Annual Statements Open main menu

LINCOLN NATIONAL CORP - Quarter Report: 2015 June (Form 10-Q)

__________________________________________________________________________________________________________

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

_________________

 

FORM 10-Q

_________________

 

 

(Mark One)

Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the quarterly period ended June 30, 2015

 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:  1-6028

 

_________________

 

LINCOLN NATIONAL CORPORATION

(Exact name of registrant as specified in its charter)

 

_________________

 

 

 

 

 

                Indiana                

35-1140070

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

 

 

150 N. Radnor Chester Road, Suite A305, Radnor, Pennsylvania

19087

(Address of principal executive offices)

(Zip Code)

 

 

(484) 583-1400

(Registrant’s telephone number, including area code)

 

Not Applicable

(Former name, former address and former fiscal year, if changed since last report.)

 

_________________

 

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     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     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.  (Check one):

 

Large accelerated filer   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 

 

As of July 27, 2015, there were 250,951,872 shares of the registrant’s common stock outstanding.

 

 

_________________________________________________________________________________________________________

 


 

Lincoln National Corporation

 

Table of Contents

 

 

 

 

 

 

 

Item

 

 

 

 

Page

PART I

 

1.

Financial Statements

 

 

 

2.

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

46 

 

 

Forward-Looking Statements – Cautionary Language

46 

 

 

Introduction

47 

 

 

    Executive Summary

47 

 

 

    Critical Accounting Policies and Estimates

48 

 

 

    Acquisitions and Dispositions

50 

 

 

Results of Consolidated Operations

50 

 

 

Results of Annuities

52 

 

 

Results of Retirement Plan Services

57 

 

 

Results of Life Insurance

63 

 

 

Results of Group Protection

69 

 

 

Results of Other Operations

72 

 

 

Realized Gain (Loss) and Benefit Ratio Unlocking

74 

 

 

Consolidated Investments

76 

 

 

Reinsurance

88 

 

 

Review of Consolidated Financial Condition

88 

 

 

   Liquidity and Capital Resources

88 

 

 

Other Matters

91 

 

 

   Other Factors Affecting Our Business

91 

 

 

   Recent Accounting Pronouncements

91 

 

 

3.

Quantitative and Qualitative Disclosures About Market Risk

92 

 

 

 

4.

Controls and Procedures

94 

 

 

 

PART II

 

 

 

 

1.

Legal Proceedings

95 

 

 

 

2.

Unregistered Sales of Equity Securities and Use of Proceeds

95 

 

 

 

6.

Exhibits

95 

 

 

 

 

Signatures

96 

 

 

 

 

Exhibit Index for the Report on Form 10-Q

E-1

 

 

 

 

 

 

 

 

 

 


 

 

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

LINCOLN NATIONAL CORPORATION

CONSOLIDATED BALANCE SHEETS

(in millions, except share data)

 

 

 

 

 

 

 

 

 

 

 

As of

 

 

As of

 

 

June 30,

December 31,

 

 

2015

 

 

2014

 

 

(Unaudited)

 

 

 

 

ASSETS

 

 

 

 

 

 

 

 

Investments:

 

 

 

 

 

 

 

 

Available-for-sale securities, at fair value:

 

 

 

 

 

 

 

 

Fixed maturity securities (amortized cost:  2015 – $80,456; 2014 – $78,609)

 

$

85,422 

 

 

$

86,240 

 

Variable interest entities’ fixed maturity securities (amortized cost:  2015 – $593; 2014 – $587)

 

 

598 

 

 

 

598 

 

Equity securities (cost:  2015 – $213; 2014 – $216)

 

 

227 

 

 

 

231 

 

Trading securities

 

 

1,949 

 

 

 

2,065 

 

Mortgage loans on real estate

 

 

8,171 

 

 

 

7,574 

 

Real estate

 

 

24 

 

 

 

20 

 

Policy loans

 

 

2,654 

 

 

 

2,670 

 

Derivative investments

 

 

1,340 

 

 

 

1,860 

 

Other investments

 

 

1,624 

 

 

 

1,709 

 

Total investments

 

 

102,009 

 

 

 

102,967 

 

Cash and invested cash

 

 

2,327 

 

 

 

3,919 

 

Deferred acquisition costs and value of business acquired

 

 

9,150 

 

 

 

8,207 

 

Premiums and fees receivable

 

 

415 

 

 

 

473 

 

Accrued investment income

 

 

1,064 

 

 

 

1,049 

 

Reinsurance recoverables

 

 

5,608 

 

 

 

5,730 

 

Funds withheld reinsurance assets

 

 

642 

 

 

 

649 

 

Goodwill

 

 

2,273 

 

 

 

2,273 

 

Other assets

 

 

3,647 

 

 

 

2,845 

 

Separate account assets

 

 

128,079 

 

 

 

125,265 

 

Total assets

 

$

255,214 

 

 

$

253,377 

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

Future contract benefits

 

$

20,166 

 

 

$

20,057 

 

Other contract holder funds

 

 

76,243 

 

 

 

75,512 

 

Short-term debt

 

 

 -

 

 

 

250 

 

Long-term debt

 

 

5,529 

 

 

 

5,270 

 

Reinsurance related embedded derivatives

 

 

120 

 

 

 

150 

 

Funds withheld reinsurance liabilities

 

 

718 

 

 

 

764 

 

Deferred gain on business sold through reinsurance

 

 

134 

 

 

 

171 

 

Payables for collateral on investments

 

 

4,587 

 

 

 

4,409 

 

Variable interest entities’ liabilities

 

 

 

 

 

13 

 

Other liabilities

 

 

4,936 

 

 

 

5,776 

 

Separate account liabilities

 

 

128,079 

 

 

 

125,265 

 

Total liabilities

 

 

240,515 

 

 

 

237,637 

 

 

 

 

 

 

 

 

 

 

Contingencies and Commitments (See Note 8)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ Equity

 

 

 

 

 

 

 

 

Preferred stock – 10,000,000 shares authorized

 

 

 -

 

 

 

 -

 

Common stock – 800,000,000 shares authorized; 250,918,893 and 256,551,440 shares

 

 

 

 

 

 

 

 

issued and outstanding as of June 30, 2015, and December 31, 2014, respectively

 

 

6,469 

 

 

 

6,622 

 

Retained earnings

 

 

6,286 

 

 

 

6,022 

 

Accumulated other comprehensive income (loss)

 

 

1,944 

 

 

 

3,096 

 

Total stockholders’ equity

 

 

14,699 

 

 

 

15,740 

 

 Total liabilities and stockholders’ equity

 

$

255,214 

 

 

$

253,377 

 

 

See accompanying Notes to Consolidated Financial Statements

1


 

 

 

LINCOLN NATIONAL CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited, in millions, except per share data)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

For the Six

 

 

Months Ended

 

Months Ended

 

 

June 30,

 

June 30,

 

 

2015

 

2014

 

2015

 

2014

 

Revenues

 

 

 

 

 

 

 

 

 

 

 

 

Insurance premiums

$

782

 

$

755

 

$

1,572

 

$

1,494

 

Fee income

 

1,239

 

 

1,134

 

 

2,460

 

 

2,232

 

Net investment income

 

1,187

 

 

1,207

 

 

2,374

 

 

2,415

 

Realized gain (loss):

 

 

 

 

 

 

 

 

 

 

 

 

Total other-than-temporary impairment losses on securities

 

(14

)

 

(5

)

 

(35

)

 

(15

)

Portion of loss recognized in other comprehensive income

 

7

 

 

2

 

 

15

 

 

8

 

Net other-than-temporary impairment losses on securities

 

 

 

 

 

 

 

 

 

 

 

 

recognized in earnings

 

(7

)

 

(3

)

 

(20

)

 

(7

)

Realized gain (loss), excluding other-than-temporary

 

 

 

 

 

 

 

 

 

 

 

 

impairment losses on securities

 

17

 

 

38

 

 

(18

)

 

23

 

Total realized gain (loss)

 

10

 

 

35

 

 

(38

)

 

16

 

Amortization of deferred gain on business sold through reinsurance

 

18

 

 

18

 

 

37

 

 

37

 

Other revenues

 

145

 

 

133

 

 

280

 

 

263

 

 Total revenues

 

3,381

 

 

3,282

 

 

6,685

 

 

6,457

 

Expenses

 

 

 

 

 

 

 

 

 

 

 

 

Interest credited

 

629

 

 

636

 

 

1,254

 

 

1,269

 

Benefits

 

1,220

 

 

1,079

 

 

2,456

 

 

2,157

 

Commissions and other expenses

 

1,014

 

 

963

 

 

2,027

 

 

1,934

 

Interest and debt expense

 

69

 

 

67

 

 

137

 

 

134

 

Total expenses

 

2,932

 

 

2,745

 

 

5,874

 

 

5,494

 

Income (loss) before taxes

 

449

 

 

537

 

 

811

 

 

963

 

Federal income tax expense (benefit)

 

105

 

 

139

 

 

167

 

 

236

 

Net income (loss)

 

344

 

 

398

 

 

644

 

 

727

 

Other comprehensive income (loss), net of tax

 

(1,709

)

 

746

 

 

(1,152

)

 

1,636

 

Comprehensive income (loss)

$

(1,365

)

$

1,144

 

$

(508

)

$

2,363

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Income (Loss) Per Common Share

 

 

 

 

 

 

 

 

 

 

 

 

Basic

$

1.37

 

$

1.52

 

$

2.54

 

$

2.77

 

Diluted

 

1.35

 

 

1.48

 

 

2.50

 

 

2.69

 

 

 

 

 

See accompanying Notes to Consolidated Financial Statements

2


 

LINCOLN NATIONAL CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(Unaudited, in millions, except per share data)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Six

 

 

Months Ended

 

 

June 30,

 

 

2015

 

2014

 

 

 

 

 

 

 

 

Common Stock

 

 

 

 

 

 

Balance as of beginning-of-year

$

6,622

 

$

6,876

 

Stock compensation/issued for benefit plans

 

68

 

 

20

 

Retirement of common stock/cancellation of shares

 

(221

)

 

(157

)

Balance as of end-of-period

 

6,469

 

 

6,739

 

 

 

 

 

 

 

 

Retained Earnings

 

 

 

 

 

 

Balance as of beginning-of-year

 

6,022

 

 

5,013

 

Net income (loss)

 

644

 

 

727

 

Retirement of common stock

 

(279

)

 

(143

)

Common stock dividends declared (2015 – $0.40; 2014 – $0.32)

 

(101

)

 

(84

)

Balance as of end-of-period

 

6,286

 

 

5,513

 

 

 

 

 

 

 

 

Accumulated Other Comprehensive Income (Loss)

 

 

 

 

 

 

Balance as of beginning-of-year

 

3,096

 

 

1,563

 

Other comprehensive income (loss), net of tax

 

(1,152

)

 

1,636

 

Balance as of end-of-period

 

1,944

 

 

3,199

 

Total stockholders’ equity as of end-of-period

$

14,699

 

$

15,451

 

 

 

 

 

 

See accompanying Notes to Consolidated Financial Statements

3


 

LINCOLN NATIONAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, in millions)

 

 

 

 

 

 

 

 

 

 

For the Six

 

 

Months Ended

 

 

June 30,

 

 

2015

 

2014

 

Cash Flows from Operating Activities

 

 

 

 

 

 

Net income (loss)

$

644

 

$

727

 

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:

 

 

 

 

 

 

Deferred acquisition costs, value of business acquired, deferred sales inducements

 

 

 

 

 

 

and deferred front-end loads deferrals and interest, net of amortization

 

(176

)

 

(213

)

Trading securities purchases, sales and maturities, net

 

86

 

 

25

 

Change in premiums and fees receivable

 

58

 

 

(45

)

Change in accrued investment income

 

(15

)

 

(52

)

Change in future contract benefits and other contract holder funds

 

17

 

 

188

 

Change in reinsurance related assets and liabilities

 

(14

)

 

(33

)

Change in accrued expenses

 

(118

)

 

(158

)

Change in federal income tax accruals

 

(54

)

 

86

 

Realized (gain) loss

 

38

 

 

(16

)

Amortization of deferred gain on business sold through reinsurance

 

(37

)

 

(37

)

Other

 

153

 

 

(101

)

Net cash provided by (used in) operating activities

 

582

 

 

371

 

 

 

 

 

 

 

 

Cash Flows from Investing Activities

 

 

 

 

 

 

Purchases of available-for-sale securities

 

(4,451

)

 

(4,186

)

Sales of available-for-sale securities

 

414

 

 

173

 

Maturities of available-for-sale securities

 

2,085

 

 

2,476

 

Purchases of other investments

 

(7,415

)

 

(1,322

)

Sales or maturities of other investments

 

7,109

 

 

1,452

 

Increase (decrease) in payables for collateral on investments

 

176

 

 

333

 

Other

 

(52

)

 

(31

)

Net cash provided by (used in) investing activities

 

(2,134

)

 

(1,105

)

 

 

 

 

 

 

 

Cash Flows from Financing Activities

 

 

 

 

 

 

Payment of long-term debt, including current maturities

 

(250

)

 

(500

)

Issuance of long-term debt, net of issuance costs

 

298

 

 

 -

 

Deposits of fixed account values, including the fixed portion of variable

 

4,966

 

 

4,884

 

Withdrawals of fixed account values, including the fixed portion of variable

 

(3,135

)

 

(2,765

)

Transfers to and from separate accounts, net

 

(1,361

)

 

(1,356

)

Common stock issued for benefit plans and excess tax benefits

 

44

 

 

 -

 

Repurchase of common stock

 

(500

)

 

(300

)

Dividends paid to common stockholders

 

(102

)

 

(84

)

Net cash provided by (used in) financing activities

 

(40

)

 

(121

)

 

 

 

 

 

 

 

Net increase (decrease) in cash and invested cash

 

(1,592

)

 

(855

)

Cash and invested cash as of beginning-of-year

 

3,919

 

 

2,364

 

Cash and invested cash as of end-of-period

$

2,327

 

$

1,509

 

 

 

See accompanying Notes to Consolidated Financial Statements

4


 

 

LINCOLN NATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1.  Nature of Operations and Basis of Presentation

 

Nature of Operations 

 

Lincoln National Corporation and its majority-owned subsidiaries (“LNC” or the “Company,” which also may be referred to as “we,” “our” or “us”) operate multiple insurance businesses through four business segments.  See Note 13 for additional details.  The collective group of businesses uses “Lincoln Financial Group” as its marketing identity.  Through our business segments, we sell a wide range of wealth protection, accumulation and retirement income products and solutions.  These products include fixed and indexed annuities, variable annuities, universal life insurance (“UL”), variable universal life insurance (“VUL”), linked-benefit UL,  indexed universal life insurance (“IUL”), term life insurance, employer-sponsored retirement plans and services, and group life, disability and dental.

 

Basis of Presentation

 

The accompanying unaudited consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions for the Securities and Exchange Commission (“SEC”) Quarterly Report on Form 10-Q, including Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements.  Therefore, the information contained in the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014 (“2014 Form 10-K”), should be read in connection with the reading of these interim unaudited consolidated financial statements.

 

Certain GAAP policies, which significantly affect the determination of financial position, results of operations and cash flows, are summarized in our 2014 Form 10-K.

 

In the opinion of management, these statements include all normal recurring adjustments necessary for a fair presentation of the Company’s results.  Operating results for the six month period ended June 30, 2015, are not necessarily indicative of the results that may be expected for the full year ending December 31, 2015.  All material inter-company accounts and transactions have been eliminated in consolidation. 

 

 

5


 

 

2.  New Accounting Standards

 

Adoption of New Accounting Standards

 

The following table provides a description of our adoption of new Accounting Standard Updates (“ASU”) issued by the Financial Accounting Standards Board and the impact of the adoption on our financial statements:

 

 

 

Standard

Description

Date of Adoption

Effect on Financial Statements or Other Significant Matters

ASU 2014-01, Accounting for Investments in Qualified Affordable Housing Projects

This standard permits an entity to make an accounting policy to use the proportional amortization method of accounting to recognize investments in qualified affordable housing projects, if certain conditions are met. Under the proportional amortization method, an 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 (benefit). Entities that previously applied the effective yield method to investments in qualified affordable housing prior to the adoption of this standard may continue to apply the effective yield method to those pre-existing investments.

January 1, 2015

The adoption of this ASU did not have an effect on our consolidated financial condition and results of operations.

ASU 2014-11, Repurchase-to-Maturity Transactions, Repurchase Financings and Disclosures

This standard eliminates a distinction in current GAAP related to certain repurchase agreements, and amends current GAAP to require repurchase-to-maturity transactions and linked repurchase financings to be accounted for as secured borrowings; consistent with the accounting for other repurchase agreements.  The standard also includes new disclosure requirements related to transfers accounted for as sales that are economically similar to repurchase agreements and information about the types of collateral pledged in repurchase agreements and similar transactions accounted for as secured borrowings.  The new disclosures are not required for comparative periods before the effective date.

January 1, 2015, except for disclosures related to collateral pledged that were adopted for the interim period ended June 30, 2015.

The adoption of this ASU did not have an effect on our consolidated financial condition and results of operations. 

 

6


 

 

Future Adoption of New Accounting Standards

 

The following table provides a description of future adoptions of new accounting standards that may have an impact on our financial statements when adopted:

 

Standard

Description

Projected Date of Adoption

Effect on Financial Statements or Other Significant Matters

ASU 2014-09, Revenue from Contracts with Customers

This standard establishes the core principle of recognizing revenue to depict the transfer of promised goods and services.  The amendments define a five-step process that systematically identifies the various components of the revenue recognition process, culminating with the recognition of revenue upon satisfaction of an entity’s performance obligation.  Retrospective application is required, and early adoption is not permitted. 

January 1, 2017

We will adopt the accounting guidance in this standard for non-insurance related products and services, and are currently evaluating the impact of adoption on our consolidated financial condition and results of operations.

ASU 2014-16, Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share Is More Akin to Debt or to Equity

This standard clarifies that when considering the nature of the host contract in a hybrid financial instrument issued in the form of a share; an entity must consider all of the stated and implied substantive terms of the hybrid instrument, including the embedded derivative feature that is being considered for separate accounting from the host contract.  Early adoption of this standard is permitted, and application is under a modified retrospective basis to existing hybrid financial instruments that are within the scope of the standard.

January 1, 2016

We are currently evaluating the impact of adopting this standard on our consolidated financial condition and results of operations.

ASU 2015-02, Amendments to the Consolidation Analysis

This standard is intended to improve consolidation accounting guidance related to limited partnerships, limited liability corporations and securitization structures.  The new standard includes changes to existing consolidation models that will eliminate the presumption that a general partner should consolidate a limited partnership, clarify when fees paid to a decision maker should be a factor in the variable interest entities (“VIEs”) consolidation evaluation and reduce the VIEs consolidation models from two to one by eliminating the indefinite deferral for certain investment funds.  Early adoption is permitted, including adoption in an interim period.

January 1, 2016

We are currently evaluating the impact of adopting this standard on our consolidated financial condition and results of operations.

ASU 2015-03,

Simplifying the Presentation of Debt Issuance Costs

Under current accounting guidance, debt issuance costs are recognized as a deferred charge in the balance sheet.  This amendment requires that debt issuance costs be presented in the balance sheet as a direct deduction from the carrying amount of that debt.  This standard does not change the recognition and measurement requirements related to debt issuance costs.  Early adoption of this standard is permitted, and retrospective application is required for all periods presented in the financial statements.

January 1, 2016

We will appropriately classify all of our debt issuance costs in accordance with this ASU as of the required effective date.

7


 

 

ASU 2015-05,

Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement

This standard clarifies the accounting requirements for recognizing cloud computing arrangements.  If an entity purchases a software license through a cloud computing arrangement, the software license should be accounted for in a manner consistent with the acquisition of other software licenses.  If a cloud computing arrangement does not include a software license, the arrangement should be accounted for as a service contract.  Early adoption of this standard is permitted, and the amendments can be adopted either prospectively or retrospectively. 

January 1, 2016

We are currently evaluating the impact of adopting this standard on our consolidated financial condition and results of operations.

Standard

Description

Projected Date of Adoption

Effect on Financial Statements or Other Significant Matters

ASU 2015-07, Disclosures for Certain Investments That Calculate Net Asset Value per Share (or its Equivalent)

This standard removes the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value per share practical expedient.  In addition, the standard also removes the requirement to make certain disclosures for all investments that are eligible to be measured at fair value using the net asset value per share practical expedient, and limits those disclosures only to those investments for which the practical expedient has been elected.  Early adoption is permitted, and the disclosures must be provided retrospectively for all periods presented in the financial statements.

January 1, 2016

We are currently evaluating these disclosure changes and will appropriately amend our financial statement disclosures in accordance with this standard as of the adoption date.

ASU 2015-09, Disclosures about Short-Duration Contracts

This standard enhances the disclosure requirements related to short-duration insurance contracts.  The new disclosure requirements focus on providing users of financial statements with more transparent information about an insurance entity’s (1) initial claims estimates and subsequent adjustments to those estimates, (2) methodologies and judgments in estimating claims, and (3) timing, frequency and severity of claims.  Early application of this standard is permitted, and retrospective application is required for each comparative period presented, except for those requirements that apply only to the current period.

Annual periods beginning January 1, 2016; interim and annual periods beginning January 1, 2017.

We are currently evaluating these disclosure changes and will provide the additional disclosures upon adoption.

  

3.  Variable Interest Entities

 

Consolidated VIEs

 

See Note 4 in our 2014 Form 10-K for a detailed discussion of our consolidated VIEs, which information is incorporated herein by reference.

 

The following summarizes information regarding the credit-linked note (“CLN”) structures (dollars in millions) as of June 30, 2015:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amount and Date of Issuance

 

 

 

 

$400

 

$200

 

 

 

 

 

December

 

April

 

 

 

 

 

2006

 

2007

 

 

Original attachment point (subordination)

5.50% 

 

2.05% 

 

 

Current attachment point (subordination)

4.21% 

 

1.48% 

 

 

Maturity

12/20/2016

 

3/20/2017

 

 

Current rating of tranche 

BBB+

 

BB

 

 

Current rating of underlying reference obligations 

AA - B

 

AAA - CCC

 

 

Number of defaults in underlying reference obligations

 

 

 

Number of entities

123 

 

99 

 

 

Number of countries

20 

 

21 

 

 

 

8


 

 

The following summarizes the exposure of the CLN structures’ underlying reference obligations by industry and rating as of June 30, 2015:  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

AAA

 

AA

 

A

 

BBB

 

BB

 

B

 

CCC

 

Total

 

Industry

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial intermediaries

0.0% 

 

2.1% 

 

5.4% 

 

3.1% 

 

0.0% 

 

0.0% 

 

0.0% 

 

10.6% 

 

Telecommunications

0.0% 

 

0.0% 

 

3.0% 

 

6.6% 

 

0.9% 

 

0.5% 

 

0.0% 

 

11.0% 

 

Oil and gas

0.3% 

 

2.1% 

 

1.3% 

 

3.4% 

 

0.9% 

 

0.0% 

 

0.0% 

 

8.0% 

 

Utilities

0.0% 

 

0.0% 

 

1.6% 

 

3.0% 

 

0.0% 

 

0.0% 

 

0.0% 

 

4.6% 

 

Chemicals and plastics

0.0% 

 

0.0% 

 

2.3% 

 

1.2% 

 

0.3% 

 

0.0% 

 

0.0% 

 

3.8% 

 

Drugs

0.3% 

 

1.6% 

 

1.8% 

 

0.0% 

 

0.0% 

 

0.0% 

 

0.0% 

 

3.7% 

 

Retailers (except food

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

and drug)

0.0% 

 

0.0% 

 

2.1% 

 

0.9% 

 

0.5% 

 

0.0% 

 

0.0% 

 

3.5% 

 

Industrial equipment

0.0% 

 

0.0% 

 

2.1% 

 

0.7% 

 

0.0% 

 

0.0% 

 

0.0% 

 

2.8% 

 

Sovereign

0.0% 

 

0.7% 

 

1.6% 

 

0.7% 

 

0.3% 

 

0.0% 

 

0.0% 

 

3.3% 

 

Conglomerates

0.0% 

 

2.3% 

 

0.9% 

 

0.0% 

 

0.0% 

 

0.0% 

 

0.0% 

 

3.2% 

 

Forest products

0.0% 

 

0.0% 

 

0.5% 

 

1.1% 

 

1.4% 

 

0.0% 

 

0.0% 

 

3.0% 

 

Other

0.0% 

 

4.1% 

 

14.2% 

 

17.4% 

 

5.8% 

 

0.7% 

 

0.3% 

 

42.5% 

 

Total

0.6% 

 

12.9% 

 

36.8% 

 

38.1% 

 

10.1% 

 

1.2% 

 

0.3% 

 

100.0% 

 

 

Asset and liability information (dollars in millions) for the consolidated VIEs included on our Consolidated Balance Sheets was as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of June 30, 2015

 

 

As of December 31, 2014

 

 

 

Number

 

 

 

 

 

 

 

 

 

Number

 

 

 

 

 

 

 

 

 

 

of

 

 

Notional

 

Carrying

 

 

of

 

 

Notional

 

Carrying

 

 

Instruments

 

Amounts

 

Value

 

Instruments

 

Amounts

 

Value

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturity securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Asset-backed credit card loans

 

 

N/A

 

 

$

 -

 

$

598 

 

 

 

N/A

 

 

$

 -

 

$

598 

 

Total return swap

 

 

 

 

 

438 

 

 

 -

 

 

 

 

 

 

423 

 

 

 -

 

Total assets (1)

 

 

 

 

$

438 

 

$

598 

 

 

 

 

 

$

423 

 

$

598 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-qualifying hedges:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Credit default swaps

 

 

 

 

$

600 

 

$

 

 

 

 

 

$

600 

 

$

13 

 

Contingent forwards

 

 

 

 

 

 -

 

 

 -

 

 

 

 

 

 

 -

 

 

 -

 

Total liabilities (2)

 

 

 

 

$

600 

 

$

 

 

 

 

 

$

600 

 

$

13 

 

 

(1)      Reported in variable interest entities’ fixed maturity securities on our Consolidated Balance Sheets.

(2)      Reported in variable interest entities’ liabilities on our Consolidated Balance Sheets.

 

For details related to the fixed maturity available-for-sale (“AFS”) securities underlying these VIEs, see Note 4.

 

As described more fully in Note 1 of our 2014 Form 10-K, we regularly review our investment holdings for other-than-temporary impairment (“OTTI”).  Based upon this review, we believe that the AFS fixed maturity securities were not other-than-temporarily impaired as of June 30, 2015.  

 

9


 

 

The gains (losses) for the consolidated VIEs (in millions) recorded on our Consolidated Statements of Comprehensive Income (Loss) were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

For the Six

 

 

 

Months Ended

 

Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2015

 

2014

 

2015

 

2014

 

Non-Qualifying Hedges

 

 

 

 

 

 

 

 

 

 

 

 

 

Credit default swaps

 

$

 

$

12 

 

$

10 

 

$

17 

 

Contingent forwards

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

Total non-qualifying hedges (1)

 

$

 

$

12 

 

$

10 

 

$

17 

 

 

(1)      Reported in realized gain (loss) on our Consolidated Statements of Comprehensive Income (Loss).

 

Unconsolidated VIEs

 

See Note 4 in our 2014 Form 10-K for a detailed discussion of our unconsolidated VIEs, which information is incorporated herein by reference.

 

Qualified Affordable Housing Projects

 

We invest in certain limited partnerships (“LPs”) that operate qualified affordable housing projects that we have concluded are VIEs.  We are not the primary beneficiary of these VIEs as we do not have the power to direct the most significant activities of the LPs.  We receive returns from the LPs in the form of income tax credits and other tax benefits, which are recognized in federal income tax expense (benefit) on our Consolidated Statements of Comprehensive Income (Loss) and were less than $1 million for the six months ended June 30, 2015 and 2014.  The carrying amount of our investments in qualified affordable housing projects is recognized in other investments on our Consolidated Balance Sheets and was $54 million and $60 million as of June 30, 2015, and December 31, 2014, respectively.  Our exposure to loss is limited to the capital we invest in the LPs, and we do not have any contingent commitments to provide additional capital funding to these LPs.  There have been no indicators of impairment that would require us to recognize an impairment loss related to these LPs due to forfeiture, ineligibility of tax credits or for any other circumstances as of June 30, 2015.

 

4.  Investments

 

AFS Securities

 

See Note 1 in our 2014 Form 10-K for information regarding our accounting policy relating to AFS securities, which also includes additional disclosures regarding our fair value measurements.

 

The amortized cost, gross unrealized gains, losses and OTTI and fair value of AFS securities (in millions) were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of June 30, 2015

 

 

Amortized

 

Gross Unrealized

 

Fair

 

 

Cost

 

Gains

 

Losses

 

OTTI (1)

 

Value

 

Fixed maturity securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

$

69,149

 

$

4,859

 

$

968

 

$

4

 

$

73,036

 

Asset-backed securities ("ABS")

 

1,087

 

 

50

 

 

19

 

 

(15

)

 

1,133

 

U.S. government bonds

 

388

 

 

42

 

 

2

 

 

 -

 

 

428

 

Foreign government bonds

 

472

 

 

68

 

 

 -

 

 

 -

 

 

540

 

Residential mortgage-backed securities ("RMBS")

 

3,815

 

 

222

 

 

24

 

 

(17

)

 

4,030

 

Commercial mortgage-backed securities ("CMBS")

 

432

 

 

17

 

 

3

 

 

 -

 

 

446

 

Collateralized loan obligations ("CLOs")

 

496

 

 

2

 

 

1

 

 

(2

)

 

499

 

State and municipal bonds

 

3,781

 

 

651

 

 

14

 

 

 -

 

 

4,418

 

Hybrid and redeemable preferred securities

 

836

 

 

97

 

 

41

 

 

 -

 

 

892

 

VIEs’ fixed maturity securities

 

593

 

 

5

 

 

 -

 

 

 -

 

 

598

 

Total fixed maturity securities

 

81,049

 

 

6,013

 

 

1,072

 

 

(30

)

 

86,020

 

Equity securities

 

213

 

 

15

 

 

1

 

 

 -

 

 

227

 

Total AFS securities

$

81,262

 

$

6,028

 

$

1,073

 

$

(30

)

$

86,247

 

 

10


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of December 31, 2014

 

 

Amortized

 

Gross Unrealized

 

Fair

 

 

Cost

 

Gains

 

Losses

 

OTTI (1)

 

Value

 

Fixed maturity securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

$

67,153

 

$

6,711

 

$

443

 

$

5

 

$

73,416

 

ABS

 

1,087

 

 

56

 

 

20

 

 

(7

)

 

1,130

 

U.S. government bonds

 

379

 

 

56

 

 

 -

 

 

 -

 

 

435

 

Foreign government bonds

 

473

 

 

68

 

 

 -

 

 

 -

 

 

541

 

RMBS

 

3,979

 

 

242

 

 

14

 

 

(19

)

 

4,226

 

CMBS

 

554

 

 

23

 

 

1

 

 

6

 

 

570

 

CLOs

 

375

 

 

 -

 

 

2

 

 

(2

)

 

375

 

State and municipal bonds

 

3,723

 

 

874

 

 

4

 

 

 -

 

 

4,593

 

Hybrid and redeemable preferred securities

 

886

 

 

108

 

 

40

 

 

 -

 

 

954

 

VIEs’ fixed maturity securities

 

587

 

 

11

 

 

 -

 

 

 -

 

 

598

 

Total fixed maturity securities

 

79,196

 

 

8,149

 

 

524

 

 

(17

)

 

86,838

 

Equity securities

 

216

 

 

15

 

 

 -

 

 

 -

 

 

231

 

Total AFS securities

$

79,412

 

$

8,164

 

$

524

 

$

(17

)

$

87,069

 

 

(1)      Includes unrealized gains and (losses) on impaired securities related to changes in the fair value of such securities subsequent to the impairment measurement date.

 

Certain amounts reported in prior years’ consolidated financial statements have been reclassified to conform to the presentation adopted in the current year.  Specifically, we reclassified amounts related to subsequent changes in the fair value of AFS securities for which non-credit OTTI was previously recognized in OCI.  Historically, these amounts were recognized through unrealized gain (loss) on AFS securities in the Consolidated Statements of Comprehensive Income (Loss).  To better reflect the economic position of our AFS fixed maturity securities, these amounts are now recognized through unrealized OTTI on AFS securities in the Consolidated Statements of Comprehensive Income (Loss).  These reclassifications had no effect on net income (loss) or stockholders’ equity of the prior years.

 

The amortized cost and fair value of fixed maturity AFS securities by contractual maturities (in millions) as of June 30, 2015, were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amortized

 

Fair

 

 

Cost

 

Value

 

Due in one year or less

$

2,556 

 

$

2,608 

 

Due after one year through five years

 

17,498 

 

 

18,781 

 

Due after five years through ten years

 

21,062 

 

 

21,644 

 

Due after ten years

 

33,510 

 

 

36,281 

 

Subtotal

 

74,626 

 

 

79,314 

 

Structured securities (ABS, MBS, CLOs)

 

6,423 

 

 

6,706 

 

Total fixed maturity AFS securities

$

81,049 

 

$

86,020 

 

 

Actual maturities may differ from contractual maturities because issuers may have the right to call or pre-pay obligations.

 

11


 

 

The fair value and gross unrealized losses, including the portion of OTTI recognized in other comprehensive income (loss) (“OCI”), of AFS securities (dollars in millions), aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of June 30, 2015

 

 

Less Than or Equal

 

Greater Than

 

 

 

 

 

 

 

 

 

to Twelve Months

 

Twelve Months

 

Total

 

 

 

 

Gross 

 

 

 

Gross 

 

 

 

 

 

Gross 

 

 

 

Unrealized

 

Unrealized

 

 

 

Unrealized

 

Fair

Losses and

Fair

Losses and

Fair

 

Losses and

 

Value

 

OTTI

 

Value

 

OTTI

 

Value

 

 

OTTI

 

Fixed maturity securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

$

15,420

 

$

802

 

$

1,508

 

$

170

 

$

16,928

 

 

$

972

 

ABS

 

121

 

 

3

 

 

403

 

 

1

 

 

524

 

 

 

4

 

U.S. government bonds

 

13

 

 

2

 

 

 -

 

 

 -

 

 

13

 

 

 

2

 

RMBS

 

711

 

 

20

 

 

443

 

 

(13

)

 

1,154

 

 

 

7

 

CMBS

 

99

 

 

2

 

 

40

 

 

1

 

 

139

 

 

 

3

 

CLOs

 

85

 

 

 -

 

 

64

 

 

(1

)

 

149

 

 

 

(1

)

State and municipal bonds

 

168

 

 

10

 

 

28

 

 

4

 

 

196

 

 

 

14

 

Hybrid and redeemable

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

preferred securities

 

73

 

 

2

 

 

146

 

 

39

 

 

219

 

 

 

41

 

Total fixed maturity securities

 

16,690

 

 

841

 

 

2,632

 

 

201

 

 

19,322

 

 

 

1,042

 

Equity securities

 

35

 

 

1

 

 

 -

 

 

 -

 

 

35

 

 

 

1

 

Total AFS securities

$

16,725

 

$

842

 

$

2,632

 

$

201

 

$

19,357

 

 

$

1,043

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total number of AFS securities in an unrealized loss position

 

 

 

 

 

 

 

 

 

 

 

 

1,538

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of December 31, 2014

 

 

Less Than or Equal

 

Greater Than

 

 

 

 

 

 

 

 

 

to Twelve Months

 

Twelve Months

 

Total

 

 

 

 

Gross 

 

 

 

Gross 

 

 

 

 

 

Gross 

 

 

 

Unrealized

 

Unrealized

 

 

 

Unrealized

 

Fair

Losses and

Fair

Losses and

Fair

 

Losses and

 

Value

 

OTTI

 

Value

 

OTTI

 

Value

 

 

OTTI

 

Fixed maturity securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

$

4,799

 

$

208

 

$

4,475

 

$

240

 

$

9,274

 

 

$

448

 

ABS

 

91

 

 

2

 

 

428

 

 

11

 

 

519

 

 

 

13

 

RMBS

 

447

 

 

7

 

 

574

 

 

(12

)

 

1,021

 

 

 

(5

)

CMBS

 

121

 

 

1

 

 

41

 

 

6

 

 

162

 

 

 

7

 

CLOs

 

110

 

 

 -

 

 

83

 

 

 -

 

 

193

 

 

 

 -

 

State and municipal bonds

 

6

 

 

 -

 

 

26

 

 

4

 

 

32

 

 

 

4

 

Hybrid and redeemable

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

preferred securities

 

31

 

 

 -

 

 

176

 

 

40

 

 

207

 

 

 

40

 

Total fixed maturity securities

 

5,605

 

 

218

 

 

5,803

 

 

289

 

 

11,408

 

 

 

507

 

Equity securities

 

37

 

 

 -

 

 

 -

 

 

 -

 

 

37

 

 

 

 -

 

Total AFS securities

$

5,642

 

$

218

 

$

5,803

 

$

289

 

$

11,445

 

 

$

507

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total number of AFS securities in an unrealized loss position

 

 

 

 

 

 

 

 

 

 

 

 

1,019

 

 

For information regarding our investments in VIEs, see Note 3.

12


 

 

The fair value, gross unrealized losses, the portion of OTTI recognized in OCI (in millions) and number of AFS securities where the fair value had declined and remained below amortized cost by greater than 20% were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of June 30, 2015

 

 

 

 

 

 

 

 

 

 

 

 

Number

 

 

Fair

 

Gross Unrealized

 

 

of

 

 

Value

 

Losses

 

OTTI

 

Securities (1)

Less than six months

$

243 

 

$

92 

 

$

 

 

 

35 

 

Six months or greater, but less than nine months

 

11 

 

 

 

 

 

 

 

 

Nine months or greater, but less than twelve months

 

41 

 

 

21 

 

 

 -

 

 

 

 

Twelve months or greater

 

130 

 

 

52 

 

 

20 

 

 

 

52 

 

Total

$

425 

 

$

170 

 

$

24 

 

 

 

103 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of December 31, 2014

 

 

 

 

 

 

 

 

 

 

 

 

Number

 

 

Fair

 

Gross Unrealized

 

 

of

 

 

Value

 

Losses

 

OTTI

 

Securities (1)

Less than six months

$

48 

 

$

19 

 

$

 -

 

 

 

12 

 

Six months or greater, but less than nine months

 

 

 

 

 

 -

 

 

 

 

Twelve months or greater

 

242 

 

 

97 

 

 

33 

 

 

 

82 

 

Total

$

298 

 

$

123 

 

$

33 

 

 

 

97 

 

 

(1)      We may reflect a security in more than one aging category based on various purchase dates. 

 

We regularly review our investment holdings for OTTI.  Our gross unrealized losses, including the portion of OTTI recognized in OCI, on AFS securities increased by $536 million for the six months ended June 30, 2015.  As discussed further below, we believe the unrealized loss position as of June 30, 2015, did not represent OTTI as (i) we did not intend to sell the fixed maturity AFS securities; (ii) it is not more likely than not that we will be required to sell the fixed maturity AFS securities before recovery of their amortized cost basis; (iii) the estimated future cash flows were equal to or greater than the amortized cost basis of the debt securities; and (iv) we had the ability and intent to hold the equity AFS securities for a period of time sufficient for recovery. 

 

Based upon this evaluation as of June 30, 2015, management believes we have the ability to generate adequate amounts of cash from our normal operations (e.g., insurance premiums and fees and investment income) to meet cash requirements with a prudent margin of safety without requiring the sale of our temporarily-impaired securities.

 

As of June 30, 2015, the unrealized losses associated with our corporate bond securities were attributable primarily to widening credit spreads and rising interest rates since purchase.  We performed a detailed analysis of the financial performance of the underlying issuers and determined that we expected to recover the entire amortized cost for each security.

 

As of June 30, 2015,  the unrealized losses associated with our mortgage-backed securities (“MBS”) and ABS were attributable primarily to collateral losses and credit spreads.  We assessed credit impairment using a cash flow model that incorporates key assumptions including default rates, severities and prepayment rates.  We estimated losses for a security by forecasting the underlying loans in each transaction.  The forecasted loan performance was used to project cash flows to the various tranches in the structure, as applicable.  Our forecasted cash flows also considered, as applicable, independent industry analyst reports and forecasts, sector credit ratings and other independent market data. Based upon our assessment of the expected credit losses of the security given the performance of the underlying collateral compared to our subordination or other credit enhancement, we expected to recover the entire amortized cost basis of each temporarily impaired security.

 

As of June 30, 2015,  the unrealized losses associated with our hybrid and redeemable preferred securities were attributable primarily to wider credit spreads caused by illiquidity in the market and subordination within the capital structure, as well as credit risk of underlying issuers.  For our hybrid and redeemable preferred securities, we evaluated the financial performance of the underlying issuers based upon credit performance and investment ratings and determined that we expected to recover the entire amortized cost of each security.

 

13


 

 

Changes in the amount of credit loss of OTTI recognized in net income (loss) where the portion related to other factors was recognized in OCI (in millions) on fixed maturity AFS securities were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

For the Six

 

 

Months Ended

 

Months Ended

 

 

June 30,

 

June 30,

 

 

2015

 

2014

 

2015

 

2014

 

Balance as of beginning-of-period

$

382

 

$

408

 

$

380

 

$

404

 

Increases attributable to:

 

 

 

 

 

 

 

 

 

 

 

 

Credit losses on securities for which an

 

 

 

 

 

 

 

 

 

 

 

 

OTTI was not previously recognized

 

3

 

 

1

 

 

16

 

 

2

 

Credit losses on securities for which an

 

 

 

 

 

 

 

 

 

 

 

 

OTTI was previously recognized

 

4

 

 

3

 

 

6

 

 

7

 

Decreases attributable to:

 

 

 

 

 

 

 

 

 

 

 

 

Securities sold, paid down or matured

 

(15

)

 

(23

)

 

(28

)

 

(24

)

Balance as of end-of-period

$

374

 

$

389

 

$

374

 

$

389

 

 

During the six months ended June 30, 2015 and 2014, we recorded credit losses on securities for which an OTTI was not previously recognized as we determined the cash flows expected to be collected would not be sufficient to recover the entire amortized cost basis of the debt security.  The credit losses we recorded on securities for which an OTTI was not previously recognized were attributable primarily to one or a combination of the following reasons:

 

•      Failure of the issuer of the security to make scheduled payments;

•      Deterioration of creditworthiness of the issuer;

•      Deterioration of conditions specifically related to the security;

•      Deterioration of fundamentals of the industry in which the issuer operates; and

•      Deterioration of the rating of the security by a rating agency.

 

We recognize the OTTI attributed to the noncredit portion as a separate component in OCI referred to as unrealized OTTI on AFS securities. 

 

Details of the amount of credit loss of OTTI recognized in net income (loss) for which a portion related to other factors was recognized in OCI (in millions), were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of June 30, 2015

 

 

 

 

 

Net

 

 

 

 

 

 

 

 

 

 

Unrealized

 

 

 

 

OTTI in

 

 

Amortized

 

Gain/(Loss)

 

Fair

 

Credit

 

 

Cost

 

Position

 

Value

 

Losses

 

Corporate bonds

$

86

 

$

(22

)

$

64

 

$

23

 

ABS

 

220

 

 

17

 

 

237

 

 

111

 

RMBS

 

409

 

 

17

 

 

426

 

 

192

 

CMBS

 

40

 

 

 -

 

 

40

 

 

48

 

Total

$

755

 

$

12

 

$

767

 

$

374

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of December 31, 2014

 

 

 

 

 

Net

 

 

 

 

 

 

 

 

 

 

Unrealized

 

 

 

 

OTTI in

 

 

Amortized

 

Gain/(Loss)

 

Fair

 

Credit

 

 

Cost

 

Position

 

Value

 

Losses

 

Corporate bonds

$

38

 

$

(4

)

$

34

 

$

20

 

ABS

 

232

 

 

9

 

 

241

 

 

108

 

RMBS

 

447

 

 

19

 

 

466

 

 

190

 

CMBS

 

46

 

 

(6

)

 

40

 

 

62

 

Total

$

763

 

$

18

 

$

781

 

$

380

 

 

Mortgage Loans on Real Estate

 

See Note 1 in our 2014 Form 10-K for information regarding our accounting policy relating to mortgage loans on real estate.

 

14


 

 

Mortgage loans on real estate principally involve commercial real estate.  The commercial loans are geographically diversified throughout the U.S. with the largest concentrations in California and Texas, which accounted for 23%  and 9%, respectively, of mortgage loans on real estate as of June 30, 2015, and December 31, 2014.

 

The following provides the current and past due composition of our mortgage loans on real estate (in millions):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of

 

As of

 

June 30,

December 31,

 

 

2015

 

 

2014

 

Current

 

$

8,171

 

 

$

7,565

 

60 to 90 days past due

 

 

 -

 

 

 

 -

 

Greater than 90 days past due

 

 

 -

 

 

 

8

 

Valuation allowance associated with impaired mortgage loans on real estate

 

 

(3

)

 

 

(3

)

Unamortized premium (discount)

 

 

3

 

 

 

4

 

Total carrying value

 

$

8,171

 

 

$

7,574

 

 

The number of impaired mortgage loans on real estate, each of which had an associated specific valuation allowance, and the carrying value of impaired mortgage loans on real estate (dollars in millions) were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of

 

 

As of

 

 

June 30,

December 31,

 

 

2015

 

 

2014

 

Number of impaired mortgage loans on real estate

 

3

 

 

3

 

 

 

 

 

 

 

 

 

 

Principal balance of impaired mortgage loans on real estate

 

$

26

 

 

$

26

 

Valuation allowance associated with impaired mortgage loans on real estate

 

 

(3

)

 

 

(3

)

Carrying value of impaired mortgage loans on real estate

 

$

23

 

 

$

23

 

 

The changes in the valuation allowance associated with impaired mortgage loans on real estate (in millions) were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of

As of

 

June 30,

December 31,

 

 

2015

 

 

2014

 

Balance as of beginning-of-year

 

$

 

 

$

 

Additions

 

 

 -

 

 

 

 -

 

Charge-offs, net of recoveries

 

 

 -

 

 

 

 -

 

Balance as of end-of-period

 

$

 

 

$

 

 

The average carrying value of the impaired mortgage loans on real estate (in millions) was as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

For the Six

 

 

Months Ended

 

Months Ended

 

 

June 30,

 

June 30,

 

 

2015

 

2014

 

2015

 

2014

 

Average carrying value for impaired mortgage loans on real estate

$

23 

 

$

24 

 

$

23 

 

$

24 

 

Interest income recognized on impaired mortgage loans on real estate

 

 -

 

 

 -

 

 

 

 

 

Interest income collected on impaired mortgage loans on real estate

 

 -

 

 

 -

 

 

 

 

 

 

15


 

 

As described in Note 1 in our 2014 Form 10-K, we use the loan-to-value and debt-service coverage ratios as credit quality indicators for our mortgage loans, which were as follows (dollars in millions):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of June 30, 2015

 

As of December 31, 2014

 

 

 

 

 

 

 

Debt-

 

 

 

 

 

 

Debt-

 

 

 

 

 

 

 

Service

 

 

 

 

 

 

Service

 

 

Carrying

 

% of

 

Coverage

 

Carrying

 

% of

 

Coverage

 

 

Value

 

Total

 

Ratio

 

Value

 

Total

 

Ratio

 

Less than 65%

$

7,250 

 

88.7% 

 

2.02

 

$

6,596 

 

87.1% 

 

1.90

 

65% to 74%

 

574 

 

7.0% 

 

1.60

 

 

631 

 

8.3% 

 

1.55

 

75% to 100%

 

317 

 

3.9% 

 

0.81

 

 

316 

 

4.2% 

 

0.77

 

Greater than 100%

 

30 

 

0.4% 

 

0.77

 

 

31 

 

0.4% 

 

0.77

 

Total mortgage loans on real estate

$

8,171 

 

100.0% 

 

 

 

$

7,574 

 

100.0% 

 

 

 

 

Alternative Investments 

 

As of June 30, 2015, and December 31, 2014, alternative investments included investments in 180 and 156 different partnerships, respectively, and the portfolio represented approximately 1% of our overall invested assets.

 

Realized Gain (Loss) Related to Certain Investments

 

The detail of the realized gain (loss) related to certain investments (in millions) was as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

For the Six

 

 

Months Ended

 

Months Ended

 

 

June 30,

 

June 30,

 

 

2015

 

2014

 

2015

 

2014

 

Fixed maturity AFS securities: (1)

 

 

 

 

 

 

 

 

 

 

 

 

Gross gains

$

21

 

$

11

 

$

23

 

$

19

 

Gross losses

 

(13

)

 

(6

)

 

(29

)

 

(13

)

Equity AFS securities:

 

 

 

 

 

 

 

 

 

 

 

 

Gross gains

 

1

 

 

3

 

 

1

 

 

3

 

Gross losses

 

 -

 

 

 -

 

 

 -

 

 

 -

 

Gain (loss) on other investments

 

 -

 

 

3

 

 

(8

)

 

3

 

Associated amortization of DAC, VOBA, DSI and DFEL

 

 

 

 

 

 

 

 

 

 

 

 

and changes in other contract holder funds

 

(10

)

 

(10

)

 

(15

)

 

(17

)

Total realized gain (loss) related to certain investments, pre-tax

$

(1

)

$

1

 

$

(28

)

$

(5

)

 

(1)      These amounts are represented net of related fair value hedging activity.  See Note 5 for more information.

 

16


 

 

Details underlying write-downs taken as a result of OTTI (in millions) that were recognized in net income (loss) and included in realized gain (loss) on AFS securities above, and the portion of OTTI recognized in OCI (in millions) were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

For the Six

 

 

Months Ended

 

Months Ended

 

 

June 30,

 

June 30,

 

 

2015

 

2014

 

2015

 

2014

 

OTTI Recognized in Net Income (Loss)

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturity securities:

 

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

$

(4

)

$

 -

 

$

(15

)

$

 -

 

ABS

 

(3

)

 

(2

)

 

(5

)

 

(5

)

RMBS

 

 -

 

 

(1

)

 

(2

)

 

(3

)

CMBS

 

 -

 

 

(1

)

 

 -

 

 

(1

)

Gross OTTI recognized in net income (loss)

 

(7

)

 

(4

)

 

(22

)

 

(9

)

Associated amortization of DAC, VOBA, DSI and DFEL

 

 -

 

 

1

 

 

2

 

 

2

 

Net OTTI recognized in net income (loss), pre-tax

$

(7

)

$

(3

)

 

(20

)

 

(7

)

 

 

 

 

 

 

 

 

 

 

 

 

 

Portion of OTTI Recognized in OCI

 

 

 

 

 

 

 

 

 

 

 

 

Gross OTTI recognized in OCI

$

9

 

$

2

 

$

18

 

$

9

 

Change in DAC, VOBA, DSI and DFEL

 

(2

)

 

 -

 

 

(3

)

 

(1

)

Net portion of OTTI recognized in OCI, pre-tax

$

7

 

$

2

 

$

15

 

$

8

 

 

Determination of Credit Losses on Corporate Bonds and ABS

 

As of June 30, 2015, and December 31, 2014, we reviewed our corporate bond and ABS portfolios for potential shortfall in contractual principal and interest based on numerous subjective and objective inputs. The factors used to determine the amount of credit loss for each individual security, include, but are not limited to, near term risk, substantial discrepancy between book and market value, sector or company-specific volatility, negative operating trends and trading levels wider than peers.

 

Credit ratings express opinions about the credit quality of a security.  Securities rated investment grade, that is those rated BBB- or higher by Standard & Poor’s (“S&P”) Rating Services or Baa3 or higher by Moody’s Investors Service (“Moody’s”), are generally considered by the rating agencies and market participants to be low credit risk.  As of June 30, 2015, and December 31, 2014,  95% and 96%, respectively, of the fair value of our corporate bond portfolio was rated investment grade.  As of June 30, 2015, and December 31, 2014, the portion of our corporate bond portfolio rated below investment grade had an amortized cost of $3.4 billion and $3.3 billion, respectively, and a fair value of $3.4 billion and $3.2 billion, respectively.  As of June 30, 2015, and December 31, 2014,  92% and 88%, respectively, of the fair value of our ABS portfolio was rated investment grade.  As of June 30, 2015, and December 31, 2014, the portion of our ABS portfolio rated below investment grade had an amortized cost of $184 million and $193 million, respectively, and fair value of $174 million and $176 million, respectively.  Based upon the analysis discussed above, we believe as of June 30, 2015, and December 31, 2014, that we would recover the amortized cost of each fixed maturity security.

 

Determination of Credit Losses on MBS

 

As of June 30, 2015, and December 31, 2014, default rates were projected by considering underlying MBS loan performance and collateral type.  Projected default rates on existing delinquencies vary between approximately 10% to 100% depending on loan type and severity of delinquency status.  In addition, we estimate the potential contributions of currently performing loans that may become delinquent in the future based on the change in delinquencies and loan liquidations experienced in the recent history.  Finally, we develop a default rate timing curve by aggregating the defaults for all loans in the pool (delinquent loans, foreclosure and real estate owned and new delinquencies from currently performing loans) and the associated loan-level loss severities. 

 

We use certain available loan characteristics such as lien status, loan sizes and occupancy to estimate the loss severity of loans.  Second lien loans are assigned 100% severity, if defaulted.  For first lien loans, we assume a minimum of 30% severity with higher severity assumed for investor properties and further adjusted by housing price assumptions.  With the default rate timing curve and loan-level severity, we derive the future expected credit losses.

 

17


 

 

Payables for Collateral on Investments

 

The carrying value of the payables for collateral on investments (in millions) included on our Consolidated Balance Sheets and the fair value of the related investments or collateral consisted of the following:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of June 30, 2015

 

As of December 31, 2014

 

 

Carrying

 

Fair

 

Carrying

 

Fair

 

 

Value

 

Value

 

Value

 

Value

 

Collateral payable for derivative investments (1)

$

1,071 

 

$

1,071 

 

$

1,673 

 

$

1,673 

 

Securities pledged under securities lending agreements (2)

 

232 

 

 

222 

 

 

204 

 

 

196 

 

Securities pledged under repurchase agreements (3)

 

1,034 

 

 

1,112 

 

 

607 

 

 

666 

 

Investments pledged for Federal Home Loan Bank of

 

 

 

 

 

 

 

 

 

 

 

 

Indianapolis (“FHLBI”) (4)

 

2,250 

 

 

3,067 

 

 

1,925 

 

 

3,151 

 

Total payables for collateral on investments

$

4,587 

 

$

5,472 

 

$

4,409 

 

$

5,686 

 

 

(1)      We obtain collateral based upon contractual provisions with our counterparties.  These agreements take into consideration the counterparties’ credit rating as compared to ours, the fair value of the derivative investments and specified thresholds that if exceeded result in the receipt of cash that is typically invested in cash and invested cash.  See Note 5 for additional information.

(2)      Our pledged securities under securities lending agreements are included in fixed maturity AFS securities on our Consolidated Balance Sheets.  We generally obtain collateral in an amount equal to 102% and 105% of the fair value of the domestic and foreign securities, respectively.  We value collateral daily and obtain additional collateral when deemed appropriate.  The cash received in our securities lending program is typically invested in cash and invested cash or fixed maturity AFS securities.

(3)      Our pledged securities under repurchase agreements are included in fixed maturity AFS securities on our Consolidated Balance Sheets.  We obtain collateral in an amount equal to 95% of the fair value of the securities, and our agreements with third parties contain contractual provisions to allow for additional collateral to be obtained when necessary.  The cash received in our repurchase program is typically invested in fixed maturity AFS securities.

(4)      Our pledged investments for FHLBI are included in fixed maturity AFS securities and mortgage loans on real estate on our Consolidated Balance Sheets.  The FHLBI overcollateralization requirements for the assets that we pledge are generally 105% to 115% of the fair value for fixed maturity AFS securities and 155% to 175% of the unpaid principal balance for mortgage loans on real estate.  The cash received in these transactions is primarily invested in cash and invested cash or fixed maturity AFS securities.

 

Increase (decrease) in payables for collateral on investments (in millions) consisted of the following:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Six

 

 

Months Ended

 

 

June 30,

 

 

2015

 

2014

 

Collateral payable for derivative investments

$

(602

)

$

319

 

Securities pledged under securities lending agreements

 

28

 

 

15

 

Securities pledged under repurchase agreements

 

427

 

 

(325

)

Investments pledged for FHLBI

 

325

 

 

325

 

Total increase (decrease) in payables for collateral on investments

$

178

 

$

334

 

 

 

18


 

 

The remaining contractual maturities of repurchase agreements, repurchase-to-maturity transactions and securities lending transactions accounted for as secured borrowings were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of June 30, 2015

 

 

Overnight and Continuous

 

Up to 30 Days

 

30 –  90 Days

 

Greater Than 90 Days

 

Total

 

Repurchase Agreements and Repurchase-to-Maturity Transactions:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ABS

$

 -

 

$

 -

 

$

 -

 

$

500 

 

$

500 

 

Corporate bonds

 

 -

 

 

105 

 

 

275 

 

 

154 

 

 

534 

 

Total

 

 -

 

 

105 

 

 

275 

 

 

654 

 

 

1,034 

 

Securities Lending

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

 

224 

 

 

 -

 

 

 -

 

 

 -

 

 

224 

 

Equity securities

 

 

 

 -

 

 

 -

 

 

 -

 

 

 

Foreign government bonds

 

 

 

 -

 

 

 -

 

 

 -

 

 

 

Total

 

232 

 

 

 -

 

 

 -

 

 

 -

 

 

232 

 

Total secured borrowings

$

232 

 

$

105 

 

$

275 

 

$

654 

 

$

1,266 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross amount of recognized liabilities for repurchase agreements and securities lending:

 

 

 

 

 

 

 

 

 

 

 

 

$

1,266 

 

Amounts related to agreements not included in offsetting disclosures:

 

 

 

 

 

 

 

 

 

 

 

 

$

 -

 

 

We accept collateral in the form of securities in connection with repurchase agreements that we are permitted to sell or re-pledge in certain cases.  In such cases, we report the fair value of the collateral and a related obligation to return the collateral.  As of June 30, 2015, the fair value of collateral received that we are permitted to sell or re-pledge was $154 million.  We have not sold or re-pledged this collateral.

 

Investment Commitments

 

As of June 30, 2015, our investment commitments were $1.3 billion, which included $656 million of LPs,  $390 million of mortgage loans on real estate, and $284 million of private debt investments.

 

Concentrations of Financial Instruments

 

As of June 30, 2015, and December 31, 2014, our most significant investments in one issuer were our investments in securities issued by the Federal Home Loan Mortgage Corporation with a fair value of $2.0 billion and $2.2 billion, respectively, or 2% of our invested assets portfolio, and our investments in securities issued by Fannie Mae with a fair value of $1.3 billion and $1.4 billion, respectively, or 1% of our invested assets portfolio. 

 

As of June 30, 2015, and December 31, 2014, our most significant investments in one industry were our investment securities in the utilities industry with a fair value of $12.4 billion and $12.8 billion, respectively, or 12% and 13%, respectively, of our invested assets portfolio, and our investment securities in the consumer non-cyclical industry with a fair value of $11.7 billion, or 12%  and 11%, respectively, of our invested assets portfolio.  These concentrations include both AFS and trading securities.

 

5.  Derivative Instruments

 

We maintain an overall risk management strategy that incorporates the use of derivative instruments to minimize significant unplanned fluctuations in earnings that are caused by interest rate risk, foreign currency exchange risk, equity market risk, default risk, basis risk and credit risk.  See Note 1 in our 2014 Form 10-K for a detailed discussion of the accounting treatment for derivative instruments.  See Note 6 in our 2014 Form 10-K for a detailed discussion of our derivative instruments and use of them in our overall risk management strategy, which information is incorporated herein by reference.  See Note 12 for additional disclosures related to the fair value of our derivative instruments and Note 3 for derivative instruments related to our consolidated VIEs.

 

19


 

 

We have derivative instruments with off-balance-sheet risks whose notional or contract amounts exceed the credit exposure.  Outstanding derivative instruments with off-balance-sheet risks (in millions) were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of June 30, 2015

 

As of December 31, 2014

 

 

Notional

 

Fair Value

 

Notional

 

Fair Value

 

 

Amounts

 

Asset

 

Liability

 

Amounts

 

Asset

 

Liability

 

Qualifying Hedges

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash flow hedges:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate contracts (1)

$

2,950 

 

$

337 

 

$

38 

 

$

3,554 

 

$

408 

 

$

198 

 

Foreign currency contracts (1)

 

642 

 

 

62 

 

 

16 

 

 

642 

 

 

45 

 

 

21 

 

Total cash flow hedges

 

3,592 

 

 

399 

 

 

54 

 

 

4,196 

 

 

453 

 

 

219 

 

Fair value hedges:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate contracts (1)

 

1,534 

 

 

217 

 

 

170 

 

 

875 

 

 

259 

 

 

 -

 

Non-Qualifying Hedges

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate contracts (1)

 

61,902 

 

 

714 

 

 

393 

 

 

54,401 

 

 

989 

 

 

342 

 

Foreign currency contracts (1)

 

143 

 

 

 -

 

 

 -

 

 

68 

 

 

 -

 

 

 -

 

Equity market contracts (1)

 

24,204 

 

 

799 

 

 

235 

 

 

24,310 

 

 

886 

 

 

243 

 

Credit contracts (2)

 

103 

 

 

 -

 

 

 

 

126 

 

 

 -

 

 

 

Embedded derivatives:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Guaranteed living benefit reserves (3)

 

 -

 

 

254 

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

Guaranteed living benefit reserves (2)

 

 -

 

 

 -

 

 

102 

 

 

 -

 

 

 -

 

 

174 

 

Reinsurance related (4)

 

 -

 

 

 -

 

 

120 

 

 

 -

 

 

 -

 

 

150 

 

Indexed annuity and IUL contracts (5)

 

 -

 

 

 -

 

 

1,155 

 

 

 -

 

 

 -

 

 

1,170 

 

Total derivative instruments

$

91,478 

 

$

2,383 

 

$

2,231 

 

$

83,976 

 

$

2,587 

 

$

2,301 

 

 

(1)      Reported in derivative investments and other liabilities on our Consolidated Balance Sheets.

(2)      Reported in other liabilities on our Consolidated Balance Sheets.

(3)      Reported in other assets on our Consolidated Balance Sheets.

(4)      Reported in reinsurance related embedded derivatives on our Consolidated Balance Sheets.

(5)      Reported in future contract benefits on our Consolidated Balance Sheets.

 

The maturity of the notional amounts of derivative instruments (in millions) was as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Remaining Life as of June 30, 2015

 

 

Less Than

 

1 – 5

 

6 – 10

 

11 – 30

 

Over 30

 

 

 

 

1 Year

 

Years

 

Years

 

Years

 

Years

 

Total

 

Interest rate contracts (1)

$

7,254 

 

$

35,137 

 

$

11,030 

 

$

11,752 

 

$

1,213 

 

$

66,386 

 

Foreign currency contracts (2)

 

173 

 

 

168 

 

 

234 

 

 

210 

 

 

 -

 

 

785 

 

Equity market contracts

 

14,463 

 

 

5,705 

 

 

3,766 

 

 

18 

 

 

252 

 

 

24,204 

 

Credit contracts

 

 -

 

 

103 

 

 

 -

 

 

 -

 

 

 -

 

 

103 

 

Total derivative instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

with notional amounts

$

21,890 

 

$

41,113 

 

$

15,030 

 

$

11,980 

 

$

1,465 

 

$

91,478 

 

 

(1)      As of June 30, 2015, the latest maturity date for which we were hedging our exposure to the variability in future cash flows for these instruments was April 2067.

(2)      As of June 30, 2015, the latest maturity date for which we were hedging our exposure to the variability in future cash flows for these instruments was December 2029.

 

20


 

 

The change in our unrealized gain (loss) on derivative instruments in accumulated OCI (“AOCI”) (in millions) was as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Six

 

 

Months Ended

 

 

June 30,

 

 

2015

 

2014

 

Unrealized Gain (Loss) on Derivative Instruments

 

 

 

 

 

 

Balance as of beginning-of-year

$

139

 

$

256

 

Other comprehensive income (loss):

 

 

 

 

 

 

Unrealized holding gains (losses) arising during the period:

 

 

 

 

 

 

Cash flow hedges:

 

 

 

 

 

 

Interest rate contracts

 

(121

)

 

(52

)

Foreign currency contracts

 

25

 

 

(7

)

Change in foreign currency exchange rate adjustment

 

16

 

 

(11

)

Income tax benefit (expense)

 

27

 

 

24

 

Less:

 

 

 

 

 

 

Reclassification adjustment for gains (losses)

 

 

 

 

 

 

included in net income (loss):

 

 

 

 

 

 

Cash flow hedges:

 

 

 

 

 

 

Interest rate contracts (1)

 

(194

)

 

(12

)

Interest rate contracts (2)

 

2

 

 

2

 

Foreign currency contracts (1)

 

3

 

 

 -

 

Associated amortization of DAC, VOBA, DSI and DFEL

 

 -

 

 

1

 

Income tax benefit (expense)

 

66

 

 

3

 

Balance as of end-of-period

$

209

 

$

216

 

 

(1)      The OCI offset is reported within net investment income on our Consolidated Statements of Comprehensive Income (Loss).

(2)      The OCI offset is reported within interest and debt expense on our Consolidated Statements of Comprehensive Income (Loss).

 

21


 

 

The gains (losses) on derivative instruments (in millions) recorded within income (loss) from continuing operations on our Consolidated Statements of Comprehensive Income (Loss) were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

For the Six

 

 

 

Months Ended

 

Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2015

 

2014

 

2015

 

2014

 

 

Qualifying Hedges

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash flow hedges:

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate contracts (1)

$

3

 

$

(5

)

$

4

 

$

(11

)

 

Interest rate contracts (2)

 

(1

)

 

 -

 

 

(1

)

 

 -

 

 

Foreign currency contracts (1)

 

1

 

 

(1

)

 

3

 

 

 -

 

 

Total cash flow hedges

 

3

 

 

(6

)

 

6

 

 

(11

)

 

Fair value hedges:

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate contracts (1)

 

(7

)

 

 -

 

 

(15

)

 

 -

 

 

Interest rate contracts (2)

 

8

 

 

9

 

 

16

 

 

18

 

 

Interest rate contracts (3)

 

60

 

 

 -

 

 

(170

)

 

 -

 

 

Total fair value hedges

 

61

 

 

9

 

 

(169

)

 

18

 

 

Non-Qualifying Hedges

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate contracts (3)

 

(673

)

 

284

 

 

(231

)

 

615

 

 

Foreign currency contracts (3)

 

(4

)

 

(1

)

 

(6

)

 

 -

 

 

Equity market contracts (3)

 

(53

)

 

(257

)

 

(283

)

 

(413

)

 

Equity market contracts (4)

 

 -

 

 

7

 

 

5

 

 

8

 

 

Credit contracts (3)

 

1

 

 

1

 

 

1

 

 

1

 

 

Embedded derivatives:

 

 

 

 

 

 

 

 

 

 

 

 

 

Guaranteed living benefit reserves (3)

 

704

 

 

(58

)

 

326

 

 

(340

)

 

Reinsurance related (3)

 

45

 

 

(21

)

 

30

 

 

(47

)

 

Indexed annuity and IUL contracts (3)

 

(9

)

 

(92

)

 

(47

)

 

(140

)

 

Total derivative instruments

$

75

 

$

(134

)

$

(368

)

$

(309

)

 

 

(1)      Reported in net investment income on our Consolidated Statements of Comprehensive Income (Loss).

(2)      Reported in interest and debt expense on our Consolidated Statements of Comprehensive Income (Loss).

(3)      Reported in realized gain (loss) on our Consolidated Statements of Comprehensive Income (Loss).

(4)      Reported in commissions and other expenses on our Consolidated Statements of Comprehensive Income (Loss).

 

Gains (losses) recognized as a component of OCI (in millions) on derivative instruments designated and qualifying as cash flow hedges were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

For the Six

 

 

Months Ended

 

Months Ended

 

 

June 30,

 

June 30,

 

 

2015

 

2014

 

2015

 

2014

 

Offset to net investment income

$

4

 

$

(6

)

$

7

 

$

(12

)

Offset to interest and debt expense

 

1

 

 

1

 

 

1

 

 

2

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of June 30, 2015,  $13 million of the deferred net gains (losses) on derivative instruments in AOCI were expected to be reclassified to earnings during the next 12 months.  This reclassification would be due primarily to interest rate variances related to our interest rate swap agreements.

 

For the six months ended June 30, 2015 and 2014, there were no material reclassifications to earnings due to hedged firm commitments no longer deemed probable or due to hedged forecasted transactions that had not occurred by the end of the originally specified time period.

 

 

 

22


 

 

Information related to our open credit default swaps for which we are the seller (dollars in millions) was as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of June 30, 2015

 

 

 

 

 

 

 

Credit

 

 

 

 

 

 

 

 

 

 

 

Reason

 

Nature

 

Rating of

 

Number

 

 

 

 

Maximum

 

 

 

for

 

of

Underlying

of

 

Fair

 

Potential

 

Maturity

 

Entering

 

Recourse

Obligation (1)

Instruments

 

Value (2)

 

Payout

 

12/20/2016 (3)

 

(4)

 

(5)

 

BBB-

 

2

 

$

(1

)

$

45

 

3/20/2017 (3)

 

(4)

 

(5)

 

BBB-

 

3

 

 

(1

)

 

58

 

 

 

 

 

 

 

 

 

5

 

$

(2

)

$

103

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of December 31, 2014

 

 

 

 

 

 

 

Credit

 

 

 

 

 

 

 

 

 

 

 

Reason

 

Nature

 

Rating of

 

Number

 

 

 

 

Maximum

 

 

 

for

 

of

Underlying

of

 

Fair

 

Potential

 

Maturity

 

Entering

 

Recourse

Obligation (1)

Instruments

 

Value (2)

 

Payout

 

12/20/2016 (3)

 

(4)

 

(5)

 

BBB-

 

3

 

$

(2

)

$

68

 

3/20/2017 (3)

 

(4)

 

(5)

 

BBB-

 

3

 

 

(1

)

 

58

 

 

 

 

 

 

 

 

 

6

 

$

(3

)

$

126

 

 

(1)      Represents average credit ratings based on the midpoint of the applicable ratings among Moody’s, S&P and Fitch Ratings, as scaled to the corresponding S&P ratings.

(2)      Broker quotes are used to determine the market value of credit default swaps.

(3)      These credit default swaps were sold to a counterparty of the consolidated VIEs discussed in Note 4 in our 2014 Form 10-K.

(4)      Credit default swaps were entered into in order to generate income by providing default protection in return for a quarterly payment.

(5)      Sellers do not have the right to demand indemnification or compensation from third parties in case of a loss (payment) on the contract.

 

Details underlying the associated collateral of our open credit default swaps for which we are the seller if credit risk-related contingent features were triggered (in millions), were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of

 

 

As of

 

 

 

June 30,

December 31,

 

 

 

2015

 

 

2014

 

 

Maximum potential payout

 

$

103 

 

 

$

126 

 

 

Less:  Counterparty thresholds

 

 

 -

 

 

 

 -

 

 

Maximum collateral potentially required to post

 

$

103 

 

 

$

126 

 

 

 

Certain of our credit default swap agreements contain contractual provisions that allow for the netting of collateral with our counterparties related to all of our collateralized financing transactions that we have outstanding.  If these netting agreements were not in place, we would have been required to post $2 million as of June 30, 2015, after considering the fair values of the associated investments counterparties’ credit ratings as compared to ours and specified thresholds that once exceeded result in the payment of cash. 

 

Credit Risk

 

We are exposed to credit loss in the event of non-performance by our counterparties on various derivative contracts and reflect assumptions regarding the credit or non-performance risk (“NPR”).  The NPR is based upon assumptions for each counterparty’s credit spread over the estimated weighted average life of the counterparty exposure less collateral held.  As of June 30, 2015, the NPR adjustment was less than $1 million.  The credit risk associated with such agreements is minimized by entering into agreements with financial institutions with long-standing, superior performance records.  Additionally, we maintain a policy of requiring derivative contracts to be governed by an International Swaps and Derivatives Association (“ISDA”) Master Agreement.  We are required to maintain minimum ratings as a matter of routine practice in negotiating ISDA agreements.  Under some ISDA agreements, our insurance subsidiaries have agreed to maintain certain financial strength or claims-paying ratings.  A downgrade below these levels could result in termination of derivative contracts, at which time any amounts payable by us would be dependent on the market value of the underlying derivative contracts.  In certain transactions, we and the counterparty have entered into a credit support annex requiring either party to post collateral when net exposures exceed pre-determined thresholds.  These thresholds vary by counterparty and credit rating.  The amount of such exposure is essentially the net replacement cost or market value less collateral held for such agreements with each counterparty if the net market value is in our favor.  As of June 30, 2015, our exposure was $26 million. 

23


 

 

The amounts recognized (in millions) by S&P credit rating of each counterparty, for which we had the right to reclaim cash collateral or were obligated to return cash collateral, were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of June 30, 2015

 

As of December 31, 2014

 

 

 

Collateral

 

Collateral

 

Collateral

 

Collateral

 

 

 

Posted by

 

Posted by

 

Posted by

 

Posted by

 

S&P

 

Counter-

 

LNC

 

Counter-

 

LNC

 

Credit

 

Party

 

(Held by

 

Party

 

(Held by

 

Rating of

 

(Held by

 

Counter-

 

(Held by

 

Counter-

 

Counterparty

 

LNC)

 

Party)

 

LNC)

 

Party)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

AA-

 

$

50

 

$

(2

)

$

64

 

$

 -

 

A+

 

 

27

 

 

 -

 

 

47

 

 

 -

 

A

 

 

803

 

 

(67

)

 

1,163

 

 

(85

)

A-

 

 

166

 

 

 -

 

 

233

 

 

 -

 

BBB+

 

 

17

 

 

 -

 

 

27

 

 

 -

 

 

 

$

1,063

 

$

(69

)

$

1,534

 

$

(85

)

 

Balance Sheet Offsetting

 

Information related to our derivative instruments and the effects of offsetting on our Consolidated Balance Sheets (in millions) was as follows:    

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of June 30, 2015

 

 

 

 

 

 

Embedded

 

 

 

 

 

Derivative

Derivative

 

 

 

 

 

Instruments

Instruments

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial Assets

 

 

 

 

 

 

 

 

 

 

 

 

Gross amount of recognized assets

 

$

2,095

 

 

$

254

 

 

$

2,349

 

Gross amounts offset

 

 

(755

)

 

 

 -

 

 

 

(755

)

Net amount of assets

 

 

1,340

 

 

 

254

 

 

 

1,594

 

Gross amounts not offset:

 

 

 

 

 

 

 

 

 

 

 

 

Cash collateral

 

 

(1,063

)

 

 

 -

 

 

 

(1,063

)

Net amount

 

$

277

 

 

$

254

 

 

$

531

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

Gross amount of recognized liabilities

 

$

99

 

 

$

1,377

 

 

$

1,476

 

Gross amounts offset

 

 

(34

)

 

 

 -

 

 

 

(34

)

Net amount of liabilities

 

 

65

 

 

 

1,377

 

 

 

1,442

 

Gross amounts not offset:

 

 

 

 

 

 

 

 

 

 

 

 

Cash collateral

 

 

(69

)

 

 

 -

 

 

 

(69

)

Net amount

 

$

(4

)

 

$

1,377

 

 

$

1,373

 

 

24


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of December 31, 2014

 

 

 

 

 

 

Embedded

 

 

 

 

 

Derivative

Derivative

 

 

 

 

 

Instruments

Instruments

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial Assets

 

 

 

 

 

 

 

 

 

 

 

 

Gross amount of recognized assets

 

$

2,537

 

 

$

 -

 

 

$

2,537

 

Gross amounts offset

 

 

(677

)

 

 

 -

 

 

 

(677

)

Net amount of assets

 

 

1,860

 

 

 

 -

 

 

 

1,860

 

Gross amounts not offset:

 

 

 

 

 

 

 

 

 

 

 

 

Cash collateral

 

 

(1,534

)

 

 

 -

 

 

 

(1,534

)

Net amount

 

$

326

 

 

$

 -

 

 

$

326

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

Gross amount of recognized liabilities

 

$

130

 

 

$

1,494

 

 

$

1,624

 

Gross amounts offset

 

 

(50

)

 

 

 -

 

 

 

(50

)

Net amount of liabilities

 

 

80

 

 

 

1,494

 

 

 

1,574

 

Gross amounts not offset:

 

 

 

 

 

 

 

 

 

 

 

 

Cash collateral

 

 

(85

)

 

 

 -

 

 

 

(85

)

Net amount

 

$

(5

)

 

$

1,494

 

 

$

1,489

 

 

 

6.  Federal Income Taxes

 

The effective tax rate is the ratio of tax expense over pre-tax income (loss).  The effective tax rate was 23% and 21% for the three and six months ended June 30, 2015, respectively.  The effective tax rate was 26% and 25% for the three and six months ended June 30, 2014, respectively.  The effective tax rate on pre-tax income from continuing operations was lower than the prevailing corporate federal income tax rate.  Differences in the effective rates and the U.S. statutory rate of 35% were the result of certain tax preferred investment income, separate account dividends-received deductions, foreign tax credits and other tax preference items.

 

 

7.  Guaranteed Benefit Features

 

Information on the guaranteed death benefit (“GDB”) features outstanding (dollars in millions) was as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of

As of

 

 

June 30,

December 31,

 

 

 

2015 (1)

 

 

2014 (1)

 

 

Return of Net Deposits

 

 

 

 

 

 

 

 

 

Total account value

 

$

87,992 

 

 

$

85,917 

 

 

Net amount at risk (2)

 

 

223 

 

 

 

183 

 

 

Average attained age of contract holders

 

 

62 years

 

 

 

62 years

 

 

 

 

 

 

 

 

 

 

 

 

Minimum Return

 

 

 

 

 

 

 

 

 

Total account value

 

$

123 

 

 

$

135 

 

 

Net amount at risk (2)

 

 

24 

 

 

 

25 

 

 

Average attained age of contract holders

 

 

74 years

 

 

 

74 years

 

 

Guaranteed minimum return

 

 

5% 

 

 

 

5% 

 

 

 

 

 

 

 

 

 

 

 

 

Anniversary Contract Value

 

 

 

 

 

 

 

 

 

Total account value

 

$

26,012 

 

 

$

26,021 

 

 

Net amount at risk (2)

 

 

651 

 

 

 

597 

 

 

Average attained age of contract holders

 

 

69 years

 

 

 

68 years

 

 

 

(1)      Our variable contracts with guarantees may offer more than one type of guarantee in each contract; therefore, the amounts listed are not mutually exclusive.

(2)      Represents the amount of death benefit in excess of the account balance that is subject to market fluctuations.

 

25


 

 

The determination of GDB liabilities is based on models that involve a range of scenarios and assumptions, including those regarding expected market rates of return and volatility, contract surrender rates and mortality experience.  The following summarizes the balances of and changes in the liabilities for GDBs (in millions), which were recorded in future contract benefits on our Consolidated Balance Sheets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Six

 

 

 

Months Ended

 

 

 

June 30,

 

 

 

2015

 

2014

 

 

Balance as of beginning-of-year

$

89

 

$

73

 

 

Changes in reserves

 

17

 

 

12

 

 

Benefits paid

 

(11

)

 

(10

)

 

Balance as of end-of-period

$

95

 

$

75

 

 

 

Variable Annuity Contracts

 

Account balances of variable annuity contracts with guarantees (in millions) were invested in separate account investment options as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of

 

 

As of

 

 

 

June 30,

December 31,

 

 

 

2015

 

 

2014

 

 

Asset Type

 

 

 

 

 

 

 

 

 

Domestic equity

 

$

50,199 

 

 

$

49,569 

 

 

International equity

 

 

19,421 

 

 

 

18,791 

 

 

Bonds

 

 

27,454 

 

 

 

26,808 

 

 

Money market

 

 

13,234 

 

 

 

12,698 

 

 

Total

 

$

110,308 

 

 

$

107,866 

 

 

 

 

 

 

 

 

 

 

 

 

Percent of total variable annuity

 

 

 

 

 

 

 

 

 

separate account values

 

 

99% 

 

 

 

99% 

 

 

 

Secondary Guarantee Products

 

Future contract benefits and other contract holder funds include reserves for our secondary guarantee products sold through our Life Insurance segment.  These UL and VUL products with secondary guarantees represented 34% of total life insurance in-force reserves as of June 30, 2015,  and 31% of total sales for the six months ended June 30, 2015.

 

8.  Contingencies and Commitments

 

Regulatory bodies, such as state insurance and securities departments, the SEC and Financial Industry Regulatory Authority regularly make inquiries and conduct examinations or investigations concerning our compliance with, among other things, insurance laws, securities laws, laws governing the activities of broker-dealers, registered investment advisors and unclaimed property laws.

 

LNC and its subsidiaries are involved in various pending or threatened legal or regulatory proceedings, including purported class actions, arising from the conduct of business both in the ordinary course and otherwise.  In some of the matters, very large and/or indeterminate amounts, including punitive and treble damages, are sought.  Modern pleading practice in the U.S. permits considerable variation in the assertion of monetary damages or other relief.  Jurisdictions may permit claimants not to specify the monetary damages sought or may permit claimants to state only that the amount sought is sufficient to invoke the jurisdiction of the trial court.  In addition, jurisdictions may permit plaintiffs to allege monetary damages in amounts well exceeding reasonably possible verdicts in the jurisdiction for similar matters.  This variability in pleadings, together with the actual experiences of LNC in litigating or resolving through settlement numerous claims over an extended period of time, demonstrates to management that the monetary relief which may be specified in a lawsuit or claim bears little relevance to its merits or disposition value.

 

Due to the unpredictable nature of litigation, the outcome of a litigation matter and the amount or range of potential loss at particular points in time is normally difficult to ascertain.  Uncertainties can include how fact finders will evaluate documentary evidence and the credibility and effectiveness of witness testimony, and how trial and appellate courts will apply the law in the context of the pleadings or evidence presented, whether by motion practice, or at trial or on appeal.  Disposition valuations are also subject to the uncertainty of how opposing parties and their counsel will themselves view the relevant evidence and applicable law.

 

We establish liabilities for litigation and regulatory loss contingencies when information related to the loss contingencies shows both that it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. It is possible that some matters could require us to pay damages or make other expenditures or establish accruals in amounts that could not be estimated as of June 30, 2015

26


 

 

While the potential future charges could be material in the particular quarterly or annual periods in which they are recorded, based on information currently known by management, management does not believe any such charges are likely to have a material adverse effect on LNC’s financial condition.

 

On June 13, 2009, a single named plaintiff filed a putative national class action in the Circuit Court of Allen County (“Court”), Indiana, captioned Peter S. Bezich v. The Lincoln National Life Insurance Company (“LNL”), No. 02C01-0906-PL73, asserting he was charged a cost of insurance fee that exceeded the applicable mortality charge, and that this fee breached the terms of the insurance contract.  Plaintiff petitioned the Court to certify a class action, on behalf of all persons who purchased or owned the relevant insurance product between 1999 and 2009, alleging that: (i) LNL breached the contract by including non-mortality factors in cost of insurance rates; (ii) LNL breached the contract when it charged administrative expenses in excess of set amount; and (iii) LNL breached the contract by failing to adjust cost of insurance rates to reflect improving mortality expectations.  On June 12, 2014, the Court issued an Order denying certification on all of the Plaintiff’s counts and claims except with respect to a single legal issue: whether the contract was breached as alleged in Count III.  However, any damages arising from this alleged breach would have to be tried on an individual case-by-case basis.  The appellate court granted permission for our interlocutory appeal of the Court’s certification of the single issue class, and plaintiff cross-appealed.  The appellate court affirmed in part and reversed in part, holding that a class could be certified on all three claims, on the legal issues only, and remanding for further proceedings.  This ruling preserves the lower court’s denial of class certification on damages, and any damages arising from the alleged breaches would have to be tried on an individual case-by-case basis.  We continue to vigorously defend the case and have petitioned to transfer it, on appeal, to the state supreme court.

 

See Note 13 in our 2014 Form 10-K for additional discussion of commitments and contingencies, which information is incorporated herein by reference.

 

9.  Shares and Stockholders’ Equity

 

Common Shares

 

The changes in our common stock (number of shares) were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

For the Six

 

 

Months Ended

 

Months Ended

 

 

June 30,

 

June 30,

 

 

2015

 

2014

 

2015

 

2014

 

Common Stock

 

 

 

 

 

 

 

 

Balance as of beginning-of-period

252,928,502

 

263,682,162

 

256,551,440

 

262,896,701

 

Stock issued for exercise of warrants

33,510

 

54,714

 

980,436

 

3,099,479

 

Stock compensation/issued for benefit plans

515,481

 

171,293

 

1,988,882

 

899,808

 

Retirement/cancellation of shares

(2,558,600

)

(3,076,461

)

(8,601,865

)

(6,064,280

)

Balance as of end-of-period

250,918,893

 

260,831,708

 

250,918,893

 

260,831,708

 

 

 

 

 

 

 

 

 

 

Common Stock as of End-of-Period

 

 

 

 

 

 

 

 

Basic basis

250,918,893

 

260,831,708

 

250,918,893

 

260,831,708

 

Diluted basis

254,126,732

 

267,622,578

 

254,126,732

 

267,622,578

 

 

Our common stock is without par value.

 

27


 

 

Average Shares

 

A reconciliation of the denominator (number of shares) in the calculations of basic and diluted earnings (loss) per common share was as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

For the Six

 

 

Months Ended

 

Months Ended

 

 

June 30,

 

June 30,

 

 

2015

 

2014

 

2015

 

2014

 

Weighted-average shares, as used in basic calculation

251,849,316

 

262,271,670

 

253,662,410

 

262,503,816

 

Shares to cover exercise of outstanding warrants

1,356,262

 

4,106,444

 

1,604,192

 

5,650,623

 

Shares to cover non-vested stock

1,220,690

 

1,370,136

 

1,357,152

 

1,464,908

 

Average stock options outstanding during the period

3,676,185

 

3,669,928

 

3,759,166

 

3,784,391

 

Assumed acquisition of shares with assumed proceeds

 

 

 

 

 

 

 

 

from exercising outstanding warrants

(240,814

)

(875,064

)

(295,871

)

(1,194,789

)

Assumed acquisition of shares with assumed

 

 

 

 

 

 

 

 

proceeds and benefits from exercising stock

 

 

 

 

 

 

 

 

options (at average market price for the period)

(2,655,466

)

(2,552,316

)

(2,701,424

)

(2,626,035

)

Shares repurchaseable from measured but

 

 

 

 

 

 

 

 

unrecognized stock option expense

(65,873

)

(85,468

)

(63,196

)

(95,257

)

Average deferred compensation shares

 -

 

1,030,237

 

1,022,523

 

1,036,339

 

Weighted-average shares, as used in diluted calculation

255,140,300

 

268,935,567

 

258,344,952

 

270,523,996

 

 

In the event the average market price of LNC common stock exceeds the issue price of stock options and the options have a dilutive effect to our earnings per share (“EPS”), such options will be shown in the table above.

 

We have participants in our deferred compensation plans who selected LNC stock as the measure for the investment return attributable to their deferral amounts.  For the six months ended June 30, 2015, and the three and six months ended June 30, 2014, the effect of settling this obligation in LNC stock (“equity classification”) was more dilutive than the scenario of settling in cash (“liability classification”).  Therefore, for our EPS calculation for these periods, we added these shares to the denominator and adjusted the numerator to present net income as if the shares had been accounted for under equity classification by removing the mark-to-market adjustment included in net income attributable to these deferred units of LNC stock.  The amount of this adjustment was $(1) million for the six months ended June 30, 2015, and $(1) million and less than $1 million for the three and six months ended June 30, 2014.

 

28


 

 

AOCI

 

The following summarizes the components and changes in AOCI (in millions):

 

 

 

 

 

 

 

 

 

 

For the Six

 

 

Months Ended

 

 

June 30,

 

 

2015

 

2014

 

Unrealized Gain (Loss) on AFS Securities

 

 

 

 

 

 

Balance as of beginning-of-year

$

3,175

 

$

1,500

 

Unrealized holding gains (losses) arising during the period

 

(2,492

)

 

3,685

 

Change in foreign currency exchange rate adjustment

 

(16

)

 

11

 

Change in DAC, VOBA, DSI, future contract benefits and other contract holder funds

 

812

 

 

(1,139

)

Income tax benefit (expense)

 

582

 

 

(895

)

Less:

 

 

 

 

 

 

Reclassification adjustment for gains (losses) included in net income (loss)

 

193

 

 

9

 

Associated amortization of DAC, VOBA, DSI and DFEL

 

(15

)

 

(18

)

Income tax benefit (expense)

 

(62

)

 

3

 

Balance as of end-of-period

$

1,945

 

$

3,168

 

Unrealized OTTI on AFS Securities

 

 

 

 

 

 

Balance as of beginning-of-year

$

64

 

$

31

 

(Increases) attributable to:

 

 

 

 

 

 

Gross OTTI recognized in OCI during the period

 

(18

)

 

(9

)

Change in DAC, VOBA, DSI and DFEL

 

3

 

 

1

 

Income tax benefit (expense)

 

6

 

 

3

 

Decreases attributable to:

 

 

 

 

 

 

Sales, maturities or other settlements of AFS securities

 

31

 

 

36

 

Change in DAC, VOBA, DSI and DFEL

 

(14

)

 

(3

)

Income tax benefit (expense)

 

(6

)

 

(12

)

Balance as of end-of-period

$

66

 

$

47

 

Unrealized Gain (Loss) on Derivative Instruments

 

 

 

 

 

 

Balance as of beginning-of-year

$

139

 

$

256

 

Unrealized holding gains (losses) arising during the period

 

(96

)

 

(59

)

Change in foreign currency exchange rate adjustment

 

16

 

 

(11

)

Income tax benefit (expense)

 

27

 

 

24

 

Less:

 

 

 

 

 

 

Reclassification adjustment for gains (losses) included in net income (loss)

 

(189

)

 

(10

)

Associated amortization of DAC, VOBA, DSI and DFEL

 

 -

 

 

1

 

Income tax benefit (expense)

 

66

 

 

3

 

Balance as of end-of-period

$

209

 

$

216

 

Foreign Currency Translation Adjustment

 

 

 

 

 

 

Balance as of beginning-of-year

$

(3

)

$

(5

)

Foreign currency translation adjustment arising during the period

 

6

 

 

(5

)

Balance as of end-of-period

$

3

 

$

(10

)

Funded Status of Employee Benefit Plans

 

 

 

 

 

 

Balance as of beginning-of-year

$

(279

)

$

(219

)

Adjustment arising during the period

 

1

 

 

(3

)

Income tax benefit (expense)

 

(1

)

 

 -

 

Balance as of end-of-period

$

(279

)

$

(222

)

 

29


 

 

The following summarizes the reclassifications out of AOCI (in millions) and the associated line item in the Consolidated Statements of Comprehensive Income (Loss):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Six

 

 

 

Months Ended

 

 

 

June 30,

 

 

 

2015

 

 

2014

 

 

Unrealized Gain (Loss) on AFS Securities

 

 

 

 

 

 

 

 

Gross reclassification

$

193

 

 

$

9

 

Total realized gain (loss)

Associated amortization of DAC, 

 

 

 

 

 

 

 

 

VOBA, DSI and DFEL

 

(15

)

 

 

(18

)

Total realized gain (loss)

Reclassification before income

 

 

 

 

 

 

 

 

tax benefit (expense)

 

178

 

 

 

(9

)

Income (loss) from continuing operations before taxes

Income tax benefit (expense)

 

(62

)

 

 

3

 

Federal income tax expense (benefit)

Reclassification, net of income tax

$

116

 

 

$

(6

)

Net income (loss)

 

 

 

 

 

 

 

 

 

Unrealized OTTI on AFS Securities

 

 

 

 

 

 

 

 

Gross reclassification

$

31

 

 

$

36

 

Total realized gain (loss)

Change in DAC, VOBA, DSI and DFEL

 

(14

)

 

 

(3

)

Total realized gain (loss)

Reclassification before income

 

 

 

 

 

 

 

 

tax benefit (expense)

 

17

 

 

 

33

 

Income (loss) from continuing operations before taxes

Income tax benefit (expense)

 

(6

)

 

 

(12

)

Federal income tax expense (benefit)

Reclassification, net of income tax

$

11

 

 

$

21

 

Net income (loss)

 

 

 

 

 

 

 

 

 

Unrealized Gain (Loss) on Derivative Instruments

 

 

 

 

 

 

Gross reclassifications:

 

 

 

 

 

 

 

 

Interest rate contracts

$

(194

)

 

$

(12

)

Net investment income

Interest rate contracts

 

2

 

 

 

2

 

Interest and debt expense

Foreign currency contracts

 

3

 

 

 

 -

 

Net investment income

Total gross reclassifications

 

(189

)

 

 

(10

)

 

Associated amortization of DAC,

 

 

 

 

 

 

 

 

VOBA, DSI and DFEL

 

 -

 

 

 

1

 

Commissions and other expenses

Reclassifications before income

 

 

 

 

 

 

 

 

tax benefit (expense)

 

(189

)

 

 

(9

)

Income (loss) from continuing operations before taxes

Income tax benefit (expense)

 

66

 

 

 

3

 

Federal income tax expense (benefit)

Reclassification, net of income tax

$

(123

)

 

$

(6

)

Net income (loss)

 

 

 

30


 

 

10.  Realized Gain (Loss)

 

Details underlying realized gain (loss) (in millions) reported on our Consolidated Statements of Comprehensive Income (Loss) were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

For the Six

 

 

Months Ended

 

Months Ended

 

 

June 30,

 

June 30,

 

 

2015

 

2014

 

2015

 

2014

 

Total realized gain (loss) related to certain investments (1)

$

(1

)

$

1

 

$

(28

)

$

(5

)

Realized gain (loss) on the mark-to-market on certain instruments (2)

 

(21

)

 

7

 

 

(10

)

 

(12

)

Indexed annuity and IUL contracts net derivatives results: (3)

 

 

 

 

 

 

 

 

 

 

 

 

Gross gain (loss)

 

(5

)

 

(16

)

 

(31

)

 

(39

)

Associated amortization of DAC, VOBA, DSI and DFEL

 

1

 

 

3

 

 

6

 

 

8

 

Variable annuity net derivatives results: (4)

 

 

 

 

 

 

 

 

 

 

 

 

Gross gain (loss)

 

44

 

 

35

 

 

30

 

 

65

 

Associated amortization of DAC, VOBA, DSI and DFEL

 

(7

)

 

5

 

 

(3

)

 

(1

)

Realized gain (loss) on sale of subsidiaries/businesses (5)

 

(1

)

 

 -

 

 

(2

)

 

 -

 

Total realized gain (loss)

$

10

 

$

35

 

$

(38

)

$

16

 

 

(1)      See “Realized Gain (Loss) Related to Certain Investments” section in Note 4.

(2)      Represents changes in the fair values of certain derivative investments (not including those associated with our variable and indexed annuity and IUL contracts net derivatives results), reinsurance related embedded derivatives and trading securities.

(3)      Represents the net difference between the change in the fair value of the S&P 500 Index ® call options that we hold and the change in the fair value of the embedded derivative liabilities of our indexed annuity and IUL contracts along with changes in the fair value of embedded derivative liabilities related to index call options we may purchase in the future to hedge contract holder index allocations applicable to future reset periods for our indexed annuity products.

(4)      Includes the net difference in the change in embedded derivative reserves of our guaranteed living benefits (“GLB”) riders and the change in the fair value of the derivative investments we own to hedge the change in embedded derivative reserves on our GLB riders and the benefit ratio unlocking on our GDB riders, including the cost of purchasing the hedging instruments.

(5)      See Note 3 in our 2014 Form 10-K for more information.

 

 

11.  Stock-Based Compensation Plans

 

We sponsor stock-based compensation plans for our employees and directors and for the employees and agents of our subsidiaries that provide for the grant of stock options, performance shares (performance-vested shares as opposed to service-vested shares), stock appreciation rights (“SARs”), restricted stock units (“RSUs”) and deferred stock units (“DSUs”).  We issue new shares to satisfy option exercises.

 

LNC stock-based awards granted were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the

For the

 

 

Three

Six

 

 

Months

Months

 

 

Ended

Ended

 

 

June 30,

June 30,

 

 

2015

2015

 

10-year LNC stock options

 

7,145 

 

 

502,664 

 

 

Performance shares

 

2,158 

 

 

161,255 

 

 

RSUs

 

22,868 

 

 

445,438 

 

 

Non-employee:

 

 

 

 

 

 

 

SARs

 

 -

 

 

48,451 

 

 

Agent stock options

 

535 

 

 

90,239 

 

 

Director DSUs

 

7,653 

 

 

15,536 

 

 

 

 

31


 

 

12Fair Value of Financial Instruments

 

The carrying values and estimated fair values of our financial instruments (in millions) were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of June 30, 2015

 

As of December 31, 2014

 

 

Carrying

 

Fair

 

Carrying

 

Fair

 

 

Value

 

Value

 

Value

 

Value

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

AFS securities:

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturity securities

$

85,422

 

$

85,422

 

$

86,240

 

$

86,240

 

VIEs’ fixed maturity securities

 

598

 

 

598

 

 

598

 

 

598

 

Equity securities

 

227

 

 

227

 

 

231

 

 

231

 

Trading securities

 

1,949

 

 

1,949

 

 

2,065

 

 

2,065

 

Mortgage loans on real estate

 

8,171

 

 

8,513

 

 

7,574

 

 

8,038

 

Derivative investments (1)

 

1,340

 

 

1,340

 

 

1,860

 

 

1,860

 

Other investments

 

1,624

 

 

1,624

 

 

1,709

 

 

1,709

 

Cash and invested cash

 

2,327

 

 

2,327

 

 

3,919

 

 

3,919

 

Other assets:

 

 

 

 

 

 

 

 

 

 

 

 

GLB reserves embedded derivatives (2)

 

254

 

 

254

 

 

 -

 

 

 -

 

Reinsurance recoverable

 

102

 

 

102

 

 

154

 

 

154

 

Separate account assets

 

128,079

 

 

128,079

 

 

125,265

 

 

125,265

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

Future contract benefits – indexed annuity

 

 

 

 

 

 

 

 

 

 

 

 

and IUL contracts embedded derivatives

 

(1,155

)

 

(1,155

)

 

(1,170

)

 

(1,170

)

Other contract holder funds:

 

 

 

 

 

 

 

 

 

 

 

 

Remaining guaranteed interest and similar contracts

 

(697

)

 

(697

)

 

(699

)

 

(699

)

Account values of certain investment contracts

 

(30,074

)

 

(32,838

)

 

(29,156

)

 

(33,079

)

Short-term debt

 

 -

 

 

 -

 

 

(250

)

 

(253

)

Long-term debt

 

(5,529

)

 

(5,754

)

 

(5,270

)

 

(5,707

)

Reinsurance related embedded derivatives

 

(120

)

 

(120

)

 

(150

)

 

(150

)

VIEs’ liabilities – derivative instruments

 

(3

)

 

(3

)

 

(13

)

 

(13

)

Other liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

Credit default swaps

 

(2

)

 

(2

)

 

(3

)

 

(3

)

Derivative liabilities (1)

 

(63

)

 

(63

)

 

(77

)

 

(77

)

GLB reserves embedded derivatives (2)

 

(102

)

 

(102

)

 

(174

)

 

(174

)

 

(1)      We have master netting agreements with each of our derivative counterparties, which allow for the netting of our derivative asset and liability positions by counterparty.

(2)      Portions of our GLB reserves embedded derivatives are ceded to third-party reinsurance counterparties.  Refer to Note 5 for additional detail.

 

Valuation Methodologies and Associated Inputs for Financial Instruments Not Carried at Fair Value

 

The following discussion outlines the methodologies and assumptions used to determine the fair value of our financial instruments not carried at fair value on our Consolidated Balance Sheets.  Considerable judgment is required to develop these assumptions used to measure fair value.  Accordingly, the estimates shown are not necessarily indicative of the amounts that would be realized in a one-time, current market exchange of all of our financial instruments.

 

Mortgage Loans on Real Estate

 

The fair value of mortgage loans on real estate is established using a discounted cash flow method based on credit rating, maturity and future income.  The ratings for mortgages in good standing are based on property type, location, market conditions, occupancy, debt-service coverage, loan-to-value, quality of tenancy, borrower and payment record.  The fair value for impaired mortgage loans is based on the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s market price or the fair value of the collateral if the loan is collateral dependent.  The inputs used to measure the fair value of our mortgage loans on real estate are classified as Level 2 within the fair value hierarchy.

 

32


 

 

Other Investments

 

The carrying value of our assets classified as other investments approximates fair value.  Other investments includes primarily LPs and other privately held investments that are accounted for using the equity method of accounting and the carrying value is based on our proportional share of the net assets of the LPs.  The inputs used to measure the fair value of our LPs and other privately held investments are classified as Level 3 within the fair value hierarchy.  Other investments also includes securities that are not LPs or other privately held investments and the inputs used to measure the fair value of these securities are classified as Level 1 within the fair value hierarchy.

 

Other Contract Holder Funds

 

Other contract holder funds include remaining guaranteed interest and similar contracts and account values of certain investment contracts.  The fair value for the remaining guaranteed interest and similar contracts is estimated using discounted cash flow calculations as of the balance sheet date.  These calculations are based on interest rates currently offered on similar contracts with maturities that are consistent with those remaining for the contracts being valued.  As of June 30, 2015, and December 31, 2014, the remaining guaranteed interest and similar contracts carrying value approximated fair value.  The fair value of the account values of certain investment contracts is based on their approximate surrender value as of the balance sheet date.  The inputs used to measure the fair value of our other contract holder funds are classified as Level 3 within the fair value hierarchy.

 

Short-Term and Long-Term Debt    

 

The fair value of short-term and long-term debt is based on quoted market pricesThe inputs used to measure the fair value of our short-term and long-term debt are classified as Level 2 within the fair value hierarchy.   

 

Financial Instruments Carried at Fair Value

 

We did not have any assets or liabilities measured at fair value on a nonrecurring basis as of June 30, 2015, or December 31, 2014, and we noted no changes in our valuation methodologies between these periods. 

33


 

 

The following summarizes our financial instruments carried at fair value (in millions) on a recurring basis by the fair value hierarchy levels described in “Summary of Significant Accounting Policies” in Note 1 of our 2014 Form 10-K:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of June 30, 2015

 

 

 

Quoted

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Prices

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

in Active

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Markets for

Significant

Significant

 

 

 

 

 

 

Identical

 

Observable

Unobservable

 

Total

 

 

 

Assets

 

 

Inputs

 

 

Inputs

 

 

Fair

 

 

 

(Level 1)

 

 

(Level 2)

 

 

(Level 3)

 

 

Value

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturity AFS securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

 

$

64

 

 

$

70,933

 

 

$

2,039

 

 

$

73,036

 

ABS

 

 

 -

 

 

 

1,100

 

 

 

33

 

 

 

1,133

 

U.S. government bonds

 

 

409

 

 

 

19

 

 

 

 -

 

 

 

428

 

Foreign government bonds

 

 

 -

 

 

 

426

 

 

 

114

 

 

 

540

 

RMBS

 

 

 -

 

 

 

4,029

 

 

 

1

 

 

 

4,030

 

CMBS

 

 

 -

 

 

 

434

 

 

 

12

 

 

 

446

 

CLOs

 

 

 -

 

 

 

38

 

 

 

461

 

 

 

499

 

State and municipal bonds

 

 

 -

 

 

 

4,418

 

 

 

 -

 

 

 

4,418

 

Hybrid and redeemable preferred securities

 

 

46

 

 

 

750

 

 

 

96

 

 

 

892

 

VIEs’ fixed maturity securities

 

 

 -

 

 

 

598

 

 

 

 -

 

 

 

598

 

Equity AFS securities

 

 

7

 

 

 

79

 

 

 

141

 

 

 

227

 

Trading securities

 

 

160

 

 

 

1,717

 

 

 

72

 

 

 

1,949

 

Other investments

 

 

154

 

 

 

 -

 

 

 

 -

 

 

 

154

 

Derivative investments (1)

 

 

 -

 

 

 

1,116

 

 

 

1,013

 

 

 

2,129

 

Cash and invested cash

 

 

 -

 

 

 

2,327

 

 

 

 -

 

 

 

2,327

 

Other assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

GLB reserves embedded derivatives 

 

 

 -

 

 

 

 -

 

 

 

254

 

 

 

254

 

Reinsurance recoverable

 

 

 -

 

 

 

 -

 

 

 

102

 

 

 

102

 

Separate account assets

 

 

670

 

 

 

127,409

 

 

 

 -

 

 

 

128,079

 

Total assets

 

$

1,510

 

 

$

215,393

 

 

$

4,338

 

 

$

221,241

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Future contract benefits – indexed annuity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

and IUL contracts embedded derivatives

 

$

 -

 

 

$

 -

 

 

$

(1,155

)

 

$

(1,155

)

Long-term debt

 

 

 -

 

 

 

(1,203

)

 

 

 -

 

 

 

(1,203

)

Reinsurance related embedded derivatives

 

 

 -

 

 

 

(120

)

 

 

 -

 

 

 

(120

)

VIEs’ liabilities – derivative instruments

 

 

 -

 

 

 

 -

 

 

 

(3

)

 

 

(3

)

Other liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Credit default swaps

 

 

 -

 

 

 

 -

 

 

 

(2

)

 

 

(2

)

Derivative liabilities (1)

 

 

 -

 

 

 

(579

)

 

 

(273

)

 

 

(852

)

GLB reserves embedded derivatives

 

 

 -

 

 

 

 -

 

 

 

(102

)

 

 

(102

)

Total liabilities

 

$

 -

 

 

$

(1,902

)

 

$

(1,535

)

 

$

(3,437

)

 

34


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of December 31, 2014

 

 

 

Quoted

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Prices

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

in Active

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Markets for

Significant

Significant

 

 

 

 

 

 

Identical

 

Observable

Unobservable

 

Total

 

 

 

Assets

 

 

Inputs

 

 

Inputs

 

 

Fair

 

 

 

(Level 1)

 

 

(Level 2)

 

 

(Level 3)

 

 

Value

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturity AFS securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

 

$

63

 

 

$

71,400

 

 

$

1,953

 

 

$

73,416

 

ABS

 

 

 -

 

 

 

1,097

 

 

 

33

 

 

 

1,130

 

U.S. government bonds

 

 

399

 

 

 

36

 

 

 

 -

 

 

 

435

 

Foreign government bonds

 

 

 -

 

 

 

432

 

 

 

109

 

 

 

541

 

RMBS

 

 

 -

 

 

 

4,225

 

 

 

1

 

 

 

4,226

 

CMBS

 

 

 -

 

 

 

555

 

 

 

15

 

 

 

570

 

CLOs

 

 

 -

 

 

 

7

 

 

 

368

 

 

 

375

 

State and municipal bonds

 

 

 -

 

 

 

4,593

 

 

 

 -

 

 

 

4,593

 

Hybrid and redeemable preferred securities

 

 

45

 

 

 

854

 

 

 

55

 

 

 

954

 

VIEs’ fixed maturity securities

 

 

 -

 

 

 

598

 

 

 

 -

 

 

 

598

 

Equity AFS securities

 

 

7

 

 

 

67

 

 

 

157

 

 

 

231

 

Trading securities

 

 

 -

 

 

 

1,992

 

 

 

73

 

 

 

2,065

 

Other investments

 

 

150

 

 

 

 -

 

 

 

 -

 

 

 

150

 

Derivative investments (1)

 

 

 -

 

 

 

1,356

 

 

 

1,231

 

 

 

2,587

 

Cash and invested cash

 

 

 -

 

 

 

3,919

 

 

 

 -

 

 

 

3,919

 

Other assets – reinsurance recoverable

 

 

 -

 

 

 

 -

 

 

 

154

 

 

 

154

 

Separate account assets

 

 

1,539

 

 

 

123,726

 

 

 

 -

 

 

 

125,265

 

Total assets

 

$

2,203

 

 

$

214,857

 

 

$

4,149

 

 

$

221,209

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Future contract benefits – indexed annuity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

and IUL contracts embedded derivatives

 

$

 -

 

 

$

 -

 

 

$

(1,170

)

 

$

(1,170

)

Long-term debt

 

 

 -

 

 

 

(1,203

)

 

 

 -

 

 

 

(1,203

)

Reinsurance related embedded derivatives

 

 

 -

 

 

 

(150

)

 

 

 -

 

 

 

(150

)

VIEs’ liabilities – derivative instruments

 

 

 -

 

 

 

 -

 

 

 

(13

)

 

 

(13

)

Other liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Credit default swaps

 

 

 -

 

 

 

 -

 

 

 

(3

)

 

 

(3

)

Derivative liabilities (1)

 

 

 -

 

 

 

(562

)

 

 

(242

)

 

 

(804

)

GLB reserves embedded derivatives

 

 

 -

 

 

 

 -

 

 

 

(174

)

 

 

(174

)

Total liabilities

 

$

 -

 

 

$

(1,915

)

 

$

(1,602

)

 

$

(3,517

)

 

(1)      Derivative investment assets and liabilities presented within the fair value hierarchy are presented on a gross basis by derivative type and not on a master netting basis by counterparty.

35


 

 

The following summarizes changes to our financial instruments carried at fair value (in millions) and classified within Level 3 of the fair value hierarchy.  This summary excludes any effect of amortization of deferred acquisition costs (“DAC”), value of business acquired (“VOBA”), deferred sales inducements (“DSI”) and deferred front-end loads (“DFEL”).  The gains and losses below may include changes in fair value due in part to observable inputs that are a component of the valuation methodology.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three Months Ended June 30, 2015

 

 

 

 

 

 

 

 

Gains

Issuances,

Transfers

 

 

 

 

 

 

 

 

Items

 

(Losses)

 

Sales,

 

Into or

 

 

 

 

 

 

 

 

Included

 

in

Maturities,

Out

 

 

 

 

 

Beginning

 

in

 

OCI

Settlements,

of

 

Ending

 

 

Fair

 

Net

 

and

 

Calls,

 

Level 3,

 

Fair

 

 

Value

 

Income

 

Other (1)

 

Net

 

Net (2)

 

Value

 

Investments: (4)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturity AFS securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

$

2,033

 

$

 -

 

$

(58

)

$

61

 

$

3

 

$

2,039

 

ABS

 

33

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

33

 

Foreign government bonds

 

113

 

 

 -

 

 

1

 

 

 -

 

 

 -

 

 

114

 

RMBS

 

1

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

1

 

CMBS

 

15

 

 

1

 

 

2

 

 

(6

)

 

 -

 

 

12

 

CLOs

 

416

 

 

 -

 

 

 -

 

 

57

 

 

(12

)

 

461

 

Hybrid and redeemable

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

preferred securities

 

75

 

 

(1

)

 

(1

)

 

 -

 

 

23

 

 

96

 

Equity AFS securities

 

135

 

 

1

 

 

(2

)

 

8

 

 

(1

)

 

141

 

Trading securities

 

75

 

 

 -

 

 

(4

)

 

1

 

 

 -

 

 

72

 

Derivative investments

 

849

 

 

122

 

 

(123

)

 

(108

)

 

 -

 

 

740

 

Other assets: (5)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

GLB reserves embedded derivatives

 

 -

 

 

254

 

 

 -

 

 

 -

 

 

 -

 

 

254

 

Reinsurance recoverable 

 

204

 

 

(102

)

 

 -

 

 

 -

 

 

 -

 

 

102

 

Future contract benefits – indexed annuity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

and universal life contracts embedded

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

derivatives (5)

 

(1,180

)

 

(9

)

 

 -

 

 

34

 

 

 -

 

 

(1,155

)

VIEs’ liabilities – derivative instruments (6)

 

(5

)

 

2

 

 

 -

 

 

 -

 

 

 -

 

 

(3

)

Other liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Credit default swaps (7)

 

(3

)

 

1

 

 

 -

 

 

 -

 

 

 -

 

 

(2

)

GLB reserves embedded derivatives (5)

 

(552

)

 

450

 

 

 -

 

 

 -

 

 

 -

 

 

(102

)

Total, net

$

2,209

 

$

719

 

$

(185

)

$

47

 

$

13

 

$

2,803

 

36


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three Months Ended June 30, 2014

 

 

 

 

 

 

 

 

Gains

Issuances,

Transfers

 

 

 

 

 

 

 

 

Items

 

(Losses)

 

Sales

 

Into or

 

 

 

 

 

 

 

 

Included

 

in

Maturities,

Out

 

 

 

 

 

Beginning

 

in

 

OCI

Settlements,

of

 

Ending

 

 

Fair

 

Net

 

and

 

Calls,

 

Level 3,

 

Fair

 

 

Value

 

Income

 

Other (1)

 

Net

 

Net (2)

 

Value

 

Investments: (4)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturity AFS securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

$

1,946

 

$

5

 

$

50

 

$

132

 

$

64

 

$

2,197

 

ABS

 

12

 

 

 -

 

 

(1

)

 

 -

 

 

(4

)

 

7

 

Foreign government bonds

 

107

 

 

 -

 

 

1

 

 

 -

 

 

 -

 

 

108

 

RMBS

 

1

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

1

 

CMBS

 

21

 

 

 -

 

 

 -

 

 

(2

)

 

 -

 

 

19

 

CLOs

 

195

 

 

 -

 

 

2

 

 

17

 

 

(4

)

 

210

 

State and municipal bonds

 

29

 

 

 -

 

 

 -

 

 

 -

 

 

(29

)

 

 -

 

Hybrid and redeemable

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

preferred securities

 

55

 

 

 -

 

 

2

 

 

(5

)

 

 -

 

 

52

 

Equity AFS securities

 

162

 

 

3

 

 

(3

)

 

(4

)

 

 -

 

 

158

 

Trading securities

 

53

 

 

1

 

 

3

 

 

4

 

 

6

 

 

67

 

Derivative investments

 

811

 

 

(42

)

 

80

 

 

(69

)

 

 -

 

 

780

 

Other assets: (5)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

GLB reserves embedded derivatives

 

979

 

 

(47

)

 

 -

 

 

 -

 

 

 -

 

 

932

 

Reinsurance recoverable

 

43

 

 

11

 

 

 -

 

 

 -

 

 

 -

 

 

54

 

Future contract benefits – indexed annuity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

universal life contracts embedded

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

derivatives (5)

 

(1,090

)

 

(92

)

 

 -

 

 

15

 

 

 -

 

 

(1,167

)

VIEs’ liabilities – derivative instruments (6)

 

(22

)

 

12

 

 

 -

 

 

 -

 

 

 -

 

 

(10

)

Other liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Credit default swaps (7)

 

(2

)

 

1

 

 

 -

 

 

 -

 

 

 -

 

 

(1

)

GLB reserves embedded derivatives (5)

 

(43

)

 

(11

)

 

 -

 

 

 -

 

 

 -

 

 

(54

)

Total, net

$

3,257

 

$

(159

)

$

134

 

$

88

 

$

33

 

$

3,353

 

 

37


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Six Months Ended June 30, 2015

 

 

 

 

 

 

 

 

 

 

Purchases,

 

 

 

 

 

 

 

 

 

 

 

 

 

Gains

Issuances,

Transfers

 

 

 

 

 

 

 

 

Items

 

(Losses)

Sales,

Into or

 

 

 

 

 

 

 

 

Included

 

in

Maturities,

Out

 

 

 

 

 

Beginning

 

in

 

OCI

Settlements,

of

 

Ending

 

 

Fair

 

Net

 

and

 

Calls,

 

Level 3,

 

Fair

 

 

Value

 

Income

 

Other (1)

 

Net

 

Net (2)

 

Value

 

Investments: (4)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturity AFS securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

$

1,953

 

$

3

 

$

(89

)

$

90

 

$

82

 

$

2,039

 

ABS

 

33

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

33

 

Foreign government bonds

 

109

 

 

 -

 

 

5

 

 

 -

 

 

 -

 

 

114

 

RMBS

 

1

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

1

 

CMBS

 

15

 

 

2

 

 

4

 

 

(9

)

 

 -

 

 

12

 

CLOs

 

368

 

 

 -

 

 

3

 

 

102

 

 

(12

)

 

461

 

Hybrid and redeemable

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

preferred securities

 

55

 

 

(1

)

 

(1

)

 

 -

 

 

43

 

 

96

 

Equity AFS securities

 

157

 

 

1

 

 

 -

 

 

(16

)

 

(1

)

 

141

 

Trading securities

 

73

 

 

1

 

 

(2

)

 

 -

 

 

 -

 

 

72

 

Derivative investments

 

989

 

 

28

 

 

(76

)

 

(201

)

 

 -

 

 

740

 

Other assets: (5)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

GLB reserves embedded derivatives

 

 -

 

 

254

 

 

 -

 

 

 -

 

 

 -

 

 

254

 

Reinsurance recoverable

 

154

 

 

(52

)

 

 -

 

 

 -

 

 

 -

 

 

102

 

Future contract benefits: (5)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Indexed annuity and IUL

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

contracts embedded derivatives

 

(1,170

)

 

(47

)

 

 -

 

 

62

 

 

 -

 

 

(1,155

)

VIEs’ liabilities – derivative instruments (6)

 

(13

)

 

10

 

 

 -

 

 

 -

 

 

 -

 

 

(3

)

Other liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Credit default swaps (7)

 

(3

)

 

1

 

 

 -

 

 

 -

 

 

 -

 

 

(2

)

GLB reserves embedded derivatives (5)

 

(174

)

 

72

 

 

 -

 

 

 -

 

 

 -

 

 

(102

)

Total, net

$

2,547

 

$

272

 

$

(156

)

$

28

 

$

112

 

$

2,803

 

 

38


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Six Months Ended June 30, 2014

 

 

 

 

 

 

 

 

 

 

Purchases,

 

 

 

 

 

 

 

 

 

 

 

 

 

Gains

Issuances,

Transfers

 

 

 

 

 

 

 

 

Items

 

(Losses)

Sales,

Into or

 

 

 

 

 

 

 

 

Included

 

in

Maturities,

Out

 

 

 

 

 

Beginning

 

in

 

OCI

Settlements,

of

 

Ending

 

 

Fair

 

Net

 

and

 

Calls,

 

Level 3,

 

Fair

 

 

Value

 

Income

 

Other (1)

 

Net

 

Net (2)(3)

 

Value

 

Investments: (4)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturity AFS securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

$

1,701

 

$

9

 

$

73

 

$

150

 

$

264

 

$

2,197

 

ABS

 

10

 

 

 -

 

 

1

 

 

 -

 

 

(4

)

 

7

 

Foreign government bonds

 

79

 

 

 -

 

 

4

 

 

 -

 

 

25

 

 

108

 

RMBS

 

1

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

1

 

CMBS

 

20

 

 

 -

 

 

1

 

 

(8

)

 

6

 

 

19

 

CLOs

 

179

 

 

 -

 

 

3

 

 

24

 

 

4

 

 

210

 

State and municipal bonds

 

28

 

 

 -

 

 

1

 

 

 -

 

 

(29

)

 

 -

 

Hybrid and redeemable

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

preferred securities

 

66

 

 

 -

 

 

1

 

 

(5

)

 

(10

)

 

52

 

Equity AFS securities

 

161

 

 

3

 

 

(1

)

 

(5

)

 

 -

 

 

158

 

Trading securities

 

52

 

 

2

 

 

6

 

 

3

 

 

4

 

 

67

 

Derivative investments

 

1,266

 

 

(150

)

 

213

 

 

(123

)

 

(426

)

 

780

 

Other assets: (5)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

GLB reserves embedded derivatives

 

 -

 

 

(312

)

 

 -

 

 

 -

 

 

1,244

 

 

932

 

Reinsurance recoverable

 

27

 

 

27

 

 

 -

 

 

 -

 

 

 -

 

 

54

 

Future contract benefits: (5)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Indexed annuity and IUL

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

contracts embedded derivatives

 

(1,048

)

 

(141

)

 

 -

 

 

22

 

 

 -

 

 

(1,167

)

GLB reserves embedded derivatives

 

1,244

 

 

 -

 

 

 -

 

 

 -

 

 

(1,244

)

 

 -

 

VIEs’ liabilities derivative instruments (6)

 

(27

)

 

17

 

 

 -

 

 

 -

 

 

 -

 

 

(10

)

Other liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Credit default swaps (7)

 

(2

)

 

1

 

 

 -

 

 

 -

 

 

 -

 

 

(1

)

GLB reserves embedded derivatives (5)

 

(27

)

 

(27

)

 

 -

 

 

 -

 

 

 -

 

 

(54

)

Total, net

$

3,730

 

$

(571

)

$

302

 

$

58

 

$

(166

)

$

3,353

 

 

(1)      The changes in fair value of the interest rate swaps are offset by an adjustment to derivative investments (see Note 5).

(2)      Transfers into or out of Level 3 for AFS and trading securities are displayed at amortized cost as of the beginning-of-period.  For AFS and trading securities, the difference between beginning-of-period amortized cost and beginning-of-period fair value was included in OCI and earnings, respectively, in the prior period.

(3)      Transfers into or out of Level 3 for GLB reserves embedded derivatives between future contract benefits, other assets and other liabilities on our Consolidated Balance Sheets.

(4)      Amortization and accretion of premiums and discounts are included in net investment income on our Consolidated Statements of Comprehensive Income (Loss).  Gains (losses) from sales, maturities, settlements and calls and OTTI are included in realized gain (loss) on our Consolidated Statements of Comprehensive Income (Loss).

(5)      Gains (losses) from sales, maturities, settlements and calls are included in realized gain (loss) on our Consolidated Statements of Comprehensive Income (Loss).

(6)      Gains (losses) from sales, maturities, settlements and calls are included in net investment income on our Consolidated Statements of Comprehensive Income (Loss).

(7)      The changes in fair value of the credit default swaps and contingency forwards are included in realized gain (loss) on our Consolidated Statements of Comprehensive Income (Loss).

 

39


 

 

The following provides the components of the items included in issuances, sales, maturities, settlements and calls, net, excluding any effect of amortization of DAC, VOBA, DSI and DFEL and changes in future contract benefits, (in millions) as reported above:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three Months Ended June 30, 2015

 

 

Issuances

 

Sales

 

Maturities

Settlements

Calls

 

Total

 

Investments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturity AFS securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

$

131

 

$

(19

)

$

(15

)

$

(25

)

$

(11

)

$

61

 

CMBS

 

 -

 

 

 -

 

 

 -

 

 

(6

)

 

 -

 

 

(6

)

CLOs

 

62

 

 

 -

 

 

 -

 

 

(5

)

 

 -

 

 

57

 

Equity AFS securities

 

10

 

 

(2

)

 

 -

 

 

 -

 

 

 -

 

 

8

 

Trading securities

 

1

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

1

 

Derivative investments

 

47

 

 

(49

)

 

(106

)

 

 -

 

 

 -

 

 

(108

)

Future contract benefits – indexed annuity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

and IUL contracts embedded derivatives

 

(16

)

 

 -

 

 

50

 

 

 -

 

 

 -

 

 

34

 

Total, net

$

235

 

$

(70

)

$

(71

)

$

(36

)

$

(11

)

$

47

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three Months Ended June 30, 2014

 

 

Issuances

 

Sales

 

Maturities

Settlements

Calls

 

Total

 

Investments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturity AFS securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

$

232

 

$

(47

)

$

(14

)

$

(16

)

$

(23

)

$

132

 

CMBS

 

 -

 

 

 -

 

 

 -

 

 

(1

)

 

(1

)

 

(2

)

CLOs

 

20

 

 

 -

 

 

 -

 

 

(3

)

 

 -

 

 

17

 

Hybrid and redeemable preferred

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

securities

 

 -

 

 

(5

)

 

 -

 

 

 -

 

 

 -

 

 

(5

)

Equity AFS securities

 

 -

 

 

(4

)

 

 -

 

 

 -

 

 

 -

 

 

(4

)

Trading securities

 

4

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

4

 

Derivative investments

 

43

 

 

(19

)

 

(93

)

 

 -

 

 

 -

 

 

(69

)

Future contract benefits – indexed annuity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

and IUL contracts embedded derivatives

 

(24

)

 

 -

 

 

 -

 

 

39

 

 

 -

 

 

15

 

Total, net

$

275

 

$

(75

)

$

(107

)

$

19

 

$

(24

)

$

88

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Six Months Ended June 30, 2015

 

 

Issuances

 

Sales

 

Maturities

Settlements

Calls

 

Total

 

Investments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturity AFS securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

$

194

 

$

(20

)

$

(15

)

$

(51

)

$

(18

)

$

90

 

CMBS

 

 -

 

 

 -

 

 

 -

 

 

(8

)

 

(1

)

 

(9

)

CLOs

 

109

 

 

 -

 

 

 -

 

 

(7

)

 

 -

 

 

102

 

Equity AFS securities

 

10

 

 

(26

)

 

 -

 

 

 -

 

 

 -

 

 

(16

)

Trading securities

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

Derivative investments

 

88

 

 

(193

)

 

(96

)

 

 -

 

 

 -

 

 

(201

)

Future contract benefits – indexed annuity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

and IUL contracts embedded derivatives

 

(30

)

 

 -

 

 

 -

 

 

92

 

 

 -

 

 

62

 

Total, net

$

371

 

$

(239

)

$

(111

)

$

26

 

$

(19

)

$

28

 

 

40


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Six Months Ended June 30, 2014

 

 

Issuances

 

Sales

 

Maturities

Settlements

Calls

 

Total

 

Investments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturity AFS securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

$

377

 

$

(58

)

$

(72

)

$

(32

)

$

(65

)

$

150

 

CMBS

 

 -

 

 

 -

 

 

 -

 

 

(7

)

 

(1

)

 

(8

)

CLOs

 

32

 

 

 -

 

 

 -

 

 

(8

)

 

 -

 

 

24

 

Hybrid and redeemable preferred

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

securities

 

 -

 

 

(5

)

 

 -

 

 

 -

 

 

 -

 

 

(5

)

Equity AFS securities

 

 -

 

 

(5

)

 

 -

 

 

 -

 

 

 -

 

 

(5

)

Trading securities

 

6

 

 

 -

 

 

 -

 

 

(3

)

 

 -

 

 

3

 

Derivative investments

 

79

 

 

(39

)

 

(163

)

 

 -

 

 

 -

 

 

(123

)

Future contract benefits – indexed annuity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

and IUL contracts embedded derivatives

 

(49

)

 

 -

 

 

 -

 

 

71

 

 

 -

 

 

22

 

Total, net

$

445

 

$

(107

)

$

(235

)

$

21

 

$

(66

)

$

58

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The following summarizes changes in unrealized gains (losses) included in net income, excluding any effect of amortization of DAC, VOBA, DSI and DFEL and changes in future contract benefits, related to financial instruments carried at fair value classified within Level 3 that we still held (in millions):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

For the Six

 

 

 

Months Ended

 

Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2015

 

2014

 

2015

 

2014

 

 

Derivative investments (1)

$

111

 

$

(57

)

$

16

 

$

(170

)

 

VIEs’ liabilities – derivative instruments (2)

 

2

 

 

12

 

 

10

 

 

17

 

 

Embedded derivatives: (1)

 

 

 

 

 

 

 

 

 

 

 

 

 

Indexed annuity and IUL contracts

 

(8

)

 

(16

)

 

(34

)

 

(40

)

 

GLB reserves

 

615

 

 

71

 

 

454

 

 

(72

)

 

Credit default swaps (1)

 

1

 

 

1

 

 

1

 

 

1

 

 

Total, net

$

721

 

$

11

 

$

447

 

$

(264

)

 

 

(1)      Included in realized gain (loss) on our Consolidated Statements of Comprehensive Income (Loss). 

(2)      Included in net investment income on our Consolidated Statements of Comprehensive Income (Loss). 

41


 

 

The following provides the components of the transfers into and out of Level 3 (in millions) as reported above:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

For the Three

 

 

Months Ended

 

Months Ended

 

 

June 30, 2015

 

June 30, 2014

 

 

Transfers

 

Transfers

 

 

 

 

Transfers

 

Transfers

 

 

 

 

 

In to

 

Out of

 

 

 

 

In to

 

Out of

 

 

 

 

 

Level 3

 

Level 3

 

Total

 

Level 3

 

Level 3

 

Total

 

Investments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturity AFS securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

$

79

 

$

(76

)

$

3

 

$

144

 

$

(80

)

$

64

 

ABS

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

(4

)

 

(4

)

CLOs

 

4

 

 

(16

)

 

(12

)

 

 -

 

 

(4

)

 

(4

)

State and municipal bonds

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

(29

)

 

(29

)

Hybrid and redeemable preferred

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

securities

 

23

 

 

 -

 

 

23

 

 

 -

 

 

 -

 

 

 -

 

Equity AFS securities

 

 -

 

 

(1

)

 

(1

)

 

 -

 

 

 -

 

 

 -

 

Trading securities

 

 -

 

 

 -

 

 

 -

 

 

6

 

 

 -

 

 

6

 

Total, net

$

106

 

$

(93

)

$

13

 

$

150

 

$

(117

)

$

33

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Six Months Ended June 30, 2015

 

For the Six Months Ended June 30, 2014

 

Transfers

 

Transfers

 

 

 

 

Transfers

 

Transfers

 

 

 

 

 

Into

 

Out of

 

 

 

 

In to

 

Out of

 

 

 

 

 

Level 3

 

Level 3

 

Total

 

Level 3

 

Level 3

 

Total

 

Investments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturity AFS securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

$

159

 

$

(77

)

$

82

 

$

404

 

$

(140

)

$

264

 

ABS

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

(4

)

 

(4

)

Foreign government bonds

 

 -

 

 

 -

 

 

 -

 

 

25

 

 

 -

 

 

25

 

CMBS

 

 -

 

 

 -

 

 

 -

 

 

6

 

 

 -

 

 

6

 

CLOs

 

4

 

 

(16

)

 

(12

)

 

8

 

 

(4

)

 

4

 

State and municipal bonds

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

(29

)

 

(29

)

Hybrid and redeemable preferred

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

securities

 

48

 

 

(5

)

 

43

 

 

12

 

 

(22

)

 

(10

)

Equity AFS securities

 

 -

 

 

(1

)

 

(1

)

 

 

 

 

 

 

 

 -

 

Trading securities

 

 -

 

 

 -

 

 

 -

 

 

10

 

 

(6

)

 

4

 

Derivative investments

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

(426

)

 

(426

)

Other assets – GLB reserves embedded

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

derivatives

 

 -

 

 

 -

 

 

 -

 

 

1,244

 

 

 -

 

 

1,244

 

Future contract benefits  – GLB reserves

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

embedded derivatives

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

(1,244

)

 

(1,244

)

Total, net

$

211

 

$

(99

)

$

112

 

$

1,709

 

$

(1,875

)

$

(166

)

 

Transfers into and out of Level 3 are generally the result of observable market information on a security no longer being available or becoming available to our pricing vendors.  For the six months ended June 30, 2015 and 2014, transfers in and out were attributable primarily to the securities’ observable market information no longer being available or becoming available.  Transfers in and out for GLB reserves embedded derivatives represent reclassifications between future contract benefits and other assets or other liabilities.  Transfers into and out of Levels 1 and 2 are generally the result of a change in the type of input used to measure the fair value of an asset or liability at the end of the reporting period.  When quoted prices in active markets become available, transfers from Level 2 to Level 1 will result.  When quoted prices in active markets become unavailable, but we are able to employ a valuation methodology using significant observable inputs, transfers from Level 1 to Level 2 will result.  For the six months ended June 30, 2015, the transfers between Levels 1 and 2 of the fair value hierarchy was $172 million for our financial instruments carried at fair value which was attributable to quoted market prices being available. For the six months ended June 30, 2014, the transfers between Levels 1 and 2 of the fair value hierarchy were less than $1 million for our financial instruments carried at fair value.

 

42


 

 

The following summarizes the fair value (in millions), valuation techniques and significant unobservable inputs of the Level 3 fair value measurements as of June 30, 2015:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair

 

Valuation

 

Significant

 

Assumption or

 

 

Value

 

Technique

 

Unobservable Inputs

 

Input Ranges

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturity AFS and trading

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

$

1,374

 

Discounted cash flow

 

Liquidity/duration adjustment (1)

 

0.8

%

 

-

9.8

%

 

ABS

 

26

 

Discounted cash flow

 

Liquidity/duration adjustment (1)

 

2.7

%

 

-

2.7

%

 

Foreign government bonds

 

80

 

Discounted cash flow

 

Liquidity/duration adjustment (1)

 

1.7

%

 

-

3.9

%

 

Hybrid and redeemable

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

preferred securities

 

20

 

Discounted cash flow

 

Liquidity/duration adjustment (1)

 

1.8

%

 

-

1.8

%

 

Equity AFS and trading securities

 

27

 

Discounted cash flow

 

Liquidity/duration adjustment (1)

 

4.3

%

 

-

5.8

%

 

Other assets – GLB reserves

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

embedded derivatives and

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

reinsurance recoverable

 

356

 

Discounted cash flow

 

Long-term lapse rate (2)

 

1

%

 

-

30

%

 

 

 

 

 

 

 

 

Utilization of guaranteed withdrawals (3)

90

%

 

-

100

%

 

 

 

 

 

 

 

 

Claims utilization factor (4)

 

60

%

 

-

100

%

 

 

 

 

 

 

 

 

Premiums utilization factor (4)

 

70

%

 

-

140

%

 

 

 

 

 

 

 

 

NPR (5)

 

0.03

%

 

-

0.35

%

 

 

 

 

 

 

 

 

Mortality rate (6)

 

 

 

 

 

(8)

 

 

 

 

 

 

 

 

 

Volatility (7)

 

1

%

 

-

29

%

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Future contract benefits – indexed

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

annuity and IUL contracts

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

embedded derivatives

 

(1,155

)

Discounted cash flow

 

Lapse rate (2)

 

1

%

 

-

15

%

 

 

 

 

 

 

 

 

Mortality rate (6)

 

 

 

 

 

(9)

 

 

Other liabilities – GLB reserves

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

embedded derivatives

 

(102

)

Discounted cash flow

 

Long-term lapse rate (2)

 

1

%

 

-

30

%

 

 

 

 

 

 

 

 

Utilization of guaranteed withdrawals (3)

90

%

 

-

100

%

 

 

 

 

 

 

 

 

Claims utilization factor (4)

 

60

%

 

-

100

%

 

 

 

 

 

 

 

 

Premiums utilization factor (4)

 

70

%

 

-

140

%

 

 

 

 

 

 

 

 

NPR (5)

 

0.03

%

 

-

0.35

%

 

 

 

 

 

 

 

 

Mortality rate (6)(8)

 

 

 

 

 

(9)

 

 

 

 

 

 

 

 

 

Volatility (7)

 

1

%

 

-

29

%

 

 

(1)      The liquidity/duration adjustment input represents an estimated market participant composite of adjustments attributable to liquidity premiums, expected durations, structures and credit quality that would be applied to the market observable information of an investment.

(2)      The lapse rate input represents the estimated probability of a contract surrendering during a year, and thereby forgoing any future benefits.  The range for indexed annuity and IUL contracts represents the lapse rates during the surrender charge period. 

(3)      The utilization of guaranteed withdrawals input represents the estimated percentage of contract holders that utilize the guaranteed withdrawal feature.

(4)      The utilization factors are applied to the present value of claims or premiums, as appropriate, in the GLB reserve calculation to estimate the impact of inefficient withdrawal behavior, including taking less than or more than the maximum guaranteed withdrawal.

(5)      The NPR input represents the estimated additional credit spread that market participants would apply to the market observable discount rate when pricing a contract.

(6)      The mortality rate input represents the estimated probability of when an individual belonging to a particular group, categorized according to age or some other factor such as gender, will die.

(7)      The volatility input represents overall volatilities assumed for the underlying variable annuity funds, which include a mixture of equity and fixed-income assets.  Fair value of the variable annuity GLB embedded derivatives would increase if higher volatilities were used for valuation. 

(8)      The mortality rate is based on a combination of company and industry experience, adjusted for improvement factors.

(9)      Based on the “Annuity 2000 Mortality Table” developed by the Society of Actuaries Committee on Life Insurance Research that was adopted by the National Association of Insurance Commissioners in 1996 for our mortality input.

 

43


 

 

From the table above, we have excluded Level 3 fair value measurements obtained from independent, third-party pricing sources.  We do not develop the significant inputs used to measure the fair value of these assets and liabilities, and the information regarding the significant inputs is not readily available to us.  Independent broker-quoted fair values are non-binding quotes developed by market makers or broker-dealers obtained from third-party sources recognized as market participants.  The fair value of a broker-quoted asset or liability is based solely on the receipt of an updated quote from a single market maker or a broker-dealer recognized as a market participant as we do not adjust broker quotes when used as the fair value measurement for an asset or liability.  Significant increases or decreases in any of the quotes received from a third-party broker-dealer may result in a significantly higher or lower fair value measurement. 

 

Changes in any of the significant inputs presented in the table above may result in a significant change in the fair value measurement of the asset or liability as follows:

 

•      Investments – An increase in the liquidity/duration adjustment input would result in a decrease in the fair value measurement. 

•      Indexed annuity and IUL contracts embedded derivatives – An increase in the lapse rate or mortality rate inputs would result in a decrease in the fair value measurement. 

•      GLB reserves embedded derivatives –  Assuming our GLB reserves embedded derivatives are in a liability position:  an increase in our lapse rate, NPR or mortality rate inputs would result in a decrease in the fair value measurement; and an increase in the utilization of guarantee withdrawal or volatility inputs would result in an increase in the fair value measurement.

 

For each category discussed above, the unobservable inputs are not inter-related; therefore, a directional change in one input will not affect the other inputs. 

 

As part of our ongoing valuation process, we assess the reasonableness of our valuation techniques or models and make adjustments as necessary.  For more information, see “Summary of Significant Accounting Policies” in Note 1 of our 2014 Form 10-K.

 

13.  Segment Information

 

We provide products and services and report results through our Annuities, Retirement Plan Services, Life Insurance and Group Protection segments.  We also have Other Operations, which includes the financial data for operations that are not directly related to the business segments.  Our reporting segments reflect the manner by which our chief operating decision makers view and manage the business.  See Note 22 of our 2014 Form 10-K for a brief description of these segments and Other Operations.

 

Segment operating revenues and income (loss) from operations are internal measures used by our management and Board of Directors to evaluate and assess the results of our segments.  Income (loss) from operations is GAAP net income excluding the after-tax effects of the following items, as applicable:

 

      Realized gains and losses associated with the following (“excluded realized gain (loss)”):

      Sales or disposals and impairments of securities;

      Changes in the fair value of derivatives, embedded derivatives within certain reinsurance arrangements and trading securities;

      Changes in the fair value of the derivatives we own to hedge our GDB riders within our variable annuities;

      Changes in the fair value of the embedded derivatives of our GLB riders accounted for at fair value, net of the change in the fair value of the derivatives we own to hedge them; and

      Changes in the fair value of the embedded derivative liabilities related to index call options we may purchase in the future to hedge contract holder index allocations applicable to future reset periods for our indexed annuity products accounted for at fair value;

•       Changes in reserves resulting from benefit ratio unlocking on our GDB and GLB riders;

•       Income (loss) from reserve changes, net of related amortization, on business sold through reinsurance;

•       Gains (losses) on early extinguishment of debt;

•       Losses from the impairment of intangible assets;

•       Income (loss) from discontinued operations; and

•       Income (loss) from the initial adoption of new accounting standards.

 

Operating revenues represent GAAP revenues excluding the pre-tax effects of the following items, as applicable:

 

•       Excluded realized gain (loss);

•       Revenue adjustments from the initial adoption of new accounting standards;

•       Amortization of DFEL arising from changes in GDB and GLB benefit ratio unlocking; and

•       Amortization of deferred gains arising from reserve changes on business sold through reinsurance.

 

We use our prevailing corporate federal income tax rate of 35% while taking into account any permanent differences for events recognized differently in our financial statements and federal income tax returns when reconciling our non-GAAP measures to the most comparable GAAP measure.  Operating revenues and income (loss) from operations do not replace revenues and net income as the GAAP measures of our consolidated results of operations.

44


 

 

Segment information (in millions) was as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

For the Six

 

 

Months Ended

 

 

Months Ended

 

 

June 30,

 

 

June 30,

 

 

2015

 

2014

 

 

2015

 

2014

 

Revenues

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

Annuities

$

991

 

$

926

 

 

$

1,981

 

$

1,835

 

Retirement Plan Services

 

270

 

 

270

 

 

 

543

 

 

541

 

Life Insurance

 

1,443

 

 

1,363

 

 

 

2,874

 

 

2,700

 

Group Protection

 

617

 

 

621

 

 

 

1,222

 

 

1,231

 

Other Operations

 

96

 

 

106

 

 

 

191

 

 

212

 

Excluded realized gain (loss), pre-tax

 

(37

)

 

(5

)

 

 

(127

)

 

(63

)

Amortization of deferred gain arising

 

 

 

 

 

 

 

 

 

 

 

 

 

from reserve changes on business

 

 

 

 

 

 

 

 

 

 

 

 

 

sold through reinsurance, pre-tax

 

1

 

 

1

 

 

 

1

 

 

1

 

Total revenues

$

3,381

 

$

3,282

 

 

$

6,685

 

$

6,457

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

For the Six

 

 

Months Ended

 

 

Months Ended

 

 

June 30,

 

 

June 30,

 

 

2015

 

2014

 

 

2015

 

2014

 

Net Income (Loss)

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from operations:

 

 

 

 

 

 

 

 

 

 

 

 

 

Annuities

$

255

 

$

227

 

 

$

494

 

$

443

 

Retirement Plan Services

 

30

 

 

39

 

 

 

65

 

 

78

 

Life Insurance

 

105

 

 

148

 

 

 

215

 

 

268

 

Group Protection

 

19

 

 

2

 

 

 

13

 

 

21

 

Other Operations

 

(38

)

 

(22

)

 

 

(63

)

 

(51

)

Excluded realized gain (loss), after-tax

 

(23

)

 

(3

)

 

 

(83

)

 

(42

)

Income (loss) from reserve changes (net of related

 

 

 

 

 

 

 

 

 

 

 

 

 

amortization) on business sold through reinsurance, after-tax

 

 -

 

 

 -

 

 

 

1

 

 

1

 

Benefit ratio unlocking, after-tax

 

(4

)

 

7

 

 

 

2

 

 

9

 

Net income (loss)

$

344

 

$

398

 

 

$

644

 

$

727

 

 

 

45


 

 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following Management’s Discussion and Analysis (“MD&A”) is intended to help the reader understand the financial condition as of June 30, 2015, compared with December 31, 2014, and the results of operations for the three and six months ended June 30, 2015, compared with the corresponding periods in 2014 of Lincoln National Corporation and its consolidated subsidiaries.  Unless otherwise stated or the context otherwise requires, “LNC,” “Company,” “we,” “our” or “us” refers to Lincoln National Corporation and its consolidated subsidiaries.  The MD&A is provided as a supplement to, and should be read in conjunction with our consolidated financial statements and the accompanying notes to the consolidated financial statements (“Notes”) presented in “Part I – Item 1. Financial Statements” our Form 10-K for the year ended December 31, 2014 (“2014 Form 10-K”), including the sections entitled “Part I – Item 1A. Risk Factors,” “Part II – Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Part II – Item 8. Financial Statements and Supplementary Data” our quarterly report on Form 10-Q filed in 2015; and our current reports on Form 8-K filed in 2015.  For more detailed information on the risks and uncertainties associated with the Company’s business activities, see the risks described in “Part I – Item 1A. Risk Factors” in our 2014 Form 10-K as updated by “Item 1A. – Risk Factors” in our first quarter 2015 Form 10-Q.

 

In this report, in addition to providing consolidated revenues and net income (loss), we also provide segment operating revenues and income (loss) from operations because we believe they are meaningful measures of revenues and the profitability of our operating segments.  Financial information that follows is presented in conformity with accounting principles generally accepted in the United States of America (“GAAP”), unless otherwise indicated.  See Note 1 in our 2014 Form 10-K for a discussion of GAAP.

 

Operating revenues and income (loss) from operations are the financial performance measures we use to evaluate and assess the results of our segments.  Accordingly, we define and report operating revenues and income (loss) from operations by segment in Note 13.  Our management believes that operating revenues and income (loss) from operations explain the results of our ongoing businesses in a manner that allows for a better understanding of the underlying trends in our current businesses because the excluded items are unpredictable and not necessarily indicative of current operating fundamentals or future performance of the business segments, and, in many instances, decisions regarding these items do not necessarily relate to the operations of the individual segments.  In addition, we believe that our definitions of operating revenues and income (loss) from operations will provide investors with a more valuable measure of our performance because it better reveals trends in our business. 

 

Certain reclassifications have been made to prior periods’ financial information.

 

FORWARD-LOOKING STATEMENTS –  CAUTIONARY LANGUAGE

 

Certain statements made in this report and in other written or oral statements made by us or on our behalf are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 (“PSLRA”).  A forward-looking statement is a statement that is not a historical fact and, without limitation, includes any statement that may predict, forecast, indicate or imply future results, performance or achievements, and may contain words like:  “believe,” “anticipate,” “expect,” “estimate,” “project,” “will,” “shall” and other words or phrases with similar meaning in connection with a discussion of future operating or financial performance.  In particular, these include statements relating to future actions, trends in our businesses, prospective services or products, future performance or financial results and the outcome of contingencies, such as legal proceedings.  We claim the protection afforded by the safe harbor for forward-looking statements provided by the PSLRA.

 

Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from the results contained in the forward-looking statements.  Risks and uncertainties that may cause actual results to vary materially, some of which are described within the forward-looking statements, include, among others: 

 

·

Deterioration in general economic and business conditions that may affect account values, investment results, guaranteed benefit liabilities, premium levels, claims experience and the level of pension benefit costs, funding and investment results;

·

Adverse global capital and credit market conditions could affect our ability to raise capital, if necessary, and may cause us to realize impairments on investments and certain intangible assets, including goodwill and the valuation allowance against deferred tax assets, which may reduce future earnings and/or affect our financial condition and ability to raise additional capital or refinance existing debt as it matures;

·

Because of our holding company structure, the inability of our subsidiaries to pay dividends to the holding company in sufficient amounts could harm the holding company’s ability to meet its obligations;

·

Legislative, regulatory or tax changes, both domestic and foreign, that affect: the cost of, or demand for, our subsidiaries’ products, the required amount of reserves and/or surplus, our ability to conduct business and our captive reinsurance arrangements as well as restrictions on revenue sharing and 12b‑1 payments, the potential for U.S. federal tax reform and the effect of the Department of Labor’s (“DOL”) proposed regulation defining fiduciary;

·

Actions taken by reinsurers to raise rates on in-force business;

·

Declines in or sustained low interest rates causing a reduction in investment income, the interest margins of our businesses, estimated gross profits (“EGPs”) and demand for our products;

·

Rapidly increasing interest rates causing contract holders to surrender life insurance and annuity policies, thereby causing realized investment losses, and reduced hedge performance related to variable annuities;

·

Uncertainty about the effect of rules and regulations to be promulgated under the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) on us and the economy and financial services sector in particular;

46


 

 

·

The initiation of legal or regulatory proceedings against us, and the outcome of any legal or regulatory proceedings, such as:  adverse actions related to present or past business practices common in businesses in which we compete; adverse decisions in significant actions including, but not limited to, actions brought by federal and state authorities and class action cases; new decisions that result in changes in law; and unexpected trial court rulings;

·

A decline in the equity markets causing a reduction in the sales of our subsidiaries’ products, a reduction of asset-based fees that our subsidiaries charge on various investment and insurance products, an acceleration of the net amortization of deferred acquisition costs (“DAC”), value of business acquired (“VOBA”), deferred sales inducements (“DSI”) and deferred front-end loads (“DFEL”) and an increase in liabilities related to guaranteed benefit features of our subsidiaries’ variable annuity products;

·

Ineffectiveness of our risk management policies and procedures, including various hedging strategies used to offset the effect of changes in the value of liabilities due to changes in the level and volatility of the equity markets and interest rates;

·

A deviation in actual experience regarding future persistency, mortality, morbidity, interest rates or equity market returns from the assumptions used in pricing our subsidiaries’ products, in establishing related insurance reserves and in the net amortization of DAC, VOBA, DSI and DFEL, which may reduce future earnings;

·

Changes in GAAP, including convergence with International Financial Reporting Standards (“IFRS”), that may result in unanticipated changes to our net income;

·

Lowering of one or more of our debt ratings issued by nationally recognized statistical rating organizations and the adverse effect such action may have on our ability to raise capital and on our liquidity and financial condition;

·

Lowering of one or more of the insurer financial strength ratings of our insurance subsidiaries and the adverse effect such action may have on the premium writings, policy retention, profitability of our insurance subsidiaries and liquidity;

·

Significant credit, accounting, fraud, corporate governance or other issues that may adversely affect the value of certain investments in our portfolios, as well as counterparties to which we are exposed to credit risk, requiring that we realize losses on investments;

·

Inability to protect our intellectual property rights or claims of infringement of the intellectual property rights of others;

·

Interruption in telecommunication, information technology or other operational systems or failure to safeguard the confidentiality or privacy of sensitive data on such systems from cyberattacks or other breaches of our data security systems;

·

The effect of acquisitions and divestitures, restructurings, product withdrawals and other unusual items;

·

The adequacy and collectability of reinsurance that we have purchased;

·

Acts of terrorism, a pandemic, war or other man-made and natural catastrophes that may adversely affect our businesses and the cost and availability of reinsurance;

·

Competitive conditions, including pricing pressures, new product offerings and the emergence of new competitors, that may affect the level of premiums and fees that our subsidiaries can charge for their products;

·

The unknown effect on our subsidiaries’ businesses resulting from changes in the demographics of their client base, as aging baby-boomers move from the asset-accumulation stage to the asset-distribution stage of life; and

·

Loss of key management, financial planners or wholesalers.

 

The risks included here are not exhaustive.  Our annual report on Form 10-K, quarterly report on Form 10-Q, current reports on Form 8-K and other documents filed with the Securities and Exchange Commission (“SEC”) include additional factors that could affect our businesses and financial performance.  Moreover, we operate in a rapidly changing and competitive environment.  New risk factors emerge from time to time, and it is not possible for management to predict all such risk factors.

 

Further, it is not possible to assess the effect of all risk factors on our businesses or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.  Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results.  In addition, we disclaim any obligation to update any forward-looking statements to reflect events or circumstances that occur after the date of this report. 

 

INTRODUCTION

 

Executive Summary

 

We are a holding company that operates multiple insurance and retirement businesses through subsidiary companies.  Through our business segments, we sell a wide range of wealth protection, accumulation and retirement income products and solutions.  These products include fixed and indexed annuities, variable annuities, universal life insurance (“UL”), variable universal life insurance (“VUL”), linked-benefit UL, indexed universal life insurance (“IUL”), term life insurance, employer-sponsored retirement plans and services, and group life, disability and dental.

 

We provide products and services and report results through our Annuities, Retirement Plan Services, Life Insurance and Group Protection segments.  We also have Other Operations.  These segments and Other Operations are described in “Part I – Item 1. Business” of our 2014 Form 10-K. 

 

For information on how we derive our revenues, see the discussion in results of operations by segment below.

 

Our current market conditions, significant operational matters, industry trends, issues and outlook are described in “Part II – Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Introduction – Executive Summary” of our 2014 Form 10-K. 

 

47


 

 

For factors that could cause actual results to differ materially from those set forth in this section, see “Forward-Looking Statements – Cautionary Language” above and “Part I – Item 1A. Risk Factors” in our 2014 Form 10-K as updated by “Item 1A. – Risk Factors” in our first quarter 2015 Form 10-Q.

 

Critical Accounting Policies and Estimates

 

The MD&A included in our 2014 Form 10-K contains a detailed discussion of our critical accounting policies and estimates.  The following information updates the “Critical Accounting Policies and Estimates” provided in our 2014 Form 10-K and, accordingly, should be read in conjunction with the “Critical Accounting Policies and Estimates” discussed in our 2014 Form 10-K.

 

DAC, VOBA, DSI and DFEL

 

Unlocking

 

As stated in “Part II – Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates – Unlocking” in our 2014 Form 10-K, we conduct our annual comprehensive review of the assumptions and projection models underlying the amortization of DAC, VOBA, DSI, DFEL, embedded derivatives and reserves for life insurance and annuity products in the third quarter of each year.  The profitability of our business depends, among other things, on assumptions regarding variable fund returns, investment margins, lapse rates and mortality. 

 

Interest rate fluctuations or prolonged low rates could negatively affect our profitability from interest rate spread businesses and thereby reduce future EGPs.  Investment margins are driven by interest rate spreads, or the difference between the interest that we are required to credit to contracts and the yields that we are able to earn on our general account investments supporting our obligations under the contracts.  Accordingly, the assumption of the yield that can be earned on new money is critical to the unlocking analysis.   

 

Although interest rates are expected to move higher in the future, new money rates continue to be at historically low levels and as a result, require careful analysis when forecasting the future direction of changes in rates.  If we change our view of future new money rates and lower our current long-term yield assumption, then, assuming that all other assumptions remain constant, we estimate the impact of lowering this assumption by 50 basis points would be approximately $(125) million to income (loss) from operations due primarily to unlocking our DAC and VOBA assets.  This impact would be most pronounced in our Life Insurance segment.  The actual impact of a 50 basis point decline in the yield would be based upon a number of factors existing at the time of the assumption-update, and therefore, the actual amount of the loss may differ from our current estimate.  In addition, lower investment margins may also impact the recoverability of intangible assets such as goodwill, require the establishment of additional liabilities or trigger loss recognition events on certain policyholder liabilities.  For information on interest rate spreads and interest rate risk, see “Item 3. Quantitative and Qualitative Disclosures About Market Risk – Interest Rate Risk” herein and “Part I – Item 1A. Risk Factors – Market Conditions – Changes in interest rates and sustained low interest rates may cause interest rate spreads to decrease and changes in interest rates may also result in increased contract withdrawals” in our 2014 Form 10-K.

 

Reversion to the Mean

 

As variable fund returns do not move in a systematic manner, we reset the baseline of account values from which EGPs are projected, which we refer to as our reversion to the mean (“RTM”) process, as discussed in our 2014 Form 10-K. 

 

Our long-term variable fund growth rate assumption, which is used in the determination of DAC, VOBA, DSI and DFEL amortization for the variable component of our variable annuity and VUL products, is an immediate drop of approximately 11% followed by growth going forward of 7% to 9% depending on the block of business and reflecting differences in contract holder fund allocations between fixed-income and equity-type investments.  If we had unlocked our RTM assumption as of June 30, 2015, we would have recorded a favorable unlocking of approximately $260 million, pre-tax, for Annuities, and approximately $25 million, pre-tax, for Retirement Plan Services and Life Insurance, respectively.

 

48


 

 

Investments

 

Investment Valuation

 

The following summarizes our available-for-sale (“AFS”) and trading securities and derivative investments carried at fair value by pricing source and fair value hierarchy level (in millions) as of June 30, 2015:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Quoted

 

 

 

 

 

 

 

 

 

 

 

 

 

Prices

 

 

 

 

 

 

 

 

 

 

 

 

 

in Active

 

 

 

 

 

 

 

 

 

 

 

 

 

Markets for

Significant

Significant

 

 

 

 

 

Identical

Observable

Unobservable

 

 

 

 

 

Assets

Inputs

Inputs

 

Total

 

 

(Level 1)

(Level 2)

(Level 3)

 

Fair Value

 

Priced by third-party pricing services

 

$

840 

 

 

$

72,088 

 

 

$

 -

 

 

$

72,928 

 

Priced by independent broker quotations

 

 

 -

 

 

 

 -

 

 

 

2,183 

 

 

 

2,183 

 

Priced by matrices

 

 

 -

 

 

 

12,990 

 

 

 

 -

 

 

 

12,990 

 

Priced by other methods (1)

 

 

 -

 

 

 

 -

 

 

 

1,526 

 

 

 

1,526 

 

Total

 

$

840 

 

 

$

85,078 

 

 

$

3,709 

 

 

$

89,627 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Percent of total

 

 

1% 

 

 

 

95% 

 

 

 

4% 

 

 

 

100% 

 

 

(1)

Represents primarily securities for which pricing models were used to compute fair value.

 

 

For more information about the valuation of our financial instruments carried at fair value, see “Part II – Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Introduction – Critical Accounting Policies and Estimates – Investments – Investment Valuation” in our 2014 Form 10-K and Note 12 herein.

 

As of June 30, 2015, we evaluated the markets that our securities trade in and concluded that none were inactive.  We will continue to re-evaluate this conclusion, as needed, based on market conditions.  We use unobservable inputs to measure the fair value of securities trading in less liquid or illiquid markets with limited or no pricing information.  We obtain broker quotes for securities such as synthetic convertibles, index-linked certificates of deposit and collateralized debt obligations (“CDOs”) when sufficient security structure or other market information is not available to produce an evaluation.  For broker-quoted only securities, non-binding quotes from market makers or broker-dealers are obtained from sources recognized as market participants.  Broker-quoted securities are based solely on receipt of updated quotes from a single market maker or a broker-dealer recognized as a market participant.  Our broker-quoted only securities are generally classified as Level 3 of the fair value hierarchy.  As of June 30, 2015,  we used broker quotes for 74 securities as our final price source, representing approximately 1% of total securities owned.

 

Derivatives

 

Our accounting policies for derivatives and the potential effect on interest spreads in a falling rate environment are discussed in Note 5 of this report and “Part II – Item 7A. Quantitative and Qualitative Disclosures About Market Risk” in our 2014 Form 10-K.

 

Guaranteed Living Benefits

 

Within our individual annuity business, approximately 68% of our variable annuity account values contained guaranteed living benefits (“GLB”) features as of June 30, 2015.  Declines in the equity markets increase our exposure to potential benefits with the GLB features, leading to an increase in our existing liability or a decline if in an asset position for those benefits.  For example, a contract with a GLB feature is “in the money” if the contract holder’s account balance falls below the present value of guaranteed withdrawal or income benefits, assuming no lapses.  As of June 30, 2015 and 2014, 4% and 3%, respectively, of all in-force contracts with a GLB feature were “in the money,” and our exposure, after reinsurance, as of June 30, 2015 and 2014, was $287 million and $245 million, respectively.  However, the only way the contract holder can realize the excess of the present value of benefits over the account value of the contract is through a series of withdrawals or income payments that do not exceed a maximum amount.  If, after the series of withdrawals or income payments, the account value is exhausted, the contract holder will continue to receive a series of annuity payments.  The account value can also fluctuate with equity market returns on a daily basis resulting in increases or decreases in the excess of the present value of benefits over account value.

 

For information on our variable annuity hedge program performance, see our discussion in “Realized Gain (Loss) and Benefit Ratio Unlocking – Variable Annuity Net Derivatives Results” below.

 

For information on our estimates of the potential instantaneous effect to net income, which could result from sudden changes that may occur in equity markets, interest rates and implied market volatilities, see our discussion in “Part II – Item 7. Management’s Discussion

49


 

 

and Analysis of Financial Condition and Results of Operations – Introduction – Critical Accounting Policies and Estimates – Derivatives – GLB” in our 2014 Form 10-K.

 

Acquisitions and Dispositions

 

On July 16, 2015, we closed on the sale of Lincoln Financial Media Company to Entercom Communications Corp. and Entercom Radio, LLC.  We received $105 million, subject to certain purchase price adjustments, consisting of cash and perpetual cumulative convertible preferred stock of Entercom Communications Corp.

 

For additional information about acquisitions and divestitures, see Note 3 in our 2014 Form 10-K.

 

RESULTS OF CONSOLIDATED OPERATIONS

 

Details underlying the consolidated results, deposits, net flows and account values (in millions) were as follows: 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

For the Six

 

 

 

 

Months Ended

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Net Income (Loss)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from operations:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Annuities

$

255

 

$

227

 

12%

 

$

494

 

$

443

 

12%

 

Retirement Plan Services

 

30

 

 

39

 

-23%

 

 

65

 

 

78

 

-17%

 

Life Insurance

 

105

 

 

148

 

-29%

 

 

215

 

 

268

 

-20%

 

Group Protection

 

19

 

 

2

 

NM

 

 

13

 

 

21

 

-38%

 

Other Operations

 

(38

)

 

(22

)

-73%

 

 

(63

)

 

(51

)

-24%

 

Excluded realized gain (loss), after-tax

 

(23

)

 

(3

)

NM

 

 

(83

)

 

(42

)

-98%

 

Income (expense) from reserve changes

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(net of related amortization) on business

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

sold through reinsurance, after-tax

 

 -

 

 

 -

 

NM

 

 

1

 

 

1

 

0%

 

Benefit ratio unlocking, after-tax

 

(4

)

 

7

 

NM

 

 

2

 

 

9

 

-78%

 

Net income (loss)

$

344

 

$

398

 

-14%

 

$

644

 

$

727

 

-11%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

For the Six

 

 

 

 

Months Ended

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Deposits

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Annuities

$

3,380 

 

$

3,566 

 

-5%

 

$

6,370 

 

$

6,945 

 

-8%

 

Retirement Plan Services

 

1,862 

 

 

1,814 

 

3% 

 

 

3,567 

 

 

3,572 

 

0% 

 

Life Insurance

 

1,344 

 

 

1,308 

 

3% 

 

 

2,655 

 

 

2,574 

 

3% 

 

Total deposits

$

6,586 

 

$

6,688 

 

-2%

 

$

12,592 

 

$

13,091 

 

-4%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Flows

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Annuities

$

397 

 

$

831 

 

-52%

 

$

593 

 

$

1,526 

 

-61%

 

Retirement Plan Services

 

306 

 

 

366 

 

-16%

 

 

422 

 

 

 

NM

 

Life Insurance

 

929 

 

 

919 

 

1% 

 

 

1,817 

 

 

1,748 

 

4% 

 

Total net flows

$

1,632 

 

$

2,116 

 

-23%

 

$

2,832 

 

$

3,279 

 

-14%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of June 30,

 

 

 

 

2015

 

2014

 

Change

 

Account Values

 

 

 

 

 

 

 

 

Annuities

$

124,535 

 

$

121,192 

 

3% 

 

Retirement Plan Services

 

54,989 

 

 

53,748 

 

2% 

 

Life Insurance

 

43,059 

 

 

41,238 

 

4% 

 

Total account values

$

222,583 

 

$

216,178 

 

3% 

 

 

50


 

 

Comparison of the Three Months Ended June 30, 2015 to 2014

 

Net income decreased due primarily to the following: 

 

·

Higher claims severity in our Life Insurance segment.

·

Lower realized gains during 2015.

·

Lower prepayment and bond make-whole premiums.

·

Spread compression due to average new money rates trailing our current portfolio yields, partially offset by actions implemented to reduce interest crediting rates.

 

The decrease in net income was partially offset by the following:

 

·

Growth in account values and insurance in force.

·

Favorable total non-medical loss ratio experience in our Group Protection segment.

 

Comparison of the Six Months Ended June 30, 2015 to 2014

 

Net income decreased due primarily to the following: 

 

·

Higher claims severity in our Life Insurance segment.

·

Realized losses during 2015 as compared to realized gains during 2014.

·

Less favorable investment income on alternative investments.

·

Spread compression due to average new money rates trailing our current portfolio yields, partially offset by actions implemented to reduce interest crediting rates.

 

The decrease in net income was partially offset by growth in account values and insurance in force.

51


 

 

RESULTS OF ANNUITIES

 

Income (Loss) from Operations

 

Details underlying the results for Annuities (in millions) were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

For the Six

 

 

 

 

Months Ended

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Operating Revenues

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Insurance premiums (1)

$

55 

 

$

42 

 

31% 

 

$

135 

 

$

87 

 

55% 

 

Fee income

 

531 

 

 

486 

 

9% 

 

 

1,041 

 

 

950 

 

10% 

 

Net investment income

 

247 

 

 

258 

 

-4%

 

 

494 

 

 

517 

 

-4%

 

Operating realized gain (loss) (2)

 

45 

 

 

40 

 

13% 

 

 

87 

 

 

78 

 

12% 

 

Other revenues (3)

 

113 

 

 

100 

 

13% 

 

 

224 

 

 

203 

 

10% 

 

Total operating revenues

 

991 

 

 

926 

 

7% 

 

 

1,981 

 

 

1,835 

 

8% 

 

Operating Expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest credited

 

139 

 

 

154 

 

-10%

 

 

283 

 

 

308 

 

-8%

 

Benefits

 

90 

 

 

80 

 

13% 

 

 

218 

 

 

166 

 

31% 

 

Commissions and other expenses

 

434 

 

 

406 

 

7% 

 

 

859 

 

 

810 

 

6% 

 

Total operating expenses

 

663 

 

 

640 

 

4% 

 

 

1,360 

 

 

1,284 

 

6% 

 

Income (loss) from operations before taxes

 

328 

 

 

286 

 

15% 

 

 

621 

 

 

551 

 

13% 

 

Federal income tax expense (benefit)

 

73 

 

 

59 

 

24% 

 

 

127 

 

 

108 

 

18% 

 

Income (loss) from operations

$

255 

 

$

227 

 

12% 

 

$

494 

 

$

443 

 

12% 

 

 

(1)

Includes primarily our income annuities, which have a corresponding offset in benefits for changes in reserves.

(2)

See “Realized Gain (Loss) and Benefit Ratio Unlocking” below.

(3)

Consists primarily of revenues attributable to broker-dealer services that are subject to market volatility.

 

Comparison of the Three and Six Months Ended June 30, 2015 to 2014

 

Income from operations for this segment increased due primarily to higher fee income driven by higher average daily variable account values as a result of increasing equity markets and positive net flows.

 

The increase in income from operations was partially offset primarily by higher commissions and other expenses due to higher account values, resulting in higher trail commissions.  This increase was partially offset by higher average equity markets than our model projections assumed, resulting in a lower amortization rate.

 

We provide information about this segment’s operating revenue and operating expense line items, the period in which amounts are recognized, key drivers of changes and historical details underlying the line items and their associated drivers below.

 

See the Variable Account Value Information table within “Fee Income” below for drivers of changes in our variable account values. 

 

Additional Information

 

New deposits are an important component of net flows and key to our efforts to grow our business.  Although deposits do not significantly affect current period income from operations, they are an important indicator of future profitability.  For the three and six months ended June 30, 2015, we increased our variable annuity deposits on products without GLB riders to 28%, respectively, compared to 23% and 21% for the corresponding periods in 2014.

 

The other component of net flows relates to the retention of the business.  An important measure of retention is the lapse rate, which compares the amount of withdrawals to the average account values.  The overall lapse rate for our annuity products was 7% for the three and six months ended June 30, 2015 and 2014.  

 

Our fixed annuity business includes products with discretionary crediting rates that are reset on an annual basis and are not subject to surrender charges.  Our ability to retain annual reset annuities will be subject to current competitive conditions at the time interest rates for these products reset.  We expect to manage the effects of spreads on near-term income from operations through portfolio management and, to a lesser extent, crediting rate actions, which assumes no significant changes in net flows into or out of our fixed accounts or other changes that may cause interest rate spreads to differ from our expectations.  For information on interest rate spreads and interest rate risk, see “Item 3. Quantitative and Qualitative Disclosures About Market Risk – Interest Rate Risk” herein and “Part II – Item 7A. Quantitative and Qualitative Disclosures About Market Risk – Interest Rate Risk – Interest Rate Risk on Fixed Insurance

52


 

 

Businesses – Falling Rates” and “Part I – Item 1A. Risk Factors – Market Conditions – Changes in interest rates and sustained low interest rates may cause interest rate spreads to decrease and changes in interest rates may also result in increased contract withdrawals” in our 2014 Form 10-K.

 

For factors that could cause actual results to differ materially from those set forth in this section, see “Forward-Looking Statements – Cautionary Language” above and “Part I – Item 1A. Risk Factors” in our 2014 Form 10-K as updated by “Item 1A. – Risk Factors” in our first quarter 2015 Form 10-Q.

 

For information about regulatory risk including the DOL proposed fiduciary advice regulation, see “Item 1A. Risk Factors – Our businesses are heavily regulated and changes in regulation may affect our insurance subsidiary capital requirements or reduce our profitability – Federal Regulation” in our first quarter 2015 Form 10-Q. 

 

Fee Income

 

Details underlying fee income, account values and net flows (in millions) were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

For the Six

 

 

 

 

Months Ended

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Fee Income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortality, expense and other assessments

$

524

 

$

478

 

10%

 

$

1,026

 

$

935

 

10%

 

Surrender charges

 

8

 

 

7

 

14%

 

 

15

 

 

15

 

0%

 

DFEL:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deferrals

 

(10

)

 

(8

)

-25%

 

 

(18

)

 

(16

)

-13%

 

Amortization, net of interest

 

9

 

 

9

 

0%

 

 

18

 

 

16

 

13%

 

Total fee income

$

531

 

$

486

 

9%

 

$

1,041

 

$

950

 

10%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of or For the Three

 

 

 

As of or For the Six

 

 

 

 

Months Ended

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Variable Account Value Information

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Variable annuity deposits (1)

$

2,302

 

$

2,495

 

-8%

 

$

4,189

 

$

4,786

 

-12%

 

Increases (decreases) in variable annuity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

account values:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net flows (1)

 

(75

)

 

286

 

NM

 

 

(463

)

 

390

 

NM

 

Change in market value (1)

 

(283

)

 

3,323

 

NM

 

 

1,537

 

 

4,111

 

-63%

 

Transfers to the variable portion

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

of variable annuity products

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

from the fixed portion of

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

variable annuity products

 

788

 

 

680

 

16%

 

 

1,507

 

 

1,478

 

2%

 

Variable annuity account values (1)

 

103,408

 

 

99,801

 

4%

 

 

103,408

 

 

99,801

 

4%

 

Average daily variable annuity account

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

values (1)

 

104,794

 

 

96,913

 

8%

 

 

103,389

 

 

95,493

 

8%

 

Average daily S&P 500

 

2,102

 

 

1,899

 

11%

 

 

2,083

 

 

1,868

 

12%

 

 

(1)

Excludes the fixed portion of variable.

 

We charge contract holders mortality and expense assessments on variable annuity accounts to cover insurance and administrative expenses.  These assessments are a function of the rates priced into the product and the average daily variable account values.  Average daily account values are driven by net flows and variable fund returns.  Charges on GLB riders are assessed based on a contractual rate that is applied either to the account value or the guaranteed amount.  In addition, for our fixed annuity contracts and for some variable contracts, we collect surrender charges when contract holders surrender their contracts during their surrender charge periods to protect us from premature withdrawals.  Fee income includes charges on both our variable and fixed annuity products, but excludes the attributed fees on our GLB products; see “Part II – Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Realized Gain (Loss) and Benefit Ratio Unlocking – Operating Realized Gain (Loss)” in our 2014 Form 10-K for discussion of these attributed fees.

 

53


 

 

Net Investment Income and Interest Credited

 

Details underlying net investment income, interest credited (in millions) and our interest rate spread were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

For the Six

 

 

 

 

Months Ended

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Net Investment Income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturity securities, mortgage loans

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

on real estate and other, net of

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

investment expenses

$

206

 

$

215

 

-4%

 

$

412

 

$

432

 

-5%

 

Commercial mortgage loan prepayment

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

and bond make-whole premiums (1)

 

3

 

 

5

 

-40%

 

 

13

 

 

9

 

44%

 

Surplus investments (2)

 

38

 

 

38

 

0%

 

 

69

 

 

76

 

-9%

 

Total net investment income

$

247

 

$

258

 

-4%

 

$

494

 

$

517

 

-4%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest Credited

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amount provided to contract holders

$

138

 

$

146

 

-5%

 

$

278

 

$

292

 

-5%

 

DSI deferrals

 

(7

)

 

(1

)

NM

 

 

(12

)

 

(3

)

NM

 

Interest credited before DSI

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

amortization

 

131

 

 

145

 

-10%

 

 

266

 

 

289

 

-8%

 

DSI amortization

 

8

 

 

9

 

-11%

 

 

17

 

 

19

 

-11%

 

Total interest credited

$

139

 

$

154

 

-10%

 

$

283

 

$

308

 

-8%

 

 

(1)

See “Consolidated Investments – Commercial Mortgage Loan Prepayment and Bond Make-Whole Premiums” below for additional information.

(2)

Represents net investment income on the required statutory surplus for this segment and includes the effect of investment income on alternative investments for such assets that are held in the portfolios supporting statutory surplus versus the portfolios supporting product liabilities.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

For the Six

 

 

 

 

Months Ended

 

Basis

 

Months Ended

 

Basis

 

 

June 30,

 

Point

 

June 30,

 

Point

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Interest Rate Spread

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturity securities, mortgage loans

 

 

 

 

 

 

 

 

 

 

 

 

on real estate and other, net of

 

 

 

 

 

 

 

 

 

 

 

 

investment expenses

4.20%

 

4.49%

 

(29

)

4.22%

 

4.52%

 

(30

)

Commercial mortgage loan prepayment

 

 

 

 

 

 

 

 

 

 

 

 

and bond make-whole premiums

0.06%

 

0.11%

 

(5

)

0.13%

 

0.09%

 

4

 

Net investment income yield on

 

 

 

 

 

 

 

 

 

 

 

 

reserves

4.26%

 

4.60%

 

(34

)

4.35%

 

4.61%

 

(26

)

Interest rate credited to contract

 

 

 

 

 

 

 

 

 

 

 

 

holders

2.61%

 

2.79%

 

(18

)

2.63%

 

2.80%

 

(17

)

Interest rate spread

1.65%

 

1.81%

 

(16

)

1.72%

 

1.81%

 

(9

)

 

54


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of or For the Three

 

 

 

As of or For the Six

 

 

 

 

Months Ended

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Fixed Account Value Information

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed annuity deposits (1)

$

1,078

 

$

1,071

 

1%

 

$

2,181

 

$

2,159

 

1%

 

Increases (decreases) in fixed annuity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

account values:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net flows (1)

 

472

 

 

545

 

-13%

 

 

1,056

 

 

1,136

 

-7%

 

Transfers from the fixed portion

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

of variable annuity products to

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

the variable portion of variable

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

annuity products

 

(788

)

 

(680

)

-16%

 

 

(1,507

)

 

(1,478

)

-2%

 

Reinvested interest credited (1)

 

146

 

 

235

 

-38%

 

 

319

 

 

427

 

-25%

 

Fixed annuity account values (1)

 

21,127

 

 

21,391

 

-1%

 

 

21,127

 

 

21,391

 

-1%

 

Average fixed account values (1)

 

21,026

 

 

21,355

 

-2%

 

 

21,114

 

 

21,295

 

-1%

 

Average invested assets on reserves

 

19,654

 

 

19,170

 

3%

 

 

19,604

 

 

19,136

 

2%

 

 

(1)

Includes the fixed portion of variable.

 

A portion of our investment income earned is credited to the contract holders of our fixed annuity products, including the fixed portion of variable annuity contracts.  We expect to earn a spread between what we earn on the underlying general account investments supporting the fixed annuity product line, including the fixed portion of variable annuity contracts, and what we credit to our fixed annuity contract holders’ accounts, including the fixed portion of variable annuity contracts.  Changes in commercial mortgage loan prepayments and bond make-whole premiums, investment income on alternative investments and surplus investment income can vary significantly from period to period due to a number of factors and, therefore, may contribute to investment income results that are not indicative of the underlying trends.

 

Benefits

 

Benefits for this segment include changes in income annuity reserves driven by premiums, changes in benefit reserves and our expected costs associated with purchases of derivatives used to hedge our benefit ratio unlocking on benefit reserves associated with our guaranteed death benefit riders.

 

55


 

 

Commissions and Other Expenses

 

Details underlying commissions and other expenses (in millions) were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

For the Six

 

 

 

 

Months Ended

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Commissions and Other Expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commissions:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deferrable

$

145

 

$

156

 

-7%

 

$

274

 

$

303

 

-10%

 

Non-deferrable

 

122

 

 

114

 

7%

 

 

242

 

 

218

 

11%

 

General and administrative expenses

 

111

 

 

106

 

5%

 

 

214

 

 

211

 

1%

 

Inter-segment reimbursement associated

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

with reserve financing and

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

LOC expenses (1)

 

1

 

 

 -

 

NM

 

 

3

 

 

1

 

200%

 

Taxes, licenses and fees

 

6

 

 

6

 

0%

 

 

18

 

 

18

 

0%

 

Total expenses incurred, excluding

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

broker-dealer

 

385

 

 

382

 

1%

 

 

751

 

 

751

 

0%

 

DAC deferrals

 

(165

)

 

(174

)

5%

 

 

(311

)

 

(339

)

8%

 

Total pre-broker-dealer expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

incurred, excluding amortization,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

net of interest

 

220

 

 

208

 

6%

 

 

440

 

 

412

 

7%

 

DAC and VOBA amortization,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

net of interest:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amortization, net of interest,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

excluding unlocking

 

101

 

 

101

 

0%

 

 

201

 

 

202

 

0%

 

Unlocking

 

 -

 

 

(1

)

100%

 

 

 -

 

 

(1

)

100%

 

Broker-dealer expenses incurred

 

113

 

 

98

 

15%

 

 

218

 

 

197

 

11%

 

Total commissions and other

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

expenses

$

434

 

$

406

 

7%

 

$

859

 

$

810

 

6%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

DAC Deferrals

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As a percentage of sales/deposits

 

4.9%

 

 

4.9%

 

 

 

 

4.9%

 

 

4.9%

 

 

 

 

(1)

Includes reimbursements to Annuities from the Life Insurance segment for reserve financing, net of expenses incurred by Annuities for its use of letters of credit (“LOCs”).  The inter-segment amounts are not reported on our Consolidated Statements of Comprehensive Income (Loss).

 

Commissions and other costs that result directly from and are essential to the successful acquisition of new or renewal business are deferred to the extent recoverable and are amortized over the lives of the contracts in relation to EGPs.  Certain types of commissions, such as trail commissions that are based on account values, are expensed as incurred rather than deferred and amortized.

 

Broker-dealer expenses that vary with and are related to sales are expensed as incurred and not deferred and amortized.  Fluctuations in these expenses correspond with fluctuations in other revenues.

 

56


 

 

RESULTS OF RETIREMENT PLAN SERVICES

 

Income (Loss) from Operations

 

Details underlying the results for Retirement Plan Services (in millions) were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

For the Six

 

 

 

 

Months Ended

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Operating Revenues

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fee income

$

61 

 

$

62 

 

-2%

 

$

123 

 

$

122 

 

1% 

 

Net investment income

 

206 

 

 

204 

 

1% 

 

 

414 

 

 

411 

 

1% 

 

Other revenues (1)

 

 

 

 

-25%

 

 

 

 

 

-25%

 

Total operating revenues

 

270 

 

 

270 

 

0% 

 

 

543 

 

 

541 

 

0% 

 

Operating Expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest credited

 

123 

 

 

118 

 

4% 

 

 

245 

 

 

236 

 

4% 

 

Benefits

 

 

 

 -

 

NM

 

 

 

 

 -

 

NM

 

Commissions and other expenses

 

107 

 

 

98 

 

9% 

 

 

209 

 

 

198 

 

6% 

 

Total operating expenses

 

231 

 

 

216 

 

7% 

 

 

455 

 

 

434 

 

5% 

 

Income (loss) from operations before taxes

 

39 

 

 

54 

 

-28%

 

 

88 

 

 

107 

 

-18%

 

Federal income tax expense (benefit)

 

 

 

15 

 

-40%

 

 

23 

 

 

29 

 

-21%

 

Income (loss) from operations

$

30 

 

$

39 

 

-23%

 

$

65 

 

$

78 

 

-17%

 

 

(1)

Consists primarily of mutual fund account program revenues for mid to large employers.

 

Comparison of the Three and Six Months Ended June 30, 2015 to 2014

 

Income from operations for this segment decreased due primarily to:

 

·

Higher commissions and other expenses due to higher incentive compensation as a result of production performance and continued strategic investments in technology platforms and distribution expansion efforts.

·

Lower net investment income, net of interest credited, driven by spread compression as a result of average new money rates trailing our current portfolio yields and less favorable investment income on alternative investments within our surplus portfolio.

 

The decrease in income from operations was partially offset by higher average fixed account values.

In addition, for the three months ended June 30, 2015, income from operations decreased due to lower prepayment and bond make-whole premiums.

 

We provide information about this segment’s operating revenue and operating expense line items, the period in which amounts are recognized, key drivers of changes and historical details underlying the line items and their associated drivers below.

 

See the Fixed Account Value Information table within “Net Investment Income and Interest Credited” below for drivers of changes in our fixed account values.

 

See “Consolidated Investments – Commercial Mortgage Loan Prepayment and Bond Make-Whole Premiums” below for more information on prepayment and bond make-whole premiums.

 

Additional Information

 

We expect to continue making strategic investments during the remainder of 2015 to improve our infrastructure and expand distribution that will result in higher expenses. 

 

Net flows in this business fluctuate based on the timing of larger plans being implemented on our platform and terminating over the course of the year.

 

New deposits are an important component of net flows and key to our efforts to grow our business.  Although deposits do not significantly affect current period income from operations, they are an important indicator of future profitability.  The other component of net flows relates to the retention of the business.  An important measure of retention is the lapse rate, which compares the amount of withdrawals to the average account values.  The overall lapse rate for the business was 11% for the three and six months ended June 30, 2015, respectively, compared to 11%  and 14% for the corresponding periods in 2014. 

57


 

 

Our net flows are negatively affected by the continued net outflows from our oldest blocks of annuities business (as presented on our Account Value Roll Forward table below as “Multi-Fund® and Other”), which are also our highest margin product lines in this segment, due to the fact that they are mature blocks with much of the account values out of their surrender charge period.  The proportion of these products to our total account values was 30% and 32% as of June 30, 2015 and 2014, respectively.  Due to this expected overall shift in business mix toward products with lower returns, a significant increase in new deposit production continues to be necessary to maintain earnings at current levels.

 

Our fixed annuity business includes products with discretionary and index-based crediting rates that are reset on either a quarterly or semi-annual basis.  Our ability to retain quarterly reset annuities will be subject to current competitive conditions at the time interest rates for these products reset.  We expect to manage the effects of spreads on near-term income from operations through portfolio management and, to a lesser extent, crediting rate actions, which assumes no significant changes in net flows into or out of our fixed accounts or other changes that may cause interest rate spreads to differ from our expectations.  For information on interest rate spreads and interest rate risk, see “Item 3. Quantitative and Qualitative Disclosures About Market Risk – Interest Rate Risk” herein and “Item 7A. Quantitative and Qualitative Disclosures About Market Risk – Interest Rate Risk – Interest Rate Risk on Fixed Insurance Businesses – Falling Rates” and “Part I – Item 1A. Risk Factors – Market Conditions – Changes in interest rates and sustained low interest rates may cause interest rate spreads to decrease and changes in interest rates may also result in increased contract withdrawals” in our 2014 Form 10-K.

 

For factors that could cause actual results to differ materially from those set forth in this section, see “Forward-Looking Statements – Cautionary Language” above and “Part I – Item 1A. Risk Factors” in our 2014 Form 10-K as updated by “Item 1A. – Risk Factors” in our first quarter 2015 Form 10-Q.

 

For information about regulatory risk including the DOL proposed fiduciary advice regulation, see “Item 1A. Risk Factors – Our businesses are heavily regulated and changes in regulation may affect our insurance subsidiary capital requirements or reduce our profitability – Federal Regulation” in our first quarter 2015 Form 10-Q. 

 

Fee Income

 

Details underlying fee income, account values and net flows (in millions) were as follows:

\

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

For the Six

 

 

 

 

Months Ended

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Fee Income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Annuity expense assessments

$

47 

 

$

49 

 

-4%

 

$

96 

 

$

96 

 

0% 

 

Mutual fund fees

 

14 

 

 

13 

 

8% 

 

 

27 

 

 

25 

 

8% 

 

Total expense assessments

 

61 

 

 

62 

 

-2%

 

 

123 

 

 

121 

 

2% 

 

Surrender charges

 

 -

 

 

 -

 

NM

 

 

 -

 

 

 

-100%

 

Total fee income

$

61 

 

$

62 

 

-2%

 

$

123 

 

$

122 

 

1% 

 

58


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

For the Six

 

 

 

 

Months Ended

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Account Value Roll Forward (1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Small Market:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance as of beginning-of-period

$

8,676

 

$

8,223

 

6%

 

$

8,574

 

$

8,203

 

5%

 

Gross deposits

 

451

 

 

409

 

10%

 

 

904

 

 

879

 

3%

 

Withdrawals and deaths

 

(449

)

 

(389

)

-15%

 

 

(921

)

 

(899

)

-2%

 

Net flows

 

2

 

 

20

 

-90%

 

 

(17

)

 

(20

)

15%

 

Transfers between fixed and variable

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

accounts

 

(10

)

 

 -

 

NM

 

 

(8

)

 

 -

 

NM

 

Change in market value and reinvestment

 

(25

)

 

278

 

NM

 

 

94

 

 

338

 

-72%

 

Balance as of end-of-period

$

8,643

 

$

8,521

 

1%

 

$

8,643

 

$

8,521

 

1%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mid – Large Market:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance as of beginning-of-period

$

29,040

 

$

26,708

 

9%

 

$

28,067

 

$

26,468

 

6%

 

Gross deposits

 

1,279

 

 

1,260

 

2%

 

 

2,396

 

 

2,371

 

1%

 

Withdrawals and deaths

 

(724

)

 

(697

)

-4%

 

 

(1,453

)

 

(1,910

)

24%

 

Net flows

 

555

 

 

563

 

-1%

 

 

943

 

 

461

 

105%

 

Transfers between fixed and variable

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

accounts

 

13

 

 

7

 

86%

 

 

(2

)

 

16

 

NM

 

Change in market value and reinvestment

 

14

 

 

829

 

-98%

 

 

614

 

 

1,162

 

-47%

 

Balance as of end-of-period

$

29,622

 

$

28,107

 

5%

 

$

29,622

 

$

28,107

 

5%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Multi-Fund® and Other:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance as of beginning-of-period

$

16,916

 

$

16,920

 

0%

 

$

16,898

 

$

16,947

 

0%

 

Gross deposits

 

132

 

 

145

 

-9%

 

 

267

 

 

322

 

-17%

 

Withdrawals and deaths

 

(383

)

 

(362

)

-6%

 

 

(771

)

 

(758

)

-2%

 

Net flows

 

(251

)

 

(217

)

-16%

 

 

(504

)

 

(436

)

-16%

 

Change in market value and reinvestment

 

59

 

 

417

 

-86%

 

 

330

 

 

609

 

-46%

 

Balance as of end-of-period

$

16,724

 

$

17,120

 

-2%

 

$

16,724

 

$

17,120

 

-2%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance as of beginning-of-period

$

54,632

 

$

51,851

 

5%

 

$

53,539

 

$

51,618

 

4%

 

Gross deposits

 

1,862

 

 

1,814

 

3%

 

 

3,567

 

 

3,572

 

0%

 

Withdrawals and deaths

 

(1,556

)

 

(1,448

)

-7%

 

 

(3,145

)

 

(3,567

)

12%

 

Net flows

 

306

 

 

366

 

-16%

 

 

422

 

 

5

 

NM

 

Transfers between fixed and variable

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

accounts

 

3

 

 

7

 

-57%

 

 

(10

)

 

16

 

NM

 

Change in market value and reinvestment

 

48

 

 

1,524

 

-97%

 

 

1,038

 

 

2,109

 

-51%

 

Balance as of end-of-period

$

54,989

 

$

53,748

 

2%

 

$

54,989

 

$

53,748

 

2%

 

 

(1)

Includes mutual fund account values and other third-party trustee-held assets.  These items are not included in the separate accounts reported on our Consolidated Balance Sheets as we do not have any ownership interest in them.

59


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of or For the Three

 

 

 

As of or For the Six

 

 

 

 

Months Ended

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Variable Account Value Information

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Variable annuity deposits (1)

$

351

 

$

326

 

8%

 

$

702

 

$

687

 

2%

 

Increases (decreases) in variable annuity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

account values:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net flows (1)

 

(222

)

 

(122

)

-82%

 

 

(413

)

 

(351

)

-18%

 

Change in market value (1)

 

(42

)

 

591

 

NM

 

 

249

 

 

755

 

-67%

 

Transfers from the variable portion

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

of variable annuity products

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

to the fixed portion of

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

variable annuity products

 

(51

)

 

(49

)

-4%

 

 

(112

)

 

(104

)

-8%

 

Variable annuity account values (1)

 

15,001

 

 

15,611

 

-4%

 

 

15,001

 

 

15,611

 

-4%

 

Average daily variable annuity account

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

values (1)

 

15,391

 

 

15,221

 

1%

 

 

15,333

 

 

15,172

 

1%

 

Average daily S&P 500

 

2,102

 

 

1,899

 

11%

 

 

2,083

 

 

1,868

 

12%

 

 

(1)

Excludes the fixed portion of variable.

 

We charge expense assessments to cover insurance and administrative expenses.  Expense assessments are generally equal to a percentage of the daily variable account values.  Average daily account values are driven by net flows and the equity markets.  Our expense assessments include fees we earn for the services that we provide to our mutual fund programs.  In addition, for both our fixed and variable annuity contracts, we collect surrender charges when contract holders surrender their contracts during the surrender charge periods to protect us from premature withdrawals.

 

Net Investment Income and Interest Credited

 

Details underlying net investment income, interest credited (in millions) and our interest rate spread were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

For the Six

 

 

 

 

Months Ended

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Net Investment Income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturity securities, mortgage loans

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

on real estate and other, net of

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

investment expenses

$

189 

 

$

183 

 

3% 

 

$

375 

 

$

368 

 

2% 

 

Commercial mortgage loan prepayment

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

and bond make-whole premiums (1)

 

 

 

 

-75%

 

 

 

 

 

0% 

 

Surplus investments (2)

 

16 

 

 

17 

 

-6%

 

 

30 

 

 

34 

 

-12%

 

Total net investment income

$

206 

 

$

204 

 

1% 

 

$

414 

 

$

411 

 

1% 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest Credited

$

123 

 

$

118 

 

4% 

 

$

245 

 

$

236 

 

4% 

 

 

(1)

See “Consolidated Investments – Commercial Mortgage Loan Prepayment and Bond Make-Whole Premiums” below for additional information.

(2)

Represents net investment income on the required statutory surplus for this segment and includes the effect of investment income on alternative investments for such assets that are held in the portfolios supporting statutory surplus versus the portfolios supporting product liabilities.

60


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

For the Six

 

 

 

 

Months Ended

 

Basis

 

Months Ended

 

Basis

 

 

June 30,

 

Point

 

June 30,

 

Point

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Interest Rate Spread

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturity securities, mortgage loans

 

 

 

 

 

 

 

 

 

 

 

 

on real estate and other, net of

 

 

 

 

 

 

 

 

 

 

 

 

investment expenses

4.61%

 

4.78%

 

(17

)

4.63%

 

4.84%

 

(21

)

Commercial mortgage loan prepayment

 

 

 

 

 

 

 

 

 

 

 

 

and bond make-whole premiums

0.03%

 

0.12%

 

(9

)

0.10%

 

0.12%

 

(2

)

Net investment income yield on reserves

4.64%

 

4.90%

 

(26

)

4.73%

 

4.96%

 

(23

)

Interest rate credited to contract holders

3.01%

 

3.05%

 

(4

)

3.01%

 

3.06%

 

(5

)

Interest rate spread

1.63%

 

1.85%

 

(22

)

1.72%

 

1.90%

 

(18

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of or For the Three

 

 

 

As of or For the Six

 

 

 

 

Months Ended

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Fixed Account Value Information

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed annuity deposits (1)

$

452

 

$

437

 

3%

 

$

870

 

$

945

 

-8%

 

Increases (decreases) in fixed annuity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

account values:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net flows (1)

 

(26

)

 

(66

)

61%

 

 

(149

)

 

(156

)

4%

 

Transfers to the fixed portion of

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

variable annuity products from

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

the variable portion of variable

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

annuity products

 

51

 

 

49

 

4%

 

 

112

 

 

104

 

8%

 

Reinvested interest credited (1)

 

123

 

 

118

 

4%

 

 

244

 

 

234

 

4%

 

Fixed annuity account values (1)

 

16,469

 

 

15,516

 

6%

 

 

16,469

 

 

15,516

 

6%

 

Average fixed account values (1)

 

16,368

 

 

15,465

 

6%

 

 

16,305

 

 

15,423

 

6%

 

Average invested assets on reserves

 

16,280

 

 

15,259

 

7%

 

 

16,201

 

 

15,204

 

7%

 

 

(1)

Includes the fixed portion of variable.

 

A portion of our investment income earned is credited to the contract holders of our fixed annuity products, including the fixed portion of variable annuity contracts.  We expect to earn a spread between what we earn on the underlying general account investments supporting the fixed annuity product line, including the fixed portion of variable annuity contracts, and what we credit to our fixed annuity contract holders’ accounts, including the fixed portion of variable annuity contracts.  Commercial mortgage loan prepayments and bond make-whole premiums, investment income on alternative investments and surplus investment income can vary significantly from period to period due to a number of factors and, therefore, may contribute to investment income results that are not indicative of the underlying trends.

61


 

 

Commissions and Other Expenses

 

Details underlying commissions and other expenses (in millions) were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

For the Six

 

 

 

 

Months Ended

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Commissions and Other Expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commissions:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deferrable

$

4

 

$

3

 

33%

 

$

7

 

$

7

 

0%

 

Non-deferrable

 

16

 

 

15

 

7%

 

 

33

 

 

30

 

10%

 

General and administrative expenses

 

81

 

 

73

 

11%

 

 

155

 

 

146

 

6%

 

Taxes, licenses and fees

 

4

 

 

3

 

33%

 

 

10

 

 

9

 

11%

 

Total expenses incurred

 

105

 

 

94

 

12%

 

 

205

 

 

192

 

7%

 

DAC deferrals

 

(7

)

 

(6

)

-17%

 

 

(14

)

 

(14

)

0%

 

Total expenses recognized before

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

amortization

 

98

 

 

88

 

11%

 

 

191

 

 

178

 

7%

 

DAC and VOBA amortization,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

net of interest

 

9

 

 

10

 

-10%

 

 

18

 

 

20

 

-10%

 

Total commissions and other

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

expenses

$

107

 

$

98

 

9%

 

$

209

 

$

198

 

6%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

DAC Deferrals

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As a percentage of annuity sales/deposits

 

0.9%

 

 

0.8%

 

 

 

 

0.9%

 

 

0.9%

 

 

 

 

Commissions and other costs that result directly from and are essential to the successful acquisition of new or renewal business are deferred to the extent recoverable and are amortized over the lives of the contracts in relation to EGPs.  Certain types of commissions, such as trail commissions that are based on account values, are expensed as incurred rather than deferred and amortized.  Distribution expenses associated with the sale of mutual fund products are expensed as incurred. 

 

 

62


 

 

RESULTS OF LIFE INSURANCE

 

Income (Loss) from Operations

 

Details underlying the results for Life Insurance (in millions) were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

For the Six

 

 

 

 

Months Ended

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Operating Revenues

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Insurance premiums (1)

$

160 

 

$

139 

 

15% 

 

$

309 

 

$

271 

 

14% 

 

Fee income

 

647 

 

 

586 

 

10% 

 

 

1,297 

 

 

1,160 

 

12% 

 

Net investment income

 

626 

 

 

632 

 

-1%

 

 

1,251 

 

 

1,256 

 

0% 

 

Operating realized gain (loss) (2)

 

 

 

 -

 

NM

 

 

 

 

 

100% 

 

Other revenues

 

 

 

 

33% 

 

 

15 

 

 

12 

 

25% 

 

Total operating revenues

 

1,443 

 

 

1,363 

 

6% 

 

 

2,874 

 

 

2,700 

 

6% 

 

Operating Expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest credited

 

345 

 

 

337 

 

2% 

 

 

683 

 

 

671 

 

2% 

 

Benefits

 

673 

 

 

519 

 

30% 

 

 

1,323 

 

 

1,060 

 

25% 

 

Commissions and other expenses

 

273 

 

 

284 

 

-4%

 

 

560 

 

 

569 

 

-2%

 

Total operating expenses

 

1,291 

 

 

1,140 

 

13% 

 

 

2,566 

 

 

2,300 

 

12% 

 

Income (loss) from operations before taxes

 

152 

 

 

223 

 

-32%

 

 

308 

 

 

400 

 

-23%

 

Federal income tax expense (benefit)

 

47 

 

 

75 

 

-37%

 

 

93 

 

 

132 

 

-30%

 

Income (loss) from operations

$

105 

 

$

148 

 

-29%

 

$

215 

 

$

268 

 

-20%

 

 

(1)

Includes term insurance premiums, which have a corresponding partial offset in benefits for changes in reserves.

(2)

See “Realized Gain (Loss) and Benefit Ratio Unlocking” below.

 

Comparison of the Three and Six Months Ended June 30, 2015 to 2014

 

Income from operations for this segment decreased due primarily to unfavorable mortality from higher claims severity (i.e., claim size), partially offset by higher fee income attributable to growth in business in force.

 

We provide information about this segment’s operating revenue and operating expense line items, the period in which amounts are recognized, key drivers of changes and historical details underlying the line items and their associated drivers below.

 

Strategies to Address Statutory Reserve Strain

 

Our insurance subsidiaries have statutory surplus and risk-based capital (“RBC”) levels above current regulatory required levels.  Term products and UL products containing secondary guarantees require reserves calculated pursuant to the Valuation of Life Insurance Policies Model Regulation (“XXX”) and Actuarial Guideline 38 (“AG38”).  During the third quarter of 2013, the New York State Department of Financial Services (“NYDFS”) announced that it would not recognize the National Association of Insurance Commissioners (“NAIC”) revisions to AG38 in applying the New York law governing the reserves to be held for UL and VUL products containing secondary guarantees.  The change, which was effective as of December 31, 2013, impacts our New York-domiciled insurance subsidiary, the Lincoln Life & Annuity Company of New York (“LLANY”).  LLANY discontinued the sale of these products in early 2013, but the change affects those policies sold prior to that time.  We began phasing in the increase in reserves over five years beginning in 2013.  As of June 30, 2015, we have increased reserves by $180 million.  The additional increase in reserves is subject to ongoing discussions with the NYDFS.  However, we do not expect the amount for each of the remaining years to exceed $90 million per year.  We do not expect the total reserve increase to have a material adverse effect on our financial condition.  For more discussion of our strategies to lessen the burden of increased XXX and AG38 statutory reserves associated with term products and UL products containing secondary guarantees on our insurance subsidiaries, see “Part I – Item 1A. Risk Factors – Legislative, Regulatory and Tax – Attempts to mitigate the impact of Regulation XXX and Actuarial Guideline 38 may fail in whole or in part resulting in an adverse effect on our financial condition and results of operations” in our 2014 Form 10-K and “Review of Consolidated Financial Condition – Liquidity and Capital Resources – Sources of Liquidity and Cash Flow – Subsidiaries Statutory Reserving and Surplus” herein.

   

Our insurance subsidiaries employ strategies to reduce the strain caused by XXX and AG38 by using long-dated LOCs as well as other financing transactions.  Included in the LOCs issued as of June 30, 2015, were $3.3 billion of long-dated LOCs issued to support inter-company reinsurance arrangements.  Approximately $2.3 billion of such LOCs were issued for UL products containing secondary guarantees ($350 million will expire in 2019, and $1.9 billion will expire in 2031), and $1.0 billion of such LOCs that will expire in 2023 were issued for term business solutions.  We have also used the proceeds from senior note issuances of $875 million to execute long-term structured solutions supporting UL products containing secondary guarantees.  LOCs and related capital market solutions lower the capital effect of term products and UL products containing secondary guarantees.  An inability to obtain appropriate capital market

63


 

 

solutions could affect our returns on our in-force term products and UL products containing secondary guarantees However, we believe that our insurance subsidiaries have sufficient capital to support the increase in statutory reserves, based on our current reserve projections, if such structures were no longer availableSee “Part I – Item 1A. Risk Factors – Legislative, Regulatory and Tax – Attempts to mitigate the impact of Regulation XXX and Actuarial Guideline 38 may fail in whole or in part resulting in an adverse effect on our financial condition and results of operations” in our 2014 Form 10-K for further information on XXX and AG38 reserves.  See the table in “Commissions and Other Expenses” below for the presentation of our expenses associated with reserve financing. 

 

Additional Information

 

During the second quarter of 2015, mortality was negatively impacted due to claims severity rather than frequency.  While the total dollar amount of claims was approximately 14% worse than expected during the quarter, the number of claims was modestly better than expected.  We believe that our long-term average claims experience will be consistent with average historical actual to expected ratios.

 

We expect to manage the effects of spreads on near-term income from operations through portfolio management, which assumes no significant changes in net flows into or out of our fixed accounts or other changes that may cause interest rate spreads to differ from our expectations. 

 

For information on interest rate spreads and interest rate risk, see “Item 3. Quantitative and Qualitative Disclosures About Market Risk – Interest Rate Risk” herein and “Part II – Item 7A. Quantitative and Qualitative Disclosures About Market Risk – Interest Rate Risk – Interest Rate Risk on Fixed Insurance Businesses – Falling Rates” and “Part I – Item 1A. Risk Factors – Market Conditions – Changes in interest rates and sustained low interest rates may cause interest rate spreads to decrease and changes in interest rates may also result in increased contract withdrawals” in our 2014 Form 10-K.

 

For factors that could cause actual results to differ materially from those set forth in this section, see “Forward-Looking Statements – Cautionary Language” above and “Part I – Item 1A. Risk Factors” in our 2014 Form 10-K as updated by “Item 1A. – Risk Factors” in our first quarter 2015 Form 10-Q.

 

Insurance Premiums

 

Insurance premiums relate to traditional products and are a function of the rates priced into the product and the level of insurance in force.  Insurance in force, in turn, is driven by sales, persistency and mortality experience.

 

Fee Income

 

Details underlying fee income, sales, net flows, account values and in-force face amount (in millions) were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

For the Six

 

 

 

 

Months Ended

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Fee Income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortality assessments

$

406

 

$

347

 

17%

 

$

812

 

$

693

 

17%

 

Expense assessments

 

286

 

 

244

 

17%

 

 

562

 

 

472

 

19%

 

Surrender charges

 

10

 

 

13

 

-23%

 

 

21

 

 

28

 

-25%

 

DFEL:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deferrals

 

(119

)

 

(82

)

-45%

 

 

(230

)

 

(155

)

-48%

 

Amortization, net of interest

 

64

 

 

64

 

0%

 

 

132

 

 

122

 

8%

 

Total fee income

$

647

 

$

586

 

10%

 

$

1,297

 

$

1,160

 

12%

 

 

 

64


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

For the Six

 

 

 

 

Months Ended

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Sales by Product

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

UL:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Excluding MoneyGuard® and IUL

$

22

 

$

24

 

-8%

 

$

42

 

$

45

 

-7%

 

MoneyGuard®

 

46

 

 

40

 

15%

 

 

86

 

 

73

 

18%

 

IUL

 

23

 

 

15

 

53%

 

 

38

 

 

33

 

15%

 

Total UL

 

91

 

 

79

 

15%

 

 

166

 

 

151

 

10%

 

VUL

 

43

 

 

56

 

-23%

 

 

88

 

 

101

 

-13%

 

COLI and BOLI

 

46

 

 

14

 

229%

 

 

60

 

 

18

 

233%

 

Term

 

21

 

 

23

 

-9%

 

 

40

 

 

47

 

-15%

 

Total sales

$

201

 

$

172

 

17%

 

$

354

 

$

317

 

12%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Flows

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits

$

1,344

 

$

1,308

 

3%

 

$

2,655

 

$

2,574

 

3%

 

Withdrawals and deaths

 

(415

)

 

(389

)

-7%

 

 

(838

)

 

(826

)

-1%

 

Net flows

$

929

 

$

919

 

1%

 

$

1,817

 

$

1,748

 

4%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Contract Holder Assessments

$

957

 

$

882

 

9%

 

$

1,902

 

$

1,735

 

10%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of June 30,

 

 

 

 

2015

 

2014

 

Change

 

Account Values

 

 

 

 

 

 

 

 

UL

$

31,880 

 

$

31,025 

 

3% 

 

VUL

 

8,902 

 

 

7,941 

 

12% 

 

Interest-sensitive whole life

 

2,277 

 

 

2,272 

 

0% 

 

Total account values

$

43,059 

 

$

41,238 

 

4% 

 

 

 

 

 

 

 

 

 

 

In-Force Face Amount

 

 

 

 

 

 

 

 

UL and other

$

326,026 

 

$

321,056 

 

2% 

 

Term insurance

 

322,848 

 

 

308,253 

 

5% 

 

Total in-force face amount

$

648,874 

 

$

629,309 

 

3% 

 

 

Fee income relates only to interest-sensitive products and includes mortality assessments, expense assessments (net of deferrals and amortization related to DFEL) and surrender charges.  Mortality and expense assessments are deducted from our contract holders’ account values.  These amounts are a function of the rates priced into the product and premiums received, face amount in force and account values.  Insurance in force, in turn, is driven by sales, persistency and mortality experience. 

 

Sales are not recorded as a component of revenues (other than for traditional products) and do not have a significant effect on current quarter income from operations but are indicators of future profitability.  Generally, we have higher sales during the second half of the year with the fourth quarter being our strongest. 

 

Sales in the table above and as discussed above were reported as follows:

 

·

MoneyGuard®, our linked-benefit product – 15% of total expected premium deposits;

·

Single premium bank-owned UL and VUL (“BOLI”) – 15% of single premium deposits;

·

UL, VUL, and corporate-owned UL and VUL (“COLI”) – first year commissionable premiums plus 5% of excess premiums received, including an adjustment for internal replacements of approximately 50% of commissionable premiums; and

·

Term – 100% of annualized first year premiums.

 

 

65


 

 

Net Investment Income and Interest Credited

 

Details underlying net investment income, interest credited (in millions) and our interest rate spread were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

For the Six

 

 

 

 

Months Ended

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Net Investment Income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturity securities, mortgage loans

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

on real estate and other, net of

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

investment expenses

$

567 

 

$

563 

 

1% 

 

$

1,137 

 

$

1,126 

 

1% 

 

Commercial mortgage loan prepayment

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

and bond make-whole premiums (1)

 

 

 

18 

 

-78%

 

 

22 

 

 

25 

 

-12%

 

Alternative investments (2)

 

17 

 

 

14 

 

21% 

 

 

22 

 

 

30 

 

-27%

 

Surplus investments (3)

 

38 

 

 

37 

 

3% 

 

 

70 

 

 

75 

 

-7%

 

Total net investment income

$

626 

 

$

632 

 

-1%

 

$

1,251 

 

$

1,256 

 

0% 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest Credited

$

345 

 

$

337 

 

2% 

 

$

683 

 

$

671 

 

2% 

 

 

(1)

See “Consolidated Investments – Commercial Mortgage Loan Prepayment and Bond Make-Whole Premiums” below for additional information.

(2)

See “Consolidated Investments – Alternative Investments” below for additional information.

(3)

Represents net investment income on the required statutory surplus for this segment and includes the effect of investment income on alternative investments for such assets that are held in the portfolios supporting statutory surplus versus the portfolios supporting product liabilities.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

For the Six

 

 

 

 

Months Ended

 

Basis

 

Months Ended

 

Basis

 

 

June 30,

 

Point

 

June 30,

 

Point

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Interest Rate Yields and Spread

 

 

 

 

 

 

 

 

 

 

 

 

Attributable to interest-sensitive products:

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturity securities, mortgage loans

 

 

 

 

 

 

 

 

 

 

 

 

on real estate and other, net of

 

 

 

 

 

 

 

 

 

 

 

 

investment expenses

5.33%

 

5.41%

 

(8

)

5.34%

 

5.44%

 

(10

)

Commercial mortgage loan prepayment

 

 

 

 

 

 

 

 

 

 

 

 

and bond make-whole premiums

0.03%

 

0.16%

 

(13

)

0.11%

 

0.10%

 

1

 

Alternative investments

0.18%

 

0.15%

 

3

 

0.11%

 

0.16%

 

(5

)

Net investment income yield

 

 

 

 

 

 

 

 

 

 

 

 

on reserves

5.54%

 

5.72%

 

(18

)

5.56%

 

5.70%

 

(14

)

Interest rate credited to contract holders

3.97%

 

3.96%

 

1

 

3.93%

 

3.95%

 

(2

)

Interest rate spread

1.57%

 

1.76%

 

(19

)

1.63%

 

1.75%

 

(12

)

 

 

 

 

 

 

 

 

 

 

 

 

 

Attributable to traditional products:

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturity securities, mortgage loans

 

 

 

 

 

 

 

 

 

 

 

 

on real estate and other, net of

 

 

 

 

 

 

 

 

 

 

 

 

investment expenses

5.08%

 

5.48%

 

(40

)

5.15%

 

5.68%

 

(53

)

Commercial mortgage loan prepayment

 

 

 

 

 

 

 

 

 

 

 

 

and bond make-whole premiums

0.04%

 

0.34%

 

(30

)

0.10%

 

0.28%

 

(18

)

Net investment income yield

 

 

 

 

 

 

 

 

 

 

 

 

on reserves

5.12%

 

5.82%

 

(70

)

5.25%

 

5.96%

 

(71

)

 

66


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

For the Six

 

 

 

 

Months Ended

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Averages

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Attributable to interest-sensitive products:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Invested assets on reserves

$

38,372 

 

$

37,222 

 

3% 

 

$

38,384 

 

$

37,037 

 

4% 

 

Account values – universal and whole life

 

34,566 

 

 

33,741 

 

2% 

 

 

34,477 

 

 

33,650 

 

2% 

 

Attributable to traditional products:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Invested assets on reserves

 

4,385 

 

 

4,237 

 

3% 

 

 

4,352 

 

 

4,202 

 

4% 

 

 

A portion of the investment income earned for this segment is credited to contract holder accounts.  Statutory reserves will typically grow at a faster rate than account values because of the AG38 reserve requirements.  Invested assets are based upon the statutory reserve liabilities and are affected by various reserve adjustments, including financing transactions providing relief from AG38 reserve requirements. These financing transactions lead to a transfer of invested assets from this segment to Other Operations.  We expect to earn a spread between what we earn on the underlying general account investments and what we credit to our contract holders’ accounts.  We use our investment income to offset the earnings effect of the associated growth of our policy reserves for traditional products.  Commercial mortgage loan prepayments and bond make-whole premiums and investment income on alternative investments can vary significantly from period to period due to a number of factors, and, therefore, may contribute to investment income results that are not indicative of the underlying trends.

 

Benefits

 

Details underlying benefits (dollars in millions) were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

For the Six

 

 

 

 

Months Ended

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Benefits

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Death claims direct and assumed

$

1,050

 

$

876

 

20%

 

$

2,050

 

$

1,802

 

14%

 

Death claims ceded

 

(464

)

 

(448

)

-4%

 

 

(879

)

 

(863

)

-2%

 

Reserves released on death

 

(149

)

 

(123

)

-21%

 

 

(293

)

 

(284

)

-3%

 

Net death benefits

 

437

 

 

305

 

43%

 

 

878

 

 

655

 

34%

 

Change in secondary guarantee life

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

insurance product reserves

 

142

 

 

127

 

12%

 

 

284

 

 

249

 

14%

 

Change in linked-benefit product reserves

 

31

 

 

22

 

41%

 

 

60

 

 

41

 

46%

 

Other benefits (1)

 

63

 

 

65

 

-3%

 

 

101

 

 

115

 

-12%

 

Total benefits

$

673

 

$

519

 

30%

 

$

1,323

 

$

1,060

 

25%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Death claims per $1,000 of in-force

 

2.70

 

 

1.95

 

38%

 

 

2.73

 

 

2.10

 

30%

 

 

(1)

Includes primarily changes in reserves and dividends on traditional and other products.

 

Benefits for this segment include claims incurred during the period in excess of the associated reserves for its interest-sensitive and traditional products.  In addition, benefits include the change in secondary guarantee and linked-benefit life insurance product reserves.  These reserves are affected by changes in expected future trends of expense assessments causing unlocking adjustments to these liabilities similar to DAC, VOBA and DFEL.  Generally, we have higher mortality in the first quarter of the year due to the seasonality of claims.  See “Future Contract Benefits and Other Contract Holder Funds” in Note 1 of our 2014 Form 10-K for additional information.

 

67


 

 

Commissions and Other Expenses

 

Details underlying commissions and other expenses (in millions) were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

For the Six

 

 

 

 

Months Ended

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Commissions and Other Expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commissions

$

160

 

$

173

 

-8%

 

$

322

 

$

336

 

-4%

 

General and administrative expenses

 

130

 

 

124

 

5%

 

 

252

 

 

243

 

4%

 

Expenses associated with reserve financing

 

19

 

 

20

 

-5%

 

 

39

 

 

39

 

0%

 

Taxes, licenses and fees

 

33

 

 

32

 

3%

 

 

75

 

 

76

 

-1%

 

Total expenses incurred

 

342

 

 

349

 

-2%

 

 

688

 

 

694

 

-1%

 

DAC and VOBA deferrals

 

(182

)

 

(187

)

3%

 

 

(362

)

 

(365

)

1%

 

Total expenses recognized before

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

amortization

 

160

 

 

162

 

-1%

 

 

326

 

 

329

 

-1%

 

DAC and VOBA amortization,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

net of interest

 

112

 

 

121

 

-7%

 

 

232

 

 

238

 

-3%

 

Other intangible amortization

 

1

 

 

1

 

0%

 

 

2

 

 

2

 

0%

 

Total commissions and

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

other expenses

$

273

 

$

284

 

-4%

 

$

560

 

$

569

 

-2%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

DAC and VOBA Deferrals

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As a percentage of sales

 

90.5%

 

 

108.7%

 

 

 

 

102.3%

 

 

115.1%

 

 

 

 

Commissions and costs that result directly from and are essential to successful acquisition of new or renewal business are deferred to the extent recoverable and for our interest-sensitive products are generally amortized over the life of the contracts in relation to EGPs.  For our traditional products, DAC and VOBA are amortized on either a straight-line basis or as a level percent of premium of the related contracts, depending on the block of business.  When comparing DAC and VOBA deferrals as a percentage of sales for the three and six months ended June 30, 2015, to the corresponding periods in 2014, the decrease was primarily a result of changes in sales mix to products with lower commission rates.

 

68


 

 

RESULTS OF GROUP PROTECTION

 

Income (Loss) from Operations

 

Details underlying the results for Group Protection (in millions) were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

For the Six

 

 

 

 

Months Ended

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Operating Revenues

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Insurance premiums

$

567 

 

$

574 

 

-1%

 

$

1,128 

 

$

1,135 

 

-1%

 

Net investment income

 

47 

 

 

44 

 

7% 

 

 

90 

 

 

89 

 

1% 

 

Other revenues

 

 

 

 

0% 

 

 

 

 

 

-43%

 

Total operating revenues

 

617 

 

 

621 

 

-1%

 

 

1,222 

 

 

1,231 

 

-1%

 

Operating Expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest credited

 

 

 

 

-50%

 

 

 

 

 

-50%

 

Benefits

 

421 

 

 

463 

 

-9%

 

 

862 

 

 

886 

 

-3%

 

Commissions and other expenses

 

165 

 

 

153 

 

8% 

 

 

339 

 

 

310 

 

9% 

 

Total operating expenses

 

587 

 

 

618 

 

-5%

 

 

1,202 

 

 

1,198 

 

0% 

 

Income (loss) from operations before taxes

 

30 

 

 

 

NM

 

 

20 

 

 

33 

 

-39%

 

Federal income tax expense (benefit)

 

11 

 

 

 

NM

 

 

 

 

12 

 

-42%

 

Income (loss) from operations

$

19 

 

$

 

NM

 

$

13 

 

$

21 

 

-38%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

For the Six

 

 

 

 

Months Ended

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Income (Loss) from Operations by

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Product Line

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Life

$

9

 

$

1

 

NM

 

$

6

 

$

6

 

0%

 

Disability

 

9

 

 

(2

)

NM

 

 

5

 

 

11

 

-55%

 

Dental

 

 -

 

 

1

 

-100%

 

 

 -

 

 

2

 

-100%

 

Total non-medical

 

18

 

 

 -

 

NM

 

 

11

 

 

19

 

-42%

 

Medical

 

1

 

 

2

 

-50%

 

 

2

 

 

2

 

0%

 

Income (loss) from operations

$

19

 

$

2

 

NM

 

$

13

 

$

21

 

-38%

 

 

Comparison of the Three Months Ended June 30, 2015 to 2014

 

Income from operations for this segment increased due primarily to more favorable total non-medical loss ratio experience due primarily to decreased long-term disability incidence and favorable mortality and life waiver experience.

 

The increase in income from operations was partially offset by higher commissions and other expenses due to higher amortization of DAC driven by higher lapses and re-pricing actions primarily on our employer-paid life and disability business. 

 

Comparison of the Six Months Ended June 30, 2015 to 2014

 

Income from operations for this segment decreased due primarily to higher commissions and other expenses due to higher amortization of DAC driven by higher lapses and re-pricing actions primarily on our employer-paid life and disability business.

 

The decrease in income from operations was partially offset by more favorable total non-medical loss ratio experience attributable to decreased long-term disability incidence and favorable mortality and life waiver experience.

 

We provide information about this segment’s operating revenue and operating expense line items, the period in which amounts are recognized, key drivers of changes and historical details underlying the line items and their associated drivers below.

 

Additional Information

 

Management compares trends in actual loss ratios to pricing expectations because group-underwriting risks change over time.  We expect normal fluctuations in our composite non-medical loss ratios of this segment, as claims experience is inherently uncertainFor every one

69


 

 

percent increase in the loss ratio, we would expect an approximate annual $13 million to $15 million decrease to income from operations.  We expect the non-medical loss ratio to be within or near the high end of our long-term expectation of 71% to 74% during the remainder of 2015.

 

We expect higher amortization of DAC during the remainder of 2015 as compared to 2014  due to increased lapses and re-pricing actions. 

 

For information on the effects of current interest rates on our long-term disability claim reserves, see “Item 3. Quantitative and Qualitative Disclosures About Market Risk – Interest Rate Risk.

 

For factors that could cause actual results to differ materially from those set forth in this section, see “Forward-Looking Statements – Cautionary Language” above and Part I – Item 1A. Risk Factors” in our 2014 Form 10-K as updated by “Item 1A. – Risk Factors” in our first quarter 2015 Form 10-Q.

 

Insurance Premiums

 

Details underlying insurance premiums (in millions) were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

For the Six

 

 

 

 

Months Ended

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Insurance Premiums by Product Line

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Life

$

231 

 

$

229 

 

1% 

 

$

460 

 

$

466 

 

-1%

 

Disability

 

246 

 

 

243 

 

1% 

 

 

494 

 

 

482 

 

2% 

 

Dental

 

58 

 

 

56 

 

4% 

 

 

116 

 

 

113 

 

3% 

 

Total non-medical

 

535 

 

 

528 

 

1% 

 

 

1,070 

 

 

1,061 

 

1% 

 

Medical

 

32 

 

 

46 

 

-30%

 

 

58 

 

 

74 

 

-22%

 

Total insurance premiums

$

567 

 

$

574 

 

-1%

 

$

1,128 

 

$

1,135 

 

-1%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sales

$

62 

 

$

73 

 

-15%

 

$

118 

 

$

137 

 

-14%

 

 

Our cost of insurance and policy administration charges are embedded in the premiums charged to our customers.  The premiums are a function of the rates priced into the product and our business in force.  Business in force, in turn, is driven by sales and persistency experience. 

 

Sales relate to new contract holders and new programs sold to existing contract holders.  We believe that the trend in sales is an important indicator of development of business in force over time.  Sales in the table above are the combined annualized premiums for our life, disability and dental products.  When comparing sales for the three and six months ended June 30, 2015, to the corresponding periods in 2014, the decrease was partly the result of re-pricing actions primarily on our employer-paid life and disability business.  We continue to shift the business mix to employee-paid blocks of business, which we expect will improve the overall profitability of the business.

 

Net Investment Income

 

We use our investment income to offset the earnings effect of the associated build of our policy reserves, which are a function of our insurance premiums and the yields on our invested assets.

 

70


 

 

Benefits and Interest Credited

 

Details underlying benefits and interest credited (in millions) and loss ratios by product line were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

For the Six

 

 

 

 

Months Ended

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Benefits and Interest Credited by

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Product Line

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Life

$

166 

 

$

183 

 

-9%

 

$

345 

 

$

363 

 

-5%

 

Disability

 

186 

 

 

201 

 

-7%

 

 

383 

 

 

377 

 

2% 

 

Dental

 

42 

 

 

40 

 

5% 

 

 

84 

 

 

82 

 

2% 

 

Total non-medical

 

394 

 

 

424 

 

-7%

 

 

812 

 

 

822 

 

-1%

 

Medical

 

28 

 

 

41 

 

-32%

 

 

51 

 

 

66 

 

-23%

 

Total benefits and interest credited

$

422 

 

$

465 

 

-9%

 

$

863 

 

$

888 

 

-3%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loss Ratios by Product Line

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Life

 

72.0% 

 

 

80.0% 

 

 

 

 

74.8% 

 

 

78.0% 

 

 

 

Disability

 

75.4% 

 

 

82.6% 

 

 

 

 

77.5% 

 

 

78.2% 

 

 

 

Dental

 

72.3% 

 

 

71.1% 

 

 

 

 

72.6% 

 

 

72.6% 

 

 

 

Total non-medical

 

73.6% 

 

 

80.3% 

 

 

 

 

75.8% 

 

 

77.5% 

 

 

 

Medical

 

90.0% 

 

 

89.0% 

 

 

 

 

89.7% 

 

 

88.4% 

 

 

 

 

Generally, we have higher mortality in the first quarter of the year due to the seasonality of claims.

 

Commissions and Other Expenses

 

Details underlying commissions and other expenses (in millions) were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

For the Six

 

 

 

 

Months Ended

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Commissions and Other Expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commissions

$

69

 

$

68

 

1%

 

$

135

 

$

135

 

0%

 

General and administrative expenses

 

80

 

 

78

 

3%

 

 

158

 

 

150

 

5%

 

Taxes, licenses and fees

 

13

 

 

14

 

-7%

 

 

29

 

 

29

 

0%

 

Total expenses incurred

 

162

 

 

160

 

1%

 

 

322

 

 

314

 

3%

 

DAC deferrals

 

(12

)

 

(18

)

33%

 

 

(30

)

 

(34

)

12%

 

Total expenses recognized before

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

amortization

 

150

 

 

142

 

6%

 

 

292

 

 

280

 

4%

 

DAC and VOBA amortization, net of

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

interest

 

15

 

 

11

 

36%

 

 

47

 

 

30

 

57%

 

Total commissions and

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

other expenses

$

165

 

$

153

 

8%

 

$

339

 

$

310

 

9%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

DAC Deferrals

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As a percentage of insurance premiums

 

2.1%

 

 

3.1%

 

 

 

 

2.7%

 

 

3.0%

 

 

 

 

Commissions and other costs that result directly from and are essential to the successful acquisition of new or renewal business are deferred to the extent recoverable and are amortized in relation to the revenues of the related contracts.  Certain broker commissions that vary with and are related to paid premiums are expensed as incurred.  The level of expenses is an important driver of profitability for this segment as group insurance contracts are offered within an environment that competes on the basis of price and service.     

 

71


 

 

RESULTS OF OTHER OPERATIONS

 

Income (Loss) from Operations

 

Details underlying the results for Other Operations (in millions) were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

For the Six

 

 

 

 

Months Ended

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Operating Revenues

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Insurance premiums

$

1

 

$

 -

 

NM

 

$

1

 

$

 -

 

NM

 

Net investment income

 

61

 

 

70

 

-13%

 

 

125

 

 

143

 

-13%

 

Amortization of deferred gain on

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

business sold through reinsurance

 

18

 

 

18

 

0%

 

 

35

 

 

36

 

-3%

 

Media revenues (net)

 

16

 

 

17

 

-6%

 

 

31

 

 

32

 

-3%

 

Other revenues

 

 -

 

 

1

 

-100%

 

 

(1

)

 

1

 

NM

 

Total operating revenues

 

96

 

 

106

 

-9%

 

 

191

 

 

212

 

-10%

 

Operating Expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest credited

 

20

 

 

26

 

-23%

 

 

41

 

 

52

 

-21%

 

Benefits

 

30

 

 

29

 

3%

 

 

57

 

 

59

 

-3%

 

Media expenses

 

14

 

 

14

 

0%

 

 

28

 

 

29

 

-3%

 

Other expenses

 

22

 

 

4

 

NM

 

 

31

 

 

17

 

82%

 

Interest and debt expense

 

69

 

 

67

 

3%

 

 

137

 

 

134

 

2%

 

Total operating expenses

 

155

 

 

140

 

11%

 

 

294

 

 

291

 

1%

 

Income (loss) from operations before taxes

 

(59

)

 

(34

)

-74%

 

 

(103

)

 

(79

)

-30%

 

Federal income tax expense (benefit)

 

(21

)

 

(12

)

-75%

 

 

(40

)

 

(28

)

-43%

 

Income (loss) from operations

$

(38

)

$

(22

)

-73%

 

$

(63

)

$

(51

)

-24%

 

 

Comparison of the Three and Six Months Ended June 30, 2015 to 2014 

 

Loss from operations for Other Operations increased due primarily to higher other expenses in 2015 attributable to higher legal expenses, and lower net investment income, net of interest credited, related to lower average invested assets driven by repurchases of common stock and lower distributable earnings received from our business segments.    

 

We provide information about Other Operations’ operating revenue and operating expense line items, the period in which amounts are recognized, key drivers of changes and historical details underlying the line items and their associated drivers below.

 

Additional Information

 

For factors that could cause actual results to differ materially from those set forth in this section, see “Forward-Looking Statements – Cautionary Language” above and “Part I – Item 1A. Risk Factors” in our 2014 Form 10-K as updated by “Item 1A. – Risk Factors” in our first quarter 2015 Form 10-Q.

 

Net Investment Income and Interest Credited

 

We utilize an internal formula to determine the amount of capital that is allocated to our business segments.  Investment income on capital in excess of the calculated amounts is reported in Other Operations.  If our business segments require increases in statutory reserves, surplus or investments, the amount of excess capital that is retained by Other Operations would decrease and net investment income would be negatively affected.

 

Write-downs for other-than-temporary impairment (“OTTI”) decrease the recorded value of our invested assets owned by the business segments.  These write-downs are not included in the income from operations of our business segments.  When impairment occurs, assets are transferred to the business segments’ portfolios and will reduce the future net investment income for Other Operations.  Statutory reserve adjustments for our business segments can also cause allocations of invested assets between the business segments and Other Operations.

   

The majority of our interest credited relates to our reinsurance operations sold to Swiss Re Life & Health America, Inc. (“Swiss Re”) in 2001.  A substantial amount of the business was sold through indemnity reinsurance transactions, which is still recorded in our consolidated financial statements.  The interest credited corresponds to investment income earnings on the assets we continue to hold for this business.  There is no effect to income or loss in Other Operations or on a consolidated basis for these amounts because interest earned on the blocks that continue to be reinsured is passed through to Swiss Re in the form of interest credited.

72


 

 

Benefits

 

Benefits are recognized when incurred for Institutional Pension products and disability income business.

 

Other Expenses

 

 

Details underlying other expenses (in millions) were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

For the Six

 

 

 

 

Months Ended

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

General and administrative expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Legal

$

12

 

$

(2

)

NM

 

$

14

 

$

(1

)

NM

 

Branding

 

7

 

 

8

 

-13%

 

 

12

 

 

13

 

-8%

 

Other (1)

 

8

 

 

12

 

-33%

 

 

14

 

 

19

 

-26%

 

Total general and administrative expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

expenses

 

27

 

 

18

 

50%

 

 

40

 

 

31

 

29%

 

Taxes, licenses and fees

 

(2

)

 

(11

)

82%

 

 

(4

)

 

(8

)

50%

 

Inter-segment reimbursement associated

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

with reserve financing and LOC expenses (2)

 

(3

)

 

(3

)

0%

 

 

(5

)

 

(6

)

17%

 

Total other expenses

$

22

 

$

4

 

NM

 

$

31

 

$

17

 

82%

 

 

(1)

Includes expenses that are corporate in nature including charitable contributions, the portion of our deferred compensation plan expense attributable to participants’ selection of LNC stock as the measure for their investment return and other expenses not allocated to our business segments.

(2)

Consists of reimbursements to Other Operations from the Life Insurance segment for the use of proceeds from certain issuances of senior notes that were used as long-term structured solutions, net of expenses incurred by Other Operations for its use of LOCs.

 

Interest and Debt Expense

 

Our current level of interest expense may not be indicative of the future due to, among other things, the timing of the use of cash, the availability of funds from our inter-company cash management program and the future cost of capital.  For additional information on our financing activities, see “Review of Consolidated Financial Condition – Liquidity and Capital Resources – Sources of Liquidity and Cash Flow – Financing Activities” below.

 

 

 

73


 

 

REALIZED GAIN (LOSS) AND BENEFIT RATIO UNLOCKING

 

Details underlying realized gain (loss), after-DAC (1) and benefit ratio unlocking (in millions) were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

For the Six

 

 

 

 

Months Ended

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Components of Realized Gain (Loss), Pre-Tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total operating realized gain (loss)

$

47

 

$

40

 

18%

 

$

89

 

$

79

 

13%

 

Total excluded realized gain (loss)

 

(37

)

 

(5

)

NM

 

 

(127

)

 

(63

)

NM

 

Total realized gain (loss), pre-tax

$

10

 

$

35

 

-71%

 

$

(38

)

$

16

 

NM

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reconciliation of Excluded Realized Gain (Loss)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net of Benefit Ratio Unlocking, After-Tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total excluded realized gain (loss)

$

(23

)

$

(3

)

NM

 

$

(83

)

$

(42

)

-98%

 

Benefit ratio unlocking

 

(4

)

 

7

 

NM

 

 

2

 

 

9

 

-78%

 

Excluded realized gain (loss) net of benefit ratio

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

unlocking, after-tax

$

(27

)

$

4

 

NM

 

$

(81

)

$

(33

)

NM

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Components of Excluded Realized Gain (Loss)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net of Benefit Ratio Unlocking, After-Tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Realized gain (loss) related to certain investments

$

(1

)

$

 -

 

NM

 

$

(18

)

$

(3

)

NM

 

Gain (loss) on the mark-to-market on

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

certain instruments

 

(13

)

 

5

 

NM

 

 

(6

)

 

(8

)

25%

 

Variable annuity net derivatives results:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Hedge program performance, including unlocking

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

for GLB reserves hedged

 

 -

 

 

16

 

-100%

 

 

(35

)

 

1

 

NM

 

GLB NPR component

 

(8

)

 

(9

)

11%

 

 

(1

)

 

(2

)

50%

 

Total variable annuity net derivatives results

 

(8

)

 

7

 

NM

 

 

(36

)

 

(1

)

NM

 

Indexed annuity forward-starting option

 

(4

)

 

(8

)

50%

 

 

(19

)

 

(21

)

10%

 

Realized gain (loss) on sale of

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

subsidiaries/businesses (2)

 

(1

)

 

 -

 

NM

 

 

(2

)

 

 -

 

NM

 

Excluded realized gain (loss) net of benefit ratio

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

unlocking, after-tax

$

(27

)

$

4

 

NM

 

$

(81

)

$

(33

)

NM

 

 

(1)

DAC refers to the associated amortization of DAC, VOBA, DSI and DFEL and changes in other contract holder funds and funds withheld reinsurance assets and liabilities.

(2)

See Note 3 in our 2014 Form 10-K for more information.

 

For factors that could cause actual results to differ materially from those set forth in this section, see “Forward-Looking Statements – Cautionary Language” above and “Part I – Item 1A. Risk Factors” in our 2014 Form 10-K as updated by “Item 1A. – Risk Factors” in our first quarter 2015 Form 10-Q.

 

For information on our counterparty exposure, see “Part I Item 3. Quantitative and Qualitative Disclosures About Market Risk.”

 

Comparison of the Three Months Ended June 30, 2015 to 2014 

 

We had lower realized gains during 2015 as compared to 2014 driven primarily by the following components of excluded realized gain (loss), which we have described net of benefit ratio unlocking, after-tax:

 

·

Losses on the mark-to-market on certain instruments during 2015 attributable primarily to an increase in interest rates leading to a decrease in the value of our trading securities.

·

More favorable hedge program performance in 2014, driven primarily by less volatile capital markets.

 

74


 

 

Comparison of the Six Months Ended June 30, 2015 to 2014 

 

We had realized losses during 2015 as compared to gains during 2014 driven primarily by the following components of excluded realized gain (loss), which we have described net of benefit ratio unlocking, after-tax:

 

·

Higher losses on variable annuity net derivatives results during 2015 attributable to more volatile capital markets resulting in more unfavorable hedge program performance during 2015.

·

An increase in OTTI attributable to individual credit risks within our corporate bond holdings. 

 

Operating Realized Gain (Loss)

 

See “Part II – Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Realized Gain (Loss) and Benefit Ratio Unlocking – Operating Realized Gain (Loss)” in our 2014 Form 10-K for a discussion of our operating realized gain (loss).

 

Realized Gain (Loss) Related to Certain Investments

 

See “Consolidated Investments – Realized Gain (Loss) Related to Certain Investments” below.

 

Gain (Loss) on the Mark-to-Market on Certain Instruments

 

See “Part II – Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Realized Gain (Loss) and Benefit Ratio Unlocking – Gain (Loss) on the Mark-to-Market on Certain Instruments” in our 2014 Form 10-K for a discussion of the mark-to-market on certain instruments and Note 3 for information about consolidated variable interest entities (“VIEs”)

 

Variable Annuity Net Derivatives Results

 

See “Part II – Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Realized Gain (Loss) and Benefit Ratio Unlocking – Variable Annuity Net Derivatives Results” in our 2014 Form 10-K for a discussion of our variable annuity net derivatives results and how our non-performance risk (“NPR”) adjustment is determined.  

 

Details underlying our variable annuity hedging program (dollars in millions) were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of

 

 

As of

 

 

As of

 

 

As of

 

 

As of

 

 

June 30,

March 31,

December 31,

September 30,

June 30,

 

 

2015

 

 

2015

 

 

2014

 

 

2014

 

 

2014

 

Variable annuity hedge program assets (liabilities)

 

$

1,626

 

 

$

2,124

 

 

$

1,722

 

 

$

1,039

 

 

$

502

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Variable annuity reserves – asset (liability):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Embedded derivative reserves, pre-NPR (1)

 

$

326

 

 

$

(291

)

 

$

50

 

 

$

694

 

 

$

1,043

 

NPR

 

 

(72

)

 

 

(57

)

 

 

(70

)

 

 

(102

)

 

 

(111

)

Embedded derivative reserves

 

 

254

 

 

 

(348

)

 

 

(20

)

 

 

592

 

 

 

932

 

Insurance benefit reserves

 

 

(391

)

 

 

(355

)

 

 

(341

)

 

 

(319

)

 

 

(265

)

Total variable annuity reserves – asset (liability)

 

$

(137

)

 

$

(703

)

 

$

(361

)

 

$

273

 

 

$

667

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

10-year credit default swap ("CDS") spread

 

 

1.43%

 

 

 

1.27%

 

 

 

1.25%

 

 

 

1.26%

 

 

 

1.15%

 

NPR factor related to 10-year CDS spread

 

 

0.22%

 

 

 

0.21%

 

 

 

0.20%

 

 

 

0.19%

 

 

 

0.08%

 

 

(1)

Embedded derivative reserves in an asset (liability) position indicate that we estimate the present value of future benefits to be less (greater) than the present value of future net valuation premiums. 

 

The following shows the approximate hypothetical effect to net income, pre-DAC (1), pre-tax (in millions) for changes in the NPR factor along all points on the spread curve as of June 30, 2015:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Hypothetical

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Effect

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

NPR factor:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Down 22 basis points to zero

 

$

(135

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Up 20 basis points

 

 

70

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1)

DAC refers to the associated amortization of DAC, VOBA, DSI and DFEL and changes in other contract holder funds and funds withheld reinsurance assets and liabilities.

 

See “Critical Accounting Policies and Estimates – Derivatives – GLB” above for additional information about our guaranteed benefits.

75


 

 

Indexed Annuity Forward-Starting Option

 

See “Part II – Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Realized Gain (Loss) and Benefit Ratio Unlocking – Indexed Annuity Forward-Starting Option” in our 2014 Form 10-K for a discussion of our indexed annuity forward-starting option. 

 

CONSOLIDATED INVESTMENTS

 

Details underlying our consolidated investment balances (in millions) were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Percentage of

 

 

 

 

 

 

 

 

 

 

 

Total Investments

 

 

 

 

As of

 

 

As of

 

 

As of

 

 

As of

 

 

 

June 30,

December 31,

June 30,

December 31,

 

 

 

2015

 

 

2014

 

 

2015

 

 

2014

 

 

Investments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

AFS securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturity

 

$

85,422 

 

 

$

86,240 

 

 

83.8% 

 

 

83.7% 

 

 

VIEs’ fixed maturity

 

 

598 

 

 

 

598 

 

 

0.6% 

 

 

0.6% 

 

 

Total fixed maturity

 

 

86,020 

 

 

 

86,838 

 

 

84.4% 

 

 

84.3% 

 

 

Equity

 

 

227 

 

 

 

231 

 

 

0.2% 

 

 

0.2% 

 

 

Trading securities

 

 

1,949 

 

 

 

2,065 

 

 

1.9% 

 

 

2.0% 

 

 

Mortgage loans on real estate

 

 

8,171 

 

 

 

7,574 

 

 

8.1% 

 

 

7.4% 

 

 

Real estate

 

 

24 

 

 

 

20 

 

 

0.0% 

 

 

0.0% 

 

 

Policy loans

 

 

2,654 

 

 

 

2,670 

 

 

2.6% 

 

 

2.6% 

 

 

Derivative investments

 

 

1,340 

 

 

 

1,860 

 

 

1.3% 

 

 

1.8% 

 

 

Alternative investments

 

 

1,170 

 

 

 

1,109 

 

 

1.1% 

 

 

1.1% 

 

 

Other investments

 

 

454 

 

 

 

600 

 

 

0.4% 

 

 

0.6% 

 

 

Total investments

 

$

102,009 

 

 

$

102,967 

 

 

100.0% 

 

 

100.0% 

 

 

 

Investment Objective

 

Invested assets are an integral part of our operations.  We follow a balanced approach to investing for both current income and prudent risk management, with an emphasis on generating sufficient current income, net of income tax, to meet our obligations to customers, as well as other general liabilities.  This balanced approach requires the evaluation of expected return and risk of each asset class utilized, while still meeting our income objectives.  This approach is important to our asset-liability management because decisions can be made based upon both the economic and current investment income considerations affecting assets and liabilities.  For a discussion of our risk management process, see “Part II – Item 7A. Quantitative and Qualitative Disclosures About Market Risk” in our 2014 Form 10-K.

 

Investment Portfolio Composition and Diversification

 

Fundamental to our investment policy is diversification across asset classes.  Our investment portfolio, excluding cash and invested cash, is composed of fixed maturity securities, mortgage loans on real estate, real estate (either wholly-owned or in joint ventures) and other long-term investments.  We purchase investments for our segmented portfolios that have yield, duration and other characteristics that take into account the liabilities of the products being supported. 

 

We have the ability to maintain our investment holdings throughout credit cycles because of our capital position, the long-term nature of our liabilities and the matching of our portfolios of investment assets with the liabilities of our various products.

76


 

 

Fixed Maturity and Equity Securities Portfolios

 

Fixed maturity securities and equity securities consist of portfolios classified as AFS and trading.  Details underlying our fixed maturity and equity securities portfolios by industry classification (in millions) are presented in the tables below.  These tables agree in total with the presentation of AFS securities in Note 4; however, the categories below represent a more detailed breakout of the AFS portfolio.  Therefore, the investment classifications listed below do not agree to the investment categories provided in Note 4.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of June 30, 2015

 

 

 

 

 

Gross Unrealized

 

 

 

 

%

 

 

Amortized

 

 

 

Losses and

 

Fair

 

Fair

 

 

Cost

 

Gains

 

OTTI (2)

 

Value

 

Value

 

Fixed Maturity AFS Securities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Industry corporate bonds:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial services

$

10,082

 

$

736

 

$

109

 

$

10,709

 

12.5%

 

Basic industry

 

5,053

 

 

237

 

 

145

 

 

5,145

 

6.0%

 

Capital goods

 

4,807

 

 

334

 

 

38

 

 

5,103

 

5.9%

 

Communications

 

4,252

 

 

327

 

 

53

 

 

4,526

 

5.3%

 

Consumer cyclical

 

4,809

 

 

311

 

 

81

 

 

5,039

 

5.9%

 

Consumer non-cyclical

 

10,867

 

 

806

 

 

117

 

 

11,556

 

13.5%

 

Energy

 

9,307

 

 

578

 

 

247

 

 

9,638

 

11.2%

 

Technology

 

3,038

 

 

127

 

 

40

 

 

3,125

 

3.6%

 

Transportation

 

2,112

 

 

133

 

 

25

 

 

2,220

 

2.6%

 

Industrial other

 

756

 

 

52

 

 

5

 

 

803

 

0.9%

 

Utilities

 

11,377

 

 

970

 

 

92

 

 

12,255

 

14.2%

 

Government related entities

 

2,689

 

 

248

 

 

20

 

 

2,917

 

3.4%

 

Collateralized mortgage and other obligations ("CMOs"):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Agency backed

 

1,206

 

 

132

 

 

2

 

 

1,336

 

1.6%

 

Non-agency backed

 

1,257

 

 

16

 

 

(3

)

 

1,276

 

1.5%

 

Mortgage pass through securities ("MPTS"):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Agency backed

 

1,352

 

 

74

 

 

8

 

 

1,418

 

1.6%

 

Commercial mortgage-backed securities ("CMBS"):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Agency backed

 

14

 

 

 -

 

 

 -

 

 

14

 

0.0%

 

Non-agency backed

 

418

 

 

17

 

 

3

 

 

432

 

0.5%

 

Asset-backed securities ("ABS"):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Collateralized loan obligations ("CLOs")

 

480

 

 

2

 

 

1

 

 

481

 

0.6%

 

Commercial real estate ("CRE") collateralized

 

 

 

 

 

 

 

 

 

 

 

 

 

 

debt obligations ("CDOs")

 

16

 

 

 -

 

 

(2

)

 

18

 

0.0%

 

Credit card

 

683

 

 

26

 

 

 -

 

 

709

 

0.8%

 

Equipment receivables

 

62

 

 

 -

 

 

 -

 

 

62

 

0.1%

 

Home equity

 

660

 

 

10

 

 

4

 

 

666

 

0.8%

 

Manufactured housing

 

52

 

 

3

 

 

 -

 

 

55

 

0.1%

 

Stranded utility costs

 

33

 

 

1

 

 

 -

 

 

34

 

0.0%

 

Other

 

190

 

 

15

 

 

 -

 

 

205

 

0.2%

 

Municipals:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

3,678

 

 

647

 

 

14

 

 

4,311

 

5.0%

 

Tax-exempt

 

103

 

 

4

 

 

 -

 

 

107

 

0.1%

 

Government:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

United States

 

388

 

 

42

 

 

2

 

 

428

 

0.5%

 

Foreign

 

472

 

 

68

 

 

 -

 

 

540

 

0.6%

 

Hybrid and redeemable preferred securities

 

836

 

 

97

 

 

41

 

 

892

 

1.0%

 

Total fixed maturity AFS securities

 

81,049

 

 

6,013

 

 

1,042

 

 

86,020

 

100.0%

 

Equity AFS Securities

 

213

 

 

15

 

 

1

 

 

227

 

 

 

Total AFS securities

 

81,262

 

 

6,028

 

 

1,043

 

 

86,247

 

 

 

Trading Securities (1)

 

1,697

 

 

263

 

 

11

 

 

1,949

 

 

 

Total AFS and trading securities

$

82,959

 

$

6,291

 

$

1,054

 

$

88,196

 

 

 

 

77


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of December 31, 2014

 

 

 

 

 

Gross Unrealized

 

 

 

 

%

 

 

Amortized

 

 

 

Losses and

 

Fair

 

Fair

 

 

Cost

 

Gains

 

OTTI (2)

 

Value

 

Value

 

Fixed Maturity AFS Securities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Industry corporate bonds:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial services

$

9,653

 

$

1,027

 

$

41

 

$

10,639

 

12.2%

 

Basic industry

 

4,953

 

 

323

 

 

87

 

 

5,189

 

6.0%

 

Capital goods

 

4,675

 

 

458

 

 

7

 

 

5,126

 

5.9%

 

Communications

 

3,982

 

 

450

 

 

15

 

 

4,417

 

5.1%

 

Consumer cyclical

 

4,703

 

 

420

 

 

53

 

 

5,070

 

5.8%

 

Consumer non-cyclical

 

10,431

 

 

1,123

 

 

28

 

 

11,526

 

13.3%

 

Energy 

 

9,265

 

 

713

 

 

172

 

 

9,806

 

11.2%

 

Technology

 

2,936

 

 

189

 

 

18

 

 

3,107

 

3.6%

 

Transportation

 

1,973

 

 

187

 

 

3

 

 

2,157

 

2.5%

 

Industrial other

 

692

 

 

62

 

 

 -

 

 

754

 

0.9%

 

Utilities 

 

11,262

 

 

1,443

 

 

15

 

 

12,690

 

14.6%

 

Government related entities

 

2,628

 

 

316

 

 

9

 

 

2,935

 

3.4%

 

CMOs:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Agency backed

 

1,317

 

 

135

 

 

 -

 

 

1,452

 

1.7%

 

Non-agency backed

 

1,291

 

 

18

 

 

(7

)

 

1,316

 

1.5%

 

MPTS:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Agency backed

 

1,371

 

 

89

 

 

2

 

 

1,458

 

1.7%

 

CMBS:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Agency backed

 

24

 

 

1

 

 

 -

 

 

25

 

0.0%

 

Non-agency backed

 

530

 

 

22

 

 

7

 

 

545

 

0.6%

 

ABS:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

CLOs

 

358

 

 

 -

 

 

2

 

 

356

 

0.4%

 

CRE CDOs

 

17

 

 

 -

 

 

(2

)

 

19

 

0.0%

 

Credit card

 

677

 

 

36

 

 

 -

 

 

713

 

0.8%

 

Equipment receivables

 

64

 

 

1

 

 

1

 

 

64

 

0.1%

 

Home equity

 

655

 

 

9

 

 

12

 

 

652

 

0.8%

 

Manufactured housing

 

54

 

 

3

 

 

 -

 

 

57

 

0.1%

 

Stranded utility costs

 

47

 

 

2

 

 

 -

 

 

49

 

0.1%

 

Other

 

177

 

 

16

 

 

 -

 

 

193

 

0.2%

 

Municipals:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

3,620

 

 

865

 

 

4

 

 

4,481

 

5.2%

 

Tax-exempt

 

103

 

 

9

 

 

 -

 

 

112

 

0.1%

 

Government:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

United States

 

379

 

 

56

 

 

 -

 

 

435

 

0.5%

 

Foreign

 

473

 

 

68

 

 

 -

 

 

541

 

0.6%

 

Hybrid and redeemable preferred securities

 

886

 

 

108

 

 

40

 

 

954

 

1.1%

 

Total fixed maturity AFS securities

 

79,196

 

 

8,149

 

 

507

 

 

86,838

 

100.0%

 

Equity AFS Securities

 

216

 

 

15

 

 

 -

 

 

231

 

 

 

Total AFS securities

 

79,412

 

 

8,164

 

 

507

 

 

87,069

 

 

 

Trading Securities (1)

 

1,764

 

 

311

 

 

10

 

 

2,065

 

 

 

Total AFS and trading securities

$

81,176

 

$

8,475

 

$

517

 

$

89,134

 

 

 

 

(1)

Certain trading securities support our modified coinsurance arrangements (“Modco”), and the investment results are passed directly to the reinsurers.  Refer to “Part II – Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Consolidated Investments – Fixed Maturity and Equity Securities Portfolios – Trading Securities” in our 2014 Form 10-K for further details.

(2)

Includes unrealized gains and (losses) on impaired securities related to changes in the fair value of such securities subsequent to the impairment measurement date.

 

78


 

 

AFS Securities

 

In accordance with the AFS accounting guidance, we reflect stockholders’ equity as if unrealized gains and losses were actually recognized, and consider all related accounting adjustments that would occur upon such a hypothetical recognition of unrealized gains and losses.  Such related balance sheet effects include adjustments to the balances of DAC, VOBA, DFEL, future contract benefits, other contract holder funds and deferred income taxes.  Adjustments to each of these balances are charged or credited to accumulated other comprehensive income (loss).  For instance, DAC is adjusted upon the recognition of unrealized gains or losses because the

amortization of DAC is based upon an assumed emergence of gross profits on certain insurance business.  Deferred income tax balances are also adjusted because unrealized gains or losses do not affect actual taxes currently paid. 

 

The quality of our AFS fixed maturity securities portfolio, as measured at estimated fair value and by the percentage of fixed maturity AFS securities invested in various ratings categories, relative to the entire fixed maturity AFS security portfolio (in millions) was as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Rating Agency

 

As of June 30, 2015

 

As of December 31, 2014

 

NAIC

 

Equivalent

 

Amortized

 

Fair

 

% of

 

Amortized

 

Fair

 

% of

 

Designation (1)

 

Designation (1)

 

Cost

 

Value

 

Total

 

Cost

 

Value

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment Grade Securities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1

 

Aaa / Aa / A

 

$

44,155 

 

$

47,841 

 

55.6% 

 

$

43,285 

 

$

48,753 

 

56.2% 

 

2

 

Baa

 

 

32,884 

 

 

34,243 

 

39.8% 

 

 

31,987 

 

 

34,229 

 

39.4% 

 

Total investment grade securities

 

 

77,039 

 

 

82,084 

 

95.4% 

 

 

75,272 

 

 

82,982 

 

95.6% 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Below Investment Grade Securities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

3

 

Ba

 

 

2,917 

 

 

2,922 

 

3.4% 

 

 

2,858 

 

 

2,884 

 

3.3% 

 

4

 

B

 

 

856 

 

 

807 

 

0.9% 

 

 

821 

 

 

766 

 

0.9% 

 

5

 

Caa and lower

 

 

214 

 

 

188 

 

0.2% 

 

 

224 

 

 

189 

 

0.2% 

 

6

 

In or near default

 

 

23 

 

 

19 

 

0.1% 

 

 

21 

 

 

17 

 

0.0% 

 

Total below investment grade securities

 

 

4,010 

 

 

3,936 

 

4.6% 

 

 

3,924 

 

 

3,856 

 

4.4% 

 

Total fixed maturity AFS securities

 

$

81,049 

 

$

86,020 

 

100.0% 

 

$

79,196 

 

$

86,838 

 

100.0% 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total securities below investment

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

grade as a percentage of total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

fixed maturity AFS securities

 

 

4.9% 

 

 

4.6% 

 

 

 

 

5.0% 

 

 

4.4% 

 

 

 

 

(1)

Based upon the rating designations determined and provided by the NAIC or the major credit rating agencies (Fitch Ratings (“Fitch”), Moody’s Investors Service (“Moody’s”) and Standard & Poor’s (“S&P”)).  For securities where the ratings assigned by the major credit agencies are not equivalent, the second highest rating assigned is used.  For those securities where ratings by the major credit rating agencies are not available, which does not represent a significant amount of our total fixed maturity AFS securities, we base the ratings disclosed upon internal ratings.  The average credit quality was A- as of June 30, 2015. 

 

Comparisons between the NAIC ratings and rating agency designations are published by the NAIC.  The NAIC assigns securities quality ratings and uniform valuations, which are used by insurers when preparing their annual statements.  The NAIC ratings are similar to the rating agency designations of the Nationally Recognized Statistical Rating Organizations for marketable bonds.  NAIC ratings 1 and 2 include bonds generally considered investment grade (rated Baa or higher by Moody’s, or rated BBB- or higher by Fitch and S&P) by such ratings organizations.  However, securities rated NAIC 1 and NAIC 2 could be deemed below investment grade by the rating agencies as a result of the current RBC rules for residential mortgage-backed securities (“RMBS”) and CMBS for statutory reporting.  NAIC ratings 3 through 6 include bonds generally considered below investment grade (rated Ba or lower by Moody’s, or rated BB+ or lower by S&P and Fitch).

 

As of June 30, 2015, and December 31, 2014, 90.7% and 86.2%, respectively, of the total publicly traded and private securities in an unrealized loss status were rated as investment grade.  Our gross unrealized losses, including the portion of OTTI recognized in other comprehensive income (loss) (“OCI”), on AFS securities as of June 30, 2015,  increased by $536 million.  As more fully described in Note 1 in our 2014 Form 10-K, we regularly review our investment holdings for OTTI.  We believe the unrealized loss position as of June 30, 2015, does not represent OTTI as(i) we do not intend to sell the debt securities; (ii) it is not more likely than not that we will be required to sell the debt securities before recovery of their amortized cost basis; (iii) the estimated future cash flows are equal to or greater than the amortized cost basis of the debt securities; and (iv) we have the ability and intent to hold the equity securities for a period of time sufficient for recovery.  For further information on our unrealized losses on AFS securities, see “Composition by Industry Categories of our Unrealized Losses on AFS Securities” below. 

 

79


 

 

Selected information for certain AFS securities in a gross unrealized loss position (dollars in millions) as of June 30, 2015, was as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross 

 

Estimated

 

Estimated

 

 

 

 

 

 

 

 

 

 

Unrealized

 

Years

 

Average

 

 

 

 

 

 

 

 

 

 

Losses

 

Until Call

 

Years

 

 

 

 

 

 

 

Fair

 

and

 

or

 

Until

 

Subordination Level

 

 

Value

 

OTTI

 

Maturity

 

Recovery

 

Current

 

Origination

CMBS

$

111 

 

$

 

1 to 36

 

11

 

0.8%

 

 

3.8%

 

Hybrid and redeemable preferred securities

 

220 

 

 

41 

 

1 to 53

 

21

 

N/A

 

 

N/A

 

 

As provided in the table above, many of the securities in these categories are long-dated with some of the preferred securities being perpetual.  This is purposeful as it matches the long-term nature of our liabilities associated with our life insurance and annuity products.  See “Part II – Item 7A. Quantitative and Qualitative Disclosures About Market Risk” in our 2014 Form 10-K where we present information related to maturities of securities and the expected cash flows for rate sensitive liabilities and maturities of our holding company debt, which also demonstrates the long-term nature of the cash flows associated with these items.  Because of this relationship, we do not believe it will be necessary to sell these securities before they recover or mature.  For these securities, the estimated range and average period until recovery is the call or maturity period.  It is difficult to predict or project when the securities will recover as it is dependent upon a number of factors including the overall economic climate.  We do not believe it is necessary to impair these securities as long as the expected future cash flows are projected to be sufficient to recover the amortized cost of these securities.

 

The actual range and period until recovery could vary significantly depending on a variety of factors, many of which are out of our control.  There are several items that could affect the length of the period until recovery, such as the pace of economic recovery, level of delinquencies, performance of the underlying collateral, changes in market interest rates, exposures to various industry or geographic conditions, market behavior and other market conditions.

 

We concluded that it is not more likely than not that we will be required to sell the fixed maturity AFS securities before recovery of their amortized cost basis, that the estimated future cash flows are equal to or greater than the amortized cost basis of the debt securities, and that we have the ability to hold the equity AFS securities for a period of time sufficient for recovery.  This conclusion is consistent with our asset-liability management process.  Management considers the following as part of the evaluation:

 

·

The current economic environment and market conditions;

·

Our business strategy and current business plans;

·

The nature and type of security, including expected maturities and exposure to general credit, liquidity, market and interest rate risk;

·

Our analysis of data from financial models and other internal and industry sources to evaluate the current effectiveness of our hedging and overall risk management strategies;

·

The current and expected timing of contractual maturities of our assets and liabilities, expectations of prepayments on investments and expectations for surrenders and withdrawals of life insurance policies and annuity contracts;

·

The capital risk limits approved by management; and

·

Our current financial condition and liquidity demands.

 

To determine the recoverability of a debt security, we consider the facts and circumstances surrounding the underlying issuer including, but not limited to, the following:

 

·

Historical and implied volatility of the security;

·

Length of time and extent to which the fair value has been less than amortized cost;

·

Adverse conditions specifically related to the security or to specific conditions in an industry or geographic area;

·

Failure, if any, of the issuer of the security to make scheduled payments; and

·

Recoveries or additional declines in fair value subsequent to the balance sheet date.

 

As reported on our Consolidated Balance Sheets, we had $104.5 billion of investments and cash, which exceeded the liabilities for our future obligations under insurance policies and contracts, net of amounts recoverable from reinsurers, which totaled $90.8 billion as of June 30, 2015.  If it were necessary to liquidate investments prior to maturity or call to meet cash flow needs, we would first look to AFS securities that are in an unrealized gain position, which had a fair value of $66.1 billion, excluding consolidated VIEs in the amount of $598 million, as of June 30, 2015, rather than selling securities in an unrealized loss position.  The amount of cash that we have on hand takes into account our liquidity needs in the future, other sources of cash, such as the maturities of investments, interest and dividends we earn on our investments and the on-going cash flows from new and existing business. 

 

See “AFS Securities – Evaluation for Recovery of Amortized Cost” in Note 1 in our 2014 Form 10-K and Note 4 for additional discussion.

 

As of June 30, 2015, and December 31, 2014, the estimated fair value for all private placement securities was $14.3 billion and $14.4 billion, respectively, representing 14% of total invested assets.

 

For information regarding our VIEs’ fixed maturity securities, see Note 3 in this report and Note 4 in our 2014 Form 10-K.

80


 

 

Mortgage-Backed Securities (“MBS”) (Included in AFS and Trading Securities)

 

See “Part II – Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Consolidated Investments – Mortgage-Backed Securities” in our 2014 Form 10-K for a discussion of our MBS. 

 

Our ABS home equity and RMBS had a market value of $4.8 billion and an unrealized gain of $229 million, or 5%, as of June 30, 2015.    

 

The market value of AFS securities and trading securities backed by subprime loans was $528  million and represented approximately 0.5% of our total investment portfolio as of June 30, 2015.   AFS securities represented $517 million, or 98%, and trading securities represented $11 million, or 2%, of the subprime exposure as of June 30, 2015.  The table below summarizes our investments in AFS securities backed by pools of residential mortgages (in millions) as of June 30, 2015:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Subprime/

 

 

 

 

 

 

 

 

Agency

 

Prime

 

Alt-A

 

Option ARM (1)

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair

Amortized

Fair

Amortized

Fair

Amortized

Fair

Amortized

Fair

Amortized

 

Value

 

Cost

 

Value

 

Cost

 

Value

 

Cost

 

Value

 

Cost

 

Value

 

Cost

 

Type

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

RMBS

$

2,754 

 

$

2,558 

 

$

470 

 

$

452 

 

$

423 

 

$

417 

 

$

383 

 

$

388 

 

$

4,030 

 

$

3,815 

 

ABS home equity

 

 

 

 

 

 -

 

 

 -

 

 

190 

 

 

190 

 

 

473 

 

 

468 

 

 

666 

 

 

660 

 

Total by type (2)(3)

$

2,757 

 

$

2,560 

 

$

470 

 

$

452 

 

$

613 

 

$

607 

 

$

856 

 

$

856 

 

$

4,696 

 

$

4,475 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Rating

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

AAA

$

2,698 

 

$

2,502 

 

$

 

$

 

$

 -

 

$

 -

 

$

15 

 

$

15 

 

$

2,714 

 

$

2,518 

 

AA

 

50 

 

 

50 

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

11 

 

 

10 

 

 

61 

 

 

60 

 

A

 

 

 

 

 

 

 

 

 

14 

 

 

13 

 

 

48 

 

 

47 

 

 

76 

 

 

73 

 

BBB

 

 -

 

 

 -

 

 

35 

 

 

34 

 

 

32 

 

 

30 

 

 

39 

 

 

38 

 

 

106 

 

 

102 

 

BB and below

 

 -

 

 

 -

 

 

429 

 

 

412 

 

 

567 

 

 

564 

 

 

743 

 

 

746 

 

 

1,739 

 

 

1,722 

 

Total by rating (2)(3)(4)

$

2,757 

 

$

2,560 

 

$

470 

 

$

452 

 

$

613 

 

$

607 

 

$

856 

 

$

856 

 

$

4,696 

 

$

4,475 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Origination Year

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2004 and prior

$

409 

 

$

371 

 

$

67 

 

$

66 

 

$

141 

 

$

140 

 

$

153 

 

$

153 

 

$

770 

 

$

730 

 

2005

 

382 

 

 

342 

 

 

100 

 

 

100 

 

 

181 

 

 

178 

 

 

279 

 

 

276 

 

 

942 

 

 

896 

 

2006

 

67 

 

 

58 

 

 

113 

 

 

105 

 

 

213 

 

 

213 

 

 

259 

 

 

261 

 

 

652 

 

 

637 

 

2007

 

331 

 

 

293 

 

 

190 

 

 

181 

 

 

78 

 

 

76 

 

 

162 

 

 

164 

 

 

761 

 

 

714 

 

2008

 

59 

 

 

53 

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

59 

 

 

53 

 

2009

 

412 

 

 

380 

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

 

 

 

 

415 

 

 

382 

 

2010

 

430 

 

 

401 

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

430 

 

 

401 

 

2011

 

207 

 

 

198 

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

207 

 

 

198 

 

2012

 

85 

 

 

87 

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

85 

 

 

87 

 

2013

 

316 

 

 

319 

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

316 

 

 

319 

 

2014

 

47 

 

 

46 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

47 

 

 

46 

 

2015

 

12 

 

 

12 

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

12 

 

 

12 

 

Total by origination

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

year (2)(3)

$

2,757 

 

$

2,560 

 

$

470 

 

$

452 

 

$

613 

 

$

607 

 

$

856 

 

$

856 

 

$

4,696 

 

$

4,475 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total AFS RMBS as a percentage of total AFS Securities

 

 

5.4% 

 

 

5.5% 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total prime, Alt-A and subprime/option ARM as a percentage of total AFS securities

 

 

2.2% 

 

 

2.4% 

 

 

(1)

Includes the fair value and amortized cost of option adjustable rate mortgages (“ARM”) within RMBS, totaling $339 million and $343 million, respectively.

(2)

Does not include the fair value of trading securities totaling $135 million, which support our Modco reinsurance agreements because investment results for these agreements are passed directly to the reinsurers.  The $135 million in trading securities consisted of $117 million prime, $7 million Alt-A and $11 million subprime.

(3)

Does not include the amortized cost of trading securities totaling $127 million, which support our Modco reinsurance agreements because investment results for these agreements are passed directly to the reinsurers.  The $127 million in trading securities consisted of $109 million prime, $7 million Alt-A and $11 million subprime. 

(4)

Based upon the rating designations determined and provided by the major credit rating agencies (Fitch, Moody’s and S&P).  For securities where the ratings assigned by the major credit agencies are not equivalent, the second highest rating assigned is used.  For those securities where ratings by the major credit rating agencies are not available, which does not represent a significant amount of our total fixed maturity AFS securities, we base the ratings disclosed upon internal ratings.

 

None of these investments included any direct investments in subprime lenders or mortgages.  We are not aware of material exposure to subprime loans in our alternative asset portfolio.

81


 

 

The following summarizes our investments in AFS securities backed by pools of commercial mortgages (in millions) as of June 30, 2015:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Multiple Property

 

Single Property

 

CRE CDOs

 

Total

 

 

Fair

 

Amortized

 

Fair

 

Amortized

 

Fair

 

Amortized

 

Fair

 

Amortized

 

 

Value

 

Cost

 

Value

 

Cost

 

Value

 

Cost

 

Value

 

Cost

 

Type

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

CMBS

$

432 

 

$

420 

 

$

14 

 

$

12 

 

$

 -

 

$

 -

 

$

446 

 

$

432 

 

CRE CDOs

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

18 

 

 

16 

 

 

18 

 

 

16 

 

Total by type (1)(2)

$

432 

 

$

420 

 

$

14 

 

$

12 

 

$

18 

 

$

16 

 

$

464 

 

$

448 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Rating

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

AAA

$

242 

 

$

238 

 

$

 -

 

$

 -

 

$

 -

 

$

 -

 

$

242 

 

$

238 

 

AA

 

28 

 

 

27 

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

28 

 

 

27 

 

A

 

85 

 

 

79 

 

 

14 

 

 

12 

 

 

 -

 

 

 -

 

 

99 

 

 

91 

 

BBB

 

26 

 

 

25 

 

 

 -

 

 

 -

 

 

 

 

 

 

31 

 

 

30 

 

BB and below

 

51 

 

 

51 

 

 

 -

 

 

 -

 

 

13 

 

 

11 

 

 

64 

 

 

62 

 

Total by rating (1)(2)(3)

$

432 

 

$

420 

 

$

14 

 

$

12 

 

$

18 

 

$

16 

 

$

464 

 

$

448 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Origination Year

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2004 and prior

$

29 

 

$

28 

 

$

 -

 

$

 -

 

$

 -

 

$

 -

 

$

29 

 

$

28 

 

2005

 

88 

 

 

90 

 

 

14 

 

 

12 

 

 

 

 

 

 

107 

 

 

107 

 

2006

 

98 

 

 

94 

 

 

 -

 

 

 -

 

 

13 

 

 

11 

 

 

111 

 

 

105 

 

2007

 

52 

 

 

45 

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

52 

 

 

45 

 

2010

 

58 

 

 

54 

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

58 

 

 

54 

 

2012

 

 -

 

 

 -

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 -

 

 

 -

 

2013

 

107 

 

 

109 

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

107 

 

 

109 

 

Total by origination

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

year (1)(2)

$

432 

 

$

420 

 

$

14 

 

$

12 

 

$

18 

 

$

16 

 

$

464 

 

$

448 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total AFS securities backed by pools of commercial mortgages as a percentage of total AFS securities

 

0.5% 

 

 

0.6% 

 

 

(1)

Does not include the fair value of trading securities totaling $4 million, which support our Modco reinsurance agreements because investment results for these agreements are passed directly to the reinsurers.  The $4 million in trading securities consisted entirely of CMBS. 

(2)

Does not include the amortized cost of trading securities totaling $3 million, which support our Modco reinsurance agreements because investment results for these agreements are passed directly to the reinsurers.  The $3 million in trading securities consisted entirely of CMBS. 

(3)

Based upon the rating designations determined and provided by the major credit rating agencies (Fitch, Moody’s and S&P).  For securities where the ratings assigned by the major credit agencies are not equivalent, the second highest rating assigned is used.  For those securities where ratings by the major credit rating agencies are not available, which does not represent a significant amount of our total fixed maturity AFS securities, we base the ratings disclosed upon internal ratings. 

 

As of June 30, 2015, the amortized cost and fair value of our AFS exposure to Monoline insurers was $481 million and $513 million, respectively.    

 

Composition by Industry Categories of our Unrealized Losses on AFS Securities

 

When considering unrealized gain and loss information, it is important to recognize that the information relates to the status of securities at a particular point in time and may not be indicative of the status of our investment portfolios subsequent to the balance sheet date.  Further, because the timing of the recognition of realized investment gains and losses through the selection of which securities are sold is largely at management’s discretion, it is important to consider the information provided below within the context of the overall unrealized gain or loss position of our investment portfolios.  These are important considerations that should be included in any evaluation of the potential effect of securities in an unrealized loss position on our future earnings. 

 

82


 

 

The composition by industry categories of all securities in unrealized loss position (in millions) as of June 30, 2015, was as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

%

 

 

 

 

 

 

 

 

 

 

 

 

Gross

 

Gross

 

 

 

 

 

%

 

 

 

 

%

 

Unrealized

 

Unrealized

 

 

Fair

 

Fair

 

Amortized

 

Amortized

 

Losses

 

Losses

 

 

Value

 

Value

 

Cost

 

Cost

 

and OTTI

 

and OTTI

 

Metals and mining

$

812 

 

4.2% 

 

$

914 

 

4.5% 

 

$

102 

 

9.8% 

 

Independent

 

1,336 

 

6.8% 

 

 

1,434 

 

7.0% 

 

 

98 

 

9.4% 

 

Oil field services

 

691 

 

3.6% 

 

 

774 

 

3.8% 

 

 

83 

 

8.0% 

 

Banking

 

1,061 

 

5.5% 

 

 

1,143 

 

5.6% 

 

 

82 

 

7.9% 

 

Electric

 

1,731 

 

8.9% 

 

 

1,808 

 

8.9% 

 

 

77 

 

7.4% 

 

Midstream

 

649 

 

3.4% 

 

 

690 

 

3.4% 

 

 

41 

 

3.9% 

 

Technology

 

1,026 

 

5.3% 

 

 

1,066 

 

5.2% 

 

 

40 

 

3.8% 

 

Chemicals

 

866 

 

4.5% 

 

 

906 

 

4.4% 

 

 

40 

 

3.8% 

 

Food and beverage

 

728 

 

3.8% 

 

 

768 

 

3.8% 

 

 

40 

 

3.8% 

 

Pharmaceuticals

 

793 

 

4.1% 

 

 

830 

 

4.1% 

 

 

37 

 

3.5% 

 

Property and casualty

 

398 

 

2.1% 

 

 

433 

 

2.1% 

 

 

35 

 

3.4% 

 

Retailers

 

296 

 

1.5% 

 

 

323 

 

1.6% 

 

 

27 

 

2.6% 

 

Healthcare

 

712 

 

3.7% 

 

 

737 

 

3.6% 

 

 

25 

 

2.4% 

 

Integrated

 

387 

 

2.0% 

 

 

411 

 

2.0% 

 

 

24 

 

2.3% 

 

Entertainment

 

497 

 

2.6% 

 

 

519 

 

2.5% 

 

 

22 

 

2.1% 

 

Industries with unrealized losses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

less than $20 million

 

7,374 

 

38.0% 

 

 

7,644 

 

37.5% 

 

 

270 

 

25.9% 

 

Total by industry

$

19,357 

 

100.0% 

 

$

20,400 

 

100.0% 

 

$

1,043 

 

100.0% 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total by industry as a percentage

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

of total AFS securities

 

22.4% 

 

 

 

 

25.1% 

 

 

 

 

100.0% 

 

 

 

 

As of June 30, 2015, the amortized cost and fair value of securities subject to enhanced analysis and monitoring for potential changes in unrealized loss position was $337 million and $256 million, respectively. 

 

Mortgage Loans on Real Estate

 

The following tables summarize key information on mortgage loans on real estate (in millions):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of June 30, 2015

 

As of December 31, 2014

 

 

Carrying

 

 

 

Carrying

 

 

 

 

Value

 

%

 

Value

 

%

 

Credit Quality Indicator

 

 

 

 

 

 

 

 

 

 

Current

$

8,171 

 

100.0% 

 

$

7,566 

 

99.9% 

 

Delinquent and/or in foreclosure (1)

 

 -

 

0.0% 

 

 

 

0.1% 

 

Total mortgage loans on real estate

$

8,171 

 

100.0% 

 

$

7,574 

 

100.0% 

 

 

(1)

As of June 30, 2015, and December 31, 2014, there were zero and two mortgage loans on real estate that were delinquent and in foreclosure, respectively.

 

83


 

 

As of June 30, 2015, and December 31, 2014, there were three impaired mortgage loans on real estate, or less than 1% of the total dollar amount of mortgage loans on real estate.  The total principal and interest past due on the mortgage loans on real estate that were two or more payments delinquent as of June 30, 2015, and December 31, 2014, was $0 and $6 million, respectively.  See Note 1 in our 2014 Form 10-K for more information regarding our accounting policy relating to the impairment of mortgage loans on real estate.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of

As of

 

 

June 30,

December 31,

 

 

 

2015

 

 

2014

 

 

By Segment

 

 

 

 

 

 

 

 

 

Annuities

 

$

1,789 

 

 

$

1,603 

 

 

Retirement Plan Services

 

 

1,907 

 

 

 

1,657 

 

 

Life Insurance

 

 

3,879 

 

 

 

3,742 

 

 

Group Protection

 

 

288 

 

 

 

266 

 

 

Other Operations

 

 

308 

 

 

 

306 

 

 

Total mortgage loans on real estate

 

$

8,171 

 

 

$

7,574 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of June 30, 2015

 

 

As of June 30, 2015

 

 

Carrying

 

 

 

 

Carrying

 

 

 

 

Value

 

%

 

 

Value

 

%

 

Property Type

 

 

 

 

 

State Exposure

 

 

 

 

 

Apartment

$

2,273 

 

27.8% 

 

CA

$

1,845 

 

22.6% 

 

Office building

 

2,100 

 

25.7% 

 

TX

 

728 

 

8.9% 

 

Industrial

 

1,719 

 

21.0% 

 

NY

 

422 

 

5.2% 

 

Retail

 

1,607 

 

19.7% 

 

MD

 

405 

 

5.0% 

 

Mixed use

 

234 

 

2.9% 

 

GA

 

387 

 

4.7% 

 

Other commercial

 

207 

 

2.5% 

 

NC

 

370 

 

4.5% 

 

Hotel/motel

 

31 

 

0.4% 

 

VA

 

350 

 

4.3% 

 

Total

$

8,171 

 

100.0% 

 

WA

 

314 

 

3.8% 

 

Geographic Region

 

 

 

 

 

OH

 

306 

 

3.7% 

 

Pacific

$

2,406 

 

29.4% 

 

TN

 

272 

 

3.3% 

 

South Atlantic

 

1,982 

 

24.3% 

 

FL

 

260 

 

3.2% 

 

East North Central

 

851 

 

10.4% 

 

PA

 

253 

 

3.1% 

 

West South Central

 

742 

 

9.1% 

 

OR

 

247 

 

3.0% 

 

Middle Atlantic

 

729 

 

8.9% 

 

MN

 

219 

 

2.7% 

 

Mountain

 

590 

 

7.2% 

 

AZ

 

214 

 

2.6% 

 

East South Central

 

381 

 

4.7% 

 

WI

 

205 

 

2.5% 

 

West North Central

 

379 

 

4.6% 

 

IN

 

178 

 

2.2% 

 

New England

 

111 

 

1.4% 

 

Other states under 2%

 

1,196 

 

14.7% 

 

Total

$

8,171 

 

100.0% 

 

Total

$

8,171 

 

100.0% 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of June 30, 2015

 

 

As of June 30, 2015

 

 

Principal

 

 

 

 

Principal

 

 

 

 

Amount

 

%

 

 

Amount

 

%

 

Origination Year

 

 

 

 

 

Future Principal Payments

 

 

 

 

 

2010 and prior

$

3,275 

 

40.1% 

 

2015

$

97 

 

1.2% 

 

2011

 

736 

 

9.0% 

 

2016

 

376 

 

4.6% 

 

2012

 

841 

 

10.3% 

 

2017

 

598 

 

7.3% 

 

2013

 

1,064 

 

13.0% 

 

2018

 

681 

 

8.3% 

 

2014

 

1,297 

 

15.9% 

 

2019

 

280 

 

3.4% 

 

2015

 

958 

 

11.7% 

 

2020 and thereafter

 

6,139 

 

75.2% 

 

Total

$

8,171 

 

100.0% 

 

Total

$

8,171 

 

100.0% 

 

 

See Note 4 for information regarding our loan-to-value and debt-service coverage ratios and our allowance for loan losses.

 

84


 

 

Alternative Investments

 

Investment income (loss) on alternative investments by business segment (in millions) was as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

For the Six

 

 

 

 

Months Ended

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Annuities

$

 

$

 

-33%

 

$

 

$

16 

 

-69%

 

Retirement Plan Services

 

 

 

 

-33%

 

 

 

 

 

-57%

 

Life Insurance

 

20 

 

 

18 

 

11% 

 

 

26 

 

 

44 

 

-41%

 

Group Protection

 

 

 

 

-50%

 

 

 

 

 

-83%

 

Other Operations

 

 

 

 -

 

NM

 

 

 

 

 

0% 

 

Total (1)

$

28 

 

$

29 

 

-3%

 

$

36 

 

$

74 

 

-51%

 

 

(1)

Includes net investment income on the alternative investments supporting the required statutory surplus of our insurance businesses.

 

As of June 30, 2015, and December 31, 2014, alternative investments included investments in 180 and 156 different partnerships, respectively, and the portfolio represented approximately 1% of our overall invested assets.  The partnerships do not represent off-balance sheet financing and generally involve several third-party partners.  Some of our partnerships contain capital calls, which require us to contribute capital upon notification by the general partner.  These capital calls are contemplated during the initial investment decision and are planned for well in advance of the call date.  The capital calls are not material in size and do not significantly impact our liquidity.  Alternative investments are accounted for using the equity method of accounting and are included in other investments on our Consolidated Balance Sheets.

 

Non-Income Producing Investments

 

As of June 30, 2015, and December 31, 2014, the carrying amount of fixed maturity securities, mortgage loans on real estate and real estate that were non-income producing was $13 million.  

 

Net Investment Income

 

Details underlying net investment income (in millions) and our investment yield were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

For the Six

 

 

 

 

Months Ended

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Fixed maturity AFS securities

$

1,005

 

$

1,009

 

0%

 

$

2,018

 

$

2,019

 

0%

 

Equity AFS securities

 

4

 

 

2

 

100%

 

 

4

 

 

4

 

0%

 

Trading securities

 

27

 

 

33

 

-18%

 

 

55

 

 

66

 

-17%

 

Mortgage loans on real estate

 

98

 

 

93

 

5%

 

 

193

 

 

188

 

3%

 

Real estate

 

 -

 

 

2

 

-100%

 

 

1

 

 

5

 

-80%

 

Policy loans

 

38

 

 

39

 

-3%

 

 

75

 

 

78

 

-4%

 

Invested cash

 

1

 

 

 -

 

NM

 

 

2

 

 

1

 

100%

 

Commercial mortgage loan prepayment

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

and bond make-whole premiums (1)

 

11

 

 

30

 

-63%

 

 

48

 

 

46

 

4%

 

Alternative investments (2)

 

28

 

 

29

 

-3%

 

 

36

 

 

74

 

-51%

 

Consent fees

 

1

 

 

1

 

0%

 

 

1

 

 

1

 

0%

 

Other investments

 

3

 

 

(3

)

200%

 

 

4

 

 

(9

)

144%

 

Investment income

 

1,216

 

 

1,235

 

-2%

 

 

2,437

 

 

2,473

 

-1%

 

Investment expense

 

(29

)

 

(28

)

-4%

 

 

(63

)

 

(58

)

-9%

 

Net investment income

$

1,187

 

$

1,207

 

-2%

 

$

2,374

 

$

2,415

 

-2%

 

 

(1)

See “Commercial Mortgage Loan Prepayment and Bond Make-Whole Premiums” below for additional information.

(2)

See “Alternative Investments” above for additional information.

85


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

 

For the Six

 

 

 

 

Months Ended

 

Basis

 

 

Months Ended

 

Basis

 

 

June 30,

 

Point

 

 

June 30,

 

Point

 

 

2015

 

2014

 

Change

 

 

2015

 

2014

 

Change

 

Interest Rate Yield

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturity securities, mortgage loans on

 

 

 

 

 

 

 

 

 

 

 

 

 

real estate and other, net of investment

 

 

 

 

 

 

 

 

 

 

 

 

 

expenses

4.80%

 

4.99%

 

(19

)

 

4.82%

 

5.10%

 

(28

)

Commercial mortgage loan prepayment and

 

 

 

 

 

 

 

 

 

 

 

 

 

bond make-whole premiums

0.05%

 

0.13%

 

(8

)

 

0.10%

 

0.07%

 

3

 

Alternative investments

0.12%

 

0.13%

 

(1

)

 

0.08%

 

0.11%

 

(3

)

Net investment income yield on invested

 

 

 

 

 

 

 

 

 

 

 

 

 

assets

4.97%

 

5.25%

 

(28

)

 

5.00%

 

5.28%

 

(28

)

 


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

 

For the Six

 

 

 

 

Months Ended

 

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

 

Change

 

2015

 

2014

 

Change

 

Average invested assets at amortized cost

$

95,496 

 

$

91,879 

 

 

4% 

 

$

94,938 

 

$

91,453 

 

4% 

 

 

We earn investment income on our general account assets supporting fixed annuity, term life, whole life, UL, interest-sensitive whole life and the fixed portion of retirement plan and VUL products.  The profitability of our fixed annuity and life insurance products is affected by our ability to achieve target spreads, or margins, between the interest income earned on the general account assets and the interest credited to the contract holder on our average fixed account values, including the fixed portion of variable.  Net investment income and the interest rate yield table each include commercial mortgage loan prepayments and bond make-whole premiums, alternative investments and contingent interest and standby real estate equity commitments.  These items can vary significantly from period to period due to a number of factors and, therefore, can provide results that are not indicative of the underlying trends.

 

Commercial Mortgage Loan Prepayment and Bond Make-Whole Premiums

 

Prepayment and make-whole premiums are collected when borrowers elect to call or prepay their debt prior to the stated maturity.  A prepayment or make-whole premium allows investors to attain the same yield as if the borrower made all scheduled interest payments until maturity.  These premiums are designed to make investors indifferent to prepayment.

 

Realized Gain (Loss) Related to Certain Investments

 

Details of the realized gain (loss) related to certain investments (in millions) were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

For the Six

 

 

 

 

Months Ended

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Fixed maturity AFS securities: (1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross gains

$

21

 

$

11

 

91%

 

$

23

 

$

19

 

21%

 

Gross losses

 

(13

)

 

(6

)

NM

 

 

(29

)

 

(13

)

NM

 

Equity AFS securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross gains

 

1

 

 

3

 

-67%

 

 

1

 

 

3

 

-67%

 

Gross losses

 

 -

 

 

 -

 

NM

 

 

 -

 

 

 -

 

NM

 

Gain (loss) on other investments

 

 -

 

 

3

 

-100%

 

 

(8

)

 

3

 

NM

 

Associated amortization of DAC, VOBA,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

DSI and DFEL and changes in

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

other contract holder funds

 

(10

)

 

(10

)

0%

 

 

(15

)

 

(17

)

12%

 

Total realized gain (loss) related to

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

certain investments, pre-tax

$

(1

)

$

1

 

NM

 

$

(28

)

$

(5

)

NM

 

 

(1)

These amounts are represented net of related fair value hedging activity.  See Note 5 for more information.

 

Amortization of DAC, VOBA, DSI and DFEL and changes in other contract holder funds reflect an assumption for an expected level of credit-related investment losses.  When actual credit-related investment losses are realized, we recognize a true-up to our DAC, VOBA,

86


 

 

DSI and DFEL amortization and changes in other contract holder funds within realized losses reflecting the incremental effect of actual versus expected credit-related investment losses.  These actual to expected amortization adjustments could create volatility in net realized gain (loss).  The write-down for impairments includes both credit-related and interest rate-related impairments.

 

Realized gains and losses generally originate from asset sales to reposition the portfolio or to respond to product experience.  During the first six months of 2015 and 2014, we sold securities for gains and losses.  In the process of evaluating whether a security with an unrealized loss reflects declines that are other-than-temporary, we consider our ability and intent to sell the security prior to a recovery of value.  However, subsequent decisions on securities sales are made within the context of overall risk monitoring, assessing value relative to other comparable securities and overall portfolio maintenance.  Although our portfolio managers may, at a given point in time, believe that the preferred course of action is to hold securities with unrealized losses that are considered temporary until such losses are recovered, the dynamic nature of portfolio management may result in a subsequent decision to sell.  These subsequent decisions are consistent with the classification of our investment portfolio as AFS.  We expect to continue to manage all non-trading invested assets within our portfolios in a manner that is consistent with the AFS classification.

 

We consider economic factors and circumstances within countries and industries where recent write-downs have occurred in our assessment of the status of securities we own of similarly situated issuers.  While it is possible for realized or unrealized losses on a particular investment to affect other investments, our risk management strategy has been designed to identify correlation risks and other risks inherent in managing an investment portfolio.  Once identified, strategies and procedures are developed to effectively monitor and manage these risks.  The areas of risk correlation that we pay particular attention to are risks that may be correlated within specific financial and business markets, risks within specific industries and risks associated with related parties.

 

When the detailed analysis by our external asset managers and investment portfolio managers leads us to the conclusion that a security’s decline in fair value is other-than-temporary, the security is written down to estimated recovery value.  In instances where declines are considered temporary, the security will continue to be carefully monitored.  See “Part II – Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Introduction – Critical Accounting Policies and Estimates – Investments – Write-downs for OTTI and Allowance for Losses” in our 2014 Form 10-K for additional information on our portfolio management strategy.

 

Details underlying write-downs taken as a result of OTTI (in millions) were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

For the Six

 

 

 

 

Months Ended

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

OTTI Recognized in Net Income (Loss)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturity securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

$

(4

)

$

 -

 

NM

 

$

(15

)

$

 -

 

NM

 

ABS

 

(3

)

 

(2

)

 

 

 

(5

)

 

(5

)

0%

 

RMBS

 

 -

 

 

(1

)

100%

 

 

(2

)

 

(3

)

33%

 

CMBS

 

 -

 

 

(1

)

100%

 

 

 -

 

 

(1

)

100%

 

Gross OTTI recognized in net income (loss)

 

(7

)

 

(4

)

 

 

 

(22

)

 

(9

)

 

 

Associated amortization of DAC,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

VOBA, DSI and DFEL

 

 -

 

 

1

 

-100%

 

 

2

 

 

2

 

0%

 

Net OTTI recognized in net income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(loss), pre-tax

$

(7

)

$

(3

)

NM

 

$

(20

)

$

(7

)

NM

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Portion of OTTI Recognized in OCI

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross OTTI recognized in OCI

$

9

 

$

2

 

NM

 

$

18

 

$

9

 

100%

 

Change in DAC, VOBA, DSI and DFEL

 

(2

)

 

 -

 

NM

 

 

(3

)

 

(1

)

NM

 

Net portion of OTTI recognized in OCI, pre-tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

pre-tax

$

7

 

$

2

 

250%

 

$

15

 

$

8

 

88%

 

 

The increase in write-downs for OTTI when comparing the first six months of 2015 to the corresponding period in 2014 was primarily attributable to individual credit risks within our corporate bond holdings.

 

The $40 million of impairments taken during the first six months of 2015 was split between $22 million of credit-related impairments and $18 million of noncredit-related impairments.  The noncredit-related impairments were due to declines in values of securities for which we do not have an intent to sell or it is not more likely than not that we will be required to sell the securities before recovery.

 

 

87


 

 

REINSURANCE

 

See “Part II – Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Reinsurance” in our 2014 Form 10-K for a detailed discussion regarding our counterparty risk with our reinsurers, including collateral securing our reinsurance recoverable, which information is incorporated herein by reference.  For more information about reinsurance, see Note 9 in our 2014 Form 10-K. 

 

REVIEW OF CONSOLIDATED FINANCIAL CONDITION

 

Liquidity and Capital Resources

 

Sources of Liquidity and Cash Flow

 

 

Liquidity refers to the ability of an enterprise to generate adequate amounts of cash from its normal operations to meet cash requirements with a prudent margin of safety.  Our principal sources of cash flow from operating activities are insurance premiums and fees and investment income, while sources of cash flows from investing activities result from maturities and sales of invested assets.  Our operating activities provided cash of $582 million and $371 million for the six months ended June 30, 2015 and 2014, respectively.  When considering our liquidity and cash flow, it is important to distinguish between the needs of our insurance subsidiaries and the needs of the holding company, LNC.  As a holding company with no operations of its own, LNC derives its cash primarily from its operating subsidiaries. 

 

The sources of liquidity of the holding company are principally comprised of dividends and interest payments from subsidiaries, augmented by holding company short-term investments, bank lines of credit and the ongoing availability of long-term public financing under an SEC-filed shelf registration statement.  These sources of liquidity and cash flow support the general corporate needs of the holding company, including its common stock dividends, interest and debt service, funding of callable securities, securities repurchases, acquisitions and investment in core businesses.  Our cash flows associated with collateral received from and posted with counterparties change as the market value of the underlying derivative contract changes.  As the value of a derivative asset declines (or increases), the collateral required to be posted by our counterparties would also decline (or increase).  Likewise, when the value of a derivative liability declines (or increases), the collateral we are required to post to our counterparties would also decline (or increase).  During the six months ended June 30, 2015, our payables for collateral on derivative investments decreased by $602 million due primarily to rising interest rates that decreased the fair values of our associated derivative investments.  In the event of adverse changes in fair value of our derivative instruments, we may need to post collateral with a counterparty if our net derivative liability position reaches certain contractual levels.  If we do not have sufficient high quality securities or cash and invested cash to provide as collateral, we have multiple liquidity sources to leverage that would be eligible for collateral posting.    For additional information, see “Credit Risk” in Note 5.

 

Details underlying the primary sources of our holding company cash flows (in millions) were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

For the Six

 

 

 

 

Months Ended

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Dividends from Subsidiaries

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The Lincoln National Life Insurance

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Company

$

225

 

$

190

 

18%

 

$

625

 

$

340

 

84%

 

First Penn-Pacific

 

 -

 

 

20

 

-100%

 

 

 -

 

 

20

 

-100%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loan Repayments and Interest from

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Subsidiaries

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest on inter-company notes

 

26

 

 

31

 

-16%

 

 

56

 

 

65

 

-14%

 

 

$

251

 

$

241

 

4%

 

$

681

 

$

425

 

60%

 

Other Cash Flow and Liquidity Items

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net capital received from (paid for taxes on)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

stock option exercises and restricted stock

$

16

 

$

3

 

NM

 

$

25

 

$

(3

)

NM

 

 

The table above focuses on significant and recurring cash flow items and excludes the effects of certain financing activities, namely the periodic issuance and retirement of debt and cash flows related to our inter-company cash management program (discussed below).  Taxes have been eliminated from the analysis due to a tax sharing agreement among our primary subsidiaries resulting in a modest effect on net cash flows at the holding company.  Also excluded from this analysis is the modest amount of investment income on short-term investments of the holding company.  For information regarding limits on the dividends that our insurance subsidiaries may pay, see “Part II – Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Review of Consolidated Financial Condition – Liquidity and Capital Resources – Dividends from Subsidiaries” in our 2014 Form 10-K.    

 

88


 

 

Subsidiaries’ Statutory Reserving and Surplus

 

Like other life insurers, we utilize inter-company reinsurance arrangements with captives primarily to manage risk and statutory capital.  Captive reinsurers are typically special purpose vehicles that either by statute or by restriction in their licensing orders are limited to reinsuring business from insurance affiliates.  Specifically, captives help us mitigate the capital impact of XXX and AG38 reserving guidelines.  XXX and AG38 require insurers to use reserving assumptions that result in statutory reserves greater than what we expect to need to adequately support term life insurance policies and UL policies with secondary guarantees.  The captive reinsurance structures we use provide a mechanism for the financing of a portion of the excess reserve amounts in a more efficient manner.  This, in turn, frees up capital that the insurance subsidiaries can use for any number of purposes, including for paying dividends to the holding company.  Once transferred to the holding company, it can deploy this capital for a variety of corporate purposes, including potentially for stock repurchases.

 

Currently, insurance companies are using a wide variety of captive reinsurance structures to support their respective businesses.  The NAIC through its various committees, task forces and working groups has been studying the use of captives and special purpose vehicles to transfer insurance risk and has been evaluating the adequacy of existing NAIC model laws and regulations applicable to life and annuity captives.  For example, the NAIC adopted Actuarial Guideline 48 (“AG48”) that regulates the terms of captive reinsurance arrangements that are entered into or amended in certain ways after December 31, 2014.  AG48 imposes restrictions on the types of assets that can be used to support these arrangements.  We believe that we will be able to implement these arrangements in compliance with the new requirements.

 

For more discussion of our strategies to lessen the burden of increased XXX and AG38 statutory reserves associated with term products and UL products containing secondary guarantees on our insurance subsidiaries, see “Results of Life Insurance – Income (Loss) from Operations – Strategies to Address Statutory Reserve Strain.”

 

Financing Activities

 

Although our subsidiaries currently generate adequate cash flow to meet the needs of our normal operations, periodically we may issue debt or equity securities to maintain ratings and increase liquidity, as well as to fund internal growth, acquisitions and the retirement of our debt and equity securities. 

 

We currently have an effective shelf registration statement, which allows us to issue, in unlimited amounts, securities, including debt securities, preferred stock, common stock, warrants, stock purchase contracts, stock purchase units and depository shares. 

 

Details underlying debt and financing activities (in millions) were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Six Months Ended June 30, 2015

 

 

 

 

 

 

 

 

Maturities,

 

Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Repayments

 

in Fair

 

 

 

 

 

 

 

 

 

Beginning

 

 

 

 

 

and

 

Value

 

 

Other

 

 

Ending

 

Balance

 

Issuance

 

Refinancing

 

Hedges

 

Changes (1)

 

Balance

Short-Term Debt

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current maturities of long-term debt

$

250

 

$

 -

 

 

$

(250

)

 

$

 -

 

 

$

 -

 

 

$

 -

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Long-Term Debt

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Senior notes

$

3,558

 

$

300

 

 

$

 -

 

 

$

(42

)

 

$

1

 

 

$

3,817

Bank borrowing

 

250

 

 

 -

 

 

 

 -

 

 

 

 -

 

 

 

 -

 

 

 

250

Federal Home Loan Bank of

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Indianapolis advance

 

250

 

 

 -

 

 

 

 -

 

 

 

 -

 

 

 

 -

 

 

 

250

Capital securities (2)

 

1,212

 

 

 -

 

 

 

 -

 

 

 

 -

 

 

 

 -

 

 

 

1,212

Total long-term debt

$

5,270

 

$

300

 

 

$

 -

 

 

$

(42

)

 

$

1

 

 

$

5,529

 

(1)

Includes the net increase (decrease) in commercial paper, non-cash reclassification of long-term debt to current maturities of long-term debt, accretion of discounts and (amortization) of premiums, as applicable.

(2)

Over the course of the next two years, the fixed rates on our capital securities are scheduled to change to floating.  To hedge the variability in rates, we have purchased forward starting swaps to effectively lock in lower rates over the remaining terms of the securities.

 

During the second quarter of 2015, we repaid a $250 million 4.30% fixed-rate senior note that matured on June 15, 2015.  On March 9, 2015, we completed the issuance and sale of $300 million aggregate principal amount of our 3.35% senior notes due 2025.  We used the proceeds from this offering to repay the maturity mentioned above and for general corporate purposes.  As of June 30, 2015, the holding company had available liquidity of $545 million.  Available liquidity consists of cash and invested cash, excluding cash held as collateral, and certain short-term investments that can be readily converted into cash, net of commercial paper outstanding.

89


 

 

For more information about our short-term and long-term debt and our credit facilities and LOCs, see Note 12 in our 2014 Form 10-K.

 

We have not accounted for repurchase agreements, securities lending transactions, or other transactions involving the transfer of financial assets with an obligation to repurchase the transferred assets as sales and do not have any other transactions involving the transfer of financial assets with an obligation to repurchase the transferred assets.  For information about our collateralized financing transactions on our investments, see “Payables for Collateral on Investments” in Note 4.

 

If current credit ratings and claims-paying ratings were downgraded in the future, terms in our derivative agreements may be triggered, which could negatively affect overall liquidity.  For the majority of our counterparties, there is a termination event should the long-term senior debt ratings of LNC drop below BBB-/Baa3 (S&P/Moody’s).  Our long-term senior debt held a rating of A-/Baa1 (S&P/Moody’s) as of June 30, 2015.  In addition, contractual selling agreements with intermediaries could be negatively affected, which could have an adverse effect on overall sales of annuities, life insurance and investment products.  See “Part I – Item 1A. Risk Factors – Liquidity and Capital Position – A decrease in the capital and surplus of our insurance subsidiaries may result in a downgrade to our credit and insurer financial strength ratings” and “Part I – Item 1A. Risk Factors – Covenants and Ratings – A downgrade in our financial strength or credit ratings could limit our ability to market products, increase the number or value of policies being surrendered and/or hurt our relationships with creditors” in our 2014 Form 10-K for more information.  See “Part I – Item 1. Business – Financial Strength Ratings” in our 2014 Form 10-K for additional information on our current financial strength ratings.

 

See “Part II – Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Review of Consolidated Financial Condition – Liquidity and Capital Resources – Financing Activities” in our 2014 Form 10-K for information on our credit ratings.

 

Alternative Sources of Liquidity

 

In order to manage our capital more efficiently, we have an inter-company cash management program where certain subsidiaries can lend to or borrow from the holding company to meet short-term borrowing needs.  The cash management program is essentially a series of demand loans between LNC and participating subsidiaries that reduces overall borrowing costs by allowing LNC and its subsidiaries to access internal resources instead of incurring third-party transaction costs.  As of June 30, 2015, the holding company had a net outstanding receivable of $115 million from certain subsidiaries resulting from loans borrowed by subsidiaries in excess of amounts placed by subsidiaries in the inter-company cash management account.  Any change in holding company cash management program balances is offset by the immediate and equal change in holding company cash and invested cash.  Loans under the cash management program are permitted under applicable insurance laws subject to certain restrictions.  For our Indiana-domiciled insurance subsidiaries, the borrowing and lending limit is currently 3% of the insurance company’s admitted assets as of its most recent year end.  For our New York-domiciled insurance subsidiary, it may borrow from LNC less than 2% of its admitted assets as of the last year end but may not lend any amounts to LNC.

 

Our insurance subsidiaries, by virtue of their general account fixed-income investment holdings, can access liquidity through securities lending programs and repurchase agreements.  As of June 30, 2015, our insurance subsidiaries had investments with a carrying value of $3.5 billion out on loan or subject to repurchase agreements.  The cash received in our securities lending programs and repurchase agreements is typically invested in cash equivalents, short-term investments or fixed maturity securities.  For additional details, see “Payables for Collateral on Investments” in Note 4.

 

For factors that could cause actual results to differ materially from those set forth in this section, see “Forward-Looking Statements – Cautionary Language” above and “Part I – Item 1A. Risk Factors” in our 2014 Form 10-K as updated by “Item 1A. – Risk Factors” in our first quarter 2015 Form 10-Q.

 

Divestitures

 

For more information on our divestitures, see “Acquisitions and Dispositions” above and Note 3 in our 2014 Form 10-K.

 

Uses of Capital

 

Our principal uses of cash are to pay policy claims and benefits, operating expenses, commissions and taxes, to purchase new investments, to purchase reinsurance, to fund policy surrenders and withdrawals, to pay dividends to our stockholders, to repurchase our stock and to repay debt.

 

Return of Capital to Common Stockholders

 

One of the Company’s primary goals is to provide a return to our common stockholders through share price accretion, dividends and stock repurchases.  In determining dividends, the Board of Directors takes into consideration items such as current and expected earnings, capital needs, rating agency considerations and requirements for financial flexibility.  The amount and timing of share repurchase depends on key capital ratios, rating agency expectations, the generation of free cash flow and an evaluation of the costs and benefits associated with alternative uses of capital.  Free cash flow for the holding company generally represents the amount of dividends and interest received from subsidiaries less interest paid on debt.

 

90


 

 

Details underlying this activity (in millions, except per share data), were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

For the Six

 

 

 

 

Months Ended

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Common dividends to stockholders

$

51 

 

$

42 

 

21% 

 

$

102 

 

$

84 

 

21% 

 

Repurchase of common stock

 

150 

 

 

150 

 

0% 

 

 

500 

 

 

300 

 

67% 

 

Total cash returned to stockholders

$

201 

 

$

192 

 

5% 

 

$

602 

 

$

384 

 

57% 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Number of shares repurchased

 

2.559 

 

 

3.076 

 

-17%

 

 

8.602 

 

 

6.064 

 

42% 

 

Average price per share

$

58.64 

 

$

48.78 

 

20% 

 

$

58.15 

 

$

49.49 

 

17% 

 

 

On October 29, 2014, our Board of Directors approved an increase of the quarterly dividend on our common stock from $0.16 to $0.20 per share.  Additionally, we expect to repurchase additional shares of common stock during 2015 depending on market conditions and alternative uses of capital.  For more information regarding share repurchases, see “Part II – Item 2(c)” below.

 

Other Uses of Capital

 

In addition to the amounts in the table above in “Return of Capital to Common Stockholders,” other uses of holding company cash flow (in millions) were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three

 

 

 

For the Six

 

 

 

 

Months Ended

 

 

 

Months Ended

 

 

 

 

June 30,

 

 

 

June 30,

 

 

 

 

2015

 

2014

 

Change

 

2015

 

2014

 

Change

 

Debt service (interest paid)

$

77 

 

$

81 

 

-5%

 

$

136 

 

$

154 

 

-12%

 

Capital contribution to subsidiaries

 

 -

 

 

 -

 

NM

 

 

75 

 

 

 -

 

NM

 

Total

$

77 

 

$

81 

 

-5%

 

$

211 

 

$

154 

 

37% 

 

 

The above table focuses on significant and recurring cash flow items and excludes the effects of certain financing activities, namely the periodic retirement of debt and cash flows related to our inter-company cash management account.  Taxes have been eliminated from the analysis due to a tax sharing agreement among our primary subsidiaries resulting in a modest effect on net cash flows at the holding company.

 

Significant Trends in Sources and Uses of Cash Flow

 

As stated above, LNC’s cash flow, as a holding company, is largely dependent upon the dividend capacity of its insurance company subsidiaries as well as their ability to advance funds to it through inter-company borrowing arrangements, which may be affected by factors influencing the insurance subsidiaries’ RBC and statutory earnings performance.  We currently expect to be able to meet the holding company’s ongoing cash needs and to have sufficient capital to offer downside protection in the event that the capital and credit markets experience another period of extreme volatility and disruption.  A decline in capital market conditions, which reduces our insurance subsidiaries’ statutory surplus and RBC, may require them to retain more capital and may pressure our subsidiaries’ dividends to the holding company, which may lead us to take steps to preserve or raise additional capital.  For factors that could affect our expectations for liquidity and capital, see “Part I – Item 1A. Risk Factors” in our 2014 Form 10-K as updated by “Item 1A. – Risk Factors” in our first quarter 2015 Form 10-Q.

 

OTHER MATTERS

 

Other Factors Affecting Our Business

 

In general, our businesses are subject to a changing social, economic, legal, legislative and regulatory environment.  Some of the changes include initiatives to require more reserves to be carried by our insurance subsidiaries.  Although the eventual effect on us of the changing environment in which we operate remains uncertain, these factors and others could have a material effect on our results of operations, liquidity and capital resources.  For factors that could cause actual results to differ materially from those set forth in this section, see “Part I – Item 1A. Risk Factors” in our 2014 Form 10-K as updated by “Item 1A. – Risk Factors” in our first quarter 2015 Form 10-Q

and “Forward-Looking Statements – Cautionary Language” above.

 

Recent Accounting Pronouncements

 

See Note 2 for a discussion of recent accounting pronouncements that have been implemented during the periods presented or that have been issued and are to be implemented in the future.

 

91


 

 

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

 

We analyze and manage the risks arising from market exposures of financial instruments, as well as other risks, in an integrated asset-liability management process that considers diversification.  By aggregating the potential effect of market and other risks on the entire enterprise, we estimate, review and in some cases manage the risk to our earnings and shareholder value.  We have exposures to several market risks including interest rate risk, equity market risk, default risk, credit risk and, to a lesser extent, foreign currency exchange risk.  The exposures of financial instruments to market risks, and the related risk management processes, are most important to our business where most of the invested assets support accumulation and investment-oriented insurance products.  As an important element of our integrated asset-liability management processes, we use derivatives to minimize the effects of changes in interest levels, the shape of the yield curve, currency movements and volatility.  In this context, derivatives serve to minimize interest rate risk by mitigating the effect of significant increases in interest rates on our earnings.  Additional market exposures exist in our other general account insurance products and in our debt structure and derivatives positions.  Our primary sources of market risk are substantial, relatively rapid and sustained increases or decreases in interest rates or a sharp drop in equity market values.  These market risks are discussed in detail in the following pages and should be read in conjunction with our consolidated financial statements and the accompanying notes to the consolidated financial statements (“Notes”) presented in “Item 1. Financial Statements,” as well as “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” (“MD&A”).

 

Interest Rate Risk  

 

Effect of Interest Rate Sensitivity

 

For information about the effect of interest rate sensitivity on our income (loss) from operations, see “Part II – Item 7A. Quantitative and Qualitative Disclosures About Market Risk – Interest Rate Risk  Effect of Interest Rate Sensitivity”  in our 2014 Form 10-K.

 

Interest Rate Risk on Fixed Insurance Businesses

 

In periods of low interest rates, we have to reinvest the cash we receive as interest or return of principal on our investments in lower yielding instruments.  Moreover, borrowers may prepay fixed-income securities, commercial mortgages and mortgage-backed securities in our general accounts in order to borrow at lower market rates, which exacerbates this risk.  Because we are entitled to reset the interest rates on our fixed-rate annuities only at limited, pre-established intervals, and because many of our contracts have guaranteed minimum interest or crediting rates, our spreads could decrease and potentially become negative. 

 

Prolonged historically low rates are not healthy for our business fundamentals.  However, we have recognized this risk and have been proactive in our investment strategies, product designs, crediting rate strategies and overall asset-liability practices to mitigate the risk of unfavorable consequences in this type of environment.  For some time now, new products have been sold with low minimum crediting floors, and we apply disciplined asset-liability management standards, such as locking in spreads on these products at the time of issue.

 

92


 

 

The following provides detail on the percentage differences between the June 30, 2015, interest rates being credited to contract holders based on the second quarter of 2015 declared rates and the respective minimum guaranteed policy rate (in millions), broken out by contract holder account values reported within our segments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Account Values

 

 

 

 

 

Retirement

 

 

 

 

 

 

 

%  

 

 

 

 

 

 

Plan

 

 

Life

 

 

 

 

 

Account

 

 

Annuities

 

 

Services

 

Insurance (1)

 

Total

 

Values

 

Excess of Crediting Rates over Contract Minimums

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Discretionary rate setting products: (2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Occurring within the next twelve months: (3)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

No difference

$

8,286 

 

 

$

10,710 

 

 

$

31,886 

 

 

$

50,882 

 

71.4% 

 

Up to 0.50%

 

1,585 

 

 

 

479 

 

 

 

454 

 

 

 

2,518 

 

3.5% 

 

0.51% to 1.00%

 

1,643 

 

 

 

142 

 

 

 

17 

 

 

 

1,802 

 

2.5% 

 

1.01% to 1.50%

 

1,639 

 

 

 

15 

 

 

 

118 

 

 

 

1,772 

 

2.5% 

 

1.51% to 2.00%

 

706 

 

 

 

 -

 

 

 

612 

 

 

 

1,318 

 

1.8% 

 

2.01% to 2.50%

 

461 

 

 

 

 -

 

 

 

 -

 

 

 

461 

 

0.6% 

 

2.51% to 3.00%

 

85 

 

 

 

 -

 

 

 

 -

 

 

 

85 

 

0.1% 

 

3.01% or greater

 

26 

 

 

 

 -

 

 

 

 -

 

 

 

26 

 

0.0% 

 

Occurring after the next twelve months (4)

 

5,149 

 

 

 

 -

 

 

 

 -

 

 

 

5,149 

 

7.2% 

 

Total discretionary rate setting products

 

19,580 

 

 

 

11,346 

 

 

 

33,087 

 

 

 

64,013 

 

89.6% 

 

Other contracts (5)

 

2,209 

 

 

 

5,123 

 

 

 

 -

 

 

 

7,332 

 

10.4% 

 

Total account values

$

21,789 

 

 

$

16,469 

 

 

$

33,087 

 

 

$

71,345 

 

100.0% 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Percentage of discretionary rate setting product account

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

values at minimum guaranteed rates

 

42.3% 

 

 

 

94.4% 

 

 

 

96.4% 

 

 

 

79.5% 

 

 

 

 

(1)

Excludes policy loans.

(2)

Contracts currently within new money rate bands are grouped according to the corresponding portfolio rate band in which they will fall upon their first anniversary.

(3)

The average crediting rates were 44 basis points, 2 basis points and 4 basis points in excess of average minimum guaranteed rates for our Annuities, Retirement Plan Services and Life Insurance segments, respectively.

(4)

The average crediting rates were 107 basis points in excess of average minimum guaranteed rates.  Of our account values for these products: 32% are scheduled to reset in more than one year but not more than two years; 20% are scheduled to reset in more than two years but not more than three years; and 48% are scheduled to reset in more than three years.

(5)

For Annuities, this amount relates primarily to income annuity and short-term dollar cost averaging business.  For Retirement Plan Services, this amount relates primarily to indexed-based rate setting products in which the average crediting rates were 9 basis points in excess of average minimum guaranteed rates and 81% of account values were already at their minimum guaranteed rates.

 

The maturity structure and call provisions of the related portfolios are structured to afford protection against erosion of investment portfolio yields during periods of declining interest rates.  We devote extensive effort to evaluating the risks associated with falling interest rates by simulating asset and liability cash flows for a wide range of interest rate scenarios.  We seek to manage these exposures by maintaining a suitable maturity structure and by limiting our exposure to call risk in each respective investment portfolio.

 

Derivatives

 

See Note 5  for information on our derivatives used to hedge our exposure to changes in interest rates.

 

Equity Market Risk

 

Our revenues, assets and liabilities are exposed to equity market risk that we often hedge with derivatives.  Due to the use of our reversion to the mean (“RTM”) process and our hedging strategies, we expect that, in general, short-term fluctuations in the equity markets should not have a significant effect on our quarterly earnings from unlocking of assumptions for deferred acquisition costs, value of business acquired, deferred sales inducements and deferred front-end loads.  However, earnings are affected by equity market movements on account values and assets under management and the related fees we earn on those assets.  Refer to “Part II – Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Introduction – Critical Accounting Policies and Estimates – DAC, VOBA, DSI and DFEL” in our 2014 Form 10-K for further discussion of the effects of equity markets on our RTM.    

 

93


 

 

Effect of Equity Market Sensitivity

 

For information about the effect of equity market sensitivity on our income (loss) from operations, see “Part II – Item 7A. Quantitative and Qualitative Disclosures About Market Risk – Equity Market Risk Effect of Equity Market Sensitivity”  in our 2014 Form 10-K.

 

Credit Risk

 

We may use credit-related derivatives to minimize our exposure to credit-related events, and we also sell credit default swaps to offer credit protection to our contract holders and investors. 

 

In addition to the information provided about our counterparty exposure in Note 5, the fair value of our exposure by rating (in millions) was as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

As of

 

As of

 

 

June 30,

December 31,

 

 

 

2015

 

 

2014

 

 

AA

 

$

 

 

$

17 

 

 

A

 

 

15 

 

 

 

19 

 

 

BBB

 

 

 

 

 

 

 

Total

 

$

26 

 

 

$

41 

 

 

 

See Note 5 for additional information on our credit risk.  

 

Item 4.  Controls and Procedures

 

Conclusions Regarding Disclosure Controls and Procedures

 

We maintain disclosure controls and procedures, which are designed to ensure that information required to be disclosed in the reports we file or submit under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.  As of the end of the period required by this report, we, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act).  Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to us and our consolidated subsidiaries required to be disclosed in our periodic reports under the Exchange Act.

 

Changes in Internal Control Over Financial Reporting

 

There was no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during the quarter ended June 30, 2015, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

A control system, no matter how well designed and operated, can provide only reasonable assurance that the control system’s objectives will be met.  Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the company have been detected.  Projections of any evaluation of controls effectiveness to future periods are subject to risks.  Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.

 

 

94


 

 

PART II – OTHER INFORMATION

 

Item 1.  Legal Proceedings

 

Information regarding reportable legal proceedings is contained in Note 8 in “Part I – Item 1.”

 

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds

 

(c)  The following table summarizes purchases of equity securities by the issuer during the quarter ended June 30, 2015 (dollars in millions, except per share data): 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(a) Total

 

 

 

 

(c) Total Number

 

(d) Approximate Dollar

 

 

 

Number

 

(b) Average

 

of Shares (or Units)

 

Value of Shares (or

 

 

 

of Shares

 

Price Paid

 

Purchased as Part of

 

Units) that May Yet Be

 

 

 

(or Units)

 

per Share

 

Publicly Announced

 

Purchased Under the

 

Period

 

Purchased (1)

 

(or Unit)

 

Plans or Programs (2)

 

Plans or Programs (2)(3)

 

4/1/15 – 4/30/15

 

 

 -

 

$

 -

 

 

 -

 

$

265 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

5/1/15 – 5/31/15

 

 

2,558,600 

 

 

58.62 

 

 

2,558,600 

 

 

968 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

6/1/15 – 6/30/15

 

 

 -

 

 

 -

 

 

 -

 

 

968 

 

 

(1)Of the total number of shares purchased, no shares were received in connection with the exercise of stock options and related taxes.  For the quarter ended June 30, 2015, there were 2,558,600 shares purchased as part of publicly announced plans or programs. 

(2)On May 21, 2015, our Board of Directors authorized an increase in our securities repurchase authorization, bringing the total aggregate repurchase authorization to $1.0 billion.  As of June 30, 2015, our remaining security repurchase authorization was $968 million.  The security repurchase authorization does not have an expiration date.  The amount and timing of share repurchase depends on key capital ratios, rating agency expectations, the generation of free cash flow and an evaluation of the costs and benefits associated with alternative uses of capital. 

(3)As of the last day of the applicable month. 

 

Item 6.  Exhibits

 

The Exhibits included in this report are listed in the Exhibit Index beginning on page E-1, which is incorporated herein by reference.

95


 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

 

 

 

 

 

LINCOLN NATIONAL CORPORATION

 

 

 

 

By:

/s/  RANDAL J. FREITAG

 

 

Randal J. Freitag

Executive Vice President and Chief Financial Officer

 

 

 

 

By:

/s/  DOUGLAS N. MILLER

 

 

Douglas N. Miller

Senior Vice President and Chief Accounting Officer

Dated:  July 30, 2015

 

 

 

 

 

 

 

 

96


 

 

LINCOLN NATIONAL CORPORATION

Exhibit Index for the Report on Form 10-Q

For the Quarter Ended June 30, 2015

 

 

 

 

4.1

Senior Indenture, dated as of March 10, 2009, between LNC and Bank of New York Mellon, is incorporated by reference to LNC’s Form S-3ASR (File No. 333-157822) filed with the SEC on March 10, 2009.

4.2

Form of 3.350% Senior Notes due 2025 incorporation by reference to Exhibit 4.1 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on March 9, 2015.

12

Historical Ratio of Earnings to Fixed Charges.

31.1

Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2

Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1

Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2

Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101.INS

XBRL Instance Document.

101.SCH

XBRL Taxonomy Extension Schema Document.

101.CAL

XBRL Taxonomy Extension Calculation Linkbase Document.

101.LAB

XBRL Taxonomy Extension Label Linkbase Document.

101.PRE

XBRL Taxonomy Extension Presentation Linkbase Document.

101.DEF

XBRL Taxonomy Extension Definition Linkbase Document.

 

 

 

 

 

 

 

E-1