10-Q 1 a14-8819_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, 2014

 

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 22, 2014, the registrant had 433,991,146 common shares, $.01 par value, outstanding.

 



 

THE ALLSTATE CORPORATION

INDEX TO QUARTERLY REPORT ON FORM 10-Q

March 31, 2014

 

PART I

FINANCIAL INFORMATION

PAGE

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

Condensed Consolidated Statements of Operations for the Three-Month Periods Ended March 31, 2014 and 2013 (unaudited)

1

 

 

 

 

Condensed Consolidated Statements of Comprehensive Income for the Three-Month Periods Ended March 31, 2014 and 2013 (unaudited)

2

 

 

 

 

Condensed Consolidated Statements of Financial Position as of March 31, 2014 (unaudited) and December 31, 2013

3

 

 

 

 

Condensed Consolidated Statements of Shareholders’ Equity for the Three-Month Periods Ended March 31, 2014 and 2013 (unaudited)

4

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the Three-Month Periods Ended March 31, 2014 and 2013 (unaudited)

5

 

 

 

 

Notes to Condensed Consolidated Financial Statements (unaudited)

6

 

 

 

 

Report of Independent Registered Public Accounting Firm

44

 

 

 

Item 2.

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

 

 

 

 

 

   Highlights

45

 

   Consolidated Net Income

46

 

   Property-Liability Highlights

46

 

   Allstate Protection Segment

49

 

   Discontinued Lines and Coverages Segment

58

 

   Property-Liability Investment Results

59

 

   Allstate Financial Highlights

60

 

   Allstate Financial Segment

60

 

   Investments Highlights

66

 

   Investments

66

 

   Capital Resources and Liquidity Highlights

73

 

   Capital Resources and Liquidity

73

 

 

 

Item 4.

Controls and Procedures

77

 

 

 

PART II

OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

78

 

 

 

Item 1A.

Risk Factors

78

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

78

 

 

 

Item 6.

Exhibits

79

 



 

PART I.  FINANCIAL INFORMATION

 

ITEM I.  FINANCIAL INFORMATION

 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

($ in millions, except per share data)

 

Three months ended
March 31,

 

 

2014

 

2013

 

 

 

 

 

 

 

(unaudited)

Revenues

 

 

 

 

 

 

Property-liability insurance premiums

$

7,064

 

$

6,770

 

Life and annuity premiums and contract charges

 

607

 

 

579

 

Net investment income

 

959

 

 

983

 

Realized capital gains and losses:

 

 

 

 

 

 

Total other-than-temporary impairment losses

 

(80

)

 

(27

)

Portion of loss recognized in other comprehensive income

 

(1

)

 

(10

)

Net other-than-temporary impairment losses recognized in earnings

 

(81

)

 

(37

)

Sales and other realized capital gains and losses

 

135

 

 

168

 

Total realized capital gains and losses

 

54

 

 

131

 

 

 

8,684

 

 

8,463

 

Costs and expenses

 

 

 

 

 

 

Property-liability insurance claims and claims expense

 

4,759

 

 

4,460

 

Life and annuity contract benefits

 

488

 

 

458

 

Interest credited to contractholder funds

 

307

 

 

345

 

Amortization of deferred policy acquisition costs

 

1,035

 

 

946

 

Operating costs and expenses

 

1,094

 

 

1,102

 

Restructuring and related charges

 

6

 

 

26

 

Interest expense

 

87

 

 

98

 

 

 

7,776

 

 

7,435

 

 

 

 

 

 

 

 

(Loss) gain on disposition of operations

 

(59

)

 

2

 

 

 

 

 

 

 

 

Income from operations before income tax expense

 

849

 

 

1,030

 

 

 

 

 

 

 

 

Income tax expense

 

249

 

 

321

 

 

 

 

 

 

 

 

Net income

 

600

 

 

709

 

 

 

 

 

 

 

 

Preferred stock dividends

 

13

 

 

--

 

 

 

 

 

 

 

 

Net income available to common shareholders

$

587

 

$

709

 

 

 

 

 

 

 

 

Earnings per common share:

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income available to common shareholders per common share - Basic

$

1.31

 

$

1.49

 

 

 

 

 

 

 

 

Weighted average common shares - Basic

 

446.4

 

 

475.4

 

 

 

 

 

 

 

 

Net income available to common shareholders per common share - Diluted

$

1.30

 

$

1.47

 

 

 

 

 

 

 

 

Weighted average common shares - Diluted

 

452.8

 

 

480.8

 

 

 

 

 

 

 

 

Cash dividends declared per common share

$

0.28

 

$

0.25

 

 

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,

 

 

2014

 

2013

 

 

 

(unaudited)

 

 

 

 

 

 

 

Net income

$

600

 

$

709

 

 

 

 

 

 

 

 

Other comprehensive income, after-tax

 

 

 

 

 

 

 

 

 

 

 

 

 

Changes in:

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized net capital gains and losses

 

445

 

 

71

 

 

 

 

 

 

 

 

Unrealized foreign currency translation adjustments

 

(16

)

 

(12

)

 

 

 

 

 

 

 

Unrecognized pension and other postretirement benefit cost

 

11

 

 

45

 

 

 

 

 

 

 

 

Other comprehensive income, after-tax

 

440

 

 

104

 

 

 

 

 

 

 

 

Comprehensive income

$

1,040

 

$

813

 

 

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,
2014

 

December 31,
2013

 

Assets

 

(unaudited)

 

 

 

Investments

 

 

 

 

 

 

Fixed income securities, at fair value (amortized cost $58,587 and $59,008)

$

61,161

 

$

60,910

 

Equity securities, at fair value (cost $4,575 and $4,473)

 

5,297

 

 

5,097

 

Mortgage loans

 

4,472

 

 

4,721

 

Limited partnership interests

 

5,024

 

 

4,967

 

Short-term, at fair value (amortized cost $2,573 and $2,393)

 

2,573

 

 

2,393

 

Other

 

3,163

 

 

3,067

 

Total investments

 

81,690

 

 

81,155

 

 

 

 

 

 

 

 

Cash

 

1,170

 

 

675

 

Premium installment receivables, net

 

5,271

 

 

5,237

 

Deferred policy acquisition costs

 

3,316

 

 

3,372

 

Reinsurance recoverables, net

 

7,512

 

 

7,621

 

Accrued investment income

 

610

 

 

624

 

Property and equipment, net

 

1,024

 

 

1,024

 

Goodwill

 

1,243

 

 

1,243

 

Other assets

 

2,187

 

 

1,937

 

Separate Accounts

 

4,878

 

 

5,039

 

Assets held for sale

 

15,390

 

 

15,593

 

Total assets

$

124,291

 

$

123,520

 

Liabilities

 

 

 

 

 

 

Reserve for property-liability insurance claims and claims expense

$

21,985

 

$

21,857

 

Reserve for life-contingent contract benefits

 

12,435

 

 

12,386

 

Contractholder funds

 

23,989

 

 

24,304

 

Unearned premiums

 

10,821

 

 

10,932

 

Claim payments outstanding

 

785

 

 

631

 

Deferred income taxes

 

886

 

 

635

 

Other liabilities and accrued expenses

 

5,566

 

 

5,156

 

Long-term debt

 

6,200

 

 

6,201

 

Separate Accounts

 

4,878

 

 

5,039

 

Liabilities held for sale

 

14,641

 

 

14,899

 

Total liabilities

 

102,186

 

 

102,040

 

 

 

 

 

 

 

 

Commitments and Contingent Liabilities (Note 12)

 

 

 

 

 

 

Equity

 

 

 

 

 

 

Preferred stock and additional capital paid-in, $1 par value, 25 million shares authorized, 62.2 thousand and 32.3 thousand shares issued and outstanding, $1,555 and $807.5 aggregate liquidation preference

 

1,505

 

 

780

 

Common stock, $.01 par value, 2.0 billion shares authorized and 900 million issued, 434 million and 449 million shares outstanding

 

9

 

 

9

 

Additional capital paid-in

 

3,017

 

 

3,143

 

Retained income

 

36,041

 

 

35,580

 

Deferred ESOP expense

 

(31

)

 

(31

)

Treasury stock, at cost (466 million and 451 million shares)

 

(19,922

)

 

(19,047

)

Accumulated other comprehensive income:

 

 

 

 

 

 

Unrealized net capital gains and losses:

 

 

 

 

 

 

Unrealized net capital gains and losses on fixed income securities with OTTI

 

66

 

 

50

 

Other unrealized net capital gains and losses

 

2,271

 

 

1,698

 

Unrealized adjustment to DAC, DSI and insurance reserves

 

(246

)

 

(102

)

Total unrealized net capital gains and losses

 

2,091

 

 

1,646

 

Unrealized foreign currency translation adjustments

 

22

 

 

38

 

Unrecognized pension and other postretirement benefit cost

 

(627

)

 

(638

)

Total accumulated other comprehensive income

 

1,486

 

 

1,046

 

Total shareholders’ equity

 

22,105

 

 

21,480

 

Total liabilities and shareholders’ equity

$

124,291

 

$

123,520

 

 

See notes to condensed consolidated financial statements.

 

3



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

 

($ in millions) 

 

Three months ended
March 31,

 

 

 

2014

 

2013

 

Preferred stock par value

 

(unaudited)

 

Balance, beginning of period

$

--

 

$

--

 

Preferred stock issuance

 

--

 

 

--

 

Balance, end of period

 

--

 

 

--

 

 

 

 

 

 

 

 

Preferred stock additional capital paid-in

 

 

 

 

 

 

Balance, beginning of period

 

780

 

 

--

 

Preferred stock issuance

 

725

 

 

--

 

Balance, end of period

 

1,505

 

 

--

 

 

 

 

 

 

 

 

Common stock

 

9

 

 

9

 

 

 

 

 

 

 

 

Additional capital paid-in

 

 

 

 

 

 

Balance, beginning of period

 

3,143

 

 

3,162

 

Forward contract on accelerated share repurchase agreement

 

(113

)

 

(75

)

Equity incentive plans activity

 

(13

)

 

(59

)

Balance, end of period

 

3,017

 

 

3,028

 

 

 

 

 

 

 

 

Retained income

 

 

 

 

 

 

Balance, beginning of period

 

35,580

 

 

33,783

 

Net income

 

600

 

 

709

 

Dividends on common stock

 

(126

)

 

(117

)

Dividends on preferred stock

 

(13

)

 

--

 

Balance, end of period

 

36,041

 

 

34,375

 

 

 

 

 

 

 

 

Deferred ESOP expense

 

 

 

 

 

 

Balance, beginning of period

 

(31

)

 

(41

)

Payments

 

--

 

 

2

 

Balance, end of period

 

(31

)

 

(39

)

 

 

 

 

 

 

 

Treasury stock

 

 

 

 

 

 

Balance, beginning of period

 

(19,047

)

 

(17,508

)

Shares acquired

 

(987

)

 

(652

)

Shares reissued under equity incentive plans, net

 

112

 

 

127

 

Balance, end of period

 

(19,922

)

 

(18,033

)

 

 

 

 

 

 

 

Accumulated other comprehensive income

 

 

 

 

 

 

Balance, beginning of period

 

1,046

 

 

1,175

 

Change in unrealized net capital gains and losses

 

445

 

 

71

 

Change in unrealized foreign currency translation adjustments

 

(16

)

 

(12

)

Change in unrecognized pension and other postretirement benefit cost

 

11

 

 

45

 

Balance, end of period

 

1,486

 

 

1,279

 

Total shareholders’ equity

$

22,105

 

$

20,619

 

 

See notes to condensed consolidated financial statements.

 

4



 

THE ALLSTATE CORPORATION AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

($ in millions)

 

Three months ended
March 31,

 

 

 

2014

 

2013

 

Cash flows from operating activities

 

(unaudited)

 

Net income

$

600

 

$

709

 

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

 

 

 

 

 

 

Depreciation, amortization and other non-cash items

 

98

 

 

87

 

Realized capital gains and losses

 

(54

)

 

(131

)

Loss (gain) on disposition of operations

 

59

 

 

(2

)

Interest credited to contractholder funds

 

307

 

 

345

 

Changes in:

 

 

 

 

 

 

Policy benefits and other insurance reserves

 

(18

)

 

(514

)

Unearned premiums

 

(92

)

 

(146

)

Deferred policy acquisition costs

 

3

 

 

(30

)

Premium installment receivables, net

 

(46

)

 

(22

)

Reinsurance recoverables, net

 

(45

)

 

406

 

Income taxes

 

(68

)

 

277

 

Other operating assets and liabilities

 

(270

)

 

(239

)

Net cash provided by operating activities

 

474

 

 

740

 

Cash flows from investing activities

 

 

 

 

 

 

Proceeds from sales

 

 

 

 

 

 

Fixed income securities

 

6,483

 

 

5,474

 

Equity securities

 

1,328

 

 

210

 

Limited partnership interests

 

238

 

 

160

 

Mortgage loans

 

10

 

 

2

 

Other investments

 

30

 

 

15

 

Investment collections

 

 

 

 

 

 

Fixed income securities

 

849

 

 

1,745

 

Mortgage loans

 

324

 

 

237

 

Other investments

 

50

 

 

54

 

Investment purchases

 

 

 

 

 

 

Fixed income securities

 

(6,252

)

 

(6,084

)

Equity securities

 

(1,330

)

 

(317

)

Limited partnership interests

 

(277

)

 

(255

)

Mortgage loans

 

(2

)

 

(75

)

Other investments

 

(243

)

 

(196

)

Change in short-term investments, net

 

189

 

 

(808

)

Change in other investments, net

 

36

 

 

34

 

Purchases of property and equipment, net

 

(55

)

 

(60

)

Disposition of operations

 

(2

)

 

--

 

Net cash provided by investing activities

 

1,376

 

 

136

 

Cash flows from financing activities

 

 

 

 

 

 

Proceeds from issuance of long-term debt

 

--

 

 

492

 

Repayments of long-term debt

 

(1

)

 

--

 

Proceeds from issuance of preferred stock

 

725

 

 

--

 

Contractholder fund deposits

 

403

 

 

591

 

Contractholder fund withdrawals

 

(1,084

)

 

(1,259

)

Dividends paid on common stock

 

(113

)

 

--

 

Dividends paid on preferred stock

 

(12

)

 

--

 

Treasury stock purchases

 

(1,115

)

 

(739

)

Shares reissued under equity incentive plans, net

 

77

 

 

17

 

Excess tax benefits on share-based payment arrangements

 

13

 

 

23

 

Other

 

(6

)

 

13

 

Net cash used in financing activities

 

(1,113

)

 

(862

)

Cash classified as held for sale

 

(242

)

 

--

 

Net increase in cash

 

495

 

 

14

 

Cash at beginning of period

 

675

 

 

806

 

Cash at end of period

$

1,170

 

$

820

 

 

See notes to condensed consolidated financial statements.

 

5



 

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 (the “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, 2014 and for the three-month periods ended March 31, 2014 and 2013 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, 2013.  The results of operations for the interim periods should not be considered indicative of results to be expected for the full year.  All significant intercompany accounts and transactions have been eliminated.

 

Pending accounting standard

 

Accounting for Investments in Qualified Affordable Housing Projects

 

In January 2014, the FASB issued guidance which allows entities that invest in certain qualified affordable housing projects through limited liability entities the option to account for these investments using the proportional amortization method if certain conditions are met.  Under the proportional amortization method, the entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense or benefit.  The guidance is effective for reporting periods beginning after December 15, 2014 and is to be applied retrospectively.  Early adoption is permitted.  The Company is in the process of evaluating the impact of adoption, which is not expected to be material to the Company’s results of operations and financial position.

 

2.  Earnings per Common Share

 

Basic earnings per common share is computed using the weighted average number of common shares outstanding, including unvested participating restricted stock units.  Diluted earnings per common 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 contingently issuable performance stock awards.

 

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

 

($ in millions, except per share data)

 

 

2014

 

 

2013

 

Numerator:

 

 

 

 

 

 

 

 

Net income

 

600

 

709

 

Less: Preferred stock dividends

 

 

13

 

 

--

 

 

Net income available to common shareholders

 

 

587

 

 

709

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

 

446.4

 

 

475.4

 

Effect of dilutive potential common shares:

 

 

 

 

 

 

 

Stock options

 

 

4.4

 

 

3.7

 

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

 

 

2.0

 

 

1.7

 

Weighted average common and dilutive potential common shares outstanding

 

 

452.8

 

 

480.8

 

 

 

 

 

 

 

 

 

Earnings per common share - Basic

 

1.31

 

1.49

 

Earnings per common share - Diluted

 

1.30

 

1.47

 

 

6



 

The effect of dilutive potential common shares does not include the effect of options with an anti-dilutive effect on earnings per common 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 6.7 million and 17.0 million Allstate common shares, with exercise prices ranging from $45.61 to $62.42 and $37.40 to $62.84, were outstanding for the three-month periods ended March 31, 2014 and 2013, respectively, but were not included in the computation of diluted earnings per common share in those periods.

 

3.  Held for Sale Transaction and Subsequent Event

 

On July 17, 2013, the Company entered into a definitive agreement with Resolution Life Holdings, Inc. to sell Lincoln Benefit Life Company (“LBL”), LBL’s life insurance business generated through independent master brokerage agencies, and all of LBL’s deferred fixed annuity and long-term care insurance business.  LBL is reported in the Allstate Financial segment.  This transaction met the criteria for held for sale accounting.  As a result, the related assets and liabilities are included as single line items in the asset and liability sections of the Condensed Consolidated Statements of Financial Position as of March 31, 2014 and December 31, 2013.  The following table summarizes the assets and liabilities held for sale.

 

($ in millions)

 

 

March 31,
2014

 

 

December 31,
2013

 

Assets

 

 

 

 

 

 

 

 

Investments

 

 

 

 

 

 

 

Fixed income securities

 

9,959

 

10,167

 

Mortgage loans

 

 

1,289

 

 

1,367

 

Short-term investments

 

 

--

 

 

160

 

Other investments

 

 

258

 

 

289

 

Total investments

 

 

11,506

 

 

11,983

 

Cash

 

 

242

 

 

--

 

Deferred policy acquisition costs

 

 

714

 

 

743

 

Reinsurance recoverables, net

 

 

1,782

 

 

1,660

 

Accrued investment income

 

 

108

 

 

109

 

Other assets

 

 

85

 

 

79

 

Separate Accounts

 

 

1,661

 

 

1,701

 

Assets held for sale

 

 

16,098

 

 

16,275

 

Less: Loss accrual

 

 

(708)

 

 

(682)

 

Total assets held for sale

 

15,390

 

15,593

 

Liabilities

 

 

 

 

 

 

 

Reserve for life-contingent contract benefits

 

2,000

 

1,894

 

Contractholder funds

 

 

10,661

 

 

10,945

 

Unearned premiums

 

 

11

 

 

12

 

Deferred income taxes

 

 

151

 

 

151

 

Other liabilities and accrued expenses

 

 

157

 

 

196

 

Separate Accounts

 

 

1,661

 

 

1,701

 

Total liabilities held for sale

 

14,641

 

14,899

 

 

Included in shareholders’ equity is $155 million and $85 million of accumulated other comprehensive income related to assets held for sale as of March 31, 2014 and December 31, 2013, respectively.

 

The estimated loss on disposition, excluding any impact of unrealized net capital gains and losses, increased by $61 million, pre-tax, ($18 million, after-tax) in first quarter 2014.

 

On April 1, 2014, the Company closed the sale.  The estimated gross sale price is $796 million, representing $594 million of cash and the retention of tax benefits.  The actual cash proceeds will be based on the actual valuation as of the closing date of April 1, 2014.

 

7



 

4.  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 $49 million and $57 million for the three months ended March 31, 2014 and 2013, respectively.  Non-cash financing activities include $39 million and $87 million related to the issuance of Allstate common shares for vested restricted stock units for the three months ended March 31, 2014 and 2013, respectively.

 

Liabilities for collateral received in conjunction with the Company’s securities lending program and over-the-counter (“OTC”) and cleared 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)

 

2014

 

2013

 

 

Net change in proceeds managed

 

 

 

 

 

Net change in short-term investments

(155)

(25)

 

Operating cash flow used

 

(155)

 

(25)

 

Net change in cash

 

(1)

 

6

 

 

Net change in proceeds managed

(156)

(19)

 

 

 

 

 

 

 

Net change in liabilities

 

 

 

 

 

Liabilities for collateral, beginning of period

(624)

(808)

 

Liabilities for collateral, end of period

 

(780)

 

(827)

 

 

Operating cash flow provided

156

19

 

 

5.  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, 2014

 

 

 

 

 

 

 

 

 

U.S. government and agencies

3,674

135

(3)

3,806

 

Municipal

 

8,295

 

472

 

(51)

 

8,716

 

Corporate

 

39,416

 

1,951

 

(208)

 

41,159

 

Foreign government

 

1,641

 

100

 

(4)

 

1,737

 

Asset-backed securities (“ABS”)

 

3,459

 

71

 

(33)

 

3,497

 

Residential mortgage-backed securities (“RMBS”)

 

1,345

 

114

 

(21)

 

1,438

 

Commercial mortgage-backed securities (“CMBS”)

 

736

 

52

 

(5)

 

783

 

Redeemable preferred stock

 

21

 

4

 

--

 

25

 

Total fixed income securities

58,587

2,899

(325)

61,161

 

 

 

 

 

 

 

 

 

 

 

December 31, 2013

 

 

 

 

 

 

 

 

 

U.S. government and agencies

2,791

129

(7)

2,913

 

Municipal

 

8,446

 

364

 

(87)

 

8,723

 

Corporate

 

39,331

 

1,659

 

(387)

 

40,603

 

Foreign government

 

1,736

 

99

 

(11)

 

1,824

 

ABS

 

4,491

 

71

 

(44)

 

4,518

 

RMBS

 

1,403

 

101

 

(30)

 

1,474

 

CMBS

 

788

 

48

 

(7)

 

829

 

Redeemable preferred stock

 

22

 

4

 

--

 

26

 

Total fixed income securities

59,008

2,475

(573)

60,910

 

 

8



 

Scheduled maturities

 

The scheduled maturities for fixed income securities are as follows as of March 31, 2014:

 

($ in millions)

 

Amortized
cost

 

Fair
value

 

Due in one year or less

3,062

3,105

 

Due after one year through five years

 

25,246

 

26,005

 

Due after five years through ten years

 

16,198

 

16,955

 

Due after ten years

 

8,541

 

9,378

 

 

 

53,047

 

55,443

 

ABS, RMBS and CMBS

 

5,540

 

5,718

 

Total

58,587

61,161

 

 

Actual maturities may differ from those scheduled as a result of calls and make-whole payments by the issuers.  ABS, RMBS and CMBS are shown separately because of the potential for prepayment of principal prior to contractual maturity dates.

 

Net investment income

 

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

 

($ in millions)

 

2014

 

2013

 

Fixed income securities

705

762

 

Equity securities

 

28

 

25

 

Mortgage loans

 

81

 

98

 

Limited partnership interests

 

142

 

107

 

Short-term investments

 

1

 

2

 

Other

 

42

 

37

 

Investment income, before expense

 

999

 

1,031

 

Investment expense

 

(40)

 

(48)

 

Net investment income

959

983

 

 

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)

 

2014

 

2013

 

Fixed income securities

36

72

 

Equity securities

 

22

 

29

 

Mortgage loans

 

3

 

31

 

Limited partnership interests

 

2

 

5

 

Derivatives

 

(12)

 

(4)

 

Other

 

3

 

(2)

 

Realized capital gains and losses

54

131

 

 

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

 

($ in millions)

 

2014

 

2013

 

Impairment write-downs

(16)

(10)

 

Change in intent write-downs

 

(65)

 

(27)

 

Net other-than-temporary impairment losses recognized in earnings

 

(81)

 

(37)

 

Sales

 

147

 

172

 

Valuation of derivative instruments

 

(4)

 

(4)

 

Settlements of derivative instruments

 

(8)

 

--

 

Realized capital gains and losses

54

131

 

 

9



 

Gross gains of $166 million and $183 million and gross losses of $36 million and $21 million were realized on sales of fixed income and equity securities during the three months ended March 31, 2014 and 2013, respectively.

 

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

 

($ in millions)

 

2014

 

2013

 

 

 

Gross

 

Included
in OCI

 

Net

 

Gross

 

Included
in OCI

 

Net

 

Fixed income securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Municipal

(5)

--

(5)

(13)

(2)

(15)

 

ABS

 

(1)

 

--

 

(1)

 

--

 

--

 

--

 

RMBS

 

--

 

(1)

 

(1)

 

--

 

(1)

 

(1)

 

CMBS

 

--

 

--

 

--

 

(19)

 

(7)

 

(26)

 

Total fixed income securities

 

(6)

 

(1)

 

(7)

 

(32)

 

(10)

 

(42)

 

Equity securities

 

(65)

 

--

 

(65)

 

(19)

 

--

 

(19)

 

Mortgage loans

 

4

 

--

 

4

 

26

 

--

 

26

 

Limited partnership interests

 

(13)

 

--

 

(13)

 

--

 

--

 

--

 

Other

 

--

 

--

 

--

 

(2)

 

--

 

(2)

 

Other-than-temporary impairment losses

(80)

(1)

(81)

(27)

(10)

(37)

 

 

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 $279 million and $260 million as of March 31, 2014 and December 31, 2013, 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,
2014

 

December 31,
2013

 

Municipal

(9)

(9)

 

ABS

 

(10)

 

(10)

 

RMBS

 

(147)

 

(152)

 

CMBS

 

(12)

 

(12)

 

Total

(178)

(183)

 

 

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,

 

 

 

2014

 

2013

 

Beginning balance

(513)

(617)

 

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

 

(5)

 

(15)

 

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

 

(1)

 

(15)

 

Reduction in credit loss for securities disposed or collected

 

26

 

47

 

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

 

--

 

--

 

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

 

--

 

--

 

Ending balance (1)

(493)

(600)

 

 

 

 

 

 

(1)

The March 31, 2014 ending balance includes $59 million of cumulative credit losses recognized in earnings for fixed income securities that are classified as held for sale.

 

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

 

10



 

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.

 

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, 2014

 

value

 

Gains

 

Losses

 

gains (losses)

 

Fixed income securities

61,161

2,899

(325)

 

$

2,574

 

Equity securities

 

5,297

 

736

 

(14)

 

 

722

 

Short-term investments

 

2,573

 

--

 

--

 

 

--

 

Derivative instruments (1)

 

(15)

 

1

 

(20)

 

 

(19

)

EMA limited partnerships (2)

 

 

 

 

 

 

 

 

(4

)

Investments classified as held for sale

 

 

 

 

 

 

 

 

327

 

Unrealized net capital gains and losses, pre-tax

 

 

 

 

 

 

 

 

3,600

 

Amounts recognized for:

 

 

 

 

 

 

 

 

 

 

Insurance reserves (3)

 

 

 

 

 

 

 

 

(134

)

DAC and DSI (4)

 

 

 

 

 

 

 

 

(245

)

Amounts recognized

 

 

 

 

 

 

 

 

(379

)

Deferred income taxes

 

 

 

 

 

 

 

 

(1,130

)

Unrealized net capital gains and losses, after-tax

 

 

 

 

 

 

 

$

2,091

 

 

 

 

 

(1)

Included in the fair value of derivative instruments are $1 million classified as assets and $16 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.

 

 

11



 

($ in millions)

 

Fair

 

Gross unrealized

 

Unrealized net

 

December 31, 2013

 

value

 

Gains

 

Losses

 

gains (losses)

 

Fixed income securities

60,910

2,475

(573)

 

$

1,902

 

Equity securities

 

5,097

 

658

 

(34)

 

 

624

 

Short-term investments

 

2,393

 

--

 

--

 

 

--

 

Derivative instruments (1)

 

(13)

 

1

 

(19)

 

 

(18

)

EMA limited partnerships

 

 

 

 

 

 

 

 

(3

)

Investments classified as held for sale

 

 

 

 

 

 

 

 

190

 

Unrealized net capital gains and losses, pre-tax

 

 

 

 

 

 

 

 

2,695

 

Amounts recognized for:

 

 

 

 

 

 

 

 

 

 

Insurance reserves

 

 

 

 

 

 

 

 

--

 

DAC and DSI

 

 

 

 

 

 

 

 

(158

)

Amounts recognized

 

 

 

 

 

 

 

 

(158

)

Deferred income taxes

 

 

 

 

 

 

 

 

(891

)

Unrealized net capital gains and losses, after-tax

 

 

 

 

 

 

 

$

1,646

 

 

 

 

(1)

Included in the fair value of derivative instruments are $1 million classified as assets and $14 million classified as liabilities.

 

Change in unrealized net capital gains and losses

 

The change in unrealized net capital gains and losses for the three months ended March 31, 2014 is as follows:

 

($ in millions)

 

 

 

 

Fixed income securities

 

672

 

Equity securities

 

 

98

 

Derivative instruments

 

 

(1

)

EMA limited partnerships

 

 

(1

)

Investments classified as held for sale

 

 

137

 

Total

 

 

905

 

Amounts recognized for:

 

 

 

 

Insurance reserves

 

 

(134

)

DAC and DSI

 

 

(87

)

Amounts recognized

 

 

(221

)

Deferred income taxes

 

 

(239

)

Increase in unrealized net capital gains and losses, after-tax

 

445

 

 

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

 

12



 

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 fixed income and equity securities managed by third parties, either the Company has contractually retained its decision making authority as it pertains to selling securities that are in an unrealized loss position or it recognizes any unrealized loss at the end of the period through a charge to earnings.

 

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.

 

13



 

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, 2014

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed income securities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government and agencies

 

23

1,335

(3)

 

--

--

--

(3

)

Municipal

 

252

 

1,646

 

(18)

 

35

 

183

 

(33)

 

(51

)

Corporate

 

513

 

7,310

 

(141)

 

54

 

541

 

(67)

 

(208

)

Foreign government

 

13

 

110

 

(2)

 

2

 

25

 

(2)

 

(4

)

ABS

 

35

 

639

 

(6)

 

31

 

303

 

(27)

 

(33

)

RMBS

 

127

 

146

 

(2)

 

167

 

200

 

(19)

 

(21

)

CMBS

 

7

 

28

 

--

 

5

 

41

 

(5)

 

(5

)

Total fixed income securities

 

970

 

11,214

 

(172)

 

294

 

1,293

 

(153)

 

(325

)

Equity securities

 

14

 

464

 

(14)

 

--

 

--

 

--

 

(14

)

Total fixed income and equity securities

 

984

$  

11,678

(186)

 

294

1,293

(153)

(339

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment grade fixed income securities

 

871

10,432

(158)

 

210

848

(91)

(249

)

Below investment grade fixed income securities

 

99

 

782

 

(14)

 

84

 

445

 

(62)

 

(76

)

Total fixed income securities

 

970

11,214

(172)

 

294

1,293

(153)

(325

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2013

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed income securities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government and agencies

 

22

700

(7)

 

--

--

--

(7

)

Municipal

 

315

 

2,065

 

(41)

 

38

 

208

 

(46)

 

(87

)

Corporate

 

796

 

10,375

 

(308)

 

54

 

550

 

(79)

 

(387

)

Foreign government

 

36

 

262

 

(9)

 

1

 

18

 

(2)

 

(11

)

ABS

 

85

 

1,715

 

(10)

 

43

 

429

 

(34)

 

(44

)

RMBS

 

134

 

149

 

(4)

 

175

 

247

 

(26)

 

(30

)

CMBS

 

8

 

22

 

--

 

7

 

52

 

(7)

 

(7

)

Total fixed income securities

 

1,396

 

15,288

 

(379)

 

318

 

1,504

 

(194)

 

(573

)

Equity securities

 

158

 

982

 

(34)

 

1

 

--

 

--

 

(34

)

Total fixed income and equity securities

 

1,554

16,270

(413)

 

319

1,504

(194)

(607

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment grade fixed income securities

 

1,217

14,019

(340)

 

221

975

(116)

(456

)

Below investment grade fixed income securities

 

179

 

1,269

 

(39)

 

97

 

529

 

(78)

 

(117

)

Total fixed income securities

 

1,396

15,288

(379)

 

318

1,504

(194)

(573

)

 

As of March 31, 2014, $279 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 $279 million, $212 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 Standards and Poor’s (“S&P”), Fitch, Dominion, Kroll 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 increasing risk-free interest rates or widening credit spreads since the time of initial purchase.

 

As of March 31, 2014, the remaining $60 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 $37 million of these unrealized losses were evaluated based on factors such as discounted 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 $60 million, $22 million are related to below investment grade fixed income securities and $1 million are related to equity securities.  Of these amounts, $10 million are related to below investment grade fixed income securities that 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, 2014.

 

ABS, RMBS and CMBS 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

 

14



 

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 ABS and RMBS 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, 2014, 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, 2014, 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, 2014 and December 31, 2013, the carrying value of equity method limited partnerships totaled $3.68 billion and $3.52 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, 2014 and 2013.

 

As of March 31, 2014 and December 31, 2013, the carrying value for cost method limited partnerships was $1.35 billion and $1.44 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 $13 million of write-downs related to cost method limited partnerships for the three months ended March 31, 2014.  The Company had no write-downs related to cost method limited partnerships for the three months ended March 31, 2013.

 

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.  Valuation allowances are adjusted for subsequent changes in the fair value of the collateral less costs to sell.  Mortgage loans are charged off against their corresponding valuation allowances 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, 2014.

 

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.

 

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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, 2014

 

December 31, 2013

 

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

179

--

179

153

--

153

 

1.0 - 1.25

 

597

 

--

 

597

 

613

 

--

 

613

 

1.26 - 1.50

 

1,184

 

2

 

1,186

 

1,233

 

2

 

1,235

 

Above 1.50

 

2,433

 

63

 

2,496

 

2,562

 

77

 

2,639

 

Total non-impaired mortgage loans

4,393

65

4,458

4,561

79

4,640

 

 

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, 
2014

 

December 31,
2013

 

Impaired mortgage loans with a valuation allowance

14

81

 

Impaired mortgage loans without a valuation allowance

 

--

 

--

 

Total impaired mortgage loans

14

81

 

Valuation allowance on impaired mortgage loans

9

21

 

 

The average balance of impaired loans was $48 million and $99 million for the three months ended March 31, 2014 and 2013, respectively.

 

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

 

($ in millions)

 

2014

 

2013

 

Beginning balance

21 

42 

 

Net decrease in valuation allowance

 

(4)

 

(26)

 

Charge offs

 

(8)

 

(1)

 

Ending balance

15 

 

 

Payments on all mortgage loans were current as of March 31, 2014 and December 31, 2013.

 

6.  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;

 

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(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 that assets and liabilities are appropriately valued through the execution of various processes and controls designed to ensure the overall reasonableness and consistent application of valuation methodologies, including inputs and assumptions, and compliance with accounting standards.  For fair values received from third parties or internally estimated, the Company’s processes and controls are designed to ensure that the valuation methodologies are appropriate and consistently applied, the inputs and 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.

 

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.

 

17



 

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 certain U.S. Treasury fixed income securities.  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 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.

 

·      Assets held for sale:  Comprise U.S. Treasury fixed income securities, short-term investments and separate account assets.  The valuation is based on the respective asset type as described above.

 

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.

 

ABS and RMBS:  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.

 

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.

 

18



 

·      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.

 

·      Assets held for sale:  Comprise U.S. government and agencies, municipal, corporate, foreign government, ABS, RMBS and CMBS fixed income securities, and short-term investments.  The valuation is based on the respective asset type as described above.

 

Level 3 measurements

 

·      Fixed income securities:

 

Municipal:  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.  Also includes auction rate securities (“ARS”) primarily backed by student loans that have become illiquid due to failures in the auction market and 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 the anticipated date liquidity will return to the market.

 

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.

 

ABS, RMBS and CMBS:  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, 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.

 

·      Assets held for sale:  Comprise municipal, corporate, ABS and CMBS fixed income securities.  The valuation is based on the respective asset type as described above.

 

·      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.

 

·      Liabilities held for sale:  Comprise derivatives embedded in life and annuity contracts.  The valuation is the same as described above for contractholder funds.

 

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

 

19



 

connection with recognizing other-than-temporary impairments are valued using net asset values.  The carrying value of the LBL business was written-down to fair value in connection with being classified as held for sale.