10-Q 1 a10-6189_110q.htm 10-Q

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 
Washington, D.C. 20549
 

FORM 10-Q

 

/X/  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2010

 

OR

 

[ ]  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 1-11840

 

THE ALLSTATE CORPORATION

(Exact name of registrant as specified in its charter)

 

Delaware

 

36-3871531

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

2775 Sanders Road, Northbrook, Illinois  60062

             (Address of principal executive offices)           (Zip Code)

 

(847) 402-5000

(Registrant’s telephone number, including area code)

 

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      

 

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      

 

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

 

Large accelerated filer   X  

 

Accelerated filer                          

 

 

 

Non-accelerated filer            (Do not check if a smaller reporting company)

 

Smaller reporting company         

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes      

 

No   X  

 

As of April 23, 2010, the registrant had 537,903,261 common shares, $.01 par value, outstanding.

 



 

THE ALLSTATE CORPORATION

INDEX TO QUARTERLY REPORT ON FORM 10-Q

March 31, 2010

 

PART I

FINANCIAL INFORMATION

PAGE

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

Condensed Consolidated Statements of Operations for the Three-Month Periods Ended March 31, 2010 and 2009 (unaudited)

1

 

 

 

 

Condensed Consolidated Statements of Financial Position as of March 31, 2010 (unaudited) and December 31, 2009

2

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the Three-Month Periods Ended March 31, 2010 and 2009 (unaudited)

3

 

 

 

 

Notes to Condensed Consolidated Financial Statements (unaudited)

4

 

 

 

 

Report of Independent Registered Public Accounting Firm

43

 

 

 

Item 2.

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

 

 

 

 

 

Highlights

44

 

Consolidated Net Income (Loss)

45

 

Property-Liability Highlights

46

 

Allstate Protection Segment

49

 

Discontinued Lines and Coverages Segment

57

 

Property-Liability Investment Results

57

 

Allstate Financial Highlights

58

 

Allstate Financial Segment

58

 

Investments Highlights

64

 

Investments

65

 

Capital Resources and Liquidity Highlights

85

 

Capital Resources and Liquidity

85

 

 

 

Item 4.

Controls and Procedures

89

 

 

 

PART II

OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

90

 

 

 

Item 1A.

Risk Factors

90

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

90

 

 

 

Item 6.

Exhibits

91

 



 

PART I. FINANCIAL INFORMATION

ITEM 1.   FINANCIAL STATEMENTS

THE ALLSTATE CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

($ in millions, except per share data)

 

Three Months Ended
March 31,

 

 

 

2010

 

 

2009

 

 

 

(unaudited)

 

Revenues

 

 

 

 

 

 

Property-liability insurance premiums

$

6,503

 

$

6,582

 

Life and annuity premiums and contract charges

 

544

 

 

484

 

Net investment income

 

1,050

 

 

1,176

 

Realized capital gains and losses:

 

 

 

 

 

 

Total other-than-temporary impairment losses

 

(250

)

 

(725

)

Portion of loss recognized in other comprehensive income

 

(5

)

 

--

 

Net other-than-temporary impairment loss recognized in earnings

 

(255

)

 

(725

)

Sales and other realized capital gains and losses

 

(93

)

 

366

 

Total realized capital gains and losses

 

(348

)

 

(359

)

 

 

7,749

 

 

7,883

 

 

 

 

 

 

 

 

Costs and expenses

 

 

 

 

 

 

Property-liability insurance claims and claims expense

 

4,792

 

 

4,720

 

Life and annuity contract benefits

 

442

 

 

387

 

Interest credited to contractholder funds

 

463

 

 

579

 

Amortization of deferred policy acquisition costs

 

1,014

 

 

1,397

 

Operating costs and expenses

 

829

 

 

801

 

Restructuring and related charges

 

11

 

 

45

 

Interest expense

 

92

 

 

88

 

 

 

7,643

 

 

8,017

 

 

 

 

 

 

 

 

Gain on disposition of operations

 

1

 

 

3

 

 

 

 

 

 

 

 

Income (loss) from operations before income tax (benefit) expense

 

107

 

 

(131

)

 

 

 

 

 

 

 

Income tax (benefit) expense

 

(13

)

 

143

 

 

 

 

 

 

 

 

Net income (loss)

$

120

 

$

(274

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss) per share - Basic

$

0.22

 

$

(0.51

)

 

 

 

 

 

 

 

Weighted average shares - Basic

 

540.5

 

 

538.9

 

 

 

 

 

 

 

 

Net income (loss) per share - Diluted

$

0.22

 

$

(0.51

)

 

 

 

 

 

 

 

Weighted average shares - Diluted

 

541.8

 

 

538.9

 

 

 

 

 

 

 

 

Cash dividends declared per share

$

0.20

 

$

0.20

 

 

See notes to condensed consolidated financial statements.

 

1



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL POSITION

 

($ in millions, except par value data)

 

March 31,
2010

 

December 31,
2009

Assets

 

(unaudited)

 

 

 

Investments

 

 

 

 

 

 

Fixed income securities, at fair value (amortized cost $82,486 and $81,243)

$

81,284

 

$

78,766

 

Equity securities, at fair value (cost $3,436 and $4,845)

 

3,807

 

 

5,024

 

Mortgage loans

 

7,639

 

 

7,935

 

Limited partnership interests

 

2,802

 

 

2,744

 

Short-term, at fair value (amortized cost $2,482 and $3,056)

 

2,482

 

 

3,056

 

Other

 

2,209

 

 

2,308

 

Total investments

 

100,223

 

 

99,833

 

Cash

 

704

 

 

612

 

Premium installment receivables, net

 

4,823

 

 

4,839

 

Deferred policy acquisition costs

 

5,186

 

 

5,470

 

Reinsurance recoverables, net

 

6,415

 

 

6,355

 

Accrued investment income

 

904

 

 

864

 

Deferred income taxes

 

1,440

 

 

1,870

 

Property and equipment, net

 

954

 

 

990

 

Goodwill

 

874

 

 

875

 

Other assets

 

1,804

 

 

1,872

 

Separate Accounts

 

9,059

 

 

9,072

 

Total assets

$

132,386

 

$

132,652

 

Liabilities

 

 

 

 

 

 

Reserve for property-liability insurance claims and claims expense

$

19,420

 

$

19,167

 

Reserve for life-contingent contract benefits

 

13,052

 

 

12,910

 

Contractholder funds

 

51,027

 

 

52,582

 

Unearned premiums

 

9,575

 

 

9,822

 

Claim payments outstanding

 

763

 

 

742

 

Other liabilities and accrued expenses

 

5,992

 

 

5,726

 

Long-term debt

 

5,910

 

 

5,910

 

Separate Accounts

 

9,059

 

 

9,072

 

Total liabilities

 

114,798

 

 

115,931

 

 

 

 

 

 

 

 

Commitments and Contingent Liabilities (Note 10)

 

 

 

 

 

 

Equity

 

 

 

 

 

 

Preferred stock, $1 par value, 25 million shares authorized, none issued

 

--

 

 

--

 

Common stock, $.01 par value, 2.0 billion shares authorized and 900 million issued, 538 million and 537 million shares outstanding

 

9

 

 

9

 

Additional capital paid-in

 

3,152

 

 

3,172

 

Retained income

 

31,514

 

 

31,492

 

Deferred ESOP expense

 

(44

)

 

(47

)

Treasury stock, at cost (362 million and 363 million shares)

 

(15,782

)

 

(15,828

)

Accumulated other comprehensive income:

 

 

 

 

 

 

Unrealized net capital gains and losses:

 

 

 

 

 

 

Unrealized net capital losses on fixed income securities with OTTI

 

(384

)

 

(441

)

Other unrealized net capital gains and losses

 

(172

)

 

(1,072

)

Unrealized adjustment to DAC, DSI and insurance reserves

 

472

 

 

643

 

Total unrealized net capital gains and losses

 

(84

)

 

(870

)

Unrealized foreign currency translation adjustments

 

60

 

 

46

 

Unrecognized pension and other postretirement benefit cost

 

(1,265

)

 

(1,282

)

Total accumulated other comprehensive loss

 

(1,289

)

 

(2,106

)

Total shareholders’ equity

 

17,560

 

 

16,692

 

Noncontrolling interest

 

28

 

 

29

 

Total equity

 

17,588

 

 

16,721

 

Total liabilities and equity

$

132,386

 

$

132,652

 

 

See notes to condensed consolidated financial statements.

 

2



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

($ in millions)

 

Three Months Ended
March 31,

 

 

2010

 

2009

Cash flows from operating activities

 

(unaudited)

 

Net income (loss)

$

120

 

$

(274

)

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

 

 

 

 

 

 

Depreciation, amortization and other non-cash items

 

16

 

 

(74

)

Realized capital gains and losses

 

348

 

 

359

 

Gain on disposition of operations

 

(1

)

 

(3

)

Interest credited to contractholder funds

 

463

 

 

579

 

Changes in:

 

 

 

 

 

 

Policy benefits and other insurance reserves

 

188

 

 

(244

)

Unearned premiums

 

(261

)

 

(330

)

Deferred policy acquisition costs

 

30

 

 

381

 

Premium installment receivables, net

 

24

 

 

71

 

Reinsurance recoverables, net

 

(72

)

 

(81

)

Income taxes

 

73

 

 

1,443

 

Other operating assets and liabilities

 

36

 

 

(305

)

Net cash provided by operating activities

 

964

 

 

1,522

 

Cash flows from investing activities

 

 

 

 

 

 

Proceeds from sales

 

 

 

 

 

 

Fixed income securities

 

4,930

 

 

4,483

 

Equity securities

 

1,990

 

 

1,872

 

Limited partnership interests

 

146

 

 

154

 

Mortgage loans

 

3

 

 

12

 

Other investments

 

37

 

 

16

 

Investment collections

 

 

 

 

 

 

Fixed income securities

 

1,122

 

 

1,203

 

Mortgage loans

 

263

 

 

472

 

Other investments

 

18

 

 

31

 

Investment purchases

 

 

 

 

 

 

Fixed income securities

 

(7,099

)

 

(5,425

)

Equity securities

 

(556

)

 

(1,933

)

Limited partnership interests

 

(185

)

 

(144

)

Mortgage loans

 

(1

)

 

(10

)

Other investments

 

(43

)

 

--

 

Change in short-term investments, net

 

411

 

 

707

 

Change in other investments, net

 

(49

)

 

(48

)

Disposition of operations

 

--

 

 

12

 

Purchases of property and equipment, net

 

(24

)

 

(53

)

Net cash provided by investing activities

 

963

 

 

1,349

 

Cash flows from financing activities

 

 

 

 

 

 

Contractholder fund deposits

 

828

 

 

1,298

 

Contractholder fund withdrawals

 

(2,569

)

 

(3,577

)

Dividends paid

 

(107

)

 

(220

)

Treasury stock purchases

 

(5

)

 

(3

)

Shares reissued under equity incentive plans, net

 

14

 

 

--

 

Excess tax benefits on share-based payment arrangements

 

(2

)

 

(6

)

Other

 

6

 

 

59

 

Net cash used in financing activities

 

(1,835

)

 

(2,449

)

Net increase in cash

 

92

 

 

422

 

Cash at beginning of period

 

612

 

 

415

 

Cash at end of period

$

704

 

$

837

 

 

See notes to condensed consolidated financial statements.

 

3



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1.  General

 

Basis of presentation

 

The accompanying condensed consolidated financial statements include the accounts of The Allstate Corporation and its wholly owned subsidiaries, primarily Allstate Insurance Company (“AIC”), a property-liability insurance company with various property-liability and life and investment subsidiaries, including Allstate Life Insurance Company (“ALIC”) (collectively referred to as the “Company” or “Allstate”).

 

The condensed consolidated financial statements and notes as of March 31, 2010, and for the three-month periods ended March 31, 2010 and 2009 are unaudited.  The condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring accruals), which are, in the opinion of management, necessary for the fair presentation of the financial position, results of operations and cash flows for the interim periods.  These condensed consolidated financial statements and notes should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.  The results of operations for the interim periods should not be considered indicative of results to be expected for the full year.

 

Adopted accounting standards

 

Disclosures about Fair Value Measurements

 

In January 2010, the FASB issued new accounting guidance which expands disclosure requirements relating to fair value measurements.  The guidance adds requirements for disclosing amounts of and reasons for significant transfers into and out of Levels 1 and 2 and requires gross rather than net disclosures about purchases, sales, issuances and settlements relating to Level 3 measurements.  The guidance also provides clarification that fair value measurement disclosures are required for each class of assets and liabilities.  Disclosures about the valuation techniques and inputs used to measure fair value for measurements that fall in either Level 2 or Level 3 are also required.  The Company adopted the provisions of the new guidance as of March 31, 2010, except for disclosures about purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measurements, which are required for fiscal years beginning after December 15, 2010.  Disclosures are not required for earlier periods presented for comparative purposes.  The new guidance affects disclosures only; and therefore, the adoption had no impact on the Company’s results of operations or financial position.

 

Consolidation of Variable Interest Entities

 

In June 2009, the FASB issued new accounting guidance which requires an entity to perform a qualitative analysis to determine whether it holds a controlling financial interest (i.e., is a primary beneficiary) in a variable interest entity (“VIE”).  The analysis identifies the primary beneficiary of a VIE as the entity that has both the power to direct the activities of the VIE that most significantly impact the economic performance of the VIE and the obligation to absorb losses, or the right to receive benefits, that could potentially be significant to the VIE.  The Company adopted the new guidance as of January 1, 2010.  The adoption resulted in the consolidation of four VIEs for which the Company concluded it is the primary beneficiary as of January 1, 2010.

 

Two of the consolidated VIEs hold investments managed by Allstate Investment Management Company (“AIMCO”), a subsidiary of the Company.  Consolidation as of January 1, 2010 resulted in an increase in total assets of $696 million, an increase in total liabilities of $679 million, an increase in retained income of $7 million and an increase in noncontrolling interest of $10 million.  During the first quarter of 2010, the Company sold substantially all its variable interests in these two VIEs.  As a result, the Company deconsolidated the VIEs as of March 26, 2010.  Since the deconsolidation was effective prior to March 31, 2010, the Condensed Consolidated Statement of Financial Position as of March 31, 2010 does not reflect the assets, liabilities and noncontrolling interests in the VIEs.  The Condensed Consolidated Statement of Operations for the first quarter of 2010 does, however, reflect the effects of the consolidation for the portion of the quarter the Company was the primary beneficiary, which were not material.

 

The adoption also resulted in the consolidation of two insurance company affiliates, Allstate Texas Lloyds and Allstate County Mutual Insurance Company, that underwrite homeowners and auto insurance polices, respectively, and reinsure all of their net business to AIC.  Consolidation as of January 1, 2010 resulted in an increase in total assets of $38 million, an increase in total liabilities of $34 million, an increase in retained income of $3 million and an increase in unrealized net capital gains and losses of $1 million.

 

4



 

In the normal course of investing activities, the Company invests in variable interests issued by VIEs. These variable interests include structured investments such as asset-backed securities, commercial mortgage-backed securities and residential mortgage-backed securities as well as limited partnerships, special purpose entities and trusts.  For these variable interests, the Company concluded it is not the primary beneficiary due to the amount of the Company’s interest in the VIEs and the Company’s lack of power to direct the activities that are most significant to the economic performance of the VIEs.  The Company’s maximum exposure to loss on these interests is limited to the amount of the Company’s investment.

 

Pending accounting standards

 

Embedded Credit Derivatives Scope Exception

 

In March 2010, the FASB issued accounting guidance that clarifies the scope exception for embedded credit derivative features related to the transfer of credit risk in the form of subordination of one financial instrument to another. The guidance addresses how to determine which embedded credit derivative features, including those in collateralized debt obligations and synthetic collateralized debt obligations, are considered to be embedded derivatives that should not be analyzed for potential bifurcation and separate accounting under the existing accounting guidance for embedded derivatives.  The guidance is effective for fiscal quarters beginning after June 15, 2010.  The Company is evaluating the impact of adoption on the Company’s results of operations or financial position.

 

Consolidation Analysis Considering Investments Held through Separate Accounts

 

In April 2010, the FASB issued guidance clarifying that an insurer is not required to combine interests in investments held in a qualifying separate account with its interests in the same investments held in the general account when performing a consolidation evaluation.  The guidance is effective for fiscal years and interim periods beginning after December 15, 2010 with early adoption permitted.  The adoption of this guidance is not expected to have a material impact on the Company’s results of operations or financial position.

 

2.  Earnings per share

 

Basic earnings per share is computed based on the weighted average number of common shares outstanding, including unvested restricted stock units.  Diluted earnings per share is computed based on the weighted average number of common and dilutive potential common shares outstanding.  For Allstate, dilutive potential common shares consist of outstanding stock options.

 

The computation of basic and diluted earnings per share is presented in the following table.

 

($ in millions, except per share data)

 

Three months
ended March 31,

 

 

2010

 

2009

 

Numerator:

 

 

 

 

 

Net income (loss)

$

120

$

(274)

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

Weighted average common shares outstanding

 

540.5

 

538.9

 

Effect of dilutive potential common shares:

 

 

 

 

 

Stock options

 

1.3

 

--

 

Weighted average common and dilutive potential common shares outstanding

 

541.8

 

538.9

 

 

 

 

 

 

 

Earnings per share - Basic

$

0.22

$

(0.51)

 

Earnings per share - Diluted

$

0.22

$

(0.51)

 

 

The effect of dilutive potential common shares does not include the effect of options with an anti-dilutive effect on earnings per share because their exercise prices exceed the average market price of Allstate common shares during the period or for which the unrecognized compensation cost would have an anti-dilutive effect.  Options to

 

5



 

purchase 24.4 million and 27.3 million Allstate common shares, with exercise prices ranging from $27.36 to $64.53 and $23.72 to $65.38, were outstanding at March 31, 2010 and 2009, respectively, but were not included in the computation of diluted earnings per share for the three-month periods.

 

As a result of the net loss for the three-month period ended March 31, 2009, weighted average dilutive potential common shares outstanding resulting from stock options of 0.6 million were not included in the computation of diluted earnings per share since inclusion of these securities would have an anti-dilutive effect.  In the absence of the net loss, weighted average common and dilutive potential common shares outstanding would have totaled 539.5 million for the three-month period ended March 31, 2009.

 

3.  Supplemental Cash Flow Information

 

Non-cash investment exchanges, including modifications of certain mortgage loans, fixed income securities, and other investments, as well as mergers completed with equity securities and limited partnerships, totaled $51 million and $75 million for the three-month periods ended March 31, 2010 and 2009, respectively.

 

Liabilities for collateral received in conjunction with the Company’s securities lending and over-the-counter (“OTC”) derivatives are reported in other liabilities and accrued expenses or other investments in the Condensed Consolidated Statements of Financial Position.  The accompanying cash flows are included in cash flows from operating activities in the Condensed Consolidated Statements of Cash Flows along with the activities resulting from management of the proceeds, which are as follows:

 

($ in millions)

 

Three months
ended March 31,

 

 

2010

 

2009

 

Net change in proceeds managed

 

 

 

 

 

Net change in fixed income securities

$

--

$

--

 

Net change in short-term investments

 

171

 

67

 

Operating cash flow provided

 

171

 

67

 

Net change in cash

 

6

 

--

 

Net change in proceeds managed

$

177

$

67

 

 

 

 

 

 

 

Net change in liabilities

 

 

 

 

 

Liabilities for collateral and security repurchase, beginning of year

$

(658)

$

(340)

 

Liabilities for collateral and security repurchase, end of period

 

(481)

 

(273)

 

Operating cash flow used

$

(177)

$

(67)

 

 

6



 

4.  Investments

 

Fair values

 

The amortized cost, gross unrealized gains and losses and fair value for fixed income securities are as follows:

 

($ in millions)

 

Amortized

 

Gross unrealized

 

Fair

 

 

cost

 

Gains

 

Losses

 

value

At March 31, 2010

 

 

 

 

 

 

 

 

 

U.S. government and agencies

$

8,204

$

238

$

(20)

$

8,422

 

Municipal

 

20,404

 

517

 

(773)

 

20,148

 

Corporate

 

33,585

 

1,413

 

(499)

 

34,499

 

Foreign government

 

3,008

 

315

 

(9)

 

3,314

 

Residential mortgage-backed securities (“RMBS”)

 

10,343

 

173

 

(1,404)

 

9,112

 

Commercial mortgage-backed securities (“CMBS”)

 

3,220

 

44

 

(812)

 

2,452

 

Asset-backed securities (“ABS”)

 

3,684

 

80

 

(467)

 

3,297

 

Redeemable preferred stock

 

38

 

2

 

--

 

40

 

Total fixed income securities

$

82,486

$

2,782

$

(3,984)

$

81,284

 

At December 31, 2009

 

 

 

 

 

 

 

 

 

U.S. government and agencies

$

7,333

$

219

$

(16)

$

7,536

 

Municipal

 

21,683

 

537

 

(940)

 

21,280

 

Corporate

 

32,770

 

1,192

 

(847)

 

33,115

 

Foreign government

 

2,906

 

306

 

(15)

 

3,197

 

RMBS

 

9,487

 

130

 

(1,630)

 

7,987

 

CMBS

 

3,511

 

30

 

(955)

 

2,586

 

ABS

 

3,514

 

62

 

(550)

 

3,026

 

Redeemable preferred stock

 

39

 

1

 

(1)

 

39

 

Total fixed income securities

$

81,243

$

2,477

$

(4,954)

$

78,766

 

 

Scheduled maturities

 

The scheduled maturities for fixed income securities are as follows at March 31, 2010:

 

($ in millions)

 

Amortized

 

Fair

 

 

cost

 

value

Due in one year or less

$

2,731

$

2,767

Due after one year through five years

 

24,024

 

24,731

Due after five years through ten years

 

15,082

 

15,757

Due after ten years

 

26,622

 

25,620

 

 

68,459

 

68,875

RMBS and ABS

 

14,027

 

12,409

Total

$

82,486

$

81,284

 

Actual maturities may differ from those scheduled as a result of prepayments by the issuers.  Because of the potential for prepayment on RMBS and ABS, they are not categorized by contractual maturity.  The CMBS are categorized by contractual maturity because they generally are not subject to prepayment risk.

 

7



 

Net investment income

 

Net investment income is as follows:

 

($ in millions)

 

Three months ended
March 31,

 

 

2010

 

2009

Fixed income securities

$

959

$

1,042

Equity securities

 

21

 

16

Mortgage loans

 

104

 

137

Limited partnership interests

 

6

 

3

Short-term investments

 

2

 

13

Other

 

1

 

1

Investment income, before expense

 

1,093

 

1,212

Investment expense

 

(43)

 

(36)

Net investment income

$

1,050

$

1,176

 

Realized capital gains and losses

 

Realized capital gains and losses by security type are as follows:

 

($ in millions)

 

Three months ended
March 31,

 

 

2010

 

2009

Fixed income securities

$

(136)

$

107

Equity securities

 

14

 

(163)

Mortgage loans

 

(25)

 

(32)

Limited partnership interests

 

(21)

 

(339)

Derivatives

 

(185)

 

95

Other

 

5

 

(27)

Realized capital gains and losses

$

(348)

$

(359)

 

Realized capital gains and losses by transaction type are as follows:

 

($ in millions)

 

Three months ended
March 31,

 

 

2010

 

2009

Impairment write-downs

$

(223)

$

(620)

Change in intent write-downs

 

(32)

 

(105)

Net OTTI losses recognized in earnings

 

(255)

 

(725)

Sales

 

88

 

418

Valuation of derivative instruments

 

(155)

 

103

Settlements of derivative instruments

 

(30)

 

(12)

EMA limited partnership income

 

4

 

(143)

Realized capital gains and losses

$

(348)

$

(359)

 

Gross gains of $142 million and $480 million and gross losses of $74 million and $82 million were realized on sales of fixed income securities during the three months ended March 31, 2010 and 2009, respectively.

 

8



 

Other-than-temporary impairment losses by asset type for the three months ended March 31, 2010 are as follows:

 

($ in millions)

 

Total

 

Included
in OCI

 

Net

Fixed income securities:

 

 

 

 

 

 

Municipal

$

(37)

$

--

$

(37)

Corporate

 

(47)

 

3

 

(44)

RMBS

 

(88)

 

(7)

 

(95)

CMBS

 

(26)

 

--

 

(26)

ABS

 

(3)

 

(1)

 

(4)

Total fixed income securities

 

(201)

 

(5)

 

(206)

Equity securities

 

(6)

 

--

 

(6)

Mortgage loans

 

(19)

 

--

 

(19)

Limited partnership interests

 

(24)

 

--

 

(24)

Other-than-temporary impairment losses

$

(250)

$

(5)

$

(255)

 

The total amount of other-than-temporary impairment losses included in accumulated other comprehensive income for fixed income securities, which were not included in earnings, are presented in the following table.  The amount excludes $269 million and $192 million as of March 31, 2010 and December 31, 2009, respectively, of net unrealized gains related to changes in valuation of the fixed income securities subsequent to the impairment measurement date.

 

($ in millions)

 

March 31,
2010

 

December 31,
2009

Municipal

$

(9)

$

(10)

Corporate

 

(51)

 

(51)

RMBS

 

(590)

 

(594)

CMBS

 

(121)

 

(127)

ABS

 

(88)

 

(89)

Total

$

(859)

$

(871)

 

A rollforward of the amount recognized in earnings related to credit losses for fixed income securities is presented in the following table.

 

($ in millions)

 

 

Beginning balance at December 31, 2009

$

(1,187)

Additional credit loss for securities previously other-than-temporarily impaired

 

(101)

Additional credit loss for securities not previously other-than-temporarily impaired

 

(79)

Reduction in credit loss for securities disposed or collected

 

131

Reduction in credit loss for securities other-than-temporarily impaired to fair value

 

--

Change in credit loss due to accretion of increase in cash flows and time value of cash flows for securities previously other-than-temporarily impaired

 

--

Ending balance at March 31, 2010

$

(1,236)

 

The Company uses its best estimate of future cash flows expected to be collected from the fixed income security discounted at the security’s original or current effective rate, as appropriate, to calculate a recovery value and determine whether a credit loss exists.  The determination of cash flow estimates is inherently subjective and methodologies may vary depending on facts and circumstances specific to the security.  All reasonably available information relevant to the collectability of the security, including past events, current conditions, and reasonable and supportable assumptions and forecasts, are considered when developing the estimate of cash flows expected to be collected.  That information generally includes, but is not limited to, the remaining payment terms of the security, prepayment speeds, foreign exchange rates, the financial condition of the issue or issuer(s), expected defaults, expected recoveries, the value of underlying collateral and current subordination levels, vintage, geographic concentration, available reserves or escrows, third party guarantees and other credit enhancements.  Additionally, other information, such as industry analyst reports and forecasts, sector credit ratings, financial condition of the bond

 

9



 

insurer for insured fixed income securities, and other market data relevant to the realizability of contractual cash flows, may also be considered.  The estimated fair value of collateral may be used to estimate recovery value if the Company determines that the security is dependent on the liquidation of collateral for ultimate settlement.  If the estimated recovery value is less than the amortized cost of the security, a credit loss exists and an other-than-temporary impairment for the difference between the estimated recovery value and amortized cost is recorded in earnings.  The unrealized loss deemed to be related to factors other than credit remains classified in OCI.  If the Company determines that the fixed income security does not have sufficient cash flow or other information to determine a recovery value for the security, the Company may conclude that the entire decline in fair value is deemed to be credit related and is recorded in earnings.

 

Unrealized net capital gains and losses

 

Unrealized net capital gains and losses included in accumulated other comprehensive income are as follows:

 

($ in millions)

 

Fair

 

Gross unrealized

 

Unrealized net

 

At March 31, 2010

 

value

 

Gains

 

Losses

 

gains (losses)

 

Fixed income securities (1)

$

81,284

$

2,782

$

(3,984)

 

$

(1,202)

 

Equity securities

 

3,807

 

457

 

(86)

 

 

371

 

Short-term investments

 

2,482

 

--

 

--

 

 

--

 

Derivative instruments (2)

 

(14)

 

3

 

(21)

 

 

(18)

 

Unrealized net capital gains and losses, pre-tax

 

 

 

 

 

 

 

 

(849)

 

Amounts recognized for:

 

 

 

 

 

 

 

 

 

 

Insurance reserves (3)

 

 

 

 

 

 

 

 

--

 

DAC and DSI (4)

 

 

 

 

 

 

 

 

726

 

Amounts recognized

 

 

 

 

 

 

 

 

726

 

Deferred income taxes

 

 

 

 

 

 

 

 

39

 

Unrealized net capital gains and losses, after-tax

 

 

 

 

 

 

 

$

(84)

 

 


(1)        Unrealized net capital gains and losses for fixed income securities as of March 31, 2010 comprises $(590) million related to unrealized net capital losses on fixed income securities with OTTI and $(612) million related to other unrealized net capital gains and losses.

(2)        Included in the fair value of derivative securities are $2 million classified as assets and $16 million classified as liabilities.

(3)        The insurance reserves adjustment represents the amount by which the reserve balance would increase if the net unrealized gains in the applicable product portfolios were realized and reinvested at current lower interest rates, resulting in a premium deficiency.  Although the Company evaluates premium deficiencies on the combined performance of life insurance and immediate annuities with life contingencies, the adjustment primarily relates to structured settlement annuities with life contingencies, in addition to annuity buy-outs and certain payout annuities with life contingencies.

(4)        The DAC and DSI adjustment balance represents the amount by which the amortization of DAC and DSI would increase or decrease if the unrealized gains or losses in the respective product portfolios were realized.

 

 

 

Fair

 

Gross unrealized

 

Unrealized net

 

At December 31, 2009

 

value

 

Gains

 

Losses

 

gains (losses)

 

Fixed income securities

$

78,766

$

2,477

$

(4,954)

 

$

(2,477)

 

Equity securities

 

5,024

 

381

 

(202)

 

 

179

 

Short-term investments

 

3,056

 

--

 

--

 

 

--

 

Derivative instruments (1)

 

(20)

 

2

 

(25)

 

 

(23)

 

Unrealized net capital gains and losses, pre-tax

 

 

 

 

 

 

 

 

(2,321)

 

Amounts recognized for:

 

 

 

 

 

 

 

 

 

 

Insurance reserves

 

 

 

 

 

 

 

 

--

 

DAC and DSI

 

 

 

 

 

 

 

 

990

 

Amounts recognized

 

 

 

 

 

 

 

 

990

 

Deferred income taxes

 

 

 

 

 

 

 

 

461

 

Unrealized net capital gains and losses, after-tax

 

 

 

 

 

 

 

$

(870)

 

 


(1)        Included in the fair value of derivative securities are $(2) million classified as assets and $18 million classified as liabilities.

 

10



 

Change in unrealized net capital gains and losses

 

The change in unrealized net capital gains and losses for the three months ended March 31, 2010 is as follows:

 

($ in millions)

 

 

Fixed income securities

$

1,275

Equity securities

 

192

Short-term investments

 

--

Derivative instruments

 

5

Total

 

1,472

Amounts recognized for:

 

 

Insurance reserves

 

--

DAC and DSI

 

(264)

Decrease in amounts recognized

 

(264)

Deferred income taxes

 

(422)

Increase in unrealized net capital gains and losses

$

786

 

Portfolio monitoring

 

The Company has a comprehensive portfolio monitoring process to identify and evaluate each fixed income and equity security whose carrying value may be other-than-temporarily impaired.

 

For each fixed income security in an unrealized loss position, the Company assesses whether management with the appropriate authority has made a decision to sell or whether it is more likely than not the Company will be required to sell the security before recovery of the amortized cost basis for reasons such as liquidity, contractual or regulatory purposes.  If a security meets either of these criteria, the security’s decline in fair value is deemed other than temporary and is recorded in earnings.

 

If the Company has not made the decision to sell the fixed income security and it is not more likely than not the Company will be required to sell the fixed income security before recovery of its amortized cost basis, the Company evaluates if it expects to receive cash flows sufficient to recover the entire amortized cost basis of the security by comparing the estimated recovery value calculated by discounting the best estimate of future cash flows at the security’s original or current effective rate, as appropriate, with the amortized cost of the security.  If the Company does not expect to receive cash flows sufficient to recover the entire amortized cost basis of the fixed income security, the credit loss component of the impairment is recorded in earnings, with the remaining amount of the unrealized loss deemed to be related to other factors and recognized in OCI.

 

For equity securities, the Company considers various factors, including whether the Company has the intent and ability to hold the equity security for a period of time sufficient to recover its cost basis.  Where the Company lacks the intent and ability to hold to recovery, or believes the recovery period is extended, the equity security’s decline in fair value is considered other than temporary and is recorded in earnings.  For equity securities managed by a third party, the Company has contractually retained its decision making authority as it pertains to selling equity securities that are in an unrealized loss position.

 

The Company’s portfolio monitoring process includes a quarterly review of all securities through a screening process which identifies instances where the fair value compared to amortized cost for fixed income securities and cost for equity securities is below established thresholds, and also includes the monitoring of other criteria such as ratings, ratings downgrades or payment defaults.  The securities identified, in addition to other securities for which the Company may have a concern, are evaluated for potential other-than-temporary impairment using all reasonably available information relevant to the collectability or recovery of the security.  Inherent in the Company’s evaluation of other-than-temporary impairment for these fixed income and equity securities are assumptions and estimates about the financial condition of the issue or issuer and its future earnings potential.  Some of the factors considered in evaluating whether a decline in fair value is other than temporary are: 1) the length of time and extent to which the fair value has been less than amortized cost for fixed income securities, or cost for equity securities; 2) the financial condition, near-term and long-term prospects of the issue or issuer, including relevant industry specific market conditions and trends, geographic location and implications of rating agency actions and offering prices; and 3) the specific reasons that a security is in a significant unrealized loss position, including overall market conditions which could affect liquidity.

 

11



 

The following table summarizes the gross unrealized losses and fair value of fixed income and equity securities by the length of time that individual securities have been in a continuous unrealized loss position.

 

($ in millions)

 

Less than 12 months

 

12 months or more

 

Total

 

 

Number

 

Fair

 

Unrealized

 

Number

 

Fair

 

Unrealized

 

unrealized

 

 

of issues

 

value

 

losses

 

of issues

 

value

 

losses

 

losses

At March 31, 2010

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed income securities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government and agencies

 

46

$

1,486

$

(20)

 

1

$

2

$

--

$

(20)

Municipal

 

556

 

2,499

 

(61)

 

752

 

4,909

 

(712)

 

(773)

Corporate

 

327

 

4,169

 

(105)

 

322

 

4,136

 

(394)

 

(499)

Foreign government

 

58

 

524

 

(7)

 

3

 

10

 

(2)

 

(9)

RMBS

 

233

 

889

 

(10)

 

439

 

2,490

 

(1,394)

 

(1,404)

CMBS

 

7

 

97

 

(5)

 

221

 

1,487

 

(807)

 

(812)

ABS

 

42

 

440

 

(17)

 

157

 

1,369

 

(450)

 

(467)

Redeemable preferred stock

 

1

 

--

 

--

 

--

 

--

 

--

 

--

Total fixed income securities (1)

 

1,270

 

10,104

 

(225)

 

1,895

 

14,403

 

(3,759)

 

(3,984)

Equity securities

 

509

 

530

 

(44)

 

14

 

284

 

(42)

 

(86)

Total fixed income and equity securities

 

1,779

$

10,634

$

(269)

 

1,909

$

14,687

$

(3,801)

$

(4,070)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment grade fixed income securities

 

1,168

$

9,477

$

(187)

 

1,429

$

11,440

$

(2,156)

$

(2,343)

Below investment grade fixed income securities

 

102

 

627

 

(38)

 

466

 

2,963

 

(1,603)

 

(1,641)

Total fixed income securities

 

1,270

$

10,104

$

(225)

 

1,895

$

14,403

$

(3,759)

$

(3,984)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

At December 31, 2009

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed income securities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government and agencies

 

38

$

3,523

$

(16)

 

--

$

--

$

--

$

(16)

Municipal

 

761

 

3,646

 

(123)

 

747

 

5,024

 

(817)

 

(940)

Corporate

 

399

 

5,072

 

(178)

 

421

 

5,140

 

(669)

 

(847)

Foreign government

 

50

 

505

 

(15)

 

1

 

1

 

--

 

(15)

RMBS

 

387

 

1,092

 

(23)

 

453

 

2,611

 

(1,607)

 

(1,630)

CMBS

 

25

 

232

 

(4)

 

259

 

1,790

 

(951)

 

(955)

ABS

 

39

 

352

 

(20)

 

173

 

1,519

 

(530)

 

(550)

Redeemable preferred stock

 

1

 

--

 

--

 

1

 

21

 

(1)

 

(1)

Total fixed income securities

 

1,700

 

14,422

 

(379)

 

2,055

 

16,106

 

(4,575)

 

(4,954)

Equity securities

 

1,665

 

1,349

 

(113)

 

28

 

450

 

(89)

 

(202)

Total fixed income and equity securities

 

3,365

$

15,771

$

(492)

 

2,083

$

16,556

$

(4,664)

$

(5,156)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment grade fixed income securities

 

1,587

$

13,891

$

(293)

 

1,561

$

13,127

$

(2,848)

$

(3,141)

Below investment grade fixed income securities

 

113

 

531

 

(86)

 

494

 

2,979

 

(1,727)

 

(1,813)

Total fixed income securities

 

1,700

$

14,422

$

(379)

 

2,055

$

16,106

$

(4,575)

$

(4,954)

 


(1)    Gross unrealized losses resulting from factors other than credit on fixed income securities with other-than-temporary impairments for which the Company has recorded a credit loss in earnings total $8 million for the less than 12 month category and $688 million for the 12 months or greater category.

 

As of March 31, 2010, $1.18 billion of unrealized losses are related to securities with an unrealized loss position less than 20% of cost or amortized cost, the degree of which suggests that these securities do not pose a high risk of being other-than-temporarily impaired.  Of the $1.18 billion, $921 million are related to unrealized losses on investment grade fixed income securities.  Investment grade is defined as a security having a rating of Aaa, Aa, A or Baa from Moody’s, a rating of AAA, AA, A or BBB from S&P, Fitch, Dominion or Realpoint, a rating of aaa, aa, a or bbb from A.M. Best, or a comparable internal rating if an externally provided rating is not available, which is consistent with the National Association of Insurance Commissioners (“NAIC”) rating.  Unrealized losses on investment grade securities are principally related to rising interest rates or changes in credit spreads since the securities were acquired.

 

As of March 31, 2010, the remaining $2.89 billion of unrealized losses are related to securities in unrealized loss positions greater than or equal to 20% of cost or amortized cost.  Investment grade securities comprising $1.42 billion of these unrealized losses were evaluated based on factors such as discounted cash flows, the financial condition and near-term and long-term prospects of the issue or issuer and were determined to have adequate

 

12



 

resources to fulfill contractual obligations, such as recent financings or bank loans, cash flows from operations, collateral or the position of a subsidiary with respect to its parent’s bankruptcy.  Of the $2.89 billion, $1.45 billion are related to below investment grade fixed income securities and $17 million are related to equity securities.  Of these amounts, $1.38 billion of the below investment grade fixed income securities had been in an unrealized loss position for a period of twelve or more consecutive months as of March 31, 2010.  Unrealized losses on below investment grade securities are principally related to RMBS, ABS and CMBS and were the result of wider credit spreads than at initial purchase which was largely due to the impact of macroeconomic conditions and credit market deterioration on real estate valuations.  Securities in an unrealized loss position were evaluated based on discounted cash flows and credit ratings, as well as the performance of the underlying collateral relative to the securities’ positions in the securities’ respective capital structure.  RMBS and ABS in an unrealized loss position were evaluated with credit enhancements from bond insurers where applicable.  Municipal bonds in an unrealized loss position were evaluated based on the quality of the underlying security, as well as with credit enhancements from bond insurers, where applicable.  Unrealized losses on equity securities are primarily related to equity market fluctuations.

 

As of March 31, 2010, the Company has not made a decision to sell and it is not more likely than not the Company will be required to sell fixed income securities with unrealized losses before recovery of the amortized cost basis.  As of March 31, 2010, the Company had the intent and ability to hold the equity securities with unrealized losses for a period of time sufficient for them to recover.

 

Limited partnership impairment

 

As of March 31, 2010 and December 31, 2009, the carrying value of equity method limited partnership interests totaled $1.69 billion and $1.64 billion, respectively.  The Company recognizes an impairment loss in value for equity method investments when evidence demonstrates that it is other-than-temporarily impaired.  Evidence of a loss in value that is other than temporary may include the absence of an ability to recover the carrying amount of the investment or the inability of the investee to sustain an earnings potential that would justify the carrying amount of the investment.  The Company had no write-downs for the three months ended March 31, 2010 and had write-downs of $10 million for the three months ended March 31, 2009, related to equity method limited partnership interests.

 

As of March 31, 2010 and December 31, 2009, the carrying value for cost method limited partnership interests was $1.11 billion and $1.10 billion, respectively.  To determine if an other-than-temporary impairment has occurred, the Company evaluates whether an impairment indicator has occurred in the period that may have a significant adverse effect on the carrying value of the investment.  Impairment indicators may include: actual recent cash flows received being significantly less than expected cash flows; reduced valuations based on financing completed at a lower value; completed sale of a material underlying investment at a price significantly lower than expected; significantly reduced valuations of the investments held by limited partnerships; or any other adverse events since the last financial statements received that might affect the fair value of the investee’s capital.  Additionally, the Company uses a screening process to identify those investments whose net asset value is below established thresholds for certain periods of time as well as investments that are performing below expectations, for further impairment consideration.  If a cost method limited partnership is deemed other-than-temporarily impaired, the carrying value is written down to fair value, generally estimated to be equivalent to the reported net asset value of the underlying funds.  The Company had write-downs of $24 million and $187 million for the three months ended March 31, 2010 and 2009, respectively, related to cost method investments that were other-than-temporarily impaired.

 

5.  Fair Value of Assets and Liabilities

 

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  The hierarchy for inputs used in determining fair value maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that observable inputs be used when available.  Assets and liabilities recorded on the Condensed Consolidated Statements of Financial Position at fair value are categorized in the fair value hierarchy based on the observability of inputs to the valuation techniques as follows:

 

Level 1:       Assets and liabilities whose values are based on unadjusted quoted prices for identical assets or liabilities in an active market that the Company can access.

 

13



 

Level 2:     Assets and liabilities whose values are based on the following:

 

(a)  Quoted prices for similar assets or liabilities in active markets;

 

(b)  Quoted prices for identical or similar assets or liabilities in markets that are not active; or

 

(c)  Valuation models whose inputs are observable, directly or indirectly, for substantially the full term of the asset or liability.

 

Level 3:     Assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement.  Unobservable inputs reflect the Company’s estimates of the assumptions that market participants would use in valuing the assets and liabilities.

 

The availability of observable inputs varies by instrument.  In situations where fair value is based on internally developed pricing models or inputs that are unobservable in the market, the determination of fair value requires more judgment.  The degree of judgment exercised by the Company in determining fair value is typically greatest for instruments categorized in Level 3.  In many instances, valuation inputs used to measure fair value fall into different levels of the fair value hierarchy.  The category level in the fair value hierarchy is determined based on the lowest level input that is significant to the fair value measurement in its entirety.  The Company uses prices and inputs that are current as of the measurement date, including during periods of market disruption.  In periods of market disruption, the ability to observe prices and inputs may be reduced for many instruments.

 

The Company has two types of situations where investments are classified as Level 3 in the fair value hierarchy.  The first is where quotes continue to be received from independent third-party valuation service providers and all significant inputs are market observable; however, there has been a significant decrease in the volume and level of activity for the asset when compared to normal market activity such that the degree of market observability has declined to a point where categorization as a Level 3 measurement is considered appropriate.  Among the indicators considered in determining whether a significant decrease in the volume and level of activity for a specific asset has occurred include the level of new issuances in the primary market, trading volume in the secondary market, level of credit spreads over historical levels, bid-ask spread, and price consensus among market participants and sources.

 

The second situation where the Company has classified securities in Level 3 is where specific inputs significant to the fair value estimation models are not market observable.  This has occurred in two primary categories.  The first is for broker quotes.  The second is for ARS backed by student loans for which a key assumption, the anticipated date liquidity will return to this market, is not market observable.

 

Certain assets are not carried at fair value on a recurring basis, including investments such as mortgage loans, limited partnership interests, bank loans and policy loans.  Accordingly, such investments are only included in the fair value hierarchy disclosure when the investment is subject to remeasurement at fair value after initial recognition and the resulting remeasurement is reflected in the condensed consolidated financial statements.  In addition, equity options embedded in fixed income securities are not disclosed in the hierarchy with free-standing derivatives as the embedded derivatives are presented with the host contract in fixed income securities. As of March 31, 2010, 73.5% of total assets are measured at fair value and 0.5% of total liabilities are measured at fair value.

 

In determining fair value, the Company principally uses the market approach which generally utilizes market transaction data for the same or similar instruments.  To a lesser extent, the Company uses the income approach which involves determining fair values from discounted cash flow methodologies.  For the majority of Level 2 and Level 3 valuations, a combination of market and income approaches is used.

 

Summary of significant valuation techniques for assets and liabilities measured at fair value on a recurring basis

 

Level 1 measurements

 

·                  Fixed income securities:  Comprise U.S. Treasuries.  Valuation is based on unadjusted quoted prices for identical assets in active markets that the Company can access.

 

·                  Equity securities:  Comprise actively traded, exchange-listed U.S. and international equity securities. Valuation is based on unadjusted quoted prices for identical assets in active markets that the Company can access.

 

14



 

·                  Short-term:  Comprise actively traded money market funds that have daily quoted net asset values for identical assets that the Company can access.

 

·                  Separate account assets:  Comprise actively traded mutual funds that have daily quoted net asset values for identical assets that the Company can access.  Net asset values for the actively traded mutual funds in which the separate account assets are invested are obtained daily from the fund managers.

 

Level 2 measurements

 

·                  Fixed income securities:

 

U.S. government and agencies:  The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields and credit spreads.

 

Municipal:  The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields and credit spreads.

 

Corporate, including privately placed:  The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields and credit spreads.  Also includes privately placed securities valued using a discounted cash flow model that is widely accepted in the financial services industry and uses market observable inputs and inputs derived principally from, or corroborated by, observable market data.  The primary inputs to the discounted cash flow model include an interest rate curve, as well as published credit spreads for similar assets in markets that are not active that incorporate the credit quality and industry sector of the issuer.

 

Foreign government:  The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields and credit spreads.

 

RMBS - U.S. government sponsored entities (“U.S. Agency”), Prime residential mortgage-backed securities (“Prime”) and Alt-A residential mortgage-backed securities (“Alt-A”); ABS - auto and student loans:  The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields, prepayment speeds, collateral performance and credit spreads.

 

Redeemable preferred stock:  The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields, underlying stock prices and credit spreads.

 

CMBS:  The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields, collateral performance and credit spreads.

 

·                  Equity securities:  The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active.

 

·                  Short-term:  The primary inputs to the valuation include quoted prices for identical or similar assets in markets that are not active, contractual cash flows, benchmark yields and credit spreads.  For certain short-term investments, amortized cost is used as the best estimate of fair value.

 

·                  Other investments:  Free-standing exchange listed derivatives that are not actively traded are valued based on quoted prices for identical instruments in markets that are not active.

 

OTC derivatives, including interest rate swaps, foreign currency swaps, foreign exchange forward contracts, certain credit default swaps, and commodity swaps, are valued using models that rely on inputs such as interest rate yield curves, currency rates, counterparty credit spreads and commodity prices that are observable for substantially the full term of the contract.  The valuation techniques underlying the models are widely accepted in the financial services industry and do not involve significant judgment.

 

·                  Contractholder funds:  Derivatives embedded in certain annuity contracts are valued based on internal models that rely on inputs such as interest rate yield curves and equity index volatility assumptions that are market observable for substantially the full term of the contract.  The valuation techniques are widely accepted in the financial services industry and do not include significant judgment.

 

15



 

Level 3 measurements

 

·                  Fixed income securities:

 

Municipal:  Auction rate securities (“ARS”) primarily backed by student loans that have become illiquid due to failures in the auction market are valued using a discounted cash flow model that is widely accepted in the financial services industry and uses significant non-market observable inputs, including estimates of future coupon rates if auction failures continue, maturity assumptions and illiquidity premium.  Also includes municipal bonds that are not rated by third party credit rating agencies but are generally rated by the NAIC, in addition to other high-yield municipal bonds.  The primary inputs to the valuation of these municipal bonds include quoted prices for identical or similar assets in markets that exhibit less liquidity relative to those markets supporting Level 2 fair value measurements, contractual cash flows, benchmark yields and credit spreads.

 

Corporate, including privately placed:  Valued based on non-binding broker quotes.  Also includes equity-indexed notes which are valued using a discounted cash flow model that is widely accepted in the financial services industry and uses significant non-market observable inputs, such as volatility.  Other inputs include an interest rate curve, as well as published credit spreads for similar assets that incorporate the credit quality and industry sector of the issuer.

 

RMBS - Subprime residential mortgage-backed securities (“Subprime”) and Alt-A:  The primary inputs to the valuation include quoted prices for identical or similar assets in markets that exhibit less liquidity relative to those markets supporting Level 2 fair value measurements, contractual cash flows, benchmark yields, prepayment speeds, collateral performance and credit spreads.  Also includes certain Subprime and Alt-A that are valued based on non-binding broker quotes.  Due to the reduced availability of actual market prices or relevant observable inputs as a result of the decrease in liquidity that has been experienced in the market for these securities, Subprime and certain Alt-A are categorized as Level 3.

 

Foreign government:  Valued based on non-binding broker quotes.

 

CMBS:  The primary inputs to the valuation include quoted prices for identical or similar assets in markets that exhibit less liquidity relative to those markets supporting Level 2 fair value measurements, contractual cash flows, benchmark yields, collateral performance and credit spreads.  Also includes CMBS that are valued based on non-binding broker quotes.  Due to the reduced availability of actual market prices or relevant observable inputs as a result of the decrease in liquidity that has been experienced in the market for these securities, certain CMBS are categorized as Level 3.

 

ABS - Collateralized debt obligations (“CDO”):  Valued based on non-binding broker quotes received from brokers who are familiar with the investments.  Due to the reduced availability of actual market prices or relevant observable inputs as a result of the decrease in liquidity that has been experienced in the market for these securities, all CDO are categorized as Level 3.

 

ABS - student loans and other:  The primary inputs to the valuation include quoted prices for identical or similar assets in markets that exhibit less liquidity relative to those markets supporting Level 2 fair value measurements, contractual cash flows, benchmark yields, prepayment speeds, collateral performance and credit spreads.  Also includes ABS that are valued based on non-binding broker quotes.  Due to the reduced availability of actual market prices or relevant observable inputs as a result of the decrease in liquidity that has been experienced in the market for these securities, certain ABS are categorized as Level 3.

 

·                  Other investments:  Certain OTC derivatives, such as interest rate caps and floors, certain credit default swaps and OTC options (including swaptions), are valued using models that are widely accepted in the financial services industry.  Non-market observable inputs such as volatility assumptions may be significant to the valuation of the instruments.  Other primary inputs include interest rate yield curves and credit spreads.

 

·                  Contractholder funds:  Derivatives embedded in certain annuity contracts are valued internally using models widely accepted in the financial services industry that determine a single best estimate of fair value for the embedded derivatives within a block of contractholder liabilities.  The models use stochastically determined cash flows based on the contractual elements of embedded derivatives and other applicable

 

16



 

market data.  These are categorized as Level 3 as a result of the significance of non-market observable inputs.

 

Assets and liabilities measured at fair value on a non-recurring basis

 

Mortgage loans written-down to fair value in connection with recognizing other-than-temporary impairments are valued based on the fair value of the underlying collateral.  Limited partnership interests written-down to fair value in connection with recognizing other-than-temporary impairments are valued using net asset values and other sources.

 

The following table summarizes the Company’s assets and liabilities measured at fair value on a recurring and non-recurring basis as of March 31, 2010:

 

($ in millions)

 

Quoted prices
in active
markets for
identical
assets

 

Significant
other
observable
inputs

 

Significant
unobservable
inputs

 

Counterparty
and cash
collateral

 

Balance
as of
March 31,

 

 

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

netting

 

2010

 

Assets

 

 

 

 

 

 

 

 

 

 

 

Fixed income securities:

 

 

 

 

 

 

 

 

 

 

 

   U.S. government and agencies

$

4,550

$

3,872

$

--

 

 

$

8,422

 

   Municipal

 

--

 

17,666

 

2,482

 

 

 

20,148

 

   Corporate

 

--

 

32,322

 

2,177

 

 

 

34,499

 

   Foreign government

 

--

 

3,314

 

--

 

 

 

3,314

 

   RMBS

 

--

 

7,033

 

2,079

 

 

 

9,112

 

   CMBS

 

--

 

1,322

 

1,130

 

 

 

2,452

 

   ABS

 

--

 

894

 

2,403

 

 

 

3,297

 

   Redeemable preferred stock

 

--

 

38

 

2

 

 

 

40

 

Total fixed income securities

 

4,550

 

66,461

 

10,273

 

 

 

81,284

 

Equity securities

 

3,568

 

167

 

72

 

 

 

3,807

 

Short-term investments

 

275

 

2,207

 

--

 

 

 

2,482

 

Other investments:

 

 

 

 

 

 

 

 

 

 

 

Free-standing derivatives

 

--

 

653

 

58

$

(276)

 

435

 

Separate account assets

 

9,059

 

--

 

--

 

 

 

9,059

 

Other assets

 

--

 

--

 

2

 

 

 

2

 

Total recurring basis assets

 

17,452

 

69,488

 

10,405

 

(276)

 

97,069

 

Non-recurring basis (1)

 

--

 

--

 

197

 

 

 

197

 

Total assets at fair value

$

17,452

$

69,488

$

10,602

$

(276)

$

97,266

 

% of total assets at fair value

 

17.9 %

 

71.5 %

 

10.9 %

 

(0.3) %

 

100.0%

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

Contractholder funds:

 

 

 

 

 

 

 

 

 

 

 

Derivatives embedded in annuity contracts

$

-- 

$

(220)

$

86 

 

   

$

(134)

 

Other liabilities:

 

 

 

 

 

 

 

 

 

 

 

Free-standing derivatives

 

(1)

 

(548)

 

(96)

$

238

 

(407)

 

Total liabilities at fair value

$

(1)

$

(768)

$

(10)

$

238

$

(541)

 

% of total liabilities at fair value

 

0.2 %

 

142.0 %

 

1.8 %

 

(44.0) %

 

100.0%

 

 


(1)

Includes $147 million of mortgage loans and $50 million of limited partnership interests written-down to fair value in connection with recognizing other-than-temporary impairments.

 

17



 

The following table summarizes the Company’s assets and liabilities measured at fair value on a recurring and non-recurring basis as of December 31, 2009:

 

($ in millions)

 

Quoted prices
in active
markets for
identical
assets

 

Significant
other
observable
inputs

 

Significant
unobservable
inputs

 

Counterparty
and cash
collateral

 

Balance
as of
December 31,

 

 

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

netting

 

2009

 

Assets

 

 

 

 

 

 

 

 

 

 

 

Fixed income securities:

 

 

 

 

 

 

 

 

 

 

 

   U.S. government and agencies

$

4,415  

$

3,121  

$

--  

 

 

$

7,536  

 

   Municipal

 

--  

 

18,574  

 

2,706  

 

 

 

21,280  

 

   Corporate

 

--  

 

30,874  

 

2,241  

 

 

 

33,115  

 

   Foreign government

 

--  

 

3,177  

 

20  

 

 

 

3,197  

 

   RMBS

 

--  

 

6,316  

 

1,671  

 

 

 

7,987  

 

   CMBS

 

--  

 

1,182  

 

1,404  

 

 

 

2,586  

 

   ABS

 

--  

 

1,025  

 

2,001  

 

 

 

3,026  

 

   Redeemable preferred stock

 

--  

 

37  

 

2  

 

 

 

39  

 

Total fixed income securities

 

4,415  

 

64,306  

 

10,045  

 

 

 

78,766  

 

Equity securities

 

4,821  

 

134  

 

69  

 

 

 

5,024  

 

Short-term investments

 

278  

 

2,778  

 

--  

 

 

 

3,056  

 

Other investments:

 

 

 

 

 

 

 

 

 

 

 

Free-standing derivatives

 

--  

 

882  

 

146  

$

(482)  

 

546  

 

Separate account assets

 

9,072  

 

--  

 

--  

 

   

 

9,072  

 

Other assets

 

--  

 

--  

 

2  

 

   

 

2  

 

Total recurring basis assets

 

18,586  

 

68,100  

 

10,262  

 

(482)  

 

96,466  

 

Non-recurring basis (1)

 

--  

 

--  

 

235  

 

   

 

235  

 

Total assets at fair value

$

18,586  

$

68,100  

$

10,497  

$

(482)  

$

96,701  

 

% of total assets at fair value

 

19.2%

 

70.4%

 

10.9%

 

(0.5)%

 

100.0%

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

Contractholder funds:

 

 

 

 

 

 

 

 

 

 

 

Derivatives embedded in annuity contracts

$

--   

$

(217) 

$

(110) 

 

   

$

(327)  

 

Other liabilities:

 

 

 

 

 

 

 

 

 

 

 

Free-standing derivatives

 

(2)  

 

(596) 

 

(91) 

$

276   

 

(413)  

 

Total liabilities at fair value

$

(2)  

$

(813) 

$

(201) 

$

276   

$

(740)  

 

% of total liabilities at fair value

 

0.3%

 

109.9%

 

27.1%

 

(37.3)%

 

100.0%

 

 


(1)

Includes $211 million of mortgage loans and $24 million of limited partnership interests written-down to fair value in connection with recognizing other-than-temporary impairments.

 

18



 

The following table presents the rollforward of Level 3 assets and liabilities held at fair value on a recurring basis during the three-month period ended March 31, 2010.

 

($ in millions)

 

 

 

Total realized and
unrealized gains (losses)
included in:

 

 

 

 

 

 

 

 

 

 

 

Balance as of
December 31,
2009

 

Net
income
(1)

 

OCI on
Statement of
Financial
Position

 

Purchases,
sales,
issuances and
settlements,
net

 

Transfers
into Level 3

 

Transfers out
of Level 3

 

Balance as
of March 31,
2010

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed income securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

   Municipal

$

2,706 

$

(16)

$

37

$

(216)

$

--

$

(29)

$

2,482 

 

   Corporate

 

2,241 

 

(27)

 

75

 

(11)

 

12

 

(113)

 

2,177 

 

 Foreign government

 

20 

 

-- 

 

--

 

(20)

 

--

 

-- 

 

-- 

 

   RMBS

 

1,671 

 

(58)

 

163

 

303 

 

--

 

-- 

 

2,079 

 

   CMBS

 

1,404 

 

(34)

 

108

 

(163)

 

24

 

(209)

 

1,130 

 

   ABS

 

2,001 

 

15 

 

93

 

331 

 

--

 

(37)

 

2,403 

 

   Redeemable preferred stock

 

 

-- 

 

--

 

-- 

 

--

 

-- 

 

 

Total fixed income securities

 

10,045 

 

(120)

 

476

 

224 

 

36

 

(388)

 

10,273 

 

Equity securities

 

69 

 

-- 

 

3

 

 

--

 

(4)

 

72 

 

Other investments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Free-standing derivatives, net

 

55 

 

(133)

 

--

 

40 

 

--

 

-- 

 

(38)

(2)

Other assets