10-Q 1 plc6301810-q.htm 10-Q Document

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
 
FORM 10-Q
 
ý  Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended June 30, 2018
 
or
 
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 001-11339
 
PROTECTIVE LIFE CORPORATION
(Exact name of registrant as specified in its charter) 
DELAWARE
 
95-2492236
(State or other jurisdiction of incorporation or organization)
 
(IRS Employer Identification Number)
 
2801 HIGHWAY 280 SOUTH
BIRMINGHAM, ALABAMA 35223
(Address of principal executive offices and zip code)
 
Registrant’s telephone number, including area code (205) 268-1000
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for 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 ý 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 ý No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definition of “large accelerated filer”, “accelerated filer”, “smaller reporting company”, and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer o
 
Accelerated Filer o
 
 
 
Non-accelerated filer x
(Do not check if a smaller reporting company)
Smaller Reporting Company o
 
 
 
 
 
Emerging Growth Company o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o No ý
 
Number of shares of Common Stock, $0.01 Par Value, outstanding as of July 23, 2018:  1,000
 





PROTECTIVE LIFE CORPORATION
QUARTERLY REPORT ON FORM 10-Q
FOR QUARTERLY PERIOD ENDED JUNE 30, 2018
 
TABLE OF CONTENTS
 
PART I
 
 
 
 
Page
Item 1.
Financial Statements (unaudited):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
Item 3.
 
Item 4.
 
 
 
 
 
 
 
 
 
Item 1A.
 
Item 2.
 
Item 6.
 
 
 





PROTECTIVE LIFE CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
(Unaudited)
 
For The
Three Months Ended
June 30,
 
For The
Six Months Ended
June 30,
 
2018
 
2017
 
2018
 
2017
 
(Dollars In Thousands)
Revenues
 

 
 
 
 
 
 

Premiums and policy fees
$
941,868

 
$
868,139

 
$
1,831,034

 
$
1,728,725

Reinsurance ceded
(390,941
)
 
(342,898
)
 
(736,364
)
 
(658,974
)
Net of reinsurance ceded
550,927

 
525,241


1,094,670

 
1,069,751

Net investment income
616,462

 
507,771

 
1,137,325

 
1,014,184

Realized investment gains (losses):
 

 
 

 
 

 
 

Derivative financial instruments
12,265

 
(108,188
)
 
90,324

 
(178,066
)
All other investments
(49,602
)
 
53,717

 
(137,201
)
 
76,558

Other-than-temporary impairment losses
(10
)
 
(33
)
 
(701
)
 
(2,758
)
Portion recognized in other comprehensive income (before taxes)
5

 
(2,752
)
 
(2,949
)
 
(7,858
)
Net impairment losses recognized in earnings
(5
)
 
(2,785
)
 
(3,650
)
 
(10,616
)
Other income
113,861

 
111,311

 
228,272

 
220,553

Total revenues
1,243,908

 
1,087,067

 
2,409,740

 
2,192,364

Benefits and expenses
 

 
 

 
 

 
 

Benefits and settlement expenses, net of reinsurance ceded: (three and six months 2018 - $298,016 and $645,653; three and six months 2017 - $286,234 and $549,611)
861,548

 
712,361

 
1,648,350

 
1,462,003

Amortization of deferred policy acquisition costs and value of business acquired
52,517

 
23,102

 
110,498

 
43,621

Other operating expenses, net of reinsurance ceded: (three and six months 2018 - $51,559 and $94,676; three and six months 2017 - $53,305 and $104,322)
231,071

 
225,836

 
460,322

 
448,623

Total benefits and expenses
1,145,136

 
961,299

 
2,219,170

 
1,954,247

Income before income tax
98,772

 
125,768

 
190,570

 
238,117

Income tax expense
17,277

 
41,500

 
34,963

 
78,435

Net income
$
81,495

 
$
84,268

 
$
155,607

 
$
159,682


See Notes to the Consolidated Condensed Financial Statements
2


PROTECTIVE LIFE CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
 
 
 
For The
Three Months Ended
June 30,
 
For The
Six Months Ended
June 30,
 
2018
 
2017
 
2018
 
2017
 
(Dollars In Thousands)
Net income
$
81,495

 
$
84,268

 
$
155,607

 
$
159,682

Other comprehensive income (loss):
 

 
 
 
 
 
 

Change in net unrealized gains (losses) on investments, net of income tax: (three months: 2018 - $(113,653); 2017 - $155,316; six months: 2018 - $(267,032); 2017 - $241,278)
(427,550
)
 
288,445

 
(1,005,262
)
 
448,086

Reclassification adjustment for investment amounts included in net income, net of income tax: (three months: 2018 - $(1,162); 2017 - $1,355; six months: 2018 - $(981); 2017 - $777)
(4,372
)
 
2,517

 
(3,691
)
 
1,445

Change in net unrealized gains (losses) relating to other-than-temporary impaired investments for which a portion has been recognized in earnings, net of income tax: (three months: 2018 - $3; 2017 - $1,390; six months: 2018 - $6; 2017 - $3,385)
11

 
2,583

 
22

 
6,286

Change in accumulated (loss) gain - derivatives, net of income tax: (three months: 2018 - $623; 2017 - $(64); six months: 2018 - $752; 2017 - $(426))
2,344

 
(120
)
 
2,831

 
(792
)
Reclassification adjustment for derivative amounts included in net income, net of income tax: (three months: 2018 - $43; 2017 - $53; six months: 2018 - $67; 2017 - $125)
162

 
100

 
251

 
233

Total other comprehensive income (loss)
(429,405
)
 
293,525

 
(1,005,849
)
 
455,258

Total comprehensive income (loss)
$
(347,910
)
 
$
377,793

 
$
(850,242
)
 
$
614,940


See Notes to the Consolidated Condensed Financial Statements
3


PROTECTIVE LIFE CORPORATION
CONSOLIDATED CONDENSED BALANCE SHEETS
(Unaudited)
 
 
As of
 
June 30, 2018
 
December 31, 2017
 
(Dollars In Thousands)
Assets
 

 
 

Fixed maturities, at fair value (amortized cost: 2018 - $53,634,144; 2017 - $41,153,551)
$
51,751,205

 
$
41,176,052

Fixed maturities, at amortized cost (fair value: 2018 - $2,582,938; 2017 - $2,776,327)
2,677,726

 
2,718,904

Equity securities, at fair value (cost: 2018 - $675,527; 2017 - $740,813)
680,232

 
754,360

Mortgage loans (related to securitizations: 2018 - $918; 2017 - $226,409)
7,516,192

 
6,817,723

Investment real estate, net of accumulated depreciation (2018 - $186; 2017 - $132)
7,179

 
8,355

Policy loans
1,721,743

 
1,615,615

Other long-term investments
939,220

 
915,595

Short-term investments
709,703

 
615,210

Total investments
66,003,200


54,621,814

Cash
190,732

 
252,310

Accrued investment income
632,574

 
491,802

Accounts and premiums receivable
171,415

 
124,934

Reinsurance receivables
4,964,793

 
5,075,698

Deferred policy acquisition costs and value of business acquired
2,870,620

 
2,199,577

Goodwill
793,470

 
793,470

Other intangibles, net of accumulated amortization (2018 - $168,852; 2017 - $140,368)
639,538

 
663,572

Property and equipment, net of accumulated depreciation (2018 - $28,055; 2017 - $22,926)
107,586

 
111,417

Other assets
199,224

 
227,357

Income tax receivable

 
76,543

Assets related to separate accounts
 
 
 

Variable annuity
13,414,407

 
13,956,071

Variable universal life
1,037,754

 
1,035,202

Total assets
$
91,025,313


$
79,629,767


See Notes to the Consolidated Condensed Financial Statements
4


PROTECTIVE LIFE CORPORATION
CONSOLIDATED CONDENSED BALANCE SHEETS
(Unaudited)
(continued)
 
 
As of
 
June 30, 2018
 
December 31, 2017
 
(Dollars In Thousands)
Liabilities
 

 
 

Future policy benefits and claims
$
42,175,692

 
$
30,957,592

Unearned premiums
869,854

 
875,405

Total policy liabilities and accruals
43,045,546

 
31,832,997

Stable value product account balances
5,025,930

 
4,698,371

Annuity account balances
13,303,399

 
10,921,190

Other policyholders’ funds
1,161,767

 
1,267,198

Other liabilities
2,535,106

 
2,353,565

Income tax payable
26,549

 

Deferred income taxes
936,045

 
1,232,407

Non-recourse funding obligations
2,675,432

 
2,747,477

Secured financing liabilities
104,539

 
1,017,749

Debt
1,109,049

 
945,052

Subordinated debt
605,358

 
495,289

Liabilities related to separate accounts
 

 
 

Variable annuity
13,414,407

 
13,956,071

Variable universal life
1,037,754

 
1,035,202

Total liabilities
84,980,881


72,502,568

Commitments and contingencies - Note 12


 


Shareowner’s equity
 

 
 

Common Stock: 2018 and 2017 - $0.01 par value; shares authorized: 5,000; shares issued: 1,000

 

Additional paid-in-capital
5,554,059

 
5,554,059

Retained earnings
1,494,078

 
1,560,444

Accumulated other comprehensive income (loss):
 

 
 

Net unrealized (losses) gains on investments, net of income tax: (2018 - $(264,124); 2017 - $6,883)
(993,609
)
 
25,896

Net unrealized losses relating to other-than-temporary impaired investments for which a portion has been recognized in earnings, net of income tax: (2018 - $0; 2017 - $(6))

 
(22
)
Accumulated gain (loss) - derivatives, net of income tax: (2018 - $1,018; 2017 - $198)
3,829

 
747

Postretirement benefits liability adjustment, net of income tax: (2018 - $(3,469); 2017 - $(3,469))
(13,925
)
 
(13,925
)
Total shareowner’s equity
6,044,432


7,127,199

Total liabilities and shareowner’s equity
$
91,025,313


$
79,629,767


See Notes to the Consolidated Condensed Financial Statements
5


PROTECTIVE LIFE CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF SHAREOWNER’S EQUITY
(Unaudited)

 
Common
Stock
 
Additional
Paid-In-
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Total
Shareowner’s
Equity
 
(Dollars In Thousands)
Balance, December 31, 2017
$

 
$
5,554,059

 
$
1,560,444

 
$
12,696

 
$
7,127,199

Net income for the six months ended June 30, 2018
 

 
 

 
155,607

 
 

 
155,607

Other comprehensive loss
 

 
 

 
 

 
(1,005,849
)
 
(1,005,849
)
Comprehensive loss for the six months ended June 30, 2018
 

 
 

 
 

 
 

 
(850,242
)
Cumulative effect adjustments
 
 
 
 
(81,973
)
 
(10,552
)
 
(92,525
)
Dividends to parent
 
 
 
 
(140,000
)
 
 
 
(140,000
)
Balance, June 30, 2018
$

 
$
5,554,059

 
$
1,494,078

 
$
(1,003,705
)
 
$
6,044,432


See Notes to the Consolidated Condensed Financial Statements
6


PROTECTIVE LIFE CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
 

 
For The
Six Months Ended
June 30,
 
2018
 
2017
 
(Dollars In Thousands)
Cash flows from operating activities
 
 
 

Net income
$
155,607

 
$
159,682

Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 

Realized investment (gains) losses
50,527

 
112,124

Amortization of DAC and VOBA
110,498

 
43,621

Capitalization of DAC
(223,686
)
 
(133,799
)
Depreciation and amortization expense
33,785

 
30,765

Deferred income tax
3,065

 
62,327

Accrued income tax
103,092

 
16,754

Interest credited to universal life and investment products
389,009

 
326,949

Policy fees assessed on universal life and investment products
(748,474
)
 
(666,174
)
Change in reinsurance receivables
111,242

 
77,594

Change in accrued investment income and other receivables
(34,198
)
 
9,326

Change in policy liabilities and other policyholders’ funds of traditional life and health products
(270,188
)
 
(163,476
)
Trading securities:
 

 
 

Maturities and principal reductions of investments
117,994

 
77,697

Sale of investments
118,370

 
136,007

Cost of investments acquired
(206,741
)
 
(193,774
)
Other net change in trading securities
13,791

 
12,504

Amortization of premiums and accretion of discounts on investments and mortgage loans
150,402

 
219,097

Change in other liabilities
37,809

 
60,499

Other, net
8,256

 
(117,697
)
Net cash (used in) provided by operating activities
$
(79,840
)
 
$
70,026



 

See Notes to the Consolidated Condensed Financial Statements
7


PROTECTIVE LIFE CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
(continued)


 
For The
Six Months Ended
June 30,
 
2018
 
2017
 
(Dollars In Thousands)
Cash flows from investing activities
 

 
 

Maturities and principal reductions of investments, available-for-sale
$
592,514

 
$
349,663

Sale of investments, available-for-sale
1,417,304

 
860,182

Cost of investments acquired, available-for-sale
(2,126,627
)
 
(1,465,086
)
Change in investments, held-to-maturity
39,000

 
21,000

Mortgage loans:
 

 
 

New lendings
(811,103
)
 
(745,445
)
Repayments
494,729

 
373,836

Change in investment real estate, net
615

 
1,546

Change in policy loans, net
25,361

 
15,431

Change in other long-term investments, net
(225,809
)
 
(6,063
)
Change in short-term investments, net
(101,662
)
 
(41,417
)
Net unsettled security transactions
141,791

 
11,312

Purchase of property, equipment, and intangibles
(6,956
)
 
(15,709
)
Cash received from reinsurance transaction
20,669

 

Net cash used in investing activities
$
(540,174
)
 
$
(640,750
)
Cash flows from financing activities
 

 
 

Borrowings under line of credit arrangements, debt, and subordinated debt
$
655,000

 
$
305,000

Principal payments on line of credit arrangement, debt, and subordinated debt
(348,684
)
 
(283,998
)
Issuance (repayment) of non-recourse funding obligations
(77,000
)
 
(21,000
)
Secured financing liabilities
(913,210
)
 
(357,596
)
Dividends to shareowner
(140,000
)
 
(143,848
)
Investment product deposits and change in universal life deposits
2,933,610

 
2,240,760

Investment product withdrawals
(1,551,086
)
 
(1,111,905
)
Other financing activities, net
(194
)
 

Net cash provided by financing activities
$
558,436

 
$
627,413

Change in cash
(61,578
)
 
56,689

Cash at beginning of period
252,310

 
348,182

Cash at end of period
$
190,732

 
$
404,871


See Notes to the Consolidated Condensed Financial Statements
8


PROTECTIVE LIFE CORPORATION
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
1.    BASIS OF PRESENTATION
Basis of Presentation
On February 1, 2015, Protective Life Corporation (the “Company”) became a wholly owned subsidiary of The Dai-ichi Life Insurance Company, Limited, a kabushiki kaisha organized under the laws of Japan (now known as Dai-ichi Life Holdings, Inc., “Dai-ichi Life”), when DL Investment (Delaware), Inc. a wholly owned subsidiary of Dai-ichi Life, merged with and into the Company. Prior to February 1, 2015, the Company’s stock was publicly traded on the New York Stock Exchange. Subsequent to the Merger date, the Company remains as an SEC registrant within the United States. The Company is a holding company with subsidiaries that provide financial services through the production, distribution, and administration of insurance and investment products. The Company markets individual life insurance, credit life and disability insurance, guaranteed investment contracts, guaranteed funding agreements, fixed and variable annuities, and extended service contracts throughout the United States. The Company also maintains a separate segment devoted to the acquisition of insurance policies from other companies. Founded in 1907, Protective Life Insurance Company (“PLICO”) is the Company’s largest operating subsidiary.
These financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for the interim periods presented herein. In the opinion of management, the accompanying financial statements reflect all adjustments (consisting only of normal recurring items) necessary for a fair statement of the results for the interim periods presented. Operating results for the three and six months ended June 30, 2018, are not necessarily indicative of the results of operations that may be expected for the year ending December 31, 2018. The year-end consolidated condensed financial data included herein was derived from audited financial statements but does not include all disclosures required by GAAP within this report. For further information, refer to the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.
The operating results of companies in the insurance industry have historically been subject to significant fluctuations due to changing competition, economic conditions, interest rates, investment performance, insurance ratings, claims, persistency, and other factors.
Entities Included
The consolidated condensed financial statements in this report include the accounts of Protective Life Corporation and subsidiaries and its affiliate companies in which the Company holds a majority voting or economic interest. Intercompany balances and transactions have been eliminated.
2.     SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Significant Accounting Policies
For a full description of significant accounting policies, see Note 2 to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017. There were no significant changes to the Company's accounting policies during the six months ended June 30, 2018 other than those discussed below.
Property and Casualty Insurance Products
Property and casualty insurance products include service contract business, surety bonds, and guaranteed asset protection ("GAP"). Premiums and fees associated with service contracts and GAP products are recognized based on expected claim patterns. For all other products, premiums are generally recognized over the terms of the contract on a pro-rata basis. Commissions and fee income associated with other products are recognized as earned when the related services are provided to the customer. Unearned premium reserves are maintained for the portion of the premiums that is related to the unexpired period of the policy. Benefit reserves are recorded when insured events occur. Benefit reserves include case basis reserves for known but unpaid claims as of the balance sheet date as well as incurred but not reported ("IBNR") reserves for claims where the insured event has occurred but has not been reported to the Company as of the balance sheet date. The case basis reserves and IBNR are calculated based on historical experience and on assumptions relating to claim severity and frequency, the level of used vehicle prices, and other factors. These assumptions are modified as necessary to reflect anticipated trends.

9


Effective January 1, 2018, the Company adopted Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts with Customers. In consideration of the amendments in this Update, the Company revised its recognition pattern for administrative fees associated with certain vehicle service and GAP products. Previously, these fees were recognized based on the work effort involved in satisfying the Company’s contract obligations. The Company will recognize these fees on a claims occurrence basis in future periods. To reflect this change in accounting principle, the Company recorded a cumulative effect adjustment as of January 1, 2018 that resulted in a decrease in retained earnings of $92.5 million. The pre-tax impact to each affected line item on the Company’s financial statements is reflected in the table below:

 
 
As Reported
 
Previous Accounting Method
 
 
As of June 30, 2018
 
 
(Dollars In Millions)
Financial Statement Line Item:
 
 
 
 
Balance Sheet
 
 
 
 
Deferred policy acquisition costs and value of business acquired
 
$
2,870.6

 
$
2,729.9

Other liabilities
 
$
2,535.1

 
$
2,270.3


 
 
As Reported
 
Previous Accounting Method
 
As Reported
 
Previous Accounting Method
 
 
For The Three Months Ended June 30, 2018
 
For The Six Months Ended June 30, 2018
 
 
(Dollars In Millions)
 
(Dollars In Millions)
Financial Statement Line Item:
 
 
 
 
 
 
 
 
Statements of Income
 
 
 
 
 
 
 
 
Other income
 
$
113.9

 
$
117.0

 
$
228.3

 
$
230.2

Amortization of deferred policy acquisition costs and value of business acquired
 
$
52.5

 
$
41.4

 
$
110.5

 
$
85.6

Other operating expenses, net of reinsurance ceded
 
$
231.1

 
$
243.9

 
$
460.3

 
$
487.4

Accounting Pronouncements Recently Adopted
ASU No. 2014-09 - Revenue from Contracts with Customers (Topic 606). This Update provides for significant revisions to the recognition of revenue from contracts with customers across various industries. Under the new guidance, entities are required to apply a prescribed 5-step process to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The accounting for revenues associated with insurance products is not within the scope of this Update. The Update was originally effective for annual and interim periods beginning after December 15, 2016. However, in August 2015, the FASB issued ASU No. 2015-14 - Revenues from Contracts with Customers: Deferral of the Effective Date, to defer the effective date of ASU No. 2014-09 by one year to annual and interim periods beginning after December 15, 2017. The Company adopted this Update using the modified retrospective approach via a cumulative effect adjustment to retained earnings as of January 1, 2018. The amendments in the Update, along with clarifying updates issued subsequent to ASU 2014-09, impacted some of the Company's smaller lines of business, specifically revenues at the Company's affiliated broker dealers and insurance agency, and certain revenues associated with the Company's Asset Protection products. The lines of business to which the revised guidance applies are not material to the Company’s financial statements. In consideration of the amendments in this Update, the Company revised its recognition pattern for administrative fees associated with certain vehicle service and GAP products. Previously, these fees were recognized based on the work effort involved in satisfying the Company’s contract obligations. The Company will recognize these fees on a claims occurrence basis in future periods. To reflect this change in accounting principle, the Company recorded a cumulative effect adjustment as of January 1, 2018 that resulted in a decrease in retained earnings of $92.5 million. The Company also implemented minor changes to its accounting and disclosures with respect to the lines of business referenced above to ensure compliance with the revised guidance. See above for additional discussion.
    ASU No. 2016-01 - Financial Instruments - Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments in this Update address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. Most notably, the Update requires that equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) be measured at fair value with changes in fair value recognized in net income. The Update also introduces a single-step impairment model for equity investments without a readily determinable fair value. Additionally, the Update requires changes in instrument-specific credit risk for fair value option liabilities to be recorded in other comprehensive income. The amendments in this Update are effective for annual and interim periods beginning after December 15, 2017 and were applied on a modified retrospective basis. The Company recorded a cumulative-effect adjustment at the date of adoption, January 1, 2018, transferring unrealized gains and losses on available-for-sale equity securities to retained earnings from accumulated other comprehensive income. The impact of this adjustment, net of income tax,

10


resulted in a $10.6 million increase to retained earnings and a corresponding decrease to accumulated other comprehensive income, resulting in no net impact to consolidated shareowner's equity. The Company has updated its disclosures in Note 5, Investment Operations and Note 6, Fair Value of Financial Instruments in accordance with the ASU.

ASU No. 2016-15 - Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments. The amendments in this Update are intended to reduce diversity in practice in how certain transactions are classified in the statement of cash flows. Specific transactions addressed in the new guidance include: Debt prepayment/extinguishment costs, contingent consideration payments, proceeds from the settlement of corporate-owned life insurance policies, and distributions received from equity method investments. The Update does not introduce any new accounting or financial reporting requirements, and is effective for annual and interim periods beginning after December 15, 2017 using the retrospective method. There was no financial impact.

ASU No. 2016-18 - Statement of Cash Flows (Topic 230): Restricted Cash (a consensus of the FASB Emerging Task Force). The amendments in this update provide guidance on the presentation of restricted cash or restricted cash equivalents in the statement of cash flows, thereby reducing diversity in practice related to the presentation of these amounts. The amendments require that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. The Update is effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. There was no impact to the Company on adoption.

ASU No. 2017-01 - Business Combinations (Topic 805): Clarifying the Definition of a Business. The purpose of this update is to clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The amendments in the Update provide a specific test by which an entity may determine whether an acquisition involves a set of assets or a business. The amendments in the Update are to be applied prospectively for periods beginning after December 15, 2017. The Company has reviewed the revised requirements, and does not anticipate that the changes will impact its policies or recent conclusions related to its acquisition activities.

ASU No. 2017-07 - Compensation - Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. The amendments in this update require entities to disaggregate the current-service-cost component from other components of net benefit cost and present it with other current compensation costs in the income statement. The other components of net benefit cost must be presented outside of income from operations if that subtotal is presented. In addition, the Update requires entities to disclose the income statement lines that contain the other components if they are not presented on appropriately described separate lines. The amendments in this update are effective for interim and annual periods beginning after December 15, 2017. As provided for in the ASU, the Company expects to apply the provisions of the statement retrospectively for components of net periodic pension costs and prospectively for capitalization of the service costs component of net periodic costs and net periodic postretirement benefits. The Update did not impact the Company’s financial position, results of operations, or current disclosures.
Accounting Pronouncements Not Yet Adopted
    
ASU No. 2016-02 - Leases. The amendments in this Update address certain aspects of recognition, measurement, presentation, and disclosure of leases. The most significant change will relate to the accounting model used by lessees. The Update will require all leases with terms greater than 12 months to be recorded on the balance sheet in the form of a lease asset and liability. The lease asset and liability will be measured at the present value of the minimum lease payments less any upfront payments or fees. The amendments in the Update are effective for annual and interim periods beginning after December 15, 2018 on a modified retrospective basis. The Company has completed an inventory of all leases in the organization. Based on our lease portfolio as of June 30, 2018, the Company expects to record a right of use asset and lease liability of approximately $21 million on its consolidated condensed balance sheet in the period of adoption. However, the ultimate impact of adopting the ASU will depend on the Company’s lease portfolio as of the adoption date.

ASU No. 2016-13 - Financial Instruments-Credit Losses: Measurement of Credit Losses on Financial Instruments. The amendments in this Update introduce a new current expected credit loss (“CECL”) model for certain financial assets, including mortgage loans and reinsurance receivables. The new model will not apply to debt securities classified as available-for-sale. For assets within the scope of the new model, an entity will recognize as an allowance against earnings its estimate of the contractual cash flows not expected to be collected on day one of the asset’s acquisition. The allowance may be reversed through earnings if a security recovers in value. This differs from the current impairment model, which requires recognition of credit losses when they have been incurred and recognizes a security’s subsequent recovery in value in other comprehensive income. The Update also makes targeted changes to the current impairment model for available-for-sale debt securities, which comprise the majority of the Company’s invested assets. Similar to the CECL model, credit loss impairments will be recorded in an allowance against earnings that may be reversed for subsequent recoveries in value. The amendments in this Update are effective for annual and interim periods beginning after December 15, 2019 on a modified retrospective basis. The Company is reviewing its policies and processes to ensure compliance with the requirements in this Update, upon adoption, and assessing the impact this standard will have on its operations and financial results.

ASU No. 2017-08 - Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities. The amendments in this Update require that premiums on callable debt securities be amortized to the first call date. This is a change from current guidance, under which premiums are amortized to the maturity date of the security. The amendments are effective for annual and interim periods beginning after December 15, 2018, and early adoption is permitted. Transition will be through a modified retrospective approach in which the cumulative effect of application is recorded

11


to retained earnings at the beginning of the annual period in which an entity adopts the revised guidance. The Company is currently reviewing its systems and processes to determine the financial and operational impact of implementing the Update.

ASU No. 2017-12 - Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. The amendments in this Update are designed to permit hedge accounting to be applied to a broader range of hedging strategies as well as to more closely align hedge accounting and risk management objectives. Specific provisions include requiring changes in the fair value of a hedging instrument be recorded in the same income statement line as the hedged item when it affects earnings. In addition, after a hedge has initially qualified as an effective hedge the Update permits the use of a qualitative hedge effectiveness test in subsequent periods. The amendments in this Update are effective for annual and interim periods beginning after December 15, 2018 and early adoption is permitted. The Company does not expect the adoption of this standard to have a material impact on its operations or financial results.
    
3.     SIGNIFICANT TRANSACTIONS
On May 1, 2018, The Lincoln National Life Insurance Company (“Lincoln Life”) completed its previously announced acquisition (the “Closing”) of Liberty Mutual Group Inc.’s (“Liberty Mutual”) Group Benefits Business and Individual Life and Annuity Business (the “Life Business”) through the acquisition of all of the issued and outstanding capital stock of Liberty Life Assurance Company of Boston (“Liberty”). In connection with the Closing and  pursuant to the Master Transaction Agreement, dated January 18, 2018 (the “Master Transaction Agreement”), previously reported in our Current Report on Form 8-K filed on January 23, 2018, PLICO and Protective Life and Annuity Insurance Company (“PLAIC”), a wholly owned subsidiary of PLICO, entered into reinsurance agreements (the “Reinsurance Agreements”) and related ancillary documents (including administrative services agreements and transition services agreements) providing for the reinsurance and administration of the Life Business. 

Pursuant to the Reinsurance Agreements, Liberty ceded to PLICO and PLAIC the insurance policies related to the Life Business on a 100% coinsurance basis. The aggregate ceding commission for the reinsurance of the Life Business was $422.9 million, which is the purchase price. Other than cash received as part of the acquired Liberty investment portfolio as reflected in “amounts received from reinsurance transaction” in the Consolidated Condensed Statement of Cash Flows and as reflected in the table below, this was a non-cash transaction.

All policies issued in states other than New York were ceded to PLICO under a reinsurance agreement between Liberty and PLICO, and all policies issued in New York were ceded to PLAIC under a reinsurance agreement between Liberty and PLAIC.  The aggregate statutory reserves of Liberty ceded to PLICO and PLAIC as of the closing of the Transaction were approximately $13.3 billion, which amount was based on initial estimates and is subject to adjustment following the Closing. Pursuant to the terms of the Reinsurance Agreements, each of PLICO and PLAIC are required to maintain assets in trust for the benefit of Liberty to secure their respective obligations to Liberty under the Reinsurance Agreements. The trust accounts were initially funded by each of PLICO and PLAIC principally with the investment assets that were received from Liberty. Additionally, PLICO and PLAIC have each agreed to provide, on behalf of Liberty, administration and policyholder servicing of the Life Business reinsured by it pursuant to administrative services agreements between Liberty and each of PLICO and PLAIC.

The terms of the Reinsurance Agreements resulted in an acquisition of the Life Business by the Company in accordance with Accounting Standards Codification (“ASC”) Topic 805, Business Combinations.
  
The following table details the purchase consideration and preliminary allocation of assets acquired and liabilities assumed from the Life Business reinsurance transaction as of the transaction date. These estimates remain preliminary and are subject to adjustment. While they are not expected to be materially different than those shown, any material adjustments to the estimates will be reflected, retroactively, as of the date of the acquisition.



12


 
 
Fair Value
as of
May 1, 2018
 
 
(Dollars In Thousands)
ASSETS
 
 
Fixed maturities
 
$
12,588,512

Mortgage loans
 
435,405

Policy loans
 
131,489

Total investments
 
13,155,406

Cash
 
20,669

Accrued investment income
 
151,610

Reinsurance receivables
 
337

Value of business acquired
 
329,630

Other assets
 
2,542

Total assets
 
13,660,194

LIABILITIES
 
 
Future policy benefits and claims
 
$
11,737,086

Unearned premiums
 

Total policy liabilities and accruals
 
11,737,086

Annuity account balances
 
1,823,444

Other policyholders' funds
 
41,954

Other liabilities
 
57,710

Total liabilities
 
13,660,194

NET ASSETS ACQUIRED
 
$

    
The following unaudited pro forma condensed consolidated results of operations assumes that the aforementioned transactions of the Life Business were completed as of January 1, 2017. The unaudited pro forma condensed results of operations are presented solely for information purposes and are not necessarily indicative of the consolidated condensed results of operations that might have been achieved had the transaction been completed as of the date indicated.
 
Unaudited
 
Unaudited
 
For The
Three Months Ended
June 30,
 
For The
Six Months Ended
June 30,
 
2018
 
2017
 
2018
 
2017
 
(Dollars In Thousands)
Revenue
$
1,317,159

 
$
1,393,776

 
$
2,733,479

 
$
2,833,439

 
 
 
 
 
 
 
 
Net income
$
88,883

 
$
115,330

 
$
201,751

 
$
228,566

The amount of revenue and income before income tax of the Life Business since the transaction date, May 1, 2018, included in the consolidated condensed statements of income for the three and six months ended June 30, 2018 amounted to $142.7 million and $7.5 million, respectively. Also, included in the income before income tax for the six months ended June 30, 2018, is approximately $5.5 million of non-recurring transaction costs.

13


Based on the balance recorded as of May 1, 2018, the expected amortization of VOBA for the next five years is as follows:
Years
 
Expected
Amortization
 
 
(Dollars In Thousands)
Remainder of 2018
 
$
10,316

2019
 
20,636

2020
 
19,546

2021
 
17,958

2022
 
16,275


4.     MONY CLOSED BLOCK OF BUSINESS
In 1998, MONY Life Insurance Company (“MONY”) converted from a mutual insurance company to a stock corporation (“demutualization”). In connection with its demutualization, an accounting mechanism known as a closed block (the “Closed Block”) was established for certain individuals’ participating policies in force as of the date of demutualization. Assets, liabilities, and earnings of the Closed Block are specifically identified to support its participating policyholders. The Company acquired the Closed Block in conjunction with the acquisition of MONY in 2013.
Assets allocated to the Closed Block inure solely to the benefit of each Closed Block’s policyholders and will not revert to the benefit of MONY or the Company. No reallocation, transfer, borrowing or lending of assets can be made between the Closed Block and other portions of MONY’s general account, any of MONY’s separate accounts or any affiliate of MONY without the approval of the Superintendent of The New York State Department of Financial Services (the “Superintendent”). Closed Block assets and liabilities are carried on the same basis as similar assets and liabilities held in the general account.
The excess of Closed Block liabilities over Closed Block assets (adjusted to exclude the impact of related amounts in AOCI) at the acquisition date of October 1, 2013, represented the estimated maximum future post-tax earnings from the Closed Block that would be recognized in income from continuing operations over the period the policies and contracts in the Closed Block remain in force. In connection with the acquisition of MONY, the Company developed an actuarial calculation of the expected timing of MONY’s Closed Block’s earnings as of October 1, 2013. Pursuant to the acquisition of the Company by Dai-ichi Life, this actuarial calculation of the expected timing of MONY's Closed Block earnings was recalculated and reset as February 1, 2015, along with the establishment of a policyholder dividend obligation as of such date.
If the actual cumulative earnings from the Closed Block are greater than the expected cumulative earnings, only the expected earnings will be recognized in the Company’s net income. Actual cumulative earnings in excess of expected cumulative earnings at any point in time are recorded as a policyholder dividend obligation because they will ultimately be paid to Closed Block policyholders as an additional policyholder dividend unless offset by future performance that is less favorable than originally expected. If a policyholder dividend obligation has been previously established and the actual Closed Block earnings in a subsequent period are less than the expected earnings for that period, the policyholder dividend obligation would be reduced (but not below zero). If, over the period the policies and contracts in the Closed Block remain in force, the actual cumulative earnings of the Closed Block are less than the expected cumulative earnings, only actual earnings would be recognized in income from continuing operations. If the Closed Block has insufficient funds to make guaranteed policy benefit payments, such payments will be made from assets outside the Closed Block.

Many expenses related to Closed Block operations, including amortization of VOBA, are charged to operations outside of the Closed Block; accordingly, net revenues of the Closed Block do not represent the actual profitability of the Closed Block operations. Operating costs and expenses outside of the Closed Block are, therefore, disproportionate to the business outside of the Closed Block.

14


Summarized financial information for the Closed Block as of June 30, 2018, and December 31, 2017, is as follows:
 
As of
 
June 30, 2018
 
December 31, 2017
 
(Dollars In Thousands)
Closed block liabilities
 

 
 

Future policy benefits, policyholders’ account balances and other policyholder liabilities
$
5,728,327

 
$
5,791,867

Policyholder dividend obligation

 
160,712

Other liabilities
25,595

 
30,764

Total closed block liabilities
5,753,922

 
5,983,343

Closed block assets
 

 
 

Fixed maturities, available-for-sale, at fair value
$
4,345,031

 
$
4,669,856

Mortgage loans on real estate
77,374

 
108,934

Policy loans
687,771

 
700,769

Cash
101,426

 
31,182

Other assets
130,468

 
122,637

Total closed block assets
5,342,070

 
5,633,378

Excess of reported closed block liabilities over closed block assets
411,852

 
349,965

Portion of above representing accumulated other comprehensive income:
 

 
 

Net unrealized investment gains (losses) net of policyholder dividend obligation: $(154,605) and $(13,429); and net of income tax: $52,196 and $2,820
(74,217
)
 

Future earnings to be recognized from closed block assets and closed block liabilities
$
337,635

 
$
349,965

Reconciliation of the policyholder dividend obligation is as follows:
 
For The
Six Months Ended
June 30,
 
2018
 
2017
 
(Dollars In Thousands)
Policyholder dividend obligation, beginning of period
$
160,712

 
$
31,932

Applicable to net revenue (losses)
(19,536
)
 
(25,901
)
Change in net unrealized investment gains (losses) allocated to the policyholder dividend obligation
(141,176
)
 
117,418

Policyholder dividend obligation, end of period
$

 
$
123,449


15


Closed Block revenues and expenses were as follows:
 
For The
Three Months Ended
June 30,
 
For The
Six Months Ended
June 30,
 
2018
 
2017
 
2018
 
2017
 
(Dollars In Thousands)
Revenues
 

 
 
 
 
 
 

Premiums and other income
$
42,465

 
$
44,898

 
$
82,077

 
$
87,734

Net investment income
50,872

 
51,343

 
101,415

 
102,701

Net investment gains
263

 
43

 
26

 
106

Total revenues
93,600

 
96,284

 
183,518

 
190,541

Benefits and other deductions
 

 
 
 
 

 
 

Benefits and settlement expenses
87,940

 
87,490

 
167,892

 
167,598

Other operating expenses
337

 
428

 
20

 
592

Total benefits and other deductions
88,277

 
87,918

 
167,912

 
168,190

Net revenues before income taxes
5,323

 
8,366

 
15,606

 
22,351

Income tax expense
1,118

 
2,928

 
3,277

 
7,823

Net revenues
$
4,205

 
$
5,438

 
$
12,329

 
$
14,528

5.     INVESTMENT OPERATIONS
Net realized gains (losses) for all other investments are summarized as follows:
 
For The
Three Months Ended
June 30,
 
For The
Six Months Ended
June 30,
 
2018
 
2017
 
2018
 
2017
 
(Dollars In Thousands)
Fixed maturities
$
5,539

 
$
(50
)
 
$
8,322

 
$
9,440

Equity gains and losses(1)
(1,044
)
 
(1,037
)
 
(9,830
)
 
(1,046
)
Impairments
(5
)
 
(2,785
)
 
(3,650
)
 
(10,616
)
Modco trading portfolio
(52,817
)
 
55,230

 
(137,525
)
 
73,782

Other investments
(1,280
)
 
(426
)
 
1,832

 
(5,618
)
Total realized gains (losses) - investments
$
(49,607
)
 
$
50,932

 
$
(140,851
)
 
$
65,942

 
 
 
 
 
 
 
 
(1) Beginning in the three month period ending March 31, 2018, all changes in the fair market value of equity securities are recorded as a realized gains (loss) as a result of the adoption of ASU No. 2016-01

16


Gross realized gains and gross realized losses on investments available-for-sale (fixed maturities and short-term investments) are as follows:
 
For The
Three Months Ended
June 30,
 
For The
Six Months Ended
June 30,
 
2018
 
2017
 
2018
 
2017
 
(Dollars In Thousands)
Gross realized gains
$
10,137

 
$
2,297

 
$
18,187

 
$
13,035

Gross realized losses:
 
 
 
 
 
 


Impairment losses
$
(5
)
 
$
(2,785
)
 
$
(3,650
)
 
$
(10,616
)
Other realized losses
$
(4,598
)
 
$
(3,384
)
 
$
(9,865
)
 
$
(4,641
)
The chart below summarizes the fair value (proceeds) and the gains (losses) realized on available-for-sale securities the Company sold that were in an unrealized gain position and an unrealized loss position.
 
For The
Three Months Ended
June 30,
 
For The
Six Months Ended
June 30,
 
2018
 
2017
 
2018
 
2017
 
(Dollars In Thousands)
Securities in an unrealized gain position:
 
 
 
 
 
 
 
Fair value (proceeds)
$
466,153

 
$
275,470

 
$
608,286

 
$
444,604

Gains realized
$
10,137

 
$
2,297

 
$
18,187

 
$
13,035

 
 
 
 
 
 
 
 
Securities in an unrealized loss position(1):
 
 
 
 
 
 
 
Fair value (proceeds)
$
201,191

 
$
71,813

 
$
258,175

 
$
84,265

Losses realized
$
(4,598
)
 
$
(3,384
)
 
$
(9,865
)
 
$
(4,641
)
 
 
 
 
 
 
 
 
(1) The Company made the decision to exit these holdings in conjunction with its overall asset/liability management process.
The chart below summarizes the realized gains (losses) on equity securities sold during the period and equity securities still held at the reporting date.
 
For The
Three Months Ended
June 30, 2018
 
For The
Six Months Ended
June 30, 2018
 
(Dollars In Thousands)
Net gains (losses) recognized during the period on equity securities
$
(1,044
)
 
$
(9,830
)
Less: net gains (losses) recognized on equity securities sold during the period
$
(680
)
 
$
(2,380
)
Gains (losses) recognized during the period on equity securities still held
$
(364
)
 
$
(7,449
)
    


17


The amortized cost and fair value of the Company’s investments classified as available-for-sale are as follows:
As of June 30, 2018
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
 
Total OTTI
Recognized
in OCI(1)
 
 
(Dollars In Thousands)
 
 
Fixed maturities:
 
 

 
 

 
 

 
 

 
 

Residential mortgage-backed securities
 
$
3,297,665

 
$
12,486

 
$
(66,171
)
 
$
3,243,980

 
$

Commercial mortgage-backed securities
 
2,298,945

 
1,344

 
(72,887
)
 
2,227,402

 

Other asset-backed securities
 
1,408,987

 
25,100

 
(10,526
)
 
1,423,561

 

U.S. government-related securities
 
1,549,033

 
295

 
(57,292
)
 
1,492,036

 

Other government-related securities
 
417,232

 
3,269

 
(18,771
)
 
401,730

 

States, municipals, and political subdivisions
 
3,699,964

 
23,107

 
(89,268
)
 
3,633,803

 

Corporate securities
 
38,372,075

 
178,729

 
(1,807,568
)
 
36,743,236

 

Redeemable preferred stock
 
94,362

 
80

 
(4,866
)
 
89,576

 

 
 
51,138,263

 
244,410

 
(2,127,349
)
 
49,255,324

 

Short-term investments
 
660,586

 

 

 
660,586

 

 
 
$
51,798,849

 
$
244,410

 
$
(2,127,349
)
 
$
49,915,910

 
$

 
 
 
 
 
 
 
 
 
 
 
As of December 31, 2017
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
 
Total OTTI
Recognized
in OCI(1)
 
 
(Dollars In Thousands)
 
 
Fixed maturities:
 
 
 
 
 
 
 
 
 
 
Residential mortgage-backed securities
 
$
2,330,832

 
$
19,413

 
$
(23,033
)
 
$
2,327,212

 
$
10

Commercial mortgage-backed securities
 
1,914,998

 
5,010

 
(30,186
)
 
1,889,822

 

Other asset-backed securities
 
1,234,376

 
20,936

 
(5,763
)
 
1,249,549

 

U.S. government-related securities
 
1,255,244

 
185

 
(32,177
)
 
1,223,252

 

Other government-related securities
 
282,767

 
9,463

 
(4,948
)
 
287,282

 

States, municipals, and political subdivisions
 
1,770,299

 
16,959

 
(45,613
)
 
1,741,645

 
(37
)
Corporate securities
 
29,606,484

 
623,713

 
(528,187
)
 
29,702,010

 
(1
)
Redeemable preferred stock
 
94,362

 
232

 
(3,503
)
 
91,091

 

 
 
38,489,362

 
695,911

 
(673,410
)
 
38,511,863

 
(28
)
Equity securities
 
735,569

 
22,318

 
(8,771
)
 
749,116

 

Short-term investments
 
558,949

 

 

 
558,949

 

 
 
$
39,783,880

 
$
718,229

 
$
(682,181
)
 
$
39,819,928

 
$
(28
)
 
 
 
 
 
 
 
 
 
 
 
(1) These amounts are included in the gross unrealized gains and gross unrealized losses columns above.

18


     The fair values of the Company's investments classified as trading are as follows:    
 
 
As of
June 30, 2018
 
As of
December 31, 2017
 
 
(Dollars In Thousands)
Fixed maturities:
 
 

 
 

Residential mortgage-backed securities
 
$
259,755

 
$
259,694

Commercial mortgage-backed securities
 
141,469

 
146,804

Other asset-backed securities
 
114,507

 
138,097

U.S. government-related securities
 
36,575

 
27,234

Other government-related securities
 
40,274

 
63,925

States, municipals, and political subdivisions
 
314,722

 
326,925

Corporate securities
 
1,585,290

 
1,698,183

Redeemable preferred stock
 
3,289

 
3,327

 
 
2,495,881

 
2,664,189

Equity securities
 
5,332

 
5,244

Short-term investments
 
49,117

 
56,261

 
 
$
2,550,330

 
$
2,725,694

The amortized cost and fair value of available-for-sale and held-to-maturity fixed maturities as of June 30, 2018, by expected maturity, are shown below. Expected maturities of securities without a single maturity date are allocated based on estimated rates of prepayment that may differ from actual rates of prepayment.
 
Available-for-sale
 
Held-to-maturity
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
 
(Dollars In Thousands)
Due in one year or less
$
931,606

 
$
928,953

 
$

 
$

Due after one year through five years
9,296,923

 
9,138,806

 

 

Due after five years through ten years
8,929,138

 
8,697,409

 

 

Due after ten years
31,980,596

 
30,490,156

 
2,677,726

 
2,582,938

 
$
51,138,263

 
$
49,255,324

 
$
2,677,726

 
$
2,582,938

The charts below summarize the Company's other-than-temporary impairments of investments. All of the impairments were related to fixed maturities.
 
For The
Three Months Ended
June 30, 2018
 
For The
Six Months Ended
June 30, 2018
 
Fixed
Maturities
 
Fixed
Maturities
 
(Dollars In Thousands)
Other-than-temporary impairments
$
(10
)
 
$
(701
)
Non-credit impairment losses recorded in other comprehensive income
5

 
(2,949
)
Net impairment losses recognized in earnings
$
(5
)
 
$
(3,650
)

19


 
For The
Three Months Ended
June 30,
 
For The
Six Months Ended
June 30,
 
2017
 
2017
 
Fixed
Maturities
 
Equity
Securities
 
Total
Securities
 
Fixed Maturities
 
Equity Securities
 
Total Securities
 
(Dollars In Thousands)
Other-than-temporary impairments
$
(33
)
 
$

 
$
(33
)
 
$
(128
)
 
$
(2,630
)
 
$
(2,758
)
Non-credit impairment losses recorded in other comprehensive income
(2,752
)
 

 
(2,752
)
 
(7,858
)
 

 
(7,858
)
Net impairment losses recognized in earnings
$
(2,785
)
 
$

 
$
(2,785
)
 
$
(7,986
)
 
$
(2,630
)
 
$
(10,616
)
There were no other-than-temporary impairments related to fixed maturities or equity securities that the Company intended to sell or expected to be required to sell for the three and six months ended June 30, 2018 and 2017.
     The following chart is a rollforward of available-for-sale credit losses on fixed maturities held by the Company for which a portion of an other-than-temporary impairment was recognized in other comprehensive income (loss):
 
For The
Three Months Ended
June 30,
 
For The
Six Months Ended
June 30,
 
2018
 
2017
 
2018
 
2017
 
(Dollars In Thousands)
Beginning balance
$
2,235

 
$

 
$
3,268

 
$
12,685

Additions for newly impaired securities

 

 

 

Additions for previously impaired securities
2

 
2,785

 
2

 
2,785

Reductions for previously impaired securities due to a change in expected cash flows

 
(2
)
 

 
(12,687
)
Reductions for previously impaired securities that were sold in the current period
(2,235
)
 

 
(3,268
)
 

Ending balance
$
2

 
$
2,783

 
$
2

 
$
2,783

The following table includes the gross unrealized losses and fair value of the Company’s investments that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position as of June 30, 2018:
 
Less Than 12 Months
 
12 Months or More
 
Total
 
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
 
(Dollars In Thousands)
Residential mortgage-backed securities
$
2,035,993

 
$
(46,339
)
 
$
366,293

 
$
(19,832
)
 
$
2,402,286

 
$
(66,171
)
Commercial mortgage-backed securities
1,231,408

 
(33,506
)
 
749,058

 
(39,381
)
 
1,980,466

 
(72,887
)
Other asset-backed securities
363,599

 
(2,966
)
 
134,941

 
(7,560
)
 
498,540

 
(10,526
)
U.S. government-related securities
362,688

 
(6,429
)
 
1,046,716

 
(50,863
)
 
1,409,404

 
(57,292
)
Other government-related securities
178,170

 
(7,279
)
 
106,367

 
(11,492
)
 
284,537

 
(18,771
)
States, municipalities, and political subdivisions
985,821

 
(20,690
)
 
988,380

 
(68,578
)
 
1,974,201

 
(89,268
)
Corporate securities
20,416,717

 
(709,257
)
 
9,820,810

 
(1,098,311
)
 
30,237,527

 
(1,807,568
)
Redeemable preferred stock
56,339

 
(2,119
)
 
22,834

 
(2,747
)
 
79,173

 
(4,866
)
 
$
25,630,735

 
$
(828,585
)
 
$
13,235,399

 
$
(1,298,764
)
 
$
38,866,134

 
$
(2,127,349
)
RMBS and CMBS had gross unrealized losses greater than twelve months of $19.8 million and $39.4 million, respectively, as of June 30, 2018. Factors such as the credit enhancement within the deal structure, the average life of the securities, and the performance of the underlying collateral support the recoverability of these investments.

20


The other asset-backed securities had a gross unrealized loss greater than twelve months of $7.6 million as of June 30, 2018. This category predominately includes student loan backed auction rate securities whose underlying collateral is at least 97% guaranteed by the Federal Family Education Loan Program (“FFELP”). At this time, the Company has no reason to believe that the U.S. Department of Education would not honor the FFELP guarantee, if it were necessary.
The U.S. government-related securities and the other government-related securities had gross unrealized losses greater than twelve months of $50.9 million and $11.5 million as of June 30, 2018, respectively. These declines were related to changes in interest rates.
The states, municipalities, and political subdivisions category had gross unrealized losses greater than twelve months of $68.6 million as of June 30, 2018. These declines were related to changes in interest rates.
The corporate securities category had gross unrealized losses greater than twelve months of $1.1 billion as of June 30, 2018. The aggregate decline in market value of these securities was deemed temporary due to positive factors supporting the recoverability of the respective investments. Positive factors considered include credit ratings, the financial health of the issuer, the continued access of the issuer to capital markets, and other pertinent information.
     As of June 30, 2018, the Company had a total of 3,951 positions that were in an unrealized loss position, but the Company does not consider these unrealized loss positions to be other-than-temporary. This is based on the aggregate factors discussed previously and because the Company has the ability and intent to hold these investments until the fair values recover, and the Company does not intend to sell or expect to be required to sell the securities before recovering the Company’s amortized cost of the securities.
The following table includes the gross unrealized losses and fair value of the Company’s investments that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position as of December 31, 2017:
 
Less Than 12 Months
 
12 Months or More
 
Total
 
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
 
(Dollars In Thousands)
Residential mortgage-backed securities
$
766,599

 
$
(9,671
)
 
$
416,221

 
$
(13,362
)
 
$
1,182,820

 
$
(23,033
)
Commercial mortgage-backed securities
757,471

 
(8,592
)
 
796,456

 
(21,594
)
 
1,553,927

 
(30,186
)
Other asset-backed securities
86,506

 
(322
)
 
134,316

 
(5,441
)
 
220,822

 
(5,763
)
U.S. government-related securities
94,110

 
(688
)
 
1,072,232

 
(31,489
)
 
1,166,342

 
(32,177
)
Other government-related securities
24,830

 
(169
)
 
115,294

 
(4,778
)
 
140,124

 
(4,947
)
States, municipalities, and political subdivisions
170,268

 
(1,738
)
 
1,027,747

 
(43,874
)
 
1,198,015

 
(45,612
)
Corporate securities
5,054,316

 
(55,795
)
 
10,962,689

 
(472,394
)
 
16,017,005

 
(528,189
)
Redeemable preferred stock
22,048

 
(1,120
)
 
23,197

 
(2,383
)
 
45,245

 
(3,503
)
Equities
86,586

 
(1,401
)
 
91,195

 
(7,370
)
 
177,781

 
(8,771
)
 
$
7,062,734

 
$
(79,496
)
 
$
14,639,347

 
$
(602,685
)
 
$
21,702,081

 
$
(682,181
)
RMBS and CMBS had gross unrealized losses greater than twelve months of $13.4 million and $21.6 million, respectively, as of December 31, 2017. Factors such as the credit enhancement within the deal structure, the average life of the securities, and the performance of the underlying collateral support the recoverability of these investments.
The other asset-backed securities had a gross unrealized loss greater than twelve months of $5.4 million as of December 31, 2017. This category predominately includes student loan backed auction rate securities whose underlying collateral is at least 97% guaranteed by the FFELP. At this time, the Company has no reason to believe that the U.S. Department of Education would not honor the FFELP guarantee, if it were necessary.
The U.S. government-related securities and other government-related securities had gross unrealized losses greater than twelve months of $31.5 million and $4.8 million as of December 31, 2017, respectively. These declines were related to changes in interest rates.
The states, municipalities, and political subdivisions category had gross unrealized losses greater than twelve months of $43.9 million as of December 31, 2017. These declines were related to changes in interest rates.
The corporate securities category had gross unrealized losses greater than twelve months of $472.4 million as of December 31, 2017. The aggregate decline in market value of these securities was deemed temporary due to positive factors supporting the recoverability of the respective investments. Positive factors considered include credit ratings, the financial health of the issuer, the continued access of the issuer to capital markets, and other pertinent information.

21


     As of June 30, 2018, the Company had securities in its available-for-sale portfolio which were rated below investment grade of $1.9 billion and had an amortized cost of $2.0 billion. In addition, included in the Company’s trading portfolio, the Company held $207.2 million of securities which were rated below investment grade. Approximately $346.9 million of the available-for-sale and trading securities that were below investment grade were not publicly traded.
The change in unrealized gains (losses), net of income tax, on fixed maturities, classified as available-for-sale is summarized as follows:
 
For The
Three Months Ended
June 30,
 
For The
Six Months Ended
June 30,
 
2018
 
2017
 
2018
 
2017
 
(Dollars In Thousands)
Fixed maturities
$
(585,527
)
 
$
476,590

 
$
(1,505,298
)
 
$
700,705

The amortized cost and fair value of the Company’s investments classified as held-to-maturity as of June 30, 2018 and December 31, 2017, are as follows:
As of June 30, 2018
 
Amortized
Cost
 
Gross
Unrecognized
Holding
Gains
 
Gross
Unrecognized
Holding
Losses
 
Fair
Value
 
Total OTTI
Recognized
in OCI
 
 
(Dollars In Thousands)
Fixed maturities:
 
 

 
 

 
 

 
 

 
 

Securities issued by affiliates:
 
 
 
 
 
 
 
 
 
 
Red Mountain, LLC
 
$
727,726

 
$

 
$
(87,248
)
 
$
640,478

 
$

Steel City, LLC
 
1,950,000

 

 
(7,540
)
 
1,942,460

 

 
 
$
2,677,726

 
$

 
$
(94,788
)
 
$
2,582,938

 
$

 
 
 
 
 
 
 
 
 
 
 
As of December 31, 2017
 
Amortized
Cost
 
Gross
Unrecognized
Holding
Gains
 
Gross
Unrecognized
Holding
Losses
 
Fair
Value
 
Total OTTI
Recognized
in OCI
 
 
(Dollars In Thousands)
Fixed maturities:
 
 
 
 
 
 
 
 
 
 
Securities issued by affiliates:
 
 
 
 
 
 
 
 
 
 
Red Mountain, LLC
 
$
704,904

 
$

 
$
(19,163
)
 
$
685,741

 
$

Steel City, LLC
 
2,014,000

 
76,586

 

 
2,090,586

 

 
 
$
2,718,904

 
$
76,586

 
$
(19,163
)
 
$
2,776,327

 
$

During the three and six months ended June 30, 2018 and 2017, the Company recorded no other-than-temporary impairments on held-to-maturity securities.
The Company’s held-to-maturity securities had $94.8 million of gross unrecognized holding losses by maturity as of June 30, 2018. The Company does not consider these unrecognized holding losses to be other-than-temporary based on certain positive factors associated with the securities which include credit ratings of the guarantor, financial health of the issuer and guarantor, continued access of the issuer to capital markets and other pertinent information. These held-to-maturity securities are issued by affiliates of the Company which are considered variable interest entities ("VIEs"). The Company is not the primary beneficiary of these entities and thus the securities are not eliminated in consolidation. These securities are collateralized by non-recourse funding obligations issued by captive insurance companies that are affiliates of the Company.
The Company’s held-to-maturity securities had $76.6 million of gross unrecognized holding gains and $19.2 million of gross unrecognized holding losses by maturity as of December 31, 2017. The Company does not consider these unrecognized holding losses to be other-than-temporary based on certain positive factors associated with the securities which include credit ratings of the guarantor, financial health of the issuer and guarantor, continued access of the issuer to capital markets and other pertinent information.

22


Variable Interest Entities
The Company holds certain investments in entities in which its ownership interests could possibly be considered variable interests under Topic 810 of the Financial Accounting Standards Board (“FASB”) Accounting Standard Codification (“ASC” or “Codification”) (excluding debt and equity securities held as trading, available for sale, or held to maturity). The Company reviews the characteristics of each of these applicable entities and compares those characteristics to applicable criteria to determine whether the entity is a VIE. If the entity is determined to be a VIE, the Company then performs a detailed review to determine whether the interest would be considered a variable interest under the guidance. The Company then performs a qualitative review of all variable interests with the entity and determines whether the Company is the primary beneficiary. ASC 810 provides that an entity is the primary beneficiary of a VIE if the entity has 1) the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance, and 2) the obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the entity that could potentially be significant to the VIE.
Based on this analysis, the Company had an interest in two subsidiaries as of June 30, 2018 and December 31, 2017, Red Mountain, LLC ("Red Mountain") and Steel City, LLC ("Steel City"), that were determined to be VIEs.
The activity most significant to Red Mountain is the issuance of a note in connection with a financing transaction involving Golden Gate V Vermont Captive Insurance Company (“Golden Gate V”) in which Golden Gate V issued non-recourse funding obligations to Red Mountain and Red Mountain issued a note (the "Red Mountain Note") to Golden Gate V. For details of this transaction, see Note 11, Debt and Other Obligations. The Company had the power, via its 100% ownership through an affiliate, to direct the activities of the VIE, but did not have the obligation to absorb losses related to the primary risks or sources of variability to the VIE. The variability of loss would be borne primarily by the third party in its function as provider of credit enhancement on the Red Mountain Note. Accordingly, it was determined that the Company is not the primary beneficiary of the VIE. The Company’s risk of loss related to the VIE is limited to its investment, through an affiliate, of $10,000. Additionally, the Company has guaranteed Red Mountain’s payment obligation for the credit enhancement fee to the unrelated third party provider. As of June 30, 2018, no payments have been made or required related to this guarantee.
Steel City, a wholly owned subsidiary of the Company, entered into a financing agreement on January 15, 2016 involving Golden Gate Captive Insurance Company ("Golden Gate"), in which Golden Gate issued non-recourse funding obligations to Steel City and Steel City issued three notes (the “Steel City Notes”) to Golden Gate. Credit enhancement on the Steel City Notes is provided by unrelated third parties. For details of the financing transaction, see Note 11, Debt and Other Obligations. The activity most significant to Steel City is the issuance of the Steel City Notes. The Company had the power, via its 100% ownership, to direct the activities of the VIE, but did not have the obligation to absorb losses related to the primary risks or sources of variability to the VIE. The variability of loss would be borne primarily by the third parties in their function as providers of credit enhancement on the Steel City Notes. Accordingly, it was determined that the Company is not the primary beneficiary of the VIE. The Company’s risk of loss related to the VIE is limited to its investment of $10,000. Additionally, the Company has guaranteed Steel City’s payment obligation for the credit enhancement fee to the unrelated third party providers. As of June 30, 2018, no payments have been made or required related to this guarantee.
6.     FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company determined the fair value of its financial instruments based on the fair value hierarchy established in FASB guidance referenced in the Fair Value Measurements and Disclosures Topic which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The Company has adopted the provisions from the FASB guidance that is referenced in the Fair Value Measurements and Disclosures Topic for non-financial assets and liabilities (such as property and equipment, goodwill, and other intangible assets) that are required to be measured at fair value on a periodic basis. The effect on the Company’s periodic fair value measurements for non-financial assets and liabilities was not material.
The Company has categorized its financial instruments, based on the priority of the inputs to the valuation technique, into a three level hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure fair value fall within different levels of the hierarchy, the category level is based on the lowest priority level input that is significant to the fair value measurement of the instrument.
Financial assets and liabilities recorded at fair value on the consolidated balance sheets are categorized as follows:
Level 1: Unadjusted quoted prices for identical assets or liabilities in an active market.

Level 2: Quoted prices in markets that are not active or significant inputs that are observable either directly or indirectly. Level 2 inputs include the following:

a.Quoted prices for similar assets or liabilities in active markets;
b.Quoted prices for identical or similar assets or liabilities in non-active markets;
c.Inputs other than quoted market prices that are observable; and
d.
Inputs that are derived principally from or corroborated by observable market data through correlation or other means.

Level 3: Prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. They reflect management’s own assumptions about the assumptions a market participant would use in pricing the asset or liability.

23


The following table presents the Company’s hierarchy for its assets and liabilities measured at fair value on a recurring basis as of June 30, 2018:
 
Measurement
Category
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
 
(Dollars In Thousands)
Assets:
 
 
 

 
 

 
 

 
 

Fixed maturity securities - available-for-sale
 
 
 

 
 

 
 

 
 

Residential mortgage-backed securities
4
 
$

 
$
3,222,200

 
$
21,780

 
$
3,243,980

Commercial mortgage-backed securities
4
 

 
2,180,175

 
47,227

 
2,227,402

Other asset-backed securities
4
 

 
907,860

 
515,701

 
1,423,561

U.S. government-related securities
4
 
969,623

 
522,413

 

 
1,492,036

State, municipalities, and political subdivisions
4
 

 
3,633,803

 

 
3,633,803

Other government-related securities
4
 

 
401,730

 

 
401,730

Corporate securities
4
 

 
36,098,425

 
644,811

 
36,743,236

Redeemable preferred stock
4
 
71,292

 
18,284

 

 
89,576

Total fixed maturity securities - available-for-sale
 
 
1,040,915

 
46,984,890

 
1,229,519

 
49,255,324

Fixed maturity securities - trading
 
 
 

 
 

 
 

 
 

Residential mortgage-backed securities
3
 

 
259,755

 

 
259,755

Commercial mortgage-backed securities
3
 

 
141,469

 

 
141,469

Other asset-backed securities
3
 

 
89,655

 
24,852

 
114,507