10-Q 1 a14-9660_110q.htm 10-Q

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

FORM 10-Q

 

x  Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the quarterly period ended March 31, 2014

 

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 x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, or a smaller reporting company. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer x

 

Accelerated Filer o

 

 

 

Non-accelerated filer o

 

Smaller Reporting Company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o  No x

 

Number of shares of Common Stock, $0.50 Par Value, outstanding as of  April 23, 2014:  78,846,898

 

 

 



Table of Contents

 

PROTECTIVE LIFE CORPORATION

QUARTERLY REPORT ON FORM 10-Q

FOR QUARTERLY PERIOD ENDED MARCH 31, 2014

 

TABLE OF CONTENTS

 

 

 

 

Page

 

PART I

 

 

 

 

 

 

Item 1.

Financial Statements (unaudited):

 

 

 

Consolidated Condensed Statements of Income For The Three Months Ended March 31, 2014 and 2013

 

3

 

Consolidated Condensed Statements of Comprehensive Income (Loss) For The Three Months Ended March 31, 2014 and 2013

 

4

 

Consolidated Condensed Balance Sheets as of March 31, 2014 and December 31, 2013

 

5

 

Consolidated Condensed Statement of Shareowners’ Equity For The Three Months Ended March 31, 2014

 

7

 

Consolidated Condensed Statements of Cash Flows For The Three Months Ended March 31, 2014 and 2013

 

8

 

Notes to Consolidated Condensed Financial Statements

 

9

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

55

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

114

Item 4.

Controls and Procedures

 

114

 

 

 

 

 

PART II

 

 

 

 

 

 

Item 1A.

Risk Factors and Cautionary Factors that may Affect Future Results

 

114

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

123

Item 6.

Exhibits

 

124

 

Signature

 

125

 

2



Table of Contents

 

PROTECTIVE LIFE CORPORATION

CONSOLIDATED CONDENSED STATEMENTS OF INCOME

(Unaudited)

 

 

 

For The Three Months Ended March 31,

 

 

 

2014

 

2013

 

 

 

(Dollars In Thousands, Except Per Share Amounts)

 

Revenues

 

 

 

 

 

Premiums and policy fees

 

$

815,896

 

$

726,847

 

Reinsurance ceded

 

(327,713

)

(335,350

)

Net of reinsurance ceded

 

488,183

 

391,497

 

Net investment income

 

538,163

 

457,634

 

Realized investment gains (losses):

 

 

 

 

 

Derivative financial instruments

 

(105,350

)

7,385

 

All other investments

 

72,114

 

(4,145

)

Other-than-temporary impairment losses

 

(423

)

(1,340

)

Portion recognized in other comprehensive income (before taxes)

 

(1,168

)

(3,244

)

Net impairment losses recognized in earnings

 

(1,591

)

(4,584

)

Other income

 

99,039

 

85,027

 

Total revenues

 

1,090,558

 

932,814

 

Benefits and expenses

 

 

 

 

 

Benefits and settlement expenses, net of reinsurance ceded: (2014 - $304,832; 2013 - $308,800)

 

728,519

 

581,880

 

Amortization of deferred policy acquisition costs and value of business acquired

 

55,582

 

52,239

 

Other operating expenses, net of reinsurance ceded: (2014 - $43,766; 2013 - $40,989)

 

181,252

 

181,068

 

Total benefits and expenses

 

965,353

 

815,187

 

Income before income tax

 

125,205

 

117,627

 

Income tax expense

 

41,566

 

39,336

 

Net income

 

$

83,639

 

$

78,291

 

 

 

 

 

 

 

Net income - basic

 

$

1.05

 

$

0.99

 

Net income - diluted

 

$

1.03

 

$

0.97

 

Cash dividends paid per share

 

$

0.20

 

$

0.18

 

 

 

 

 

 

 

Average shares outstanding - basic

 

79,608,461

 

79,139,392

 

Average shares outstanding - diluted

 

80,872,152

 

80,706,744

 

 

See Notes to Consolidated Condensed Financial Statements

 

3



Table of Contents

 

PROTECTIVE LIFE CORPORATION

CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited)

 

 

 

For The Three Months Ended March 31,

 

 

 

2014

 

2013

 

 

 

(Dollars In Thousands)

 

Net income

 

$

83,639

 

$

78,291

 

Other comprehensive income (loss):

 

 

 

 

 

Change in net unrealized gains (losses) on investments, net of income tax: (2014 - $259,589; 2013 - $(76,295))

 

482,093

 

(141,691

)

Reclassification adjustment for investment amounts included in net income, net of income tax: (2014 - $(2,023); 2013 - $(2,704))

 

(3,756

)

(5,022

)

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: (2014 - $2,429; 2013 - $4,219)

 

4,511

 

7,837

 

Change in accumulated (loss) gain - derivatives, net of income tax: (2014 - $316; 2013 - $1,543)

 

587

 

2,866

 

Reclassification adjustment for derivative amounts included in net income, net of income tax: (2014 - $235; 2013 - $174)

 

436

 

323

 

Change in postretirement benefits liability adjustment, net of income tax: (2014 - $(632); 2013 - $(922))

 

(1,173

)

(1,712

)

Total other comprehensive income (loss)

 

482,698

 

(137,399

)

Total comprehensive income (loss)

 

$

566,337

 

$

(59,108

)

 

See Notes to Consolidated Condensed Financial Statements

 

4



Table of Contents

 

PROTECTIVE LIFE CORPORATION

CONSOLIDATED CONDENSED BALANCE SHEETS

(Unaudited)

 

 

 

As of

 

 

 

March 31, 2014

 

December 31, 2013

 

 

 

(Dollars In Thousands)

 

Assets

 

 

 

 

 

Fixed maturities, at fair value (amortized cost: 2014 - $33,955,913; 2013 - $33,662,295)

 

$

36,076,644

 

$

34,815,931

 

Fixed maturities, at amortized cost (fair value: 2014 - $420,747; 2013 - $335,676)

 

385,000

 

365,000

 

Equity securities, at fair value (cost: 2014 - $718,387; 2013 - $675,758)

 

716,985

 

646,027

 

Mortgage loans (2014 and 2013 includes: $582,177 and $627,731 related to securitizations)

 

5,390,844

 

5,486,417

 

Investment real estate, net of accumulated depreciation (2014 - $1,129; 2013 - $1,066)

 

20,351

 

20,413

 

Policy loans

 

1,793,110

 

1,815,744

 

Other long-term investments

 

509,766

 

521,811

 

Short-term investments

 

194,299

 

134,146

 

Total investments

 

45,086,999

 

43,805,489

 

Cash

 

407,532

 

466,542

 

Accrued investment income

 

490,723

 

465,333

 

Accounts and premiums receivable, net of allowance for uncollectible amounts (2014 - $4,307; 2013 - $4,283)

 

128,899

 

127,830

 

Reinsurance receivables

 

6,194,131

 

6,175,115

 

Deferred policy acquisition costs and value of business acquired

 

3,405,259

 

3,584,199

 

Goodwill

 

104,688

 

105,463

 

Property and equipment, net of accumulated depreciation (2014 - $113,404; 2013 - $111,579)

 

53,611

 

52,403

 

Other assets

 

420,604

 

426,677

 

Assets related to separate accounts

 

 

 

 

 

Variable annuity

 

12,946,329

 

12,791,438

 

Variable universal life

 

792,200

 

783,618

 

Total assets

 

$

70,030,975

 

$

68,784,107

 

 

See Notes to Consolidated Condensed Financial Statements

 

5



Table of Contents

 

PROTECTIVE LIFE CORPORATION

CONSOLIDATED CONDENSED BALANCE SHEETS

(continued)

(Unaudited)

 

 

 

As of

 

 

 

March 31, 2014

 

December 31, 2013

 

 

 

(Dollars In Thousands)

 

Liabilities

 

 

 

 

 

Future policy benefits and claims

 

$

29,811,041

 

$

29,781,325

 

Unearned premiums

 

1,560,585

 

1,549,815

 

Total policy liabilities and accruals

 

31,371,626

 

31,331,140

 

Stable value product account balances

 

2,537,504

 

2,559,552

 

Annuity account balances

 

11,113,637

 

11,125,253

 

Other policyholders’ funds

 

1,301,773

 

1,214,380

 

Other liabilities

 

1,227,464

 

1,143,371

 

Income tax payable

 

57,235

 

12,761

 

Deferred income taxes

 

1,310,111

 

1,069,759

 

Non-recourse funding obligations

 

582,437

 

562,448

 

Repurchase program borrowings

 

475,000

 

350,000

 

Debt

 

1,510,000

 

1,585,000

 

Subordinated debt securities

 

540,593

 

540,593

 

Liabilities related to separate accounts

 

 

 

 

 

Variable annuity

 

12,946,329

 

12,791,438

 

Variable universal life

 

792,200

 

783,618

 

Total liabilities

 

65,765,909

 

65,069,313

 

Commitments and contingencies - Note 9

 

 

 

 

 

Shareowners’ equity

 

 

 

 

 

Preferred Stock; $1 par value, shares authorized: 4,000,000; Issued: None

 

 

 

 

 

Common Stock, $.50 par value, shares authorized: 2014 and 2013 - 160,000,000 shares issued: 2014 and 2013 - 88,776,960

 

44,388

 

44,388

 

Additional paid-in-capital

 

601,367

 

606,934

 

Treasury stock, at cost (2014 - 9,931,123; 2013 - 10,199,514)

 

(195,192

)

(200,416

)

Retained earnings

 

2,837,739

 

2,769,822

 

Accumulated other comprehensive income (loss):

 

 

 

 

 

Net unrealized gains (losses) on investments, net of income tax: (2014 - $547,474; 2013 - $289,908)

 

1,016,737

 

538,400

 

Net unrealized (losses) gains relating to other-than-temporary impaired investments for which a portion has been recognized in earnings, net of income tax: (2014 - $2,754; 2013 - $325)

 

5,114

 

603

 

Accumulated loss - derivatives, net of income tax: (2014 - $(115); 2013 - $(666))

 

(212

)

(1,235

)

Postretirement benefits liability adjustment, net of income tax: (2014 - $(24,164); 2013 - $(23,532))

 

(44,875

)

(43,702

)

Total shareowners’ equity

 

4,265,066

 

3,714,794

 

Total liabilities and shareowners’ equity

 

$

70,030,975

 

$

68,784,107

 

 

See Notes to Consolidated Condensed Financial Statements

 

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Table of Contents

 

PROTECTIVE LIFE CORPORATION

CONSOLIDATED CONDENSED STATEMENTS OF SHAREOWNERS’ EQUITY

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

Additional

 

 

 

 

 

Other

 

Total

 

 

 

Common

 

Paid-In-

 

Treasury

 

Retained

 

Comprehensive

 

Shareowners’

 

 

 

Stock

 

Capital

 

Stock

 

Earnings

 

Income

 

Equity

 

 

 

(Dollars In Thousands)

 

Balance, December 31, 2013

 

$

44,388

 

$

606,934

 

$

(200,416

)

$

2,769,822

 

$

494,066

 

$

3,714,794

 

Net income for three months ended March 31, 2014

 

 

 

 

 

 

 

83,639

 

 

 

83,639

 

Other comprehensive income

 

 

 

 

 

 

 

 

 

482,698

 

482,698

 

Comprehensive income for the three months ended March 31, 2014

 

 

 

 

 

 

 

 

 

 

 

566,337

 

Cash dividends ($0.20 per share)

 

 

 

 

 

 

 

(15,722

)

 

 

(15,722

)

Stock-based compensation

 

 

 

(5,567

)

5,224

 

 

 

 

 

(343

)

Balance, March 31, 2014

 

$

44,388

 

$

601,367

 

$

(195,192

)

$

2,837,739

 

$

976,764

 

$

4,265,066

 

 

See Notes to Consolidated Condensed Financial Statements

 

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Table of Contents

 

PROTECTIVE LIFE CORPORATION

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

 

For The Three Months Ended March 31,

 

 

 

2014

 

2013

 

 

 

(Dollars In Thousands)

 

Cash flows from operating activities

 

 

 

 

 

Net income

 

$

83,639

 

$

78,291

 

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

 

 

 

 

 

Realized investment losses

 

34,827

 

1,344

 

Amortization of deferred policy acquisition costs and value of business acquired

 

55,582

 

52,239

 

Capitalization of deferred policy acquisition costs

 

(58,461

)

(63,154

)

Depreciation expense

 

1,865

 

2,205

 

Deferred income tax

 

(19,101

)

38,963

 

Accrued income tax

 

48,333

 

35,609

 

Interest credited to universal life and investment products

 

210,800

 

223,468

 

Policy fees assessed on universal life and investment products

 

(253,394

)

(222,969

)

Change in reinsurance receivables

 

(19,016

)

(36,723

)

Change in accrued investment income and other receivables

 

(13,635

)

(6,367

)

Change in policy liabilities and other policyholders’ funds of traditional life and health products

 

17,791

 

34,278

 

Trading securities:

 

 

 

 

 

Maturities and principal reductions of investments

 

25,257

 

54,121

 

Sale of investments

 

47,457

 

40,031

 

Cost of investments acquired

 

(37,070

)

(65,419

)

Other net change in trading securities

 

(20,589

)

(11,225

)

Change in other liabilities

 

2,744

 

(55,658

)

Other income - gains on repurchase of non-recourse funding obligations

 

 

(1,250

)

Other, net

 

(38,293

)

(708

)

Net cash provided by operating activities

 

68,736

 

97,076

 

Cash flows from investing activities

 

 

 

 

 

Maturities and principal reductions of investments, available-for-sale

 

221,379

 

229,316

 

Sale of investments, available-for-sale

 

351,930

 

652,347

 

Cost of investments acquired, available-for-sale

 

(900,641

)

(1,436,523

)

Change in investments, held-to-maturity

 

(20,000

)

(15,000

)

Mortgage loans:

 

 

 

 

 

New lendings

 

(126,896

)

(42,919

)

Repayments

 

222,646

 

156,924

 

Change in investment real estate, net

 

62

 

924

 

Change in policy loans, net

 

22,634

 

3,189

 

Change in other long-term investments, net

 

(73,019

)

(43,089

)

Change in short-term investments, net

 

(41,199

)

60,888

 

Net unsettled security transactions

 

45,145

 

48,166

 

Purchase of property and equipment

 

(3,073

)

(6,140

)

Sales of property and equipment

 

 

57

 

Net cash used in investing activities

 

(301,032

)

(391,860

)

Cash flows from financing activities

 

 

 

 

 

Borrowings under line of credit arrangements and debt

 

25,000

 

40,000

 

Principal payments on line of credit arrangement and debt

 

(100,000

)

(50,000

)

Issuance (repayment) of non-recourse funding obligations

 

19,989

 

10,000

 

Repurchase program borrowings

 

125,000

 

150,000

 

Dividends to shareowners

 

(15,722

)

(14,070

)

Repurchase of common stock

 

 

 

Investment product deposits and change in universal life deposits

 

696,229

 

798,912

 

Investment product withdrawals

 

(577,210

)

(733,756

)

Other financing activities, net

 

 

 

Net cash provided by financing activities

 

173,286

 

201,086

 

Change in cash

 

(59,010

)

(93,698

)

Cash at beginning of period

 

466,542

 

368,801

 

Cash at end of period

 

$

407,532

 

$

275,103

 

 

See Notes to Consolidated Condensed Financial Statements

 

8



Table of Contents

 

PROTECTIVE LIFE CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(Unaudited)

 

1.                                      BASIS OF PRESENTATION

 

Basis of Presentation

 

The accompanying unaudited consolidated condensed financial statements of Protective Life Corporation and subsidiaries (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the disclosures required by GAAP for complete financial statements. 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 month period ended March 31, 2014, are not necessarily indicative of the results that may be expected for the year ending December 31, 2014. The year-end consolidated condensed financial data was derived from audited financial statements but does not include all disclosures required by GAAP. 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, 2013.

 

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.

 

Reclassifications

 

Certain reclassifications have been made in the previously reported financial statements and accompanying notes to make the prior year amounts comparable to those of the current year. Such reclassifications had no effect on previously reported net income or shareowners’ equity.

 

Entities Included

 

The consolidated condensed financial statements 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, 2013. There were no significant changes to the Company’s accounting policies during the three months ended March 31, 2014.

 

Accounting Pronouncements Not Yet Adopted

 

Accounting Standard Update (“ASU”) No. 2014–08—Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. This Update changes the requirements for reporting discontinued operations and related disclosures. The Update limits the definition of a discontinued operation to disposals that represent “strategic shifts” that will have a major effect on an entity’s operation and financial results. Additionally, the Update requires enhanced disclosures about the components of discontinued operations and the financial effects of the disposal. The amendments in this Update are effective for annual and interim periods beginning after December 15, 2014. The Company is reviewing the additional disclosures required by the Update, and will apply the revised guidance to any disposals occurring after the effective date.

 

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3.                                      SIGNIFICANT ACQUISITIONS

 

On October 1, 2013 PLICO completed the acquisition contemplated by the master agreement (the “Master Agreement”) dated April 10, 2013. Pursuant to that Master Agreement with AXA Financial, Inc. (“AXA”) and AXA Equitable Financial Services, LLC (“AEFS”), PLICO acquired the stock of MONY Life Insurance Company (“MONY”) from AEFS and entered into a reinsurance agreement (the “Reinsurance Agreement”) pursuant to which it reinsured on a 100% indemnity reinsurance basis certain business (the “MLOA Business”) of MONY Life Insurance Company of America (“MLOA”). The aggregate purchase price of MONY was $686 million. The ceding commission for the reinsurance of the MLOA Business was $370 million. Together, the purchase of MONY and reinsurance of the MLOA Business are hereto referred to as (the “MONY acquisition”). The MONY acquisition allowed the Company to invest its capital and increase the scale of its Acquisitions segment. The MONY acquisition business is comprised of traditional and universal life insurance policies and fixed and variable annuities, most of which were written prior to 2004.

 

The MONY acquisition was accounted for under the acquisition method of accounting under ASC Topic 805. In accordance with ASC 805-20-30, all identifiable assets acquired and liabilities assumed were measured at fair value as of the acquisition date. The MONY acquisition will be subject to customary post-closing adjustments as the Company finalizes the determination and analysis of assets acquired and liabilities assumed.

 

The following (unaudited) pro forma consolidated condensed results of operations assumes that the aforementioned acquisition was completed as of January 1, 2012:

 

 

 

Unaudited

 

 

 

For The

 

 

 

Three Months Ended

 

 

 

March 31, 2013

 

 

 

(Dollars In Thousands)

 

Revenue

 

$

1,153,317

 

Net income

 

$

84,926

 

EPS - basic

 

$

1.07

 

EPS - diluted

 

$

1.05

 

 

4.                                      MONY CLOSED BLOCK OF BUSINESS

 

In 1998, 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 MONY acquisition as discussed in Note 3, Significant Acquisitions.

 

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 Insurance Department (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 accumulated other comprehensive income (loss) (“AOCI”)) at the acquisition date 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 has developed an actuarial calculation of the expected timing of MONY’s Closed Block’s earnings as of October 1, 2013.

 

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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.

 

Summarized financial information for the Closed Block from December 31, 2013 through March 31, 2014 is as follows:

 

 

 

As of

 

 

 

March 31, 2014

 

December 31, 2013

 

 

 

(Dollars In Thousands)

 

Closed block liabilities

 

 

 

 

 

Future policy benefits, policyholders’ account balances and other

 

$

6,240,290

 

$

6,274,719

 

Policyholder dividend obligation

 

254,081

 

190,494

 

Other liabilities

 

5,840

 

1,259

 

Total closed block liabilities

 

6,500,211

 

6,466,472

 

Closed block assets

 

 

 

 

 

Fixed maturities, available-for-sale, at fair value

 

$

4,102,407

 

$

4,109,142

 

Equity securities, available-for-sale, at fair value

 

5,260

 

5,223

 

Mortgage loans on real estate

 

560,882

 

594,884

 

Policy loans

 

796,863

 

802,013

 

Cash and other invested assets

 

235,578

 

140,577

 

Other assets

 

204,813

 

207,265

 

Total closed block assets

 

5,905,803

 

5,859,104

 

Excess of reported closed block liabilities over closed block assets

 

594,408

 

607,368

 

Portion of above representing accumulated other comprehensive income:

 

 

 

 

 

Net unrealized investments gains (losses) net of deferred tax benefit of $0 and $1,074 net of policyholder dividend obligation of $37,405 and $12,720

 

 

(1,994

)

Future earnings to be recognized from closed block assets and closed block liabilities

 

$

594,408

 

$

605,374

 

 

Reconciliation of the policyholder dividend obligation from December 31, 2013 through March 31, 2014 is as follows:

 

 

 

For The

 

 

 

Three Months Ended

 

 

 

March 31, 2014

 

 

 

(Dollars In Thousands)

 

Policyholder dividend obligation, at December 31, 2013

 

$

190,494

 

Applicable to net revenue (losses)

 

(6,680

)

Change in net unrealized investment gains (losses) allocated to policyholder dividend obligation

 

70,267

 

Policyholder dividend obligation, end of period

 

$

254,081

 

 

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Closed Block revenues and expenses for the three month period ended March 31, 2014 are as follows:

 

 

 

For The

 

 

 

Three Months Ended

 

 

 

March 31, 2014

 

 

 

(Dollars In Thousands)

 

Revenues

 

 

 

Premiums and other income

 

$

50,066

 

Net investment income (loss)

 

52,207

 

Net investment gains (losses)

 

5,019

 

Total revenues

 

107,292

 

Benefits and other deductions

 

 

 

Benefits and settlement expenses

 

96,326

 

Total benefits and other deductions

 

96,326

 

Net revenues before income taxes

 

10,966

 

Income tax expense

 

3,838

 

Net revenues

 

$

7,128

 

 

5.                                      INVESTMENT OPERATIONS

 

Net realized gains (losses) for all other investments are summarized as follows:

 

 

 

For The Three Months Ended March 31,

 

 

 

2014

 

2013

 

 

 

(Dollars In Thousands)

 

Fixed maturities

 

$

7,370

 

$

12,309

 

Equity securities

 

 

1

 

Impairments on fixed maturity securities

 

(1,591

)

(3,587

)

Impairments on equity securities

 

 

(997

)

Modco trading portfolio

 

66,303

 

(15,328

)

Other investments

 

(1,559

)

(1,127

)

Total realized gains (losses) - investments

 

$

70,523

 

$

(8,729

)

 

For the three months ended March 31, 2014, gross realized gains on investments available-for-sale (fixed maturities, equity securities, and short-term investments) were $7.6 million and gross realized losses were $1.8 million, including $1.6 million of impairment losses.

 

For the three months ended March 31, 2013, gross realized gains on investments available-for-sale (fixed maturities, equity securities, and short-term investments) were $12.9 million and gross realized losses were $4.9 million, including $4.4 million of impairment losses.

 

For the three months ended March 31, 2014, the Company sold securities in an unrealized gain position with a fair value (proceeds) of $264.7 million. The gain realized on the sale of these securities was $7.6 million.

 

For the three months ended March 31, 2013, the Company sold securities in an unrealized gain position with a fair value (proceeds) of $388.6 million. The gain realized on the sale of these securities was $12.9 million.

 

For the three months ended March 31, 2014, the Company sold or otherwise disposed of securities in an unrealized loss position with a fair value (proceeds) of $2.7 million. The loss realized on the sale of these securities was $0.3 million. The Company made the decision to exit these holdings in conjunction with our overall asset liability management process.

 

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For the three months ended March 31, 2013, the Company sold securities in an unrealized loss position with a fair value (proceeds) of $4.0 million. The loss realized on the sale of these securities was $0.6 million. The Company made the decision to exit these holdings in conjunction with our overall asset liability management process.

 

The amortized cost and fair value of the Company’s investments classified as available-for-sale as of March 31, 2014 and December 31, 2013, are as follows:

 

 

 

 

 

Gross

 

Gross

 

 

 

Total OTTI

 

 

 

Amortized

 

Unrealized

 

Unrealized

 

Fair

 

Recognized

 

 

 

Cost

 

Gains

 

Losses

 

Value

 

in OCI(1)

 

 

 

(Dollars In Thousands)

 

 

 

2014

 

 

 

 

 

 

 

 

 

 

 

Fixed maturities:

 

 

 

 

 

 

 

 

 

 

 

Bonds

 

 

 

 

 

 

 

 

 

 

 

Residential mortgage-backed securities

 

$

1,409,310

 

$

44,397

 

$

(14,934

)

$

1,438,773

 

$

7,942

 

Commercial mortgage-backed securities

 

997,605

 

36,151

 

(10,390

)

1,023,366

 

 

Other asset-backed securities

 

908,643

 

15,971

 

(63,869

)

860,745

 

(74

)

U.S. government-related securities

 

1,508,287

 

37,403

 

(34,449

)

1,511,241

 

 

Other government-related securities

 

48,937

 

2,742

 

(1

)

51,678

 

 

States, municipals, and political subdivisions

 

1,351,460

 

176,525

 

(4,045

)

1,523,940

 

 

Corporate bonds

 

24,893,867

 

2,109,682

 

(174,452

)

26,829,097

 

 

 

 

31,118,109

 

2,422,871

 

(302,140

)

33,238,840

 

7,868

 

Equity securities

 

695,939

 

19,924

 

(21,327

)

694,536

 

 

Short-term investments

 

122,905

 

 

 

122,905

 

 

 

 

$

31,936,953

 

$

2,442,795

 

$

(323,467

)

$

34,056,281

 

$

7,868

 

2013

 

 

 

 

 

 

 

 

 

 

 

Fixed maturities:

 

 

 

 

 

 

 

 

 

 

 

Bonds

 

 

 

 

 

 

 

 

 

 

 

Residential mortgage-backed securities

 

$

1,435,477

 

$

34,155

 

$

(24,564

)

$

1,445,068

 

$

979

 

Commercial mortgage-backed securities

 

963,461

 

26,900

 

(19,705

)

970,656

 

 

Other asset-backed securities

 

926,396

 

15,135

 

(69,548

)

871,983

 

(51

)

U.S. government-related securities

 

1,529,818

 

32,150

 

(54,078

)

1,507,890

 

 

Other government-related securities

 

49,171

 

2,257

 

(1

)

51,427

 

 

States, municipals, and political subdivisions

 

1,315,457

 

103,663

 

(8,291

)

1,410,829

 

 

Corporate bonds

 

24,644,025

 

1,507,630

 

(392,067

)

25,759,588

 

 

 

 

30,863,805

 

1,721,890

 

(568,254

)

32,017,441

 

928

 

Equity securities

 

654,579

 

6,631

 

(36,362

)

624,848

 

 

Short-term investments

 

81,703

 

 

 

81,703

 

 

 

 

$

31,600,087

 

$

1,728,521

 

$

(604,616

)

$

32,723,992

 

$

928

 

 


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

 

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Table of Contents

 

The amortized cost and fair value of the Company’s investments classified as held-to-maturity as of March 31, 2014 and December 31, 2013, are as follows:

 

 

 

 

 

Gross

 

Gross

 

 

 

Total OTTI

 

 

 

Amortized

 

Unrealized

 

Unrealized

 

Fair

 

Recognized

 

 

 

Cost

 

Gains

 

Losses

 

Value

 

in OCI

 

 

 

(Dollars In Thousands)

 

 

 

2014

 

 

 

 

 

 

 

 

 

 

 

Fixed maturities:

 

 

 

 

 

 

 

 

 

 

 

Other

 

$

385,000

 

$

35,747

 

$

 

$

420,747

 

$

 

 

 

$

385,000

 

$

35,747

 

$

 

$

420,747

 

$

 

2013

 

 

 

 

 

 

 

 

 

 

 

Fixed maturities:

 

 

 

 

 

 

 

 

 

 

 

Other

 

$

365,000

 

$

 

$

(29,324

)

$

335,676

 

$

 

 

 

$

365,000

 

$

 

$

(29,324

)

$

335,676

 

$

 

 

During the three months ended March 31, 2014 and the year ended December 31, 2013, the Company did not record any other-than-temporary impairments on held-to-maturity securities. The Company’s held-to-maturity securities had no gross unrecognized holding losses for the three months ended March 31, 2014 and $29.3 million for the year ended December 31, 2013. 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, financial health of the issuer, continued access of the issuer to capital markets and other pertinent information.

 

As of March 31, 2014 and December 31, 2013, the Company had an additional $2.8 billion and $2.8 billion of fixed maturities, $22.4 million and $21.2 million of equity securities, and $71.4 million and $52.4 million of short-term investments classified as trading securities, respectively.

 

The amortized cost and fair value of available-for-sale and held-to-maturity fixed maturities as of March 31, 2014, 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

 

Fair

 

Amortized

 

Fair

 

 

 

Cost

 

Value

 

Cost

 

Value

 

 

 

(Dollars In Thousands)

 

(Dollars In Thousands)

 

Due in one year or less

 

$

835,262

 

$

848,692

 

$

 

$

 

Due after one year through five years

 

6,083,022

 

6,460,856

 

 

 

Due after five years through ten years

 

8,357,580

 

8,689,900

 

 

 

Due after ten years

 

15,842,245

 

17,239,392

 

385,000

 

420,747

 

 

 

$

31,118,109

 

$

33,238,840

 

$

385,000

 

$

420,747

 

 

During the three months ended March 31, 2014, the Company recorded pre-tax other-than-temporary impairments of investments of $0.4 million, all of which related to fixed maturities. Credit impairments recorded in earnings during the period were $1.6 million. During the three months ended March 31, 2014, $1.2 million of non-credit losses previously recorded in other comprehensive income were recorded in earnings as credit losses. 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 months ended March 31, 2014.

 

During the three months ended March 31, 2013, the Company recorded pre-tax other-than-temporary impairments of investments of $1.3 million, of which $0.3 million related to fixed maturities and $1.0 million were related to equity securities. Credit impairments recorded in earnings during the period were $4.6 million. During the three months ended March 31, 2013, $3.3 million of non-credit losses previously recorded in other comprehensive income were recorded in earnings as credit losses. 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 months ended March 31, 2013.

 

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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 March 31,

 

 

 

2014

 

2013

 

 

 

(Dollars In Thousands)

 

Beginning balance

 

$

41,692

 

$

122,121

 

Additions for newly impaired securities

 

 

997

 

Additions for previously impaired securities

 

474

 

1,486

 

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

 

(21,327

)

 

Reductions for previously impaired securities that were sold in the current period

 

 

 

Ending balance

 

$

20,839

 

$

124,604

 

 

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 March 31, 2014:

 

 

 

Less Than 12 Months

 

12 Months or More

 

Total

 

 

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

 

 

Value

 

Loss

 

Value

 

Loss

 

Value

 

Loss

 

 

 

(Dollars In Thousands)

 

Residential mortgage-backed securities

 

$

358,843

 

$

(11,652

)

$

49,735

 

$

(3,282

)

$

408,578

 

$

(14,934

)

Commercial mortgage-backed securities

 

252,504

 

(7,095

)

50,623

 

(3,295

)

303,127

 

(10,390

)

Other asset-backed securities

 

118,684

 

(8,498

)

532,361

 

(55,371

)

651,045

 

(63,869

)

U.S. government-related securities

 

737,715

 

(33,565

)

14,770

 

(884

)

752,485

 

(34,449

)

Other government-related securities

 

10,052

 

(1

)

 

 

10,052

 

(1

)

States, municipalities, and political subdivisions

 

40,385

 

(3,500

)

1,242

 

(545

)

41,627

 

(4,045

)

Corporate bonds

 

3,578,369

 

(129,320

)

452,733

 

(45,132

)

4,031,102

 

(174,452

)

Equities

 

218,131

 

(13,057

)

22,116

 

(8,270

)

240,247

 

(21,327

)

 

 

$

5,314,683

 

$

(206,688

)

$

1,123,580

 

$

(116,779

)

$

6,438,263

 

$

(323,467

)

 

RMBS have a gross unrealized loss greater than twelve months of $3.3 million as of March 31, 2014. 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.

 

CMBS have a gross unrealized loss greater than twelve months of $3.3 million as of March 31, 2014. 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 have a gross unrealized loss greater than twelve months of $55.4 million as of March 31, 2014. This category predominately includes student-loan backed auction rate securities, the underlying collateral, of which is at least 97% guaranteed by the Federal Family Education Loan Program (“FFELP”). These unrealized losses have occurred within the Company’s auction rate securities (“ARS”) portfolio since the market collapse during 2008. 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 corporate bonds category has gross unrealized losses greater than twelve months of $45.1 million as of March 31, 2014. These declines were primarily related to changes in interest rates during the period. 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.

 

The equities category has a gross unrealized loss greater than twelve months of $8.3 million as of March 31, 2014. The aggregate decline in market value of these securities was deemed temporary due to factors supporting the

 

15



Table of Contents

 

recoverability of the respective investments. Positive factors include credit ratings, the financial health of the issuer, the continued access of the issuer to the capital markets, and other pertinent information.

 

The Company does not consider these unrealized loss positions to be other-than-temporary, based on the factors discussed and because the Company has the ability and intent to hold these investments until the fair values recover, and 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, 2013:

 

 

 

Less Than 12 Months

 

12 Months or More

 

Total

 

 

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

 

 

Value

 

Loss

 

Value

 

Loss

 

Value

 

Loss

 

 

 

(Dollars In Thousands)

 

Residential mortgage-backed securities

 

$

333,235

 

$

(14,051

)

$

210,486

 

$

(10,513

)

$

543,721

 

$

(24,564

)

Commercial mortgage-backed securities

 

429,228

 

(18,467

)

13,840

 

(1,238

)

443,068

 

(19,705

)

Other asset-backed securities

 

175,846

 

(14,555

)

497,512

 

(54,993

)

673,358

 

(69,548

)

U.S. government-related securities

 

891,698

 

(53,508

)

6,038

 

(570

)

897,736

 

(54,078

)

Other government-related securities

 

10,161

 

(1

)

 

 

10,161

 

(1

)

States, municipalities, and political subdivisions

 

172,157

 

(8,113

)

335

 

(178

)

172,492

 

(8,291

)

Corporate bonds

 

7,484,010

 

(353,211

)

272,423

 

(38,856

)

7,756,433

 

(392,067

)

Equities

 

376,776

 

(27,861

)

21,974

 

(8,501

)

398,750

 

(36,362

)

 

 

$

9,873,111

 

$

(489,767

)

$

1,022,608

 

$

(114,849

)

$

10,895,719

 

$

(604,616

)

 

RMBS had a gross unrealized loss greater than twelve months of $10.5 million as of December 31, 2013. 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.

 

CMBS had a gross unrealized loss greater than twelve months of $1.2 million as of December 31, 2013. 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 $55.0 million as of December 31, 2013. This category predominately includes student-loan backed auction rate securities, the underlying collateral, of which is at least 97% guaranteed by the FFELP. These unrealized losses have occurred within the Company’s ARS portfolio since the market collapse during 2008. 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 corporate bonds category had gross unrealized losses greater than twelve months of $38.9 million as of December 31, 2013. These declines were primarily related to changes in interest rates during the period. 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.

 

The equities category had a gross unrealized loss greater than twelve months of $8.5 million as of December 31, 2013. The aggregate decline in market value of these securities was deemed temporary due to factors supporting the recoverability of the respective investments. Positive factors include credit ratings, the financial health of the issuer, the continued access of the issuer to the capital markets, and other pertinent information.

 

The Company does not consider these unrealized loss positions to be other-than-temporary, based on the factors discussed and because the Company has the ability and intent to hold these investments until the fair values recover, and does not intend to sell or expect to be required to sell the securities before recovering the Company’s amortized cost of the securities.

 

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Table of Contents

 

As of March 31, 2014, the Company had securities in its available-for-sale portfolio which were rated below investment grade of $1.6 billion and had an amortized cost of $1.6 billion. In addition, included in the Company’s trading portfolio, the Company held $328.9 million of securities which were rated below investment grade. Approximately $877.9 million of the below investment grade securities were not publicly traded.

 

The change in unrealized gains (losses), net of income tax, on fixed maturity and equity securities, classified as available-for-sale is summarized as follows:

 

 

 

For The Three Months Ended March 31,

 

 

 

2014

 

2013

 

 

 

(Dollars In Thousands)

 

Fixed maturities

 

$

628,612

 

$

(169,788

)

Equity securities

 

18,413

 

3,790

 

 

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 Variable Interest Entity (“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 one wholly owned subsidiary, Red Mountain, LLC (“Red Mountain”), that was determined to be a VIE as of March 31, 2014 and December 31, 2013. 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”) and the Company in which Golden Gate V issued non-recourse funding obligations to Red Mountain and Red Mountain issued the note to Golden Gate V. Credit enhancement on the Red Mountain Note is provided by an unrelated third party. For details of this transaction, see Note 8, 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 of $10,000. Additionally, the Company has guaranteed the VIE’s payment obligation for the credit enhancement fee to the unrelated third party provider. As of March 31, 2014, no payments have been made or required related to this guarantee.

 

6.                                      MORTGAGE LOANS

 

Mortgage Loans

 

The Company invests a portion of its investment portfolio in commercial mortgage loans. As of March 31, 2014, the Company’s mortgage loan holdings were approximately $5.4 billion. The Company has specialized in making loans on either credit-oriented commercial properties or credit-anchored strip shopping centers and apartments. The Company’s underwriting procedures relative to its commercial loan portfolio are based, in the Company’s view, on a conservative and disciplined approach. The Company concentrates on a small number of commercial real estate asset types associated with the necessities of life (retail, multi-family, professional office buildings, and warehouses). The Company believes these asset types tend to weather economic downturns better than other commercial asset classes in which it has chosen not to participate. The Company believes this disciplined approach has helped to maintain a

 

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relatively low delinquency and foreclosure rate throughout its history. The majority of the Company’s mortgage loans portfolio was underwritten and funded by the Company. From time to time, the Company may acquire loans in conjunction with an acquisition.

 

The Company’s commercial mortgage loans are stated at unpaid principal balance, adjusted for any unamortized premium or discount, and net of valuation allowances. Interest income is accrued on the principal amount of the loan based on the loan’s contractual interest rate. Amortization of premiums and discounts is recorded using the effective yield method. Interest income, amortization of premiums and discounts and prepayment fees are reported in net investment income.

 

Certain of our mortgage loans have call options or interest rate reset options between 3 and 10 years. However, if interest rates were to significantly increase, we may be unable to exercise the call options or increase the interest rates on our existing mortgage loans commensurate with the significantly increased market rates. Assuming the loans are called at their next call dates, approximately $54.9 million would become due for the remainder of 2014, $1.2 billion in 2015 through 2019, $506.4 million in 2020 through 2024, and $133.3 million thereafter.

 

The Company offers a type of commercial mortgage loan under which the Company will permit a loan-to-value ratio of up to 85% in exchange for a participating interest in the cash flows from the underlying real estate. As of March 31, 2014 and December 31, 2013, approximately $630.3 million and $666.6 million, respectively, of the Company’s mortgage loans have this participation feature. Cash flows received as a result of this participation feature are recorded as interest income. During the three months ended March 31, 2014 and 2013, the Company recognized $3.0 million and $3.4 million, respectively, of participating mortgage loan income.

 

As of March 31, 2014, approximately $14.2 million, or 0.03%, of invested assets consisted of nonperforming, restructured or mortgage loans that were foreclosed and were converted to real estate properties. The Company does not expect these investments to adversely affect its liquidity or ability to maintain proper matching of assets and liabilities. During the three months ended March 31, 2014, certain mortgage loan transactions occurred that were accounted for as troubled debt restructurings under Topic 310 of the FASB ASC. For all mortgage loans, the impact of troubled debt restructurings is generally reflected in our investment balance and in the allowance for mortgage loan credit losses. Transactions accounted for as troubled debt restructurings during the quarter either involved the modification of payment terms pursuant to bankruptcy proceedings or included acceptance of assets in satisfaction of principal or foreclosure on collateral property, and were the result of agreements between the creditor and the debtor. With respect to the modified loans we expect to collect all amounts due related to these loans as well as expenses incurred as a result of the restructurings. Additionally, there were no material changes to the principal balance of these loans, as a result of restructuring or modifications, which was $5.8 million as of March 31, 2014.

 

The Company’s mortgage loan portfolio consists of two categories of loans: (1) those not subject to a pooling and servicing agreement and (2) those subject to a contractual pooling and servicing agreement. As of March 31, 2014, $12.0 million of mortgage loans not subject to a pooling and servicing agreement were nonperforming or restructured. The Company did not foreclose on any loans during the three months ended March 31, 2014.

 

As of March 31, 2014, $2.2 million of loans subject to a pooling and servicing agreement were nonperforming. None of these nonperforming loans have been restructured during the three months ended March 31, 2014. The Company did not foreclose on any loans during the three months ended March 31, 2014.

 

As of March 31, 2014 and December 31, 2013, the Company had an allowance for mortgage loan credit losses of $4.5 million and $3.1 million, respectively. Due to the Company’s loss experience and nature of the loan portfolio, the Company believes that a collectively evaluated allowance would be inappropriate. The Company believes an allowance calculated through an analysis of specific loans that are believed to have a higher risk of credit impairment provides a more accurate presentation of expected losses in the portfolio and is consistent with the applicable guidance for loan impairments in ASC Subtopic 310. Since the Company uses the specific identification method for calculating the allowance, it is necessary to review the economic situation of each borrower to determine those that have higher risk of credit impairment. The Company has a team of professionals that monitors borrower conditions such as payment practices, borrower credit, operating performance, and property conditions, as well as ensuring the timely payment of property taxes and insurance. Through this monitoring process, the Company assesses the risk of each loan. When issues are identified, the severity of the issues are assessed and reviewed for possible credit impairment. If a loss is

 

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probable, an expected loss calculation is performed and an allowance is established for that loan based on the expected loss. The expected loss is calculated as the excess carrying value of a loan over either the present value of expected future cash flows discounted at the loan’s original effective interest rate, or the current estimated fair value of the loan’s underlying collateral. A loan may be subsequently charged off at such point that the Company no longer expects to receive cash payments, the present value of future expected payments of the renegotiated loan is less than the current principal balance, or at such time that the Company is party to foreclosure or bankruptcy proceedings associated with the borrower and does not expect to recover the principal balance of the loan.

 

A charge off is recorded by eliminating the allowance against the mortgage loan and recording the renegotiated loan or the collateral property related to the loan as investment real estate on the balance sheet, which is carried at the lower of the appraised fair value of the property or the unpaid principal balance of the loan, less estimated selling costs associated with the property:

 

 

 

As of

 

 

 

March 31, 2014

 

December 31, 2013

 

 

 

(Dollars In Thousands)

 

Beginning balance

 

$

3,130

 

$

2,875

 

Charge offs

 

 

(6,838

)

Recoveries

 

(167

)

(1,016

)

Provision

 

1,542

 

8,109

 

Ending balance

 

$

4,505

 

$

3,130

 

 

It is the Company’s policy to cease to carry accrued interest on loans that are over 90 days delinquent. For loans less than 90 days delinquent, interest is accrued unless it is determined that the accrued interest is not collectible. If a loan becomes over 90 days delinquent, it is the Company’s general policy to initiate foreclosure proceedings unless a workout arrangement to bring the loan current is in place. For loans subject to a pooling and servicing agreement, there are certain additional restrictions and/or requirements related to workout proceedings, and as such, these loans may have different attributes and/or circumstances affecting the status of delinquency or categorization of those in nonperforming status. An analysis of the delinquent loans is shown in the following chart as of March 31, 2014.

 

 

 

 

 

 

 

Greater

 

 

 

 

 

30-59 Days

 

60-89 Days

 

than 90 Days

 

Total

 

 

 

Delinquent

 

Delinquent

 

Delinquent

 

Delinquent

 

 

 

(Dollars In Thousands)

 

Commercial mortgage loans

 

$

10,102

 

$

6,209

 

$

2,201

 

$

18,512

 

Number of delinquent commercial mortgage loans

 

5

 

3

 

1

 

9

 

 

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The Company’s commercial mortgage loan portfolio consists of mortgage loans that are collateralized by real estate. Due to the collateralized nature of the loans, any assessment of impairment and ultimate loss given a default on the loans is based upon a consideration of the estimated fair value of the real estate. The Company limits accrued interest income on impaired loans to 90 days of interest. Once accrued interest on the impaired loan is received, interest income is recognized on a cash basis. For information regarding impaired loans, please refer to the following chart as of March 31, 2014 and December 31, 2013:

 

 

 

 

 

Unpaid

 

 

 

Average

 

Interest

 

Cash Basis

 

 

 

Recorded

 

Principal

 

Related

 

Recorded

 

Income

 

Interest

 

 

 

Investment

 

Balance

 

Allowance

 

Investment

 

Recognized

 

Income

 

 

 

(Dollars In Thousands)

 

2014 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial mortgage loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

With no related allowance recorded

 

$

3,331

 

$

3,331

 

$

 

$

1,666

 

$

31

 

$

22

 

With an allowance recorded

 

27,032

 

27,022

 

4,505

 

5,406

 

392

 

444

 

2013 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial mortgage loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

With no related allowance recorded

 

$

2,208

 

$

2,208

 

$

 

$

2,208

 

$

31

 

$

 

With an allowance recorded

 

21,288

 

21,281

 

3,130

 

5,322

 

304

 

304

 

 

7.                                      GOODWILL

 

During the three months ended March 31, 2014, the Company decreased its goodwill balance by approximately $0.8 million. The decrease was due to an adjustment in the Acquisitions segment related to tax benefits realized during 2014 on the portion of tax goodwill in excess of GAAP basis goodwill. As of March 31, 2014, the Company had an aggregate goodwill balance of $104.7 million.

 

Accounting for goodwill requires an estimate of the future profitability of the associated lines of business to assess the recoverability of the capitalized acquisition goodwill. The Company evaluates the carrying value of goodwill at the segment (or reporting unit) level at least annually and between annual evaluations if events occur or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying amount. Such circumstances could include, but are not limited to: 1) a significant adverse change in legal factors or in business climate, 2) unanticipated competition, or 3) an adverse action or assessment by a regulator. When evaluating whether goodwill is impaired, the Company first determines through qualitative analysis whether relevant events and circumstances indicate that it is more likely than not that segment goodwill balances are impaired as of the testing date. If it is determined that it is more likely than not that impairment exists, the Company compares its estimate of the fair value of the reporting unit to which the goodwill is assigned to the reporting unit’s carrying amount, including goodwill. The Company utilizes a fair value measurement (which includes a discounted cash flows analysis) to assess the carrying value of the reporting units in consideration of the recoverability of the goodwill balance assigned to each reporting unit as of the measurement date. The Company’s material goodwill balances are attributable to certain of its operating segments (which are each considered to be reporting units). The cash flows used to determine the fair value of the Company’s reporting units are dependent on a number of significant assumptions. The Company’s estimates, which consider a market participant view of fair value, are subject to change given the inherent uncertainty in predicting future results and cash flows, which are impacted by such things as policyholder behavior, competitor pricing, capital limitations, new product introductions, and specific industry and market conditions. Additionally, the discount rate used is based on the Company’s judgment of the appropriate rate for each reporting unit based on the relative risk associated with the projected cash flows. As of December 31, 2013, the Company performed its annual evaluation of goodwill and determined that no adjustment to impair goodwill was necessary. During the three months ended March 31, 2014, no events occurred which indicate an impairment was required or which would invalidate the previous results of the Company’s impairment assessment.

 

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8.                                      DEBT AND OTHER OBLIGATIONS

 

The Company has access to a Credit Facility that provides the ability to borrow on an unsecured basis up to an aggregate principal amount of $750 million. The Company has the right in certain circumstances to request that the commitment under the Credit Facility be increased up to a maximum principal amount of $1.0 billion. Balances outstanding under the Credit Facility accrue interest at a rate equal to, at the option of the Borrowers, (i)  LIBOR plus a spread based on the ratings of the Company’s senior unsecured long-term debt (“Senior Debt”), or (ii) the sum of (A) a rate equal to the highest of (x) the Administrative Agent’s prime rate, (y) 0.50% above the Federal Funds rate, or (z) the one-month LIBOR plus 1.00% and (B) a spread based on the ratings of the Company’s Senior Debt. The Credit Facility also provides for a facility fee at a rate that varies with the ratings of the Company’s Senior Debt and that is calculated on the aggregate amount of commitments under the Credit Facility, whether used or unused. The maturity date on the Credit Facility is July 17, 2017. The Company is not aware of any non-compliance with the financial debt covenants of the Credit Facility as of March 31, 2014. There was an outstanding balance of $410.0 million at an interest rate of LIBOR plus 1.20% under the Credit Facility as of March 31, 2014.

 

Non-Recourse Funding Obligations

 

Golden Gate II Captive Insurance Company

 

Golden Gate II Captive Insurance Company (“Golden Gate II”), a special purpose financial captive insurance company wholly owned by Protective Life Insurance Company (“PLICO”), had $575 million of outstanding non-recourse funding obligations as of March 31, 2014. These outstanding non-recourse funding obligations were issued to special purpose trusts, which in turn issued securities to third parties. Certain of our affiliates own a portion of these securities. As of March 31, 2014, securities related to $194.9 million of the outstanding balance of the non-recourse funding obligations were held by external parties and securities related to $380.1 million of the non-recourse funding obligations were held by our affiliates. The Company has entered into certain support agreements with Golden Gate II obligating the Company to make capital contributions or provide support related to certain of Golden Gate II’s expenses and in certain circumstances, to collateralize certain of the Company’s obligations to Golden Gate II. These support agreements provide that amounts would become payable by the Company to Golden Gate II if its annual general corporate expenses were higher than modeled amounts or if Golden Gate II’s investment income on certain investments or premium income was below certain actuarially determined amounts. As of March 31, 2014, no payments have been made under these agreements.

 

Golden Gate V Vermont Captive Insurance Company

 

On October 10, 2012, Golden Gate V and Red Mountain, indirect wholly owned subsidiaries of the Company, entered into a 20-year transaction to finance up to $945 million of “AXXX” reserves related to a block of universal life insurance policies with secondary guarantees issued by our direct wholly owned subsidiary PLICO and indirect wholly owned subsidiary, West Coast Life Insurance Company (“WCL”). Golden Gate V issued non-recourse funding obligations to Red Mountain, and Red Mountain issued a note with an initial principal amount of $275 million, increasing to a maximum of $945 million in 2027, to Golden Gate V for deposit to a reinsurance trust supporting Golden Gate V’s obligations under a reinsurance agreement with WCL, pursuant to which WCL cedes liabilities relating to the policies of WCL and retrocedes liabilities relating to the policies of PLICO. Through the structure, Hannover Life Reassurance Company of America (“Hannover Re”), the ultimate risk taker in the transaction, provides credit enhancement to the Red Mountain note for the 20-year term in exchange for a fee. The transaction is “non-recourse” to Golden Gate V, Red Mountain, WCL, PLICO and the Company, meaning that none of these companies are liable for the reimbursement of any credit enhancement payments required to be made. As of March 31, 2014, the principal balance of the Red Mountain note was $385.0 million. In connection with the transaction, the Company has entered into certain support agreements under which it guarantees or otherwise supports certain obligations of Golden Gate V or Red Mountain. Future scheduled capital contributions to prefund credit enhancement fees amount to approximately $144.3 million and will be paid in annual installments through 2031. The support agreements provide that amounts would become payable by the Company if Golden Gate V’s annual general corporate expenses were higher than modeled amounts or in the event write-downs due to other-than-temporary impairments on assets held in certain accounts exceed defined threshold levels. Additionally, the Company has entered into separate agreements to indemnify Golden Gate V with respect to material adverse changes in non-guaranteed elements of insurance policies reinsured by Golden Gate V, and to guarantee payment of certain fee amounts in connection with the

 

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credit enhancement of the Red Mountain note. As of March 31, 2014, no payments have been made under these agreements.

 

In connection with the transaction outlined above, Golden Gate V had a $385.0 million outstanding non-recourse funding obligation as of March 31, 2014. This non-recourse funding obligation matures in 2037, has scheduled increases in principal to a maximum of $945 million, and accrues interest at a fixed annual rate of 6.25%.

 

Non-recourse funding obligations outstanding as of March 31, 2014, on a consolidated basis, are shown in the following table:

 

 

 

 

 

 

 

Year-to-Date

 

 

 

 

 

Maturity

 

Weighted-Avg

 

Issuer

 

Balance

 

Year

 

Interest Rate

 

 

 

(Dollars In Thousands)

 

 

 

 

 

Golden Gate II Captive Insurance Company

 

$

194,900

 

2052

 

1.11

%

Golden Gate V Vermont Captive Insurance Company(1)

 

385,000

 

2037

 

6.25

%

MONY Life Insurance Company(1)

 

2,537

 

2024

 

6.63

%

Total

 

$

582,437

 

 

 

 

 

 


(1) Fixed rate obligations

 

During the three months ended March 31, 2014, the Company did not repurchase any of its outstanding non-recourse funding obligations. For the three months ended March 31, 2013, the Company repurchased $5.0 million of its outstanding non-recourse funding obligations, at a discount. The repurchase resulted in a $1.3 million pre-tax gain for the Company. These gains are recorded in other income in the consolidated condensed statements of income.

 

Letters of Credit

 

Golden Gate III Vermont Captive Insurance Company (“Golden Gate III”), a Vermont special purpose financial captive insurance company and wholly owned subsidiary of PLICO, is party to a Reimbursement Agreement (the “Reimbursement Agreement”) with UBS AG, Stamford Branch (“UBS”), as issuing lender. Under the original Reimbursement Agreement, dated April 23, 2010, UBS issued a letter of credit (the “LOC”) in the initial amount of $505 million to a trust for the benefit of WCL. The Reimbursement Agreement was subsequently amended and restated effective November 21, 2011 (the “First Amended and Restated Reimbursement Agreement”), to replace the existing LOC with one or more letters of credit from UBS, and to extend the maturity date from April 1, 2018, to April 1, 2022. On August 7, 2013, the Company entered into a Second Amended and Restated Reimbursement Agreement with UBS (the “Second Amended and Restated Reimbursement Agreement”), which amended and restated the First Amended and Restated Reimbursement Agreement. Under the Second and Amended and Restated Reimbursement Agreement a new LOC in an initial amount of $710 million was issued by UBS in replacement of the existing LOC issued under the First Amended and Restated Reimbursement Agreement. The term of the LOC was extended from April 1, 2022 to October 1, 2023, subject to certain conditions being satisfied including scheduled capital contributions being made to Golden Gate III by one of its affiliates. The maximum stated amount of the LOC was increased from $610 million to $720 million in 2015 if certain conditions are met. The LOC is held in trust for the benefit of WCL, and supports certain obligations of Golden Gate III to WCL under an indemnity reinsurance agreement originally effective April 1, 2010, as amended and restated on November 21, 2011, and as further amended and restated on August 7, 2013 to include an additional block of policies, and pursuant to which WCL cedes liabilities relating to the policies of WCL and retrocedes liabilities relating to the policies of PLICO. The LOC balance was $715 million as of March 31, 2014. Subject to certain conditions, the amount of the LOC will be periodically increased up to a maximum of $720 million in 2015. The term of the LOC is expected to be approximately 13.5 years from the original issuance date. This transaction is “non-recourse” to WCL, PLICO, and the Company, meaning that none of these companies other than Golden Gate III are liable for reimbursement on a draw of the LOC. The Company has entered into certain support agreements with Golden Gate III obligating the Company to make capital contributions or provide support related to certain of Golden Gate III’s expenses and in certain circumstances, to collateralize certain of the Company’s obligations to Golden Gate III. Future scheduled capital contributions amount to approximately $102.5 million and will be paid in two installments with the last payment occurring in 2019, and these contributions may be subject to potential offset against dividend payments as permitted under the terms of the Second Amended and Restated Reimbursement Agreement. The support

 

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agreements provide that amounts would become payable by the Company to Golden Gate III if its annual general corporate expenses were higher than modeled amounts or if specified catastrophic losses occur during defined time periods with respect to the policies reinsured by Golden Gate III. Pursuant to the terms of an amended and restated letter agreement with UBS, the Company has continued to guarantee the payment of fees to UBS as specified in the Second and Amended and Restated Agreement. As of March 31, 2014, no payments have been made under these agreements.

 

Golden Gate IV Vermont Captive Insurance Company (“Golden Gate IV”), a Vermont special purpose financial captive insurance company and wholly owned subsidiary of PLICO, is party to a Reimbursement Agreement with UBS AG, Stamford Branch, as issuing lender. Under the Reimbursement Agreement, dated December 10, 2010, UBS issued an LOC in the initial amount of $270 million to a trust for the benefit of WCL. The LOC balance increased, in accordance with the terms of the Reimbursement Agreement, during the first quarter of 2014 and was $715 million as of March 31, 2014. Subject to certain conditions, the amount of the LOC will be periodically increased up to a maximum of $790 million in 2016. The term of the LOC is expected to be 12 years from the original issuance date (stated maturity of December 30, 2022). The LOC was issued to support certain obligations of Golden Gate IV to WCL under an indemnity reinsurance agreement, pursuant to which WCL cedes liabilities relating to the policies of WCL and retrocedes liabilities relating to the policies of PLICO. This transaction is “non-recourse” to WCL, PLICO, and the Company, meaning that none of these companies other than Golden Gate IV are liable for reimbursement on a draw of the LOC. The Company has entered into certain support agreements with Golden Gate IV obligating the Company to make capital contributions or provide support related to certain of Golden Gate IV’s expenses and in certain circumstances, to collateralize certain of the Company’s obligations to Golden Gate IV. The support agreements provide that amounts would become payable by the Company to Golden Gate IV if its annual general corporate expenses were higher than modeled amounts or if specified catastrophic losses occur during defined time periods with respect to the policies reinsured by Golden Gate IV. The Company has also entered into a separate agreement to guarantee the payments of LOC fees under the terms of the Reimbursement Agreement. As of March 31, 2014, no payments have been made under these agreements.

 

Repurchase Program Borrowings

 

While the Company anticipates that the cash flows of its operating subsidiaries will be sufficient to meet its investment commitments and operating cash needs in a normal credit market environment, the Company recognizes that investment commitments scheduled to be funded may, from time to time, exceed the funds then available. Therefore, the Company has established repurchase agreement programs for certain of its insurance subsidiaries to provide liquidity when needed. The Company expects that the rate received on its investments will equal or exceed its borrowing rate. Under this program, the Company may, from time to time, sell an investment security at a specific price and agree to repurchase that security at another specified price at a later date. These borrowings are for a term less than ninety days. The market value of securities to be repurchased is monitored and collateral levels are adjusted where appropriate to protect the counterparty against credit exposure. Cash received is invested in fixed maturity securities, and the agreements provided for net settlement in the event of default or on termination of the agreements. As of March 31, 2014, the fair value of securities pledged under the repurchase program was $522.2 million and the repurchase obligation of $475.0 million was included in the Company’s consolidated condensed balance sheets (at an average borrowing rate of 9 basis points). During the three months ended March 31, 2014, the maximum balance outstanding at any one point in time related to these programs was $613.3 million. The average daily balance was $477.2 million (at an average borrowing rate of 10 basis points) during the three months ended March 31, 2014. As of December 31, 2013, the Company had a $350.0 million outstanding balance related to such borrowings. During 2013, the maximum balance outstanding at any one point in time related to these programs was $815.0 million. The average daily balance was $496.9 million (at an average borrowing rate of 11 basis points) during the year ended December 31, 2013.

 

9.                                      COMMITMENTS AND CONTINGENCIES

 

The Company has entered into indemnity agreements with each of its current directors that provide, among other things and subject to certain limitations, a contractual right to indemnification to the fullest extent permissible under the law. The Company has agreements with certain of its officers providing up to $10 million in indemnification. These obligations are in addition to the customary obligation to indemnify officers and directors contained in the Company’s governance documents.

 

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Under insurance guaranty fund laws, in most states insurance companies doing business therein can be assessed up to prescribed limits for policyholder losses incurred by insolvent companies. In addition, from time to time, companies may be asked to contribute amounts beyond prescribed limits. Most insurance guaranty fund laws provide that an assessment may be excused or deferred if it would threaten an insurer’s own financial strength. The Company does not believe its insurance guaranty fund assessments will be materially different from amounts already provided for in the financial statements.

 

A number of civil jury verdicts have been returned against insurers, broker dealers and other providers of financial services involving sales, refund or claims practices, alleged agent misconduct, failure to properly supervise representatives, relationships with agents or persons with whom the insurer does business, and other matters. Often these lawsuits have resulted in the award of substantial judgments that are disproportionate to the actual damages, including material amounts of punitive and non-economic compensatory damages. In some states, juries, judges, and arbitrators have substantial discretion in awarding punitive non-economic compensatory damages which creates the potential for unpredictable material adverse judgments or awards in any given lawsuit or arbitration. Arbitration awards are subject to very limited appellate review. In addition, in some class action and other lawsuits, companies have made material settlement payments. Publicly held companies in general and the financial services and insurance industries in particular are also sometimes the target of law enforcement and regulatory investigations relating to the numerous laws and regulations that govern such companies. Some companies have been the subject of law enforcement or regulatory actions or other actions resulting from such investigations. The Company, in the ordinary course of business, is involved in such matters.

 

The Company establishes liabilities for litigation and regulatory actions when it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. For matters where a loss is believed to be reasonably possible, but not probable, no liability is established. For such matters, the Company may provide an estimate of the possible loss or range of loss or a statement that such an estimate cannot be made. The Company reviews relevant information with respect to litigation and regulatory matters on a quarterly and annual basis and updates its established liabilities, disclosures and estimates of reasonably possible losses or range of loss based on such reviews.

 

Although the Company cannot predict the outcome of any litigation or regulatory action, the Company does not believe that any such outcome will have an impact, either individually or in the aggregate, on its financial condition or results of operations that differs materially from the Company’s established liabilities. Given the inherent difficulty in predicting the outcome of such matters, however, it is possible that an adverse outcome in certain such matters could be material to the Company’s financial condition or results of operations for any particular reporting period.

 

The Company was audited by the IRS and the IRS proposed favorable and unfavorable adjustments to the Company’s 2003 through 2007 reported taxable income. The Company protested certain unfavorable adjustments and sought resolution at the IRS’ Appeals Division. The case has followed normal procedure and is now under review at Congress’ Joint Committee on Taxation. The Company believes the matter will conclude within the next twelve months. If the IRS prevails on every issue that it identified in this audit, and the Company does not litigate these issues, then the Company will make an income tax payment of approximately $26.6 million. However, this payment, if it were to occur, would not materially impact the Company or its effective tax rate.

 

Through the acquisition of MONY by PLICO certain income tax credit carryforwards, which arose in MONY’s pre-acquisition tax years transferred to the Company. This transfer was in accordance with the applicable rules of the Internal Revenue Code and the related Regulations. In spite of this transfer, AXA, the former parent of the consolidated income tax return group in which MONY was a member, retains the right to utilize these credits in the future to offset future increases in its 2010 through 2013 tax liabilities. The Company has determined that, based on all information known as of the acquisition date and through the March 31, 2014 reporting date, it is probable that a loss of the utilization of these carryforwards has been incurred and the amount of the loss can be reasonably estimated. Accordingly, in the table summarizing the fair value of net assets acquired from the Acquisition, the amount of the deferred tax asset from the credit carryforwards has been offset by the aforementioned liability. However, given the inherent difficulty in predicting the ultimate outcome of such matters, it is possible that adjustments to the values of this deferred tax asset and the related liability may occur in future reporting periods.

 

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The Company has received notice from two third party auditors that certain of the Company’s insurance subsidiaries, as well as certain other insurance companies for which the Company has co-insured blocks of life insurance and annuity policies, are under audit for compliance with the unclaimed property laws of a number of states. The audits are being conducted on behalf of the treasury departments in such states. The focus of the audits is on whether there have been unreported deaths, maturities, or policies that have exceeded limiting age with respect to which death benefits or other payments under life insurance or annuity policies should be treated as unclaimed property that should be escheated to the state. The Company has recorded a reserve with respect to life insurance policies issued by the Company’s subsidiaries and certain co-insured blocks of life insurance policies issued by other companies in connection with these pending audits. The Company does not consider the amount of this reserve to be material to the Company’s financial condition or results of operations. With respect to one block of life insurance policies that is co-insured by a subsidiary of the Company, the Company is presently unable to estimate the reasonably possible loss or range of loss due to a number of factors, including uncertainty as to the legal theory or theories that may give rise to liability, uncertainty as to whether the Company or other companies are responsible for the liabilities, if any, arising in connection with such policies, the distinct characteristics of this co-insured block of policies which differentiate it from the blocks of life insurance policies for which the Company has recorded a reserve, and the early stages of the audits being conducted. The Company will continue to monitor the matter for any developments that would make the loss contingency associated with this block of co-insured policies probable or reasonably estimable.

 

Certain of the Company’s subsidiaries have received notice that they are subject to a targeted multi-state examination with respect to their claims paying practices and their use of the U.S. Social Security Administration’s Death Master File or similar databases (a “Death Database”) to identify unreported deaths in their life insurance policies, annuity contracts and retained asset accounts. There is no clear basis in previously existing law for requiring a life insurer to search for unreported deaths in order to determine whether a benefit is owed, and substantial legal authority exists to support the position that the prevailing industry practice was lawful. A number of life insurers, however, have entered into settlement or consent agreements with state insurance regulators under which the life insurers agreed to implement procedures for periodically comparing their life insurance and annuity contracts and retained asset accounts against a Death Database, treating confirmed deaths as giving rise to a death benefit under their policies, locating beneficiaries and paying them the benefits and interest, and escheating the benefits and interest as well as penalties to the state if the beneficiary could not be found.  It has been publicly reported that the life insurers have paid substantial administrative and/or examination fees to the insurance regulators in connection with the settlement or consent agreements. The Company believes it is reasonably possible that insurance regulators could demand from the Company administrative and/or examination fees relating to the targeted multi-state examination. Based on publicly reported payments by other life insurers, the Company estimates the range of such fees to be from $0 to $3.5 million.

 

10.                               STOCK-BASED COMPENSATION

 

During the three months ended March 31, 2014, 201,350 performance shares with an estimated fair value of $10.4 million were awarded. The criteria for payment of the 2014 performance awards is based primarily on the Company’s average operating return on average equity (“ROE”) over a three-year period. If the Company’s ROE is below 10.5%, no award is earned. If the Company’s ROE is at or above 12.0%, the award maximum is earned. Awards are paid in shares of the Company’s common stock.

 

Restricted stock units are awarded to participants and include certain restrictions relating to vesting periods. The Company issued 97,950 restricted stock units for the three months ended March 31, 2014. These awards had a total fair value at grant date of $5.0 million. Approximately half of these restricted stock units vest after three years from the grant date and the remainder vest after four years.

 

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Stock appreciation right (“SARs”) have been granted to certain officers of the Company to provide long-term incentive compensation based solely on the performance of the Company’s common stock. The SARs are exercisable either five years after the date of grant or in three or four equal annual installments beginning one year after the date of grant (earlier upon the death, disability, or retirement of the officer, or in certain circumstances, of a change in control of the Company) and expire after ten years or upon termination of employment. The SARs activity as well as weighted-average base price is as follows:

 

 

 

Weighted-Average

 

 

 

 

 

Base Price per share

 

No. of SARs

 

Balance at December 31, 2013

 

$

23.08

 

1,305,101

 

SARs granted

 

 

 

SARs exercised / forfeited

 

30.67

 

(44,118

)

Balance at March 31, 2014

 

$

22.81

 

1,260,983

 

 

The Company will pay an amount in stock equal to the difference between the specified base price of the Company’s common stock and the market value at the exercise date for each SAR. There were no SARs issued for the three months ended March 31, 2014.

 

11.                               EMPLOYEE BENEFIT PLANS

 

Components of the net periodic benefit cost of the Company’s defined benefit pension plan and unfunded excess benefit plan are as follows:

 

 

 

For The Three Months Ended March 31,

 

 

 

2014

 

2013

 

 

 

(Dollars In Thousands)

 

Service cost — benefits earned during the period

 

$

2,453

 

$

2,708

 

Interest cost on projected benefit obligation

 

2,993

 

2,553

 

Expected return on plan assets

 

(3,065

)

(2,759

)

Amortization of prior service cost/(credit)

 

(95

)

(95

)

Amortization of actuarial losses

 

1,897

 

2,729

 

Total benefit cost

 

$

4,183

 

$

5,136

 

 

During the three months ended March 31, 2014, the Company contributed $2.3 million to its defined benefit pension plan for the 2013 plan year. During April of 2014, the Company contributed $3.1 million to the defined benefit pension plan for the 2014 plan year. The Company will continue to make contributions in future periods as necessary to at least satisfy minimum funding requirements. The Company may also make additional contributions in future periods to maintain an adjusted funding target attainment percentage (“AFTAP”) of at least 80% and to avoid certain Pension Benefit Guaranty Corporation (“PBGC”) reporting triggers.

 

In addition to pension benefits, the Company provides life insurance benefits to eligible retirees and limited healthcare benefits to eligible retirees who are not yet eligible for Medicare. For a closed group of retirees over age 65, the Company provides a prescription drug benefit. The cost of these plans for the three months ended March 31, 2014, was immaterial to the Company’s financial statements.

 

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12.          ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

 

The following tables summarize the changes in the accumulated balances for each component of accumulated other comprehensive income (loss) (“AOCI”) as of March 31, 2014 and December 31, 2013.

 

Changes in Accumulated Other Comprehensive Income (Loss) by Component

 

 

 

 

 

 

 

 

 

Total

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

Unrealized

 

Accumulated

 

Minimum

 

Other

 

 

 

Gains and Losses

 

Gain and Loss

 

Pension Liability

 

Comprehensive

 

 

 

on Investments(2)

 

Derivatives

 

Adjustment

 

Income (Loss)

 

 

 

(Dollars In Thousands, Net of Tax)

 

Beginning Balance, December 31, 2013

 

$

539,003

 

$

(1,235

)

$

(43,702

)

$

494,066

 

Other comprehensive income (loss) before reclassifications

 

482,093

 

587

 

(1,173

)

481,507

 

Other comprehensive income (loss) relating to other- than-temporary impaired investments for which a portion has been recognized in earnings

 

4,511

 

 

 

4,511

 

Amounts reclassified from accumulated other comprehensive income (loss)(1)

 

(3,756

)

436

 

 

(3,320

)

Net current-period other comprehensive income (loss)

 

482,848

 

1,023

 

(1,173

)

482,698

 

Ending Balance, March 31, 2014

 

$

1,021,851

 

$

(212

)

$

(44,875

)

$

976,764

 

 


(1) See Reclassification table below for details.

(2) These balances were offset by the impact of DAC and VOBA by $198.1 million and $316.2 million as of December 31, 2013 and March 31, 2014, respectively.

 

Changes in Accumulated Other Comprehensive Income (Loss) by Component

 

 

 

 

 

 

 

 

 

Total

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

Unrealized

 

Accumulated

 

Minimum

 

Other

 

 

 

Gains and Losses

 

Gain and Loss

 

Pension Liability

 

Comprehensive

 

 

 

on Investments(2)

 

Derivatives

 

Adjustment

 

Income (Loss)

 

 

 

(Dollars In Thousands, Net of Tax)

 

Beginning Balance, December 31, 2012

 

$

1,813,516

 

$

(3,496

)

$

(73,298

)

$

1,736,722

 

Other comprehensive income (loss) before reclassifications

 

(1,250,498

)

734

 

29,596

 

(1,220,168

)

Other comprehensive income (loss) relating to other- than-temporary impaired investments for which a portion has been recognized in earnings

 

4,591

 

 

 

4,591

 

Amounts reclassified from accumulated other comprehensive income (loss)(1)

 

(28,606

)

1,527

 

 

(27,079

)

Net current-period other comprehensive income (loss)

 

(1,274,513

)

2,261

 

29,596

 

(1,242,656

)

Ending Balance, December 31, 2013

 

$

539,003

 

$

(1,235

)

$

(43,702

)

$

494,066

 

 


(1) See Reclassification table below for details.

(2) These balances were offset by the impact of DAC and VOBA by $204.9 million and $198.1 million as of December 31, 2012 and 2013, respectively.

 

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The following tables summarize the reclassifications amounts out of AOCI for the three months ended March 31, 2014 and 2013.

 

Reclassifications Out of Accumulated Other Comprehensive Income (Loss)

 

 

 

Amount

 

 

 

 

Reclassified

 

 

 

 

from Accumulated

 

 

 

 

Other Comprehensive

 

Affected Line Item in the

 

 

Income (Loss)

 

Consolidated Condensed Statements of Income

 

 

(Dollars In Thousands)

 

 

For The Three Months Ended March 31, 2014

 

 

 

 

Gains and losses on derivative instruments

 

 

 

 

Net settlement (expense)/benefit(1)

 

$

(670

)

Benefits and settlement expenses, net of reinsurance ceded

 

 

(670

)

Total before tax

 

 

234

 

Tax benefit

 

 

$

(436

)

Net of tax

 

 

 

 

 

Unrealized gains and losses on available-for-sale securities

 

 

 

 

Net investment gains/losses

 

$

7,370

 

Realized investment gains (losses): All other investments

Impairments recognized in earnings

 

(1,591

)

Net impairment losses recognized in earnings

 

 

5,779

 

Total before tax

 

 

(2,023

)

Tax expense

 

 

$

3,756

 

Net of tax

 


(1) See Note 16, Derivative Financial Instruments for additional information.

 

Reclassifications Out of Accumulated Other Comprehensive Income (Loss)

 

 

 

Amount

 

 

 

 

Reclassified

 

 

 

 

from Accumulated

 

 

 

 

Other Comprehensive

 

Affected Line Item in the

 

 

Income (Loss)

 

Consolidated Condensed Statements of Income

 

 

(Dollars In Thousands)

 

 

For The Three Months Ended March 31, 2013

 

 

 

 

Gains and losses on derivative instruments

 

 

 

 

Net settlement (expense)/benefit(1)

 

$

(497

)

Benefits and settlement expenses, net of reinsurance ceded

 

 

(497

)

Total before tax

 

 

174

 

Tax benefit

 

 

$

(323

)

Net of tax

Unrealized gains and losses on available-for-sale securities

 

 

 

 

Net investment gains/losses

 

$

12,310

 

Realized investment gains (losses): All other investment