10-Q 1 a14-19796_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 September 30, 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
(State or other jurisdiction of incorporation or organization)

 

95-2492236
(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 October 27, 2014:  79,288,518

 

 

 



Table of Contents

 

PROTECTIVE LIFE CORPORATION

QUARTERLY REPORT ON FORM 10-Q

FOR QUARTERLY PERIOD ENDED SEPTEMBER 30, 2014

 

TABLE OF CONTENTS

 

PART I

 

 

 

 

Page

Item 1.

Financial Statements (unaudited):

 

 

 

Consolidated Condensed Statements of Income For The Three and Nine Months Ended September 30, 2014 and 2013

 

3

 

Consolidated Condensed Statements of Comprehensive Income (Loss) For The Three and Nine Months Ended September 30, 2014 and 2013

 

4

 

Consolidated Condensed Balance Sheets as of September 30, 2014 and December 31, 2013

 

5

 

Consolidated Condensed Statements of Shareowners’ Equity For The Nine Months Ended September 30, 2014

 

7

 

Consolidated Condensed Statements of Cash Flows For The Nine Months Ended September 30, 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

 

68

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

135

Item 4.

Controls and Procedures

 

135

 

 

 

 

PART II

 

 

 

 

Item 1.

Legal Proceedings

 

136

Item 1A.

Risk Factors and Cautionary Factors that may Affect Future Results

 

137

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

147

Item 6.

Exhibits

 

148

 

Signature

 

149

 

2



Table of Contents

 

PROTECTIVE LIFE CORPORATION

CONSOLIDATED CONDENSED STATEMENTS OF INCOME

(Unaudited)

 

 

 

For The

 

For The

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

 

 

(Dollars In Thousands, Except Per Share Amounts)

 

Revenues

 

 

 

 

 

 

 

 

 

Premiums and policy fees

 

$

759,038

 

$

657,218

 

$

2,426,736

 

$

2,140,396

 

Reinsurance ceded

 

(277,136

)

(270,730

)

(947,817

)

(996,570

)

Net of reinsurance ceded

 

481,902

 

386,488

 

1,478,919

 

1,143,826

 

Net investment income

 

558,174

 

454,275

 

1,647,153

 

1,378,129

 

Realized investment gains (losses):

 

 

 

 

 

 

 

 

 

Derivative financial instruments

 

3,781

 

41,326

 

(191,495

)

192,592

 

All other investments

 

1,194

 

(19,508

)

153,456

 

(133,631

)

Other-than-temporary impairment losses

 

(1,142

)

(6,635

)

(2,026

)

(9,764

)

Portion recognized in other comprehensive income (before taxes)

 

(1,212

)

(2,046

)

(3,379

)

(7,501

)

Net impairment losses recognized in earnings

 

(2,354

)

(8,681

)

(5,405

)

(17,265

)

Other income

 

105,389

 

98,794

 

311,359

 

278,213

 

Total revenues

 

1,148,086

 

952,694

 

3,393,987

 

2,841,864

 

Benefits and expenses

 

 

 

 

 

 

 

 

 

Benefits and settlement expenses, net of reinsurance ceded: (three months: 2014 - $217,641; 2013 - $204,065; nine months: 2014 - $851,028; 2013 - $882,123)

 

630,285

 

624,577

 

2,106,620

 

1,764,323

 

Amortization of deferred policy acquisition costs and value of business acquired

 

134,918

 

22,446

 

242,031

 

149,631

 

Other operating expenses, net of reinsurance ceded: (three months: 2014 - $49,196; 2013 - $47,506; nine months: 2014 - $139,507; 2013 - $138,901)

 

198,000

 

163,550

 

573,038

 

511,149

 

Total benefits and expenses

 

963,203

 

810,573

 

2,921,689

 

2,425,103

 

Income before income tax

 

184,883

 

142,121

 

472,298

 

416,761

 

Income tax expense

 

65,974

 

49,060

 

161,773

 

142,210

 

Net income

 

$

118,909

 

$

93,061

 

$

310,525

 

$

274,551

 

 

 

 

 

 

 

 

 

 

 

Net income - basic

 

$

1.48

 

$

1.17

 

$

3.88

 

$

3.46

 

Net income - diluted

 

$

1.46

 

$

1.15

 

$

3.82

 

$

3.39

 

Cash dividends paid per share

 

$

0.24

 

$

0.20

 

$

0.68

 

$

0.58

 

 

 

 

 

 

 

 

 

 

 

Average shares outstanding - basic

 

80,231,591

 

79,492,274

 

79,942,018

 

79,346,771

 

Average shares outstanding - diluted

 

81,458,870

 

80,852,078

 

81,261,249

 

80,882,552

 

 

See Notes to Consolidated Condensed Financial Statements

 

3



Table of Contents

 

PROTECTIVE LIFE CORPORATION

CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited)

 

 

 

For The

 

For The

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

 

 

(Dollars In Thousands)

 

Net income

 

$

118,909

 

$

93,061

 

$

310,525

 

$

274,551

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

Change in net unrealized gains (losses) on investments, net of income tax: (three months: 2014 - $(44,766); 2013 - $(145,224); nine months: 2014 - $431,299; 2013 - $(641,532))

 

(83,138

)

(269,703

)

800,982

 

(1,191,416

)

Reclassification adjustment for investment amounts included in net income, net of income tax: (three months: 2014 - $(7,446); 2013 - $(653); nine months: 2014 - $(16,027); 2013 - $(9,488))

 

(13,827

)

(1,212

)

(29,763

)

(17,621

)

Change in net unrealized gains (losses) relating to other-than-temporary impaired investments for which a portion has been recognized in earnings, net of income tax: (three months: 2014 - $561; 2013 - $(1,543) nine months: 2014 - $2,419; 2013 - $1,383)

 

1,044

 

(2,865

)

4,494

 

2,570

 

Change in accumulated (loss) gain - derivatives, net of income tax: (three months: 2014 - $(22); 2013 - $8; nine months: 2014 - $(31); 2013 - $(55))

 

(41

)

14

 

(58

)

(103

)

Reclassification adjustment for derivative amounts included in net income, net of income tax: (three months: 2014 - $103; 2013 - $200; nine months: 2014 - $552; 2013 - $577)

 

190

 

372

 

1,025

 

1,072

 

Change in postretirement benefits liability adjustment, net of income tax: (three months: 2014 - $631; 2013 - $(922); nine months: 2014 - $1,895; 2013 - $(2,766))

 

1,173

 

(1,712

)

3,520

 

(5,136

)

Total other comprehensive income (loss)

 

(94,599

)

(275,106

)

780,200

 

(1,210,634

)

Total comprehensive income (loss)

 

$

24,310

 

$

(182,045

)

$

1,090,725

 

$

(936,083

)

 

See Notes to Consolidated Condensed Financial Statements

 

4



Table of Contents

 

PROTECTIVE LIFE CORPORATION

CONSOLIDATED CONDENSED BALANCE SHEETS

(Unaudited)

 

 

 

As of

 

 

 

September 30, 2014

 

December 31, 2013

 

 

 

(Dollars In Thousands)

 

Assets

 

 

 

 

 

Fixed maturities, at fair value (amortized cost: 2014 - $34,222,620; 2013 - $33,668,770)

 

$

36,922,395

 

$

34,823,093

 

Fixed maturities, at amortized cost (fair value: 2014 - $453,741; 2013 - $335,676)

 

415,000

 

365,000

 

Equity securities, at fair value (cost: 2014 - $791,964; 2013 - $675,758)

 

809,648

 

646,027

 

Mortgage loans (2014 and 2013 includes $489,667 and $627,731 related to securitizations)

 

5,232,463

 

5,493,492

 

Investment real estate, net of accumulated depreciation (2014 - $376; 2013 - $1,066)

 

13,998

 

20,413

 

Policy loans

 

1,767,228

 

1,815,744

 

Other long-term investments

 

470,174

 

521,811

 

Short-term investments

 

183,411

 

134,146

 

Total investments

 

45,814,317

 

43,819,726

 

Cash

 

328,487

 

466,542

 

Accrued investment income

 

491,864

 

465,333

 

Accounts and premiums receivable, net of allowance for uncollectible amounts (2014 - $3,839; 2013 - $4,283)

 

123,136

 

101,039

 

Reinsurance receivables

 

6,132,550

 

6,175,115

 

Deferred policy acquisition costs and value of business acquired

 

3,263,299

 

3,570,215

 

Goodwill

 

103,139

 

105,463

 

Property and equipment, net of accumulated depreciation (2014 - $116,986; 2013 - $111,579)

 

52,939

 

52,403

 

Other assets

 

371,233

 

426,471

 

Income tax receivable

 

18,257

 

 

Assets related to separate accounts

 

 

 

 

 

Variable annuity

 

13,040,828

 

12,791,438

 

Variable universal life

 

813,178

 

783,618

 

Total assets

 

$

70,553,227

 

$

68,757,363

 

 

See Notes to Consolidated Condensed Financial Statements

 

5



Table of Contents

 

PROTECTIVE LIFE CORPORATION

CONSOLIDATED CONDENSED BALANCE SHEETS

(continued)

(Unaudited)

 

 

 

As of

 

 

 

September 30, 2014

 

December 31, 2013

 

 

 

(Dollars In Thousands)

 

Liabilities

 

 

 

 

 

Future policy benefits and claims

 

$

29,876,778

 

$

29,772,325

 

Unearned premiums

 

1,521,330

 

1,549,815

 

Total policy liabilities and accruals

 

31,398,108

 

31,322,140

 

Stable value product account balances

 

2,261,546

 

2,559,552

 

Annuity account balances

 

11,083,763

 

11,125,253

 

Other policyholders’ funds

 

1,377,504

 

1,214,380

 

Other liabilities

 

1,469,374

 

1,144,853

 

Income tax payable

 

 

12,761

 

Deferred income taxes

 

1,476,749

 

1,050,533

 

Non-recourse funding obligations

 

594,066

 

562,448

 

Repurchase program borrowings

 

359,804

 

350,000

 

Debt

 

1,380,000

 

1,585,000

 

Subordinated debt securities

 

540,593

 

540,593

 

Liabilities related to separate accounts

 

 

 

 

 

Variable annuity

 

13,040,828

 

12,791,438

 

Variable universal life

 

813,178

 

783,618

 

Total liabilities

 

65,795,513

 

65,042,569

 

Commitments and contingencies - Note 10

 

 

 

 

 

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

 

599,199

 

606,934

 

Treasury stock, at cost (2014 - 9,490,513; 2013 - 10,199,514)

 

(186,818

)

(200,416

)

Retained earnings

 

3,026,679

 

2,769,822

 

Accumulated other comprehensive income (loss):

 

 

 

 

 

Net unrealized gains (losses) on investments, net of income tax: (2014 - $705,180; 2013 - $289,908)

 

1,309,619

 

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 - $2,744; 2013 - $325)

 

5,097

 

603

 

Accumulated loss - derivatives, net of income tax: (2014 - $(145); 2013 - $(666))

 

(268

)

(1,235

)

Postretirement benefits liability adjustment, net of income tax: (2014 - $(21,637); 2013 - $(23,532))

 

(40,182

)

(43,702

)

Total shareowners’ equity

 

4,757,714

 

3,714,794

 

Total liabilities and shareowners’ equity

 

$

70,553,227

 

$

68,757,363

 

 

See Notes to Consolidated Condensed Financial Statements

 

6



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 the nine months ended September 30, 2014

 

 

 

 

 

 

 

310,525

 

 

 

310,525

 

Other comprehensive income

 

 

 

 

 

 

 

 

 

780,200

 

780,200

 

Comprehensive income for the nine months ended September 30, 2014

 

 

 

 

 

 

 

 

 

 

 

1,090,725

 

Cash dividends ($0.68 per share)

 

 

 

 

 

 

 

(53,668

)

 

 

(53,668

)

Stock-based compensation

 

 

 

(7,735

)

13,598

 

 

 

 

 

5,863

 

Balance, September 30, 2014

 

$

44,388

 

$

599,199

 

$

(186,818

)

$

3,026,679

 

$

1,274,266

 

$

4,757,714

 

 

See Notes to Consolidated Condensed Financial Statements

 

7



Table of Contents

 

PROTECTIVE LIFE CORPORATION

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

 

For The Nine Months Ended September 30,

 

 

 

2014

 

2013

 

 

 

(Dollars In Thousands)

 

Cash flows from operating activities

 

 

 

 

 

Net income

 

$

310,525

 

$

274,551

 

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

 

 

 

 

 

Realized investment losses (gains)

 

43,444

 

(41,696

)

Amortization of deferred policy acquisition costs and value of business acquired

 

242,031

 

149,631

 

Capitalization of deferred policy acquisition costs

 

(215,616

)

(240,398

)

Depreciation expense

 

5,687

 

6,731

 

Deferred income tax

 

8,390

 

154,457

 

Accrued income tax

 

(11,220

)

6,857

 

Interest credited to universal life and investment products

 

663,117

 

532,396

 

Policy fees assessed on universal life and investment products

 

(729,929

)

(659,058

)

Change in reinsurance receivables

 

42,565

 

60,600

 

Change in accrued investment income and other receivables

 

(28,297

)

7,370

 

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

 

12,184

 

261,691

 

Trading securities:

 

 

 

 

 

Maturities and principal reductions of investments

 

71,646

 

152,948

 

Sale of investments

 

187,829

 

220,711

 

Cost of investments acquired

 

(160,134

)

(297,558

)

Other net change in trading securities

 

(43,699

)

(9,069

)

Change in other liabilities

 

220,160

 

(48,694

)

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

 

(4,587

)

(3,359

)

Other, net

 

(8,593

)

(85,008

)

Net cash provided by operating activities

 

605,503

 

443,103

 

Cash flows from investing activities

 

 

 

 

 

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

 

941,989

 

752,754

 

Sale of investments, available-for-sale

 

1,465,632

 

1,718,810

 

Cost of investments acquired, available-for-sale

 

(3,056,904

)

(3,076,555

)

Change in investments, held-to-maturity

 

(50,000

)

(50,000

)

Mortgage loans:

 

 

 

 

 

New lendings

 

(649,125

)

(392,883

)

Repayments

 

908,364

 

543,297

 

Change in investment real estate, net

 

6,048

 

1,300

 

Change in policy loans, net

 

48,516

 

9,058

 

Change in other long-term investments, net

 

(69,778

)

(169,668

)

Change in short-term investments, net

 

(26,392

)

(10,912

)

Net unsettled security transactions

 

8,243

 

31,686

 

Purchase of property and equipment

 

(6,223

)

(17,983

)

Sales of property and equipment

 

 

86

 

Payments for business acquisitions

 

(906

)

 

Net cash used in investing activities

 

(480,536

)

(661,010

)

Cash flows from financing activities

 

 

 

 

 

Borrowings under line of credit arrangements and debt

 

190,000

 

430,000

 

Principal payments on line of credit arrangement and debt

 

(395,000

)

(380,000

)

Issuance (repayment) of non-recourse funding obligations

 

31,651

 

33,900

 

Repurchase program borrowings

 

9,804

 

(50,000

)

Dividends to shareowners

 

(53,668

)

(45,474

)

Investment product deposits and change in universal life deposits

 

2,415,424

 

2,413,676

 

Investment product withdrawals

 

(2,461,200

)

(2,198,547

)

Other financing activities, net

 

(33

)

 

Net cash (used in) provided by financing activities

 

(263,022

)

203,555

 

Change in cash

 

(138,055

)

(14,352

)

Cash at beginning of period

 

466,542

 

368,801

 

Cash at end of period

 

$

328,487

 

$

354,449

 

 

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 and nine month periods ended September 30, 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. Although there were no significant changes to the Company’s accounting policies during the nine months ended September 30, 2014, the Company has clarified the disclosures related to its reinsurance accounting methodology as follows:

 

Reinsurance Accounting Methodology—Ceded premiums of the Company’s traditional life insurance products are treated as an offset to direct premium and policy fee revenue and are recognized when due to the assuming company. Ceded claims are treated as an offset to direct benefits and settlement expenses and are recognized when the claim is incurred on a direct basis. Ceded policy reserve changes are also treated as an offset to benefits and settlement expenses and are recognized during the applicable financial reporting period. Expense allowances paid by the assuming companies which are allocable to the current period are treated as an offset to other operating expenses. Since reinsurance treaties typically provide for allowance percentages that decrease over the lifetime of a policy, allowances in excess of the “ultimate” or final level allowance are capitalized. Amortization of capitalized reinsurance expense allowances representing recovery of acquisition costs is treated as an offset to direct amortization of DAC or VOBA.

 

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Amortization of deferred expense allowances is calculated as a level percentage of expected premiums in all durations given expected future lapses and mortality and accretion due to interest.

 

The Company utilizes reinsurance on certain short duration insurance contracts (primarily issued through the Asset Protection segment). As part of these reinsurance transactions the Company receives reinsurance allowances which reimburse the Company for acquisition costs such as commissions and premium taxes. A ceding fee is also collected to cover other administrative costs and profits for the Company. As a component of reinsurance costs, reinsurance allowances are accounted for in accordance with the relevant provisions of ASC Financial Services — Insurance Topic, which state that reinsurance costs should be amortized over the contract period of the reinsurance if the contract is short-duration.  Accordingly, reinsurance allowances received related to short-duration contracts are capitalized and charged to expense in proportion to premiums earned. Ceded unamortized acquisition costs are netted with direct unamortized acquisition costs in the balance sheet.

 

Ceded premiums and policy fees on the Company’s universal life (“UL”), VUL, bank-owned life insurance (“BOLI”), and annuity products reduce premiums and policy fees recognized by the Company. Ceded claims are treated as an offset to direct benefits and settlement expenses and are recognized when the claim is incurred on a direct basis. Ceded policy reserve changes are also treated as an offset to benefits and settlement expenses and are recognized during the applicable valuation period.

 

Since reinsurance treaties typically provide for allowance percentages that decrease over the lifetime of a policy, allowances in excess of the “ultimate” or final level allowance are capitalized. Amortization of capitalized reinsurance expense allowances are amortized based on future expected gross profits. Assumptions regarding mortality, lapses, and interest rates are continuously reviewed and may be periodically changed. These changes will result in “unlocking” that changes the balance in the ceded deferred acquisition cost and can affect the amortization of DAC and VOBA. Ceded unearned revenue liabilities are also amortized based on expected gross profits. Assumptions are based on the best current estimate of expected mortality, lapses and interest spread.

 

The Company has also assumed certain policy risks written by other insurance companies through reinsurance agreements. Premiums and policy fees as well as Benefits and settlement expenses include amounts assumed under reinsurance agreements and are net of reinsurance ceded. Assumed reinsurance is accounted for in accordance with ASC Financial Services—Insurance Topic.

 

Reinsurance Allowances — Long-Duration Contracts — Reinsurance allowances are intended to reimburse the ceding company for some portion of the ceding company’s commissions, expenses, and taxes. The amount and timing of reinsurance allowances (both first year and renewal allowances) are contractually determined by the applicable reinsurance contract and do not necessarily bear a relationship to the amount and incidence of expenses actually paid by the ceding company in any given year.

 

Ultimate reinsurance allowances are defined as the lowest allowance percentage paid by the reinsurer in any policy duration over the lifetime of a universal life policy (or through the end of the level term period for a traditional life policy). Ultimate reinsurance allowances are determined during the negotiation of each reinsurance agreement and will differ between agreements.

 

The Company determines its “cost of reinsurance” to include amounts paid to the reinsurer (ceded premiums) net of amounts reimbursed by the reinsurer (in the form of allowances).  As noted within ASC Financial Services—Insurance Topic, “The difference, if any, between amounts paid for a reinsurance contract and the amount of the liabilities for policy benefits relating to the underlying reinsured contracts is part of the estimated cost to be amortized.”  The Company’s policy is to amortize the cost of reinsurance over the life of the underlying reinsured contracts (for long-duration policies) in a manner consistent with the way in which benefits and expenses on the underlying contracts are recognized.  For the Company’s long-duration contracts, it is the Company’s practice to defer reinsurance allowances as a component of the cost of reinsurance and recognize the portion related to the recovery of acquisition costs as a reduction of applicable unamortized acquisition costs in such a manner that net acquisition costs are capitalized and charged to expense in proportion to net revenue recognized. The remaining balance of reinsurance allowances are included as a component of the cost of reinsurance and those allowances which are allocable to the current period are recorded as an offset to operating expenses in the current period consistent with the recognition of benefits and expenses on the underlying reinsured contracts. This practice is consistent with the Company’s practice of

 

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capitalizing direct expenses (e.g. commissions), and results in the recognition of reinsurance allowances on a systematic basis over the life of the reinsured policies on a basis consistent with the way in which acquisition costs on the underlying reinsured contracts would be recognized.  In some cases reinsurance allowances allocable to the current period may exceed non-deferred direct costs, which may cause net other operating expenses (related to specific contracts) to be negative.

 

Amortization of Reinsurance Allowances—Reinsurance allowances do not affect the methodology used to amortize DAC and VOBA, or the period over which such DAC and VOBA are amortized. Reinsurance allowances offset the direct expenses capitalized, reducing the net amount that is capitalized. DAC and VOBA on traditional life policies are amortized based on the pattern of estimated gross premiums of the policies in force. Reinsurance allowances do not affect the gross premiums, so therefore they do not impact traditional life amortization patterns. DAC and VOBA on universal life products are amortized based on the pattern of estimated gross profits of the policies in force. Reinsurance allowances are considered in the determination of estimated gross profits, and therefore do impact amortization patterns.

 

Reinsurance Liabilities—Claim liabilities and policy benefits are calculated consistently for all policies in accordance with GAAP, regardless of whether or not the policy is reinsured. Once the claim liabilities and policy benefits for the underlying policies are estimated, the amounts recoverable from the reinsurers are estimated based on a number of factors including the terms of the reinsurance contracts, historical payment patterns of reinsurance partners, and the financial strength and credit worthiness of reinsurance partners. Liabilities for unpaid reinsurance claims are produced from claims and reinsurance system records, which contain the relevant terms of the individual reinsurance contracts. The Company monitors claims due from reinsurers to ensure that balances are settled on a timely basis. Incurred but not reported claims are reviewed by the Company’s actuarial staff to ensure that appropriate amounts are ceded.

 

The Company analyzes and monitors the credit worthiness of each of its reinsurance partners to minimize collection issues. For newly executed reinsurance contracts with reinsurance companies that do not meet predetermined standards, the Company requires collateral such as assets held in trusts or letters of credit.

 

Components of Reinsurance Cost—The following income statement lines are affected by reinsurance cost:

 

Premiums and policy fees (“reinsurance ceded” on the Company’s financial statements) represent consideration paid to the assuming company for accepting the ceding company’s risks. Ceded premiums and policy fees increase reinsurance cost.

 

Benefits and settlement expenses include incurred claim amounts ceded and changes in ceded policy reserves. Ceded benefits and settlement expenses decrease reinsurance cost.

 

Amortization of deferred policy acquisition cost and VOBA reflects the amortization of capitalized reinsurance allowances representing recovery of acquisition costs. Ceded amortization decreases reinsurance cost.

 

Other expenses include reinsurance allowances paid by assuming companies to the Company less amounts representing recovery of acquisition costs. Reinsurance allowances decrease reinsurance cost.

 

The Company’s reinsurance programs do not materially impact the other income line of the Company’s income statement. In addition, net investment income generally has no direct impact on the Company’s reinsurance cost. However, it should be noted that by ceding business to the assuming companies, the Company forgoes investment income on the reserves ceded to the assuming companies. Conversely, the assuming companies will receive investment income on the reserves assumed which will increase the assuming companies’ profitability on business assumed from the Company.

 

Accounting Pronouncements Not Yet Adopted

 

Accounting Standards Update (“ASU”) No. 2014-08 — Reporting Discontinued Operations and Disclosure 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

 

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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.

 

ASU No. 2014-09 — Revenue from Contracts with Customers (Topic 606). This Update provides for significant revisions to the recognition of revenue from contracts with customers across various industries. Under the new guidance, entities are required to apply a prescribed 5-step process to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The accounting for revenues associated with insurance products is not within the scope of this Update. The Update is effective for annual and interim periods beginning after December 15, 2016. The Company is reviewing its policies and processes to ensure compliance with the requirements in this Update, upon adoption.

 

ASU No. 2014-11 — Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures. This Update changes the requirements for classification of certain repurchase agreements, and will expand the use of secured borrowing accounting for repurchase-to-maturity transactions. In addition, the Update requires additional disclosures for repurchase agreements accounted for both as sales and as secured borrowings. The amendments in this Update are effective for annual and interim periods beginning after December 15, 2014. The Update is not anticipated to impact the Company’s financial position or results of operations. The Company is reviewing its policies and processes to ensure compliance with the additional disclosure requirements in this Update.

 

ASU No. 2014-15 — Presentation of Financial Statements—Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. This Update will require management to assess an entity’s ability to continue as a going concern, and will require footnote disclosures in certain circumstances. Under the updated guidance, management should consider relevant conditions and evaluate whether it is probable that the entity will be unable to meet its obligations within one year after the issuance date of the financial statements. The Update is effective for annual periods ending December 31, 2016 and interim periods thereafter, with early adoption is permitted. The amendments in this Update will not impact the Company’s financial position or results of operations. However, the new guidance will require a formal assessment of going concern by management based on criteria prescribed in the new guidance. The Company is reviewing its policies and processes to ensure compliance with the new guidance.

 

3.                                      SIGNIFICANT ACQUISITIONS

 

On October 1, 2013 Protective Life Insurance Company (“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 final aggregate purchase price of MONY was $689 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. During the nine months ended September 30, 2014, as a result of new information obtained about facts and circumstances that existed as of the acquisition date, the Company recorded certain measurement period adjustments to fixed maturities, mortgage loans, cash, accounts and premiums receivable, VOBA, other assets, deferred income taxes, future policy benefits and claims, other policyholders’ funds, and other liabilities. These were customary adjustments that occurred during the normal course of reviewing and integrating the MONY acquisition. The net result on the amount of VOBA recorded by the Company in relation to the MONY acquisition was to decrease VOBA by approximately $14.0 million. This impact has been revised in the comparative consolidated balance sheet presented as

 

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of December 31, 2013. The Company has determined that the impact on amortization and other related amounts within the comparative interim and annual periods from that previously presented in the annual or interim consolidated condensed statements of income is immaterial. The amounts presented in the following table related to the MONY acquisition (presented as of the acquisition date of October 1, 2013) have been retrospectively revised for the aforementioned measurement period adjustments.

 

The following table summarizes the consideration paid for the acquisition and the determination of the fair value of assets acquired and liabilities assumed at the acquisition date:

 

 

 

Fair Value

 

 

 

As of

 

 

 

October 1, 2013

 

 

 

(Dollars In Thousands)

 

Assets

 

 

 

Fixed maturities, at fair value

 

$

6,557,853

 

Equity securities, at fair value

 

108,413

 

Mortgage loans

 

830,415

 

Policy loans

 

967,534

 

Short-term investments

 

130,963

 

Total investments

 

8,595,178

 

Cash

 

216,164

 

Accrued investment income

 

114,695

 

Accounts and premiums receivable, net of allowance for uncollectible amounts

 

26,055

 

Reinsurance receivable

 

422,692

 

Value of business acquired

 

205,767

 

Other assets

 

5,104

 

Income tax receivables

 

21,197

 

Deferred income taxes

 

188,142

 

Separate account assets

 

195,452

 

Total assets

 

$

9,990,446

 

Liabilities

 

 

 

Future policy benefits and claims

 

$

7,645,969

 

Unearned premiums

 

3,066

 

Total policy liabilities and accruals

 

7,649,035

 

Annuity account balances

 

752,163

 

Other policyholders’ funds

 

636,448

 

Other liabilities

 

66,124

 

Non-recourse funding obligation

 

2,548

 

Separate account liabilities

 

195,344

 

Total liabilities

 

9,301,662

 

Net assets acquired

 

$

688,784

 

 

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

 

 

 

Unaudited

 

 

 

For The

 

For The

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30, 2013

 

September 30, 2013

 

 

 

(Dollars In Thousands)

 

Revenue

 

$

1,166,516

 

$

3,482,582

 

Net income

 

$

128,036

 

$

333,552

 

EPS - basic

 

$

1.61

 

$

4.20

 

EPS - diluted

 

$

1.58

 

$

4.12

 

 

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.

 

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.

 

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Summarized financial information for the Closed Block from December 31, 2013 through September 30, 2014 is as follows:

 

 

 

As of

 

 

 

September 30, 2014

 

December 31, 2013

 

 

 

(Dollars In Thousands)

 

Closed block liabilities

 

 

 

 

 

Future policy benefits, policyholders’ account balances and other

 

$

6,172,310

 

$

6,261,819

 

Policyholder dividend obligation

 

301,215

 

190,494

 

Other liabilities

 

28,102

 

1,259

 

Total closed block liabilities

 

6,501,627

 

6,453,572

 

Closed block assets

 

 

 

 

 

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

 

$

4,441,257

 

$

4,113,829

 

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

 

5,384

 

5,223

 

Mortgage loans on real estate

 

483,836

 

601,959

 

Policy loans

 

780,450

 

802,013

 

Cash and other invested assets

 

16,411

 

140,577

 

Other assets

 

214,785

 

206,938

 

Total closed block assets

 

5,942,123

 

5,870,539

 

Excess of reported closed block liabilities over closed block assets

 

559,504

 

583,033

 

Portion of above representing accumulated other comprehensive income:

 

 

 

 

 

Net unrealized investment gains (losses) net of deferred tax benefit of $0 and $1,074 net of policyholder dividend obligation of $69,409 and $12,720

 

 

(1,994

)

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

 

$

559,504

 

$

581,039

 

 

Reconciliation of the policyholder dividend obligation from December 31, 2013 through September 30, 2014 is as follows:

 

 

 

For The

 

 

 

Nine Months Ended

 

 

 

September 30, 2014

 

 

 

(Dollars In Thousands)

 

Policyholder dividend obligation, at December 31, 2013

 

$

190,494

 

Applicable to net revenue (losses)

 

(8,781

)

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

 

119,502

 

Policyholder dividend obligation, end of period

 

$

301,215

 

 

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Closed Block revenues and expenses were as follows:

 

 

 

For The

 

For The

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30, 2014

 

September 30, 2014

 

 

 

(Dollars In Thousands)

 

Revenues

 

 

 

 

 

Premiums and other income

 

$

48,596

 

$

151,442

 

Net investment income

 

63,847

 

176,470

 

Net investment gains

 

223

 

6,328

 

Total revenues

 

112,666

 

334,240

 

Benefits and other deductions

 

 

 

 

 

Benefits and settlement expenses

 

101,200

 

300,735

 

Other operating expenses

 

286

 

376

 

Total benefits and other deductions

 

101,486

 

301,111

 

Net revenues before income taxes

 

11,180

 

33,129

 

Income tax expense

 

3,913

 

11,595

 

Net revenues

 

$

7,267

 

$

21,534

 

 

5.                                      PROPOSED DAI-ICHI MERGER

 

On June 3, 2014, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with The Dai-ichi Life Insurance Company, Limited, a kabushiki kaisha organized under the laws of Japan (“Dai-ichi”) and DL Investment (Delaware), Inc., a Delaware corporation and wholly owned subsidiary of Dai-ichi which provides for the merger of DL Investment (Delaware), Inc. with and into the Company (the “Merger”), with the Company surviving the Merger as a wholly owned subsidiary of Dai-ichi.

 

The Company’s Board of Directors unanimously (1) determined that the Merger and the other transactions contemplated by the Merger Agreement are fair to, advisable and in the best interests of, the Company and its shareowners, (2) approved the execution, delivery and performance of the Merger Agreement by the Company and the consummation of the Merger and the other transactions contemplated by the Merger Agreement, and (3) resolved to recommend the approval and adoption of the Merger Agreement and the transactions contemplated by the Merger Agreement by the shareowners of the Company. The Board of Directors received an opinion as to the fairness of the Merger consideration to be received by the shareowners of the Company from its financial advisor, Morgan Stanley & Co. LLC related to the terms of the Merger Agreement.

 

If the proposed Merger is completed, at the effective time of the Merger (the “Effective Time”), each share of the Company’s common stock, par value $0.50 per share, issued and outstanding immediately prior to the Effective Time, other than certain excluded shares, will be converted into the right to receive $70 in cash, without interest (the “Per Share Merger Consideration”). Shares of common stock held by Dai-ichi or the Company or their respective direct or indirect wholly-owned subsidiaries will not be entitled to receive the Merger Consideration. Stock appreciation rights, restricted stock units and performance shares issued under various benefit plans will be paid out as described below under “Treatment of Benefit Plans”.

 

Completion of the Merger is subject to various closing conditions, including, but not limited to, (1) adoption of the Merger Agreement by the affirmative vote of the holders of at least a majority of all outstanding shares of the Company’s common stock, which adoption was approved at a Special Meeting of Shareholders held on October 6, 2014, (2) requisite approval of the Japan Financial Services Agency of an application and notification filing by Dai-ichi and its affiliates, (3) the receipt of certain insurance regulatory approvals, (4) the absence of any laws that have been adopted or promulgated, or any order, injunction, decision or decree issued or remaining in effect, that would prohibit the Merger or make the Merger illegal, and (5) the expiration or termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, which waiting period terminated on July 25, 2014, pursuant to a grant of early termination by the Federal Trade Commission. Each party’s obligation to consummate the Merger also is subject to certain additional conditions that include the accuracy of the other party’s representations and warranties contained in the Merger Agreement (subject to certain materiality qualifiers) and the

 

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other party’s compliance with its covenants and agreements contained in the Merger Agreement in all material respects. The Merger Agreement does not contain a financing condition.

 

The Merger Agreement contains representations and warranties customary for transactions of this type. The Company has agreed to various customary covenants and agreements, including, among others, agreements to conduct its business in the ordinary course during the period between the execution of the Merger Agreement and the Effective Time, and not to engage in certain kinds of transactions during this period. In addition, and subject to certain limitations, either party may terminate the Merger Agreement if the Merger is not consummated by February 28, 2015, which date is extended until April 30, 2015 in the event of delays in obtaining regulatory approval.

 

Treatment of Benefit Plans

 

Pursuant to the Merger Agreement, at or immediately prior to the Effective Time, each stock appreciation right with respect to shares of Common Stock granted under any Stock Plan (each, a “SAR”) that is outstanding and unexercised immediately prior to the Effective Time and that has a base price per share of Common Stock underlying such SAR (the “Base Price”) that is less than the Per Share Merger Consideration (each such SAR, an “In-the-Money SAR”), whether or not exercisable or vested, will be cancelled and converted into the right to receive an amount in cash, without interest, determined by multiplying (i) the excess of the Per Share Merger Consideration over the Base Price of such In-the-Money SAR by (ii) the number of shares of Common Stock subject to such In-the-Money SAR (such amount, the “SAR Consideration”). At the Effective Time, each SAR that has a Base Price that is equal to or greater than the Per Share Merger Consideration, whether or not exercisable or vested, will be cancelled and the holder of such SAR will not be entitled to receive any payment in exchange for such cancellation.

 

Pursuant to the Merger Agreement, at or immediately prior to the Effective Time, each restricted share unit with respect to a share of Common Stock granted under any Stock Plan (each, a “RSU”) that is outstanding immediately prior to the Effective Time, whether or not vested, will be cancelled and converted into the right to receive an amount in cash, without interest, determined by multiplying (i) the Per Share Merger Consideration by (ii) the number of RSUs.

 

Pursuant to the Merger Agreement, at or immediately prior to the Effective Time, the number of performance shares earned for each award of performance shares granted under any Stock Plan will be calculated by determining the number of performance shares that would have been paid if the subject award period had ended on the December 31 immediately preceding the Effective Time (based on the conditions set for payment of performance share awards for the subject award period), provided that the number of performance shares earned for each award will not be less than the aggregate number of performance shares at the target performance level, and provided further that with respect to awards granted in the year in which the Effective Time occurs, performance shares will be earned at the same percentage as awards granted in the year preceding the year in which the Effective Time occurs. At or immediately prior to the Effective Time, each performance share so earned (each, a “Performance Share”) that is outstanding immediately prior to the Effective Time, whether or not vested, will be cancelled and converted into the right to receive an amount in cash, without interest, determined by multiplying (i) the Per Share Merger Consideration by (ii) the number of Performance Shares.

 

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6.                                      INVESTMENT OPERATIONS

 

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

 

 

 

For The

 

For The

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

 

 

(Dollars In Thousands)

 

Fixed maturities

 

$

22,329

 

$

10,546

 

$

49,897

 

$

42,007

 

Equity securities

 

1,298

 

 

1,298

 

2,367

 

Impairments on fixed maturity securities

 

(2,354

)

(7,421

)

(5,405

)

(13,918

)

Impairments on equity securities

 

 

(1,260

)

 

(3,347

)

Modco trading portfolio

 

(17,225

)

(25,960

)

110,067

 

(167,982

)

Other investments

 

(5,208

)

(4,094

)

(7,806

)

(10,023

)

Total realized gains (losses) - investments

 

$

(1,160

)

$

(28,189

)

$

148,051

 

$

(150,896

)

 

For the three and nine months ended September 30, 2014, gross realized gains on investments available-for-sale (fixed maturities, equity securities, and short-term investments) were $23.9 million and $51.9 million and gross realized losses were $2.5 million and $5.9 million, including $2.3 million and $5.1 million of impairment losses, respectively.

 

For the three and nine months ended September 30, 2013, gross realized gains on investments available-for-sale (fixed maturities, equity securities, and short-term investments) were $11.7 million and $48.5 million and gross realized losses were $9.6 million and $20.8 million, including $8.5 million and $16.7 million of impairment losses, respectively.

 

For the three and nine months ended September 30, 2014, the Company sold securities in an unrealized gain position with a fair value (proceeds) of $497.1 million and $1.1 billion, respectively. The gain realized on the sale of these securities was $23.9 million and $51.9 million, respectively.

 

For the three and nine months ended September 30, 2013, the Company sold securities in an unrealized gain position with a fair value (proceeds) of $332.1 million and $1.1 billion, respectively. The gain realized on the sale of these securities was $11.7 million and $48.5 million, respectively.

 

For the three and nine months ended September 30, 2014, the Company sold securities in an unrealized loss position with a fair value (proceeds) of $2.3 million and $6.7 million, respectively. The losses realized on the sale of these securities were $0.3 million and $0.8 million, respectively. These securities were sold in conjunction with the Company’s overall asset liability management process.

 

For the three and nine months ended September 30, 2013, the Company sold securities in an unrealized loss position with a fair value (proceeds) of $7.0 million and $64.2 million, respectively. The losses realized on the sale of these securities were $1.1 million and $4.1 million, respectively. These securities were sold in conjunction with the Company’s overall asset liability management process.

 

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Table of Contents

 

The amortized cost and fair value of the Company’s investments classified as available-for-sale as of September 30, 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

 

$

1,405,720

 

$

51,253

 

$

(14,134

)

$

1,442,839

 

$

7,945

 

Commercial mortgage-backed securities

 

1,137,642

 

43,744

 

(5,863

)

1,175,523

 

 

Other asset-backed securities

 

869,175

 

13,437

 

(34,273

)

848,339

 

(105

)

U.S. government-related securities

 

1,563,337

 

43,178

 

(22,305

)

1,584,210

 

 

Other government-related securities

 

19,004

 

3,016

 

 

22,020

 

1

 

States, municipals, and political subdivisions

 

1,371,113

 

243,943

 

(2,349

)

1,612,707

 

 

Corporate bonds

 

25,026,858

 

2,497,515

 

(117,387

)

27,406,986

 

 

 

 

31,392,849

 

2,896,086

 

(196,311

)

34,092,624

 

7,841

 

Equity securities

 

767,889

 

34,209

 

(16,525

)

785,573

 

 

Short-term investments

 

108,088

 

 

 

108,088

 

 

 

 

$

32,268,826

 

$

2,930,295

 

$

(212,836

)

$

34,986,285

 

$

7,841

 

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

 

24,650,500

 

1,508,317

 

(392,067

)

25,766,750

 

 

 

 

30,870,280

 

1,722,577

 

(568,254

)

32,024,603

 

928

 

Equity securities

 

654,579

 

6,631

 

(36,362

)

624,848

 

 

Short-term investments

 

81,703

 

 

 

81,703

 

 

 

 

$

31,606,562

 

$

1,729,208

 

$

(604,616

)

$

32,731,154

 

$

928

 

 


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

 

The amortized cost and fair value of the Company’s investments classified as held-to-maturity as of September 30, 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

 

$

415,000

 

$

38,741

 

$

 

$

453,741

 

$

 

 

 

$

415,000

 

$

38,741

 

$

 

$

453,741

 

$

 

2013 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturities:

 

 

 

 

 

 

 

 

 

 

 

Other

 

$

365,000

 

$

 

$

(29,324

)

$

335,676

 

$

 

 

 

$

365,000

 

$

 

$

(29,324

)

$

335,676

 

$

 

 

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Table of Contents

 

During the nine months ended September 30, 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 period ended September 30, 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 September 30, 2014 and December 31, 2013, the Company had an additional $2.8 billion and $2.8 billion of fixed maturities, $24.1 million and $21.2 million of equity securities, and $75.3 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 September 30, 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

 

$

1,043,275

 

$

1,057,236

 

$

 

$

 

Due after one year through five years

 

4,538,893

 

4,831,128

 

 

 

Due after five years through ten years

 

8,886,075

 

9,347,371

 

 

 

Due after ten years

 

16,924,606

 

18,856,889

 

415,000

 

453,741

 

 

 

$

31,392,849

 

$

34,092,624

 

$

415,000

 

$

453,741

 

 

During the three and nine months ended September 30, 2014, the Company recorded pre-tax other-than-temporary impairments of investments of $1.1 million and $2.0 million, all of which related to fixed maturities, respectively. Credit impairments recorded in earnings during the three and nine months ended September 30, 2014 were $2.3 million and $5.4 million, respectively. During the three and nine months ended September 30, 2014, $1.2 million and $3.4 million of non-credit losses previously recorded in other comprehensive income were recorded in earnings as credit losses, respectively. For the three and nine months ended September 30, 2014, 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.

 

During the three and nine months ended September 30, 2013, the Company recorded pre-tax other-than-temporary impairments of investments of $6.7 million and $9.8 million, of which $5.4 million and $6.4 million related to fixed maturities and $1.3 million and $3.4 million related to equity securities, respectively. Credit impairments recorded in earnings during the three and nine months ended September 30, 2013 were $8.7 million and $17.3 million, respectively. During the three and nine months ended September 30, 2013, $2.0 million and $7.5 million of non-credit losses previously recorded in other comprehensive income were recorded in earnings as credit losses, respectively. For the three and nine months ended September 30, 2013, 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.

 

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Table of Contents

 

The following chart is a rollforward of available-for-sale credit losses on fixed maturities held by the Company for which a portion of other-than-temporary impairments were recognized in other comprehensive income (loss):

 

 

 

For The

 

For The

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

 

 

(Dollars In Thousands)

 

Beginning balance

 

$

17,985

 

$

51,832

 

$

41,692

 

$

122,121

 

Additions for newly impaired securities

 

 

1,663

 

 

3,278

 

Additions for previously impaired securities

 

626

 

4,840

 

1,653

 

7,894

 

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

 

(3,672

)

(6,537

)

(28,406

)

(74,007

)

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

 

 

 

 

(7,488

)

Ending balance

 

$

14,939

 

$

51,798

 

$

14,939

 

$

51,798

 

 

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 September 30, 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

 

$

149,282

 

$

(7,781

)

$

88,374

 

$

(6,353

)

$

237,656

 

$

(14,134

)

Commercial mortgage-backed securities

 

123,244

 

(1,534

)

124,578

 

(4,329

)

247,822

 

(5,863

)

Other asset-backed securities

 

109,657

 

(5,537

)

551,045

 

(28,736

)

660,702

 

(34,273

)

U.S. government-related securities

 

374,160

 

(7,835

)

348,900

 

(14,470

)

723,060

 

(22,305

)

Other government-related securities

 

 

 

 

 

 

 

States, municipalities, and political subdivisions

 

880

 

(6

)

40,936

 

(2,343

)

41,816

 

(2,349

)

Corporate bonds

 

2,218,594

 

(54,117

)

995,498

 

(63,270

)

3,214,092

 

(117,387

)

Equities

 

90,797

 

(1,305

)

128,465

 

(15,220

)

219,262

 

(16,525

)

 

 

$

3,066,614

 

$

(78,115

)

$

2,277,796

 

$

(134,721

)

$

5,344,410

 

$

(212,836

)

 

RMBS have a gross unrealized loss greater than twelve months of $6.4 million as of September 30, 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 $4.3 million as of September 30, 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 $28.7 million as of September 30, 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 U.S. government-related category has gross unrealized losses greater than twelve months of $14.5 million as of September 30, 2014. These declines were entirely related to changes in interest rates.

 

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Table of Contents

 

The corporate bonds category has gross unrealized losses greater than twelve months of $63.3 million as of September 30, 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 $15.2 million as of September 30, 2014. 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.

 

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. 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.

 

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Table of Contents

 

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.

 

As of September 30, 2014, the Company had securities in its available-for-sale portfolio which were rated below investment grade of $1.7 billion and had an amortized cost of $1.6 billion. In addition, included in the Company’s trading portfolio, the Company held $322.6 million of securities which were rated below investment grade. Approximately $786.5 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

 

For The

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

 

 

(Dollars In Thousands)

 

Fixed maturities

 

$

(143,367

)

$

(156,636

)

$

1,004,990

 

$

(1,175,458

)

Equity securities

 

(2,184

)

(12,791

)

30,820

 

(17,393

)

 

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 FASB ASC (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 continued to be classified as a VIE as of September 30, 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 9, 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 holding company (“PLC”) has guaranteed the VIE’s payment obligation for the credit enhancement fee to the unrelated third party provider. As of September 30, 2014, no payments have been made or required related to this guarantee.

 

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Table of Contents

 

7.                                      MORTGAGE LOANS

 

Mortgage Loans

 

The Company invests a portion of its investment portfolio in commercial mortgage loans. As of September 30, 2014, the Company’s mortgage loan holdings were approximately $5.2 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 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 the Company’s mortgage loans have call options or interest rate reset options between 3 and 10 years. However, if interest rates were to significantly increase, the Company may be unable to exercise the call options or increase the interest rates on its existing mortgage loans commensurate with the significantly increased market rates. Assuming the loans are with these options called at their next call dates, approximately $29.9 million would become due for the remainder of 2014, $1.1 billion in 2015 through 2019, $510.0 million in 2020 through 2024, and $129.3 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 September 30, 2014 and December 31, 2013, approximately $583.4 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 and nine month periods ended September 30, 2014 and 2013, the Company recognized $8.0 million, $13.8 million, $3.7 million and $12.9 million, respectively, of participating mortgage loan income.

 

As of September 30, 2014, approximately $34.0 million, or 0.07%, 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 nine months ended September 30, 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 included either the acceptance of assets in satisfaction of principal at a future date or the recognition of permanent impairments to principal, and were the result of agreements between the creditor and the debtor. During the three and nine month periods ending September 30, 2014, the Company accepted or agreed to accept assets of $11.2 million and $26.3 million in satisfaction of $14.6 million and $30.6 million of principal, respectively. The Company also identified one loan whose principal of $12.6 million was permanently impaired to a value of $7.3 million. These transactions resulted in a $5.3 million and $6.2 million decrease in the Company’s investment in mortgage loans net of existing allowances for mortgage loans losses. Of the mortgage loan transactions accounted for as troubled debt restructurings, $21.8 million remain on the Company’s balance sheet as of September 30, 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 September 30,

 

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2014, $34.0 million of mortgage loans not subject to a pooling and servicing agreement were nonperforming or restructured; $21.8 million of these nonperforming loans were restructured during the nine months ended September 30, 2014. The Company did not foreclose on any loans during the nine months ended September 30, 2014.

 

As of September 30, 2014, none of the loans subject to a pooling and servicing agreement were nonperforming. The Company did not foreclose on any nonperforming loans during the nine months ended September 30, 2014.

 

As of September 30, 2014 and December 31, 2013, the Company had an allowance for mortgage loan credit losses of $3.7 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 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

 

 

 

September 30, 2014

 

December 31, 2013

 

 

 

(Dollars In Thousands)

 

Beginning balance

 

$

3,130

 

$

2,875

 

Charge offs

 

(416

)

(6,838

)

Recoveries

 

(2,600

)

(1,016

)

Provision

 

3,536

 

8,109

 

Ending balance

 

$

3,650

 

$

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 September 30, 2014.

 

 

 

 

 

 

 

Greater

 

 

 

 

 

30-59 Days

 

60-89 Days

 

than 90 Days

 

Total

 

 

 

Delinquent

 

Delinquent

 

Delinquent

 

Delinquent

 

 

 

(Dollars In Thousands)

 

Commercial mortgage loans

 

$

15,104

 

$

1,659

 

$

10,502

 

$

27,265

 

Number of delinquent commercial mortgage loans

 

5

 

1

 

5

 

11

 

 

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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 September 30, 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

 

$

6,045

 

$

7,558

 

$

 

$

1,511

 

$

 

$

 

With an allowance recorded

 

16,054

 

16,043

 

3,650

 

3,211

 

187

 

187

 

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

 

 

Mortgage loans that were modified in a troubled debt restructuring were as follows:

 

 

 

 

 

 

 

Post-

 

 

 

 

 

Pre-Modification

 

Modification

 

 

 

 

 

Outstanding

 

Outstanding

 

 

 

Number of

 

Recorded

 

Recorded

 

 

 

Contracts

 

Investment

 

Investment

 

 

 

(Dollars In Thousands)

 

2014 

 

 

 

 

 

 

 

Troubled debt restructuring:

 

 

 

 

 

 

 

Commercial mortgage loans

 

5

 

$

27,164

 

$

21,848

 

 

8.                                      GOODWILL

 

During the nine months ended September 30, 2014, the Company decreased its goodwill balance by approximately $2.3 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 September 30, 2014, the Company had an aggregate goodwill balance of $103.1 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

 

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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 nine months ended September 30, 2014, no events occurred which indicate an impairment should be recorded or which would invalidate the previous results of the Company’s impairment assessment.

 

9.                                      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 September 30, 2014. There was an outstanding balance of $280.0 million at an interest rate of LIBOR plus 1.20% under the Credit Facility as of September 30, 2014.

 

Non-Recourse Funding Obligations

 

Golden Gate II Captive Insurance Company

 

Golden Gate II Captive Insurance Company (“Golden Gate II”), a South Carolina special purpose financial captive insurance company wholly owned by PLICO, had $575 million of outstanding non-recourse funding obligations as of September 30, 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 September 30, 2014, securities related to $176.6 million of the outstanding balance of the non-recourse funding obligations were held by external parties and securities related to $398.4 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 September 30, 2014, no payments have been made under these agreements.

 

Golden Gate V Vermont Captive Insurance Company

 

On October 10, 2012, Golden Gate V, a Vermont special purpose financial insurance company, and Red Mountain, both wholly owned subsidiaries of PLICO, 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

 

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of September 30, 2014, the principal balance of the Red Mountain note was $415 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 credit enhancement of the Red Mountain note. As of September 30, 2014, no payments have been made under these agreements.

 

In connection with the transaction outlined above, Golden Gate V had a $415 million outstanding non-recourse funding obligation as of September 30, 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 September 30, 2014, on a consolidated basis, are shown in the following table:

 

 

 

 

 

 

 

Year-to-Date

 

 

 

 

 

Maturity

 

Weighted-Avg