default rate	0.24%
				Recovery rate	45%

———————

(1) Excludes Level 3 assets which are valued based upon non-binding independent third-party valuations for which unobservable inputs are not reasonably available to us.

Significant unobservable inputs used in the fair value measurement of variable annuity GMAB and GMWB liabilities are equity volatility, swap curve, mortality and lapse rates and an adjustment for non-performance risk. Keeping other inputs unchanged, an increase in the equity volatility would increase the fair value of the liability while an increase in the swap curve or CSA would result in a decrease to the fair value of the liability. The impact of changes in mortality and lapse rates are dependent on overall market conditions. The fair value of fixed indexed annuity and indexed universal life embedded derivative related to index credits is calculated using the swap curve, mortality and lapse rates, as well as an adjustment for non-performance risk. Keeping other inputs unchanged, an increase in any of these significant unobservable inputs would result in a decrease of the fixed indexed annuity embedded derivative liability.

The following table presents quantitative estimates about unobservable inputs used in the fair value measurement of internally priced liabilities.

Level 3 Liabilities:	As of September 30, 2012
($ in millions)	Fair Value		Valuation Technique(s)	Unobservable Input	Range
Embedded derivatives	$	48.7	Budget method	Swap curve	0.24% - 2.32%
(EIA VED)				Mortality rate	75% of A2000 basic table
				Lapse rate	1.00% - 35.00%
				CSA	4.75%
Embedded derivatives (GMAB / GMWB)	$	35.7	Risk neutral stochastic   valuation methodology	Volatility surface	11.75% - 48.97%
				Swap curve	0.24% - 2.98%
				Mortality rate	75% of A2000 basic table
				Lapse rate	0.00% - 60.00%
				CSA	4.75%
Total Level 3 liabilities	$	84.4

Level 3 Assets and Liabilities by Pricing Source:	As of September 30, 2012
($ in millions)	Internal(1)		External(2)		Total
Assets
Available-for-sale debt securities
U.S. government and agency(3)	$	282.8	$	37.8	$	320.6
State and political subdivision		85.7		107.2		192.9
Foreign government		10.1		44.9		55.0
Corporate		2,825.9		907.3		3,733.2
CMBS		—		73.7		73.7
RMBS		—		832.8		832.8
CDO/CLO		18.0		198.5		216.5
Other asset-backed		41.9		279.1		321.0
Available-for-sale equity securities		—		29.3		29.3
Fair value investments		4.8		159.3		164.1
Total assets	$	3,269.2	$	2,669.9	$	5,939.1
Liabilities
Embedded derivatives	$	84.4	$	—	$	84.4
Total liabilities	$	84.4	$	—	$	84.4

———————

(1)	Represents valuations reflecting both internally-derived and market inputs, as well as third-party information or quotes.
(2)	Represents unadjusted prices from independent pricing services, third-party financial statements and independent indicative broker quotes where pricing inputs are not readily available.

(3) Includes securities whose underlying collateral is an obligation of a U.S. government entity.

Level 3 Assets and Liabilities by Pricing Source:	As of December 31, 2011
	As restated and amended
($ in millions)	Internal(1)		External(2)		Total
Assets
Available-for-sale debt securities
U.S. government and agency(3)	$	315.4	$	20.8	$	336.2
State and political subdivision		30.9		85.7		116.6
Foreign government		10.4		41.4		51.8
Corporate		2,662.8		838.7		3,501.5
CMBS		—		100.6		100.6
RMBS		—		944.2		944.2
CDO/CLO		199.3		33.1		232.4
Other asset-backed		59.1		276.4		335.5
Available-for-sale equity securities		—		29.4		29.4
Fair value investments		37.9		106.9		144.8
Total assets	$	3,315.8	$	2,477.2	$	5,793.0
Liabilities
Embedded derivatives	$	84.5	$	—	$	84.5
Total liabilities	$	84.5	$	—	$	84.5

———————

(1)	Represents valuations reflecting both internally-derived and market inputs, as well as third-party information or quotes.
(2)	Represents unadjusted prices from independent pricing services, third-party financial statements and independent indicative broker quotes where pricing inputs are not readily available.

(3) Includes securities whose underlying collateral is an obligation of a U.S. government entity.

Financial instruments not carried at fair value

The Company is required by U.S. GAAP to disclose the fair value of certain financial instruments including those that are not carried at fair value. The following table discloses the Company’s financial instruments where the carrying amounts and fair values differ:

Carrying Amounts and Fair Values		As of September 30, 2012				As of December 31, 2011
of Financial Instruments:	Fair Value					As restated and amended
($ in millions)	Hierarchy	Carrying		Fair		Carrying		Fair
	Level	Value		Value		Value		Value
Financial assets:
Policy loans	Level 3	$	2,338.4	$	2,326.8	$	2,379.3	$	2,367.7
Cash and cash equivalents	Level 1		283.8		283.8		168.2		168.2
Financial liabilities:
Investment contracts	Level 3	$	2,914.6	$	2,920.2	$	2,432.3	$	2,443.5
Surplus notes	Level 3		126.1		95.0		174.2		126.9
Senior unsecured bonds	Level 2		252.7		245.1		252.7		195.1