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AEL_10Q 063011


FORM 10-Q
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2011
o 
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 : 001-31911
American Equity Investment Life Holding Company
(Exact name of registrant as specified in its charter)
Iowa
 
42-1447959
(State of Incorporation)
 
(I.R.S. Employer Identification No.)
 
 
 
6000 Westown Parkway
West Des Moines, Iowa
 
50266
(Address of principal executive offices)
 
(Zip Code)
 
 
 
Registrant's telephone number, including area code
 
(515) 221-0002
 
 
(Telephone)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Name of each exchange on which registered
Common Stock, par value $1
 
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $1
Indicate by check mark whether the registrant (1) has filed all documents and reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or 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 o
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 o No o
Indicate by check mark whether the registrant is a large accelerated filed, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o
 
Accelerated filer x
Non-accelerated filer o
 
Smaller reporting company o
(Do not check if a 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 o No x
APPLICABLE TO CORPORATE ISSUERS:
Shares of common stock outstanding at July 31, 2011: 59,574,989


TABLE OF CONTENTS
 
Page
 
 
 
 
 
 





PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
 
June 30, 2011
 
December 31, 2010
 
(Unaudited)
 
 
Assets
 
 
 
Investments:
 
 
 
Fixed maturity securities:
 
 
 
Available for sale, at fair value (amortized cost: 2011 - $15,323,420; 2010 - $15,621,894)
$
15,682,872

 
$
15,830,663

Held for investment, at amortized cost (fair value: 2011 - $2,124,918; 2010 - $781,748)
2,135,968

 
822,200

Equity securities, available for sale, at fair value (cost: 2011 - $59,196; 2010 - $61,185)
66,612

 
65,961

Mortgage loans on real estate
2,798,233

 
2,598,641

Derivative instruments
537,920

 
479,786

Other investments
26,030

 
19,680

Total investments
21,247,635

 
19,816,931

 
 
 
 
Cash and cash equivalents
949,484

 
597,766

Coinsurance deposits
2,699,158

 
2,613,191

Accrued investment income
215,457

 
167,645

Deferred policy acquisition costs
1,825,392

 
1,747,760

Deferred sales inducements
1,326,984

 
1,227,328

Deferred income taxes
185,152

 
143,253

Income taxes recoverable
9,442

 
6,134

Other assets
108,067

 
106,755

Total assets
$
28,566,771

 
$
26,426,763

 
 
 
 
Liabilities and Stockholders' Equity
 
 
 
Liabilities:
 
 
 
Policy benefit reserves
$
25,940,513

 
$
23,655,807

Other policy funds and contract claims
318,420

 
222,860

Notes payable
337,239

 
330,835

Subordinated debentures
268,512

 
268,435

Other liabilities
662,555

 
1,010,779

Total liabilities
27,527,239

 
25,488,716

 
 
 
 
Stockholders' equity:
 
 
 
Preferred stock, no par value, 2,000,000 shares authorized, 2011 and 2010 no shares issued and oustanding
—

 
—

Common stock, par value $1 per share, 125,000,000 shares authorized; issued and outstanding:
2011 - 57,832,075 shares (excluding 5,568,860 treasury shares); 2010 - 56,968,446 shares (excluding 5,874,392 treasury shares)
57,832

 
56,968

Additional paid-in capital
463,245

 
454,454

Unallocated common stock held by ESOP; 2011 - 395,859 shares; 2010 - 447,048 shares
(4,264
)
 
(4,815
)
Accumulated other comprehensive income
123,482

 
81,820

Retained earnings
399,237

 
349,620

Total stockholders' equity
1,039,532

 
938,047

Total liabilities and stockholders' equity
$
28,566,771

 
$
26,426,763


See accompanying notes to unaudited consolidated financial statements.

2


AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except per share data)
(Unaudited)

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2011
 
2010
 
2011
 
2010
Revenues:
 
 
 
 
 
 
 
Traditional life and accident and health insurance premiums
$
3,289

 
$
2,643

 
$
6,205

 
$
5,930

Annuity product charges
19,892

 
18,617

 
36,854

 
34,135

Net investment income
296,878

 
254,845

 
589,006

 
497,755

Change in fair value of derivatives
(22,029
)
 
(208,737
)
 
126,624

 
(126,722
)
Net realized gains (losses) on investments, excluding other than temporary impairment ("OTTI") losses
(854
)
 
1,063

 
(2,047
)
 
10,966

OTTI losses on investments:
 
 
 
 
 
 
 
Total OTTI losses
(113
)
 
(1,603
)
 
(5,213
)
 
(14,187
)
Portion of OTTI losses recognized in (from) other comprehensive income
(2,116
)
 
785

 
(3,587
)
 
10,146

Net OTTI losses recognized in operations
(2,229
)
 
(818
)
 
(8,800
)
 
(4,041
)
Loss on extinguishment of debt
—

 
(292
)
 
—

 
(292
)
Total revenues
294,947

 
67,321

 
747,842

 
417,731

 
 
 
 
 
 
 
 
Benefits and expenses:
 
 
 
 
 
 
 
Insurance policy benefits and change in future policy benefits
2,499

 
2,169

 
4,394

 
4,501

Interest sensitive and index product benefits
238,420

 
228,818

 
398,085

 
425,687

Amortization of deferred sales inducements
20,265

 
3,243

 
50,957

 
16,332

Change in fair value of embedded derivatives
(60,963
)
 
(190,211
)
 
67,340

 
(126,336
)
Interest expense on notes payable
7,832

 
4,673

 
15,739

 
9,324

Interest expense on subordinated debentures
3,481

 
3,716

 
6,947

 
7,401

Interest expense on amounts due under repurchase agreements
1

 
—

 
5

 
—

Amortization of deferred policy acquisition costs
38,862

 
917

 
94,085

 
28,185

Other operating costs and expenses
16,634

 
16,702

 
34,108

 
32,687

Total benefits and expenses
267,031

 
70,027

 
671,660

 
397,781

Income (loss) before income taxes
27,916

 
(2,706
)
 
76,182

 
19,950

Income tax expense (benefit)
9,642

 
(1,202
)
 
26,565

 
6,569

Net income (loss)
$
18,274

 
$
(1,504
)
 
$
49,617

 
$
13,381

 
 
 
 
 
 
 
 
Earnings (loss) per common share
$
0.31

 
$
(0.03
)
 
$
0.84

 
$
0.23

Earnings (loss) per common share - assuming dilution
$
0.28

 
$
(0.03
)
 
$
0.77

 
$
0.23


See accompanying notes to unaudited consolidated financial statements.
 


3


AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Dollars in thousands, except per share data)
(Unaudited)

 
Common
Stock
 
Additional
Paid-in
Capital
 
Unallocated
Common
Stock Held
by ESOP
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Retained
Earnings
 
Total
Stockholders'
Equity
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2010
$
56,968

 
$
454,454

 
$
(4,815
)
 
$
81,820

 
$
349,620

 
$
938,047

Other comprehensive income:
 
 
 
 
 
 
 
 
 
 
 
Net income for period
—

 
—

 
—

 
—

 
49,617

 
49,617

Change in net unrealized investment gains/losses
—

 
—

 
—

 
40,687

 
—

 
40,687

Noncredit component of OTTI losses, available for sale securities, net
—

 
—

 
—

 
975

 
—

 
975

Other comprehensive income
 
 
 
 
 
 
 
 
 
 
91,279

Acquisition of 500 shares of common stock
—

 
(6
)
 
—

 
—

 
—

 
(6
)
Allocation of 51,189 shares of common stock by ESOP, including excess income tax benefits
—

 
69

 
551

 
—

 
—

 
620

Share-based compensation, including excess income tax benefits
—

 
5,229

 
—

 
—

 
—

 
5,229

Issuance of 864,129 shares of common stock under compensation plans, including excess income tax benefits
864

 
3,499

 
—

 
—

 
—

 
4,363

Balance at June 30, 2011
$
57,832

 
$
463,245

 
$
(4,264
)
 
$
123,482

 
$
399,237

 
$
1,039,532

 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2009
$
56,203

 
$
422,225

 
$
(5,679
)
 
$
(30,456
)
 
$
312,330

 
$
754,623

Other comprehensive income:
 
 
 
 
 
 
 
 
 
 
 
Net income for period
—

 
—

 
—

 
—

 
13,381

 
13,381

Change in net unrealized investment gains/losses
—

 
—

 
—

 
146,867

 
—

 
146,867

Noncredit component of OTTI losses, available for sale securities, net
—

 
—

 
—

 
(2,762
)
 
—

 
(2,762
)
Other comprehensive income
 
 
 
 
 
 
 
 
 
 
157,486

Conversion of $60 of subordinated debentures
7

 
49

 
—

 
—

 
—

 
56

Acquisition of 6,300 shares of common stock
(6
)
 
(44
)
 
—

 
—

 
—

 
(50
)
Allocation of 29,745 shares of common stock by ESOP, including excess income tax benefits
—

 
(27
)
 
321

 
—

 
—

 
294

Share-based compensation, including excess income tax benefits
—

 
4,150

 
—

 
—

 
—

 
4,150

Issuance of 377,215 shares of common stock under compensation plans, including excess income tax benefits
377

 
1,546

 
—

 
—

 
—

 
1,923

Other
—

 
—

 
—

 
—

 
(13
)
 
(13
)
Balance at June 30, 2010
$
56,581

 
$
427,899

 
$
(5,358
)
 
$
113,649

 
$
325,698

 
$
918,469


See accompanying notes to unaudited consolidated financial statements.

4


AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)

 
Six Months Ended June 30,
 
2011
 
2010
Operating activities
 
 
 
Net income
$
49,617

 
$
13,381

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Interest sensitive and index product benefits
398,085

 
425,687

Amortization of deferred sales inducements
50,957

 
16,332

Annuity product charges
(36,854
)
 
(34,135
)
Change in fair value of embedded derivatives
67,340

 
(126,336
)
Increase in traditional life and accident and health insurance reserves
45,720

 
11,616

Policy acquisition costs deferred
(222,358
)
 
(155,813
)
Amortization of deferred policy acquisition costs
94,085

 
28,185

Provision for depreciation and other amortization
9,292

 
4,744

Amortization of discounts and premiums on investments
(78,582
)
 
(122,658
)
Realized gains on investments and net OTTI losses recognized
10,847

 
(6,925
)
Change in fair value of derivatives
(127,799
)
 
125,469

Deferred income taxes
(64,332
)
 
(68,812
)
Loss on extinguishment of debt
—

 
292

Share-based compensation
4,181

 
3,975

Change in accrued investment income
(47,812
)
 
637

Change in income taxes recoverable/payable
(3,308
)
 
118,267

Change in other assets
2,182

 
6,641

Change in other policy funds and contract claims
95,560

 
34,767

Change in collateral held for derivatives
12,910

 
(244,816
)
Change in other liabilities
(74,889
)
 
(16,479
)
Other
703

 
255

Net cash provided by operating activities
185,545

 
14,274

 
 
 
 
Investing activities
 
 
 
Sales, maturities, or repayments of investments:
 
 
 
Fixed maturity securities - available for sale
3,244,966

 
2,038,295

Fixed maturity securities - held for investment
—

 
892,464

Equity securities - available for sale
2,958

 
23,020

Mortgage loans on real estate
86,079

 
53,277

Derivative instruments
275,473

 
307,799

Other investments
57

 
—

Acquisition of investments:
 
 
 
Fixed maturity securities - available for sale
(3,189,624
)
 
(3,641,409
)
Fixed maturity securities - held for investment
(1,279,831
)
 
—

Equity securities - available for sale
—

 
(10,125
)
Mortgage loans on real estate
(296,884
)
 
(137,301
)
Derivative instruments
(189,759
)
 
(156,318
)
Other investments
(1,660
)
 
(81
)
Purchases of property, furniture and equipment
(3,552
)
 
(4,985
)
Net cash used in investing activities
(1,351,777
)
 
(635,364
)

5


AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Dollars in thousands)
(Unaudited)

 
Six Months Ended June 30,
 
2011
 
2010
Financing activities
 
 
 
Receipts credited to annuity policyholder account balances
$
2,450,646

 
$
1,893,642

Coinsurance deposits
(37,196
)
 
(158,442
)
Return of annuity policyholder account balances
(898,472
)
 
(788,938
)
Financing fees incurred and deferred
(1,566
)
 
—

Repayments of notes payable
—

 
(6,641
)
Acquisition of common stock
(6
)
 
(50
)
Excess tax benefits realized from share-based compensation plans
1,117

 
250

Proceeds from issuance of common stock
4,255

 
1,864

Change in checks in excess of cash balance
(828
)
 
(3,222
)
Net cash provided by financing activities
1,517,950

 
938,463

Increase in cash and cash equivalents
351,718

 
317,373

 
 
 
 
Cash and cash equivalents at beginning of period
597,766

 
528,002

Cash and cash equivalents at end of period
$
949,484

 
$
845,375

 
 
 
 
Supplemental disclosures of cash flow information
 
 
 
Cash paid during period for:
 
 
 
Interest expense
$
15,210

 
$
12,983

Income taxes
93,200

 
56,488

Income tax refunds received
—

 
100,000

Non-cash operating activity:
 
 
 
Deferral of sales inducements
189,200

 
151,079

Non-cash investing activity:
 
 
 
Real estate acquired in satisfaction of mortgage loans
6,308

 
4,300

Mortgage loan on real estate sold
1,215

 
—

Non-cash financing activities:
 
 
 
Conversion of subordinated debentures
—

 
56


See accompanying notes to unaudited consolidated financial statements.
 

6


AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2011
(Unaudited)

1. Significant Accounting Policies
Consolidation and Basis of Presentation
The accompanying consolidated financial statements of American Equity Investment Life Holding Company (“we”, “us” or “our”) have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and notes required by GAAP for complete financial statements. The consolidated financial statements reflect all adjustments, consisting only of normal recurring items, which are necessary to present fairly our financial position and results of operations on a basis consistent with the prior audited consolidated financial statements. Operating results for the three and six month periods ended June 30, 2011 are not necessarily indicative of the results that may be expected for the year ended December 31, 2011. All significant intercompany accounts and transactions have been eliminated. The preparation of financial statements requires the use of management estimates. For further information related to a description of areas of judgment and estimates and other information necessary to understand our financial position and results of operations, refer to the audited consolidated financial statements and notes included in our Annual Report on Form 10-K for the year ended December 31, 2010.
During 2011, we discovered a prior period error related to policy benefit reserves for our single premium immediate annuity products. Accordingly, we made an adjustment in the first quarter of 2011 which resulted in a decrease of policy benefit reserves and a decrease in interest sensitive and index product benefits of $4.2 million. On an after-tax basis, the adjustment resulted in a $2.7 million increase in net income for the six months ended June 30, 2011.
Adopted Accounting Pronouncements
In January 2010, the Financial Accounting Standards Board ("FASB") issued an accounting standards update that expands the disclosure requirements related to fair value measurements. A reporting entity is now required to present on a gross basis rather than as one net number information about the purchases, sales, issuances and settlements of financial instruments that are categorized as Level 3 for fair value measurements. Clarification on existing disclosure requirements is also provided in this update relating to the level of disaggregation of information as to determining appropriate classes of assets and liabilities as well as disclosure requirements regarding valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. This standard was effective for us on January 1, 2011, and has not had a material impact on our consolidated financial statements.
New Accounting Pronouncements
In October 2010, as a result of a consensus of the FASB Emerging Issues Task Force, the FASB issued an accounting standards update that modifies the definition of the types of costs incurred that can be capitalized in the acquisition of new and renewal insurance contracts. This guidance defines the costs that qualify for deferral as incremental direct costs that result directly from and are essential to successful contract transactions and would not have been incurred by the insurance entity had the contract transactions not occurred. In addition, it lists certain costs as deferrable as those that are directly related to underwriting, policy issuance and processing, medical and inspection, and sales force contract selling as deferrable, as well as the portion of an employee's total compensation related directly to time spent performing those activities for actual acquired contracts and other costs related directly to those activities that would not have been incurred if the contract had not been acquired. This amendment to current GAAP should be applied prospectively and is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011, with retrospective application permitted. We are currently evaluating the impact of the guidance on our consolidated financial statements. See note 6 to our audited consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2010, for the policy issue costs that could be subject to non-deferral.
In April 2011, the FASB issued an accounting standards update that gives creditors guidance in determining whether a creditor has granted a concession and whether a debtor is experiencing financial difficulties for purposes of determining whether a restructuring constitutes a troubled debt restructuring. Troubled debt restructures are considered impaired receivables for which an amount of impairment loss is determined at the time the loan is restructured. This accounting standards update is effective for us beginning on July 1, 2011, and will be applied retrospectively to restructures that we have completed on or after January 1, 2011. We do not expect this guidance to have a material effect on our financial statements.

7


In May 2011, the FASB issued an accounting standards update that addresses fair value measurement and disclosure as part of its convergence efforts with the International Accounting Standards Board. The result is common fair value measurement and disclosure requirements in GAAP and International Financial Reporting Standards. This accounting standards update changes the wording used to describe many of the requirements in GAAP for measuring fair value and for disclosing information about fair value measurements. Some changes clarify the FASB's intent about the application of existing fair value measurement requirements. Other amendments change a particular principle or requirement for measuring fair value or for disclosing informations about fair value measurements. The disclosure requirements add information about transfers between Level 1 and Level 2 of the fair value hierarchy, information about the sensitivity of a fair value measurement categorized within Level 3 of the fair value hierarchy to changes in unobservable inputs and any interrelationships between those unobservable inputs, and the categorization by level of the fair value hierarchy for items that are not measured at fair value in the statement of financial position, but for which the fair value of such items is required to be disclosed. This accounting standards update is effective during interim and annual periods beginning after December 15, 2011 and early application is not permitted. We do not anticipate any effect to our financial position, results of operations or cash flows upon adoption.
In June 2011, the FASB issued an accounting standards update that expands the disclosure requirements related to other comprehensive income. A reporting entity is now required to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. Under both choices, the reporting entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income and a total amount for comprehensive income. This standard also requires the reporting entity to present reclassification adjustments from other comprehensive income to net income and eliminates the presentation of other comprehensive income as part of the statements of stockholders' equity. This accounting standards update is effective during interim and annual periods beginning after December 15, 2011 and should be applied retrospectively. We do not anticipate any effect to our financial position, results of operations or cash flows upon adoption.

2. Fair Values of Financial Instruments
The following sets forth a comparison of the fair values and carrying amounts of our financial instruments:
 
 
June 30, 2011
 
December 31, 2010
 
 
Carrying
Amount
 
Fair Value
 
Carrying
Amount
 
Fair Value
 
 
(Dollars in thousands)
Assets
 
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
 
Available for sale
 
$
15,682,872

 
$
15,682,872

 
$
15,830,663

 
$
15,830,663

Held for investment
 
2,135,968

 
2,124,918

 
822,200

 
781,748

Equity securities, available for sale
 
66,612

 
66,612

 
65,961

 
65,961

Mortgage loans on real estate
 
2,798,233

 
2,856,400

 
2,598,641

 
2,670,009

Derivative instruments
 
537,920

 
537,920

 
479,786

 
479,786

Other investments
 
2,120

 
2,185

 
558

 
558

Cash and cash equivalents
 
949,484

 
949,484

 
597,766

 
597,766

Coinsurance deposits
 
2,699,158

 
2,394,311

 
2,613,191

 
2,282,998

2015 notes hedges
 
63,141

 
63,141

 
66,595

 
66,595

 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
Policy benefit reserves
 
25,702,884

 
21,448,934

 
23,464,810

 
19,594,396

Notes payable
 
337,239

 
480,635

 
330,835

 
489,097

Subordinated debentures
 
268,512

 
246,502

 
268,435

 
213,369

2015 notes embedded derivatives
 
63,141

 
63,141

 
66,595

 
66,595

Interest rate swaps
 
937

 
937

 
1,976

 
1,976

Fair value is the price that would be received to sell an asset or paid to transfer a liability (exit price) in an orderly transaction between market participants at the measurement date. The objective of a fair value measurement is to determine that price for each financial instrument at each measurement date. We meet this objective using various methods of valuation that include market, income and cost approaches.

8


We categorize our financial instruments into three levels of fair value hierarchy based on the priority of inputs used in determining fair value. The hierarchy defines the highest priority inputs (Level 1) as quoted prices in active markets for identical assets or liabilities. The lowest priority inputs (Level 3) are our own assumptions about what a market participant would use in determining fair value such as estimated future cash flows. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, a financial instrument's level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the financial instrument. We categorize financial assets and liabilities recorded at fair value in the consolidated balance sheets as follows:
Level 1—    Quoted prices are available in active markets for identical financial instruments as of the reporting date. We do not adjust the quoted price for these financial instruments, even in situations where we hold a large position and a sale could reasonably impact the quoted price.
Level 2—    Quoted prices in active markets for similar financial instruments, quoted prices for identical or similar financial instruments in markets that are not active; and models and other valuation methodologies using inputs other than quoted prices that are observable.
Level 3—    Models and other valuation methodologies using significant inputs that are unobservable for financial instruments and include situations where there is little, if any, market activity for the financial instrument. The inputs into the determination of fair value require significant management judgment or estimation. Financial instruments that are included in Level 3 are securities for which no market activity or data exists and for which we used discounted expected future cash flows with our own assumptions about what a market participant would use in determining fair value.
Transfers of securities among the levels occur at times and depend on the type of inputs used to determine fair value of each security, however there were no transfers between levels during the six months ended June 30, 2011.

9


Our assets and liabilities which are measured at fair value on a recurring basis as of June 30, 2011 and December 31, 2010 are presented below based on the fair value hierarchy levels:
 
 
Total
Fair Value
 
Quoted
Prices in
Active
Markets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
 
(Dollars in thousands)
June 30, 2011
 
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
 
United States Government full faith and credit
 
$
4,419

 
$
4,419

 
$
—

 
$
—

United States Government sponsored agencies
 
1,152,300

 
—

 
1,152,300

 
—

United States municipalities, states and territories
 
2,763,142

 
—

 
2,763,142

 
—

Corporate securities
 
8,657,083

 
61,324

 
8,595,759

 
—

Residential mortgage backed securities
 
2,827,512

 
—

 
2,825,319

 
2,193

Other asset backed securities
 
278,416

 
—

 
278,416

 
—

Equity securities, available for sale: finance, insurance and real estate
 
66,612

 
46,842

 
19,770

 
—

Derivative instruments
 
537,920

 
—

 
537,920

 
—

Cash and cash equivalents
 
949,484

 
949,484

 
—

 
—

2015 notes hedges
 
63,141

 
—

 
63,141

 
—

 
 
$
17,300,029

 
$
1,062,069

 
$
16,235,767

 
$
2,193

Liabilities
 
 
 
 
 
 
 
 
Interest rate swaps
 
$
937

 
$
—

 
$
937

 
$
—

2015 notes embedded derivatives
 
63,141

 
—

 
63,141

 
—

Fixed index annuities - embedded derivatives
 
2,368,533

 
—

 
—

 
2,368,533

 
 
$
2,432,611

 
$
—

 
$
64,078

 
$
2,368,533

 
 
 
 
 
 
 
 
 
December 31, 2010
 
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
 
United States Government full faith and credit
 
$
4,388

 
$
4,388

 
$
—

 
$
—

United States Government sponsored agencies
 
3,003,651

 
—

 
3,003,651

 
—

United States municipalities, states and territories
 
2,367,003

 
—

 
2,367,003

 
—

Corporate securities
 
7,372,537

 
71,230

 
7,301,307

 
—

Residential mortgage backed securities
 
2,878,557

 
—

 
2,875,855

 
2,702

Other asset backed securities
 
204,527

 
—

 
204,527

 
—

Equity securities, available for sale: finance, insurance and real estate
 
65,961

 
46,925

 
19,036

 
—

Derivative instruments
 
479,786

 
—

 
479,786

 
—

Cash and cash equivalents
 
597,766

 
597,766

 
—

 
—

2015 notes hedges
 
66,595

 
—

 
66,595

 
—

 
 
$
17,040,771

 
$
720,309

 
$
16,317,760

 
$
2,702

Liabilities
 
 
 
 
 
 
 
 
Interest rate swaps
 
$
1,976

 
$
—

 
$
1,976

 
$
—

2015 notes embedded derivatives
 
66,595

 
—

 
66,595

 
—

Fixed index annuities - embedded derivatives
 
1,971,383

 
—

 
—

 
1,971,383

 
 
$
2,039,954

 
$
—

 
$
68,571

 
$
1,971,383


10


The following methods and assumptions were used in estimating the fair values of financial instruments during the periods presented in these consolidated financial statements.
Fixed maturity securities and equity securities
The fair values of fixed maturity securities and equity securities in an active and orderly market are determined by utilizing independent pricing services. The independent pricing services incorporate a variety of observable market data in their valuation techniques, including:
•
reported trading prices,
•
benchmark yields
•
broker-dealer quotes,
•
benchmark securities,
•
bids and offers,
•
credit ratings,
•
relative credit information, and
•
other reference data.
The independent pricing services also take into account perceived market movements and sector news, as well as a security's terms and conditions, including any features specific to that issue that may influence risk and marketability. Depending on the security, the priority of the use of observable market inputs may change as some observable market inputs may not be relevant or additional inputs may be necessary.
The independent pricing services provide quoted market prices when available. Quoted prices are not always available due to market inactivity. When quoted market prices are not available, the third parties use yield data and other factors relating to instruments or securities with similar characteristics to determine fair value for securities that are not actively traded. We generally obtain one value from our primary external pricing service. In situations where a price is not available from this service, we may obtain further quotes or prices from additional parties as needed. In addition, for our callable United States Government sponsored agencies we obtain two broker quotes and take the average of two broker prices received. Market indices of similar rated asset class spreads are considered for valuations and broker indications of similar securities are compared. Inputs used by the broker include market information, such as yield data and other factors relating to instruments or securities with similar characteristics. Valuations and quotes obtained from third party commercial pricing services are non-binding and do not represent quotes on which one may execute the disposition of the assets.
We validate external valuations at least quarterly through a combination of procedures that include the evaluation of methodologies used by the pricing services, analytical reviews and performance analysis of the prices against trends, and maintenance of a securities watch list. Additionally, as needed we utilize discounted cash flow models or perform independent valuations on a case-by-case basis of inputs and assumptions similar to those used by the pricing services. Although we do identify differences from time to time as a result of these validation procedures, we did not make any significant adjustments as of June 30, 2011 and December 31, 2010.
Mortgage loans on real estate
The fair values of mortgage loans on real estate are calculated using discounted expected cash flows using current competitive market interest rates currently being offered for similar loans which are not fair value exit prices.
Derivative instruments
The fair values of derivative instruments, primarily call options, are based upon the amount of cash that we will receive to settle each derivative instrument on the reporting date. These amounts are obtained from each of the counterparties using industry accepted valuation models and are adjusted for the nonperformance risk of each counterparty net of any collateral held. Inputs include market volatility and risk free interest rates and are used in income valuation techniques in arriving at a fair value for each option contract. The nonperformance risk for each counterparty is based upon its credit default swap rate. We have no performance obligations related to the call options purchased to fund our fixed index annuity policy liabilities.
Other investments
Other investments is comprised of policy loans and an equity method investment. We have not attempted to determine the fair values associated with our policy loans, as we believe any differences between carrying value and the fair values afforded these instruments are immaterial to our consolidated financial position and, accordingly, the cost to provide such disclosure does not justify the benefit to be derived. The fair value of of our equity method investment was determined by calculating the present value of future cash flows discounted by a risk free rate, a risk spread, and a liquidity discount.
Cash and cash equivalents
Amounts reported in the consolidated balance sheets for these instruments are reported at their historical cost which approximates fair value due to the nature of the assets assigned to this category.
2015 notes hedges
The fair value of these call options is determined by a third party who applies market observable data such as our common stock price, its dividend yield and its volatility, as well as the time to expiration of the call options to determine a fair value of the buy side of these options.

11


Policy benefit reserves and coinsurance deposits
The fair values of the liabilities under contracts not involving significant mortality or morbidity risks (principally deferred annuities), are stated at the cost we would incur to extinguish the liability (i.e., the cash surrender value) as these contracts are generally issued without an annuitization date. The coinsurance deposits related to the annuity benefit reserves have fair values determined in a similar fashion. We are not required to and have not estimated the fair value of the liabilities under contracts that involve significant mortality or morbidity risks, as these liabilities fall within the definition of insurance contracts that are exceptions from financial instruments that require disclosures of fair value.
Notes payable
The fair value of the convertible senior notes is based upon quoted market prices.
Subordinated debentures
Fair values for subordinated debentures are estimated using discounted cash flow calculations based principally on observable inputs including our incremental borrowing rates, which reflect our credit rating, for similar types of borrowings with maturities consistent with those remaining for the debt being valued.
Interest rate swaps
The fair values of our pay fixed/receive variable interest rate swaps are obtained from third parties and are determined by discounting expected future cash flows using projected LIBOR rates for the term of the swaps.
2015 notes embedded derivatives
The fair value of this embedded derivative is determined by pricing the call options that hedge this potential liability. The terms of the conversion premium are identical to the 2015 notes hedges and the method of determining fair value of the call options is based upon observable market data.
Fixed index annuities - embedded derivatives
We estimate the fair value of the embedded derivative component of our fixed index annuity policy liabilities at each valuation date by (i) projecting policy contract values and minimum guaranteed contract values over the expected lives of the contracts and (ii) discounting the excess of the projected contract value amounts at the applicable risk free interest rates adjusted for our nonperformance risk related to those liabilities. The projections of policy contract values are based on our best estimate assumptions for future policy growth and future policy decrements. Our best estimate assumptions for future policy growth include assumptions for the expected index credit on the next policy anniversary date which are derived from the fair values of the underlying call options purchased to fund such index credits and the expected costs of annual call options we will purchase in the future to fund index credits beyond the next policy anniversary. The projections of minimum guaranteed contract values include the same best estimate assumptions for policy decrements as were used to project policy contract values.
The following tables provide a reconciliation of the beginning and ending balances for our Level 3 assets and liabilities, which are measured at fair value on a recurring basis using significant unobservable inputs for the three and six months ended June 30, 2011 and 2010:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2011
 
2010
 
2011
 
2010
 
(Dollars in thousands)
Available for sale securities
 
 
 
 
 
 
 
Beginning balance
$
4,301

 
$
18,909

 
$
2,702

 
$
17,918

Sales
—

 
(14,838
)
 
—

 
(14,838
)
Principal returned
(78
)
 
(157
)
 
(266
)
 
(314
)
(Amortization)/accretion of premium/discount
(4
)
 
10

 
8

 
32

Reclassification
(1,600
)
 
—

 
—

 
—

Total gains (losses) (realized/unrealized):
 
 
 
 
 
 
 
Included in other comprehensive income (loss)
104

 
7,216

 
279

 
8,342

Included in operations
(530
)
 
(2,230
)
 
(530
)
 
(2,230
)
Ending balance
$
2,193

 
$
8,910

 
$
2,193

 
$
8,910

In the second quarter of 2011 we removed an ownership interest in a limited partnership from the preceding table because it is an equity method investment that does not have a readily determinable fair value and is not measured at fair value on a recurring basis.

12


 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2011
 
2010
 
2011
 
2010
 
(Dollars in thousands)
Fixed index annuities - embedded derivatives
 
 
 
 
 
 
 
Beginning balance
$
2,242,000

 
$
1,526,117

 
$
1,971,383

 
$
1,375,866

Premiums less benefits
251,733

 
251,587

 
467,676

 
414,735

Change in unrealized gains, net
(125,200
)
 
(295,275
)
 
(70,526
)
 
(308,172
)
Ending balance
$
2,368,533

 
$
1,482,429

 
$
2,368,533

 
$
1,482,429

Change in unrealized gains, net for each period in our embedded derivatives are included in change in fair value of embedded derivatives in the unaudited consolidated statements of operations.

3. Investments
At June 30, 2011 and December 31, 2010, the amortized cost and fair value of fixed maturity securities and equity securities were as follows:
 
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
 
 
(Dollars in thousands)
June 30, 2011
 
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
 
United States Government full faith and credit
 
$
4,083

 
$
345

 
$
(9
)
 
$
4,419

United States Government sponsored agencies
 
1,137,254

 
15,390

 
(344
)
 
1,152,300

United States municipalities, states and territories
 
2,723,736

 
66,969

 
(27,563
)
 
2,763,142

Corporate securities
 
8,362,716

 
422,447

 
(128,080
)
 
8,657,083

Residential mortgage backed securities
 
2,820,507

 
100,566

 
(93,561
)
 
2,827,512

Other asset backed securities
 
275,124

 
8,933

 
(5,641
)
 
278,416

 
 
$
15,323,420

 
$
614,650

 
$
(255,198
)
 
$
15,682,872

 
 
 
 
 
 
 
 
 
Held for investment:
 
 
 
 
 
 
 
 
United States Government sponsored agencies
 
$
2,060,110

 
$
10,172

 
$
(407
)
 
$
2,069,875

Corporate security
 
75,858

 
—

 
(20,815
)
 
55,043

 
 
$
2,135,968

 
$
10,172

 
$
(21,222
)
 
$
2,124,918

 
 
 
 
 
 
 
 
 
Equity securities, available for sale:
 
 
 
 
 
 
 
 
Finance, insurance, and real estate
 
$
59,196

 
$
8,370

 
$
(954
)
 
$
66,612

 
 
 
 
 
 
 
 
 
December 31, 2010
 
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
 
United States Government full faith and credit
 
$
4,082

 
$
324

 
$
(18
)
 
$
4,388

United States Government sponsored agencies
 
2,994,174

 
11,123

 
(1,646
)
 
3,003,651

United States municipalities, states and territories
 
2,397,622

 
22,765

 
(53,384
)
 
2,367,003

Corporate securities
 
7,124,316

 
380,124

 
(131,903
)
 
7,372,537

Residential mortgage backed securities
 
2,900,028

 
86,950

 
(108,421
)
 
2,878,557

Other asset backed securities
 
201,672

 
7,792

 
(4,937
)
 
204,527

 
 
$
15,621,894

 
$
509,078

 
$
(300,309
)
 
$
15,830,663

 
 
 
 
 
 
 
 
 
Held for investment:
 
 
 
 
 
 
 
 
United States Government sponsored agencies
 
$
746,414

 
$
—

 
$
(15,309
)
 
$
731,105

Corporate security
 
75,786

 
—

 
(25,143
)
 
50,643

 
 
$
822,200

 
$
—

 
$
(40,452
)
 
$
781,748

 
 
 
 
 
 
 
 
 
Equity securities, available for sale:
 
 
 
 
 
 
 
 
Finance, insurance, and real estate
 
$
61,185

 
$
6,722

 
$
(1,946
)
 
$
65,961



13


During the six months ended June 30, 2011 and 2010, we received $2.9 billion and $2.4 billion, respectively, in redemption proceeds related to calls of our callable United States Government sponsored agency securities and public and private corporate bonds, of which $892.5 million were classified as held for investment for the six months ended June 30, 2010. There were no calls of held for investment securities during the six months ended June 30, 2011. We reinvested the proceeds from these redemptions primarily in United States Government sponsored agencies, United States municipalities, states, and territories, corporate securities and residential mortgage and asset backed securities. At June 30, 2011, 34% of our fixed income securities have call features and 1% ($0.1 billion) were subject to call redemption. Another 19% ($3.2 billion) will become subject to call redemption during the next twelve months (principally the first and second quarters of 2012).
The amortized cost and fair value of fixed maturity securities at June 30, 2011, by contractual maturity, are shown below. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. All of our residential mortgage and other asset backed securities provide for periodic payments throughout their lives and are shown below as separate lines.
 
 
Available-for-sale
 
Held for investment
 
 
Amortized
Cost
 
Fair Value
 
Amortized
Cost
 
Fair Value
 
 
(Dollars in thousands)
Due in one year or less
 
$
28,157

 
$
28,971

 
$
—

 
$
—

Due after one year through five years
 
416,992

 
470,079

 
—

 
—

Due after five years through ten years
 
1,858,825

 
2,039,722

 
—

 
—

Due after ten years through twenty years
 
3,830,178

 
3,916,472

 
—

 
—

Due after twenty years
 
6,093,637

 
6,121,700

 
2,135,968

 
2,124,918

 
 
12,227,789

 
12,576,944

 
2,135,968

 
2,124,918

Residential mortgage backed securities
 
2,820,507

 
2,827,512

 
—

 
—

Other asset backed securities
 
275,124

 
278,416

 
—

 
—

 
 
$
15,323,420

 
$
15,682,872

 
$
2,135,968

 
$
2,124,918

Net unrealized gains on available for sale fixed maturity securities and equity securities reported as a separate component of stockholders' equity were comprised of the following:
 
 
June 30,
2011
 
December 31,
2010
 
 
(Dollars in thousands)
Net unrealized gains on available for sale fixed maturity securities and equity securities
 
$
366,868

 
$
213,545

Adjustments for assumed changes in amortization of deferred policy acquisition costs and deferred sales inducements
 
(211,564
)
 
(122,336
)
Deferred income tax valuation allowance reversal
 
22,534

 
22,534

Deferred income tax benefit
 
(54,356
)
 
(31,923
)
Net unrealized gains reported as accumulated other comprehensive income
 
$
123,482

 
$
81,820

The National Association of Insurance Commissioners (“NAIC”) assigns designations to fixed maturity securities. These designations range from Class 1 (highest quality) to Class 6 (lowest quality). In general, securities are assigned a designation based upon the ratings they are given by the Nationally Recognized Statistical Rating Organizations (“NRSRO’s”). The NAIC designations are utilized by insurers in preparing their annual statutory statements. NAIC Class 1 and 2 designations are considered “investment grade” while NAIC Class 3 through 6 designations are considered “non-investment grade.” Based on the NAIC designations, we had 99% and 98% of our fixed maturity portfolio rated investment grade at June 30, 2011 and December 31, 2010, respectively.
The following table summarizes the credit quality, as determined by NAIC designation, of our fixed maturity portfolio as of the dates indicated:
 
 
June 30, 2011
 
December 31, 2010
NAIC
Designation
 
Amortized Cost

 
Fair Value
 
Amortized Cost
 
Fair Value
 
 
(Dollars in thousands)
 
1
 
$
12,923,194

 
$
13,134,579

 
$
12,152,552

 
$
12,246,954

2
 
4,260,986

 
4,427,188

 
3,892,680

 
4,012,076

3
 
248,488

 
218,080

 
368,680

 
323,113

4
 
17,933

 
17,125

 
19,820

 
19,178

5
 
5,302

 
5,868

 
6,089

 
6,262

6
 
3,485

 
4,950

 
4,273

 
4,828

 
 
$
17,459,388

 
$
17,807,790

 
$
16,444,094

 
$
16,612,411



14


The following tables show our investments' gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities (consisting of 707 and 780 securities, respectively) have been in a continuous unrealized loss position, at June 30, 2011 and December 31, 2010:
 
 
Less than 12 months
 
12 months or more
 
Total
 
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
 
(Dollars in thousands)
June 30, 2011
 
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
 
 
 
 
 
United States Government full faith and credit
 
$
558

 
$
(9
)
 
$
—

 
$
—

 
$
558

 
$
(9
)
United States Government sponsored agencies
 
$
53,253

 
$
(344
)
 
$
—

 
$
—

 
$
53,253

 
$
(344
)
United States municipalities, states and territories
 
945,652

 
(27,181
)
 
8,554

 
(382
)
 
954,206

 
(27,563
)
Corporate securities:
 
 
 
 
 
 
 
 
 
 
 
 
Finance, insurance and real estate
 
608,845

 
(23,541
)
 
86,065

 
(7,415
)
 
694,910

 
(30,956
)
Manufacturing, construction and mining
 
1,203,704

 
(41,396
)
 
12,998

 
(1,874
)
 
1,216,702

 
(43,270
)
Utilities and related sectors
 
1,046,966

 
(37,300
)
 
15,833

 
(2,855
)
 
1,062,799

 
(40,155
)
Wholesale/retail trade
 
173,230

 
(5,147
)
 
9,150

 
(1,324
)
 
182,380

 
(6,471
)
Services, media and other
 
235,752

 
(7,228
)
 
—

 
—

 
235,752

 
(7,228
)
Residential mortgage backed securities
 
248,319

 
(14,285
)
 
819,884

 
(79,276
)
 
1,068,203

 
(93,561
)
Other asset backed securities
 
93,237

 
(5,641
)
 
—

 
—

 
93,237

 
(5,641
)
 
 
$
4,609,516

 
$
(162,072
)
 
$
952,484

 
$
(93,126
)
 
$
5,562,000

 
$
(255,198
)
Held for investment:
 
 
 
 
 
 
 
 
 
 
 
 
United States Government sponsored agencies
 
993,800

 
(407
)
 
—

 
—

 
993,800

 
(407
)
Corporate security:
 
 
 
 
 
 
 
 
 
 
 
 
Insurance
 
—

 
—

 
55,043

 
(20,815
)
 
55,043

 
(20,815
)
 
 
993,800

 
(407
)
 
55,043

 
(20,815
)
 
1,048,843

 
(21,222
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Equity securities, available for sale:
 
 
 
 
 
 
 
 
 
 
 
 
Finance, insurance and real estate
 
$
—

 
$
—

 
$
16,828

 
$
(954
)
 
$
16,828

 
$
(954
)
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2010
 
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
 
 
 
 
 
United States Government full faith and credit
 
$
548

 
$
(18
)
 
$
—

 
$
—

 
$
548

 
$
(18
)
United States Government sponsored agencies
 
110,101

 
(1,646
)
 
—

 
—

 
110,101

 
(1,646
)
United States municipalities, states and territories
 
1,510,354

 
(51,989
)
 
7,525

 
(1,395
)
 
1,517,879

 
(53,384
)
Corporate securities:
 
 
 
 
 
 
 
 
 
 
 
 
Finance, insurance and real estate
 
570,978

 
(27,603
)
 
114,128

 
(13,001
)
 
685,106

 
(40,604
)
Manufacturing, construction and mining
 
1,024,454

 
(33,239
)
 
34,490

 
(2,333
)
 
1,058,944

 
(35,572
)
Utilities and related sectors
 
927,476

 
(34,630
)
 
14,157

 
(4,552
)
 
941,633

 
(39,182
)
Wholesale/retail trade
 
153,699

 
(4,947
)
 
9,175

 
(1,304
)
 
162,874

 
(6,251
)
Services, media and other
 
181,857

 
(10,294
)
 
—

 
—

 
181,857

 
(10,294
)
Residential mortgage backed securities
 
396,083

 
(14,100
)
 
966,332

 
(94,321
)
 
1,362,415

 
(108,421
)
Other asset backed securities
 
83,011

 
(4,937
)
 
—

 
—

 
83,011

 
(4,937
)
 
 
$
4,958,561

 
$
(183,403
)
 
$
1,145,807

 
$
(116,906
)
 
$
6,104,368

 
$
(300,309
)
Held for investment: