9. FAIR VALUE OF FINANCIAL INSTRUMENTS

The carrying amount and estimated fair value of financial instruments are shown below (in thousands):


	September 30, 2012				December 31, 2011
	Carrying		Estimated		Carrying		Estimated
	Amount		Fair Value		Amount		Fair Value
Financial assets
Fixed maturity securities, bonds held-to-maturity
U.S. treasury and other U.S. government corporations and agencies	$	8,503	$	8,595	$	13,704	$	13,897
States of the U.S. and political subdivisions of the states		401,608		443,181		405,526		437,792
Foreign governments		29,064		33,935		29,044		34,022
Corporate debt securities		8,105,733		8,881,773		8,011,901		8,550,744
Residential mortgage-backed securities		602,449		649,445		714,659		761,447
Commercial mortgage-backed securities		—		—		31,341		11,183
Collateralized debt securities		2,504		2,846		7,134		6,116
Other debt securities		38,020		41,442		38,663		42,490

Total bonds held-to-maturity		9,187,881		10,061,217		9,251,972		9,857,691

Fixed maturity securities, bonds available-for-sale
U.S. treasury and other U.S. government corporations and agencies		17,507		17,507		13,086		13,086
States of the U.S. and political subdivisions of the states		625,914		625,914		618,848		618,848
Foreign governments		7,409		7,409		7,435		7,435
Corporate debt securities		3,856,760		3,856,760		3,505,146		3,505,146
Residential mortgage-backed securities		118,386		118,386		202,721		202,721
Commercial mortgage-backed securities		11,341		11,341		—		—
Collateralized debt securities		19,723		19,723		19,077		19,077
Other debt securities		11,537		11,537		15,294		15,294

Total bonds available-for-sale		4,668,577		4,668,577		4,381,607		4,381,607

Equity securities
Common stock		1,059,162		1,059,162		968,907		968,907
Preferred stock		35,225		35,225		37,173		37,173

Total equity securities		1,094,387		1,094,387		1,006,080		1,006,080

Options		88,476		88,476		65,188		65,188
Mortgage loans on real estate, net of allowance		3,058,663		3,297,046		2,925,482		3,178,205
Policy loans		393,774		393,774		393,195		393,195
Short-term investments		321,512		321,512		345,330		345,330
Separate account assets		817,057		817,057		747,867		747,867

Total financial assets	$	19,630,327	$	20,742,046	$	19,116,721	$	19,975,163

Financial liabilities
Investment contracts	$	10,066,103	$	10,066,103	$	9,993,804	$	9,993,804
Embedded derivative liability for equity-indexed annuities		80,324		80,324		63,275		63,275
Notes payable		161,247		161,247		58,894		58,894
Separate account liabilities		817,057		817,057		747,867		747,867

Total financial liabilities	$	11,124,731	$	11,124,731	$	10,863,840	$	10,863,840

Summary

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability. A fair value hierarchy is used to determine fair value based on a hypothetical transaction at the measurement date from the perspective of a market participant. The classification of assets or liabilities within the fair value hierarchy is based on the lowest level of significant input to its valuation. The input levels are defined as follows:

Level 1

Unadjusted quoted prices in active markets for identical assets or liabilities. American National defines active markets based on average trading volume for equity securities. The size of the bid/ask spread is used as an indicator of market activity for fixed maturity securities.

Level 2

Quoted prices in markets that are not active or inputs that are observable directly or indirectly. Level 2 inputs include quoted prices for similar assets or liabilities other than quoted prices in Level 1; quoted prices in markets that are not active; or other inputs that are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3

Unobservable inputs that are supported by little or no market activity and are significant to the fair value of the assets or liabilities. Unobservable inputs reflect American National’s own assumptions about the assumptions that market participants would use in pricing the asset or liability. Level 3 assets and liabilities include financial instruments whose values are determined using pricing models and third-party evaluation, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

American National has evaluated the types of securities in its investment portfolio to determine an appropriate fair value hierarchy level based upon trading activity and the observability of market inputs. Based on the results of this evaluation and investment class analysis, each financial instrument was classified into Level 1, 2, or 3 measurements.

Fixed Maturity Securities and Equity Options

American National utilizes a pricing service to estimate fair value measurements for approximately 99.0% of fixed maturity securities. The pricing service utilizes market quotations for fixed maturity securities that have quoted prices in active markets. Since fixed maturity securities generally do not trade on a daily basis, the pricing service prepares estimates of fair value measurements for these securities using its proprietary pricing applications, which include available relevant market information, benchmark curves, benchmarking of like securities, sector groupings and matrix pricing. Additionally, the pricing service uses an option adjusted spread model to develop prepayment and interest rate scenarios.

The pricing service evaluates each asset class based on relevant market information, relevant credit information, perceived market movements and sector news. The market inputs utilized in the pricing evaluation, listed in the approximate order of priority, include: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, and economic events. The extent of the use of each market input depends on the asset class and the market conditions. Depending on the security, the priority of the use of inputs may change or some market inputs may not be relevant. For some securities, additional inputs may be necessary.

American National has reviewed the inputs and methodology used by the pricing service and the techniques applied by the pricing service to produce quotes that represent the fair value of a specific security. The review of the pricing services’ methodology confirms the service is utilizing information from organized transactions or a technique that represents a market participant’s assumptions. American National does not adjust quotes received from the pricing service. The pricing service utilized by American National has indicated that they will only produce an estimate of fair value if there is objectively verifiable information available.

The fair value estimates of most fixed maturity investments including municipal bonds are based on observable market information rather than market quotes. Accordingly, the estimates of fair value for such fixed maturity securities provided by the pricing service are disclosed as Level 2 measurements.

Additionally, American National holds a small amount of fixed maturity securities that have characteristics that make them unsuitable for matrix pricing. For these fixed maturity securities, a quote from an independent broker (typically a market maker) is obtained. Due to the disclaimers on the quotes that indicate that the price is indicative only, American National includes these fair value estimates in Level 3. The pricing of certain private placement debt also includes significant non-observable inputs, the internally determined credit rating of the security, and an externally provided credit spread, and these securities are classified as Level 3 measurements.

For securities priced using a quote from an independent broker, such as the equity options and certain fixed maturity securities, American National uses a market-based fair value analysis to validate the reasonableness of prices received from an independent broker. Price variances above a certain threshold are analyzed further to determine if any pricing issue exists. This analysis is generally performed on a weekly basis, but no less frequently than on a monthly basis.

Equity Securities

For publicly-traded equity securities, American National receives prices from a nationally recognized pricing service that are based on observable market transactions and these securities are classified as Level 1 measurements. For certain preferred stock, current market quotes in active markets are unavailable. In these instances, American National receives an estimate of fair value from the pricing service. The service utilizes similar methodologies to price preferred stocks as it does for fixed maturity securities. These estimates for equity securities are disclosed as Level 2 measurements.

Mortgage Loans

The fair value of mortgage loans is estimated using discounted cash flow analyses. Fair value is calculated on a loan by loan basis by applying a discount rate to expected cash flows from future installment and balloon payments. The discount rate takes into account general market trends and specific credit risk trends for the individual loan. Factors used to arrive at the discount rate include inputs from spreads based on U.S. Treasury notes and the loan’s credit rating, region, property type, lien number, payment type and current status.

Embedded Derivative

The embedded derivative liability for equity-indexed annuities is measured at fair value. The embedded derivative liability is recalculated each reporting period using equity option pricing models. To validate the assumptions used to price the embedded derivative, American National measures and compares embedded derivative returns against the returns of equity options held to hedge the liability cash flows.

The significant unobservable input used to calculate the fair value of the embedded derivatives is equity option implied volatility. This volatility assumption is the range of implied volatilities that American National has determined market participants would use to price equity options that match the current derivative characteristics of our in-force equity-indexed annuities. Implied volatility can vary by term and strike price. An increase in implied volatility will result in an increase in the value of the equity-indexed annuity embedded derivatives, all other things being equal. At September 30, 2012, the implied volatility used to estimate embedded derivative value ranges from 13.0% to 30.5%.

Other Financial Instruments

For other financial instruments discussed below, American National believes that their carrying value approximates fair value. This assumption is supported by the qualitative information discussed below. These financial instruments are classified as level 3 measurements.

Policy loans – The carrying value of policy loans is equivalent to outstanding balance plus any accrued interest. Due to the collateralized nature of policy loans, unpredictable timing of repayments and the fact that it cannot be separated from the policy contract, American National believes that the carrying value of policy loans approximates fair value.

Investment contracts liability – The carrying value of investment contracts liability is equivalent to the accrued account balance. The accrued account balance consists of deposits, net of withdrawals, plus or minus interest credited, fees and charges assessed and other adjustments. American National believes that the carrying value of investment contracts liability approximates fair value because the majority of these contracts’ interest rates reset to current rates offered at anniversary.

Notes payable – Notes payable are carried at outstanding principal balance. The carrying value of the notes payable approximates fair value because the underlying interest rates approximate market rates at the balance sheet date.

Quantitative Disclosures

The quantitative disclosures regarding fair value hierarchy measurements of the financial instruments are shown below (in thousands):


	Fair Value Measurement as of September 30, 2012 Using:
	Total Estimated Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Financial assets
Fixed maturity securities, bonds held-to-maturity
U.S. treasury and other U.S. government corporations and agencies	$	8,595	$	—	$	8,595	$	—
States of the U.S. and political subdivisions of the states		443,181		—		443,181		—
Foreign governments		33,935		—		33,935		—
Corporate debt securities		8,881,773		—		8,811,273		70,500
Residential mortgage-backed securities		649,445		—		649,443		2
Collateralized debt securities		2,846		—		1		2,845
Other debt securities		41,442		—		34,961		6,481

Total bonds held-to-maturity		10,061,217		—		9,981,389		79,828

Fixed maturity securities, bonds available-for-sale
U.S. treasury and other U.S. government corporations and agencies		17,507		—		17,507		—
States of the U.S. and political subdivisions of the states		625,914		—		623,389		2,525
Foreign governments		7,409		—		7,409		—
Corporate debt securities		3,856,760		—		3,811,608		45,152
Residential mortgage-backed securities		118,386		—		118,382		4
Commercial mortgage-backed securities		11,341		—		—		11,341
Collateralized debt securities		19,723		—		17,788		1,935
Other debt securities		11,537		—		11,537		—

Total bonds available-for-sale		4,668,577		—		4,607,620		60,957

Equity securities
Common stock		1,059,162		1,059,162		—		—
Preferred stock		35,225		35,197		—		28

Total equity securities		1,094,387		1,094,359		—		28

Options		88,476		—		—		88,476
Mortgage loans on real estate		3,297,046		—		3,297,046		—
Policy loans		393,774		—		—		393,774
Short-term investments		321,512		—		321,512		—
Separate account assets		817,057		—		817,057		—

Total financial assets	$	20,742,046	$	1,094,359	$	19,024,624	$	623,063

Financial liabilities
Investment contracts	$	10,066,103	$	—	$	—	$	10,066,103
Embedded derivative liability for equity-indexed annuities		80,324		—		—		80,324
Notes payable		161,247		—		—		161,247
Separate account liabilities		817,057		—		817,057		—

Total financial liabilities	$	11,124,731	$	—	$	817,057	$	10,307,674


	Fair Value Measurement as of December 31, 2011 Using:
	Total Estimated Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Financial assets
Fixed maturity securities, bonds held-to-maturity
U.S. treasury and other U.S. government corporations and agencies	$	13,897	$	—	$	13,897	$	—
States of the U.S. and political subdivisions of the states		437,792		—		437,792		—
Foreign governments		34,022		—		34,022		—
Corporate debt securities		8,550,744		—		8,492,957		57,787
Residential mortgage-backed securities		761,447		—		759,773		1,674
Commercial mortgage-backed securities		11,183		—		—		11,183
Collateralized debt securities		6,116		—		—		6,116
Other debt securities		42,490		—		35,147		7,343

Total bonds held-to-maturity		9,857,691		—		9,773,588		84,103

Fixed maturity securities, bonds available-for-sale
U.S. treasury and other U.S. government corporations and agencies		13,086		—		13,086		—
States of the U.S. and political subdivisions of the states		618,848		—		616,323		2,525
Foreign governments		7,435		—		7,435		—
Corporate debt securities		3,505,146		—		3,492,113		13,033
Residential mortgage-backed securities		202,721		—		202,715		6
Collateralized debt securities		19,077		—		18,826		251
Other debt securities		15,294		—		15,294		—

Total bonds available-for-sale		4,381,607		—		4,365,792		15,815

Equity securities
Common stock		968,907		968,907		—		—
Preferred stock		37,173		37,173		—		—

Total equity securities		1,006,080		1,006,080		—		—

Options		65,188		—		—		65,188
Mortgage loans on real estate		3,178,205		—		3,178,205		—
Policy loans		393,195		—		—		393,195
Short-term investments		345,330		—		345,330		—
Separate account assets		747,867		—		747,867		—

Total financial assets	$	19,975,163	$	1,006,080	$	18,410,782	$	558,301

Financial liabilities
Investment contracts	$	9,993,804	$	—	$	—	$	9,993,804
Embedded derivative liability for equity-indexed annuities		63,275		—		—		63,275
Notes payable		58,894		—		—		58,894
Separate account liabilities		747,867		—		747,867		—

Total financial liabilities	$	10,863,840	$	—	$	747,867	$	10,115,973

For financial instruments measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the period, a reconciliation of the beginning and ending balances is shown below at estimated fair value (in thousands):


	Three months ended September 30,												Nine months ended September 30,
				Equity-			Embedded									Equity-			Embedded
	Investment			Indexed			Derivative						Investment			Indexed			Derivative
	Securities			Options			Liability			Total			Securities			Options			Liability			Total
Beginning balance, 2011	$	76,886		$	71,525		$	(65,025	)	$	83,386		$	90,477		$	66,716		$	(59,644	)	$	97,549
Total realized and unrealized investment gains/losses
Included in other comprehensive income		1,606			—			—			1,606			1,348			—			—			1,348
Net fair value change included in realized gains/losses		—			—			—			—			168			—			—			168
Net gain (loss) for derivatives included in net investment income		—			(23,449	)		—			(23,449	)		—			(18,152	)		—			(18,152	)
Net change included in interest credited		—			—			25,193			25,193			—			—			21,585			21,585
Purchases, sales and settlements or maturities
Purchases		1			5,350			—			5,351			13			14,226			—			14,239
Sales		(257	)		—			—			(257	)		(10,438	)		—			—			(10,438	)
Settlements or maturities		(123	)		(3,719	)		—			(3,842	)		(3,455	)		(13,083	)		—			(16,538	)
Premiums less benefits		—			—			(3,066	)		(3,066	)		—			—			(4,839	)		(4,839	)
Gross transfers into Level 3		—			—			—			—			—			—			—			—

Ending balance, 2011	$	78,113		$	49,707		$	(42,898	)	$	84,922		$	78,113		$	49,707		$	(42,898	)	$	84,922

Beginning balance, 2012	$	141,026		$	77,136		$	(72,194	)	$	145,968		$	99,918		$	65,188		$	(63,275	)	$	101,831
Total realized and unrealized investment gains/losses
Included in other comprehensive income		11,811			—			—			11,811			13,909			—			—			13,909
Net fair value change included in realized gains/losses		(11,431	)		—			—			(11,431	)		(11,449	)		—			—			(11,449	)
Net gain (loss) for derivatives included in net investment income		—			9,708			—			9,708			—			17,878			—			17,878
Net change included in interest credited		—			—			(7,711	)		(7,711	)		—			—			(16,779	)		(16,779	)
Purchases, sales and settlements or maturities
Purchases		(19	)		2,991			—			2,972			504			11,472			—			11,976
Sales		(192	)		(6,062	)		—			(6,254	)		(3,073	)		(6,062	)		—			(9,135	)
Settlements or maturities		(382	)		4,703			—			4,321			(725	)		—			—			(725	)
Premiums less benefits		—			—			(419	)		(419	)		—			—			(270	)		(270	)
Gross transfers into Level 3		—			—			—			—			41,729			—			—			41,729

Ending balance, 2012	$	140,813		$	88,476		$	(80,324	)	$	148,965		$	140,813		$	88,476		$	(80,324	)	$	148,965

Within the net gain (loss) for derivatives included in net investment income were an unrealized gain of $16,334,000 and an unrealized loss of $12,613,000 relating to assets still held at September 30, 2012 and December 31, 2011, respectively.

The transfers into Level 3 were the result of existing securities no longer being priced by the third-party pricing service at the end of the period. American National’s valuation of these securities involves judgment regarding assumptions market participants would use including quotes from independent brokers. The transfers out of Level 3 were securities being priced by a third-party service at the end of the period, using inputs that are observable or derived from market data, which resulted in classification of these assets as Level 2.

There were no transfers between Level 1 and Level 2 fair value hierarchies.