Edgar Filing: AMERICAN EQUITY INVESTMENT LIFE HOLDING CO

2015-06-30_AEL 10Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)



x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2015



o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________ to ________

Commission File Number : 001-31911

American Equity Investment Life Holding Company

(Exact name of registrant as specified in its charter)



Iowa		42-1447959
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

6000 Westown Parkway

West Des Moines, Iowa 50266

(Address of principal executive offices, including zip code)

(515) 221-0002

(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer," “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):



Large accelerated filer x		Accelerated filer o
Non-accelerated filer o		Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

APPLICABLE TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:

As of July 31, 2015, there were 77,146,375 shares of the registrant's common stock, $1 par value, outstanding.

TABLE OF CONTENTS



	Page
PART I — FINANCIAL INFORMATION
Item 1: Financial Statements:	2
Consolidated Balance Sheets	2
Consolidated Statements of Operations	3
Consolidated Statements of Comprehensive Income (Loss)	4
Consolidated Statements of Changes in Stockholders’ Equity	5
Consolidated Statements of Cash Flows	6
Notes to Consolidated Financial Statements	8
Note 1. Significant Accounting Policies	8
Note 2. Fair Values of Financial Instruments	9
Note 3. Investments	14
Note 4. Mortgage Loans on Real Estate	20
Note 5. Derivative Instruments	25
Note 6. Notes Payable	28
Note 7. Commitments and Contingencies	28
Note 8. Earnings Per Share	29
Note 9. Subsequent Event	30
Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations	31
Item 3: Quantitative and Qualitative Disclosures about Market Risk	50
Item 4: Controls and Procedures	51

PART II — OTHER INFORMATION
Item 1: Legal Proceedings	52
Item 1A: Risk Factors	52
Item 2: Unregistered Sales of Equity Securities and Use of Proceeds	52
Item 6: Exhibits	53

Signatures	54

Table of Contents

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except share and per share data)



	June 30, 2015		December 31, 2014
	(Unaudited)
Assets
Investments:
Fixed maturity securities:
Available for sale, at fair value (amortized cost: 2015 - $32,692,702; 2014 - $30,205,046)	$	33,905,869	$	32,445,202
Held for investment, at amortized cost (fair value: 2015 - $65,705; 2014 - $75,838)	76,526		76,432
Equity securities, available for sale, at fair value (cost: 2015 - $7,512; 2014 - $7,509)	7,861		7,805
Mortgage loans on real estate	2,450,676		2,434,580
Derivative instruments	503,953		731,113
Other investments	285,743		286,726
Total investments	37,230,628		35,981,858

Cash and cash equivalents	733,814		701,514
Coinsurance deposits	3,101,189		3,044,342
Accrued investment income	343,172		326,559
Deferred policy acquisition costs	2,522,277		2,058,556
Deferred sales inducements	1,944,619		1,587,257
Deferred income taxes	172,114		—
Income taxes recoverable	21,888		9,252
Other assets	177,781		280,396
Total assets	$	46,247,482	$	43,989,734

Liabilities and Stockholders' Equity
Liabilities:
Policy benefit reserves	$	42,494,314	$	39,802,861
Other policy funds and contract claims	342,878		365,819
Notes payable	422,163		421,679
Subordinated debentures	246,345		246,243
Deferred income taxes	—		3,895
Other liabilities	834,020		1,009,361
Total liabilities	44,339,720		41,849,858

Stockholders' equity:
Preferred stock, par value $1 per share, 2,000,000 shares authorized, 2015 and 2014 - no shares issued and outstanding	—		—
Common stock, par value $1 per share, 200,000,000 shares authorized; issued and outstanding: 2015 - 76,793,577 shares (excluding 3,620,484 treasury shares); 2014 - 76,062,407 shares (excluding 4,126,167 treasury shares)	76,794		76,062
Additional paid-in capital	524,246		513,218
Accumulated other comprehensive income	388,779		721,401
Retained earnings	917,943		829,195
Total stockholders' equity	1,907,762		2,139,876
Total liabilities and stockholders' equity	$	46,247,482	$	43,989,734

See accompanying notes to unaudited consolidated financial statements.

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AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in thousands, except per share data)

(Unaudited)



	Three Months Ended June 30,						Six Months Ended June 30,
	2015			2014			2015			2014
Revenues:
Premiums and other considerations	$	10,037		$	9,123		$	17,034		$	16,454
Annuity product charges	32,409			29,247			61,091			54,519
Net investment income	418,176			370,882			817,845			740,887
Change in fair value of derivatives	(23,024		)	270,883			(54,124		)	319,376
Net realized gains (losses) on investments, excluding other than temporary impairment ("OTTI") losses	4,324			(2,230		)	9,203			(2,944		)
OTTI losses on investments:
Total OTTI losses	—			—			(132		)	—
Portion of OTTI losses recognized from other comprehensive income	(828		)	(594		)	(828		)	(1,499		)
Net OTTI losses recognized in operations	(828		)	(594		)	(960		)	(1,499		)
Loss on extinguishment of debt	—			(6,574		)	—			(10,551		)
Total revenues	441,094			670,737			850,089			1,116,242

Benefits and expenses:
Insurance policy benefits and change in future policy benefits	12,450			10,987			21,670			21,082
Interest sensitive and index product benefits	306,141			367,774			588,966			684,966
Amortization of deferred sales inducements	75,518			55,349			86,471			56,015
Change in fair value of embedded derivatives	(219,601		)	80,935			(168,388		)	173,554
Interest expense on notes payable	7,354			9,121			14,693			19,385
Interest expense on subordinated debentures	3,047			3,024			6,063			6,032
Amortization of deferred policy acquisition costs	104,700			67,084			118,986			74,278
Other operating costs and expenses	24,868			20,887			45,990			39,972
Total benefits and expenses	314,477			615,161			714,451			1,075,284
Income before income taxes	126,617			55,576			135,638			40,958
Income tax expense	43,772			18,832			46,890			13,967
Net income	$	82,845		$	36,744		$	88,748		$	26,991

Earnings per common share	$	1.07		$	0.49		$	1.15		$	0.37
Earnings per common share - assuming dilution	$	1.05		$	0.46		$	1.12		$	0.34
Weighted average common shares outstanding (in thousands):
Earnings per common share	77,237			74,461			77,140			73,495
Earnings per common share - assuming dilution	79,227			79,518			79,173			79,583

See accompanying notes to unaudited consolidated financial statements.

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AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Dollars in thousands)

(Unaudited)



	Three Months Ended June 30,						Six Months Ended June 30,
	2015			2014			2015			2014

Net income	$	82,845		$	36,744		$	88,748		$	26,991
Other comprehensive income (loss):
Change in net unrealized investment gains/losses (1)	(778,097		)	343,316			(513,984		)	784,004
Noncredit component of OTTI losses (1)	413			286			413			694
Reclassification of unrealized investment gains/losses to net income (1)	825			454			1,844			(276		)
Other comprehensive income (loss) before income tax	(776,859		)	344,056			(511,727		)	784,422
Income tax effect related to other comprehensive income (loss)	271,900			(120,420		)	179,105			(274,547		)
Other comprehensive income (loss)	(504,959		)	223,636			(332,622		)	509,875
Comprehensive income (loss)	$	(422,114	)	$	260,380		$	(243,874	)	$	536,866


(1)	Net of related adjustments to amortization of deferred sales inducements and deferred policy acquisition costs.

See accompanying notes to unaudited consolidated financial statements.

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AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

(Dollars in thousands, except share data)

(Unaudited)



	Common Stock		Additional Paid-in Capital			Unallocated Common Stock Held by ESOP			Accumulated Other Comprehensive Income			Retained Earnings		Total Stockholders' Equity

Balance at December 31, 2014	$	76,062	$	513,218		$	—		$	721,401		$	829,195	$	2,139,876
Net income for period	—		—			—			—			88,748		88,748
Other comprehensive loss	—		—			—			(332,622		)	—		(332,622		)
Share-based compensation, including excess income tax benefits	—		6,361			—			—			—		6,361
Issuance of 731,170 shares of common stock under compensation plans, including excess income tax benefits	732		4,667			—			—			—		5,399
Balance at June 30, 2015	$	76,794	$	524,246		$	—		$	388,779		$	917,943	$	1,907,762

Balance at December 31, 2013	$	70,535	$	550,400		$	(631	)	$	46,196		$	718,187	$	1,384,687
Net income for period	—		—			—			—			26,991		26,991
Other comprehensive income	—		—			—			509,875			—		509,875
Allocation of 58,618 shares of common stock by ESOP, including excess income tax benefits	—		721			631			—			—		1,352
Share-based compensation, including excess income tax benefits	—		3,607			—			—			—		3,607
Issuance of 1,109,882 shares of common stock under compensation plans, including excess income tax benefits	1,110		7,720			—			—			—		8,830
Extinguishment of convertible senior notes, net of tax, including 2,443,457 shares of common stock issued upon conversion	2,444		6,479			—			—			—		8,923
Warrants reclassified to embedded derivative liability to be settled in cash	—		(30,455		)	—			—			—		(30,455		)
Balance at June 30, 2014	$	74,089	$	538,472		$	—		$	556,071		$	745,178	$	1,913,810

See accompanying notes to unaudited consolidated financial statements.

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AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(Unaudited)



	Six Months Ended June 30,
	2015			2014
Operating activities
Net income	$	88,748		$	26,991
Adjustments to reconcile net income to net cash provided by operating activities:
Interest sensitive and index product benefits	588,966			684,966
Amortization of deferred sales inducements	86,471			56,015
Annuity product charges	(61,091		)	(54,519		)
Change in fair value of embedded derivatives	(168,388		)	173,554
Decrease in traditional life and accident and health insurance reserves	1,699			1,323
Policy acquisition costs deferred	(292,140		)	(199,978		)
Amortization of deferred policy acquisition costs	118,986			74,278
Provision for depreciation and other amortization	2,518			5,398
Amortization of discounts and premiums on investments	(6,528		)	(2,424		)
Realized gains/losses on investments and net OTTI losses recognized in operations	(8,243		)	4,443
Change in fair value of derivatives	53,191			(319,853		)
Deferred income taxes	3,096			(42,918		)
Loss on extinguishment of debt	—			10,551
Share-based compensation	3,347			620
Change in accrued investment income	(16,613		)	(2,400		)
Change in income taxes recoverable/payable	(12,636		)	(37,087		)
Change in other assets	178			(80		)
Change in other policy funds and contract claims	(27,115		)	(30,857		)
Change in collateral held for derivatives	(97,273		)	81,341
Change in other liabilities	13,141			(32,286		)
Other	(4,817		)	(1,697		)
Net cash provided by operating activities	265,497			395,381

Investing activities
Sales, maturities, or repayments of investments:
Fixed maturity securities - available for sale	886,573			939,430
Mortgage loans on real estate	229,179			217,785
Derivative instruments	452,212			532,867
Other investments	10,930			13,245
Acquisition of investments:
Fixed maturity securities - available for sale	(3,312,404		)	(1,993,092		)
Mortgage loans on real estate	(239,408		)	(193,731		)
Derivative instruments	(275,523		)	(227,024		)
Other investments	(4,901		)	(5,598		)
Purchases of property, furniture and equipment	(592		)	(622		)
Net cash used in investing activities	(2,253,934		)	(716,740		)

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AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

(Dollars in thousands)

(Unaudited)



	Six Months Ended June 30,
	2015			2014
Financing activities
Receipts credited to annuity and single premium universal life policyholder account balances	$	3,095,837		$	1,950,707
Coinsurance deposits	(16,800		)	14,113
Return of annuity policyholder account balances	(1,022,667		)	(944,679		)
Financing fees incurred and deferred	—			(100		)
Repayment of notes payable	—			(119,677		)
Net proceeds from settlement of notes hedges and warrants	—			10,401
Excess tax benefits realized from share-based compensation plans	3,014			3,776
Proceeds from issuance of common stock	5,399			8,041
Change in checks in excess of cash balance	(44,046		)	(34,219		)
Net cash provided by financing activities	2,020,737			888,363
Increase in cash and cash equivalents	32,300			567,004
Cash and cash equivalents at beginning of period	701,514			897,529
Cash and cash equivalents at end of period	$	733,814		$	1,464,533

Supplemental disclosures of cash flow information
Cash paid during period for:
Interest expense	$	19,526		$	22,097
Income taxes	53,401			68,423
Non-cash operating activity:
Deferral of sales inducements	219,191			155,957
Non-cash investing activity:
Real estate acquired in satisfaction of mortgage loans	—			10,007
Non-cash financing activities:
Common stock issued in extinguishment of debt	—			56,292

See accompanying notes to unaudited consolidated financial statements.

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AMERICAN EQUITY INVESTMENT LIFE HOLDING COMPANY AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2015

(Unaudited)

1. Significant Accounting Policies

Consolidation and Basis of Presentation

The accompanying consolidated financial statements of American Equity Investment Life Holding Company (“we”, “us” or “our”) have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and notes required by GAAP for complete financial statements. The consolidated financial statements reflect all adjustments, consisting only of normal recurring items, which are necessary to present fairly our financial position and results of operations on a basis consistent with the prior audited consolidated financial statements. Operating results for the three and six month periods ended June 30, 2015 are not necessarily indicative of the results that may be expected for the year ended December 31, 2015. All significant intercompany accounts and transactions have been eliminated. The preparation of financial statements requires the use of management estimates. For further information related to a description of areas of judgment and estimates and other information necessary to understand our financial position and results of operations, refer to the audited consolidated financial statements and notes included in our Annual Report on Form 10-K for the year ended December 31, 2014.

Adopted Accounting Pronouncements

There were no accounting pronouncements that were adopted during the current period.

New Accounting Pronouncements

In April 2015, the Financial Accounting Standards Board ("FASB") issued an accounting standards update ("ASU") which requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. This ASU will be effective for us on January 1, 2016, and retroactive application is required. It is not expected to have a material impact on our consolidated financial statements.

In June 2014, the FASB issued an ASU that requires that a performance target in a share-based payment arrangement that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. The requisite service period ends when the employee can cease rendering service and still be eligible to vest in the award if the performance target is achieved. This ASU will be effective for us on January 1, 2016, and early adoption is permitted, but it is not expected to have a material impact on our consolidated financial statements.

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2. Fair Values of Financial Instruments

The following sets forth a comparison of the carrying amounts and fair values of our financial instruments:



	June 30, 2015				December 31, 2014
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
	(Dollars in thousands)
Assets
Fixed maturity securities:
Available for sale	$	33,905,869	$	33,905,869	$	32,445,202	$	32,445,202
Held for investment	76,526		65,705		76,432		75,838
Equity securities, available for sale	7,861		7,861		7,805		7,805
Mortgage loans on real estate	2,450,676		2,494,270		2,434,580		2,493,901
Derivative instruments	503,953		503,953		731,113		731,113
Other investments	272,785		279,575		266,488		273,004
Cash and cash equivalents	733,814		733,814		701,514		701,514
Coinsurance deposits	3,101,189		2,767,173		3,044,342		2,698,552
Interest rate caps	2,324		2,324		2,778		2,778
2015 notes hedges	26,916		26,916		30,291		30,291
Counterparty collateral	112,449		112,449		206,096		206,096

Liabilities
Policy benefit reserves	42,153,741		35,569,121		39,463,987		33,078,978
Single premium immediate annuity (SPIA) benefit reserves	342,621		354,769		365,440		377,654
Notes payable	422,163		446,345		421,679		503,349
Subordinated debentures	246,345		217,653		246,243		244,437
2015 notes embedded conversion derivative	26,916		26,916		30,291		30,291
Interest rate swap	2,644		2,644		2,644		2,644

Fair value is the price that would be received to sell an asset or paid to transfer a liability (exit price) in an orderly transaction between market participants at the measurement date. The objective of a fair value measurement is to determine that price for each financial instrument at each measurement date. We meet this objective using various methods of valuation that include market, income and cost approaches.

We categorize our financial instruments into three levels of fair value hierarchy based on the priority of inputs used in determining fair value. The hierarchy defines the highest priority inputs (Level 1) as quoted prices in active markets for identical assets or liabilities. The lowest priority inputs (Level 3) are our own assumptions about what a market participant would use in determining fair value such as estimated future cash flows. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, a financial instrument's level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the financial instrument. We categorize financial assets and liabilities recorded at fair value in the consolidated balance sheets as follows:


Level 1—	Quoted prices are available in active markets for identical financial instruments as of the reporting date. We do not adjust the quoted price for these financial instruments, even in situations where we hold a large position and a sale could reasonably impact the quoted price.


Level 2—	Quoted prices in active markets for similar financial instruments, quoted prices for identical or similar financial instruments in markets that are not active; and models and other valuation methodologies using inputs other than quoted prices that are observable.

Level 3—

Models and other valuation methodologies using significant inputs that are unobservable for financial instruments and include situations where there is little, if any, market activity for the financial instrument. The inputs into the determination of fair value require significant management judgment or estimation. Financial instruments that are included in Level 3 are securities for which no market activity or data exists and for which we used discounted expected future cash flows with our own assumptions about what a market participant would use in determining fair value.

Transfers of securities among the levels occur at times and depend on the type of inputs used to determine fair value of each security. There were no transfers between levels during any period presented.

Table of Contents

Our assets and liabilities which are measured at fair value on a recurring basis as of June 30, 2015 and December 31, 2014 are presented below based on the fair value hierarchy levels:



	Total Fair Value		Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(Dollars in thousands)
June 30, 2015
Assets
Fixed maturity securities:
Available for sale:
United States Government full faith and credit	$	37,269	$	3,776	$	33,493	$	—
United States Government sponsored agencies	1,346,299		—		1,346,299		—
United States municipalities, states and territories	3,683,015		—		3,683,015		—
Foreign government obligations	220,439		—		220,439		—
Corporate securities	22,399,342		12		22,399,330		—
Residential mortgage backed securities	1,619,463		—		1,619,437		26
Commercial mortgage backed securities	3,558,419		—		3,558,419		—
Other asset backed securities	1,041,623		365		1,041,258		—
Equity securities, available for sale: finance, insurance and real estate	7,861		—		7,861		—
Derivative instruments	503,953		—		503,953		—
Cash and cash equivalents	733,814		733,814		—		—
Interest rate caps	2,324		—		2,324		—
2015 notes hedges	26,916		—		26,916		—
Counterparty collateral	112,449		—		112,449		—
	$	35,293,186	$	737,967	$	34,555,193	$	26
Liabilities
2015 notes embedded conversion derivative	$	26,916	$	—	$	26,916	$	—
Interest rate swap	2,644		—		2,644		—
Fixed index annuities - embedded derivatives	5,984,007		—		—		5,984,007
	$	6,013,567	$	—	$	29,560	$	5,984,007

December 31, 2014
Assets
Fixed maturity securities:
Available for sale:
United States Government full faith and credit	$	138,460	$	4,255	$	134,205	$	—
United States Government sponsored agencies	1,393,890		—		1,393,890		—
United States municipalities, states and territories	3,723,309		—		3,723,309		—
Foreign government obligations	193,803		—		193,803		—
Corporate securities	21,490,292		11		21,490,281		—
Residential mortgage backed securities	1,751,345		—		1,750,970		375
Commercial mortgage backed securities	2,807,620		—		2,807,620		—
Other asset backed securities	946,483		—		946,483		—
Equity securities, available for sale: finance, insurance and real estate	7,805		—		7,805		—
Derivative instruments	731,113		—		731,113		—
Cash and cash equivalents	701,514		701,514		—		—
Interest rate caps	2,778		—		2,778		—
2015 notes hedges	30,291		—		30,291		—
Counterparty collateral	206,096		—		206,096		—
	$	34,124,799	$	705,780	$	33,418,644	$	375
Liabilities
2015 notes embedded conversion derivative	$	30,291	$	—	$	30,291	$	—
Interest rate swap	2,644		—		2,644		—
Fixed index annuities - embedded derivatives	5,574,653		—		—		5,574,653
	$	5,607,588	$	—	$	32,935	$	5,574,653

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The following methods and assumptions were used in estimating the fair values of financial instruments during the periods presented in these consolidated financial statements.

Fixed maturity securities and equity securities

The fair values of fixed maturity securities and equity securities in an active and orderly market are determined by utilizing independent pricing services. The independent pricing services incorporate a variety of observable market data in their valuation techniques, including:


•	reported trading prices,


•	benchmark yields,


•	broker-dealer quotes,


•	benchmark securities,


•	bids and offers,


•	credit ratings,


•	relative credit information, and


•	other reference data.

The independent pricing services also take into account perceived market movements and sector news, as well as a security's terms and conditions, including any features specific to that issue that may influence risk and marketability. Depending on the security, the priority of the use of observable market inputs may change as some observable market inputs may not be relevant or additional inputs may be necessary.

The independent pricing services provide quoted market prices when available. Quoted prices are not always available due to market inactivity. When quoted market prices are not available, the third parties use yield data and other factors relating to instruments or securities with similar characteristics to determine fair value for securities that are not actively traded. We generally obtain one value from our primary external pricing service. In situations where a price is not available from this service, we may obtain further quotes or prices from additional parties as needed. In addition, for our callable United States Government sponsored agencies, we obtain multiple broker quotes and take the average of the broker prices received. Market indices of similar rated asset class spreads are considered for valuations and broker indications of similar securities are compared. Inputs used by the broker include market information, such as yield data and other factors relating to instruments or securities with similar characteristics. Valuations and quotes obtained from third party commercial pricing services are non-binding and do not represent quotes on which one may execute the disposition of the assets.

We validate external valuations at least quarterly through a combination of procedures that include the evaluation of methodologies used by the pricing services, analytical reviews and performance analysis of the prices against trends, and maintenance of a securities watch list. Additionally, as needed we utilize discounted cash flow models or perform independent valuations on a case-by-case basis using inputs and assumptions similar to those used by the pricing services. Although we do identify differences from time to time as a result of these validation procedures, we did not make any significant adjustments as of June 30, 2015 and December 31, 2014.

Mortgage loans on real estate

Mortgage loans on real estate are not measured at fair value on a recurring basis. The fair values of mortgage loans on real estate are calculated using discounted expected cash flows using current competitive market interest rates currently being offered for similar loans. The fair values of impaired mortgage loans on real estate that we have considered to be collateral dependent are based on the fair value of the real estate collateral (based on appraised values) less estimated costs to sell. The inputs utilized to determine fair value of all mortgage loans are unobservable market data (competitive market interest rates and appraised property values); therefore, fair value of mortgage loans falls into Level 3 in the fair value hierarchy.

Derivative instruments

The fair values of derivative instruments, primarily call options, are based upon the amount of cash that we will receive to settle each derivative instrument on the reporting date. These amounts are determined by our investment team using industry accepted valuation models and are adjusted for the nonperformance risk of each counterparty net of any collateral held. Inputs include market volatility and risk free interest rates and are used in income valuation techniques in arriving at a fair value for each option contract. The nonperformance risk for each counterparty is based upon its credit default swap rate. We have no performance obligations related to the call options purchased to fund our fixed index annuity policy liabilities.

Other investments

None of the financial instruments included in other investments are measured at fair value on a recurring basis. Financial instruments included in other investments are policy loans, equity method investments and company owned life insurance (COLI). We have not attempted to determine the fair values associated with our policy loans, as we believe any differences between carrying value and the fair values afforded these instruments are immaterial to our consolidated financial position and, accordingly, the cost to provide such disclosure does not justify the benefit to be derived. The fair value of our equity method investments qualify as Level 3 fair values and were determined by calculating the present value of future cash flows discounted by a risk free rate, a risk spread and a liquidity discount. The risk spread and liquidity discount are rates determined by our investment professionals and are unobservable market inputs. The fair value of our COLI approximates the cash surrender value of the policies and whose fair values fall within Level 2 of the fair value hierarchy.

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Cash and cash equivalents

Amounts reported in the consolidated balance sheets for these instruments are reported at their historical cost which approximates fair value due to the nature of the assets assigned to this category.

Interest rate swap and caps

The fair values of our pay fixed/receive variable interest rate swap and our interest rate caps are obtained from third parties and are determined by discounting expected future cash flows using projected LIBOR rates for the term of the swap and caps.

2015 notes hedges

The fair value of these call options has been determined by a third party who applies market observable data such as our common stock price, its dividend yield and its volatility, as well as the time to expiration of the call options to determine a fair value of the buy side of these options.

Counterparty collateral

Amounts reported in other assets on the consolidated balance sheets for these instruments are reported at their historical cost which approximates fair value due to the nature of the assets assigned to this category.

Policy benefit reserves, coinsurance deposits and SPIA benefit reserves

The fair values of the liabilities under contracts not involving significant mortality or morbidity risks (principally deferred annuities), are stated at the cost we would incur to extinguish the liability (i.e., the cash surrender value) as these contracts are generally issued without an annuitization date. The coinsurance deposits related to the annuity benefit reserves have fair values determined in a similar fashion. For period-certain annuity benefit contracts, the fair value is determined by discounting the benefits at the interest rates currently in effect for newly purchased immediate annuity contracts. We are not required to and have not estimated the fair value of the liabilities under contracts that involve significant mortality or morbidity risks, as these liabilities fall within the definition of insurance contracts that are exceptions from financial instruments that require disclosures of fair value. Policy benefit reserves, coinsurance deposits and SPIA benefit reserves are not measured at fair value on a recurring basis. All of the fair values presented within these categories fall within Level 3 of the fair value hierarchy as most of the inputs are unobservable market data.

Notes payable

The fair values of our senior unsecured notes and convertible senior notes are based upon pricing matrices developed by a third party pricing service when quoted market prices are not available and are categorized as Level 2 within the fair value hierarchy. Notes payable are not remeasured at fair value on a recurring basis.

Subordinated debentures

Fair values for subordinated debentures are estimated using discounted cash flow calculations based principally on observable inputs including our incremental borrowing rates, which reflect our credit rating, for similar types of borrowings with maturities consistent with those remaining for the debt being valued. These fair values are categorized as Level 2 within the fair value hierarchy. Subordinated debentures are not measured at fair value on a recurring basis.

2015 notes embedded conversion derivative

The fair value of this embedded derivative is determined by pricing the call options that hedge this potential liability. The terms of the conversion option are identical to the 2015 notes hedges and the method of determining fair value of the call options is based upon observable market data.

Fixed index annuities - embedded derivatives

We estimate the fair value of the embedded derivative component of our fixed index annuity policy benefit reserves at each valuation date by (i) projecting policy contract values and minimum guaranteed contract values over the expected lives of the contracts and (ii) discounting the excess of the projected contract value amounts at the applicable risk free interest rates adjusted for our nonperformance risk related to those liabilities. The projections of policy contract values are based on our best estimate assumptions for future policy growth and future policy decrements. Our best estimate assumptions for future policy growth include assumptions for the expected index credit on the next policy anniversary date which are derived from the fair values of the underlying call options purchased to fund such index credits and the expected costs of annual call options we will purchase in the future to fund index credits beyond the next policy anniversary. The projections of minimum guaranteed contract values include the same best estimate assumptions for policy decrements as were used to project policy contract values.

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The following tables provide a reconciliation of the beginning and ending balances for our Level 3 assets and liabilities, which are measured at fair value on a recurring basis using significant unobservable inputs for the three and six months ended June 30, 2015 and 2014:



	Three Months Ended June 30,						Six Months Ended June 30,
	2015			2014			2015			2014
	(Dollars in thousands)
Available for sale securities
Beginning balance	$	342		$	1,080		$	375		$	1,376
Principal returned	(9		)	(114		)	(21		)	(192		)
Amortization of premium/accretion of discount	(409		)	(138		)	(466		)	(165		)
Total gains (losses) (realized/unrealized):
Included in other comprehensive income (loss)	240			45			276			(146		)
Included in operations	(138		)	(205		)	(138		)	(205		)
Ending balance	$	26		$	668		$	26		$	668

The Level 3 assets included in the table above are not material to our financial position, results of operations or cash flows, and it is management's opinion that the sensitivity of the inputs used in determining the fair value of these assets is not material as well.



	Three Months Ended June 30,						Six Months Ended June 30,
	2015			2014			2015			2014
	(Dollars in thousands)
Fixed index annuities - embedded derivatives
Beginning balance	$	5,865,171		$	4,755,913		$	5,574,653		$	4,406,163
Premiums less benefits	453,317			425,776			813,712			797,729
Change in fair value, net	(334,481		)	(61,866		)	(404,358		)	(84,069		)
Ending balance	$	5,984,007		$	5,119,823		$	5,984,007		$	5,119,823

Change in fair value, net for each period in our embedded derivatives are included in change in fair value of embedded derivatives in the unaudited consolidated statements of operations.

Certain derivatives embedded in our fixed index annuity contracts are our most significant financial instrument measured at fair value that are categorized as Level 3 in the fair value hierarchy. The contractual obligations for future annual index credits within our fixed index annuity contracts are treated as a "series of embedded derivatives" over the expected life of the applicable contracts. We estimate the fair value of these embedded derivatives at each valuation date by the method described above under fixed index annuities - embedded derivatives. The projections of minimum guaranteed contract values include the same best estimate assumptions for policy decrements as were used to project policy contract values.

The most sensitive assumption in determining policy liabilities for fixed index annuities is the rates used to discount the excess projected contract values. As indicated above, the discount rate reflects our nonperformance risk. If the discount rates used to discount the excess projected contract values at June 30, 2015, were to increase by 100 basis points, the fair value of the embedded derivatives would decrease by $399.3 million recorded through operations as a decrease in the change in fair value of embedded derivatives and there would be a corresponding decrease of $238.6 million to our combined balance for deferred policy acquisition costs and deferred sales inducements recorded through operations as an increase in amortization of deferred policy acquisition costs and deferred sales inducements. A decrease by 100 basis points in the discount rate used to discount the excess projected contract values would increase the fair value of the embedded derivatives by $444.8 million recorded through operations as an increase in the change in fair value of embedded derivatives and there would be a corresponding increase of $254.4 million to our combined balance for deferred policy acquisition costs and deferred sales inducements recorded through operations as a decrease in amortization of deferred policy acquisition costs and deferred sales inducements.

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3. Investments

At June 30, 2015 and December 31, 2014, the amortized cost and fair value of fixed maturity securities and equity securities were as follows:



	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(Dollars in thousands)
June 30, 2015
Fixed maturity securities:
Available for sale:
United States Government full faith and credit	$	36,574	$	789	$	(94	)	$	37,269
United States Government sponsored agencies	1,345,273		22,461		(21,435		)	1,346,299
United States municipalities, states and territories	3,384,101		314,439		(15,525		)	3,683,015
Foreign government obligations	210,930		14,110		(4,601		)	220,439
Corporate securities	21,682,728		1,038,079		(321,465		)	22,399,342
Residential mortgage backed securities	1,498,441		126,122		(5,100		)	1,619,463
Commercial mortgage backed securities	3,528,243		62,158		(31,982		)	3,558,419
Other asset backed securities	1,006,412		46,800		(11,589		)	1,041,623
	$	32,692,702	$	1,624,958	$	(411,791	)	$	33,905,869
Held for investment:
Corporate security	$	76,526	$	—	$	(10,821	)	$	65,705

Equity securities, available for sale:
Finance, insurance, and real estate	$	7,512	$	349	$	—		$	7,861

December 31, 2014
Fixed maturity securities:
Available for sale:
United States Government full faith and credit	$	137,710	$	765	$	(15	)	$	138,460
United States Government sponsored agencies	1,364,424		43,399		(13,933		)	1,393,890
United States municipalities, states and territories	3,293,551		430,469		(711		)	3,723,309
Foreign government obligations	181,128		16,628		(3,953		)	193,803
Corporate securities	19,984,747		1,628,941		(123,396		)	21,490,292
Residential mortgage backed securities	1,616,846		136,704		(2,205		)	1,751,345
Commercial mortgage backed securities	2,720,294		90,649		(3,323		)	2,807,620
Other asset backed securities	906,346		48,022		(7,885		)	946,483
	$	30,205,046	$	2,395,577	$	(155,421	)	$	32,445,202
Held for investment:
Corporate security	$	76,432	$	—	$	(594	)	$	75,838

Equity securities, available for sale:
Finance, insurance, and real estate	$	7,509	$	296	$	—		$	7,805

At June 30, 2015, 33% of our fixed income securities have call features, of which 1.0% ($0.4 billion) were subject to call redemption and another 2% ($0.6 billion) will become subject to call redemption during the next twelve months. Approximately 63% of our fixed income securities that have call features are not callable until within six months of their stated maturities.

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The amortized cost and fair value of fixed maturity securities at June 30, 2015, by contractual maturity, are shown below. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. All of our mortgage and other asset backed securities provide for periodic payments throughout their lives and are shown below as separate lines.



	Available for sale				Held for investment
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
	(Dollars in thousands)
Due in one year or less	$	115,065	$	119,061	$	—	$	—
Due after one year through five years	1,568,460		1,718,885		—		—
Due after five years through ten years	9,583,053		9,673,185		—		—
Due after ten years through twenty years	7,890,764		8,338,748		—		—
Due after twenty years	7,502,264		7,836,485		76,526		65,705
	26,659,606		27,686,364		76,526		65,705
Residential mortgage backed securities	1,498,441		1,619,463		—		—
Commercial mortgage backed securities	3,528,243		3,558,419		—		—
Other asset backed securities	1,006,412		1,041,623		—		—
	$	32,692,702	$	33,905,869	$	76,526	$	65,705

Net unrealized gains on available for sale fixed maturity securities and equity securities reported as a separate component of stockholders' equity were comprised of the following:



	June 30, 2015			December 31, 2014
	(Dollars in thousands)
Net unrealized gains on available for sale fixed maturity securities and equity securities	$	1,213,516		$	2,240,452
Adjustments for assumed changes in amortization of deferred policy acquisition costs and deferred sales inducements	(650,062		)	(1,165,271		)
Deferred income tax valuation allowance reversal	22,534			22,534
Deferred income tax expense	(197,209		)	(376,314		)
Net unrealized gains reported as accumulated other comprehensive income	$	388,779		$	721,401

The National Association of Insurance Commissioners (“NAIC”) assigns designations to fixed maturity securities. These designations range from Class 1 (highest quality) to Class 6 (lowest quality). In general, securities are assigned a designation based upon the ratings they are given by the Nationally Recognized Statistical Rating Organizations (“NRSRO’s”). The NAIC designations are utilized by insurers in preparing their annual statutory statements. NAIC Class 1 and 2 designations are considered “investment grade” while NAIC Class 3 through 6 designations are considered “non-investment grade.” Based on the NAIC designations, we had 98% of our fixed maturity portfolio rated investment grade at both June 30, 2015 and December 31, 2014.

The following table summarizes the credit quality, as determined by NAIC designation, of our fixed maturity portfolio as of the dates indicated:



	June 30, 2015				December 31, 2014
NAIC Designation	Amortized Cost		Fair Value		Amortized Cost		Fair Value
	(Dollars in thousands)
1	$	20,987,149	$	21,984,922	$	19,223,151	$	20,941,634
2	11,066,108		11,324,503		10,432,593		10,981,618
3	678,879		642,995		602,191		583,313
4	24,032		13,774		22,888		14,089
5	—		—		—		—
6	13,060		5,380		655		386
	$	32,769,228	$	33,971,574	$	30,281,478	$	32,521,040

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The following table shows our investments' gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities (consisting of 926 and 402 securities, respectively) have been in a continuous unrealized loss position, at June 30, 2015 and December 31, 2014:



	Less than 12 months					12 months or more					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
	(Dollars in thousands)
June 30, 2015
Fixed maturity securities:
Available for sale:
United States Government full faith and credit	$	7,614	$	(94	)	$	—	$	—		$	7,614	$	(94	)
United States Government sponsored agencies	789,276		(21,435		)	—		—			789,276		(21,435		)
United States municipalities, states and territories	384,668		(15,340		)	2,815		(185		)	387,483		(15,525		)
Foreign government obligations	43,757		(1,279		)	11,088		(3,322		)	54,845		(4,601		)
Corporate securities:
Finance, insurance and real estate	1,677,103		(45,815		)	77,533		(12,230		)	1,754,636		(58,045		)
Manufacturing, construction and mining	3,137,250		(113,863		)	235,631		(33,320		)	3,372,881		(147,183		)
Utilities and related sectors	1,669,968		(65,725		)	65,412		(5,704		)	1,735,380		(71,429		)
Wholesale/retail trade	387,401		(14,280		)	23,173		(2,312		)	410,574		(16,592		)
Services, media and other	875,606		(25,991		)	33,938		(2,225		)	909,544		(28,216		)
Residential mortgage backed securities	226,168		(4,380		)	9,214		(720		)	235,382		(5,100		)
Commercial mortgage backed securities	1,516,961		(31,982		)	—		—			1,516,961		(31,982		)
Other asset backed securities	147,816		(1,213		)	51,077		(10,376		)	198,893		(11,589		)
	$	10,863,588	$	(341,397	)	$	509,881	$	(70,394	)	$	11,373,469	$	(411,791	)
Held for investment:
Corporate security:
Insurance	$	65,705	$	(10,821	)	$	—	$	—		$	65,705	$	(10,821	)

December 31, 2014
Fixed maturity securities:
Available for sale:
United States Government full faith and credit	$	—	$	—		$	498	$	(15	)	$	498	$	(15	)
United States Government sponsored agencies	—		—			610,339		(13,933		)	610,339		(13,933		)
United States municipalities, states and territories	—		—			27,947		(711		)	27,947		(711		)
Foreign government obligations	14,194		(1,068		)	11,542		(2,885		)	25,736		(3,953		)
Corporate securities:
Finance, insurance and real estate	253,439		(2,586		)	399,874		(16,277		)	653,313		(18,863		)
Manufacturing, construction and mining	1,078,089		(35,151		)	694,088		(35,926		)	1,772,177		(71,077		)
Utilities and related sectors	373,952		(8,185		)	344,313		(10,153		)	718,265		(18,338		)
Wholesale/retail trade	88,766		(2,290		)	99,427		(3,122		)	188,193		(5,412		)
Services, media and other	131,940		(1,567		)	277,296		(8,139		)	409,236		(9,706		)
Residential mortgage backed securities	22,115		(1,219		)	20,427		(986		)	42,542		(2,205		)
Commercial mortgage backed securities	241,637		(1,344		)	187,241		(1,979		)	428,878		(3,323		)
Other asset backed securities	142,094		(3,519		)	58,958		(4,366		)	201,052		(7,885		)
	$	2,346,226	$	(56,929	)	$	2,731,950	$	(98,492	)	$	5,078,176	$	(155,421	)
Held for investment:
Corporate security:
Insurance	$	—	$	—		$	75,838	$	(594	)	$	75,838	$	(594	)

Based on the results of our process for evaluating available for sale securities in unrealized loss positions for other-than-temporary-impairments, which is discussed in detail later in this footnote, we have determined that the unrealized losses on the securities in the preceding table are temporary. The unrealized losses at June 30, 2015 are principally related to timing of the purchases of these securities, which carry less yield than those available at June 30, 2015. In addition, a number of securities have seen their credit spreads remain wide due to issuer or industry specific news while some financial and industrial sector credit spreads remain wide due to continued economic uncertainty and concerns of prolonged economic weakness.

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At June 30, 2015, we had no exposure to sub-prime residential mortgage backed securities. All of our residential mortgage backed securities are pools of first-lien residential mortgage loans. Substantially all of the securities that we own are in the most senior tranche of the securitization in which they are structured and are not subordinated to any other tranche. Our "Alt-A" residential mortgage backed securities are comprised of 34 securities with a total amortized cost basis of $226.2 million and a fair value of $253.5 million.

Approximately 86% and 78% of the unrealized losses on fixed maturity securities shown in the above table for June 30, 2015 and December 31, 2014, respectively, are on securities that are rated investment grade, defined as being the highest two NAIC designations. All of the fixed maturity securities with unrealized losses are current with respect to the payment of principal and interest.

Changes in net unrealized gains on investments for the three and six months ended June 30, 2015 and 2014 are as follows:



	Three Months Ended June 30,						Six Months Ended June 30,
	2015			2014			2015			2014
	(Dollars in thousands)
Fixed maturity securities held for investment carried at amortized cost	$	(17,326	)	$	1,607		$	(10,227	)	$	5,644
Investments carried at fair value:
Fixed maturity securities, available for sale	$	(1,547,155	)	$	716,779		$	(1,026,989	)	$	1,693,910
Equity securities, available for sale	11			(6		)	53			(19		)
	(1,547,144		)	716,773			(1,026,936		)	1,693,891
Adjustment for effect on other balance sheet accounts:
Deferred policy acquisition costs and deferred sales inducements	770,285			(372,717		)	515,209			(909,469		)
Deferred income tax asset/liability	271,900			(120,420		)	179,105			(274,547		)
	1,042,185			(493,137		)	694,314			(1,184,016		)
Change in net unrealized gains on investments carried at fair value	$	(504,959	)	$	223,636		$	(332,622	)	$	509,875

Proceeds from sales of available for sale securities for the six months ended June 30, 2015 and 2014 were $242.8 million and $130.4 million, respectively. Scheduled principal repayments, calls and tenders for available for sale securities for the six months ended June 30, 2015 and 2014 were $643.8 million and $809.0 million, respectively.

Realized gains and losses on sales are determined on the basis of specific identification of investments based on the trade date. Net realized gains (losses) on investments, excluding net OTTI losses for the three and six months ended June 30, 2015 and 2014, are as follows:



	Three Months Ended June 30,		Six Months Ended June 30,
	2015	2014	2015	2014
	(Dollars in thousands)
Available for sale fixed maturity securities: