6. Fair Value Measurements

Recurring fair value measurements

The following tables present the Company’s financial assets and liabilities carried at fair value on a recurring basis by fair value hierarchy category as of December 31, 2012 and 2011:

	Assets and liabilities measured at fair value on a recurring basis
	December 31, 2012
	Quoted prices		Significant
	in active		other		Significant
	markets for		observable		unobservable
	identical assets		inputs		inputs
	(Level 1)		(Level 2)		(Level 3)		Total
Assets
Fixed maturities available-for-sale:
U.S. government direct obligations and U.S. agencies	$	—	$	2,834,074	$	—	$	2,834,074
Obligations of U.S. states and their subdivisions	—		2,018,505		—		2,018,505
Corporate debt securities	—		10,372,269		1,822		10,374,091
Asset-backed securities	—		1,595,601		265,538		1,861,139
Residential mortgage-backed securities	—		425,585		—		425,585
Commercial mortgage-backed securities	—		662,955		—		662,955
Collateralized debt obligations	—		11,963		32		11,995
Total fixed maturities available- for-sale	—		17,920,952		267,392		18,188,344
Fixed maturities held for trading:
U.S. government direct obligations and U.S. agencies	—		263,634		—		263,634
Corporate debt securities	—		61,336		—		61,336
Asset-backed securities	—		42,630		—		42,630
Total fixed maturities held for trading	—		367,600		—		367,600
Short-term investments available-for-sale	19,459		246,873		—		266,332
Collateral under securities lending agreements	142,022		—		—		142,022
Collateral under derivative counterparty collateral agreements	54,400		—		—		54,400
Derivative instruments designated as hedges:
Interest rate swaps	—		26,371		—		26,371
Cross-currency swaps	—		4,643		—		4,643
Derivative instruments not designated as hedges:
Interest rate swaps	—		1,062		—		1,062
Interest rate swaptions	—		342		—		342
Total derivative instruments	—		32,418		—		32,418
Separate account assets	12,171,024		12,434,502		—		24,605,526
Total assets	$	12,386,905	$	31,002,345	$	267,392	$	43,656,642

Liabilities
Payable under securities lending agreements	$	142,022	$	—	$	—	$	142,022
Derivative instruments designated as hedges:
Interest rate swaps	—		1,649		—		1,649
Cross-currency swaps	—		85,752		—		85,752
Derivative instruments not designated as hedges:
Interest rate swaps	—		757		—		757
Total derivative instruments	—		88,158		—		88,158
Separate account liabilities (1)	14		352,653		—		352,667
Total liabilities	$	142,036	$	440,811	$	—	$	582,847

(1) Includes only separate account instruments which are carried at the fair value of the underlying liabilities owned by the separate accounts.

	Assets and liabilities measured at fair value on a recurring basis
	December 31, 2011
	Quoted prices		Significant
	in active		other		Significant
	markets for		observable		unobservable
	identical assets		inputs		inputs
	(Level 1)		(Level 2)		(Level 3)		Total
Assets
Fixed maturities available-for-sale:
U.S. government direct obligations and U.S. agencies	$	—	$	2,315,671	$	—	$	2,315,671
Obligations of U.S. states and their subdivisions	—		2,071,170		—		2,071,170
Corporate debt securities	—		8,859,250		36,496		8,895,746
Asset-backed securities	—		1,672,423		279,021		1,951,444
Residential mortgage-backed securities	—		591,542		—		591,542
Commercial mortgage-backed securities	—		747,797		—		747,797
Collateralized debt obligations	—		16,391		22		16,413
Total fixed maturities available- for-sale	—		16,274,244		315,539		16,589,783
Fixed maturities held for trading:
U.S. government direct obligations and U.S. agencies	—		36,352		—		36,352
Corporate debt securities	—		60,243		—		60,243
Asset-backed securities	—		43,905		—		43,905
Commercial mortgage-backed securities	—		7,026		—		7,026
Total fixed maturities held for trading	—		147,526		—		147,526
Short-term investments available-for-sale	45,869		286,895		—		332,764
Collateral under securities lending agreements	7,099		—		—		7,099
Collateral under derivative counterparty collateral agreements	11,985		—		—		11,985
Derivative instruments designated as hedges:
Interest rate swaps	—		20,894		—		20,894
Cross-currency swaps	—		6,241		—		6,241
Derivative instruments not designated as hedges:
Interest rate swaps	—		4,687		—		4,687
Interest rate swaptions	—		944		—		944
Total derivative instruments	—		32,766		—		32,766
Separate account assets (1)	10,646,426		11,568,489		2,118		22,217,033
Total assets	$	10,711,379	$	28,309,920	$	317,657	$	39,338,956

Liabilities
Payable under securities lending agreements	$	7,099	$	—	$	—	$	7,099
Payable under derivative counterparty collateral agreements	11,985		—		—		11,985
Derivative instruments designated as hedges:
Interest rate swaps	—		1,011		—		1,011
Derivative instruments not designated as hedges:
Interest rate swaps	—		13,003		—		13,003
Total derivative instruments	—		14,014		—		14,014
Separate account liabilities (1)	74		278,796		—		278,870
Total liabilities	$	19,158	$	292,810	$	—	$	311,968

(1) Includes only separate account instruments which are carried at the fair value of the underlying invested assets or liabilities owned by the separate accounts.

The methods and assumptions used to estimate the fair value of the Company’s financial assets and liabilities carried at fair value on a recurring basis are as follows:

Fixed maturity investments

The fair values for fixed maturity investments are based upon market prices from independent pricing services. In cases where market prices are not readily available, such as for private fixed maturity investments, fair values are estimated by the Company. To determine estimated fair value for these instruments, the Company generally utilizes discounted cash flows calculated at current market rates on investments of similar quality and term. Fair value estimates are made at a specific point in time, based on available market information and judgments about financial instruments, including estimates of the timing and amounts of expected future cash flows and the credit standing of the issuer or counterparty.

Short-term investments and securities lending agreements

The amortized cost of short-term investments, collateral under securities lending agreements and payable under securities lending agreements is a reasonable estimate of fair value due to their short-term nature and high credit quality of the issuer.

Derivative counterparty collateral agreements

Included in other assets and other liabilities is cash collateral received from derivative counterparties and the obligation to return the cash collateral to the counterparties. The carrying value of the collateral is a reasonable estimate of fair value.

Derivative instruments

Included in other assets and other liabilities are derivative financial instruments. The estimated fair values of OTC derivatives, primarily consisting of cross-currency swaps, interest rate swaps and interest rate swaptions which are held for other than trading purposes, are the estimated amounts the Company would receive or pay to terminate the agreements at the end of each reporting period, taking into consideration current interest rates, counterparty credit risk and other relevant factors.

Separate account assets

Separate account assets primarily include investments in mutual fund, fixed maturity and short-term securities. Mutual funds are recorded at net asset value, which approximates fair value, on a daily basis. The fixed maturity and short-term investments are valued in the same manner, and using the same pricing sources and inputs as the fixed maturity and short-term investments of the Company.

The following tables present additional information about assets and liabilities measured at fair value on a recurring basis and for which the Company has utilized Level 3 inputs to determine fair value:

	Recurring Level 3 financial assets and liabilities Year ended December 31, 2012
	Fixed maturities available-for-sale
	Corporate debt securities			Asset-backed securities			Collateralized debt obligations			Separate accounts			Total
Balance, January 1, 2012	$	36,496		$	279,021		$	22		$	2,118		$	317,657
Realized and unrealized gains (losses) included in:
Net income	(66		)	—			—			(3,692		)	(3,758		)
Other comprehensive income (loss)	102			33,346			11			3,604			37,063
Sales	(1,598		)	—			—			(1,997		)	(3,595		)
Settlements	(874		)	(41,809		)	(1		)	(33		)	(42,717		)
Transfers out of Level 3 (1)	(32,238		)	(5,020		)	—			—			(37,258		)
Balance, December 31, 2012	$	1,822		$	265,538		$	32		$	—		$	267,392
Total gains (losses) for the period included in net income attributable to the change in unrealized gains and losses relating to assets held at December 31, 2012	$	—		$	—		$	—		$	—		$	—

(1) Transfers out of Level 3 are due primarily to increased observability of inputs in valuation methodologies as evidenced by corroboration of market prices with multiple pricing vendors and internal models.

	Recurring Level 3 financial assets and liabilities Year ended December 31, 2011
	Fixed maturities available-for-sale
	Corporate debt securities			Asset-backed securities			Collateralized debt obligations		Separate accounts			Total
Balance, January 1, 2011	$	58,692		$	290,488		$	14	$	4,278		$	353,472
Realized and unrealized gains (losses) included in:
Net income	3,961			(192		)	—		37			3,806
Other comprehensive income (loss)	779			20,031			8		260			21,078
Sales	(14,430		)	—			—		(1,847		)	(16,277		)
Settlements	(17,460		)	(31,306		)	—		(158		)	(48,924		)
Transfers into Level 3 (1)	7,333			—			—		1,400			8,733
Transfers out of Level 3 (1)	(2,379		)	—			—		(1,852		)	(4,231		)
Balance, December 31, 2011	$	36,496		$	279,021		$	22	$	2,118		$	317,657
Total gains (losses) for the period included in net income attributable to the change in unrealized gains and losses relating to assets held at December 31, 2011	$	—		$	—		$	—	$	—		$	—

(1) Transfers into Level 3 are due primarily to decreased observability of inputs in valuation methodologies. Transfers out of Level 3 are due primarily to increased observability of inputs in valuation methodologies as evidenced by corroboration of market prices with multiple pricing vendors.

	Recurring Level 3 financial assets and liabilities Year ended December 31, 2010
	Fixed maturities available-for-sale
	Corporate debt securities			Asset-backed securities			Commercial mortgage-backed securities			Collateralized debt obligations			Derivative instruments			Separate accounts			Total
Balance, January 1, 2010	$	188,936		$	392,365		$	58,270		$	1,729		$	(3,317	)	$	9,960		$	647,943
Realized and unrealized gains (losses) included in:
Net income	475			(49,393		)	—			(34		)	—			—			(48,952		)
Other comprehensive income (loss)	5,630			70,026			—			161			—			622			76,439
Purchases, issuances and settlements	(30,084		)	(98,807		)	—			(1,842		)	—			(1,700		)	(132,433		)
Transfers in (out) of Level 3 (1)	(106,265		)	(23,703		)	(58,270		)	—			3,317			(4,604		)	(189,525		)
Balance, December 31, 2010	$	58,692		$	290,488		$	—		$	14		$	—		$	4,278		$	353,472
Total gains (losses) for the period included in net income attributable to the change in unrealized gains and losses relating to assets held at December 31, 2010	$	—		$	—		$	—		$	—		$	—		$	—		$	—

The following table presents significant unobservable inputs used during the valuation of certain assets categorized within Level 3 of the recurring fair value measurements table:

	December 31, 2012
	Fair Value		Valuation Technique	Unobservable Input	Weighted Average
Fixed maturities available-for-sale:
Asset-backed securities(1)	$	265,470	Internal model pricing	Prepayment speed assumption	5

				Constant default rate assumption	5

				Adjusted ABX Index spread assumption (2)	655

(1) Includes home improvement loans only.

(2) Includes an internally calculated liquidity premium adjustment of 217.

After adjusting the ABX Index spread assumption by the liquidity premium, the overall discount rate ranged from 384 to 918 basis points. The constant default rate assumption ranged from 1.2 to 7.9.

The significant unobservable inputs used in the fair value measurement of asset-backed securities are prepayment speed assumptions, constant default rate assumptions and the ABX Index spread adjusted by an internally calculated liquidity premium with the primary inputs being the constant default rate assumption and the adjusted ABX Index spread assumption. As the constant default rate assumption or the adjusted ABX Index spread assumption increases, the price and therefore, the fair value, of the securities decreases.

Non-recurring fair value measurements - Certain assets are measured at estimated fair value on a non-recurring basis and are not included in the tables above. The Company held $2,903 and $19,745 of adjusted cost basis limited partnership and other corporation interests which were impaired at December 31, 2012 and 2011, respectively, based on the fair value disclosed in the limited partnership financial statements or the estimated fair value of the underlying collateral. The estimated fair value was categorized as Level 3.

Fair value of financial instruments

The following tables summarize the carrying amounts and estimated fair values of the Company’s financial instruments not carried at fair value on a recurring basis at December 31, 2012 and 2011:

	December 31, 2012				December 31, 2011
	Carrying amount		Estimated fair value		Carrying amount		Estimated fair value
Assets
Mortgage loans on real estate	$	2,881,758	$	3,114,796	$	2,513,087	$	2,679,474
Policy loans	4,260,200		4,260,200		4,219,849		4,219,849
Limited partnership interests	46,707		43,954		48,053		41,931
Other investments	18,890		45,050		22,990		47,915

Liabilities
Annuity contract benefits without life contingencies	$	9,622,357	$	9,731,734	$	8,727,286	$	8,888,585
Policyholders’ funds	374,821		374,821		382,816		382,816
Commercial paper	97,987		97,987		97,536		97,536
Notes payable	532,491		563,860		532,463		515,104

The methods and assumptions used to estimate the fair value of financial instruments not carried at fair value on a recurring basis are summarized as follows:

Mortgage loans on real estate

Mortgage loan fair value estimates are generally based on discounted cash flows. A discount rate matrix is used where the discount rate valuing a specific mortgage generally corresponds to that mortgage’s remaining term and credit quality. Management believes the discount rate used is comparable to the credit, interest rate, term, servicing costs and risks of loans similar to the portfolio loans that the Company would make today given its internal pricing strategy. The estimated fair value was classified as Level 2.

Policy loans

The Company believes the fair value of policy loans approximates book value. Policy loans are funds provided to policy holders in return for a claim on the policy. The funds provided are limited to the cash surrender value of the underlying policy. The nature of policy loans is to have a negligible default risk as the loans are fully collateralized by the value of the policy. Policy loans do not have a stated maturity and the balances and accrued interest are repaid either by the policyholder or with proceeds from the policy. Due to the collateralized nature of policy loans and unpredictable timing of repayments, the Company believes the fair value of policy loans approximates carrying value. The estimated fair value was classified as Level 2.

Limited partnership interests

Limited partnership interests, accounted for using the cost method, represent the Company’s minor ownership interests in pooled investment funds. These funds employ varying investment strategies that principally make private equity investments across diverse industries and geographical focuses. The estimated fair value was determined by using the partnership financial statement reported capital account or net asset value adjusted for other relevant information which may impact the exit value of the investments. Distributions by these investments are generated from investment gains, from operating income generated by the underlying investments of the funds and from liquidation of the underlying assets of the funds which are estimated to be liquidated over the next one to ten years. The estimated fair value was classified as Level 3.

Other investments

Other investments primarily include real estate held for investment. The estimated fair value for real estate is based on the unadjusted annual appraised value which includes factors such as comparable property sales, property income analysis, and capitalization rates. The estimated fair value was classified as Level 2.

Annuity contract benefits without life contingencies

The estimated fair value of annuity contract benefits without life contingencies is estimated by discounting the projected expected cash flows to the maturity of the contracts utilizing risk-free spot interest rates plus a provision for the Company’s credit risk. The estimated fair value was classified as Level 2.

Policyholders’ funds

The carrying amount of policyholders’ funds approximates the fair value since the Company can change the interest crediting rates with 30 days notice. The estimated fair value was classified as Level 2.

Commercial paper

The amortized cost of commercial paper is a reasonable estimate of fair value due to their short-term nature and high credit quality of the obligor. The estimated fair value was classified as Level 2.

Notes payable

The estimated fair value of the notes payable to GWL&A Financial is based upon quoted market prices from independent pricing services of securities with characteristics similar to those of the notes payable. The estimated fair value was classified as Level 2.