10-Q 1 a11-25039_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 September 30, 2011

 

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 October 18, 2011, the registrant had 505,352,126 common shares, $.01 par value, outstanding.

 



 

THE ALLSTATE CORPORATION

INDEX TO QUARTERLY REPORT ON FORM 10-Q

September 30, 2011

 

PART I

FINANCIAL INFORMATION

PAGE

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

Condensed Consolidated Statements of Operations for the Three-Month and Nine-Month Periods Ended September 30, 2011 and 2010 (unaudited)

1

 

 

 

 

Condensed Consolidated Statements of Financial Position as of September 30, 2011 (unaudited) and December 31, 2010

2

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the Nine-Month Periods Ended September 30, 2011 and 2010 (unaudited)

3

 

 

 

 

Notes to Condensed Consolidated Financial Statements (unaudited)

4

 

 

 

 

Report of Independent Registered Public Accounting Firm

49

 

 

 

Item 2.

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

 

 

 

 

 

   Highlights

50

 

   Consolidated Net Income

51

 

   Property-Liability Highlights

52

 

   Allstate Protection Segment

56

 

   Discontinued Lines and Coverages Segment

65

 

   Property-Liability Investment Results

66

 

   Allstate Financial Highlights

66

 

   Allstate Financial Segment

67

 

   Investments Highlights

74

 

   Investments

75

 

   Goodwill

93

 

   Capital Resources and Liquidity Highlights

95

 

   Capital Resources and Liquidity

95

 

 

 

Item 4.

Controls and Procedures

99

 

 

 

PART II

OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

100

 

 

 

Item 1A.

Risk Factors

100

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

100

 

 

 

Item 6.

Exhibits

101

 



 

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
September 30,

 

 

Nine Months Ended
September 30,

 

 

 

2011

 

 

2010

 

 

2011

 

 

2010

 

 

 

(unaudited)

 

 

(unaudited)

Revenues

 

 

 

 

 

 

 

 

 

 

 

 

Property-liability insurance premiums

 

6,432  

 

6,499  

 

19,337  

 

$

19,515  

Life and annuity premiums and contract charges

 

 

552  

 

 

548  

 

 

1,668  

 

 

1,637  

Net investment income

 

 

994  

 

 

1,005  

 

 

2,996  

 

 

3,104  

Realized capital gains and losses:

 

 

 

 

 

 

 

 

 

 

 

 

Total other-than-temporary impairment losses

 

 

(197) 

 

 

(99) 

 

 

(435) 

 

 

(637) 

Portion of loss recognized in other comprehensive income

 

 

(6) 

 

 

(68) 

 

 

(37) 

 

 

(91) 

Net other-than-temporary impairment losses recognized in earnings

 

 

(203) 

 

 

(167) 

 

 

(472) 

 

 

(728) 

Sales and other realized capital gains and losses

 

 

467  

 

 

23  

 

 

889  

 

 

(215) 

Total realized capital gains and losses

 

 

264  

 

 

(144) 

 

 

417  

 

 

(943) 

 

 

 

8,242  

 

 

7,908  

 

 

24,418  

 

 

23,313  

 

 

 

 

 

 

 

 

 

 

 

 

 

Costs and expenses

 

 

 

 

 

 

 

 

 

 

 

 

Property-liability insurance claims and claims expense

 

 

5,132  

 

 

4,603  

 

 

15,963  

 

 

14,109  

Life and annuity contract benefits

 

 

455  

 

 

445  

 

 

1,331  

 

 

1,372  

Interest credited to contractholder funds

 

 

405  

 

 

445  

 

 

1,240  

 

 

1,358  

Amortization of deferred policy acquisition costs

 

 

1,122  

 

 

1,006  

 

 

3,191  

 

 

2,969  

Operating costs and expenses

 

 

825  

 

 

828  

 

 

2,465  

 

 

2,446  

Restructuring and related charges

 

 

8  

 

 

9  

 

 

28  

 

 

33  

Interest expense

 

 

92  

 

 

91  

 

 

275  

 

 

275  

 

 

 

8,039  

 

 

7,427  

 

 

24,493  

 

 

22,562  

Gain (loss) on disposition of operations

 

 

--  

 

 

9  

 

 

(17) 

 

 

12  

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

203  

 

 

490  

 

 

(92) 

 

 

763  

 

 

 

 

 

 

 

 

 

 

 

 

 

Income tax expense (benefit)

 

 

38  

 

 

123  

 

 

(156) 

 

 

131  

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

165  

 

367  

 

64  

 

$

632  

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income per share - Basic

 

0.32  

 

0.68  

 

0.12  

 

$

1.17  

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares - Basic

 

 

512.0  

 

 

540.9  

 

 

520.4  

 

 

540.6  

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income per share - Diluted

 

0.32  

 

0.68  

 

0.12  

 

$

1.16  

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares - Diluted

 

 

514.2  

 

 

543.0  

 

 

522.9  

 

 

542.7  

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash dividends declared per share

 

0.21  

 

0.20  

 

0.63  

 

$

0.60  

 

 

 

 

 

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) 

 

September 30,

2011

 

December 31,

2010

 

Assets

 

(unaudited)

 

 

 

Investments

 

 

 

 

 

Fixed income securities, at fair value (amortized cost $73,935 and $78,786)

$

76,394   

$

79,612  

 

Equity securities, at fair value (cost $4,252 and $4,228)

 

4,157   

 

4,811  

 

Mortgage loans

 

6,956   

 

6,679  

 

Limited partnership interests

 

4,407   

 

3,816  

 

Short-term, at fair value (amortized cost $3,517 and $3,279)

 

3,517   

 

3,279  

 

Other

 

2,094   

 

2,286  

 

Total investments

 

97,525   

 

100,483  

 

Cash

 

1,026   

 

562  

 

Premium installment receivables, net

 

4,988   

 

4,839  

 

Deferred policy acquisition costs

 

4,444   

 

4,769  

 

Reinsurance recoverables, net

 

6,720   

 

6,552  

 

Accrued investment income

 

854   

 

809  

 

Deferred income taxes

 

792   

 

784  

 

Property and equipment, net

 

908   

 

921  

 

Goodwill

 

874   

 

874  

 

Other assets

 

2,037   

 

1,605  

 

Separate Accounts

 

6,791   

 

8,676  

 

Total assets

$

126,959   

$

130,874  

 

Liabilities

 

 

 

 

 

Reserve for property-liability insurance claims and claims expense

$

20,395   

$

19,468  

 

Reserve for life-contingent contract benefits

 

14,308   

 

13,482  

 

Contractholder funds

 

43,776   

 

48,195  

 

Unearned premiums

 

10,002   

 

9,800  

 

Claim payments outstanding

 

960   

 

737  

 

Other liabilities and accrued expenses

 

6,691   

 

5,564  

 

Long-term debt

 

5,907   

 

5,908  

 

Separate Accounts

 

6,791   

 

8,676  

 

Total liabilities

 

108,830   

 

111,830  

 

 

 

 

 

 

 

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, 505 million and 533 million shares outstanding

 

9   

 

9  

 

Additional capital paid-in

 

3,177   

 

3,176  

 

Retained income

 

31,704   

 

31,969  

 

Deferred ESOP expense

 

(43)  

 

(44) 

 

Treasury stock, at cost (395 million and 367 million shares)

 

(16,693)  

 

(15,910) 

 

Accumulated other comprehensive income:

 

 

 

 

 

Unrealized net capital gains and losses:

 

 

 

 

 

Unrealized net capital losses on fixed income securities with OTTI

 

(155)  

 

(190) 

 

Other unrealized net capital gains and losses

 

1,683   

 

1,089  

 

Unrealized adjustment to DAC, DSI and insurance reserves

 

(496)  

 

36  

 

Total unrealized net capital gains and losses

 

1,032   

 

935  

 

Unrealized foreign currency translation adjustments

 

49   

 

69  

 

Unrecognized pension and other postretirement benefit cost

 

(1,135)  

 

(1,188) 

 

Total accumulated other comprehensive loss

 

(54)  

 

(184) 

 

Total shareholders’ equity

 

18,100   

 

19,016  

 

Noncontrolling interest

 

29   

 

28  

 

Total equity

 

18,129   

 

19,044  

 

Total liabilities and equity

$

126,959   

$

130,874  

 

 

See notes to condensed consolidated financial statements.

2



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

($ in millions)

 

Nine Months Ended

 

 

 

September 30,

 

 

 

2011

 

2010

 

Cash flows from operating activities

 

(unaudited)

 

Net income

$  

64   

$  

632   

 

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

 

 

 

 

 

Depreciation, amortization and other non-cash items

 

149   

 

55   

 

Realized capital gains and losses

 

(417)  

 

943   

 

Loss (gain) on disposition of operations

 

17   

 

(12)  

 

Interest credited to contractholder funds

 

1,240   

 

1,358   

 

Changes in:

 

 

 

 

 

Policy benefits and other insurance reserves

 

546   

 

143   

 

Unearned premiums

 

220   

 

172   

 

Deferred policy acquisition costs

 

138   

 

(138)  

 

Premium installment receivables, net

 

(158)  

 

(137)  

 

Reinsurance recoverables, net

 

(275)  

 

(229)  

 

Income taxes

 

(188)  

 

178   

 

Other operating assets and liabilities

 

335   

 

58   

 

Net cash provided by operating activities

 

1,671   

 

3,023   

 

Cash flows from investing activities

 

 

 

 

 

Proceeds from sales

 

 

 

 

 

Fixed income securities

 

23,916   

 

17,345   

 

Equity securities

 

1,116   

 

4,262   

 

Limited partnership interests

 

762   

 

387   

 

Mortgage loans

 

74   

 

121   

 

Other investments

 

149   

 

98   

 

Investment collections

 

 

 

 

 

Fixed income securities

 

3,864   

 

3,672   

 

Mortgage loans

 

491   

 

784   

 

Other investments

 

105   

 

96   

 

Investment purchases

 

 

 

 

 

Fixed income securities

 

(21,900)  

 

(20,712)  

 

Equity securities

 

(1,066)  

 

(2,721)  

 

Limited partnership interests

 

(1,159)  

 

(1,040)  

 

Mortgage loans

 

(896)  

 

(55)  

 

Other investments

 

(199)  

 

(99)  

 

Change in short-term investments, net

 

64   

 

104   

 

Change in other investments, net

 

(357)  

 

(464)  

 

Purchases of property and equipment, net

 

(160)  

 

(114)  

 

Disposition of operations

 

1   

 

7   

 

Net cash provided by investing activities

 

4,805   

 

1,671   

 

Cash flows from financing activities

 

 

 

 

 

Repayment of long-term debt

 

(1)  

 

(1)  

 

Contractholder fund deposits

 

1,606   

 

2,297   

 

Contractholder fund withdrawals

 

(6,439)  

 

(6,779)  

 

Dividends paid

 

(327)  

 

(322)  

 

Treasury stock purchases

 

(858)  

 

(5)  

 

Shares reissued under equity incentive plans, net

 

18   

 

26   

 

Excess tax benefits on share-based payment arrangements

 

(4)  

 

(7)  

 

Other

 

(7)  

 

(15)  

 

Net cash used in financing activities

 

(6,012)  

 

(4,806)  

 

Net increase (decrease) in cash

 

464   

 

(112)  

 

Cash at beginning of period

 

562   

 

612   

 

Cash at end of period

$  

1,026   

$  

500   

 

 

 

See notes to condensed consolidated financial statements.

 

3



 

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 September 30, 2011 and for the three-month and nine-month periods ended September 30, 2011 and 2010 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, 2010.  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

 

Consolidation Analysis Considering Investments Held through Separate Accounts

 

In April 2010, the Financial Accounting Standards Board (“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 adoption of this guidance as of January 1, 2011 had no impact on the Company’s results of operations or financial position.

 

Disclosure of Supplementary Pro Forma Information for Business Combinations

 

In December 2010, the FASB issued disclosure guidance for entities that enter into business combinations that are material.  The guidance specifies that if an entity presents comparative financial statements, the entity should disclose pro forma revenue and earnings of the combined entity as though the business combination that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only.  The guidance expands the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination.  The Company will apply the guidance to any business combinations entered into on or after January 1, 2011.

 

Criteria for Classification as a Troubled Debt Restructuring (“TDR”)

 

In April 2011, the FASB issued clarifying guidance related to determining whether a loan modification or restructuring should be classified as a TDR.  The additional guidance provided pertains to the two criteria used to determine whether a TDR exists, specifically whether the creditor has granted a concession and whether the debtor is experiencing financial difficulties.  The guidance related to the identification of a TDR is to be applied retrospectively to the beginning of the annual period of adoption.  The measurement of impairment on a TDR identified under this guidance is effective prospectively.  Disclosures about the credit quality of financing receivables and the allowance for credit losses previously deferred for TDRs, is also effective for reporting periods beginning on or after June 15, 2011.  The adoption of this guidance as of July 1, 2011 did not have a material effect on the Company’s results of operations or financial position.

 

Pending accounting standards

 

Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts

 

In October 2010, the FASB issued guidance modifying the definition of the types of costs incurred by insurance entities that can be capitalized in the acquisition of new and renewal contracts.  The guidance specifies that the costs must be based on successful efforts.  The guidance also specifies that advertising costs should be included as deferred acquisition costs only when the direct-response advertising accounting criteria are met.  If application of the guidance would result in the capitalization of acquisition costs that had not been capitalized prior to adoption, the entity may elect not to capitalize those additional costs.  The new guidance is effective for reporting periods beginning after December 15, 2011 and should be applied prospectively, with retrospective application permitted.   The Company plans to adopt the new guidance retrospectively.  Upon adoption on January 1, 2012, the deferred policy acquisition costs (“DAC”) balance will be reduced with a corresponding decrease to retained income, net of taxes.  In periods subsequent to January 1, 2012, a lower amount of acquisition costs will be capitalized which will

 

4



 

increase operating costs and expenses and the smaller DAC balance will result in decreased amortization of DAC.  The Company is in the process of completing the retrospective adoption calculations and measuring the impact of adoption on the Company’s results of operations and financial position.

 

Criteria for Determining Effective Control for Repurchase Agreements

 

In April 2011, the FASB issued guidance modifying the assessment criteria of effective control for repurchase agreements.  The new guidance removes the criterion requiring an entity to have the ability to repurchase or redeem financial assets on substantially the agreed terms and the collateral maintenance implementation guidance related to that criterion.  The guidance is to be applied prospectively to transactions or modifications of existing transactions that occur during reporting periods beginning on or after December 15, 2011.  Early adoption is not permitted.  The impact of adoption is not expected to be material to the Company’s results of operations and financial position.

 

Amendments to Fair Value Measurement and Disclosure Requirements

 

In May 2011, the FASB issued guidance that clarifies the application of existing fair value measurement and disclosure requirements and amends certain fair value measurement principles, requirements and disclosures.  To improve consistency in global application, changes in wording were made.  The guidance is to be applied prospectively for reporting periods beginning after December 15, 2011.  Early adoption is not permitted.  The impact of adoption is not expected to be material to the Company’s results of operations and financial position.

 

Presentation of Comprehensive Income

 

In June 2011, the FASB issued guidance amending the presentation of comprehensive income and its components.  Under the new guidance, an entity has the option to present comprehensive income in a single continuous statement or in two separate but consecutive statements.  Both options require an entity to present reclassification adjustments for items reclassified from other comprehensive income to net income in the statement(s) where the components of net income and the components of comprehensive income are presented.  The guidance is effective for reporting periods beginning after December 15, 2011 and is to be applied retrospectively.  Early adoption is permitted.  The impact of adoption is related to presentation only and will have no impact on the Company’s results of operations and financial position.  In October 2011, the FASB announced that they will discuss at a future meeting whether to delay the effective date of certain provisions in the new guidance related to the presentation of reclassification adjustments.

 

Intangibles – Goodwill and Other

 

In September 2011, the FASB issued guidance providing the option to first assess qualitative factors, such as macroeconomic conditions and industry and market considerations, to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount.  If indicated by the qualitative assessment, then it is necessary to perform the two-step goodwill impairment test.  If the option is not elected, the guidance requiring the two-step goodwill impairment test is unchanged.  The new guidance is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011, with early adoption permitted.  The impact of adoption is not expected to be material to the Company’s results of operations and financial position.

 

2.  Earnings per share

 

Basic earnings per share is computed using the weighted average number of common shares outstanding, including unvested participating restricted stock units.  Diluted earnings per share is computed using the weighted average number of common and dilutive potential common shares outstanding.  For the Company, dilutive potential common shares consist of outstanding stock options and unvested non-participating restricted stock units.

 

5



 

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

 

($ in millions, except per share data)

 

Three months ended 
September 30,

 

Nine months ended 
September 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Numerator:

 

 

 

 

 

 

 

 

 

Net income

$  

165  

$  

367  

$  

64   

$  

632   

 

 

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

512.0  

 

540.9  

 

520.4   

 

540.6   

 

Effect of dilutive potential common shares:

 

 

 

 

 

 

 

 

 

Stock options

 

1.6  

 

1.9  

 

2.0   

 

2.0   

 

Restricted stock units (non-participating)

 

0.6  

 

0.2  

 

0.5   

 

0.1   

 

Weighted average common and dilutive potential common shares outstanding

 

514.2  

 

543.0  

 

522.9   

 

542.7   

 

 

 

 

 

 

 

 

 

 

 

Earnings per share - Basic

$  

0.32  

$  

0.68  

$  

0.12   

$  

1.17   

 

Earnings per share - Diluted

$  

0.32  

$  

0.68  

$  

0.12   

$  

1.16   

 

 

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 purchase 27.6 million and 27.6 million Allstate common shares, with exercise prices ranging from $24.70 to $62.84 and $27.36 to $62.84, were outstanding for the three-month periods ended September 30, 2011 and 2010, respectively, but were not included in the computation of diluted earnings per share in those periods.  Options to purchase 27.6 million and 26.6 million Allstate common shares, with exercise prices ranging from $25.91 to $62.84 and $27.36 to $64.53, were outstanding for the nine-month periods ended September 30, 2011 and 2010, respectively, but were not included in the computation of diluted earnings per share in those periods.

 

3.  Supplemental Cash Flow Information

 

Non-cash investment exchanges, including modifications of certain mortgage loans (primarily refinances at maturity with no concessions granted to the borrower), fixed income securities, limited partnerships and other investments, as well as mergers completed with equity securities, totaled $564 million and $544 million for the nine months ended September 30, 2011 and 2010, respectively.

 

Liabilities for collateral received in conjunction with the Company’s securities lending program and over-the-counter (“OTC”) derivatives are reported in other liabilities and accrued expenses or other investments.  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)

 

Nine months ended 
September 30,

 

 

 

2011

 

2010

 

Net change in proceeds managed

 

 

 

 

 

Net change in short-term investments

(301)  

187   

 

Operating cash flow (used) provided

 

(301)  

 

187   

 

Net change in cash

 

1   

 

2   

 

Net change in proceeds managed

(300)  

189   

 

 

 

 

 

 

 

Net change in liabilities

 

 

 

 

 

Liabilities for collateral, beginning of year

(484)  

(658)  

 

Liabilities for collateral, end of period

 

(784)  

 

(469)  

 

Operating cash flow provided (used)

300   

(189)  

 

 

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

 

September 30, 2011

 

 

 

 

 

 

 

 

 

U.S. government and agencies

$  

4,009  

$  

337  

$  

--    

$  

4,346

 

Municipal

 

14,445  

 

816  

 

(262)  

 

14,999

 

Corporate

 

42,335  

 

2,644  

 

(450)  

 

44,529

 

Foreign government

 

1,941  

 

197  

 

(5)  

 

2,133

 

Residential mortgage-backed securities (“RMBS”)

 

5,027  

 

146  

 

(541)  

 

4,632

 

Commercial mortgage-backed securities (“CMBS”)

 

2,045  

 

37  

 

(258)  

 

1,824

 

Asset-backed securities (“ABS”)

 

4,110  

 

87  

 

(291)  

 

3,906

 

Redeemable preferred stock

 

23  

 

2  

 

--   

 

25

 

Total fixed income securities

$  

73,935  

$  

4,266  

$  

(1,807)  

$  

76,394

 

 

 

 

 

 

 

 

 

 

 

December 31, 2010

 

 

 

 

 

 

 

 

 

U.S. government and agencies

$  

8,320  

$  

327  

$  

(51)  

$  

8,596

 

Municipal

 

16,201  

 

379  

 

(646)  

 

15,934

 

Corporate

 

36,260  

 

1,816  

 

(421)  

 

37,655

 

Foreign government

 

2,821  

 

347  

 

(10)  

 

3,158

 

RMBS

 

8,509  

 

216  

 

(732)  

 

7,993

 

CMBS

 

2,213  

 

58  

 

(277)  

 

1,994

 

ABS

 

4,425  

 

113  

 

(294)  

 

4,244

 

Redeemable preferred stock

 

37  

 

1  

 

--   

 

38

 

Total fixed income securities

$  

78,786  

$  

3,257  

$  

(2,431)  

$  

79,612

 

 

Scheduled maturities

 

The scheduled maturities for fixed income securities are as follows as of September 30, 2011:

 

($ in millions)

 

Amortized

 

Fair

 

 

 

cost

 

value

 

Due in one year or less

$  

3,441  

$  

3,507

 

Due after one year through five years

 

20,985  

 

21,764

 

Due after five years through ten years

 

20,860  

 

22,097

 

Due after ten years

 

19,512  

 

20,488

 

 

 

64,798  

 

67,856

 

RMBS and ABS

 

9,137  

 

8,538

 

Total

$  

73,935  

$  

76,394

 

 

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.  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
September 30,

 

Nine months ended
September 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Fixed income securities

$  

862   

$  

926   

$  

2,661   

$  

2,840

 

Equity securities

 

23   

 

17   

 

76   

 

63

 

Mortgage loans

 

91   

 

92   

 

267   

 

295

 

Limited partnership interests

 

33   

 

6   

 

61   

 

19

 

Short-term investments

 

2   

 

2   

 

5   

 

6

 

Other

 

27   

 

5   

 

64   

 

12

 

Investment income, before expense

 

1,038   

 

1,048   

 

3,134   

 

3,235

 

Investment expense

 

(44)  

 

(43)  

 

(138)  

 

(131

)

Net investment income

$  

994   

$  

1,005   

$  

2,996   

$  

3,104

 

 

Realized capital gains and losses

 

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

 

($ in millions)

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Fixed income securities

$  

603   

$  

84  

$  

615

 

$  

(240

)

Equity securities

 

(77)  

 

83  

 

60

 

 

142

 

Mortgage loans

 

(28)  

 

(1) 

 

(37

)

 

(54

)

Limited partnership interests

 

8   

 

(20) 

 

129

 

 

(15

)

Derivatives

 

(234)  

 

(286) 

 

(354

)

 

(779

)

Other

 

(8)  

 

(4) 

 

4

 

 

3

 

Realized capital gains and losses

$  

264   

$  

(144) 

$  

417

 

$  

(943

)

 

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

 

($ in millions)

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Impairment write-downs

$  

(190)   

$  

(137)   

$  

(374

)

$  

(599

)

Change in intent write-downs

 

(13)   

 

(30)   

 

(98

)

 

(129

)

Net other-than-temporary impairment losses recognized in earnings

 

(203)  

 

(167)  

 

(472

)

 

(728

)

Sales

 

692   

 

319   

 

1,116

 

 

552

 

Valuation of derivative instruments

 

(254)  

 

(133)  

 

(282

)

 

(571

)

Settlements of derivative instruments

 

20   

 

(152)  

 

(72

)

 

(209

)

Equity method of accounting (“EMA”) limited partnership income

 

9   

 

(11)  

 

127

 

 

13

 

Realized capital gains and losses

$  

264   

$  

(144)  

$  

417

 

$  

(943

)

 

Gross gains of $709 million and $387 million and gross losses of $32 million and $173 million were realized on sales of fixed income securities during the three months ended September 30, 2011 and 2010, respectively.  Gross gains of $1.10 billion and $673 million and gross losses of $218 million and $360 million were realized on sales of fixed income securities during the nine months ended September 30, 2011 and 2010, respectively.

 

8



 

Other-than-temporary impairment losses by asset type are as follows:

 

($ in millions)

 

Three months ended
September 30, 2011

 

 

Nine months ended
 September 30, 2011

 

 

 

 

Gross

 

 

Included
in OCI

 

 

Net

 

 

Gross

 

 

Included
in OCI

 

 

Net

 

 

Fixed income securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Municipal

(8

)

--

 

(8

)

(50

)

(3

)

(53

)

 

Corporate

 

(14

)

 

--

 

 

(14

)

 

(19

)

 

1

 

 

(18

)

 

Foreign government

 

--

 

 

--

 

 

--

 

 

(1

)

 

--

 

 

(1

)

 

RMBS

 

(57

)

 

(3

)

 

(60

)

 

(164

)

 

(28

)

 

(192

)

 

CMBS

 

(1

)

 

(3

)

 

(4

)

 

(27

)

 

(10

)

 

(37

)

 

ABS

 

--

 

 

--

 

 

--

 

 

(7

)

 

3

 

 

(4

)

 

Total fixed income securities

 

(80

)

 

(6

)

 

(86

)

 

(268

)

 

(37

)

 

(305

)

 

Equity securities

 

(81

)

 

--

 

 

(81

)

 

(114

)

 

--

 

 

(114

)

 

Mortgage loans

 

(29

)

 

--

 

 

(29

)

 

(42

)

 

--

 

 

(42

)

 

Limited partnership interests

 

(2

)

 

--

 

 

(2

)

 

(4

)

 

--

 

 

(4

)

 

Other

 

(5

)

 

--

 

 

(5

)

 

(7

)

 

--

 

 

(7

)

 

Other-than-temporary impairment losses

(197

)

(6

)

(203

)

(435

)

(37

)

(472

)

 

 

 

 

 

Three months ended
September 30, 2010

 

 

Nine months ended 
September 30, 2010

 

 

 

 

Gross

 

 

Included
in OCI

 

 

Net

 

 

Gross

 

 

Included
in OCI

 

 

Net

 

 

Fixed income securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Municipal

 (1

)

--

 

(1

)

(106

)

4

 

 (102

)

 

Corporate

 

(14

)

 

(1

)

 

(15

)

 

(67

)

 

1

 

 

(66

)

 

RMBS

 

(56

)

 

(41

)

 

(97

)

 

(268

)

 

(43

)

 

(311

)

 

CMBS

 

(1

)

 

(26

)

 

(27

)

 

(44

)

 

(37

)

 

(81

)

 

ABS

 

--

 

 

--

 

 

--

 

 

(9

)

 

(16

)

 

(25

)

 

Total fixed income securities

 

(72

)

 

(68

)

 

(140

)

 

(494

)

 

(91

)

 

(585

)

 

Equity securities

 

(14

)

 

--

 

 

(14

)

 

(51

)

 

--

 

 

(51

)

 

Mortgage loans

 

(3

)

 

--

 

 

(3

)

 

(50

)

 

--

 

 

(50

)

 

Limited partnership interests

 

(10

)

 

--

 

 

(10

)

 

(42

)

 

--

 

 

(42

)

 

Other-than-temporary impairment losses

 (99

)

 (68

)

(167

)

(637

)

(91

)

(728

)

 

 

The total amount of other-than-temporary impairment losses included in accumulated other comprehensive income at the time of impairment for fixed income securities, which were not included in earnings, are presented in the following table.  The amount excludes $211 million and $322 million as of September 30, 2011 and December 31, 2010, respectively, of net unrealized gains related to changes in valuation of the fixed income securities subsequent to the impairment measurement date.

 

($ in millions)

 

September 30,
2011

 

 

December 31,
2010

 

 

Municipal

 (12

)

 (27

)

 

Corporate

 

(36

)

 

(31

)

 

RMBS

 

(372

)

 

(467

)

 

CMBS

 

(8

)

 

(49

)

 

ABS

 

(22

)

 

(41

)

 

Total

 (450

)

 (615

)

 

 

9



 

Rollforwards of the cumulative credit losses recognized in earnings for fixed income securities held as of the end of the period are as follows:

 

($ in millions)

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

 

2011

 

 

2010

 

 

2011

 

 

2010

 

 

Beginning balance

 (912

)

 (1,309

)

 (1,046

)

 (1,187

)

 

Cumulative effect of change in accounting principle

 

--

 

 

81

 

 

--

 

 

81

 

 

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

 

(56

)

 

(101

)

 

(133

)

 

(265

)

 

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

 

(25

)

 

(9

)

 

(82

)

 

(197

)

 

Reduction in credit loss for securities disposed or collected

 

66

 

 

104

 

 

313

 

 

330

 

 

Reduction in credit loss for securities the Company has made the decision to sell or more likely than not will be required to sell

 

--

 

 

42

 

 

15

 

 

43

 

 

Change in credit loss due to accretion of increase in cash flows

 

4

 

 

1

 

 

10

 

 

4

 

 

Ending balance

 (923

)

 (1,191

)

 (923

)

 (1,191

)

 

 

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 and future earnings potential of the issue or issuer, expected defaults, expected recoveries, the value of underlying collateral, vintage, geographic concentration, available reserves or escrows, current subordination levels, third party guarantees and other credit enhancements.  Other information, such as industry analyst reports and forecasts, sector credit ratings, financial condition of the bond 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 will 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 portion of the unrealized loss related to factors other than credit remains classified in accumulated other comprehensive income.  If the Company determines that the fixed income security does not have sufficient cash flow or other information to estimate a recovery value for the security, the Company may conclude that the entire decline in fair value is deemed to be credit related and the loss is recorded in earnings.

 

10



 

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

September 30, 2011

 

value

 

Gains

 

Losses

 

gains (losses)

Fixed income securities

76,394 

4,266

(1,807)

 

2,459

 

Equity securities

 

4,157 

 

250

 

(345)

 

 

(95

)

Short-term investments

 

3,517 

 

--

 

-- 

 

 

--

 

Derivative instruments (1)

 

(10)

 

2

 

(17)

 

 

(15

)

EMA limited partnership interests (2)

 

 

 

 

 

 

 

 

7

 

Unrealized net capital gains and losses, pre-tax

 

 

 

 

 

 

 

 

2,356

 

Amounts recognized for:

 

 

 

 

 

 

 

 

 

 

Insurance reserves (3)

 

 

 

 

 

 

 

 

(641

)

DAC and DSI (4)

 

 

 

 

 

 

 

 

(122

)

Amounts recognized

 

 

 

 

 

 

 

 

(763

)

Deferred income taxes

 

 

 

 

 

 

 

 

(561

)

Unrealized net capital gains and losses, after-tax

 

 

 

 

 

 

 

1,032

 

_________________

 

 

 

 

 

 

 

 

 

(1)

Included in the fair value of derivative instruments are $(6) million classified as assets and $4 million classified as liabilities.

(2)

Unrealized net capital gains and losses for limited partnership interests represent the Company’s share of EMA limited partnerships’ other comprehensive income. Fair value and gross gains and losses are not applicable.

(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

December 31, 2010

 

value

 

Gains

 

Losses

 

gains (losses)

Fixed income securities

$

79,612 

$

3,257

$

(2,431)

 

826 

Equity securities

 

4,811 

 

646

 

(63)

 

583 

Short-term investments

 

3,279 

 

--

 

-- 

 

-- 

Derivative instruments (1)

 

(17)

 

2

 

(24)

 

(22)

Unrealized net capital gains and losses, pre-tax

 

 

 

 

 

 

 

 

1,387 

Amounts recognized for:

 

 

 

 

 

 

 

 

Insurance reserves

 

 

 

 

 

 

 

(41)

DAC and DSI

 

 

 

 

 

 

 

 

97 

Amounts recognized

 

 

 

 

 

 

 

56 

Deferred income taxes

 

 

 

 

 

 

 

 

(508)

Unrealized net capital gains and losses, after-tax

 

 

 

 

 

 

 

935 

_________________

 

 

 

 

 

 

 

 

 

 

(1)

Included in the fair value of derivative instruments are $2 million classified as assets and $19 million classified as liabilities.

 

11



 

Change in unrealized net capital gains and losses

 

The change in unrealized net capital gains and losses for the nine months ended September 30, 2011 is as follows:

 

($ in millions)

 

 

Fixed income securities

1,633 

Equity securities

 

(678)

Derivative instruments

 

EMA limited partnership interests

 

Total

 

969 

Amounts recognized for:

 

 

Insurance reserves

 

(600)

DAC and DSI

 

(219)

Amounts recognized

 

(819)

Deferred income taxes

 

(53)

Increase in unrealized net capital gains and losses

97 

 

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 the 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 considered 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 whether it expects to receive cash flows sufficient to recover the entire amortized cost basis of the security.  The Company calculates the estimated recovery value by discounting the best estimate of future cash flows at the security’s original or current effective rate, as appropriate, and compares this to 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 related to other factors recognized in other comprehensive income.

 

For equity securities, the Company considers various factors, including whether it 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 to identify instances where the fair value of a security compared to its amortized cost (for fixed income securities) or cost (for equity securities) is below established thresholds. The process also includes the monitoring of other impairment indicators such as ratings, ratings downgrades and 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 and future earnings potential of the issue or issuer.  Some of the factors that may be considered in evaluating whether a decline in fair value is other than temporary are: 1) 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; 2) the specific reasons that a security is in an unrealized loss position, including overall market conditions which could affect liquidity; and 3) the length of time and extent to which the fair value has been less than amortized cost or cost.

 

12



 

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

September 30, 2011

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed income securities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government and agencies

 

6

151

-- 

 

--

--

-- 

-- 

Municipal

 

173

 

1,243

 

(26)

 

303

 

1,958

 

(236)

 

(262)

Corporate

 

509

 

6,073

 

(219)

 

104

 

1,327

 

(231)

 

(450)

Foreign government

 

18

 

346

 

(5)

 

--

 

--

 

-- 

 

(5)

RMBS

 

110

 

284

 

(13)

 

289

 

1,193

 

(528)

 

(541)

CMBS

 

69

 

566

 

(58)

 

74

 

530

 

(200)

 

(258)

ABS

 

49

 

683

 

(8)

 

114

 

1,062

 

(283)

 

(291)

Total fixed income securities

 

934

 

9,346

 

(329)

 

884

 

6,070

 

(1,478)

 

(1,807)

Equity securities

 

2,453

 

2,067

 

(339)

 

49

 

20

 

(6)

 

(345)

Total fixed income and equity securities

 

3,387

11,413

(668)

 

933

6,090

(1,484)

(2,152)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment grade fixed income securities

 

633

6,733

(182)

 

567

4,147

(728)

(910)

Below investment grade fixed income securities

 

301

 

2,613

 

(147)

 

317

 

1,923

 

(750)

 

(897)

Total fixed income securities

 

934

9,346

(329)

 

884

6,070

(1,478)

(1,807)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2010

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed income securities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government and agencies

 

32

2,081

(51)

 

--

--

-- 

(51)

Municipal

 

847

 

4,130

 

(175)

 

411

 

2,715

 

(471)

 

(646)

Corporate

 

438

 

5,994

 

(186)

 

150

 

1,992

 

(235)

 

(421)

Foreign government

 

33

 

277

 

(9)

 

1

 

10

 

(1)

 

(10)

RMBS

 

280

 

583

 

(12)

 

422

 

1,939

 

(720)

 

(732)

CMBS

 

14

 

158

 

(3)

 

114

 

835

 

(274)

 

(277)

ABS

 

68

 

762

 

(8)

 

133

 

1,313

 

(286)

 

(294)

Total fixed income securities

 

1,712

 

13,985

 

(444)

 

1,231

 

8,804

 

(1,987)

 

(2,431)

Equity securities

 

773

 

610

 

(48)

 

44

 

91

 

(15)

 

(63)

Total fixed income and equity securities

 

2,485

14,595

(492)

 

1,275

8,895

(2,002)

(2,494)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment grade fixed income securities

 

1,607

13,280

(408)

 

857

6,217

(943)

(1,351)

Below investment grade fixed income securities

 

105

 

705

 

(36)

 

374

 

2,587

 

(1,044)

 

(1,080)

Total fixed income securities

 

1,712

13,985

(444)

 

1,231

8,804

(1,987)

(2,431)

 

As of September 30, 2011, $837 million of unrealized losses are related to securities with an unrealized loss position less than 20% of amortized cost or cost, the degree of which suggests that these securities do not pose a high risk of being other-than-temporarily impaired.  Of the $837 million, $422 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 Standard & Poor’s (“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.  Unrealized losses on investment grade securities are principally related to widening credit spreads or rising interest rates since the time of initial purchase.

 

As of September 30, 2011, the remaining $1.31 billion of unrealized losses are related to securities in unrealized loss positions greater than or equal to 20% of amortized cost or cost.  Investment grade fixed income securities comprising $488 million of these unrealized losses were evaluated based on factors such as expected cash flows and the financial condition and near-term and long-term prospects of the issue or issuer and were determined to have adequate resources to fulfill contractual obligations.  Of the $1.31 billion, $668 million are related to below investment grade fixed income securities and $159 million are related to equity securities.  Of these amounts, $512 million of the below investment grade fixed income securities had been in an unrealized loss position greater than or equal to 20% of amortized cost for a period of twelve or more consecutive months as of September 30, 2011.  Unrealized losses on below investment grade securities are principally related to RMBS, CMBS and ABS and were

 

13



 

the result of wider credit spreads resulting from higher risk premiums since the time of initial purchase, largely due to macroeconomic conditions and credit market deterioration, including the impact of lower real estate valuations.

 

RMBS, CMBS and ABS in an unrealized loss position were evaluated based on actual and projected collateral losses relative to the securities’ positions in the respective securitization trusts, security specific expectations of cash flows, and credit ratings.  This evaluation also takes into consideration credit enhancement, measured in terms of (i) subordination from other classes of securities in the trust that are contractually obligated to absorb losses before the class of security the Company owns, (ii) the expected impact of other structural features embedded in the securitization trust beneficial to the class of securities the Company owns, such as overcollateralization and excess spread, and (iii) for RMBS and ABS in an unrealized loss position, credit enhancements from reliable bond insurers, where applicable.  Municipal bonds in an unrealized loss position were evaluated based on the quality of the underlying securities, taking into consideration credit enhancements from reliable bond insurers, where applicable.  Unrealized losses on equity securities are primarily related to temporary equity market fluctuations of securities that are expected to recover.

 

As of September 30, 2011, the Company has not made the 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 September 30, 2011, the Company had the intent and ability to hold equity securities with unrealized losses for a period of time sufficient for them to recover.

 

Limited partnerships

 

As of September 30, 2011 and December 31, 2010, the carrying value of equity method limited partnership interests totaled $2.96 billion and $2.47 billion, respectively.  The Company recognizes an impairment loss for equity method investments when evidence demonstrates that the loss is other than temporary.  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 a level of earnings that would justify the carrying amount of the investment.  The Company had no write-downs related to equity method limited partnership interests for the three months and nine months ended September 30, 2011 and the three months ended September 30, 2010, and write-downs of $1 million for the nine months ended September 30, 2010.

 

As of September 30, 2011 and December 31, 2010, the carrying value for cost method limited partnership interests was $1.45 billion and $1.35 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: significantly reduced valuations of the investments held by the limited partnerships; 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; 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’s portfolio monitoring process includes a quarterly review of all cost method limited partnerships to identify instances where the 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 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 related to cost method investments of $2 million and $10 million for the three months ended September 30, 2011 and 2010, respectively, and $4 million and $41 million for the nine months ended September 30, 2011 and 2010, respectively.

 

Mortgage loans

 

Mortgage loans are evaluated for impairment on a specific loan basis through a quarterly credit monitoring process and review of key credit quality indicators.  Mortgage loans are considered impaired when it is probable that the Company will not collect the contractual principal and interest.  Valuation allowances are established for impaired loans to reduce the carrying value to the fair value of the collateral less costs to sell or the present value of the loan’s expected future repayment cash flows discounted at the loan’s original effective interest rate.  Impaired mortgage loans may not have a valuation allowance when the fair value of the collateral less costs to sell is higher than the carrying value.  Mortgage loan valuation allowances are charged off when there is no reasonable expectation of recovery.  The impairment evaluation is non-statistical in respect to the aggregate portfolio but considers facts and circumstances attributable to each loan.  It is not considered probable that additional impairment losses, beyond those identified on a specific loan basis, have been incurred as of September 30, 2011.

 

14



 

Accrual of income is suspended for mortgage loans that are in default or when full and timely collection of principal and interest payments is not probable.  Cash receipts on mortgage loans on nonaccrual status are generally recorded as a reduction of carrying value.

 

Debt service coverage ratio is considered a key credit quality indicator when mortgage loans are evaluated for impairment.  Debt service coverage ratio represents the amount of estimated cash flows from the property available to the borrower to meet principal and interest payment obligations.  Debt service coverage ratio estimates are updated annually or more frequently if conditions are warranted based on the Company’s credit monitoring process.  The following table reflects the carrying value of non-impaired fixed rate and variable rate mortgage loans summarized by debt service coverage ratio distribution:

 

($ in millions)

 

September 30, 2011

 

December 31, 2010

Debt service coverage
ratio distribution

 

Fixed rate
mortgage
loans

 

Variable rate
mortgage
loans

 

Total

 

Fixed rate
mortgage
loans

 

Variable rate
mortgage
loans

 

Total

Below 1.0

277

--

277

280

--

280

1.0 - 1.25

 

1,699

 

--

 

1,699

 

1,583

 

16

 

1,599

1.26 - 1.50

 

1,584

 

69

 

1,653

 

1,520

 

5

 

1,525

Above 1.50

 

2,888

 

168

 

3,056

 

2,540

 

546

 

3,086

Total non-impaired mortgage loans

6,448

237

6,685

5,923

567

6,490

 

Mortgage loans with a debt service coverage ratio below 1.0 that are not considered impaired primarily relate to instances where the borrower has the financial capacity to fund the revenue shortfalls from the properties for the foreseeable term, the decrease in cash flows from the properties is considered temporary, or there are other risk mitigating circumstances such as additional collateral, escrow balances or borrower guarantees.

 

The net carrying value of impaired mortgage loans is as follows:

 

($ in millions)

 

September 30,
2011

 

December 31,
2010

Impaired mortgage loans with a valuation allowance

257

168

Impaired mortgage loans without a valuation allowance

 

14

 

21

Total impaired mortgage loans

271

189

Valuation allowance on impaired mortgage loans

70

84

 

The average balance of impaired loans was $201 million during the nine months ended September 30, 2011.

 

The rollforward of the valuation allowance on impaired mortgage loans is as follows:

 

($ in millions)

 

Three months ended
September 30, 2011

 

Nine months ended
September 30, 2011

Beginning balance

68 

84 

Net increase in valuation allowance

 

29 

 

42 

Charge offs

 

(27)

 

(56)

Ending balance

70 

70 

 

The carrying value of past due mortgage loans is as follows:

 

($ in millions)

 

September 30,
2011

 

December 31,
2010

Less than 90 days past due

--

12

90 days or greater past due

 

64

 

78

Total past due

 

64

 

90

Current loans

 

6,892

 

6,589

Total mortgage loans

6,956

6,679

 

15



 

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.

 

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.  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, the level of credit spreads over historical levels, applicable bid-ask spreads, and price consensus among market participants and other pricing sources.

 

The second situation where the Company classifies securities in Level 3 is where specific inputs significant to the fair value estimation models are not market observable.  This occurs in two primary instances.  The first relates to the Company’s use of broker quotes.  The second relates to auction rate securities (“ARS”) backed by student loans for which a key input, 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, derivatives embedded in fixed income securities are not disclosed in the hierarchy as free-standing derivatives since they are presented with the host contracts in fixed income securities.

 

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 the market and income approaches is used.

 

16



 

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.

 

·                  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 included are 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 yield 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 and ABS:  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.

 

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.

 

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.

 

·                  Equity securities:  The primary inputs to the valuation include quoted prices or quoted net asset values 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 options and certain credit default swaps, are valued using models that rely on inputs such as interest rate yield curves, currency rates, and counterparty credit spreads that are observable for

 

17



 

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.

 

Level 3 measurements

 

·                  Fixed income securities:

 

Municipal:  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, the anticipated date liquidity will return to the market and illiquidity premium.  Also included are municipal bonds that are not rated by third party credit rating agencies but are rated by the National Association of Insurance Commissioners (“NAIC”), and 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:  Primarily valued based on non-binding broker quotes.  Also included are 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 yield curve, as well as published credit spreads for similar assets that incorporate the credit quality and industry sector of the issuer.

 

RMBS, CMBS and ABS:  Valued based on non-binding broker quotes received from brokers who are familiar with the investments.

 

·                  Other investments:  Certain OTC derivatives, such as interest rate caps and floors, certain credit default swaps and certain options (including swaptions), are valued using models that are widely accepted in the financial services industry.  These are categorized as Level 3 as a result of the significance of non-market observable inputs such as volatility.  Other primary inputs include interest rate yield curves and credit spreads.

 

·                  Contractholder funds:  Derivatives embedded in certain life and 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 primarily use stochastically determined cash flows based on the contractual elements of embedded derivatives, projected option cost and applicable market data, such as interest rate yield curves and equity index volatility assumptions.  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 impairments are valued based on the fair value of the underlying collateral less costs to sell.  Limited partnership interests written-down to fair value in connection with recognizing other-than-temporary impairments are valued using net asset values.

 

18



 

The following table summarizes the Company’s assets and liabilities measured at fair value on a recurring and non-recurring basis as of September 30, 2011:

 

($ in millions)

 

 

Quoted prices
in active
markets for
identical
assets

 

 

Significant
other
observable
inputs

 

 

Significant
unobservable
inputs

 

 

 

Counterparty
and cash
collateral

 

 

Balance
as of
September 30,

 

 

 

 

(Level 1)