Form 10-Q
Table of Contents

 
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2009
OR
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission file number: 001-34280
AMERICAN NATIONAL INSURANCE COMPANY
(Exact name of registrant as specified in its charter)
     
Texas   74-0484030
     
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. employer
identification number)
     
One Moody Plaza
Galveston, Texas
(Address of principal executive offices)
  77550-7999
(Zip code)
(409) 763-4661
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES o NO þ
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
             
Large accelerated filer o   Accelerated filer o   Non-accelerated filer þ   Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). YES o NO þ
As of July 31, 2009, the registrant had 26,820,166 shares of common stock, $1.00 par value per share, outstanding.
 
 

 

 


 

TABLE OF CONTENTS
         
       
 
       
       
 
       
    3  
 
       
    4  
 
       
    5  
 
       
    5  
 
       
    6  
 
       
    7  
 
       
    32  
 
       
    69  
 
       
    70  
 
       
       
 
       
    71  
 
       
    72  
 
       
    72  
 
       
    72  
 
       
    72  
 
       
    72  
 
       
    73  
 
       
    73  
 
       
EXHIBIT INDEX
    74  
 
       
 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32.1
 Exhibit 32.2

 

2


Table of Contents

PART I — FINANCIAL INFORMATION
ITEM 1   FINANCIAL STATEMENTS
Consolidated Statements of Income
(Unaudited and in thousands, except for per share data)
                                 
    Three Months Ended June 30,     Six Months Ended June 30,  
    2009     2008     2009     2008  
PREMIUMS AND OTHER REVENUE
                               
Premiums
                               
Life
  $ 65,228     $ 72,859     $ 135,318     $ 147,014  
Annuity
    53,641       27,347       90,857       71,646  
Accident and health
    69,651       73,040       149,573       145,077  
Property and casualty
    276,427       293,088       568,916       593,194  
Other policy revenues
    44,768       43,379       88,448       85,445  
Net investment income
    214,664       215,868       407,860       403,456  
Realized investments gains (losses)
    (2,674 )     15,564       (8,061 )     17,131  
Other-than-temporary impairments
    (6,074 )     (19,897 )     (74,148 )     (27,049 )
Other income
    12,159       10,314       21,024       19,728  
 
                       
Total revenues
    727,790       731,562       1,379,787       1,455,642  
 
                       
 
                               
BENEFITS, LOSSES AND EXPENSES
                               
Policy Benefits
                               
Life
    72,317       73,901       146,266       145,867  
Annuity
    63,151       35,954       106,808       85,704  
Accident and health
    57,699       54,471       121,766       115,050  
Property and casualty
    243,771       279,508       491,845       497,119  
Interest credited to policy account balances
    95,714       75,942       177,302       143,089  
Commissions for acquiring and servicing policies
    114,675       132,318       227,590       257,588  
Other operating costs and expenses
    120,378       133,169       231,540       250,714  
Increase in deferred policy acquisition costs
    (27,396 )     (40,617 )     (34,029 )     (69,348 )
 
                       
Total benefits, losses and expenses
    740,309       744,646       1,469,088       1,425,783  
 
                       
 
                               
Income (loss) from continuing operations before federal income tax, and equity in earnings of unconsolidated affiliates,
    (12,519 )     (13,084 )     (89,301 )     29,859  
Provision (benefit) for federal income taxes
                               
Current
    (10,330 )     (27,631 )     (25,105 )     (17,278 )
Deferred
    (446 )     16,604       (16,694 )     16,471  
 
                               
Equity in earnings (losses) of unconsolidated affiliates, net of tax
    (3,180 )     348       (5,117 )     7,996  
 
                       
 
                               
Income (loss) from continuing operations
    (4,923 )     (1,709 )     (52,619 )     38,662  
Loss from discontinued operations
          (1,100 )           (2,446 )
 
                       
Net income (loss)
  $ (4,923 )   $ (2,809 )   $ (52,619 )   $ 36,216  
 
                       
Less Net income (loss) attributable to noncontrolling interests
    (568 )     126       (569 )     126  
 
                       
Net income (loss) attributable to American National Insurance Company and Subsidiaries
  $ (4,355 )   $ (2,935 )   $ (52,050 )   $ 36,090  
 
                       
 
                               
Amounts attributable to American National Insurance Company common stockholders
                               
Earnings (loss) per share:
                               
Basic
  $ (0.16 )   $ (0.11 )   $ (1.96 )   $ 1.36  
Diluted
  $ (0.16 )   $ (0.11 )   $ (1.96 )   $ 1.35  
 
                               
Weighted average common shares outstanding
    26,498,832       26,479,832       26,498,832       26,479,832  
Weighted average common shares outstanding and dilutive potential common shares
    26,599,550       26,646,008       26,599,550       26,646,008  
 
                       
See accompanying notes to consolidated financial statements.

 

3


Table of Contents

CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
(Unaudited and In thousands)
                 
    June 30,     December 31,  
    2009     2008  
ASSETS
               
Investments, other than investments in unconsolidated affiliates
               
Fixed Securities:
               
Bonds held-to-maturity, at amortized cost
  $ 7,313,157     $ 6,681,837  
Bonds available-for-sale, at market
    4,042,267       3,820,837  
Preferred stocks, at market
    27,126       48,822  
Equity securities:
               
Common stocks, at market
    863,805       853,530  
Mortgage loans on real estate, net of allowance
    2,003,300       1,877,053  
Policy loans
    357,289       354,398  
Investment real estate, net of accumulated depreciation of $200,657 and $191,435
    562,067       528,905  
Short-term investments
    456,332       295,170  
Other invested assets
    84,822       85,151  
 
           
Total investments
    15,710,165       14,545,703  
 
           
Cash
    32,638       66,096  
Investments in unconsolidated affiliates
    151,459       154,309  
Accrued investment income
    188,504       184,801  
Reinsurance ceded receivables
    416,504       482,846  
Prepaid reinsurance premiums
    57,339       61,433  
Premiums due and other receivables
    316,105       325,019  
Deferred policy acquisition costs
    1,412,936       1,482,664  
Property and equipment, net
    93,055       92,458  
Current federal income taxes
    24,087       68,327  
Deferred federal income taxes
    97,342       195,508  
Other assets
    148,855       159,254  
Separate account assets
    604,374       561,021  
 
           
Total assets
  $ 19,253,363     $ 18,379,439  
 
           
LIABILITIES
               
Policyholder funds
               
Future policy benefits:
               
Life
  $ 2,457,811     $ 2,436,001  
Annuity
    702,583       664,136  
Accident and health
    96,001       96,548  
Policy account balances
    9,038,280       8,295,527  
Policy and contract claims
    1,315,485       1,401,960  
Participating policyholder share
    152,757       149,970  
Other policyholder funds
    962,126       959,134  
 
           
Total policyholder liabilities
    14,725,043       14,003,276  
 
           
Liability for Retirement Benefits
    188,527       184,124  
Notes payable
    110,493       111,922  
Other liabilities
    367,576       376,863  
Separate account liabilities
    604,374       561,021  
 
           
Total liabilities
    15,996,013       15,237,206  
 
           
STOCKHOLDERS’ EQUITY
               
Common stock, $1.00 par value, — Authorized 50,000,000 Issued 30,832,449, Outstanding 26,820,166 shares
    30,832       30,832  
Additional paid-in capital
    9,891       7,552  
Accumulated other comprehensive (loss)
    (64,606 )     (221,148 )
Retained earnings
    3,371,598       3,414,946  
Treasury stock, at cost
    (98,308 )     (98,326 )
 
           
Total American National stockholders’ equity
    3,249,407       3,133,856  
Noncontrolling interest
    7,943       8,377  
 
           
Total equity
    3,257,350       3,142,233  
 
           
Total liabilities and equity
  $ 19,253,363     $ 18,379,439  
 
           
See accompanying notes to consolidated financial statements.

 

4


Table of Contents

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (Unaudited)
(Unaudited and in thousands, except for per share data)
                 
    Six Months Ended June 30,  
    2009     2008  
Common Stock
               
Balance at beginning and end of the period
  $ 30,832     $ 30,832  
 
           
 
 
Additional Paid-In Capital
               
Balance at beginning of year
    7,552       6,080  
Issuance of treasury shares as restricted stock
    (18 )     (1,139 )
Amortization of restricted stock
    2,357       1,097  
 
           
Balance as of June 30,
  $ 9,891     $ 6,038  
 
           
 
               
Accumulated Other Comprehensive Income
               
Balance at beginning of year
    (221,148 )     145,972  
Change in unrealized gains on marketable securities, net
    205,645       (154,236 )
Impact of adoption of FSP FAS 115-2 and FAS 124-2, net
    (49,890 )      
Foreign exchange adjustments
    (776 )     259  
Minimum pension liability adjustment
    1,563       (572 )
 
           
Balance as of June 30,
  $ (64,606 )   $ (8,577 )
 
           
 
               
Retained Earnings
               
Balance at beginning of year
    3,414,946       3,653,365  
Net income (loss)
    (52,050 )     36,090  
Cash dividends to common stockholders ($0.77, and $0.77 per share)
    (41,188 )     (41,273 )
Impact of adoption of FSP FAS 115-2 and FAS 124-2, net
    49,890        
 
           
Balance as of June 30,
  $ 3,371,598     $ 3,648,182  
 
           
 
               
Treasury Stock
               
Balance at beginning of year
    (98,326 )     (99,465 )
Net issuance of restricted stock
    18       1,139  
 
           
Balance as of June 30,
  $ (98,308 )   $ (98,326 )
 
           
 
               
Noncontrolling Interest
               
Balance at beginning of the year
    8,377       4,539  
Contributions
    491       836  
Distributions
    (50 )     (376 )
Gain (loss) attributable to noncontrolling interest
    (875 )     194  
 
           
Balance as of June 30,
  $ 7,943     $ 5,193  
 
           
 
               
Total Equity
               
Balance as of June 30,
  $ 3,257,350     $ 3,583,342  
 
           
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
(In thousands)
                 
    Six Months Ended June 30,  
    2009     2008  
 
               
Net Income (loss)
  $ (52,050 )   $ 36,090  
 
           
 
               
Other comprehensive income (loss), net of tax
               
Change in unrealized gains on marketable securities, net
    205,645       (154,236 )
Foreign exchange adjustments
    (776 )     259  
Minimum pension liability adjustment
    1,563       (572 )
 
           
Total other comprehensive income (loss)
  $ 206,432     $ (154,549 )
 
           
 
               
Total comprehensive income (loss) attributable to American National Insurance Company and Subsidiaries
  $ 154,382     $ (118,459 )
 
           
See accompanying notes to consolidated financial statements.

 

5


Table of Contents

CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited and in thousands)
                 
    Six Months Ended June 30,  
    2009     2008  
 
               
OPERATING ACTIVITIES
               
Net income (loss)
  $ (52,050 )   $ 36,090  
Adjustments to reconcile net income/(loss) to net cash provided by operating activities:
               
Realized losses on investments
    82,209       9,918  
Amortization of discounts and premiums on bonds
    7,979       8,284  
Capitalized interest on policy loans and mortgage loans
    (13,853 )     1,201  
Depreciation
    17,293       15,421  
Interest credited to policy account balances
    176,546       143,133  
Charges to policy account balances
    (85,177 )     (87,198 )
Deferred federal income tax (benefit) expense
    16,694       (16,471 )
Deferral of policy acquisition costs
    (248,564 )     (275,574 )
Amortization of deferred policy acquisition costs
    214,539       206,589  
Equity in earnings of unconsolidated affiliates
    (7,872 )     12,709  
Changes in:
               
Policyholder funds liabilities
    (20,986 )     71,783  
Reinsurance ceded receivables
    66,342       1,303  
Premiums due and other receivables
    8,914       (17,602 )
Accrued investment income
    (3,703 )     (8,389 )
Current federal income tax liability
    44,240       (29,502 )
Liability for retirement benefits
    4,403       314  
Prepaid reinsurance premiums
    4,094       1,200  
Other, net
    (13,080 )     46,671  
 
           
Net cash provided by operating activities
    197,968       119,880  
 
           
INVESTING ACTIVITIES
               
Proceeds from sales of:
               
Bonds — available for sale
    20,910       6,132  
Stocks
    60,451       53,805  
Real Estate
    1,204       4,500  
Other invested assets
          3,933  
Proceeds from maturities of:
               
Bonds — available for sale
    146,260       238,001  
Bonds — held to maturity
    441,781       385,610  
Principal payments received on:
               
Mortgage loans
    63,860       72,270  
Policy loans
    22,889       4,869  
Purchases of investments:
               
Bonds — available for sale
    (67,110 )     (629,718 )
Bonds — held to maturity
    (1,081,138 )     (680,943 )
Stocks
    (19,847 )     (156,547 )
Real estate
    (32,656 )     (64,397 )
Mortgage loans
    (208,828 )     (296,702 )
Policy loans
    (13,920 )     (7,342 )
Other invested assets
    (6,270 )     (19,086 )
Decrease (increase) in short-term investments, net
    (161,162 )     435,323  
Decrease (increase) in investment in unconsolidated affiliates, net
    2,850       (29,495 )
(Increase) in property and equipment, net
    (8,767 )     (7,003 )
 
           
Net cash used in investing activities
    (839,493 )     (686,790 )
 
           
FINANCING ACTIVITIES
               
Policyholders’ deposits to policy account balances
    1,347,735       1,282,013  
Policyholders’ withdrawals from policy account balances
    (697,051 )     (670,300 )
Increase (Decrease) in notes payable
    (1,429 )     22,442  
Dividends to stockholders
    (41,188 )     (41,273 )
 
           
Net cash provided by financing activities
    608,067       592,882  
 
           
NET INCREASE (DECREASE) IN CASH
    (33,458 )     25,972  
Cash:
               
Beginning of the year
    66,096       134,069  
Balance as of June 30,
  $ 32,638     $ 160,041  
 
           
See accompanying notes to consolidated financial statements.

 

6


Table of Contents

1. NATURE OF OPERATIONS
American National Insurance Company and its consolidated subsidiaries (collectively “American National”) operate primarily in the insurance industry. Operating on a multiple product line basis, American National offers a broad line of insurance coverage, including individual and group life, health, and annuities; personal lines property and casualty; and credit insurance. In addition, through non-insurance subsidiaries, American National offers mutual funds and invests in real estate. The majority of revenues are generated by the insurance business. Business is conducted in all states and the District of Columbia, as well as Puerto Rico, Guam and American Samoa. Various distribution systems are utilized, including home service, multiple line, group brokerage, credit, independent third-party marketing organizations and direct sales to the public.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
These consolidated financial statements have been prepared in conformity with (i) U.S. generally accepted accounting principles (“GAAP”) for interim financial information; and (ii) the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) for Form 10-Q. In addition to GAAP accounting literature, specific SEC regulation is also applied to the financial statements issued by insurance companies.
The consolidated financial statements and notes as of June 30, 2009 and for the three and six months ended June 30, 2009 are unaudited. These financial statements reflect all adjustments which are, in the opinion of management, considered necessary for the fair presentation of the financial position, statements of income and cash flows for the interim periods. In preparing the accompanying financial statements, we have evaluated subsequent events through the financial statements filing date. These financial statements and notes should be read in conjunction with American National’s Annual Consolidated Financial Statements and related notes incorporated within the amended Form 10 Registration Statement filed with the SEC on July 1, 2009.
All significant intercompany accounts and transactions have been eliminated in consolidation. Investments in unconsolidated affiliates are shown at cost plus equity in undistributed earnings since the dates of acquisition. American National’s life insurance business in Mexico, which is reported as discontinued operations, had an immaterial impact on revenue for the three and six months ended June 30, 2009.
Certain reclassifications have been made to prior period amounts to conform to the current period presentation.
The preparation of consolidated financial statements in conformity with GAAP requires the use of estimates and assumptions that affect the reported financial statement balances. Actual results could differ from those estimates. The following estimates have been identified as critical in that they involve a high degree of judgment and are subject to a significant degree of variability:
    Other-than-temporary impairment of investment securities;
    Deferred acquisition costs;
    Reserves;
    Reinsurance recoverable;
    Pension and postretirement benefit plans;
    Litigation contingencies; and
    Federal income taxes.
As of June 30, 2009, American National’s significant accounting policies and practices remain materially unchanged from those disclosed in Note 2 of its 2008 Annual Consolidated Financial Statements incorporated within the amended Form 10 Registration Statement filed with the SEC on July 1, 2009 with the exception of the other-than-temporary impairment (“OTTI”) of debt securities accounting policy.
American National’s accounting policy on OTTI of debt securities was significantly modified due to the April 2009 issuance of the Financial Accounting Standards Board’s (“FASB’s”) FSP FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments” (refer to Note 3). Under the new policy, an OTTI has occurred for a debt security in an unrealized loss position when American National either (a) has the intent to sell the debt security or (b) it is more likely than not that it will be required to sell the debt security before its anticipated recovery of its amortized costs basis. If either criteria is met, OTTI is recognized in earnings in the amount of the amortized cost basis of the debt security in excess of its fair value, as of the impairment measurement date.

 

7


Table of Contents

For all debt securities in unrealized loss positions which American National does not intend to sell and for which it is not more likely than not that they will be required to sell before its anticipated recovery, American National assesses whether the amortized cost basis of the debt security will be recovered by comparing the net present value of cash flows expected to be collected from the debt security with its amortized cost basis. Management estimates cash flows expected to be collected from the debt security using information based on its historical experience as well as using market observable data, such as industry analyst reports and forecasts, sector credit ratings and other data relevant to the collectability of a security. The net present value of cash flows expected to be collected from the debt security is calculated by discounting management’s best estimate of cash flows expected to be collected on the debt security at the effective interest rate implicit in the debt security when acquired. If the net present value of the cash flows expected to be collected from the debt security is less than the amortized cost basis of the debt security, an OTTI has occurred in the form of a credit loss. The credit loss is recognized in earnings in the amount of excess amortized costs over the net present value of the cash flows expected to be collected from the debt security. If the fair value of the debt security is in excess of its net present value of the cash flows expected to be collected from the debt security at the impairment measurement date, a non-credit loss exists which is recorded in other comprehensive income (loss) in the amount of the fair value of the debt security in excess of the net present value of the cash flows expected to be collected from the debt security.
After the recognition of an OTTI, the debt security is accounted for as if it had been purchased on the measurement date of the OTTI, with an amortized cost basis equal to its previous amortized cost basis less the related OTTI recognized in earnings. The new amortized cost basis of an impaired security is not adjusted for subsequent increases in estimated fair value. Should there be a significant increase in the estimate of cash flows expected to be collected from a previously impaired debt security, the increase would be accounted for prospectively by accreting it as interest income over the remaining life of the debt security.
3. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
Adoption of New Accounting Standards
In May 2009, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No.165, “Subsequent Events” (“SFAS 165”). SFAS 165 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued. It requires that an entity evaluate its subsequent events up through the date of issuance of its financial statements as well as disclosure of the date of such evaluation. SFAS 165 is effective for interim and annual periods ending after June 15, 2009. Accordingly, American National adopted SFAS 165 prospectively in its second quarter of fiscal year 2009. The adoption of this standard on April 1, 2009 did not have a material effect on American National’s consolidated financial statements.
In April 2009, the FASB issued FASB Staff Position (“FSP”) Financial Accounting Standard (“FAS”) 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments” (“FSP FAS 115-2/124-2”). FSP FAS 115-2/124-2 requires entities to separate an OTTI of a debt security into two components when there are credit related losses associated with the impaired debt security for which management asserts that it does not have the intent to sell the security, and it is more likely than not that it will not be required to sell the security before recovery of its cost basis. The amount of the other-than-temporary impairment related to a credit loss is recognized in earnings, and the amount of the other-than-temporary impairment related to other factors (the “non-credit loss”) is recorded in other comprehensive income (loss). FSP FAS 115-2/124-2 is effective for interim and annual periods ending after June 15, 2009. As of the beginning of the interim period of adoption, FSP FAS 115-2/124-2 requires a cumulative-effect adjustment to reclassify the non-credit component of previously recognized other-than-temporary impairment losses from retained earnings to other comprehensive loss. On April 1, 2009, American National adopted FSP FAS 115-2/124-2 which resulted in a cumulative-effect adjustment of $49,890,000, net of taxes, as an adjustment to the opening balance of retained earnings with a corresponding adjustment to accumulated other comprehensive income.
In April 2009, the FASB issued FSP FAS 157-4, “Determining Fair Value When Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions that are Not Orderly” (“FSP FAS 157-4”). Under FSP FAS 157-4, if an entity determines that there has been a significant decrease in the volume and level of activity for the asset or the liability in relation to the normal market activity for the asset or liability (or similar assets or liabilities), then transactions or quoted prices may not accurately reflect fair value. In addition, if there is evidence that the transaction for the asset or liability is not orderly, the entity shall place little, if any weight on that transaction price as an indicator of fair value. FSP FAS 157-4 is effective for interim and annual periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. American National adopted FSP FAS 157-4 on April 1, 2009, and the adoption of this standard did not have a material effect on American National’s consolidated financial statements.

 

8


Table of Contents

In April 2009, the FASB issued FSP FAS 107-1 and Accounting Principles Board Opinion (“APB”) 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (“FSP FAS 107-1 and APB 28-1”). FSP FAS 107-1 and APB 28-1 require disclosures about fair value of financial instruments in interim and annual financial statements. FSP FAS 107-1 and APB 28-1 are effective for interim and annual periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. American National adopted FSP FAS 107-1 and APB 28-1 on April 1, 2009 and the adoption of this standard did not have a material effect on American National’s consolidated financial statements.
Future Adoption of New Accounting Standards
In June 2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles — a replacement of FASB Statement No. 162” (“SFAS 168”). SFAS 168 establishes the FASB Accounting Standards Codification as the source of authoritative accounting principles recognized by the FASB to be applied by non-governmental entities in the preparation of financial statements in conformity with GAAP in the United States, superseding existing FASB, American Institute of Certified Public Accountants (“AICPA”), Emerging Issues Task Force (“EITF”), and related accounting literature. SFAS 168 is effective for financial statements issued for interim and annual periods ending after September 15, 2009. SFAS 168 will not have an impact on American National’s consolidated financial statements, other than changes in reference from specific accounting standards to accounting standards codification references.
In June 2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46R” (“SFAS 167”). SFAS 167 amends FASB Interpretation No. (“FIN”) 46 (revised December 2003), “Consolidation of Variable Interest Entities” (“FIN 46R”) to require an analysis to determine whether a variable interest gives the entity a controlling financial interest in a variable interest entity. This statement requires an ongoing reassessment and eliminates the quantitative approach previously required for determining whether an entity is the primary beneficiary. This standard is effective for fiscal years beginning after November 15, 2009. Accordingly, American National will adopt SFAS 167 in fiscal year 2010 and is currently evaluating the impact of adopting this standard on its consolidated financial statements.
In June 2009, the FASB issued SFAS No. 166, “Accounting for Transfers of Financial Assets” (“SFAS 166”). SFAS 166 removes the concept of a qualifying special-purpose entity (QSPE) from SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities” (“SFAS 140”) and removes the exception from applying FIN 46R. This standard also clarifies the requirements for isolation and limitations on portions of financial assets that are eligible for sale accounting. This standard is effective for fiscal years beginning after November 15, 2009. Accordingly, American National will adopt SFAS 166 in fiscal year 2010 and is currently evaluating the impact of adopting this standard on its consolidated financial statements.

 

9


Table of Contents

4. INVESTMENTS
The amortized cost and estimated fair values of investments in held-to-maturity and available-for-sale securities are shown below (in thousands):
                                 
            Gross     Gross        
            Unrealized     Unrealized     Estimated Fair  
    Amortized Cost     Gains     Losses     Value  
June 30, 2009
                               
Debt Securities
                               
Bonds held-to-maturity:
                               
U.S. treasury and other U.S. government corporations and agencies
  $ 21,345     $ 225     $ (19 )   $ 21,551  
States of the U.S. and political subdivisions of the states
    214,603       5,668       (1,696 )     218,575  
Foreign governments
    28,986       2,837             31,823  
Corporate debt securities
    6,251,024       144,414       (281,547 )     6,113,891  
Residential mortgage backed securities
    722,045       22,129       (29,097 )     715,077  
Commercial mortgage backed securities
    32,609             (25,038 )     7,571  
Collateralized debt securities
    9,447       44       (746 )     8,745  
Other debt securities
    33,098       2,225             35,323  
 
                       
Total bonds held-to-maturity
  $ 7,313,157     $ 177,542     $ (338,143 )   $ 7,152,556  
 
                       
 
                               
Bonds available-for-sale:
                               
U.S. treasury and other U.S. government corporations and agencies
    3,450       491             3,941  
States of the U.S. and political subdivisions of the states
    582,276       11,623       (6,465 )     587,434  
Foreign governments
    5,000       1,053             6,053  
Corporate debt securities
    3,230,468       40,047       (233,459 )     3,037,056  
Residential mortgage backed securities
    379,787       8,564       (7,599 )     380,752  
Collateralized debt securities
    26,303       492       (4,077 )     22,718  
Other debt securities
    4,207       106             4,313  
 
                       
Total bonds available-for-sale
  $ 4,231,491     $ 62,376     $ (251,600 )   $ 4,042,267  
 
                       
 
                               
Total debt securities
  $ 11,544,648     $ 239,918     $ (589,743 )   $ 11,194,823  
 
                       
 
                               
Marketable equity securities
                               
Common stock:
                               
Consumer goods
    147,365       30,234       (8,047 )     169,552  
Energy & utilities
    90,584       33,480       (3,370 )     120,694  
Finance
    106,616       26,601       (6,794 )     126,423  
Healthcare
    86,891       20,780       (4,792 )     102,879  
Industrials
    60,858       12,574       (2,887 )     70,545  
Information technology
    109,655       24,443       (4,700 )     129,398  
Materials
    19,090       3,191       (580 )     21,701  
Telecommuncation services
    34,812       3,908       (1,734 )     36,986  
Mutual funds
    83,478       2,911       (762 )     85,627  
 
                       
Total common stock
  $ 739,349     $ 158,122     $ (33,666 )   $ 863,805  
 
                       
Preferred stock
    30,359       3,959       (7,192 )     27,126  
 
                       
Total marketable equity securities
  $ 769,708     $ 162,081     $ (40,858 )   $ 890,931  
 
                       
 
                               
Total investments in securities
  $ 12,314,356     $ 401,999     $ (630,601 )   $ 12,085,754  
 
                       

 

10


Table of Contents

                                 
            Gross     Gross        
            Unrealized     Unrealized     Estimated Fair  
    Amortized Cost     Gains     Losses     Value  
December 31, 2008
                               
Debt Securities
                               
Bonds held-to-maturity:
                               
U.S. treasury and other U.S. government corporations and agencies
  $ 11,484     $ 346     $     $ 11,830  
States of the U.S. and political subdivisions of the states
    155,420       4,485       (1,611 )     158,294  
Foreign governments
    28,975       3,481             32,456  
Corporate debt securities
    5,602,250       48,963       (532,544 )     5,118,669  
Residential mortgage backed securities
    735,025       13,557       (39,288 )     709,294  
Commercial mortgage backed securities
    32,110             (24,368 )     7,742  
Collateralized debt securities
    39,768       330       (5,274 )     34,824  
Other debt securities
    76,805       81       (1,292 )     75,594  
 
                       
Total bonds held-to-maturity
  $ 6,681,837     $ 71,243     $ (604,377 )   $ 6,148,703  
 
                       
 
                               
Bonds available-for-sale:
                               
U.S. treasury and other U.S. government corporations and agencies
    3,462       900             4,362  
States of the U.S. and political subdivisions of the states
    591,405       6,281       (19,477 )     578,209  
Foreign governments
    5,000       2,332             7,332  
Corporate debt securities
    3,195,355       29,053       (441,400 )     2,783,008  
Residential mortgage backed securities
    427,460       4,355       (14,618 )     417,197  
Collateralized debt securities
    25,649       133       (4,710 )     21,072  
Other debt securities
    11,229             (1,572 )     9,657  
 
                       
Total bonds available-for-sale
  $ 4,259,560     $ 43,054     $ (481,777 )   $ 3,820,837  
 
                       
 
 
Total debt securities
  $ 10,941,397     $ 114,297     $ (1,086,154 )   $ 9,969,540  
 
                       
 
                               
Marketable equity securities
                               
Common stock:
                               
Consumer goods
    159,068       23,558       (15,093 )     167,533  
Energy & utilities
    97,103       25,105       (8,889 )     113,319  
Finance
    128,866       17,824       (13,048 )     133,642  
Healthcare
    94,807       21,076       (6,380 )     109,503  
Industrials
    72,360       10,786       (9,618 )     73,528  
Information technology
    111,976       7,910       (15,207 )     104,679  
Materials
    30,725       1,685       (6,886 )     25,524  
Telecommuncation services
    39,171       5,359       (3,840 )     40,690  
Mutual funds
    86,832       2,389       (4,109 )     85,112  
 
                       
Total common stock
  $ 820,908     $ 115,692     $ (83,070 )   $ 853,530  
 
                       
Preferred stock
    60,718       3,609       (15,505 )     48,822  
 
                       
Total marketable equity securities
  $ 881,626     $ 119,301     $ (98,575 )   $ 902,352  
 
                       
 
                               
Total investments in securities
  $ 11,823,023     $ 233,598     $ (1,184,729 )   $ 10,871,892  
 
                       
The net unrealized losses were primarily related to corporate bonds concentrated within the financial services sector. These net unrealized losses were primarily company specific and due to current credit market conditions.

 

11


Table of Contents

DEBT SECURITIES
The amortized cost and estimated fair value, by contractual maturity, of debt securities at June 30, 2009, are shown below (in thousands). Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
                                 
    Bonds Held-to-Maturity     Bonds Available-for-Sale  
            Estimated Fair             Estimated Fair  
    Amortized Cost     Value     Amortized Cost     Value  
 
 
Due in one year or less
  $ 127,596     $ 124,453     $ 160,341     $ 160,027  
 
 
Due after one year through five years
    3,348,029       3,321,556       1,743,430       1,664,582  
 
 
Due after five years through ten years
    3,057,602       2,939,790       1,663,808       1,564,363  
 
 
Due after ten years
    774,080       762,682       653,636       645,364  
 
                       
 
  $ 7,307,307     $ 7,148,481     $ 4,221,215     $ 4,034,336  
 
 
Without single maturity date
    5,850       4,075       10,276       7,931  
 
                       
 
 
Total
  $ 7,313,157     $ 7,152,556     $ 4,231,491     $ 4,042,267  
 
                       
For the six months ended June 30, 2009, securities with an amortized cost of $230,000 were transferred from held-to-maturity to available-for-sale due to evidence of a significant deterioration in the issuers’ creditworthiness. An unrealized loss of $136,000 was established at the time of transfer.
At June 30, 2008, there were no carrying value transfers from held-to-maturity to available-for-sale due to evidence of a significant deterioration in the issurers’ creditworthiness.
DERIVATIVE INSTRUMENTS
American National purchases derivative contracts that serve as economic hedges against fluctuations in the equity markets to which equity indexed annuity products are exposed. Equity indexed annuities include a fixed host annuity contract and an embedded equity derivative. These derivative instruments are not accounted for as hedging under SFAS 133. The following table details the gain or loss on derivatives related to equity indexed annuities:
                                     
      Amount of Gain (Loss) Recognized in Income on Derivatives  
Derivatives Not Designated as Hedging   Location of Gain (Loss) Recognized in   Three Months Ended June 30,     Six Months Ended June 30,  
Instruments Under FAS Statement 133   Income on Derivatives   2009     2008     2009     2008  
 
                                   
Equity Index Options
  Investment Income   $ 1,757     $ (3,546 )   $ (2,101 )   $ (12,736 )
Equity Index Annuity Embedded Derivative
  Interest Credited to Policyholders   $ (3,000 )   $ 4,321     $ (738 )   $ 14,318  

 

12


Table of Contents

UNREALIZED GAINS AND LOSSES ON SECURITIES
Unrealized gains (losses) on marketable equity securities and bonds available-for-sale, presented in the stockholders’ equity section of the consolidated statements of financial position, are net of deferred tax assets of $1,608,000 and $15,731,000 for the periods ended June 30, 2009 and 2008 respectively.
The change in the net unrealized gains (losses) on securities for the six months period ended June 30, 2009 and 2008 are summarized as follows (in thousands):
                 
    2009     2008  
 
               
Bonds available-for-sale
  $ 249,499     $ (85,774 )
Preferred stocks
    8,663       (12,063 )
Common stocks
    91,834       (153,429 )
Amortization of deferred policy acquisition costs
    (103,757 )     6,791  
 
           
 
    246,239       (244,475 )
Provision (benefit) for federal income taxes
    85,004       (85,516 )
 
           
 
  $ 161,235     $ (158,959 )
 
           
Change in unrealized gains (losses) of investments attributable to participating policyholders’ interest
    (5,480 )     4,723  
Impact of adoption of FSP FAS 115-2 and FAS 124-2
    49,890          
 
           
 
               
Total
  $ 205,645     $ (154,236 )
 
           

 

13


Table of Contents

Gross unrealized losses on investment securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, as of June 30, 2009 and December 31, 2008, are summarized as follows (in thousands):
                                                 
    Less than 12 months     12 Months or more     Total  
    Unrealized     Fair     Unrealized     Fair     Unrealized     Fair  
June 30, 2009   Losses     Value     Losses     Value     Losses     Value  
 
 
Debt Securities
                                               
Bonds held-to-maturity:
                                               
U.S. treasury and other U.S. government corporations and agencies
  $ 19     $ 4,843     $     $     $ 19     $ 4,843  
States of the U.S. and political subdivisions of the states
    883       47,474       813       7,433       1,696       54,907  
Corporate debt securities
    26,586       522,048       254,961       2,166,474       281,547       2,688,522  
Residential mortgage backed securities
    338       28,183       28,759       202,439       29,097       230,622  
Commercial mortgage backed securities
                25,038       7,571       25,038       7,571  
Collateralized debt securities
    746       5,031                   746       5,031  
 
                                   
Total bonds held-to-maturity
  $ 28,572     $ 607,579     $ 309,571     $ 2,383,917     $ 338,143     $ 2,991,496  
 
                                   
 
                                               
Bonds available-for-sale:
                                               
States of the U.S. and political subdivisions of the states
    1,663       91,363       4,802       123,366       6,465       214,729  
Corporate debt securities
    51,660       495,747       181,799       1,357,494       233,459       1,853,241  
Residential mortgage backed securities
    1,556       28,414       6,043       36,605       7,599       65,019  
Collateralized debt securities
    599       2,615       3,478       8,463       4,077       11,078  
 
                                   
Total bonds available-for-sale
  $ 55,478     $ 618,139     $ 196,122     $ 1,525,928     $ 251,600     $ 2,144,067  
 
                                   
 
 
Total debt securities
  $ 84,050     $ 1,225,718     $ 505,693     $ 3,909,845     $ 589,743     $ 5,135,563  
 
                                   
 
                                               
Marketable equity securities
                                               
Common stock:
                                               
Consumer goods
    7,589       39,882       458       4,202       8,047       44,084  
Energy & utilities
    2,488       16,450       882       4,623       3,370       21,073  
Finance
    6,321       44,605       473       2,002       6,794       46,607  
Healthcare
    3,505       30,825       1,287       8,296       4,792       39,121  
Industrials
    2,210       14,415       677       3,932       2,887       18,347  
Information technology
    4,270       26,559       430       3,712       4,700       30,271  
Materials
    580       5,589                   580       5,589  
Telecommunications services
    1,353       9,138       381       2,631       1,734       11,769  
Mutual funds
    746       12,410       16       391       762       12,801  
 
                                   
Total common stock
  $ 29,062     $ 199,873     $ 4,604     $ 29,789     $ 33,666     $ 229,662  
 
                                   
Preferred stock
    1,288       3,877       5,904       15,196       7,192       19,073  
 
                                   
Total marketable equity securities
  $ 30,350     $ 203,750     $ 10,508     $ 44,985     $ 40,858     $ 248,735  
 
                                   
 
                                               
Total investments in securities
  $ 114,400     $ 1,429,468     $ 516,201     $ 3,954,830     $ 630,601     $ 5,384,298  
 
                                   

 

14


Table of Contents

                                                 
    Less than 12 months     12 Months or more     Total  
    Unrealized     Fair     Unrealized     Fair     Unrealized     Fair  
December 31, 2008   Losses     Value     Losses     Value     Losses     Value  
 
 
Debt Securities
                                               
Bonds held-to-maturity:
                                               
U.S. treasury and other U.S. government corporations and agencies
  $     $     $     $     $     $  
States of the U.S. and political subdivisions of the states
    1,571       21,104       40       383       1,611       21,487  
Corporate debt securities
    280,110       2,685,787       252,434       928,186       532,544       3,613,973  
Residential mortgage backed securities
    31,471       186,404       7,817       50,425       39,288       236,829  
Commercial mortgage backed securities
    24,368       7,742                   24,368       7,742  
Collateralized debt securities
    613       4,785       4,661       23,844       5,274       28,629  
Other debt securities
    1,292       9,566                   1,292       9,566  
 
                                   
Total bonds held-to-maturity
  $ 339,425     $ 2,915,388     $ 264,952     $ 1,002,838     $ 604,377     $ 3,918,226  
 
                                   
 
                                               
Bonds available-for-sale:
                                               
States of the U.S. and political subdivisions of the states
    15,383       274,191       4,094       35,295       19,477       309,486  
Corporate debt securities
    247,590       1,683,287       193,810       643,327       441,400       2,326,614  
Residential mortgage backed securities
    8,067       102,382       6,551       51,327       14,618       153,709  
Collateralized debt securities
    1,822       10,295       2,888       8,529       4,710       18,824  
Other debt securities
    1,572       9,657                   1,572       9,657  
 
                                   
Total bonds available-for-sale
  $ 274,434     $ 2,079,812     $ 207,343     $ 738,478     $ 481,777     $ 2,818,290  
 
                                   
 
                                               
Total debt securities
  $ 613,859     $ 4,995,200     $ 472,295     $ 1,741,316     $ 1,086,154     $ 6,736,516  
 
                                   
 
                                               
Marketable equity securities
                                               
Common stock:
                                               
Consumer goods
    13,717       66,398       1,376       5,014       15,093       71,412  
Energy & utilities
    8,203       24,909       686       2,818       8,889       27,727  
Finance
    12,729       49,150       319       1,190       13,048       50,340  
Healthcare
    5,177       29,429       1,203       5,826       6,380       35,255  
Industrials
    9,496       23,880       122       593       9,618       24,473  
Information technology
    13,859       57,237       1,348       2,583       15,207       59,820  
Materials
    6,665       15,164       221       456       6,886       15,620  
Telecommunications services
    3,838       16,570       2       7       3,840       16,577  
Mutual funds
    4,107       16,775       2       6       4,109       16,781  
 
                                   
Total common stock
  $ 77,791     $ 299,512     $ 5,279     $ 18,493     $ 83,070     $ 318,005  
 
                                   
Preferred stock
    1,238       7,853       14,267       31,835       15,505       39,688  
 
                                   
Total marketable equity securities
  $ 79,029     $ 307,365     $ 19,546     $ 50,328     $ 98,575     $ 357,693  
 
                                   
 
                                               
Total investments in securities
  $ 692,888     $ 5,302,565     $ 491,841     $ 1,791,644     $ 1,184,729     $ 7,094,209  
 
                                   
For all investment securities, including those securities in an unrealized loss position for 12 months or more, American National performs quarterly analyses to determine if an other-than-temporary impairment loss should be recorded for any securities. As of June 30, 2009, the securities above did not meet the criteria for other-than temporary impairment. At June 30, 2009, the unrealized losses were primarily the result of the deterioration in credit spreads as well as the continuance of an illiquid market. There were no delinquent coupon payments attributed to the unimpaired bonds as of June 30, 2009. Even though the duration of the unrealized gain on the securities exceeds one year, American National maintains the intent and ability to hold the securities until either their maturity or their value recovers.

 

15


Table of Contents

INVESTMENT INCOME AND REALIZED GAINS (LOSSES)
Investment income and realized gains (losses) on investments, before federal income taxes, for the three and six months ended June 30, 2009 and 2008 are summarized as follows (in thousands):
                                                                 
    Investment Income     Realized Gains/(Losses)     Investment Income     Realized Gains/(Losses)  
    Three Months Ended June 30,     Three Months Ended June 30,     Six Months Ended June 30,     Six Months Ended June 30,  
    2009     2008     2009     2008     2009     2008     2009     2008  
 
                                                               
Bonds
  $ 156,284     $ 157,063     $ (2,433 )   $ 3,244     $ 307,730     $ 309,391     $ (3,403 )   $ 3,425  
Preferred stocks
    1,128       1,747             554       2,066       2,951       (1,620 )     554  
Common stocks
    6,708       8,875       (2 )     12,922       12,701       15,256       (818 )     13,583  
Mortgage loans
    34,333       28,351                   66,309       53,890              
Real estate
    36,706       31,636             145       62,065       55,419             1,739  
Other invested assets
    10,610       14,183       (49 )     515       14,984       17,083       287        
 
                                               
 
    245,769       241,855       (2,484 )     17,380       465,855       453,990       (5,554 )     19,301  
Investment expenses
    (31,105 )     (25,987 )                 (57,995 )     (50,534 )            
Decrease (increase) in valuation allowances
                (190 )     (1,816 )                 (2,507 )     (2,170 )
 
                                               
Total
  $ 214,664     $ 215,868     $ (2,674 )   $ 15,564     $ 407,860     $ 403,456     $ (8,061 )   $ 17,131  
 
                                               
OTHER-THAN-TEMPORARY IMPAIRMENT
The following tables summarize other-than-temporary impairments (“OTTI”) for the periods indicated (in thousands):
                                 
    Three Months Ended June 30,     Six Months Ended June 30,  
    2009     2008     2009     2008  
 
                               
Bonds
  $     $ (16,989 )   $ (5,898 )   $ (16,989 )
Common stocks
    (6,074 )     (2,908 )     (67,750 )     (10,060 )
Mortgage loans
                (500 )      
 
                       
Total
  $ (6,074 )   $ (19,897 )   $ (74,148 )   $ (27,049 )
 
                       
As discussed in Note 2, certain OTTI losses on bonds are bifurcated into two components: credit losses and non-credit losses. The net amount recognized in earnings (“credit loss impairments”) represents the difference between the amortized cost of the bond and the net present value of its projected future cash flows discounted at the effective interest rate implicit in the bond prior to impairment. Any remaining difference between the bond’s fair value and amortized cost (“non-credit loss impairments”) is recognized in other comprehensive income.
Since the adoption of FSP FAS 115-2/124-2 on April 1, 2009 (see Note 2), all OTTIs recognized on bonds were entirely comprised of credit losses. Therefore, during the three months ended June 30, 2009, no non-credit loss was recognized in OCI.
5. CREDIT RISK MANAGEMENT
American National employs a strategy to invest funds at the highest return possible commensurate with sound and prudent investing practices to ensure a well-diversified investment portfolio.
BONDS
Management believes American National’s bond portfolio is diversified and of investment grade. The bond portfolio distributed by quality rating at June 30, 2009 and December 31, 2008 is summarized as follows:
                 
    June 30,     December 31,  
    2009     2008  
AAA
    13 %     17 %
AA+
    1 %     1 %
AA
    2 %     6 %
AA-
    4 %     4 %
A+
    9 %     11 %
A
    13 %     16 %
A-
    13 %     13 %
BBB+
    14 %     11 %
BBB
    17 %     12 %
BBB-
    7 %     4 %
BB+ and below
    7 %     5 %
 
           
 
    100 %     100 %
 
           

 

16


Table of Contents

COMMON STOCK
American National’s stock portfolio by market sector distribution at June 30, 2009 and December 31, 2008 is summarized as follows:
                 
    June 30,     December 31,  
    2009     2008  
Consumer Goods
    20 %     20 %
Financials
    15 %     16 %
Energy & Utilities
    14 %     13 %
Information Technology
    15 %     13 %
Health Care
    12 %     13 %
Mutual Funds
    10 %     10 %
Industrials
    8 %     8 %
Communications
    4 %     5 %
Materials
    2 %     2 %
 
           
 
    100 %     100 %
 
           
MORTGAGE LOANS AND INVESTMENT REAL ESTATE
American National invests primarily in the commercial sector in areas that offer the potential for property value appreciation. Generally, mortgage loans are secured by first liens on income-producing real estate.
Mortgage loans and investment real estate by property type distribution at June 30, 2009 and December 31, 2008 are summarized as follows:
                                 
    Mortgage Loans     Investment Real Estate  
    June 30,     December 31,     June 30,     December 31,  
    2009     2008     2009     2008  
Office Buildings
    29 %     30 %     18 %     18 %
Industrial
    28 %     25 %     42 %     45 %
Shopping Centers
    19 %     21 %     23 %     23 %
Hotels/Motels
    16 %     17 %     2 %     2 %
Other
    5 %     4 %     13 %     11 %
Commercial
    3 %     3 %     2 %     1 %
 
                       
 
    100 %     100 %     100 %     100 %
 
                       
American National has a diversified portfolio of mortgage loans and real estate properties. Mortgage loans and real estate investments by geographic distribution at June 30, 2009 and December 31, 2008 are as follows:
                                 
    Mortgage Loans     Investment Real Estate  
    June 30,     December 31,     June 30,     December 31,  
    2009     2008     2009     2008  
West South Central
    23 %     22 %     63 %     64 %
East North Central
    20 %     22 %     8 %     6 %
South Atlantic
    16 %     17 %     15 %     16 %
Pacific
    11 %     13 %     3 %     2 %
Middle Atlantic
    9 %     10 %            
Mountain
    5 %     5 %     1 %     1 %
New England
    5 %     5 %            
East South Central
    7 %     4 %     9 %     10 %
West North Central
    4 %     2 %     1 %     1 %
 
                       
 
    100 %     100 %     100 %     100 %
 
                       

 

17


Table of Contents

6. FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts and estimated fair values of financial instruments at June 30, 2009 and December 31, 2008 are as follows (in thousands):
                                 
    June 30, 2009     December 31, 2008  
    Carrying     Estimated     Carrying     Estimated  
    Amount     Fair Value     Amount     Fair Value  
 
                               
Financial Assets:
                               
Fixed maturities
                               
Held-to-maturity:
                               
U.S. treasury and other U.S. government corporations and agencies
  $ 21,345     $ 21,551     $ 11,484     $ 11,830  
States of the U.S. and political subdivisions of the states
    214,603       218,575       155,420       158,294  
Foreign governments
    28,986       31,823       28,975       32,456  
Corporate debt securities
    6,251,024       6,113,891       5,602,250       5,118,669  
Residential mortgage backed securities
    722,045       715,077       735,025       709,294  
Commercial mortgage backed securities
    32,609       7,571       32,110       7,742  
Collateralized debt securities
    9,447       8,745       39,768       34,824  
Other debt securities
    33,098       35,323       76,805       75,594  
 
                       
Total fixed maturities, held-to-maturity
  $ 7,313,157     $ 7,152,556     $ 6,681,837     $ 6,148,703  
 
                       
Available-for-sale:
                               
U.S. treasury and other U.S. government corporations and agencies
    3,941       3,941       4,362       4,362  
States of the U.S. and political subdivisions of the states
    587,434       587,434       578,209       578,209  
Foreign governments
    6,053       6,053       7,332       7,332  
Corporate debt securities
    3,037,056       3,037,056       2,783,008       2,783,008  
Residential mortgage backed securities
    380,752       380,752       417,197       417,197  
Collateralized debt securities
    22,718       22,718       21,072       21,072  
Other debt securities
    4,313       4,313       9,657       9,657  
 
                       
Total fixed maturities, available-for-sale
  $ 4,042,267     $ 4,042,267     $ 3,820,837     $ 3,820,837  
 
                       
Total fixed maturities
  $ 11,355,424     $ 11,194,823     $ 10,502,674     $ 9,969,540  
 
                       
Marketable equity securities
                               
Common stock:
                               
Consumer Goods
    169,552       169,552       167,533       167,533  
Energy & Utilities
    120,694       120,694       113,319       113,319  
Finance
    126,423       126,423       133,642       133,642  
Healthcare
    102,879       102,879       109,503       109,503  
Industrials
    70,545       70,545       73,528       73,528  
Information Technology
    129,398       129,398       104,679       104,679  
Materials
    21,701       21,701       25,524       25,524  
Mutual Funds
    85,627       85,627       85,112       85,112  
Telecommunication Services
    36,986       36,986       40,690       40,690  
Preferred stock
    27,126       27,126       48,822       48,822  
 
                       
Total marketable equity securities
  $ 890,931     $ 890,931     $ 902,352     $ 902,352  
 
                       
Options
    9,996       9,996       6,157       6,157  
Mortgage loans on real estate
    2,003,300       1,996,051       1,877,053       1,891,895  
Policy loans
    357,289       357,289       354,398       354,398  
Short-term investments
    456,332       456,332       295,170       295,170  
 
                       
Total financial assets
  $ 15,073,272     $ 14,905,422     $ 13,937,804     $ 13,419,512  
 
                       
Financial Liabilities:
                               
Investment contracts
    7,372,671       7,372,671       6,626,561       6,626,561  
Liability for embedded derivatives of equity indexed annuities
    10,268       10,268       6,208       6,208  
Notes payable
    110,493       110,493       111,922       111,922  
 
                       
Total financial liabilities
  $ 7,493,432     $ 7,493,432     $ 6,744,691     $ 6,744,691  
 
                       

 

18


Table of Contents

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability. A fair value hierarchy is used to determine fair value based on a hypothetical transaction at the measurement date from the perspective of a market participant. An asset or liability’s classification within the fair value hierarchy is based on the lowest level of significant input to its valuation. The input levels are defined as follows:
         
 
  Level 1   Unadjusted quoted prices in active markets for identical assets or liabilities. American National defines active markets based on average trading volume for equity securities. The size of the bid/ask spread is used as an indicator of market activity for fixed maturity securities.
 
       
 
  Level 2   Quoted prices in markets that are not active or inputs that are observable either directly or indirectly. Level 2 inputs include quoted prices for similar assets or liabilities other than quoted prices in Level 1; quoted prices in markets that are not active; or other inputs that are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities.
 
       
 
  Level 3   Unobservable inputs that are supported by little or no market activity and are significant to the fair value of the assets or liabilities. Unobservable inputs reflect American National’s own assumptions about the assumptions that market participants would use in pricing the asset or liability. Level 3 assets and liabilities include financial instruments whose values are determined using pricing models and third-party evaluation, as well as instruments for which the determination of fair value requires significant management judgment or estimation.
American National has analyzed the third-party pricing services valuation methodologies and related inputs, and has also evaluated the various types of securities in its investment portfolio to determine an appropriate fair value hierarchy level based upon trading activity and the observability of market inputs. Based on the results of this evaluation and investment class analysis, each price was classified into Level 1, 2, or 3.
American National utilizes a pricing service to estimate fair value measurements for approximately 99.0% of fixed maturity securities. The pricing service utilizes market quotations for fixed maturity securities that have quoted prices in active markets. Since fixed maturities generally do not trade on a daily basis, the pricing service prepares estimates of fair value measurements for these securities using its proprietary pricing applications which include available relevant market information, benchmark curves, benchmarking of like securities, sector groupings and matrix pricing. Additionally, the pricing service uses an Option Adjusted Spread model to develop prepayment and interest rate scenarios.
The pricing service evaluates each asset class based on relevant market information, relevant credit information, perceived market movements and sector news. The market inputs utilized in the pricing evaluation, listed in the approximate order of priority, include: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, and economic events. The extent of the use of each market input depends on the asset class and the market conditions. Depending on the security, the priority of the use of inputs may change or some market inputs may not be relevant. For some securities additional inputs may be necessary.
American National has reviewed the inputs and methodology used by the pricing service and the techniques applied by the pricing service to produce quotes that represent the fair value of a specific security. The review of the pricing service’s methodology confirms the service is utilizing information from organized transactions or a technique that represents a market participant’s assumptions. American National does not adjust quotes received by the pricing service.
The pricing service utilized by American National has indicated that it will only produce an estimate of fair value if there is objectively verifiable information available. If the pricing service discontinues pricing an investment, American National would be required to produce an estimate of fair value using some of the same methodologies as the pricing service, but would have to make assumptions for market based inputs that are unavailable due to market conditions.
The fair value estimates of most fixed maturity investments including municipal bonds are based on observable market information rather than market quotes. Accordingly, the estimates of fair value for such fixed maturities provided by the pricing service are included in the amount disclosed in Level 2 of the hierarchy.
Additionally, American National holds a small amount of fixed maturities that have characteristics that make them unsuitable for matrix pricing. For these fixed securities, a quote from a broker (typically a market maker) is obtained. Due to the disclaimers on the quotes that indicate that the price is indicative only, American National includes these fair value estimates in Level 3. The pricing of certain private placement debt also includes significant non-observable inputs, the internally determined credit rating of the security and an externally provided credit spread, and are classified in Level 3.

 

19


Table of Contents

For public common and preferred stocks, American National receives prices from a nationally recognized pricing service that are based on observable market transactions and these securities are disclosed in Level 1. For certain preferred stock held, current market quotes in active markets are unavailable. In these instances, American National receives an estimate of fair value from the pricing service that provides fair value estimates for the fixed maturity securities. The service utilizes some of the same methodologies to price the preferred stocks as it does for the fixed maturities. These estimates for equity securities are disclosed in Level 2.
Some assets and liabilities do not fit the hierarchical model for determining fair value. For policy loans, the carrying amount approximates their fair value, because the policy loans cannot be separated from the policy contract. The fair value of investment contract liabilities is determined in accordance with GAAP rules on insurance products and is estimated using a discounted cash flow model, assuming the companies’ current interest rates on new products. The carrying value for these contracts approximates their fair value. The carrying amount for notes payable approximates their fair value.
The following table provides quantitative disclosures regarding fair value hierarchy measurements of our financial assets and liabilities at June 30, 2009 (in thousands):
                                 
            Fair Value Measurement at June 30, 2009 Using:  
            Quoted Prices     Significant        
            in Active     Other     Significant  
            Markets for     Observable     Unobservable  
    Fair Value at     Identical Assets     Inputs     Inputs  
    June 30, 2009     (Level 1)     (Level 2)     (Level 3)  
Financial Assets:
                               
Fixed maturities
                               
Held-to-maturity:
                               
U.S. treasury and other U.S. government corporations and agencies
  $ 21,551     $     $ 21,551     $  
States of the U.S. and political subdivisions of the states
    218,575             218,575        
Foreign governments
    31,823             31,823        
Corporate debt securities
    6,113,891             6,106,786       7,105  
Residential mortgage backed securities
    715,077             711,556       3,521  
Commercial mortgage backed securities
    7,571             7,571        
Collateralized debt securities
    8,745             834       7,911  
Other debt securities
    35,323             35,323        
 
                       
Total fixed maturities, held-to-maturity
  $ 7,152,556     $     $ 7,134,019     $ 18,537  
 
                       
Available-for-sale:
                               
U.S. treasury and other U.S. government corporations and agencies
    3,941             3,941        
States of the U.S. and political subdivisions of the states
    587,434             587,434        
Foreign governments
    6,053             6,053        
Corporate debt securities
    3,037,056             3,020,421       16,635  
Residential mortgage backed securities
    380,752             380,734       18  
Commercial mortgage backed securities
                       
Collateralized debt securities
    22,718             10,252       12,466  
Other debt securities
    4,313             4,313        
 
                       
Total fixed maturities, available-for-sale
  $ 4,042,267     $     $ 4,013,148     $ 29,119  
 
                       
Total fixed maturities
  $ 11,194,823     $     $ 11,147,167     $ 47,656  
 
                       
Marketable equity securities
                               
Common stock:
                               
Consumer Goods
    169,552       169,552              
Energy & Utilities
    120,694       120,694              
Finance
    126,423       126,423              
Healthcare
    102,879       102,879              
Industrials
    70,545       70,545              
Information Technology
    129,398       129,398              
Materials
    21,701       21,701              
Mutual Funds
    85,627       85,627              
Telecommunication Services
    36,986       36,986              
Preferred stock
    27,126       26,364             762  
 
                       
Total marketable equity securities
  $ 890,931     $ 890,169     $     $ 762  
 
                       
Options
    9,996                   9,996  
Mortgage loans on real estate
    1,996,051             1,996,051        
Short-term investments
    456,332             456,332        
 
                       
Total financial assets
  $ 14,548,133     $ 890,169     $ 13,599,550     $ 58,414  
 
                       
Financial Liabilities:
                               
Liability for embedded derivatives of equity indexed annuities
  $ 10,268     $     $     $ 10,268  
 
                       

 

20


Table of Contents

                                 
            Fair Value Measurement at December 31, 2008 Using:  
            Quoted Prices                
            in Active                
            Markets for             Significant  
            Identical     Significant Other     Unobservable  
    Fair Value at     Assets     Observable Inputs     Inputs  
    December 31, 2008     (Level 1)     (Level 2)     (Level 3)  
Financial Assets:
                               
Fixed maturities
                               
Held-to-maturity:
                               
U.S. treasury and other U.S. government corporations and agencies
  $ 11,830     $     $ 11,830     $  
States of the U.S. and political subdivisions of the states
    158,294             158,294        
Foreign governments
    32,456             32,456        
Corporate debt securities
    5,118,669             5,111,068       7,601  
Residential mortgage backed securities
    709,294             705,491       3,803  
Commercial mortgage backed securities
    7,742             7,742        
Collateralized debt securities
    34,824             26,117       8,707  
Other debt securities
    75,594             75,584       10  
 
                       
Total fixed maturities, held-to-maturity
  $ 6,148,703     $     $ 6,128,582     $ 20,121  
 
                       
Available-for-sale:
                               
U.S. treasury and other U.S. government corporations and agencies
    4,362             4,362        
States of the U.S. and political subdivisions of the states
    578,209             578,209        
Foreign governments
    7,332             7,332        
Corporate debt securities
    2,783,008             2,752,640       30,368  
Residential mortgage backed securities
    417,197             407,754       9,443  
Commercial mortgage backed securities
                       
Collateralized debt securities
    21,072             18,062       3,010  
Other debt securities
    9,657             9,657        
 
                       
Total fixed maturities, available-for-sale
  $ 3,820,837     $     $ 3,778,016     $ 42,821  
 
                       
Total fixed maturities
  $ 9,969,540     $     $ 9,906,598     $ 62,942  
 
                       
Marketable equity securities
                               
Common stock:
                               
Consumer Goods
    167,533       167,533              
Energy & Utilities
    113,319       113,319              
Finance
    133,642       133,642              
Healthcare
    109,503       109,503              
Industrials
    73,528       73,528              
Information Technology
    104,679       104,679              
Materials
    25,524       25,524              
Mutual Funds
    85,112       85,112              
Telecommunication Services
    40,690       40,690              
Preferred stock
    48,822       27,566             21,256  
 
                       
Total marketable equity securities
  $ 902,352     $ 881,096     $     $ 21,256  
 
                       
Options
    6,157                   6,157  
Mortgage loans on real estate
    1,891,895             1,891,895        
Short-term investments
    295,170             295,170        
 
                       
Total financial assets
  $ 13,065,114     $ 881,096     $ 12,093,663     $ 90,355  
 
                       
Financial Liabilities:
                               
Liability for embedded derivatives of equity indexed annuities
  $ 6,208     $     $     $ 6,208  
 
                       

 

21


Table of Contents

For assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the period, a reconciliation of the beginning and ending balances, is as follows (in thousands):
         
    Fair Value Measurements Using Significant  
    Unobservable Inputs  
    Level 3 Totals  
Beginning Balance — January 1, 2009
  $ 84,148  
Net losses included in other comprehensive income (loss)
    (1,656 )
Net fair value change for derivatives included in net income (loss)
    (4,300 )
Purchases, sales, and settlements of derivatives (net)
    4,441  
Transfers into Level 3
    175  
Transfers (out) of Level 3
    (34,662 )
 
     
Ending balance — June 30, 2009
    48,146  
 
     
The unrealized loss for the six months ended June 30, 2009 of Level 3 assets was $1,656,000. There were no unrealized gains in Level 3 assets at June 30, 2009.
The transfers into Level 3 were the result of securities no longer being priced by the third-party pricing service. As the securities were priced by a third-party service, inputs were used that are observable or derived from market data which resulted in classification of these assets as Level 2. In accordance with American National’s pricing methodology, these securities are being valued with similar techniques as the pricing service; however, company developed data is used in the process, which results in unobservable inputs, and a corresponding transfer into Level 3. The transfers out of level 3 were comprised of $13.0 million of sales, $20.8 million of maturities, and $0.9 of transfers into Level 2.

 

22


Table of Contents

7. DEFERRED POLICY ACQUISITION COSTS
Deferred policy acquisition costs as of June 30, 2009 and December 31, 2008, and premiums for the six month periods ended June 30, 2009 and 2008 are summarized as follows (in thousands):
                                 
    Life     Accident     Property &        
    & Annuity     & Health     Casualty     Total  
Balance at December 31, 2008
  $ 1,269,308     $ 74,870     $ 138,486     $ 1,482,664  
 
                       
Additions
    99,964       8,101       140,503       248,568  
Amortization
    (68,826 )     (11,940 )     (133,773 )     (214,539 )
Effect of change in unrealized loss on available-for-sale securities
    (103,757 )                 (103,757 )
 
                       
Net change
    (72,619 )     (3,839 )     6,730       (69,728 )
 
                       
 
                               
Balance at June 30, 2009
  $ 1,196,689     $ 71,031     $ 145,216     $ 1,412,936  
 
                       
 
                               
Premiums for the six months ended:
                               
June 30, 2009
  $ 226,175       149,573       568,916     $ 944,664  
 
                       
June 30, 2008
  $ 218,660       145,077       593,194     $ 956,931  
 
                       
Commissions comprise the majority of the additions to deferred policy acquisition costs for each year.
8. LIABILITY FOR UNPAID CLAIMS AND CLAIM ADJUSTMENT EXPENSES
Activity in the liability for accident and health and property and casualty unpaid claims and claim adjustment expenses is summarized as shown below (in thousands):
                 
    2009     2008  
Balance at January 1
  $ 1,310,272     $ 1,256,698  
Less reinsurance recoverables
    377,692       363,140  
 
           
Net beginning balance
    932,580       893,558  
 
           
Incurred related to:
               
Current year
    599,573       622,266  
Prior years
    (6,165 )     (31,216 )
 
           
Total incurred
    593,408       591,050  
 
           
Paid related to:
               
Current year
    293,295       316,917  
Prior years
    270,953       243,648  
 
           
Total paid
    564,248       560,565  
 
           
Net balance at June 30
    961,740       924,043  
Plus reinsurance recoverables
    283,519       353,634  
 
           
Balance at June 30
  $ 1,245,259     $ 1,277,677  
 
           
The balances at June 30 are included in policy and contract claims in the consolidated statements of financial position.

 

23


Table of Contents

The potential uncertainty generated by volatility in loss development profiles is adjusted for through the selection of loss development factor patterns for each line of insurance. The net and gross reserve calculations have shown redundancies for the last several years as a result of losses emerging favorably compared to what was implied by the loss development patterns used in the original estimation of losses in prior years. Estimates for ultimate incurred losses and loss adjustment expenses attributable to insured events of prior years decreased by approximately $6,000,000 for the six months ended June 30, 2009 and $31,000,000 for the same period in 2008.
9. NOTES PAYABLE
At June 30, 2009 and December 31, 2008, American National’s real estate holding companies were partners in affiliates that had notes payable to third-party lenders totaling $110,493,000 and $111,922,000, respectively. These notes have interest rates ranging from 5.15% to 8.07% and maturities from 2010 to 2014. Each note is secured by the real estate owned through the respective affiliated entity, and American National’s liability for these notes are limited to the amount of its investment in the respective affiliate, which totaled $13,255,000 and $13,226,000 at June 30, 2009 and December 31, 2008, respectively.
10. FEDERAL INCOME TAXES
The federal income tax provisions vary from the amounts computed when applying the statutory federal income tax rate. A reconciliation of the effective tax rate of the companies to the statutory federal income tax rate for the three and six months ended June 30, 2009 and 2008 is as follows (in thousands, except percentages):
                                                                 
    Three Months Ended     Six Months Ended  
    June 30,     June 30,  
    2009     2008     2009     2008  
    Amount     Rate     Amount     Rate     Amount     Rate     Amount     Rate  
Income tax on pre-tax income
  $ (4,382 )     35.0 %   $ (4,579 )     35.0 %   $ (31,255 )     35.0 %   $ 10,451       35.0 %
Tax-exempt investment income
    (2,381 )     2.7       (2,265 )     (7.6 )     (4,704 )     5.3       (4,312 )     (14.4 )
Dividend exclusion
    (1,692 )     1.9       (5,406 )     (18.1 )     (6,422 )     7.2       (7,092 )     (23.8 )
Miscellaneous tax credits, net
    (1,635 )     1.8       (1,758 )     (5.9 )     (3,186 )     3.6       (2,398 )     (8.0 )
Other items, net
    (686 )     0.8       3,366       10.0       3,768       (4.2 )     2,544       8.5  
 
                                               
 
  $ (10,776 )     42.2 %   $ (10,642 )     13.4 %   $ (41,799 )     46.9 %   $ (807 )     (2.7 )%
 
                                               

 

24


Table of Contents

The tax effects of temporary differences that gave rise to significant portions of the deferred tax assets and deferred tax liabilities at June 30, 2009 and December 31, 2008 are as follows (in thousands):
                 
    June 30,     December 31,  
    2009     2008  
DEFERRED TAX ASSETS:
               
Marketable securities, principally due to impairment losses
  $ 120,814     $ 138,487  
Marketable securities, principally due to net unrealized (gains) losses
    24,049       146,192  
Investment in real estate and other invested assets, principally due to investment valuation allowances
    1,870       1,279  
Policyholder funds, principally due to policy reserve discount
    192,726       187,277  
Policyholder funds, principally due to unearned premium reserve
    32,004       30,716  
Non-qualified pension
    28,532       27,630  
Participating policyholders’ surplus
    27,673       28,615  
Pension
    37,326       36,968  
Commissions and other expenses
    19,626       24,395  
Other assets
          8,518  
 
           
Net deferred tax assets
  $ 484,620     $ 630,077  
 
           
 
               
DEFERRED TAX LIABILITIES:
               
Investment in bonds, principally due to accrual of discount on bonds
    (10,865 )     (18,221 )
Deferred policy acquisition costs, due to difference between GAAP and tax amortization methods
    (371,498 )     (410,970 )
Property, plant and equipment, principally due to difference between GAAP and tax depreciation methods
    (4,075 )     (5,377 )
Other liabilities
    (840 )      
 
           
Net deferred tax liabilities
    (387,278 )     (434,568 )
 
           
Total deferred tax
  $ 97,342     $ 195,508  
 
           
In the second quarter of 2009, American National removed a $25,000,000 valuation allowance that was established in the first quarter of 2009. The valuation allowance was removed as a result of a decrease in unrealized losses in the investment portfolio. The change in the valuation allowance is included in “Accumulated Other Comprehensive Income” in the Consolidated Statements of Financial Position.
American National implemented FIN No. 48, “Accounting for Uncertainty in Income Taxes”, on January 1, 2007. Related interest expense is included with the “Other operating costs and expenses” in the Consolidated Statements of Income. No interest expense has been incurred during the six months ended June 30, 2009, while $94,000 in interest was recognized during the six months ended June 30, 2008. No provision has provided for penalties related to American National’s uncertain tax positions.
The statute of limitations for the examination of federal income tax returns by the Internal Revenue Service for years 2005 to 2008 has either been extended or has not expired. In the opinion of management, all prior year deficiencies have been paid or adequate provisions have been made for any tax deficiencies that may be upheld.

 

25


Table of Contents

11. COMPONENTS OF COMPREHENSIVE INCOME (LOSS)
The items included in comprehensive income (loss), other than net income (loss), are unrealized gains and losses on available-for-sale securities (net of deferred acquisition costs), foreign exchange adjustments and pension liability adjustments. The details on the unrealized gains and losses included in comprehensive income (loss), and the related tax effects thereon, are as follows (in thousands):
                         
    Before     Federal        
    Federal     Income Tax     Net of Federal  
    Income Tax     Expense     Income Tax  
June 30, 2009
                       
Unrealized gain (loss)
  $ 349,995     $ 92,685     $ 257,310  
Less: reclassification adjustment for net losses realized in net income
    (79,484 )     (27,819 )     (51,665 )
 
                 
Net unrealized gain component of comprehensive income
  $ 270,511     $ 64,866     $ 205,645  
 
                 
 
                       
June 30, 2008
                       
Unrealized gain (loss)
  $ (251,266 )   $ (103,199 )   $ (148,067 )
Less: reclassification adjustment for net losses realized in net income
    (9,490 )     (3,321 )     (6,169 )
 
                 
Net unrealized loss component of comprehensive income
  $ (260,756 )   $ (106,520 )   $ (154,236 )
 
                 
12. STOCKHOLDERS’ EQUITY AND NONCONTROLLING INTERESTS
Common Stock
American National has only one class of common stock with a par value of $1.00 per share and 50,000,000 authorized shares. The amounts outstanding at the dates indicated were as follows:
                         
    June 30,     December 31,     June 30,  
    2009     2008     2008  
Common Stock
                       
Shares issued
    30,832,449       30,832,449       30,832,449  
Treasury shares
    4,012,283       4,013,616       4,013,616  
Restricted shares
    321,334       339,001       339,001  
 
                 
Unrestricted outstanding shares
    26,498,832       26,479,832       26,479,832  
 
                 
Stock-Based Compensation
American National has one stock-based compensation plan. Under this plan, American National can grant Non-Qualified Stock Options, Stock Appreciation Rights, Restricted Stock Awards, Performance Awards, Incentive Awards and any combination of these. The number of shares available for grants under the plan cannot exceed 2,900,000 shares, and no more than 200,000 shares may be granted to any one individual in any calendar year.
The plan provides for the award of Restricted Stock. Restricted Stock awards entitle the participant to full dividend and voting rights. Unvested shares are restricted as to disposition, and are subject to forfeiture under certain circumstances. Compensation expense is recognized over the vesting period. The restrictions on these awards lapse after 10 years and feature a graded vesting schedule in the case of the retirement of an award holder. Seven awards of restricted stock have been granted, with a total of 321,000 shares granted at an exercise price of zero. These awards result in compensation expense to American National over the vesting period. The amount of compensation expense recorded was $1,516,000 for the six months ended June 30, 2009 and $2,694,000 for the 12 months ended December 31, 2008.

 

26


Table of Contents

The plan provides for the award of Stock Appreciation Rights (SAR). The SARs give the holder the right to compensation based on the difference between the price of a share of stock on the grant date and the price on the exercise date. The SAR’s vest at a rate of 20% per year for 5 years and expire 5 years after the vesting period. American National uses the average of the high and low price on the last trading day of the period to calculate the fair value and compensation expense for SARs. The fair value of the SARs was $22,000 at June 30, 2009 and $16,000 at December 31, 2008. Compensation expense or (income) was recorded totaling $7,000 for the six months ended June 30, 2009 and ($1,777,000) for the year ended December 31, 2008.
SAR and Restricted Stock (RS) information for June 30, 2009 and December 31, 2008 and 2007 are as follows:
                                 
            SAR Weighted-             RS Weighted-  
            Average Price per             Average Price per  
    SAR Shares     Share     RS Shares     Share  
Outstanding at December 31, 2007
    96,724     $ 97.84       253,000     $ 4.40  
 
                       
Granted
    96,917       115.92       86,001        
Exercised
    (4,109 )     81.30              
Canceled
                       
 
                       
Outstanding at December 31, 2008
    189,532     $ 107.44       339,001     $ 3.28  
 
                       
Granted
    2,999       66.76       1,333        
Exercised
    (100 )     57.00       (19,000 )      
Canceled
    (6,630 )     107.45              
 
                       
Outstanding at June 30, 2009
    185,801     $ 106.81       321,334     $  
 
                       
The weighted-average contractual remaining life for the 185,801 SAR shares outstanding as of June 30, 2009, is 7.1 years. The weighted-average exercise price for these shares is $106.81 per share. Of the shares outstanding, 88,218 are exercisable at a weighted-average exercise price of $100.80 per share.
The weighted-average contractual remaining life for the 321,334 Restricted Stock shares outstanding as of June 30, 2009, is 5.3 years. The weighted-average exercise price for these shares is $0 per share. None of the shares outstanding was exercisable.
Earnings (Loss) Per Share
Basic earnings per share was calculated using a weighted average number of shares outstanding of 26,498,832 at June 30, 2009 and 26,479,832 at December 31, and June 30, 2008. The Restricted Stock resulted in diluted earnings per share as follows for the year 2008. Due to the net losses incurred in 2009 and 2008, diluted earnings per share are equal to basic earnings per share.
                         
    June 30,     December 31,     June 30,  
    2009     2008     2008  
Unrestricted shares outstanding
    26,498,832       26,479,832       26,479,832  
Incremental shares from restricted stock
    100,718       137,625       166,176  
 
                 
Total shares for diluted calculations
    26,599,550       26,617,457       26,646,008  
Diluted earnings (losses) per share
  $ (1.96 )   $ (5.82 )   $ 1.35  
 
                 
Dividends
American National’s payment of dividends to stockholders is restricted by statutory regulations. Generally, the restrictions require life insurance companies to maintain minimum amounts of capital and surplus, and in the absence of special approval, limit the payment of dividends to the greater of statutory net gain from operations on an annual, non-cumulative basis, or 10% of statutory surplus. Additionally, insurance companies are not permitted to distribute the excess of stockholders’ equity, as determined on a GAAP basis over that determined on a statutory basis. At June 30, 2009 and December 31, 2008, American National’s statutory capital and surplus was $1,757,110,000 and $1,804,712,000, respectively.
Generally, the same restrictions on amounts that can transfer in the form of dividends, loans, or advances apply to American National’s insurance subsidiaries.

 

27


Table of Contents

At June 30, 2009, approximately $1,297,599,000 of American National’s consolidated stockholders’ equity represents net assets of its insurance subsidiaries, compared to $1,297,226,000 at December 31, 2008. Any transfer of these net assets to American National would be subject to statutory restrictions and approval.
Noncontrolling Interests
American National County Mutual Insurance Company (“County Mutual”) is a mutual insurance company that is owned by its policyholders. However, the company has a management agreement which effectively gives complete control of County Mutual to American National. As a result, County Mutual is included in the consolidated financial statements. The interest that the policyholders of County Mutual have in the financial position of County Mutual is reflected as a noncontrolling interest totaling $6,750,000 at June 30, 2009 and December 31, 2008.
American National’s subsidiary, ANTAC, Inc., is a partner in various joint ventures. ANTAC exercises significant control or ownership of these joint ventures, resulting in their consolidation into the American National consolidated financial statements. As a result of the consolidation, the interest of the other partners of the joint ventures is shown as a minority interest. Noncontrolling interests were a net liability of $1,193,000 and $1,627,000 at June 30, 2009 and December 31, 2008, respectively
13. SEGMENT INFORMATION
American National and its subsidiaries are engaged principally in the insurance business. Management organizes the business into five operating segments:
    The Life segment markets whole, term, universal, variable and credit life insurance on a national basis primarily through employee, independent and multiple line agents, direct marketing channels and independent third-party marketing organizations.
    The Annuity segment develops, sells and supports fixed, equity-indexed, and variable annuity products. These products are primarily sold through independent agents and brokers, but are also sold through employee agents, financial institutions and multiple line agents.
    The Health segment’s primary lines of business are Medicare Supplement, medical expense, employer medical stop loss, true group, other supplemental health products and credit disability insurance. Health products are typically distributed through employee agents, exclusive agents, independent agents and Managing General Underwriters.
    The Property and Casualty segment writes auto, homeowners, agribusiness, and other personal and commercial insurance. These products are primarily sold through multiple line exclusive agents. Credit related property insurance is also written through independent agents.
    The Corporate and Other business segment consists of net investment income on the capital not allocated to the insurance lines and the operations of non-insurance lines of business. This segment also provides mutual fund products.
The accounting policies of the segments are the same as those described in the summary of significant accounting policies. Many of the principal factors that drive the profitability of each operating segment are separate and distinct. All income and expense amounts specifically attributable to policy transactions are recorded directly to the appropriate operating segment. Income and expenses not specifically attributable to policy transactions are allocated to each segment as follows:
    Net investment income from fixed income assets (bonds and mortgage loans) is allocated based on the funds generated by each line of business at the average yield available from these fixed income assets at the time such funds become available.
    Net investment income from all other assets is allocated to the operating segments in accordance with the amount of equity invested in each segment, with the remainder going to Corporate and Other.
    Expenses are allocated to the lines based upon various factors, including premium and commission ratios within the respective operating segments.
    Realized gains or losses on investments are all allocated to Corporate and Other. The insurance segments are assessed a default charge, as a reduction to their investment income on a monthly basis, to compensate the Corporate and Other segment for any realized losses incurred on the assets supporting the insurance business.

 

28


Table of Contents

    Equity in earnings of unconsolidated affiliates are allocated to Corporate and Other.
    Federal income taxes have been applied to the net earnings of each segment based on a fixed tax rate. Any difference between the amount allocated to the segments and the total federal income tax amount is allocated to Corporate and Other.
Segment operating income provides pertinent and advantageous information to investors, as it represents the basis on which American National’s business performance is internally assessed by its chief operating decision makers. During the third quarter of 2008, the chief operating decision makers redefined the segment reporting structure to better align it with their current processes for assessing business performance and allocating resources. In previous financial reporting periods, operating segments were aggregated based on marketing distribution channels. In accordance with the performance measurements used by the chief operating decision makers, the segment reporting has been reorganized into five operating segments according to the type of insurance products sold or services rendered. The segment reporting for prior periods has been restated to reflect the change in business segments.
The following tables summarizes American National’s key financial measures used by the chief operating decision makers, including operating results and allocation of assets as of and for the six months ended June 30, 2009 and 2008 (in thousands):
                                                 
(Six Months Ended June 30, 2009)   Life     Annuity     Health     Property & Casualty     Corporate & Other     TOTAL  
Premiums and other revenues:
                                               
Premiums
  $ 135,318     $ 90,857     $ 149,573     $ 568,916     $     $ 944,664  
Other policy revenues
    80,851       7,597                         88,448  
Net investment income
    110,786       212,644       8,049       33,770       42,611       407,860  
Other income
    920       2,463       5,028       4,452       8,161       21,024  
 
                                   
Total operating revenues
    327,875       313,561       162,650       607,138       50,772       1,461,996  
 
                                   
Realized investment gains (losses)
                            (82,209 )     (82,209 )
 
                                   
Total revenues
    327,875       313,561       162,650       607,138       (31,437 )     1,379,787  
 
                                   
 
                                               
Benefits, losses and expenses:
                                               
Policy benefits
    146,266       106,808       121,766       491,845             866,685  
Interest credited to policy account balances
    30,208       147,094                         177,302  
Commissions for acquiring and servicing policies
    43,690       55,983       22,812       105,105             227,590  
Other operating costs and expenses
    90,712       29,283       31,567       59,483       20,495       231,540  
Decrease (increase) in deferred policy acquisition costs
    329       (31,467 )     3,839       (6,730 )           (34,029 )
 
                                   
Total benefits, losses and expenses
    311,205       307,701       179,984       649,703       20,495       1,469,088  
 
                                   
 
                                               
Income (loss) before other items and federal income taxes
  $ 16,670     $ 5,860     $ (17,334 )   $ (42,565 )   $ (51,932 )   $ (89,301 )
 
                                   
                                                 
(Six Months Ended June 30, 2008)   Life     Annuity     Health     Property & Casualty     Corporate & Other     TOTAL  
Premiums and other revenues:
                                               
Premiums
  $ 147,014     $ 71,646     $ 145,077     $ 593,194     $     $ 956,931  
Other policy revenues
    74,696       10,749                         85,445  
Net investment income
    112,654       180,598       8,233       38,947       63,024       403,456  
Other income (loss)
    1,781       (3,044 )     6,686       4,388       9,917       19,728  
 
                                   
Total operating revenues
    336,145       259,949       159,996       636,529       72,941       1,465,560  
 
                                   
Realized investment gains (losses)
                            (9,918 )     (9,918 )
 
                                   
Total revenues
    336,145       259,949       159,996       636,529       63,023       1,455,642  
 
                                   
 
                                               
Benefits, losses and expenses:
                                               
Policy benefits
    145,867       85,704       115,050       497,119             843,740  
Interest credited to policy account balances
    32,030       111,059                         143,089  
Commissions for acquiring and servicing policies
    72,404       49,967       20,599       114,618             257,588  
Other operating costs and expenses
    104,950       22,472       29,817       58,881       34,594       250,714  
Decrease (increase) in deferred policy acquisition costs
    (39,200 )     (23,929 )     3,138       (9,357 )           (69,348 )
 
                                   
Total benefits, losses and expenses
    316,051       245,273       168,604       661,261       34,594       1,425,783  
 
                                   
 
                                               
Income (loss) before other items and federal income taxes
  $ 20,094     $ 14,676     $ (8,608 )   $ (24,732 )   $ 28,429     $ 29,859  
 
                                   

 

29


Table of Contents

14. COMMITMENTS AND CONTINGENCIES
In the ordinary course of their operations, American National had commitments outstanding at June 30, 2009, to purchase, expand or improve real estate, to fund mortgage loans, and to purchase other invested assets aggregating $262,909,000, of which $244,631,000 is expected to be funded in 2009. The remaining balance of $18,278,000 will be funded in 2010 and beyond. As of June 30, 2009, all of the mortgage loan commitments have interest rates that are fixed.
Guarantees
In the normal course of business, American National has guaranteed bank loans for customers of a third-party marketing operation. The bank loans are used to fund premium payments on life insurance policies issued by American National. The loans are secured by the cash values of the life insurance policies. If the customer were to default on the bank loan, American National would be obligated to pay off the loan. However, since the cash value of the life insurance policies always equals or exceeds the balance of the loans, management does not foresee any loss on the guarantees. The total amount of the guarantees outstanding as of June 30, 2009, was approximately $206,513,000, while the total cash values of the related life insurance policies was approximately $207,961,000.
Litigation
American National was a defendant in a lawsuit related to the alleged inducement of another company’s insurance agents to become agents of American National (Farm Bureau Life Insurance Company and Farm Bureau Mutual Insurance Company v. American National Insurance Company et al., D. Utah, filed July 23, 2003). Plaintiffs initially alleged that American National improperly induced agents to leave Plaintiffs and join American National, asserting claims against American National for inducing one of Plaintiffs’ managers to breach duties allegedly owed to Plaintiffs as well as claims against American National for misappropriation of trade secrets, tortious interference with contractual relationships, business disparagement, libel, defamation, civil conspiracy, unjust enrichment and unfair competition. By the time of trial, some claims had been dismissed; however, Plaintiffs’ surviving claims continued to allege that their damages from the wrongful conduct exceeded $3.9 million, and Plaintiffs also sought punitive damages. The jury reached a verdict adverse to American National, and the court reduced the amount of such verdict as to American National to approximately $7.1 million. An appeal has been taken to the Tenth Circuit. American National has accrued an appropriate amount for resolution of this case, including attorneys’ fees, and believes that any additional amounts necessary will not be material to the consolidated financial statements.
American National is a defendant in a lawsuit which proposed to certify one or more classes of persons who contend that American National allegedly violated various provisions of the Fair Labor Standards Act and the California Labor Code, engaged in unfair business practices, fraud and deceit, conversion, and negligent misrepresentation with respect to certain of its sales agents (Dulanto v. American National Insurance Company, C.D. Cal., filed October 31, 2008). Upon Plaintiff’s motion, the Court dismissed the class allegations in this lawsuit leaving only the Plaintiff’s individual claims against the company. The plaintiff seeks statutory penalties, restitution, interest, penalties, attorneys’ fees, punitive damages and injunctive relief in an unspecified amount. The parties reached an agreement to resolve the remaining claims in this lawsuit and are in the process of finalizing those documents. American National believes that it has meritorious defenses. At this time, however, no prediction can be made as to the probability or remoteness of any recovery against American National.
American National is a defendant in a putative class action lawsuit wherein the Plaintiff proposes to certify a class of persons who purchased certain American National proprietary deferred annuity products (Rand v. American National Insurance Company, N.D. Cal., filed February 12, 2009). Plaintiff alleges that American National violated the California Insurance, Business & Professions, Welfare & Institutions, and Civil Codes through its marketing practices. Plaintiff seeks statutory penalties, restitution, interest, penalties, attorneys’ fees, punitive damages and injunctive relief in an unspecified amount. American National believes that it has meritorious defenses; however, no prediction can be made as to the probability or remoteness of any recovery against American National.
American National is also a defendant in various other lawsuits concerning alleged failure to honor certain loan commitments, alleged breach of certain agency and real estate contracts, various employment matters, allegedly deceptive insurance sales and marketing practices, and other litigation arising in the ordinary course of operations. Certain of these lawsuits include claims for compensatory and punitive damages. After reviewing these matters with legal counsel, management is of the opinion that the ultimate resultant liability, if any, would not have a material adverse effect on American National’s consolidated financial position or results of operations. However, these lawsuits are in various stages of development, and future facts and circumstances could result in management’s changing its conclusions.
Based on information currently available, management also believes that amounts ultimately paid, if any, arising from these cases would not have a material effect on the company’s consolidated results of operations and financial position. However, it should be noted that the frequency of large damage awards, which bear little or no relation to the economic damages incurred by plaintiffs in some jurisdictions, continue to create the potential for an unpredictable judgment in any given lawsuit. It is possible that, if the defenses in these lawsuits are not successful, and the judgments are greater than management can anticipate, the resulting liability could have a material impact on the consolidated financial results.

 

30


Table of Contents

15. RELATED PARTY TRANSACTIONS
American National has entered into recurring transactions and agreements with certain related parties as a part of its ongoing operations. These include mortgage loans, management contracts, agency commission contracts, marketing agreements, health insurance contracts, legal services, and insurance contracts. The impact on the consolidated financial statements of the significant related party transactions as of June 30, 2009, is shown below (amounts in thousands):
             
        Amount as of  
Related Party   Financial Statement Line Impacted   June 30, 2009  
Gal-Tex Hotel Corporation
  Mortgage loans on real estate   $ 12,312  
Gal-Tex Hotel Corporation
  Investment income     453  
Gal-Tex Hotel Corporation
  Other operating costs & expenses     171  
Moody Insurance Group, Inc.
  Commissions     1,803  
Moody Insurance Group, Inc.
  Other operating costs & expenses     116  
National Western Life Ins. Co.
  Accident& health premiums     95  
National Western Life Ins. Co.
  Other operating costs & expenses     640  
Moody Foundation
  Accident & health premiums     54  
Greer, Herz & Adams, LLP
  Other operating costs & expenses     4,544  
16. SUBSEQUENT EVENTS
Included in American National’s investment portfolio are debt securities issued by CIT Group, Inc. (“CIT”) with an amortized cost of $74.2 million as of June 30, 2009. As has been widely reported, CIT, a bank holding company, is experiencing liquidity issues. During July of 2009, CIT’s Troubled Asset Relief Program application for assistance was denied by the U.S. government. On July 20, 2009, CIT announced that it entered into a $3.0 billion loan facility provided by a group of its major bondholders. On the same day, CIT also announced a debt tender offer in an attempt to avoid bankruptcy and improve its liquidity. As of August 3, 2009, CIT has said that it has received enough offers to complete the debt repurchase program.
As of August 7, 2009, we are unable to determine the impact that CIT’s liquidity issues will have on the value of our debt securities, if any.
American National will continue to monitor CIT’s situation and evaluate any potential impact to our debt securities which are scheduled to mature at various dates between April 2012 and June 2015.

 

31


Table of Contents

ITEM 2   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Set forth on the following pages is management’s discussion and analysis (“MD&A”) of the financial condition and results of operations for the three and six months ended June 30, 2009 and June 30, 2008 of American National Insurance Company and its subsidiaries (referred to in this document as “we”, “our”, “us”, or the “Company” ). Such information should be read in conjunction with our consolidated financial statements together with the notes to the consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q and our amended Form 10 Registration Statement filed with the Securities and Exchange Commission (“SEC”) on July 1, 2009.
Forward-Looking Statements
Certain statements contained herein are forward-looking statements. The forward-looking statements contained herein are made pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, and include estimates and assumptions related to economic, competitive and legislative developments. Forward looking statements may be identified by words such as “expects”, “intends”, “anticipates”, “plans”, “believes”, “estimates”, “will” or words of similar meaning; and include, but are not limited to, statements regarding the outlook of our business and financial performance. These forward looking statements are subject to change and uncertainty which are, in many instances, beyond our control and, have been made based upon our expectations and beliefs concerning future developments and their potential effect upon us. There can be no assurance that future developments will be in accordance with our expectations, or that the effect of future developments on us will be anticipated. These forward-looking statements are not a guarantee of future performance and involve risks and uncertainties. There are certain important factors that could cause actual results to differ, possibly materially, from expectations or estimates reflected in such forward-looking statements. These factors include among others:
    international economic and financial crisis, including the performance and fluctuations of fixed income, equity, real estate, credit capital and other financial markets;
    interest rate fluctuations;
    estimates of our reserves for future policy benefits and claims;
    differences between actual experience regarding mortality, morbidity, persistency, surrender experience, interest rates or market returns, and the assumptions we use in pricing our products, establishing liabilities and reserves or for other purposes;
    changes in our assumptions related to deferred policy acquisition costs, valuation of business acquired or goodwill;
    changes in our claims-paying or credit ratings;
    investment losses and defaults;
    competition in our product lines and for personnel;
    changes in tax law;
    regulatory or legislative changes;
    adverse determinations in litigation or regulatory matters and our exposure to contingent liabilities, including in connection with our divestiture or winding down of businesses;
    domestic or international military actions, natural or man-made disasters, including terrorist activities or pandemic disease, or other events resulting in catastrophic loss of life and/or property;
    ineffectiveness of risk management policies and procedures in identifying, monitoring and managing risks;
    effects of acquisitions, divestitures and restructurings, including possible difficulties in integrating and realizing the projected results of acquisitions;
    changes in statutory or U.S. Generally Accepted Accounting Principles (“GAAP”) practices or policies; and
    changes in assumptions for retirement expense.

 

32


Table of Contents

We describe these risks and uncertainties in greater detail in Item IA, Risk Factors, in our amended Form 10 Registration Statement filed with the SEC on July 1, 2009. It has never been a matter of corporate policy for us to make specific projections relating to future earnings, and we do not endorse any projections regarding future performance made by others. Additionally, we do not publicly update or revise forward-looking statements based on the outcome of various foreseeable or unforeseeable events.
Overview
American National Insurance Company has more than 100 years of experience. We have maintained our home office in Galveston, Texas since our founding in 1905. Historically, our core business has been life insurance; however, we also offer individual and group health insurance and annuities, credit insurance, pension products, mutual funds, and property and casualty insurance for personal lines, agribusiness, and targeted commercial exposures. We provide personalized service to more than eight million policyholders throughout the United States, the District of Columbia, Puerto Rico, Guam, and American Samoa. Our total assets and stockholders’ equity as of June 30, 2009 were $19.3 billion and $3.3 billion, respectively, and at December 31, 2008 were $18.4 billion and $3.1 billion, respectively.
General Trends
There were no material changes to the general trends we are experiencing, as discussed in the MD&A included in our amended Form 10 filed with the SEC on July 1, 2009
Critical Accounting Estimates
We have prepared unaudited interim consolidated financial statements on the basis of U.S. GAAP. In addition to GAAP accounting literature, insurance companies have to apply specific SEC regulation to the financial statements. The preparation of financial statements in accordance with GAAP requires us to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and their accompanying notes. Actual results could differ from results reported using those estimates.
We have identified the following estimates as critical to our business operations and the understanding of the results of our operations, as they involve a higher degree of judgment and are subject to a significant degree of variability: evaluation of other-than-temporary impairments on securities; deferred policy acquisition costs; reserves; valuation of policyholder liabilities and associated reinsurance recoverables; pension and other postretirement benefit obligations; contingencies relating to corporate litigation and regulatory matters; and federal income taxes.
Our accounting policies inherently require the use of judgments relating to a variety of assumptions and estimates, particularly expectations of current and future mortality, morbidity, persistency, expenses and interest rates. Due to the inherent uncertainty when using the assumptions and estimates, the effect of certain accounting policies under different conditions or assumptions could be different from those reported in the consolidated financial statements.
For a discussion of the critical accounting estimates, see the MD&A in our amended Form 10 Registration Statement filed with the SEC on July 1, 2009. There were no material changes in accounting policies from December 31, 2008, with the exception of changes made to the other-than-temporary impairment of debt securities accounting policy. Refer to Item 1, Note 2 to the Consolidated Financial Statements included in this report for a discussion on the other-than-temporary impairment of debt securities accounting policy.
Recently Issued Accounting Pronouncements
Refer to Item 1, Note 3 to the Consolidated Financial Statements for a discussion on “Adoption of New Accounting Standards” and “Future Adoption of New Accounting Standards.”

 

33


Table of Contents

Consolidated Results of Operations
The following is a discussion of our consolidated results of operations for the three and six months ended June 30, 2009 and 2008. For a discussion of our segment results, see Results of Operations and Related Information by Segment. The following table sets forth the consolidated results of operations:
                                                 
    Three Months Ended June 30,     Increase/     Six Months Ended June 30,     Increase/  
    2009     2008     (Decrease)     2009     2008     (Decrease)  
    (in thousands)  
Revenues:
                                               
Premiums
  $ 464,947     $ 466,334     $ (1,387 )   $ 944,664     $ 956,931     $ (12,267 )
Other Policy Revenues
    44,768       43,379       1,389       88,448       85,445       3,003  
Net Investment Income
    214,664       215,868       (1,204 )     407,860       403,456       4,404  
Realized investment gains (losses)
    (8,748 )     (4,333 )     (4,415 )     (82,209 )     (9,918 )     (72,291 )
Other Income
    12,159       10,314       1,845       21,024       19,728       1,296  
 
                                   
Total Revenues
    727,790       731,562       (3,772 )     1,379,787       1,455,642       (75,855 )
 
                                   
 
                                               
Benefits And Expenses:
                                               
Policy Benefits
    436,938       443,834       (6,896 )     866,685       843,740       22,945  
Interest credited to policy account balances
    95,714       75,942       19,772       177,302       143,089       34,213  
Commissions
    114,675       132,318       (17,643 )     227,590       257,588       (29,998 )
Other operating costs and expenses
    120,378       133,169       (12,791 )     231,540       250,714       (19,174 )
Change in deferred policy acquisition costs
    (27,396 )     (40,617 )     13,221       (34,029 )     (69,348 )     35,319  
 
                                   
Total Benefits and Expenses
    740,309       744,646       (4,337 )     1,469,088       1,425,783       43,305  
 
                                   
 
                                               
Income (loss) before other items and federal income taxes
  $ (12,519 )   $ (13,084 )   $ 565     $ (89,301 )   $ 29,859     $ (119,160 )
 
                                   
Three Months ended June 30, 2009 compared with the Three Months ended June 30, 2008 - Consolidated
Consolidated revenues declined $3.8 million to $727.8 million for the three months ended June 30, 2009 from $731.6 million for the same period in 2008. This decrease was primarily due to lower revenues in our Life segment, lower earned premiums in our Property and Casualty segment, and investment losses realized during the quarter. The decrease was offset by the increase in sales of Single Premium Immediate Annuities.
Consolidated benefits and expenses decreased $4.3 million to $740.3 million for the three months ended June 30, 2009 compared to $744.6 million for the same period in 2008. This change was primarily due to the decrease in catastrophe losses in our Property and Casualty business from the record level we experienced during the three months ended June 30, 2008.
Six Months ended June 30, 2009 compared with the Six Months ended June 30, 2008 — Consolidated
Consolidated revenues declined $75.9 million to $1.4 billion for the six months ended June 30, 2009 from $1.5 billion for the same period in 2008. This decrease was primarily due to investment losses realized during the six months ended June 30, 2009, including $74.1 million in other-than-temporary impairment write-downs compared to $27.0 million in the same period in 2008, lower revenues in our Life segment, and lower earned premiums in our Property and Casualty segment.
The investment losses and lower revenues were partially offset by net investment income due to an increase in invested assets resulting from sales of fixed deferred annuities.
Consolidated benefits and expenses increased $43.3 million to approximately $1.5 billion for the six months ended June 30, 2009 compared to approximately $1.4 billion for the same period in 2008. This change was primarily due to interest credited to deferred annuity policy account balances, partially offset by decreased catastrophe losses in our Property and Casualty business from record amounts in 2008, and decreased commissions and other expenses as a result of the decrease of net premiums written.

 

34


Table of Contents

RESULTS OF OPERATIONS AND RELATED INFORMATION BY SEGMENT
Life
The Life segment markets traditional life insurance products such as whole life and term life, and interest sensitive life insurance products such as universal life and variable universal life. These products are marketed on a nationwide basis through employee agents, multiple line agents, independent agents and brokers and direct marketing channels.
Life segment financial results for the periods indicated were as follows:
                                                 
    Three Months Ended June 30,     Increase/     Six Months Ended June 30,     Increase/  
    2009     2008     (Decrease)     2009     2008     (Decrease)  
    (in thousands)  
Revenues:
                                               
Premiums
  $ 65,228     $ 72,859     $ (7,631 )   $ 135,318     $ 147,014     $ (11,696 )
Other Policy Revenues
    40,657       37,887       2,770       80,851       74,696       6,155  
Net Investment Income
    55,497       56,607       (1,110 )     110,786       112,654       (1,868 )
Other Income
    51       910       (859 )     920       1,781       (861 )
 
                                   
Total Revenues
    161,433       168,263       (6,830 )     327,875       336,145       (8,270 )
 
                                   
 
                                               
Benefits And Expenses:
                                               
Policy Benefits
    72,317       73,901       (1,584 )     146,266       145,867       399  
Interest credited to policy account balances
    16,202       15,857       345       30,208       32,030       (1,822 )
Commissions
    21,888       39,083       (17,195 )     43,690       72,404       (28,714 )
Other operating costs and expenses
    43,627       53,950       (10,323 )     90,712       104,950       (14,238 )
Change in deferred policy acquisition costs
    428       (23,663 )     24,091       329       (39,200 )     39,529  
 
                                   
Total Benefits and Expenses
    154,462       159,128       (4,666 )     311,205       316,051       (4,846 )
 
                                   
 
                                               
Income before other items and federal income taxes
  $ 6,971     $ 9,135     $ (2,164 )   $ 16,670     $ 20,094     $ (3,424 )
 
                                   
Overall, earnings decreased $2.2 million and $3.4 million to $6.9 million and $16.7 million for the three and six months ended June 30, 2009, respectively, from $9.1 million and $20.1 million for the same periods in 2008. During 2009, we continued to see a decrease in earnings from lower premium revenue due to an increase in ceded premiums and the change in investment income. This decrease was partially offset by an increase in other policy revenue which was due to the increased mortality charges and fees. The decrease in benefits and expenses was primarily a result of lower production bonuses due to lower sales. The three month and six month decrease in commissions and other operating costs and expenses was primarily offset by the change in deferred acquisition costs. The remaining $3 million increase in expenses resulted from additional defined benefit pension costs and compliance costs associated with the Sarbanes-Oxley Act.
During the second quarter of 2009, we settled a class action lawsuit related to certain credit life and disability sales. This settlement resulted in our issuing $12.9 million in settlement payments, consisting of premium refunds and related damages and fees, to certain previously insured persons. The Life segment fully reserved for this settlement and did not incur any related impact to its income (loss) from operations during the three or six months ended June 30, 2009. However, during the three and six months ended June 30, 2009, several categories of the consolidated statement of income were impacted by the recording of the settlement as follows: premiums decreased by $4.5 million, other income decreased by $0.8 million, commissions decreased by $0.9 million, and other operating costs and expenses decreased by $4.5 million. For additional information on this settlement, refer to the discussion of the Perkins litigation in our Commitments and Contingencies footnote within the Notes to the Consolidated Financial Statements in our amended Form 10 Registration Statement, filed with the SEC on July 1, 2009.

 

35


Table of Contents

The following table summarizes changes in the Life segment’s direct in-force amounts and direct policy counts:
                         
    As of June 30,     As of December 31,     Increase/  
    2009     2008     (Decrease)  
    (in thousands)  
Life Insurance in-force:
                       
Traditional life
  $ 46,126,438     $ 46,473,285     $ (346,847 )
Interest sensitive life
    23,237,976       23,397,571       (159,595 )
 
                 
Total life insurance in-force
  $ 69,364,414     $ 69,870,856     $ (506,442 )
 
                 
                         
    As of June 30,     As of December 31,     Increase/  
    2009     2008     (Decrease)  
    (in thousands)  
Number of policies:
                       
Traditional life
    2,385,140       2,453,270       (68,130 )
Interest sensitive life
    173,660       174,031       (371 )
 
                 
Total life insurance policies
    2,558,800       2,627,301       (68,501 )
 
                 
Life insurance in-force decreased $111.0 million to $69.4 billion in the three months ended June 30, 2009 as compared to an increase of $877.2 million to $70.0 billion in the three months ended June 30, 2008. The decrease as of June 30, 2009 is primarily due to the development and re-pricing of life products which has resulted in lower sales. Life insurance in-force decreased $506.4 million to $69.4 billion in the six months ended June 30, 2009.
Three Months ended June 30, 2009 compared with the Three Months ended June 30, 2008 — Life
Premiums
Premiums decreased $7.6 million to $65.2 million for the three months ended June 30, 2009 compared to $72.8 million for the same period in 2008. We recorded a reversal of $4.5 million related to the previously noted settlement payments,. Excluding the effect of the settlement payments, earned premiums decreased $3.1 million during the three months ended June 30, 2009, which was due to the decline in career agency renewals and lower sales.
Other Policy Revenues
Other policy revenues increased $2.8 million to $40.7 million for the three months ended June 30, 2009 from $37.9 million for the same period in 2008. The increase was due to increased mortality charges and fees, which is primarily due to increased sales of life products in 2008.
Net Investment Income
Net investment income decreased $1.1 million to $55.5 million for the three months ended June 30, 2009 from $56.6 million for the same period in 2008. This decrease was due to the increased amount of cash we held and lower yields on cash during the three months ended June 30, 2009 compared to the same period in 2008. Refer to the Investments discussion for further analysis.
Policy Benefits
Policy benefits decreased $1.6 million to $72.3 million for the three month period ended June 30, 2009, from $73.9 million for the same period in 2008. This change was primarily due to a decrease in claims and a decline in reserves on traditional life products.
Commissions
Commissions decreased $17.2 million to $21.9 million for the three months ended June 30, 2009, from $39.1 million for the same period in 2008. We recorded a reversal of $0.9 million related to the previously noted settlement payments,. Excluding the effect of the settlement payments, commissions decreased $16.3 million during the three months ended June 30, 2009. The decline is primarily related to a decrease in sales of our life products during such period.

 

36


Table of Contents

Other Operating Costs and Expenses
Other operating costs and expenses decreased $10.3 million to $43.6 million for the three months ended June 30, 2009, from $53.9 million for the same period in 2008. We recorded a reversal of $4.5 million related to the previously noted settlement payments,. Excluding the effect of the settlement payments, other operating costs and expenses decreased $5.8 million during the three months ended June 30, 2009. The decrease was attributable to a decline in production bonuses due to the drop off in sales for 2009.
Change in Deferred Policy Acquisition Costs
We incur significant costs in connection with acquiring new business such costs are referred to as deferred policy acquisition costs (“DAC”) and are amortized over the life of the policy. The following table presents the components of the change in DAC for the three months ended June 30, 2009 and 2008:
                         
    Three Months Ended June 30,     Increase/  
    2009     2008     (Decrease)  
    (in thousands)  
Acquisition costs capitalized
  $ 16,802     $ 51,298     $ (34,496 )
Amortization of DAC
    (17,230 )     (27,635 )     10,405  
 
                 
Change in DAC
  $ (428 )   $ 23,663     $ (24,091 )
 
                 
The amortization of DAC as a percentage of gross profits for the three months ended June 30, 2009 was 42.4% compared to 51.6% in the same period in 2008. The change in the amortization ratio is primarily driven by the premium refund lawsuit.
Acquisition costs capitalized decreased $34.5 million to $16.8 million for the three months ended June 30, 2009 from $51.3 million for the same period in 2008. This decrease is primarily related to the decrease in commission expenses and acquisition costs related to lower sales of our life products for the three months ended June 30, 2009.
An increase in the lapse rate would cause an acceleration in DAC amortization/ (write-off); therefore controlling the lapse is an important measure of company performance. Average lapse/surrender rates in the Life segment decreased to an annualized rate of 9.7% in the three months ended June 30, 2009 from 11.0% in the same period in 2008. The decrease in the lapse rate we are experiencing is primarily due to a decrease in lapses across all life products. These rates reflect both first year and renewal business.
Six Months ended June 30, 2009 compared with the Six Months ended June 30, 2008 — Life
Premiums
Premiums decreased $11.7 million to $135.3 million for the six months ended June 30, 2009, compared to $147.0 million for the same period in 2008. We recorded a reversal of $4.5 million related to the previously noted settlement payments,. Excluding the effect of the settlement payments, earned premium decreased $7.2 million during the six months ended June 30, 2009 which was due primarily to the increase in ceded premiums on reinsurance noted above. There has been a trend towards higher utilization of reinsurance on larger policies.
Other Policy Revenues
Other policy revenues increased $6.2 million to $80.9 million for the six months ended June 30, 2009 from $74.7 million for the same period in 2008. The increase was primarily due to increased mortality charges and fees on universal life policies.
Net Investment Income
Net investment income decreased to $110.8 million for the six months ended June 30, 2009 from $112.7 million for the same period in 2008. This decline was a result of the increased amount of cash we held and the lower yields on cash during the six months ended June 30, 2009 compared to the same period in 2008. Refer to the Investments discussion for further analysis.
Policy Benefits
Policy benefits increased $0.4 million to $146.3 million for the period ended June 30, 2009, from $145.9 million for the same period in 2008. Benefits increased due to higher claim amounts and reserve accruals in the six months ended June 30, 2009.

 

37


Table of Contents

Commissions
Commissions decreased $28.7 million to $43.7 million for the six months ended June 30, 2009, from $72.4 million for the same period in 2008. We recorded a reversal of $0.9 million related to the previously noted settlement payments,. Excluding the effect of the settlement payments, commissions decreased $27.8 million during the three months ended June 30, 2009. The decrease is primarily related to a decrease in the sales of our universal life products.
Other Operating Costs and Expenses
Other operating costs and expenses decreased $14.2 million to $90.7 million for the six months ended June 30, 2009, from $104.9 million for the same period in 2008. Related to the previously noted settlement payments, we recorded a reversal of $4.5 million. Excluding the effect of the settlement payments, other operating costs and expenses decreased $9.7 million during the three months ended June 30, 2009. The decline is primarily a result of lower production bonuses. This decrease was offset slightly by an increase in defined benefit pension costs.
Change in Deferred Policy Acquisition Costs
The following table presents the components of the change in deferred policy acquisition costs for the six months ended June 30, 2009 and 2008:
                         
    Six Months Ended June 30,     Increase/  
    2009     2008     (Decrease)  
    (in thousands)  
 
 
Acquisition costs capitalized
  $ 35,122     $ 85,662     $ (50,540 )
Amortization of DAC
    (35,451 )     (46,462 )     11,011  
 
                 
Change in DAC
  $ (329 )   $ 39,200     $ (39,529 )
 
                 
The amortization of DAC as a percentage of gross profits for the six months ended June 30, 2009 was 41.3% compared with 46.1% in the same period in 2008. The change in the amortization ratio is due to the premium refund lawsuit.
Acquisition costs capitalized decreased $50.5 million to $35.1 million for the six months ended June 30, 2009 from $85.6 million for the same period in 2008. This decrease in capitalized acquisition costs is primarily related to the decrease in commission expenses for the six months ended June 30, 2009 as a result of lower sales for the quarter.
An increase in the lapse rate would cause an acceleration of DAC amortization (write-off); therefore, controlling the lapse is an important measure of company performance. Average lapse/surrender rates declined to an annualized rate of 10.4% in the six months ended June 30, 2009 from 10.6% in the same period in 2008. In the second quarter of 2009, we experienced a slight decrease in lapses across all life products which have caused the decrease in our average lapse/surrender rates.

 

38


Table of Contents

Annuity
The Annuity segment develops, sells, and supports a variety of immediate and deferred annuities, including fixed, equity-indexed and variable products. We sell these products through independent agents, brokers, financial institutions, and employee agents.
Annuity segment financial results for the periods indicated were as follows:
                                                 
    Three Months Ended June 30,     Increase/     Six Months Ended June 30,     Increase/  
    2009     2008     (Decrease)     2009     2008     (Decrease)  
    (in thousands)  
Revenues:
                                               
Premiums
  $ 53,641     $ 27,347     $ 26,294     $ 90,857     $ 71,646     $ 19,211  
Other Policy Revenues
    4,111       5,492       (1,381 )     7,597       10,749       (3,152 )
Net Investment Income
    112,812       96,618       16,194       212,644       180,598       32,046  
Other Income (loss)
    3,195       (725 )     3,920       2,463       (3,044 )     5,507  
 
                                   
Total Revenues
    173,759       128,732       45,027       313,561       259,949       53,612  
 
                                   
 
                                               
Benefits And Expenses:
                                               
Policy Benefits
    63,151       35,954       27,197       106,808       85,704       21,104  
Interest credited to policy account balances
    79,512       60,085       19,427       147,094       111,059       36,035  
Commissions
    29,739       24,603       5,136       55,983       49,967       6,016  
Other operating costs and expenses
    15,506       11,272       4,234       29,283       22,472       6,811  
Change in deferred policy acquisition costs
    (19,419 )     (12,678 )     (6,741 )     (31,467 )     (23,929 )     (7,538 )
 
                                   
Total Benefits and Expenses
    168,489       119,236       49,253       307,701       245,273       62,428  
 
                                   
 
                                               
Income before other items and federal income taxes
  $ 5,270     $ 9,496     $ (4,226 )   $ 5,860     $ 14,676     $ (8,816 )
 
                                   
Earnings decreased $4.2 million and $8.8 million for the three and six months ended June 30, 2009, respectively, compared to the same periods in 2008. The decreases were due to increased operating expenses, compressed earned investment spreads and decreased annuity surrender charge revenue. Other operating costs and expenses increased $4.2 million and $6.8 million to $15.5 million and $29.3 million for the three and six months ended June 30, 2009, respectively.
Three Months ended June 30, 2009 compared with the Three Months ended June 30, 2008 — Annuity
Premiums
Annuity premium and deposit amounts received during the three months ended June 30, 2009 and 2008 are shown in the table below:
                         
    Three Months Ended June 30,     Increase/  
    2009     2008     (Decrease)  
    (in thousands)  
Fixed Deferred Annuity
  $ 577,669     $ 500,863     $ 76,806  
Equity Indexed Deferred Annuity
    39,807       22,946       16,861  
Variable Deferred Annuity
    19,265       26,586       (7,321 )
Single Premium Immediate Annuity
    55,460       29,239       26,221  
 
                 
Total
    692,201       579,634       112,567  
 
                       
Less: Policy Deposits
    (638,560 )     (552,287 )     (86,273 )
 
                 
 
                       
Total Earned Premiums
  $ 53,641     $ 27,347     $ 26,294  
 
                 

 

39


Table of Contents

Fixed deferred annuity premiums and deposits increased $76.8 million to $577.7 million for the three months ended June 30, 2009 from $500.9 million for the same period in 2008. In 2009, we continue to see the increase in our fixed deferred annuity products. We believe this is a result of the economic environment, which may be leading investors to seek safer, less volatile investments. Equity indexed annuity premiums and deposits increased by $16.9 million to $39.8 million from $22.9 million for the three months ended June 30, 2009 as compared to the same period in 2008.
The economic environment and challenging equity market continue to contribute to the decline in variable deferred annuity premiums and deposits. Premiums and deposits declined $7.3 million to $19.3 million for the three months ended June 30, 2009 from $26.6 million for the same period in 2008. Premiums from single premium immediate annuities increased $26.2 million to $55.4 million for the three months ended June 30, 2009 from $29.2 million for the same period in 2008.
Other Policy Revenues
Other policy revenues declined to $4.1 million for the three months ended June 30, 2009 from $5.5 million for the same period in 2008. The decrease is primarily due to a decline in surrender charges. Income from surrender charges fell during the second quarter of 2009, as there was a change in the mix of surrenders between those which earned surrender charges and those where policyholders utilized optional penalty-free withdrawal provisions. The annualized surrender rate on deferred annuities which represents all withdrawals both full and partial, was 14.0% of account balances for 2009 compared with 15.1% for 2008.
Net Investment Income
Net Investment income increased to $112.8 million for the three months ended June 30, 2009 from $96.6 million for the same period in 2008. This increase was largely a result of a $791.1 million increase in fixed deferred annuity account values to $7.6 billion as of June 30, 2009 compared to $6.9 billion as of June 30, 2008. The change in the derivative hedge portfolio total return (realized and unrealized gain/ (loss)) also added to the increase in net investment income. Refer to the Investments discussion for further analysis of net investment income.
Realized and unrealized gains or losses on the derivative hedge portfolio that supports the equity index annuities portfolio are recognized in earnings as investment income. Equity indexed annuities include a fixed host annuity contract and an embedded equity derivative option. The gain or loss on the embedded option is recognized in earnings as interest credited to policyholders. The following table details the gain or loss on derivatives related to equity indexed annuities:
                         
    Three Months Ended June 30,     Increase/  
    2009     2008     (Decrease)  
    (in thousands)  
Derivative hedge gain/ (loss) included in Net Investment Income
  $ 1,757     $ (3,546 )   $ 5,303  
 
                 
 
                       
Embedded derivative gain/ (loss) Included in Interest Credited
  $ (3,000 )   $ 4,321     $ (7,321 )
 
                 
Policy Benefits
Benefits consist of annuity payments and reserve increases on single premium immediate annuity contracts. These benefits increased $27.2 million to $63.2 million for the three months ended June 30, 2009, compared to $36.0 million for the same period in 2008. The change is primarily due to an increase in single premium immediate annuity reserves resulting from increased sales in the three months ended June 30, 2009.
Interest Credited to Policy Account Balances
Interest credited increased $19.4 million to $79.5 million for the three months ended June 30, 2009 from $60.1 million for same period in 2008. The increase is primarily the result of the 15.3% increase in the average fixed deferred annuity account balances, a minor change in crediting rates on certain fixed deferred annuities and the change in embedded derivative total return (embedded derivative gain/(loss)), partially offset by a change in product mix.

 

40


Table of Contents

Commissions
Commissions increased $5.1 million to $29.7 million for the three months ended June 30, 2009, from $24.6 million for the same period in 2008. The change is primarily due to increased sales of fixed deferred annuity policies during 2009.
Other Operating Costs and Expenses
Other operating costs and expenses increased $4.2 million to $15.5 million for the three months ended June 30, 2009, from $11.3 million for the same period in 2008. This increase is attributable to defined benefit pension costs and fees incurred for compliance with Sarbanes-Oxley Act requirements.
Change in Deferred Policy Acquisition Costs
The following table presents the components of the change in DAC for the three months ended June 30, 2009 and 2008:
                         
    Three Months Ended June 30,     Increase/  
    2009     2008     (Decrease)  
    (in thousands)  
Acquisition costs capitalized
  $ 34,440     $ 30,238     $ 4,202  
Amortization of DAC
    (15,021 )     (17,560 )     2,539  
 
                 
Change in DAC
  $ 19,419     $ 12,678     $ 6,741  
 
                 
Acquisition costs capitalized increased $4.2 million to $34.4 million for the three months ended June 30, 2009 from $30.2 million for the same period in 2008. This increase was the result of commissions and other costs related to increased sales of fixed deferred annuities.
The amortization of DAC as a percentage of gross profits for the three months ended June 30, 2009 was 57.5% compared to 56.5% for the same period in 2008. The slight change of this ratio was primarily driven by lower profits in 2009.
Six Months ended June 30, 2009 compared with the Six Months ended June 30, 2008 — Annuity
Premiums
Annuity premium and deposit amounts received during the six months ended June 30, 2009 and 2008 are shown in the table below:
                         
    Six Months Ended June 30,     Increase/  
    2009     2008     (Decrease)  
    (in thousands)  
Fixed Deferred Annuity
  $ 1,141,906     $ 1,048,092     $ 93,814  
Equity Indexed Deferred Annuity
    63,204       43,427       19,777  
Variable Deferred Annuity
    41,231       60,203       (18,972 )
Single Premium Immediate Annuity
    93,490       74,358       19,132  
 
                 
Total
    1,339,831       1,226,080       113,751  
 
                       
Less: Policy Deposits
    (1,248,974 )     (1,154,434 )     (94,540 )
 
                 
 
                       
Total Earned Premiums
  $ 90,857     $ 71,646     $ 19,211  
 
                 
Fixed deferred annuity premiums and deposits increased $93.8 million to $1.1 billion for the six months ended June 30, 2009 from $1.0 billion for the same period in 2008. Equity indexed annuity premiums and deposits increased by $19.8 million to $63.2 million from $43.4 million for the six months ended June 30, 2009 and 2008, respectively. We believe this increase was the result of the continuing adverse economic circumstances in 2009, leading investors to seek safer, less volatile investments.

 

41


Table of Contents

Variable Annuity premiums and deposits declined $19.0 million to $41.2 million for the six months ended June 30, 2009 from $60.2 million for the same period in 2008. We believe the decrease in variable deferred annuity premiums and deposits is primarily due to the volatility in the financial markets.
Premiums from single premium immediate annuities increased $19.1 million to $93.5 million for the six months ended June 30, 2009 from $74.4 million for the same period in 2008.
We do not expect the increase of these Annuity sales to continue through the end of 2009, as sales in the first half of the year consistently outpace those sales in the second half.
Other Policy Revenues
Other policy revenues declined to $7.6 million for the six months ended June 30, 2009 from $10.7 million for the same period in 2008. The decrease is primarily due to decreased surrender charges as a result of a change in our product mix.
Net Investment Income
Net investment income increased to $212.6 million for the six months ended June 30, 2009 from $180.6 million for the same period in 2008. The increase was the result of an increase in invested assets and the change in the derivative hedge total return (realized and unrealized gain/ (loss)) for the six months ended June 30, 2009 compared to the same period in 2008. Fixed deferred annuity account values increased $794.6 million to $7.6 billion as of June 30, 2009 compared to $6.9 billion as of June 30, 2008. Refer to the Investments discussion further analysis.
The following table details the gain or loss on derivatives related to equity indexed annuities:
                         
    Six Months Ended June 30,     Increase/  
    2009     2008     (Decrease)  
    (in thousands)  
Derivative hedge gain/ (loss) included in Net Investment Income
  $ (2,101 )   $ (12,736 )   $ 10,635  
 
                 
 
                       
Embedded derivative gain/ (loss) Included in Interest Credited
  $ (738 )   $ 14,318     $ (15,056 )
 
                 
Interest Spread and Account Values
The table below shows the interest spreads for our annuity products.
                 
    Six Months Ended June 30,  
    2009     2008  
    (in thousands)  
Fixed Deferred Annuity
               
Interest Spread:
               
Dollar Amount
  $ 56,492     $ 54,563  
Annualized Rate
    1.55 %     1.67 %
 
               
Variable Deferred Annuity
               
Mortality & Expense Charge:
               
Dollar Amount
  $ 1,871     $ 2,432  
Annualized Rate
    1.16 %     1.17 %
 
               
Total Annuity:
               
Gross Margins Including SPIA Mortality:
               
Dollar Amount
  $ 58,363     $ 56,995  
Annualized Rate
    1.54 %     1.65 %

 

42


Table of Contents

Interest Spreads: The profits on fixed deferred annuity contracts and single premium immediate annuities are driven by interest spreads and, to a lesser extent, other policy fees. Target interest margins vary by product depending on such factors as the level and term of interest guarantees, interest bonuses, level of commissions, length of surrender charge periods and the level of inherent risk.
As shown in the table above, interest spreads on fixed deferred annuities decreased 12 basis points to 1.55% for the six months ended June 30, 2009 from 1.67% for the same period in 2008. The portion of supporting assets comprised of cash holdings is a significant factor here, explaining 6 basis points of this spread decrease. The yield on cash decreased 149 basis points from 3.33% in the first half of 2008 to 1.84% in the first half of 2009, and the average level of cash relative to total assets increased from 3.1% to 3.5%.
The average rate for variable annuity mortality and expense charges stayed relatively unchanged for the six months ended June 30, 2009 from 1.17% for the same period in 2008.
Account Values: In addition to interest margins, we monitor account values and changes in account values as a key indicator of the performance of our Annuity segment. The table below shows the account values and the changes in these values as a result of net inflows, fees, interest credited and market value changes for the six months ended June 30, 2009 and 2008.
                         
    Six Months Ended June 30,     Increase/  
    2009     2008     (Decrease)  
    (in thousands)  
Fixed Deferred Annuity:
                       
Account value, beginning of period
  $ 6,918,365     $ 6,210,456     $ 707,909  
Net inflows
    586,704       537,504       49,200  
Fees
    (5,711 )     (8,333 )     2,622  
Interest credited
    145,558       110,674       34,884  
 
                 
Account value, end of period
  $ 7,644,916     $ 6,850,301     $ 794,615  
 
                 
 
                       
Variable Deferred Annuity:
                       
Account value, beginning of period
  $ 309,011     $ 429,505     $ (120,494 )
Net inflows
    7,904       13,502       (5,598 )
Fees
    (1,870 )     (2,432 )     562  
Change in market value and other
    21,675       (36,735 )     58,410  
 
                 
Account value, end of period
  $ 336,720     $ 403,840     $ (67,120 )
 
                 
 
                       
Single Premium Immediate Annuity:
                       
Reserve, beginning of period
  $ 701,141     $ 693,137     $ 8,004  
Net inflows
    24,419       (667 )     25,086  
Interest and mortality
    15,142       17,715       (2,573 )
 
                 
Reserve, end of period
  $ 740,702     $ 710,185     $ 30,517  
 
                 
Fixed Deferred Annuity: For the six months ended June 30, 2009, account values associated with fixed deferred annuities increased $726.6 million to $7.6 billion, compared to a similar increase of $639.8 million to $6.9 billion for the same period in 2008. The change in account value was attributable to net inflows of $586.7 million and interest credited of $145.6 million less fees of $5.7 million. Sales of fixed deferred annuity products rose to $1.1 billion for the six months ended June 30, 2009 compared to $1.0 billion in the same period of 2008. In the second quarter of 2009, we continue to see increased sales as investors elected the safety of fixed deferred annuities over the current volatility of other investment vehicles. We do not expect the increase in sales to continue through the remainder of 2009 due to the seasonality of the annuity product.
Fees charged against account values decreased $2.6 million to $5.7 million for the six months ended June 30, 2009 compared to $8.3 million for the same period in 2008. These fees include withdrawal charges levied against policies being partially withdrawn or fully surrendered. Income from surrender charges continue to decline as we had a change in the mix of surrenders between products which earned surrender charges and products which include an option for penalty-free surrenders from 2008 to 2009.

 

43


Table of Contents

Variable Deferred Annuity: For the six months ended June 30, 2009, variable deferred annuity account values increased $27.7 million to $336.7 million, compared to a decrease of $25.7 million to $403.8 million for the same period in 2008. The increase in account value for the six months ended June 30, 2009 was attributable to net inflows and market appreciation. The decrease in value for the six months ended June 30, 2008 is a result of the decline in the financial markets.
Single Premium Immediate Annuity: For the six months ended June 30, 2009, single premium immediate annuity reserves increased $39.6 million to $740.7 million, compared to an increase of $17.0 million to $710.2 million for the same period in 2008. This increase is due to reserves established on inflows from new sales and increases in reserves on existing policies due to interest and mortality. Net inflows for the six months ended June 30, 2009 were $24.4 million, compared to net outflows of $0.7 million for the same period in 2008.
Policy Benefits
Benefits consist of annuity payments and reserve increases on single premium immediate annuity contracts. These benefits increased $21.1 million to $106.8 million for the six months ended June 30, 2009, compared to $85.7 million for the same period in 2008. These benefits increased due to increased reserves from new single premium immediate annuity sales.
Interest Credited to Policy Account Balances
Interest credited increased $36.0 million to $147.1 million for the six months ended June 30, 2009 from $111.1 million for same period in 2008. This increase is due to the increase in fixed deferred annuity account balances, the increase in crediting rates and the change in embedded derivative total return (total gain/ (loss)) for the six months ended June 30, 2009 compared to 2008.
The annualized surrender rate on deferred annuities, which represents all withdrawals, both full and partial, was 14.4% of the account balances for 2009 compared with 13.6% for 2008. The change in the surrender rate reflects an unfavorable surrender experience for the six months ended June 30, 2009.
Commissions
Commissions increased $6.0 million to $56.0 million for the six months ended June 30, 2009, from $50.0 million for the same period in 2008. The increase is primarily a result of sales increases in the six months ended June 30, 2009.
Other Operating Costs and Expenses
Other operating costs and expenses increased $6.8 million to $29.3 million for the six months ended June 30, 2009, from $22.5 million for the same period in 2008. These increases are primarily due to defined benefit pension costs, and fees incurred for compliance with Sarbanes-Oxley Act requirements.
Change in Deferred Policy Acquisition Costs
The following table presents the components of the change in DAC for the six months ended June 30, 2009 and 2008:
                         
    Six Months Ended June 30,     Increase/  
    2009     2008     (Decrease)  
    (in thousands)  
Acquisition costs capitalized
  $ 64,842     $ 59,543     $ 5,299  
Amortization of DAC
    (33,375 )     (35,614 )     2,239  
 
                 
Change in DAC
  $ 31,467     $ 23,929     $ 7,538  
 
                 
Acquisition costs capitalized increased $5.3 million to $64.8 million for the six months ended June 30, 2009 from $59.5 million for the same period in 2008. This increase was primarily the result of commissions and other costs related to increased sales of fixed deferred annuity policies.
The amortization of DAC as a percentage of gross profits for the six months ended June 30, 2009 was 66.4% compared with 61.5% for the same period in 2008. The change in this ratio was a result of lower gross profits for the six months ended June 30, 2009.

 

44


Table of Contents

Health
The Health segment is primarily focused on supplemental and limited benefit coverage products including Medicare Supplement insurance for the aged population as well as cancer and hospital surgical for the general population. Other health products include credit accident and health, employer-based stop loss, major medical and others.
Health segment financial results for the periods indicated were as follows:
                                                 
    Three Months Ended June 30,     Increase/     Six Months Ended June 30,     Increase/  
    2009     2008     (Decrease)     2009     2008     (Decrease)  
    (in thousands)     (in thousands)  
Revenues:
                                               
Premiums
  $ 69,651     $ 73,040     $ (3,389 )   $ 149,573     $ 145,077     $ 4,496  
Net Investment Income
    4,024       4,169       (145 )     8,049       8,233       (184 )
Other Income
    2,100       3,356       (1,256 )     5,028       6,686       (1,658 )
 
                                   
Total Revenues
    75,775       80,565       (4,790 )     162,650       159,996       2,654  
 
                                   
 
                                               
Benefits And Expenses:
                                               
Policy Benefits
    57,699       54,471       3,228       121,766       115,050       6,716  
Commissions
    9,929       11,082       (1,153 )     22,812       20,599       2,213  
Other operating costs and expenses
    15,864       14,754       1,110       31,567       29,817       1,750  
Change in deferred policy acquisition costs
    1,377       449       928       3,839       3,138       701  
 
                                   
Total Benefits and Expenses
    84,869       80,756       4,113       179,984       168,604       11,380  
 
                                   
 
                                               
(Loss) from operations before other items and federal income taxes
  $ (9,094 )   $ (191 )   $ (8,903 )   $ (17,334 )   $ (8,608 )   $ (8,726 )
 
                                   
The Health segment experienced losses from operations of $9.1 million and $17.3 million for the three and six months ended June 30, 2009, respectively, as compared to losses of $0.2 million and $8.6 million, respectively, for the same periods in 2008. During the three months ended June 30, 2009, the decrease in earnings was due primarily to a decrease in premiums as the result of the settlement of certain litigation concerning our credit accident and health product, noted below. Benefits and expenses increased mainly due to an excise tax on reinsured foreign premiums, a one-time marketing expense of $2.6 million for the write-off of agents’ balances as part of reconciliation performed in the second quarter of 2009, and an increase in policy benefit expense related to our Medicare Supplement product. During the six months ended June 30, 2009, the decrease in earnings was primarily due to litigation during the first quarter, an increase in benefits attributable to growth in the amount of claims incurred on the hospital surgical product line, and commissions associated with the unwinding of a Managing General Underwriter (“MGU”) agreement. These items are discussed in further detail below.
During the second quarter of 2009, we settled a class action lawsuit on our credit accident and health product which resulted in issuing $12.4 million in settlement payments comprised of credit accident and health premium refunds and other related damages and fees, to certain previously insured persons. The Health segment was fully reserved for this settlement and did not incur any related impact to its income (loss) from operations during the three or six months ended June 30, 2009. However, during the three and six months ended June 30, 2009, several categories of the consolidated statements of income were impacted by the recording of the settlement as follows: premiums decreased by $4.3 million, other income decreased by $0.8 million, commissions decreased by $0.9 million, and other operating costs and expenses decreased by $4.3 million. For additional information on this settlement, refer to the discussion of the Perkins litigation in our Commitments and Contingencies footnote within Notes to the Consolidated Financial Statements in our amended Form 10 Registration Statement, filed with the SEC on July 1, 2009.

 

45


Table of Contents

The following tables summarize key data for the Health segment:
                                 
    For the three months ended June 30, 2009     For the three months ended June 30, 2008  
    Premiums     Premiums  
    Dollars     Percentage     Dollars     Percentage  
    (in thousands)  
Medicare Supplement
  $ 29,963       43.0 %   $ 31,700       43.4 %
Managing General Underwriter
    2,493       3.6 %     3,422       4.7 %
Group
    9,895       14.2 %     8,008       11.0 %
Major Medical
    7,750       11.1 %     10,028       13.7 %
Hospital Surgical
    12,880       18.5 %     9,248       12.7 %
Long Term Care
    541       0.8 %     689       0.9 %
Supplemental Insurance
    2,061       3.0 %     2,078       2.8 %
Credit Accident and Health
    1,887       2.7 %     5,519       7.6 %
All Other
    2,181       3.1 %     2,348       3.2 %
 
                       
Total
  $ 69,651       100.0 %   $ 73,040       100.0 %
 
                       
                                 
    As of June 30, 2009     As of June 30, 2008  
    Certificates / Policies     Certificates / Policies  
    Number     Percentage     Number     Percentage  
 
                               
Medicare Supplement
    59,094       8.8 %     57,858       8.1 %
Managing General Underwriter
    117,203       17.4 %     135,191       18.9 %
Group
    19,049       2.8 %     19,826       2.8 %
Major Medical
    3,943       0.6 %     6,055       0.8 %
Hospital Surgical
    16,084       2.4 %     13,861       1.9 %
Long Term Care
    1,962       0.3 %     2,132       0.3 %
Supplemental Insurance
    98,717       14.6 %     113,969       15.9 %
Credit Accident and Health
    308,723       45.8 %     311,619       43.6 %
All Other
    49,601       7.3 %     54,136       7.7 %
 
                       
Total
    674,376       100.0 %     714,647       100.0 %
 
                       
Three Months ended June 30, 2009 compared with the Three Months ended June 30, 2008 — Health
Premiums
The Health segment’s earned premiums were $69.7 million for the three months ended June 30, 2009, compared to $73.0 million earned for the same period in 2008. We recorded a reversal of $4.3 million related to the previously noted settlement payments,. Excluding the effect of the settlement payments, earned premium increased $1.0 million during the three months ended June 30, 2009 which was primarily attributable to increased sales of our hospital surgical product. In addition, Medicare Supplement experienced a decrease of $1.7 million in premiums while adding a net of 1,200 policies due to a shift from a higher premium individual product to a lower premium group product.
Net Investment Income
Net investment income remained relatively flat at approximately $4.0 million and $4.2 million for the three months ended June 30, 2009 and 2008. Refer to the Investments discussion for further analysis.
Policy Benefits
The benefit ratio increased to 82.8% for the three months ended June 30, 2009, from 74.6% for same period in 2008. The Medicare Supplement product was the primary contributor to the increase in the benefit ratio. The increase was mainly due to a shift from a higher premium individual product to a lower premium group product. This increase was partially offset by an improvement in the hospital surgical benefit ratio as a result of its benefits cost growing at a slower rate than its earned premium.

 

46


Table of Contents

Commissions
Commissions decreased by $1.2 million or 10.4% to $9.9 million for the three months ended June 30, 2009, from $11.1 million for the same period in 2008. Related to the previously noted settlement payments, we recorded a reversal of $0.8 million. Excluding the effect of the settlement payments, commissions decreased $0.4 million during the three months ended June 30, 2009. This decrease was primarily due to a decrease in MGU premium.
Other Operating Costs and Expenses
Other operating costs and expenses increased by $1.1 million or 7.5% to $15.9 million for the three months ended June 30, 2009 from $14.8 million for the same period in 2008. Related to the previously noted settlement payments, we recorded a reversal of $4.3 million. Excluding the effect of the settlement payments, other operating costs and expenses increased $5.4 million during the three months ended June 30, 2009. The increase was primarily driven by an excise tax on reinsured foreign premiums, employee benefits, and a one-time marketing expense of $2.5 million for the write-off of agents’ balances.
Change in Deferred Policy Acquisition Costs
The following table presents the components of the change in DAC expense for the three months ended June 30, 2009 and 2008:
                         
    Three Months Ended June 30,     Increase/  
    2009     2008     (Decrease)  
    (in thousands)  
 
                       
Acquisition costs capitalized
  $ 3,624     $ 6,054     $ (2,430 )
Amortization of DAC
    (5,001 )     (6,503 )     1,502  
 
                 
Change in DAC
  $ (1,377 )   $ (449 )   $ (928 )
 
                 
The change in DAC increased $1.0 million to $1.4 million for the three months ended June 30, 2009, compared to $0.4 million for the same period in 2008. The increase was primarily driven by a reversal of acquisition costs previously capitalized and related amortization expense associated with the previously noted settlement payments. Generally, we expect the change in DAC to remain relatively consistent as a percentage of earned premiums.
As of June 30, 2009, the Health segment related DAC was $71.0 million compared to $76.8 million as of June 30, 2008. The decrease in DAC reflects a reversal of acquisition costs previously capitalized and related amortization expense associated with the previously noted settlement payments, as well as a reduction in the acquisition costs capitalized due to the decline in new production of our credit accident and health product.

 

47


Table of Contents

Six Months ended June 30, 2009 compared with the Six Months ended June 30, 2008 — Health
                                 
    For the six months ended June 30, 2009     For the six months ended June 30, 2008  
    Premiums     Premiums  
    Dollars     Percentage     Dollars     Percentage  
    (in thousands)  
Medicare Supplement
  $ 60,178       40.2 %   $ 60,905       42.0 %
Managing General Underwriter
    13,742       9.1 %     6,644       4.6 %
Group
    16,989       11.4 %     17,382       12.0 %
Major Medical
    15,950       10.7 %     20,784       14.3 %
Hospital Surgical
    25,063       16.8 %     17,278       11.9 %
Long Term Care
    1,070       0.7 %     1,506       1.0 %
Supplemental Insurance
    4,206       2.8 %     4,298       3.0 %
Credit Accident and Health
    7,949       5.3 %     11,720       8.1 %
All Other
    4,426       3.0 %     4,560       3.1 %
 
                       
Total
  $ 149,573       100.0 %   $ 145,077       100.0 %
 
                       
Premiums
The Health segment’s earned premiums were $149.6 million for the six month period ended June 30, 2009, compared to $145.1 million earned for the same period in 2008. Related to the previously noted settlement payments, we recorded a reversal of $4.3 million. Excluding the effect of the settlement payments, premiums increased $8.8 million during the six months ended June 30, 2009. The increase was primarily attributable to an increase in premiums earned on our hospital surgical product and a one-time realized premium associated with the unwinding of an MGU agreement. The timing of the premium recognition for this pool is based on the timing of the settlements and participation based allocation in the first quarter of 2009. The aforementioned earned premium increases were partially offset by a decrease in premium earned on our major medical product, due to the run-off of the product.
As expected, major medical business continues to lapse in favor of less comprehensive hospital surgical coverage. As of June 30, 2009, there were about 3,900 major medical policies in-force compared to about 6,100 as of June 30, 2008, a decrease of 34.9%. We expect the major medical policies in-force to continue to decline at the current pace. This line of business is no longer competitively priced and new sales have diminished. However, major medical premiums will continue to influence Health segment results since premiums from this product are at least twice that of other products sold. The decline in major medical is offset by the increase in hospital surgical policies to about 16,100 as of June 30, 2009 from 13,900 as of June 30, 2008. We anticipate that Medicare supplement and hospital surgical policies will continue to be the main drivers of top line growth in 2009. Medicare supplement policies increased to about 59,100 policies in-force as of June 30, 2009 from about 57,900 policies in-force as of June 30, 2008.
Net Investment Income
Net investment income remained relatively flat at approximately $8.0 million for the six months ended June 30, 2009 and 2008. Refer to the Investments discussion for further analysis.
Policy Benefits
The benefit ratio increased to 81.4% for the six months ended June 30, 2009 from 79.3% for same period in 2008. Much of the increase was attributable to growth in the amount of claims incurred on the hospital surgical product line, which primarily resulted from aggressive rates and underwriting practices in prior periods. Rate increases to the hospital surgical line were made over the last two years, and we anticipate that these rate increases will positively impact our benefits ratio in the remainder of 2009. This increase was partially offset by expenses associated with litigation involving one MGU that resulted in $8.9 million of reinsurance write offs in the first quarter of 2008. We have terminated our relationship with this particular MGU.
Commissions
Commissions increased by $2.2 million or 10.7% to $22.8 million for the six months ended June 30, 2009, from $20.6 million for the same period in 2008. We recorded a reversal of $0.8 million related to the previously noted settlement payments,. Excluding the effect of the settlement payments, commissions increased $3.0 million during the six months ended June 30, 2009. This increase is primarily associated with the increase in premium from MGUs during the first quarter of 2009, as noted above, and an increase in commission attributed to an increase in premium earned on our hospital surgical line.

 

48


Table of Contents

Other Operating Costs and Expenses
Other operating costs and expenses increased by $1.8 million or 5.9% to $31.6 million for the six months ended June 30, 2009 from $29.8 million for the same period in 2008. We recorded a reversal of $4.3 million related to the settlement payments noted above,. Excluding the effect of the settlement payments, other operating costs and expenses increased $6.1 million during the six months ended June 30, 2009. The increase was primarily driven by an excise tax on reinsured foreign premiums, employee benefits and a one-time marketing expense of $2.5 million for the write-off for agents’ balances as part of reconciling performed in the second quarter of 2009.
Change in Deferred Policy Acquisition Costs
The following table presents the components of the change in DAC expense for the six months ended June 30, 2009 and 2008:
                         
    Six Months Ended June 30,     Increase/  
    2009     2008     (Decrease)  
    (in thousands)  
 
                       
Acquisition costs capitalized
  $ 8,101     $ 13,179     $ (5,078 )
Amortization of DAC
    (11,940 )     (16,317 )     4,377  
 
                 
Change in DAC
  $ (3,839 )   $ (3,138 )   $ (701 )
 
                 
The change in DAC was a decrease of $3.8 million for the six months ended June 30, 2009 compared to $3.1 million for the same period in 2008. The increase was primarily driven by a reversal of acquisition costs previously capitalized and related amortization expense associated with the previously noted settlement payments. Generally, we expect the change in DAC to remain relatively consistent as a percentage of earned premiums.
As of June 30, 2009, the Health related DAC was $71.0 million compared to $76.8 million as of June 30, 2008. The decrease in DAC reflects a reversal of acquisition costs previously capitalized and related amortization expense associated with the previously noted settlement payments as well as a reduction in the acquisition costs capitalized due to the decline in new production of our credit accident and health product.

 

49


Table of Contents

Property and Casualty
We write Property and Casualty business through our Multiple Line agents and Credit Insurance Division agents. We evaluate our Property and Casualty insurance operations based on the total underwriting results (net premiums earned less incurred losses and loss expenses, policy acquisition costs and other underwriting expenses) and the following ratios:
Property and Casualty segment financial results for the periods indicated were as follows:
                                                 
    Three Months Ended June 30,     Increase/     Six Months Ended June 30,     Increase/  
    2009     2008     (Decrease)     2009     2008     (Decrease)  
    (in thousands)  
Revenues:
                                               
Net premiums written
  $ 306,656     $ 311,445     $ (4,789 )   $ 603,476     $ 618,849     $ (15,373 )
 
                                   
 
                                               
Net Premiums Earned
    276,427       293,088       (16,661 )     568,916       593,194       (24,278 )
Net Investment Income
    16,952       19,803       (2,851 )     33,770       38,947       (5,177 )
Other Income
    2,422       2,386       36       4,452       4,388       64  
 
                                   
Total Revenues
    295,801       315,277       (19,476 )     607,138       636,529       (29,391 )
 
                                   
 
                                               
Benefits And Expenses:
                                               
Policy Benefits
    243,771       279,508       (35,737 )     491,845       497,119       (5,274 )
Commissions
    53,119       57,550       (4,431 )     105,105       114,618       (9,513 )
Other operating costs and expenses
    31,719       30,369       1,350       59,483       58,881       602  
Change in deferred policy acquisition costs
    (9,782 )     (4,725 )     (5,057 )     (6,730 )     (9,357 )     2,627  
 
                                   
Total Benefits and Expenses
    318,827       362,702       (43,875 )     649,703       661,261       (11,558 )
 
                                   
 
                                               
Income/(Loss) from operations before other items and federal income taxes
  $ (23,026 )   $ (47,425 )   $ 24,399     $ (42,565 )   $ (24,732 )   $ (17,833 )
 
                                   
 
                                               
Loss ratio
    88.2 %     95.4 %     (7.2 )     86.5 %     83.8 %     2.7  
Underwriting expense ratio
    27.2 %     28.4 %     (1.2 )     27.7 %     27.7 %     0.0  
 
                                   
Combined ratio
    115.4 %     123.8 %     (8.4 )     114.2 %     111.5 %     (2.7 )
 
                                   
Property and Casualty earnings increased $24.4 million and decreased $17.8 million for the three and six months ended June 30, 2009, respectively, as compared to the same periods in 2008. The changes are primarily due to differences in catastrophe losses as well as an overall decrease of premiums during 2009 due to rate pressures and adverse economic conditions. These are discussed in further detail below.
Three Months ended June 30, 2009 compared with the Three Months ended June 30, 2008 — Property & Casualty
Net Premiums Written and Earned
Net premiums written decreased $4.7 million to $306.7 million for the three months ended June 30, 2009 from $311.4 million for the same period in 2008. This change was primarily due to a $4.5 million decrease in personal and commercial auto net premiums written. The decrease in auto business is due to continued high levels of competition and the resulting rate decreases in this line.
Net premiums earned decreased $16.7 million to $276.4 million for the three months ended June 30, 2009 from $293.1 million for the three months ended June 30, 2008. This decrease was primarily due to an internal review of our methodology for establishing reserves for our “Cashback” program, which refunds a portion of premiums paid on homeowners and auto policies within certain product lines and certain states, to customers that retain the eligible products and that do not have any claims reported during a three-year period. Part of the changes implemented as a result of this review included expanding our previous 3-factor system for establishing such reserves to 29 factors in order to refine our methodology on a portion of the reserve. We are also replacing a bulk reserve on the remaining portion with a programmatic monthly calculation. These changes resulted in a decrease of $4.6 million and $2.7 million in auto and homeowner earned premium revenues, respectively, during the second quarter of 2009. Auto premiums decreased an additional $5.8 million as a result of the lower net written premiums for the year and rate decreases from the prior year. Homeowner premiums decreased an additional $2.8 million as a result of our continued risk management initiatives to reduce our exposure in the coastal regions.

 

50


Table of Contents

Net Investment Income
Net investment income decreased by $2.8 million to $17.0 million for the three months ended June 30, 2009 from $19.8 million for the same period in 2008. This decrease was due to the increased amount of cash we held during the three months ended June 30, 2009 compared to the same period in 2008. Refer to the Investments discussion for further analysis.
Policy Benefits
Claims and other benefits include loss and loss adjustment expenses (“LAE”) incurred on property and casualty policies. The loss ratios were 88.2% and 95.4% for the three months ended June 30, 2009 and 2008, respectively.
The second quarter of 2009 saw an improvement in the catastrophe loss experience from the record high experienced in the previous year. Relative to 2008, fewer and less severe catastrophes occurred during the second quarter in 2009; however, the catastrophes were still some of the highest we have experienced. For the three months ended June 30, 2009 and 2008, we experienced net catastrophe losses of $34.7 million on 11 catastrophes and $66.9 million on 18 catastrophes, respectively. These catastrophe losses contributed 12.6% to the loss ratio for the second quarter of 2009, compared to 22.8% for the same period in 2008.
For the three months ended June 30, 2009, net favorable prior year loss and loss adjustment expense development was $14.5 million compared to $1.6 million of net favorable prior year loss and LAE development for the same period in 2008, as a result of better than expected paid and incurred loss emergence across several lines of business (workers compensation, agribusiness and commercial multi-peril lines) as well as savings on catastrophe claims. This favorable emergence was offset by adverse development for the commercial auto and homeowners lines of business.
Commissions and Change in Deferred Policy Acquisition Costs
                         
    Three Months Ended June 30,     Increase/  
    2009     2008     (Decrease)  
    (in thousands)  
Commissions
  $ 53,119     $ 57,550     $ (4,431 )
Change in deferred policy acquisition costs
    (9,782 )     (4,725 )     (5,057 )
 
                 
Commissions and change in deferred acquistion costs
  $ 43,337     $ 52,825     $ (9,488 )
 
                 
Commissions decreased $4.5 million to $53.1 million for the three months ended June 30, 2009 from $57.6 million for the same period in 2008. This decrease was primarily the result of a $3.3 million decrease in credit related insurance commissions due to a shift toward products with lower commission structures. Commissions decreased further due to personal and commercial auto policies for the three months ended June 30, 2009 due to reductions in net earned premiums.
The change in deferred acquisition costs for the three months ended June 30, 2009 was $5.1 million, which represented an increase to deferred policy acquisition costs and a decrease in expenses for the period compared to the same period in the prior year. This was primarily driven by a change in our deferral methodology, deferring less in some policies and more in others in order to improve our consistency among subsidiaries.

 

51


Table of Contents

Other Operating Costs and Expenses
Other operating costs and expenses increased $1.3 million to $31.7 million for the three months ended June 30, 2009 from $30.4 million for the same period in 2008. The increase was due primarily to an increase in expenses in our agribusiness products as a result of increasing business and our efforts to improve the underwriting of this line.
The underwriting expense ratio decreased slightly to 27.2% for the three months ended June 30, 2009 from 28.4% for the same period in 2008. The decrease in the underwriting expense ratio during the second quarter of 2009, as compared to the same period in 2008, was primarily the result of a decrease in expenses due to the greater amount of expenses being deferred through our new deferral methodology noted above.
Products
The following table shows net premiums written and earned and key ratios for our auto, homeowners, agribusiness, credit related property and other policies for the three months ended June 30, 2009, and 2008:
                                                 
    Automobile     Homeowner     Agribusiness     Credit Related     Other     Total  
    (in thousands)  
Three months ended June 30, 2009
                                               
 
 
Net premiums written
  $ 137,919     $ 57,644     $ 27,843     $ 33,275     $ 49,975     $ 306,656  
 
                                   
 
                                               
Net premiums earned
  $ 130,869     $ 45,867     $ 26,323     $ 32,418     $ 40,950     $ 276,427  
 
                                   
 
                                               
Loss ratio
    81.9 %     146.3 %     97.3 %     49.4 %     68.0 %     88.2 %
Underwriting expense ratio
    19.1 %     21.7 %     36.7 %     59.9 %     27.0 %     27.2 %
 
                                   
Combined ratio
    101.0 %     168.0 %     134.0 %     109.3 %     95.0 %     115.4 %
 
                                   
 
                                               
Three months ended June 30, 2008
                                               
 
                                               
Net premiums written
  $ 142,452     $ 55,067     $ 28,272     $ 34,413     $ 51,240     $ 311,444  
 
                                   
 
                                               
Net premiums earned
  $ 141,232     $ 51,171     $ 26,110     $ 31,582     $ 42,993     $ 293,088  
 
                                   
 
                                               
Loss ratio
    81.7 %     170.4 %     125.0 %     45.7 %     69.5 %     95.4 %
Underwriting expense ratio
    22.4 %     28.4 %     33.4 %     63.1 %     19.7 %     28.4 %
 
                                   
Combined ratio
    104.1 %     198.8 %     158.4 %     108.8 %     89.2 %     123.8 %
 
                                   
The following is a discussion of our most significant products:
Automobile: Net earned premiums decreased $10.4 million, or 7.3%, for the three months ended June 30, 2009 compared to the same period in 2008, due to the continued price competition and the change in our “Cashback” program methodology, discussed in the “Net Premiums Written and Earned” section above.
The loss ratios for the period ended June 30, 2009 and 2008 were relatively flat at 81.9% and 81.7%, respectively. The combined ratios for the three months ended June 30, 2009 and 2008 were 101.1% and 104.1%, respectively. The reduction in the combined ratio was primarily a result of the reduced underwriting expense ratio to 19.1% from 22.4%. This reduction in underwriting expense was primarily driven by the change in the deferral methodology discussed above, which decreased the auto expense for the quarter by $4.6 million.
Homeowners: Net earned premiums decreased $5.3 million to $45.9 million for the three months ended June 30, 2009 from $51.2 million for the same period in 2008. This decrease is a direct result of fewer policies in-force during the current year as compared to the prior year and the change in our “Cashback” program methodology, discussed in the “Net Premiums Written and Earned” section above.

 

52


Table of Contents

The loss ratios for the three months ended June 30, 2009 and 2008 were 146.3% and 170.4%, respectively. The significant decrease in the loss ratio for 2009 compared to 2008 is due to the decreased level of catastrophe losses during the second quarter of 2009 as compared to the record levels we experienced in 2008. Gross catastrophe losses for all lines of business combined in the second quarter of 2009 were $34.7 million, compared to approximately $66.9 million for the same period in 2008.
The combined ratios for the three months ended June 30, 2009 and 2008 were 168.0% and 198.7%, respectively. Our combined ratio continued to be negatively impacted in 2009 due to our concentration of business in the Midwest, which experienced significant catastrophes during the second quarters of 2009 and 2008.
Agribusiness Product: Earned premium increased $0.2 million to $26.3 million for the three months ended June 30, 2009, compared to $26.1 million for 2008. This increase is primarily the result of rate increases.
The loss ratios for the three months ended June 30, 2009 and 2008 were 97.3% and 125.0%, respectively. The change in the loss ratio reflects a decrease in policy benefits of $7.0 million, or 21.6%. This decrease is primarily due to our focus on improving the discipline in underwriting within this line, increasing the profitability potential of this product.
Credit related property: Net earned premiums increased $0.8 million to $32.4 million from $31.6 million for the three months ended June 30, 2009 and 2008, respectively. The increase in revenue is due to an increase in our Collateral Protection line of business as lenders move to protect their consumer lending products, offset by the decrease in our Guaranteed Auto Protection (“GAP”) product as a result of declining auto sales. GAP insurance covers the amount of indebtedness in excess of the insured value of the car.
The loss ratios for the three months ended June 30, 2009 and 2008 were 49.4% and 45.7%, respectively, while the expense ratios were 59.9%, and 63.1%, respectively. The increase in the loss ratio is attributable to a continued increase in the frequency and severity of GAP claims during the second quarter of 2009.
Six Months ended June 30, 2009 compared with the Six Months ended June 30, 2008 — Property & Casualty
Net Premiums Written and Earned
Net premiums written decreased $15.4 million to $603.5 million for the six months ended June 30, 2009 from $618.9 million for the same period in 2008. This change was primarily due to an $11.5 million decrease in personal and commercial auto net premiums written, and a $3.2 million decrease in workers’ compensation insurance net written premium. The decrease in auto business is due to continued high levels of competition and the resulting rate decreases in this line. The decrease we are experiencing in workers compensation net written premium is due to the current economic environment as lower payrolls result in lower premiums written and earned. We expect this to continue in the short-term until the economy shows signs of recovery and payrolls begin to rise.
Net premiums earned decreased $24.3 million to $568.9 million for the six months ended June 30, 2009 from $593.2 million for the six months ended June 30, 2008. This decrease was primarily the result of a $9.9 million decrease in auto premiums earned, as a result of fewer policies in-force during the year as well as rate decreases from the prior year, and a $5.0 million decrease in Homeowner net premiums earned as we move to lower the number of policies we carry in the coastal region. The change in methodology for the calculation of the reserve for the “Cashback” program, discussed in the three-month “Net Premiums Written and Earned” section, also contributes to the decrease in net premiums earned.
Net Investment Income
Net investment income decreased by $5.1 million to $33.8 million for the six months ended June 30, 2009 from $38.9 million for the same period in 2008. This decrease was due to the increased amount of cash we held during the six months ended June 30, 2009 compared to the same period in 2008. As investing opportunities arise, we are reinvesting the cash held in primarily fixed maturity securities. Refer to the Investments discussion for further analysis.

 

53


Table of Contents

Policy Benefits
Policy benefits decreased $5.3 million to $491.8 million for the six months ended June 30, 2009 from $497.1 million for the same period in 2008. The decrease was due to a $16.6 million improvement in the record catastrophe loss experience from the previous year as fewer and less severe catastrophes occurred during the period. For the six months ended June 30, 2009 and 2008, we experienced net catastrophe losses of $66.0 million on 17 catastrophes and $82.6 million on 25 catastrophes, respectively. The improvement was offset by increases in our workers compensation insurance product of $4.1 million and other specific product lines noted in the “Products” section below.
The loss ratios were 86.5% and 83.8% for the six months ended June 30, 2009 and 2008, respectively. The primary factor in the increased loss ratio was lower net earned premiums and increased benefits in certain products during 2009 as compared to 2008, offset by the decrease in catastrophe losses. Catastrophe losses contributed 11.6% and 13.9% to the loss ratio for the first six months of 2009 and 2008, respectively.
For the six months ended June 30, 2009, net favorable prior year loss and loss adjustment expense development was $19.2 million compared to $33.1 million of net favorable prior year loss and LAE development for the same period in 2008, as a result of better than expected paid and incurred loss emergence across several lines of business (personal auto, commercial auto, agribusiness and commercial multi-peril lines) as well as savings on catastrophe claims. This favorable emergence was offset by adverse development for the workers compensation and homeowners lines of business.
Commissions and Change in Deferred Policy Acquisition Costs
                         
    Six Months Ended June 30,     Increase/  
    2009     2008     (Decrease)  
    (in thousands)  
Commissions
  $ 105,105     $ 114,618     $ (9,513 )
Change in deferred policy acquisition costs
    (6,730 )     (9,357 )     2,627  
 
                 
Commissions and change in deferred acquistion costs
  $ 98,375     $ 105,261     $ (6,886 )
 
                 
Commissions decreased $9.5 million to $105.1 million for the six months ended June 30, 2009 from $114.6 million for the same period in 2008. This decrease was primarily the result of a $7.2 million decrease in credit related insurance commissions due to a shift toward products with lower commission structures. Commissions on personal and commercial auto policies for the six months ended June 30, 2009 also decreased $4.0 million as compared to the same period in 2008 due to reductions in net earned premiums.
The change in deferred acquisition costs for the six months ended June 30, 2009 was $2.6 million, which represented a reduction to deferred policy acquisition costs and a decrease in expenses for the period. This was primarily driven by the $15 million decrease in net premiums written during the quarter, and changes in the product mix within our credit related property lines towards products that have lower commission structures, resulting in fewer additions to DAC as compared to the same periods in 2008.
Other Operating Costs and Expenses
Other operating costs and expenses increased $0.6 million to $59.5 million for the six months ended June 30, 2009 from $58.9 million for the same period in 2008. The underwriting expense ratio remained consistent at 27.7% for the six months ended June 30, 2009 and 2008. This was primarily the result of a $2.5 million reversal of a legal accrual during the first quarter of 2009 due to our expectation of an outcome from the Farm Bureau litigation to be less adverse than originally estimated and reserved for.

 

54


Table of Contents

Products
The following table shows net premiums written and earned and key ratios for our auto, homeowners, agribusiness, credit related property and other policies for the six months ended June 30, 2009, and 2008:
                                                 
    Automobile     Homeowner     Agribusiness     Credit Related     Other     Total  
    (in thousands)  
Six months ended June 30, 2009
                                               
 
                                               
Net premiums written
  $ 281,407     $ 103,746     $ 52,579     $ 69,302     $ 96,442     $ 603,476  
 
                                   
 
                                               
Net premiums earned
  $ 267,797     $ 97,818     $ 52,593     $ 68,860     $ 81,848     $ 568,916  
 
                                   
 
                                               
Loss ratio
    82.2 %     131.0 %     100.0 %     43.9 %     74.4 %     86.5 %
Underwriting expense ratio
    19.8 %     22.7 %     36.2 %     60.3 %     27.0 %     27.7 %
 
                                   
Combined ratio
    102.0 %     153.7 %     136.2 %     104.2 %     101.4 %     114.2 %
 
                                   
 
                                               
Six months ended June 30, 2008
                                               
 
                                               
Net premiums written
  $ 292,893     $ 101,432     $ 52,760     $ 72,060     $ 99,704     $ 618,849  
 
                                   
 
                                               
Net premiums earned
  $ 284,784     $ 105,490     $ 51,782     $ 66,329     $ 84,809     $ 593,194  
 
                                   
 
                                               
Loss ratio
    77.8 %     123.5 %     117.0 %     41.4 %     67.5 %     83.8 %
Underwriting expense ratio
    21.5 %     24.6 %     31.6 %     64.0 %     21.6 %     27.7 %
 
                                   
Combined ratio
    99.3 %     148.1 %     148.6 %     105.4 %     89.1 %     111.5 %
 
                                   
The following is a discussion of our most significant products:
Automobile: Net earned premiums decreased $17.0 million, or 6.0%, for the six months ended June 30, 2009 compared to the same period in 2008, due to continued price competition and the change in “Cashback” program methodology, discussed in the three-month “Net Premiums Written and Earned” section above. The recent trend of competition pushing rates down has reversed, and rate increases are now being implemented which should result in improved operating results for the remainder of 2009 and into 2010.
The loss ratios for the period ended June 30, 2009 and 2008 were 82.2% and 77.8%, respectively. The increase of the ratio is primarily due to the decrease in premiums noted above. Additionally, in contrast to the prior year, we noted an increase in both the severity and frequency of claims. The increase in loss severity is primarily due to increased bodily injury claims and increased litigation costs associated with these claims. The combined ratios for the six months ended June 30, 2009 and 2008 were 102.0% and 99.3%, respectively.
Homeowners: Net earned premiums decreased $7.7 million to $97.8 million for the six months ended June 30, 2009 from $105.5 million for the same period in 2008. During the same period, policy count decreased by approximately 3,500 policies as we continued our risk management initiatives to reduce exposure in the coastal areas. The decrease in policy counts was partially offset by an increase in premiums per policy due to our focus on increasing insured values on existing policies.
The loss ratios for the six months ended June 30, 2009 and 2008 were 131.0% and 123.5%, respectively. The increase in the loss ratio for 2009 compared to 2008 is due to the lower net premiums earned during the first half of the year, offset by the decrease in catastrophe losses. The combined ratios for the six months ended June 30, 2009 and 2008 were 153.7% and 148.1%, respectively. Our combined ratio was negatively impacted in 2009 due to our concentration of business in the Midwest, which experienced continued significant catastrophe losses as well as numerous non-catastrophe storm damages.

 

55


Table of Contents

Agribusiness Product: Net earned premiums increased slightly for the six months ended June 30 2009, compared to the same period in 2008. This increase is primarily the result of rate increases initiated during the prior year that are being earned in the first two quarters of 2009. In-force policy counts as of June 30, 2009 remained flat as compared to the counts as of June 30, 2008. Our focus on disciplined underwriting will assist us in achieving the profitability potential of this product in the long term.
The loss ratios for the six months ended June 30, 2009 and 2008 were 100.0% and 117.0%, respectively. The change in the loss ratio reflects an improvement in our underwriting and lower catastrophe losses in this line, equating to $8.0 million less of policy benefit expense during the first half of 2009. This also represents expected variability in this line, which is sensitive to the frequency and severity of storm and weather related losses.
Credit related property: Net earned premiums were $68.9 million and $66.3 million for the six months ended June 30, 2009 and 2008, respectively. The increase in revenue is due to an increase in our collateral protection line of business as lenders move to protect their consumer lending products, offset by the decrease in our GAP product as a result of declining auto sales. We expect the current economic recession combined with increased lending standards to continue the reduction in the demand for credit and credit related insurance products. However, as credit standards are tightened, we expect to write higher quality business and to continue to add new business partners as the economy shows signs of recovery. In the current economic environment, we expect our Collateral Protection to continue to grow until the economy begins to recover, at which time we expect the sales of our GAP products to begin to increase.
The loss ratios for the six months ended June 30, 2009 and 2008 were 43.9% and 41.4%, respectively, while the expense ratios were 60.3%, and 64.0%, respectively. The increase in the loss ratio is attributable to an increase in frequency and severity of GAP claims during the first two quarters of 2009 as compared to the same period in 2008. Policy benefits in this line increased 70.0% to $6.9 million in the six months ended June 30, 2009 compared to the same period in 2008. Slowing auto sales have driven down the replacement values of most vehicles, thus creating a significantly larger difference between a vehicle’s value and its indebtedness. The decrease in the expense ratio mainly reflects a decrease in commission expense relative to earned premium as compared to the prior year. This is attributable to a shift in product mix during the first two quarters of 2009 towards products that have lower commission structures.

 

56


Table of Contents

Corporate & Other
Corporate and Other primarily includes the capital not allocated to support our insurance business segments. Investments include publicly traded equities, real estate, mortgage loans, high-yield bonds, venture capital partnerships, mineral interests and tax-advantaged instruments. Refer to the Investments discussion on for further analysis. Our registered investment advisor subsidiary also manages a family of mutual funds and earns management fees, which are insignificant to the overall segment results.
Corporate and Other segment financial results for the periods indicated were as follows:
                                                 
    Three Months Ended June 30,     Increase/     Six Months Ended June 30,     Increase/  
    2009     2008     (Decrease)     2009     2008     (Decrease)  
    (in thousands)  
 
                                               
Revenues:
                                               
 
                                               
Net Investment Income
  $ 25,379     $ 38,671     $ (13,292 )   $ 42,611     $ 63,024     $ (20,413 )
(Loss) from sale of investments, net
    (8,748 )     (4,333 )     (4,415 )     (82,209 )     (9,918 )     (72,291 )
Other Income
    4,391       4,388       3       8,161       9,917       (1,756 )
 
                                   
Total Revenues
    21,022       38,726       (17,704 )     (31,437 )     63,023       (94,460 )
 
                                   
 
                                               
Benefits And Expenses:
                                               
Other operating costs and expenses
    13,664       22,824       (9,160 )     20,495       34,594       (14,099 )
 
                                   
Total Benefits and Expenses
    13,664       22,824       (9,160 )     20,495       34,594       (14,099 )
 
                                   
 
                                               
Income/(Loss) from operations before other items and federal income taxes
  $ 7,358     $ 15,902     $ (8,544 )   $ (51,932 )   $ 28,429     $ (80,361 )
 
                                   
Three Months and Six Months ended June 30, 2009 compared with the Three Months and Six Months ended June 30, 2008
Total income (loss) from operations before other items and federal income taxes decreased $8.5 million and $80.3 million to a gain of $7.4 million and a loss of $51.9 million for the three and six months ended June 30, 2009, respectively, from a gain of $15.9 million and $28.4 million for the same periods in 2008. We recorded other-than-temporary impairments of $6.0 million and $74.1 million on security investments during the three and six months ended June 30, 2009, respectively, due to market volatility.
In accordance with our invested asset allocation process, the illiquid credit market and the other-than-temporary impairments recorded, required us to reallocate some invested assets, including additional cash, from the Corporate and Other segment to the insurance segments in the second quarter of 2009. The reallocation resulted in a decrease in net investment income for the Corporate and Other segment.
We issue participating life insurance policies in which our policyholders share in our investment gains and/or losses. In the six months ended June 30, 2009, we allocated a portion of our realized losses to participating policyholders. The allocation is done through an adjustment to other operating costs and expenses in our Corporate and Other segment and resulted in the other operating costs and expenses for the three and six months ended June 30, 2009 being significantly lower when compared to the same periods in 2008.

 

57


Table of Contents

Liquidity and Capital Resources
Liquidity
Our liquidity requirements have been and are expected to continue to be met by funds from operations. Current and expected patterns of claim frequency and severity may change from period to period but continue to be within historical norms. Our current liquidity position is considered to be sufficient to meet anticipated demands over the next twelve months.
                 
    Six Months Ended June 30,  
    2009     2008  
    (in thousands)  
Net cash provided by (used in):
               
Operating activities
  $ 197,968     $ 119,880  
Investing activities
    (839,493 )     (686,790 )
Financing activities
    608,067       592,882  
 
           
Net increase (decrease) in cash
  $ (33,458 )   $ 25,972  
 
           
The increase in operating cash flows primarily relates to a decrease in our federal income taxes as a result of the increased realized losses on investments in the six months ended June 30, 2009 compared to the same period in 2008.
Cash flows used in investing activities increased primarily due to increased investments in fixed income securities and short-term investments offset by the decrease in mortgage loans in the six months ended June 30, 2009 compared to the same period in 2008.
Increased deposits on annuity products contributed to the increase in cash provided by financing activities for the six months ended June 30, 2009 from the same period in 2008. Annuity sales are recorded as part of the cash flows from financing activities in accordance with U.S. GAAP rules.
Capital Resources
Our capital resources at June 30, 2009 and December 31, 2008 consisted of stockholders’ equity summarized as follows:
                         
    As of June 30, 2009     As of December 31, 2008     Increase/ (Decrease)  
    (in thousands)  
 
                       
Equity, excluding accumulated other comprehensive income (loss), net of tax (“AOCI”)
  $ 3,314,013     $ 3,355,004     $ (40,991 )
AOCI, net of tax
    (64,606 )     (221,148 )     156,542  
 
                 
Total stockholders’ equity
  $ 3,249,407     $ 3,133,856     $ 115,551  
 
                 
We have notes payable on our consolidated statement of financial position that are not part of our capital resources. These notes payable represent amounts borrowed by real estate joint ventures that we are required to consolidate into our results in accordance with accounting rules. The lenders for the notes payable have no recourse to us in the event of default by the joint ventures. Therefore, the only amount of liability that have for these notes payable is limited to our investment in the joint ventures, which totaled $13.3 million at June 30, 2009.
Total stockholders’ equity in the six month period ended June 30, 2009 increased $0.1 million as a result of unrealized gains on marketable equity securities, offset by the net loss of $52.1 million and $41.2 million in dividends paid to stockholders.
Statutory Surplus and Risk-based Capital
Statutory surplus represents the capital of our insurance companies reported in accordance with accounting practices prescribed or permitted by the applicable state insurance departments. As of June 30, 2009, the levels of our insurance subsidiaries’ surplus and risk-based capital exceeded the minimum risk-based capital requirements of the National Association of Insurance Commissioners. As of June 30, 2009, on a stand-alone basis the surplus of American National Insurance Company, the parent company, increased from the level recorded at December 31, 2008.

 

58


Table of Contents

Contractual Obligations
Our future cash payments associated with loss and LAE reserves, life, annuity and disability obligations, contractual obligations pursuant to operating leases for office space and equipment, and notes payable have not materially changed since December 31, 2008. We expect to have the capacity to repay and/or refinance these obligations as they come due.
Off Balance Sheet Arrangements
Our only off-balance sheet transactions relate to third-party marketing operation bank loans which were discussed previously under Note 14 “Commitments and Contingencies” of the footnotes to the consolidated financial statements. In 2010, the third-party marketing operation plans to renegotiate the bank loans. If these renegotiations are unsuccessful, we would have to pay the bank loans using the cash value of the underlying insurance contracts. As of December 31, 2008, the cash value of the policies totaled $212.0 million. At June 30, 2009, the third-party marketing operation still plans to renegotiate the bank loans, however if they are unable to renegotiate the loans, they will be due in the second quarter of 2010.
Investments
General
We manage our investment portfolio to optimize the rate of return that is commensurate with sound and prudent underwriting practices and maintaining a well diversified portfolio. Our investment operations are governed by various regulatory authorities, including state insurance departments. Investment activity, including the setting of investment policies and defining acceptable risk levels, is subject to review and approval of our Finance Committee, a committee made up of two members of the Board of Directors and senior investment professionals. For additional information on the composition and responsibilities of the Finance Committee, see our amended Form 10 Registration Statement filed with the SEC on July 1, 2009.
Our insurance and annuity products are primarily supported by fixed-income securities and commercial mortgage loans. We purchase fixed income security investments and designate them as either held-to-maturity or available-for-sale as necessary to match our estimated future cash flow needs. We make use of statistical measures such as duration and the modeling of future cash flows using stochastic interest rate scenarios to balance our investment portfolio to match the pricing objectives of our underlying insurance products. As part of our asset/liability management program, we monitor the composition of our fixed income securities between held-to-maturity and available-for-sale securities and adjust the concentrations of various investments within the portfolio as investments mature or with the purchase of new investments.
We invest directly in quality commercial mortgage loans with yields that compare favorably with other fixed income securities. Investments in residential mortgage loans have not historically been part of our investment portfolio, and we do not anticipate investing in them in the future.
Our historically strong capitalization enabled us to invest in equity securities and investment real estate where there were opportunities for more significant returns. We make investments in real estate and equity securities based on a risk/reward analysis.

 

59


Table of Contents

Composition of Invested Assets
The following summarizes the carrying values of our investment portfolio by asset class as of June 30, 2009 and December 31, 2008 (other than investments in unconsolidated affiliates):
                                 
    As of:  
    June 30, 2009     December 31, 2008  
    Amount     Percent     Amount     Percent  
    (in thousands)  
Bonds Held to Maturity, at amortized cost
  $ 7,313,157       46.6 %   $ 6,681,837       45.9 %
Bonds Available for Sale, at fair value
    4,042,267       25.7 %     3,820,837       26.3 %
Preferred Stock, at fair value
    27,126       0.2 %     48,822       0.3 %
Common Stock, at fair value
    863,805       5.5 %     853,530       5.9 %
Mortgage Loans, at amortized cost
    2,003,300       12.8 %     1,877,053       13.0 %
Policy Loans, at outstanding balance
    357,289       2.3 %     354,398       2.4 %
Investment Real Estate, net of depreciation
    562,067       3.6 %     528,905       3.6 %
Short-term Investments
    456,332       2.9 %     295,170       2.0 %
Other Invested Assets
    84,822       0.4 %     85,151       0.6 %
 
                       
Total Investments
  $ 15,710,165       100.0 %   $ 14,545,703       100.0 %
 
                       
Total invested assets increased by $1.2 billion to $15.7 billion as of June 30, 2009 from $14.5 billion as of December 31, 2008. The increase in our invested assets in the six months ended June 30, 2009 was a reflection of increasing account values in fixed deferred annuities.
Fair Value Disclosures
The fair value of fixed income securities, equity securities, mortgage loans and short-term investments is determined by the use of third party pricing services, independent broker quotes and internal valuation methodologies. See Note 6 of the consolidated financial statements for further discussion of the calculation of fair value for our investments. Below is a summary of the valuation techniques we utilize to measure fair value of the noted invested assets. There have been no material changes to our fair value methodologies since December 31, 2008.
As of June 30, 2009, 100% of our equity securities are considered to be Level 1 securities as their fair values are determined by observable market prices.
We obtain publicly available prices from third party pricing services for our fixed maturity securities. The typical inputs from pricing services include, but are not limited to, reported trades, bids, offers, issuer spreads, cash flow and performance data. These inputs are usually market observable; however, based on the trading volumes and the lack of quoted market prices for fixed maturities, the pricing services may adjust these values. The adjustments made to the quoted prices are based on recently reported trades for comparable securities. We perform a periodic analysis of the prices received from the third parties to verify that the price represents a reasonable estimate of fair value. These prices obtained from third party services are classified as Level 2.
The discount rate for the fair value of mortgage loans is determined by the weighted average adjustment of the “spread factor” against U.S. treasury rates. The spread factor includes an adjustment for quality rating, property type, geographic distribution and payment status (current, delinquent, in process of foreclosure) of each loan. Management performs periodic reviews and weighs each adjustment to calculate the spread factor based on the current economic environment and lending practices. All mortgage loan investments are classified as Level 2. Mortgage loan pricing is evaluated for consistency with our knowledge of the current market environment to ensure amounts are reflective of fair value.
Certain private placement debt securities are priced via independent broker quotes and internal valuation methodologies. The quotations received from the broker may use inputs that are difficult to corroborate with observable market data. Additionally, we only obtain non-binding quotations from the independent brokers. Internal pricing methodologies include inputs such as externally provided credit spreads and internally determined credit ratings. Due to the significant non-observable inputs, these prices determined by the use of independent broker pricing and internal valuation methodologies are classified as Level 3.

 

60


Table of Contents

Other-Than-Temporary Impairments
In order to identify and evaluate investments that may be other-than-temporarily impaired, we have various quarterly processes in place. For our securities investments, we review the entire portfolio of investments that have unrealized losses. We use various techniques to determine which securities need further review to determine if the impairment is other than temporary. The criteria include the amount by which our cost exceeds the market value, the length of time the market value has been below our cost, any public information about the issuer that would indicate the security could be impaired and our intent and ability to hold the security until its value recovers. Furthermore, we review current ratings, rating downgrades and exposure to continued deterioration in the financial and credit markets.
Corporate Bonds
During the second quarter of 2009, we adopted the FASB’s FSP 115-2, which significantly modified the rules regarding other-than-temporary impairments on bonds (see Note 2 to the consolidated financial statements for further information on our adoption of FSP 115-2). Bonds were subjected to further review if any of the following situations were observed: a) fair value was more than 50% below our cost, b) fair value was 35% or more below our cost at the reporting date and had been below cost by some amount continuously for nine months, c) the issue had been downgraded by a national rating agency, or d) the issuer had widely publicized financial problems. Once a bond is determined as needing further review, it was subjected to a three part test:
  1.   We determined if we intend to hold the bond until maturity.
  2.   We determined if it is more likely than not that we will have to sell the bond before maturity.
  3.   If it was determined that we would hold the bond and we would not have to sell it, then we would determine the present value of the future cash flows of the bond.
If the cash flows were determined as equal to or greater than our amortized cost, then it was determined that we did not have an other-than-temporary impairment. If it was determined that we would sell the bond or be required to sell the bond, or if the present value of the cash flows was less than our amortized cost, then we would determine that the bond was other-than-temporarily impaired. Once a bond was determined to be other-than-temporarily impaired, we would use the present value of expected cash flows versus the market value to determine the amount of the credit loss versus the non-credit loss. The amount of credit loss is recorded as a realized loss in earnings, and the amount of non-credit loss is recorded as an unrealized loss as part of other comprehensive income.
Equity
Equity investments were subjected to further review if any of the following situations were observed: a) fair value was more than 50% below our cost, b) fair value was 25% or more below our cost at the reporting date and had been below cost by some amount continuously for six months, or c) the issuer had widely publicized financial problems. Equity investments were evaluated individually to determine the reason for the decline in fair value and whether such decline was other than temporary. The individual determination included multiple factors including our ability and intent to hold the security, performance of the security against other securities in its sector; historical price/earnings ratios together with forecast earnings, stock re-purchase programs, and other information specific to each issue.
Real Estate, Mortgage Loan, and other Long-Lived Investment Assets
We perform a quarterly review of assets to determine if there are any valuation issues. We evaluate various information on each asset including but not limited to payment history, property inspection, tenant creditworthiness, guarantees and the effect of economic conditions. Once we determine there is a possible adverse change in the condition of the investment, we complete debt service coverage analysis, appraisals and comparisons to similar properties to determine if the investment has a valuation impairment.

 

61


Table of Contents

In the first quarter of 2009, we recorded $68.1 million in other-than-temporary impairments. With the change in the rules from FSP 115-2, we recorded only $6.0 million in the second quarter making a total of $74.1 million for the six months ended June 30, 2009. No other-than-temporary impairment was recorded in the first two quarters of 2009 as a result of a change in our intent and ability to hold to recovery. The following summarizes our other-than-temporary impairments by investment type:
                 
    Six Months Ended     Year Ended  
    June 30,     December 31,  
    2009     2008  
    (in thousands)  
 
               
Corporate bonds
  $ (5,898 )   $ (165,802 )
Equities: