Note 2. Fair Value of Financial Instruments

Fair Value Measurements

Accounting Standards Codification (“ASC”) ASC 820 defines fair value, establishes a framework for measuring fair value, establishes a three-level fair value hierarchy based on the quality of inputs used to measure fair value and enhances disclosure requirements for fair value measurements.

Fair Value Hierarchy

The Company has categorized its financial instruments into the three-level hierarchy based on the priority of the inputs to the valuation technique. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure fair value fall within different levels of the hierarchy, the category level is based on the lowest priority level input that is significant to the fair value measurement of the instrument.

Assets and liabilities recorded at fair value on the Balance Sheets are categorized as follows:

Level 1. Unadjusted quoted prices for identical assets or liabilities in an active market.

Level 2. Quoted prices in markets that are not active or inputs that are observable either directly or indirectly for substantially the full term of the asset or liability. Level 2 inputs include the following:

Quoted prices for similar assets or liabilities in active markets

Quoted prices for identical or similar assets or liabilities in non-active markets

Inputs other than quoted market prices that are observable

Inputs that are derived principally from or corroborated by observable market data through correlation or other means

Level 3. Prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. Both observable and unobservable inputs may be used to determine the fair value of positions classified in Level 3. The circumstances for using unobservable measurements include those in which there is little, if any, market activity for the assets or liabilities. Therefore, we must make assumptions about inputs a hypothetical market participant would use to value the assets and liabilities.

The Company recognizes transfers between levels at the beginning of the quarter.

The following tables present the Company’s hierarchy for its assets and liabilities measured at fair value on a recurring basis at March 31, 2017 and December 31, 2016:

	March 31, 2017
	Level 1		Level 2		Level 3		Total
Assets
Fixed maturity available-for-sale ("AFS") securities (a)
Corporate securities	$	-	$	892,795	$	-	$	892,795
Asset-backed securities		-		36,098		13,288		49,386
Commercial mortgage-backed securities		-		74,572		-		74,572
Residential mortgage-backed securities		-		68,444		-		68,444
Municipals		-		871		-		871
Government and government agencies
United States		351,481		199		-		351,680
Foreign		1,474		24,222		-		25,696
Total fixed maturity AFS securities	$	352,955	$	1,097,201	$	13,288	$	1,463,444
Equity AFS securities (a)
Banking securities	$	-	$	27,405	$	-	$	27,405
Industrial securities		-		5,800		-		5,800
Total equity AFS securities	$	-	$	33,205	$	-	$	33,205
Cash equivalents (b)	$	-	$	106,058	$	-	$	106,058
Derivative assets (c)		-		2,609		-		2,609
Fair value recoverable of ceded guaranteed minimum income benefits ("GMIB") embedded derivatives (d)		-		-		39,244		39,244
Investments measured at net asset value ("NAV") (e)		-		-		-		5,796,266
Total assets	$	352,955	$	1,239,073	$	52,532	$	7,440,826

Liabilities
Future policy benefits (embedded derivatives only) (f)	$	-	$	-	$	48,395	$	48,395
Derivative liabilities (c)		-		7,051		-		7,051
Total liabilities	$	-	$	7,051	$	48,395	$	55,446

	December 31, 2016
	Level 1		Level 2		Level 3		Total
Assets
Fixed maturity AFS securities (a)
Corporate securities	$	-	$	911,851	$	-	$	911,851
Asset-backed securities		-		43,372		9,215		52,587
Commercial mortgage-backed securities		-		76,513		-		76,513
Residential mortgage-backed securities		-		96,177		-		96,177
Municipals		-		856		-		856
Government and government agencies
United States		341,379		-		-		341,379
Foreign		1,480		6,194		-		7,674
Total fixed maturity AFS securities	$	342,859	$	1,134,963	$	9,215	$	1,487,037
Equity AFS securities (a)
Banking securities	$	-	$	26,726	$	-	$	26,726
Industrial securities		-		5,825		-		5,825
Total equity AFS securities	$	-	$	32,551	$	-	$	32,551
Cash equivalents (b)		-		265,538		-		265,538
Derivative assets (c)		-		16,526		-		16,526
Fair value recoverable of ceded GMIB embedded derivatives (d)		-		-		48,166		48,166
Investments measured at NAV (e)		-		-		-		5,730,860
Total assets	$	342,859	$	1,449,578	$	57,381	$	7,580,678

Liabilities
Future policy benefits (embedded derivatives only) (f)	$	-	$	-	$	55,143	$	55,143
Derivative liabilities (c)		-		15,165		-		15,165

Total liabilities	$	-	$	15,165	$	55,143	$	70,308

(a)

The fair values of debt securities are determined by management after taking into consideration several sources of data. When available, the Company uses quoted market prices in active markets to determine the fair value of its debt securities. The Company’s valuation policy utilizes a pricing hierarchy that dictates that publicly available prices are initially sought from indices and third party pricing services. In the event that pricing is not available from these sources, those securities are submitted to brokers to obtain quotes. The majority of brokers’ quotes are non-binding. As part of the pricing process, the Company assesses the appropriateness of each quote (i.e., as to whether the quote is based on observable market transactions or not) to determine the most appropriate estimate of fair value. Lastly, securities are priced using internal cash flow modeling techniques. These valuation methodologies commonly use the following inputs: reported trades, bids, offers, issuer spreads, benchmark yields, estimated prepayment speeds, and/or estimated cash flows.

Third-party pricing services and brokers will often determine prices using recently reported trades for identical or similar securities. The third-party pricing services and brokers make adjustments for the elapsed time from the trade date to the Balance Sheet date to take into account available market information. Lacking recently reported trades, third-party pricing services and brokers will use modeling techniques to determine a security price where expected future cash flows are developed based on the performance of the underlying collateral and discounted using an estimated market rate.

Periodically, the Company performs an analysis of the inputs obtained from third-party pricing services and brokers to ensure that the inputs are reasonable and produce a reasonable estimate of fair value. The Company’s asset specialists and investment valuation specialists consider both qualitative and quantitative factors as part of this analysis. Several examples of analytical procedures performed include, but are not limited to, recent transactional activity for similar debt securities, review of pricing statistics and trends and consideration of recent relevant market events. Other controls and procedures over pricing received from indices, third-party pricing services, or brokers include validation checks, such as exception reports that highlight significant price changes, stale prices or un-priced securities.

Following is additional discussion of the valuation methodologies for certain types of debt securities:

Corporate debt securities - Valuations of corporate debt securities are monitored and reviewed on a monthly basis. The pricing hierarchy is dependent on the possibility of corroboration of market prices when available. If no market prices are available, valuations are determined by a discounted cash flow methodology using an internally calculated yield. The yield is comprised of a credit spread over a given benchmark, taking into effect liquidity risk for thinly traded securities.

Residential mortgage-backed securities (“RMBS”), commercial mortgage-backed securities (“CMBS”) and asset backed securities (“ABS”) - Valuations of RMBS, CMBS and ABS are monitored and reviewed on a monthly basis. Valuations are based on a pricing hierarchy and, depending on the asset type, the pricing hierarchy consists of a waterfall that starts with making use of market prices from indices and follows with making use of third-party pricing services or brokers. The pricing hierarchy is dependent on the possibility of corroborating the market prices. If no market prices are available, the Company uses either internal models or another available pricing source to determine fair value. Significant inputs included in the internal models are generally determined based on relative value analyses, which incorporate comparisons to instruments with similar collateral and risk profiles. Market standard models may be used to model the specific collateral composition and cash flow structure of each transaction. The most significant unobservable input is the illiquidity premium, which is embedded in the discount rate.

Government and government agencies - When available, the Company uses quoted market prices in active markets to determine the fair value of its government and government agencies’ investments. When the Company cannot make use of quoted market prices, market prices from indices or quotes from third-party pricing services or brokers are used.

Equity securities – Valuations of equity securities are monitored and reviewed on a monthly basis. When available, the Company uses quoted market prices in active markets to determine the fair value of its equity investments. When the Company cannot make use of quoted market prices, quotes from a third-party vendor, broker, or custodian are used.

(b)	Cash equivalents are primarily valued at amortized cost, which approximates fair value. Operating cash is not included in the above table.

(c)

Level 2 derivatives include interest rate swaps, inflation swaps, variance swaps, total return swaps, and credit default swaps for which the Company utilized readily accessible quoted index levels and broker quotes. The fair value of interest rate swaps is calculated based on the change in the underlying floating rate curve measured using the London Inter-Bank Offered Rate (“LIBOR”) at the reporting date, as compared to the fixed leg of the swap. The fair value for inflation swaps is calculated as the difference between the consumer price index (or related readily accessible quoted inflation index level) at the reporting date and the last reset date, multiplied by the notional value of the swap. The fair value for variance swaps is calculated as the difference between the estimated volatility of the underlying Standard & Poor’s 500 Composite Price Index (“S&P”) at maturity and the actual volatility of the underlying S&P at initiation (i.e., strike) multiplied by the notional value of the swap. Total return swaps are valued based on the change in the underlying equity index as of the last reset date. The fair value for equity options is calculated using the Black-Scholes model and market observable inputs for the underlying market price and volatility surface. Credit default swaps are valued using a discounted cash flow model where future premium payments and protection payments are corrected for the probability of default, which is modeled using an arbitrage free credit spread model.

(d)	The Company reinsures a portion of its variable annuity business that offer GMIB reinsurance. GMIB reinsurance contracts are treated as embedded derivatives since they contain payment provisions for net settlement and are therefore reported separately from the host contract.

(e)	Amounts are comprised of certain investments that are measured at fair value using the NAV per share (or its equivalent) as a practical expedient and have not been classified in the fair value hierarchy in accordance with Subtopic 820-10. These investments do not have lockup periods.

		March 31, 2017								December 31, 2016
Investment:		Fair			Unfunded		Redemption	Redemption		Fair			Unfunded
Limited Partnerships		Value			Commitments		Frequency	Notice Period		Value			Commitments
Limited Partnership - Private Equity	$		1,704	$		-	None	None	$		1,759	$		-
Limited Partnership - Hedge Funds			70,905			102	Quarterly	60-65 days			69,151			-
	$		72,609	$		102			$		70,910	$		-
Separate Accounts			5,723,657			-	None	None			5,659,950			-
Investments measured at NAV	$		5,796,266	$		102			$		5,730,860	$		-

(f)

The Company recognizes liabilities for contracts containing guaranteed minimum withdrawal benefits ("GMWB") and stand-alone living benefits ("SALB"), which are reported at fair value. The liabilities for the contracts containing GMWB are treated as embedded derivatives, which are required to be reported separately from the host contract. The fair value of these guarantees is calculated as the present value of future expected payments to policyholders less the present value of assessed fees attributable to the guarantees. Given the complexity and long-term nature of the guarantees, their fair values are determined using stochastic techniques under a variety of market return, discount rate and actuarial assumptions. Since two of the assumptions are unobservable and are considered to be significant inputs to the liability valuation, the liability included in future policy benefits has been reflected within Level 3 of the fair value hierarchy.

For the three months ended March 31, 2017 and twelve months ended December 31, 2016, there were no transfers between Level 1 and 2, respectively.

The following table provides a summary of the change in fair value of the Company's Level 3 fixed maturity AFS securities at March 31, 2017 and December 31, 2016:

		Three Months Ended March 31, 2017				Twelve Months Ended December 31, 2016
Balance at beginning of period (a)	$		9,215		$		6,666

Change in unrealized gains (losses) (b)			116				(243	)
Purchases			3,999				2,792
Sales			(42	)			(326	)
Transfers into Level 3			-				2,113
Transfers out of Level 3			-				(1,954	)
Net realized investment gains (c)			-				167
Balance at end of period (a)	$		13,288		$		9,215

(a)	Recorded as a component of fixed maturity AFS securities on the Balance Sheets.

(b)	Recorded as a component of other comprehensive income (loss) in net unrealized holding gains (losses) on AFS securities arising during the period.

(c)	Recorded as a component of net realized investment gains (losses) for fixed maturity in the Statements of Income (Loss).

In certain circumstances, the Company will obtain non-binding broker quotes from brokers to assist in the determination of fair value. If those quotes can be corroborated by other market observable data, the investments will be classified as Level 2 investments. If not, the investments are classified as Level 3 due to the unobservable nature of the brokers’ valuation processes. The primary driver for the increase in Level 3 fixed maturity AFS securities at March 31, 2017 is due to an asset-backed non-housing security being purchased as a Level 3 during the first quarter.

The Company's Level 3 (assets) consist of GMIB reinsurance and Level 3 liabilities consist of provisions for GMWB and SALB. The fair value of these guarantees is calculated as the present value of future expected payments to policyholders less the present value of assessed fees attributable to the guarantees. Given the complexity and long-term nature of these guarantees, which are unlike instruments available in financial markets, their fair values are determined using stochastic techniques under a variety of market return scenarios. A variety of factors are considered, including expected market rates of return, equity and interest rate volatility, credit spread, correlations of market returns, discount rates and actuarial assumptions. For GMWB and SALB, an increase (decrease) in credit spread in isolation would result in a lower (higher) fair value liability measurement and an increase (decrease) in volatility in isolation would result in a higher (lower) fair value liability measurement. Changes in the Company’s credit spread and volatility assumptions have an inverse effect on the GMIB reinsurance assets.

The expected market rates of return are based on risk-free rates, such as the current LIBOR forward curve. The credit spread, which is a significant unobservable input, is set by using the credit default swap (“CDS”) spreads of a reference portfolio of life insurance companies, adjusted to reflect the subordination of senior debt holders at the holding company level to the position of policyholders at the operating company level (who have priority in payments to other creditors). The credit spread was 45 basis points (“bps”) and 50 bps at March 31, 2017 and December 31, 2016, respectively.

For equity volatility, the Company uses a term structure assumption with market-based implied volatility inputs for the first five years and a long-term forward rate assumption of 25%-30% thereafter. The volume of observable option trading from which volatilities are derived generally declines as the contracts’ term increases; therefore, the volatility curve grades from implied volatilities for five years to the ultimate rate. The resulting volatility assumption in year 20 for the S&P (expressed as a spot rate) was 23.4% and 24.0% at March 31, 2017 and December 31, 2016, respectively. Correlations of market returns across underlying indices are based on historical market returns and their inter-relationships over a number of years preceding the valuation date. Assumptions regarding policyholder behavior, such as lapses, included in the models are derived in the same way as the assumptions used to measure insurance liabilities. These assumptions are reviewed at each valuation date and updated based on historical experience and observable market data as required.

The following table provides a summary of the changes in fair value of the Company’s Level 3 liabilities (assets) at March 31, 2017 and December 31, 2016:

	Three Months Ended								Twelve Months Ended
	March 31, 2017								December 31, 2016
				GMIB								GMIB
	GMWB			Reinsurance			SALB		GMWB			Reinsurance			SALB
Balance at beginning of period (a)	$	54,414		$	(48,166	)	$	729	$	60,618		$	(61,426	)	$	511
Changes in interest rates (b)		1,532			(802	)		-		(4,179	)		2,262			-
Changes in equity markets (b)		(7,963	)		9,199			-		(5,988	)		12,560			218
Other (b)		(317	)		525			-		3,963			(1,562	)		-
Balance at end of period (a)	$	47,666		$	(39,244	)	$	729	$	54,414		$	(48,166	)	$	729

(a)	GMWB and SALB are recorded as a component of future policy benefits on the Balance Sheets and GMIB reinsurance is recorded as recoverable of ceded GMIB embedded derivatives, at fair value on the Balance Sheets.

(b)	Recorded as a component of policy benefits in the Statements of Income (Loss).

For the three months ended March 31, 2017, the change in the fair value of the GMWB and GMIB reinsurance guarantees was primarily driven by changes in interest rates and equity market performance. The fair value of the GMWB decreased due to favorable equity market returns and was partially offset by the decrease in 10 year Treasury interest rates and own credit spread. The increase to the GMIB reinsurance guarantees was driven primarily by the favorable equity market returns.

The following tables provides a summary of the quantitative inputs and assumptions of the Company's Level 3 assets and liabilities at March 31, 2017 and December 31, 2016:

March 31, 2017

Estimated

Range

Description

Fair Value

Valuation Techniques

Unobservable Inputs

(Weighted Average)

Assets

Fixed maturity securities

Asset-backed securities

13,288

Broker

See comment below (a)

Total fixed maturity securities

13,288

Future policy benefits (embedded derivatives) -

GMIB Reinsurance

39,244

Discounted cash flows

Own credit risk

Long-term volatility

25% - 30%

Total assets

52,532

Liabilities

Future policy benefits (embedded derivatives) - GMWB

47,666

Discounted cash flows

Own credit risk

Long-term volatility

25% - 30%

Future policy benefits - SALB

729

See comment below (b)

Total liabilities

48,395

	December 31, 2016
	Estimated				Range
Description	Fair Value		Valuation Techniques	Unobservable Inputs	(Weighted Average)
Assets
Fixed maturity securities
Asset-backed securities	$	9,215	Broker	See comment below (a)	See comment below (a)

Future policy benefits (embedded derivatives) - GMIB Reinsurance		48,166	Discounted cash flows	Own credit risk	50
				Long-term volatility	25% - 30%
Total assets	$	57,381

Liabilities
Future policy benefits (embedded derivatives) - GMWB	$	54,414	Discounted cash flows	Own credit risk	50
				Long-term volatility	25% - 30%

Future policy benefits - SALB		729	See comment below (b)	See comment below (b)	See comment below (b)
Total liabilities	$	55,143

(a)

The Company has obtained non-binding broker quotes, which cannot be corroborated by market observable data, to assist in determining the fair values of the Level 3 asset-backed securities. The Company does not receive the unobservable inputs used by the broker but performs annual reviews to approve the use of brokers and obtains an asset specialist’s review of the broker’s price.

(b)	The SALB is a product with fewer than 150 policies. Due to the small size of this block, the liability was established based on the fees.

The following tables provides the estimated fair value of the Company's assets not carried at fair value on the Balance Sheets at March 31, 2017 and December 31, 2016:

	March 31, 2017
	Level 1		Level 2		Level 3		Total
Assets
Mortgage loans on real estate (a)	$	-	$	-	$	124,725	$	124,725
Policy loans (b)		-		627,399		-		627,399
Total assets	$	-	$	627,399	$	124,725	$	752,124

	December 31, 2016
	Level 1		Level 2		Level 3		Total
Assets
Mortgage loans on real estate (a)	$	-	$	-	$	115,020	$	115,020
Policy loans (b)		-		632,834		-		632,834
Total assets	$	-	$	632,834	$	115,020	$	747,854

(a)	The fair value of mortgage loans on real estate is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and/or similar remaining maturities.

(b)	Policy loans are stated at unpaid principal balance. The book value of policy loans approximates their fair value.