Fair Value of Financial Instruments

9 Months Ended

Sep. 30, 2020

The Company is required to disclose estimated fair values for certain financial and nonfinancial assets and liabilities. Fair values of the Company’s insurance contracts other than annuity contracts (which are investment contracts) are not required to be disclosed. However, the estimated fair values of liabilities under all insurance contracts are taken into consideration in the Company’s overall management of interest rate risk through the matching of investment maturities with amounts due under insurance contracts.

Information regarding the three-level hierarchy presented below and the valuation methodologies utilized by the Company to estimate fair values at each reporting date is included in Part II - Item 8, Note 4 of the Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.

Financial Instruments Measured and Carried at Fair Value on a Recurring Basis

The following table presents the Company's fair value hierarchy for those assets and liabilities measured and carried at fair value on a recurring basis. During the nine months ended September 30, 2020 and 2019, there were no transfers between Level 1 and Level 2. At September 30, 2020, Level 3 invested assets comprised 5.0% of the Company’s total investment portfolio at fair value.


($ in thousands)					Fair Value Measurements at
	Carrying		Fair		Reporting Date Using
	Amount		Value		Level 1		Level 2		Level 3
September 30, 2020
Financial Assets
Investments
Fixed maturity securities
U.S. Government and federally sponsored agency obligations:
Mortgage-backed securities	$	702,862	$	702,862	$	—	$	690,663	$	12,199
Other, including U.S. Treasury securities	384,137		384,137		18,446		365,691		—
Municipal bonds	1,816,501		1,816,501		—		1,750,830		65,671
Foreign government bonds	44,787		44,787		—		44,787		—
Corporate bonds	1,983,483		1,983,483		14,076		1,848,222		121,185
Other asset-backed securities	1,236,788		1,236,788		—		1,108,189		128,599
Total fixed maturity securities	6,168,558		6,168,558		32,522		5,808,382		327,654
Equity securities	102,303		102,303		36,274		65,941		88
Short-term investments	254,309		254,309		250,206		4,103		—
Other investments	30,245		30,245		—		30,245		—
Totals	$	6,555,415	$	6,555,415	$	319,002	$	5,908,671	$	327,742
Separate Account (variable annuity) assets (1)	$	2,488,528	$	2,488,528	$	2,488,528	$	—	$	—
Financial Liabilities
Investment contract and policy reserves, embedded derivatives	$	1,703	$	1,703	$	—	$	1,703	$	—
Other policyholder funds, embedded derivatives	$	98,070	$	98,070	$	—	$	—	$	98,070

December 31, 2019
Financial Assets
Investments
Fixed maturity securities
U.S. Government and federally sponsored agency obligations:
Mortgage-backed securities	$	724,319	$	724,319	$	—	$	711,004	$	13,315
Other, including U.S. Treasury securities	458,868		458,868		17,699		441,169		—
Municipal bonds	1,686,203		1,686,203		—		1,641,912		44,291
Foreign government bonds	45,370		45,370		—		45,370		—
Corporate bonds	1,581,424		1,581,424		14,470		1,463,002		103,952
Other asset-backed securities	1,295,492		1,295,492		—		1,161,979		133,513
Total fixed maturity securities	5,791,676		5,791,676		32,169		5,464,436		295,071
Equity securities	101,864		101,864		49,834		51,923		107
Short-term investments	172,667		172,667		172,667		—		—
Other investments	25,997		25,997		—		25,997		—
Totals	$	6,092,204	$	6,092,204	$	254,670	$	5,542,356	$	295,178
Separate Account (variable annuity) assets (1)	$	2,490,469	$	2,490,469	$	2,490,469	$	—	$	—
Financial Liabilities
Investment contract and policy reserves, embedded derivatives	$	1,314	$	1,314	$	—	$	1,314	$	—
Other policyholder funds, embedded derivatives	$	93,733	$	93,733	$	—	$	—	$	93,733

(1) Separate Account (variable annuity) liabilities are equal to the estimated fair value of the Separate Account (variable annuity) assets.

Changes in Level 3 Fair Value Measurements

The reconciliation for all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) was as follows:


($ in thousands)	Financial Assets												Financial Liabilities (1)
	Municipal Bonds		Corporate Bonds		Other Mortgage- Backed Securities(2)		Total Fixed Maturity Securities		Equity Securities		Total
Beginning balance, July 1, 2020	$	73,171	$	126,292	$	200,146	$	399,609	$	115	$	399,724	$	93,619
Transfers into Level 3 (3)	6,209		6,798		8,663		21,670		—		21,670		—
Transfers out of Level 3 (3)	(16,708)		(12,511)		(70,950)		(100,169)		—		(100,169)		—
Total gains or losses
Net investment gains (losses) included in net income related to financial assets	—		—		(238)		(238)		(27)		(265)		—
Net investment (gains) losses included in net income related to financial liabilities	—		—		—		—		—		—		4,406
Net unrealized investment gains (losses) included in OCI	3,150		551		6,321		10,022		—		10,022		—
Purchases	—		—		—		—		—		—		—
Issuances	—		—		—		—		—		—		1,951
Sales	—		—		—		—		—		—		—
Settlements	—		—		—		—		—		—		—
Paydowns, maturities and distributions	(151)		55		(3,144)		(3,240)		—		(3,240)		(1,906)
Ending balance, September 30, 2020	$	65,671	$	121,185	$	140,798	$	327,654	$	88	$	327,742	$	98,070

Beginning balance, January 1, 2020	$	44,291	$	103,952	$	146,828	$	295,071	$	107	$	295,178	$	93,733
Transfers into Level 3 (3)	80,686		39,601		95,377		215,664		—		215,664		—
Transfers out of Level 3 (3)	(62,625)		(26,699)		(77,335)		(166,659)		—		(166,659)		—
Total gains or losses
Net investment gains (losses) included in net income related to financial assets	—		—		(238)		(238)		(19)		(257)		—
Net investment (gains) losses included in net income related to financial liabilities	—		—		—		—		—		—		5,330
Net unrealized investment gains (losses) included in OCI	3,962		378		(14,780)		(10,440)		—		(10,440)		—
Purchases	—		6,875		1,890		8,765		—		8,765		—
Issuances	—		—		—		—		—		—		5,818
Sales	—		—		—		—		—		—		—
Settlements	—		—		—		—		—		—		—
Paydowns, maturities and distributions	(643)		(2,922)		(10,944)		(14,509)		—		(14,509)		(6,811)
Ending balance, September 30, 2020	$	65,671	$	121,185	$	140,798	$	327,654	$	88	$	327,742	$	98,070

(1)Represents embedded derivatives, all related to the Company's fixed indexed annuity products, reported in Other policyholder funds in the Company's Consolidated Balance Sheets.

(2)Includes U.S. Government and federally sponsored agency obligations for mortgage-backed securities and other mortgage-backed securities.

(3)Transfers into and out of Level 3 during the three and nine months ended September 30, 2020 were attributable to changes in the availability of observable market information for individual fixed maturity securities. The Company's policy is to recognize transfers into and out of the levels as having occurred at the end of the reporting period in which the transfers were determined.


($ in thousands)	Financial Assets												Financial Liabilities (1)
	Municipal Bonds		Corporate Bonds		Other Mortgage- Backed Securities (2)		Total Fixed Maturity Securities		Equity Securities		Total
Beginning balance, July 1, 2019	$	46,984	$	79,222	$	128,438	$	254,644	$	69	$	254,713	$	85,961
Transfers into Level 3 (3)	—		18,916		21,004		39,920		1		39,921		—
Transfers out of Level 3 (3)	—		(2,822)		(449)		(3,271)		—		(3,271)		—
Total gains or losses
Net investment gains (losses) included in net income related to financial assets	—		—		—		—		46		46		—
Net investment (gains) losses included in net income related to financial liabilities	—		—		—		—		—		—		3,661
Net unrealized investment gains (losses) included in OCI	842		1,744		397		2,983		—		2,983		—
Purchases	—		—		—		—		—		—		—
Issuances	—		—		—		—		—		—		2,033
Sales	—		—		—		—		—		—		—
Settlements	—		—		—		—		—		—		—
Paydowns, maturities and distributions	(121)		(387)		(2,685)		(3,193)		—		(3,193)		(2,557)
Ending balance, September 30, 2019	$	47,705	$	96,673	$	146,705	$	291,083	$	116	$	291,199	$	89,098

Beginning balance, January 1, 2019	$	47,531	$	80,742	$	120,211	$	248,484	$	5	$	248,489	$	78,700
Transfers into Level 3 (3)	—		24,798		42,938		67,736		65		67,801		—
Transfers out of Level 3 (3)	—		(7,698)		(449)		(8,147)		—		(8,147)		—
Total gains or losses
Net investment gains (losses) included in net income related to financial assets	—		—		—		—		46		46		—
Net investment (gains) losses included in net income related to financial liabilities	—		—		—		—		—		—		8,366
Net unrealized investment gains (losses) included in OCI	649		6,254		3,052		9,955		—		9,955		—
Purchases	—		1,566		—		1,566		—		1,566		—
Issuances	—		—		—		—		—		—		7,482
Sales	—		—		(607)		(607)		—		(607)		—
Settlements	—		—		—		—		—		—		—
Paydowns, maturities and distributions	(475)		(8,989)		(18,440)		(27,904)		—		(27,904)		(5,450)
Ending balance, September 30, 2019	$	47,705	$	96,673	$	146,705	$	291,083	$	116	$	291,199	$	89,098

(1) Represents embedded derivatives, all related to the Company's fixed indexed annuity products, reported in Other policyholder funds in the Company's Consolidated Balance Sheets.

(2) Includes U.S. Government and federally sponsored agency obligations for mortgage-backed securities and other mortgage-backed securities.

(3) Transfers into and out of Level 3 during the three and nine months ended September 30, 2019 were attributable to changes in the availability of observable market information for individual fixed maturity securities. The Company's policy is to recognize transfers into and out of the levels as having occurred at the end of the reporting period in which the transfers were determined.

For the nine months ended September 30, 2020 and September 30, 2019, the Company had $0.3 million and no net investment losses on Level 3 financial assets, respectively. For the three and nine months ended September 30, 2020, net investment losses of $4.4 million and $5.3 million were included in net income that were attributable to changes in the fair value of Level 3 financial liabilities; for the three and nine months ended September 30, 2019, the respective net investment losses were $3.7 million and $8.4 million.

Quantitative Information about Level 3 Fair Value Measurements

The following table provides quantitative information about the significant unobservable inputs for recurring fair value measurements categorized within Level 3.

($ in thousands)

Financial
Assets

Fair Value at
September 30, 2020

Valuation Technique(s)

Unobservable Inputs

Range

(Weighted Average)

and Single Point Best Estimate (1)

Municipal bonds

65,671

discounted cash flow

I spread (2)

578 bps

Corporate bonds

121,185

discounted cash flow

N spread (3)

320 - 818 bps

market comparable

option adjusted spread

12.54%

Other asset-backed securities

128,599

vendor price

haircut

3.00% - 5.00%

discounted cash flow

constant prepayment rate

20.00%

discounted cash flow

T spread (4)

235 - 800 bps

discounted cash flow

PDI interest margin (5)

7.13%

discounted cash flow

SBL interest margin (6)

4.50%

Government mortgage-backed securities

12,199

vendor price

haircut

3.00% - 5.00%

Equity securities

Black Scholes

equity value

low - $43.27; high - $44.53

($ in thousands)

Financial
Liabilities

Fair Value at
September 30, 2020

Valuation Technique(s)

Unobservable Inputs

Range

(Weighted Average)

and Single Point Best Estimate (1)

Derivatives
embedded in
fixed indexed annuity products

98,070

discounted cash flow

lapse rate

5.25%

mortality multiplier (7)

61.00%

option budget

1.00% - 2.50%

non-performance adjustment (8)

5.00%

(1) When a range of unobservable inputs is not readily available, the Company uses a single point best estimate.

(2) "I spread" is the interpolated weighted average life point on the "on the run" (OTR) point of the curve.

(3) "N spread" is the interpolated weighted average life point on the swap curve.

(4) "T spread" is a specific point on the OTR curve.

(5) "PDI" stands for private debt investment.

(6) "SBL" stands for broadly syndicated loans.

(7) Mortality multiplier is applied to the Annuity 2000 table.

(8) Determined as a percentage of a risk-free rate.

The valuation techniques and significant unobservable inputs used in the fair value measurement for financial assets and liabilities classified as Level 3 are subject to the control processes as described in Part II - Item 8, Note 4 in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019. Generally, valuation techniques for fixed maturity securities include spread pricing, matrix pricing and discounted cash flow methodologies; include inputs such as quoted prices for identical or similar securities that are less liquid; and are based on lower levels of trading activity than securities classified as Level 2. The valuation techniques and significant unobservable inputs used in the fair value measurement for equity securities classified as Level 3 use similar valuation techniques and significant unobservable inputs as those used for fixed maturity securities.

The sensitivity of the estimated fair values to changes in the significant unobservable inputs for fixed maturity and equity securities included in Level 3 include: benchmark yield, liquidity premium, estimated cash flows, prepayment and default speeds, spreads, weighted average life, and credit rating. Significant spread widening in isolation will adversely impact the overall valuation, while significant tightening will lead to substantial valuation increases. Significant increases (decreases) in illiquidity premiums in isolation will result in substantially lower (higher) valuations. Significant increases (decreases) in expected default rates in isolation will result in substantially lower (higher) valuations.

Financial Instruments Not Carried at Fair Value; Disclosure Required

The Company has various other financial assets and financial liabilities used in the normal course of business that are not carried at fair value, but for which fair value disclosure is required. These financial assets and financial liabilities are further described in Part II - Item 8, Note 4 in the Company's Annual Report on Form 10-K for the year ended December 31, 2019. The following table presents the carrying value, fair value and fair value hierarchy of these financial assets and financial liabilities.


($ in thousands)					Fair Value Measurements at
	Carrying		Fair		Reporting Date Using
	Amount		Value		Level 1		Level 2		Level 3
September 30, 2020
Financial Assets
Investments
Other investments	$	168,500	$	172,303	$	—	$	—	$	172,303
Deposit asset on reinsurance	2,402,539		2,925,672		—		—		2,925,672
Financial Liabilities
Investment contract and policy reserves, fixed annuity contracts	4,812,911		4,720,941		—		—		4,720,941
Investment contract and policy reserves, account values on life contracts	97,522		102,290		—		—		102,290
Other policyholder funds	646,424		646,424		—		590,687		55,737
Short-term debt	135,000		135,000		—		—		135,000
Long-term debt	302,247		331,829		—		331,829		—

December 31, 2019
Financial Assets
Investments
Other investments	$	163,312	$	167,185	$	—	$	—	$	167,185
Deposit asset on reinsurance	2,346,166		2,634,012		—		—		2,634,012
Financial Liabilities
Investment contract and policy reserves, fixed annuity contracts	4,675,774		4,609,880		—		—		4,609,880
Investment contract and policy reserves, account values on life contracts	93,465		98,332		—		—		98,332
Other policyholder funds	553,550		553,550		—		495,812		57,738
Short-term debt	135,000		135,000		—		—		135,000
Long-term debt	298,025		322,678		—		322,678		—

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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