Overview
The following narrative analysis presents a review of the results of operations
of ING USA Annuity and Life Insurance Company ("ING USA" or the "Company", "we",
"us", as appropriate) for each of the three and six months ended June 30, 2012
and 2011 and financial condition as of June 30, 2012 and December 31, 2011. This
item should be read in its entirety and in conjunction with the Condensed
Financial Statements and related notes, which can be found under Part I, Item 1.
contained herein, as well as the "Management's Narrative Analysis of the Results
of Operations and Financial Condition" section contained in our 2011 Annual
Report on Form 10-K.
Forward-Looking Information/Risk Factors
In connection with the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995, we caution readers regarding certain
forward-looking statements contained in this report and in any other statements
made by, or on behalf of, us, whether or not in future filings with the
Securities and Exchange Commission ("SEC"). Forward-looking statements are
statements not based on historical information and which relate to future
operations, strategies, financial results, or other developments. Statements
using verbs such as "expect," "anticipate," "believe," or words of similar
import, generally involve forward-looking statements. Without limiting the
foregoing, forward-looking statements include statements that represent our
beliefs concerning future levels of sales and redemptions of our products,
investment spreads and yields, or the earnings and profitability of our
activities.
Forward-looking statements are necessarily based on estimates and assumptions
that are inherently subject to significant business, economic and competitive
uncertainties and contingencies, many of which are beyond our control and many
of which are subject to change. These uncertainties and contingencies could
cause actual results to differ materially from those expressed in any
forward-looking statements made by, or on behalf of, us. Whether or not actual
results differ materially from forward-looking statements may depend on numerous
foreseeable and unforeseeable developments, including, but not limited to the
following:
1. While the global economy continues to recover from the financial crisis and
subsequent recession, risks remain for the United States and other world
economies. The uncertainty concerning current global market conditions and
the impact it has on the U.S. economy, has affected and may continue to
affect our results of operations.
2. The default of a major market participant could disrupt the markets.
3. Adverse financial market conditions, changes in rating agency standards and
practices and/or actions taken by ratings agencies may significantly affect
our ability to meet liquidity needs, access to capital and cost of capital.
4. Circumstances associated with implementation of ING Groep's recently
announced global business strategy and the final restructuring plan submitted
to the European Commission in connection with its review of ING Groep's
receipt of state aid from the Dutch State could adversely affect our results
of operations and financial condition.
5. The amount of statutory capital that we hold and our risk-based capital
("RBC") ratio can vary significantly from time to time and is sensitive to a
number of factors, many of which are outside of our control and influences
our financial strength and credit ratings.
6. We have experienced ratings downgrades and may experience additional future
downgrades in our ratings, which may negatively affect profitability,
financial condition and access to liquidity.
7. The new federal financial regulatory reform law, its implementing regulations
and other financial regulatory reform initiatives, could have adverse
consequences for the financial services industry, including us and/or
materially affect our results of operations, financial condition and
liquidity.
8. The valuation of many of our financial instruments includes methodologies,
estimations and assumptions that are subject to differing interpretations and
could result in changes to investment valuations that may materially
adversely affect results of operations and financial condition.
9. The determination of the amount of impairments taken on our investments is
subjective and could materially impact results of operations.
10. We may be required to accelerate the amortization of deferred policy
acquisition cost ("DAC"), deferred sales inducements ("DSI") and/or the
valuation of business acquired ("VOBA"), any of which could adversely affect
our results of operations or financial condition.
11. Changes in underwriting and actual experience could materially affect
profitability.
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12. We may be required to establish an additional valuation allowance against the
deferred income tax assets if our business does not generate sufficient
taxable income or if our tax planning strategies are modified. Increases in
the deferred tax valuation allowance could have a material adverse effect on
results of operations and financial condition.
13. Reinsurance subjects us to the credit risk of reinsurers and may not be
adequate to protect against losses arising from ceded reinsurance.
14. Offshore reinsurance subjects us to the risk that the reinsurer is unable to
provide acceptable credit for reinsurance.
15. Our risk management program attempts to balance a number of important factors
including regulatory capital, risk based capital, liquidity, earnings and
other factors. Certain actions taken as part of our risk management strategy
could result in materially lower or more volatile U.S. GAAP earnings in
periods of changes in equity markets.
16. The inability to manage market risk successfully through the usage of
derivative instruments could adversely affect our business, operations,
financial condition and liquidity.
17. The inability of counterparties to meet their financial obligations could
have an adverse effect on our results of operations.
18. Changes in reserve estimates may reduce profitability and/or increase
reserves ceded to reinsurers.
19. A loss of or significant change in key product distribution relationships
could materially affect sales.
20. Competition could negatively affect the ability to maintain or increase
profitability.
21. Changes in federal income tax law or interpretations of existing tax law
could affect profitability and financial condition by making some products
less attractive to contract owners and increasing our tax costs or tax costs
of contract owners.
22. We are considering amending a tax sharing agreement in a manner that could
limit the availability of cash payments to which we would otherwise be
entitled without such amendment.
23. We may be adversely affected by increased governmental and regulatory
scrutiny or negative publicity.
24. The loss of key personnel could negatively affect our financial results and
impair our ability to implement our business strategy.
25. Litigation may adversely affect profitability and financial condition.
26. Our businesses are heavily regulated and changes in regulation in the United
States and regulatory investigations may reduce profitability.
27. Our products are subject to extensive regulation and failure to meet any of
the complex product requirements may reduce profitability.
28. Changes in accounting requirements could negatively impact our reported
results of operations and our reported financial position.
29. Failure of our operating or information systems or a compromise of security
with respect to an operating or information system or portable electronic
device or a failure to implement system modifications or a new accounting,
actuarial or other operating system effectively could adversely affect our
results of operations and financial condition or the effectiveness of
internal controls over financial reporting.
30. Requirements to post collateral or make payments due to declines in market
value on assets posted as collateral may adversely affect liquidity.
31. Defaults or delinquencies in the commercial mortgage loan portfolio may
adversely affect our profitability.
32. The occurrence of unidentified or unanticipated risks within our risk
management programs could negatively affect our business or result in losses.
33. The occurrence of natural or man-made disasters may adversely affect our
results of operations and financial condition.
Investors are also directed to consider the risks and uncertainties discussed in
this Item 2. and in Item 1A. of Part II contained herein, as well as in other
documents filed by us with the SEC. Except as may be required by the federal
securities laws, we disclaim any obligation to update forward-looking
information.
Basis of Presentation
ING USA is a stock life insurance company domiciled in the State of Iowa and
provides financial products and services in the United States. ING USA is
authorized to conduct its insurance business in all states, except New York and
the District of Columbia.
ING USA is a direct, wholly owned subsidiary of Lion, which is an indirect,
wholly owned subsidiary of ING Groep N.V. ("ING"). ING is a global financial
services holding company based in the Netherlands, with American Depository
Shares listed on the New York Stock Exchange under the symbol "ING."
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ING has announced the anticipated separation of its banking and insurance
businesses. While all options for effecting this separation remain open, on
November 10, 2010, ING announced that, in connection with the separation plan,
it will prepare for a base case of an initial public offering ("IPO") of ING
U.S., Inc. which constitutes ING's U.S.-based retirement, investment management,
and insurance operations, including us.
We have one operating segment.
Critical Accounting Policies, Judgments and Estimates
The preparation of financial statements in conformity with U.S. GAAP requires
the use of estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period. Critical estimates and assumptions are evaluated on
an on-going basis based on historical developments, market conditions, industry
trends, and other information that is reasonable under the circumstances. There
can be no assurance that actual results will conform to estimates and
assumptions and that reported results of operations will not be materially
adversely affected by the need to make future accounting adjustments to reflect
changes in these estimates and assumptions from time to time.
We have identified the following accounting policies, judgments, and estimates
as critical in that they involve a higher degree of judgment and are subject to
a significant degree of variability:
Reserves for future policy benefits, valuation and amortization of DAC and VOBA,
valuation of investments and derivatives, impairments, income taxes, and
contingencies.
In developing these accounting estimates and policies, our management makes
subjective and complex judgments that are inherently uncertain and subject to
material changes as facts and circumstances develop. Although variability is
inherent in these estimates, management believes the amounts provided are
appropriate based upon the facts available upon compilation of the Condensed
Financial Statements.
The above critical accounting estimates are described in Management's Discussion
and Analysis of Financial Condition and Results of Operations - Critical
Accounting Policies, Judgments and Estimates and the Business, Basis of
Presentation and Significant Accounting Policies note to the Financial
Statements in the 2011 Annual Report.
Results of Operations
Overview
Products currently offered by us include immediate and deferred fixed annuities,
designed to address individual customer needs for tax-advantaged savings,
retirement needs and wealth-protection concerns and guaranteed investment
contracts and funding agreements (collectively referred to as "GICs"), sold
primarily to institutional investors and corporate benefit plans.
On April 9, 2009, our ultimate parent, ING, announced a global business strategy
which identified certain core and non-core businesses and geographies, stated
ING's intention to explore divestiture of non-core businesses over time,
withdraw from certain non-core geographies, limit future acquisitions and
implement enterprise-wide expense reductions. In particular, with respect to
ING's U.S. insurance operations, ING is seeking to further reduce its risk by
focusing on individual life products, retirement services and lower risk annuity
products to be sold by ING USA's affiliate, ING Life Insurance and Annuity
Company. As part of this strategy, ING USA ceased new sales of variable annuity
products in March of 2010. Some new amounts will continue to be deposited on ING
USA variable annuities as add-on premiums to existing contracts.
We derive our revenue mainly from (a) fee income generated on variable assets
under management ("AUM"), (b) investment income earned on fixed AUM and
(c) certain other management fees. Fee income is primarily generated from
separate account assets supporting variable options under variable annuity
contract investments, as designated by contract owners. Investment income from
fixed AUM is mainly generated from annuity products with fixed investment
options and GIC deposits. Our expenses primarily consist of (a) interest
credited and other benefits to contract owners, (b) amortization of DAC and
value of business acquired ("VOBA"), (c) expenses related to the selling and
servicing of the various products offered by us and (d) other general business
expenses.
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Economic Analysis
The pace of economic growth in the U.S. remains subdued. The U.S. economy grew
1.5% and industrial production rose approximately 4.0% on an annualized basis in
the second quarter of 2012. The pace of growth has stayed modest and below
trend growth rates due to a variety of factors. Consumer spending has expanded
tepidly because of the slow improvement in the labor market, the elevated
unemployment rate, and the mediocre increase in real disposable income.
Business fixed investment is increasing less rapidly, while the housing sector
is still depressed and residential investment remains weak. House prices,
however, have started to stabilize in several metro areas. Real export growth
has been disappointing. The expansion of global industrial production and trade
has been sluggish because of a slowing in growth and investors' concerns about
global financial fragility. Employment growth did improve late last year and in
the first quarter of this year, however the pace of employment growth slowed
noticeably during the quarter ended June 30, 2012. Meanwhile, initial and
continuing unemployment claims have been declining at an unimpressive pace.
Overall inflation, as measured by Consumer Price Index and Personal Consumption
Expenditures indices, has declined in 2012, primarily due to a fall in energy
and commodity prices from previously elevated levels.
The pace of economic growth is still constrained by high unemployment, modest
income growth, lower housing wealth, and tepid expansion of credit and bank
lending. The sustainability of the ongoing recovery still depends on supportive
fiscal and monetary policies.
The Board of Governors of the Federal Reserve System (the "Fed") remains
conditionally committed to keeping the federal funds target rate in the range of
0 to 25 basis points until late-2014. In June 2012 the Fed announced that it
will continue its program to extend the average maturity of its holdings of
securities through the end of the year. Specifically, the Fed intends to
purchase Treasury securities with remaining maturities of 6 years to 30 years at
the current pace and to sell or redeem an equal amount of Treasury securities
with remaining maturities of approximately 3 years or less. This continuation of
the maturity extension program is likely to exert downward pressure on
longer-term interest rates. The Fed will also maintain its existing policy of
reinvesting principal payments from its holdings of agency debt and agency
mortgage-backed securities into agency mortgage-backed securities.
Short-term LIBOR remains low by historic standards but has been gradually rising
since mid 2011. However, U.S. Treasury rates have declined noticeably since the
beginning of last year. Long-term U.S. Treasury rates decreased in the second
quarter of 2012 as compared to the same period in 2011. The decline in U.S.
Treasury rates is mainly due to the Fed's commitment to keep the federal funds
target rate low until late 2014, low short-term rates, the Fed's policy to exert
downward pressure on long-term rates, well-anchored inflationary expectations,
weak growth in the U.S. and the rest of the world, and flight to safety arising
out of private investors' concerns about public debt and deficits in several
euro zone countries.
In spite of modest expansion in economic activity since the beginning of the
year, risks to the U.S. economy continue to point to possible negative
developments. These risks include strains in global financial conditions;
weakness in household financial conditions, which would lead to slower consumer
spending; larger-than-expected near-term fiscal tightening, which would lower
aggregate demand; financial and economic spillover from the euro zone's
inability to contain the region's debt crisis; and crude oil prices spiking in
the event of an escalation of conflict between the U.S. and Iran. There could
also be a drag on real GDP growth arising from a decrease in public expenditure
and higher taxes next year. These economic conditions and risks are not unique
to us, but present challenges to the entire insurance and financial services
industry.
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Three Months Ended June 30, 2012 compared to Three Months Ended June 30, 2011
Our results of operations for the three months ended June 30, 2012 and changes
therein, primarily reflect unfavorable Interest credited and other benefits to
contract owners, lower Net investment income, and lower Fee income. These
unfavorable items were partially offset by favorable Net realized capital gains,
lower amortization of DAC/VOBA, and higher Income tax benefit.
Three Months Ended June 30, $ Increase % Increase
2012 2011 (Decrease) (Decrease)
Revenues: (As revised)
Net investment income $ 315.2 $ 368.5 $ (53.3 ) (14.5 )%
Fee income 205.1 224.6 (19.5 ) (8.7 )%
Premiums 117.4 118.5 (1.1 ) (0.9 )%
Net realized capital gains
(losses):
Total other-than-temporary
impairments (4.7 ) (26.0 ) 21.3 81.9 %
Less: Portion of
other-than-temporary impairments
recognized in Other
comprehensive income (loss) (2.6 ) (2.2 ) (0.4 ) (18.2 )%
Net other-than-temporary
impairments recognized in
earnings (2.1 ) (23.8 ) 21.7 91.2 %
Other net realized capital gains
(losses) 457.8 10.7 447.1 NM
Total net realized capital gains
(losses) 455.7 (13.1 ) 468.8 NM
Other income 12.2 16.0 (3.8 ) (23.8 )%
Total revenues 1,105.6 714.5 391.1 54.7 %
Benefits and expenses:
Interest credited and other
benefits to contract owners 1,282.9 530.8 752.1 NM
Operating expenses 114.3 115.2 (0.9 ) (0.8 )%
Net amortization of deferred
policy acquisition costs and
value of business acquired (81.2 ) 2.5 (83.7 ) NM
Interest expense 7.8 7.9 (0.1 ) (1.3 )%
Other expense 5.3 7.0 (1.7 ) (24.3 )%
Total benefits and expenses 1,329.1 663.4 665.7 NM
Income (loss) before income
taxes (223.5 ) 51.1 (274.6 ) NM
Income tax expense (benefit) (40.2 ) (22.0 ) (18.2 ) (82.7 )%
Net income (loss) $ (183.3 ) $ 73.1 $ (256.4 ) NM
NM - Not Meaningful
Revenues
Total revenues increased for the three months ended June 30, 2012, primarily due
to improved Net realized capital gains, partially offset by lower Net investment
income and lower Fee income.
Net realized capital gains (losses) improved $468.8 from ($13.1) to $455.7
primarily driven by changes in the equity and interest markets, and their impact
on our hedging programs. This increase in Net realized capital gains (losses)
was primarily due to favorable changes in the fair value of derivatives related
to (a) hedges of variable annuity guaranteed living benefits ("VAGLB") ceded to
Security Life of Denver International Limited ("SLDI") under the combined
coinsurance and coinsurance funds withheld agreement; (b) hedges of variable
annuity guaranteed death benefits; and (c) hedges designed to mitigate the
impact of potential declines in equity markets on regulatory capital. The
favorable changes were partially offset by unfavorable changes in the fair value
of hedges of FIA products and embedded derivatives on product guarantees.
Net investment income decreased $53.3 from $368.5 to $315.2 primarily due to the
loss recorded on the sale of certain general account private equity limited
partnership investment interest holdings ("sale of certain alternative
investments") and due to
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decreases in general account assets. The sale of certain alternative investments
resulted in a net pretax loss of $16.9 in the second quarter of 2012 reported in
Net investment income in the Condensed Statements of Operations. The transaction
is discussed in "Investments - Sale of Alternative Investments." General account
assets decreased as a result of multi-year guaranteed annuities ("MYGAs")
lapsing at the end of their initial terms, largely due to MYGA crediting rates
established following the initial terms that were lower than fixed crediting
rates established for MYGAs during the initial term.
Fee income decreased $19.5 from $224.6 to $205.1 due to a decrease in average
variable AUM, driven by the continued runoff of our variable annuity business
and a decrease in equity markets.
Benefits and Expenses
Total benefits and expenses increased primarily due to unfavorable variance in
Interest credited and other benefits to contract owners, partially offset by
lower amortization of DAC/VOBA.
Interest credited and other benefits to contract owners increased $752.1 from
$530.8 to $1,282.9 primarily due to the transfer of gains (losses) on
derivatives and investment income under the combined coinsurance and coinsurance
funds withheld agreement with SLDI. The corresponding gains and Net investment
income are reported in Net realized capital gains (losses) and Net investment
income, respectively.
Net amortization of DAC and VOBA changed $83.7 from $2.5 to ($81.2) primarily
due to a decrease in amortization resulting from lower current period gross
profits. This is partially offset by unfavorable DAC unlocking primarily due to
a decrease in projected investment margins on the MYGA policies.
Income Taxes
Income tax benefit increased $18.2 from $22.0 to $40.2 primarily due to a
decrease in income before taxes which was partially offset by an increase in the
valuation allowance in the three months ended June 30, 2012 compared to a
decrease in the valuation allowance in the three months ended June 30, 2011.
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Six Months Ended June 30, 2012 compared to Six Months Ended June 30, 2011
Our results of operations for the six months ended June 30, 2012 and changes
therein, primarily reflect unfavorable Net realized capital losses, lower Net
investment income and lower Fee income. These unfavorable items were partially
offset by lower amortization of DAC/VOBA, lower Interest credited and other
benefits to contract owners and higher Income tax benefit.
Six Months Ended June 30, $ Increase % Increase
2012 2011 (Decrease) (Decrease)
Revenues: (As revised)
Net investment income $ 661.2 $ 725.9 $ (64.7 ) (8.9 )%
Fee income 413.0 448.4 (35.4 ) (7.9 )%
Premiums 229.9 233.6 (3.7 ) (1.6 )%
Net realized capital gains
(losses):
Total other-than-temporary
impairments (8.6 ) (91.0 ) 82.4 90.5 %
Less: Portion of
other-than-temporary impairments
recognized in Other
comprehensive income (loss) (2.7 ) (5.1 ) 2.4 47.1 %
Net other-than-temporary
impairments recognized in
earnings (5.9 ) (85.9 ) 80.0 93.1 %
Other net realized capital gains
(losses) (852.1 ) (299.4 ) (552.7 ) NM
Total net realized capital gains
(losses) (858.0 ) (385.3 ) (472.7 ) NM
Other income 20.3 33.6 (13.3 ) (39.6 )%
Total revenues 466.4 1,056.2 (589.8 ) (55.8 )%
Benefits and expenses:
Interest credited and other
benefits to contract owners 478.3 550.1 (71.8 ) (13.1 )%
Operating expenses 225.7 224.9 0.8 0.4 %
Net amortization of deferred
policy acquisition costs and
value of business acquired 46.1 129.3 (83.2 ) (64.3 )%
Interest expense 15.6 15.7 (0.1 ) (0.6 )%
Other expense 16.5 16.6 (0.1 ) (0.6 )%
Total benefits and expenses 782.2 936.6 (154.4 ) (16.5 )%
Income (loss) before income
taxes (315.8 ) 119.6 (435.4 ) NM
Income tax expense (benefit) (73.0 ) 5.5 (78.5 ) NM
Net income (loss) $ (242.8 ) $ 114.1 $ (356.9 ) NM
NM - Not Meaningful
Revenues
Total revenues decreased for the six months ended June 30, 2012, primarily due
to higher Net realized capital losses, lower Net investment income and lower Fee
income.
Net realized capital losses increased $472.7 from $385.3 to $858.0 primarily
driven by changes in the equity and interest markets, and how these impact our
hedging programs. This increase in Net realized capital gains (losses) was
primarily due to unfavorable changes in the fair value of derivatives related to
(a) hedges designed to mitigate the impact of potential declines in equity
markets on regulatory capital; (b) hedges of VAGLB ceded to SLDI under the
combined coinsurance and coinsurance funds withheld agreement; (c) hedges of
variable annuity guaranteed death benefits; and (d) changes in the fair value of
embedded derivatives on certain product guarantees. These unfavorable changes
were partially offset by changes in the fair value of derivatives used to hedge
FIA products as well as lower credit and intent related impairments on fixed
maturities driven by the improved economic environment.
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Fee income decreased $35.4 from $448.4 to $413.0 due to a decrease in average
variable AUM, driven by the continued runoff of our variable annuity business.
Net investment income decreased $64.7 from $725.9 to $661.2 primarily due to the
loss recorded on the sale of certain alternative investments and due to a
decrease in average general account assets. The sale of certain alternative
investments resulted in a net pretax loss of $16.9 in the second quarter of 2012
reported in Net investment income in the Condensed Statements of Operations.
General account assets decreased as a result of MYGAs lapsing at the end of
their initial terms, largely due to MYGA crediting rates established following
the initial terms that were lower than fixed crediting rates established for
MYGAs during the initial term.
Benefits and Expenses
Total benefits and expenses decreased for the six months ended June 30, 2012
primarily due to lower amortization of DAC/VOBA and a favorable variance in
Interest credited and other benefits to contract owners.
Net amortization of DAC and VOBA changed $83.2 from $129.3 to $46.1 primarily
due to a decrease in amortization resulting from lower current period gross
profits. This is partially offset by unfavorable DAC unlocking primarily due to
a decrease in projected investment margins on the MYGA policies.
Interest credited and other benefits to contract owners decreased $71.8 from
$550.1 to $478.3 primarily due to the transfer of gains (losses) on derivatives
and investment income under the combined coinsurance and coinsurance funds
withheld agreement with SLDI. The corresponding losses and investment income are
reported in Net realized capital gains (losses) and Net investment income,
respectively. This decrease was partially offset by higher amortization on sales
inducements.
Income Taxes
Income tax benefit increased $78.5 from ($5.5) to $73.0 primarily due to a
decrease in income before taxes which was partially offset by an increase in the
tax valuation allowance in the six months ended June 30, 2012 compared to a
decrease in the valuation allowance in the six months ended June 30, 2011.
Financial Condition
Investments
Investment Strategy
Our investment strategy seeks to achieve sustainable risk-adjusted returns by
focusing on principal preservation, disciplined matching of asset
characteristics with liability requirements and the diversification of risks.
Investment activities are undertaken according to investment policy statements
that contain internally established guidelines and risk tolerances and in all
cases are required to comply with applicable laws and insurance regulations.
Risk tolerances are established for credit risk, credit spread risk, market
risk, liquidity risk and concentration risk across issuers, sectors and asset
types that seek to mitigate the impact of cash flow variability arising from
these risks. Investments are managed by ING Investment Management LLC, our
affiliate, pursuant to an investment advisory agreement. Segmented portfolios
are established for groups of products with similar liability characteristics.
Our investment portfolio consists largely of high quality fixed maturity
securities and short-term investments, investments in commercial mortgage loans,
limited partnerships and other instruments, including a small amount of equity
holdings. Fixed maturity securities include publicly issued corporate bonds,
government bonds, privately placed notes and bonds, mortgage-backed securities
and asset-backed securities. We use derivatives for hedging purposes and to
replicate exposure to other assets as a more efficient means of assuming credit
exposure similar to bonds of the underlying issuer(s).
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Portfolio Composition
The following table presents the investment portfolio as of June 30, 2012 and
December 31, 2011.
2012 2011
Carrying % of Carrying % of
Value Total Value Total
Fixed maturities, available-for-sale,
including securities pledged $ 21,963.2 70.8 % $ 22,413.5 72.0 %
Fixed maturities, at fair value using
the fair value option 345.7 1.1 % 335.0 1.1 %
Equity securities, available-for-sale 29.2 0.1 % 27.7 0.1 %
Short-term investments 2,748.9 8.9 % 2,397.0 7.7 %
Mortgage loans on real estate 3,033.7 9.8 % 3,137.3 10.1 %
Policy loans 106.3 0.3 % 112.0 0.4 %
Loan - Dutch State obligation 575.2 1.9 % 658.2 2.1 %
Limited partnerships/corporations 249.8 0.8 % 305.4 1.0 %
Derivatives 1,865.4 6.0 % 1,609.1 5.2 %
Other investments 82.1 0.3 % 82.2 0.3 %
Total investments $ 30,999.5 100.0 % $ 31,077.4 100.0 %
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Fixed Maturities and Equity Securities
Available-for-sale and fair value option ("FVO") fixed maturities and equity
securities were as follows as of June 30, 2012.
Gross Gross
Unrealized Unrealized
Amortized Capital Capital Embedded
Cost Gains Losses Derivatives(3) Fair Value OTTI(2)
Fixed maturities:
U.S. Treasuries $ 1,748.2 $ 101.9 $ 0.1 $ - $ 1,850.0 $ -U.S. government agencies
and authorities 19.4 4.3 - - 23.7 -
State, municipalities and
political subdivisions 89.7 10.9 0.5 - 100.1 -
U.S. corporate securities 9,566.1 887.7 34.9
- 10,418.9 -
Foreign securities(1):
Government 418.8 23.7 3.6 - 438.9 -
Other 4,619.8 391.5 35.5 - 4,975.8 0.1
Total foreign securities 5,038.6 415.2 39.1 - 5,414.7 0.1
Residential mortgage-backed
securities:
Agency 1,169.5 169.2 4.3 43.3 1,377.7 0.2
Non-Agency 635.4 59.2 63.1 16.2 647.7 70.3
Total residential
mortgage-backed securities 1,804.9 228.4 67.4 59.5 2,025.4 70.5
Commercial mortgage-backed
securities 1,717.8 142.9 14.7 - 1,846.0 -
Other asset-backed
securities 670.4 17.9 52.8 (5.4 ) 630.1 0.3
Total fixed maturities,
including securities
pledged 20,655.1 1,809.2 209.5 54.1 22,308.9 70.9
Less: securities pledged 740.7 44.5 1.9 - 783.3 -
Total fixed maturities 19,914.4 1,764.7 207.6 54.1 21,525.6 70.9
Equity securities 27.2 2.6 0.6 - 29.2 -
Total fixed maturities and
equity securities $ 19,941.6 $ 1,767.3 $ 208.2 $ 54.1 $ 21,554.8 $ 70.9
(1) Primarily U.S. dollar denominated.
(2) Represents other-than-temporary impairments ("OTTI") reported as a component of Other comprehensive income.
(3) Embedded derivatives within fixed maturity securities are reported with the host investment. The changes in fair value of
embedded derivatives are reported in Other net realized capital gains (losses) in the Condensed Statements of Operations.
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Available-for-sale and FVO fixed maturities and equity securities were as
follows as of December 31, 2011 (As revised).
Gross Gross
Unrealized Unrealized
Amortized Capital Capital Embedded Fair
Cost Gains Losses Derivatives(3) Value OTTI(2)
Fixed maturities:
U.S. Treasuries $ 1,692.9 $ 92.9 $ - $ - $ 1,785.8 $ -U.S. government agencies
and authorities 19.9 3.8 - - 23.7 -
State, municipalities and
political subdivisions 98.9 6.8 0.9 - 104.8 -
U.S. corporate securities 9,527.7 784.5 41.4
- 10,270.8 -
Foreign securities(1):
Government 349.0 26.7 5.4 - 370.3 -
Other 4,939.4 336.8 64.4 - 5,211.8 0.1
Total foreign securities 5,288.4 363.5 69.8 - 5,582.1 0.1
Residential mortgage-backed
securities
Agency 1,354.6 186.9 2.4 46.4 1,585.5 0.3
Non-Agency 735.4 58.3 88.5 15.1 720.3 75.7
Total residential
mortgage-backed securities 2,090.0 245.2 90.9 61.5 2,305.8 76.0
Commercial mortgage-backed
securities 1,910.3 118.0 26.4 - 2,001.9 1.9
Other asset-backed
securities 734.3 15.4 69.6 (6.5 ) 673.6 -
Total fixed maturities,
including securities
pledged 21,362.4 1,630.1 299.0 55.0 22,748.5 78.0
Less: securities pledged 965.0 49.8 2.0 - 1,012.8 -
Total fixed maturities 20,397.4 1,580.3 297.0 55.0 21,735.7 78.0
Equity securities 26.7 1.8 0.8 - 27.7 -
Total fixed maturities and
equity securities $ 20,424.1 $ 1,582.1 $ 297.8 $ 55.0 $ 21,763.4 $ 78.0
(1) Primarily U.S. dollar denominated.
(2) Represents OTTI reported as a component of Other comprehensive income.
(3) Embedded derivatives within fixed maturity securities are reported with the host investment. The changes in fair value of
embedded derivatives are reported in Other net realized capital gains (losses) in the Condensed Statements of Operations.
Fixed Maturities Securities Credit Quality - Ratings
The Securities Valuation Office ("SVO") of the National Association of Insurance
Commissioners ("NAIC") evaluates the fixed
maturity security investments of insurers for regulatory reporting and capital
assessment purposes and assigns securities to one of six credit quality
categories called "NAIC designations." An internally developed rating is used as
permitted by the NAIC if no rating is available. These designations are
generally similar to the credit quality designations of the NAIC acceptable
rating organizations ("ARO") for marketable fixed maturity securities, called
"rating agency designations," except for certain structured securities as
described below. NAIC designations of "1," highest quality and "2," high
quality, include fixed maturity securities generally considered investment grade
("IG") by such rating organizations. NAIC designations 3 through 6 include fixed
maturity securities generally considered below investment grade ("BIG") by such
rating organizations.
The NAIC adopted revised designation methodologies for non-agency Residential
mortgage-backed securities ("RMBS"), including RMBS backed by subprime mortgage
loans reported within other Asset-backed securities ("ABS") that became
effective
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December 31, 2009 and for Commercial mortgage-backed securities ("CMBS") that
became effective December 31, 2010. The NAIC's objective with the revised
designation methodologies for these structured securities was to increase the
accuracy in assessing expected losses and to use the improved assessment to
determine a more appropriate capital requirement for such structured securities.
The revised methodologies reduce regulatory reliance on rating agencies and
allow for greater regulatory input into the assumptions used to estimate
expected losses from such structured securities.
As a result of time lags between the funding of investments, the finalization of
legal documents and the completion of the SVO filing process, the fixed maturity
portfolio generally includes securities that have not yet been rated by the SVO
as of each balance sheet date, such as private placements. Pending receipt of
SVO ratings, the categorization of these securities by NAIC designation is based
on the expected ratings indicated by internal analysis.
Information about our fixed maturity securities holdings, including securities
pledged, by NAIC designations is set forth in the following tables.
Corresponding rating agency designation does not directly translate into NAIC
designation, but represents our best estimate of comparable ratings from rating
agencies, including Moody's Investors Service ("Moody's"), Standard & Poor's
("S&P") and Fitch Ratings Ltd. ("Fitch"). If no rating is available from a
rating agency, then an internally developed rating is used on a basis believed
to be similar to that used by the rating agencies.
The fixed maturities in our portfolio are generally rated by external rating
agencies and, if not externally rated, are rated by us. As of June 30, 2012 and
December 31, 2011, the average quality rating of our fixed maturities portfolio
was A. Ratings are derived from three ARO ratings and are applied as follows
based on the number of agency rating received:
? when three ratings are received then the middle rating is applied;
? when two ratings are received then the lower rating is applied;
? when a single rating is received, the ARO rating is applied; and
? when ratings are unavailable then an internal rating is applied.
Total fixed maturities by NAIC quality designation category, including
securities pledged to creditors, were as follows as of June 30, 2012 and
December 31, 2011.
2012
NAIC Quality Fair % of Amortized % of
Designation Value Total Cost Total
1 $ 12,687.1 56.9 % $ 11,662.9 56.5 %
2 8,577.7 38.4 % 7,944.3 38.5 %
3 715.7 3.2 % 730.5 3.5 %
4 122.8 0.6 % 137.5 0.7 %
5 142.9 0.6 % 150.6 0.7 %
6 62.7 0.3 % 29.3 0.1 %
Total $ 22,308.9 100.0 % $ 20,655.1 100.0 %
2011
NAIC Quality Fair % of Amortized % of
Designation Value Total Cost Total
1 $ 13,324.2 58.6 % $ 12,420.9 58.1 %
2 8,152.0 35.8 % 7,679.6 36.0 %
3 905.7 4.0 % 907.9 4.2 %
4 173.8 0.8 % 199.3 1.0 %
5 117.4 0.5 % 113.6 0.5 %
6 75.4 0.3 % 41.1 0.2 %
Total $ 22,748.5 100.0 % $ 21,362.4 100.0 %
Total fixed maturities by ARO quality rating category, including securities
pledged to creditors, were as follows as of June 30, 2012 and December 31,
2011.
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2012
ARO Quality Fair % of Amortized % of
Rating Value Total Cost Total
AAA $ 4,865.2 21.8 % $ 4,438.2 21.5 %
AA 1,502.7 6.7 % 1,400.7 6.8 %
A 5,958.6 26.7 % 5,454.2 26.4 %
BBB 8,606.7 38.6 % 7,971.8 38.5 %
BB 695.1 3.1 % 677.4 3.3 %
B and below 680.6 3.1 % 712.8 3.5 %
Total $ 22,308.9 100.0 % $ 20,655.1 100.0 %
2011
ARO Quality Fair % of Amortized % of
Rating Value Total Cost Total
AAA $ 5,312.8 23.4 % $ 4,892.1 22.9 %
AA 1,464.5 6.4 % 1,373.7 6.4 %
A 6,327.4 27.9 % 5,895.1 27.6 %
BBB 8,107.7 35.5 % 7,636.8 35.8 %
BB 831.4 3.7 % 809.8 3.8 %
B and below 704.7 3.1 % 754.9 3.5 %
Total $ 22,748.5 100.0 % $ 21,362.4 100.0 %
As of June 30, 2012 and December 31, 2011, 93.8% and 93.2% of the fixed
maturities were invested in securities rated BBB and above (Investment Grade
("IG")) respectively.
Fixed maturities rated BB and below (Below Investment Grade ("BIG")) may have
speculative characteristics and changes in economic conditions or other
circumstances are more likely to lead to a weakened capacity of the issuer to
make principal and interest payments than is the case with higher rated fixed
maturities.
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Total fixed maturities by market sector, including securities pledged to
creditors, were as follows as of June 30, 2012 and December 31, 2011.
2012
Fair % of Amortized % of
Value Total Cost Total
U.S. Treasuries $ 1,850.0 8.3 % $ 1,748.2 8.5 %
U.S. government agencies and authorities 23.7 0.1 % 19.4 0.1 %
U.S. corporate, state and municipalities 10,519.0 47.1 % 9,655.8 46.7 %
Foreign 5,414.7 24.3 % 5,038.6 24.4 %
Residential mortgage-backed 2,025.4 9.1 % 1,804.9 8.8 %
Commercial mortgage-backed 1,846.0 8.3 % 1,717.8 8.3 %
Other asset-backed 630.1 2.8 % 670.4 3.2 %
Total $ 22,308.9 100.0 % $ 20,655.1 100.0 %
2011
Fair % of Amortized % of
Value Total Cost Total
U.S. Treasuries $ 1,785.8 7.9 % $ 1,692.9 7.9 %
U.S. government agencies and authorities 23.7 0.1 % 19.9 0.1 %
U.S. corporate, state and municipalities 10,375.6 45.6 % 9,626.6 45.1 %
Foreign 5,582.1 24.5 % 5,288.4 24.8 %
Residential mortgage-backed 2,305.8 10.1 % 2,090.0 9.8 %
Commercial mortgage-backed 2,001.9 8.8 % 1,910.3 8.9 %
Other asset-backed 673.6 3.0 % 734.3 3.4 %
Total $ 22,748.5 100.0 % $ 21,362.4 100.0 %
The amortized cost and fair value of fixed maturities, including securities
pledged, as of June 30, 2012, are shown below by contractual maturity. Actual
maturities may differ from contractual maturities as securities may be
restructured, called, or prepaid. Mortgage-backed securities ("MBS") and ABS are
shown separately because they are not due at a single maturity date.
Amortized Fair
Cost Value
Due to mature:
One year or less $ 1,307.3 $ 1,338.2
After one year through five years 5,181.9 5,393.2
After five years through ten years 6,098.1 6,600.2
After ten years 3,874.7 4,475.8
Mortgage-backed securities 3,522.7 3,871.4
Other asset-backed securities 670.4 630.1
Fixed maturities, including securities pledged $ 20,655.1$ 22,308.9
The investment portfolio is monitored to maintain a diversified portfolio on an
on-going basis. Credit risk is mitigated by monitoring concentrations by issuer,
sector and geographic stratification and limiting exposure to any one issuer.
As of June 30, 2012 and December 31, 2011, we did not have any investments in a
single issuer, other than obligations of the U.S. government and government
agencies and the State of the Netherlands (the "Dutch State") loan obligation,
with a carrying value in excess of 10% of our Shareholder's equity.
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We invest in various categories of collateralized mortgage obligations ("CMOs"),
including CMOs that are not agency-backed, that are subject to different degrees
of risk from changes in interest rates and defaults. The principal risks
inherent in holding CMOs are prepayment and extension risks related to
significant decreases and increases in interest rates resulting in the
prepayment of principal from the underlying mortgages, either earlier or later
than originally anticipated. As of June 30, 2012 and December 31, 2011,
approximately 30.2% and 28.3%, respectively, of our CMO holdings were invested
in those types of CMOs such as interest only or principal only strips, which are
subject to more prepayment and extension risk than traditional CMOs.
We are a member of the Federal Home Loan Bank of Des Moines ("FHLB") and are
required to maintain a collateral deposit that backs funding agreements issued
to the FHLB. As of June 30, 2012 and December 31, 2011, we had $1,579.6, in
non-putable funding agreements, including accrued interest, issued to the FHLB.
These non-putable funding agreements are included in Future policy benefits and
claims reserves, on the Condensed Balance Sheets. As of June 30, 2012 and
December 31, 2011, assets with a market value of $1,898.0 and $1,897.9,
respectively, collateralized the funding agreements to the FHLB. Assets pledged
to the FHLB are included in Fixed maturities, available-for-sale, on the
Condensed Balance Sheets.
Subprime and Alt-A Mortgage Exposure
Underlying collateral, originated prior to 2008, has continued to reflect the
problems associated with a housing market that has experienced substantial price
declines and an employment market that declined significantly and remains under
stress. Credit spreads have widened meaningfully from issuance and rating
agency downgrades have been widespread and severe within the sector. Over the
course of 2010 and 2011, market prices and liquidity within the sector exhibited
volatility, driven by various factors, both domestically and globally. During
the first half of 2012, market prices and sector liquidity exhibited sustained
improvements, driven by an improved technical picture and positive sentiment
regarding the potential for fundamental improvements within the sector. In
managing our risk exposure to subprime and Alt-A mortgages, we take into account
collateral performance and structural characteristics associated with our
various positions.
We do not originate or purchase subprime or Alt-A whole-loan mortgages. We do
have exposure to RMBS and ABS. Subprime lending is the origination of loans to
customers with weaker credit profiles. We define Alt-A Loans to include the
following: residential mortgage loans to customers who have strong credit
profiles but lack some element(s), such as documentation to substantiate income;
residential mortgage loans to borrowers that would otherwise be classified as
prime but whose loan structure provides repayment options to the borrower that
increase the risk of default; and any securities backed by residential mortgage
collateral not clearly identifiable as prime or subprime.
Our exposure to subprime mortgages was primarily in the form of ABS structures
collateralized by subprime residential mortgages and the majority of these
holdings were included in other asset-backed securities in the fixed maturities
by market sector table previously referenced. As of June 30, 2012, the fair
value and gross unrealized losses related to our exposure to subprime mortgages
was $186.8 and $52.9, respectively, representing 0.8% of total fixed maturities,
including securities pledged. As of December 31, 2011, the fair value and gross
unrealized losses related to our exposure to subprime mortgages were $189.3 and
$69.7, respectively, representing 0.8% of total fixed maturities, including
securities pledged.
The following tables summarize our exposure to subprime mortgage-backed holdings
by credit quality using NAIC designations, ARO ratings and vintage year as of
June 30, 2012 and December 31, 2011:
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% of Total Subprime Mortgage-backed Securities
NAIC Designation ARO Rating Vintage
2012
1 77.9 % AAA 0.5 % 2007 16.0 %
2 6.7 % AA 4.0 % 2006 7.3 %
3 11.3 % A 10.3 % 2005 and prior 76.7 %
4 1.9 % BBB 4.9 % 100.0 %
5 1.0 % BB and below 80.3 %
6 1.2 % 100.0 %
100.0 %
2011
1 79.0 % AAA 1.6 % 2007 18.9 %
2 6.2 % AA 5.9 % 2006 6.6 %
3 10.5 % A 7.9 % 2005 and prior 74.5 %
4 1.5 % BBB 9.8 % 100.0 %
5 1.3 % BB and below 74.8 %
6 1.5 % 100.0 %
100.0 %
Our exposure to Alt-A mortgages was included in "residential mortgage-backed
securities" line item in the "Fixed Maturities" table under "Fixed Maturities"
above. As of June 30, 2012, the fair value and gross unrealized losses related
to our exposure to Alt-A RMBS aggregated to $127.4 and $43.2, respectively,
representing 0.6% of total fixed maturities including securities pledged. As of
December 31, 2011, the fair value and gross unrealized losses related to our
exposure to Alt-A RMBS aggregated to $129.7 and $52.7, respectively,
representing 0.6 % of total fixed maturities, including securities pledged.
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The following tables summarize our exposure to Alt-A residential mortgage-backed
securities by credit quality using NAIC designations, ARO ratings and vintage
year as of June 30, 2012 and December 31, 2011:
% of Total Alt-A Mortgage-backed Securities
NAIC Designation ARO Rating Vintage
2012
1 44.2 % AAA 0.4 % 2007 30.5 %
2 10.8 % AA 1.2 % 2006 18.7 %
3 13.5 % A 3.7 % 2005 and prior 50.8 %
4 22.8 % BBB 2.2 % 100.0 %
5 7.8 % BB and below 92.5 %
6 0.9 % 100.0 %
100.0 %
2011
1 38.5 % AAA 0.3 % 2007 30.0 %
2 11.6 % AA 1.7 % 2006 18.9 %
3 12.2 % A 5.0 % 2005 and prior 51.1 %
4 29.1 % BBB 2.9 % 100.0 %
5 7.4 % BB and below 90.1 %
6 1.2 % 100.0 %
100.0 %
Commercial Mortgage-backed and Other Asset-backed Securities
Similar to what has been observed in non-agency RMBS, delinquency rates on
commercial mortgages have been elevated since the credit crisis, reflecting the
significant deterioration in commercial real estate values and challenged credit
environment. In late 2011 and early 2012, the pace of increase in commercial
mortgage delinquencies exhibited signs of stabilization and, in more limited
instances, signs of improvements. In addition, other performance metrics like
vacancies, property values and rent levels have exhibited improvements,
providing signals of a recovery in commercial real estate.
The primary market for CMBS has contributed to the recovery, with meaningful new
issuance volumes in 2012 contributing to an improvement in the credit
environment.
For consumer asset-backed securities, delinquency and loss rates have exhibited
meaningful and sustained improvements post credit crisis. These sustained
improvements have been observed in a wide range of credit metrics across
multiple types of asset-backed loans. This has positively impacted the market
values of consumer asset-backed securities.
As of June 30, 2012 and December 31, 2011, the fair value of our CMBS totaled
$1.8 billion and $2.0 billion, respectively, and other ABS, excluding subprime
exposure, totaled $448.4 and $489.7, respectively. CMBS investments represent
pools of commercial mortgages that are broadly diversified across property types
and geographical areas. As of June 30, 2012 and December 31, 2011, the gross
unrealized losses related to CMBS totaled $14.7 and $26.4 respectively, and
gross unrealized losses related to Other ABS, excluding subprime exposure,
totaled $0.1 and $0.2, respectively.
As of June 30, 2012, the other ABS was also broadly diversified both by type and
issuer with credit card receivables, nonconsolidated collateralized loan
obligations and automobile receivables, comprising 30.2%, 12.8% and 29.9%,
respectively, of total Other ABS, excluding subprime exposure. As of
December 31, 2011, Other ABS was also broadly diversified both by type and
issuer with credit card receivables, nonconsolidated collateralized loan
obligations and automobile receivables, comprising 31.6%, 13.1% and 31.3%,
respectively, of total Other ABS, excluding subprime exposure.
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The following tables summarize our exposure to CMBS holdings by credit quality
using NAIC designations, ARO ratings and vintage year as of June 30, 2012 and
December 31, 2011:
% of Total CMBS
NAIC Designation ARO Rating Vintage
2012
1 95.2 % AAA 45.5 % 2008 0.5 %
2 2.1 % AA 20.0 % 2007 28.7 %
3 1.6 % A 11.7 % 2006 33.9 %
4 - % BBB 13.1 % 2005 and prior 36.9 %
5 1.1 % BB and below 9.7 % 100.0 %
6 - % 100.0 %
100.0 %
2011
1 97.1 % AAA 52.7 % 2008 0.5 %
2 1.8 % AA 18.4 % 2007 25.9 %
3 - % A 12.7 % 2006 31.2 %
4 - % BBB 8.8 % 2005 and prior 42.4 %
5 - % BB and below 7.4 % 100.0 %
6 1.1 % 100.0 %
100.0 %
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The following tables summarize our exposure to Other ABS holdings, excluding
subprime exposure, by credit quality using NAIC designations, ARO ratings and
vintage year as of June 30, 2012 and December 31, 2011:
% of Total Other ABS
NAIC Designation ARO Rating Vintage
2012
1 94.7 % AAA 88.8 % 2012 8.5 %
2 2.9 % AA 2.6 % 2011 18.8 %
3 - % A 3.3 % 2010 5.2 %
4 0.1 % BBB 2.9 % 2009 6.7 %
5 2.3 % BB and below 2.4 % 2008 3.5 %
6 - % 100.0 % 2007 14.6 %
100.0 % 2006 22.9 %
2005 and prior 19.8 %
100.0 %
2011
1 96.0 % AAA 86.1 % 2011 18.7 %
2 1.8 % AA 3.8 % 2010 10.7 %
3 - % A 3.0 % 2009 8.3 %
4 0.1 % BBB 3.8 % 2008 3.6 %
5 2.1 % BB and below 3.3 % 2007 19.3 %
6 - % 100.0 % 2006 20.2 %
100.0 % 2005 and prior 19.2 %
100.0 %
Mortgage Loans on Real Estate
Our mortgage loans on real estate are all commercial mortgage loans, which
totaled $3.0 billion and $3.1 billion as of June 30, 2012 and December 31, 2011,
respectively. These loans are reported at amortized cost, less impairment
write-downs and allowance for losses.
We diversify our commercial mortgage loan portfolio by geographic region and
property type to reduce concentration risk. We manage risk when originating
commercial mortgage loans by generally lending only up to 75% of the estimated
fair value of the underlying real estate. Subsequently, we continuously
evaluate all mortgage loans based on relevant current information including an
appraisal of loan-specific credit quality, property characteristics and market
trends. Loan performance is monitored on a loan-specific basis through the
review of submitted appraisals, operating statements, rent revenues and annual
inspection reports, among other items. This review ensures properties are
performing at a consistent and acceptable level to secure the debt.
All commercial mortgages are evaluated for the purpose of quantifying the level
of risk. Those loans with higher risk are placed on a watch list and are
closely monitored for collateral deficiency or other credit events that may lead
to a potential loss of principal or interest. If the value of any mortgage loan
is determined to be impaired (i.e., when it is probable that we will be unable
to collect on all amounts due according to the contractual terms of the loan
agreement), the carrying value of the mortgage loan is reduced to the lower of
the present value of expected cash flows from the loan, discounted at the loan's
effective interest rate, or fair value of the collateral. There were no
impairments taken on the mortgage loan portfolio for the three and six months
ended June 30, 2012. Impairments taken on the mortgage loan portfolio were $0.3
and $2.3 for the three and six months ended June 30, 2011, respectively. For
those mortgages that are determined to require foreclosure, the carrying value
is reduced to the fair value of the underlying collateral, net of estimated
costs to obtain and sell at the point of foreclosure. There were no mortgage
loans in our portfolio in arrears with respect to principal and interest as of
June 30, 2012 and December 31, 2011. Due to challenges that the economy presents
to the commercial mortgage market, we recorded an allowance for probable
incurred, but not specifically identified, losses related to factors inherent in
the lending process. As of June 30, 2012 and December 31, 2011, we had a $1.5
allowance for mortgage loan credit losses.
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Loan-to-value ("LTV") and debt service coverage ("DSC") ratios are measures
commonly used to assess the risk and quality of commercial mortgage loans. The
LTV ratio, calculated at time of origination, is expressed as a percentage of
the amount of the loan relative to the value of the underlying property. The DSC
ratio, based upon the most recently received financial statements, is expressed
as a percentage of the amount of a property's net income to its debt service
payments. These ratios are utilized as part of the review process described
above. LTV and DSC ratios as of June 30, 2012 and December 31, 2011, are as
follows:
2012(1) 2011(1)
Loan-to-Value Ratio:
0% - 50% $ 838.1 $ 920.9
50% - 60% 868.6 833.9
60% - 70% 1,139.5 1,173.2
70% - 80% 177.5 191.3
80% - 90% 11.5 19.5
Total Commercial mortgage loans $ 3,035.2 $ 3,138.8
(1) Balances do not include allowance for mortgage loan credit losses.
2012(1) 2011(1)
Debt Service Coverage Ratio:
Greater than 1.5x $ 2,047.8 $ 2,105.3
1.25x - 1.5x 566.8 565.8
1.0x - 1.25x 321.8 355.5
Less than 1.0x 98.8 112.2
Commercial mortgages secured by loans on land or
construction loans - -
Total Commercial mortgage loans $ 3,035.2 $
3,138.8
(1) Balances do not include allowance for mortgage loan credit losses.
Properties collateralizing mortgage loans are geographically dispersed
throughout the United States, as well as diversified by property type, as
reflected in the following tables as of June 30, 2012 and December 31, 2011.
2012(1) 2011(1)
Gross Gross
Carrying Value % of Total Carrying Value % of Total
Commercial mortgage loans by
U.S. Region:
Pacific $ 661.9 21.8 % $ 702.5 22.4 %
South Atlantic 581.3 19.1 % 582.8 18.6 %
Middle Atlantic 341.9 11.2 % 361.7 11.5 %
East North Central 393.6 13.0 % 411.4 13.1 %
West South Central 407.3 13.4 % 414.1 13.2 %
Mountain 355.0 11.7 % 364.9 11.6 %
New England 81.3 2.7 % 82.2 2.6 %
West North Central 135.2 4.5 % 138.2 4.4 %
East South Central 77.7 2.6 % 81.0 2.6 %
Total Commercial mortgage
loans $ 3,035.2 100.0 % $ 3,138.8 100.0 %
(1) Balances do not include allowance for mortgage loan credit losses.
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2012(1) 2011(1)
Gross Gross
Carrying Value % of Total Carrying Value % of TotalCommercial mortgage loans by
Property Type:
Apartments $ 353.6 11.6 % $ 371.5 11.8 %
Hotel/Motel 128.9 4.2 % 129.6 4.1 %
Industrial 1,188.6 39.2 % 1,223.2 39.0 %
Office 525.2 17.3 % 542.2 17.3 %
Other 54.3 1.8 % 52.3 1.7 %
Retail 767.8 25.3 % 807.4 25.7 %
Mixed use 16.8 0.6 % 12.6 0.4 %
Total Commercial mortgage
loans $ 3,035.2 100.0 % $ 3,138.8 100.0 %
(1) Balances do not include allowance for mortgage loan credit losses.
The following table sets forth the breakdown of commercial mortgages by year of
origination as of June 30, 2012 and December 31, 2011.
2012(1) 2011(1)
Year of Origination:
2012 $ 120.3 $ -
2011 807.8 791.2
2010 187.0 272.1
2009 77.2 77.8
2008 403.0 406.5
2007 399.2 447.7
2006 and prior 1,040.7 1,143.5
Total Commercial mortgage loans $ 3,035.2 $ 3,138.8
(1) Balances do not include allowance for mortgage loan credit losses.
Troubled Debt Restructuring
We invest in high quality, well performing portfolios of commercial mortgage
loans and private placements. Under certain circumstances, modifications to
these contracts are granted. Each modification is evaluated as to whether a
troubled debt restructuring has occurred. A modification is a troubled debt
restructure when the borrower is in financial difficulty and the creditor makes
concessions. Generally, the types of concessions may include reducing the face
amount or maturity amount of the debt as originally stated, reducing the
contractual interest rate, extending the maturity date at an interest rate lower
than current market interest rates and/or reducing accrued interest. We consider
the amount, timing and extent of the concession granted in determining any
impairment or changes in the specific valuation allowance recorded in connection
with the troubled debt restructuring. A valuation allowance may have been
recorded prior to the quarter when the loan is modified in a troubled debt
restructuring. Accordingly, the carrying value (net of the specific valuation
allowance) before and after modification through a troubled debt restructuring
may not change significantly, or may increase if the expected recovery is higher
than the pre-modification recovery assessment.
During the three and six months ended June 30, 2012, we had no mortgage loans
modified in a troubled debt restructuring with a subsequent payment default.
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Unrealized Capital Losses
Unrealized capital losses (including noncredit impairments) in fixed maturities,
including securities pledged to creditors, for IG and BIG securities by
duration, based on NAIC designations, were as follows as of June 30, 2012 and
December 31, 2011.
2012 2011
% of IG % of IG % of IG % of IG
IG and BIG BIG and BIG IG and BIG BIG and BIG
Six months or
less below
amortized cost $ 19.0 9.1 % $ 4.4 2.1 % $ 40.0 13.4 % $ 10.9 3.6 %
More than six
months and
twelve months or
less below
amortized cost 8.6 4.1 % 5.5 2.6 % 38.3 12.8 % 4.0 1.3 %
More than twelve
months below
amortized cost 92.7 44.2 % 79.3 37.9 % 136.5 45.7 % 69.3 23.2 %
Total unrealized
capital losses $ 120.3 57.4 % $ 89.2 42.6 % $ 214.8
71.9 % $ 84.2 28.1 %
Unrealized capital losses (including noncredit impairments) in fixed maturities,
including securities pledged to creditors, for securities rated IG and
securities rated BIG by duration, based on ARO ratings, were as follows as of
June 30, 2012 and December 31, 2011.
2012 2011
% of IG % of IG % of IG % of IG
IG and BIG BIG and BIG IG and BIG BIG and BIG
Six months or
less below
amortized cost $ 14.7 7.0 % $ 8.7 4.3 % $ 40.3 13.5 % $ 10.6 3.5 %
More than six
months and
twelve months or
less below
amortized cost 8.1 3.9 % 6.0 3.0 % 26.9 9.0 % 15.4 5.2 %
More than twelve
months below
amortized cost 37.8 17.9 % 134.2 63.9 % 69.8 23.3 % 136.0 45.5 %
Total unrealized
capital losses $ 60.6 28.8 % $ 148.9 71.2 % $ 137.0 45.8 % $ 162.0 54.2 %
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Unrealized capital losses (including noncredit impairments), along with the fair
value of fixed maturities, including securities pledged, by market sector and
duration were as follows as of June 30, 2012 and December 31, 2011.
More Than
Six
Six Months or Less Below Amortized Months and Twelve Months or Less More Than Twelve Months Below
Cost Below Amortized Cost Amortized Cost Total
Unrealized Unrealized Unrealized Unrealized
Fair Value Capital Losses Fair Value Capital Losses Fair Value Capital Losses Fair Value Capital Losses
2012
U.S. Treasuries $ 516.5 $ 0.1 $ - $ - $ - $ - $ 516.5 $ 0.1
U.S. corporate,
state and
municipalities 546.1 9.1 103.5 5.5 228.5 20.8 878.1 35.4
Foreign 183.2 8.2 98.8 7.8 141.0 23.1 423.0 39.1
Residential
mortgage-backed 162.1 1.8 14.5 0.7 317.8 64.9 494.4 67.4
Commercial
mortgage-backed 147.6 3.8 - - 135.9 10.9 283.5 14.7
Other
asset-backed 12.2 0.4 6.0 0.1 152.5 52.3 170.7 52.8
Total $ 1,567.7 $ 23.4 $ 222.8 $ 14.1 $ 975.7 $ 172.0 $ 2,766.2 $ 209.5
2011
U.S. Treasuries $ - $ - $ - $ - $ - $ - $ - $ -
U.S. corporate,
state and
municipalities 798.9 17.6 97.6 4.1 208.0 20.6 1,104.5 42.3
Foreign 476.5 30.2 51.1 5.0 339.5 34.6 867.1 69.8
Residential
mortgage-backed 74.6 0.9 188.2 5.7 305.6 84.3 568.4 90.9
Commercial
mortgage-backed 155.1 1.9 234.7 17.9 35.7 6.6 425.5 26.4
Other
asset-backed 42.6 0.3 26.5 9.6 142.1 59.7 211.2 69.6
Total $ 1,547.7 $ 50.9 $ 598.1 $ 42.3 $ 1,030.9 $ 205.8 $ 3,176.7 $ 299.0
Of the unrealized capital losses aged more than twelve months, the average
market value of the related fixed maturities was 85.0% and 83.4%% of the average
book value as of June 30, 2012 and December 31, 2011, respectively.
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Unrealized capital losses (including noncredit impairments) in fixed maturities,
including securities pledged to creditors, for instances in which fair value
declined below amortized cost by greater than or less than 20% for consecutive
months as indicated in the tables below, were as follows as of June 30, 2012 and
December 31, 2011.
Amortized Cost Unrealized Capital Losses Number of Securities
< 20% > 20% < 20% > 20% < 20% > 20%
2012
Six months or less below
amortized cost $ 1,704.9 $ 78.6 $ 38.5 $ 21.5 192 19
More than six months and
twelve months or less
below amortized cost 233.3 65.4 11.3 23.1 42 19
More than twelve months
below amortized cost 670.6 222.9 33.3 81.8 111 87
Total $ 2,608.8 $ 366.9 $ 83.1 $ 126.4 345 125
2011
Six months or less below
amortized cost $ 1,638.7 $ 178.0 $ 52.5 $ 52.5 271 49
More than six months and
twelve months or less
below amortized cost 645.4 57.1 38.0 17.3 67 22
More than twelve months
below amortized cost 735.1 221.4 47.0 91.7 126 80
Total $ 3,019.2 $ 456.5 $ 137.5 $ 161.5 464 151
Unrealized capital losses (including noncredit impairments) in fixed maturities,
including securities pledged to creditors, by market sector for instances in
which fair value declined below amortized cost by greater than or less than 20%
for consecutive months as indicated in the tables below, were as follows as of
June 30, 2012 and December 31, 2011.
Amortized Cost Unrealized Capital Losses Number of Securities
< 20% > 20% < 20% > 20% < 20% > 20%
2012
U.S. Treasuries $ 516.6 $ - $ 0.1 $ - 2 0
U.S. corporate, state and
municipalities 877.4 36.1 19.9 15.5 121 5
Foreign 388.0 74.1 18.3 20.8 60 11
Residential mortgage-backed 445.9 115.9 24.9 42.5 101 73
Commercial mortgage-backed 284.6 13.6 11.1 3.6 20 3
Other asset-backed 96.3 127.2 8.8 44.0 41 33
Total $ 2,608.8 $ 366.9 $ 83.1 $ 126.4 345 125
2011
U.S. Treasuries $ - $ - $ - $ - 0 0
U.S. corporate, state and
municipalities 1,112.3 34.5 32.4 9.9 137 5
Foreign 850.6 86.3 41.7 28.1 131 12
Residential mortgage-backed 500.9 158.4 31.7 59.2 98 89
Commercial mortgage-backed 446.3 5.6 25.1 1.3 24 1
Other asset-backed 109.1 171.7 6.6 63.0 74 44
Total $ 3,019.2 $ 456.5 $ 137.5 $ 161.5 464 151
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For the six months ended June 30, 2012, unrealized capital losses on fixed
maturities decreased by $89.5. The decrease in gross unrealized losses is
primarily due to market improvement and the overall declining yields, leading to
higher fair value of fixed maturities.
As of June 30, 2012 and December 31, 2011, we held no fixed maturities with an
unrealized capital loss in excess of $10.0.
All investments with fair values less than amortized cost are included in our
other-than-temporary impairment analysis and impairments were recognized as
disclosed in "Evaluating Securities for Other-Than-Temporary Impairments"
section, which follows this section. After detailed impairment analysis was
completed, we determined that the remaining investments in an unrealized loss
position were not other-than-temporarily impaired and therefore no further
other-than-temporary impairment was necessary.
Evaluating Securities for Other-than-Temporary Impairments
We perform a regular evaluation, on a security-by-security basis, of our
available-for-sale securities holdings, including fixed maturity securities and
equity securities in accordance with its impairment policy in order to evaluate
whether such investments are other-than-temporarily impaired.
The following tables identify our credit-related and intent-related
other-than-temporary impairments included in the Condensed Statements of
Operations, excluding noncredit impairments included in Other comprehensive
income (loss), by type for the three and six months ended June 30, 2012 and
2011.
Three Months Ended June 30,
2012 2011
No. of No. of
Impairment Securities Impairment Securities
U.S. corporate $ 0.5 1 $ 1.2 1
Foreign(1) 0.3 1 1.2 4
Residential mortgage-backed 1.2 30 2.4 39
Commercial mortgage-backed - 0 9.2 10
Other asset-backed 0.1 1 9.5 28
Mortgage loans on real estate - 0 0.3
1
Total $ 2.1 33 $ 23.8
83
(1) Primarily U.S. dollar denominated.
Six Months Ended June 30,
2012 2011
No. of No. of
Impairment Securities Impairment Securities
U.S. corporate $ 0.5 1 $ 3.1 4
Foreign(1) 0.7 3 4.0 12
Residential mortgage-backed 2.7 41 2.9 41
Commercial mortgage-backed 1.7 1 10.4 10
Other asset-backed 0.3 3 63.2 51
Mortgage loans on real estate - 0 2.3 3
Total $ 5.9 49 $ 85.9
121
(1) Primarily U.S. dollar denominated.
The above tables include $1.4 and $3.0 of write-downs related to credit
impairments for the three and six months ended June 30, 2012, respectively, in
Other-than-temporary impairments, which are recognized in the Condensed
Statements of Operations. The remaining $0.7 and $2.9 in write-downs for the
three and six months ended June 30, 2012, respectively, are related to intent
impairments.
The above tables include $2.8 and $9.5 of write-downs related to credit
impairments for the three and six months ended June 30, 2011, respectively, in
Other-than-temporary impairments, which are recognized in the Condensed
Statements of Operations. The
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remaining $21.0 and $76.4 in write-downs for the three and six months ended
June 30, 2011, respectively, are related to intent impairments.
The following tables summarize these intent impairments, which are also
recognized in earnings, by type for the three and six months ended June 30, 2012
and 2011.
Three Months Ended June 30,
2012 2011
No. of No. of
Impairment Securities Impairment Securities
U.S. corporate $ 0.4 1 $ 1.2 1
Foreign(1) 0.3 1 1.1 1
Commercial mortgage-backed - 0 9.2 10
Other asset-backed - 0 9.5 28
Total $ 0.7 2 $ 21.0 40
(1) Primarily U.S. dollar denominated.
Six Months Ended June 30,
2012 2011
No. of No. of
Impairment Securities Impairment Securities
U.S. corporate $ 0.4 1 $ 3.1 4
Foreign(1) 0.7 3 2.4 9
Commercial mortgage-backed 1.7 1 9.2 10
Other asset-backed 0.1 1 61.7 51
Total $ 2.9 6 $ 76.4 74(1) Primarily U.S. dollar denominated.
We may sell securities during the period in which fair value has declined below
amortized cost for fixed maturities or cost for equity securities. In certain
situations, new factors, including changes in the business environment, can
change our previous intent to continue holding a security. Accordingly, these
factors may lead us to record additional intent related capital losses.
The fair value of fixed maturities with OTTI as of June 30, 2012 and 2011 was
$1.9 billion and $2.2 billion, respectively.
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The following tables identify the amount of credit impairments on fixed
maturities for which a portion of the OTTI was recognized in Other comprehensive
income (loss) and the corresponding changes in such amounts for the three and
six months ended June 30, 2012 and 2011.
Three Months Ended June 30,
2012 2011
Balance at April 1 $ 61.5 $ 112.8
Additional credit impairments:
On securities not previously impaired 0.4
0.1
On securities previously impaired 1.0
2.4
Reductions:
Securities intent impairments - (0.6 )
Securities sold, matured, prepaid or paid down (2.4 ) (22.1 )
Balance at June 30 $ 60.5 $ 92.6
Six Months Ended June 30,
2012 2011
Balance at January 1 $ 64.1 $ 136.5
Additional credit impairments:
On securities not previously impaired 0.4 0.5
On securities previously impaired 2.5
4.2
Reductions:
Securities intent impairments - (16.9 )
Securities sold, matured, prepaid or paid down (6.5 ) (31.7 )
Balance at June 30 $ 60.5 $ 92.6
Net Investment Income
We use the equity method of accounting for investments in limited partnership
interests that are not consolidated. This asset group consists primarily of
private equities, hedge funds and certain VIEs. We record our share of earnings
using a lag methodology, relying upon the most recent financial information
available, generally not to exceed three months, where the contractual right
exists to receive such financial information on a timely basis. Our equity in
earnings from limited partnership interests accounted for under the equity
method is recorded in Net investment income.
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The following tables summarize Net investment income (loss) for the three and
six months ended June 30, 2012 and 2011.
Three Months Ended June 30,
2012 2011
Fixed maturities $ 285.9 $ 315.0
Equity securities, available-for-sale 1.0 0.9
Mortgage loans on real estate 44.6 42.8
Policy loans 1.5 1.6
Short-term investments and cash equivalents 0.1 0.6
Other (4.8 ) 21.9
Gross investment income 328.3 382.8
Less: investment expenses (13.1 ) (14.3 )
Net investment income $ 315.2 $ 368.5
Six Months Ended June 30,
2012 2011
Fixed maturities $ 585.2 $ 622.5
Equity securities, available-for-sale 1.8 5.1
Mortgage loans on real estate 86.7 84.4
Policy loans 2.9 3.3
Short-term investments and cash equivalents 0.3 1.4
Other 10.7 38.1
Gross investment income 687.6 754.8
Less: investment expenses (26.4 ) (28.9 )
Net investment income $ 661.2 $ 725.9
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Net Realized Capital Gains (Losses)
Net realized capital gains (losses) are comprised of the difference between the
amortized cost of investments and proceeds from sale and redemption, as well as
losses incurred due to credit-related and intent-related other-than-temporary
impairment of investments. Realized investment gains and losses are also
generated primarily from changes in fair value of embedded derivatives within
product guarantees and fixed maturities, changes in fair value of fixed
maturities recorded at FVO and changes in fair value including accruals on
derivative instruments, except for effective cash flow hedges. The cost of the
investments on disposal is generally determined based on first-in-first-out
("FIFO") methodology. Net realized capital gains (losses) were as follows for
the three and six months ended June 30, 2012 and 2011.
Three Months Ended June 30,
2012 2011
Fixed maturities, available-for-sale, including
securities pledged $ 17.8
$ 36.2
Fixed maturities, at fair value using the fair value
option
(3.1 ) (3.8 )
Equity securities, available-for-sale (0.1 ) (0.1 )
Derivatives 999.0
91.5
Embedded derivatives - fixed maturities 2.5
6.6
Embedded derivatives - product guarantees (562.5 ) (143.5 )
Other investments 2.1 -
Net realized capital gains (losses) $ 455.7 $ (13.1 )
After-tax net realized capital gains (losses) $ 293.2 $ 16.5
Six Months Ended June 30,
2012 2011
Fixed maturities, available-for-sale, including
securities pledged $ 81.3 $ (10.5 )
Fixed maturities, at fair value using the fair value
option
(26.4 ) (8.2 )
Equity securities, available-for-sale (0.1 )
1.2
Derivatives (622.4 ) (250.1 )
Embedded derivatives - fixed maturities (0.9 )
0.2
Embedded derivatives - product guarantees (290.2 ) (115.6 )
Other investments 0.7 (2.3 )
Net realized capital gains (losses) $ (858.0 )
$ (385.3 )
After-tax net realized capital gains (losses) $ (571.7 ) $ (240.4 )
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Fair Value Hierarchy
The following tables present our hierarchy for assets and liabilities measured
at fair value on a recurring basis as of June 30, 2012 and December 31, 2011.
2012
Level 1 Level 2 Level 3 Total
Assets:
Fixed maturities, including securities
pledged:
U.S. Treasuries $ 1,842.2 $ 7.8 $ - $ 1,850.0
U.S government agencies and authorities - 23.7 - 23.7
U.S. corporate, state and municipalities - 10,416.6 102.4 10,519.0
Foreign - 5,399.5 15.2 5,414.7
Residential mortgage-backed securities - 2,003.7 21.7 2,025.4
Commercial mortgage-backed securities - 1,846.0 - 1,846.0
Other asset-backed securities - 562.5 67.6 630.1
Equity securities, available-for-sale 12.4 - 16.8 29.2
Derivatives:
Interest rate contracts 2.1 1,757.4 - 1,759.5
Foreign exchange contracts - 6.5 - 6.5
Equity contracts 23.4 66.4 9.6 99.4
Credit contracts - - - -
Cash and cash equivalents, short-term
investments and short-term investments
under securities loan agreement 3,105.2 - - 3,105.2
Assets held in separate accounts 39,501.8 - - 39,501.8
Total $ 44,487.1 $ 22,090.1 $ 233.3 $ 66,810.5
Liabilities:
Investment contract guarantees:
Fixed Indexed Annuities ("FIA") $ - $ - $ 1,384.2 $ 1,384.2
GMAB / GMWB / GMWBL(1) - - 2,458.6 2,458.6
Embedded derivative on reinsurance - 269.2 - 269.2
Derivatives:
Interest rate contracts - 644.9 - 644.9
Foreign exchange contracts - 41.3 - 41.3
Equity contracts 315.2 10.1 - 325.3
Credit contracts - 0.3 - 0.3
Total $ 315.2 $ 965.8 $ 3,842.8 $ 5,123.8
(1) Guaranteed minimum accumulation benefits ("GMAB"), Guaranteed minimum
withdrawal benefits ("GMWB"), Guaranteed minimum withdrawal benefits with life
payouts ("GMWBL").
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2011
(As revised)
Level 1 Level 2 Level 3 Total
Assets:
Fixed maturities, including securities
pledged:
U.S. Treasuries $ 1,778.0 $ 7.8 $ - $ 1,785.8
U.S government agencies and authorities - 23.7 - 23.7
U.S. corporate, state and municipalities - 10,251.1 124.5 10,375.6
Foreign - 5,525.2 56.9 5,582.1
Residential mortgage-backed securities - 2,245.1 60.7 2,305.8
Commercial mortgage-backed securities - 2,001.9 - 2,001.9
Other asset-backed securities - 600.8 72.8 673.6
Equity securities, available-for-sale 11.4 - 16.3 27.7
Derivatives:
Interest rate contracts 4.0 1,534.4 - 1,538.4
Foreign exchange contracts - 9.7 - 9.7
Equity contracts 26.5 - 33.6 60.1
Credit contracts - 0.9 - 0.9
Cash and cash equivalents, short-term
investments and short-term investments
under securities loan agreement 2,760.7 5.8 - 2,766.5
Assets held in separate accounts 39,356.9 - - 39,356.9
Total $ 43,937.5 $ 22,206.4 $ 364.8 $ 66,508.7
Liabilities:
Investment contract guarantees:
Fixed Indexed Annuities ("FIA") $ - $ - $ 1,282.2 $ 1,282.2
GMAB / GMWB / GMWBL(1) - - 2,229.9 2,229.9
Embedded derivative on reinsurance - 230.9 - 230.9
Derivatives:
Interest rate contracts - 520.0 - 520.0
Foreign exchange contracts - 42.4 - 42.4
Equity contracts 3.3 - 25.1 28.4
Credit contracts - 1.2 12.9 14.1
Total $ 3.3 $ 794.5 $ 3,550.1 $ 4,347.9
(1)Guaranteed minimum accumulation benefits ("GMAB"), Guaranteed minimum
withdrawal benefits ("GMWB"), Guaranteed minimum withdrawal benefits with life
payouts ("GMWBL").
European Exposures
In the first half of 2010 concerns arose regarding the creditworthiness of
several European countries, which later spread more broadly to countries in the
European currency union. As a result of these concerns the fair value of
sovereign debt decreased and those exposures were being monitored more closely.
With regard to troubled European countries, our main focus is on Greece, Italy,
Ireland, Portugal and Spain (henceforth defined as "peripheral Europe") as these
countries have applied for support from the European Financial Stability Fund
("EFSF") or received support from the European Central Bank ("ECB") via
government bond purchases in the secondary market.
The financial turmoil in Europe continues to be a threat to global capital
markets and remains a challenge to global financial stability. Additionally, the
possibility of capital market volatility spreading through a highly integrated
and interdependent banking system remains elevated. Furthermore, it is our view
that the risk among European sovereigns and financial institutions warrants
specific scrutiny, in addition to its customary surveillance and risk
monitoring, given how highly correlated these sectors of the region have become.
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We quantify and allocate our exposure to the region, as described in the table
below, by attempting to identify all aspects of the region or country risk to
which we are exposed. Among the factors we consider are the nationality of the
issuer, the nationality of the issuer's ultimate parent, the corporate and
economic relationship between the issuer and its parent, as well as the
political, legal and economic environment in which each functions. By
undertaking this assessment, we believe that we develop a more accurate
assessment of the actual geographic risk, with a more integrated understanding
of all contributing factors to the full risk profile of the issuer.
In the normal course of our ongoing risk and portfolio management process, we
closely monitor compliance with a credit limit hierarchy designed to minimize
overly concentrated risk exposures by geography, sector and issuer. This
framework takes into account various factors such as internal and external
ratings, capital efficiency and liquidity and is overseen by a combination of
Investment and Corporate Risk Management, as well as insurance portfolio
managers focused specifically on managing the investment risk embedded in our
portfolio.
As of June 30, 2012, we had $381.8 of exposure to peripheral Europe, which
consists of a broadly diversified portfolio of credit-related investments solely
in the industrial and utility sectors. We had no fixed maturity and equity
securities exposure to peripheral European sovereigns or financial institutions
based in peripheral Europe. Peripheral European exposure included non-sovereign
exposure in Italy of $152.9, Ireland of $129.0, Spain of $99.0, and Portugal of
$0.9. We had no exposure to Greece. As of June 30, 2012, there were no
derivative assets exposure to financial institutions in peripheral Europe. For
purposes of calculating the derivative assets exposure, we had aggregated
exposure to single name and portfolio product credit default swaps ("CDS"), as
well as all non-CDS derivative exposure for which we either had counterparty or
direct credit exposure to a company whose country of risk is in scope.
Among the remaining $3.0 billion of total non-peripheral European exposure, we
had a portfolio of credit-related assets similarly diversified by country and
sector across developed and developing Europe. Sovereign exposure is $675.3,
which consists of fixed maturity and equity securities of $100.1 and loans and
receivables of $575.2, comprised entirely of the Dutch State loan obligation to
us under the Illiquid Assets Back-up Facility. We also had $247.9 in net
exposure to non-peripheral financial institutions with a concentration in the
United Kingdom of $74.5, France of $46.7, and Switzerland of $31.7. The balance
of $2.1 billion was invested across non-peripheral, non-financial institutions.
In addition to aggregate concentration to the Netherlands of $948.4 (which
includes the $575.2 Dutch State loan obligation) and the United Kingdom of
$798.1, we had significant non-peripheral European total country exposures to
Switzerland of $220.6, Germany of $216.4, and France of $243.9. We place
additional scrutiny on our financial exposure in the United Kingdom, France and
Switzerland given our concern for the potential for volatility to spread through
the European banking system. We believe the primary risk results from market
value fluctuations resulting from spread volatility and the secondary risk is
default risk, should the European crisis worsen or fail to be resolved.
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The following table represents our European exposures at fair value and
amortized cost as of June 30, 2012.
Fixed Maturity and Equity Securities Derivative Assets
Loan and
Receivables
Total Sovereign Total, Net Non-U.S.
Financial Non-Financial (Fair Total (Amortized Financial Non-Financial Less: Margin & (Fair Funded at June
Sovereign Institutions Institutions Value) (Amortized Cost) Cost) Institutions Sovereign Institutions Collateral Value) 30, 2012 (1)
Greece $ - $ - $ - $ - $ - $ - $ - $ - $ - $ - $ - $ -
Ireland - - 129.0 129.0 118.5 - - - - - - 129.0
Italy - - 152.9 152.9 143.8 - - - - - - 152.9
Portugal - - 0.9 0.9 0.8 - - - - - - 0.9
Spain - - 99.0 99.0 97.4 - - - - - - 99.0
Total
Peripheral
Europe - - 381.8 381.8 360.5 - - - - - - 381.8
France - 46.7 197.2 243.9 231.2 - 359.6 - - 359.6 - 243.9
Germany - 7.8 201.9 209.7 192.0 - 28.9 - - 22.2 6.7 216.4
Netherlands - 75.3 297.9 373.2 338.0 575.2 10.3 - - 10.3 - 948.4
Switzerland - 22.0 188.9 210.9 194.5 - 131.0 - - 121.3 9.7 220.6
United Kingdom - 68.5 723.6 792.1 745.6 - 74.3 - - 68.3 6.0 798.1
Other
non-peripheral
(2) 100.1 5.2 450.7 556.0 518.6 - - - - - - 556.0
Total
Non-Peripheral
Europe 100.1 225.5 2,060.2 2,385.8 2,219.9 575.2 604.1 - - 581.7 22.4 2,983.4
Total $ 100.1 $ 225.5 $ 2,442.0 $ 2,767.6 $ 2,580.4 $ 575.2 $ 604.1 $ - $ - $ 581.7 $ 22.4$ 3,365.2
(1) Represents: (i) Fixed maturity and equity securities at fair value; (ii)
Loan receivables sovereign at amortized cost; and (iii) Derivative assets at
fair value.
(2) Other non-peripheral countries include: Austria, Belgium, Bulgaria, Croatia,
Denmark, Finland, Hungary, Iceland, Kazakhstan, Latvia, Lithuania, Luxembourg,
Norway, Russian Federation, Sweden and Turkey.
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Liquidity and Capital Resources
Liquidity is our ability to generate sufficient cash flows to meet the cash
requirements of operating, investing and financing activities.
Liquidity Management
Our principal available sources of liquidity are annuity product charges, GIC
and fixed annuity deposits, investment income, proceeds from the maturity and
sale of investments, proceeds from debt issuance and borrowing facilities,
repurchase agreements, securities lending, reinsurance and capital
contributions. Primary uses of these funds are payments of commissions and
operating expenses, interest and premium credits, payments under guaranteed
death and living benefits, investment purchases, repayment of debt and contract
maturities, withdrawals and surrenders.
Our liquidity position is managed by maintaining adequate levels of liquid
assets, such as cash, cash equivalents and short-term investments. As part of
the liquidity management process, different scenarios are modeled to determine
whether existing assets are adequate to meet projected cash flows. Key variables
in the modeling process include interest rates, equity market movements,
quantity and type of interest and equity market hedges, anticipated contract
owner behavior, market value of the general account assets, variable separate
account performance and implications of rating agency actions.
The fixed account liabilities are supported by a general account portfolio,
principally composed of fixed rate investments with matching duration
characteristics that can generate predictable, steady rates of return. The
portfolio management strategy for the fixed account considers the assets
available-for-sale. This strategy enables us to respond to changes in market
interest rates, prepayment risk, relative values of asset sectors and individual
securities and loans, credit quality outlook and other relevant factors. The
objective of portfolio management is to maximize returns, taking into account
interest rate and credit risk, as well as other risks. Our asset/liability
management discipline includes strategies to minimize exposure to loss as
interest rates and economic and market conditions change. In executing this
strategy, we use derivative instruments to manage these risks. Our derivative
counterparties are of high credit quality.
Liquidity and Capital Resources
Additional sources of liquidity include borrowing facilities to meet short-term
cash requirements that arise in the ordinary course of business. We maintain
the following agreements:
• A reciprocal loan agreement with ING U.S., Inc. an affiliate, whereby either
party can borrow from the other up to 3.0% of our statutory net admitted
assets, excluding Separate Accounts, as of the preceding December 31. As of
June 30, 2012, we did not have any outstanding receivable from ING U.S., Inc.
under the reciprocal loan agreement. As of December 31, 2011, we had an
outstanding receivable of $535.9 from ING U.S., Inc. under the reciprocal
loan agreement. During the second quarter of 2012, ING U.S., Inc. repaid the
then outstanding receivable due under the reciprocal loan agreement from the
proceeds of its $5.0 billion Senior Unsecured Credit Facility which was
entered into on April 20, 2012. We and ING U.S., Inc. continue to maintain
the reciprocal loan agreement and future borrowings by either party will be
subject to the reciprocal loan terms summarized above.
• We hold approximately 48.3% of its assets in marketable securities. These
assets include cash, U.S. Treasuries, Agencies and Public, Corporate Bonds,
ABS, CMBS and CMO and Equity securities. In the event of a temporary
liquidity need, cash may be raised by entering into reverse repurchase,
dollar rolls and/or security lending agreements by temporarily lending
securities and receiving cash collateral. Under our Liquidity Plan, up to
12% of our general account statutory admitted assets may be allocated to
repurchase, securities lending and dollar roll programs. At the time a
temporary cash need arises, the actual percentage of admitted assets available for reverse repurchase transactions will depend upon outstanding
allocations to the three programs. As of June 30, 2012, we had securities
lending obligations of $74.3, which represents approximately 0.1% of our
general account statutory admitted assets.
We are a member of the FHLB and is required to maintain a collateral deposit
that backs funding agreements issued to the FHLB. As of June 30, 2012 and
December 31, 2011, we had $1,579.6 in non-putable funding agreements, including
accrued interest, issued to the FHLB. These non-putable funding agreements are
included in Future policy benefits and claims reserves, on the Condensed Balance
Sheets. As of June 30, 2012 and December 31, 2011, assets with a market value of
$1,898.0 and $1,897.9, respectively, collateralized the funding agreements to
the FHLB. Assets pledged to the FHLB are included in Fixed maturities,
available-for-sale, on the Condensed Balance Sheets.
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Management believes that its sources of liquidity are adequate to meet our
short-term cash obligations.
Capital Contributions and Dividends
During the six months ended June 30, 2012 , we did not receive any capital
contributions from our Parent. During the six months ended June 30, 2011, we
received capital contributions of $44.0 from our Parent.
During the six months ended June 30, 2012, following receipt of required
approval from our domiciliary state insurance regulator, we paid a return of
capital distribution of $250.0 on our capital stock to our Parent. During the
six months ended June 30, 2011, we did not pay a dividend or return of capital
distribution on our capital stock to our Parent.
Collateral
Under the terms of our Over-The-Counter Derivative International Swaps and
Derivatives Association, Inc. Agreements ("ISDA Agreements"), we may receive
from, or deliver to, counterparties, collateral to assure that all terms of the
ISDA Agreements will be met with regard to the Credit Support Annex ("CSA").
The terms of the CSA call for us to pay interest on any cash received equal to
the Federal Funds rate. As of June 30, 2012 and December 31, 2011, we held $1.2
billion and $821.2, respectively, of cash collateral, which was included in
Payables under securities loan agreement, including collateral held, on the
Condensed Balance Sheets. In addition, as of June 30, 2012 and December 31,
2011, we delivered collateral of $711.6 and $779.8, respectively, in fixed
maturities pledged under derivatives contracts, which was included in Securities
pledged on the Condensed Balance Sheets.
Reinsurance Agreements
Reinsurance Ceded
Waiver of Premium - Coinsurance Funds Withheld
Effective October 1, 2010, we entered into a coinsurance funds withheld
agreement with its affiliate, Security Life of Denver International Limited
("SLDI"). Under the terms of the agreement, we ceded to SLDI 100% of the group
life waiver of premium liability (except for groups covered under rate credit
agreements) assumed from ReliaStar Life Insurance Company ("RLI"), an affiliate,
related to the Group Annual Term Coinsurance Funds Withheld agreement between us
and RLI.
Upon inception of the agreement, we paid SLDI a premium of $245.6. At the same
time, we established a funds withheld liability for $188.5 to SLDI and SLDI
purchased a $60.0 letter of credit to support the ceded Statutory reserves of
$245.6. In addition, we recognized a gain of $17.9 based on the difference
between the premium paid and the ceded U.S. GAAP reserves of $227.7, which
partially offsets the $57.1 ceding allowance paid by SLDI. The ceding allowance
will be amortized over the life of the business.
As of June 30, 2012, the value of the funds withheld liability under this
agreement was $186.9, which is included in Other liabilities on the Condensed
Balance Sheets.
Guaranteed Investment Contract - Coinsurance
Effective August 20, 1999, we entered into a Facultative Coinsurance Agreement
with its affiliate, SLD. Under the terms of the agreement, we facultatively
cede to SLD, from time to time, certain GICs on a 100% coinsurance basis. We
utilize this reinsurance facility primarily for diversification and
asset-liability management purposes in connection with this business, which is
facilitated by the fact that SLD is also a major GIC issuer. Our senior
management has established a current maximum of $4.0 billion for GIC reserves
ceded under this agreement.
The value of GIC reserves ceded by us under this agreement was $658.4 and $121.4
as of June 30, 2012 and December 31, 2011, respectively.
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Guaranteed Living Benefit - Coinsurance and Coinsurance Funds Withheld
Effective June 30, 2008, we entered into an automatic reinsurance agreement with
its affiliate, SLDI, covering 100% of the benefits guaranteed under specific
variable annuity guaranteed living benefit riders attached to certain variable
annuity contracts issued by us on or after January 1, 2000.
Also effective June 30, 2008, we entered into a services agreement with SLDI,
under which we provide certain actuarial risk modeling consulting services to
SLDI with respect to hedge positions undertaken by SLDI in connection with the
reinsurance agreement. For the six months ended June 30, 2012 and 2011, revenue
related to the agreement was $6.0 and $6.5, respectively.
Effective July 1, 2009, the reinsurance agreement was amended and restated to
change the reinsurance basis from coinsurance to a combined coinsurance and
coinsurance funds withheld basis. On July 31, 2009, SLDI transferred assets with
a market value of $3.2 billion to us and we deposited those assets into a funds
withheld trust account. As of June 30, 2012, the assets on deposit in the trust
account increased to $4.9 billion. We also established a corresponding funds
withheld liability to SLDI, which is included in Other liabilities on the
Condensed Balance Sheets.
Also effective July 1, 2009, we and SLDI entered into an asset management
services agreement, under which SLDI serves as asset manager for the funds
withheld account. SLDI has retained its affiliate, ING Investment Management
LLC, as subadviser for the funds withheld account.
As of June 30, 2012 and December 31, 2011, the value of reserves ceded by us
under this agreement was $2.0 billion and $1.9 billion, respectively. In
addition, a deferred loss in the amount of $354.6 and $365.3 as of June 30, 2012
and December 31, 2011, respectively, is included in Other assets on the
Condensed Balance Sheets and is amortized over the period of benefit.
Ratings
Our access to funding and its related cost of borrowing, requirements for
derivatives collateral posting and the attractiveness of certain of its products
to customers are affected by our credit ratings and insurance financial strength
ratings, which are periodically reviewed by the rating agencies.
On July 23, 2012, AM Best removed from under review with negative implications
and affirmed our "A" financial strength rating and "a" issuer credit rating. AM
Best assigned a stable outlook to the ratings.
On April 17, 2012, Moody's affirmed our A3 insurance financial strength ratings
with a stable outlook.
On December 7, 2011, Moody's downgraded our insurance financial strength rating
to "A3" from "A2" and revised the outlook to Stable from Negative.
On March 7, 2012, S&P affirmed our counterparty credit and insurance financial
strength rating at "A-" and revised the outlook to Stable from Watch Negative.
On December 8, 2011, S&P downgraded our counterparty credit and insurance
financial strength rating to "A-" from "A" and revised the outlook to Watch
Negative from Stable. On November 17, 2011, S&P affirmed our "A" rating and
revised the outlook to Stable from Negative based on de-risking and improving
business fundamentals.
On August 19, 2011, Fitch revised our Rating Watch status to Evolving from
Negative.
On December 14, 2011, A.M. Best affirmed our insurance financial strength rating
at "A", downgraded the issuer credit rating to "a" from "a+" and revised the
outlook to Ratings Under Review with Negative Implications from Stable. On June
16, 2011, A.M. Best affirmed our insurance financial strength rating of "A" and
the issuer credit rating of "a+."
Our ratings by S&P, Fitch, A.M. Best and Moody's reflect a broader view of how
the financial services industry is being challenged by the current economic
environment, but also are based on the rating agencies' specific views of our
financial strength. In making their ratings decisions, the agencies consider
past and expected future capital and earnings, asset quality and risk,
profitability and risk of existing liabilities and current products, market
share and product distribution capabilities and direct or implied support from
parent companies, including implications of the ING restructuring plan, among
other factors. The ratings actions, affirmations
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and outlook changes by S&P , Moody's and A.M. Best in December 2011 followed the
fourth quarter 2011 announcements by ING regarding a charge of EUR 0.9 billion
to EUR 1.1 billion against fourth quarter results of the U.S. Closed Block
Variable Annuity business.
Minimum Guarantees
Variable annuity contracts containing minimum guaranteed death and living
benefits expose us to equity risk. A decrease in the equity markets may cause a
decrease in the account values, thereby increasing the possibility that we may
be required to pay amounts to contract owners due to guaranteed death and living
benefits. An increase in the value of the equity markets may increase account
values for these contracts, thereby decreasing our risk associated with
guaranteed death and living benefits.
We ceased new sales of variable annuity products in March 2010. However, our
existing variable annuity block of business contains certain guaranteed death
and living benefits made available to contract owners as described below:
Guaranteed Minimum Death Benefits ("GMDBs"):
• Standard - Guarantees that, upon death, the death benefit will be no less
than the premiums paid by the contract owner, adjusted for any contract
withdrawals.
• Ratchet - Guarantees that, upon death, the death benefit will be no less than
the greater of (1) Standard or (2) the maximum contract anniversary (or
quarterly) value of the variable annuity, adjusted for contract withdrawals.
• Combo (Max 7) - Guarantees that, upon death, the death benefit will be no
less than the greater of (1) Ratchet or (2) Rollup (Rollup guarantees that,
upon death, the death benefit will be no less than the aggregate premiums
paid by the contract owner accruing interest at the contractual rate per
annum, adjusted for contract withdrawals, which may be subject to a maximum
cap on the rolled up amount.)
A number of other versions of death benefits were offered previously but sales
were discontinued. For contracts issued prior to January 1, 2000, most contracts
with enhanced death benefit guarantees were reinsured to third party reinsurers
to mitigate the risk produced by such guaranteed death benefits. For contracts
issued after December 31, 1999, we instituted a variable annuity guarantee
hedging program in lieu of reinsurance. The variable annuity guarantee hedging
program is based on us entering into derivative positions to offset exposures to
guaranteed minimum death benefits due to adverse changes in the equity markets.
As of June 30, 2012 and December 31, 2011, the guaranteed value of these death
benefits in excess of account values was estimated to be as follows:
(in billions)
2012
Net amount at risk, before reinsurance $ 8.6
Net amount at risk, net of reinsurance 7.8
2011
Net amount at risk, before reinsurance $ 9.6
Net amount at risk, net of reinsurance 8.7
The decrease in the guaranteed value of these death benefits was primarily
driven by favorable equity market performance during Q1 2012 in excess of
unfavorable market performance in Q2 2012. The guaranteed value of GMDB's in
excess of account values, net of reinsurance, was projected to be covered by our
variable annuity guarantee hedging program.
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The additional liabilities recognized related to GMDB's, as of June 30, 2012 and
December 31, 2011, were as follows:
2012
Additional liability balance $ 499.1
2011
Additional liability balance $ 510.3
The above additional liability recorded by us, net of reinsurance, represented
the estimated net present value of our future obligation for guaranteed minimum
death benefits in excess of account values. The liability decreased mainly due
to a decrease in expected future claims attributable to favorable equity market
performance during the year.
Guaranteed Living Benefits:
• Guaranteed Minimum Income Benefit ("GMIB") - Guarantees a minimum income
payout, exercisable each contract anniversary on or after a specified date,
in most cases the 10th rider anniversary.
• Guaranteed Minimum Withdrawal Benefit ("GMWB") and Guaranteed Minimum
Withdrawal Benefit for Life ("GMWBL") - Guarantees an annual withdrawal
amount for a specified period of time (GMWB) or life (GMWBL) that is
calculated as a percentage of the benefit base that equals premium at the
time of contract issue and may increase over time, based on a number of
factors, including a rollup percentage (7%, 6%, 5% or 0%, depending on
versions of the benefit) and ratchet frequency (primarily annual or
quarterly, depending on versions). The percentage used to determine the guaranteed annual withdrawal amount may vary by age at first withdrawal and
depends on versions of the benefit. A joint life-time withdrawal benefit
option was available to include coverage for spouses. Most versions of the
withdrawal benefit included reset and/or step-up features that may increase
the guaranteed withdrawal amount in certain conditions. Earlier versions of
the withdrawal benefit guarantee that annual withdrawals of up to 7.0% of
eligible premiums may be made until eligible premiums previously paid by the
contract owner are returned, regardless of account value performance. Asset
allocation requirements apply at all times where withdrawals are guaranteed
for life.
• Guaranteed Minimum Accumulation Benefit ("GMAB") - Guarantees that the
account value will be at least 100% of the eligible premiums paid by the
contract owner after 10 years, net of any contract withdrawals (GMAB 10). In
the past, we offered an alternative design that guaranteed the account value
to be at least 200% of the eligible premiums paid by contract owners after 20
years (GMAB 20).
We reinsured most of our living benefit guarantee riders to SLDI, an affiliated
reinsurer, to mitigate the risk produced by such benefits. This reinsurance
agreement covers all of the GMIBs, as well as the GMWBs with lifetime guarantees
(the "Reinsured living benefits"). The GMABs and the GMWBs without lifetime
guarantees (the "Non-reinsured living benefits") are not covered by this
reinsurance. The Non-reinsured living benefits are still covered by our variable
annuity guarantee hedging program.
The following guaranteed living benefits information is as of June 30, 2012 and
December 31, 2011:
Non-reinsured Reinsured Living
Living Benefits Benefits
(GMAB/GMWB) (GMIB/GMWBL)
2012
Net amount at risk, before reinsurance $ 50.2 $ 5,959.5
Net amount at risk, net of reinsurance 50.2 -
2011
Net amount at risk, before reinsurance $ 63.2 $ 5,692.0
Net amount at risk, net of reinsurance 63.2 -
The net amount at risk for the reinsured living benefits is equal to the excess
of the present value of the minimum guaranteed annuity payments available to the
contractholder over the current account value. During 2011, we revised the
methodology used to calculate the net amount at risk to better reflect the
nature of the underlying living benefits and to align the methodology with
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peers. The current methodology partially reflects the current interest rate
environment and also includes a provision for the expected mortality of the
clients covered by these living benefits. The values for the reinsured living
benefits in the above table are presented under the new methodology as of
June 30, 2012 and December 31, 2011.
The net amount at risk for the non-reinsured living benefits is equal to the
guaranteed value of these benefits in excess of the account values, which is
reflected in the table above.
The additional liabilities recognized related to minimum guarantees, by type, as
of June 30, 2012 and December 31, 2011 were as follows:
Reinsured Living
Non-reinsured Living Benefits
Benefits (GMAB/GMWB) (GMIB/GMWBL)
2012
Additional liability balance, net of reinsurance $ 101.8 $ 1,952.4
2011
(As revised)
Additional liability balance, net of reinsurance $ 114.9 $ 1,738.1
As of June 30, 2012 and December 31, 2011, the above additional liabilities for
non-reinsured living benefits recorded by us, net of reinsurance, represent the
estimated net present value of its future obligations for these benefits. The
prior year additional liability balance for reinsured living benefits has been
revised due to us retrospectively electing fair value accounting for GMWBL
riders as of January 1, 2012. The above additional liabilities for reinsured
living benefits recorded by us, net of reinsurance, represent the present value
of future claims less the present value of future attributed fees (GMWBLs) or
the benefits ratio approach (GMIBs), less the reinsurance ceded reserve
calculated under Accounting Standards Codification Topic 944. The resulting
additional liability balance for reinsured living benefits represents the GMWBL
liability, as the GMIB liability is zero and has increased mainly due to lower
interest rates and reduced credit default swap spreads partially offset by
favorable equity market performance during the year.
Variable Annuity Guarantee Hedging Program
We primarily mitigate variable annuity market risk exposures through hedging.
Market risk arises primarily from the minimum guarantees within the variable
annuity products, whose economic costs are primarily dependent on future equity
market returns, interest rate levels, equity volatility levels, and policyholder
behavior. The variable annuity hedging program is used to mitigate our exposure
to equity market and interest rate changes and to ensure that the required
assets are available to satisfy future death benefit and living benefit
obligations.
We do not hedge interest rate risks for our GMIB or GMDB primarily because doing
so would result in volatility in our regulatory capital that exceeds our
tolerances. Equity index futures on various equity indices are used to mitigate
the risk of the change in value of the policyholder-directed separate account
funds underlying the variable annuity contracts with minimum guarantees. A
dynamic trading program is utilized to seek replication of the performance of
targeted fund groups (i.e., the fund groups that can be covered by indices where
liquid futures markets exist).
Total return swaps are primarily used to mitigate the risk of the change in
value of certain policyholder directed separate account funds which are not
sensitive to equity markets. These include fund classes such as emerging markets
and real estate. They may also be used instead of futures of more liquid indices
where it may be deemed advantageous. This hedging strategy is employed at our
discretion based on current risk exposures and related transaction costs.
Interest rate swaps are used to mitigate the impact of interest rates changes on
the economic liabilities associated with certain minimum guaranteed living
benefits.
Variance swaps and equity options are used to mitigate the impact of changes in
equity volatility on the economic liabilities associated with certain minimum
guaranteed living benefits. This program began in the second quarter of 2012.
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Foreign exchange forwards are used to mitigate the impact of
policyholder-directed investments in international funds with exposure to
fluctuations in exchange rates of certain foreign currencies. Rebalancing is
performed based on pre-determined notional exposures to the specific currencies.
Variable Annuity Capital Hedge Overlay Program
Variable annuity guaranteed benefits are hedged based on their economic or fair
value; however, the statutory reserves are not based on a market value. When
equity markets decrease, the statutory reserve for the variable annuity
guaranteed benefits can increase more quickly than the value of the derivatives
held under the Guarantee Hedging Program. This causes statutory capital to
decrease. To protect the residual risk to statutory capital in a decreasing
equity market, we implemented a capital hedge program. The current strategy is
intended to actively mitigate equity risk to the regulatory capital of the
Company. The hedge is executed through the purchase and sale of equity index
futures and is designed to limit the uncovered reserve increase in a down equity
market scenario to an amount we believe reasonable for a company of our size and
scale. This amount and program changes with market movements, changes in
regulatory capital and management actions.
During December 2010, we entered into a series of interest rate swaps with
external counterparties. We also entered into a short-term mirror total return
swap ("TRS") transaction with ING V, our indirect parent company. The
outstanding market value of the TRS was $11.6 as of December 31, 2010. The TRS
matured January 3, 2011.
Repurchase Agreements
We engage in dollar repurchase agreements with mortgage-backed securities
("dollar rolls") and repurchase agreements with other collateral types to
increase its return on investments and improve liquidity. Such arrangements
typically meet the requirements to be accounted for as financing arrangements.
As of June 30, 2012 and December 31, 2011, we did not have any securities
pledged in dollar rolls and repurchase agreement transactions.
We also enter into reverse repurchase agreements. These transactions involve a
purchase of securities and an agreement to sell substantially the same
securities as those purchased. As of June 30, 2012 and December 31, 2011, we
did not have any securities pledged under reverse repurchase agreements.
The primary risk associated with short-term collateralized borrowings is that
the counterparty will be unable to perform under the terms of the contract. Our
exposure is limited to the excess of the net replacement cost of the securities
over the value of the short-term investments. We believe the counterparties to
the dollar rolls, repurchase and reverse repurchase agreements are financially
responsible and that the counterparty risk is minimal.
Securities Lending
We engage in securities lending whereby certain domestic securities from our
portfolio are loaned to other institutions for short periods of time. As of
June 30, 2012 and December 31, 2011, the fair value of loaned securities was
$71.7 and $233.0, respectively, and is included in Securities pledged on the
Condensed Balance Sheets. Collateral retained by the lending agent and invested
in liquid assets on our behalf is recorded in Short-term investments under
securities loan agreement including collateral delivered on the Condensed
Balance Sheets.
As of June 30, 2012 and December 31, 2011, liabilities to return collateral of
$74.3 and $248.3, respectively, are included in Payables under securities loan
agreement, including collateral held, on the Condensed Balance Sheets.
Income Taxes
Income tax obligations include the allowance on uncertain tax benefits related
to IRS tax audits and state tax exams that have not been completed. The timing
of the payment of the remaining allowance of $2.7 cannot be reliably estimated.
Sale of Alternative Investments
On June 4, 2012, we entered into an agreement to sell certain general account
private equity limited partnership investment interest holdings ("sale of
certain alternative investments") with a carrying value of $146.1 as of March
31, 2012 to a group of private equity funds that are or will be managed by
Pomona Management LLC, an affiliate of the Company. The transaction resulted in
a net pretax loss of $16.9 in the second quarter of 2012 reported in Net
investment income on the Condensed Statements of Operations. The transaction is
expected to close in two tranches with the first tranche closed on June 29, 2012
and the second
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tranche expected to close prior to December 31, 2012, after one of the buyer
funds has completed a fundraising effort. As of June 30, 2012, the fair value of
these alternative investments in the second tranche was reduced to $68.0, which
represents the sales price of the remaining alternative investments involved in
this transaction. No additional loss is anticipated on the second tranche since
the fair value of the alternative investments was reduced to the agreed-upon
sales price as of June 30, 2012.
We are selling these assets in order to reduce our exposure to alternative
investments as part of our ordinary course portfolio management. We anticipate
that the transaction will reduce our required capital levels, in light of the
high capital charge associated with the asset class and improve liquidity and
reduce earnings volatility.
Recent Initiatives
On April 9, 2009, our ultimate parent, ING, announced a global business strategy
which identified certain core and non-core businesses and geographies, stated
ING's intention to explore divestiture of non-core businesses over time,
withdraw from certain non-core geographies, limit future acquisitions and
implement enterprise-wide expense reductions. In particular, with respect to
ING's U.S. insurance operations, ING is seeking to further reduce its risk by
focusing on individual life products, retirement services and lower risk annuity
products which ING USA's affiliate, ING Life Insurance and Annuity Company
commenced selling during the first quarter of 2010.
ING has announced the anticipated separation of its banking and insurance
businesses. While all options for effecting this separation remain open, ING has
announced that the base case for this separation includes an initial public
offering ("IPO") of ING U.S., Inc. which constitutes ING's U.S.-based
retirement, investment management and insurance operations, including us. ING
anticipates selling a portion of its ownership interest in ING U.S., Inc. in the
IPO and thereafter divesting its ownership interest over time, while all options
remain open. ING U.S., Inc. and its subsidiaries, including us, are actively
engaged in numerous projects across the enterprise to become ready for an IPO.
While the base case is an IPO, it is possible that ING's divestment of ING U.S.,
Inc. and its subsidiaries, including us, may take place by means of a sale to a
single buyer or group of buyers.
Volatile capital market conditions commencing in the fourth quarter of 2008 and
continuing into 2009, coupled with numerous changes in regulatory and accounting
requirements and changes in policyholder behavior as a result of the recent
changed economic environment, presented extraordinary challenges to actuarial
reserve valuation methodologies and controls. Since the second quarter of 2009,
ING USA has undertaken a review and strengthening of its systems, processes and
internal controls, including those with respect to actuarial calculations on
fixed and variable annuity products. As part of its internal controls review,
ING USA has from time to time identified control issues that require corrective
action and has taken and will continue to undertake appropriate corrective
action to address identified control issues.
On June 14, 2012, our affiliate ING North America Insurance Corporation
announced that it had entered into a seven-year agreement with Cognizant
Technology Solutions U.S. Corporation ("Cognizant") to receive a comprehensive
array of insurance business process services. Under the terms of the agreement,
Cognizant has made employment offers to more than 1,000 employees of
subsidiaries of ING U.S., Inc., most of whom are employed by certain of our U.S.
affiliates and may provide services to us from time to time, and approximately
220 of whom we employ. Employees who accept offers of employment with Cognizant
will continue to perform comparable roles to those they currently perform,
either for us or our applicable affiliates. We do not expect these matters to
have a material financial or operational impact on us.
Impact of New Accounting Pronouncements
For information regarding the impact of new accounting pronouncements, refer to
the Business, Basis of Presentation and Significant Accounting Policies note to
the Condensed Financial Statements, included in Part I, Item 1., herein.
Recently Enacted Legislation
On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and
Consumer Protection Act (the "Dodd-Frank Act"). The Dodd-Frank Act directs
existing and newly-created government agencies and bodies to conduct certain
studies and promulgate regulations implementing the law, a process that is
underway and is expected to continue over the next few years. While some studies
have already been completed and the rulemaking process has begun, there
continues to be significant uncertainty regarding the results of ongoing studies
and the ultimate requirements of those regulations that have not yet been
adopted. Until such studies and rulemaking are completed, the precise impact of
the Dodd-Frank Act on ING and its affiliates, including us cannot be determined.
However, there are major elements of the legislation that we have identified to
date that are of particular significance to ING and/or its affiliates, including
us, as described below.
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The Dodd-Frank Act creates a new agency, the Financial Stability Oversight
Council ("FSOC"), which is authorized to subject non-bank financial companies to
the supervision of the Federal Reserve if the FSOC determines that material
financial distress of a company or the scope of a company's activities could
pose risks to the financial stability of the United States. A company determined
to be systemically significant by the FSOC would be supervised by the Federal
Reserve Board and would be subject to a comprehensive system of prudential
regulation, including, among other matters, minimum capital requirements,
liquidity standards, credit exposure requirements, management interlock
prohibitions, maintenance of resolution plans, stress testing, additional fees
and assessments and restrictions on proprietary trading and other investments.
The exact scope and consequences of these standards and requirements are subject
to ongoing rulemaking activity by various federal banking regulators and
therefore are currently unclear. However, this comprehensive system of
prudential regulation, if applied to ING U.S., Inc. or us, would significantly
impact the manner in which we operate and could materially and adversely impact
the profitability of our business lines or the level of capital required to
support our activities. So long as we and ING U.S., Inc. continue to be
controlled by ING, the FSOC may consider ING U.S., Inc. and its subsidiaries,
including us, together with ING's other operations in the United States for
purposes of making this determination. Therefore, while we believe it is
unlikely that ING U.S., Inc. or its subsidiaries, including us, either on a
standalone basis or together with ING's other operations in the United States,
will ultimately receive this designation, there is a greater likelihood of such
a designation being made for so long as we are controlled by ING.
Although existing state insurance regulators will remain the primary regulators
of us and our U.S. insurance company affiliates, the legislation also creates a
Federal Insurance Office to be housed within the Treasury Department, which will
be charged with monitoring (but not regulating) the insurance industry,
including gathering information to identify issues or gaps in the regulation of
insurers that could contribute to systemic crisis in the insurance industry or
U.S. financial system; preparing annual reports to Congress on the insurance
industry; conducting studies on modernization of U.S. insurance regulation and
the global reinsurance market; and entering into/implementing agreements with
foreign governments relating to the recognition of prudential measures with
respect to insurance and reinsurance ("International Agreements"), including the
authority to preempt U.S. state law if it is found to be inconsistent with an
International Agreement and treats a non-U.S. insurer less favorably than a U.S.
insurer.
The legislation creates a new framework for regulating over-the-counter ("OTC")
derivatives, which may increase the costs of hedging and other permitted
derivatives trading activity undertaken by us. Under the new regulatory regime
and subject to certain exceptions, OTC derivatives will be cleared through a
centralized clearinghouse and executed on a centralized exchange. It establishes
new regulatory authority for the SEC and the Commodity Futures Trading
Commission ("CFTC") over derivatives and "swap dealers," "security-based swap
dealers," "major swap participants," and "major security-based swap
participants," as to be defined by SEC and CFTC regulations. Based on final
rules jointly developed by the CFTC and the SEC, and published in the Federal
Register on May 23, 2012, which further define the terms "swap dealer,"
"security-based swap dealer," "major swap participant," and "major
security-based swap participant," we do not believe we should be considered a
"swap dealer," "security-based swap dealer," "major swap participant," or "major
security-based swap participant." However, if it is determined that we meet one
of these definitions, it could substantially increase the amount of regulatory
requirements for us and the cost of hedging and other permitted derivatives
trading activity undertaken by us.
The CFTC and SEC also jointly adopted final rules, the adopting release for
which was made publicly available on July 13, 2012, to further define the terms
"swap" and "security-based swap," and to clarify that certain products (i)
issued by entities subject to supervision by the insurance commissioner (or
similar official or agency) of any state or by the United States or an agency or
instrumentality thereof (the "Provider Test") and (ii) regulated as insurance or
otherwise enumerated by rule are excluded from the definition of a "swap" and
"security-based swap." Thus, companies would not be considered "swap dealers,"
"security-based swap dealers," "major swap participants" or "major
security-based swap participants" as a result of issuing such insurance
products. In addition, any insurance contracts which might otherwise be included
within the definition of "swap" or "security-based swap" which are issued on or
before the effective date of the rules will be grandfathered and thereby
excluded from the definitions, so long as the issuer satisfies the Provider
Test. However, the rulemaking does not extend the exemption to certain products
issued by insurance companies including guaranteed investment contracts
("GICs"), synthetic GICs, funding agreements, structured settlements and deposit
administration contracts which the CFTC and SEC determined should be considered
in a facts and circumstances analysis. As a result, there remains some
uncertainty regarding the applicability of the definitions of "swap" and
"security-based swap" to some products offered by us. We do not believe our
products come within the definition of "swap" or "security-based swap." However,
if any products issued by us meet the criteria for either definition they would
be subject to regulation under the Dodd-Frank Act, including clearing of
transactions through a centralized clearinghouse, execution of trades on a
centralized exchange and related reporting requirements.
The Dodd-Frank Act also imposes various ex-post assessments on certain financial
companies, which may include us, to provide funds necessary to repay any
borrowings and to cover the costs of any special resolution of a financial
company under the new resolution authority established under the legislation
(although assessments already imposed under state insurance guaranty funds
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will be taken into account in calculating such assessments).
We will continue to monitor and assess the potential effects of the Dodd-Frank
Act as regulatory requirements are finalized and mandated studies are conducted.
Legislative and Regulatory Initiatives
Legislative proposals, which have been or may again be considered by Congress,
include changing the taxation of annuity benefits, changing the tax treatment of
insurance products relative to other financial products and changing life
insurance company taxation. Some of these proposals, if enacted, either on
their own or as part of an omnibus deficit reduction package could have a
material adverse effect on life insurance, annuity and other retirement savings
product sales, while others could have a material beneficial effect.
Administrative budget proposals to disallow insurance companies a portion of the
dividends received deduction in connection with variable product separate
accounts could increase the cost of such products to policyholders.
The SEC proposed in the third quarter of 2010, rescinding Rule 12b-1 under the
Investment Company Act of 1940 and adopting a new Rule 12b-2. If adopted, the
proposal would impose new limitations on the level of distribution-related
charges that could be paid by mutual funds, including funds available under our
variable annuity products. At this time, it is unclear when or if further action
will be taken on this proposal.
Contingencies
For information regarding other contingencies related to legal proceedings,
regulatory matters and other contingencies involving us, see the Commitments and
Contingent Liabilities note to the Condensed Financial Statements included in
Part I, Item1.
