ING USA ANNUITY & LIFE INSURANCE CO – 10-Q – Management’s Narrative Analysis of the Results of Operations and Financial Condition (Dollar amounts in millions, unless otherwise stated)
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Overview
The following narrative analysis presents a review of the results of operations ofING USA Annuity and Life Insurance Company ("ING USA " or the "Company", "we", "us", as appropriate) for each of the three and nine months endedSeptember 30, 2012 and 2011 and financial condition as ofSeptember 30, 2012 andDecember 31, 2011 . This item should be read in its entirety and in conjunction with the Condensed Financial Statements and related notes, which can be found under Part I, Item 1. contained herein, as well as the "Management's Narrative Analysis of the Results of Operations and Financial Condition" section contained in our 2011 Annual Report on Form 10-K.
Forward-Looking Information/Risk Factors
In connection with the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, we caution readers regarding certain forward-looking statements contained in this report and in any other statements made by, or on behalf of, us, whether or not in future filings with theSecurities and Exchange Commission ("SEC"). Forward-looking statements are statements not based on historical information and which relate to future operations, strategies, financial results, or other developments. Statements using verbs such as "expect," "anticipate," "believe," or words of similar import, generally involve forward-looking statements. Without limiting the foregoing, forward-looking statements include statements that represent our beliefs concerning future levels of sales and redemptions of our products, investment spreads and yields, or the earnings and profitability of our activities. Forward-looking statements are necessarily based on estimates and assumptions that are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control and many of which are subject to change. These uncertainties and contingencies could cause actual results to differ materially from those expressed in any forward-looking statements made by, or on behalf of, us. Whether or not actual results differ materially from forward-looking statements may depend on numerous foreseeable and unforeseeable developments, including, but not limited to the following:
1. While the global economy continues to recover from the financial crisis and
subsequent recession, risks remain for
economies. The uncertainty concerning current global market conditions and
the impact it has on the U.S. economy, has affected and may continue to
affect our results of operations.
2. The default of a major market participant could disrupt the markets.
3. Adverse financial market conditions, changes in rating agency standards and
practices and/or actions taken by ratings agencies may significantly affect
our ability to meet liquidity needs, access to capital and cost of capital.
4. Circumstances associated with implementation of ING Groep's recently
announced global business strategy and the final restructuring plan submitted
to the
receipt of state aid from the Dutch State could adversely affect our results
of operations and financial condition.
5. The amount of statutory capital that we hold and our risk-based capital
("RBC") ratio can vary significantly from time to time and is sensitive to a
number of factors, many of which are outside of our control and influences
our financial strength and credit ratings.
6. We have experienced ratings downgrades and may experience additional future
downgrades in our ratings, which may negatively affect profitability, financial condition and access to liquidity.
7. The new federal financial regulatory reform law, its implementing regulations
and other financial regulatory reform initiatives, could have adverse consequences for the financial services industry, including us and/or materially affect our results of operations, financial condition and liquidity.
8. The valuation of many of our financial instruments includes methodologies,
estimations and assumptions that are subject to differing interpretations and
could result in changes to investment valuations that may materially
adversely affect results of operations and financial condition.
9. The determination of the amount of impairments taken on our investments is
subjective and could materially impact results of operations.
10. We may be required to accelerate the amortization of deferred policy
acquisition cost ("DAC"), deferred sales inducements ("DSI") and/or the
valuation of business acquired ("VOBA"), any of which could adversely affect
our results of operations or financial condition.
11. Changes in underwriting and actual experience could materially affect
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12. We may be required to establish an additional valuation allowance against the
deferred income tax assets if our business does not generate sufficient
taxable income or if our tax planning strategies are modified. Increases in
the deferred tax valuation allowance could have a material adverse effect on
results of operations and financial condition.
13. Reinsurance subjects us to the credit risk of reinsurers and may not be
adequate to protect against losses arising from ceded reinsurance.
14. Offshore reinsurance subjects us to the risk that the reinsurer is unable to
provide acceptable credit for reinsurance.
15. Our risk management program attempts to balance a number of important factors
including regulatory capital, risk based capital, liquidity, earnings and
other factors. Certain actions taken as part of our risk management strategy
could result in materially lower or more volatile U.S. GAAP earnings in
periods of changes in equity markets.
16. The inability to manage market risk successfully through the usage of
derivative instruments could adversely affect our business, operations,
financial condition and liquidity.
17. The inability of counterparties to meet their financial obligations could
have an adverse effect on our results of operations.
18. Changes in reserve estimates may reduce profitability and/or increase
reserves ceded to reinsurers.
19. A loss of or significant change in key product distribution relationships
could materially affect sales.
20. Competition could negatively affect the ability to maintain or increase
profitability.
21. Changes in federal income tax law or interpretations of existing tax law
could affect profitability and financial condition by making some products
less attractive to contract owners and increasing our tax costs or tax costs
of contract owners.
22. We are considering amending a tax sharing agreement in a manner that could
limit the availability of cash payments to which we would otherwise be
entitled without such amendment.
23. We may be adversely affected by increased governmental and regulatory
scrutiny or negative publicity.
24. The loss of key personnel could negatively affect our financial results and
impair our ability to implement our business strategy.
25. Litigation may adversely affect profitability and financial condition.
26. Our businesses are heavily regulated and changes in regulation in the United
States and regulatory investigations may reduce profitability.
27. Our products are subject to extensive regulation and failure to meet any of
the complex product requirements may reduce profitability.
28. Changes in accounting requirements could negatively impact our reported
results of operations and our reported financial position.
29. Failure of our operating or information systems or a compromise of security
with respect to an operating or information system or portable electronic
device or a failure to implement system modifications or a new accounting,
actuarial or other operating system effectively could adversely affect our
results of operations and financial condition or the effectiveness of
internal controls over financial reporting.
30. Requirements to post collateral or make payments due to declines in market
value on assets posted as collateral may adversely affect liquidity.
31. Defaults or delinquencies in the commercial mortgage loan portfolio may
adversely affect our profitability.
32. The occurrence of unidentified or unanticipated risks within our risk
management programs could negatively affect our business or result in losses.
33. The occurrence of natural or man-made disasters may adversely affect our
results of operations and financial condition.
Investors are also directed to consider the risks and uncertainties discussed in this Item 2. and in Item 1A. of Part II contained herein, as well as in other documents filed by us with theSEC . Except as may be required by the federal securities laws, we disclaim any obligation to update forward-looking information.
Basis of Presentation
ING USA is a stock life insurance company domiciled in theState of Iowa and provides financial products and services inthe United States .ING USA is authorized to conduct its insurance business in all states, exceptNew York and theDistrict of Columbia .
ING has announced the anticipated separation of its banking and insurance businesses. While all options for effecting this separation remain open, onNovember 10, 2010 ,ING announced that, in connection with the separation plan, it will prepare for a base case of an initial public offering ("IPO") ofING U.S., Inc. which constitutesING's U.S.-based retirement, investment management, and insurance operations, including us.
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We have one operating segment.
Critical Accounting Policies, Judgments and Estimates
The preparation of financial statements in conformity with U.S. GAAP requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Critical estimates and assumptions are evaluated on an on-going basis based on historical developments, market conditions, industry trends, and other information that is reasonable under the circumstances. There can be no assurance that actual results will conform to estimates and assumptions and that reported results of operations will not be materially adversely affected by the need to make future accounting adjustments to reflect changes in these estimates and assumptions from time to time. We have identified the following accounting policies, judgments, and estimates as critical in that they involve a higher degree of judgment and are subject to a significant degree of variability: Reserves for future policy benefits, DAC/VOBA and other intangibles and related amortization (including unlocking), valuation of investments and derivatives, impairments, income taxes, and contingencies. In developing these accounting estimates and policies, our management makes subjective and complex judgments that are inherently uncertain and subject to material changes as facts and circumstances develop. Although variability is inherent in these estimates, management believes the amounts provided are appropriate based upon the facts available upon compilation of the Condensed Financial Statements.
The above critical accounting estimates are described in Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies, Judgments and Estimates and the Business, Basis of Presentation and Significant Accounting Policies note to the Financial Statements in the 2011 Annual Report on Form 10-K.
Results of Operations
Overview
Products currently offered by us include immediate and deferred fixed annuities, designed to address individual customer needs for tax-advantaged savings, retirement needs and wealth-protection concerns and guaranteed investment contracts and funding agreements sold primarily to institutional investors and corporate benefit plans. OnApril 9, 2009 , our ultimate parent,ING , announced a global business strategy which identified certain core and non-core businesses and geographies, statedING's intention to explore divestiture of non-core businesses over time, withdraw from certain non-core geographies, limit future acquisitions and implement enterprise-wide expense reductions. In particular, with respect toING's U.S. insurance operations,ING is seeking to further reduce its risk by focusing on individual life products, retirement services and lower risk annuity products to be sold byING USA's affiliate, ING Life Insurance and Annuity Company. As part of this strategy,ING USA ceased new sales of variable annuity products in March of 2010. Some new amounts will continue to be deposited onING USA variable annuities as add-on premiums to existing contracts. We derive our revenue mainly from (a) fee income generated on variable assets under management ("AUM"), (b) investment income earned on fixed AUM and (c) certain other management fees. Fee income is primarily generated from separate account assets supporting variable options under variable annuity contract investments, as designated by contract owners. Investment income from fixed AUM is mainly generated from annuity products with fixed investment options, guaranteed investment contract ("GIC") deposits and funding agreements. Our expenses primarily consist of (a) interest credited and other benefits to contract owners, (b) amortization of DAC and value of business acquired ("VOBA"), (c) expenses related to the selling and servicing of the various products offered by us and (d) other general business expenses. Economic Analysis The pace of economic growth in the U.S. remains subdued. The U.S. economy grew 1.3% on an annualized basis in the second quarter of this year. Industrial production declined approximately 1.3% on an annualized basis in the third quarter of 2012. The pace of growth has stayed modest and below trend growth rates due to a variety of factors. Consumer spending has expanded but fairly tepidly because of the slow improvement in the labor market, the elevated unemployment rate, and the mediocre increase in real disposable income. Business fixed investment is rising quite slowly, while the housing sector is gradually recovering from 63
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very depressed conditions. Residential investment remains weak but is improving as indicated by gradual increases in housing starts and building permits. House prices, though well below their peaks, have started to stabilize in several metro areas. Real export growth has been disappointing. The expansion of global industrial production and trade has been sluggish because of a slowing in growth rates, both in advanced countries and emerging markets, and investors' concerns about global financial fragility. The U.S. labor market remains weak. Job growth per month has averaged 146,000 year to date, compared to an average of 153,000 per same period last year. Meanwhile, initial and continuing unemployment claims have been stabilized since the beginning of the year but are no longer declining markedly due to the cautiousness of firms to hire additional employees. Overall inflation, as measured by CPI and PCE indices, has declined in 2012, even though commodity and energy prices are elevated. Core inflation has also declined since the beginning of the year. The pace of economic growth is still constrained by high unemployment, modest income growth, lower housing wealth, and tepid expansion of credit and bank lending. The sustainability of the ongoing recovery still depends on supportive fiscal and monetary policies. The Federal Reserve (the "Fed") has extended its conditional commitment to keeping the federal funds target rate in the range of 0 to 25 basis points until mid-2015, beyond its earlier commitment to low rates until late 2014. InSeptember 2012 the Fed announced a new open ended program of purchasing agency mortgage-backed securities at a pace of$40.0 billion per month, while continuing its earlier program to extend the average maturity of its holdings of securities through the end of the year by purchasing Treasury securities with remaining maturities of six years to thirty years at the current pace and to sell or redeem an equal amount of Treasury securities with remaining maturities of approximately three years or less. The Fed will also maintain its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities into agency mortgage-backed securities. These actions will increase the Fed's holdings of longer-term securities by about$85.0 billion each month through the end of the year. These programs are likely to exert downward pressure on longer-term interest rates, mortgage rates, and be supportive of financial conditions. Short-term London Interbank Offered Rate remains low by historic standards and has declined since the beginning of this year after increasing since the middle of last year. However, U.S. Treasury rates have declined somewhat since the beginning of last year. Long-term U.S. Treasury rates decreased in the third quarter of 2012 as compared to the same period in 2011. The decline in U.S. Treasury rates is mainly due to the Fed's commitment to keep the federal funds target rate low until mid-2015, low short-term rates, the Fed's policy to exert downward pressure on long-term rates, well-anchored inflationary expectations, feeble growth in the U.S. and the rest of the world, and private investors' uncertainty about economic outlook and global financial conditions. In spite of modest expansion in economic activity since the beginning of the year, risks to the U.S. economy continue to point to possible negative developments. These risks include strains in global financial conditions; weakness in household financial conditions, which would lead to slower consumer spending; larger-than-expected fiscal tightening in the coming year, which would lower aggregate demand; financial and economic spillover from the euro zone's inability to contain the region's debt crisis; and crude oil prices spiking in the event of an escalation of conflict between the U.S. andIran . There would also be a drag on real GDP growth arising from a decrease in public expenditure and higher tax rates next year. These economic conditions and risks are not unique to the Company, but present challenges to the entire insurance and financial services industry. 64
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Three Months Ended
Our results of operations for the three months endedSeptember 30, 2012 and changes therein, primarily reflect favorable variances in Interest credited and other benefits to contract owners, partially offset by unfavorable Total net realized capital gains (losses), lower Net investment income, lower Fee income and higher Net amortization of DAC/VOBA. Three Months Ended September 30, $ Increase % Increase 2012 2011 (Decrease) (Decrease) Revenues: (As revised) Net investment income $ 317.5 $ 358.9 $ (41.4 ) (11.5 )% Fee income 196.8 210.1 (13.3 ) (6.3 )% Premiums 112.0 112.2 (0.2 ) (0.2 )% Net realized capital gains (losses): Total other-than-temporary impairments (3.5 ) (61.9 ) 58.4 94.3 % Less: Portion of other-than-temporary impairments recognized in Other comprehensive income (loss) (0.2 ) (10.0 ) 9.8 98.0 % Net other-than-temporary impairments recognized in earnings (3.3 ) (51.9 ) 48.6 93.6 % Other net realized capital gains (losses) (208.9 ) 1,151.3 (1,360.2 ) NM Total net realized capital gains (losses) (212.2 ) 1,099.4 (1,311.6 ) NM Other revenue 7.3 12.8 (5.5 ) (43.0 )% Total revenues 421.4 1,793.4 (1,372.0 ) (76.5 )%
Benefits and expenses: Interest credited and other benefits to contract owners (173.5 ) 2,340.0 (2,513.5 ) NM Operating expenses 106.3 108.4 (2.1 ) (1.9 )% Net amortization of deferred policy acquisition costs and value of business acquired 238.5 (695.9 ) 934.4 NM Interest expense 7.9 8.0 (0.1 ) (1.3 )% Other expense 4.4 10.6 (6.2 ) (58.5 )% Total benefits and expenses 183.6 1,771.1 (1,587.5 ) (89.6 )% Income (loss) before income taxes 237.8 22.3 215.5 NM Income tax expense (benefit) 45.6 (100.0 ) 145.6 NM Net income (loss) $ 192.2 $ 122.3 $ 69.9 57.2 % NM - Not Meaningful Revenues Total revenues decreased$1,372.0 for the three months endedSeptember 30, 2012 , primarily due to unfavorable Total net realized capital gains (losses), lower Net investment income and lower Fee income. Total net realized capital gains (losses) changed by$(1,311.6) from a gain of$1,099.4 to a loss of$(212.2) primarily driven by the impact of market conditions on our hedging programs. Under the variable annuity hedge program, changes in equity and interest markets during the three months endedSeptember 30, 2012 resulted in net losses on interest, equity and foreign exchange derivatives compared to net gains during the same period of 2011, resulting in a net change of$(3.0) billion . Of this amount,$(2.5) billion is ceded to Security Life ofDenver International Limited ("SLDI") under the combined coinsurance and coinsurance funds withheld agreement, and an offset is recorded in Interest credited and other benefits to contract holders. The unfavorable changes were partially offset by a$1,554.2 change in the fair value of embedded derivatives on variable annuity product guarantees (from a loss of$998.0 to a gain of$556.2 ). Other derivative gains and lower impairments on fixed maturities were favorable, which also partially offset the change.
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Net investment income decreased$41.4 from$358.9 to $317.5 primarily due to lower general account assets. General account assets decreased as a result of multi-year guaranteed annuities ("MYGAs") lapsing at the end of their initial terms, largely due to crediting rates that were lower than the crediting rates during the initial term. Lower yields on the CMO-B portfolio and lower prepayment fees also contributed to the decrease.
Fee income decreased
Benefits and Expenses
Total benefits and expenses decreased
Interest credited and other benefits to contract owners changed by$2,513.5 from$2,340.0 to $(173.5) primarily due to the change in the amount of equity and interest rate derivative gains/losses transferred under the combined coinsurance and coinsurance funds withheld agreement with SLDI. The total change was$2,468.6 (loss of$615.3 in 2012, gain of$1,853.3 in 2011). The corresponding offsetting amounts are reported in Total net realized capital gains (losses) and Net investment income, respectively.
Net amortization of DAC and VOBA increased
Income Taxes
Income tax expense increased$145.6 from$(100.0) to$45.6 primarily due to an increase in income before taxes and a reduction in the benefit associated with the tax valuation allowance which is partially offset by an increase in the dividends received deduction. 66
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Nine Months Ended
Our results of operations for the nine months endedSeptember 30, 2012 and changes therein, primarily reflect unfavorable Total net realized capital gains (losses), lower Net investment income, lower Fee income and higher Net amortization of DAC/VOBA. These unfavorable items were partially offset by lower Interest credited and other benefits to contract owners. Nine Months Ended September 30, $ Increase % Increase 2012 2011 (Decrease) (Decrease) Revenues: (As revised) Net investment income $ 978.7 $ 1,084.8 $ (106.1 ) (9.8 )% Fee income 609.8 658.5 (48.7 ) (7.4 )% Premiums 341.9 345.8 (3.9 ) (1.1 )% Net realized capital gains (losses): Total other-than-temporary impairments (12.1 ) (152.9 ) 140.8 92.1 % Less: Portion of other-than-temporary impairments recognized in Other comprehensive income (loss) (2.9 ) (15.1 ) 12.2 80.8 % Net other-than-temporary impairments recognized in earnings (9.2 ) (137.8 ) 128.6 93.3 % Other net realized capital gains (losses) (1,061.0 ) 851.9 (1,912.9 ) NM Total net realized capital gains (losses) (1,070.2 ) 714.1 (1,784.3 ) NM Other revenue 27.6 46.4 (18.8 ) (40.5 )% Total revenues 887.8 2,849.6 (1,961.8 ) (68.8 )% Benefits and expenses: Interest credited and other benefits to contract owners 304.8 2,890.1 (2,585.3 ) (89.5 )% Operating expenses 332.0 333.3 (1.3 ) (0.4 )% Net amortization of deferred policy acquisition costs and value of business acquired 284.6 (566.6 ) 851.2 NM Interest expense 23.5 23.7 (0.2 ) (0.8 )% Other expense 20.9 27.2 (6.3 ) (23.2 )% Total benefits and expenses 965.8 2,707.7 (1,741.9 ) (64.3 )% Income (loss) before income taxes (78.0 ) 141.9 (219.9 ) NM Income tax expense (benefit) (27.4 ) (94.5 ) 67.1 71.0 % Net income (loss) $ (50.6 ) $ 236.4 $ (287.0 ) NM NM - Not Meaningful Revenues Total revenues decreased$1,961.8 for the nine months endedSeptember 30, 2012 , primarily due to unfavorable Total net realized capital gains (losses), lower Net investment income and lower Fee income. Total net realized capital gains (losses) changed$(1,784.3) from a gain of$714.1 to a loss of$(1,070.2) primarily driven by the impact of market conditions on our hedging programs. Under the variable annuity hedge program, changes in equity and interest markets during the nine months endedSeptember 30, 2012 resulted in net losses on interest, equity and foreign exchange derivatives compared to net gains during the same period of 2011, resulting in a net change of$(3.4) billion . Of this amount,$(2.6) billion is ceded to Security Life ofDenver International Limited ("SLDI") under the combined coinsurance and coinsurance funds withheld agreement, and an offset is recorded in Interest credited and other benefits to contract holders. The unfavorable changes were partially offset by a$1,356.2 change in the fair value of embedded derivatives on variable annuity product guarantees (from a loss of$958.8 to a gain of$397.4 ). Other derivative gains and lower impairments on fixed maturities were favorable, which also partially offset the change.
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Fee income decreased
Net investment income decreased$106.1 from$1,084.8 to $978.7 primarily due to lower general account assets and due to the loss recorded on the sale of certain alternative investments. General account assets decreased as a result of MYGAs lapsing at the end of their initial terms, largely due to MYGA crediting rates that were lower than the crediting rates during the initial term. The sale of certain alternative investments resulted in a net pretax loss of$16.9 in the second quarter of 2012. Benefits and Expenses Total benefits and expenses decreased$1,741.9 for the nine months endedSeptember 30, 2012 primarily due to favorable variance in Interest credited and other benefits to contract owners, partially offset by higher amortization of DAC/VOBA. Interest credited and other benefits to contract owners decreased$2,585.3 from$2,890.1 to $304.8 primarily due to the change in the amount of equity and interest rate derivative gains/losses transferred under the combined coinsurance and coinsurance funds withheld agreement with SLDI. The total change was$2,620.6 (loss of$927.0 in 2012, gain of$1,693.6 in 2011). The corresponding offsetting amounts are reported in Total net realized capital gains (losses) and Net investment income, respectively.
Net amortization of DAC and VOBA changed
Income Taxes
Income tax expense increased$67.1 from$(94.5) to$(27.4) primarily due to an increase in the tax valuation allowance in the nine months endedSeptember 30, 2012 , as compared to a decrease in the tax valuation in the nine months endedSeptember 30, 2011 , which is partially offset by a decrease in income before taxes and an increase in the dividends received deduction. Financial Condition Investments Investment Strategy Our investment strategy seeks to achieve sustainable risk-adjusted returns by focusing on principal preservation, disciplined matching of asset characteristics with liability requirements and the diversification of risks. Investment activities are undertaken according to investment policy statements that contain internally established guidelines and risk tolerances and in all cases are required to comply with applicable laws and insurance regulations. Risk tolerances are established for credit risk, credit spread risk, market risk, liquidity risk and concentration risk across issuers, sectors and asset types that seek to mitigate the impact of cash flow variability arising from these risks. Investments are managed byING Investment Management LLC , our affiliate, pursuant to an investment advisory agreement. Segmented portfolios are established for groups of products with similar liability characteristics. Our investment portfolio consists largely of high quality fixed maturity securities and short-term investments, investments in commercial mortgage loans, limited partnerships and other instruments, including a small amount of equity holdings. Fixed maturity securities include publicly issued corporate bonds, government bonds, privately placed notes and bonds, mortgage-backed securities and asset-backed securities. We use derivatives for hedging purposes and to replicate exposure to other assets as a more efficient means of assuming credit exposure similar to bonds of the underlying issuer(s).
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Portfolio Composition
The following table presents the investment portfolio as ofSeptember 30, 2012 andDecember 31, 2011 : 2012 2011 Carrying % of Carrying % of Value Total Value Total Fixed maturities, available-for-sale, including securities pledged $ 21,614.2 74.6 % $ 22,413.5 72.0 % Fixed maturities, at fair value using the fair value option 354.1 1.2 % 335.0 1.1 % Equity securities, available-for-sale 29.8 0.1 % 27.7 0.1 % Short-term investments(1) 1,489.7 5.1 % 2,397.0 7.7 % Mortgage loans on real estate 2,908.4 10.0 % 3,137.3 10.1 % Loan - Dutch State obligation(2) 545.4 1.9 % 658.2 2.1 % Policy loans 105.1 0.4 % 112.0 0.4 % Limited partnerships/corporations 245.5 0.8 % 305.4 1.0 % Derivatives 1,628.8 5.6 % 1,609.1 5.2 % Other investments 82.0 0.3 % 82.2 0.3 % Total investments $ 29,003.0 100.0 % $ 31,077.4 100.0 %
(1) Short-term investments include investments with remaining maturities of one year or less, but greater than 3 months, at the time of purchase. (2) The reported value of the Dutch State loan obligation is based on the outstanding loan balance plus any unamortized premium.
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Fixed Maturities
Total fixed maturities by market sector, including securities pledged, were as follows as of
As of September 30, 2012 Amortized % of Fair % of Cost Total Value Total Fixed Maturities: U.S. Treasuries $ 1,268.6 6.3 % $ 1,368.8 6.3 % U.S. government agencies and authorities 19.3 0.1 % 23.8 0.2 % U.S. corporate, state and municipalities 9,666.7 48.5 % 10,713.2 48.7 % Foreign securities(1) 4,873.3 24.5 % 5,347.7 24.3 % Residential mortgage-backed 1,750.7 8.9 % 1,998.6 9.1 % Commercial mortgage-backed 1,630.2 8.2 % 1,826.4 8.3 % Other asset-backed 706.1 3.5 % 689.8 3.1 % Total fixed maturities, including securities pledged $ 19,914.9 100.0 % $ 21,968.3 100.0 % (1) Primarily U.S. dollar denominated. As of December 31, 2011 Amortized % of Fair % of Cost Total Value Total Fixed Maturities: U.S. Treasuries $ 1,692.9 7.9 % $ 1,785.8 7.9 % U.S. government agencies and authorities 19.9 0.1 % 23.7 0.1 % U.S. corporate, state and municipalities 9,626.6 45.1 % 10,375.6 45.6 % Foreign securities(1) 5,288.4 24.8 % 5,582.1 24.5 % Residential mortgage-backed 2,090.0 9.8 % 2,305.8 10.1 % Commercial mortgage-backed 1,910.3 8.9 % 2,001.9 8.8 % Other asset-backed 734.3 3.4 % 673.6 3.0 % Total fixed maturities, including securities pledged $ 21,362.4 100.0 % $ 22,748.5 100.0 % (1) Primarily U.S. dollar denominated.
As of
Fixed Maturities Credit Quality - Ratings
The Securities Valuation Office ("SVO") of the NAIC evaluates the fixed maturities investments of insurers for regulatory reporting and capital assessment purposes and assigns securities to one of six credit quality categories called "NAIC designations." An internally developed rating is used if no rating is available as permitted by the NAIC. These designations are generally similar to the credit quality designations of the NAIC acceptable rating organization ("ARO") for marketable fixed maturities, called "rating agency designations," except for certain structured securities as described below. NAIC designations of "1," highest quality and "2," high quality, include fixed maturities generally considered investment grade (i.e., rated "Baa3" or better by Moody's or rated "BBB-" or better by S&P and Fitch). NAIC designations "3" through "6" include fixed maturities generally considered below investment grade (i.e., rated "Ba1" or lower by Moody's or rated "BB+" or lower by S&P and Fitch). The NAIC adopted revised designation methodologies for non-agency Residential mortgage-backed securities ("RMBS"), including RMBS backed by subprime mortgage loans reported within other Asset-backed securities ("ABS") that became effectiveDecember 31, 2009 and for Commercial mortgage-backed securities ("CMBS") that became effectiveDecember 31, 2010 . The NAIC's objective with the revised designation methodologies for these structured securities was to increase the accuracy in assessing
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expected losses and to use the improved assessment to determine a more appropriate capital requirement for such structured securities. The revised methodologies reduce regulatory reliance on rating agencies and allow for greater regulatory input into the assumptions used to estimate expected losses from such structured securities.
As a result of time lags between the funding of investments, the finalization of legal documents and the completion of the SVO filing process, the fixed maturity portfolio generally includes securities that have not yet been rated by the SVO as of each balance sheet date, such as private placements. Pending receipt of SVO ratings, the categorization of these securities by NAIC designation is based on the expected ratings indicated by internal analysis. Information about certain of our fixed maturity securities holdings by NAIC designations is set forth in the following tables. Corresponding rating agency designation does not directly translate into NAIC designation, but represents our best estimate of comparable ratings from rating agencies, including Moody's Investors Service ("Moody's"), Standard & Poor's ("S&P") andFitch Ratings Ltd. ("Fitch"). If no rating is available from a rating agency, then an internally developed rating is used on a basis believed to be similar to that used by the rating agencies. The fixed maturities in our portfolio are generally rated by external rating agencies and, if not externally rated, are rated by us. As ofSeptember 30, 2012 andDecember 31, 2011 , the average quality rating of our fixed maturities portfolio was A. Ratings are derived from three ARO ratings and are applied as follows based on the number of agency rating received:
• when three ratings are received then the middle rating is applied;
• when two ratings are received then the lower rating is applied;
• when a single rating is received, the ARO rating is applied; and
• when ratings are unavailable then an internal rating is applied.
Total fixed maturities by NAIC quality designation category, including securities pledged, were as follows as ofSeptember 30, 2012 andDecember 31, 2011 : 2012 NAIC Quality Amortized % of Fair % of Designation Cost Total Value Total 1 $ 11,072.6 55.6 % $ 12,267.1 55.9 % 2 7,896.2 39.6 % 8,709.3 39.6 % 3 658.1 3.3 % 678.5 3.1 % 4 132.7 0.7 % 125.6 0.6 % 5 115.8 0.6 % 112.2 0.5 % 6 39.5 0.2 % 75.6 0.3 % Total $ 19,914.9 100.0 % $ 21,968.3 100.0 % 2011 NAIC Quality Amortized % of Fair % of Designation Cost Total Value Total 1 $ 12,420.9 58.1 % $ 13,324.2 58.6 % 2 7,679.6 36.0 % 8,152.0 35.8 % 3 907.9 4.2 % 905.7 4.0 % 4 199.3 1.0 % 173.8 0.8 % 5 113.6 0.5 % 117.4 0.5 % 6 41.1 0.2 % 75.4 0.3 % Total $ 21,362.4 100.0 % $ 22,748.5 100.0 % 71
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Total fixed maturities by ARO quality rating category, including securities pledged, were as follows as of
2012 ARO Quality Amortized % of Fair % of Ratings Cost Total Value Total AAA $ 3,921.3 19.8 % $ 4,344.6 19.8 % AA 1,421.9 7.1 % 1,552.3 7.1 % A 5,360.5 26.9 % 5,968.4 27.1 % BBB 7,899.5 39.7 % 8,722.3 39.7 % BB 666.1 3.3 % 714.1 3.3 % B and below 645.6 3.2 % 666.6 3.0 % Total $ 19,914.9 100.0 % $ 21,968.3 100.0 % 2011 ARO Quality Amortized % of Fair % of Ratings Cost Total Value Total AAA $ 4,892.1 22.9 % $ 5,312.8 23.4 % AA 1,373.7 6.4 % 1,464.5 6.4 % A 5,895.1 27.6 % 6,327.4 27.9 % BBB 7,636.8 35.8 % 8,107.7 35.5 % BB 809.8 3.8 % 831.4 3.7 % B and below 754.9 3.5 % 704.7 3.1 % Total $ 21,362.4 100.0 % $ 22,748.5 100.0 %
As of
Fixed maturities rated BB and below (Below Investment Grade ("BIG")) may have speculative characteristics and changes in economic conditions or other circumstances are more likely to lead to a weakened capacity of the issuer to make principal and interest payments than is the case with higher rated fixed maturities. The amortized cost and fair value of fixed maturities, including securities pledged, as ofSeptember 30, 2012 andDecember 31, 2011 , are shown below by contractual maturity. Actual maturities may differ from contractual maturities as securities may be restructured, called, or prepaid. Mortgage-backed securities ("MBS") and ABS are shown separately because they are not due at a single maturity date. 2012 2011 Amortized Fair Amortized Fair Cost Value Cost Value Due to mature: One year or less $ 1,149.4 $ 1,178.3 $ 1,444.7 $ 1,472.2 After one year through five years 4,807.7 5,077.6 5,479.9 5,669.9 After five years through ten years 5,984.8 6,611.9 5,987.4 5,987.4 After ten years 3,886.0 4,585.7 3,715.8 3,715.8 Mortgage-backed securities 3,380.9 3,825.0 400.3 4,061.8 Other asset-backed securities 706.1 689.8 734.3 727.8 Fixed maturities, including securities pledged $ 19,914.9 $ 21,968.3 $ 17,762.4 $ 21,634.9 72
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As ofSeptember 30, 2012 andDecember 31, 2011 , we did not have any investments in a single issuer, other than obligations of the U.S. government and government agencies and the Dutch State loan obligation, with a carrying value in excess of 10% of our shareholder's equity.
Unrealized Capital Losses
Unrealized capital losses (including noncredit impairments), along with the fair value of fixed maturities, including securities pledged, by market sector and duration were as follows as ofSeptember 30, 2012 andDecember 31, 2011 : More Than
Six
Six Months or Less Below Amortized Months and Twelve Months or Less More Than Twelve Months Below Cost Below Amortized Cost Amortized Cost Total Unrealized Unrealized Unrealized Unrealized Fair Value Capital Losses Fair Value Capital Losses Fair Value Capital Losses Fair Value Capital Losses 2012 U.S. corporate, state and municipalities $ 255.8 $ 2.3 $ 55.2 $ 3.8 $ 132.1 $ 17.2 $ 443.1 $ 23.3 Foreign 79.8 4.1 10.0 1.5 161.1 22.3 250.9 27.9 Residential mortgage-backed 26.2 0.6 21.3 0.6 219.6 35.4 267.1 36.6 Commercial mortgage-backed 26.9 0.8 1.3 0.5 16.6 3.2 44.8 4.5 Other asset-backed 3.2 - - - 156.4 36.2 159.6 36.2 Total $ 391.9 $ 7.8 $ 87.8 $ 6.4 $ 685.8 $ 114.3 $ 1,165.5 $ 128.5 2011 U.S. corporate, state and municipalities $ 798.9 $ 17.6 $ 97.6 $ 4.1 $ 208.0 $ 20.6 $ 1,104.5 $ 42.3 Foreign 476.5 30.2 51.1 5.0 339.5 34.6 867.1 69.8 Residential mortgage-backed 74.6 0.9 188.2 5.7 305.6 84.3 568.4 90.9 Commercial mortgage-backed 155.1 1.9 234.7 17.9 35.7 6.6 425.5 26.4 Other asset-backed 42.6 0.3 26.5 9.6 142.1 59.7 211.2 69.6 Total $ 1,547.7 $ 50.9 $ 598.1 $ 42.3 $ 1,030.9 $ 205.8 $ 3,176.7 $ 299.0
Of the unrealized capital losses aged more than twelve months, the average market value of the related fixed maturities was 85.7% and 83.4% of the average book value as of
For the nine months endedSeptember 30, 2012 , unrealized capital losses on fixed maturities decreased by$170.5 . The decrease in gross unrealized losses is primarily due to market improvement and the overall declining yields, leading to higher fair value of fixed maturities.
As of
Subprime and Alt-A Mortgage Exposure
The performance of underlying subprime and Alt-A mortgage collateral, originated prior to 2008, has continued to reflect the problems associated with a housing market that has since seen substantial price declines and an employment market that has declined significantly and remains under stress. Credit spreads have widened meaningfully from issuance and rating agency downgrades have been widespread and severe within the sector. Over the course of 2010 and 2011, market prices and liquidity within the sector exhibited volatility, driven by various factors, both domestically and globally. During the nine months endedSeptember 30, 2012 , market prices and sector liquidity have exhibited some improvements, driven by an improved technical
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picture and positive sentiment regarding the potential for improvements within the sector. In managing its risk exposure to subprime and Alt-A mortgages, we take into account collateral performance and structural characteristics associated with its various positions. We do not originate or purchase subprime or Alt-A whole-loan mortgages. Subprime lending is the origination of loans to customers with weaker credit profiles. We define Alt-A mortgages to include the following: residential mortgage loans to customers who have strong credit profiles but lack some element(s), such as documentation to substantiate income; residential mortgage loans to borrowers that would otherwise be classified as prime but whose loan structure provides repayment options to the borrower that increase the risk of default; and any securities backed by residential mortgage collateral not clearly identifiable as prime or subprime. We have exposure to RMBS, CMBS and ABS. Our exposure to subprime mortgage-backed securities is primarily in the form of ABS structures collateralized by subprime residential mortgages and the majority of these holdings were included in Other ABS under "Fixed Maturities" above. As ofSeptember 30, 2012 , the fair value and gross unrealized losses related to our exposure to subprime mortgage-backed securities was$187.9 and$36.3 , respectively, representing 0.9% of total fixed maturities, including securities pledged. As ofDecember 31, 2011 , the fair value and gross unrealized losses related to our exposure to subprime mortgage-backed securities were$189.3 and$69.7 , respectively, representing 0.8% of total fixed maturities, including securities pledged.
The following tables summarize our exposure to subprime mortgage-backed securities by credit quality using NAIC designations, ARO ratings and vintage year as of
% of Total Subprime Mortgage-backed Securities NAIC Designation ARO Ratings Vintage 2012 1 77.5 % AAA 0.3 % 2007 15.6 % 2 8.5 % AA 4.1 % 2006 6.4 % 3 9.9 % A 10.5 % 2005 and prior 78.0 % 4 1.9 % BBB 10.2 % 100.0 % 5 0.9 % BB and below 74.9 % 6 1.3 % 100.0 % 100.0 % 2011 1 79.0 % AAA 1.6 % 2007 18.9 % 2 6.2 % AA 5.9 % 2006 6.6 % 3 10.5 % A 7.9 % 2005 and prior 74.5 % 4 1.5 % BBB 9.8 % 100.0 % 5 1.3 % BB and below 74.8 % 6 1.5 % 100.0 % 100.0 % Our exposure to Alt-A mortgages is included in the "Residential mortgage-backed securities" line item in the "Fixed Maturities" table under "Fixed Maturities" section above. As ofSeptember 30, 2012 , the fair value and gross unrealized losses related to our exposure to Alt-A RMBS aggregated to$135.6 and$26.0 , respectively, representing 0.6% of total fixed maturities including securities pledged. As ofDecember 31, 2011 , the fair value and gross unrealized losses related to our exposure to Alt-A RMBS aggregated to$129.7 and$52.7 , respectively, representing 0.6% of total fixed maturities, including securities pledged. 74
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The following tables summarize our exposure to Alt-A residential mortgage-backed securities by credit quality using NAIC designations, ARO ratings and vintage year as ofSeptember 30, 2012 andDecember 31, 2011 : % of Total Alt-A Mortgage-backed Securities NAIC Designation ARO Ratings Vintage 2012 1 43.7 % AAA 0.2 % 2007 31.1 % 2 11.3 % AA 1.1 % 2006 19.6 % 3 12.5 % A 3.5 % 2005 and prior 49.3 % 4 24.3 % BBB 2.0 % 100.0 % 5 6.8 % BB and below 93.2 % 6 1.4 % 100.0 % 100.0 % 2011 1 38.5 % AAA 0.3 % 2007 30.0 % 2 11.6 % AA 1.7 % 2006 18.9 % 3 12.2 % A 5.0 % 2005 and prior 51.1 % 4 29.1 % BBB 2.9 % 100.0 % 5 7.4 % BB and below 90.1 % 6 1.2 % 100.0 % 100.0 %
CMBS investments represent pools of commercial mortgages that are broadly diversified across property types and geographical areas. Delinquency rates on commercial mortgages have remained elevated in recent months. However, the steep pace of increases observed in the months following the credit crisis has slowed and some recent months have posted month over month declines in mortgage delinquencies. In addition, other performance metrics like vacancies, property values and rent levels have shown improvements. These metrics may provide early signals of a recovery in commercial real estate. In addition, the primary market for CMBS continued its recovery from the credit crisis with higher total new issuances in 2011, which was the third straight year of higher new issuances. Higher new issuances resulted in increased credit availability within the commercial real estate market. For consumer ABS, delinquency and loss rates have continued to decline after the credit crisis. Improvements in various credit metrics across multiple types of asset-backed loans have been observed on a sustained basis.
As of
As ofSeptember 30, 2012 andDecember 31, 2011 , the gross unrealized losses related to CMBS totaled$4.5 and$26.4 respectively. As ofSeptember 30, 2012 , there were no gross unrealized losses related to Other ABS, excluding subprime exposure. As ofDecember 31, 2011 , gross unrealized losses related to Other ABS, excluding subprime exposure, totaled$0.2 .
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The following tables summarize our exposure to CMBS holdings by credit quality using NAIC designations, ARO ratings and vintage year as ofSeptember 30, 2012 andDecember 31, 2011 : % of Total CMBS NAIC Designation ARO Ratings Vintage 2012 1 97.1 % AAA 42.3 % 2008 0.6 % 2 2.2 % AA 22.1 % 2007 29.9 % 3 0.7 % A 11.9 % 2006 34.3 % 4 - % BBB 15.5 % 2005 and prior 35.2 % 5 - % BB and below 8.2 % 100.0 % 6 - % 100.0 % 100.0 % 2011 1 97.1 % AAA 52.7 % 2008 0.5 % 2 1.8 % AA 18.4 % 2007 25.9 % 3 - % A 12.7 % 2006 31.2 % 4 - % BBB 8.8 % 2005 and prior 42.4 % 5 - % BB and below 7.4 % 100.0 % 6 1.1 % 100.0 % 100.0 % As ofSeptember 30, 2012 , the other ABS was also broadly diversified both by type and issuer with credit card receivables, nonconsolidated collateralized loan obligations and automobile receivables, comprising 29.3%, 12.0% and 35.6%, respectively, of total Other ABS, excluding subprime exposure. As ofDecember 31, 2011 , Other ABS was also broadly diversified both by type and issuer with credit card receivables, nonconsolidated collateralized loan obligations and automobile receivables, comprising 31.6%, 13.1% and 31.3%, respectively, of total Other ABS, excluding subprime exposure.
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The following tables summarize our exposure to Other ABS holdings, excluding subprime exposure, by credit quality using NAIC designations, ARO ratings and vintage year as ofSeptember 30, 2012 andDecember 31, 2011 : % of Total Other ABS NAIC Designation ARO Ratings Vintage 2012 1 95.7 % AAA 90.6 % 2012 17.4 % 2 2.1 % AA 1.5 % 2011 16.7 % 3 - % A 3.6 % 2010 4.6 % 4 - % BBB 2.1 % 2009 5.8 % 5 - % BB and below 2.2 % 2008 3.1 % 6 2.2 % 100.0 % 2007 15.0 % 100.0 % 2006 20.5 % 2005 and prior 16.9 % 100.0 % 2011 1 96.0 % AAA 86.1 % 2011 18.7 % 2 1.8 % AA 3.8 % 2010 10.7 % 3 - % A 3.0 % 2009 8.3 % 4 0.1 % BBB 3.8 % 2008 3.6 % 5 2.1 % BB and below 3.3 % 2007 19.3 % 6 - % 100.0 % 2006 20.2 % 100.0 % 2005 and prior 19.2 % 100.0 % Troubled Debt Restructuring We invest in high quality, well performing portfolios of commercial mortgage loans and private placements. Under certain circumstances, modifications to these contracts are granted. Each modification is evaluated as to whether a troubled debt restructuring has occurred. A modification is a troubled debt restructure when the borrower is in financial difficulty and the creditor makes concessions. Generally, the types of concessions may include reducing the face amount or maturity amount of the debt as originally stated, reducing the contractual interest rate, extending the maturity date at an interest rate lower than current market interest rates and/or reducing accrued interest. We consider the amount, timing and extent of the concession granted in determining any impairment or changes in the specific valuation allowance recorded in connection with the troubled debt restructuring. A valuation allowance may have been recorded prior to the quarter when the loan is modified in a troubled debt restructuring. Accordingly, the carrying value (net of the specific valuation allowance) before and after modification through a troubled debt restructuring may not change significantly, or may increase if the expected recovery is higher than the pre-modification recovery assessment. As ofSeptember 30, 2012 andDecember 31, 2011 , we did not have any troubled debt restructurings.
During the three and nine months ended
Mortgage Loans on Real Estate
Our mortgage loans on real estate are all commercial mortgage loans, which totaled$2.9 billion and$3.1 billion as ofSeptember 30, 2012 andDecember 31, 2011 , respectively. The carrying value of these loans is reported at amortized cost, less impairment write-downs and allowance for losses. We diversify our commercial mortgage loan portfolio by geographic region and property type to manage concentration risk. We manage risk when originating commercial mortgage loans by generally lending only up to 75% of the estimated fair value of the underlying real estate. Subsequently, we continuously evaluate all mortgage loans based on relevant current information including a review of loan-specific credit, property characteristics and market trends. Loan performance is continuously monitored on a loan-specific basis throughout the year. Our review includes submitted appraisals,
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operating statements, rent revenues and annual inspection reports, among other items. This review evaluates whether the properties are performing at a consistent and acceptable level to secure the debt.
We rate all commercial mortgages to quantify the level of risk. We place those loans with higher risk on a watch list and closely monitor these loans for collateral deficiency or other credit events that may lead to a potential loss of principal and/or interest. If we determine the value of any mortgage loan to be OTTI (i.e., when it is probable that we will be unable to collect on all amounts due according to the contractual terms of the loan agreement), the carrying value of the mortgage loan is reduced to either the present value of expected cash flows from the loan, discounted at the loan's effective interest rate, or fair value of the collateral. For those mortgages that are determined to require foreclosure, the carrying value is reduced to the fair value of the underlying collateral, net of estimated costs to obtain and sell at the point of foreclosure. The carrying value of the impaired loans is reduced by establishing an other-than-temporary write-down recorded in net realized capital gains (losses) in the Condensed Statements of Operations. The following tables summarize our investment in commercial mortgage loans, the related valuation allowance and changes in the valuation allowance for the nine months endedSeptember 30, 2012 and the year endedDecember 31, 2011 : 2012 2011 Commercial mortgage loans $ 2,909.8 $ 3,138.8 Collective valuation allowance (1.4 ) (1.5 )
Total net commercial mortgage loans
2012
2011
Collective valuation allowance for losses, beginning of period
(0.1 )
(1.5 ) Collective valuation allowance for losses, end of period
There were no impairments taken on the mortgage loan portfolio for the three and nine months ended
Our policy is to recognize interest income until a loan becomes 90 days delinquent or foreclosure proceedings are commenced, at which point interest accrual is discontinued. Interest accrual is not resumed until the loan is brought current.
Loan-to-value ("LTV") and debt service coverage ("DSC") ratios are measures commonly used to assess the risk and quality of commercial mortgage loans. The LTV ratio, calculated at time of origination, is expressed as a percentage of the amount of the loan relative to the value of the underlying property. An LTV ratio in excess of 100% indicates the unpaid loan amount exceeds the value of the underlying collateral. The DSC ratio, based upon the most recently received financial statements, is expressed as a percentage of the amount of a property's net income (loss) to its debt service payments. A DSC ratio of less than 1.0 indicates that property's operations do not generate sufficient income to cover debt payments. These ratios are utilized as part of the review process described above. 78
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LTV and DSC ratios as ofSeptember 30, 2012 andDecember 31, 2011 were as follows: 2012(1) 2011(1) Loan-to-Value Ratio: 0% - 50% $ 772.5 $ 920.9 50% - 60% 863.3 833.9 60% - 70% 1,089.0 1,173.2 70% - 80% 173.9 191.3 80% and above 11.1 19.5 Total Commercial mortgage loans $ 2,909.8 $
3,138.8
(1) Balances do not include allowance for mortgage loan credit losses.
2012(1) 2011(1) Debt Service Coverage Ratio: Greater than 1.5x $ 2,023.4 $ 2,105.3 1.25x - 1.5x 453.2 565.8 1.0x - 1.25x 285.0 355.5 Less than 1.0x 148.2 112.2 Total Commercial mortgage loans $ 2,909.8 $
3,138.8
(1) Balances do not include allowance for mortgage loan credit losses.
Other-Than-Temporary Impairments
We evaluate available-for-sale fixed maturities and equity securities for impairment on a quarterly basis. The assessment of whether impairments have occurred is based on a case-by-case evaluation of the underlying reasons for the decline in estimated fair value.
The following table identifies our credit-related and intent-related impairments included in the Condensed Statements of Operations, excluding impairments included in Accumulated other comprehensive income (loss) ("AOCI"), by type for the three and nine months endedSeptember 30, 2012 and 2011:
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The following tables identify our credit-related and intent-related impairments included in the Condensed Statements of Operations, excluding impairments included in Accumulated other comprehensive income (loss) ("AOCI"), by type for the three and nine months endedSeptember 30, 2012 and 2011. Three Months Ended September 30, 2012 2011 No. of No. of Impairment Securities Impairment Securities U.S. corporate $ 1.3 1 $ 1.7 4 Foreign(1) - - 12.8 13 Residential mortgage-backed 2.0 29 4.1 50 Commercial mortgage-backed - - 19.3 11 Other asset-backed - - 9.4 8 Mortgage loans on real estate - - 4.6 3 Total $ 3.3 30 $ 51.9 89
(1) Primarily U.S. dollar denominated.
Nine Months Ended September 30, 2012 2011 No. of No. of Impairment Securities Impairment Securities U.S. corporate $ 1.8 2 $ 4.8 6 Foreign(1) 0.7 3 16.8 22 Residential mortgage-backed 4.7 46 7.0 56 Commercial mortgage-backed 1.7 1 29.7 12 Other asset-backed 0.3 3 72.6 58 Mortgage loans on real estate - - 6.9 5 Total $ 9.2 55 $ 137.8 159
(1) Primarily U.S. dollar denominated.
The above tables include$3.3 and$6.3 of write-downs related to credit impairments for the three and nine months endedSeptember 30, 2012 , respectively, in Other-than-temporary impairment losses, which are recognized in the Condensed Statements of Operations. There were no remaining write-downs for the three months endedSeptember 30, 2012 related to intent impairments. The remaining$2.9 in write-downs for the nine months endedSeptember 30, 2012 are related to intent impairments.
The above tables include
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The following tables summarize these intent impairments, which are also recognized in earnings, by type for the three and nine months endedSeptember 30, 2012 and 2011. Three Months Ended September 30, 2012 2011 No. of No. of Impairment Securities Impairment Securities U.S. corporate $ - - $ 1.7 4 Foreign(1) - - 11.3 11 Residential mortgage-backed - - 0.1 3 Commercial mortgage-backed - - 19.3 11 Other asset-backed - - 8.1 7 Total $ - - $ 40.5 36
(1) Primarily U.S. dollar denominated.
Nine Months Ended September 30, 2012 2011 No. of No. of Impairment Securities Impairment Securities U.S. corporate $ 0.4 1 $ 4.8 6 Foreign(1) 0.7 3 13.7 19 Residential mortgage-backed - - 0.1 4 Commercial mortgage-backed 1.7 1 28.5 12 Other asset-backed 0.1 1 69.8 57 Total $ 2.9 6 $ 116.9 98
(1) Primarily U.S. dollar denominated.
As part of our investment strategy, we may sell securities during the period in which fair value has declined below amortized cost for fixed maturities or cost for equity securities. In certain situations, new factors, including changes in the business environment, can change our previous intent to continue holding a security. Accordingly, these factors may lead us to record additional intent related capital losses.
The fair value of fixed maturities with OTTI as of
During the nine months ended
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Net Investment Income
The following tables summarize Net investment income for the three and nine months ended
Three Months Ended September 30, 2012 2011 Fixed maturities $ 280.5 $ 311.8 Equity securities, available-for-sale 1.2 1.0 Mortgage loans on real estate 40.1 46.5 Policy loans 1.5 1.7 Short-term investments and cash equivalents (0.2 ) 0.4 Other 7.5 13.1 Gross investment income 330.6 374.5 Less: investment expenses (13.1 ) (15.6 ) Net investment income $ 317.5 $ 358.9 Nine Months Ended September 30, 2012 2011 Fixed maturities $ 865.7 $ 934.3 Equity securities, available-for-sale 3.0 6.1 Mortgage loans on real estate 126.8 130.9 Policy loans 4.4 5.0 Short-term investments and cash equivalents 0.1 1.8 Other 18.2 51.2 Gross investment income 1,018.2 1,129.3 Less: investment expenses (39.5 ) (44.5 ) Net investment income $ 978.7 $ 1,084.8 Net investment income decreased for the three and nine months endedSeptember 30, 2012 , primarily due to lower general account assets and due to the loss recorded on the sale of certain alternative investments. General account assets decreased as a result of MYGAs lapsing at the end of their initial terms, largely due to MYGA crediting rates that were lower than the crediting rates during the initial term. The sale of certain alternative investments resulted in a net pretax loss of$16.9 in the second quarter of 2012. In addition, lower yields on the CMO-B portfolio and lower prepayment fees also contributed to the decrease for the three months endedSeptember 30, 2012 .
Net Realized Capital Gains (Losses)
Net realized capital gains (losses) are comprised of the difference between the amortized cost of investments and proceeds from sale and redemption, as well as losses incurred due to the credit-related and intent-related other-than-temporary impairment of investments. Realized investment gains and losses are also primarily generated from changes in fair value of embedded derivatives within product guarantees and fixed maturities, changes in fair value of fixed maturity securities recorded at FVO and changes in fair value including accruals on derivative instruments, except for effective cash flow hedges. The cost of the investments on disposal is generally determined based on first-in-first-out ("FIFO") methodology.
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Net realized capital gains (losses) were as follows for the three and nine months ended
Three Months
Ended September 30,
2012
2011
Fixed maturities, available-for-sale, including securities pledged $ 54.3 $ 66.3 Fixed maturities, at fair value option (7.4 ) (9.3 ) Equity securities, available-for-sale (0.1 ) 1.4 Derivatives (773.4 )
1,897.8
Embedded derivatives - fixed maturities (3.0 ) 8.8 Embedded derivatives - product guarantees 517.3 (861.4 ) Other investments 0.1 (4.2 ) Net realized capital gains (losses) $ (212.2 ) $ 1,099.4 After-tax net realized capital gains (losses) $ (123.9 ) $ 831.6 Nine Months Ended September 30, 2012 2011 Fixed maturities, available-for-sale, including securities pledged $ 135.6 $ 55.8 Fixed maturities, at fair value option (33.8 ) (17.6 ) Equity securities, available-for-sale (0.2 ) 2.6 Derivatives (1,395.8 )
1,647.7
Embedded derivatives - fixed maturities (3.9 ) 9.0 Embedded derivatives - product guarantees 227.1 (977.0 ) Other investments 0.8 (6.4 ) Net realized capital gains (losses) $ (1,070.2 ) $ 714.1 After-tax net realized capital gains (losses) $ (695.6 )
$ 591.2
Total net realized capital gains (losses) decreased for the three and nine months endedSeptember 30, 2012 , primarily driven by the impact of market conditions on our hedging programs. Under the variable annuity hedge program, changes in equity and interest markets resulted in net losses on interest, equity and foreign exchange derivatives for the three and nine month endedSeptember 30, 2012 compared to net gains during the same periods of 2011. The majority of the unfavorable change in derivatives is ceded to SLDI under the combined coinsurance and coinsurance funds withheld agreement, and an offset is recorded in Interest credited and other benefits to contract holders. The unfavorable changes were partially offset by changes in the fair value of embedded derivatives on variable annuity product guarantees. Other derivative gains and lower impairments on fixed maturities were favorable, which also partially offset the change.
Sale of Certain Alternative Investments
OnJune 4, 2012 , we entered into an agreement to sell certain general account private equity limited partnership investment interest holdings ("sale of certain alternative investments") with a carrying value of$146.1 as ofMarch 31, 2012 to a group of private equity funds that are managed byPomona Management LLC , an affiliate of the Company. The transaction resulted in a net pretax loss of$16.9 in the second quarter of 2012 reported in Net investment income on the Condensed Statements of Operations. The transaction closed in two tranches with the first tranche closed onJune 29, 2012 and the second tranche closed onOctober 29, 2012 . Consideration received included$8.2 of promissory notes due in two equal installments atDecember 31, 2013 and 2014. In connection with these promissory notes,ING U.S., Inc. unconditionally guaranteed payment of the notes in the event of any default of payments due. No additional loss was incurred on the second tranche since the fair value of the alternative investments was reduced to the agreed-upon sales price as ofJune 30, 2012 .
We are selling these assets in order to reduce our exposure to alternative investments as part of our portfolio management. We anticipate that the transaction will reduce our required capital levels, in light of the high capital charge associated with the asset class and improve liquidity and reduce earnings volatility.
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European Exposures
In the first half of 2010 concerns arose regarding the creditworthiness of several European countries, which later spread more broadly to countries in the European currency union. As a result of these concerns the fair value of sovereign debt decreased and those exposures were being monitored more closely. With regard to troubled European countries, our main focus is onGreece ,Italy ,Ireland ,Portugal andSpain (henceforth defined as "peripheralEurope ") as these countries have applied for support from theEuropean Financial Stability Fund ("EFSF") or received support from theEuropean Central Bank ("ECB") via government bond purchases in the secondary market. The financial turmoil inEurope continues to be a threat to global capital markets and remains a challenge to global financial stability. Additionally, the possibility of capital market volatility spreading through a highly integrated and interdependent banking system remains elevated. Furthermore, it is our view that the risk among European sovereigns and financial institutions warrants specific scrutiny, in addition to its customary surveillance and risk monitoring, given how highly correlated these sectors of the region have become. We quantify and allocate our exposure to the region, as described in the table below, by attempting to identify all aspects of the region or country risk to which we are exposed. Among the factors we consider are the nationality of the issuer, the nationality of the issuer's ultimate parent, the corporate and economic relationship between the issuer and its parent, as well as the political, legal and economic environment in which each functions. By undertaking this assessment, we believe that we develop a more accurate assessment of the actual geographic risk, with a more integrated understanding of all contributing factors to the full risk profile of the issuer. In the normal course of our ongoing risk and portfolio management process, we closely monitor compliance with a credit limit hierarchy designed to minimize overly concentrated risk exposures by geography, sector and issuer. This framework takes into account various factors such as internal and external ratings, capital efficiency and liquidity and is overseen by a combination of Investment and Corporate Risk Management, as well as insurance portfolio managers focused specifically on managing the investment risk embedded in our portfolio. As ofSeptember 30, 2012 , we had$375.9 of exposure to peripheralEurope , which consists of a broadly diversified portfolio of credit-related investments solely in the industrial and utility sectors. We had no fixed maturity and equity securities exposure to peripheral European sovereigns or financial institutions based in peripheralEurope . Peripheral European exposure included non-sovereign exposure inItaly of$149.7 ,Ireland of$130.3 andSpain of$95.9 . We had no exposure toGreece andPortugal . As ofSeptember 30, 2012 , there were no derivative assets exposure to financial institutions in peripheralEurope . For purposes of calculating the derivative assets exposure, we had aggregated exposure to single name and portfolio product credit default swaps ("CDS"), as well as all non-CDS derivative exposure for which we either had counterparty or direct credit exposure to a company whose country of risk is in scope. Among the remaining$2.9 billion of total non-peripheral European exposure, we had a portfolio of credit-related assets similarly diversified by country and sector across developed and developingEurope . Sovereign exposure is$649.5 , which consists of fixed maturity and equity securities of$104.1 and loans and receivables of$545.4 , comprised entirely of the Dutch State loan obligation to us under the Illiquid Assets Back-up Facility. We also had$267.7 in net exposure to non-peripheral financial institutions with a concentration in theUnited Kingdom of$88.2 ,France of$47.3 , andSwitzerland of$34.7 . The balance of$2.0 billion was invested across non-peripheral, non-financial institutions. In addition to aggregate concentration tothe Netherlands of$891.0 (which includes the$545.4 Dutch State loan obligation) and theUnited Kingdom of$830.4 , we had significant non-peripheral European total country exposures toSwitzerland of$215.5 ,Germany of$213.3 , andFrance of$247.8 . We place additional scrutiny on our financial exposure in theUnited Kingdom ,France andSwitzerland given our concern for the potential for volatility to spread through the European banking system. We believe the primary risk results from market value fluctuations resulting from spread volatility and the secondary risk is default risk, should the European crisis worsen or fail to be resolved. 84
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The following table represents our European exposures at fair value and amortized cost as of
Fixed Maturity and Equity Securities Derivative Assets Loan and Receivables Total Sovereign Total, Net Non-U.S. Funded Financial Non-Financial (Fair Total (Amortized Financial Non-Financial Less: Margin & (Fair
at
Sovereign Institutions Institutions Value) (Amortized Cost) Cost) Sovereign Institutions Institutions Collateral Value) 2012 (1)Greece $ - $ - $ - $ - $ - $ - $ - $ - $ - $ - $ - $ -Ireland - - 130.3 130.3 118.5 - - - - - - 130.3Italy - - 149.7 149.7 136.4 - - - - - - 149.7Portugal - - - - - - - - - - - -Spain - - 95.9 95.9 97.4 - - - - - - 95.9 Total PeripheralEurope - - 375.9 375.9 352.3 - - - - - - 375.9France - 41.0 200.5 241.5 222.6 - - 323.2 - 316.9 6.3 247.8Germany - 7.8 200.0 207.8 188.9 - - 23.6 - 18.1 5.5 213.3Netherlands - 78.9 266.7 345.6 308.6 545.4 - 21.8 - 21.8 - 891.0Switzerland - 22.4 180.8 203.2 183.5 - - 114.5 - 102.2 12.3 215.5United Kingdom - 70.4 742.2 812.6 748.4 - - 81.2 - 63.4 17.8 830.4 Other non-peripheral (2) 104.1 5.3 435.1 544.5 493.5 - - - - - - 544.5 Total Non-PeripheralEurope 104.1 225.8 2,025.3 2,355.2 2,145.5 545.4 - 564.3 - 522.4 41.9 2,942.5 Total$ 104.1 $ 225.8 $ 2,401.2$ 2,731.1 $ 2,497.8 $ 545.4 $ - $ 564.3 $ - $ 522.4$ 41.9 $ 3,318.4 (1) Represents: (i) Fixed maturity and equity securities at fair value; (ii) Loan receivables sovereign at amortized cost; and (iii) Derivative assets at fair value. (2) Other non-peripheral countries include:Austria ,Belgium ,Bulgaria ,Croatia ,Denmark ,Finland ,Hungary ,Iceland ,Kazakhstan ,Latvia ,Lithuania , Luxembourg,Norway ,Russian Federation ,Slovakia ,Sweden andTurkey .
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Liquidity and Capital Resources
Liquidity is our ability to generate sufficient cash flows to meet the cash requirements of operating, investing and financing activities.
Liquidity Management
Our principal available sources of liquidity are annuity product charges, guaranteed investment contracts (GICs), funding agreements and fixed annuity deposits, investment income, proceeds from the maturity and sale of investments, proceeds from debt issuance and borrowing facilities, repurchase agreements, securities lending, reinsurance and capital contributions. Primary uses of these funds are payments of commissions and operating expenses, interest and premium credits, payments under guaranteed death and living benefits, investment purchases, repayment of debt and contract maturities, withdrawals and surrenders. Our liquidity position is managed by maintaining adequate levels of liquid assets, such as cash, cash equivalents and short-term investments. As part of the liquidity management process, different scenarios are modeled to determine whether existing assets are adequate to meet projected cash flows. Key variables in the modeling process include interest rates, equity market movements, quantity and type of interest and equity market hedges, anticipated contract owner behavior, market value of the general account assets, variable separate account performance and implications of rating agency actions. The fixed account liabilities are supported by a general account portfolio, principally composed of fixed rate investments with matching duration characteristics that can generate predictable, steady rates of return. The portfolio management strategy for the fixed account considers the assets available-for-sale. This strategy enables us to respond to changes in market interest rates, prepayment risk, relative values of asset sectors and individual securities and loans, credit quality outlook and other relevant factors. The objective of portfolio management is to maximize returns, taking into account interest rate and credit risk, as well as other risks. Our asset/liability management discipline includes strategies to minimize exposure to loss as interest rates and economic and market conditions change. In executing this strategy, we use derivative instruments to manage these risks. Our derivative counterparties are of high credit quality.
Liquidity and Capital Resources
Additional sources of liquidity include borrowing facilities to meet short-term cash requirements that arise in the ordinary course of business. We maintain the following agreements:
• A reciprocal loan agreement with
party can borrow from the other up to 3.0% of our statutory net admitted
assets, excluding Separate Accounts, as of the preceding
Inc. under the reciprocal loan agreement. As of
outstanding receivable of
loan agreement. During the second quarter of 2012,
then outstanding receivable due under the reciprocal loan agreement from the
proceeds of its
entered into on
the reciprocal loan agreement and future borrowings by either party will be
subject to the reciprocal loan terms summarized above.
• We hold approximately 47.9% of our assets in marketable securities. These
assets include cash, U.S. Treasuries, Agencies and Public, Corporate Bonds,
ABS, CMBS and CMO and Equity securities. In the event of a temporary liquidity need, cash may be raised by entering into reverse repurchase, dollar rolls and/or security lending agreements by temporarily lending securities and receiving cash collateral. Under our Liquidity Plan, up to 12% of our general account statutory admitted assets may be allocated to
reverse repurchase, securities lending and dollar roll programs. At the time
a temporary cash need arises, the actual percentage of admitted assets
available for reverse repurchase transactions will depend upon outstanding
allocations to the three programs. As of
securities lending obligations of
of our general account statutory admitted assets.
Management believes that its sources of liquidity are adequate to meet our short-term cash obligations.
Capital Contributions and Dividends
During the nine months endedSeptember 30, 2012 , we did not receive any capital contributions from our Parent. During the nine months endedSeptember 30, 2011 , we received capital contributions of$44.0 from our Parent.
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During the nine months endedSeptember 30, 2012 , following receipt of required approval from its domiciliary state insurance regulator, we paid a return of capital distribution of$250.0 on our capital stock to our Parent. During the nine months endedSeptember 30, 2011 , we did not pay a dividend or return of capital distribution on our capital stock to our Parent.
Transfer of Alt-A RMBS Participation Interest and Related Loan to Dutch State
In the first quarter of 2009,ING reached an agreement, for itself and on behalf of certainING affiliates including us, with the Dutch State on the Back-Up Facility covering 80% ofING's Alt-A RMBS. Under the terms of the Back-Up Facility, a full credit risk transfer to the Dutch State was realized on 80% ofING's Alt-A RMBS owned byING Bank, FSB and certain subsidiaries ofING U.S., Inc. , including the Company, with an aggregate book value of$36.0 billion , including book value of$1.4 billion of the Alt-A RMBS portfolio owned by us (with respect to our portfolio, the "Designated Securities Portfolio") (the "ING-Dutch State Transaction"). As a result of the risk transfer, the Dutch State participates in 80% of any results of the ING Alt-A RMBS portfolio. The risk transfer to the Dutch State took place at a discount of approximately 10% of par value. In addition, under the Back-Up Facility, other fees are paid by us and the Dutch State. EachING company participating in the ING-Dutch State Transaction, including us remains the legal owner of 100% of its Alt-A RMBS portfolio and remains exposed to 20% of any results on its portfolio. The ING-Dutch State Transaction closed onMarch 31, 2009 , with the risk transfer to the Dutch State taking effect as ofJanuary 26, 2009 . In order to implement that portion of the ING-Dutch State Transaction related to our Designated Securities Portfolio, we entered into a participation agreement with our affiliates,ING Support Holding andING pursuant to which we conveyed toING Support Holding an 80% participation interest in our Designated Securities Portfolio and agreed to pay a periodic transaction fee, and received, as consideration for the participation, an assignment byING Support Holding of its right to receive payments from the Dutch State under the Illiquid Assets Back-Up Facility related to our Designated Securities Portfolio among,ING ,ING Support Holding and the Dutch State (the "Company Back-Up Facility"). Under the Company Back-Up Facility, the Dutch State is obligated to pay certain periodic fees and make certain periodic payments with respect to our Designated Securities Portfolio, andING Support Holding is obligated to pay a periodic guarantee fee and make periodic payments to the Dutch State equal to the distributions it receives with respect to the 80% participation interest in our Designated Securities Portfolio. The Dutch State payment obligation to us under the Company Back-Up Facility is accounted for as a loan receivable for U.S. GAAP and is reported inLoan-Dutch State obligation on the Condensed Balance Sheets (the "Dutch State Obligation"). We incurred net fees of$0.7 and$2.0 for the three and nine months endedSeptember 30, 2012 , respectively, and$0.8 and$2.3 for the three and nine months endedSeptember 30, 2011 , respectively. On or aroundNovember 13, 2012 ,ING , all participatingING U.S., Inc. subsidiaries, including the Company,ING Support Holding ,ING Bank N.V. (ING Bank ) and the Dutch State expect to enter into agreements to restructure the Back-up Facility and terminate the participation of all participatingING U.S., Inc. subsidiaries in the Back-up Facility as another step in furtherance of the anticipated separation ofING U.S., Inc. and its subsidiaries, including the Company, fromING . The restructure transaction is expected to close onNovember 14, 2012 and is anticipated to be immaterial to the results of operations and financial position of the Company. At closing, we will sell the Dutch State Obligation with a carrying value of approximately$545.4 as ofSeptember 30, 2012 toING Support Holding for cash at fair value, and, at the same time, will transfer legal title to 80% of our Designated Securities Portfolio toING Bank , which securities will be held byING Bank in a custody account for the benefit of the Dutch State. Following the closing, we will continue to own 20% of our Designated Securities Portfolio (the "Retained 20%") and going forward will have the right to sell the Retained 20% subject to a right of first refusal granted toING Bank . Collateral Under the terms of ourOver-The-Counter Derivative International Swaps and Derivatives Association, Inc. Agreements ("ISDA Agreements"), we may receive from, or deliver to, counterparties, collateral to assure that all terms of the ISDA Agreements will be met with regard to the Credit Support Annex ("CSA"). The terms of the CSA call for us to pay interest on any cash received equal to the Federal Funds rate. As ofSeptember 30, 2012 andDecember 31, 2011 , we held$847.1 and$821.2 , respectively, of net cash collateral, which was included in Payables under securities loan agreement, including collateral held, on the Condensed Balance Sheets. In addition, as ofSeptember 30, 2012 andDecember 31, 2011 , we delivered collateral of$582.9 and$779.8 , respectively, in fixed maturities pledged under derivatives contracts, which was included in Securities pledged on the Condensed Balance Sheets.
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Reinsurance Agreements Reinsurance Ceded
Waiver of Premium - Coinsurance Funds Withheld
EffectiveOctober 1, 2010 , we entered into a coinsurance funds withheld agreement with an affiliate, Security Life ofDenver International Limited ("SLDI"). Under the terms of the agreement, we ceded to SLDI 100% of the group life waiver of premium liability (except for groups covered under rate credit agreements) assumed fromReliaStar Life Insurance Company ("RLI"), an affiliate, related to the Group Annual Term Coinsurance Funds Withheld agreement between us and RLI. Upon inception of the agreement, we paid SLDI a premium of$245.6 . At the same time, we established a funds withheld liability for$188.5 to SLDI and SLDI purchased a$60.0 letter of credit to support the ceded Statutory reserves of$245.6 . In addition, we recognized a gain of$17.9 based on the difference between the premium paid and the ceded U.S. GAAP reserves of$227.7 , which partially offsets the$57.1 ceding allowance paid by SLDI. The ceding allowance will be amortized over the life of the business. As ofSeptember 30, 2012 , the value of the funds withheld liability under this agreement was$185.9 , which is included in Other liabilities on the Condensed Balance Sheets.
Guaranteed Investment Contract - Coinsurance
EffectiveAugust 20, 1999 , we entered into a Facultative Coinsurance Agreement with an affiliate, SLD. Under the terms of the agreement, we facultatively ceded to SLD, from time to time, certain GICs on a 100% coinsurance basis. We utilize this reinsurance facility primarily for diversification and asset-liability management purposes in connection with this business, which is facilitated by the fact that SLD is also a major GIC issuer. Our senior management has established a current maximum of$4.0 billion for GIC reserves ceded under this agreement.
The value of GIC reserves ceded by us under this agreement was
Guaranteed Living Benefit - Coinsurance and Coinsurance Funds Withheld
EffectiveJune 30, 2008 , we entered into an automatic reinsurance agreement with an affiliate, SLDI, covering 100% of the benefits guaranteed under specific variable annuity guaranteed living benefit riders attached to certain variable annuity contracts issued by us on or afterJanuary 1, 2000 . Also effectiveJune 30, 2008 , we entered into a services agreement with SLDI, under which we provide certain actuarial risk modeling consulting services to SLDI with respect to hedge positions undertaken by SLDI in connection with the reinsurance agreement. For the nine months endedSeptember 30, 2012 and 2011, revenue related to the agreement was$9.0 and$9.5 , respectively. EffectiveJuly 1, 2009 , the reinsurance agreement was amended and restated to change the reinsurance basis from coinsurance to a combined coinsurance and coinsurance funds withheld basis. OnJuly 31, 2009 , SLDI transferred assets with a market value of$3.2 billion to us and we deposited those assets into a funds withheld trust account. As ofSeptember 30, 2012 , the assets on deposit in the trust account increased to$4.4 billion . We also established a corresponding funds withheld liability to SLDI, which is included in Funds held under reinsurance treaties with affiliates on the Condensed Balance Sheets.
Also effective
As ofSeptember 30, 2012 andDecember 31, 2011 , the value of reserves ceded by us under this agreement was$2.0 billion and$1.9 billion , respectively. In addition, a deferred loss in the amount of$349.7 and$365.3 as ofSeptember 30, 2012 andDecember 31, 2011 , respectively, is included in Other assets on the Condensed Balance Sheets and is amortized over the period of benefit.
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Ratings
Our access to funding and our related cost of borrowing, requirements for derivatives collateral posting and the attractiveness of certain of our products to customers are affected by our credit ratings and insurance financial strength ratings, which are periodically reviewed by the rating agencies. OnJuly 23, 2012 ,A.M. Best removed from under review with negative implications and affirmed our "A" financial strength rating and "a" issuer credit rating.A.M. Best assigned a stable outlook to the ratings.
On
On
OnMarch 7, 2012 , S&P affirmed our counterparty credit and insurance financial strength rating at "A-" and revised the outlook to Stable from Watch Negative. OnDecember 8, 2011 , S&P downgraded our counterparty credit and insurance financial strength rating to "A-" from "A" and revised the outlook to Watch Negative from Stable. OnNovember 17, 2011 , S&P affirmed our "A" rating and revised the outlook to Stable from Negative.
On
OnDecember 14, 2011 ,A.M. Best affirmed our insurance financial strength rating at "A", downgraded the issuer credit rating to "a" from "a+" and revised the outlook to Ratings Under Review with Negative Implications from Stable. OnJune 16, 2011 ,A.M. Best affirmed our insurance financial strength rating of "A" and the issuer credit rating of "a+." Our ratings by S&P, Fitch,A.M. Best and Moody's reflect a broader view of how the financial services industry is being challenged by the current economic environment, but also are based on the rating agencies' specific views of our financial strength. In making their ratings decisions, the agencies consider past and expected future capital and earnings, asset quality and risk, profitability and risk of existing liabilities and current products, market share and product distribution capabilities and direct or implied support from parent companies, including implications of theING restructuring plan, among other factors. The ratings actions, affirmations and outlook changes by S&P , Moody's andA.M. Best inDecember 2011 followed the fourth quarter 2011 announcements byING regarding a charge ofEUR 0.9 billion to EUR 1.1 billion against fourth quarter results of the U.S. Closed Block Variable Annuity business.
Minimum Guarantees
Variable annuity contracts containing minimum guaranteed death and living benefits expose us to equity risk. A decrease in the equity markets may cause a decrease in the account values, thereby increasing the possibility that we may be required to pay amounts to contract owners due to guaranteed death and living benefits. An increase in the value of the equity markets may increase account values for these contracts, thereby decreasing our risk associated with guaranteed death and living benefits. We ceased new sales of variable annuity products inMarch 2010 . However, our existing variable annuity block of business contains certain guaranteed death and living benefits made available to contract owners as described below:
Guaranteed Minimum Death Benefits ("GMDBs"):
• Standard - Guarantees that, upon death, the death benefit will be no less
than the premiums paid by the contract owner, adjusted for any contract
withdrawals.
• Ratchet - Guarantees that, upon death, the death benefit will be no less than
the greater of (1) Standard or (2) the maximum contract anniversary (or
quarterly) value of the variable annuity, adjusted for contract withdrawals.
• Combo (Max 7) - Guarantees that, upon death, the death benefit will be no
less than the greater of (1) Ratchet or (2) Rollup (Rollup guarantees that,
upon death, the death benefit will be no less than the aggregate premiums
paid by the contract owner accruing interest at the contractual rate per
annum, adjusted for contract withdrawals, which may be subject to a maximum
cap on the rolled up amount.)
A number of other versions of death benefits were offered previously but sales were discontinued. For contracts issued prior toJanuary 1, 2000 , most contracts with enhanced death benefit guarantees were reinsured to third party reinsurers to mitigate the risk produced by such guaranteed death benefits. For contracts issued afterDecember 31, 1999 , we instituted a variable annuity
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guarantee hedging program in lieu of reinsurance. The variable annuity guarantee hedging program is based on us entering into derivative positions to offset exposures to guaranteed minimum death benefits due to adverse changes in the equity markets.
As of
(in billions) 2012 Net amount at risk, before reinsurance $ 7.6 Net amount at risk, net of reinsurance 6.9 2011 Net amount at risk, before reinsurance $ 9.6 Net amount at risk, net of reinsurance 8.7
The decrease in the guaranteed value of these death benefits was primarily driven by favorable equity market performance during Q1 2012 and Q3 2012 in excess of unfavorable market performance in Q2 2012.
The additional liabilities recognized related to GMDB's, as of
2012
Additional liability balance
2011
Additional liability balance
The above additional liability recorded by us, net of reinsurance, represented the estimated net present value of our future obligation for guaranteed minimum death benefits in excess of account values. The liability decreased mainly due to a decrease in expected future claims attributable to favorable equity market performance during the year. Guaranteed Living Benefits:
• Guaranteed Minimum Income Benefit ("GMIB") - Guarantees a minimum income
payout, exercisable each contract anniversary on or after a specified date,
in most cases the 10th rider anniversary.
• Guaranteed Minimum Withdrawal Benefit ("GMWB") and Guaranteed Minimum
Withdrawal Benefit for Life ("GMWBL") - Guarantees an annual withdrawal
amount for a specified period of time (GMWB) or life (GMWBL) that is
calculated as a percentage of the benefit base that equals premium at the
time of contract issue and may increase over time, based on a number of
factors, including a rollup percentage (7%, 6%, or 0%, depending on versions
of the benefit) and ratchet frequency (primarily annual or quarterly,
depending on versions). The percentage used to determine the guaranteed
annual withdrawal amount may vary by age at first withdrawal and depends on
versions of the benefit. A joint life-time withdrawal benefit option was
available to include coverage for spouses. Most versions of the withdrawal
benefit included reset and/or step-up features that may increase the
guaranteed withdrawal amount in certain conditions. Earlier versions of the
withdrawal benefit guarantee that annual withdrawals of up to 7.0% of
eligible premiums may be made until eligible premiums previously paid by the
contract owner are returned, regardless of account value performance. Asset
allocation requirements apply at all times where withdrawals are guaranteed
for life.
• Guaranteed Minimum Accumulation Benefit ("GMAB") - Guarantees that the
account value will be at least 100% of the eligible premiums paid by the
contract owner after 10 years, net of any contract withdrawals (GMAB 10). In
the past, we offered an alternative design that guaranteed the account value
to be at least 200% of the eligible premiums paid by contract owners after 20
years (GMAB 20). We reinsured most of our living benefit guarantee riders to SLDI, an affiliated reinsurer, to mitigate the risk produced by such benefits. This reinsurance agreement covers all of the GMIBs, as well as the GMWBs with lifetime guarantees (the "Reinsured 90
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living benefits"). The GMABs and the GMWBs without lifetime guarantees (the "Non-reinsured living benefits") are not covered by this reinsurance. The Non-reinsured living benefits are still covered by our variable annuity guarantee hedging program.
The following guaranteed living benefits information is as ofSeptember 30, 2012 andDecember 31, 2011 : Non-reinsured Reinsured Living Living Benefits Benefits (GMAB/GMWB) (GMIB/GMWBL) 2012 Net amount at risk, before reinsurance $ 40.0 $
5,306.1
Net amount at risk, net of reinsurance 40.0 - 2011 Net amount at risk, before reinsurance $ 63.2 $
5,692.0
Net amount at risk, net of reinsurance 63.2 - The net amount at risk for the reinsured living benefits is equal to the excess of the present value of the minimum guaranteed annuity payments available to the contractholder over the current account value. During 2011, we revised the methodology used to calculate the net amount at risk to better reflect the nature of the underlying living benefits and to align the methodology with peers. The current methodology partially reflects the current interest rate environment and also includes a provision for the expected mortality of the clients covered by these living benefits. The values for the reinsured living benefits in the above table are presented under the new methodology as ofSeptember 30, 2012 andDecember 31, 2011 . The net amount at risk for the non-reinsured living benefits is equal to the guaranteed value of these benefits in excess of the account values, which is reflected in the table above.
The additional liabilities recognized related to minimum guarantees, by type, as of
Reinsured Living Non-reinsured Living Benefits Benefits (GMAB/GMWB) (GMIB/GMWBL) 2012 Additional liability balance, net of reinsurance $ 82.5 $ 1,466.7 2011 (As revised) Additional liability balance, net of reinsurance $ 114.9
$ 1,738.1
As ofSeptember 30, 2012 andDecember 31, 2011 , the above additional liabilities for non-reinsured living benefits recorded by us, net of reinsurance, represent the estimated net present value of our future obligations for these benefits. The prior year additional liability balance for reinsured living benefits has been revised due to us retrospectively electing fair value accounting for GMWBL riders as ofJanuary 1, 2012 . The above additional liabilities for reinsured living benefits recorded by us, net of reinsurance, represent the present value of future claims less the present value of future attributed fees (GMWBLs) or the benefits ratio approach (GMIBs), less the reinsurance ceded reserve calculated under Accounting Standards Codification Topic 944. The additional GMIB's liability is fully reinsured, and thus is zero. The decrease in the additional liability balance for reinsured living benefits corresponds to the GMWBL liability which decreased mainly due to favorable equity market performance partially offset by lower interest rates.
Variable Annuity Guarantee Hedging Program
We primarily mitigate variable annuity market risk exposures through hedging. Market risk arises primarily from the minimum guarantees within the variable annuity products, whose economic costs are primarily dependent on future equity market returns, interest rate levels, equity volatility levels, and policyholder behavior. The variable annuity hedging program is used to mitigate
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our exposure to equity market and interest rate changes and to ensure that the required assets are available to satisfy future death benefit and living benefit obligations. While the variable annuity guarantee hedge program does not explicitly hedge statutory or GAAP reserves, as markets move up or down, in aggregate the returns generated by the variable annuity hedge program will significantly offset the statutory and GAAP reserve changes due to market movements. The objective of the guarantee hedging program is to offset changes in equity market returns for most minimum guaranteed death benefits and all guaranteed living benefits, while also providing interest rate protection for certain minimum guaranteed living benefits. We do not hedge interest rate risks for our GMIB or GMDB primarily because doing so would result in volatility in our regulatory capital that exceeds our tolerances and, secondarily, because doing so would produce additional volatility in our GAAP financial statements. Equity index futures on various equity indices are used to mitigate the risk of the change in value of the policyholder-directed separate account funds underlying the variable annuity contracts with minimum guarantees. A dynamic trading program is utilized to seek replication of the performance of targeted fund groups (i.e., the fund groups that can be covered by indices where liquid futures markets exist). Total return swaps are also used to mitigate the risk of the change in value of certain policyholder directed separate account funds. These include fund classes such as emerging markets and real estate. They may also be used instead of futures of more liquid indices where it may be deemed advantageous. This hedging strategy is employed at our discretion based on current risk exposures and related transaction costs.
Interest rate swaps are used to mitigate the impact of interest rates changes on the economic liabilities associated with certain minimum guaranteed living benefits.
Variance swaps and equity options are used to mitigate the impact of changes in equity volatility on the economic liabilities associated with certain minimum guaranteed living benefits. This program began in the second quarter of 2012.
Foreign exchange forwards are used to mitigate the impact of policyholder-directed investments in international funds with exposure to fluctuations in exchange rates of certain foreign currencies. Rebalancing is performed based on pre-determined notional exposures to the specific currencies.
DuringDecember 2010 , we entered into a series of interest rate swaps with external counterparties. We also entered into a short-term mirror total return swap ("TRS") transaction with ING V, our indirect parent company. The outstanding market value of the TRS was$11.6 as ofDecember 31, 2010 . The TRS maturedJanuary 3, 2011 .
Variable Annuity Capital Hedge Overlay Program
Variable annuity guaranteed benefits are hedged based on their economic or fair value; however, the statutory reserves are not based on a market value. When equity markets decrease, the statutory reserve and rating agency required assets for the variable annuity guaranteed benefits can increase more quickly than the value of the derivatives held under the guarantee hedging program. This causes regulatory reserves to increase and rating agency capital to decrease. To protect the residual risk to regulatory reserves and rating agency capital in a decreasing equity market, we implemented the use of a static capital hedge in 2008. In 2010, we shifted to the dynamic Capital Hedge Overlay ("CHO") program. The current CHO strategy is intended to actively mitigate equity risk to the regulatory reserves and rating agency capital of the Company. The hedge is executed through the purchase and sale of equity index futures and is designed to limit the uncovered reserve increase in an immediate down equity market scenario to an amount we believe prudent for a company of our size and scale. This amount will change over time with market movements, changes in regulatory and rating agency capital and our risk tolerance.
Other Annuity Matters
ThroughJune 30, 2012 , our nonperformance risk adjustment was based on the credit default swap spreads ofING Verzekeringen N.V. ("ING V"), our indirect parent company, with similar term to maturity and priority of payment. As a result of the availability ofING U.S., Inc's market observable data following the issuance of its long-term debt onJuly 13, 2012 , we changed our estimate of nonperformance risk to incorporate a blend of observable, similarly rated peer company credit default swap spreads, adjusted to reflect our own credit quality as well as an adjustment to reflect the priority of policyholder claims. This change in estimate resulted in an increase of$425.6 , pretax, to Other net realized capital gains (losses) and a corresponding decrease to the Future policy benefits and claims reserves.
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During the third quarter of 2012 we conducted a periodic review of actuarial assumptions, including policyholder behavior assumptions. As a result of this review, Future policy benefits and claims reserves increased by approximately$113.0 driven primarily by an update to lapse rates on variable annuity contracts with lifetime living benefit guarantees. This amount excludes the net impacts of amortization of DAC/VOBA and DSI and reinsurance with SLDI. After these items, the net impact is immaterial to the financial position of the Company.
Repurchase Agreements
We engage in dollar repurchase agreements with mortgage-backed securities ("dollar rolls") and repurchase agreements with other collateral types to increase our return on investments and improve liquidity. Such arrangements meet the requirements to be accounted for as financing arrangements. We enter into dollar rolls by selling existing MBS and concurrently entering into an agreement to repurchase similar securities within a short time frame at a lower price. Under repurchase agreements, we borrow cash from a counterparty at an agreed upon interest rate for an agreed upon time frame and pledge collateral in the form of securities. At the end of the agreement, the counterparty returns the collateral to us, and we, in turn, repay the loan amount along with the additional agreed upon interest. We require that all times during the term of the dollar rolls and repurchase agreements that cash or other collateral types obtained is sufficient to allow us to fund substantially all of the cost of purchasing replacement assets. Cash received is invested in short-term investments, with the offsetting obligation to repay the loan included as a liability on the Condensed Balance Sheets. As per the terms of the agreements, the market value of the loaned securities is monitored with additional collateral obtained or refunded as the market value of the loaned securities fluctuates due to changes in interest rates, spreads and other risk factors. The carrying value of the securities pledged in dollar rolls and repurchase agreement transactions and the related repurchase obligation are included in Securities pledged and Short-term debt, respectively, on the Condensed Balance Sheets. As ofSeptember 30, 2012 andDecember 31, 2011 we did not have any securities pledged in dollar rolls and repurchase agreement transactions. We also enter into reverse repurchase agreements. These transactions involve a purchase of securities and an agreement to sell substantially the same securities as those purchased. We required that, at all times during the term of the reverse repurchase agreements, cash or other collateral types provided is sufficient to allow the counterparty to fund substantially all of the cost of purchasing the replacement assets. As ofSeptember 30, 2012 andDecember 31, 2011 , we did not have any securities pledged under reverse repurchase agreements. The primary risk associated with short-term collateralized borrowings is that the counterparty will be unable to perform under the terms of the contract. Our exposure is limited to the excess of the net replacement cost of the securities over the value of the short-term investments. We believe the counterparties to the dollar rolls, repurchase and reverse repurchase agreements are financially responsible and that the counterparty risk is minimal.
Securities Lending
We engage in securities lending whereby certain domestic securities from our portfolio are loaned to other institutions for short periods of time. Initial collateral, primarily cash, is required at a rate of 102% of the market value of the loaned domestic securities. Under the program, the lending agent retains all of the cash collateral. Collateral retained by the agent is invested in liquid assets on our behalf. The market value of the loaned securities is monitored on a daily basis with additional collateral obtained or refunded as the market value of the loaned securities fluctuates due to interest rates, spreads and other risk factors. As ofSeptember 30, 2012 andDecember 31, 2011 , the fair value of loaned securities was$66.1 and$233.0 , respectively, and is included in Securities pledged on the Condensed Balance Sheets. Collateral retained by the lending agent and invested in liquid assets on our behalf is recorded in Short-term investments under securities loan agreement, including collateral delivered. As ofSeptember 30, 2012 andDecember 31, 2011 , liabilities to return collateral of$68.9 and$248.3 , respectively, are included in Payables under securities loan agreement, including collateral held on the Condensed Balance Sheets. Income Taxes Income tax obligations include the allowance on uncertain tax benefits related toIRS tax audits and state tax exams that have not been completed. The timing of the payment of the remaining allowance of$2.7 cannot be reliably estimated. 93
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Recent Initiatives
OnApril 9, 2009 , our ultimate parent,ING , announced a global business strategy which identified certain core and non-core businesses and geographies, statedING's intention to explore divestiture of non-core businesses over time, withdraw from certain non-core geographies, limit future acquisitions and implement enterprise-wide expense reductions. In particular, with respect toING's U.S. insurance operations,ING is seeking to further reduce its risk by focusing on individual life products, retirement services and lower risk annuity products whichING USA's affiliate, ING Life Insurance and Annuity Company commenced selling during the first quarter of 2010.ING has announced the anticipated separation of its banking and insurance businesses. While all options for effecting this separation remain open,ING has announced that the base case for this separation includes an initial public offering ("IPO") ofING U.S., Inc. which constitutesING's U.S.-based retirement, investment management and insurance operations, including us.ING anticipates selling a portion of its ownership interest inING U.S., Inc. in the IPO and thereafter divesting its ownership interest over time, while all options remain open.ING U.S., Inc. and its subsidiaries, including us, are actively engaged in numerous projects across the enterprise to become ready for an IPO. While the base case is an IPO, it is possible thatING's divestment ofING U.S., Inc. and its subsidiaries, including us, may take place by means of a sale to a single buyer or group of buyers. OnNovember 9, 2012 ,ING U.S., Inc. filed a registration statement on Form S-1 with theSEC in connection with the proposed IPO of its common stock. Volatile capital market conditions commencing in the fourth quarter of 2008 and continuing into 2009, coupled with numerous changes in regulatory and accounting requirements and changes in policyholder behavior as a result of the recent changed economic environment, presented extraordinary challenges to actuarial reserve valuation methodologies and controls. In 2009, we initiated actions to review and strengthen our systems, processes and internal controls, including those with respect to actuarial calculations on fixed and variable annuity products. Management has substantially completed this review and the identified corrective actions, and will continue to monitor the effectiveness of internal controls going forward as a part of its ongoing practices. OnJune 14, 2012 , our affiliateING North America Insurance Corporation announced that it had entered into a seven-year agreement withCognizant Technology Solutions U.S. Corporation ("Cognizant") to receive a comprehensive array of insurance business process services. Under the terms of the agreement, which was executed onAugust 16, 2012 , Cognizant made employment offers to more than 1,000 employees of subsidiaries ofING U.S., Inc. , most of whom were employed by certain of our U.S. affiliates and may have provided services to us from time to time, and approximately 220 of whom we employed. Employees who accepted offers of employment with Cognizant will continue to perform comparable roles to those they previously performed, either for us or our applicable affiliates. We do not expect these matters to have a material financial or operational impact on us.
Impact of New Accounting Pronouncements
For information regarding the impact of new accounting pronouncements, refer to the Business, Basis of Presentation and Significant Accounting Policies note to the Condensed Financial Statements, included in Part I, Item 1., herein.
Recently Enacted Legislation
OnJuly 21, 2010 ,President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"). The Dodd-Frank Act directs existing and newly-created government agencies and bodies to conduct certain studies and promulgate regulations implementing the law, a process that is underway and is expected to continue over the next few years. While some studies have already been completed and the rulemaking process has begun, there continues to be significant uncertainty regarding the results of ongoing studies and the ultimate requirements of those regulations that have not yet been adopted. Until such studies and rulemaking are completed, the precise impact of the Dodd-Frank Act onING and its affiliates, including us cannot be determined. However, there are major elements of the legislation that we have identified to date that are of particular significance toING and/or its affiliates, including us, as described below. The Dodd-Frank Act creates a new agency, theFinancial Stability Oversight Council ("FSOC"), which is authorized to subject non-bank financial companies to the supervision of the Federal Reserve if the FSOC determines that material financial distress of a company or the scope of a company's activities could pose risks to the financial stability ofthe United States . A company determined to be systemically significant by the FSOC would be supervised by theFederal Reserve Board and would be subject to a comprehensive system of prudential regulation, including, among other matters, minimum capital requirements, liquidity standards, credit exposure requirements, management interlock prohibitions, maintenance of resolution plans, stress testing, additional fees and assessments and restrictions on proprietary trading and other investments. The exact scope and consequences of these standards and requirements are subject to ongoing rulemaking activity by various federal banking regulators and therefore are currently unclear. However, this comprehensive system of prudential regulation, if applied toING U.S., Inc. or us, would
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significantly impact the manner in which we operate and could materially and adversely impact the profitability of our business lines or the level of capital required to support our activities. So long as we andING U.S., Inc. continue to be controlled byING , the FSOC may considerING U.S., Inc. and its subsidiaries, including us, together withING's other operations inthe United States for purposes of making this determination. Therefore, while we believe it is unlikely thatING U.S., Inc. or its subsidiaries, including us, either on a standalone basis or together withING's other operations inthe United States , will ultimately receive this designation, there is a greater likelihood of such a designation being made for so long as we are controlled byING . Although existing state insurance regulators will remain the primary regulators of us and our U.S. insurance company affiliates, the legislation also creates a Federal Insurance Office to be housed within theTreasury Department , which will be charged with monitoring (but not regulating) the insurance industry, including gathering information to identify issues or gaps in the regulation of insurers that could contribute to systemic crisis in the insurance industry or U.S. financial system; preparing annual reports toCongress on the insurance industry; conducting studies on modernization of U.S. insurance regulation and the global reinsurance market; and entering into/implementing agreements with foreign governments relating to the recognition of prudential measures with respect to insurance and reinsurance ("International Agreements"), including the authority to preempt U.S. state law if it is found to be inconsistent with an International Agreement and treats a non-U.S. insurer less favorably than a U.S. insurer. The legislation creates a new framework for regulating over-the-counter ("OTC") derivatives, which may increase the costs of hedging and other permitted derivatives trading activity undertaken by us. Under the new regulatory regime and subject to certain exceptions, OTC derivatives will be cleared through a centralized clearinghouse and executed on a centralized exchange. It establishes new regulatory authority for theSEC and theCommodity Futures Trading Commission ("CFTC") over derivatives and "swap dealers," "security-based swap dealers," "major swap participants," and "major security-based swap participants," as to be defined bySEC and CFTC regulations. Based on final rules jointly adopted by the CFTC and theSEC , and effective onJuly 23, 2012 , which further define the terms "swap dealer," "security-based swap dealer," "major swap participant," and "major security-based swap participant," we do not believe we should be considered a "swap dealer," "security-based swap dealer," "major swap participant," or "major security-based swap participant." However, if it is determined that we meet one of these definitions, it could substantially increase the amount of regulatory requirements for us and the cost of hedging and other permitted derivatives trading activity undertaken by us. The CFTC andSEC also jointly adopted final rules, which became effective onOctober 12, 2012 , to further define the terms "swap" and "security-based swap," and to clarify that certain products (i) issued by entities subject to supervision by the insurance commissioner (or similar official or agency) of any state or bythe United States or an agency or instrumentality thereof (the "Provider Test") and (ii) regulated as insurance or otherwise enumerated by rule are excluded from the definition of a "swap" and "security-based swap." Thus, companies would not be considered "swap dealers," "security-based swap dealers," "major swap participants" or "major security-based swap participants" as a result of issuing such insurance products. In addition, any insurance contracts which might otherwise be included within the definition of "swap" or "security-based swap" which are issued on or before the effective date of the rules will be grandfathered and thereby excluded from the definitions, so long as the issuer satisfies the Provider Test. However, the final rules do not extend the exemption to certain products issued by insurance companies including guaranteed investment contracts ("GICs"), synthetic GICs, funding agreements, structured settlements and deposit administration contracts which the CFTC andSEC determined should be considered in a facts and circumstances analysis. As a result, there remains some uncertainty regarding the applicability of the definitions of "swap" and "security-based swap" to some products offered by us. We do not believe our products come within the definition of "swap" or "security-based swap." However, if any products issued by us meet the criteria for either definition they would be subject to regulation under the Dodd-Frank Act, including clearing of transactions through a centralized clearinghouse, execution of trades on a centralized exchange and related reporting requirements. The Dodd-Frank Act also imposes various ex-post assessments on certain financial companies, which may include us, to provide funds necessary to repay any borrowings and to cover the costs of any special resolution of a financial company under the new resolution authority established under the legislation (although assessments already imposed under state insurance guaranty funds will be taken into account in calculating such assessments).
We will continue to monitor and assess the potential effects of the Dodd-Frank Act as regulatory requirements are finalized and mandated studies are conducted.
Legislative and Regulatory Initiatives
Legislative proposals, which have been or may again be considered byCongress , include changing the taxation of annuity benefits, changing the tax treatment of insurance products relative to other financial products and changing life insurance company taxation. Some of these proposals, if enacted, either on their own or as part of an omnibus deficit reduction package could have a material 95
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adverse effect on life insurance, annuity and other retirement savings product sales, while others could have a material beneficial effect. Administrative budget proposals to disallow insurance companies a portion of the dividends received deduction in connection with variable product separate accounts could increase the cost of such products to policyholders. In the third quarter of 2010, theSEC proposed rescinding Rule 12b-1 under the Investment Company Act of 1940 and adopting a new Rule 12b-2. If adopted, the proposal would impose new limitations on the level of distribution-related charges that could be paid by mutual funds, including funds available under our variable annuity products. At this time, it is unclear when or if further action will be taken on this proposal.
Contingencies
For information regarding other contingencies related to legal proceedings, regulatory matters and other contingencies involving us, see the Commitments and Contingencies note to the Condensed Financial Statements included in Part I, Item1.
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