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 September 30, 2011
or
     
o   Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Commission File No. 001- 34280
(AMERICAL NATIONAL LOGO)
American National Insurance Company
(Exact name of registrant as specified in its charter)
     
     
Texas
(State or other jurisdiction of
  74-0484030
(I.R.S. Employer Identification No.)
incorporation or organization)    
One Moody Plaza
Galveston, Texas 77550-7999
(Address of principal executive offices) (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. þ Yes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). þ Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:
             
Large accelerated filer o   Accelerated filer þ   Non-accelerated filer o   Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes þ No
As of October 31, 2011, there were 26,821,284 shares of the registrant’s voting common stock, $1.00 par value per share, outstanding.
 
 

 

 


 

AMERICAN NATIONAL INSURANCE COMPANY
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 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32.1
 Exhibit 32.2
 EX-101 INSTANCE DOCUMENT
 EX-101 SCHEMA DOCUMENT
 EX-101 CALCULATION LINKBASE DOCUMENT
 EX-101 LABELS LINKBASE DOCUMENT
 EX-101 PRESENTATION LINKBASE DOCUMENT
 EX-101 DEFINITION LINKBASE DOCUMENT

 

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Table of Contents

PART I — FINANCIAL INFORMATION
ITEM 1.   FINANCIAL STATEMENTS
AMERICAN NATIONAL INSURANCE COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited and in thousands, except for per share data)
                                 
    Three months ended September 30,     Nine months ended September 30,  
    2011     2010     2011     2010  
PREMIUMS AND OTHER REVENUES
                               
Premiums
                               
Life
  $ 71,926     $ 71,352     $ 207,786     $ 209,670  
Annuity
    21,704       51,180       73,304       132,140  
Accident and health
    57,708       64,288       174,736       200,553  
Property and casualty
    289,796       297,703       856,958       871,672  
Other policy revenues
    46,350       46,342       141,860       138,066  
Net investment income
    225,942       238,081       715,186       667,964  
Realized investments gains (losses)
    17,531       20,141       62,488       54,702  
Other-than-temporary impairments
    (4,851 )     (1,515 )     (4,851 )     (4,265 )
Other income
    7,238       6,144       20,752       19,570  
 
                       
Total premiums and other revenues
    733,344       793,716       2,248,219       2,290,072  
 
                       
 
                               
BENEFITS, LOSSES AND EXPENSES
                               
Policyholder benefits
                               
Life
    75,472       73,402       232,013       220,408  
Annuity
    29,960       56,963       102,770       155,100  
Claims incurred
                               
Accident and health
    38,691       43,140       119,764       141,330  
Property and casualty
    215,226       208,917       685,168       702,134  
Interest credited to policyholders’ account balances
    82,813       110,847       288,343       284,733  
Commissions for acquiring and servicing policies
    109,980       120,408       339,603       343,182  
Other operating expenses
    111,667       114,211       347,133       340,187  
Change in deferred policy acquisition costs
    (5,558 )     (13,806 )     (42,534 )     (46,815 )
 
                       
Total benefits, losses and expenses
    658,251       714,082       2,072,260       2,140,259  
 
                       
 
                               
Income(loss) from continuing operations before federal income tax, and equity in earnings/losses of unconsolidated affiliates
    75,093       79,634       175,959       149,813  
 
                       
Provision (benefit) for federal income taxes
                               
Current
    12,610       29,162       40,127       48,690  
Deferred
    6,444       2,095       656       (4,110 )
 
                       
Total provision (benefit) for federal income taxes
    19,054       31,257       40,783       44,580  
 
                               
Equity in earnings (losses) of unconsolidated affiliates, net of tax
    3,077       (144 )     2,839       (75 )
 
                       
 
                               
Income (loss) from continuing operations
    59,116       48,233       138,015       105,158  
Income (loss) from discontinued operations, net of tax (See Note 17)
          (513 )           1,488  
 
                       
Net income (loss)
    59,116       47,720       138,015       106,646  
Less: Net income (loss) attributable to noncontrolling interest, net of tax
    1,547       664       1,906       (1,810 )
 
                       
Net income (loss) attributable to American National Insurance Company and Subsidiaries
  $ 57,569     $ 47,056     $ 136,109     $ 108,456  
 
                       
 
                               
Amounts available to American National Insurance Company common stockholders
                               
Earnings per share:
                               
Basic
  $ 2.17     $ 1.77     $ 5.12     $ 4.08  
Diluted
    2.15       1.76       5.10       4.07  
 
                               
Weighted average common shares outstanding
    26,559,950       26,558,832       26,559,865       26,558,832  
Weighted average common shares outstanding and dilutive potential common shares
    26,718,464       26,678,394       26,706,798       26,678,394  
See accompanying notes to the unaudited consolidated financial statements.

 

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AMERICAN NATIONAL INSURANCE COMPANY
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
(Unaudited and in thousands, except for share and per share data)
                 
    September 30,     December 31,  
    2011     2010  
ASSETS
               
Fixed maturity, bonds held-to-maturity, at amortized cost (Fair Value $9,949,686 and $8,979,834)
  $ 9,322,794     $ 8,513,550  
Fixed maturity, bonds available-for-sale, at fair value (Amortized cost $4,060,142 and $3,925,317)
    4,309,643       4,123,613  
Equity securities, at fair value (Cost $723,418 and $720,665)
    945,494       1,082,755  
Mortgage loans on real estate, net of allowance
    2,793,656       2,679,909  
Policy loans
    389,844       380,505  
Investment real estate, net of accumulated depreciation of $202,095 and $202,111
    461,710       521,768  
Short-term investments
    350,430       486,206  
Other invested assets
    96,655       119,251  
 
           
Total investments
    18,670,226       17,907,557  
 
           
Cash and cash equivalents
    100,100       101,449  
Investments in unconsolidated affiliates
    231,867       195,472  
Accrued investment income
    218,434       201,286  
Reinsurance recoverables
    411,999       355,188  
Prepaid reinsurance premiums
    73,228       75,542  
Premiums due and other receivables
    303,060       287,184  
Deferred policy acquisition costs
    1,353,340       1,318,426  
Property and equipment, net
    78,209       77,974  
Current tax receivable
    1,958       8,579  
Other assets
    135,362       138,978  
Separate account assets
    711,135       780,563  
 
           
Total assets
  $ 22,288,918     $ 21,448,198  
 
           
LIABILITIES
               
Future policy benefits:
               
Life
  $ 2,580,445     $ 2,539,334  
Annuity
    737,889       865,480  
Accident and health
    76,102       81,266  
Policyholders’ account balances
    11,449,494       10,475,159  
Policy and contract claims
    1,331,260       1,298,457  
Unearned premium reserve
    841,654       824,299  
Other policyholder funds
    270,625       277,285  
Liability for retirement benefits
    184,030       187,453  
Current portion of long-term notes payable
          47,632  
Long-term notes payable
    58,481       12,508  
Deferred tax liabilities, net
    20,421       53,737  
Other liabilities
    388,720       368,332  
Separate account liabilities
    711,135       780,563  
 
           
Total liabilities
    18,650,256       17,811,505  
 
           
STOCKHOLDERS’ EQUITY
               
Common stock, $1.00 par value, — Authorized 50,000,000 Issued 30,832,449, Outstanding 26,821,284 shares
    30,832       30,832  
Additional paid-in capital
    18,526       15,190  
Accumulated other comprehensive income
    163,032       225,212  
Retained earnings
    3,534,063       3,459,911  
Treasury stock, at cost
    (98,490 )     (98,494 )
 
           
Total American National stockholders’ equity
    3,647,963       3,632,651  
Noncontrolling interest
    (9,301 )     4,042  
 
           
Total stockholders’ equity
    3,638,662       3,636,693  
 
           
Total liabilities and stockholders’ equity
  $ 22,288,918     $ 21,448,198  
 
           
See accompanying notes to the unaudited consolidated financial statements.

 

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AMERICAN NATIONAL INSURANCE COMPANY
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
(Unaudited and in thousands, except for per share data)
                 
    Nine months ended September 30,  
    2011     2010  
Common Stock
               
Balance at beginning and end of the period
  $ 30,832     $ 30,832  
 
           
 
               
Additional Paid-In Capital
               
Balance as of January 1,
    15,190       11,986  
Issuance of treasury shares as restricted stock
    (4 )      
Income tax effect from restricted stock arrangement
    (14 )      
Amortization of restricted stock
    3,354       2,360  
 
           
Balance at end of the period
    18,526       14,346  
 
           
 
               
Accumulated Other Comprehensive Income (Loss)
               
Balance as of January 1,
    225,212       117,649  
Change in unrealized gain (loss) on available-for-sale securities, net
    (61,595 )     99,612  
Foreign exchange adjustments
    (277 )     69  
Defined benefit plan adjustment
    (308 )     133  
 
           
Balance at end of the period
    163,032       217,463  
 
           
 
               
Retained Earnings
               
Balance as of January 1,
    3,459,911       3,398,492  
Net income (loss) attributable to American National Insurance Company and Subsidiaries
    136,109       108,456  
Cash dividends to common stockholders ($2.31 per share)
    (61,957 )     (61,955 )
 
           
Balance at end of the period
    3,534,063       3,444,993  
 
           
 
               
Treasury Stock
               
Balance as of January 1,
    (98,494 )     (98,505 )
Issuance of treasury shares as restricted stock
    4        
 
           
Balance at end of the period
    (98,490 )     (98,505 )
 
           
 
               
Noncontrolling Interest
               
Balance as of January 1,
    4,042       12,202  
Contributions
    29       843  
Distributions
    (15,278 )     (944 )
Gain (loss) attributable to noncontrolling interest
    1,906       (1,810 )
 
           
Balance at end of the period
    (9,301 )     10,291  
 
           
 
               
Total Equity
               
Balance at end of the period
  $ 3,638,662     $ 3,619,420  
 
           
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited and in thousands)
                                 
    Three months ended September 30,     Nine months ended September 30,  
    2011     2010     2011     2010  
Net income (loss) attributable to American National
                               
Insurance Company and Subsidiaries
  $ 57,569     $ 47,056     $ 136,109     $ 108,456  
 
                       
 
                               
Other comprehensive income (loss), net of tax
                               
Change in unrealized gain (loss) on available-for-sale securities, net
    (101,144 )     103,635       (61,595 )     99,612  
Foreign exchange adjustments
    (470 )     137       (277 )     69  
Defined benefit plan adjustment
    (120 )     44       (308 )     133  
 
                       
Total other comprehensive income (loss)
    (101,734 )     103,816       (62,180 )     99,814  
 
                       
 
                               
Total comprehensive income (loss) attributable to American National Insurance Company and Subsidiaries
  $ (44,165 )   $ 150,872     $ 73,929     $ 208,270  
 
                       
See accompanying notes to the unaudited consolidated financial statements.

 

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AMERICAN NATIONAL INSURANCE COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited and in thousands)
                 
    Nine months ended September 30,  
    2011     2010  
OPERATING ACTIVITIES
               
Net income (loss)
  $ 138,015     $ 106,646  
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
               
Realized investments (gains) losses
    (62,488 )     (57,223 )
Other-than-temporary impairments
    4,851       4,265  
Amortization of discounts and premiums on bonds
    12,755       12,353  
Net capitalized interest on policy loans and mortgage loans
    (21,412 )     (22,737 )
Depreciation
    30,168       37,601  
Interest credited to policy holders’ account balances
    288,343       284,733  
Charges to policyholders’ account balances
    (141,860 )     (138,066 )
Deferred federal income tax (benefit) expense
    656       (2,764 )
Deferral of policy acquisition costs
    (377,158 )     (370,695 )
Amortization of deferred policy acquisition costs
    334,624       323,880  
Equity in (earnings) losses of unconsolidated affiliates
    (2,839 )     75  
Changes in:
               
Policyholder liabilities
    122,824       119,524  
Reinsurance recoverables
    (56,811 )     4,475  
Premiums due and other receivables
    (15,876 )     (21,683 )
Accrued investment income
    (17,148 )     (14,332 )
Current tax receivable/payable
    6,621       12,589  
Liability for retirement benefits
    (3,423 )     1,050  
Prepaid reinsurance premiums
    2,314       6,231  
Other, net
    23,318       6,548  
 
           
Net cash provided by (used in) operating activities
    265,474       292,470  
 
           
INVESTING ACTIVITIES
               
Proceeds from sale/maturity/prepayment of:
               
Bonds — held-to-maturity
    479,123       314,846  
Bonds — available-for-sale
    330,839       496,073  
Equity securities
    76,082       96,528  
Real estate
    91,679       28,802  
Mortgage loans
    322,949       91,638  
Policy loans
    39,317       37,734  
Other invested assets
    29,039       8,613  
Disposals of property and equipment
    1,358       751  
Distributions from unconsolidated affiliates
    22,612       3,902  
Payment for the purchase/origination of:
               
Bonds — held-to-maturity
    (1,284,363 )     (802,600 )
Bonds — available-for-sale
    (466,316 )     (395,588 )
Equity securities
    (53,015 )     (99,403 )
Real estate
    (9,531 )     (35,939 )
Mortgage loans
    (447,627 )     (330,497 )
Policy loans
    (31,727 )     (30,114 )
Other invested assets
    (29,107 )     (31,189 )
Additions to property and equipment
    (13,555 )     (7,029 )
Contributions to unconsolidated affiliates
    (58,560 )     (20,882 )
Change in short-term investments
    135,776       (138,191 )
Other, net
    19,878       3,136  
 
           
Net cash provided by (used in) investing activities
    (845,149 )     (809,409 )
 
           
FINANCING ACTIVITIES
               
Policyholders’ account deposits
    1,722,051       1,342,376  
Policyholders’ account withdrawals
    (1,064,860 )     (750,417 )
Change in notes payable
    (1,659 )     (790 )
Dividends to stockholders
    (61,957 )     (61,955 )
Proceeds from (payments to) noncontrolling interest
    (15,249 )     (101 )
 
           
Net cash provided by (used in) financing activities
    578,326       529,113  
 
           
 
               
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    (1,349 )     12,174  
Beginning of the year
    101,449       161,483  
Cash attributed to assets held-for-sale (See Note 17)
          (8,828 )
 
           
Balance as of September 30,
  $ 100,100     $ 164,829  
 
           
See accompanying notes to the unaudited consolidated financial statements.

 

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NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF OPERATIONS
American National Insurance Company and its consolidated subsidiaries (collectively “American National”) operate 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 insurance, health insurance, annuities, and property and casualty insurance. In addition, through non-insurance subsidiaries, American National invests in stocks and 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 multiple-line exclusive agents, independent agents, third-party marketing organizations, career agents, and direct sales to the public.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES
The consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles (“GAAP”) and the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) for Form 10-Q. In addition to GAAP, specific SEC requirements applicable to insurance companies are applied to the consolidated financial statements.
The interim consolidated financial statements and notes herein are unaudited. These interim consolidated financial statements reflect all adjustments, which are in the opinion of management, considered necessary for the fair presentation of the consolidated statements of operations, financial position, changes in equity, comprehensive income (loss), and cash flows for the interim periods. These interim consolidated financial statements and notes should be read in conjunction with the annual consolidated financial statements and notes thereto included in American National’s Annual Report on Form 10-K as of and for the year ended December 31, 2010. The consolidated results of operations for the interim periods should not be considered indicative of results to be expected for the full year.
American National consolidates all entities that are wholly-owned and those in which American National owns less than 100% but controls, as well as any variable interest entities in which American National is the primary beneficiary. Investments in unconsolidated affiliates are accounted for using the equity method of accounting.
Certain amounts in prior years have been reclassified to conform to current year presentation.
The preparation of the consolidated financial statements in conformity with GAAP requires the use of estimates and assumptions that affect the reported consolidated 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 (“OTTI”);
    Deferred policy acquisition costs;
    Reserves;
    Reinsurance;
    Pension and postretirement benefit plans;
    Litigation contingencies; and
    Federal income taxes.
As of September 30, 2011, American National’s significant accounting policies and practices remain materially unchanged from those disclosed in Note 2, Summary of Significant Accounting Policies and Practices, of the Notes to Consolidated Financial Statements included in American National’s 2010 Annual Report on Form 10-K.

 

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3. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
Adoption of New Accounting Standards
In January 2010, the FASB issued ASU No. 2010-06, Improving Disclosures about Fair Value Measurements. ASU 2010-06 was issued to improve and expand fair value disclosures. Newly required disclosures are as follows: 1) provide information about movements of assets among Levels 1 and 2 of the three-tier fair value hierarchy; 2) provide a reconciliation of purchases, sales, issuance, and settlements of anything valued with a Level 3 method; and 3) provide fair value disclosures for each class of assets and liabilities. This guidance is effective for interim and annual periods commencing after December 15, 2009, except for the disclosure of the reconciliation of the Level 3 activities, which is effective for annual periods commencing after December 15, 2010. American National adopted this guidance on January 1, 2010, except for the disclosure of the reconciliation of the Level 3 activities, which was adopted effective January 1, 2011. American National’s adoption of this guidance did not have a material impact on its consolidated financial statements.
In April 2010, the FASB issued ASU No. 2010-15, How Investments Held through Separate Accounts Affect an Insurer’s Consolidation Analysis of Those Investments. For accounting purposes, ASU 2010-15 clarifies that an insurance entity should not consider any separate account interests held for the benefit of policyholders in an investment to be the insurer’s interests and should not combine those interests with its general account interest in the same investment when assessing the investment for consolidation, unless the separate account interests are held for the benefit of a related-party policyholder. This guidance also clarifies that for the purpose of evaluating whether the retention of specialized accounting for investments in consolidation is appropriate, a separate account arrangement should be considered a subsidiary. The amendments do not require an insurer to consolidate an investment in which a separate account holds a controlling financial interest if the investment is not or would not be consolidated in the stand-alone financial statements of the separate account. ASU 2010-15 is effective for interim and annual periods commencing after December 15, 2010. American National’s adoption of this guidance did not have a material effect on its consolidated financial statements.
In July 2010, the FASB issued ASU No. 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. Additional disclosures are now required that enable readers of the financial statements to understand the nature of the credit risk inherent in the financing receivable portfolio, how the portfolio’s credit risk is analyzed and assessed in order to arrive at the allowance for credit losses for each portfolio, and the changes and underlying reason for the changes in the allowance for credit losses for each portfolio. Disclosures previously required for financing receivables are now required to be disclosed on a disaggregated basis. In addition, new disclosures under ASU 2010-20 are required for each financing receivable class including credit quality indicators of financing receivables at the end of the reporting period, aging of past due financing receivables, the nature and extent of troubled debt restructurings that occurred during the reporting period, the nature and extent of financing receivables modified as troubled debt restructurings within the previous 12 months that defaulted during the reporting period, and significant purchases and sales of financing receivables during the reporting period. The ASU 2010-20 disclosures required as of the end of a reporting period are effective for interim and annual periods ending on or after December 15, 2010. Disclosures concerning the activity that occurs during a reporting period are effective for interim and annual periods beginning on or after December 15, 2010. American National adopted this guidance effective January 1, 2010, except for the disclosure requirements for activities that occur during a reporting period, which was adopted effective January 1, 2011. American National’s adoption of this guidance did not have a material impact on its consolidated financial statements.
In January 2011, the FASB issued ASU No. 2011-01, Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20. This update temporarily delays the effective date of the disclosures about troubled debt restructuring required within ASU 2010-20. The delay was intended to allow the FASB time to complete its deliberations on what constitutes a troubled debt restructuring. ASU 2011-01 is effective upon issuance. Accordingly, this update was retrospectively adopted on December 31, 2010 and did not have a material effect on American National’s consolidated financial statements.

 

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In April 2011, the FASB issued ASU No. 2011-02, A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring. The new guidance clarifies the creditor’s evaluation of whether it has granted a concession and whether a borrower is experiencing financial difficulties. In addition, the new guidance precludes the creditor from using the effective interest rate test in the borrower’s guidance on restructuring payables when evaluating whether a restructuring constitutes a troubled debt restructuring. ASU 2011-02 is effective for public companies for interim and annual periods beginning on or after June 15, 2011 and must be applied retrospectively to restructurings occurring on or after the beginning of the year. American National’s adoption of this guidance did not have a material effect on its consolidated financial statements.
Future Adoption of New Accounting Standards
In October 2010, the FASB issued ASU No. 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts. The new guidance redefines the term “acquisition cost” and added the term “incremental direct cost of contract acquisition” to the master glossary. These changes limit the deferrable cost to those costs that are related directly to the successful acquisition of insurance contracts and those that result directly from and are essential to the contract acquisition and costs that would have not been incurred had the contract acquisition not occurred. The new guidance also specifies that advertising costs should be deferred only if the capitalization criteria for direct-response advertising are met. ASU 2010-26 is effective for interim and annual periods, commencing after December 15, 2011. This guidance will be adopted by American National on January 1, 2012. American National is currently assessing the effect of ASU 2010-26 on its consolidated financial statements.
In May 2011, the FASB issued ASU No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in the U.S. GAAP and IFRSs. ASU 2011-04 clarifies the intent of the FASB about the application of existing fair value measurement and disclosure requirements such as: (1) the application of the highest and best use and valuation premise concepts; (2) a requirement specific to measuring the fair value of an instrument classified in a reporting entity’s shareholders’ equity; and (3) a requirement to disclose unobservable inputs used in the fair value of an instrument categorized within Level 3 of the fair value hierarchy. The new guidance also prohibits the use of block premiums and discounts for all fair value measurement, regardless of hierarchy. In addition, ASU 2011-04 expands the disclosures about fair value measurements. ASU 2011-04 is effective for interim and annual periods, beginning after December 15, 2011. American National is currently assessing the effect of ASU 2011-04 on its consolidated financial statements.
In June 2011, the FASB issued ASU No. 2011-05, Presentation of Comprehensive Income. ASU 2011-05 makes the presentation of other comprehensive income (“OCI”) more prominent by giving reporting entities two presentation options. Reporting entities can present the total net income and total OCI along with their respective components as one continuous statement or as two separate consecutive statements. The new guidance also eliminates the option to present OCI in the statement of changes in stockholders’ equity. In addition, the new guidance requires reporting entities to present reclassification adjustments from OCI to net income on the face of the financial statements. ASU 2011-05 is effective for interim and annual periods, beginning after December 15, 2011. American National’s adoption of this guidance on January 1, 2012 is not expected to have a material effect on its consolidated financial statements.

 

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In July 2011, the FASB issued ASU No. 2011-06, Fees Paid to the Federal Government by Health Insurers. ASU 2011-06 addresses questions about how health insurers should recognize and classify in their income statements fees mandated by the Patient Protection and Affordable Care Act, which imposes an annual fee on health insurers for each calendar year beginning on or after January 1, 2014. The new guidance specifies that the liability for the fee should be estimated and recorded in full once the entity provides qualifying health insurance in the applicable calendar year. The corresponding deferred cost is then amortized to expense using a straight-line method of allocation unless another method better allocates the fee over the calendar year that it is payable. ASU 2011-06 is effective for calendar years beginning after December 31, 2013. American National’s adoption of this guidance on January 1, 2014 is not expected to have a material effect on its consolidated financial statements.
In September 2011, the FASB issued ASU No. 2011-08, Testing Goodwill for Impairment. ASU 2011-08 allows an assessment of qualitative factors to determine if it is more likely than not that the fair value of a reporting unit is less than its carrying value as a basis to determining whether the two-step goodwill impairment test is necessary. ASU 2011-08 is effective for interim and annual periods beginning after December 15, 2011. American National’s adoption of this guidance on January 1, 2012 is not expected to have a material effect on its consolidated financial statements.

 

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4. INVESTMENTS
The cost or amortized cost and estimated fair value of investments in fixed maturity and equity securities are shown below (in thousands):
                                 
    September 30, 2011  
            Gross     Gross        
    Cost or     Unrealized     Unrealized     Estimated Fair  
    Amortized Cost     Gains     Losses     Value  
Fixed maturity securities
                               
Bonds held-to-maturity
                               
U.S. treasury and other U.S. government corporations and agencies
  $ 22,277     $ 231     $     $ 22,508  
States of the U.S. and political subdivisions of the states
    411,656       29,780       (61 )     441,375  
Foreign governments
    29,038       4,698             33,736  
Corporate debt securities
    8,041,927       575,753       (26,349 )     8,591,331  
Residential mortgage-backed securities
    740,757       58,168       (3,456 )     795,469  
Commercial mortgage-backed securities
    31,340             (14,693 )     16,647  
Collateralized debt securities
    7,142       45       (1,013 )     6,174  
Other debt securities
    38,657       3,789             42,446  
 
                       
Total bonds held-to-maturity
    9,322,794       672,464       (45,572 )     9,949,686  
 
                       
 
                               
Bonds available-for-sale
                               
U.S. treasury and other U.S. government corporations and agencies
    9,955       1,138       (1 )     11,092  
States of the U.S. and political subdivisions of the states
    578,274       36,531       (123 )     614,682  
Foreign governments
    5,000       2,437             7,437  
Corporate debt securities
    3,223,097       227,317       (33,215 )     3,417,199  
Residential mortgage-backed securities
    211,733       13,796       (825 )     224,704  
Collateralized debt securities
    17,945       1,644       (228 )     19,361  
Other debt securities
    14,138       1,030             15,168  
 
                       
Total bonds available-for-sale
    4,060,142       283,893       (34,392 )     4,309,643  
 
                       
 
                               
Total fixed maturity securities
    13,382,936       956,357       (79,964 )     14,259,329  
 
                       
 
                               
Equity securities
                               
Common stock
    692,460       246,896       (31,468 )     907,888  
Preferred stock
    30,958       8,068       (1,420 )     37,606  
 
                       
Total equity securities
    723,418       254,964       (32,888 )     945,494  
 
                       
 
                               
Total investments in securities
  $ 14,106,354     $ 1,211,321     $ (112,852 )   $ 15,204,823  
 
                       

 

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    December 31, 2010  
            Gross     Gross        
    Cost or     Unrealized     Unrealized     Estimated Fair  
    Amortized Cost     Gains     Losses     Value  
Fixed maturity securities
                               
Bonds held-to-maturity
                               
U.S. treasury and other U.S. government corporations and agencies
  $ 23,117     $ 288     $     $ 23,405  
States of the U.S. and political subdivisions of the states
    422,249       7,117       (6,920 )     422,446  
Foreign governments
    29,020       4,910             33,930  
Corporate debt securities
    7,293,501       478,353       (33,077 )     7,738,777  
Residential mortgage-backed securities
    661,516       33,702       (3,398 )     691,820  
Commercial mortgage-backed securities
    31,340             (17,758 )     13,582  
Collateralized debt securities
    8,562       80       (327 )     8,315  
Other debt securities
    44,245       3,314             47,559  
 
                       
Total bonds held-to-maturity
    8,513,550       527,764       (61,480 )     8,979,834  
 
                       
 
                               
Bonds available-for-sale
                               
U.S. treasury and other U.S. government corporations and agencies
    13,268       643       (4 )     13,907  
States of the U.S. and political subdivisions of the states
    583,163       15,142       (4,193 )     594,112  
Foreign governments
    5,000       1,967             6,967  
Corporate debt securities
    3,030,671       197,485       (26,587 )     3,201,569  
Residential mortgage-backed securities
    259,560       13,250       (1,417 )     271,393  
Collateralized debt securities
    19,468       1,459       (218 )     20,709  
Other debt securities
    14,187       769             14,956  
 
                       
Total bonds available-for-sale
    3,925,317       230,715       (32,419 )     4,123,613  
 
                       
 
                               
Total fixed maturity securities
    12,438,867       758,479       (93,899 )     13,103,447  
 
                       
 
                               
Equity securities
                               
Common stock
    690,245       361,048       (5,405 )     1,045,888  
Preferred stock
    30,420       6,714       (267 )     36,867  
 
                       
Total equity securities
    720,665       367,762       (5,672 )     1,082,755  
 
                       
 
                               
Total investments in securities
  $ 13,159,532     $ 1,126,241     $ (99,571 )   $ 14,186,202  
 
                       

 

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Investment securities
Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Residential and commercial mortgage-backed securities, which are not due at a single maturity, have been allocated to their respective categories based on the year of final contractual maturity. The amortized cost and estimated fair value, by contractual maturity of fixed maturity securities are shown below (in thousands):
                                 
    September 30, 2011  
    Bonds Held-to-Maturity     Bonds Available-for-Sale  
    Amortized     Estimated Fair     Amortized     Estimated Fair  
    Cost     Value     Cost     Value  
 
                               
Due in one year or less
  $ 815,499     $ 830,484     $ 211,463     $ 216,539  
Due after one year through five years
    3,557,030       3,795,130       1,861,964       1,968,865  
Due after five years through ten years
    3,917,217       4,219,597       1,499,334       1,596,808  
Due after ten years
    1,027,198       1,099,991       482,381       523,691  
 
                       
 
    9,316,944       9,945,202       4,055,142       4,305,903  
 
                               
Without single maturity date
    5,850       4,484       5,000       3,740  
 
                       
 
                               
Total
  $ 9,322,794     $ 9,949,686     $ 4,060,142     $ 4,309,643  
 
                       
Available-for-sale securities are sold throughout the year for various reasons. All gains and losses were determined using specific identification of the securities sold. Proceeds from the sales of these securities, with the gross realized gains and losses, are shown below (in thousands):
                                 
    Three months ended September 30,     Nine months ended September 30,  
    2011     2010     2011     2010  
 
                               
Proceeds from sales of available-for-sale securities
  $ 23,224     $ 120,348     $ 122,574     $ 325,848  
Gross realized gains
    11,702       8,610       32,679       31,485  
Gross realized losses
          (23 )     (840 )     (1,170 )
There were no securities transferred from held-to-maturity to available-for-sale during the nine months ended September 30, 2011 and 2010.
Derivative Instruments
American National purchases derivative contracts (equity-indexed options) 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 equity-indexed embedded derivative. These derivative instruments are not designated as accounting hedges. The following tables detail the volume, estimated fair value and the gains or losses on derivatives related to equity-indexed annuities (in thousands):
                                                     
    Location of Asset (Liability)   September 30, 2011     December 31, 2010  
Derivatives Not Designated   Reported in the Consolidated   Number of     Notional     Estimated     Number of     Notional     Estimated  
as Hedging Instruments   Statements of Financial Position   Instruments     Amounts     Fair Value     Instruments     Amounts     Fair Value  
 
                                                   
Equity-indexed options
  Other invested assets     322     $ 770,800     $ 49,707       286     $ 668,800     $ 66,716  
Equity-indexed annuity embedded derivative
  Future policy benefits - Annuity     13,464       651,500       (42,898 )     12,663       591,100       (59,644 )
                                     
    Location of Gains (Losses)   Gains (Losses) Recognized in Income on Derivatives  
Derivatives Not Designated   Recognized in the Consolidated   Three months ended September 30,     Nine months ended September 30,  
as Hedging Instruments   Statements of Operations   2011     2010     2011     2010  
 
                                   
Equity-indexed options
  Net investment income   $ (23,449 )   $ 10,231     $ (18,152 )   $ (1,658 )
Equity-indexed annuity embedded derivative
  Interest credited to policyholders’ account balances     4,299       2,473       7,907       (10,438 )

 

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Unrealized gains (losses) on securities
Unrealized gains (losses) on available-for-sale securities, presented in the stockholders’ equity section of the consolidated statements of financial position, are net of deferred tax expense of $130,510,000 and $158,200,000 as of September 30, 2011 and 2010, respectively.
The change in the net unrealized gains (losses) on available-for-sale securities are shown below (in thousands):
                 
    Nine months ended September 30,  
    2011     2010  
 
               
Bonds available-for-sale
  $ 51,205     $ 212,830  
Equity securities
    (140,014 )     29,470  
Adjustment to deferred policy acquisition costs
    (7,620 )     (80,063 )
 
           
 
    (96,429 )     162,237  
Less: Provision (benefit) for federal income taxes
    (33,717 )     56,760  
 
           
 
    (62,712 )     105,477  
Change in unrealized (gains) losses of investments attributable to participating policyholders’ interest
    1,117       (5,865 )
 
           
Total
  $ (61,595 )   $ 99,612  
 
           
Gross unrealized losses on investment securities and the estimated 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, are shown below (in thousands):
                                                 
    September 30, 2011  
    Less than 12 months     12 Months or more     Total  
    Unrealized     Estimated     Unrealized     Estimated     Unrealized     Estimated  
    Losses     Fair Value     Losses     Fair Value     Losses     Fair Value  
Fixed maturity securities
                                               
Bonds held-to-maturity
                                               
States of the U.S. and political subdivisions of the states
  $ 55     $ 5,307     $ 6     $ 153     $ 61     $ 5,460  
Corporate debt securities
    22,607       710,530       3,742       52,982       26,349       763,512  
Residential mortgage-backed securities
    163       12,712       3,293       38,497       3,456       51,209  
Commercial mortgage-backed securities
                14,693       16,647       14,693       16,647  
Collateralized debt securities
                1,013       4,511       1,013       4,511  
 
                                   
Total bonds held-to-maturity
    22,825       728,549       22,747       112,790       45,572       841,339  
 
                                   
 
                                               
Bonds available-for-sale
                                               
U.S. treasury and other U.S. government corporations and agencies
    1       3,304                   1       3,304  
States of the U.S. and political subdivisions of the states
    123       3,617             214       123       3,831  
Corporate debt securities
    12,730       336,983       20,485       110,058       33,215       447,041  
Residential mortgage-backed securities
    108       33,105       717       13,656       825       46,761  
Collateralized debt securities
                228       3,399       228       3,399  
 
                                   
Total bonds available-for-sale
    12,962       377,009       21,430       127,327       34,392       504,336  
 
                                   
Total fixed maturity securities
    35,787       1,105,558       44,177       240,117       79,964       1,345,675  
 
                                   
 
                                               
Equity securities
                                               
Common stock
    31,322       178,166       146       1,171       31,468       179,337  
Preferred stock
    1,420       11,031                   1,420       11,031  
Total equity securities
    32,742       189,197       146       1,171       32,888       190,368  
 
                                   
Total investments in securities
  $ 68,529     $ 1,294,755     $ 44,323     $ 241,288     $ 112,852     $ 1,536,043  
 
                                   

 

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    December 31, 2010  
    Less than 12 months     12 Months or more     Total  
    Unrealized     Estimated     Unrealized     Estimated     Unrealized     Estimated  
    Losses     Fair Value     Losses     Fair Value     Losses     Fair Value  
Fixed maturity securities
                                               
Bonds held-to-maturity
                                               
States of the U.S. and political subdivisions of the states
  $ 6,898     $ 195,634     $ 22     $ 878     $ 6,920     $ 196,512  
Corporate debt securities
    22,493       912,554       10,584       128,721       33,077       1,041,275  
Residential mortgage-backed securities
    579       57,160       2,819       64,798       3,398       121,958  
Commercial mortgage-backed securities
                17,758       13,583       17,758       13,583  
Collateralized debt securities
                327       5,465       327       5,465  
 
                                   
Total bonds held-to-maturity
    29,970       1,165,348       31,510       213,445       61,480       1,378,793  
 
                                   
 
                                               
Bonds available-for-sale
                                               
U.S. treasury and other U.S. government corporations and agencies
    4       7,040                   4       7,040  
States of the U.S. and political subdivisions of the states
    4,193       151,860                   4,193       151,860  
Corporate debt securities
    8,378       249,240       18,209       159,227       26,587       408,467  
Residential mortgage-backed securities
    81       26,909       1,336       29,393       1,417       56,302  
Collateralized debt securities
                218       4,664       218       4,664  
 
                                   
Total bonds available-for-sale
    12,656       435,049       19,763       193,284       32,419       628,333  
 
                                   
Total fixed maturity securities
    42,626       1,600,397       51,273       406,729       93,899       2,007,126  
 
                                   
 
                                               
Equity securities
                                               
Common stock
    3,302       57,781       2,103       37,479       5,405       95,260  
Preferred stock
    231       6,133       36       4,464       267       10,597  
 
                                   
Total equity securities
    3,533       63,914       2,139       41,943       5,672       105,857  
 
                                   
Total investments in securities
  $ 46,159     $ 1,664,311     $ 53,412     $ 448,672     $ 99,571     $ 2,112,983  
 
                                   
For all investment securities with an unrealized loss, including those in an unrealized loss position for 12 months or more, American National performs a quarterly analysis to determine if an OTTI loss should be recorded. As of September 30, 2011, the securities with unrealized losses were not deemed to be other-than-temporarily impaired. Even though the duration of the unrealized losses on some of the securities exceeds one year, American National has no intent to sell and it is not more-likely-than-not that American National will be required to sell these securities prior to recovery, and recovery is expected in a reasonable period of time.

 

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Net investment income and realized investments gains (losses)
Net investment income and realized investments gains (losses) before federal income taxes are shown below (in thousands):
                                 
    Net Investment Income  
    Three months ended September 30,     Nine months ended September 30,  
    2011     2010     2011     2010  
 
                               
Bonds
  $ 175,183     $ 164,026     $ 519,582     $ 489,325  
Equity securities
    6,357       5,603       19,764       17,731  
Mortgage loans
    49,471       42,901       152,178       124,743  
Real estate
    32,490       39,243       87,065       100,842  
Options
    (23,449 )     10,231       (18,152 )     (1,658 )
Other invested assets
    12,022       10,263       32,336       30,975  
 
                       
 
    252,074       272,267       792,773       761,958  
Investment expenses
    (26,132 )     (34,186 )     (77,587 )     (93,994 )
 
                       
Total
  $ 225,942     $ 238,081     $ 715,186     $ 667,964  
 
                       
                                 
    Realized Investment Gains (Losses)  
    Three months ended September 30,     Nine months ended September 30,  
    2011     2010     2011     2010  
 
                               
Bonds
  $ 788     $ 7,631     $ 13,895     $ 24,183  
Equity securities
    11,975       3,869       30,789       13,888  
Mortgage loans
    4,968             4,968        
Real estate
    (338 )     8,814       12,775       10,816  
Other invested assets
    (412 )     (1,024 )     (489 )     (1,078 )
 
                       
 
    16,981       19,290       61,938       47,809  
Change in allowances
    550       851       550       6,893  
 
                       
Total
  $ 17,531     $ 20,141     $ 62,488     $ 54,702  
 
                       
The other-than-temporary impairments which are not included in the realized investments gains (losses) above are shown below (in thousands):
                                 
    Three months ended September 30,     Nine months ended September 30,  
    2011     2010     2011     2010  
 
                               
Equity securities
  $ (4,851 )   $ (1,515 )   $ (4,851 )   $ (4,265 )
 
                       

 

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5. VARIABLE INTEREST ENTITIES
In the normal course of investment activities, American National and its wholly-owned subsidiaries enter into various real estate partnership agreements. Generally, real estate partnership opportunities are presented to American National by a sponsor, with the significant activities being conducted on behalf of the sponsor. American National participates in the design of these entities, but in most cases, American National’s involvement is limited to financing. Through analysis performed by American National, some of these partnerships have been determined to be variable interest entities (“VIEs”). In certain instances, in addition to an economic interest in the entity, American National holds the power to direct the most significant activities of the entity and is deemed the primary beneficiary or consolidator of the entity. The assets of the consolidated VIEs are restricted and must be used first to settle the liabilities of the VIE. Creditors or beneficial interest holders of these VIEs have no recourse to the general credit of American National, as American National’s obligation is limited to the amount of its committed investment. The total assets and liabilities relating to VIEs in which American National is the primary beneficiary and which are consolidated in its financial statements for the periods indicated are as follows (in thousands):
                 
    September 30,     December 31,  
    2011     2010  
Investment real estate
  $ 154,751     $ 156,441  
Short-term investments
    3,364       1,991  
Cash and cash equivalents
    1,463       1,164  
Accrued investment income
    2,047       2,035  
Other receivables
    14,191       16,524  
Other assets
    4,384       3,884  
 
           
Total assets of consolidated VIEs
  $ 180,200     $ 182,039  
 
           
 
               
Notes payable
  $ 58,481     $ 60,140  
Other liabilities
    2,553       3,499  
 
           
Total liabilities of consolidated VIEs
  $ 61,034     $ 63,639  
 
           
For other real estate partnerships in which American National is a partner, the major decisions that most significantly impact the economic activities of the partnership require unanimous consent of all partners. American National is not the primary beneficiary and these entities were not consolidated. The following table presents the carrying amount and maximum exposure to loss relating to VIEs for which American National holds significant variable interests but is not the primary beneficiary and which have not been consolidated (in thousands):
                                 
    September 30, 2011     December 31, 2010  
            Maximum             Maximum  
    Carrying     Exposure to     Carrying     Exposure to  
    Amount     Loss     Amount     Loss  
 
                               
Investment in unconsolidated affiliates
  $ 76,297     $ 76,297     $ 36,226     $ 36,226  
Financial or other support was not provided to investees designated as VIEs in the form of liquidity arrangements, guarantees, or other commitments by third parties that may affect the fair value or risk of American National’s variable interest in the investees designated as VIEs as of September 30, 2011 and December 31, 2010.

 

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6. CREDIT LOSSES
A financing receivable is a contractual right to receive money on demand or on fixed or determinable dates that is recognized as an asset in a company’s statement of financial position. Commercial mortgage loans on real estate are the only financing receivables reported by American National.
Nonaccrual and Past Due Mortgage Loans
Interest ceases to be accrued for loans on which interest is more than 90 days past due, when the collection of interest is not considered probable, or when a loan is in foreclosure. Interest received on non-accrual status mortgage loans is included in net investment income in the period received. Once a loan becomes current, it is placed back into accrual status.
The amounts of commercial mortgage loans placed on nonaccrual status are shown in the table below (in thousands):
                 
    September 30, 2011     December 31, 2010  
 
               
Office
  $ 8,436     $  
Retail
    10,857       3,685  
 
           
Total
  $ 19,293     $ 3,685  
 
           
The age analysis of past due commercial mortgage loans is shown in the table below (in thousands):
                                                 
    September 30, 2011  
    30-59 Days     60-89 Days     Greater Than     Total Past             Total  
    Past Due     Past Due     90 Days     Due     Current     Mortgage Loans  
 
                                               
Office
  $     $     $ 8,436     $ 8,436     $ 881,852     $ 890,288  
Industrial
                            703,019       703,019  
Retail
                10,857       10,857       542,167       553,024  
Other
                            680,855       680,855  
 
                                   
Total
  $     $     $ 19,293     $ 19,293     $ 2,807,893     $ 2,827,186  
 
                                   
                                                 
    December 31, 2010  
    30-59 Days     60-89 Days     Greater Than     Total Past             Total  
    Past Due     Past Due     90 Days     Due     Current     Mortgage Loans  
 
                                               
Office
  $     $     $     $     $ 798,651     $ 798,651  
Industrial
                            858,241       858,241  
Retail
    8,579             3,685       12,264       456,983       469,247  
Other
                            596,763       596,763  
 
                                   
Total
  $ 8,579     $     $ 3,685     $ 12,264     $ 2,710,638     $ 2,722,902  
 
                                   

 

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Allowance for Credit Losses
Each loan is evaluated quarterly and placed in a watchlist if events occur or circumstances exist that could indicate that American National will be unable to collect all amounts due according to the contractual terms of the loan. If, in evaluating loans for inclusion in the watchlist, sufficient analysis is performed to conclude that a loan is fully collectible, no allowance is required. All loans in the watchlist are then analyzed individually for impairment. Fair value is determined by estimating the present value of future cash flows or the fair value of the underlying collateral. Estimation techniques vary depending on the quality of available data, the type of collateral, and other factors. When the fair value analysis shows that not all of the amount due is collectible, the difference between the estimated fair value and the loan balance is recorded as an allowance (a loss). The allowance is reviewed quarterly to determine whether further allowance is required, or whether recovery of the asset is assured and the allowance can be reduced.
Loans not evaluated individually for collectibility are segregated by collateral property-type and location and allowance factors are applied. These factors are developed annually, and reviewed quarterly based on our historical loss experience adjusted for the expected trend in the rate of foreclosure losses. Allowance factors are higher for loans of certain property types and in certain regions based on loss experience or a blended historical loss factor.
The allowance for credit losses and unpaid principal balance in commercial mortgage loans are shown in the table below (in thousands):
                         
    Collectively     Individually        
    Evaluated     Evaluated        
    for Impairment     for Impairment     Total  
Allowance for credit losses
                       
December 31, 2010
  $ 11,395     $ 2,393     $ 13,788  
Write down
          (1,900 )     (1,900 )
Change in allowance
    (567 )           (567 )
 
                 
September 30, 2011
  $ 10,828     $ 493     $ 11,321  
 
                 
 
                       
Unpaid principal balance
                       
September 30, 2011
  $ 2,697,148     $ 130,038     $ 2,827,186  
 
                 
December 31, 2010
  $ 2,481,997     $ 240,905     $ 2,722,902  
 
                 
Impaired loans
Mortgage loans on real estate are considered impaired when, based on current information and events, it is probable that American National will be unable to collect all amounts due according to the contractual terms of the loan agreement. American National closely monitors its commercial mortgage loan portfolio on a loan-by-loan basis. Loans with an estimated collateral value less than the loan balance, as well as loans with other characteristics indicative of higher than normal credit risks are reviewed quarterly for purposes of establishing an allowance for credit losses and placing loans on non-accrual status as necessary. The allowance account for mortgage loans on real estate is maintained at a level believed adequate by management and reflects management’s best estimate of probable credit losses, including losses incurred at the reporting date but not yet identified by specific loan. Management’s periodic evaluation of the adequacy of the allowance for credit losses is based on past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of the underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. Loans are charged off as uncollectible only when the loan is forgiven by a legal agreement. Prior to charging off the loan, an allowance is recorded based on the estimated recoverable amount. Upon forgiveness, the allowance is reduced and the loan balance is reduced which results in no further gain or loss.

 

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The detail of loans individually evaluated for impairment with and without an allowance recorded by collateral property-type is shown in the tables below (in thousands):
                                         
    Nine months ended September 30, 2011  
            Unpaid             Average     Interest  
    Recorded     Principal     Related     Recorded     Income  
    Investment     Balance     Allowance     Investment     Recognized  
With an allowance recorded
                                       
Retail
  $     $ 493     $ 493     $     $  
 
                             
 
                                       
Without an allowance recorded
                                       
Office
  $ 15,442     $ 15,442     $     $ 11,939     $ 871  
Industrial
                      59,630        
Retail
    15,676       15,676             13,706       1,099  
Other
    98,427       98,427             95,415       4,818  
 
                             
Total without an allowance recorded
  $ 129,545     $ 129,545     $     $ 180,690     $ 6,788  
 
                             
                                         
    Twelve months ended December 31, 2010  
            Unpaid             Average     Interest  
    Recorded     Principal     Related     Recorded     Income  
    Investment     Balance     Allowance     Investment     Recognized  
With an allowance recorded
                                       
Retail
  $ 6,679     $ 9,072     $ 2,393     $ 7,573     $ 406  
 
                             
 
                                       
Without an allowance recorded
                                       
Office
  $ 8,436     $ 8,436     $     $ 8,436     $  
Industrial
    119,260       119,260             119,285       5,333  
Retail
    11,735       11,735             13,011       1,220  
Other
    92,402       92,402             86,312       5,844  
 
                             
Total without an allowance recorded
  $ 231,833     $ 231,833     $     $ 227,044     $ 12,397  
 
                             
Credit Quality Indicators
The credit quality of the mortgage loan portfolio is assessed monthly to determine the credit risk of each borrower. A loan is classified as performing or non-performing based on whether all of the contractual terms of the loan have been met. Retail loans classified as non-performing amounted to $10,857,000 and $3,685,000 as of September 30, 2011 and December 31, 2010, respectively. Office loans classified as non-performing amounted to $8,436,000 and $0 at September 30, 2011 and December 31, 2010, respectively. All other loans were classified as performing.
During the nine months ended September 30, 2011, American National sold one industrial loan with a recorded investment of $27,532,000 and realized a gain of $4,968,000.
There were no troubled debt restructurings during the nine months ended September 30, 2011.

 

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7. CREDIT RISK MANAGEMENT
American National employs a strategy to invest funds at the highest return possible commensurate with sound and prudent underwriting 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 credit quality rating, using both S&P and Moody’s ratings, is shown below:
                 
    September 30,     December 31,  
    2011     2010  
 
               
AAA
    8.5 %     10.0 %
AA
    12.2       10.2  
A
    38.5       37.0  
BBB
    36.6       37.2  
BB and below
    4.2       5.6  
 
           
Total
    100.0 %     100.0 %
 
           
Equity Securities
American National’s equity securities by market sector distribution are shown below:
                 
    September 30,     December 31,  
    2011     2010  
 
               
Consumer goods
    20.9 %     20.7 %
Energy and utilities
    17.9       18.5  
Financials
    17.6       16.6  
Information technology
    16.1       16.3  
Healthcare
    11.2       10.4  
Industrials
    8.8       10.3  
Communications
    4.5       4.2  
Materials
    2.8       3.0  
Other
    0.2        
 
           
Total
    100.0 %     100.0 %
 
           

 

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Mortgage loans and investment real estate
American National makes mortgage loans and invests in real estate 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. American National attempts to maintain a diversified portfolio of mortgage loans and real estate properties by considering the property-type as well as the geographic distribution of the property, which is the underlying mortgage collateral or investment property.
Mortgage loans and investment real estate by property-type distribution are as follows:
                                 
    Mortgage Loans     Investment Real Estate  
    September 30,     December 31,     September 30,     December 31,  
    2011     2010     2011     2010  
 
                               
Office buildings
    31.4 %     29.3 %     22.5 %     20.8 %
Industrial
    24.9       31.5       16.8       24.1  
Shopping centers
    19.6       17.3       39.6       35.6  
Hotels and motels
    11.9       12.5       2.1       2.0  
Other
    12.2       9.4       19.0       17.5  
 
                       
Total
    100.0 %     100.0 %     100.0 %     100.0 %
 
                       
Mortgage loans and investment real estate by geographic distribution are as follows:
                                 
    Mortgage Loans     Investment Real Estate  
    September 30,     December 31,     September 30,     December 31,  
    2011     2010     2011     2010  
 
                               
West South Central
    24.8 %     23.0 %     67.6 %     61.2 %
South Atlantic
    21.3       19.3       11.4       18.4  
East North Central
    18.6       20.4       5.4       5.6  
Pacific
    10.3       9.4       2.4       2.2  
Mountain
    7.0       7.4       7.1       1.3  
Middle Atlantic
    5.8       6.2              
East South Central
    5.7       6.5       5.2       10.1  
West North Central
    3.1       4.1       0.9       1.2  
New England
    2.8       3.1              
Other
    0.6       0.6              
 
                       
Total
    100.0 %     100.0 %     100.0 %     100.0 %
 
                       

 

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8. FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amount and estimated fair value of financial instruments are shown below (in thousands):
                                 
    September 30, 2011     December 31, 2010  
    Carrying     Estimated     Carrying     Estimated  
    Amount     Fair Value     Amount     Fair Value  
Financial assets:
                               
Fixed maturity securities
                               
Bonds held-to-maturity
                               
U.S. treasury and other U.S. government corporations and agencies
  $ 22,277     $ 22,508     $ 23,117     $ 23,405  
States of the U.S. and political subdivisions of the states
    411,656       441,375       422,249       422,446  
Foreign governments
    29,038       33,736       29,020       33,930  
Corporate debt securities
    8,041,927       8,591,331       7,293,501       7,738,777  
Residential mortgage-backed securities
    740,757       795,469       661,516       691,820  
Commercial mortgage-backed securities
    31,340       16,647       31,340       13,582  
Collateralized debt securities
    7,142       6,174       8,562       8,315  
Other debt securities
    38,657       42,446       44,245       47,559  
 
                       
Total bonds held-to-maturity
    9,322,794       9,949,686       8,513,550       8,979,834  
 
                       
Bonds available-for-sale
                               
U.S. treasury and other U.S. government corporations and agencies
    11,092       11,092       13,907       13,907  
States of the U.S. and political subdivisions of the states
    614,682       614,682       594,112       594,112  
Foreign governments
    7,437       7,437       6,967       6,967  
Corporate debt securities
    3,417,199       3,417,199       3,201,569       3,201,569  
Residential mortgage-backed securities
    224,704       224,704       271,393       271,393  
Collateralized debt securities
    19,361       19,361       20,709       20,709  
Other debt securities
    15,168       15,168       14,956       14,956  
 
                       
Total bonds available-for-sale
    4,309,643       4,309,643       4,123,613       4,123,613  
 
                       
Total fixed maturity securities
    13,632,437       14,259,329       12,637,163       13,103,447  
 
                       
Equity securities
                               
Common stock
    907,888       907,888       1,045,888       1,045,888  
Preferred stock
    37,606       37,606       36,867       36,867  
 
                       
Total equity securities
    945,494       945,494       1,082,755       1,082,755  
 
                       
Options
    49,707       49,707       66,716       66,716  
Mortgage loans on real estate, net of allowance
    2,793,656       2,913,882       2,679,909       2,703,674  
Policy loans
    389,844       389,844       380,505       380,505  
Short-term investments
    350,430       350,430       486,206       486,206  
Separate account assets
    711,135       711,135       780,563       780,563  
 
                       
Total financial assets
  $ 18,872,703     $ 19,619,821     $ 18,113,817     $ 18,603,866  
 
                       
Financial liabilities:
                               
Investment contracts
  $ 9,458,567       9,458,567     $ 8,586,041     $ 8,586,041  
Liability for embedded derivatives of
                               
equity-indexed annuities
    42,898       42,898       59,644       59,644  
Notes payable
    58,481       58,481       60,140       60,140  
Separate account liabilities
    711,135       711,135       780,563       780,563  
 
                       
Total financial liabilities
  $ 10,271,081     $ 10,271,081     $ 9,486,388     $ 9,486,388  
 
                       
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 equity securities.

 

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Level 2
  Quoted prices in markets that are not active or inputs that are observable 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 evaluated the 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 maturity securities 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 they 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 securities including municipal bonds are based on observable market information rather than market quotes. Accordingly, the estimates of fair value for such fixed maturity securities provided by the pricing service are included in the amount disclosed in Level 2 of the hierarchy.

 

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Additionally, American National holds a small amount of fixed maturity securities that have characteristics that make them unsuitable for matrix pricing. For these fixed maturity 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 these securities are classified as Level 3 measurements.
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, 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 maturity securities. These estimates for equity securities are classified as Level 2 measurements.
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 using American National’s 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.

 

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The quantitative disclosures regarding fair value hierarchy measurements of the financial instruments are shown below (in thousands):
                                 
    Fair Value Measurement as of September 30, 2011 Using:  
            Quoted Prices in             Significant  
            Active Markets for     Significant Other     Unobservable  
    Total Estimated     Identical Assets     Observable Inputs     Inputs  
    Fair Value     (Level 1)     (Level 2)     (Level 3)  
Financial assets:
                               
Fixed maturity securities
                               
Bonds held-to-maturity
                               
U.S. treasury and other U.S. government corporations and agencies
  $ 22,508     $     $ 22,508     $  
States of the U.S. and political subdivisions of the states
    441,375             441,237       138  
Foreign governments
    33,736             33,736          
Corporate debt securities
    8,591,331             8,532,503       58,828  
Residential mortgage-backed securities
    795,469             793,644       1,825  
Commercial mortgage-backed securities
    16,647             16,647        
Collateralized debt securities
    6,174                   6,174  
Other debt securities
    42,446             42,446        
 
                       
Total bonds held-to-maturity
    9,949,686             9,882,721       66,965  
 
                       
Bonds available-for-sale
                               
U.S. treasury and other U.S. government corporations and agencies
    11,092             11,092        
States of the U.S. and political subdivisions of the states
    614,682             612,157       2,525  
Foreign governments
    7,437             7,437        
Corporate debt securities
    3,417,199             3,408,842       8,357  
Residential mortgage-backed securities
    224,704             224,697       7  
Collateralized debt securities
    19,361             19,102       259  
Other debt securities
    15,168             15,168        
 
                       
Total bonds available-for-sale
    4,309,643             4,298,495       11,148  
 
                       
Total fixed maturity securities
    14,259,329             14,181,216       78,113  
 
                       
Equity securities
                               
Common stock
    907,888       907,888              
Preferred stock
    37,606       37,606              
 
                       
Total equity securities
    945,494       945,494              
 
                       
Options
    49,707                   49,707  
Mortgage loans on real estate
    2,913,882             2,913,882        
Short-term investments
    350,430             350,430        
Separate account assets
    711,135             711,135        
 
                       
Total financial assets
  $ 19,229,977     $ 945,494     $ 18,156,663     $ 127,820  
 
                       
Financial liabilities:
                               
Liability for embedded derivatives of equity-indexed annuities
  $ 42,898     $     $     $ 42,898  
Separate account liabilities
    711,135             711,135        
 
                       
Total financial liabilities
  $ 754,033     $     $ 711,135     $ 42,898  
 
                       

 

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    Fair Value Measurement as of December 31, 2010 Using:  
            Quoted Prices in             Significant  
            Active Markets for     Significant Other     Unobservable  
    Total Estimated     Identical Assets     Observable Inputs     Inputs  
    Fair Value     (Level 1)     (Level 2)     (Level 3)  
Financial assets:
                               
Fixed maturity securities
                               
Bonds held-to-maturity
                               
U.S. treasury and other U.S. government corporations and agencies
  $ 23,405     $     $ 23,405     $  
States of the U.S. and political subdivisions of the states
    422,446             422,308       138  
Foreign governments
    33,930             33,930        
Corporate debt securities
    7,738,777             7,680,834       57,943  
Residential mortgage-backed securities
    691,820             689,487       2,333  
Commercial mortgage-backed securities
    13,582             13,582        
Collateralized debt securities
    8,315                   8,315  
Other debt securities
    47,559             47,559        
 
                       
Total bonds held-to-maturity
    8,979,834             8,911,105       68,729  
 
                       
Bonds available-for-sale
                               
U.S. treasury and other U.S. government corporations and agencies
    13,907             13,907        
States of the U.S. and political subdivisions of the states
    594,112             591,587       2,525  
Foreign governments
    6,967             6,967        
Corporate debt securities
    3,201,569             3,182,625       18,944  
Residential mortgage-backed securities
    271,393             271,376       17  
Collateralized debt securities
    20,709             20,447       262  
Other debt securities
    14,956             14,956        
 
                       
Total bonds available-for-sale
    4,123,613             4,101,865       21,748  
 
                       
Total fixed maturity securities
    13,103,447             13,012,970       90,477  
 
                       
Equity securities
                               
Common stock
    1,045,888       1,045,888                  
Preferred stock
    36,867       36,867              
 
                       
Total equity securities
    1,082,755       1,082,755              
 
                       
Options
    66,716                   66,716  
Mortgage loans on real estate
    2,703,674             2,703,674        
Short-term investments
    486,206             486,206        
Separate account assets
    780,563             780,563        
 
                       
Total financial assets
  $ 18,223,361     $ 1,082,755     $ 16,983,413     $ 157,193  
 
                       
Financial liabilities:
                               
Liability for embedded derivatives of equity-indexed annuities
  $ 59,644     $     $     $ 59,644  
Separate account liabilities
    780,563             780,563        
 
                       
Total financial liabilities
  $ 840,207     $     $ 780,563     $ 59,644  
 
                       

 

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For financial instruments 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 shown below at estimated fair value (in thousands)
                                 
            Equity-     Liability for        
    Investment     Indexed     Embedded        
    Securities     Options     Derivatives     Total  
Three Months Ended September 30, 2011
                               
Balance, beginning of period
  $ 76,886     $ 71,525     $ (65,025 )   $ 83,386  
Total realized and unrealized investment gains/losses
                               
Included in other comprehensive income
    1,606                   1,606  
Net fair value change included in realized gains/losses
                       
Net gain for derivatives included in net investment income
          (23,449 )           (23,449 )
Net change included in interest credited
                22,127       22,127  
Purchases, sales and settlements or maturities
                               
Purchases
    1       5,350             5,351  
Sales
    (257 )                 (257 )
Settlements or maturities
    (123 )     (3,719 )           (3,842 )
 
                       
Balance, end of period
  $ 78,113     $ 49,707     $ (42,898 )   $ 84,922  
 
                       
 
                               
Three Months Ended September 30, 2010
                               
Balance, beginning of period
  $ 81,900     $ 41,344     $ (23,341 )   $ 99,903  
Total realized and unrealized investment gains/losses
                               
Included in other comprehensive income
    (174 )                 (174 )
Net fair value change included in realized gains/losses
    7                   7  
Net loss for derivatives included in net investment income
          10,231             10,231  
Net change included in interest credited
                (25,662 )     (25,662 )
Purchases, sales and settlements or maturities
                               
Purchases
    14,895       7,676             22,571  
Sales
    (418 )                 (418 )
Settlements or maturities
          (3,892 )           (3,892 )
Gross transfers out of Level 3
    (1,874 )                 (1,874 )
 
                       
Balance, end of period
  $ 94,336     $ 55,359     $ (49,003 )   $ 100,692  
 
                       
                                 
            Equity-     Liability for        
    Investment     Indexed     Embedded        
    Securities     Options     Derivatives     Total  
Nine Months Ended September 30, 2011
                               
Balance, beginning of period
  $ 90,477     $ 66,716     $ (59,644 )   $ 97,549  
Total realized and unrealized investment gains/losses
                               
Included in other comprehensive income
    1,348                   1,348  
Net fair value change included in realized gains/losses
    168                   168  
Net gain for derivatives included in net investment income
          (18,152 )           (18,152 )
Net change included in interest credited
                16,746       16,746  
Purchases, sales and settlements or maturities
                               
Purchases
    13       14,226             14,239  
Sales
    (10,438 )                 (10,438 )
Settlements or maturities
    (3,455 )     (13,083 )           (16,538 )
 
                       
Balance, end of period
  $ 78,113     $ 49,707     $ (42,898 )   $ 84,922  
 
                       
 
                               
Nine Months Ended September 30, 2010
                               
Balance, beginning of period
  $ 36,966     $ 32,801     $ (22,487 )   $ 47,280  
Total realized and unrealized investment gains/losses
                               
Included in other comprehensive income
    1,004                   1,004  
Net fair value change included in realized gains/losses
    (10 )                 (10 )
Net loss for derivatives included in net investment income
          (1,658 )           (1,658 )
Net change included in interest credited
                (26,516 )     (26,516 )
Purchases, sales and settlements or maturities
                               
Purchases
    65,036       31,141             96,177  
Settlements or maturities
    (1,472 )     (6,925 )           (8,397 )
Gross transfers into Level 3
    5,913                   5,913  
Gross transfers out of Level 3
    (13,101 )                 (13,101 )
 
                       
Balance, end of period
  $ 94,336     $ 55,359     $ (49,003 )   $ 100,692  
 
                       
The transfers into Level 3 were the result of existing securities no longer being priced by the third-party pricing service at the end of the period. In accordance with American National’s pricing methodology, these securities are being valued using similar techniques as the pricing service; however, the service-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 securities being priced by a third-party service at the end of the period, using inputs that are observable or derived from market data, which resulted in classification of these assets as Level 2.
There were no transfers between Level 1 and Level 2 fair value hierarchies.

 

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9. DEFERRED POLICY ACQUISITION COSTS
Deferred policy acquisition costs and premiums are shown below (in thousands):
                                         
                    Accident     Property &        
    Life     Annuity     & Health     Casualty     Total  
Balance at December 31, 2010
  $ 661,377     $ 446,996     $ 64,967     $ 145,086     $ 1,318,426  
 
                             
Additions
    59,672       98,345       9,599       209,542       377,158  
Amortization
    (55,848 )     (67,840 )     (16,011 )     (194,925 )     (334,624 )
Effect of change in unrealized gains/losses on available-for-sale securities
    3,005       (10,625 )                 (7,620 )
 
                             
Net change
    6,829       19,880       (6,412 )     14,617       34,914  
 
                               
Balance at September 30, 2011
  $ 668,206     $ 466,876     $ 58,555     $ 159,703     $ 1,353,340  
 
                             
 
                                       
Premiums for the nine months ended:
                                       
September 30, 2011
  $ 207,786     $ 73,304     $ 174,736     $ 856,958     $ 1,312,784  
 
                             
September 30, 2010
  $ 209,670     $ 132,140     $ 200,553     $ 871,672     $ 1,414,035  
 
                             
Commissions comprise the majority of the additions to deferred policy acquisition costs for each year. All amounts for the present value of future profits resulting from the acquisition of life insurance portfolios have been accounted for in accordance with the relevant accounting literature and are immaterial in all periods presented.
10. LIABILITY FOR UNPAID CLAIMS AND CLAIM ADJUSTMENT EXPENSES
The liability for unpaid claims and claim adjustment expenses for accident and health, and property and casualty insurance is included in the liability for policy and contract claims in the consolidated statements of financial position and represents the amount estimated for claims that have been reported but not settled and claims incurred but not reported. Liability for unpaid claims and claim adjustment expenses are estimated based upon American National’s historical experience and other actuarial assumptions that consider the effects of current developments, anticipated trends and risk management programs, reduced for anticipated salvage and subrogation. The effects of changes in such estimated liability are included in the consolidated results of operations in the period in which the changes occur.
Activities in the liability for unpaid claims and claim adjustment expenses (“claims”) are shown below (in thousands):
                 
    2011     2010  
 
               
Unpaid claims balance at January 1
  $ 1,210,126     $ 1,214,996  
Less reinsurance recoverables
    222,635       252,502  
 
           
Net beginning balance
    987,491       962,494  
 
           
Incurred claims related to:
               
Current
    857,660       919,021  
Prior years
    (47,864 )     (70,174 )
 
           
Total incurred claims
    809,796       848,847  
 
           
Paid claims related to:
               
Current
    536,834       552,163  
Prior years
    290,279       273,531  
 
           
Total paid claims
    827,113       825,694  
 
           
Net balance
    970,174       985,647  
Plus reinsurance recoverables
    253,178       230,077  
 
           
Unpaid claims balance at September 30
  $ 1,223,352     $ 1,215,724  
 
           

 

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The potential uncertainty caused by volatility in loss development profiles is adjusted through the selection of loss development factor patterns for each line of insurance. The net and gross reserve calculations have shown favorable development for the last several years as a result of favorable loss emergence compared to what was implied by the loss development patterns used in the original estimation of losses in prior years. Estimates for ultimate incurred claims and claims adjustment expenses attributable to insured events of prior years decreased by approximately $47,864,000 during the first nine months of 2011 and $70,174,000 during the same period in 2010.
11. NOTES PAYABLE
American National’s real estate holding subsidiaries are partners in certain ventures determined to be VIEs, and are consolidated in American National’s consolidated financial statements. At September 30, 2011, the current portion and the long-term portion of the notes payable to third-party lenders associated with these consolidated VIEs were $0 and $58,481,000, respectively. At December 31, 2010, the current portion and long-term portion of the notes payable to third-party lenders associated with these consolidated VIEs were $47,632,000 and $12,508,000, respectively. The long-term notes payable have interest rates equivalent to adjusted LIBOR plus 1.00% and 2.50%. The average interest rate on the long-term notes payable was 4.33% and 6.38% during the first nine months of 2011 and 2010, respectively, and will mature in 2012, 2016 and 2049. The real estate owned through the respective venture entity secures each of these notes, and American National’s liability for these notes is limited to the amount of its investment in the respective venture, which totaled $21,505,000 at September 30, 2011 and $21,224,000 at December 31, 2010.
12. 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 to the statutory federal income tax rate is shown below (in thousands, except percentages):
                                                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2011     2010     2011     2010  
    Amount     Rate     Amount     Rate     Amount     Rate     Amount     Rate  
 
                                                               
Income tax expense on pre-tax income
  $ 26,283       35.0 %   $ 27,872       35.0 %   $ 61,586       35.0 %   $ 52,435       35.0 %
Tax-exempt investment income
    (1,968 )     (2.6 )     (2,211 )     (2.8 )     (6,035 )     (3.4 )     (6,771 )     (4.5 )
Dividend exclusion
    (1,342 )     (1.8 )     (636 )     (0.8 )     (4,046 )     (2.3 )     (3,485 )     (2.3 )
Miscellaneous tax credits, net
    (1,515 )     (2.0 )     (1,766 )     (2.2 )     (5,644 )     (3.2 )     (5,344 )     (3.6 )
Other items, net
    (2,404 )     (3.2 )     7,998       10.0       (5,078 )     (2.9 )     7,745       5.2  
 
                                               
Total
  $ 19,054       25.4 %   $ 31,257       39.2 %   $ 40,783       23.2 %   $ 44,580       29.8 %
 
                                               

 

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The tax effects of temporary differences that gave rise to the deferred tax assets and liabilities are shown below (in thousands):
                 
    September 30,     December 31,  
    2011     2010  
DEFERRED TAX ASSETS:
               
Investments, principally due to impairment losses
  $ 96,535     $ 106,445  
Investment in real estate and other invested assets principally due to investment valuation allowances
    8,631       9,237  
Policyholder funds, principally due to policy reserve discount
    231,301       230,496  
Policyholder funds, principally due to unearned premium reserve
    33,381       31,840  
Non-qualified pension
    28,841       29,345  
Participating policyholders’ surplus
    34,403       31,180  
Pension
    37,589       37,759  
Commissions and other expenses
    14,470       13,870  
Tax carryforwards
    30,408       26,599  
Other assets
    11,577        
 
           
Gross deferred tax assets
    527,136       516,771  
 
           
 
               
DEFERRED TAX LIABILITIES:
               
Available-for-sale securities, principally due to net unrealized gains
    (164,848 )     (195,840 )
Investment in bonds, principally due to accrual of discount on bonds
    (11,033 )     (16,639 )
Deferred policy acquisition costs, due to difference between GAAP and tax amortization methods
    (361,428 )     (350,981 )
Property, plant and equipment, principally due to difference between
               
GAAP and tax depreciation methods
    (10,248 )     (5,668 )
Other liabilities
          (1,380 )
 
           
Gross deferred tax liabilities
    (547,557 )     (570,508 )
 
           
Total net deferred tax asset (liability)
  $ (20,421 )   $ (53,737 )
 
           
Management believes that a sufficient level of taxable income will be achieved to utilize the deferred tax assets of the companies in the consolidated federal tax return; therefore, no valuation allowance was recorded as of September 30, 2011 or December 31, 2010. However, if not utilized beforehand, approximately $30,408,000 in ordinary loss tax carryforwards will expire at the end of tax year 2030.
American National recognizes interest expense and penalties related to uncertain tax positions. Interest expense and penalties are included in the “Other operating expenses” line in the consolidated statements of operations. No interest or penalties were recognized or accrued for the nine months ended September 30, 2011 or year ended December 31, 2010. Management does not believe that there are any uncertain tax benefits that could be recognized within the next twelve months that would affect American National’s effective tax rate.
The statute of limitations for the examination of federal income tax returns by the Internal Revenue Service (“IRS”) for years 2006 to 2010 either has 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.
Approximately $34,441,000 and $35,893,000 in net federal income taxes were paid to the IRS during the nine months ended September 30, 2011 and 2010, respectively.

 

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13. COMPONENTS OF COMPREHENSIVE INCOME (LOSS)
The details on the unrealized gains and losses included in comprehensive income (loss), and the related tax effects thereon, are shown below (in thousands):
                         
    Before Federal     Federal Income     Net of Federal  
    Income Tax     Tax     Income Tax  
September 30, 2011
                       
Unrealized holding gains (losses) during the period
  $ (61,422 )   $ (21,498 )   $ (39,924 )
Reclassification adjustment for net (gains) losses realized in net income
    (27,387 )     (9,494 )     (17,893 )
 
                 
Unrealized gains (losses) on available-for-sale securities
    (88,809 )     (30,992 )     (57,817 )
Adjustment to deferred policy acquisition costs
    (7,620 )     (2,725 )     (4,895 )
Unrealized (gains) losses on investments attributable to participating policyholders’ interest
    1,718       601       1,117  
 
                 
Net unrealized gain (loss)
  $ (94,711 )   $ (33,116 )   $ (61,595 )
 
                 
 
                       
September 30, 2010
                       
Unrealized holding gains (losses) during the period
  $ 271,202     $ 94,897     $ 176,305  
Reclassification adjustment for net (gains) losses realized in net income
    (28,902 )     (10,116 )     (18,786 )
 
                 
Unrealized gains (losses) on available-for-sale securities
    242,300       84,781       157,519  
Adjustment to deferred policy acquisition costs
    (80,063 )     (28,021 )     (52,042 )
Unrealized (gains) losses on investments attributable to participating policyholders’ interest
    (9,023 )     (3,158 )     (5,865 )
 
                 
Net unrealized gain (loss)
  $ 153,214     $ 53,602     $ 99,612  
 
                 
14. 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 are shown below:
                 
    September 30,     December 31,  
    2011     2010  
Common stock
               
Shares issued
    30,832,449       30,832,449  
Treasury shares
    (4,011,165 )     (4,011,472 )
Restricted shares
    (261,334 )     (261,334 )
 
           
Unrestricted outstanding shares
    26,559,950       26,559,643  
 
           
Stock-based compensation
American National has one stock-based compensation plan which allows for grants of Non-Qualified Stock Options, Stock Appreciation Rights (“SAR”), Restricted Stock (“RS”) Awards, Restricted Stock Units (“RSU”), Performance Awards, Incentive Awards or 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.
RS 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. Restricted stock has been granted, with a total of 340,334 shares granted at an exercise price of zero, of which 261,334 shares are unvested. The compensation expense recorded for the three months and nine months ended September 30, 2011 was $678,000 and $2,011,000, respectively. The compensation expense recorded for the three and nine months ended September 30, 2010 was $630,000 and $1,970,000, respectively.

 

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The SARs give the holder the right to cash 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 SARs vest at a rate of 20% per year for 5 years and expire 5 years after the vesting period. American National uses the Black-Scholes option pricing model to calculate the fair value and compensation expense for SARs. The fair value of the SARs was $4,000 and $17,000 at September 30, 2011 and December 31, 2010, respectively. Compensation income was recorded totaling $9,000 and $13,000 for the three and nine months ended September 30, 2011, respectively. Compensation income was recorded totaling $23,000 and $1,606,000 for the three and nine months ended September 30, 2010, respectively.
RSUs are awarded as part of American National’s incentive compensation plan. In 2011, RSUs were also awarded as part of the Board of Directors compensation. The RSUs are converted to American National’s common stock on a one-for-one basis subject to a two-year cliff or three-year graded vesting requirement, depending on the grant date. These awards result in compensation expense to American National over the vesting period. Compensation expense was $530,000 and $1,343,000 for the three and nine months ended September 30, 2011, respectively. Compensation expense was $130,000 and $390,000 for the three and nine months ended September 30, 2010, respectively.
SAR, RS and RSU information for the period indicated is shown below:
                                                 
            SAR Weighted-             RS Weighted-             RSU Weighted-  
            Average Grant             Average Grant             Average Grant  
    SAR Shares     Date Fair Value     RS Shares     Date Fair Value     RS Units     Date Fair Value  
 
                                               
Outstanding at December 31, 2010
    144,727     $ 109.40       261,334     $ 102.98       9,419     $ 109.29  
 
                                         
Granted
                            61,481       79.63  
Exercised
    (133 )     66.76                   (480 )     79.63  
Forfeited
    (4,358 )     115.63                   (854 )     86.47  
Expired
    (12,800 )     101.11                          
 
                                         
Outstanding at September 30, 2011
    127,436     $ 110.06       261,334     $ 102.98       69,566     $ 83.56  
 
                                         
The weighted-average contractual remaining life for the outstanding SAR shares as of September 30, 2011, is 3.8 years. The weighted-average exercise price, which is the same with the weighted-average grant date fair value above, for these shares is $110.06 per share. Of the shares outstanding, 92,407 are exercisable at a weighted-average exercise price of $108.96 per share.
The weighted-average contractual remaining life for the outstanding RS shares as of September 30, 2011, is 5.3 years. The weighted-average price at the date of grant for these shares is $102.98 per share. None of the shares outstanding were exercisable.
The weighted-average contractual remaining life for the outstanding RSUs as of September 30, 2011, is 2.3 years. The weighted-average price at the date of grant for these units is $83.56 per share. None of the outstanding units were exercisable.

 

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Earnings (losses) per share
Basic earnings (losses) per share was calculated using a weighted-average number of shares outstanding of 26,559,865 and 26,558,832 at September 30, 2011 and 2010, respectively. The Restricted Stock resulted in diluted earnings per share as follows:
                                 
    Three months ended September 30,     Nine months ended September 30,  
    2011     2010     2011     2010  
Weighted average shares outstanding
    26,559,950       26,558,832       26,559,865       26,558,832  
Incremental shares from restricted stock
    158,514       119,562       146,933       119,562  
 
                       
Total shares for diluted calculations
    26,718,464       26,678,394       26,706,798       26,678,394  
 
                               
Net income (loss) from continuing operations attributable to American National Insurance Company and Subsidiaries
  $ 57,569,000     $ 47,569,000     $ 136,109,000     $ 106,968,000  
Net income (loss) from discontinued operations
          (513,000 )           1,488,000  
 
                       
Net income (loss) attributable to American National Insurance Company and Subsidiaries
  $ 57,569,000     $ 47,056,000     $ 136,109,000     $ 108,456,000  
 
                       
 
                               
Basic earnings (loss) per share from continued operations
  $ 2.17     $ 1.79     $ 5.12     $ 4.02  
Basic earnings (loss) per share from discontinued operations
        $ (0.02 )         $ 0.06  
 
                       
 
                               
Basic earnings (loss) per share
  $ 2.17     $ 1.77     $ 5.12     $ 4.08  
 
                       
 
                               
Diluted earnings (loss) per share from continued operations
  $ 2.15     $ 1.78     $ 5.10     $ 4.01  
Diluted earnings (loss) per share from discontinued operations
          (0.02 )           0.06  
 
                       
 
                               
Diluted earnings (loss) per share
  $ 2.15     $ 1.76     $ 5.10     $ 4.07  
 
                       
Dividends
American National Insurance Company’s payment of dividends to stockholders is restricted by statutory regulations. 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 determined on a GAAP basis over that determined on a statutory basis. American National Insurance Company’s statutory capital and surplus was $2,008,626,000 at September 30, 2011 and $1,954,149,000 at December 31, 2010.
The same restrictions on amounts that can transfer in the form of dividends, loans, or advances to the parent company apply to American National’s insurance subsidiaries. Dividends received by the parent company from its non-insurance subsidiaries was zero for the three and nine months ended September 30, 2011 and $2,000,000 and $6,000,000 for the three and nine months ended September 30, 2010, respectively.
At September 30, 2011, approximately $1,383,199,000 of American National’s consolidated stockholders’ equity represents net assets of its insurance subsidiaries, compared to approximately $1,396,736,000 at December 31, 2010. Any transfer of these net assets to American National Insurance Company would be subject to statutory restrictions or approval.
Noncontrolling interests
American National County Mutual Insurance Company (“County Mutual”) is a mutual insurance company that is owned by its policyholders. County Mutual 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 of American National. The interests that the policyholders of County Mutual have in the financial position of County Mutual is reflected as noncontrolling interest totaling $6,750,000 at September 30, 2011 and December 31, 2010.
American National’s wholly-owned subsidiary, ANTAC, Inc., is a partner in various joint ventures. ANTAC exercises significant control or ownership to certain 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 noncontrolling interests. Noncontrolling interests were a deficit of $16,051,000 and $2,708,000 at September 30, 2011 and December 31, 2010, respectively.

 

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15. 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 and variable life insurance on a national basis primarily through employee 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 financial institutions, multiple-line agents and employee agents.
    The Health segment’s primary lines of business are Medicare Supplement, stop loss, other supplemental health products and credit disability insurance. Health products are typically distributed through independent agents and managing general underwriters.
    The Property and Casualty segment writes personal, commercial and credit-related property insurance. These products are primarily sold through multiple-line agents and independent agents.
    The Corporate and Other business segment consists of net investment income on the investments not allocated to the insurance segments and the operations of non-insurance lines of business.
The accounting policies of the segments are the same as those referred to in Note 2, Summary of Significant Accounting Policies and Practices, of the Notes to the Unaudited Consolidated Financial Statements. 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:
    Recurring income from bonds and mortgage loans is allocated based on the funds accumulated by each line of business at the average yield available from these assets.
    Net investment income from all other assets is allocated to the insurance segments in accordance with the amount of equity allocated to each segment, with the remainder recorded in the Corporate and Other business segment.
    Expenses are allocated based upon various factors, including premium and commission ratios within the respective operating segments.
    Realized gains or losses on investments and equity in earnings of unconsolidated affiliates are allocated to the Corporate and Other business segment.
    Federal income taxes have been applied to the net earnings of each insurance segment based on a fixed tax rate. Any difference between the amount allocated to the insurance segments and the total federal income tax is allocated to the Corporate and Other business segment.
Beginning in 2011, American National discontinued the allocation of a “default charge” to its segments to improve the comparability for measuring business results between segments and between periods. This default charge represented compensation to the Corporate and Other business segment for the risk it assumed for realized investment losses through a charge to the insurance segments. Allocation of such charge was reducing the amount of net investment income allocated to those insurance segments. Net investment income of each business segment in the prior year was reclassified to be comparable with the current year’s measurement basis.

 

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The following tables summarize results of operations by operating segments (in thousands):
                                                 
    Three months ended September 30, 2011  
                            Property &     Corporate &        
    Life     Annuity     Health     Casualty     Other     TOTAL  
Premiums and other revenues:
                                               
Premiums
  $ 71,926     $ 21,704     $ 57,708     $ 289,796     $     $ 441,134  
Other policy revenues
    42,831       3,519                         46,350  
Net investment income
    59,496       121,359       3,331       17,852       23,904       225,942  
Other income
    808       64       3,354       2,504       508       7,238  
 
                                   
Total operating revenues
    175,061       146,646       64,393       310,152       24,412       720,664  
Realized gains (losses)on investments
                            12,680       12,680  
 
                                   
Total premium and other revenues
    175,061       146,646       64,393       310,152       37,092       733,344  
 
                                   
 
                                               
Benefits, losses and expenses:
                                               
Policyholder benefits
    75,472       29,960                         105,432  
Claims incurred
                38,691       215,226             253,917  
Interest credited to policyholders’ account balances
    15,476       67,337                         82,813  
Commissions for acquiring and servicing policies
    22,897       21,093       6,636       59,354             109,980  
Other operating expenses
    43,178       16,260       11,089       30,150       10,990       111,667  
Change in deferred policy acquisition costs
    1,012       (2,285 )     2,717       (7,002 )           (5,558 )
 
                                   
Total benefits, losses and expenses
    158,035       132,365       59,133       297,728       10,990       658,251  
 
                                   
 
                                               
Income (loss) from continuing operations before federal income taxes, and equity in earnings/losses of unconsolidated affiliates
  $ 17,026     $ 14,281     $ 5,260     $ 12,424     $ 26,102     $ 75,093  
 
                                   
                                                 
    Three months ended September 30, 2010  
                            Property &     Corporate &        
    Life     Annuity     Health     Casualty     Other     TOTAL  
Premiums and other revenues:
                                               
Premiums
  $ 71,352     $ 51,180     $ 64,288     $ 297,703     $     $ 484,523  
Other policy revenues
    42,837       3,505                         46,342  
Net investment income
    58,426       143,154       3,753       17,751       14,997       238,081  
Other income
    996       121       2,364       2,226       437       6,144  
 
                                   
Total operating revenues
    173,611       197,960       70,405       317,680       15,434       775,090  
Realized gains (losses) on investments
                            18,626       18,626  
 
                                   
Total premiums and other revenues
    173,611       197,960       70,405       317,680       34,060       793,716  
 
                                   
 
                                               
Benefits, losses and expenses:
                                               
Policyholder benefits
    73,402       56,963                         130,365  
Claims incurred
                43,140       208,917             252,057  
Interest credited to policyholders’ account balances
    16,283       94,564                         110,847  
Commissions for acquiring and servicing policies
    23,851       24,795       8,150       63,612             120,408  
Other operating expenses
    45,229       18,572       10,694       30,758       8,958       114,211  
Change in deferred policy acquisition costs
    (1,759 )     (11,644 )     891       (1,294 )           (13,806 )
 
                                   
Total benefits, losses and expenses
    157,006       183,250       62,875       301,993       8,958       714,082  
 
                                   
 
                                               
Income (loss) from continuing operations before federal income taxes, and equity in earnings/losses of unconsolidated affiliates
  $ 16,605     $ 14,710     $ 7,530     $ 15,687     $ 25,102     $ 79,634  
 
                                   

 

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    Nine months ended September 30, 2011  
                            Property &     Corporate &        
    Life     Annuity     Health     Casualty     Other     TOTAL  
Premiums and other revenues:
                                               
Premiums
  $ 207,786     $ 73,304     $ 174,736     $ 856,958     $     $ 1,312,784  
Other policy revenues
    129,742       12,118                         141,860  
Net investment income
    178,989       413,683       10,172       54,230       58,112       715,186  
Other income
    2,506       185       9,874       6,004       2,183       20,752  
 
                                   
Total operating revenues
    519,023       499,290       194,782       917,192       60,295       2,190,582  
Realized gains (losses) on investments
                            57,637       57,637  
 
                                   
Total premium and other revenues
    519,023       499,290       194,782       917,192       117,932       2,248,219  
 
                                   
 
                                               
Benefits, losses and expenses:
                                               
Policyholder benefits
    232,013       102,770                         334,783  
Claims incurred
                119,764       685,168             804,932  
Interest credited to policyholders’ account balances
    45,612       242,731                         288,343  
Commissions for acquiring and servicing policies
    66,680       80,642       20,202       172,079             339,603  
Other operating expenses
    129,860       57,296       35,085       92,042       32,850       347,133  
Change in deferred policy acquisition costs
    (3,824 )     (30,505 )     6,412       (14,617 )           (42,534 )
 
                                   
Total benefits, losses and expenses
    470,341       452,934       181,463       934,672       32,850       2,072,260  
 
                                   
 
                                               
Income (loss) from continuing operations before federal income taxes, and equity in earnings/losses of unconsolidated affiliates
  $ 48,682     $ 46,356     $ 13,319     $ (17,480 )   $ 85,082     $ 175,959  
 
                                   
                                                 
    Nine months ended September 30, 2010  
                            Property &     Corporate &        
    Life     Annuity     Health     Casualty     Other     TOTAL  
Premiums and other revenues:
                                               
Premiums
  $ 209,670     $ 132,140     $ 200,553     $ 871,672     $     $ 1,414,035  
Other policy revenues
    126,613       11,453                         138,066  
Net investment income
    175,732       387,439       11,770       55,096       37,927       667,964  
Other income
    2,786       282       7,654       6,121       2,727       19,570  
 
                                   
Total operating revenues
    514,801       531,314       219,977       932,889       40,654       2,239,635  
Realized gains (losses) on investments
                            50,437       50,437  
 
                                   
Total premium and other revenues
    514,801       531,314       219,977       932,889       91,091       2,290,072  
 
                                   
 
                                               
Benefits, losses and expenses:
                                               
Policyholder benefits
    220,408       155,100                         375,508  
Claims incurred
                141,330       702,134             843,464  
Interest credited to policyholders’ account balances
    44,277       240,456                         284,733  
Commissions for acquiring and servicing policies
    67,513       75,944       27,265       172,460             343,182  
Other operating expenses
    131,604       52,456       35,806       94,028       26,293       340,187  
Change in deferred policy acquisition costs
    (5,903 )     (40,584 )     3,784       (4,112 )           (46,815 )
 
                                   
Total benefits, losses and expenses
    457,899       483,372       208,185       964,510       26,293       2,140,259  
 
                                   
 
                                               
Income (loss) from continuing operations before federal income taxes, and equity in earnings/losses of unconsolidated affiliates
  $ 56,902     $ 47,942     $ 11,792     $ (31,621 )   $ 64,798     $ 149,813  
 
                                   

 

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16. COMMITMENTS AND CONTINGENCIES
Commitments
In the ordinary course of operations, American National and its subsidiaries had commitments outstanding at September 30, 2011, to purchase, expand or improve real estate, to fund mortgage loans, and to purchase other invested assets aggregating $274,457,000, of which $173,999,000 is expected to be funded in 2011. The remaining balance of $100,458,000 will be funded in 2012 and beyond. As of September 30, 2011, all of the mortgage loan commitments have fixed interest rates.
In September 2011, American National renewed a previous $100,000,000 short-term variable rate borrowing facility containing a $55,000,000 subfeature for the issuance of letters of credit. The renewal contained a slight modification to duration from a mid-month to quarter-end expiration. Borrowings under the facility are at the discretion of the lender and would be used only for funding American National’s working capital requirements. The combination of borrowings and outstanding letters of credit cannot exceed $100,000,000 at any time. As of September 30, 2011 and December 31, 2010, the outstanding letters of credit were $33,823,000 and $37,452,000, respectively, and there were no borrowings on this facility to meet liquidity requirements. This facility expires on September 30, 2012. American National expects it will be renewed on substantially equivalent terms upon expiration.
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 loans. As the cash values of the life insurance policies always equal or exceed the balance of the loans, management does not foresee any loss on these guarantees. The total amount of the guarantees outstanding as of September 30, 2011, was approximately $206,513,000 while the total cash value of the related life insurance policies was approximately $209,109,000.
Litigation
As previously disclosed, American National negotiated a settlement agreement with Plaintiff in a putative class action lawsuit, Rand v. American National Insurance Company (U.S. District Court for the Northern District of California, filed February 12, 2009). During the quarter ended March 31, 2011, American National reserved $12,000,000 for this settlement agreement. In September of 2011, the Court entered an Order approving the Settlement and entered Final Judgment on the case. American National is in the process of completing administration of the settlement pursuant to the terms of the settlement agreement and anticipates finalizing administration at the beginning of 2012.
American National and certain subsidiaries are defendants in 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. We have provided accruals for these items to the extent we deem the losses probable and reasonably estimable. 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.
In addition, 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.

 

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17. DISCONTINUED OPERATIONS
On December 31, 2010, American National sold its wholly-owned broker-dealer subsidiary, Securities Management & Research, Inc. (“SM&R”), to a third-party financial services corporation. The sale qualified for discontinued operations accounting and accordingly, the results of operations for this subsidiary are presented as discontinued operations in American National’s consolidated statements of operations for the three and nine months ended September 30, 2010. SM&R had previously been a component of the Corporate and Other business segment.
The following table summarizes income (loss) from discontinued operations (in thousands):
                 
    Three months ended     Nine months ended  
    September 30,     September 30,  
    2010     2010  
Revenues:
               
Net investment income
  $     $ 145  
Realized investment gains (losses)
    591       3,521  
Other Income
    1,997       8,504  
 
           
 
               
Total revenues
    2,588       12,170  
 
           
 
               
Expenses
               
Other operating costs
    2,378       8,928  
 
           
 
               
Total expenses
    2,378       8,928  
 
           
 
               
Income (loss) from discontinued operations
    210       3,242  
 
               
Impairment
    (1,000 )     (1,000 )
 
           
 
               
Income (loss) from discontinued operations before income tax
    (790 )     2,242  
 
               
Income tax expense (benefit)
    (277 )     754  
 
           
 
               
Income (loss) from discontinued operations, net of tax
  $ (513 )   $ 1,488  
 
           
Cash flows related to discontinued operations have been combined with cash flows from continuing operations within each category of the consolidated statements of cash flows, the effect of which is immaterial to all periods presented.

 

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18. 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, accident and health insurance contracts and legal services. The impact on the consolidated financial statements of the significant related party transactions for the periods indicated is shown below (in thousands):
                                     
                        Amount due to/(from)  
        Dollar Amount of Transactions     American National  
        Nine months ended September 30,     September 30,     December 31,  
Related Party   Financial Statement Line Impacted   2011     2010     2011     2010  
 
               
Gal-Tex Hotel Corporation
  Mortgage loans on real estate   $ 738     $ 687     $ 10,212     $ 10,951  
Gal-Tex Hotel Corporation
  Net investment income     578       629       62       66  
Gal-Tex Hotel Corporation
  Other operating expenses     199       196       20       21  
Gal-Tex Hotel Corporation
  Accident and health premiums     32       56       32       56  
Moody Insurance Group, Inc.
  Commissions for acquiring and servicing policies     2,409       2,249       (346 )     (7,173 )
Moody Insurance Group, Inc.
  Other operating expenses     97       103              
National Western Life Ins. Co.
  Accident and health premiums     152       116       17       14  
National Western Life Ins. Co.
  Other operating expenses     1,031       925       (76 )     (71 )
Moody Foundation
  Accident and health premiums     234       206       24       7  
Greer, Herz and Adams, LLP
  Other operating expenses     5,830       8,387       348       251  
Information Regarding Related Parties and Transactions
Mortgage Loans to Gal-Tex Hotel Corporation (“Gal-Tex”): The Moody Foundation and the Libbie Shearn Moody Trust own 34.0% and 50.2%, respectively, of Gal-Tex Hotel Corporation (“Gal-Tex”). The Moody Foundation and the Libbie Shearn Moody Trust also own approximately 22.9% and 37.1%, respectively, of American National. American National held a first mortgage loan issued to Gal-Tex secured by hotel property in San Antonio, Texas. This loan was originated in 1999, had a balance of $10,212,000 as of September 30, 2011, has a current interest rate of 7.30%, and has a final maturity date of April 1, 2019. This loan is current as to principal and interest payments.
Management Contracts with Gal-Tex: American National entered into management contracts with a subsidiary of Gal-Tex for the management of a hotel and adjacent fitness center owned by American National. Such contracts can be terminated upon thirty days’ prior written notice.
Transactions with Moody Insurance Group, Inc.: Robert L. Moody, Jr. (“RLM Jr.”) is the son of American National’s Chairman and Chief Executive Officer, brother of two of American National’s directors, and he is one of American National’s advisory directors. RLM Jr., mainly through his wholly-owned insurance agency, Moody Insurance Group, Inc. (“MIG”), has entered into a number of agency agreements with American National and some of its subsidiaries in connection with the marketing of insurance products.
MIG and American National are also parties to a Consulting and Special Marketing Agreement concerning development and marketing of new products. In addition to consulting fees paid under such agreement, compensation also includes dividends on shares of American National’s Restricted Stock granted to MIG as a consultant.

 

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Health Insurance Contracts with Certain Affiliates: American National’s Merit Plan is insured by National Western Life Insurance Company (“National Western”). Robert L. Moody, Sr., American National’s Chairman of the Board and Chief Executive Officer, is also the Chairman of the Board, Chief Executive Officer, and controlling stockholder of National Western. The Merit Plan is an insured medical plan that supplements American National’s core medical insurance plan for certain officers by providing coverage for co-pays, deductibles, and other out-of-pocket expenses that are not covered by the core medical insurance plan, limited to medical expenses that could be deducted by the recipient for federal income tax purposes.
In addition, American National insures substantially similar plans offered by National Western, Gal-Tex, and The Moody Foundation to certain of their officers. American National also insures The Moody Foundation’s basic health insurance plan.
Transactions with Greer, Herz & Adams, L.L.P.: Irwin M. Herz, Jr. is one of American National’s advisory directors and a Partner with Greer, Herz & Adams, L.L.P. which serves as American National’s General Counsel.

 

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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 financial condition and results of operations for the three and nine months ended September 30, 2011 and 2010 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 unaudited consolidated financial statements included in Item 1, Financial Statements, of this Form 10-Q.
INDEX
         
    43  
 
       
    44  
 
       
    44  
 
       
    44  
 
       
    44  
 
       
    45  
 
       
    46  
 
       
    48  
 
       
    52  
 
       
    54  
 
       
    59  
 
       
    59  
 
       
    62  
 
       
    63  
 
       
    64  
 
       
    64  
 
       
    64  

 

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Forward-Looking Statements
Certain statements contained herein are forward-looking statements. The forward-looking statements 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 as anticipated. These forward-looking statements are not a guarantee of future performance and involve risks and uncertainties. There are certain important risks and uncertainties that could cause actual results to differ, possibly materially, from expectations or estimates reflected in such forward-looking statements. These factors include among others:
    domestic and international economic and financial factors, including the performance and fluctuations of fixed income, equity, real estate, credit capital and other financial markets;
    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;
    the effect of increased claims activity from natural or man-made catastrophes, pandemic disease, or other events resulting in catastrophic loss of life or property;
    adverse determinations in litigation or regulatory matters and our exposure to contingent liabilities, including and in connection with our divestiture or winding down of businesses;
    inherent uncertainties in the determination of investment allowances and impairments and in the determination of the valuation allowance on the deferred income tax asset;
    investment losses and defaults;
    competition in our product lines;
    attraction and retention of qualified employees and agents;
    ineffectiveness of risk management policies and procedures in identifying, monitoring and managing risks;
    the availability, affordability and adequacy of reinsurance protection;
    the effects of emerging claim and coverage issues;
    the cyclical nature of the insurance business;
    the effects of inflation on claim payments in our property and casualty and health lines;
    interest rate fluctuations;
    changes in our experiences related to deferred policy acquisition costs;
    the ability and willingness of counterparties to our reinsurance arrangements and derivative instruments to pay balances due to us;
    changes in our financial strength ratings;
    domestic or international military actions;
    the effects of extensive government regulation of the insurance industry;
    changes in tax and securities law;
    changes in statutory or U.S. generally accepted accounting principles (“GAAP”), practices or policies;
    regulatory or legislative changes or developments;
    the effects of unanticipated events on our disaster recovery and business continuity planning;
    failures or limitations of our computer, data security and administration systems;
    risks of employee error or misconduct;
    the introduction of alternative healthcare solutions; and
    changes in assumptions for retirement expense.

 

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We describe these risks and uncertainties in detail in Item IA, Risk Factors, in our 2010 Annual Report on Form 10-K filed with the SEC on March 2, 2011, as supplemented by our discussion in Part II Item 1A, Risk Factors, to this Form 10Q. 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
We are a diversified insurance and financial services company, offering a broad spectrum of life, annuity, health, and property and casualty insurance products. Chartered in 1905, we are headquartered in Galveston, Texas. We operate in all 50 states, the District of Columbia, Guam, American Samoa and Puerto Rico.
General Trends
There were no material changes to the general trends we are experiencing, as discussed in the MD&A included in our 2010 Annual Report on Form 10-K filed with the SEC on March 2, 2011.
Critical Accounting Estimates
The unaudited interim consolidated financial statements have been prepared in conformity with GAAP. In addition to GAAP, insurance companies apply specific SEC regulations when preparing the consolidated financial statements. The preparation of the consolidated financial statements in accordance with GAAP requires us to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and notes. Actual results could differ from results reported using those estimates.
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, interest rates, and property and casualty frequency, severity, claim reporting and settlement patterns. 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 our critical accounting estimates, see the MD&A in our 2010 Annual Report on Form 10-K filed with the SEC on March 2, 2011. There were no material changes in accounting policies from December 31, 2010.
Recently Issued Accounting Pronouncements
Refer to Note 3, Recently Issued Accounting Pronouncements, of the Notes to the Unaudited Consolidated Financial Statements.

 

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Consolidated Results of Operations
The following is a discussion of our consolidated results of operations. For discussions of our segment results, see the “Results of Operations and Related Information by Segment” section. The following table sets forth the consolidated results of operations (in thousands):
                                                 
    Three months ended September 30,     Nine months ended September 30,  
    2011     2010     Change     2011     2010     Change  
Premiums and other revenues:
                                               
Premiums
  $ 441,134     $ 484,523     $ (43,389 )   $ 1,312,784     $ 1,414,035     $ (101,251 )
Other policy revenues
    46,350       46,342       8       141,860       138,066       3,794  
Net investment income
    225,942       238,081       (12,139 )     715,186       667,964       47,222  
Realized investments gains, net
    12,680       18,626       (5,946 )     57,637       50,437       7,200  
Other income
    7,238       6,144       1,094       20,752       19,570       1,182  
 
                                   
Total premiums and other revenues
    733,344       793,716       (60,372 )     2,248,219       2,290,072       (41,853 )
 
                                   
 
                                               
Benefits, losses and expenses:
                                               
Policyholder benefits
    105,432       130,365       (24,933 )     334,783       375,508       (40,725 )
Claims incurred
    253,917       252,057       1,860       804,932       843,464       (38,532 )
Interest credited to policyholders’ account balances
    82,813       110,847       (28,034 )     288,343       284,733       3,610  
Commissions for acquiring and servicing policies
    109,980       120,408       (10,428 )     339,603       343,182       (3,579 )
Other operating expenses
    111,667       114,211       (2,544 )     347,133       340,187       6,946  
Change in deferred policy acquisition costs (1)
    (5,558 )     (13,806 )     8,248       (42,534 )     (46,815 )     4,281  
 
                                   
Total benefits and expenses
    658,251       714,082       (55,831 )     2,072,260       2,140,259       (67,999 )
 
                                   
 
                                               
Income before other items and federal income taxes
  $ 75,093     $ 79,634     $ (4,541 )   $ 175,959     $ 149,813     $ 26,146  
 
                                   
     
(1)   A negative amount of net change indicates more expense was deferred than amortized and represents a decrease to expenses in the periods indicated.
Consolidated earnings decreased during the three months ended September 30, 2011 compared to 2010 primarily as a result of:
    a decrease in our property and casualty segment earnings due to weather-related events,
 
    a decrease in health segment earnings, as a result of discontinued products and
 
    decreases in net investment income and realized investment gains due to negative market value adjustments for option investments, which support our equity-indexed annuity products.
The decrease was partially offset by decreases in interest credited to policyholders’ account balances (“interest credited”).
Consolidated earnings increased during the nine months ended September 30, 2011 compared to 2010 primarily as a result of:
    improved property and casualty segment results and
 
    an increase in net investment income primarily due to an increase in invested assets.
In the Consolidated Results of Operations above and in the segment discussions that follow, certain amounts in the prior year have been reclassified to conform to the current year presentation. See Note 15, Segment Information, of the Notes to the Unaudited Consolidated Financial Statements.

 

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Results of Operations and Related Information by Segment
Life
The Life segment markets traditional life insurance products such as whole and term life, and interest-sensitive life insurance products such as universal life and variable universal life as well as indexed universal life. These products are marketed on a nationwide basis through employee agents, multiple-line agents, independent agents, brokers and direct marketing channels. Life segment financial results for the periods indicated were as follows (in thousands):
                                                 
    Three months ended September 30,     Nine months ended September 30,  
    2011     2010     Change     2011     2010     Change  
Premiums and other revenues:
                                               
Premiums
  $ 71,926     $ 71,352     $ 574     $ 207,786     $ 209,670     $ (1,884 )
Other policy revenues
    42,831       42,837       (6 )     129,742       126,613       3,129  
Net investment income
    59,496       58,426       1,070       178,989       175,732       3,257  
Other income
    808       996       (188 )     2,506       2,786       (280 )
 
                                   
Total premiums and other revenues
    175,061       173,611       1,450       519,023       514,801       4,222  
 
                                   
 
                                               
Benefits, losses and expenses:
                                               
Policyholder benefits
    75,472       73,402       2,070       232,013       220,408       11,605  
Interest credited to policyholders’ account balances
    15,476       16,283       (807 )     45,612       44,277       1,335  
Commissions for acquiring and servicing policies
    22,897       23,851       (954 )     66,680       67,513       (833 )
Other operating expenses
    43,178       45,229       (2,051 )     129,860       131,604       (1,744 )
Change in deferred policy acquisition costs (1)
    1,012       (1,759 )     2,771       (3,824 )     (5,903 )     2,079  
 
                                   
Total benefits and expenses
    158,035       157,006       1,029       470,341       457,899       12,442  
 
                                   
 
                                               
Income before other items and federal income taxes
  $ 17,026     $ 16,605     $ 421     $ 48,682     $ 56,902     $ (8,220 )
 
                                   
     
(1)   A negative amount of net change indicates more expense was deferred than amortized and represents a decrease to expenses in the periods indicated.
Earnings for the three months ended September 30, 2011 were relatively flat compared to the same period for 2010. For the nine months ended September 30, 2011, earnings decreased compared to the same periods in 2010, primarily attributable to an increase in policyholder benefits.
Premiums and other revenues
Changes in premiums are primarily driven by new sales during the period and the persistency of in-force policies. Premiums were relatively flat in the three and nine months ended September 30, 2011.
Other policy revenues include mortality charges, earned policy service fees and surrender charges on interest-sensitive life insurance policies. The increase during the nine-month period was primarily driven by growth in total mortality charges, as well as an increase in terminations during the first quarter, resulting in additional surrender charges and related fees.
Benefits, losses and expenses
Policyholder benefits increased for the three and nine months ended September 30, 2011 compared to 2010. The increases were the result of higher mortality costs net of reinsurance, primarily due to an increase in claims, most notably on larger face-value policies.

 

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The following table presents the components of the change in DAC (in thousands):
                                                 
    Three months ended September 30,     Nine months ended September 30,  
    2011     2010     Change     2011     2010     Change  
 
               
Acquisition cost capitalized
  $ 20,153     $ 21,474     $ (1,321 )   $ 59,672     $ 59,622     $ 50  
Amortization of DAC
    (21,165 )     (19,715 )     (1,450 )     (55,848 )     (53,719 )     (2,129 )
 
                                   
Change in deferred policy acquisition costs (1)
  $ (1,012 )   $ 1,759     $ (2,771 )   $ 3,824     $ 5,903     $ (2,079 )
 
                                   
     
(1)   A positive amount of net change indicates more expense was deferred than amortized and represents a decrease to expenses in the periods indicated.
The increase in the amortization of DAC was the result of the previously described increase in policy terminations.
Regulatory Matters
On July 5, 2011, the State of New York Insurance Department issued a directive requiring life insurers doing business in the State of New York to utilize data available in the U. S. Social Security Death Master File (“SSA Master File”) to identify situations where death benefits under life insurance contracts, annuities and retained assets accounts could be due, to locate and pay beneficiaries under such contracts, and to report the results of the use of the data. We are reviewing our claims settlement procedures and utilizing information in the SSA Master File to determine when insureds have died. American National is evaluating the impact of the previously mentioned regulatory directive, if any, on its consolidated financial statements.
Policy In-Force Information
The following table summarizes changes in the Life segment’s in-force amounts (in thousands):
                         
    September 30,  
    2011     2010     Change  
 
               
Life insurance in-force
                       
Traditional life
  $ 46,562,702     $ 45,751,640     $ 811,062  
Interest-sensitive life
    23,640,651       23,999,398       (358,747 )
 
                 
Total life insurance in-force
  $ 70,203,353     $ 69,751,038     $ 452,315  
 
                 
The following table summarizes changes in the Life segment’s number of policies in-force:
                         
    September 30,  
    2011     2010     Change  
 
               
Number of policies in-force
                       
Traditional life
    2,220,085       2,298,203       (78,118 )
Interest-sensitive life
    177,734       175,873       1,861  
 
                 
Total number of policies
    2,397,819       2,474,076       (76,257 )
 
                 
There was an increase in total life insurance in-force in 2011 compared to 2010. The increase to our traditional life products is believed to be the result of consumers seeking contract guarantees due to the economic environment in recent years. This increase was partially offset by a decrease in our interest-sensitive life policies as the result of lower prevailing interest rates.
The decrease in our policy count is attributable to surrenders and lapses, as well as new business activity generally being comprised of fewer but larger face-value policies.

 

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Annuity
We develop, sell and support a variety of immediate and deferred annuities, including fixed, equity-indexed and variable products. We sell these products through independent agents, brokers, financial institutions, multiple-line and employee agents. Annuity segment financial results for the periods indicated were as follows (in thousands):
                                                 
    Three months ended September 30,     Nine months ended September 30,  
    2011     2010     Change     2011     2010     Change  
Premiums and other revenues:
                                               
Premiums
  $ 21,704     $ 51,180     $ (29,476 )   $ 73,304     $ 132,140     $ (58,836 )
Other policy revenues
    3,519       3,505       14       12,118       11,453       665  
Net investment income
    121,359       143,154       (21,795 )     413,683       387,439       26,244  
Other income
    64       121       (57 )     185       282       (97 )
 
                                   
Total premiums and other revenues
    146,646       197,960       (51,314 )     499,290       531,314       (32,024 )
 
                                   
 
                                               
Benefits, losses and expenses:
                                               
Policyholder benefits
    29,960       56,963       (27,003 )     102,770       155,100       (52,330 )
Interest credited to policyholders’ account balances
    67,337       94,564       (27,227 )     242,731       240,456       2,275  
Commissions for acquiring and servicing policies
    21,093       24,795       (3,702 )     80,642       75,944       4,698  
Other operating expenses
    16,260       18,572       (2,312 )     57,296       52,456       4,840  
Change in deferred policy acquisition costs (1)
    (2,285 )     (11,644 )     9,359       (30,505 )     (40,584 )     10,079  
Total benefits and expenses
    132,365       183,250       (50,885 )     452,934       483,372       (30,438 )
 
                                   
 
                                               
Income before other items and federal income taxes
  $ 14,281     $ 14,710     $ (429 )   $ 46,356     $ 47,942     $ (1,586 )
 
                                   
     
(1)   A negative amount of net change indicates more expense was deferred than amortized and represents a decrease to expenses in the periods indicated.
Earnings remained relatively flat for the three months ended September 30, 2011 compared to 2010. The significant decreases in net investment income and offset to interest credited was primarily the result of benchmark interest rates declining during the period compared to the increases during the same period in 2010.
Earnings decreased slightly for the nine months ended September 30, 2011 compared to 2010 primarily as the result of a decrease in premiums offset by the related decrease in policyholders’ benefits, as well as growth in net investment income outpacing the growth in interest credited. The increase in other operating expenses was primarily the result of an accrual for a previously disclosed litigation matter resolved in the first quarter. For additional information, see Note 16, Commitments and Contingencies, of the Notes to the Unaudited Consolidated Financial Statements. Without this accrual, earnings would have increased $10.4 million compared to the first nine months of 2010.
Premiums and other revenues
Annuity premium and deposit amounts received are shown in the table below (in thousands):
                                                 
    Three months ended September 30,     Nine months ended September 30,  
    2011     2010     Change     2011     2010     Change  
 
                                               
Fixed deferred annuity
  $ 265,606     $ 334,649     $ (69,043 )   $ 1,297,211     $ 781,041     $ 516,170  
Single premium immediate annuity
    38,067       61,692       (23,625 )     120,674       310,647       (189,973 )
Equity-indexed deferred annuity
    41,147       52,478       (11,331 )     117,800       135,253       (17,453 )
Variable deferred annuity
    29,367       18,864       10,503       75,481       67,168       8,313  
 
                                   
Total
    374,187       467,683       (93,496 )     1,611,166       1,294,109       317,057  
Less: policy deposits
    352,483       416,503       (64,020 )     1,537,862       1,161,969       375,893  
 
                                   
Total earned premiums
  $ 21,704     $ 51,180     $ (29,476 )   $ 73,304     $ 132,140     $ (58,836 )
 
                                   
Market interest rates reached and remained at record lows during the first nine months of 2011, keeping sales of our fixed annuity products strong as consumers sought the protection of these investments, though market volatility slowed sales during the third quarter. Fixed deferred annuity deposits decreased for the three months ended September 30, 2011 compared to 2010. We believe the decrease was driven primarily by consumer uncertainty during the third quarter as compared to the first half of the year and compared to the more optimistic environment in 2010. The financial market’s volatility and analysts’ predictions of increased chances of a “double-dip” recession may have impacted consumer intent to enter the market during the quarter.

 

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Fixed deferred annuity deposits increased significantly for the nine months ended September 30, 2011 compared to 2010. The increase was primarily a result of our marketing efforts to expand bank distribution through new accounts. In addition, continued depressed interest rates assisted in making our fixed deferred annuity rates more attractive relative to other competing financial products.
Single premium immediate annuities (“SPIA”) decreased for the three and nine months ended September 30, 2011 compared to 2010. Premiums for this product decreased primarily as a result of lower investment yields, restraining demand for this product in anticipation of increased income payments in the future.
Equity-indexed annuities allow policyholders to participate in equity returns while also having certain downside protection resulting from guaranteed minimum crediting rates. Deposits for this product decreased during the three and nine months ended September 30, 2011 compared to the same period in 2010. We believe this decrease was primarily due to lower fixed investment yields resulting in lower declared indexed crediting terms.
Net investment income, a key component of the annuity segment profitability, decreased for the three months ended September 30, 2011 compared to 2010 as a result of negative returns from option investments which support our equity-indexed annuity products. Refer to the “Options and Derivatives” discussion for further analysis of these results.
Net investment income increased for the nine months ended September 30, 2011 compared to 2010. The increase was mainly attributed to a 9.9% increase in the average assets backing the in-force fixed deferred annuity account balances. The increase was partially offset by our option losses.
Benefits, losses and expenses
Policyholder benefits consist primarily of reserve increases and benefit payments on single premium immediate annuity contracts. The changes in this expense are consistent with the changes in total earned premiums in the current and comparable periods.
The decrease in the interest credited during the three months ended September 30, 2011 compared to 2010, as well as the increase in the nine months ended compared to 2010, were a direct result of the fluctuations in net investment income. Refer to the “Options and Derivatives” discussion for further analysis of these results.
Commissions decreased and increased for the three and nine months ended September 30, 2011, respectively, compared to 2010. These fluctuations were primarily due to the changes in premiums and annuity deposits.
Other operating expenses increased during the nine months ended September 30, 2011 compared to 2010 primarily as the result of an accrual related to the previously disclosed litigation matter. Without this accrual, other operating expenses would have decreased $7.2 million.

 

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The change in DAC represents acquisition costs capitalized, net of amortization of existing DAC. The amortization of DAC is calculated in proportion to gross profits. The following table presents the components of the change in DAC (in thousands):
                                                 
    Three months ended September 30,     Nine months ended September 30,  
    2011     2010     Change     2011     2010     Change  
 
                                               
Acquisition cost capitalized
  $ 27,321     $ 28,633     $ (1,312 )   $ 98,345     $ 92,038     $ 6,307  
Amortization of DAC
    (25,036 )     (16,989 )     (8,047 )   $ (67,840 )     (51,454 )     (16,386 )
 
                                   
Change in deferred policy acquisition costs (1)
  $ 2,285     $ 11,644     $ (9,359 )   $ 30,505     $ 40,584     $ (10,079 )
 
                                   
     
(1)   A positive amount of net change indicates more expense was deferred than amortized and is a decrease to expense in the periods indicated.
The decrease in acquisition costs capitalized during the three months ended September 30, 2011 compared to the same period in 2010 was the result of lower premium and deposit inflows and related commissions. Conversely, the increase in acquisition costs capitalized during the nine months ended September 30, 2011 compared to the same period in 2010 were the result of higher premium and deposit inflows and related commissions.
The increase in amortization during the three and nine months ended September 30, 2011 compared to 2010 was the result of increased surrenders and withdrawals.
An important measure of the Annuity segment is the amortization of DAC as a percentage of gross profits. The amortization of DAC as a percentage of gross profits for the three and nine months ended September 30, 2011, was 50.7% and 44.1%, respectively, compared to 36.6% and 37.9%, respectively, for the same periods in 2010. The increases in the ratios were primarily driven by the increase in surrenders during 2011 compared to 2010.
Options and Derivatives
We utilize equity options as a means to hedge equity-indexed deferred annuity benefits. Equity-indexed deferred annuities include a fixed host annuity contract and an embedded equity derivative. Interest credited is generally comprised of interest accruals to fixed deferred annuity account balances. In addition to the accrual of interest on the host contract, the gain or loss on the embedded equity derivative is also recognized as interest credited for equity-indexed deferred annuities. Embedded derivative gains and losses can introduce material fluctuations in interest credited from one period to the next.
The profits on fixed deferred annuity contracts are driven by the difference between interest earned and credited (interest spreads) and, to a lesser extent, other policy fees. When determining crediting rates for fixed deferred annuities, management considers current investment yields in setting new money crediting rates and looks at average portfolio yields when setting renewal rates. Management also takes into account target spreads established by pricing models while factoring in price levels needed to maintain a competitive position. Target interest spreads vary by product depending on specific attributes.

 

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Shown below is the analysis of the impact to net investment income resulting from the change in market value of options (“option change”), along with the impact to interest credited to equity-indexed deferred annuity account values resulting from the change in market value of their underlying contracts (“equity-indexed change”) (in thousands):
                                                 
    Three months ended September 30,     Nine months ended September 30,  
    2011     2010     Change     2011     2010     Change  
Net investment income
                                               
Without option change
  $ 144,808     $ 132,923     $ 11,885     $ 431,835     $ 389,097     $ 42,738  
Option change
    (23,449 )     10,231       (33,680 )     (18,152 )     (1,658 )     (16,494 )
 
                                               
Interest credited to policy account balances
                                               
Without equity-indexed change
    71,636       97,037       (25,401 )     250,638       230,018       20,620  
Equity-indexed change
    (4,299 )     (2,473 )     (1,826 )     (7,907 )     10,438       (18,345 )
Net investment income without option change, as well as the related interest credited without equity-indexed change, increased during the three and nine months ended September 30, 2011 compared to the same periods in 2010. The increases were due to increases in aggregate annuity account values from year-to-date sales during 2011 and additional interest being credited on annuities in-force at year end 2010. The overall increase in the investment asset base attributed to annuities was 11.1% and 9.9% during the three and nine months ended September 30, 2011, respectively.
Option change, as well as the related equity-indexed change, decreased during the three and nine months ended September 30, 2011 compared to the same periods in 2010. These decreases were due to the deterioration of the S&P 500 Index of 14.3% and 10.0% during the three and nine months ended September 30, 2011 compared to the gains of 10.7% and 2.3% during the same periods in 2010.
Account Values
We monitor account values and changes in those values as key indicators of the performance of our Annuity segment. Changes in account values may result from net inflows, surrenders, policy fees, interest credited and market value changes. Account values and reserves of our annuity products increased during the first nine months of 2011 compared to the same period in 2010, primarily as a result of new deposits and interest credited. Shown below are the changes in account values (in thousands):
                 
    Nine months ended September 30,  
    2011     2010  
Fixed deferred annuity:
               
Account value, beginning of period
  $ 9,006,692     $ 8,151,366  
Net inflows
    1,212,531       460,618  
Surrenders
    (669,048 )     (476,208 )
Fees
    (8,395 )     (7,746 )
Interest credited
    240,826       243,082  
 
           
Account value, end of period
  $ 9,782,606     $ 8,371,112  
 
           
 
               
Variable deferred annuity:
               
Account value, beginning of period
  $ 415,757     $ 400,624  
Net inflows
    68,429       65,353  
Surrenders
    (81,452 )     (84,416 )
Fees
    (3,644 )     (3,586 )
Change in market value and other
    (29,702 )     20,518  
 
           
Account value, end of period
  $ 369,388     $ 398,493  
 
           
 
               
Single premium immediate annuity:
               
Reserve, beginning of period
  $ 903,126     $ 820,295  
Net inflows
    26,485       33,231  
Interest and mortality
    31,593       29,981  
 
           
Reserve, end of period
  $ 961,204     $ 883,507  
 
           

 

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Health
The Health segment primarily focuses on supplemental and limited benefit coverage products including Medicare Supplement insurance for the senior market as well as hospital surgical and cancer policies for the general population. For the first nine months of 2011, premium volume was concentrated in our Medicare Supplement (43.7%) and medical expense (20.9%) lines. Our other health products include credit accident and health policies and other limited benefit coverages. Health products are distributed through a network of independent agents and Managing General Underwriters (“MGU”). Health segment results for the periods indicated were as follows (in thousands):
                                                 
    Three months ended September 30,     Nine months ended September 30,  
    2011     2010     Change     2011     2010     Change  
Premiums and other revenues:
                                               
Premiums
  $ 57,708     $ 64,288     $ (6,580 )   $ 174,736     $ 200,553     $ (25,817 )
Net investment income
    3,331       3,753       (422 )     10,172       11,770       (1,598 )
Other income
    3,354       2,364       990       9,874       7,654       2,220  
 
                                   
Total premiums and other revenues
    64,393       70,405       (6,012 )     194,782       219,977       (25,195 )
 
                                   
 
                                               
Benefits, losses and expenses:
                                               
Claims incurred
    38,691       43,140       (4,449 )     119,764       141,330       (21,566 )
Commissions for acquiring and servicing policies
    6,636       8,150       (1,514 )     20,202       27,265       (7,063 )
Other operating expenses
    11,089       10,694       395       35,085       35,806       (721 )
Change in deferred policy acquisition costs (1)
    2,717       891       1,826       6,412       3,784       2,628  
 
                                   
Total benefits and expenses
    59,133       62,875       (3,742 )     181,463       208,185       (26,722 )
 
                                   
 
                                               
Income before other items and federal income taxes
  $ 5,260     $ 7,530     $ (2,270 )   $ 13,319     $ 11,792     $ 1,527  
 
                                   
     
(1)   A negative amount of net change indicates more expense was deferred than amortized and represents a decrease to expenses in the periods indicated.
Changes in earnings for the three and nine months ended September 30, 2011 were driven primarily by the discontinuation of sales of our medical expense insurance plans effective June 30, 2010. Additionally, sales of our Medicare Supplement product decreased due to aggressive pricing by a large competitor. Earnings for the three months ended September 30, 2011 decreased compared to 2010, due to the contracting block of business. Earnings improved for the nine months ended September 30, 2011 compared to 2010, primarily because the reductions in claims incurred and commissions outpaced the reduction in premiums.
Premiums and other revenues
Health premiums for the periods indicated are as follows (in thousands, except percentages):
                                                                 
    Three months ended September 30,     Nine months ended September 30,  
    2011     2010     2011     2010  
 
                                                               
Medicare Supplement
  $ 25,030       43.4 %   $ 29,218       45.5 %   $ 76,361       43.7 %   $ 89,340       44.6 %
Medical expense
    11,355       19.7       16,007       24.9       36,594       20.9       52,468       26.2  
Group
    8,820       15.3       7,459       11.6       24,535       14.0       21,761       10.9  
Credit accident and health
    5,027       8.7       5,283       8.2       15,184       8.7       16,126       8.0  
MGU
    3,438       6.0       2,541       4.0       9,911       5.7       8,288       4.1  
All other
    4,038       7.0       3,780       5.9       12,151       7.0       12,570       6.3  
 
                                               
Total
  $ 57,708       100.0 %   $ 64,288       100.0 %   $ 174,736       100.0 %   $ 200,553       100.0 %
 
                                               
Premiums decreased during the three and nine months ended September 30, 2011 compared to 2010, primarily due to the discontinuation of sales of our medical expense insurance plans effective June 30, 2010. Additionally, sales of our Medicare Supplement product decreased due to aggressive pricing of a large competitor.

 

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Our in-force certificates or policies as of the dates indicated are as follows:
                                 
    September 30,  
    2011     2010  
 
                               
Medicare Supplement
    42,991       6.8 %     51,164       8.3 %
Medical expense
    8,515       1.4       12,634       2.1  
Group
    15,666       2.5       13,443       2.2  
Credit accident and health
    281,685       44.7       300,826       49.1  
MGU
    141,770       22.5       79,960       13.0  
All other
    139,582       22.1       155,157       25.3  
 
                       
Total
    630,209       100.0 %     613,184       100.0 %
 
                       
 
                               
In-force policies increased primarily due to an increase in MGU production.
Benefits, losses and expenses
Claims incurred decreased during the three and nine months ended September 30, 2011 compared to the same periods in 2010. The decrease was primarily due to the discontinuance of sales of our medical expense insurance plans, as well as the decrease in sales of our Medicare Supplement products.
Commissions decreased for the three and nine months ended September 30, 2011 compared to the same period in 2010, consistent with lower premiums.
The following table presents the components of the change in DAC (in thousands):
                                                 
    Three months ended September 30,     Nine months ended September 30,  
    2011     2010     Change     2011     2010     Change  
 
               
Acquisition cost capitalized
  $ 2,859     $ 4,455     $ (1,596 )   $ 9,599     $ 13,775     $ (4,176 )
Amortization of DAC
    (5,576 )     (5,346 )     (230 )     (16,011 )     (17,559 )     1,548  
 
                                   
Change in deferred policy acquisition costs (1)
  $ (2,717 )   $ (891 )   $ (1,826 )   $ (6,412 )   $ (3,784 )   $ (2,628 )
 
                                   
     
(1)   A negative amount of net change indicates less expense was deferred than amortized and represents an increase to expenses in the periods indicated.
Acquisition cost capitalized decreased for the three and nine months ended September 30, 2011 compared to the same period in 2010, primarily due to the decrease in sales.

 

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Property and Casualty
Property and Casualty business is written through our Multiple-Line and Credit Insurance Division agents. Property and Casualty segment results for the periods indicated were as follows (in thousands, except percentages):
                                                 
    Three months ended September 30,     Nine months ended September 30,  
    2011     2010     Change     2011     2010     Change  
Premiums and other revenues:
                                               
Net premiums written
  $ 293,228     $ 298,743     $ (5,515 )   $ 878,015     $ 899,399     $ (21,384 )
 
                                   
 
                                               
Net premiums earned
  $ 289,796     $ 297,703     $ (7,907 )   $ 856,958     $ 871,672     $ (14,714 )
Net investment income
    17,852       17,751       101       54,230       55,096       (866 )
Other income
    2,504       2,226       278       6,004       6,121       (117 )
 
                                   
Total premiums and other revenues
    310,152       317,680       (7,528 )     917,192       932,889       (15,697 )
 
                                   
 
                                               
Benefits, losses and expenses:
                                               
Claims incurred
    215,226       208,917       6,309       685,168       702,134       (16,966 )
Commissions for acquiring and servicing policies
    59,354       63,612       (4,258 )     172,079       172,460       (381 )
Other operating expenses
    30,150       30,758       (608 )     92,042       94,028       (1,986 )
Change in deferred policy acquisition costs (1)
    (7,002 )     (1,294 )     (5,708 )     (14,617 )     (4,112 )     (10,505 )
 
                                   
Total benefits and expenses
    297,728       301,993       (4,265 )     934,672       964,510       (29,838 )
 
                                   
 
                                               
Income (Loss) before other items and federal income taxes
  $ 12,424     $ 15,687     $ (3,263 )   $ (17,480 )   $ (31,621 )   $ 14,141  
 
                                   
 
                                               
Loss ratio
    74.3 %     70.2 %     4.1       80.0 %     80.6 %     (0.6 )
Underwriting expense ratio
    28.5       31.3       (2.8 )     29.1       30.1       (1.0 )
 
                                   
Combined ratio
    102.8 %     101.5 %     1.3       109.1 %     110.7 %     (1.6 )
 
                                   
 
                                               
Effect of net catastrophe losses on the combined ratio
    7.5       2.3       5.2       14.6       12.3       2.3  
 
                                   
Combined ratio without net catastrophe losses (2)
    95.3 %     99.2 %     (3.9 )     94.5 %     98.4 %     (3.9 )
 
                                   
 
                                               
Gross catastrophe losses
  $ 17,130     $ 4,561     $ 12,569     $ 207,084     $ 124,204     $ 82,880  
Net catastrophe losses
    22,789       7,183       15,606       113,619       104,185       9,434  
     
(1)   A negative amount of net change indicates more expense was deferred than amortized and represents a decrease to expenses in the periods indicated.
 
(2)   Excludes reinstatement premiums
The Property and Casualty segment earnings decreased during the three months ended September 30, 2011 compared to 2010, primarily due to claims incurred from Hurricane Irene, which impacted much of the east coast of the United States, as well as Midwest weather-related catastrophe events. Results improved through the nine months ended September 30, 2011 compared to 2010. This is primarily due to improvement in our non-catastrophe combined ratios.
Premiums and other revenues
Net premiums written and earned decreased during the three and nine months ended September 30, 2011 compared to 2010. The three-month decrease is primarily due to decreased premiums in our personal auto products. During this time period, our average premium per policy has increased as we are obtaining additional premium per exposure. The nine-month decrease is primarily due to our catastrophe reinsurance reinstatement premium and decreased premiums across both personal and commercial lines of business. During the nine months ended September 30, 2011 our catastrophe reinsurance reinstatement premium increased by $9.3 million over the same period in 2010 as the result of higher catastrophe reinsurance recoveries in 2011 compared to 2010.
Benefits, losses and expenses
Claims incurred include losses and loss adjustment expenses (“LAE”) on property and casualty policies. Claims incurred increased during the three months ended September 30, 2011 and decreased for the nine months ended September 30, 2011 compared to 2010. The three-month increase was primarily due to increased claims incurred in our homeowner and agribusiness lines from the previously mentioned catastrophe events. The nine-month decrease resulted primarily from the decreases in losses incurred related to our personal and commercial auto policies and losses from our other commercial and credit-related property products.

 

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The loss ratio increased for the three months ended September 30, 2011 compared to 2010 primarily from increased catastrophe claims activity for both personal and commercial lines of business.
Gross catastrophes for the three months and nine months ended September 30, 2011 were $17.1 million and $207.1 million, respectively, compared to $4.6 million and $124.2 million, respectively, for the same periods in 2010. Although we experienced a significant increase in our gross catastrophe losses, this was mitigated by our improved reinsurance program, which provided us with a significant increase in catastrophe reinsurance recoveries in 2011 compared to 2010. The additional catastrophe reinsurance recovery was attributable to lower catastrophe loss retentions and an aggregate property catastrophe excess reinsurance contract in place during 2011.
While the frequency of catastrophe events in 2011 was consistent with 2010, gross catastrophe losses increased primarily from the severity of the catastrophe events over the three months and nine months ended September 30, 2011. The nine months catastrophe activity includes a record number of tornados, two events which impacted primarily Alabama in late April and Joplin, Missouri in May. These two events alone accounted for $102.4 million in gross catastrophe losses and $28.8 million in net catastrophe losses during the nine-month period ending September 30, 2011.
The combined ratio, excluding net catastrophe losses, improved to 95.3% and 94.5% for the three and nine months ending September 30, 2011, respectively, compared with 99.2% and 98.4%, respectively, for the same periods in 2010. This was primarily driven by an improvement in rate adequacy. Inherent to our fundamental risk management practices, we continue to evaluate and manage our aggregate catastrophe risk exposure with targeted rate changes, risk selection and reinsurance coverage.
For the three and nine months ended September 30, 2011, the net favorable prior year loss and LAE development was $10.2 million and $38.1 million, respectively, compared to $20.9 million and $65.0 million favorable development for the three and nine months ended September 30, 2010, respectively. This favorable development is primarily in our workers’ compensation, personal auto and commercial liability lines, which are demonstrating better than expected loss emergence compared to what was implied by our historical development patterns.
Commissions for acquiring and servicing policies decreased during the three months ended September 30, 2011. This is primarily from an $8.0 million expense incurred during 2010 related to a revision in our post termination compensation plan with some agents which was not incurred in 2011 partially offset by increased commissions in our credit-related property products.
The decrease in expense as a result of the change in deferred policy acquisition costs for the three and nine months ended September 30, 2011 compared to 2010 is attributable to a shift in our credit-related property products from shorter duration products to longer duration products.
Products
Our Property and Casualty segment consists of three product lines: (i) Personal Lines, which we market primarily to individuals, represent 60.3% of net premiums written, (ii) Commercial Lines, which focus primarily on agricultural and other targeted commercial markets, represent 27.9% of net premiums written, and (iii) Credit-related property insurance products which are marketed to and through financial institutions and retailers and represent 11.8% of net premiums written.

 

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Personal Products
Property and Casualty segment results for Personal Products for the periods indicated were as follows (in thousands, except percentages):
                                                 
    Three months ended September 30,     Nine months ended September 30,  
    2011     2010     Change     2011     2010     Change  
Net premiums written
                                               
Auto
  $ 111,701     $ 120,238     $ (8,537 )   $ 340,111     $ 356,067     $ (15,956 )
Homeowner
    61,483       61,715       (232 )     161,484       168,854       (7,370 )
Other Personal
    9,675       9,916       (241 )     27,699       30,825       (3,126 )
 
                                   
Total net premiums written
  $ 182,859     $ 191,869     $ (9,010 )   $ 529,294     $ 555,746     $ (26,452 )
 
                                   
 
                                               
Net premiums earned
                                               
Auto
    114,730       121,408       (6,678 )     349,542       351,905       (2,363 )
Homeowner
    56,612       56,794       (182 )     160,112       162,471       (2,359 )
Other Personal
    9,537       10,033       (496 )     27,392       29,353       (1,961 )
 
                                   
Total net premiums earned
  $ 180,879     $ 188,235     $ (7,356 )   $ 537,046     $ 543,729     $ (6,683 )
 
                                   
 
                                               
Loss ratio
                                               
Auto
    77.3 %     76.0 %     1.3       74.3 %     75.5 %     (1.2 )
Homeowner
    95.3       80.5       14.8       123.5       107.8       15.7  
Other Personal
    56.9       64.7       (7.8 )     74.2       61.4       12.8  
Personal line loss ratio
    81.8 %     76.8 %     5.0       89.0 %     84.4 %     4.6  
 
                                               
Combined Ratio
                                               
Auto
    96.3 %     101.8 %     (5.5 )     94.9 %     98.9 %     (4.0 )
Homeowner
    115.0       110.2