10-Q 1 a12-8030_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, 2012

 

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 18, 2012, the registrant had 491,360,562 common shares, $.01 par value, outstanding.

 



 

THE ALLSTATE CORPORATION

INDEX TO QUARTERLY REPORT ON FORM 10-Q

March 31, 2012

 

PART I

 

FINANCIAL INFORMATION

 

PAGE

 

 

 

 

 

Item 1.

 

Financial Statements

 

 

 

 

 

 

 

 

 

Condensed Consolidated Statements of Operations for the Three-Month Periods Ended March 31, 2012 and 2011 (unaudited)

 

1

 

 

 

 

 

 

 

Condensed Consolidated Statements of Comprehensive Income for the Three-Month Periods Ended March 31, 2012 and 2011 (unaudited)

 

2

 

 

 

 

 

 

 

Condensed Consolidated Statements of Financial Position as of March 31, 2012 (unaudited) and December 31, 2011

 

3

 

 

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the Three-Month Periods Ended March 31, 2012 and 2011 (unaudited)

 

4

 

 

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements (unaudited)

 

5

 

 

 

 

 

 

 

Report of Independent Registered Public Accounting Firm

 

46

 

 

 

 

 

Item 2.

 

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

 

 

 

 

 

 

 

 

 

Highlights

 

47

 

 

Consolidated Net Income

 

48

 

 

Property-Liability Highlights

 

48

 

 

Allstate Protection Segment

 

52

 

 

Discontinued Lines and Coverages Segment

 

59

 

 

Property-Liability Investment Results

 

60

 

 

Allstate Financial Highlights

 

61

 

 

Allstate Financial Segment

 

61

 

 

Investments Highlights

 

67

 

 

Investments

 

67

 

 

Capital Resources and Liquidity Highlights

 

80

 

 

Capital Resources and Liquidity

 

81

 

 

 

 

 

Item 4.

 

Controls and Procedures

 

85

 

 

 

 

 

PART II

 

OTHER INFORMATION

 

 

 

 

 

 

 

Item 1.

 

Legal Proceedings

 

86

 

 

 

 

 

Item 1A.

 

Risk Factors

 

86

 

 

 

 

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

86

 

 

 

 

 

Item 5.

 

Other Information

 

87

 

 

 

 

 

Item 6.

 

Exhibits

 

87

 


 


 

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,

 

 

2012

 

2011

 

 

(unaudited)

 

 

 

 

(As Adjusted
See Note 1)

Revenues

 

 

 

 

 

Property-liability insurance premiums

$  

6,630  

$  

6,448

 

Life and annuity premiums and contract charges

 

553  

 

569

 

Net investment income

 

1,011  

 

982

 

Realized capital gains and losses:

 

 

 

 

 

Total other-than-temporary impairment losses

 

(87) 

 

(156

)

Portion of loss recognized in other comprehensive income

 

4  

 

(27

)

Net other-than-temporary impairment losses recognized in earnings

 

(83) 

 

(183

)

Sales and other realized capital gains and losses

 

251  

 

279

 

Total realized capital gains and losses

 

168  

 

96

 

 

 

8,362  

 

8,095

 

 

 

 

 

 

 

Costs and expenses

 

 

 

 

 

Property-liability insurance claims and claims expense

 

4,339  

 

4,476

 

Life and annuity contract benefits

 

439  

 

454

 

Interest credited to contractholder funds

 

378  

 

418

 

Amortization of deferred policy acquisition costs

 

979  

 

984

 

Operating costs and expenses

 

1,017  

 

900

 

Restructuring and related charges

 

6  

 

9

 

Interest expense

 

95  

 

92

 

 

 

7,253  

 

7,333

 

 

 

 

 

 

 

Gain (loss) on disposition of operations

 

3  

 

(20

)

 

 

 

 

 

 

Income from operations before income tax expense

 

1,112  

 

742

 

 

 

 

 

 

 

Income tax expense

 

346  

 

218

 

 

 

 

 

 

 

Net income

$  

766  

$  

524

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

Net income per share - Basic

$  

1.54  

$  

0.99

 

Weighted average shares - Basic

 

498.7  

 

531.0

 

Net income per share - Diluted

$  

1.53  

$  

0.98

 

Weighted average shares - Diluted

 

501.5  

 

533.6

 

Cash dividends declared per share

$  

0.22  

$  

0.21

 

 

See notes to condensed consolidated financial statements.

 

1



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

($ in millions)

 

Three Months Ended
March 31,

 

 

2012

 

2011

 

 

(unaudited)

 

 

 

 

(As Adjusted
See Note 1)

Net income

$  

766

$  

524

 

 

 

 

 

 

 

 

 

 

Other comprehensive income, after-tax

 

 

 

 

 

 

 

 

 

Changes in:

 

 

 

 

 

 

 

 

 

Unrealized net capital gains and losses

 

474

 

124

 

 

 

 

 

Unrealized foreign currency translation adjustments

 

9

 

10

 

 

 

 

 

Unrecognized pension and other postretirement benefit cost

 

20

 

15

 

 

 

 

 

Other comprehensive income, after-tax

 

503

 

149

 

 

 

 

 

Comprehensive income

$  

1,269

$  

673

 

See notes to condensed consolidated financial statements.

 

2



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL POSITION

 

($ in millions, except par value data)

 

March 31,
2012

 

December 31,
2011

 

 

(unaudited)

Assets

 

 

 

(As Adjusted

 

Investments

 

 

 

See Note 1)

 

Fixed income securities, at fair value (amortized cost $74,060 and $73,379)

$  

77,223  

$  

76,113

 

Equity securities, at fair value (cost $3,430 and $4,203)

 

3,847  

 

4,363

 

Mortgage loans

 

7,167  

 

7,139

 

Limited partnership interests

 

4,637  

 

4,697

 

Short-term, at fair value (amortized cost $1,886 and $1,291)

 

1,886  

 

1,291

 

Other

 

2,249  

 

2,015

 

Total investments

 

97,009  

 

95,618

 

Cash

 

577  

 

776

 

Premium installment receivables, net

 

4,908  

 

4,920

 

Deferred policy acquisition costs

 

3,716  

 

3,871

 

Reinsurance recoverables, net

 

7,118  

 

7,251

 

Accrued investment income

 

846  

 

826

 

Deferred income taxes

 

201  

 

722

 

Property and equipment, net

 

912  

 

914

 

Goodwill

 

1,242  

 

1,242

 

Other assets

 

2,049  

 

2,069

 

Separate Accounts

 

7,355  

 

6,984

 

Total assets

$  

125,933  

$  

125,193

 

Liabilities

 

 

 

 

 

Reserve for property-liability insurance claims and claims expense

$  

20,283  

$  

20,375

 

Reserve for life-contingent contract benefits

 

14,296  

 

14,406

 

Contractholder funds

 

41,603  

 

42,332

 

Unearned premiums

 

9,888  

 

10,057

 

Claim payments outstanding

 

750  

 

827

 

Other liabilities and accrued expenses

 

6,490  

 

5,978

 

Long-term debt

 

6,058  

 

5,908

 

Separate Accounts

 

7,355  

 

6,984

 

Total liabilities

 

106,723  

 

106,867

 

 

 

 

 

 

 

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, 493 million and 501 million shares outstanding

 

9  

 

9

 

Additional capital paid-in

 

3,151  

 

3,189

 

Retained income

 

32,565  

 

31,909

 

Deferred ESOP expense

 

(41) 

 

(43

)

Treasury stock, at cost (407 million and 399 million shares)

 

(17,034) 

 

(16,795

)

Accumulated other comprehensive income:

 

 

 

 

 

Unrealized net capital gains and losses:

 

 

 

 

 

Unrealized net capital losses on fixed income securities with OTTI

 

(100) 

 

(174

)

Other unrealized net capital gains and losses

 

2,412  

 

2,041

 

Unrealized adjustment to DAC, DSI and insurance reserves

 

(438) 

 

(467

)

Total unrealized net capital gains and losses

 

1,874  

 

1,400

 

Unrealized foreign currency translation adjustments

 

65  

 

56

 

Unrecognized pension and other postretirement benefit cost

 

(1,407) 

 

(1,427

)

Total accumulated other comprehensive income

 

532  

 

29

 

Total shareholders’ equity

 

19,182  

 

18,298

 

Noncontrolling interest

 

28  

 

28

 

Total equity

 

19,210  

 

18,326

 

Total liabilities and equity

$  

125,933  

$  

125,193

 

 

See notes to condensed consolidated financial statements.

 

3



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

($ in millions)

 

Three months ended

March 31,

 

 

2012

 

2011

 

 

(unaudited)

Cash flows from operating activities

 

 

 

(As Adjusted  

See Note 1)  

Net income

$  

766   

$  

524   

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

 

 

 

 

Depreciation, amortization and other non-cash items

 

96   

 

31   

Realized capital gains and losses

 

(168)  

 

(96)  

(Gain) loss on disposition of operations

 

(3)  

 

20   

Interest credited to contractholder funds

 

378   

 

418   

Changes in:

 

 

 

 

Policy benefits and other insurance reserves

 

(346)  

 

(58)  

Unearned premiums

 

(180)  

 

(248)  

Deferred policy acquisition costs

 

52   

 

67   

Premium installment receivables, net

 

19   

 

3   

Reinsurance recoverables, net

 

57   

 

(117)  

Income taxes

 

333   

 

203   

Other operating assets and liabilities

 

(197)  

 

(21)  

Net cash provided by operating activities

 

807   

 

726   

Cash flows from investing activities

 

 

 

 

Proceeds from sales

 

 

 

 

Fixed income securities

 

5,689   

 

8,363   

Equity securities

 

1,059   

 

642   

Limited partnership interests

 

403   

 

113   

Mortgage loans

 

6   

 

26   

Other investments

 

36   

 

63   

Investment collections

 

 

 

 

Fixed income securities

 

966   

 

1,201   

Mortgage loans

 

170   

 

88   

Other investments

 

23   

 

77   

Investment purchases

 

 

 

 

Fixed income securities

 

(7,008)  

 

(10,207)  

Equity securities

 

(128)  

 

(144)  

Limited partnership interests

 

(318)  

 

(334)  

Mortgage loans

 

(216)  

 

(26)  

Other investments

 

(163)  

 

(58)  

Change in short-term investments, net

 

(379)  

 

1,649   

Change in other investments, net

 

(9)  

 

(119)  

Purchases of property and equipment, net

 

(51)  

 

(48)  

Disposition of operations

 

(1)  

 

(1)  

Net cash provided by investing activities

 

79   

 

1,285   

Cash flows from financing activities

 

 

 

 

Proceeds from issuance of long-term debt

 

493   

 

--   

Repayment of long-term debt

 

(350)  

 

--   

Contractholder fund deposits

 

485   

 

596   

Contractholder fund withdrawals

 

(1,299)  

 

(2,122)  

Dividends paid

 

(106)  

 

(107)  

Treasury stock purchases

 

(309)  

 

(305)  

Shares reissued under equity incentive plans, net

 

15   

 

9   

Excess tax benefits on share-based payment arrangements

 

(1)  

 

(3)  

Other

 

(13)  

 

--   

Net cash used in financing activities

 

(1,085)  

 

(1,932)  

Net (decrease) increase in cash

 

(199)  

 

79   

Cash at beginning of period

 

776   

 

562   

Cash at end of period

$  

577   

$  

641   

 

See notes to consolidated financial statements.

 

4


 


 

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, 2012 and for the three-month periods ended March 31, 2012 and 2011 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, 2011.  The results of operations for the interim periods should not be considered indicative of results to be expected for the full year.

 

To conform to the current year presentation, certain amounts in the prior year condensed consolidated financial statements and notes have been reclassified.

 

Adopted 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 insurance contracts.  The guidance specifies that the costs must be directly related to the successful acquisition of insurance contracts.  The guidance also specifies that advertising costs should be included as deferred acquisition costs (“DAC”) only when the direct-response advertising accounting criteria are met.  The Company adopted the new guidance on a retrospective basis as of January 1, 2012.  The cumulative effect of the adoption to shareholders’ equity as of January 1, 2011 was a decrease of $399 million, net of taxes.  The impacts of the retrospective adjustments on previously issued financial statements are summarized in the following table.

 

($ in millions, except per share data)

 

Previously
Reported

 

As
Adjusted

Three months ended March 31, 2011

 

 

 

 

Amortization of DAC

$  

1,051 

$  

984 

Operating costs and expenses

 

838 

 

900 

Loss on disposition of operations

 

(23)

 

(20)

Income tax expense

 

215 

 

218 

Net income

 

519 

 

524 

Net income per share - Basic

 

0.98 

 

0.99 

Net income per share - Diluted

 

0.97 

 

0.98 

As of December 31, 2011

 

 

 

 

DAC

 

4,443 

 

3,871 

Deferred income taxes

 

520 

 

722 

Reserve for life-contingent contract benefits

 

14,449 

 

14,406 

Other liabilities and accrued expenses

 

5,929 

 

5,978 

Retained income

 

32,321 

 

31,909 

Unrealized adjustment to DAC, DSI and insurance reserves

 

(504)

 

(467)

Unrealized foreign currency translation adjustments

 

57 

 

56 

 

In future periods, operating costs and expenses will increase since a lower amount of acquisition costs will be capitalized, which will be partially offset by a decrease in amortization of DAC due to the retrospective reduction of the DAC balance.  The effect of the adoption on net income and related per share amounts for interim periods after

 

5



 

adoption is not determinable since calculations under the historic DAC accounting policy were not continued after adoption.

 

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 criteria requiring an entity to have the ability to repurchase or redeem financial assets on substantially the agreed terms and the collateral maintenance guidance related to that criteria.  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. The adoption of this guidance as of January 1, 2012 had no impact on the Company’s results of operations or 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.  Changes were made to improve consistency in global application.  The guidance is to be applied prospectively for reporting periods beginning after December 15, 2011.  The adoption of this guidance as of January 1, 2012 had no impact on the Company’s results of operations or financial position.

 

Presentation of Comprehensive Income

 

In June and December 2011, the FASB issued guidance amending the presentation of comprehensive income and its components. Under the new guidance, a reporting entity has the option to present comprehensive income in a single continuous statement or in two separate but consecutive statements.  The Company adopted the new guidance in the first quarter of 2012.  The new guidance affects presentation only and therefore had no impact on the Company’s results of operations or financial position.

 

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 impairment is 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 adoption of this guidance as of January 1, 2012 had no impact on the Company’s results of operations or financial position.

 

Pending accounting standard

 

Disclosures about Offsetting Assets and Liabilities for Financial Instruments and Derivative Instruments

 

In December 2011, the FASB issued guidance requiring expanded disclosures, including both gross and net information, for financial instruments and derivative instruments that are either offset in the reporting entity’s financial statements or those that are subject to an enforceable master netting arrangement or similar agreement.  The guidance is effective for reporting periods beginning on or after January 1, 2013 and is to be applied retrospectively.  The new guidance affects disclosures only and will have no impact on the Company’s results of operations or 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 and performance stock awards.

 

6



 

The computation of basic and diluted earnings per share for the three months ended March 31 is presented in the following table.

 

($ in millions, except per share data)

 

2012

 

2011

Numerator:

 

 

 

 

Net income

$  

766

$  

524

 

 

 

 

 

Denominator:

 

 

 

 

Weighted average common shares outstanding

 

498.7

 

531.0

Effect of dilutive potential common shares:

 

 

 

 

Stock options

 

2.0

 

2.2

Restricted stock units and performance stock awards (non-participating)

 

0.8

 

0.4

Weighted average common and dilutive potential common shares outstanding

 

501.5

 

533.6

 

 

 

 

 

Earnings per share - Basic

$  

1.54

$  

0.99

Earnings per share - Diluted

$  

1.53

$  

0.98

 

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 28.5 million and 30.4 million Allstate common shares, with exercise prices ranging from $25.91 to $62.84 and $27.36 to $62.84, were outstanding for the three-month periods ended March 31, 2012 and 2011, respectively, but were not included in the computation of diluted earnings per share in those periods.

 

3.  Supplemental Cash Flow Information

 

Non-cash modifications of certain mortgage loans, fixed income securities, limited partnership interests and other investments, as well as mergers completed with equity securities, totaled $22 million and $53 million for the three months ended March 31, 2012 and 2011, respectively.  Non-cash financing activities include $39 million related to the issuance of Allstate shares for vested restricted stock units for the three months ended March 31, 2012.

 

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 for the three months ended March 31 are as follows:

 

($ in millions)

 

2012

 

2011

Net change in proceeds managed

 

 

 

 

 

 

Net change in short-term investments

$  

(210

)

$  

(351

)

Operating cash flow used

 

(210

)

 

(351

)

Net change in cash

 

(2

)

 

(3

)

Net change in proceeds managed

$  

(212

)

$  

(354

)

 

 

 

 

 

 

 

Net change in liabilities

 

 

 

 

 

 

Liabilities for collateral, beginning of year

$  

(462

)

$  

(484

)

Liabilities for collateral, end of period

 

(674

)

 

(838

)

Operating cash flow provided

$  

212

 

$  

354

 

 

7



 

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

March 31, 2012

 

 

 

 

 

 

 

 

U.S. government and agencies

$

5,259

$

287

$

(5) 

$

5,541

Municipal

 

12,970

 

864

 

(220) 

 

13,614

Corporate

 

43,819

 

2,760

 

(248) 

 

46,331

Foreign government

 

1,794

 

196

 

(1) 

 

1,989

Residential mortgage-backed securities (“RMBS”)

 

3,959

 

126

 

(357) 

 

3,728

Commercial mortgage-backed securities (“CMBS”)

 

1,864

 

63

 

(174) 

 

1,753

Asset-backed securities (“ABS”)

 

4,372

 

108

 

(238) 

 

4,242

Redeemable preferred stock

 

23

 

2

 

--  

 

25

     Total fixed income securities

$

74,060

$

4,406

$

(1,243) 

$

77,223

 

 

 

 

 

 

 

 

 

December 31, 2011

 

 

 

 

 

 

 

 

U.S. government and agencies

$

5,966

$

349

$

--  

$

6,315

Municipal

 

13,634

 

863

 

(256) 

 

14,241

Corporate

 

41,217

 

2,743

 

(379) 

 

43,581

Foreign government

 

1,866

 

216

 

(1) 

 

2,081

RMBS

 

4,532

 

110

 

(521) 

 

4,121

CMBS

 

1,962

 

48

 

(226) 

 

1,784

ABS

 

4,180

 

73

 

(287) 

 

3,966

Redeemable preferred stock

 

22

 

2

 

--  

 

24

     Total fixed income securities

$

73,379

$

4,404

$

(1,670) 

$

76,113

 

Scheduled maturities

 

The scheduled maturities for fixed income securities are as follows as of March 31, 2012:

 

($ in millions)

 

Amortized

 

Fair

 

 

cost

 

value

Due in one year or less

$

4,031

$

4,081

Due after one year through five years

 

20,971

 

21,893

Due after five years through ten years

 

23,172

 

24,703

Due after ten years

 

17,555

 

18,576

 

 

65,729

 

69,253

RMBS and ABS

 

8,331

 

7,970

     Total

$

74,060

$

77,223

 

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.

 

8


 


 

Net investment income

 

Net investment income for the three months ended March 31 is as follows:

 

($ in millions)

 

2012

 

2011

Fixed income securities

$

806  

$

900  

Equity securities

 

21  

 

19  

Mortgage loans

 

93  

 

89  

Limited partnership interests (1)

 

109  

 

10  

Short-term investments

 

1  

 

2  

Other

 

30  

 

11  

     Investment income, before expense

 

1,060  

 

1,031  

     Investment expense

 

(49) 

 

(49) 

          Net investment income

$

1,011  

$

982  

                                                                                                                                                                                                                                                                                               

 

 

 

 

 

(1)  Income from limited partnership interests accounted for under the equity method of accounting (“EMA”) is reported in net investment income in 2012 and realized capital gains and losses in 2011.

 

Realized capital gains and losses

 

Realized capital gains and losses by asset type for the three months ended March 31 are as follows:

 

($ in millions)

 

2012

 

2011

Fixed income securities

$

(29) 

$

(27) 

Equity securities

 

159  

 

122  

Mortgage loans

 

(1) 

 

(6) 

Limited partnership interests (1)

 

10  

 

68  

Derivatives

 

21  

 

(67) 

Other

 

8  

 

6  

     Realized capital gains and losses

$

168  

$

96  

 

 

 

 

 

 

(1)   Income from EMA limited partnerships is reported in net investment income in 2012 and realized capital gains and losses in 2011.

 

Realized capital gains and losses by transaction type for the three months ended March 31 are as follows:

 

($ in millions)

 

2012

 

2011

Impairment write-downs

$

(39) 

$

(114) 

Change in intent write-downs

 

(44) 

 

(69) 

Net other-than-temporary impairment losses recognized in earnings

 

(83) 

 

(183) 

Sales

 

229  

 

283  

Valuation of derivative instruments

 

11  

 

22  

Settlements of derivative instruments

 

11  

 

(89) 

EMA limited partnership income

 

--  

 

63  

Realized capital gains and losses

$

168  

$

96  

 

Gross gains of $115 million and $211 million and gross losses of $90 million and $88 million were realized on sales of fixed income securities during the three months ended March 31, 2012 and 2011, respectively.

 

9



 

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

 

($ in millions)

 

2012

 

2011

 

 

Gross

 

Included
in OCI

 

Net

 

Gross

 

Included
in OCI

 

Net

Fixed income securities:

 

 

 

 

 

 

 

 

 

 

 

 

   Municipal

(1) 

-- 

(1) 

(27) 

(2) 

(29) 

   Corporate

 

(18) 

 

-- 

 

(18) 

 

(5) 

 

1  

 

(4) 

   Foreign government

 

--  

 

-- 

 

--  

 

(1) 

 

--  

 

(1) 

   RMBS

 

(43) 

 

 

(39) 

 

(72) 

 

(25) 

 

(97) 

   CMBS

 

(6) 

 

-- 

 

(6) 

 

(16) 

 

(4) 

 

(20) 

   ABS

 

--  

 

-- 

 

--  

 

(7) 

 

3  

 

(4) 

Total fixed income securities

 

(68) 

 

 

(64) 

 

(128) 

 

(27) 

 

(155) 

Equity securities

 

(16) 

 

-- 

 

(16) 

 

(20) 

 

--  

 

(20) 

Mortgage loans

 

(3) 

 

-- 

 

(3) 

 

(6) 

 

--  

 

(6) 

Limited partnership interests

 

(2) 

 

-- 

 

(2) 

 

(1) 

 

--  

 

(1) 

Other

 

2  

 

-- 

 

2  

 

(1) 

 

--  

 

(1) 

Other-than-temporary impairment losses

 

(87) 

 

 

(83) 

 

(156) 

 

(27) 

 

(183) 

 

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 $225 million and $172 million as of March 31, 2012 and December 31, 2011, 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,
2012

 

December 31,
2011

Municipal

$

(11)

$

(11)

Corporate

 

(35)

 

(35)

RMBS

 

(292)

 

(353)

CMBS

 

(20)

 

(19)

ABS

 

(21)

 

(21)

     Total

$

(379)

$

(439)

 

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
March 31

 

 

2012

 

2011

Beginning balance

$

(944) 

$

(1,046) 

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

 

(20) 

 

(59) 

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

 

(9) 

 

(27) 

Reduction in credit loss for securities disposed or collected

 

146  

 

153  

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

 

7  

 

15  

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

 

--  

 

1  

Ending balance

$

(820) 

$

(963) 

 

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

 

10



 

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.

 

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

March 31, 2012

 

value

 

Gains

 

Losses

 

gains (losses)

Fixed income securities

$

77,223  

$

4,406  

$

(1,243) 

 

$  

3,163  

Equity securities

 

3,847  

 

464  

 

(47) 

 

 

417  

Short-term investments

 

1,886  

 

--  

 

--  

 

 

--  

Derivative instruments (1)

 

(16)  

 

2  

 

(23) 

 

 

(21) 

EMA limited partnerships (2)

 

 

 

 

 

 

 

 

1  

     Unrealized net capital gains and losses, pre-tax

 

 

 

 

 

 

 

 

3,560  

Amounts recognized for:

 

 

 

 

 

 

 

 

 

     Insurance reserves (3)

 

 

 

 

 

 

 

 

(443) 

     DAC and DSI (4)

 

 

 

 

 

 

 

 

(230) 

         Amounts recognized

 

 

 

 

 

 

 

 

(673) 

     Deferred income taxes

 

 

 

 

 

 

 

 

(1,013) 

     Unrealized net capital gains and losses, after-tax

 

 

 

 

 

 

 

$  

1,874  

 

 

 

(1)  Included in the fair value of derivative instruments are $(10) million classified as assets and $6 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, 2011

 

value

 

Gains

 

Losses

 

gains (losses)

Fixed income securities

$

76,113  

$

4,404  

$

(1,670) 

 

$  

2,734  

Equity securities

 

4,363  

 

369  

 

(209) 

 

 

160  

Short-term investments

 

1,291  

 

--  

 

--  

 

 

--  

Derivative instruments (1)

 

(12) 

 

3  

 

(20) 

 

 

(17) 

EMA limited partnerships

 

 

 

 

 

 

 

 

2  

    Unrealized net capital gains and losses, pre-tax

 

 

 

 

 

 

 

 

2,879 

Amounts recognized for:

 

 

 

 

 

 

 

 

 

     Insurance reserves

 

 

 

 

 

 

 

 

(594) 

     DAC and DSI

 

 

 

 

 

 

 

 

(124) 

         Amounts recognized

 

 

 

 

 

 

 

 

(718) 

    Deferred income taxes

 

 

 

 

 

 

 

 

(761) 

    Unrealized net capital gains and losses, after-tax

 

 

 

 

 

 

 

$  

1,400  

 

 

 

(1)  Included in the fair value of derivative instruments are $(5) million classified as assets and $7 million classified as liabilities.

 

11



 

Change in unrealized net capital gains and losses

 

The change in unrealized net capital gains and losses for the three months ended March 31, 2012 is as follows:

 

($ in millions)

 

 

Fixed income securities

429  

Equity securities

 

257  

Derivative instruments

 

(4) 

EMA limited partnerships

 

(1) 

          Total

 

681  

Amounts recognized for:

 

 

     Insurance reserves

 

151  

     DAC and DSI

 

(106) 

         Amounts recognized

 

45  

     Deferred income taxes

 

(252) 

     Increase in unrealized net capital gains and losses

474  

 

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

March 31, 2012

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed income securities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

   U.S. government and agencies

 

16

996

(5) 

 

--

--

--  

(5)  

   Municipal

 

92

 

589

 

(11) 

 

193

 

1,448

 

(209) 

 

(220)  

   Corporate

 

263

 

3,521

 

(82) 

 

95

 

1,208

 

(166) 

 

(248)  

   Foreign government

 

23

 

78

 

(1) 

 

1

 

1

 

--  

 

(1)  

   RMBS

 

337

 

146

 

(3) 

 

267

 

1,089

 

(354) 

 

(357)  

   CMBS

 

28

 

255

 

(27) 

 

61

 

434

 

(147) 

 

(174)  

   ABS

 

58

 

751

 

(14) 

 

97

 

975

 

(224) 

 

(238)  

   Redeemable preferred stock

 

1

 

--

 

--  

 

--

 

--

 

--  

 

--   

        Total fixed income securities

 

818

 

6,336

 

(143) 

 

714

 

5,155

 

(1,100) 

 

(1,243)  

Equity securities

 

852

 

362

 

(42) 

 

62

 

33

 

(5) 

 

(47)  

        Total fixed income and equity securities

 

1,670

6,698

(185) 

 

776

5,188

(1,105) 

(1,290)  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment grade fixed income securities

 

679

5,144

(94) 

 

429

3,190

(472) 

(566)  

Below investment grade fixed income securities

 

139

 

1,192

 

(49) 

 

285

 

1,965

 

(628) 

 

(677)  

        Total fixed income securities

 

818

6,336

(143) 

 

714

5,155

(1,100) 

(1,243)  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2011

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed income securities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

   U.S. government and agencies

 

4

61

--  

 

--

--

--  

--   

   Municipal

 

29

 

135

 

(11) 

 

303

 

1,886

 

(245) 

 

(256)  

   Corporate

 

307

 

3,439

 

(113) 

 

105

 

1,273

 

(266) 

 

(379)  

   Foreign government

 

11

 

85

 

(1) 

 

1

 

1

 

--  

 

(1)  

   RMBS

 

321

 

373

 

(11) 

 

294

 

1,182

 

(510) 

 

(521)  

   CMBS

 

47

 

378

 

(49) 

 

68

 

489

 

(177) 

 

(226)  

   ABS

 

89

 

960

 

(17) 

 

108

 

1,020

 

(270) 

 

(287)  

   Redeemable preferred stock

 

1

 

--

 

--  

 

--

 

--

 

--  

 

--   

        Total fixed income securities

 

809

 

5,431

 

(202) 

 

879

 

5,851

 

(1,468) 

 

(1,670)  

Equity securities

 

1,397

 

2,120

 

(203) 

 

32

 

30

 

(6) 

 

(209)  

        Total fixed income and equity securities

 

2,206

7,551

(405) 

 

911

5,881

(1,474) 

(1,879)  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment grade fixed income securities

 

665

4,480

(145) 

 

555

3,773

(700) 

(845)  

Below investment grade fixed income securities

 

144

 

951

 

(57) 

 

324

 

2,078

 

(768) 

 

(825)  

        Total fixed income securities

 

809

5,431

(202) 

 

879

5,851

(1,468) 

(1,670)  

 

As of March 31, 2012, $505 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 $505 million, $325 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 March 31, 2012, the remaining $785 million 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 $241 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 $785 million, $528 million are related to below investment grade fixed income securities and $16 million are related to equity securities.  Of these amounts, $409 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 March 31, 2012.  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.  Unrealized losses on equity securities are primarily related to temporary equity market fluctuations of securities that are expected to recover.

 

As of March 31, 2012, 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 March 31, 2012, 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 March 31, 2012 and December 31, 2011, the carrying value of equity method limited partnerships totaled $3.36 billion and $3.13 billion, respectively.  The Company recognizes an impairment loss for equity method limited partnerships 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 partnerships for the three months ended March 31, 2012 and 2011.

 

As of March 31, 2012 and December 31, 2011, the carrying value for cost method limited partnerships was $1.28 billion and $1.57 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 limited partnerships for the three months ended March 31, 2012 and 2011 of $2 million and $1 million, 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 March 31, 2012.

 

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.

 

14



 

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)

 

March 31, 2012

 

December 31, 2011

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

289

--

289

345

--

345

1.0 - 1.25

 

1,536

 

44

 

1,580

 

1,527

 

44

 

1,571

1.26 - 1.50

 

1,660

 

23

 

1,683

 

1,573

 

24

 

1,597

Above 1.50

 

3,220

 

168

 

3,388

 

3,214

 

168

 

3,382

    Total non-impaired mortgage loans

6,705

235

6,940

6,659

236

6,895

 

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)

 

March 31,
2012

 

December 31,
2011

Impaired mortgage loans with a valuation allowance

227

244

Impaired mortgage loans without a valuation allowance

 

--

 

--

Total impaired mortgage loans

227

244

Valuation allowance on impaired mortgage loans

60

63

 

The average balance of impaired loans was $236 million and $180 million for the three months ended March 31, 2012 and 2011, respectively.

 

The rollforward of the valuation allowance on impaired mortgage loans for the three months ended March 31 is as follows:

 

($ in millions)

 

2012

 

2011

Beginning balance

63  

84  

Net increase in valuation allowance

 

3  

 

6  

Charge offs

 

(6) 

 

(13) 

Ending balance

60  

77  

 

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

 

($ in millions)

 

March 31,
2012

 

December 31,
2011

Less than 90 days past due

--

--

90 days or greater past due

 

68

 

43

Total past due

 

68

 

43

Current loans

 

7,099

 

7,096

Total mortgage loans

7,167

7,139

 

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 is responsible for the determination of fair value and the supporting assumptions and methodologies.  The Company gains assurance on the overall reasonableness and consistent application of valuation methodologies and inputs and compliance with accounting standards through the execution of various processes and controls designed to provide assurance that our assets and liabilities are appropriately valued.  For fair values received from third parties or internally estimated, the Company’s processes are designed to provide assurance that the valuation methodologies and inputs are appropriate and consistently applied, the assumptions are reasonable and consistent with the objective of determining fair value, and the fair values are accurately recorded,. For example, on a continuing basis, the Company assesses the reasonableness of individual fair values that have stale security prices or that exceed certain thresholds as compared to previous fair values received from valuation service providers or brokers or derived from internal models.  The Company performs procedures to understand and assess the methodologies, processes and controls of valuation service providers.  In addition, the Company may validate the reasonableness of fair values by comparing information obtained from valuation service providers or brokers to other third party valuation sources for selected securities.  The Company performs ongoing price validation procedures such as back-testing of actual sales, which corroborate the various inputs used in internal models to market observable data.  When fair value determinations are expected to be more variable, the Company validates them through reviews by members of management who have relevant expertise and who are independent of those charged with executing investment transactions.

 

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.

 

16



 

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 primarily occurs in the Company’s use of broker quotes to value certain securities where the inputs have not been corroborated to be market observable, and the use of valuation models that use significant non-market observable inputs.

 

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.

 

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.  Certain ABS are valued based on non-binding broker quotes whose inputs have been corroborated to be market observable.

 

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.

 

17



 

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 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”).  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 where the inputs have not been corroborated to be market observable.  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 and where the inputs have not been corroborated to be market observable.

 

·                  Equity securities:  The primary inputs to the valuation include quoted prices or quoted net asset values for identical or similar assets in markets that exhibit less liquidity relative to those markets supporting Level 2 fair value measurements.

 

·                  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.

 

18


 


 

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.

 

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, 2012:

 

($ 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

 

2012

Assets

 

 

 

 

 

 

 

 

 

 

Fixed income securities:

 

 

 

 

 

 

 

 

 

 

U.S. government and agencies

$

3,764

$

1,777

$

-- 

 

 

$

5,541 

Municipal

 

--

 

12,347

 

1,267 

 

 

 

13,614 

Corporate

 

--

 

44,870

 

1,461 

 

 

 

46,331 

Foreign government

 

--

 

1,989

 

-- 

 

 

 

1,989 

RMBS

 

--

 

3,724

 

 

 

 

3,728 

CMBS

 

--

 

1,703

 

50 

 

 

 

1,753 

ABS

 

--

 

3,943

 

299 

 

 

 

4,242 

Redeemable preferred stock

 

--

 

24

 

 

 

 

25 

Total fixed income securities

 

3,764

 

70,377

 

3,082 

 

 

 

77,223 

Equity securities

 

2,984

 

750

 

113 

 

 

 

3,847 

Short-term investments

 

150

 

1,736

 

-- 

 

 

 

1,886 

Other investments:

 

 

 

 

 

 

 

 

 

 

Free-standing derivatives

 

--

 

374

 

$

(103)

 

273 

Separate account assets

 

7,355

 

--

 

-- 

 

 

 

7,355 

Other assets

 

1

 

--

 

 

 

 

Total recurring basis assets

 

14,254

 

73,237

 

3,198 

 

(103)

 

90,586 

Non-recurring basis (1)

 

--

 

--

 

11 

 

 

 

11 

Total assets at fair value

$

14,254

$

73,237

$

3,209 

$

(103)

$

90,597 

% of total assets at fair value

 

15.7 %

 

80.8 %

 

3.6 %

 

(0.1) %

 

100.0 %

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

Contractholder funds:

 

 

 

 

 

 

 

 

 

 

Derivatives embedded in life and annuity contracts

$

--

$

-- 

$

(730)

 

 

$

(730)

Other liabilities:

 

 

 

 

 

 

 

 

 

 

Free-standing derivatives

 

--

 

(160)

 

(72)

$

65

 

(167)

Total liabilities at fair value

$

--

$

(160)

$

(802)

$

65

$

(897)

% of total liabilities at fair value

 

--  %

 

17.8 %

 

89.4 %

 

(7.2) %

 

100.0 %

_______________

(1)  Includes $8 million of mortgage loans and $3 million of limited partnership interests written-down to fair value in connection with recognizing other-than-temporary impairments.

 

19



 

The following table summarizes quantitative information about the significant unobservable inputs used in Level 3 fair value measurements as of March 31, 2012. 

 

($ in millions)

 

Fair
value

 

Valuation technique

 

Unobservable
input

 

Range

 

Weighted
average

ARS backed by student loans

 

$

685  

 

Discounted cash flow model

 

Anticipated date liquidity will return to the market

 

18 - 60 months

 

30 - 42 months

Derivatives embedded in life and annuity contracts – Equity-indexed and forward starting options

 

$

(591) 

 

Stochastic cash flow model

 

Projected option cost

 

1.50 - 3.50%

 

3.35%

 

If the anticipated date liquidity will return to the market is sooner (later), it would result in a higher (lower) fair value.  If the projected option cost increased (decreased), it would result in a higher (lower) liability fair value.

 

As of March 31, 2012, Level 3 fair value measurements include $1.73 billion of fixed income securities valued based on non-binding broker quotes where the inputs have not been corroborated to be market observable and $461 million of municipal fixed income securities that are not rated by third party credit rating agencies.  The Company does not develop the unobservable inputs used in measuring fair value; therefore, these are not included in the table above.  However, an increase (decrease) in credit spreads for fixed income securities valued based on non-binding broker quotes would result in a lower (higher) fair value, and an increase (decrease) in the credit rating of municipal bonds that are not rated by third party credit rating agencies would result in a higher (lower) fair value. 

 

20



 

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, 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
December 31,

 

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

netting

 

2011

Assets

 

 

 

 

 

 

 

 

 

 

Fixed income securities:

 

 

 

 

 

 

 

 

 

 

U.S. government and agencies

$

4,707

$

1,608

$

--

 

 

$

6,315

Municipal

 

--

 

12,909

 

1,332

 

 

 

14,241

Corporate

 

--

 

42,176

 

1,405

 

 

 

43,581

Foreign government

 

--

 

2,081

 

--

 

 

 

2,081

RMBS

 

--

 

4,070

 

51

 

 

 

4,121

CMBS

 

--

 

1,724

 

60

 

 

 

1,784

ABS

 

--

 

3,669

 

297

 

 

 

3,966

Redeemable preferred stock

 

--

 

23

 

1

 

 

 

24

Total fixed income securities

 

4,707

 

68,260

 

3,146

 

 

 

76,113

Equity securities

 

3,433

 

887

 

43

 

 

 

4,363

Short-term investments

 

188

 

1,103

 

--

 

 

 

1,291

Other investments:

 

 

 

 

 

 

 

 

 

 

Free-standing derivatives

 

--

 

281

 

1

$

(114)

 

168

Separate account assets

 

6,984

 

--

 

--

 

 

 

6,984

Other assets

 

1

 

--

 

1

 

 

 

2

Total recurring basis assets

 

15,313

 

70,531

 

3,191

 

(114)

 

88,921

Non-recurring basis (1)

 

--

 

--

 

35

 

 

 

35

Total assets at fair value

$

15,313

$

70,531

$

3,226

$

(114)

$

88,956

% of total assets at fair value

 

17.2 %

 

79.3 %

 

3.6 %

 

(0.1) %

 

100.0 %