Attached files
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8-K - FORM 8-K - Fidelity & Guaranty Life | d658993d8k.htm |
EX-99.2 - EX-99.2 - Fidelity & Guaranty Life | d658993dex992.htm |
Table of Contents
Exhibit 99.1
FIDELITY & GUARANTY LIFE HOLDINGS, INC.
Consolidated Financial Statements
(With Independent Auditors Report Thereon)
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
3 | ||||||
Consolidated Balance Sheets as of September 30, 2013 and 2012 |
4 | |||||
5 | ||||||
6 | ||||||
7 | ||||||
8 | ||||||
(1) | 10 | |||||
(2) | 11 | |||||
(3) | 16 | |||||
(4) | 18 | |||||
(5) | 24 | |||||
(6) | 27 | |||||
(7) | 38 | |||||
(8) | 39 | |||||
(9) | 40 | |||||
(10) | 40 | |||||
(11) | 40 | |||||
(12) | 43 | |||||
(13) | 47 | |||||
(14) | 48 | |||||
(15) | 51 | |||||
(16) | 51 | |||||
(17) | 53 |
2
Table of Contents
KPMG LLP 1 East Pratt Street Baltimore, MD 21202-1128 |
The Board of Directors
Fidelity & Guaranty Life Holdings, Inc.:
Report on the Financial Statements
We have audited the accompanying consolidated balance sheets of Fidelity & Guaranty Life Holdings, Inc. and subsidiaries as of September 30, 2013 and 2012, and the related consolidated statements of operations, comprehensive income, changes in shareholders equity, and cash flows for the years ended September 30, 2013 and 2012 and the period April 6, 2011 through September 30, 2011, and the related notes to the consolidated financial statements.
Managements Responsibility for the Financial Statements
Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with U.S. generally accepted accounting principles; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement, whether due to fraud or error.
Auditors Responsibility
Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditors judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entitys preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entitys internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.
Opinion
In our opinion, the consolidated financial statements referred to above present fairly in all material respects, the financial position of Fidelity & Guaranty Life Holdings, Inc. and subsidiaries as of September 30, 2013 and 2012, and the results of their operations and their cash flows for the years ended September 30, 2013 and 2012 and the period April 6, 2011 through September 30, 2011 in accordance with U.S. generally accepted accounting principles.
December 18, 2013
KPMG LLP is a Delaware limited liability partnership,
the U.S. member firm of KPMG International Cooperative
(KPMG International), a Swiss entity.
3
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
(In thousands)
September 30, | September 30, | |||||||
2013 | 2012 | |||||||
ASSETS | ||||||||
Investments: |
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Fixed maturity securities, available-for-sale, at fair value |
$ | 15,541,526 | $ | 16,088,913 | ||||
Equity securities, available-for-sale, at fair value |
271,075 | 248,087 | ||||||
Derivative investments |
221,758 | 200,667 | ||||||
Other invested assets |
188,180 | 18,814 | ||||||
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Total investments |
16,222,539 | 16,556,481 | ||||||
Related party loans and investments |
119,044 | 150,069 | ||||||
Cash and cash equivalents |
1,204,334 | 1,049,374 | ||||||
Accrued investment income |
159,287 | 191,577 | ||||||
Reinsurance recoverable |
3,728,632 | 2,363,083 | ||||||
Intangibles, net |
523,245 | 273,543 | ||||||
Deferred tax assets |
240,531 | 279,636 | ||||||
Other assets |
205,891 | 42,067 | ||||||
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Total assets |
$ | 22,403,503 | $ | 20,905,830 | ||||
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LIABILITIES AND SHAREHOLDERS EQUITY | ||||||||
Contractholder funds |
$ | 15,248,216 | $ | 15,290,475 | ||||
Future policy benefits |
3,556,808 | 3,614,788 | ||||||
Funds withheld for reinsurance liabilities |
1,407,713 | 54,691 | ||||||
Liability for policy and contract claims |
51,456 | 91,082 | ||||||
Long-term debt: |
300,000 | 224,363 | ||||||
Other liabilities |
700,053 | 646,705 | ||||||
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Total liabilities |
21,264,246 | 19,922,104 | ||||||
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Shareholders equity: |
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Common stock |
| | ||||||
Additional paid-in capital |
468,166 | 254,999 | ||||||
Retained earnings |
558,201 | 294,245 | ||||||
Accumulated other comprehensive income |
112,890 | 434,482 | ||||||
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Total shareholders equity |
1,139,257 | 983,726 | ||||||
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Total liabilities and shareholders equity |
$ | 22,403,503 | $ | 20,905,830 | ||||
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See accompanying notes to consolidated financial statements.
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Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Consolidated Statements of Operations
(In thousands)
Year Ended | April 6, 2011 to | |||||||||||
September 30, | September 30, | September 30, | ||||||||||
2013 | 2012 | 2011 | ||||||||||
Revenues: |
||||||||||||
Premiums |
$ | 58,367 | $ | 55,297 | $ | 39,002 | ||||||
Net investment income |
672,948 | 716,176 | 369,840 | |||||||||
Net investment gains (losses) |
544,576 | 410,000 | (166,891 | ) | ||||||||
Insurance and investment product fees and other |
57,711 | 40,251 | 48,915 | |||||||||
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Total revenues |
1,333,602 | 1,221,724 | 290,866 | |||||||||
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Benefits and expenses: |
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Benefits and other changes in policy reserves |
496,684 | 777,372 | 247,632 | |||||||||
Acquisition and operating expenses, net of deferrals |
98,464 | 119,913 | 72,390 | |||||||||
Amortization of intangibles |
224,993 | 160,656 | (11,115 | ) | ||||||||
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Total benefits and expenses |
820,141 | 1,057,941 | 308,907 | |||||||||
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Operating income (loss) |
513,461 | 163,783 | (18,041 | ) | ||||||||
Interest expense |
(20,428 | ) | (23,485 | ) | (15,414 | ) | ||||||
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Income (loss) before income taxes |
493,033 | 140,298 | (33,455 | ) | ||||||||
Income tax (expense) benefit |
(156,077 | ) | 145,658 | 41,744 | ||||||||
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Net income |
$ | 336,956 | $ | 285,956 | $ | 8,289 | ||||||
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Supplemental disclosures: |
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Total other-than-temporary impairments |
$ | (2,940 | ) | $ | (24,336 | ) | $ | (17,466 | ) | |||
Less non-credit portion of other-than-temporary impairments included other comprehensive income |
| (1,529 | ) | 500 | ||||||||
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Net other-than-temporary impairments |
(2,940 | ) | (22,807 | ) | (17,966 | ) | ||||||
Gain (losses) on derivative instruments |
266,974 | 146,052 | (170,752 | ) | ||||||||
Other realized investment gains |
280,542 | 286,755 | 21,827 | |||||||||
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Total net investment gains (losses) |
$ | 544,576 | $ | 410,000 | $ | (166,891 | ) | |||||
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See accompanying notes to consolidated financial statements.
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Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Consolidated Statements of Comprehensive Income
(In thousands)
Year Ended | ||||||||||||
April 6, 2011 to | ||||||||||||
September 30, | September 30, | September 30, | ||||||||||
2013 | 2012 | 2011 | ||||||||||
Net income |
$ | 336,956 | $ | 285,956 | $ | 8,289 | ||||||
Other comprehensive income (loss): |
||||||||||||
Unrealized investment (losses) gains: |
||||||||||||
Change in unrealized investment (losses) gains before reclassification adjustment |
(488,622 | ) | 906,473 | 420,929 | ||||||||
Net reclassification adjustment for (gains) losses included in net income |
(333,426 | ) | (263,948 | ) | (3,861 | ) | ||||||
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Changes in unrealized investment (losses) gains after reclassification adjustment |
(822,048 | ) | 642,525 | 417,068 | ||||||||
Adjustments to intangible assets |
327,293 | (218,454 | ) | (172,057 | ) | |||||||
Changes in deferred income tax asset/liability |
173,163 | (148,469 | ) | (85,709 | ) | |||||||
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Net unrealized (loss) gain on investments |
(321,592 | ) | 275,602 | 159,302 | ||||||||
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Non-credit related other-than-temporary impairment: |
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Changes in non-credit related other than-temporary impairment |
| (1,529 | ) | 500 | ||||||||
Adjustments to intangible assets |
| 586 | (206 | ) | ||||||||
Changes in deferred income tax asset/liability |
| 330 | (103 | ) | ||||||||
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Net non-credit related other than-temporary impairment |
| (613 | ) | 191 | ||||||||
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Net change to derive comprehensive (loss) income for the period |
(321,592 | ) | 274,989 | 159,493 | ||||||||
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Comprehensive income, net of tax |
$ | 15,364 | $ | 560,945 | $ | 167,782 | ||||||
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See accompanying notes to consolidated financial statements.
6
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Consolidated Statements of Changes in Shareholders Equity
(In thousands)
Additional Paid-in Capital |
Retained Earnings |
Accumulated Other Comprehensive Income |
Total Equity | |||||||||||||
Balances at April 6, 2011 |
$ | 254,836 | $ | | $ | | $ | 254,836 | ||||||||
Net income |
| 8,289 | | 8,289 | ||||||||||||
Unrealized investment gains, net |
| | 159,302 | 159,302 | ||||||||||||
Non-credit related other-than-temporary impairments |
| | 191 | 191 | ||||||||||||
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Balances at September 30, 2011 |
$ | 254,836 | $ | 8,289 | $ | 159,493 | $ | 422,618 | ||||||||
Net income |
| 285,956 | | 285,956 | ||||||||||||
Unrealized investment gains, net |
| | 275,602 | 275,602 | ||||||||||||
Non-credit related other-than-temporary impairments |
| | (613 | ) | (613 | ) | ||||||||||
Stock compensation |
163 | | | 163 | ||||||||||||
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Balances at September 30, 2012 |
$ | 254,999 | $ | 294,245 | $ | 434,482 | $ | 983,726 | ||||||||
Dividend payment |
| (73,000 | ) | | (73,000 | ) | ||||||||||
Issuance of common stock |
| | | | ||||||||||||
Net income |
| 336,956 | | 336,956 | ||||||||||||
Unrealized investment losses, net |
| | (321,592 | ) | (321,592 | ) | ||||||||||
Stock compensation |
(163 | ) | | | (163 | ) | ||||||||||
Debt to equity conversion |
213,330 | | | 213,330 | ||||||||||||
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Balances at September 30, 2013 |
$ | 468,166 | $ | 558,201 | $ | 112,890 | $ | 1,139,257 | ||||||||
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See accompanying notes to consolidated financial statements.
7
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Consolidated Statements of Cash Flows
(In thousands)
Fiscal Year Ended | April 6, 2011 to | |||||||||||
September 30, | September 30, | September 30, | ||||||||||
2013 | 2012 | 2011 | ||||||||||
Cash flows from operating activities: |
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Net income |
$ | 336,956 | $ | 285,956 | $ | 8,289 | ||||||
Adjustments to reconcile net income to net cash provided by (used in) operating activities: |
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Net recognized (gains) losses on investments |
(544,576 | ) | (410,000 | ) | 166,891 | |||||||
Amortization of intangibles |
224,993 | 160,656 | (11,115 | ) | ||||||||
Depreciation of properties |
3,938 | 2,846 | 1,685 | |||||||||
Stock-based compensation |
5,896 | 163 | | |||||||||
Amortization of debt issuance costs |
1,693 | | | |||||||||
Amortization of fixed maturity discounts and premiums |
16,747 | 86,943 | 59,937 | |||||||||
Deferred income taxes |
212,268 | (220,046 | ) | (40,869 | ) | |||||||
Deferred policy acquisition costs |
(147,402 | ) | (194,900 | ) | (41,152 | ) | ||||||
Interest credited/index credits and other changes to contractholder account balances |
355,394 | 586,814 | 140,004 | |||||||||
Charges assessed to contractholders for mortality and administration |
(31,520 | ) | (14,932 | ) | (28,358 | ) | ||||||
Cash received (transferred) to reinsurers |
15,000 | (176,770 | ) | (52,585 | ) | |||||||
Changes in operating assets and liabilities: |
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Reinsurance recoverable |
7,542 | (89,078 | ) | (39,446 | ) | |||||||
Accrued investment income |
32,288 | 15,224 | 1,674 | |||||||||
Future policy benefits |
(57,980 | ) | 16,579 | (6,337 | ) | |||||||
Funds withheld from reinsurers |
(216,840 | ) | | | ||||||||
Liability for policy and contract claims |
(39,626 | ) | 34,432 | (3,750 | ) | |||||||
Collateral returned (posted) |
72,000 | 140 | (99,081 | ) | ||||||||
Other operating |
(20,558 | ) | 170,371 | (7,884 | ) | |||||||
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Net cash provided by operating activities |
226,213 | 254,398 | 47,903 | |||||||||
Cash flows from investing activities: |
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Proceeds from investments sold, matured or repaid: |
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Fixed maturities |
8,920,083 | 5,723,266 | 1,468,427 | |||||||||
Equity securities |
68,731 | 110,157 | 13,768 | |||||||||
Derivative investments and other invested assets |
317,385 | 157,563 | 86,437 | |||||||||
Cost of investments acquired: |
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Fixed maturities |
(8,896,686 | ) | (5,583,495 | ) | (1,285,951 | ) | ||||||
Equity securities |
(102,337 | ) | (56,595 | ) | | |||||||
Derivative investments and other invested assets |
(319,446 | ) | (141,603 | ) | (66,655 | ) | ||||||
Related party loans and investments |
28,553 | (150,069 | ) | | ||||||||
Capital expenditures |
(4,062 | ) | (6,209 | ) | (1,745 | ) | ||||||
Other investing activities, net |
| | (1,642 | ) | ||||||||
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Net cash provided by investing activities |
12,221 | 53,015 | 212,639 | |||||||||
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Cash flows from financing activities: |
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Contractholder account deposits |
1,356,081 | 2,040,512 | 494,956 | |||||||||
Contractholder account withdrawals |
(1,636.360 | ) | (1,979,558 | ) | (959,961 | ) | ||||||
Repayment of subordinated debt |
| (95,000 | ) | | ||||||||
Dividend paid |
(73,000 | ) | | | ||||||||
Payment on note payable |
(20,000 | ) | (40,000 | ) | (20,000 | ) | ||||||
Proceeds from issuance of new debt |
300,000 | | | |||||||||
Debt issuance costs |
(10,195 | ) | | | ||||||||
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Net cash used in financing activities |
(83,474 | ) | (74,046 | ) | (485,005 | ) | ||||||
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Change in cash & cash equivalents |
154,960 | 233,367 | (224,463 | ) | ||||||||
Cash and cash equivalents at beginning of period |
1,049,374 | 816,007 | 1,040,470 | |||||||||
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Cash and cash equivalents at end of period |
$ | 1,204,334 | $ | 1,049,374 | $ | 816,007 | ||||||
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See accompanying notes to consolidated financial statements.
8
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Consolidated Statements of Cash Flows
(In thousands)
Supplemental disclosures of cash flow information |
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Interest paid |
$ | 39,008 | $ | 25,379 | $ | 23,296 | ||||||
Income taxes paid |
3,683 | 8,059 | | |||||||||
Non-cash operating activities: |
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Transfer of reinsurance recoverable balance related to life contracts and |
$ | | $ | (95,447 | ) | $ | (125,515 | ) | ||||
Non-cash investing activities: |
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Transfer of invested assets |
$ | | $ | 414,591 | $ | 443,555 | ||||||
Non-cash financing activities: |
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Transfer of reinsurance recoverable balance related to deposit-type contracts and other |
$ | | $ | (495,914 | ) | $ | (320,625 | ) | ||||
Conversion of notes payable to additional paid in capital |
$ | (213,330 | ) | $ | | $ | |
See accompanying notes to consolidated financial statements.
9
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
(1) Basis of Presentation and Nature of Operations
The accompanying financial statements include the accounts of Fidelity & Guaranty Life Holdings, Inc. (FGLH and the Company), a Delaware corporation, which is a direct, wholly-owned subsidiary of Fidelity & Guaranty Life (FGL, formerly, Harbinger F&G, LLC (HFG).
On April 6, 2011 (the Acquisition Date), Harbinger F&G acquired FGL from OM Group (UK) Limited (OMGUK). Such acquisition (the FGL Acquisition) has been accounted for using the acquisition method of accounting.
The Companys primary business is the sale of individual life insurance products and annuities through independent agents, managing general agents, and specialty brokerage firms and in selected institutional markets. The Companys principal products are deferred annuities (including fixed indexed annuity (FIA) contracts), immediate annuities and life insurance products. The Company markets products through its wholly-owned insurance subsidiaries, Fidelity & Guaranty Life Insurance Company (FGL Insurance) and Fidelity & Guaranty Life Insurance Company of New York (FGL NY Insurance), which together are licensed in all fifty states and the District of Columbia.
The Companys business consists primarily of fixed rate annuities and, accordingly, there is only one reporting segment. Premiums and annuity deposits (net of coinsurance), which are not included as revenues (except for traditional premiums) in the accompanying Consolidated Statements of Operations, collected during the year ended September 30, 2013, September 30, 2012, and the period from April 6, 2011 to September 30, 2011, by product type were as follows:
Year Ended | ||||||||||||
Product Type |
September 30, 2013 | September 30, 2012 |
April 6, 2011 to September 30, 2011 |
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Fixed indexed annuities |
$ | 983,050 | $ | 1,614,211 | $ | 314,521 | ||||||
Fixed rate annuities |
37,973 | 64,718 | 26,423 | |||||||||
Single premium immediate annuities |
7,295 | 7,844 | 3,659 | |||||||||
Life insurance (1) |
118,898 | 85,919 | 93,264 | |||||||||
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$ | 1,147,216 | $ | 1,772,692 | $ | 437,867 | |||||||
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(1) | Life insurance includes Universal Life (UL) and traditional life insurance products. |
The accompanying financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (US GAAP).
Dollar amounts in the accompanying footnotes are presented in thousands, unless otherwise noted.
10
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
(2) Significant Accounting Policies and Practices
Principles of Consolidation
The accompanying audited consolidated financial statements include the accounts of FGLH and all other entities in which FGLH has a controlling financial interest (none of which are variable interest entities). All intercompany accounts and transactions have been eliminated in consolidation.
Revenue Recognition
Insurance Premiums
The Companys insurance premiums for traditional life insurance products are recognized as revenue when due from the contractholder. The Companys traditional life insurance products include those products with fixed and guaranteed premiums and benefits and consist primarily of term life insurance and certain annuities with life contingencies.
Premium collections for fixed indexed and fixed rate annuities, indexed universal life (IUL) policies and immediate annuities without life contingency are reported as deposit liabilities (i.e., contractholder funds) instead of as revenues. Similarly, cash payments to policyholders are reported as decreases in the liability for contractholder funds and not as expenses. Sources of revenues for products accounted for as deposit liabilities are net investment income, surrender and other charges deducted from contractholder funds, and net realized gains (losses) on investments.
Net Investment Income
Dividends and interest income, recorded in Net investment income, are recognized when earned. Amortization of premiums and accretion of discounts on investments in fixed maturity securities are reflected in Net investment income over the contractual terms of the investments in a manner that produces a constant effective yield.
For mortgage-backed securities, included in the fixed maturity available-for-sale (AFS) securities portfolios, the Company recognizes income using a constant effective yield based on anticipated prepayments and the estimated economic life of the securities. When actual prepayments differ significantly from originally anticipated prepayments, the effective yield is recalculated prospectively to reflect actual payments to date plus anticipated future payments. Any adjustments resulting from changes in effective yield are reflected in Net investment income.
Net Investment Gains (Losses)
Net investment gains (losses) include realized gains and losses from the sale of investments, write-downs for other-than-temporary impairments of AFS investments, and gains and losses on derivative investments. Realized gains and losses on the sale of investments are determined using the specific identification method.
Product Fees
Product fee revenue from IUL products and deferred annuities is comprised of policy and contract fees charged for the cost of insurance, policy administration and rider fees is assessed on a monthly basis and recognized as revenue when assessed and earned. Product fee revenue also includes surrender charges which are recognized and collected when the policy is surrendered.
Cash and Cash Equivalents
The Company considers all highly liquid debt instruments purchased with original maturities of three months or less to be cash equivalents. As of September 30, 2013 and 2012, cash equivalents were $0 and $2,250, respectively.
11
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
Investments
Investment Securities
The Companys investments in debt and equity securities have been designated as AFS and are carried at fair value with unrealized gains and losses included in Accumulated other comprehensive income (AOCI), net of associated intangibles shadow adjustments (discussed in Note 7) and deferred income taxes.
Available-for-Sale SecuritiesOther-Than-Temporary Impairments (OTTI)
The Company regularly reviews AFS securities for declines in fair value that it determines to be other-than-temporary. For an equity security, if the Company does not have the ability and intent to hold the security for a sufficient period of time to allow for a recovery in value, it concludes that an other-than-temporary impairment has occurred and the cost of the equity security is written down to the current fair value, with a corresponding charge to Net investment gains (losses) in the accompanying Consolidated Statements of Operations. When assessing its ability and intent to hold an equity security to recovery, the Company considers, among other things, the severity and duration of the decline in fair value of the equity security as well as the cause of the decline, a fundamental analysis of the liquidity, business prospects and the overall financial condition of the issuer.
For its fixed maturity available-for-sale securities, the Company generally considers the following in determining whether its unrealized losses are other-than-temporarily impaired:
| The estimated range and period until recovery; |
| Current delinquencies and nonperforming assets of underlying collateral; |
| Expected future default rates; |
| Collateral value by vintage, geographic region, industry concentration or property type; |
| Subordination levels or other credit enhancements as of the balance sheet date as compared to origination; and |
| Contractual and regulatory cash obligations. |
The Company recognizes OTTI on debt securities in an unrealized loss position when one of the following circumstances exists:
| The Company does not expect full recovery of its amortized cost based on the estimate of cash flows expected to be collected; |
| The Company intends to sell a security; or |
| It is more likely than not that the Company will be required to sell a security prior to recovery. |
If the Company intends to sell a debt security or it is more likely than not the Company will be required to sell the security before recovery of its amortized cost basis and the fair value of the security is below amortized cost, the Company will conclude that an other-than-temporary impairment has occurred and the amortized cost is written down to current fair value, with a corresponding charge to Net investment gains (losses) in the accompanying Consolidated Statements of Operations. If the Company does not intend to sell a debt security or it is more likely than not the Company will not be required to sell a debt security before recovery of its amortized cost basis and the present value of the cash flows expected to be collected is less than the amortized cost of the security (referred to as the credit loss), an other-than-temporary impairment has occurred and the amortized cost is written down to the estimated recovery value with a corresponding charge to Net investment gains (losses) in the accompanying Consolidated Statements of Operations, as this amount is deemed the credit loss portion of the other-than-temporary impairment. The remainder of the decline to fair value is recorded in AOCI as unrealized other-than-temporary impairment on available-for-sale securities, as this amount is considered a non-credit (i.e., recoverable) impairment.
When assessing the Companys intent to sell a debt security or if it is more likely than not the Company will be required to sell a debt security before recovery of its cost basis, the Company evaluates facts and circumstances such as, but not limited to, decisions to reposition the Companys security portfolio, sale of securities to meet cash flow needs and sales of securities to capitalize on favorable pricing and tax planning strategies. In order to determine the amount of the credit loss for a security, the Company calculates the recovery value by performing a discounted cash flow analysis based on the current cash flows and future cash flows the Company expects to recover. The discount rate is the effective interest rate implicit in the underlying security. The effective interest rate is the original purchased yield or the yield at the date the debt security was previously impaired.
12
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
When evaluating mortgage-backed securities and asset-backed securities, the Company considers a number of pool-specific factors as well as market level factors when determining whether or not the impairment on the security is temporary or other-than-temporary. The most important factor is the performance of the underlying collateral in the security and the trends of that performance. The Company uses this information about the collateral to forecast the timing and rate of mortgage loan defaults, including making projections for loans that are already delinquent and for those loans that are currently performing but may become delinquent in the future. Other factors used in this analysis include type of underlying collateral (e.g., prime, Alternative A-paper (Alt-A), or subprime), geographic distribution of underlying loans and timing of liquidations by state. Once default rates and timing assumptions are determined, the Company then makes assumptions regarding the severity of a default if it were to occur. Factors that impact the severity assumption include expectations for future home price appreciation or depreciation, loan size, first lien versus second lien, existence of loan level private mortgage insurance, type of occupancy and geographic distribution of loans. Once default and severity assumptions are determined for the security in question, cash flows for the underlying collateral are projected, including expected defaults and prepayments. These cash flows on the collateral are then translated to cash flows on the Companys tranche based on the cash flow waterfall of the entire capital security structure. If this analysis indicates the entire principal on a particular security will not be returned, the security is reviewed for OTTI by comparing the present value of expected cash flows to amortized cost. To the extent that the security has already been impaired or was purchased at a discount, such that the amortized cost of the security is less than or equal to the present value of cash flows expected to be collected, no impairment is required. The Company also considers the ability of monoline insurers to meet their contractual guarantees on wrapped mortgage-backed securities. Otherwise, if the amortized cost of the security is greater than the present value of the cash flows expected to be collected, then an impairment is recognized.
The Company includes on the face of the Consolidated Statements of Operations the total OTTI recognized in net investment gains (losses), with an offset for the amount of non-credit impairments recognized in AOCI. The Company discloses the amount of OTTI recognized in AOCI and other disclosures related to OTTI in Note 4 and the Consolidated Statements of Comprehensive Income.
Derivative Financial Instruments
The Company hedges certain portions of its exposure to product related equity market risk by entering into derivative transactions. All of such derivative instruments are recognized as either assets or liabilities in the accompanying Consolidated Balance Sheets at fair value. The change in fair value is recognized within Net investment gains (losses) in the accompanying Consolidated Statements of Operations.
The Company purchases financial instruments and issues products that may contain embedded derivative instruments. If it is determined that the embedded derivative possesses economic characteristics that are not clearly and closely related to the economic characteristics of the host contract, and a separate instrument with the same terms would qualify as a derivative instrument, the embedded derivative is bifurcated from the host contract for measurement purposes. The embedded derivative is carried at fair value with changes in fair value reported in the accompanying Consolidated Statements of Operations.
Intangible Assets
The Companys intangible assets include value of business acquired (VOBA), deferred acquisition cost (DAC) and deferred sales inducements (DSI).
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Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
VOBA represents the estimated fair value of the right to receive future net cash flows from in-force contracts in a life insurance company acquisition at the Acquisition Date. DAC represents costs that are related directly to new or renewal insurance contracts, which may be deferred to the extent recoverable. These costs include incremental direct costs of contract acquisition, primarily commissions, as well as certain costs related directly to underwriting, policy issuance and processing. DSI represents up front bonus credits and vesting bonuses to policyholder account values, which are accounted for similarly to DAC and are recorded within the DAC asset balance.
The methodology for determining the amortization of DAC and VOBA varies by product type. For all insurance contracts accounted for under long-duration contract deposit accounting, amortization is based on assumptions consistent with those used in the development of the underlying contract adjusted for emerging experience and expected trends. Under traditional insurance contract accounting, US GAAP requires that assumptions for these types of products not be modified unless recoverability testing deems them to be inadequate. DAC and VOBA amortization are reported within Amortization of intangibles in the accompanying Consolidated Statements of Operations.
DAC and VOBA for IUL and investment-type products are generally amortized over the lives of the policies in relation to the incidence of estimated gross profits (EGPs) from investment income, surrender charges and other product fees, policy benefits, maintenance expenses, mortality net of reinsurance ceded and expense margins, and recognized gains (losses) on investments and changes in fair value of the coinsurance embedded derivative.
Changes in assumptions can have a significant impact on DAC and VOBA balances and amortization rates. Due to the relative size and sensitivity to minor changes in underlying assumptions of DAC and VOBA balances, the Company performs quarterly and annual analyses of DAC and VOBA for the annuity and IUL businesses. The DAC and VOBA balances are also periodically evaluated for recoverability to ensure that the unamortized portion does not exceed the expected recoverable amounts. At each evaluation date, actual historical gross profits are reflected, and estimated future gross profits and related assumptions are evaluated for continued reasonableness. Any adjustment in estimated future gross profits requires that the amortization rate be revised (unlocking) retroactively to the date of the policy or contract issuance. The cumulative unlocking adjustment is recognized as a component of current period amortization.
The carrying amounts of DAC and VOBA are adjusted for the effects of realized and unrealized gains and losses on debt securities classified as available-for-sale and certain derivatives and embedded derivatives. Amortization expense of DAC and VOBA reflects an assumption for an expected level of credit-related investment losses. When actual credit-related investment losses are realized, the Company performs a retrospective unlocking of DAC and VOBA amortization as actual margins vary from expected margins. This unlocking is reflected in the accompanying Consolidated Statements of Operations.
For investment-type products, the DAC and VOBA assets are adjusted for the impact of unrealized gains (losses) on investments as if these gains (losses) had been realized, with corresponding credits or charges included in AOCI.
Reinsurance
The Companys insurance subsidiaries enter into reinsurance agreements with other companies in the normal course of business. The assets, liabilities, premiums and benefits of certain reinsurance contracts are presented on a net basis in the accompanying Consolidated Balance Sheets and Consolidated Statements of Operations, respectively, when there is a right of offset explicit in the reinsurance agreements. All other reinsurance agreements are reported on a gross basis in the Companys Consolidated Balance Sheets as an asset for amounts recoverable from reinsurers or as a component of other liabilities for amounts, such as premiums, owed to the reinsurers, with the exception of amounts for which the right of offset also exists. Premiums and benefits are reported net of insurance ceded.
14
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
Income Taxes
FGLH and certain of its non-life insurance subsidiaries are included in the consolidated U.S. Federal income tax return of Harbinger Group, Inc. (HGI). The Companys life insurance subsidiaries file a consolidated life insurance income tax return. Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The Company has the ability and intent to recover in a tax-free manner any assets (or liabilities) with book/tax basis differences for which no deferred taxes have been provided, in accordance with ASC Topic 740, Income Taxes.
The Company applies the accounting guidance for uncertain tax positions which prescribes a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. The guidance also provides information on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. The Company recognizes the effect of income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. Accrued interest expense and penalties related to uncertain tax positions are recorded in Income tax (expense) benefit in the Companys Consolidated Statements of Operations. The Company had no unrecognized tax benefits related to uncertain tax positions as of September 30, 2013 and 2012.
Contractholder Funds and Future Policy Benefits
The liabilities for contractholder funds and future policy benefits for deferred annuities, IUL and UL policies consist of contract account balances that accrue to the benefit of the contractholders, excluding surrender charges and other liabilities. The liabilities for FIAs consist of the value of the host contract plus the value of the embedded derivative. The embedded derivative is carried at fair value in Contractholder funds in the accompanying Consolidated Balance Sheets with changes in fair value reported in the accompanying Consolidated Statements of Operations. Liabilities for immediate annuities without life contingencies are the present value of future benefits.
The liabilities for future policy benefits and claim reserves for traditional life policies and life contingent pay-out annuity policies are computed using assumptions for investment yields, mortality and withdrawals based principally on generally accepted actuarial methods and assumptions at the time of contract issue.
Liabilities for the secondary guarantees on UL-type products or Investment-type contracts are calculated by multiplying the benefit ratio by the cumulative assessments recorded from contract inception through the balance sheet date less the cumulative secondary guarantee benefit payments plus interest. If experience or assumption changes result in a new benefit ratio, the reserves are adjusted to reflect the changes in a manner similar to the unlocking of DAC and VOBA. The accounting for secondary guarantee benefits impacts, and is impacted by, EGPs used to calculate amortization of DAC and VOBA.
Federal Home Loan Bank of Atlanta Agreements
Contractholder funds include funds related to funding agreements that have been issued to the Federal Home Loan Bank of Atlanta (FHLB) as a funding medium for single premium funding agreements issued by the Company to the FHLB.
15
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
Funding agreements were issued to the FHLB in 2003, 2004, 2005, 2011 and 2012. The funding agreements (i.e., immediate annuity contracts without life contingencies) provide a guaranteed stream of payments. Single premiums were received at the initiation of the funding agreements and were in the form of advances from the FHLB. Payments under the funding agreements extend through 2022. The reserves for the funding agreements totaled $554,764 and $364,140 at September 30, 2013 and 2012, respectively, and are included in Contractholder funds in the accompanying Consolidated Balance Sheets.
In accordance with the agreements, the investments supporting the funding agreement liabilities are pledged as collateral to secure the FHLB funding agreement liabilities. The collateral investments had a fair value of $604,899 and $390,563 at September 30, 2013 and September 30, 2012, respectively.
Benefits and Other Changes in Policy Reserves
Benefit expenses for deferred annuity, FIA and IUL policies include benefit claims incurred during the period in excess of contract account balances. Other changes in policy reserves also include the change in reserves for life insurance products. For traditional life and immediate annuities, policy benefit claims are charged to expense in the period that the claims are incurred.
Recent Accounting Pronouncements Not Yet Adopted
Offsetting Assets and Liabilities
In December 2011, the FASB issued amended disclosure requirements for offsetting financial assets and financial liabilities to allow investors to better compare financial statements prepared under US GAAP with financial statements prepared under International Financial Reporting Standards. The new standards are effective for the Company beginning in the first quarter of its fiscal year ending September 30, 2014. The Company is currently evaluating the impact of this new accounting guidance on the disclosures included in its consolidated financial statements.
(3) Significant Risks and Uncertainties
Use of Estimates
The preparation of financial statements in conformity with US GAAP requires management to make 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. Due to the inherent uncertainty involved in making estimates, actual results in future periods could differ from those estimates.
The Companys significant estimates which are susceptible to change in the near term relate to (1) recognition of deferred tax assets and related valuation allowances (see Notes 13 and 18), (2) fair value of certain invested assets and derivatives including embedded derivatives (see Notes 4 and 5), (3) OTTI of available-for-sale investments (see Note 4), (4) amortization of intangibles (see Note 7), (5) estimates of reserves for loss contingencies, including litigation and regulatory reserves (see Note 13) and (6) reserves for future policy benefits and product guarantees.
The Company periodically, and at least annually, reviews the assumptions associated with reserves for policy benefits and products guarantees and amortization of intangibles. As part of the assumption review process that occurred in the September 2013, changes were made to the surrender rates, earned rates and future index credits to bring the assumptions in line with current and expected future experience. The change in assumptions resulted in a net increase in future expected margins and corresponding unlocking and amortization adjustments, increasing intangible assets and reducing the net intangible asset amortization by $33.1 million in Fiscal 2013. These assumptions are also used in the FIA embedded derivative reserve calculation and resulted in a decrease in benefits and other changes in policy reserves and a decrease in reserves of $45.3 million during Fiscal 2013, net of related intangible amortization.
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Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
Concentrations of Financial Instruments
As of September 30, 2013 and 2012, the Companys most significant investment in one industry, excluding U.S. government securities, was its investment securities in the banking industry with a fair value of $1,892,103, or 11.7%, and $2,000,355, or 12.0%, respectively, of the invested assets portfolio. The Companys holdings in this industry include investments in 80 different issuers with the top ten investments accounting for 41.8% of the total holdings in this industry. As of September 30, 2013 and September 30, 2012 the Company had investments in 6 and 13 issuers that exceeded 10% of stockholders equity with a fair value of $788,696 and $1,625,900, or 4.9% and 9.8% of the invested assets portfolio, respectively. Additionally, the Companys largest concentration in any single issuer as of September 30, 2013 and September 30, 2012 had a fair value of $150,716 and $152,876 or 0.9% and 0.9% of the invested assets portfolio, respectively.
Concentrations of Financial and Capital Markets Risk
The Company is exposed to financial and capital markets risk, including changes in interest rates and credit spreads which can have an adverse effect on the Companys results of operations, financial condition and liquidity. The Company expects to continue to face challenges and uncertainties that could adversely affect its results of operations and financial condition.
The Companys exposure to interest rate risk relates primarily to the market price and cash flow variability associated with changes in interest rates. A rise in interest rates, in the absence of other countervailing changes, will decrease the net unrealized gain position of the Companys investment portfolio and, if long-term interest rates rise dramatically within a six to twelve month time period, certain of the Companys products may be exposed to disintermediation risk. Disintermediation risk refers to the risk that policyholders may surrender their contracts in a rising interest rate environment, requiring the Company to liquidate assets in an unrealized loss position. This risk is mitigated to some extent by the high level of surrender charge protection provided by the Companys products.
Concentration of Reinsurance Risk
The Company has a significant concentration of reinsurance with Wilton Reassurance Company (Wilton Re) (see Note 14) and Front Street Re (Cayman) Ltd. (FSRCI), an affiliate (see Note 14) that could have a material impact on the Companys financial position in the event that Wilton Re and FSRCI fail to perform their obligations under the various reinsurance treaties. As of September 30, 2013 the net amount recoverable from Wilton Re was $1,337,741 and the net amount recoverable from FSRCI is $1,364,965. The Company monitors both the financial condition of individual reinsurers and risk concentration arising from similar geographic regions, activities and economic characteristics of reinsurers to reduce the risk of default by such reinsurers.
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Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
The Companys debt and equity securities have been designated as available-for-sale and are carried at fair value with unrealized gains and losses included in AOCI, net of associated adjustments for VOBA, DAC and deferred income taxes. The Companys consolidated investments at September 30, 2013 and September 30, 2012 are summarized as follows:
September 30, 2013 | ||||||||||||||||||||
Gross | Gross | |||||||||||||||||||
Amortized | Unrealized | Unrealized | Carrying | |||||||||||||||||
Cost | Gains | Losses | Fair Value | Value | ||||||||||||||||
Available-for-sale securities |
||||||||||||||||||||
Asset-backed securities |
$ | 1,745,241 | $ | 24,529 | $ | (5,176 | ) | $ | 1,764,594 | $ | 1,764,594 | |||||||||
Commercial mortgage-backed securities |
431,265 | 24,660 | (1,596 | ) | 454,329 | 454,329 | ||||||||||||||
Corporates |
9,314,661 | 288,702 | (185,054 | ) | 9,418,309 | 9,418,309 | ||||||||||||||
Equities |
274,647 | 6,683 | (10,255 | ) | 271,075 | 271,075 | ||||||||||||||
Hybrids |
412,640 | 19,481 | (3,304 | ) | 428,817 | 428,817 | ||||||||||||||
Municipals |
998,832 | 49,013 | (40,835 | ) | 1,007,010 | 1,007,010 | ||||||||||||||
Agency residential mortgage-backed securities |
96,452 | 2,397 | (252 | ) | 98,597 | 98,597 | ||||||||||||||
Non-agency residential mortgage-backed securities |
1,304,007 | 77,410 | (13,394 | ) | 1,368,023 | 1,368,023 | ||||||||||||||
U.S. Government |
998,530 | 7,174 | (3,857 | ) | 1,001,847 | 1,001,847 | ||||||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||
Total available-for-sale securities |
15,576,275 | 500,049 | (263,723 | ) | 15,812,601 | 15,812,601 | ||||||||||||||
Derivative investments |
141,664 | 88,461 | (8,367 | ) | 221,758 | 221,758 | ||||||||||||||
Other invested assets |
188,180 | | | 188,180 | 188,180 | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||
Total investments |
$ | 15,906,119 | $ | 588,510 | $ | (272,090 | ) | $ | 16,222,539 | $ | 16,222,539 | |||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||
September 30, 2012 | ||||||||||||||||||||
Gross | Gross | |||||||||||||||||||
Amortized | Unrealized | Unrealized | Carrying | |||||||||||||||||
Cost | Gains | Losses | Fair Value | Value | ||||||||||||||||
Available-for-sale securities |
||||||||||||||||||||
Asset-backed securities |
$ | 1,010,938 | $ | 18,553 | $ | (1,609 | ) | $ | 1,027,882 | $ | 1,027,882 | |||||||||
Commercial mortgage-backed securities |
520,043 | 36,178 | (2,407 | ) | 553,814 | 553,814 | ||||||||||||||
Corporates |
10,211,804 | 807,175 | (9,968 | ) | 11,009,011 | 11,009,011 | ||||||||||||||
Equities |
237,499 | 11,860 | (1,272 | ) | 248,087 | 248,087 | ||||||||||||||
Hybrids |
519,009 | 18,836 | (9,550 | ) | 528,295 | 528,295 | ||||||||||||||
Municipals |
1,083,231 | 141,854 | (1,090 | ) | 1,223,995 | 1,223,995 | ||||||||||||||
Agency residential mortgage-backed securities |
149,455 | 5,769 | (334 | ) | 154,890 | 154,890 | ||||||||||||||
Non-agency residential mortgage-backed securities |
629,122 | 35,799 | (4,262 | ) | 660,659 | 660,659 | ||||||||||||||
U.S. Government |
917,452 | 12,915 | | 930,367 | 930,367 | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||
Total available-for-sale securities |
15,278,553 | 1,088,939 | (30,492 | ) | 16,337,000 | 16,337,000 | ||||||||||||||
Derivative investments |
142,123 | 66,973 | (8,429 | ) | 200,667 | 200,667 | ||||||||||||||
Other invested assets |
18,814 | | | 18,814 | 18,814 | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||
Total investments |
$ | 15,439,490 | $ | 1,155,912 | $ | (38,921 | ) | $ | 16,556,481 | $ | 16,556,481 | |||||||||
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18
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
Included in AOCI were cumulative unrealized gains of $851 and unrealized losses of $1,880 related to the non-credit portion of OTTI on non-agency residential mortgage-backed securities (RMBS) at September 30, 2013 and September 30, 2012. The non-agency RMBS unrealized losses and gains represent the difference between book value and fair value on securities that were previously impaired. There have been no impairments or write downs on any of the 2013 purchased non-agency RMBS securities.
Securities held on deposit with various state regulatory authorities had a fair value of $19,350 and $20,692 at September 30, 2013 and September 30, 2012, respectively.
The amortized cost and fair value of fixed maturity available-for-sale securities by contractual maturities, as applicable, are shown below. Actual maturities may differ from contractual maturities because issuers may have the right to call or pre-pay obligations.
September 30, 2013 | ||||||||
Amortized | Fair | |||||||
Cost | Value | |||||||
Corporate, Non-structured Hybrids, Municipal and U.S. Government securities: |
||||||||
Due in one year or less |
$ | 978,494 | $ | 982,395 | ||||
Due after one year through five years |
2,739,091 | 2,805,778 | ||||||
Due after five years through ten years |
2,972,452 | 3,000,940 | ||||||
Due after ten years |
5,007,510 | 5,037,497 | ||||||
|
|
|
|
|||||
Subtotal |
11,697,547 | 11,826,610 | ||||||
Other securities which provide for periodic payments: |
||||||||
Asset-backed securities |
1,745,241 | 1,764,594 | ||||||
Commercial mortgage-backed securities |
431,265 | 454,329 | ||||||
Structured hybrids |
27,116 | 29,373 | ||||||
Agency residential mortgage-backed securities |
96,452 | 98,597 | ||||||
Non-agency residential mortgage-backed securities |
1,304,007 | 1,368,023 | ||||||
|
|
|
|
|||||
Total fixed maturity available-for-sale securities |
$ | 15,301,628 | $ | 15,541,526 | ||||
|
|
|
|
The Companys available-for-sale securities with unrealized losses are reviewed for potential OTTI. In evaluating whether a decline in value is other-than-temporary, the Company considers several factors including, but not limited to the following: (1) the extent and the duration of the decline; (2) the reasons for the decline in value (credit event, currency or interest-rate related, including general credit spread widening); and (3) the financial condition of and near-term prospects of the issuer. The Company also considers the ability and intent to hold the investment for a period of time to allow for a recovery of value.
The Company analyzes its ability to recover the amortized cost by comparing the net present value of cash flows expected to be collected with the amortized cost of the security. For mortgage-backed and asset-backed securities, cash flow estimates consider the payment terms of the underlying assets backing a particular security, including interest rate and prepayment assumptions, based on data from widely accepted third-party data sources or internal estimates. In addition to interest rate and prepayment assumptions, cash flow estimates also include other assumptions regarding the underlying collateral including default rates and recoveries, which vary based on the asset type and geographic location, as well as the vintage year of the security. For structured securities, the payment priority within the tranche structure is also considered. For all other debt securities, cash flow estimates are driven by assumptions regarding probability of default and estimates regarding timing and amount of recoveries associated with a default. If the net present value is less than the amortized cost of the investment, an other-than-temporary impairment is recognized. The Company has concluded that the fair values of the securities presented in the table below were not other-than-temporarily impaired as of September 30, 2013.
19
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
The fair value and gross unrealized losses of available-for-sale securities, aggregated by investment category, were as follows:
September 30, 2013 | ||||||||||||||||||||||||
Less than 12 months | 12 months or longer | Total | ||||||||||||||||||||||
Gross | Gross | Gross | ||||||||||||||||||||||
Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | |||||||||||||||||||
Value | Losses | Value | Losses | Value | Losses | |||||||||||||||||||
Available-for-sale securities |
||||||||||||||||||||||||
Asset-backed securities |
$ | 329,319 | $ | (4,496 | ) | $ | 81,483 | $ | (680 | ) | $ | 410,802 | $ | (5,176 | ) | |||||||||
Commercial-mortgage-backed securities |
26,575 | (525 | ) | 4,860 | (1,071 | ) | 31,435 | (1,596 | ) | |||||||||||||||
Corporates |
3,457,206 | (174,989 | ) | 185,956 | (10,065 | ) | 3,643,162 | (185,054 | ) | |||||||||||||||
Equities |
118,609 | (9,120 | ) | 32,240 | (1,135 | ) | 150,849 | (10,255 | ) | |||||||||||||||
Hybrids |
52,027 | (3,304 | ) | | | 52,027 | (3,304 | ) | ||||||||||||||||
Municipals |
333,278 | (27,359 | ) | 144,365 | (13,476 | ) | 477,643 | (40,835 | ) | |||||||||||||||
Agency residential mortgage-backed securities |
9,791 | (117 | ) | 1,148 | (135 | ) | 10,939 | (252 | ) | |||||||||||||||
Non-agency residential mortgage-backed securities |
325,170 | (12,224 | ) | 69,910 | (1,170 | ) | 395,080 | (13,394 | ) | |||||||||||||||
U.S. Government |
753,899 | (3,857 | ) | | | 753,899 | (3,857 | ) | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total available-for-sale securities |
$ | 5,405,874 | $ | (235,991 | ) | $ | 519,962 | $ | (27,732 | ) | $ | 5,925,836 | $ | (263,723 | ) | |||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total number of available-for-sale securities in an unrealized loss position less than twelve months |
|
588 | ||||||||||||||||||||||
|
|
|||||||||||||||||||||||
Total number of available-for-sale securities in an unrealized loss position twelve months or longer |
|
78 | ||||||||||||||||||||||
|
|
|||||||||||||||||||||||
Total number of available-for-sale securities in an unrealized loss position |
|
666 | ||||||||||||||||||||||
|
|
|||||||||||||||||||||||
September 30, 2012 | ||||||||||||||||||||||||
Less than 12 months | 12 months or longer | Total | ||||||||||||||||||||||
Gross | Gross | Gross | ||||||||||||||||||||||
Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | |||||||||||||||||||
Value | Losses | Value | Losses | Value | Losses | |||||||||||||||||||
Available-for-sale securities |
||||||||||||||||||||||||
Asset-backed securities |
$ | 169,794 | $ | (1,042 | ) | $ | 7,533 | $ | (567 | ) | $ | 177,327 | $ | (1,609 | ) | |||||||||
Commercial-mortgage-backed securities |
813 | (853 | ) | 10,716 | (1,554 | ) | 11,529 | (2,407 | ) | |||||||||||||||
Corporates |
411,310 | (8,124 | ) | 45,482 | (1,844 | ) | 456,792 | (9,968 | ) | |||||||||||||||
Equities |
| | 44,513 | (1,272 | ) | 44,513 | (1,272 | ) | ||||||||||||||||
Hybrids |
13,407 | (339 | ) | 107,707 | (9,211 | ) | 121,114 | (9,550 | ) | |||||||||||||||
Municipals |
71,160 | (1,090 | ) | | | 71,160 | (1,090 | ) | ||||||||||||||||
Agency residential mortgage-backed securities |
1,754 | (199 | ) | 6,110 | (135 | ) | 7,864 | (334 | ) | |||||||||||||||
Non-agency residential mortgage-backed securities |
12,853 | (289 | ) | 101,777 | (3,973 | ) | 114,630 | (4,262 | ) | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total available-for-sale securities |
$ | 681,091 | $ | (11,936 | ) | $ | 323,838 | $ | (18,556 | ) | $ | 1,004,929 | $ | (30,492 | ) | |||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total number of available-for-sale securities in an unrealized loss position less than twelve months |
|
100 | ||||||||||||||||||||||
|
|
|||||||||||||||||||||||
Total number of available-for-sale securities in an unrealized loss position twelve months or longer |
|
56 | ||||||||||||||||||||||
|
|
|||||||||||||||||||||||
Total number of available-for-sale securities in an unrealized loss position |
|
156 | ||||||||||||||||||||||
|
|
20
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
At September 30, 2013 and September 30, 2012, securities in an unrealized loss position were primarily concentrated in investment grade corporate debt instruments and municipals. Total unrealized losses were $263,723 and $30,492 at September 30, 2013 and September 30, 2012, respectively. The increase in the unrealized loss position is largely due to the increase in Treasury yields in the current fiscal year. 10 year US Treasury yields increased from 1.63% at September 30, 2012 to 2.64% at September 30, 2013. As a result, corporate debt holdings generally declined in value during this period. Management believes the increase in Treasury yields during the fiscal year is attributable to concerns about the cessation of liquidity measures being provided by the Federal Reserve.
At September 30, 2013 and September 30, 2012, securities with a fair value of $60,931 and $1,192, respectively, were depressed greater than 20% of amortized cost (excluding United States Government and United States Government sponsored agency securities), which represented less than 1% of the carrying values of all investments.
The following table provides a reconciliation of the beginning and ending balances of the credit loss portion of OTTI on fixed maturity securities held by the Company for the year ended September 30, 2013 and September 30, 2012, for which a portion of the OTTI was recognized in AOCI:
Year Ended | ||||||||
September 30, | September 30, | |||||||
2013 | 2012 | |||||||
Beginning Balance |
$ | 2,681 | 667 | |||||
Increases attributable to credit losses on securities: |
||||||||
Other-than-temporary impairment was previously recognized |
| 112 | ||||||
Other-than-temporary impairment was not previously recognized |
| 1,902 | ||||||
|
|
|
|
|||||
Ending Balance |
$ | 2,681 | 2,681 | |||||
|
|
|
|
For the year ended September 30, 2013, the Company recognized impairment losses in operations totaling $2,940, including credit impairments of $757 and change-of-intent impairments of $2,183 and had an amortized cost of $9,623 and a fair value of $6,683 at the time of impairment.
For the year ended September 30, 2012, the Company recognized impairment losses in operations totaling $22,807, including credit impairments of $5,712 and change-of-intent impairments of $17,095 as well as non-credit losses in other comprehensive income totaling $1,529, for investments which experienced OTTI and had an amortized cost of $162,349 and a fair value of $138,013 at September 30, 2012.
For the period April 6, 2011 through September 30, 2011, the Company recognized impairment losses in operations totaling $17,966, including credit impairments of $5,059 and change-of-intent impairments of $12,907 as well as non-credit gains totaling $500 in other comprehensive income, for investments which experienced other-than-temporary impairments and had an amortized cost of $103,312 and a fair value of $85,846 at the time of impairment.
21
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
Details underlying write-downs taken as a result of OTTI that were recognized in net income and included in net realized gains on securities were as follows:
Year Ended | April 6, 2011 to | |||||||||||
September 30, 2013 |
September 30, 2012 |
September 30, 2011 |
||||||||||
OTTI recognized in net income |
||||||||||||
Commercial mortgage-backed securities |
$ | | $ | | $ | 20 | ||||||
Corporates |
1,193 | 4,116 | 1,462 | |||||||||
Equities |
| | 11,007 | |||||||||
Hybrids |
| 9,688 | | |||||||||
Non-agency residential mortgage-backed securities |
1,246 | 7,531 | 5,059 | |||||||||
Other assets |
501 | 1,472 | 418 | |||||||||
|
|
|
|
|
|
|||||||
Total OTTI |
$ | 2,940 | $ | 22,807 | $ | 17,966 | ||||||
|
|
|
|
|
|
The portion of OTTI recognized in AOCI is disclosed in the Statement of Comprehensive Income.
Net Investment Income
The major sources of Net investment income in the accompanying Consolidated Statements of Operations were as follows:
Year Ended | April 6, 2011 to | |||||||||||
September 30, 2013 |
September 30, 2012 |
September 30, 2011 |
||||||||||
Fixed maturity available-for-sale securities |
$ | 653,586 | $ | 705,132 | $ | 364,771 | ||||||
Equity available-for-sale securities |
14,252 | 13,966 | 10,190 | |||||||||
Related party loans |
7,999 | 2,040 | | |||||||||
Policy loans |
794 | 707 | 1,511 | |||||||||
Invested cash and short-term investments |
1,356 | 4,881 | 129 | |||||||||
Other investments |
8,408 | 1,179 | 326 | |||||||||
|
|
|
|
|
|
|||||||
Gross investment income |
686,395 | 727,905 | 376,927 | |||||||||
Investment expense |
(13,447 | ) | (11,729 | ) | (7,087 | ) | ||||||
|
|
|
|
|
|
|||||||
Net investment income |
$ | 672,948 | $ | 716,176 | $ | 369,840 | ||||||
|
|
|
|
|
|
22
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
Net Investment Gains (Losses)
Details underlying Net investment gains (losses) reported in the accompanying Consolidated Statements of Operations were as follows:
Year Ended | ||||||||||||
September 30, 2013 |
September 30, 2012 |
April 6, 2011 to September 30, 2011 |
||||||||||
Net realized gains on fixed maturity available-for-sale securities |
$ | 274,363 | $ | 264,408 | $ | 16,912 | ||||||
Realized gains (losses) on equity securities |
3,344 | 924 | (10,977 | ) | ||||||||
|
|
|
|
|
|
|||||||
Net realized gains on securities |
277,707 | 265,332 | 5,935 | |||||||||
|
|
|
|
|
|
|||||||
Realized gains (losses) on certain derivative instruments |
135,737 | (10,280 | ) | (44,776 | ) | |||||||
Unrealized gains (losses) on certain derivative instruments |
13,212 | 156,332 | (125,976 | ) | ||||||||
Change in fair value of reinsurance related embedded derivative |
118,025 | | | |||||||||
|
|
|
|
|
|
|||||||
Realized gains (losses) on derivatives and reinsurance related embedded derivative |
266,974 | 146,052 | (170,752 | ) | ||||||||
|
|
|
|
|
|
|||||||
Realized (losses) on other invested assets |
(105 | ) | (1,384 | ) | (2,074 | ) | ||||||
|
|
|
|
|
|
|||||||
Net investment gains (losses) |
$ | 544,576 | $ | 410,000 | $ | (166,891 | ) | |||||
|
|
|
|
|
|
For the year ended September 30, 2013, principal repayments, calls, tenders, and proceeds from the sale of fixed maturity available-for-sale securities totaled $8,920,083, gross gains on such sales totaled $352,618 and gross losses totaled $77,172, respectively.
For year ended September 30, 2012, principal repayments, calls, tenders, and proceeds from the sale of fixed maturity available-for-sale securities, including assets transferred to Wilton Re as discussed in Note 14, Reinsurance, totaled $4,602,958 gross gains on such sales totaled $295,923 and gross losses totaled $13,482, respectively.
For the period of April 6, 2011 to September 30, 2011, proceeds from the sale of fixed maturity available-for-sale securities, totaled $1,803,964, gross gains on such sales totaled $41,989 and gross losses totaled $17,109, respectively.
23
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
(5) Derivative Financial Instruments
The carrying amounts (which equal fair value) of derivative instruments, including derivative instruments embedded in FIA contracts, is as follows:
September 30, | September 30, | |||||||
2013 | 2012 | |||||||
Assets: |
||||||||
Derivative investments: |
||||||||
Call options |
$ | 221,758 | $ | 200,667 | ||||
Other Assets: |
||||||||
Reinsurance related embedded derivative |
118,025 | | ||||||
|
|
|
|
|||||
$ | 339,783 | $ | 200,667 | |||||
|
|
|
|
|||||
Liabilities: |
||||||||
Contractholder funds: |
||||||||
FIA embedded derivative |
$ | 1,544,447 | $ | 1,550,805 | ||||
Funds withheld for reinsurance liabilities: |
||||||||
Options payable to FSRCI |
22,833 | |||||||
Other liabilities: |
||||||||
Futures contracts |
1,028 | 928 | ||||||
|
|
|
|
|||||
$ | 1,568,308 | $ | 1,551,733 | |||||
|
|
|
|
The change in fair value of derivative instruments included in the accompanying Consolidated Statements of Operations is as follows:
Year Ended | ||||||||||||
September 30, 2013 |
September 30, 2012 |
April 6, 2011 to September 30, 2011 |
||||||||||
Revenues: |
||||||||||||
Net investment gains: |
||||||||||||
Call options |
$ | 131,484 | $ | 100,030 | $ | (142,665 | ) | |||||
Futures contracts |
17,465 | 46,022 | (28,087 | ) | ||||||||
Reinsurance related embedded derivative |
118,025 | | | |||||||||
|
|
|
|
|
|
|||||||
266,974 | 146,052 | (170,752 | ) | |||||||||
Net investment income: |
||||||||||||
Available-for-sale embedded derivatives |
| 400 | 19 | |||||||||
|
|
|
|
|
|
|||||||
266,974 | 146,452 | (170,733 | ) | |||||||||
|
|
|
|
|
|
|||||||
Benefits and other changes in policy reserves: |
||||||||||||
FIA embedded derivatives |
$ | (6,358 | ) | $ | 154,465 | $ | (69,968 | ) | ||||
|
|
|
|
|
|
24
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
Additional Disclosures
FIA Contracts
The Company has FIA Contracts that permit the holder to elect an interest rate return or an equity index linked component, where interest credited to the contracts is linked to the performance of various equity indices, primarily the Standard and Poors (S&P) 500 Index. This feature represents an embedded derivative under US GAAP. The FIA embedded derivative is valued at fair value and included in the liability for contractholder funds in the accompanying Consolidated Balance Sheets with changes in fair value included as a component of Benefits and other changes in policy reserves in the Consolidated Statements of Operations.
The Company purchases derivatives consisting of a combination of call options and futures contracts on the applicable market indices to fund the index credits due to FIA contractholders. The call options are one, two and three year options purchased to match the funding requirements of the underlying policies. On the respective anniversary dates of the index policies, the index used to compute the interest credit is reset and the Company purchases new one, two or three year call options to fund the next index credit. The Company manages the cost of these purchases through the terms of its FIA contracts, which permit the Company to change caps, spreads or participation rates, subject to guaranteed minimums, on each contracts anniversary date. The change in the fair value of the call options and futures contracts is generally designed to offset the portion of the change in the fair value of the FIA embedded derivative related to index performance. The call options and futures contracts are marked to fair value with the change in fair value included as a component of Net investment gains. The change in fair value of the call options and futures contracts includes the gains and losses recognized at the expiration of the instrument term or upon early termination and the changes in fair value of open positions.
Other market exposures are hedged periodically depending on market conditions and the Companys risk tolerance. The Companys FIA hedging strategy economically hedges the equity returns and exposes the Company to the risk that unhedged market exposures result in divergence between changes in the fair value of the liabilities and the hedging assets. The Company uses a variety of techniques, including direct estimation of market sensitivities and value-at-risk to monitor this risk daily. The Company intends to continue to adjust the hedging strategy as market conditions and the Companys risk tolerance change.
Reinsurance Related Embedded Derivatives
Effective December 31, 2012, FGL Insurance entered into a modified coinsurance arrangement with FSRCI, meaning that funds were withheld by FGL Insurance. This arrangement creates an obligation for the FGL Insurance to pay FSRCI at a later date, which resulted in an embedded derivative. This embedded derivative is considered a total return swap with contractual returns that are attributable to assets and liabilities associated with this reinsurance arrangement. The fair value of the total return swap is based on the change in fair value of the underlying assets held in the funds withheld portfolio. Investment results for the assets that support the coinsurance with funds withheld reinsurance arrangement, including gains and losses from sales, are passed directly to the reinsurer pursuant to contractual terms of the reinsurance arrangement. The reinsurance related embedded derivative is reported in Other assets on the Consolidated Balance Sheets and the related gains or losses are reported in Net investment gains (losses) on the Consolidated Statements of Operations.
Credit Risk
The Company is exposed to credit loss in the event of nonperformance by its counterparties on the call options and reflects assumptions regarding this nonperformance risk in the fair value of the call options. The nonperformance risk is the net counterparty exposure based on the fair value of the open contracts less collateral held. The Company maintains a policy of requiring all derivative contracts to be governed by an International Swaps and Derivatives Association (ISDA) Master Agreement.
25
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
Information regarding the Companys exposure to credit loss on the call options it holds is presented in the following table:
Credit Rating |
September 30, 2013 | |||||||||||||||||
Counterparty |
(Moodys/ S&P) |
Notional Amount |
Fair Value | Collateral | Net Credit Risk |
|||||||||||||
Merrill Lynch |
NA/A | $ | 2,037,781 | $ | 70,695 | $ | | $ | 70,695 | |||||||||
Deutsche Bank |
A2/A | 1,620,404 | 51,667 | 23,000 | 28,667 | |||||||||||||
Morgan Stanley |
Baa1/A | 2,264,136 | 75,729 | 49,000 | 26,729 | |||||||||||||
Royal Bank of Scotland |
A3/A | 364,300 | 20,313 | | 20,313 | |||||||||||||
Barclays Bank |
A2/A | 120,789 | 3,354 | | 3,354 | |||||||||||||
Credit Suisse |
A2/A- | | | | | |||||||||||||
|
|
|
|
|
|
|
|
|||||||||||
$ | 6,407,410 | $ | 221,758 | $ | 72,000 | $ | 149,758 | |||||||||||
|
|
|
|
|
|
|
|
|||||||||||
Credit Rating |
September 30, 2012 | |||||||||||||||||
Counterparty |
(Moodys/ S&P) |
Notional Amount |
Fair Value | Collateral | Net Credit Risk |
|||||||||||||
Merrill Lynch |
NA/A | $ | 1,884,047 | $ | 64,101 | $ | | $ | 64,101 | |||||||||
Deutsche Bank |
A2/A | 1,816,532 | 61,704 | | 61,704 | |||||||||||||
Morgan Stanley |
Baa1/A | 1,634,686 | 51,630 | | 51,630 | |||||||||||||
Royal Bank of Scotland |
A3/A | 353,875 | 19,595 | | 19,595 | |||||||||||||
Barclays Bank |
A2/A | 131,255 | 3,081 | | 3,081 | |||||||||||||
Credit Suisse |
A2/A- | 10,000 | 556 | | 556 | |||||||||||||
|
|
|
|
|
|
|
|
|||||||||||
$ | 5,830,395 | $ | 200,667 | $ | | $ | 200,667 | |||||||||||
|
|
|
|
|
|
|
|
Collateral Agreements
The Company is required to maintain minimum ratings as a matter of routine practice under its ISDA agreements. Under some ISDA agreements, the Company has agreed to maintain certain financial strength ratings. A downgrade below these levels provides the counterparty under the agreement the right to terminate the open derivative contracts between the parties, at which time any amounts payable by the Company or the counterparty would be dependent on the market value of the underlying derivative contracts. The Companys current rating allows multiple counterparties the right to terminate ISDA agreements. No ISDA agreements have been terminated, although the counterparties have reserved the right to terminate the ISDA agreements at any time. In certain transactions, the Company and the counterparty have entered into a collateral support agreement requiring either party to post collateral when the net exposures exceed pre-determined thresholds. These thresholds vary by counterparty and credit rating. As of September 30, 2013 counterparties posted $72,000 of collateral. As of September 30, 2012, no collateral was posted by the Companys counterparties as they did not meet the net exposure thresholds. Accordingly, the maximum amount of loss due to credit risk that the Company would incur if parties to the call options failed completely to perform according to the terms of the contracts was $149,758 and $200,667 at September 30, 2013 and September 30, 2012, respectively.
26
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
The Company held 1,693 and 2,835 futures contracts at September 30, 2013 and September 30, 2012, respectively. The fair value of futures contracts represents the cumulative unsettled variation margin (open trade equity net of cash settlements). The Company provides cash collateral to the counterparties for the initial and variation margin on the futures contracts which is included in Cash and cash equivalents in the accompanying Consolidated Balance Sheets. The amount of collateral held by the counterparties for such contracts was $5,861 and $9,820 at September 30, 2013 and September 30, 2012, respectively.
(6) Fair Value of Financial Instruments
The Companys measurement of fair value is based on assumptions used by market participants in pricing the asset or liability, which may include inherent risk, restrictions on the sale or use of an asset or non-performance risk, which may include the Companys own credit risk. The Companys estimate of an exchange price is the price in an orderly transaction between market participants to sell the asset or transfer the liability (exit price) in the principal market, or the most advantageous market in the absence of a principal market, for that asset or liability, as opposed to the price that would be paid to acquire the asset or receive a liability (entry price). The Company categorizes financial instruments carried at fair value into a three-level fair value hierarchy, based on the priority of inputs to the respective valuation technique. The three-level hierarchy for fair value measurement is defined as follows:
Level 1 - Values are unadjusted quoted prices for identical assets and liabilities in active markets accessible at the measurement date.
Level 2 - Inputs include quoted prices for similar assets or liabilities in active markets, quoted prices from those willing to trade in markets that are not active, or other inputs that are observable or can be corroborated by market data for the term of the instrument. Such inputs include market interest rates and volatilities, spreads and yield curves.
Level 3 - Certain inputs are unobservable (supported by little or no market activity) and significant to the fair value measurement. Unobservable inputs reflect the Companys best estimate of what hypothetical market participants would use to determine a transaction price for the asset or liability at the reporting date based on the best information available in the circumstances.
In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an investments level within the fair value hierarchy is based on the lower level of input that is significant to the fair value measurement. The Companys assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the investment.
When a determination is made to classify an asset or liability within Level 3 of the fair value hierarchy, the determination is based upon the significance of the unobservable inputs to the overall fair value measurement. Because certain securities trade in less liquid or illiquid markets with limited or no pricing information, the determination of fair value for these securities is inherently more difficult. However, Level 3 fair value investments may include, in addition to the unobservable or Level 3 inputs, observable components, which are components that are actively quoted or can be validated to market-based sources.
The carrying amounts and estimated fair values of the Companys consolidated financial instruments for which the disclosure of fair values is required, including financial assets and liabilities measured and carried at fair value on a recurring basis, with the exception of investment contracts, related party loans, portions of other invested assets, and debt are summarized according to the hierarchy previously described, as follows:
27
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
September 30, 2013 | ||||||||||||||||||||
Level 1 | Level 2 | Level 3 | Fair Value | Carrying Amount |
||||||||||||||||
Assets |
||||||||||||||||||||
Cash and cash equivalents |
$ | 1,204,334 | $ | | $ | | $ | 1,204,334 | $ | 1,204,334 | ||||||||||
Fixed maturity securities available-for-sale: |
||||||||||||||||||||
Asset-backed securities |
| 1,518,066 | 246,528 | 1,764,594 | 1,764,594 | |||||||||||||||
Commercial mortgage-backed securities |
| 448,694 | 5,635 | 454,329 | 454,329 | |||||||||||||||
Corporates |
| 8,957,196 | 461,113 | 9,418,309 | 9,418,309 | |||||||||||||||
Hybrids |
| 428,817 | | 428,817 | 428,817 | |||||||||||||||
Municipals |
| 1,007,010 | | 1,007,010 | 1,007,010 | |||||||||||||||
Agency residential mortgage-backed securities |
| 98,597 | | 98,597 | 98,597 | |||||||||||||||
Non-agency residential mortgage-backed securities |
| 1,368,023 | | 1,368,023 | 1,368,023 | |||||||||||||||
U.S. Government |
790,926 | 210,921 | | 1,001,847 | 1,001,847 | |||||||||||||||
Equity securities available-for-sale |
| 271,075 | | 271,075 | 271,075 | |||||||||||||||
Derivative financial instruments |
| 221,758 | | 221,758 | 221,758 | |||||||||||||||
Reinsurance related embedded derivative |
| 118,025 | | 118,025 | 118,025 | |||||||||||||||
Related party loans |
| | 119,044 | 119,044 | 119,044 | |||||||||||||||
Other invested assets |
| | 188,180 | 188,180 | 188,180 | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||
Total financial assets at fair value |
$ | 1,995,260 | $ | 14,648,182 | $ | 1,020,500 | $ | 17,663,942 | $ | 17,663,942 | ||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||
Liabilities |
||||||||||||||||||||
Derivatives: |
||||||||||||||||||||
FIA embedded derivatives, included in contractor funds |
$ | | $ | | $ | 1,544,447 | $ | 1,544,447 | $ | 1,544,447 | ||||||||||
Derivative instruments - futures contracts |
| 1,028 | | 1,028 | 1,028 | |||||||||||||||
Investment contracts, included in contractholder funds |
| | 12,378,645 | 12,378,645 | 13,703,769 | |||||||||||||||
Call options payable to FSRCI, included in funds withheld for reinsurance liabilities |
| 22,833 | | 22,833 | 22,833 | |||||||||||||||
Debt |
| 300,000 | | 300,000 | 300,000 | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||
Total financial liabilities |
$ | | $ | 323,861 | $ | 13,923,092 | $ | 14,246,953 | $ | 15,572,077 | ||||||||||
|
|
|
|
|
|
|
|
|
|
28
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
September 30, 2012 | ||||||||||||||||||||
Level 1 | Level 2 | Level 3 | Fair Value | Carrying Amount |
||||||||||||||||
Assets |
||||||||||||||||||||
Cash and cash equivalents |
$ | 1,047,124 | $ | 2,250 | $ | | $ | 1,049,374 | $ | 1,049,374 | ||||||||||
Fixed maturity securities, available-for-sale: |
||||||||||||||||||||
Asset-backed securities |
| 1,012,027 | 15,855 | 1,027,882 | 1,027,882 | |||||||||||||||
Commercial mortgage-backed securities |
| 548,791 | 5,023 | 553,814 | 553,814 | |||||||||||||||
Corporates |
| 10,873,715 | 135,296 | 11,009,011 | 11,009,011 | |||||||||||||||
Hybrids |
| 519,422 | 8,873 | 528,295 | 528,295 | |||||||||||||||
Municipals |
| 1,223,995 | | 1,223,995 | 1,223,995 | |||||||||||||||
Agency residential mortgage-backed securities |
| 154,890 | | 154,890 | 154,890 | |||||||||||||||
Non-agency residential mortgage-backed securities |
| 660,659 | | 660,659 | 660,659 | |||||||||||||||
U.S. Government |
930,367 | | | 930,367 | 930,367 | |||||||||||||||
Equity securities |
| 248,087 | | 248,087 | 248,087 | |||||||||||||||
Derivative financial instruments |
| 200,667 | | 200,667 | 200,667 | |||||||||||||||
Other invested assets |
| | 18,814 | 18,814 | 18,814 | |||||||||||||||
Related party loans |
| | 150,069 | 150,069 | 150,069 | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||
Total financial assets |
$ | 1,977,491 | $ | 15,444,503 | $ | 333,930 | $ | 17,755,924 | $ | 17,755,924 | ||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||
Liabilities |
||||||||||||||||||||
Derivatives: |
||||||||||||||||||||
FIA embedded derivatives, included in contractholder funds |
$ | | $ | | $ | 1,550,805 | $ | 1,550,805 | $ | 1,550,805 | ||||||||||
Futures contracts |
| 928 | | 928 | 928 | |||||||||||||||
Investment contracts, included in contractholder funds |
| | 12,271,882 | 12,271,882 | 13,739,670 | |||||||||||||||
Note payable to affiliate |
| | 224,363 | 224,363 | 224,363 | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||
Total financial liabilities |
$ | | $ | 928 | $ | 14,047,050 | $ | 14,047,050 | $ | 15,515,766 | ||||||||||
|
|
|
|
|
|
|
|
|
|
The carrying amounts of accrued investment income and portions of other liabilities approximate fair value due to their short duration and, accordingly, they are not presented in the table above.
Valuation Methodologies
Fixed Maturity Securities & Equity Securities
The Company measures the fair value of its securities based on assumptions used by market participants in pricing the security. The most appropriate valuation methodology is selected based on the specific characteristics of the fixed maturity or equity security, and the Company will then consistently apply the valuation methodology to
29
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
measure the securitys fair value. The Companys fair value measurement is based on a market approach, which utilizes prices and other relevant information generated by market transactions involving identical or comparable securities. Sources of inputs to the market approach include a third-party pricing service, independent broker quotations or pricing matrices. The Company uses observable and unobservable inputs in its valuation methodologies. Observable inputs include benchmark yields, reported trades, broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data. In addition, market indicators and industry and economic events are monitored and further market data will be acquired when certain thresholds are met. For certain security types, additional inputs may be used, or some of the inputs described above may not be applicable. For broker-quoted only securities, quotes from market makers or broker-dealers are obtained from sources recognized to be market participants. Management believes the broker quotes are prices at which trades could be executed based on historical trades executed at broker-quoted or slightly higher prices.
The Company did not adjust prices received from third parties as of September 30, 2013 and September 30, 2012. However, the Company does analyze the third party valuation methodologies and its related inputs to perform assessments to determine the appropriate level within the fair value hierarchy.
Derivative Financial Instruments
The fair value of derivative assets and liabilities is based upon valuation pricing models, which represents what the Company would expect to receive or pay at the balance sheet date if it canceled the options, entered into offsetting positions, or exercised the options. The fair value of futures contracts represent the cumulative unsettled variation margin (open trade equity net of cash settlements). Fair values for these instruments are determined externally by an independent actuarial firm using market observable inputs, including interest rates, yield curve volatilities, and other factors. Credit risk related to the counterparty is considered when estimating the fair values of these derivatives. The fair values of the embedded derivatives in the Companys FIA products are derived using market indices, pricing assumptions and historical data. The fair value of the reinsurance related embedded derivative in the funds withheld reinsurance agreement with FSRCI is estimated based upon the change in the fair value of the assets supporting the funds withheld from reinsurance liabilities. As the fair value of the assets are based on a quoted market price (Level 2), the fair value of the embedded derivative is based on market observable inputs and is classified as Level 2.
Investment contracts include deferred annuities, FIAs, IULs and immediate annuities. The fair values of deferred annuities, FIA, and IUL contracts are based on their cash surrender value (i.e. the cost the Company would incur to extinguish the liability) as these contracts are generally issued without an annuitization date. The fair value of immediate annuities contracts is derived by calculating a new fair value interest rate using the updated yield curve and treasury spreads as of the respective reporting date. At September 30, 2013 and September 30, 2012, this resulted in lower fair value reserves relative to the carrying value. The Company is not required to and has not estimated the fair value of the liabilities under contracts that involve significant mortality or morbidity risks, as these liabilities fall within the definition of insurance contracts that are exceptions from financial instruments that require disclosures of fair value.
Other Invested Assets
Fair value of the loan participation interest securities has been assessed to be equal to the unpaid principal balance of the participation interest as of September 30, 2013. In making this assessment the Company considered the sufficiency of the underlying loan collateral, movements in the benchmark interest rate between origination date and September 30, 2013 and the primary market participant for these securities.
None of the other financial instruments included in other investments are measured at fair value on a recurring basis. Financial instruments included in other investments are primarily policy loans. We have not attempted to determine the fair values associated with our policy loans, as we believe any differences between carrying value and the fair values afforded these instruments are immaterial to our consolidated financial position and, accordingly, the cost to provide such disclosure does not justify the benefit to be derived.
30
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
Related Party Loans & Related Party Investments
The related party loans (discussed in Note 15) carrying value at par approximates fair value as this is the exit price for the obligation of these loans.
Quantitative information regarding significant unobservable inputs used for recurring Level 3 fair value measurements of financial instruments carried at fair value at September 30, 2013 and September 30, 2012 is as follows:
Fair Value at September 30, 2013 |
Valuation Technique | Unobservable Input(s) | Range (Weighted average) | |||||||
Assets |
||||||||||
Asset-backed securities |
246,528 | Broker-quoted | Offered quotes | 100.00% - 107.25% (100.91%) | ||||||
Corporates |
404,508 | Broker-quoted | Offered quotes | 0.00% - 113.00% (90.45%) | ||||||
Corporates |
56,605 | Market Pricing | Quoted prices | 90.06% - 130.92% (97.19%) | ||||||
Commercial mortgage-backed securities |
5,635 | Broker-quoted | Offered quotes | 95.50% | ||||||
Other Invested Assets |
157,000 | Market Pricing | Offered quotes | 100.00% | ||||||
|
|
|||||||||
Total |
$ | 870,276 | ||||||||
|
|
|||||||||
Liabilities |
||||||||||
Derivatives: |
||||||||||
FIA embedded derivatives included in contractholder funds |
$ | 1,544,447 | Discounted cash flow | Market value of option | 0% - 38.24% (3.82%) | |||||
SWAP rates | 1.54% - 2.77% (2.16%) | |||||||||
Mortality multiplier | 80% | |||||||||
Surrender rates | 0.50% - 75% (7%) | |||||||||
Non-performance spread |
0.25% - 0.25% (0.25%) | |||||||||
|
|
|||||||||
Total liabilities at fair value |
$ | 1,544,447 | ||||||||
|
|
31
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
Fair Value at September 30, 2012 |
Valuation Technique | Unobservable Input(s) |
Range (Weighted average) | |||||||
Assets |
||||||||||
Asset-backed securities |
15,855 | Broker-quoted | Offered quotes | 100% - 109.73% (103.09%) | ||||||
Corporates |
103,319 | Broker-quoted | Offered quotes | 0% - 140.61% (68.47%) | ||||||
Corporates |
31,977 | Market pricing | Quoted prices | 87.50% - 158.11% (97.89%) | ||||||
Hybrids |
8,873 | Broker-quoted | Offered quotes | 0% - 103% (25.35%) | ||||||
Commercial mortgage-backed securities |
5,023 | Broker-quoted | Offered quotes | 100.69% | ||||||
|
|
|||||||||
Total |
$ | 165,047 | ||||||||
|
|
|||||||||
Liabilities |
||||||||||
Derivatives: |
||||||||||
FIA embedded derivatives included in contractholder funds |
$ | 1,550,805 | Discounted cash flow | Market value of option | 0% - 31.05% (3.55%) | |||||
SWAP rates | 0.76% - 1.7% (1.22%) | |||||||||
Mortality multiplier | 70% | |||||||||
Surrender rates | 2% -50% (7%) | |||||||||
Non-performance spread |
0.25% - 0.25% (0.25%) | |||||||||
|
|
|||||||||
Total liabilities at fair value |
$ | 1,550,805 | ||||||||
|
|
The significant unobservable inputs used in the fair value measurement of FIA embedded derivatives included in contractholder funds are market value of option, interest swap rates, mortality multiplier, surrender rates, and non-performance spread. The mortality multiplier at September 30, 2013 and 2012, is based on the 2000 and 1983 annuity tables, respectively and assumes the contractholder population is 50% female and 50% male. Significant increases (decreases) in the market value of option in isolation would result in a higher (lower) fair value measurement. Significant increases (decreases) in interest swap rates, mortality multiplier, surrender rates, or non-performance spread in isolation would result in a lower (higher) fair value measurement. Generally, a change in any one unobservable input would not result in a change in any other unobservable input.
Changes in unrealized losses (gains), net in the Companys FIA embedded derivatives are included in Benefits and other changes in policy reserves in the Consolidated Statement of Operations.
The following tables summarize changes to the Companys financial instruments carried at fair value and financial instruments carried at amortized cost (note payable to affiliate, related party loan and subordinated debt) and classified within Level 3 of the fair value hierarchy for the years ended September 30, 2013 and September 30, 2012. This summary excludes any impact of amortization of VOBA and DAC. The gains and losses below may include changes in fair value due in part to observable inputs that are a component of the valuation methodology.
32
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
Year Ended September 30, 2013 | ||||||||||||||||||||||||
Total Gains (Losses) | ||||||||||||||||||||||||
Balance at Beginning of Period |
Included in Earnings |
Included in AOCI |
Net Purchases, Sales, & Settlements |
Net Transfer In (Out) of Level 3 (a) |
Balance at End of Period |
|||||||||||||||||||
Assets |
||||||||||||||||||||||||
Fixed maturity securities available-for-sale: |
||||||||||||||||||||||||
Asset-backed securities |
$ | 15,855 | $ | | $ | 1,666 | $ | 239,507 | $ | (10,500 | ) | $ | 246,528 | |||||||||||
Commercial mortgage-backed securities |
5,023 | | (330 | ) | 942 | | 5,635 | |||||||||||||||||
Corporates |
135,296 | (345 | ) | (13,360 | ) | 373,309 | (33,787 | ) | 461,113 | |||||||||||||||
Hybrids |
8,873 | | (175 | ) | | (8,698 | ) | | ||||||||||||||||
Equity securities available-for-sale |
| 199 | (1 | ) | (198 | ) | | | ||||||||||||||||
Other invested assets |
| | | 157,000 | | 157,000 | ||||||||||||||||||
Related party loans |
150,069 | | | (31,025 | ) | 119,044 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total assets at Level 3 fair value |
$ | 315,116 | $ | (146 | ) | $ | (12,200 | ) | $ | 739,535 | $ | (52,985 | ) | $ | 989,320 | |||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Liabilities |
||||||||||||||||||||||||
FIA embedded derivatives |
1,550,805 | (6,358 | ) | | | | 1,544,447 | |||||||||||||||||
Note payable to affiliate |
224,363 | | | (224,363 | ) | | | |||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total liabilities at Level 3 fair value |
$ | 1,775,168 | $ | (6,358 | ) | $ | | $ | (224,363 | ) | $ | | $ | 1,544,447 | ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
(a) | The net transfers in and out of Level 3 during the fiscal year ended September 30, 2013 were exclusively to or from Level 2. |
33
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
Year Ended September 30, 2012 | ||||||||||||||||||||||||
Total Gains (Losses) | ||||||||||||||||||||||||
Balance at Beginning of Period |
Included in Earnings |
Included in AOCI |
Net Purchases, Sales, & Settlements |
Net transfer In (Out) of Level 3 (a) |
Balance at End of Period |
|||||||||||||||||||
Assets |
||||||||||||||||||||||||
Fixed maturity securities available-for-sale: |
||||||||||||||||||||||||
Asset-backed securities |
$ | 374,518 | $ | | $ | 7,355 | $ | 371,896 | $ | (737,914 | ) | $ | 15,855 | |||||||||||
Commercial mortgage-backed securities |
| | 24 | 4,999 | | 5,023 | ||||||||||||||||||
Corporates |
159,684 | 28 | (3,662 | ) | (39,686 | ) | 18,932 | 135,296 | ||||||||||||||||
Hybrids |
5,205 | | (44 | ) | | 3,712 | 8,873 | |||||||||||||||||
Municipals |
| (2 | ) | 72 | 10,177 | (10,247 | ) | | ||||||||||||||||
Agency residential mortgage-backed securities |
3,312 | | 18 | | (3,330 | ) | | |||||||||||||||||
Non-agency residential mortgage-backed securities |
3,759 | (126 | ) | 4 | (777 | ) | (2,860 | ) | | |||||||||||||||
Related party loans |
| | | 150,069 | | 150,069 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total assets at Level 3 fair value |
$ | 546,478 | $ | (100 | ) | $ | 3,767 | $ | 496,678 | $ | (731,707 | ) | $ | 315,116 | ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Liabilities |
||||||||||||||||||||||||
Fixed indexed annuities |
1,396,340 | 154,465 | | | | 1,550,805 | ||||||||||||||||||
AFS embedded derivatives |
400 | (400 | ) | | | | | |||||||||||||||||
Subordinated debt |
95,000 | | | (95,000 | ) | | | |||||||||||||||||
Note payable to affiliate |
241,132 | | | (16,769 | ) | | 224,363 | |||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total liabilities at Level 3 fair value |
$ | 1,732,872 | $ | 154,065 | $ | | $ | (111,769 | ) | $ | | $ | 1,775,168 | |||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
(a) | The net transfers in and out of Level 3 during the fiscal year ended September 30, 2012 were exclusively to or from Level 2 |
34
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
April 6, 2011 to September 30, 2011 | ||||||||||||||||||||||||
Total Gains (Losses) | ||||||||||||||||||||||||
Balance at Beginning of Period |
Included in Earnings |
Included in AOCI |
Net Purchases, Sales, & Settlements |
Net transfer In (Out) of Level 3 (a) |
Balance at End of Period |
|||||||||||||||||||
Assets |
||||||||||||||||||||||||
Fixed maturity securities available-for-sale: |
||||||||||||||||||||||||
Asset-backed securities |
$ | 399,967 | $ | | $ | 863 | $ | (11,709 | ) | $ | (14,603 | ) | $ | 374,518 | ||||||||||
Corporates |
197,573 | 1,993 | 5,408 | (45,229 | ) | (61 | ) | 159,684 | ||||||||||||||||
Hybrids |
8,305 | | (61 | ) | | (3,039 | ) | 5,205 | ||||||||||||||||
Agency residential mortgage-backed securities |
3,271 | | 41 | | | 3,312 | ||||||||||||||||||
Non-agency residential mortgage-backed securities |
18,519 | 2,364 | 379 | (17,503 | ) | | 3,759 | |||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total assets at Level 3 fair value |
$ | 627,635 | $ | 4,357 | $ | 6,630 | $ | (74,441 | ) | $ | (17,703 | ) | $ | 546,478 | ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Liabilities |
||||||||||||||||||||||||
Fixed indexed annuities |
1,466,308 | (69,968 | ) | | | | 1,396,340 | |||||||||||||||||
AFS embedded derivatives |
419 | (19 | ) | | | | 400 | |||||||||||||||||
Subordinated debt |
95,000 | | | | | 95,000 | ||||||||||||||||||
Note payable to affiliate |
248,505 | | | (7,373 | ) | | 241,132 | |||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total liabilities at Level 3 fair value |
$ | 1,810,232 | $ | (69,987 | ) | $ | | $ | (7,373 | ) | $ | | $ | 1,732,872 | ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
(a) | The net transfers in and out of Level 3 during the period April 5, 2011 to September 30, 2011 were exclusively to or from Level 2 |
The Company reviews the fair value hierarchy classifications each reporting period. Changes in the observability of the valuation attributes may result in a reclassification of certain financial assets or liabilities. Such reclassifications are reported as transfers in and out of Level 3, or between other levels, at the beginning fair value for the reporting period in which the changes occur. We transferred $79,324 U.S. Government securities from Level 1 into Level 2 for the fiscal year ended September 30, 2013 reflecting the level of market activity in these instruments. There were no transfers between Level 1 and Level 2 for the fiscal year ended September 30, 2012, and the period of April 6, 2011 to September 30, 2011.
Primary market issuance and secondary market activity for certain asset-backed, hybrid and corporate securities during the fiscal years ended September 30, 2013 and 2012 increased the market observable inputs used to establish fair values for similar securities. These factors, along with more consistent pricing from third-party sources, resulted in the Company concluding that there is sufficient trading activity in similar instruments to support classifying these securities as Level 2 as of September 30, 2013. Accordingly, the Companys assessment resulted in a net transfer out of Level 3 of $52,985 related to asset-backed, corporate and hybrid securities during the fiscal year ended September 30, 2013. The Companys assessment resulted in a net transfer out of Level 3 of $731,707 related to asset-backed securities, corporates, hybrids, municipals and residential mortgage-backed securities during the year ended September 30, 2012, and a net transfer out of $17,703 related to asset-backed securities, corporates and hybrids during the period of April 6, 2011 to September 30, 2011.
35
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
The following tables present the gross components of purchases, sales, and settlements, net, of Level 3 financial instruments for the fiscal year ended September 30, 2013, September 30, 2012, and the period of April 6, 2011 to September 30, 2011.
Year Ended September 30, 2013 | ||||||||||||||||
Purchases | Sales | Settlements | Net purchases, sales, issuances, & settlements |
|||||||||||||
Assets |
||||||||||||||||
Fixed maturity securities available-for-sale: |
||||||||||||||||
Asset-backed securities |
$ | 247,082 | $ | (7,500 | ) | $ | (75 | ) | $ | 239,507 | ||||||
Commercial mortgage-backed securities |
1,026 | | (84 | ) | 942 | |||||||||||
Corporates |
409,548 | (9,561 | ) | (26,678 | ) | 373,309 | ||||||||||
Equity securities available-for-sale |
10,455 | (10,653 | ) | | (198 | ) | ||||||||||
Other invested assets |
157,000 | | | 157,000 | ||||||||||||
Related party loans |
| (31,025 | ) | | (31,025 | ) | ||||||||||
|
|
|
|
|
|
|
|
|||||||||
Total assets at fair value |
$ | 825,111 | $ | (58,739 | ) | $ | (26,837 | ) | $ | 739,535 | ||||||
|
|
|
|
|
|
|
|
|||||||||
Liabilities |
||||||||||||||||
Note payable to affiliate |
| | (224,363 | ) | (224,363 | ) | ||||||||||
|
|
|
|
|
|
|
|
|||||||||
Total liabilities at fair value |
$ | | $ | | $ | (224,363 | ) | $ | (224,363 | ) | ||||||
|
|
|
|
|
|
|
|
|||||||||
Year Ended September 30, 2012 | ||||||||||||||||
Purchases | Sales | Settlements | Net purchases, sales, issuances, & settlements |
|||||||||||||
Assets |
||||||||||||||||
Fixed maturity securities available-for-sale: |
||||||||||||||||
Asset-backed securities |
$ | 410,707 | $ | | $ | (38,811 | ) | $ | 371,896 | |||||||
Commercial mortgage-backed securities |
4,999 | | | 4,999 | ||||||||||||
Corporates |
1,326 | (26,788 | ) | (14,224 | ) | (39,686 | ) | |||||||||
Municipals |
10,197 | | (20 | ) | 10,177 | |||||||||||
Non-agency residential mortgage-backed securities |
| (475 | ) | (302 | ) | (777 | ) | |||||||||
Related party loans |
150,069 | | | 150,069 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
Total assets at fair value |
$ | 577,298 | $ | (27,263 | ) | $ | (53,357 | ) | $ | 496,678 | ||||||
|
|
|
|
|
|
|
|
|||||||||
Liabilities |
||||||||||||||||
Subordinated debt |
| | (95,000 | ) | (95,000 | ) | ||||||||||
Note payable to affiliate |
| | (16,769 | ) | (16,769 | ) | ||||||||||
|
|
|
|
|
|
|
|
|||||||||
Total liabilities at fair value |
$ | | $ | | $ | (111,769 | ) | $ | (111,769 | ) | ||||||
|
|
|
|
|
|
|
|
36
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
April 6, 2011 to September 30, 2011 | ||||||||||||||||
Purchases | Sales | Settlements | Net purchases, sales, issuances, & settlements |
|||||||||||||
Assets |
||||||||||||||||
Fixed maturity securities available-for-sale: |
||||||||||||||||
Asset-backed securities |
$ | 2,007 | $ | | $ | (13,716 | ) | $ | (11,709 | ) | ||||||
Corporates |
10,365 | (48,898 | ) | (6,696 | ) | (45,229 | ) | |||||||||
Non-agency residential mortgage-backed securities |
| (15,729 | ) | (1,774 | ) | (17,503 | ) | |||||||||
|
|
|
|
|
|
|
|
|||||||||
Total assets at fair value |
$ | 12,372 | $ | (64,627 | ) | $ | (22,186 | ) | $ | (74,441 | ) | |||||
|
|
|
|
|
|
|
|
|||||||||
Liabilities |
||||||||||||||||
Note payable to affiliate |
| | (7,373 | ) | (7,373 | ) | ||||||||||
|
|
|
|
|
|
|
|
|||||||||
Total liabilities at fair value |
$ | | $ | | $ | (7,373 | ) | $ | (7,373 | ) | ||||||
|
|
|
|
|
|
|
|
The note payable settlement balance for the year ended September, 2012 includes payments of $40,000 on the note payable to affiliate, net of interest expense of $23,231. The period from April 6, 2011 through September 30, 2011 includes payments of $20,000 on the note payable to affiliate, net of interest expense of $12,627.
37
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
Information regarding VOBA and DAC, DSI, is as follows:
VOBA | DAC | Total | ||||||||||
Balance at April 6, 2011 |
$ | 577,163 | $ | | $ | 577,163 | ||||||
Deferrals |
| 41,152 | 41,152 | |||||||||
Less: Components of amortization: |
||||||||||||
Unlocking |
(2,320 | ) | 97 | (2,223 | ) | |||||||
Interest |
14,040 | | 14,040 | |||||||||
Other amortization |
294 | (996 | ) | (702 | ) | |||||||
Add: Adjustment for unrealized investment gains/losses, net |
(170,117 | ) | (2,146 | ) | (172,263 | ) | ||||||
|
|
|
|
|
|
|||||||
Balance at September 30, 2011 |
$ | 419,060 | $ | 38,107 | $ | 457,167 | ||||||
|
|
|
|
|
|
|||||||
Deferrals |
| 194,900 | 194,900 | |||||||||
Less: Components of amortization: |
||||||||||||
Other amortization |
(171,833 | ) | (20,239 | ) | (192,072 | ) | ||||||
Interest |
28,883 | 1,942 | 30,825 | |||||||||
Unlocking |
(2,487 | ) | 3,078 | 591 | ||||||||
Add: Adjustment for unrealized investment gains/losses, net |
(169,303 | ) | (48,565 | ) | (217,868 | ) | ||||||
|
|
|
|
|
|
|||||||
Balance at Balance at September 30, 2012 |
$ | 104,320 | $ | 169,223 | $ | 273,543 | ||||||
Deferrals |
| 147,402 | 147,402 | |||||||||
Less: Amortization related to: |
||||||||||||
Unlocking |
35,826 | 7,357 | 43,183 | |||||||||
Interest |
21,781 | 9,457 | 31,238 | |||||||||
Other amortization |
(227,710 | ) | (71,704 | ) | (299,414 | ) | ||||||
Add: Adjustment for unrealized investment gains/losses |
257,978 | 69,315 | 327,293 | |||||||||
|
|
|
|
|
|
|||||||
Balance at September 30, 2013 |
$ | 192,195 | $ | 331,050 | $ | 523,245 | ||||||
|
|
|
|
|
|
Amortization of VOBA and DAC is based on the amount of gross margins or profits recognized, including investment gains and losses. The adjustment for unrealized net investment gains represents the amount of VOBA and DAC that would have been amortized if such unrealized gains and losses had been recognized. This is referred to as the shadow adjustments as the additional amortization is reflected in AOCI rather than the statements of operations. As of September 30, 2013 and September 30, 2012, the VOBA balance included cumulative adjustments for net unrealized investment gains/losses of $81,442 and $339,420, respectively, and the DAC balances included cumulative adjustments for net unrealized investment gains/losses of $18,604 and $50,711, respectively.
The above DAC balances include $26,159 and $9,068 of DSI, net of shadow adjustments, as of September 30, 2013 and September 30, 2012, respectively.
38
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
The weighted average amortization period for VOBA and DAC are approximately 4.2 and 6.6 years, respectively. Estimated amortization expense for VOBA and DAC in future fiscal years is as follows:
Estimated Amortization Expense | ||||||||
Fiscal Year |
VOBA | DAC | ||||||
2014 |
45,493 | 29,485 | ||||||
2015 |
43,653 | 32,081 | ||||||
2016 |
37,940 | 31,213 | ||||||
2017 |
30,721 | 29,554 | ||||||
2018 |
24,732 | 27,582 | ||||||
Thereafter |
91,099 | 162,530 |
In March 2013, FGLH issued $300,000 aggregate principal amount of its 6.375% senior notes (Notes offering) due April 1, 2021, at par value, which FGLH may elect to redeem after April 1, 2015. Interest payments are due semi-annually, April and October 1, commencing October 1, 2013 and total interest expense was $9,768 for the fiscal year ended September 30, 2013.
In connection with the Notes offering, FGLH capitalized $10,195 of debt issue costs. The fees are classified as Other assets in the accompanying Consolidated Balance Sheets as of September 30, 2013 and are being are amortized over the redemption date using the straight-line method over the remaining term of the debt, of which $1,693 has been amortized for the fiscal year ended September 30, 2013.
On February 25, 2009, FGLH and OMGUK entered into an intercompany term loan agreement for $225,000 and a revolving credit facility agreement for $100,000. Effective April 6, 2011, a deed of novation was entered into as part of the sale of FGLH to HFG whereby OM Group (UK) Limited transferred all of its rights, obligations and liabilities under the intercompany loan agreements to HFG. The term loan carried a 10.24% fixed interest rate payable annually on February 28th and total interest expense was $8,908, $22,281 and $11,712 for the year ended September 30, 2013 and 2012 and period from April 6, 2011 to September 30, 2011, respectively. The revolving credit facility carried an interest rate of three month LIBOR plus 8.18% payable on February 28, 2014 and total interest expense was $59, $1,204 and $915 for the year ended September 30, 2013 and 2012 and period from April 6, 2011 to September 30, 2011, respectively.
On February 28, 2013, HFG and FGLH entered into a termination and release agreement whereby HFG notified FGLH of its election to convert the loans to equity. Accordingly, the Company converted the balance of the note payable and revolving credit facility as of February 28, 2013 of $213,330 to equity on February 28, 2013. This resulted in an increase in the Companys paid in capital without issuance of stock as FGLH is a wholly owned subsidiary of HFG. No gain or loss was recognized on the conversion of the debt.
On April 7, 2011, Raven Reinsurance Company (Raven Re), a newly-formed wholly-owned subsidiary of FGL, issued a $95,000 surplus note to OMGUK. The surplus note was issued at par and carried a 6% fixed interest rate. The note had a maturity date which was the later of (i) December 31, 2012 or (ii) the date on which all amounts due and payable to the lender have been paid in full. Total interest expense for the period April 6, 2011 to September 30, 2011 was 2,787. The note was settled in October 2011 at face value.
39
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
Other liabilities consisted of the following:
September 30, | ||||||||
2013 | 2012 | |||||||
Amounts payable for investment purchases |
$ | 208,182 | $ | 206,681 | ||||
Retained asset account |
207,524 | 203,685 | ||||||
Amounts payable to reinsurers |
77,906 | 31,959 | ||||||
Remittances and items not allocated |
44,092 | 29,469 | ||||||
Accrued expenses |
34,973 | 23,555 | ||||||
Income taxes payable |
7,321 | 66,284 | ||||||
Derivatives - futures |
1,028 | 928 | ||||||
Other |
119,027 | 84,144 | ||||||
|
|
|
|
|||||
$ | 700,053 | $ | 646,705 | |||||
|
|
|
|
The Company sponsors a defined contribution plan in which eligible participants may defer a fixed amount or a percentage of their eligible compensation, subject to limitations, and the Company makes a discretionary matching contribution of up to 5% of eligible compensation. The Company has also established a nonqualified defined contribution plan for independent agents. The Company makes contributions to the plan based on both the Companys and the agents performance. Contributions are discretionary and evaluated annually. Aggregate contributions charged to operations for the defined contribution plans, including discretionary amounts, were $922, $812 and $319 for the year ended September 30, 2013, the year ended September 30, 2012, and the period of April 6, 2011 to September 30, 2011, respectively.
The Company sponsors stock-based incentive plans and dividend plans for its employees. Awards under the FGLH plans are based on the common stock of FGLH. During Fiscal Year 2012, the stock-based incentive plan was accounted for as an equity plan. In December 2012, FGLH elected an alternate settlement for the then-vested equity awards, electing to settle the vested awards in cash when exercised, which reclassified the plans from equity plans to liability plans. In 2013, FGLH determined that all equity awards will be settled in cash when exercised.
On November 2, 2011, FGLHs compensation committee (on behalf of its board of directors) approved a long-term stock-based incentive plan (the Stock Incentive Plan) that permits the grant of options to purchase shares of the FGLH common stock to key employees of FGLH. On November 2, 2011, FGLHs compensation committee also approved a dividend equivalent plan (the 2011 DEP) that permits holders of these options the right to receive a payment in cash in an amount equal to the ordinary dividends declared and paid or debt service payments to HGI by FGLH in each calendar year starting in the year in which the dividend equivalent is granted through the year immediately prior to the year in which the dividend equivalents vests, divided by the total number of common shares outstanding. The awards under the 2011 DEP vest on March 31, 2014. As of September 30, 2012, FGLH determined that it was probable that the dividend equivalent awards will vest and compensation expense would be recognized ratably over the dividend equivalent vesting period.
40
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
During the Fiscal Year 2012, FGLH granted 207 stock option awards under the terms of the Stock Incentive Plan. These stock options vest over a period of 3 years and expire on the seventh anniversary of the grant. The total fair value of the grants on their grant dates was approximately $807.
In December 2012, FGLHs compensation committee amended and restated the Stock Incentive Plan (the Amended and Restated Stock Incentive Plan). Under the Amended and Restated Stock Incentive Plan, the compensation committee may grant stock options and restricted stock awards. Effective January 29, 2013, FGLH granted 195 stock option awards and 53 restricted stock units, under the terms of the Amended and Restated Stock Incentive Plan. These stock options and restricted share units vest over a period of 3 years and expire on the seventh anniversary of the grant date. The total fair value of the option grant and restricted stock unit grant on the grant date was $581 and $2,019, respectively.
In connection with the adoption of the Amended and Restated Stock Incentive Plan, FGLHs compensation committee also approved and adopted the 2012 Dividend Equivalent Plan (the 2012 DEP). Similar to the 2011 DEP, the 2012 DEP permits holders of the options and restricted stock units granted under the Amended and Restated Stock Incentive Plan the right to receive a payment in cash in an amount equal to the ordinary dividends declared and paid or debt service payments to HGI by FGLH in each calendar year starting in the year in which the dividend equivalent is granted through the year immediately prior to the year in which the dividend equivalent vests, divided by the total number of common shares outstanding. The awards under the 2012 DEP vest on March 31, 2016.
The Company recognized stock compensation expense related to stock option awards, restricted stock units and dividend equivalents as follows:
Year Ended | ||||||||
September 30, 2013 |
September 30, 2012 |
|||||||
Stock Incentive Plan stock options |
$ | 2,561 | $ | 163 | ||||
2011 DEP |
1,464 | 503 | ||||||
Amended and Restated Stock Incentive Plan stock options |
784 | | ||||||
Amended and Restated Stock Incentive Plan restricted stock units |
758 | | ||||||
2012 DEP |
329 | | ||||||
|
|
|
|
|||||
Total stock compensation expense |
5,896 | 666 | ||||||
Related tax benefit |
2,064 | 233 | ||||||
|
|
|
|
|||||
Net stock compensation expense |
$ | 3,832 | $ | 433 | ||||
|
|
|
|
No stock compensation expense was incurred during the period of April 6, 2011 to September 30, 2011.
The stock compensation expense is included in Acquisition and operating expenses, net of deferrals in the Consolidated Statements of Operations.
41
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
Total compensation expense related to the stock option awards, restricted stock units and dividend equivalents not yet recognized as of September 30, 2013 and the weighted-average period over which this expense will be recognized are as follows:
Unrecognized Compensation Expense |
Weighted- Average Recognition Period in Years |
|||||||
Stock Incentive Plan |
$ | 1,302 | $ | 1.0 | ||||
2011 DEP |
567 | 0.5 | ||||||
Amended and Restated Stock Incentive Plan - options |
1,205 | 1.9 | ||||||
Amended and Restated Stock Incentive Plan - restricted stock units |
1,826 | 2.2 | ||||||
2012 DEP |
1,104 | 2.5 | ||||||
|
|
|
|
|||||
Total unrecognized stock compensation expense |
$ | 6,004 | $ | 1.8 | ||||
|
|
|
|
A summary of the Companys outstanding stock options as of September 30, 2013 and changes during the fiscal years then ended are as follows:
Stock Option Awards |
Options | Weighted Average Exercise Price(a) |
Weighted Average Grant Date Fair Value |
|||||||||
Stock options outstanding at September 30, 2011 |
| $ | | $ | | |||||||
Granted |
207 | 38.20 | 3.90 | |||||||||
Exercised |
| | | |||||||||
Forfeited or expired |
(6 | ) | 38.14 | 3.90 | ||||||||
|
|
|||||||||||
Stock options outstanding at September 30, 2012 |
201 | 38.20 | 3.90 | |||||||||
Granted |
195 | 49.49 | 3.85 | |||||||||
Exercised |
(31 | ) | 39.19 | 3.90 | ||||||||
Forfeited or expired |
(30 | ) | 43.96 | 3.87 | ||||||||
|
|
|||||||||||
Stock options outstanding at September 30, 2013 |
335 | 44.23 | 3.87 | |||||||||
|
|
|||||||||||
Exercisable at September 30, 2013 |
40 | 38.21 | 3.90 | |||||||||
|
|
|||||||||||
Vested or expected to vest at September 30, 2013 |
323 | 44.16 | 3.87 | |||||||||
|
|
The following assumptions were used in the determination of these grant date fair values using the Black-Scholes option pricing model and based on the value of FGLHs common stock:
2012 | 2013 | |||||||
Risk-free interest rate |
0.8 | % | 0.8 | % | ||||
Assumed dividend yield |
10.0 | % | 6.0 | % | ||||
Expected option term |
4.5 years | 4.5 years | ||||||
Volatility |
35.0 | % | 27.0 | % |
42
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
A summary of restricted stock units outstanding as of September 30, 2013 and related activity during the fiscal year then ended is as follows:
Restricted Stock Awards |
Shares | Average Grant Date Fair Value |
||||||
estricted shares outstanding at September 30, 2012 |
| $ | | |||||
Granted |
53 | 49.58 | ||||||
Exercised |
| | ||||||
Forfeited or expired |
(7 | ) | 49.45 | |||||
|
|
|||||||
Restricted shares outstanding at September 30, 2013 |
46 | 49.60 | ||||||
|
|
|||||||
Exercisable at September 30, 2013 |
| | ||||||
|
|
|||||||
Restricted stock expected to vest |
42 | 49.54 | ||||||
|
|
The Company is a U.S. taxpayer and does not do business outside the United States. The Company does not record a separate provision for state income taxes as most of its income is derived from its insurance subsidiaries, which pay premium taxes in lieu of state income taxes in nearly all jurisdictions. The Companys non-life subsidiaries file as part of HGIs consolidated U.S. Federal income tax return. The Companys insurance company subsidiaries file their own consolidated U.S. Federal life insurance tax return and are not eligible to join the consolidated HGI return until January 1, 2017. The income tax liabilities of the members of the consolidated HGI return are calculated on a standalone basis and payables or receivables are recorded for the use of tax attributes amongst group members. As of September 30, 2013, the Company and its subsidiaries have intercompany taxes payable due to HGI totaling $1,541 for the use of consolidated tax attributes. This payable is subject to the Companys debt covenants which limit cash settlements to amounts actually paid to the Internal Revenue Service.
The NOLs, capital losses and tax credits of the Companys subsidiaries were subject to limitation under IRC Section 382 of the Internal Revenue Code, as a result of the change of ownership that occurred when the companies were purchased in 2011. This caused the net value of attributes that could be utilized to be limited to $4,841 each year, subject to increases for realized built-in gains on certain assets on the date of the change of ownership. On or about September 27, 2013, the Company underwent a second change of control within the meaning of IRC Section 382(g), triggered by the sale of HGI shares by Harbinger Capital Partners. At the time of this ownership change, the Companys tax attributes consisted of NOL carryforwards of $92,719, capital loss carry forwards totaling approximately $350,369, investment tax credits of approximately $54,230, and AMT credits of approximately $6,316.
Income tax benefit was calculated based upon the following components of income before income taxes:
September 30, 2013 | September 30, 2012 | April 6, 2011 to September 30, 2011 |
||||||||||
Pretax income (loss): |
||||||||||||
United States |
$ | 493,033 | $ | 140,298 | $ | (33,455 | ) | |||||
Outside the United States |
| | | |||||||||
|
|
|
|
|
|
|||||||
Total pretax income |
$ | 493,033 | $ | 140,298 | $ | (33,455 | ) | |||||
|
|
|
|
|
|
43
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
The components of income tax benefit were as follows:
September 30, 2013 | September 30, 2012 | April 6, 2011 to September 30, 2011 |
||||||||||
Current: |
||||||||||||
Federal |
$ | 56,191 | $ | (74,388 | ) | $ | 875 | |||||
State |
| | | |||||||||
|
|
|
|
|
|
|||||||
Total current |
56,191 | (74,388 | ) | 875 | ||||||||
|
|
|
|
|
|
|||||||
Deferred: |
||||||||||||
Federal |
(212,268 | ) | 220,046 | 40,869 | ||||||||
State |
| | | |||||||||
|
|
|
|
|
|
|||||||
Total deferred |
(212,268 | ) | 220,046 | 40,869 | ||||||||
|
|
|
|
|
|
|||||||
Income tax (expense)/benefit |
$ | (156,077 | ) | $ | 145,658 | $ | 41,744 |
The difference between income taxes expected at the U.S. Federal statutory income tax rate of 35% and reported income tax benefit is summarized as follows:
September 30, 2013 | September 30, 2012 | April 6, 2011 to September 30, 2011 |
||||||||||
Expected income tax (expense)/benefit at Federal statutory rate |
$ | (172,561 | ) | $ | (49,104 | ) | $ | 11,709 | ||||
Valuation allowance for deferred tax assets |
18,842 | 197,798 | 30,064 | |||||||||
Other |
(2,358 | ) | (3,036 | ) | (29 | ) | ||||||
|
|
|
|
|
|
|||||||
Reported income tax (expense)/benefit |
$ | (156,077 | ) | $ | 145,658 | $ | 41,744 | |||||
|
|
|
|
|
|
|||||||
Effective tax rate |
31.7 | % | (103.8 | )% | 124.8 | % |
For September 30, 2013, the Companys effective tax rate of 31.7% was positively impacted by the partial release of valuation allowance attributed to the Companys utilization of capital loss carry forwards that management previously concluded were more-likely-than-not unrealizable.
For September 30, 2012, the Companys effective tax rate of (103.8)%, representing a tax benefit despite pretax income, was positively impacted by the partial release of valuation allowances based on managements conclusion that certain of its deferred tax assets were more likely than not realizable.
44
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
For the period April 6, 2011 to September 30, 2011, the Companys effective tax rate of 124.8% was positively impacted by the partial release of valuation allowance based on managements conclusion that certain of its deferred tax assets were more likely than not realizable.
For the years ended September 30, 2013 and 2012 and the period April 6, 2011 to September 30, 2011, the Company recorded a net valuation allowance releases of $18,842 (comprised of a full year valuation allowance release of $20,708 related to the life insurance companies, partially offset by a net increase to valuation allowance of $1,866 related to FGLHs non-life companies), $197,798 (comprised of a full year valuation release of $204,736 related to the life insurance companies, partially offset by an increase to valuation allowance of $6,938 related to FGLHs non-life companies) and $30,064, respectively, based on managements reassessment of the amount of its deferred tax assets that are more-likely-than-not realizable.
The following table is a summary of the components of deferred income tax assets and liabilities:
September 30, 2013 | September 30, 2012 | |||||||
Deferred tax assets: |
||||||||
Net operating loss, credit and capital loss carryforwards |
$ | 215,628 | $ | 283,988 | ||||
Insurance reserves and claim related adjustments |
377,538 | 620,285 | ||||||
Deferred acquisition costs |
| 9,906 | ||||||
Other |
27,239 | 19,680 | ||||||
Valuation allowance |
(158,667 | ) | (177,508 | ) | ||||
|
|
|
|
|||||
Total Deferred tax assets |
461,738 | 756,351 | ||||||
|
|
|
|
|||||
Deferred tax liabilities: |
||||||||
Value of business acquired |
$ | (67,269 | ) | $ | (36,512 | ) | ||
Investments |
(96,677 | ) | (438,655 | ) | ||||
Deferred acquisition costs |
(48,800 | ) | | |||||
Other |
(8,461 | ) | (1,548 | ) | ||||
|
|
|
|
|||||
Total deferred tax liabilities |
(221,207 | ) | (476,715 | ) | ||||
|
|
|
|
|||||
Net deferred tax assets and liabilities |
$ | 240,531 | $ | 279,636 |
As of September 30, 2013, the Companys valuation allowance of $158,667 consisted of a valuation allowance of $118,759 on capital loss carryforwards and a full valuation allowance of $39,908 on the Companys non-life insurance net deferred taxes. As of September 30, 2012, the Companys valuation allowance of $177,508 consisted of a partial valuation allowance of $145,854 on capital loss carryforwards and a full valuation allowance of $31,654 on FGLHs non-life insurance net deferred taxes.
45
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
The Company maintains a valuation allowance against certain IRC section 382 limited capital loss carry forwards and the deferred tax assets of its non-life insurance company subsidiaries. A valuation allowance has been recorded against capital loss carryforwards limited under Section IRC 382 to reduce the associated deferred tax assets to an amount that is more-likely than not realizable. The non-life insurance company subsidiaries have a history of losses and insufficient sources of future income in order to recognize any portion of their deferred tax assets. For the year ended September 30, 2013, the Company recorded an income tax benefit to reduce the valuation allowance placed against previously unrealizable capital loss carryforwards that are now expected to be utilized during the current fiscal year, partially offset by a full valuation allowance recorded against the current period income tax benefit of the non-life insurance entities.
As of September 30, 2013, and 2012, the Company had NOL carryforwards of $92,719 and $86,978, respectively, which, if unused, will expire in years 2026 through 2033. The Company has capital loss carryforwards totaling $350,369 and $551,897 as of September 30, 2013 and 2012, respectively, which if unused, will expire in years 2014 through 2018. In addition, as of September 30, 2013 and 2012, the Company has low income housing tax credit carryforwards totaling $54,230 and $52,780, respectively, which, if unused, will expire in years 2017 through 2033, and alternative minimum tax credits of $6,316 and $7,602, respectively that may be carried forward indefinitely.
The U.S. Federal income tax returns of the Company for years prior to 2009 are no longer subject to examination by the taxing authorities. With limited exception, the Company is no longer subject to state and local income tax audits for years prior to 2009. However, Federal NOL carryforwards from tax years ended June 30, 2006 and December 31, 2006, respectively, continue to be subject to Internal Revenue Service examination until the statute of limitations expires for the years in which these NOL carryforwards are ultimately utilized.
The Company does not have any unrecognized tax benefits (UTBs) as of September 30, 2013 and 2012. In the event the Company has UTBs, interest and penalties related to uncertain tax positions would be recorded as part of income tax expense in the financial statements. The Company regularly assesses the likelihood of additional tax assessments by jurisdiction and, if necessary, adjusts its tax reserves based on new information or developments.
46
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
(13) Commitments and Contingencies
Lease Commitments
The Company leases office space under non-cancelable operating leases that expire in May 2021. The Company also leased office furniture and office equipment under non-cancelable operating leases that expired in 2012. For the years ended September 30, 2013 and 2012, and the period of April 6, 2011 to September 30, 2011, the Companys total rent expense was $1,736, $2,301, and $1,346, respectively. As of September 30, 2013, the minimum rental commitments under the non-cancelable leases are as follows:
Fiscal Year |
Amount | |||
2014 |
$ | 1,253 | ||
2015 |
1,273 | |||
2016 |
1,263 | |||
2017 |
1,249 | |||
2018 |
1,239 | |||
Thereafter |
3,945 | |||
|
|
|||
Total |
$ | 10,222 | ||
|
|
Contingencies
Regulatory and Litigation Matters
FGLH is assessed amounts by the state guaranty funds to cover losses to policyholders of insolvent or rehabilitated insurance companies. Those mandatory assessments may be partially recovered through a reduction in future premium taxes in certain states. At September 30, 2013, FGLH has accrued $5,331 for guaranty fund assessments which is expected to be offset by estimated future premium tax deductions of $5,006.
The Company has received inquiries from a number of state regulatory authorities regarding its use of the U.S. Social Security Administrations Death Master File (Death Master File) and compliance with state claims practices regulation. To date, the Company has received inquiries from authorities in Maryland, Minnesota and New York. The New York Insurance Department issued a letter and subsequent regulation requiring life insurers doing business in New York to use the Death Master File or similar databases to determine if benefits were payable under life insurance policies, annuities and retained asset accounts. Legislation requiring insurance companies to use the Death Master File to identify potential claims has recently been enacted in Maryland and other states. As a result of these legislative and regulatory developments, in May 2012 the Company undertook an initiative to use the Death Master File and other publicly available databases to identify persons potentially entitled to benefits under life insurance policies, annuities and retained asset accounts. During Fiscal 2012, the Company incurred an $11,000 benefit expense, net of reinsurance, to increase reserves to cover potential benefits payable resulting from this ongoing effort. Based on its analysis to date and managements estimate, the Company believes the remaining accrual will cover the reasonably estimated liability arising out of these developments. In addition, the Company has received audit and examination notices from several state agencies responsible for escheatment and unclaimed property regulation in those states. The Company has established a contingency of $2,000, the mid-point of an estimated range of $1,000 to $3,000, relative to the external legal costs and potential liabilities of said audits and examinations. Additional costs that cannot be reasonably estimated as of the date of this filing are possible as a result of ongoing regulatory developments and other future requirements related to this matter.
47
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
The Company is involved in various pending or threatened legal proceedings, including purported class actions, arising in the ordinary course of business. In some instances, these proceedings include claims for unspecified or substantial punitive damages and similar types of relief in addition to amounts for alleged contractual liability or requests for equitable relief. In the opinion of management and in light of existing insurance and other potential indemnification, reinsurance and established reserves, such litigation is not expected to have a material adverse effect on the Companys financial position, although it is possible that the results of operations and cash flows could be materially affected by an unfavorable outcome in any one period.
Guarantees
The First Amended and Restated Stock Purchase Agreement, dated February 17, 2011 (the F&G Stock Purchase Agreement) between HFG and OMGUK includes a Guarantee and Pledge Agreement which creates certain obligations for FGLH as a grantor and also grants a security interest to OMGUK of FGLHs equity interest in FGL Insurance in the event that HFG fails to perform in accordance with the terms of the F&G Stock Purchase Agreement. The Company is not aware of any events or transactions that resulted in non-compliance with the Guarantee and Pledge Agreement.
The Company reinsures portions of its policy risks with other insurance companies. The use of reinsurance does not discharge an insurer from liability on the insurance ceded. The insurer is required to pay in full the amount of its insurance liability regardless of whether it is entitled to or able to receive payment from the reinsurer. The portion of risks exceeding the Companys retention limit is reinsured with other insurers. The Company seeks reinsurance coverage in order to limit its exposure to mortality losses and enhance capital management. The Company follows reinsurance accounting when there is adequate risk transfer. Otherwise, the deposit method of accounting is followed. The Company also assumes policy risks from other insurance companies.
The effect of reinsurance on premiums earned, benefits incurred and reserve changes for the fiscal year periods ended September 30, 2013, September 30, 2012, and the period from April 6, 2011 through September 30, 2011:
Year Ended | April 6, 2011 to | |||||||||||||||||||||||
September 30, 2013 | September 30, 2012 | September 30, 2011 | ||||||||||||||||||||||
Net Premiums Earned |
Net Benefits Incurred |
Net Premiums Earned |
Net Benefits Incurred |
Net Premiums Earned |
Net Benefits Incurred |
|||||||||||||||||||
Direct |
$ | 279,232 | $ | 776,513 | $ | 297,964 | $ | 1,033,336 | $ | 157,772 | $ | 392,073 | ||||||||||||
Assumed |
32,794 | 23,271 | 47,179 | 34,940 | 22,858 | 19,571 | ||||||||||||||||||
Ceded |
(253,659 | ) | (303,100 | ) | (289,846 | ) | (290,904 | ) | (141,628 | ) | (164,012 | ) | ||||||||||||
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|
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|
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|
|
|
|||||||||||||
Net |
$ | 58,367 | $ | 496,684 | $ | 55,297 | $ | 777,372 | $ | 39,002 | $ | 247,632 | ||||||||||||
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Amounts payable or recoverable for reinsurance on paid and unpaid claims are not subject to periodic or maximum limits. During the fiscal year periods ended September 30, 2013 and September 30, 2012, and the period April 6, 2011 to September 30, 2011 the Company did not write off any reinsurance balances. During the fiscal year period ended September 30, 2012, and the period April 6, 2011 to September 30, 2011 the Company did not commute any ceded reinsurance. Effective June 17, 2013, the Company rescinded the portion of the coinsurance agreement dated April 1, 2011 between FGL Insurance and Wilton Re which covers certain disability income riders. Wilton Re has agreed to pay FGL Insurance a rescission settlement of $6,428. In addition, FGL Insurance will re-establish the $4,489 reserve liability previously ceded to Wilton Re in connection with this business. FGL Insurance recognized a net gain on the rescission of $1,939.
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Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
No policies issued by the Company have been reinsured with any foreign company, which is controlled, either directly or indirectly, by a party not primarily engaged in the business of insurance.
The Company has not entered into any reinsurance agreements in which the reinsurer may unilaterally cancel any reinsurance for reasons other than non-payment of premiums or other similar credit issues.
The Company has the following significant reinsurance agreements as of September 30, 2013:
Wilton Agreement
On January 26, 2011, HFG entered into a commitment agreement (the Commitment Agreement) with Wilton Re U.S. Holdings, Inc. (Wilton) committing Wilton Re, a wholly-owned subsidiary of Wilton and a Minnesota insurance company, to enter into one of two amendments to an existing reinsurance agreement with FGL Insurance. On April 8, 2011, FGL Insurance ceded significantly all of the remaining life insurance business that it had retained to Wilton Re under the first of the two amendments with Wilton. FGL Insurance transferred assets with a fair value of $535,826, net of ceding commission, to Wilton Re. The Company considered the effects of the first amendment in the opening balance sheet and purchase price allocation as of FGLH Acquisition Date. Effective April 26, 2011, HFG elected the second of the two amendments under the Commitment Agreement (the Raven Springing Amendment), which committed FGL Insurance to cede to Wilton Re all of the business (the Raven Block) then reinsured with Raven Re on or before March 31, 2013, subject to regulatory approval. The Raven Springing Amendment was intended to mitigate the risk associated with HFGs obligation under the F&G Stock Purchase Agreement, by replacing the Raven Re reserve facility by December 31, 2012. On September 9, 2011, FGL Insurance and Wilton Re executed an amended and restated Raven Springing Amendment whereby the recapture of the business ceded to Raven Re by FGL Insurance and the re-cession to Wilton Re closed on October 17, 2011 with an effective date of October 1, 2011. In connection with the closing, FGL Insurance transferred assets with a fair value of $580,683, including ceding commission, to Wilton Re.
In September 2012, Wilton Re and FGL Insurance reached a final agreement on the initial settlements associated with the reinsurance transactions FGL Insurance entered into subsequent to the FGLH Acquisition. The final settlement amounts did not result in any material adjustments to the amounts reflected in the financial statements. FGL Insurance recognized a net pre-tax gain of $18,029 on these reinsurance transactions which has been deferred and is being amortized over the remaining life of the underlying reinsured contracts.
Commissioners Annuity Reserve Valuation Method Facility (CARVM)
Effective October 1, 2012, FGL Insurance recaptured the CARVM reinsurance agreement from OM Re and simultaneously ceded the business to Raven Re. The recapture of the OM Re CARVM reinsurance agreement satisfies the Companys obligation under the F&G Stock Purchase Agreement to replace the letter of credit provided by OM no later than December 31, 2015. In connection with the new CARVM reinsurance agreement, FGL Insurance and Raven Re entered into an agreement with Nomura Bank International plc (Nomura) to establish a $295,000 reserve financing facility in the form of a letter of credit issued by Nomura and Nomura charged an upfront structuring fee in the amount of $2,800. The reserve financing facility is set to be reduced by $6,250 each quarter subsequent to establishment. The structuring fee was paid by FGL Insurance and will be deferred and amortized over the expected life of the facility. As this letter of credit is provided by an unaffiliated financial institution, Raven Re is permitted to carry the letter of credit as an admitted asset on the Raven Re statutory balance sheet.
As of September 30, 2013, there was $276.3 million available under the letter of credit facility. The Nomura Facility will terminate on September 30, 2017, although the facility may terminate earlier, in accordance with the terms of the Reimbursement Agreement. Under the terms of the Reimbursement Agreement, in the event the letter of credit is
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Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
drawn upon, Raven Re is required to repay the amounts utilized, and FGLH is obligated to repay the amounts utilized if Raven Re fails to make the required reimbursement. FGLH also is required to make capital contributions to Raven Re in the event that Raven Res statutory capital and surplus falls below certain defined levels. As of September 30, 2013, Raven Res statutory capital and surplus was $14.1 million (unaudited) in excess of the minimum level required under the Reimbursement Agreement.
FSRCI
Effective December 31, 2012, FGL Insurance entered into a reinsurance treaty with FSRCI, an indirectly wholly-owned subsidiary of HFG, FGLHs parent, whereby FGLH cedes 10% of its June 30, 2012 in-force annuity block business not already reinsured on a funds withheld basis. Under the terms of the agreement, FSRCI paid FGL Insurance an initial ceding allowance of $15,000. A study prepared by an independent third party actuarial firm determined that the initial ceding allowance of $15,000 is a fair and reasonable valuation. The coinsurance agreement was on a funds withheld basis, meaning that funds were withheld by FGL Insurance from the coinsurance premium owed to FSRCI as collateral for FSRCIs payment obligations. Accordingly, the collateral assets remain under the ultimate ownership of FGL Insurance. The following table is the operating results that are ceded to Front Street Re from December 31, 2012 to September 30, 2013:
December 31, 2012 to September 30, 2013 |
||||
Revenues: |
||||
Premiums |
$ | 405 | ||
Net investment income |
38,591 | |||
Net investment gains |
75,981 | |||
Insurance and investment product fees |
4,791 | |||
|
|
|||
Total Revenues |
119,768 | |||
|
|
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Benefits and expenses: |
||||
Benefits and other changes in policy reserves |
35,146 | |||
Acquisition & operating expenses, net of deferrals |
3,245 | |||
Amortization of intangibles |
| |||
|
|
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Total benefits and expenses |
38,391 | |||
|
|
|||
Operating income |
$ | 81,377 | ||
|
|
50
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
(15) Related Party Transactions
FGL Insurance participates in loans to third parties originated by Salus, an affiliated company indirectly owned by HGI that provides asset-based financing. In addition to the participation in loans originated by Salus, the Company also agreed to provide Salus with financing in the form of a revolving loan.
The Companys consolidated related party investments at September 30, 2013 and September 30, 2012 were summarized as follows:
September 30, 2013 | ||||||||||||||||||
Type |
Balance Sheet Classification |
Asset carrying value |
Accrued Investment Income |
Total carrying value | Net investment income |
|||||||||||||
Salus collateralized loan obligation (CLO) |
Fixed Maturities, available for sale | $ | 241,482 | $ | 427 | $ | 241,909 | $ | 4,517 | |||||||||
Salus 2013 participations |
Other Invested Assets | 157,000 | 1,517 | 158,517 | 6,753 | |||||||||||||
HGI energy loan |
Related Party Loans, including accrued investment income | 70,000 | 1,575 | 71,575 | 3,758 | |||||||||||||
Salus 2012 participations |
Related Party Loans, including accrued investment income | 27,287 | 124 | 27,411 | 3,538 | |||||||||||||
Salus promissory note |
Related Party Loans, including accrued investment income | 20,000 | 12 | 20,012 | 1,404 | |||||||||||||
Salus revolver |
Related Party Loans, including accrued investment income | | 46 | 46 | 258 | |||||||||||||
September 30, 2012 | ||||||||||||||||||
Type |
Balance Sheet Classification |
Asset carrying value |
Accrued Investment Income |
Total carrying value | Net investment income |
|||||||||||||
Salus 2012 participations |
Related Party Loans, including accrued investment income | $ | 129,467 | $ | 587 | 130,054 | $ | 1,985 | ||||||||||
Salus promissory note |
Related Party Loans, including accrued investment income | 20,000 | 15 | 20,015 | 15 |
As of September 30, 2013, the Company had paid $2,860 for offering costs associated with the in progress or pending initial public offering of FGLHs parent company, Fidelity and Guaranty Life. FGLH recorded an intercompany receivable for this amount which is included in Other assets in the Consolidated Balance Sheet at September 30, 2013.
(16) Insurance Subsidiary Financial Information
The Companys insurance subsidiaries file financial statements with state insurance regulatory authorities and the National Association of Insurance Commissioners (NAIC) that are prepared in accordance with Statutory Accounting Principles (SAP) prescribed or permitted by such authorities, which may vary materially from US GAAP. Prescribed SAP includes the Accounting Practices and Procedures Manual of the NAIC as well as state laws, regulations and administrative rules. Permitted SAP encompasses all accounting practices not so prescribed. The principal differences between statutory financial statements and financial statements prepared in accordance with US GAAP are that statutory financial statements do not reflect DAC and VOBA, some bond portfolios may be carried at amortized cost, assets and liabilities are presented net of reinsurance, contractholder liabilities are generally valued using more conservative assumptions and certain assets are non-admitted. Accordingly, statutory operating results and statutory capital and surplus may differ substantially from amounts reported in the US GAAP
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Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
basis financial statements for comparable items. For example, in accordance with the US GAAP acquisition method of accounting, the amortized cost of FGLHs invested assets was adjusted to fair value as of the FGLH Acquisition Date while it was not adjusted for statutory reporting. Thus, the net unrealized gains on a statutory basis were $283,626 (unaudited) and $1,245,445 (unaudited) as of September 30, 2013 and 2012, respectively, compared to net unrealized gains of $236,326 and $1,058,447, respectively, on a US GAAP basis, as reported in Note 4.
The Companys principal insurance subsidiaries statutory financial statements are based on a December 31 year end. Statutory net income (loss) and statutory capital and surplus of the Companys wholly owned insurance subsidiaries were as follows:
Subsidiary (state of domicile)(a) | ||||||||
FGL Insurance (MD) | FGL NY Insurance (NY) | |||||||
Statutory Net Income (Loss): |
||||||||
Fiscal year ended September 30, 2013 (Unaudited) |
$ | 36,177 | $ | 3,092 | ||||
Fiscal year ended September 30, 2012 (Unaudited) |
$ | 145,199 | $ | 703 | ||||
Period April 6, 2011 to September 30, 2011 (Unaudited) |
$ | 38,169 | $ | 4,850 | ||||
Year ended December 31, 2012 |
$ | 102,208 | $ | 1,036 | ||||
Year ended December 31, 2011 |
$ | 110,264 | $ | 4,540 | ||||
Statutory Capital and Surplus: |
||||||||
September 30, 2013 (Unaudited) |
$ | 1,064,305 | $ | 62,233 | ||||
September 30, 2012 (Unaudited) |
$ | 861,588 | $ | 45,330 | ||||
December 31, 2012 |
$ | 900,472 | $ | 41,107 | ||||
December 31, 2011 |
$ | 846,434 | $ | 44,657 |
(a) | FGL NY Insurance is a subsidiary of FGL Insurance, and the columns should not be added together. |
The amount of statutory capital and surplus necessary to satisfy the applicable regulatory requirements is not significant in relation to FGL Insurances and FGL NY Insurances respective statutory capital and surplus.
Life insurance companies are subject to certain Risk-Based Capital (RBC) requirements as specified by the NAIC. The RBC is used to evaluate the adequacy of capital and surplus maintained by an insurance company in relation to risks associated with: (i) asset risk, (ii) insurance risk, (iii) interest rate risk and (iv) business risk. The Company monitors the RBC of FGLHs insurance subsidiaries. As of September 30, 2013 and 2012, each of FGLHs insurance subsidiaries had exceeded the minimum RBC requirements (unaudited).
The Companys insurance subsidiaries are restricted by state laws and regulations as to the amount of dividends they may pay to their parent without regulatory approval in any year, the purpose of which is to protect affected insurance policyholders, depositors or investors. Any dividends in excess of limits are deemed extraordinary and require approval. Based on statutory results as of December 31, 2012, in accordance with applicable dividend restrictions, the Companys subsidiaries could pay ordinary dividends of $106,262 to FGLH in 2013, less any dividends paid during the 12 month period from the last dividend payment. On July 12, 2013, FGL Insurance paid a dividend to FGLH in the amount of $40,000. On September 26, 2012 and December 20, 2012, FGL Insurance paid dividends to FGLH in the amount of $20,000 and $20,000 respectively, with regard to its 2011 results. Based on its 2012 calendar year statutory results, FGL Insurance is able to declare an ordinary dividend up to $30,047 through October 31, 2013 (taking into account the dividend payments of $40,000 on July 12, 2013 and $20,000 on December 20, 2012). In addition, after October 31, 2013, FGL Insurance will be able to declare an ordinary dividend of $66,262 with respect to its 2012 statutory results, subject to managements discretion.
52
Table of Contents
Fidelity & Guaranty Life Holdings, Inc.
Notes to Consolidated Financial Statements
(Dollars in thousands)
As of September 30, 2013 neither FGL Insurance nor FGL NY Insurance follow any prescribed or permitted statutory accounting practices that differ from the NAICs statutory accounting practices in the preparation of their statutory basis financial statements. However, FGL Insurances statutory carrying value of Raven Re reflects the effect of a permitted practice Raven Re received to treat the available amount of the letter of credit as an admitted asset. Without such permitted statutory accounting Raven Res statutory capital and surplus would be negative $118,485 (unaudited) at September 30, 2013 and its risk-based capital would fall below the minimum regulatory requirements. The letter of credit facility is collateralized by NAIC 1 rated debt securities. If the permitted practice was revoked, the letter of credit could be replaced by the collateral assets with Nomuras consent.
On November 1, 2013, FGL Insurance re-domesticated from Maryland to Iowa. After re-domestication, FGL Insurance elected to apply Iowa-prescribed accounting practices that permit Iowa-domiciled insurers to report equity call options used to economically hedge FIA index credits at amortized cost for statutory accounting purposes and to calculate FIA statutory reserves such that index credit returns will be included in the reserve only after crediting to the annuity contract. Also, the Iowa Insurance Division granted FGL Insurance a permitted statutory accounting practice to reclassify its negative unassigned surplus balance of $805,818 (unaudited) to additional paid in capital as of April 6, 2011, the date the Company acquired FGL Insurance, which will have the effect of setting FGL Insurances statutory unassigned surplus to zero as of this date. The prescribed and permitted statutory accounting practice will have no impact on the Companys consolidated financial statements which are prepared in accordance with U. S. GAAP.
The Company evaluates all events and transactions that occurred after September 30, 2013 through December 18, 2013, the date these financial statements were available to be issued.
53