UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

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

For the Quarterly Period EndedSeptember 30, 2011March 31, 2012

 

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

For the transition period from             to             

Commission File Number001-11462

 

 

DELPHI FINANCIAL GROUP, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware (302) 478-5142 13-3427277

(State or other jurisdiction of

incorporation or organization)

 

(Registrant’s telephone number,

including area code)

 

(I.R.S. Employer

Identification Number)

1105 North Market Street, Suite 1230, P.O. Box 8985, Wilmington, Delaware 19899
(Address of principal executive offices) (Zip Code)

 

 

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§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  ¨

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

 

Large accelerated filer x  Accelerated filer ¨
Non-accelerated filer ¨  (Do not check if a smaller reporting company)  Smaller reporting company ¨

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

As of October 31, 2011,April 30, 2012, the Registrant had 48,845,12750,529,529 shares of Class A Common Stock and 5,753,8336,111,557 shares of Class B Common Stock outstanding.

 

 

 


DELPHI FINANCIAL GROUP, INC.

FORM 10-Q

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

AND OTHER INFORMATION

 

      Page 

PARTI.PART I.

 

FINANCIAL INFORMATION (UNAUDITED)

 
 

Item 1.

 

Financial Statements

 
  

Consolidated Statements of Income for the Three and Nine Months Ended September 30,March 31, 2012 and 2011 and 2010

  3  
  

Consolidated Balance Sheets at September 30,Statements of Comprehensive Income for the Three Months Ended March 31, 2012 and 2011 and December 31, 2010

  4  
  

Consolidated Statements of Equity for the Nine Months Ended September 30,Balance Sheets at March 31, 2012 and December 31, 2011 and 2010

  5  
  

Consolidated Statements of Cash FlowsEquity for the NineThree Months Ended September 30,March 31, 2012 and 2011 and 2010

  6

Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2012 and 2011

7  
  

Notes to Consolidated Financial Statements

  78  
 

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

  23  
 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

  3129  
 

Item 4.

 

Controls and Procedures

  3129  

PART II.

 

OTHER INFORMATION

 
 

Item 1.

 

Legal Proceedings

  3230  
 

Item 1A.

 

Risk Factors

  3231  
 Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

33
Item 6.

 

Exhibits

  3431  
 

Signatures

  3532  

 

-2-


PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

DELPHI FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Dollars in Thousands, Except Per Share Data)

(Unaudited)

 

  Three Months Ended
September 30,
 Nine Months Ended
September 30,
 
  2011 2010 2011 2010   Three Months Ended
March 31,
 
    (Restated)   (Restated)   2012 2011 

Revenue:

        

Premium and fee income

  $398,619   $357,019   $1,160,030   $1,057,348    $418,385   $376,399  

Net investment income

   80,102    86,886    255,587    249,170     105,780    92,294  

Net realized investment (losses) gains:

     

Net realized investment gains (losses):

   

Total other than temporary impairment losses

   (11,969  (13,886  (27,283  (62,818   (6,791  (7,539

Portion of other than temporary impairment losses recognized in other comprehensive income

   2,617    7,498    3,570    12,599  

Portion of other than temporary impairment losses recognized in (reclassified from) other comprehensive income

   368    (1,479
  

 

  

 

  

 

  

 

   

 

  

 

 

Net impairment losses recognized in earnings

   (9,352  (6,388  (23,713  (50,219   (6,423  (9,018

Other net realized investment gains

   4,350    7,580    17,862    22,431     7,454    7,046  
  

 

  

 

  

 

  

 

   

 

  

 

 

Net realized investment gains (losses)

   1,031    (1,972
   (5,002  1,192    (5,851  (27,788  

 

  

 

 

Loss on early retirement of senior notes

   —      (3,760  —      (3,972
  

 

  

 

  

 

  

 

    525,196    466,721  

Total revenues

   473,719    441,337    1,409,766    1,274,758  
  

 

  

 

  

 

  

 

   

 

  

 

 

Benefits and expenses:

        

Benefits, claims and interest credited to policyholders

   290,033    250,594    834,461    741,602     311,531    271,265  

Commissions

   24,647    24,149    71,182    69,339     22,696    22,568  

Amortization of cost of business acquired

   21,418    20,062    59,404    53,973     21,333    18,961  

Other operating expenses

   79,093    75,392    235,147    226,080     116,243    77,909  
  

 

  

 

  

 

  

 

   

 

  

 

 
   415,191    370,197    1,200,194    1,090,994     471,803    390,703  
  

 

  

 

  

 

  

 

   

 

  

 

 

Operating income

   58,528    71,140    209,572    183,764     53,393    76,018  

Interest expense:

        

Corporate debt

   6,049    7,783    18,066    23,370     6,130    6,010  

Junior subordinated debentures

   3,249    3,241    9,739    9,730     3,242    3,242  
  

 

  

 

  

 

  

 

   

 

  

 

 
   9,298    11,024    27,805    33,100     9,372    9,252  
  

 

  

 

  

 

  

 

   

 

  

 

 

Income before income tax expense

   49,230    60,116    181,767    150,664     44,021    66,766  

Income tax expense

   7,995    15,266    40,152    34,563     10,923    16,395  
  

 

  

 

  

 

  

 

   

 

  

 

 

Net income

   41,235    44,850    141,615    116,101     33,098    50,371  

Less: Net income attributable to noncontrolling interest

   200    42    929    115  

Less: Net (loss) income attributable to noncontrolling interest

   (1,842  147  
  

 

  

 

  

 

  

 

   

 

  

 

 

Net income attributable to shareholders

  $41,035   $44,808   $140,686   $115,986    $34,940   $50,224  
  

 

  

 

  

 

  

 

   

 

  

 

 

Basic results per share of common stock:

        

Net income attributable to shareholders

  $0.73   $0.81   $2.51   $2.10    $0.62   $0.90  

Diluted results per share of common stock:

        

Net income attributable to shareholders

  $0.73   $0.80   $2.48   $2.08    $0.60   $0.89  

Dividends paid per share of common stock

  $0.12   $0.11   $0.35   $0.31    $0.12   $0.11  

See notes to consolidated financial statements.

 

-3-


DELPHI FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Dollars in Thousands)

(Unaudited)

   Three Months Ended
March 31,
 
   2012  2011 

Net income

  $33,098   $50,371  
  

 

 

  

 

 

 

Other comprehensive income, net of tax:

   

Increase in net unrealized appreciation on investments

   83,618    5,804  

Decrease in other than temporary impairment losses recognized in other comprehensive income

   4,146    4,393  

Change in net periodic pension cost

   555    77  
  

 

 

  

 

 

 

Change in other comprehensive income attributable to shareholders

   88,319    10,274  
  

 

 

  

 

 

 

Total comprehensive income

   121,417    60,645  

Less: Net (loss) income attributable to noncontrolling interest

   (1,842  147  
  

 

 

  

 

 

 

Total comprehensive income attributable to shareholders

  $123,259   $60,498  
  

 

 

  

 

 

 

See notes to consolidated financial statements.

-4-


DELPHI FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Dollars in Thousands, Except Per Share Data)

(Unaudited)

 

  September 30,
2011
 December 31,
2010
 
    (Restated)   March 31,
2012
 December 31,
2011
 

Assets:

      

Investments:

      

Fixed maturity securities, available for sale

  $6,373,799   $5,717,090    $6,827,169   $6,489,637  

Short-term investments

   201,529    334,215     141,521    277,552  

Investment accounts receivable

   87,159    45,645     77,189    24,406  

Other investments

   673,715    453,033     873,793    678,133  
  

 

  

 

   

 

  

 

 
   7,336,202    6,549,983     7,919,672    7,469,728  

Cash

   91,055    72,806     109,180    93,898  

Cost of business acquired

   159,322    149,325     149,128    156,675  

Reinsurance receivables

   367,628    360,255     363,726    365,391  

Premiums receivable

   186,179    130,111     193,297    154,612  

Accrued investment income

   70,071    60,831     73,190    74,672  

Goodwill

   93,929    93,929     93,929    93,929  

Other assets

   117,745    120,635     113,950    108,138  

Assets held in separate account

   115,043    123,674     124,068    117,365  
  

 

  

 

   

 

  

 

 

Total assets

  $8,537,174   $7,661,549    $9,140,140   $8,634,408  
  

 

  

 

   

 

  

 

 

Liabilities and Equity:

      

Future policy benefits:

      

Life

  $337,168   $331,816    $334,764   $328,678  

Disability and accident

   835,511    812,258     858,442    845,750  

Unpaid claims and claim expenses:

      

Life

   55,285    53,763     53,728    57,049  

Disability and accident

   469,558    457,642     489,129    481,826  

Casualty

   1,452,338    1,314,910     1,571,758    1,506,129  

Policyholder account balances

   2,030,328    1,753,744     2,171,804    2,100,675  

Unearned premium reserve

   236,031    159,169     253,495    192,261  

Corporate debt

   375,000    375,000     375,000    375,000  

Junior subordinated debentures

   175,000    175,000     175,000    175,000  

Advances from Federal Home Loan Bank

   55,342    55,342     55,342    55,342  

Investment accounts payable

   138,232    27,667     85,627    41,719  

Net deferred tax liability

   130,052    75,545     193,316    135,559  

Other liabilities and policyholder funds

   404,128    410,889     448,904    442,172  

Liabilities related to separate account

   115,043    123,674     124,068    117,365  
  

 

  

 

   

 

  

 

 

Total liabilities

   6,809,016    6,126,419     7,190,377    6,854,525  
  

 

  

 

   

 

  

 

 

Equity:

      

Preferred Stock, $.01 par; 50,000,000 shares authorized, none issued

   —      —       —      —    

Class A Common Stock, $.01 par; 150,000,000 shares authorized; 56,755,585 and 56,463,776 shares issued and outstanding, respectively

   568    565  

Class B Common Stock, $.01 par; 20,000,000 shares authorized; 5,981,049 shares issued and outstanding

   60    60  

Class A Common Stock, $.01 par; 150,000,000 shares authorized; 58,398,268 and 56,798,526 shares issued and outstanding, respectively

   584    568  

Class B Common Stock, $.01 par; 20,000,000 shares authorized; 6,338,773 shares issued and outstanding

   63    63  

Additional paid-in capital

   697,751    682,816     759,980    705,036  

Accumulated other comprehensive income

   94,939    30,932     195,848    107,529  

Retained earnings

   1,134,442    1,013,369     1,193,968    1,165,756  

Treasury stock, at cost; 8,182,716 and 7,761,216 shares of Class A Common Stock, and 227,216 shares of Class B Common Stock

   (206,931  (197,246

Treasury stock, at cost; 8,182,716 shares of Class A Common Stock and 227,216 shares of Class B Common Stock

   (206,931  (206,931
  

 

  

 

   

 

  

 

 

Total shareholders’ equity

   1,720,829    1,530,496     1,943,512    1,772,021  

Noncontrolling interest

   7,329    4,634     6,251    7,862  
  

 

  

 

   

 

  

 

 

Total equity

   1,728,158    1,535,130     1,949,763    1,779,883  
  

 

  

 

   

 

  

 

 

Total liabilities and equity

  $8,537,174   $7,661,549    $9,140,140   $8,634,408  
  

 

  

 

   

 

  

 

 

See notes to consolidated financial statements.

 

-4--5-


DELPHI FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EQUITY

(Dollars in Thousands)

(Unaudited)

 

   Class A
Common
Stock
   Class B
Common
Stock
   Additional
Paid in
Capital
   Accumulated
Other
Comprehensive
Income

(Loss)
  Retained
Earnings
  Treasury
Stock
  Total
Shareholders’
Equity
  Non-
controlling
Interest
  Total
Equity
 

Balance, January 1, 2010

  $560    $60    $661,895    $(33,956 $927,706   $(197,246 $1,359,019   $3,546   $1,362,565  

Cumulative effect adjustment

   —       —       —       —      (60,002  —      (60,002  —      (60,002
  

 

 

   

 

 

   

 

 

   

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Adjusted balance January 1, 2010

   560     60     661,895     (33,956  867,704    (197,246  1,299,017    3,546    1,302,563  
           

 

 

   

 

 

 

Net income

   —       —       —       —      115,986    —      115,986    115    116,101  

Other comprehensive income:

             

Increase in net unrealized appreciation on investments

   —       —       —       165,893    —      —      165,893    —      165,893  

Decrease in other than temporary impairment losses recognized in other comprehensive income

   —       —       —       4,407    —      —      4,407    —      4,407  

Decrease in net loss on cash flow hedge

   —       —       —       1,682    —      —      1,682    —      1,682  

Change in net periodic pension cost

   —       —       —       154    —      —      154     154  
           

 

 

  

 

 

  

 

 

 

Comprehensive income

            288,122    115    288,237  

Net distribution to noncontrolling interest

   —       —       —       —      —      —      —      (2,239  (2,239

Issuance of deferred and restricted shares and exercise of stock options

   3     —       8,604     —      —      —      8,607    —      8,607  

Stock-based compensation

   —       —       4,929     —      —      —      4,929    —      4,929  

Cash dividends

   —       —       —       —      (17,150  —      (17,150  —      (17,150
  

 

 

   

 

 

   

 

 

   

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Balance, September 30, 2010

  $563    $60    $675,428    $138,180   $966,540   $(197,246 $1,583,525   $1,422   $1,584,947  
  

 

 

   

 

 

   

 

 

   

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Balance, January 1, 2011

  $565    $60    $682,816    $30,932   $1,013,369   $(197,246 $1,530,496   $4,634   $1,535,130  
           

 

 

   

 

 

 

Net income

   —       —       —       —      140,686    —      140,686    929    141,615  

Other comprehensive income:

             

Increase in net unrealized appreciation on investments

   —       —       —       62,029    —      —      62,029    —      62,029  

Decrease in other than temporary impairment losses recognized in other comprehensive income

   —       —       —       1,745    —      —      1,745    —      1,745  

Change in net periodic pension cost

   —       —       —       233    —      —      233    —      233  
           

 

 

  

 

 

  

 

 

 

Comprehensive income

            204,693    929    205,622  

Net contribution from noncontrolling interest

   —       —       —       —      —      —      —      1,766    1,766  

Issuance of deferred and restricted shares and exercise of stock options

   3     —       12,618     —      —      —      12,621    —      12,621  

Stock-based compensation

   —       —       2,317     —      —      —      2,317    —      2,317  

Acquisition of treasury stock

   —       —       —       —      —      (9,685  (9,685  —      (9,685

Cash dividends

   —       —       —       —      (19,613  —      (19,613  —      (19,613
  

 

 

   

 

 

   

 

 

   

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Balance, September 30, 2011

  $568    $60    $697,751    $94,939   $1,134,442   $(206,931 $1,720,829   $7,329   $1,728,158  
  

 

 

   

 

 

   

 

 

   

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 
   Class A
Common
Stock
   Class B
Common
Stock
   Additional
Paid in
Capital
  Accumulated
Other
Comprehensive
Income
   Retained
Earnings
  Treasury
Stock
  Total
Shareholders’
Equity
  Non-
controlling
Interest
  Total
Equity
 

Balance, January 1, 2011

  $565    $60    $682,816   $30,932    $1,013,369   $(197,246 $1,530,496   $4,634   $1,535,130  

Net income

   —       —       —      —       50,224    —      50,224    147    50,371  

Change in other comprehensive income

   —       —       —      10,274     —      —      10,274    —      10,274  

Change in noncontrolling interest ownership

   —       —       —      —       —      —      —      774    774  

Issuance of deferred and restricted shares and exercise of stock options

   1     —       4,343    —       —      —      4,344    —      4,344  

Stock-based compensation

   —       —       1,141    —       —      —      1,141    —      1,141  

Cash dividends

   —       —       —      —       (6,158  —      (6,158  —      (6,158
  

 

 

   

 

 

   

 

 

  

 

 

   

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Balance, March 31, 2011

  $566    $60    $688,300   $41,206    $1,057,435   $(197,246 $1,590,321   $5,555   $1,595,876  
  

 

 

   

 

 

   

 

 

  

 

 

   

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Balance, January 1, 2012

  $568    $63    $705,036   $107,529    $1,165,756   $(206,931 $1,772,021   $7,862   $1,779,883  

Net income (loss)

   —       —       —      —       34,940    —      34,940    (1,842  33,098  

Change in other comprehensive income

   —       —       —      88,319     —      —      88,319    —      88,319  

Change in noncontrolling interest ownership

   —       —       —      —       —      —      —      231    231  

Issuance of deferred and restricted shares and exercise of stock options

   16     —       62,281    —       —      —      62,297    —      62,297  

Stock-based compensation

   —       —       (7,337  —       —      —      (7,337  —      (7,337

Cash dividends

   —       —       —      —       (6,728  —      (6,728  —      (6,728
  

 

 

   

 

 

   

 

 

  

 

 

   

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Balance, March 31, 2012

  $584    $63    $759,980   $195,848    $1,193,968   $(206,931 $1,943,512   $6,251   $1,949,763  
  

 

 

   

 

 

   

 

 

  

 

 

   

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

See notes to consolidated financial statements.

 

-5--6-


DELPHI FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in Thousands)

(Unaudited)

 

  Nine Months Ended
September 30,
 
  2011 2010   Three Months Ended
March 31,
 
    (Restated)   2012 2011 

Operating activities:

      

Net income attributable to shareholders

  $140,686   $115,986    $34,940   $50,224  

Adjustments to reconcile net income attributable to shareholders to net cash provided by operating activities:

      

Change in policy liabilities and policyholder accounts

   268,982    180,506     161,289    123,648  

Net change in reinsurance receivables and payables

   (9,007  (9,657   1,232    1,017  

Net change in premiums receivable

   (56,068  (30,045   (38,685  (33,471

Amortization, principally the cost of business acquired and investments

   29,819    37,376     8,808    13,912  

Deferred costs of business acquired

   (78,908  (65,782   (29,364  (26,032

Net realized losses on investments

   5,851    27,788  

Net realized (gains) losses on investments

   (1,031  1,972  

Net change in federal income taxes

   26,145    9,630     (1,250  23,875  

Other

   (3,754  (12,804

Other operating activities

   (41,909  (37,706
  

 

  

 

   

 

  

 

 

Net cash provided by operating activities

   323,746    252,998     94,030    117,439  
  

 

  

 

   

 

  

 

 

Investing activities:

      

Purchases of investments and loans made

   (2,416,481  (1,599,851   (1,482,137  (826,996

Sales of investments and receipts from repayment of loans

   1,429,610    1,057,614     1,052,706    592,455  

Maturities of investments

   308,805    70,801     114,336    71,970  

Net change in short-term investments

   132,686    46,367     136,031    66,826  
  

 

  

 

   

 

  

 

 

Net cash used by investing activities

   (545,380  (425,069   (179,064  (95,745
  

 

  

 

   

 

  

 

 

Financing activities:

      

Deposits to policyholder accounts

   433,239    277,854     89,101    99,076  

Withdrawals from policyholder accounts

   (169,258  (82,832   (29,590  (97,028

Proceeds from issuance of 2020 Senior Notes

   —      250,000  

Borrowings under revolving credit facility

   —      50,000  

Principal payments under bank credit facility

   —      (222,000

Early retirement of senior notes

   —      (75,000

Acquisition of treasury stock

   (9,685  —    

Proceeds from the issuance of common stock under share-based compensation plans

   43,301    3,907  

Cash dividends paid on common stock

   (19,613  (17,150   (6,728  (6,158

Other financing activities

   5,200    2,983     4,232    (1,272
  

 

  

 

   

 

  

 

 

Net cash provided by financing activities

   239,883    183,855  

Net cash provided (used) by financing activities

   100,316    (1,475
  

 

  

 

   

 

  

 

 

Increase in cash

   18,249    11,784     15,282    20,219  

Cash at beginning of year

   72,806    65,464     93,898    72,806  
  

 

  

 

   

 

  

 

 

Cash at end of period

  $91,055   $77,248    $109,180   $93,025  
  

 

  

 

   

 

  

 

 

See notes to consolidated financial statements.

 

-6--7-


DELPHI FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note A – Significant Accounting Policies

The financial statements of Delphi Financial Group, Inc. (the “Company,” which term includes the Company and its consolidated subsidiaries unless the context indicates otherwise) included herein were prepared in conformity with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. The information furnished includes all adjustments and accruals of a normal recurring nature which, in the opinion of management, are necessary for a fair presentation of results for the interim periods. Certain reclassifications have been made in the September 30, 2010 and DecemberMarch 31, 20102011 consolidated financial statements to conform to the September 30, 2011March 31, 2012 presentation. In addition, as discussed below under the caption “Accounting Changes,” certain 2010 financial information has been restated as a result of the Company’s adoption of new accounting principles. Operating results for the three and nine months ended September 30, 2011March 31, 2012 are not necessarily indicative of the results that may be expected for the year ended December 31, 2011.2012. For further information refer to the consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 20102011, as amended by Amendment No. 1 on Form 10-K/A (the “2010“2011 Form 10-K”). Capitalized terms used herein without definition have the meanings ascribed to them in the 20102011 Form 10-K.

Accounting Changes

The Company defers certain costs relating to the acquisition of new insurance business, such as commissions, certain costs associated with policy issuance and underwriting and certain sales support expenses, when incurred. On January 1, 2011, the Company adopted, on a retrospective basis, guidance issued by the Financial Accounting Standards Board (“FASB”) limiting the extent to which an insurer may capitalize costs incurred in the acquisition of an insurance contract. The guidance provides that, in order to be capitalized, such costs must be incremental and directly related to the acquisition of a new or renewal insurance contract. Insurers may only capitalize costs related to successful efforts in attaining a contract and advertising costs may only be capitalized if certain direct response advertising criteria are met. As a result of adopting this guidance, the Company made an after-tax reduction to its retained earnings at January 1, 2010 in the amount of $60.0 million, net of an income tax benefit of $32.3 million, which represents the net reduction in deferred policy acquisition cost included in cost of business acquired on the consolidated balance sheet, and net income attributable to shareholders was reduced by $0.03 per diluted share and $0.09 per diluted share for the three and nine months ended September 30, 2010, respectively. This adoption also resulted in the restatement of certain financial information for 2010.

On January 1, 2011,2012, the Company adopted new guidance issued by the FASB clarifying that an insurance company should not consider any interests of its separate accounts in an investment to be the insurer’s own interests and should not combine those interests with any interest of its general account in the same investment when assessing the investment for consolidation. Insurance companies are also required to consider a separate account as a subsidiary for purposes of evaluating whether the application of specialized accounting for investments in consolidation is appropriate. The adoption of this guidance did not have any effect on the Company’s consolidated financial position or results of operations.

On January 1, 2011, the Company adopted new guidance issued by the FASB requiring additional disclosures regarding fair value measurements. The guidance applies to all entities that are required to make disclosures about recurring or nonrecurring fair value measurements and requires separate disclosure of the activity in the Level 3 category related to purchases, sales, issuances and settlements on a gross basis. The requirement became effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. The adoption of this guidance did not have any effect on the Company’s consolidated financial position or results of operations.

In December 2010, the FASB issued guidance providing clarification relating to the testing of goodwill for impairment for entities carrying goodwill as an asset which have one or more reporting units whose carrying amount for purposes of performing the first step of the goodwill impairment test is zero or negative. For those reporting units, an entity is required to perform the second step of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist. This guidance became effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2010. The adoption of this guidance did not have any effect on the Company’s consolidated financial position or results of operations.

-7-


DELPHI FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Note A – Significant Accounting Policies – (Continued)

Recently Issued Accounting Standards

In May 2011, the FASB issued new guidance regarding fair value measurements in order to have a common fair value measurement and disclosure requirement for purposes of both GAAP and International Financial Reporting Standards. This guidance further elaborates upon techniques used in measuring fair value. It does not require additional fair value measurements and is not intended to establish valuation standards or affect valuation practices. This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011. Early adoption is not permitted. The Company has not yet determined the impact, if any, that the adoption of this guidance willdid not have any effect on itsthe Company’s consolidated financial position or results of operations.

In June 2011,On January 1, 2012, the FASBCompany adopted new guidance issued new guidanceby the FASB regarding the presentation of comprehensive income. This guidance eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity and requires that all changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The guidance does not change the items that must be reported in other comprehensive income or the calculation or presentation of earnings per share. This guidance is effective retrospectively for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011 with early2011. The adoption permitted. Because the newof this guidance affects financial statement presentation only, it willdid not have no impactany effect on the Company’s consolidated financial position or results of operations.

In September 2011,On January 1, 2012, the FASBCompany adopted new guidance issued new guidanceby the FASB addressing the valuation process for goodwill. This guidance provides the ability to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. Under this guidance, an entity will no longer be required to calculate the fair value of a reporting unit unless it determines, based on a qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. This guidance is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted. The Company has not yet determined the impact, if any, that the adoption of this guidance willdid not have any impact on itsthe Company’s consolidated financial position or results of operations.

Note B – Investments

At September 30,March 31, 2012, the Company had fixed maturity securities available for sale with a carrying value and a fair value of $6,827.2 million and an amortized cost of $6,468.1 million. At December 31, 2011, the Company had fixed maturity securities available for sale with a carrying value and a fair value of $6,373.8$6,489.6 million and an amortized cost of $6,195.1 million. At December 31, 2010, the Company had fixed maturity securities available for sale with a carrying value and a fair value of $5,717.1 million and an amortized cost of $5,650.6$6,274.6 million. Declines in market value relative to such securities’ amortized cost which are determined to be other than temporary pursuant to the Company’s methodology for such determinations and to represent credit losses are reflected as reductions in the amortized cost of such securities, as further discussed below.

 

-8-


DELPHI FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

 

Note B – Investments – (Continued)

 

The amortized cost and fair value of investments in fixed maturity securities available for sale are as follows:

 

   September 30, 2011 
       Gross Unrealized    
              Other Than    
   Amortized          Temporary  Fair 
   Cost   Gains   Losses  Impairments  Value 
   (dollars in thousands) 

Agency residential mortgage-backed securities

  $629,779    $65,816    $(108 $—     $695,487  

Non-agency residential mortgage-backed securities

   816,842     61,182     (20,439  (21,048  836,537  

Commercial mortgage-backed securities

   70,062     653     (2,181  (55  68,479  

Corporate securities

   1,885,056     82,492     (63,742  (847  1,902,959  

Collateralized debt obligations

   251,824     2,464     (34,663  (2,125  217,500  

U.S. Treasury and other U.S. Government guaranteed securities

   95,533     7,710     (431  —      102,812  

U.S. Government-sponsored enterprise securities

   50,585     137     (29  —      50,693  

Obligations of U.S. states, municipalities and political subdivisions

   2,395,399     113,745     (9,812  —      2,499,332  
  

 

 

   

 

 

   

 

 

  

 

 

  

 

 

 

Total fixed maturity securities

  $6,195,080    $334,199    $(131,405 $(24,075 $6,373,799  
  

 

 

   

 

 

   

 

 

  

 

 

  

 

 

 

 

  December 31, 2010 
      Gross Unrealized   $6,274,590$6,274,590$6,274,590$6,274,590$6,274,590
            Other Than     March 31, 2012 
  Amortized         Temporary Fair       Gross Unrealized   
  Cost   Gains   Losses Impairments Value   Amortized
Cost
   Gains   Losses Other Than
Temporary
Impairments
 Fair
Value
 
  (dollars in thousands)   (dollars in thousands) 

Agency residential mortgage-backed securities

  $626,494    $38,586    $(1,379 $—     $663,701    $520,634    $54,259    $(68 $—     $574,825  

Non-agency residential mortgage-backed securities

   800,380     77,742     (27,518  (24,896  825,708     957,752     66,292     (14,435  (17,439  992,170  

Commercial mortgage-backed securities

   35,863     300     (3,020  (139  33,004     190,530     11,172     (3,466  (39  198,197  

Corporate securities

   1,466,561     81,919     (18,761  —      1,529,719     1,738,458     102,003     (14,889  (378  1,825,194  

Collateralized debt obligations

   199,594     3,652     (26,337  (1,725  175,184     289,437     12,744     (19,088  (22  283,071  

Foreign government securities

   137,802     11,083     (2,861  —      146,024  

U.S. Treasury and other U.S. Government guaranteed securities

   269,264     6,001     (3,362  —      271,903     119,478     5,586     (606  —      124,458  

U.S. Government-sponsored enterprise securities

   113,446     107     (2,012  —      111,541     38,089     106     (249  —      37,946  

Obligations of U.S. states, municipalities and political subdivisions

   2,138,994     36,421     (69,085  —      2,106,330     2,475,876     174,828     (5,420  —      2,645,284  
  

 

   

 

   

 

  

 

  

 

   

 

   

 

   

 

  

 

  

 

 

Total fixed maturity securities

  $5,650,596    $244,728    $(151,474 $(26,760 $5,717,090    $6,468,056    $438,073    $(61,082 $(17,878 $6,827,169  
  

 

   

 

   

 

  

 

  

 

   

 

   

 

   

 

  

 

  

 

 

$6,274,590$6,274,590$6,274,590$6,274,590$6,274,590
   December 31, 2011 
       Gross Unrealized    
   Amortized
Cost
   Gains   Losses  Other Than
Temporary
Impairments
  Fair
Value
 
   (dollars in thousands) 

Agency residential mortgage-backed securities

  $606,678    $61,928    $(22 $—     $668,584  

Non-agency residential mortgage-backed securities

   819,027     50,256     (27,009  (21,637  820,637  

Commercial mortgage-backed securities

   96,251     2,135     (1,665  (38  96,683  

Corporate securities

   1,668,160     82,377     (42,269  (771  1,707,497  

Collateralized debt obligations

   284,667     6,582     (31,368  (1,810  258,071  

Foreign government securities

   258,578     12,557     (13,854  —      257,281  

U.S. Treasury and other U.S. Government guaranteed securities

   96,281     8,043     (487  —      103,837  

U.S. Government-sponsored enterprise securities

   42,229     156     (6  —      42,379  

Obligations of U.S. states, municipalities and political subdivisions

   2,402,719     140,851     (8,902  —      2,534,668  
  

 

 

   

 

 

   

 

 

  

 

 

  

 

 

 

Total fixed maturity securities

  $6,274,590    $364,885    $(125,582 $(24,256 $6,489,637  
  

 

 

   

 

 

   

 

 

  

 

 

  

 

 

 

 

-9-


DELPHI FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

 

Note B – Investments – (Continued)

 

The following table contains information, as of September 30, 2011, regarding the portions of the Company’s investments in non-agency residential mortgage-backed securities (“RMBS”) represented by securities whose underlying mortgage loans are categorized as prime, Alt-A and subprime, respectively, and the distributions of the securities within these categories by the years in which they were issued (vintages) and the highest of their ratings from Standard & Poor’s, Moody’s and Fitch. All dollar amounts in this table are based upon the fair values of these securities as of September 30, 2011. As of this date, based upon the most recently available data regarding the concentrations by state of the mortgage loans underlying these securities, the states having loan concentrations in excess of 5% were as follows: California (38.3%), New York (7.8%) and Florida (6.7%).

   Non-Agency Prime RMBS – Fair Value 
Vintage  AAA   AA   A   BBB   BB and
Below(1)
   Total 
   (dollars in thousands) 

2001 and prior

  $1,706    $—      $—      $—      $—      $1,706  

2002

   5,619     —       2,514     —       1,406     9,539  

2003

   63,395     1,407     —       3,593     10,920     79,315  

2004

   16,406     15,577     —       10,404     6,105     48,492  

2005

   10,952     5,661     1,453     17,017     87,164     122,247  

2006

   14,372     —       —       —       26,250     40,622  

2007

   4,637     —       —       —       88,951     93,588  

2008

   729     —       —       —       445     1,174  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $117,816    $22,645    $3,967    $31,014    $221,241    $396,683  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(1)

The securities enumerated in this column include securities having a total of $182.1 million in fair value that have received the equivalent of an investment grade rating from the National Association of Insurance Commissioners (the “NAIC”) under its process which takes into account, among other things, the discounts at which the Company originally purchased the securities and modeling of the potential losses with respect to the securities’ underlying loans.

   Non-Agency Alt-A RMBS – Fair Value 
Vintage  AAA   AA   A   BBB   BB and
Below(1)
   Total 
   (dollars in thousands) 

2001 and prior

  $—      $—      $—      $1,561    $—      $1,561  

2002

   183     1,512     —       —       —       1,695  

2003

   42,676     —       —       —       971     43,647  

2004

   18,927     1,834     1,341     —       1,732     23,834  

2005

   6,497     17,057     —       —       64,499     88,053  

2006

   9,928     —       50     7,676     73,117     90,771  

2007

   252     —       —       —       127,474     127,726  

2010

   —       —       3,879     —       —       3,879  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $78,463    $20,403    $5,270    $9,237    $267,793    $381,166  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(1)

The securities enumerated in this column include securities having a total of $ 203.5 million in fair value that have received the equivalent of an investment grade rating from the NAIC under its process which takes into account, among other things, the discounts at which the Company originally purchased the securities and modeling of the potential losses with respect to the securities’ underlying loans.

-10-


DELPHI FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Note B – Investments – (Continued)

   Non-Agency Subprime RMBS – Fair Value 
Vintage  AAA   AA   A   BBB   BB and
Below (1)
   Total 
   (dollars in thousands) 

2003

  $9,943    $—      $1,010    $—      $—      $10,953  

2004

   9,344     —       —       —       3,260     12,604  

2005

   11,339     —       —       —       21,030     32,369  

2006

   —       —       —       1,072     737     1,809  

2007

   —       —       —       —       953     953  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $30,626    $—      $1,010    $1,072    $25,980    $58,688  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(1)

The securities enumerated in this column include securities having a total of $23.3 million in fair value that have received the equivalent of an investment grade rating from the NAIC under its process which takes into account, among other things, the discounts at which the Company originally purchased the securities and modeling of the potential losses with respect to the securities’ underlying loans.

The amortized cost and fair value of fixed maturity securities available for sale at September 30, 2011,March 31, 2012, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations, with or without prepayment penalties.

 

   Amortized
Cost
   Fair
Value
 
   (dollars in thousands) 

Agency residential mortgage-backed securities

  $629,779    $695,487  

Non-agency residential mortgage-backed securities

   816,842     836,537  

Commercial mortgage-backed securities

   70,062     68,479  

Other fixed maturity securities:

    

One year or less

   92,032     82,246  

Greater than 1, up to 5 years

   650,026     654,513  

Greater than 5, up to 10 years

   1,228,058     1,214,880  

Greater than 10 years

   2,708,281     2,821,657  
  

 

 

   

 

 

 

Total

  $6,195,080    $6,373,799  
  

 

 

   

 

 

 

   Amortized
Cost
   Fair
Value
 
   (dollars in thousands) 

Agency residential mortgage-backed securities

  $520,634    $574,825  

Non-agency residential mortgage-backed securities

   957,752     992,170  

Commercial mortgage-backed securities

   190,530     198,197  

Other fixed maturity securities:

    

One year or less

   79,904     77,358  

Greater than 1, up to 5 years

   684,167     707,749  

Greater than 5, up to 10 years

   1,210,076     1,251,704  

Greater than 10 years

   2,824,993     3,025,166  
  

 

 

   

 

 

 

Total

  $6,468,056    $6,827,169  
  

 

 

   

 

 

 

Net investment income was attributable to the following:

 

-11-

   Three Months Ended 
   March 31, 
   2012  2011 
   (dollars in thousands) 

Gross investment income:

   

Fixed maturity securities, available for sale

  $96,264   $86,112  

Mortgage loans

   1,031    233  

Other

   18,903    14,210  
  

 

 

  

 

 

 
   116,198    100,555  

Less: Investment expenses

   (10,418  (8,261
  

 

 

  

 

 

 
  $105,780   $92,294  
  

 

 

  

 

 

 

Net realized investment gains (losses) arose from the following:

   Three Months Ended 
   March 31, 
   2012  2011 
   (dollars in thousands) 

Credit related other than temporary impairment losses:

   

Fixed maturity securities, available for sale

  $(6,423 $(9,018
  

 

 

  

 

 

 

Other net realized investment gains:

   

Fixed maturity securities, available for sale

  $6,814   $6,799  

Other investments

   640    247  
  

 

 

  

 

 

 
   7,454    7,046  
  

 

 

  

 

 

 

Total

  $1,031   $(1,972
  

 

 

  

 

 

 

Proceeds from sales of fixed maturity securities during the first three months of 2012 and 2011 were $806.1 million and $520.0 million, respectively. Gross gains of $25.7 million and gross losses of $18.9 million were realized on the 2012 sales and gross gains of $10.6 million and gross losses of $3.8 million were realized on the 2011 sales. Net realized investment gains and losses on investment sales are determined under the specific identification method and are included in income. The change in unrealized appreciation and depreciation on investments, primarily relating to fixed maturity securities, is included as a component of accumulated other comprehensive income or loss.

-10-


DELPHI FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

 

Note B – Investments – (Continued)

 

The gross unrealized losses and fair value of fixed maturity securities available for sale, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows:

 

   September 30, 2011 
   Less Than 12 Months  12 Months or More  Total 
   Fair
Value
   Gross
Unrealized
Losses
  Fair
Value
   Gross
Unrealized
Losses
  Fair
Value
   Gross
Unrealized
Losses
 
          
          
   (dollars in thousands) 

Agency residential mortgage-backed securities

  $19,940    $(88 $218    $(20 $20,158    $(108

Non-agency residential mortgage-backed securities

   124,169     (4,942  192,712     (36,545  316,881     (41,487

Commercial mortgage-backed securities

   47,946     (1,779  4,607     (457  52,553     (2,236

Corporate securities

   737,495     (48,990  42,626     (15,599  780,121     (64,589

Collateralized debt obligations

   130,274     (11,396  62,385     (25,392  192,659     (36,788

U.S. Treasury and other U.S. Government guaranteed securities

   21,997     (431  —       —      21,997     (431

U.S. Government-sponsored enterprise securities

   10,306     (11  4,982     (18  15,288     (29

Obligations of U.S. states, municipalities and political subdivisions

   86,888     (1,668  122,912     (8,144  209,800     (9,812
  

 

 

   

 

 

  

 

 

   

 

 

  

 

 

   

 

 

 

Total fixed maturity securities

  $1,179,015    $(69,305 $430,442    $(86,175 $1,609,457    $(155,480
  

 

 

   

 

 

  

 

 

   

 

 

  

 

 

   

 

 

 

 

  December 31, 2010 
  Less Than 12 Months 12 Months or More Total $1,067,809$1,067,809$1,067,809$1,067,809$1,067,809$1,067,809
  Fair
Value
   Gross
Unrealized
Losses
  Fair
Value
   Gross
Unrealized
Losses
  Fair
Value
   Gross
Unrealized
Losses
   March 31, 2012 
          Less Than 12 Months 12 Months or More Total 
          Fair
Value
   Gross
Unrealized
Losses
 Fair
Value
   Gross
Unrealized
Losses
 Fair
Value
   Gross
Unrealized
Losses
 
        (dollars in thousands)           (dollars in thousands)       

Agency residential mortgage-backed securities

  $52,300    $(1,329 $233    $(50 $52,533    $(1,379  $7,489    $(41 $194    $(27 $7,683    $(68

Non-agency residential mortgage-backed securities

   56,290     (1,584  230,655     (50,830  286,945     (52,414   141,479     (5,295  167,360     (26,579  308,839     (31,874

Commercial mortgage-backed securities

   12,500     (447  5,188     (2,712  17,688     (3,159   45,937     (3,466  5     (39  45,942     (3,505

Corporate securities

   301,150     (9,005  61,904     (9,756  363,054     (18,761   298,662     (8,855  40,417     (6,412  339,079     (15,267

Collateralized debt obligations

   5,451     (587  130,104     (27,475  135,555     (28,062   82,953     (3,115  76,582     (15,995  159,535     (19,110

Foreign government securities

   60,391     (2,861  —       —      60,391     (2,861

U.S. Treasury and other U.S. Government guaranteed securities

   81,442     (3,362  —       —      81,442     (3,362   30,384     (206  7,281     (400  37,665     (606

U.S. Government-sponsored enterprise securities

   61,277     (2,012  —       —      61,277     (2,012   28,199     (249  —       —      28,199     (249

Obligations of U.S. states, municipalities and political subdivisions

   1,169,724     (57,589  65,337     (11,496  1,235,061     (69,085   88,668     (1,578  24,259     (3,842  112,927     (5,420
  

 

   

 

  

 

   

 

  

 

   

 

   

 

   

 

  

 

   

 

  

 

   

 

 

Total fixed maturity securities

  $1,740,134    $(75,915 $493,421    $(102,319 $2,233,555    $(178,234  $784,162    $(25,666 $316,098    $(53,294 $1,100,260    $(78,960
  

 

   

 

  

 

   

 

  

 

   

 

   

 

   

 

  

 

   

 

  

 

   

 

 

$1,067,809$1,067,809$1,067,809$1,067,809$1,067,809$1,067,809
   December 31, 2011 
   Less Than 12 Months  12 Months or More  Total 
   Fair
Value
   Gross
Unrealized

Losses
  Fair
Value
   Gross
Unrealized
Losses
  Fair
Value
   Gross
Unrealized
Losses
 
          (dollars in thousands)        

Agency residential mortgage-backed securities

  $2,489    $(7 $217    $(15 $2,706    $(22

Non-agency residential mortgage-backed securities

   236,953     (10,510  165,137     (38,136  402,090     (48,646

Commercial mortgage-backed securities

   23,116     (1,480  4,829     (223  27,945     (1,703

Corporate securities

   440,672     (23,617  69,933     (19,423  510,605  ��  (43,040

Collateralized debt obligations

   132,496     (9,397  64,410     (23,781  196,906     (33,178

Foreign government securities

   160,615     (13,854  —       —      160,615     (13,854

U.S. Treasury and other U.S. Government guaranteed securities

   15,178     (487  —       —      15,178     (487

U.S. Government-sponsored enterprise securities

   8,232     (6  —       —      8,232     (6

Obligations of U.S. states, municipalities and political subdivisions

   48,058     (2,766  82,220     (6,136  130,278     (8,902
  

 

 

   

 

 

  

 

 

   

 

 

  

 

 

   

 

 

 

Total fixed maturity securities

  $1,067,809    $(62,124 $386,746    $(87,714 $1,454,555    $(149,838
  

 

 

   

 

 

  

 

 

   

 

 

  

 

 

   

 

 

 

-11-


DELPHI FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Note B – Investments – (Continued)

The following table contains information, as of March 31, 2012, regarding the portions of the Company’s investments in non-agency residential mortgage-backed securities (“RMBS”) represented by securities whose underlying mortgage loans are categorized as prime, Alt-A and sub-prime, respectively, and the distributions of the securities within these categories by the years in which they were issued (vintages) and the highest of their ratings from Standard & Poor’s, Moody’s and Fitch. All dollar amounts in this table are based upon the fair values of these securities as of March 31, 2012. As of this date, based upon the most recently available data regarding the concentrations by state of the mortgage loans underlying these securities, the states having loan concentrations in excess of 5% were as follows: California (38.8%), New York (8.0%) and Florida (6.7%).

   Non-Agency Prime RMBS – Fair Value 
Vintage  AAA   AA   A   BBB   BB and
Below(1)
   Total 
   (dollars in thousands) 

2001 and prior

  $—      $1,121    $—      $—      $207    $1,328  

2002

   5,579     —       2,269     —       1,375     9,223  

2003

   69,764     1,235     —       2,084     10,739     83,822  

2004

   19,876     8,354     17,184     9,103     6,312     60,829  

2005

   5,327     85     6,387     —       117,464     129,263  

2006

   13,737     —       —       —       59,169     72,906  

2007

   4,106     —       —       —       118,476     122,582  

2008

   —       687     —       —       366     1,053  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $118,389    $11,482    $25,840    $11,187    $314,108    $481,006  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(1)

The securities enumerated in this column include securities having a total of $277.6 million in fair value that have received the equivalent of an investment grade rating from the National Association of Insurance Commissioners (the “NAIC”) under its process which takes into account, among other things, the discounts at which the Company originally purchased the securities and modeling of the potential losses with respect to the securities’ underlying loans.

   Non-Agency Alt-A RMBS – Fair Value 
Vintage  AAA   AA   A   BBB   BB and
Below(1)
   Total 
   (dollars in thousands) 

2001 and prior

  $—      $—      $—      $1,525    $—      $1,525  

2002

   184     —       1,249     —       —       1,433  

2003

   39,060     —       —       —       747     39,807  

2004

   13,514     3,473     665     1,149     5,323     24,124  

2005

   1,934     —       4,412     —       85,346     91,692  

2006

   7,430     —       38     —       83,540     91,008  

2007

   224     —       —       —       138,663     138,887  

2010

   —       —       3,960     —       —       3,960  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $62,346    $3,473    $10,324    $2,674    $313,619    $392,436  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(1)

The securities enumerated in this column include securities having a total of $279.5 million in fair value that have received the equivalent of an investment grade rating from the NAIC under its process which takes into account, among other things, the discounts at which the Company originally purchased the securities and modeling of the potential losses with respect to the securities’ underlying loans.

 

-12-


DELPHI FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

 

Note B – Investments – (Continued)

 

Net investment income was attributable to the following:

   Non-Agency Subprime RMBS – Fair Value 
Vintage  AAA   AA   A   BBB   BB and
Below(1)
   Total 
   (dollars in thousands) 

2003

  $9,235    $—      $885    $—      $—      $10,120  

2004

   8,768     —       —       —       2,665     11,433  

2005

   10,771     1,143     6,276     —       25,677     43,867  

2006

   —       —       456     1,171     45,301     46,928  

2007

   —       —       —       —       6,380     6,380  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $28,774    $1,143    $7,617    $1,171    $80,023    $118,728  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

   Three Months Ended
September 30,
  Nine Months Ended
September 30,
 
   2011  2010  2011  2010 
   (dollars in thousands) 

Gross investment income (loss):

     

Fixed maturity securities, available for sale

  $88,808   $82,926   $261,815   $244,109  

Mortgage loans

   1,184    630    2,765    3,948  

Short-term investments

   86    32    181    69  

Other

   (2,166  10,130    14,530    21,477  
  

 

 

  

 

 

  

 

 

  

 

 

 
   87,912    93,718    279,291    269,603  

Less: Investment expenses

   (7,810  (6,832  (23,704  (20,433
  

 

 

  

 

 

  

 

 

  

 

 

 
  $80,102   $86,886   $255,587   $249,170  
  

 

 

  

 

 

  

 

 

  

 

 

 

Net realized investment (losses) gains arose from the following:

   Three Months Ended
September 30,
  Nine Months Ended
September 30,
 
   2011  2010  2011  2010 
   (dollars in thousands) 

Credit related other than temporary impairment losses:

     

Fixed maturity securities, available for sale

  $(9,300 $(5,840 $(23,314 $(32,802

Mortgage loans

   —      (57  —      (15,159

Other investments

   (52  (491  (399  (2,258
  

 

 

  

 

 

  

 

 

  

 

 

 
   (9,352  (6,388  (23,713  (50,219
  

 

 

  

 

 

  

 

 

  

 

 

 

Other net realized investment gains (losses):

     

Fixed maturity securities, available for sale

   8,509    7,544    20,140    19,290  

Mortgage loans

   —      (1  290    418  

Other investments

   (4,159  37    (2,568  2,723  
  

 

 

  

 

 

  

 

 

  

 

 

 
   4,350    7,580    17,862    22,431  
  

 

 

  

 

 

  

 

 

  

 

 

 

Total

  $(5,002 $1,192   $(5,851 $(27,788
  

 

 

  

 

 

  

 

 

  

 

 

 

Proceeds from sales of fixed maturity securities during the first nine months of 2011 and 2010 were $1,000.9 million and $357.5 million, respectively. Gross gains, including mortgage loans and other, of $39.8 million and gross losses of $(21.9) million were realized on the 2011 sales and gross gains of $24.8 million and gross losses of $(5.5) million were realized on the 2010 sales. Proceeds from sales of fixed maturity securities during the third quarters of 2011 and 2010 were $299.5 million and $100.0 million, respectively. Gross gains, including mortgage loans and other, of $17.4 million and gross losses of $(13.1) million were realized on sales during the third quarter of 2011 and gross gains of $8.5 million and gross losses of $(1.0) million were realized on sales during the third quarter of 2010. Net realized investment gains and losses on investment sales are determined under the specific identification method and are included in income. The change in unrealized appreciation and depreciation on investments, primarily relating to fixed maturity securities, is included as a component of accumulated other comprehensive income or loss.

(1)The securities enumerated in this column include securities having a total of $77.3 million in fair value that have received the equivalent of an investment grade rating from the NAIC under its process which takes into account, among other things, the discounts at which the Company originally purchased the securities and modeling of the potential losses with respect to the securities’ underlying loans.

The Company regularly evaluates its investment portfolio utilizing its established methodology to determine whether declines in the fair values of its investments below the Company’s amortized cost are other than temporary. Under this methodology, management evaluates whether and when the Company will recover an investment’s amortized cost, taking into account, among other things, the financial position and prospects of the issuer, conditions in the issuer’s industry and geographic area, liquidity of the investment, the expected amount and timing of future cash flows from the investment, recent changes in credit ratings of the issuer by nationally recognized rating agencies and the length of time and extent to which the fair value of the investment has been lower than its amortized cost to determine if and when a decline in the fair value of an investment below amortized cost is other than temporary. In the case of structured securities such as RMBS, commercial mortgage-backed

-13-


DELPHI FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Note B – Investments – (Continued)

securities and collateralized debt obligations, the most significant factor in these evaluations is the expected amount and timing of the future cash flows from the investment. In the case of fixed maturity securities, in instances where management determines that a security’s amortized cost will be recovered during its remaining term to maturity, an additional component of this methodology is the Company’s evaluation of whether it intends to, or will more likely than not be required to, sell the security before such anticipated recovery.

If the fair value of a fixed maturity security declines in value below the Company’s amortized cost and the Company intends to sell, or determines that it will more likely than not be required to sell, the security before recovery of its amortized cost basis, management considers the security to be other than temporarily impaired and reports its decline in fair value as a realized investment loss in the income statement. If, however, the Company does not intend to sell the security and determines that it is not more likely than not that it will be required to do so, a decline in its fair value that is considered in the judgment of management to be other than temporary is separated into the amount representing credit loss and the amount related to other factors. Amounts representing credit losses are reported as realized investment losses in the income statement and amounts related to other factors are included as a component of accumulated other comprehensive income or loss, net of the related income tax benefit and the related adjustment to cost of business acquired. Declines in the fair value of all other investments below the Company’s amortized cost that are considered in the judgment of management to be other than temporary are reported as realized investment losses in the income statement.

In the case of structured securities such as RMBS, commercial mortgage-backed securities and collateralized debt obligations as to which a decline in fair value is judged to be other than temporary, the amount of the credit loss arising from the impairment of the security is determined by discounting such security’s expected cash flows at its effective interest rate, taking into account the security’s purchase price. The key inputs relating to such expected cash flows consist of the future scheduled payments on the underlying loans and the estimated frequency and severity of future defaults on these loans. For those securities as to which the Company recognized credit losses in 20112012 as a result of determinations that such securities were other than temporarily impaired, representative default frequency estimates ranged from 2.2%2.6% to 5.3%4.5% and representative default severity estimates ranged from 45.8%43.3% to 62.6%60.1%.

In the case of corporate securities as to which a decline in fair value is determined to be other than temporary, the key input utilized to establish the amount of credit loss arising from the impairment of the security is the market price for such security. For each such security, the Company obtains such market price from a single independent nationally recognized pricing

-13-


DELPHI FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Note B – Investments – (Continued)

service. The Company has not in any instance adjusted the market price so obtained; however, management reviews these prices for reasonableness, taking into account both security-specific factors and its knowledge and understanding of the pricing methodologies used by the service. The credit loss for such security is determined to be equal to the excess of the Company’s amortized cost over such market price, as measured at the time of the impairment; as such, the entirety of the depreciation in market value is deemed to be reflective of credit loss.

During the first ninethree months of 2011,2012, the Company recognized $17.7$4.4 million of after-tax other than temporary impairment losses, of which $15.4$4.2 million was recognized as after-tax realized investment losses in the income statement related to credit losses and $2.3$0.2 million was recognized, net of the related income tax benefit, as a component of accumulated other comprehensive income on the balance sheet related to noncredit losses. Impairment losses were offset by $11.6 million of after-tax other realized investment gains, resulting in a net of $3.8 million after-tax realized investment losses being recognized during the period.

-14-


DELPHI FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Note B – Investments – (Continued)

The following table provides a reconciliation of the beginning and ending balances of other than temporary impairments on fixed maturity securities held by the Company for which a portion of the other than temporary impairment was recognized in accumulated other comprehensive income or loss:loss (dollars in thousands):

 

   Three Months Ended
September 30,
  Nine Months Ended
September 30,
 
   2011  2010  2011  2010 
   (dollars in thousands) 

Balance at the beginning of the period

  $75,594   $83,156   $79,602   $89,658  

Increases attributable to credit losses on securities for which an other than temporary impairment was not previously recognized

   1,822    1,995    3,567    12,359  

Increases attributable to credit losses on securities for which an other than temporary impairment was previously recognized

   5,236    3,548    16,886    16,759  

Reductions due to sales, maturities, pay downs or prepayments of securities for which an other than temporary impairment was previously recognized

   (5,475  (7,997  (22,878  (38,074
  

 

 

  

 

 

  

 

 

  

 

 

 

Balance at the end of the period

  $77,177   $80,702   $77,177   $80,702  
  

 

 

  

 

 

  

 

 

  

 

 

 

   Three Months Ended 
   March 31 
   2012  2011 

Balance at the beginning of the period

  $76,623   $79,602  

Increases attributable to credit losses on securities for which an other than temporary impairment was not previously recognized

   484    732  

Increases attributable to credit losses on securities for which an other than temporary impairment was previously recognized

   4,066    7,666  

Reductions due to sales, maturities, pay downs or prepayments of securities for which an other than temporary impairment was previously recognized

   (5,398  (7,826
  

 

 

  

 

 

 

Balance at the end of the period

  $75,775   $80,174  
  

 

 

  

 

 

 

The gross unrealized losses at September 30, 2011March 31, 2012 are attributable to 840604 fixed maturity security positions, with the largest unrealized loss associated with any one security equal to $7.4$4.1 million. At September 30, 2011March 31, 2012, approximately 27.8%29.0% of these aggregate gross unrealized losses were attributable to fixed maturity security positions as to which the unrealized loss represented 10%10.0% or less of the amortized cost for such security. Unrealized losses attributable to fixed maturity securities having investment grade ratings by a nationally recognized statistical rating organization comprised 44.7%35.0% of the aggregate gross unrealized losses at September 30, 2011,March 31, 2012, with the remainder of such losses being attributable to non-investment grade fixed maturity securities.

At September 30, 2011,March 31, 2012, the Company held approximately $861.8$883.2 million of insured municipal fixed maturity securities, which represented approximately 12%11.2% of the Company’s total invested assets. TheseBased upon the highest of the ratings assigned to the respective securities by nationally recognized statistical rating organizations, these securities had a weighted average credit rating of “A” by nationally recognized statistical rating organizations at September 30, 2011. For the portion of these securities having ratings by nationally recognized statistical rating organizations without giving effect to the credit enhancementMarch 31, 2012. Credit enhancements provided by the insurance which totaled $807.7 million at September 30, 2011,did not impact the weighted average credit rating at such date by such organizations was “AA”.organizations. Insurers of significant portions of the municipal fixed maturity securities held by the Company at September 30, 2011March 31, 2012 included Assured Guaranty ($304.8 million), National Public Finance Guarantee Corp. ($285.1 million), Assured Guaranty ($282.6298.6 million), Ambac Financial Group, Inc. ($156.7153.4 million), Texas Permanent School Fund ($52.4 million), Financial Guaranty Insurance Company ($28.953.8 million) and Radian ($25.925.0 million). At September 30, 2011,March 31, 2012, the Company did not have significant holdings of credit enhanced asset-backed or mortgage-backed securities, nor did it have any significant direct investments in the guarantors of the municipal fixed maturity securities held by the Company.

-14-


DELPHI FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Note C – Fair Value Measurements

The Company measures its assets and liabilities recorded at fair value in the consolidated balance sheet based on the framework set forth in the GAAP fair value accounting guidance. This framework establishes a fair value hierarchy of three levels based upon the transparency and availability of information used in measuring the fair value of assets or liabilities as of the measurement date. The levels are categorized as follows:

Level 1 - Valuation is based upon quoted prices for identical assets or liabilities in active markets. Level 1 fair value is not subject to valuation adjustments or block discounts.

-15-


DELPHI FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Note C – Fair Value Measurements – (Continued)

Level 2 - Valuation is based upon quoted prices for similar assets or liabilities in active markets or quoted prices for identical or similar instruments in markets that are not active. In addition, a company may use various valuation techniques or pricing models that use observable inputs to measure fair value.

Level 3 - Valuation is generated from techniques in which one or more of the significant inputs for valuing such assets or liabilities are not observable. These inputs may reflect the Company’s best estimates of the various assumptions that market participants would use in valuing the financial assets and financial liabilities.

For these purposes, the Company determines the existence of an active market for an asset or liability based on its judgment as to whether transactions for the asset or liability occur in such market with sufficient frequency and volume to provide reliable pricing information. If the Company concludes that there has been a significant decrease in the volume and level of activity for an investment in relation to normal market activity for such investment, adjustments to transactions and quoted prices are made to estimate fair value.

The inputs used in the valuation techniques employed by the Company are provided by nationally recognized pricing services, external investment managers and internal resources. To assess these inputs, the Company’s review process includes, but is not limited to, quantitative analysis including benchmarking, initial and ongoing evaluations of methodologies used by external parties to calculate fair value, and ongoing evaluations of fair value estimates based on the Company’s knowledge and monitoring of market conditions.

The Company, from time-to-time, surveys its external pricing service providers to better understand the process performed in determining fair value. The Company administers meetings with these external parties, speaking directly with the individuals who are involved in the valuation process. Certain pricing service providers also have policies in place, along with committees, that evaluate the reasonability of its valuations given the information available. The Company requests to understand these policies and the involvement of the committees to determine the process in arriving at fair value.

The assumptions underlying the valuations from external service providers, including unobservable inputs, is generally not readily available as this information is often deemed proprietary. Accordingly, the Company is unable to obtain comprehensive results of these assumptions and methodologies.

The Company’s investments in fixed maturity securities available for sale, equity securities available for sale, trading account securities, assets held in the separate account and its liabilities for securities sold, not yet purchased are carried at fair value. The methodologies and valuation techniques used by the Company to value its assets and liabilities measured at fair value are described below.

Instruments included in fixed maturity securities available for sale include mortgage-backed and corporate securities, U.S. Treasury and other U.S. government guaranteed securities, securities issued by U.S. government-sponsored enterprises, securities issued by foreign governments and obligations of U.S. states, municipalities and political subdivisions. The market liquidity of each security is taken into consideration in the valuation technique used to value such security. For securities where market transactions involving identical or comparable assets generate sufficient relevant information, the Company employs a market approach to valuation. If sufficient information is not generated from market transactions involving identical or comparable assets, the Company uses an income approach to valuation. If sufficient information is not generated from market transactions involving identical or comparable assets, the Company uses an income approach to valuation. The majority of the instruments included in fixed maturity securities available for sale are valued utilizing observable inputs; accordingly, they are categorized in either Level l or Level 2 of the fair value hierarchy described above. However, in instances where significant inputs utilized are unobservable, the securities are categorized in Level 3 of the fair value hierarchy.

The inputs used in the valuation techniques employed by the Company are provided by nationally recognized pricing services, external investment managers and internal resources. To assess these inputs, the Company’s review process includes, but is not limited to, quantitative analysis including benchmarking, initial and ongoing evaluations of methodologies used by external parties to calculate fair value, and ongoing evaluations of fair value estimates based on the Company’s knowledge and monitoring of market conditions.

-15-


DELPHI FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Note C – Fair Value Measurements – (Continued)

The Company uses various valuation techniques and pricing models to measure the fair value of its investments in residential mortgage-backed securities and commercial mortgage-backed securities, including option-adjusted spread models, volatility-driven multi-dimensional single cash flow stream models and matrix correlation to comparable securities. Residential mortgage-backed securities include U.S. agency securities and collateralized mortgage obligations. Inputs utilized in connection with the valuation techniques relating to this class of securities include monthly payment and performance information with respect to the underlying loans, including prepayments, default severity, delinquencies, market indices and the amounts of the tranches in the particular structure which are senior or subordinate, as applicable, to the tranche represented by the Company’s investment. A portion of the Company’s investments in mortgage-backed securities are valued using observable inputs and therefore categorized in Level 2 of the fair value hierarchy. The remaining mortgage-backed securities are valued using non-binding broker quotes. These methodologies rely on unobservable inputs and thus these securities are categorized in Level 3 of the fair value hierarchy.

Corporate securities primarily include fixed rate corporate bonds, floating and variable rate notes and securities acquired through private placements. Inputs utilized in connection with the Company’s valuation techniques relating to this class of securities include recently executed transactions, market price quotations, benchmark yields, issuer spreads and, in the case of private placement corporate securities, cash flow models. These cash flow models utilize yield curves, issuer-provided information and material events as key inputs. Corporate securities are categorized in Level 2 of the fair value hierarchy, other than securities acquired through private placements, which are categorized in Level 3 of the fair value hierarchy.

-16-


DELPHI FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Note C – Fair Value Measurements – (Continued)

Collateralized debt obligations consist of collateralized loan obligations. The Company’s valuation techniques relating to this class of securities utilize non-binding broker quotes as the key input. As this input is generally unobservable, collateralized debt obligations are categorized in Level 3 of the fair value hierarchy.

Foreign government securities consist of bonds that are issued by a foreign government. Inputs utilized in connection with the Company's valuation techniques relating to this class of securities include recently executed transactions, interest rate yield curves, maturity dates, foreign currency exchange rates, and market price quotations relating to similar instruments. These inputs are generally observable and accordingly, these securities are generally categorized in Level 2 of the fair value hierarchy.

U.S. Treasury and other U.S. government guaranteed securities include U.S. Treasury bonds and notes, Treasury Inflation Protected Securities (“TIPS”) and other U.S. government guaranteed securities. The fair values of the U.S. Treasury securities and TIPS are based on quoted prices in active markets and are generally categorized in Level 1 of the fair value hierarchy.

Inputs utilized in connection with the Company’s valuation techniques relating to its investments in other U.S. government guaranteed securities, as well as its investments in U.S. government-sponsored enterprise securities, which consist of medium term notes issued by these enterprises, include recently executed transactions, interest rate yield curves, maturity dates, market price quotations and credit spreads relating to similar instruments. These inputs are generally observable and accordingly, these securities are generally categorized in Level 2 of the fair value hierarchy.

Obligations of U.S. states, municipalities and political subdivisions primarily include bonds or notes issued by U.S municipalities. Inputs utilized in connection with the Company’s valuation techniques relating to this class of securities include recently executed transactions and other market data, spreads, benchmark curves including treasury and other benchmarks, trustee reports, material event notices, new issue data, and issuer financial statements. These inputs are generally observable and these securities are generally categorized in Level 2 of the fair value hierarchy.

Other investments held at fair value primarily consist of equity securities available for sale and trading account securities. These investmentssecurities are primarily valued at quoted active market prices and are therefore categorized in Level 1 of the fair value hierarchy. For private equity investments, since quoted market prices are not available, the transaction price is used as the best estimate of fair value at inception. When evidence is believed to support a change to the carrying value from the transaction price, adjustments are made to reflect expected exit values. Ongoing reviews by Company management are based on assessments of each underlying investment and the inputs utilized in these reviews include, among other things, the evaluation of financing and sale transactions with third parties, expected cash flows, material events and market-based information. These investments are included in Level 3 of the fair value hierarchy.

Assets held in the separate account represent funds invested in a separately administered variable life insurance product for which the policyholder, rather than the Company, bears the investment risk. These assets are invested in interests in a limited

-16-


DELPHI FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Note C – Fair Value Measurements – (Continued)

liability company that invests in funds which trade in various financial instruments. This limited liability company, all of whose interests are owned by the Company’s separate account, utilizes the financial statements furnished by the funds to determine the values of its investments in such funds and the carrying value of each such investment, which is based on its proportionate interest in the relevant fund as of the balance sheet date. As such, these funds’ financial statements constitute the key input in the Company’s valuation of its investment in this limited liability company. The Company concluded that the value calculated using the equity method of accounting on its investment in this limited liability company was reflective of the fair market value of such investments.investment. The investment portfolios of the funds in which the fund investments are maintained vary from fund to fund, but are generally comprised of liquid, publicly traded securities that have readily determinable market values and which are carried at fair value on the financial statements of such funds, substantially all of which are audited annually. The amount that an investor is entitled to receive upon the redemption of its investment from the applicable fund is determined by reference to such security values. These investments are included in Level 3 of the fair value hierarchy.

Other liabilities measured at fair value consist of securities sold, not yet purchased. These securities are valued using the quoted active market prices of the securities sold and are categorized in Level 1 of the fair value hierarchy.

Assets and liabilities measured at fair value in the consolidated balance sheet on a recurring basis are summarized below:

   March 31, 2012 
   Total   Level 1   Level 2   Level 3 
   (dollars in thousands) 

Assets:

        

Fixed maturity securities, available for sale:

        

Agency residential mortgage-backed securities

  $574,825    $—      $557,509    $17,316  

Non-agency residential mortgage-backed securities

   992,170     —       968,336     23,834  

Commercial mortgage-backed securities

   198,197     —       190,849     7,348  

Corporate securities

   1,825,194     —       1,646,088     179,106  

Collateralized debt obligations

   283,071     —       126     282,945  

Foreign government securities

   146,024     —       144,813     1,211  

U.S. Treasury and other U.S. Government guaranteed securities

   124,458     93,222     18,624     12,612  

U.S. Government-sponsored enterprise securities

   37,946     —       37,946     —    

Obligations of U.S. states, municipalities and political subdivisions

   2,645,284     —       2,637,957     7,327  

Other investments

   542,143     517,072     10,193     14,878  

Assets held in separate account

   124,068     —       —       124,068  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $7,493,380    $610,294    $6,212,441    $670,645  
  

 

 

   

 

 

   

 

 

   

 

 

 

Liabilities:

        

Other liabilities

  $84,933    $84,933    $—      $—    
  

 

 

   

 

 

   

 

 

   

 

 

 

 

-17-


DELPHI FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

 

Note C – Fair Value Measurements – (Continued)

 

Assets and liabilities measured at fair value in the consolidated balance sheet on a recurring basis are summarized below:

  September 30, 2011   December 31, 2011 
  Total   Level 1   Level 2   Level 3   Total   Level 1   Level 2   Level 3 
  (dollars in thousands)   (dollars in thousands) 

Assets:

                

Fixed maturity securities, available for sale:

                

Agency residential mortgage-backed securities

  $695,487    $—      $687,077    $8,410    $668,584    $—      $660,632    $7,952  

Non-agency residential mortgage-backed securities

   836,537     —       801,100     35,437     820,637     —       796,243     24,394  

Commercial mortgage-backed securities

   68,479     —       67,620     859     96,683     —       95,981     702  

Corporate securities

   1,902,959     —       1,770,038     132,921     1,707,497     —       1,539,274     168,223  

Collateralized debt obligations

   217,500     —       —       217,500     258,071     —       157     257,914  

Foreign government securities

   257,281     —       256,015     1,266  

U.S. Treasury and other U.S. Government guaranteed securities

   102,812     67,945     27,086     7,781     103,837     69,867     26,330     7,640  

U.S. Government-sponsored enterprise securities

   50,693     —       47,567     3,126     42,379     —       40,531     1,848  

Obligations of U.S. states, municipalities and political subdivisions

   2,499,332     —       2,498,034     1,298     2,534,668     —       2,527,370     7,298  

Other investments

   316,125     310,236     —       5,889     359,624     353,729     —       5,895  

Assets held in separate account

   115,043     —       —       115,043     117,365     —       —       117,365  
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 

Total

  $6,804,967    $378,181    $5,898,522    $528,264    $6,966,626    $423,596    $5,942,533    $600,497  
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 

Liabilities:

                

Other liabilities

  $83,993    $83,993    $—      $—      $85,123    $85,123    $—      $—    
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 

The following table provides reconciliations for Level 3 assets measured at fair value on a recurring basis. Transfers into and out of Level 3 are recognized as of the end of the quarter in which they occur.

 

   Three Months Ended September 30, 2011 
   Balance at
Beginning
of Quarter
   Total Gains
(Losses)
Included in
Earnings
  Total Gains
(Losses)
Included in
Other Com-
prehensive
Income
  Purchases   Issuances   Settlements  Transfers
Into
Level 3
   Transfers
Out of
Level 3
  Balance
End of the
Period
 
   (dollars in thousands) 

Agency residential mortgage-backed securities

  $9,578    $(18 $121   $—      $—      $(1,271 $—      $—     $8,410  

Non-agency residential mortgage-backed securities

   34,344     182    (349  13,548     —       (1,043  —       (11,245  35,437  

Commercial mortgage-backed securities

   1,405     (12  (3  —       —       (531  —       —      859  

Corporate securities

   114,984     1,071    (1,822  31,600     —       (6,935  1,041     (7,018  132,921  

Collateralized debt obligations

   219,458     1,421    (21,669  20,658     —       (3,030  662     —      217,500  

U.S. Treasury and other U.S. Government guaranteed securities

   7,847     (3  25    —       —       (88  —       —      7,781  

U.S. Government-sponsored enterprise securities

   4,036     5    121    —       —       (1,040  4     —      3,126  

Obligations of U.S. states, municipalities and political subdivisions

   2,911     17    238    —       —       (1  —       (1,867  1,298  

Other investments

   5,895     60    (6  —       —       (60  —       —      5,889  

Assets held in separate account (1)

   126,213     (10,534  —      6,904     —       (7,540  —       —      115,043  
  

 

 

   

 

 

  

 

 

  

 

 

   

 

 

   

 

 

  

 

 

   

 

 

  

 

 

 

Total

  $526,671    $(7,811 $(23,344 $72,710    $—      $(21,539 $1,707    $(20,130 $528,264  
  

 

 

   

 

 

  

 

 

  

 

 

   

 

 

   

 

 

  

 

 

   

 

 

  

 

 

 

  Three Months Ended March 31, 2012 
  Balance at
Beginning
of Year
  Total Gains
(Losses)
Included in
Earnings
  Total Gains
(Losses)
Included in
Other

Comprehensive
Income(2)
  Purchases  Issuances  Settlements  Transfers
Into
Level 3 (3)
  Transfers
Out of
Level 3 (4)
  Balance
End of the
Period
 
  (dollars in thousands) 

Agency residential mortgage-backed securities

 $7,952   $(18 $(27 $10,366   $—     $(957 $—     $—     $17,316  

Non-agency residential mortgage-backed securities

  24,394    74    381    —      —      (1,015  —      —      23,834  

Commercial mortgage-backed securities

  702    22    555    6,222    —      (153  —      —      7,348  

Corporate securities

  168,223    184    3,435    22,911    —      (8,185  411    (7,873  179,106  

Collateralized debt obligations

  257,914    (2,001  20,229    17,610    —      (10,807  —      —      282,945  

Foreign government securities

  1,266    19    —      1,171    —      (1,245  —      —      1,211  

U.S. Treasury and other U.S. Government guaranteed securities

  7,640    (3  77    254    —      (99  4,743    —      12,612  

U.S. Government-sponsored enterprise securities

  1,848    10    (8  —      —      (1,850  —      —      —    

Obligations of U.S. states, municipalities and political subdivisions

  7,298    5    24    —      —      —      —      —      7,327  

Other investments

  5,895    159    2    9,561    —      (739  —      —      14,878  

Assets held in separate account(1)

  117,365    7,299    —      15,891    —      (16,487  —      —      124,068  
 

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Total

 $600,497   $5,750   $24,668   $83,986   $—     $(41,537 $5,154   $(7,873 $670,645  
 

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

 

(1)Because the positive or negative investment performance of these assets accrues to policyholders, who bear the investment risk of these assets, net investment income and capital gains and losses arising from these assets and are not included in the Company’s consolidated investment earnings. In addition, purchases and settlements relating to the separate account are not included in the Company’s consolidated statements of cash flows.
(2)Other comprehensive income includes $14.8 million, net of an income tax expense of $8.1 million, in increases to net unrealized appreciation on investments and $1.2 million, net of an income tax expense of $0.6 million, in decreases in other than temporary impairments.
(3)

In the case of each transfer into Level 3 for the period, an independent service dropped coverage of pricing the security and such pricing was replaced with broker quotes.

 

-18-


DELPHI FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

 

Note C – Fair Value Measurements – (Continued)

 

   Nine Months Ended September 30, 2011 
   Balance at
Beginning
of Year
   Total Gains
(Losses)
Included in
Earnings
  Total Gains
(Losses)
Included in
Other Com-
prehensive
Income
  Purchases   Issuances   Settlements  Transfers
Into
Level 3
   Transfers
Out of
Level 3
  Balance
End of the
Period
 
   (dollars in thousands) 

Agency residential mortgage-backed securities

  $11,266    $(56 $138   $365    $—      $(3,303 $—      $—     $8,410  

Non-agency residential mortgage-backed securities

   37,520     453    (1,521  17,421     —       (3,316  —       (15,120  35,437  

Commercial mortgage-backed securities

   1,327     (13  (37  396     —       (814  —       —      859  

Corporate securities

   60,968     2,274    (2,474  107,637     —       (15,845  2,686     (22,325  132,921  

Collateralized debt obligations

   175,184     5,204    (9,873  64,913     —       (18,590  662     —      217,500  

U.S. Treasury and other U.S. Government guaranteed securities

   9,015     (27  (845  —       —       (362  —       —      7,781  

U.S. Government-sponsored enterprise securities

   4,020     140    131    23,272     —       (26,104  2,037     (370  3,126  

Obligations of U.S. states, municipalities and political subdivisions

   2,855     17    178    1,606     —       (1  1,302     (4,659  1,298  

Other investments

   6,449     60    59    334     —       (60  —       (953  5,889  

Assets held in separate account(1)

   123,674     (6,695  —      30,107     —       (32,043  —       —      115,043  
  

 

 

   

 

 

  

 

 

  

 

 

   

 

 

   

 

 

  

 

 

   

 

 

  

 

 

 

Total

  $432,278    $1,357   $(14,244 $246,051    $—      $(100,438 $6,687    $(43,427 $528,264  
  

 

 

   

 

 

  

 

 

  

 

 

   

 

 

   

 

 

  

 

 

   

 

 

  

 

 

 

(1)(4)BecauseIn the positive or negative investment performancecase of these assets accrues to policyholders, who beareach transfer out of Level 3 for the investment risk of these assets, net investment incomeperiod, an independent pricing service initiated coverage in pricing the security and capital gains and losses arising from these assets and are not included in the Company’s consolidated investment earnings. In addition, purchases and settlements relating to the separate account are not included in the Company’s consolidated statements of cash flows.such pricing replaced broker quotes.

The carrying values and estimated fair values of certain of the Company’s financial instruments not recorded at fair value in the consolidated balance sheets are shown below. Because fair values for all balance sheet items are not required to be disclosed, the aggregate fair value amounts presented below are not reflective of the underlying value of the Company.

 

   September 30, 2011   December 31, 2010 
   Carrying
Value
   Fair
Value
   Carrying
Value
   Fair
Value
 
   (dollars in thousands) 

Assets:

        

Short-term investments

  $201,529    $201,529    $334,215    $334,215  

Investment accounts receivable

   87,159     87,159     45,645     45,645 ��

Other investments

   357,590     357,590     306,033     306,033  

Liabilities:

        

Policyholder account balances

  $1,936,520    $2,004,997    $1,662,932    $1,761,795  

Corporate debt

   375,000     424,575     375,000     402,618  

Junior subordinated debentures

   175,000     166,339     175,000     161,541  

Advances from Federal Home Loan Bank

   55,342     76,982     55,342     70,046  

Investment accounts payable

   138,232     138,232     27,667     27,667  

Liabilities related to separate account

   115,043     115,043     123,674     123,674  

   March 31, 2012 
   Carrying
Value
   Fair
Value
Total
   Fair
Value
Level 2
   Fair
Value
Level 3
 
   (dollars in thousands) 

Assets:

        

Short-term investments

  $141,521    $141,521    $141,521    $—    

Investment accounts receivable

   77,189     77,189     —       77,189  

Other investments

   331,650     331,650     —       331,650  

Liabilities:

        

Policyholder account balances

  $2,092,555    $2,170,052    $—      $2,170,052  

Corporate debt

   375,000     418,808     418,808     —    

Junior subordinated debentures

   175,000     173,390     173,390     —    

Advances from Federal Home Loan Bank

   55,342     74,365     74,365     —    

Investment accounts payable

   85,627     85,627     —       85,627  

Liabilities related to separate account

   124,068     124,068     —       124,068  

    December 31, 2011 
    Carrying
Value
   Fair
Value
 
   

(dollars in thousands)

 

Assets:

    

Short-term investments

  $277,552    $277,552  

Investment accounts receivable

   24,406     24,406  

Other investments

   318,509     318,509  

Liabilities:

    

Policyholder account balances

  $2,008,285    $2,066,609  

Corporate debt

   375,000     415,310  

Junior subordinated debentures

   175,000     166,617  

Advances from Federal Home Loan Bank

   55,342     75,352  

Investment accounts payable

   41,719     41,719  

Liabilities related to separate account

   117,365     117,365  

The carrying values for short-term investments approximate fair values based on the nature of the investments. The carrying values of investment accounts receivable and investment accounts payable approximate fair values based on the short-term nature of the expected cash receipt. Other investments primarily include investment funds organized as limited partnerships and limited liability companies and real estate investmentsinvestment held by limited liability companies, which are reflected in the Company’s financial statements under the equity method of accounting. In determining the fair valuesvalue of such investments for purposes of this footnote disclosure, the

-19-


DELPHI FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Note C – Fair Value Measurements – (Continued)

Company concluded that the valuesvalue calculated using the equity method of accounting werewas reflective of the fair market valuesvalue of such investments. The investment portfolios of the funds in which the fund investments are maintained vary from fund to fund, but are generally comprised of liquid, publicly traded securities that have readily determinable market values and are carried at fair value on the financial statements of such funds, substantially all of which are audited annually. The amount that an investor is entitled to receive upon the redemption of its investment from the applicable fund is determined by reference to such security values. The Company utilizes the financial statements furnished by the funds to determine the values of its investments in such funds and the carrying value of each such investment, which is based on its

-19-


DELPHI FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Note C – Fair Value Measurements – (Continued)

proportionate interest in the relevant fund as of the balance sheet date. The carrying values of all other invested assets and separate account liabilities approximate their fair values.value.

The fair values of policyholder account balances are net of reinsurance receivables and the carrying values have been decreased for related acquisition costs of $87.2$73.1 million and $82.1$87.1 million at September 30, 2011March 31, 2012 and December 31, 2010,2011, respectively. Fair values for policyholder account balances were determined by estimating future cash flows discounted at a current market rate.

The Company believes that the fair value of its variable rate long-term debt is equal to its carrying value, since the variable rates of interest on this debt are reflective of market conditions in effect from time to time. The fair values of the 7.875% Senior Notes due 2020 (“2020 Senior Notes”), the outstanding borrowings under the Company’s Credit Agreement with Bank of America, N.A., as administrative agent, and a group of lenders and the 7.376% fixed-to-floating rate junior subordinated debentures due 2067 (“2007 Junior Debentures”) are based on the expected cash flows discounted to net present value. The fair values for fixed rate advances from the FHLB were calculated using discounted cash flow analyses based on the interest rates for the advances at the balance sheet date.

Note D – Segment Information

 

   Three Months Ended
September 30,
  Nine Months Ended
September 30,
 
   2011  2010  2011  2010 
   (dollars in thousands) 

Revenues:

     

Group employee benefit products

  $432,970   $399,976   $1,275,550   $1,173,139  

Asset accumulation products

   32,017    32,020    99,291    94,107  

Other(1)

   13,734    11,909    40,776    39,272  
  

 

 

  

 

 

  

 

 

  

 

 

 
   478,721    443,905    1,415,617    1,306,518  

Net realized investment (losses) gains

   (5,002  1,192    (5,851  (27,788

Loss on early retirement of senior notes

   —      (3,760  —      (3,972
  

 

 

  

 

 

  

 

 

  

 

 

 
  $473,719   $441,337   $1,409,766   $1,274,758  
  

 

 

  

 

 

  

 

 

  

 

 

 

Operating income:

     

Group employee benefit products

  $64,199   $71,026   $213,359   $205,414  

Asset accumulation products

   9,207    10,596    28,538    32,324  

Other(1)

   (9,876  (7,914  (26,474  (22,214
  

 

 

  

 

 

  

 

 

  

 

 

 
   63,530    73,708    215,423    215,524  

Net realized investment (losses) gains

   (5,002  1,192    (5,851  (27,788

Loss on early retirement of senior notes

   —      (3,760  —      (3,972
  

 

 

  

 

 

  

 

 

  

 

 

 
  $58,528   $71,140   $209,572   $183,764  
  

 

 

  

 

 

  

 

 

  

 

 

 

   Three Months Ended
March 31,
 
   2012  2011 
   (dollars in thousands) 

Revenues:

   

Group employee benefit products

  $470,013   $421,293  

Asset accumulation products

   42,360    34,112  

Other(1)

   11,792    13,288  
  

 

 

  

 

 

 
   524,165    468,693  

Net realized investment gains (losses)

   1,031    (1,972
  

 

 

  

 

 

 
  $525,196   $466,721  
  

 

 

  

 

 

 

Operating income (loss):

   

Group employee benefit products

  $79,127   $76,078  

Asset accumulation products

   15,300    9,703  

Other(1)

   (42,065  (7,791
  

 

 

  

 

 

 
   52,362    77,990  

Net realized investment gains (losses)

   1,031    (1,972
  

 

 

  

 

 

 
  $53,393   $76,018  
  

 

 

  

 

 

 

 

(1)Primarily consists of operations from integrated disability and absence management services and certain corporate activities. Operating income results for the three months ended March 31, 2012 includes $30.7 million of merger-related corporate expenses.

Note E – Comprehensive Income

Total comprehensive income attributable to common shareholders is comprised of net income attributable to shareholders and other comprehensive income, which includes the change in unrealized gains and losses on securities available for sale, the change in other than temporary impairments recognized in other comprehensive income and the change in net periodic pension cost. Total comprehensive income attributable to common shareholders was $204.7 million and $288.1 million for the first nine months of 2011 and 2010, respectively, and $57.7 million and $149.7 million for the third quarters of 2011 and 2010,

 

-20-


DELPHI FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

 

Note E – Comprehensive Income – (Continued)

respectively. Net unrealized gains on securities available for sale increased $62.0 million and $165.9 million in the first nine months of 2011 and 2010, respectively.

Note F – Stock-Based Compensation

The Company recognized stock-based compensation expenses of $6.2$4.1 million and $6.5$2.2 million in the first nine monthsquarters of 2012 and 2011, and 2010, respectively, of which $2.2 million and $2.1 million was recognized inrespectively.

The Company did not grant any options during the thirdfirst quarter of 2011 and 2010, respectively. The remaining unrecognized compensation expense related to unvested awards at September 30, 2011 was $15.7 million and the weighted average period of time over which this expense will be recognized is 3.0 years.

2012. The fair values of options granted during the first quarter of 2011 were estimatedcalculated at the grant date using the Black-Scholes option pricing model with the following weighted average assumptions:

 

   Nine Months Ended
September 30,
 
   2011  2010 

Expected volatility

   44.7  43.0

Expected dividends

   1.5  1.8

Expected lives of options (in years)

   5.8    6.1  

Risk-free rate

   2.4  2.7

Expected volatility

43.9

Expected dividends

1.4

Expected lives of options (in years)

6.0

Risk-free rate

2.6

The expected volatility reflects the Company’s past monthly stock price volatility. The dividend yield is based on the Company’s historical dividend payments. The Company used the historical average period from the Company’s issuance of an option to its exercise or cancellation and the average remaining years until expiration for the Company’s outstanding options to estimate the expected life of options granted in 2011 and 2010 for which the Company had sufficient historical exercise data.

The Company used the “simplified method” to estimate the expected life of certain options granted in 2011 and 2010 for which sufficient historical data was not available. The risk-free rate is derived from public data sources at the time of each option grant. Compensation cost is recognized over the requisite service period of the option using the straight-line method.

Option activity with respect to the Company’s plans, excluding the performance-contingent incentive options referenced further below, was as follows:

 

Options

  Number
of
Options
  Weighted
Average
Exercise
Price
   Weighted
Average
Remaining
Contractual
Term
   Aggregate
Intrinsic
Value
($000)
 

Outstanding at January 1, 2011

   3,989,995   $29.10      

Granted

   592,389    30.58      

Exercised

   (184,841  23.66      

Forfeited

   (26,150  25.05      

Expired

   (16,877  35.09      
  

 

 

      

Outstanding at September 30, 2011

   4,354,516    29.53     6.4    $2,242  
  

 

 

      

Exercisable at September 30, 2011

   2,618,029   $30.78     5.3    $1,192  

Options

  Number of
Options
  Weighted
Average
Exercise
Price
   Weighted
Average
Remaining
Contractual
Term
   Aggregate
Intrinsic
Value
($000)
 

Outstanding at January 1, 2012

   4,256,785   $29.61      

Exercised

   (276,220  30.09      

Expired

   (2,225  35.16      
  

 

 

      

Outstanding at March 31, 2012

   3,978,340    29.57     6.0    $60,475  
  

 

 

      

Exercisable at March 31, 2012

   2,685,333   $30.60     5.2    $ 38,064  

The weighted average grant date fair value of options granted during the first nine months of 2011 and 2010 was $11.95 and $8.22, respectively. The Company did not grant any options during the third quarter of 2011 or 2010.was $12.19. The cash proceeds from stock options exercised were $4.9$42.2 million and $1.8$2.8 million in the first nine monthsquarters of 20112012 and 2010,2011, respectively. The total intrinsic value of options exercised during the first nine monthsquarters of 2012 and 2011 and 2010 was $1.3$27.1 million and $2.5$0.8 million, respectively. The Company’s actual benefits from the tax deductions realized in excess of recognized compensation cost were $0.8$5.7 million and $0.5$0.2 million in the first nine monthsquarters of 20112012 and 2010,2011, respectively, and are included as a component of additional paid in capital.

At March 31, 2012, 3,018,000 performance-contingent incentive options were outstanding with a weighted average exercise price of $25.12, a weighted average contractual term of 3.5 years and an intrinsic value of $59.3 million. 2,325,000 of such options with a weighted average exercise price of $24.68, a weighted average contractual term of 2.5 years and an intrinsic value of $46.7 million were exercisable at March 31, 2012. At March 31, 2012, a total of 251,035 performance-contingent restricted shares were outstanding.

 

-21-


DELPHI FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

 

Note F – Stock-Based Compensation – (Continued)

At September 30, 2011, 4,296,250 performance-contingent incentive options were outstanding with a weighted average exercise price of $25.49, a weighted average contractual term of 3.6 years and an intrinsic value of $3.0 million. 3,603,250 of such options with a weighted average exercise price of $25.32, a weighted average contractual term of 2.9 years and an intrinsic value of $3.0 million were exercisable at September 30, 2011. At September 30, 2011, a total of 251,029 performance-contingent restricted shares were outstanding.

Note G – Computation of Results per Share

The following table sets forth the calculation of basic and diluted results per share:share (amounts in thousands, except per share data):

 

   Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
   2011   2010   2011   2010 
   (amounts in thousands, except per share data) 

Numerator:

        

Net income attributable to shareholders

  $41,035    $44,808    $140,686    $115,986  
  

 

 

   

 

 

   

 

 

   

 

 

 

Denominator:

        

Weighted average common shares outstanding

   56,004     55,404     56,006     55,284  

Effect of dilutive securities

   401     396     663     390  
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average common shares outstanding, assuming dilution

   56,405     55,800     56,669     55,674  
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic results per share of common stock:

        

Net income attributable to shareholders

  $0.73    $0.81    $2.51    $2.10  
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted results per share of common stock:

        

Net income attributable to shareholders

  $0.73    $0.80    $2.48    $2.08  
  

 

 

   

 

 

   

 

 

   

 

 

 

   Three Months Ended
March 31,
 
   2012   2011 

Numerator:

    

Net income attributable to shareholders

  $34,940    $50,224  
  

 

 

   

 

 

 

Denominator:

    

Weighted average common shares outstanding

   56,543     55,921  

Effect of dilutive securities

   2,017     813  
  

 

 

   

 

 

 

Weighted average common shares outstanding, assuming dilution

   58,560     56,734  
  

 

 

   

 

 

 

Basic results per share of common stock:

    

Net income attributable to shareholders

  $0.62    $0.90  
  

 

 

   

 

 

 

Diluted results per share of common stock:

    

Net income attributable to shareholders

  $0.60    $0.89  
  

 

 

   

 

 

 

Note G – Merger Agreement

On December 21, 2011, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) among the Company, Tokio Marine Holdings, Inc., a Japanese corporation (“Tokio Marine”), and TM Investment (Delaware) Inc., a Delaware corporation and wholly owned subsidiary of Tokio Marine (“TM Sub”). The Merger Agreement provides that at the effective time of the merger, TM Sub will be merged with and into the Company, with the Company continuing as the surviving corporation and becoming an indirect wholly owned subsidiary of Tokio Marine. Pursuant to the Merger Agreement, at the effective time of the merger (1) each share of the Company’s Class A Common Stock (other than (a) shares of our Class A Common Stock owned by the Company, Tokio Marine or any of their respective wholly owned subsidiaries, in each case not held on behalf of third parties, and (b) shares in respect of which appraisal rights have been properly demanded and those demands not effectively withdrawn) will be converted into the right to receive $43.875 in cash, without interest and less any applicable withholding taxes, and (2) each share of the Company’s Class B Common Stock (other than (a) shares of the Company’s Class B Common Stock owned by the Company, Tokio Marine or any of their respective wholly owned subsidiaries, in each case not held on behalf of third parties, and (b) shares in respect of which appraisal rights have been properly demanded and those demands not effectively withdrawn) will be converted into the right to receive $52.875 in cash, without interest and less any applicable withholding taxes. In addition, the Merger Agreement provides that record holders of common stock immediately prior to the effective time of the merger will be entitled to receive a special dividend of $1.00 in cash per share that is contingent upon the completion of the merger and will be paid shortly after closing. The acquisition has been approved by the Company’s stockholders and by the relevant regulatory authorities in Japan and in the U.S. The closing of the merger, which remains subject to the satisfaction of other customary closing conditions, is expected to occur on or about May 15, 2012.

On February 21, 2012, the Company filed a definitive proxy statement with the Securities and Exchange Commission which contains detailed information about the merger and the board and special committee process conducted in connection with the merger.

 

-22-


DELPHI FINANCIAL GROUP, INC.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Introduction

The Company, through its subsidiaries, underwrites a diverse portfolio of group employee benefit products, primarily long-term and short-term disability, life, excess workers’ compensation insurance for self-insured employers, large casualty programs including large deductible workers’ compensation, workers’ compensation and casualty treaty reinsurance, travel accident, dental and limited benefit health insurance. Revenues from this group of products are primarily comprised of earned premiums and investment income. The profitability of group employee benefit products is affected by, among other things, differences between actual and projected claims experience, the retention of existing customers, product mix and the Company’s ability to attract new customers, change premium rates and contract terms for existing customers and control administrative expenses. The Company transfers its exposure to a portion of its group employee benefit risks through reinsurance ceded arrangements with other insurance and reinsurance companies. Accordingly, the profitability of the Company’s group employee benefit products is affected by the amount, cost and terms of reinsurance it obtains. The profitability of those group employee benefit products for which reserves are discounted, in particular, the Company’s disability and large deductible and excess workers’ compensation products, is also significantly affected by the difference between the yield achieved on invested assets and the discount rate used to calculate the related reserves.

In recent years, the Company has benefited from the stable market conditions prevailingwhich prevailed for its excess workers’ compensation products as to pricing and other contract terms.terms and has enhanced its leadership position in the market for these products. However, because pricing in the primary workers’ compensation market has been increasingly competitive, the demand for excess workers’ compensation products has not significantly increased. In addition, the downward pressure on employment and wage levels exerted by the recent recession and its aftereffects has negatively affected premium levels for insurance products which are based upon employers’ payrolls, such as the Company’s excess workers’ compensation products. This effect has been ameliorated by the Company’s emphasis on municipalities, hospitals and schools; sectors whose payroll levels generally have been less adversely affected by the recent recession. The Company has enhanced its focus on its sales and marketing function for these products. During the first ninethree months of 2011,2012, the Company achieved significantly improved levels of new business production, as well as improvements in pricing for these products.

For its other group employee benefit products, the Company is continuing to experience challenging market conditions from a competitive standpoint.standpoint, particularly as to pricing. These conditions, in addition to the continuing effects of the recent recession on employment and wage levels have, in recent years, adversely impacted the Company’s ability to achieve higher levels of new business production and growth in premiums for these products. For these products, the Company is continuing to enhance its focus on the small case niche (insured groups of 10 to 500 individuals), including employers which are first-time providers of these employee benefits, which the Company believes to offer opportunities for superior profitability. During the first nine months of 2011, the Company achieved significantly improved levels of new business production, as well as improvements in pricing, for these products. The Company is also emphasizing its suite of voluntary group insurance products, which includes, among others, its group limited benefit health insurance product. The Company is generally marketing this product with a fixed indemnity benefit structure that is exempt from certain of the requirements of the federal health care reform legislation; however, it is uncertain whether this product can be effectively marketed once the minimum medical coverage requirements of the legislation become effective in 2014, since this product’s coverage will not satisfy these requirements. The Company markets its other group employee benefit products on an unbundled basis and as part of an integrated employee benefit program that combines employee benefit insurance coverages and absence management services. This integrated employee benefit program, which the Company believes helps to differentiate itself from competitors by offering clients improved productivity from reduced employee absence, has enhanced the Company’s ability to market its other group employee benefit products to large employers.

The Company also operates an asset accumulation business that focuses primarily on offering fixed annuities to individuals. Beginning in the second half of 2010, the Company has experienced particularly advantageous conditions in the fixed annuity marketplace resulting from various competitors having terminated their marketing of comparable fixed annuity products and, in some cases, having experienced ratings downgrades. From time to time, the Company acquires blocks of existing SPDA and FPA policies from other insurers through indemnity assumed reinsurance transactions and issues funding agreements. The Company believes that annuity reinsurance arrangements and funding agreements enhance the Company’s asset accumulation business by providing alternative sources of funds for this business. The Company’s liabilities for its annuity reinsurance arrangements and funding agreements are recorded in policyholder account balances. Deposits from the Company’s asset accumulation business are recorded as liabilities rather than as premiums. Revenues from the Company’s asset accumulation business are primarily comprised of investment income earned on the funds under management. The profitability of asset accumulation products is primarily dependent on the spread achieved between the return on investments and the interest credited with respect to these products. The Company sets the crediting rates offered on its asset accumulation products in an effort to achieve its targeted

-23-


interest rate spreads on these products, and is willing to accept lower levels of sales on these products when market conditions make these targeted spreads more difficult to achieve.

-23-


The management of the Company’s investment portfolio is an important component of its profitability. In recent years, the Company has repositioned its investment portfolio to reducereducing its holdings of those investments whose changes in value, positive or negative, are included in the Company’s net investment income, such as investment funds organized as limited partnerships and limited liability companies and trading account securities and hybrid financial instruments; in particular, those investments whose performance had demonstrated the highest levels of variability.securities. As part of this effort, the Company has increased its investments in more traditional sectors of the fixed income market such as mortgage-backed securities and municipal bonds. In addition, while in light of the market conditions of recent years the Company has been maintaining a significant proportionportion of its portfolio in short-term investments, which totaled $201.5 million and $334.2$277.6 million at September 30, 2011 and December 31, 2010, respectively. The2011, the Company has made progress in its recent efforts to deploy a significant portion of these short-term investments into longer-term fixed maturity securities which offer more attractive yields. However, sinceAt March 31, 2012, the market environment continuesCompany’s short-term investments had decreased to be challenging from the standpoint of making new investments on attractive terms, no assurance can be given as to the timing of the completion of these efforts or their ultimate outcome or variability of its future net investment income.$141.5 million.

The Company has achievedcontinued to achieve improved levels of investment income in its repositioned investment portfolio in 2010 and induring the first nine monthsquarter of 2011.2012. However, in light of the continuing volatility in financial market conditions, significant fluctuations in the Company’s net investment income, and as a result, in its results of operations may occur. Accordingly, there can be no assurance as to the impact of the Company’s investment repositioning on the level or variability of its future net investment income. In addition, while the levels of the Company’s realized investment losses from declines in market value relative to the amortized cost of various securities that it determined to be other than temporary decreased significantly in the first nine monthsquarter of 20112012 as compared to 2010 and 2009,the same period of 2011, investment losses may recur in the future and it is not possible to predict the timing or magnitude of such losses.

The following discussion and analysis of the results of operations and financial condition of the Company should be read in conjunction with the Consolidated Financial Statements and related notes included in this document, as well as the Company’s annual report on Form 10-K for the year ended December 31, 20102011, as amended by Amendment No. 1 on Form 10-K/A (the “2010“2011 Form 10-K”). Capitalized terms used herein without definition have the meanings ascribed to them in the 20102011 Form 10-K. The preparation of financial statements in conformity with GAAP requires management, in some instances, to make judgments about the application of these principles. The amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period could differ materially from the amounts reported if different conditions existed or different judgments were utilized. A discussion of how management applies certain critical accounting policies and makes certain estimates is contained in the 20102011 Form 10-K in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Operations - Critical Accounting Policies and Estimates” and should be read in conjunction with the following discussion and analysis of results of operations and financial condition of the Company. In addition, a discussion of uncertainties and contingencies which can affect actual results and could cause future results to differ materially from those expressed in certain forward-looking statements contained in this Management’s Discussion and Analysis of Financial Condition and Results of Operations can be found below under the caption “Forward-Looking Statements And Cautionary Statements Regarding Certain Factors That May Affect Future Results,” in Part I, Item 1A of the 20102011 Form 10-K, “Risk Factors”.

Recent Developments

On December 21, 2011, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) among the Company, Tokio Marine Holdings, Inc., a Japanese corporation (“Tokio Marine”), and TM Investment (Delaware) Inc., a Delaware corporation and wholly owned subsidiary of Tokio Marine (“TM Sub”). The Merger Agreement provides that at the effective time of the merger, TM Sub will be merged with and into the Company, with the Company continuing as the surviving corporation and becoming an indirect wholly owned subsidiary of Tokio Marine. Pursuant to the Merger Agreement, at the effective time of the merger (1) each share of the Company’s Class A Common Stock (other than (a) shares of the Company’s Class A Common Stock owned by the Company, Tokio Marine or any of their respective wholly owned subsidiaries, in each case not held on behalf of third parties, and (b) shares in respect of which appraisal rights have been properly demanded and those demands not effectively withdrawn) will be converted into the right to receive $43.875 in cash, without interest and less any applicable withholding taxes, and (2) each share of the Company’s Class B Common Stock (other than (a) shares of the Company’s Class B Common Stock owned by the Company, Tokio Marine or any of their respective wholly owned subsidiaries, in each case not held on behalf of third parties, and (b) shares in respect of which appraisal rights have been properly demanded and those demands not effectively withdrawn) will be converted into the right to receive $52.875 in cash, without interest and less any applicable withholding taxes. In addition, the Merger Agreement provides that record holders of common stock immediately prior to the effective time of the merger will be entitled to receive a special dividend of $1.00 in cash per share that is contingent upon the completion of the merger and will be paid shortly after closing. The acquisition has been approved by the Company’s stockholders and by the relevant regulatory authorities in Japan and in the U.S. The closing of the merger, which remains subject to the satisfaction of other customary closing conditions, is expected to occur on or about May 15, 2012.

-24-


On February 21, 2012, the Company filed a definitive proxy statement with the Securities and Exchange Commission which contains detailed information about the merger and the board and special committee process conducted in connection with the merger.

Results of Operations

NineThree Months Ended September 30, 2011March 31, 2012 Compared to Nine

Three Months Ended September 30, 2010March 31, 2011

Summary of Results.Net income attributable to shareholders was $140.7$34.9 million, or $2.48$0.60 per diluted share, for the first nine monthsquarter of 20112012 as compared to $116.0$50.2 million, or $2.08$0.89 per diluted share, for the first nine monthsquarter of 2010.2011. Net income in the first nine monthsquarter of 2012 compared to the first quarter of 2011 benefited from an increase in net investment income, a decreased level of realized investment losses and 2010growth in income from the Company’s core group employee benefit products. Net income in the first quarter of 2012 was adversely impacted by merger-related corporate expenses, net of related income tax, of $23.0 million or $0.39 per diluted share. Net income in the first quarter of 2012 and 2011 included net realized investment losses,gains (losses), net of the related income tax benefit,(expense) benefits, of $3.8$0.7 million, or $0.07$0.01 per diluted share, and $18.1$(1.3) million, or $0.32$(0.02) per diluted share, respectively. Net income in the first nine months of 2011 as compared to the prior period benefited from growth in income from the Company’s group employee benefit products, an increase in net investment income and decreases in the levels of realized investment losses and interest expense. Net realized investment losses in the first nine monthsquarter of 20112012 and 20102011 included losses, net of the related income tax benefit, of $15.4$4.2 million, or $0.27$0.07 per diluted share, and $32.6$5.9 million, or $0.59$0.10 per diluted share, respectively, due to credit loss-related impairments in the values of certain investments. The decrease in interest expense was primarily due to the early retirement of the 2033 Senior Notes during 2010.

The Company believes the non-GAAP financial measure of “operating earnings” is informative when analyzing the trends relating to the Company’s insurance operations. Operating earnings consist of net income attributable to shareholders excluding after-tax realized investment gains and losses, losses on early retirement of senior notes and junior subordinated deferrable interest debentures, merger-related corporate expenses and results from discontinued operations, as applicable. The Company believes that because these excluded items arise from events that are largely within management’s discretion and whose fluctuations can distort comparisons between periods, a measure excluding their impact is useful in

-24-


analyzing the Company’sCompany's operating trends. Investment gains or losses are realized based on management’s decision to dispose of an investment, and investment losses are realized based on management’s judgment that a decline in the fairmarket value of an investment is other than temporary. Early retirement of senior notes occurs based on management’s decision to redeem or repurchase these notes prior to maturity. Merger-related corporate expenses represent costs incurred during the first quarter of 2012 relating to the pending merger with Tokio Marine. Discontinued operations resultresults from management’s decision to exit or sell a particular business. Thus, these excluded items are not reflective of the Company’s ongoing earnings capacity, and trends in the earnings of the Company’s underlying insurance operations can be more clearly identified without the effects. For these reasons, management uses the measure of operating earnings to assess performance and make operating plans and decisions, and the Company believes that analysts and investors typically utilize measures of this type as one element of their evaluations of insurers’ financial performance. However, gains or losses from the excluded items, particularly as to investments, can occur frequently and should not be considered as nonrecurring items. Further, operating earnings should not be considered a substitute for net income attributable to shareholders, the most directly comparable GAAP measure, as an indication of the Company’s overall financial performance and may not be calculated in the same manner as similarly titled measures utilized by other companies.

Operating earnings were $144.5$57.2 million, or $2.55$0.98 per diluted share, forin the first nine monthsquarter of 20112012 compared to $136.6$51.5 million, or $2.45$0.91 per diluted share, forin the first nine monthsquarter of 2010. This increase is primarily due to growth in income from the Company’s core group employee benefit products, an increase in net investment income and a decrease in interest expense.2011.

The following table reconciles the amount of operating earnings to the corresponding amount of net income attributable to shareholders for the indicated periods:

 

  Nine Months Ended
September 30,
   Three Months Ended
March 31,
 
  2011 2010   2012 2011 

Operating earnings

  $144,489   $136,630    $57,237   $51,506  

Net realized investment losses, net of taxes(1)

   (3,803  (18,062

Loss on early retirement of senior notes(2)

   —      (2,582

Net realized investment gains (losses), net of taxes(A)

   670    (1,282

Merger-related corporate expenses, net of taxes(B)

   (22,967  —    
  

 

  

 

   

 

  

 

 

Net income attributable to shareholders

  $140,686   $115,986    $34,940   $50,224  
  

 

  

 

   

 

  

 

 

Diluted results per share of common stock

      

Operating earnings

  $2.55   $2.45    $0.98   $0.91  

Net realized investment losses, net of taxes(1)

   (0.07  (0.32

Loss on early retirement of senior notes(2)

   —      (0.05

Net realized investment gains (losses), net of taxes(A)

   0.01    (0.02

Merger-related corporate expenses, net of taxes(B)

   (0.39  —    
  

 

  

 

   

 

  

 

 

Net income attributable to shareholders

  $2.48   $2.08    $0.60   $0.89  
  

 

  

 

   

 

  

 

 

 

-25-


(1)(A)

Net of an income tax (expense) benefit of $2.0$(0.4) million and $9.7$0.7 million, or $0.04$(0.01) per diluted share and $0.17$0.01 per diluted share, for the ninethree months ended September 30,March 31, 2012 and 2011, and 2010, respectively. The tax effect is calculated using the Company’sCompany's statutory tax rate of 35%.

(2)(B)

Net of an income tax benefit of $1.4$7.7 million or $0.02$0.13 per diluted share for the ninethree months ended September 30, 2010. The tax effect is calculated usingMarch 31, 2012. These expenses are included in the Company’s statutory tax rate"Other Operating Expenses" line of 35%.

the Consolidated Statements of Income.

Premium and Fee Income. Premium and fee income for the first nine monthsquarter of 20112012 was $1,160.0$418.4 million as compared to $1,057.3$376.4 million for the first nine monthsquarter of 2010,2011, an increase of 1011%.Premiums from core group employee benefit products, which include disability, life, excess workers’ compensation, travel accident and dental insurance limited benefit health insurance and workers’ compensation and casualty treaty reinsurance, increased 9%11% to $1,105.5$399.0 million for the first nine monthsquarter of 20112012 from $1,012.6$359.4 million for the first nine monthsquarter of 2010,2011, reflecting higher new business production, price increases and improved persistency. New business production for the Company’s core group employee benefit products increased 23% to $237.6was $80.0 million and $82.5 million in the first nine monthsquarter of 2012 and 2011, from $192.8 million in the first nine months of 2010.respectively. Premiums from excess workers’ compensation insurance for self-insured employers increased 13%20% to $241.0$89.7 million in the first nine monthsquarter of 20112012 from $213.3$74.9 million in the first nine monthsquarter of 2010.2011. Excess workers’ compensation new business production, which represents the annualized amount of new premium sold, was $61.0$16.9 million in the first nine monthsquarter of 20112012 as compared to $39.0$19.1 million in the first nine monthsquarter of 2010, an increase of 56%.2011. Premiums from workers’ compensation and casualty treaty reinsurance increased 46%27% to $53.5$21.9 million in the first nine monthsquarter of 20112012 from $36.8$17.3 million in the first nine monthsquarter of 2010. This product was recently renamed by the Company and was previously known as assumed workers’ compensation and casualty reinsurance.2011. Workers’ compensation and casualty treaty reinsurance production was $18.8$14.3 million in the first nine monthsquarter of 20112012 as compared to $12.2$7.3 million in the first nine monthsquarter of 2010,2011, an increase of 54%96%. The Company’sSNCC’s retention of its existing excess workers’ compensation customers remained strong in the first nine monthsquarter of 2011.2012.

During the first nine months of 2011, premiumsPremiums from the Company’s other core group employee benefit products increased 6%8% to $810.9 million from $762.5$287.4 million in the first nine monthsquarter of 2010. Premiums from the Company’s group life products

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increased 7%2012 as compared to $312.5$267.2 million in the first nine monthsquarter of 2011 from $291.8 million in the first nine months of 2010.2011. Premiums from the Company’s group disability products increased 6%10% to $430.9$154.5 million in the first nine monthsquarter of 20112012 from $406.2$140.8 million in the first nine monthsquarter of 2010.2011. Premiums from the Company’s turnkey disability business were $37.0$15.1 million during the first nine monthsquarter of 20112012 as compared to $37.2$12.2 million during the first nine monthsquarter of 2010.2011. Premiums from the Company’s group life products increased 5% to $108.4 million in the first quarter of 2012 from $103.4 million in the first quarter of 2011. New business production for the Company’s other core group employee benefit products increased 11% to $157.8was $48.8 million in the first nine monthsquarter of 2011 from $141.62012 as compared to $56.1 million in the first nine monthsquarters of 2010. The level of production achieved from these products reflects the Company’s focus on the small case niche (insured groups of 10 to 500 individuals).2011. The Company continues to implement price increases for certain group disability and group life insurance customers; in particular, where warranted in particular instances due to adverse claims experience. In addition, the Company has increased pricing levels for new long-term disability insurance customers as a result of the decrease in the discount rate for its disability reserves that was implemented in 2010. The payments received by the Company in connection with LPT’s, which are episodic in nature and are recorded as liabilities rather than as premiums, were $39.4$27.7 million in the first nine monthsquarter of 20112012 as compared to $11.4$25.0 million in the first nine monthsquarter of 2010.2011.

Deposits from the Company’s asset accumulation products were $422.2$87.5 million in the first nine monthsquarter of 20112012 as compared to $270.4$97.6 million in the first nine monthsquarter of 2010, an increase of 56%. This increase reflects the continuation in the current year of the advantageous conditions for the Company in the fixed annuity marketplace which emerged during the second half 2010.2011. Deposits from the Company’s asset accumulation products, consisting of new annuity sales and issuances of funding agreements, are recorded as liabilities rather than as premiums. The Company is continuing to maintain its discipline in setting the crediting rates offered on its asset accumulation products in 20112012 in an effort to achieve its targeted interest rate spreads on these products. The Company’s funds under management increased 23%24% to $2,002.8$2,144.4 million at September 30, 2011March 31, 2012 from $1,634.3$1,728.4 million at September 30, 2010.March 31, 2011.

Net Investment Income. Net investment income in the first nine monthsquarter of 20112012 was $255.6$105.8 million as compared to $249.2$92.3 million in the first nine monthsquarter of 2010,2011, an increase of 3%15%. This increase reflects a 14%16% increase in average invested assets to $6,774.4$7,637.6 million in 2012 from $6,598.3 million in 2011 from $5,960.7 million in 2010,and a higher level of investment income from the Company’s fixed maturity security portfolio and trading account securities, partially offset by adverse performance on the part of the Company’s investments in investment funds organized as limited partnerships and limited liability companies.portfolio. The tax equivalent weighted average annualized yield on invested assets was 5.5% and 6.0% in for the first nine monthsquarters of 2011both 2012 and 2010, respectively.2011.

Net Realized Investment Losses.Gains (Losses).Net realized investment lossesgains were $5.9$1.0 million in the first nine monthsquarter of 20112012 as compared to $27.8net realized investment losses of $(2.0) million in the first nine monthsquarter of 2010.2011. The Company monitors its investments on an ongoing basis. When the fair value of an available for sale security declines below its amortized cost, the decline is included as a component of accumulated other comprehensive income or loss, net of the related income tax benefit and adjustment to cost of business acquired, on the Company’s balance sheet. In the case of a fixed maturity security, if management judges the decline to be other than temporary, the portion of the decline representing credit lossesloss is recognized as a realized investment loss in the Company’s income statement and the remaining portion of the decline continues to be included as a component of accumulated other comprehensive income or loss. For all other types of investments, the entire amount of the decline is recognized as a realized investment loss. TheDuring the first quarter of 2012, the Company recognized $27.3 million and $62.8$6.8 million of losses in the first nine months of 2011 and 2010, respectively, due to the other than temporary declines in the fair values of certain fixed maturity securities available for sale and other investments, of which respectively, $23.7 million and $50.2$6.4 million was recognized as credit-related realized investment losses and $3.6 million and $12.6$0.4 million remained as a component of accumulated other comprehensive income. The Company recognized $7.5 million of credit losses in the first quarter of 2011 due to the other than temporary declines in the fair values of certain fixed maturity securities available for sale

-26-


and other investments. In total, $9.0 million of impairment losses were recognized, including an additional $1.5 million of losses previously recognized as a component of accumulated other comprehensive income on the balance sheet that became credit losses during the first three months of 2011. The Company’s investment strategy results in periodic sales of securities and, therefore, the recognition of realized investment gains and losses. During the first nine monthsquarters of 20112012 and 2010,2011, the Company recognized $17.8$7.5 million and $22.4$7.0 million, respectively, of net gains on sales of investments.securities.

The Company may continue to recognize losses due to other than temporary declines in security fair values in the future, and such losses may be significant. The extent of such losses will depend on, among other things, future developments in the United States and global economies, financial and credit markets, credit spreads, interest rates, foreign currency exchange rates, expected future cash flows from structured securities, the outlook for the performance by the security issuers of their obligations and changes in security values. The Company continuously monitors its investments in securities whose fair values are below the Company’s amortized cost pursuant to its procedures for evaluation for other than temporary impairment in valuation. See Note B to the Consolidated Financial Statements and the section in the 20102011 Form 10-K entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Operations - Critical Accounting Policies and Estimates” for a description of these procedures, which take into account a number of factors. It is not possible to predict the extent of any future changes in value, positive or negative, or the results of the future application of these procedures, with respect to these securities. For further information concerning the Company’s investment portfolio, see “Liquidity and Capital Resources – Investments.”

Benefits and Expenses. Policyholder benefits and expenses were $1,200.2$471.8 million in the first nine monthsquarter of 20112012 as compared to $1,091.0$390.7 million in the first nine monthsquarter of 2010.2011. This increase primarily reflects thean increase in premiums from the

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Company’s group employee benefit products discussed above.above, and does not reflect significant additions to reserves for prior years’ claims and claim expenses. However, there can be no assurance that future periods will not include additions to reserves of this type, which will depend on the Company’s future loss development. If the Company were to experience significant adverse loss development in the future, the Company’s results of operations could be materially adversely affected. This increase also reflects $30.7 million of merger-related corporate expenses incurred during the first quarter of 2012 relating to the pending merger with Tokio Marine. The combined ratio (loss ratio plus expense ratio) for group employee benefit products was 95.0%96.7% and 94.9%95.2% in the first nine monthsquarters of 20112012 and 2010,2011, respectively. The weighted average annualized crediting rate on the Company’s asset accumulation products was 3.6% and 3.8%4.0% in the first nine monthsquarters of 20112012 and 2010, respectively.2011.

Interest Expense. Interest expense was $27.8$9.4 million and $9.3 million in the first nine monthsquarters of 2012 and 2011, as compared to $33.1 million in the first nine months of 2010. This decrease primarily reflects a decrease in interest expense resulting from the early retirement of the 2033 Senior Notes during 2010, partially offset by an increase in interest expense associated with the 2020 Senior Notes, which were issued by the Company in the first quarter of 2010, as well as increased interest paid on the Company’s new bank credit facility.respectively.

Income Tax Expense. Income tax expense was $40.2$10.9 million in the first nine monthsquarter of 20112012 as compared to $34.6$16.4 million in the first nine monthsquarter of 2010.2011. This increasedecrease primarily reflects the decrease in the income tax benefit resulting from realized investment losses due to thea lower level of such losses, as well as a higher leveloperating income during the first quarter of taxable income.2012. The Company’s effective tax rate was 22.2% and 23.0%23.8% in the first nine monthsquarter of 2011 and 2010, respectively.

Three Months Ended September, 30, 2011 Compared2012 as compared to Three Months Ended September 30, 2010

Summary of Results. Net income attributable to shareholders was $41.0 million, or $0.73 per diluted share, for24.6% in the thirdfirst quarter of 2011, as compared to $44.8 million, or $0.80 per diluted share, for the third quarter of 2010. Net income in the third quarter of 2011 and 2010 included net realized investment (losses) gains (net of the related income tax benefit (expense)) of $(3.3) million, or $(0.06) per diluted share, and $0.8 million, or $0.01 per diluted share, respectively. Net income in the third quarter of 2011 was adversely impacted by a significant decrease in net investment income as compared to the prior period, partially offset by a decrease in interest expense. Net investment income decreased due to a lower tax equivalent weighted average annualized yield on invested assets of 5.0% during the third quarter of 2011 as compared with 6.0% in the prior period. Net realized investment (losses) gains in the third quarter of 2011 and 2010 included losses, net of the related income tax benefit, of $(6.1) million, or $(0.11) per diluted share, and $(4.2) million, or $(0.07) per diluted share, respectively, due to credit loss-related impairments in the values of certain investments. The decrease in interest expense primarily reflects a decrease in interest expense associated with the 2033 Senior Notes, which were redeemed during 2010.

The Company believes the non-GAAP financial measure of “operating earnings” is informative when analyzing the trends relating to the Company’s insurance operations. Operating earnings consist of net income attributable to shareholders excluding after-tax realized investment gains and losses, losses on early retirement of senior notes and results from discontinued operations, as applicable. The Company believes that because these excluded items arise from events that are largely within management’s discretion and whose fluctuations can distort comparisons between periods, a measure excluding their impact is useful in analyzing the Company’s operating trends. Investment gains or losses are realized based on management’s decision to dispose of an investment, and investment losses are realized based on management’s judgment that a decline in the fair value of an investment is other than temporary. Early retirement of senior notes occurs based on management’s decision to redeem or repurchase these notes prior to maturity. Discontinued operations result from management’s decision to exit or sell a particular business. Thus, these excluded items are not reflective of the Company’s ongoing earnings capacity, and trends in the earnings of the Company’s underlying insurance operations can be more clearly identified without the effects. For these reasons, management uses the measure of operating earnings to assess performance and make operating plans and decisions, and the Company believes that analysts and investors typically utilize measures of this type as one element of their evaluations of insurers’ financial performance. However, gains or losses from the excluded items, particularly as to investments, can occur frequently and should not be considered as nonrecurring items. Further, operating earnings should not be considered a substitute for net income attributable to shareholders, the most directly comparable GAAP measure, as an indication of the Company’s overall financial performance and may not be calculated in the same manner as similarly titled measures utilized by other companies.

Operating earnings were $44.3 million, or $0.79 per diluted share, in the third quarter of 2011 compared to $46.5 million, or $0.83 per diluted share. This decrease was primarily due to a decrease in net investment income, partially offset by a decrease in interest expense.

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The following table reconciles the amount of operating earnings to the corresponding amount of net income attributable to shareholders for the indicated periods:

   Three months Ended
September 30,
 
   2011  2010 

Operating earnings

  $44,286   $46,477  

Net realized investment (losses) gains, net of taxes(1)

   (3,251  775  

Loss on early retirement of senior notes(2)

   —      (2,444
  

 

 

  

 

 

 

Net income attributable to shareholders

  $41,035   $44,808  
  

 

 

  

 

 

 

Diluted results per share of common stock

   

Operating earnings

  $0.79   $0.83  

Net realized investment (losses) gains, net of taxes(1)

   (0.06  0.01  

Loss on early retirement of senior notes(2)

   —      (0.04
  

 

 

  

 

 

 

Net income attributable to shareholders

  $0.73   $0.80  
  

 

 

  

 

 

 

(1)Net of an income tax benefit (expense) of $1.8 million and $(0.4) million, or $0.03 per diluted share and $(0.01) per diluted share, for the three months ended September 30, 2011 and 2010, respectively. The tax effect is calculated using the Company’s statutory tax rate of 35%.

(2)Net of an income tax benefit of $1.3 million or $0.02 per diluted share for the three months ended September 30, 2010. The tax effect is calculated using the Company’s statutory tax rate of 35%.

Premium and Fee Income. Premium and fee income for the third quarter of 2011 was $398.6 million as compared to $357.0 million for the third quarter of 2010, an increase of 12%.Premiums from core group employee benefit products, which include disability, life, excess workers’ compensation, travel accident and dental insurance, limited benefit health insurance and workers’ compensation and casualty treaty reinsurance, increased 11% to $379.6 million for the third quarter of 2011 from $341.6 million for the third quarter of 2010, reflecting higher new business production, price increases and improved persistency. New business production for the Company’s core group employee benefit products increased 24% to $89.6 million in the third quarter of 2011 from $72.1 million in the third quarter of 2010. Premiums from excess workers’ compensation insurance for self-insured employers increased 17% to $87.1 million in the third quarter of 2011 from $74.4 million in the third quarter of 2010. Excess workers’ compensation new business production, which represents the annualized amount of new premium sold, was $29.5 million in the third quarter of 2011 as compared to $19.3 million in the third quarter of 2010, an increase of 53%. Premiums from workers’ compensation and casualty treaty reinsurance increased 40% to $18.8 million in the third quarter of 2011 from $13.4 million in the third quarter of 2010. This product was recently renamed by the Company and was previously known as assumed workers compensation and casualty reinsurance. Workers’ compensation and casualty treaty reinsurance production was $6.7 million in the third quarter of 2011 as compared to $3.7 million in the third quarter of 2010, an increase of 81%. Rates increased 3.9% in the third quarter of 2011 on excess workers’ compensation renewals and self-insured retentions were on average up 5.5% in such quarter on new and renewal policies. The Company’s retention of its existing excess workers’ compensation customers remained strong in the third quarter of 2011.

During the third quarter of 2011, premiums from the Company’s other core group employee benefit products increased 8% to $273.7 million in the third quarter of 2011 from $253.8 million in the third quarter of 2010. Premiums from the Company’s group life products increased 7% to $105.0 million in the third quarter of 2011 from $97.9 million in the third quarter of 2010. Premiums from the Company’s group disability products increased 9% to $147.6 million in the third quarter of 2011 from $135.1 million in the third quarter of 2010. Premiums from the Company’s turnkey disability business were $12.6 million during the third quarter of 2011 compared to $12.0 million during the third quarter of 2010, an increase of 5%. New business production for the Company’s other core group employee benefit products increased 9% to $53.4 million in the third quarter of 2011 compared to $49.1 million in the third quarter of 2010. The level of production achieved from these products reflects the Company’s focus on the small case niche (insured groups of 10 to 500 individuals). The Company continues to implement price increases for certain group disability and group life insurance customers; in particular, where warranted in particular instances due to adverse claims experience. In addition, the Company has increased pricing levels for new long-term disability insurance customers as a result of the decrease in the discount rate for its disability reserves that was implemented in 2010. The payments received by the Company in connection with LPT’s, which are episodic in nature and are recorded as liabilities rather than as premiums, were $2.4 million in the third quarter of 2011 as compared to $4.5 million in the third quarter of 2010.

Deposits from the Company’s asset accumulation products were $175.6 million in the third quarter of 2011 as compared to $153.6 million in the third quarter of 2010, an increase of 14%. This increase reflects the advantageous conditions for the Company in the fixed annuity marketplace which emerged during the second half of 2010 and have continued into 2011. Deposits from the Company’s asset accumulation products, consisting of new annuity sales and issuances of funding agreements, are recorded as liabilities rather than as premiums. The Company is continuing to maintain its discipline in setting the crediting

-28-


rates offered on its asset accumulation products in 2011 in an effort to achieve its targeted interest rate spreads on these products.

Net Investment Income. Net investment income in the third quarter of 2011 was $80.1 million as compared to $86.9 million in the third quarter of 2010. This decrease was primarily due to the unfavorable performance of the Company’s investments in investment funds organized as limited partnerships and limited liability companies. This decrease was partially offset by a 14% increase in average invested assets to $7,135.9 million in 2011 from $6,283.9 million in 2010 and a higher level of investment income from the Company’s fixed maturity security portfolio resulting from the portfolio repositioning discussed above. The tax equivalent weighted average annualized yield on invested assets was 5.0% and 6.0% for the third quarter of 2011 and 2010, respectively.

Net Realized Investment (Losses) Gains.Net realized investment (losses) gains were $(5.0) million in the third quarter of 2011 as compared to $1.2 million in the third quarter of 2010. The Company monitors its investments on an ongoing basis. When the fair value of an available for sale security declines below its amortized cost, the decline is included as a component of accumulated other comprehensive income or loss, net of the related income tax benefit and adjustment to cost of business acquired, on the Company’s balance sheet. In the case of a fixed maturity security, if management judges the decline to be other than temporary, the portion of the decline representing credit losses is recognized as a realized investment loss in the Company’s income statement and the remaining portion of the decline continues to be included as a component of accumulated other comprehensive income or loss. For all other types of investments, the entire amount of the decline is recognized as a realized investment loss. The Company recognized $12.0 million of losses in the third quarter of 2011 due to the other than temporary declines in the fair values of certain fixed maturity securities and other investments, of which $9.4 million was recognized as realized investment losses related to credit losses and $2.6 million remained as a component of accumulated other comprehensive income on the balance sheet related to non-credit losses. During the third quarter of 2010, the Company recognized $13.9 million of losses due to the other than temporary declines in the fair values of certain fixed maturity securities and other investments, of which $6.4 million was recognized as realized investment losses related to credit losses and $7.5 million remained as a component of accumulated other comprehensive income on the balance sheet related to non-credit losses. The Company’s investment strategy results in periodic sales of securities and, therefore, the recognition of realized investment gains and losses. During the third quarters of 2011 and 2010, the Company recognized $4.4 million and $7.6 million, respectively, of net gains on sales of investments.

The Company may continue to recognize losses due to other than temporary declines in security fair values in the future, and such losses may be significant. The extent of such losses will depend on, among other things, future developments in the United States and global economies, financial and credit markets, credit spreads, interest rates, expected future cash flows from structured securities, the outlook for the performance by the security issuers of their obligations and changes in security values. The Company continuously monitors its investments in securities whose fair values are below the Company’s amortized cost pursuant to its procedures for evaluation for other than temporary impairment in valuation. See Note B to the Consolidated Financial Statements and the section in the 2010 Form 10-K entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies and Estimates” for a description of these procedures, which take into account a number of factors. It is not possible to predict the extent of any future changes in value, positive or negative, or the results of the future application of these procedures, with respect to these securities. For further information concerning the Company’s investment portfolio, see “Liquidity and Capital Resources – Investments.”

Benefits and Expenses. Policyholder benefits and expenses were $415.2 million in the third quarter of 2011 as compared to $370.2 million in the third quarter of 2010. This increase primarily reflects the increase in premiums from the Company’s group employee benefit products discussed above. The combined ratio (loss ratio plus expense ratio) for group employee benefit products was 95.9% and 95.5% in the third quarters of 2011 and 2010, respectively. The weighted average annualized crediting rate on the Company’s asset accumulation products was 3.3% and 3.7% in the third quarters of 2011 and 2010, respectively.

Interest Expense. Interest expense was $9.3 million in the third quarter of 2011 as compared to $11.0 million in the third quarter of 2010. This decrease primarily reflects a decrease in interest expense associated with the 2033 Senior Notes, which were redeemed during 2010, partially offset by an increase in interest expense associated with the Company’s new bank credit facility.

Income Tax Expense. Income tax expense was $8.0 million in the third quarter of 2011 as compared to $15.3 million in the third quarter of 2010 primarily due to a lower level of operating income. The Company’s effective tax rate was 16.3% and 25.4% in the third quarter of 2011 and 2010, respectively, primarily due to a significantly higher proportion of its net investment income consisting ofrepresented by tax-exempt interest income.

-29-


Liquidity and Capital Resources

General.The Company’s current liquidity needs include principal and interest payments on outstanding borrowings under its bank credit facility and interest payments on the 2020 Senior Notes and 2007 Junior Debentures, as well as funding its operating expenses and dividends to stockholders. The 2007 Junior Debentures will become due on May 15, 2037, but only to the extent that the Company has received sufficient net proceeds from the sale of certain specified qualifying capital securities. Any remaining outstanding principal amount will be due on May 1, 2067. The 2020 Senior Notes and 2007 Junior Debentures are not subject to any sinking fund requirements and contain certain provisions permitting their early redemption by the Company. For descriptions of these provisions, see Notes E and H to the Consolidated Financial Statements included in the 20102011 Form 10-K. The Company announced on April 27, 2012 that it plans to voluntarily delist from the New York Stock Exchange the 2007 Junior Debentures and to terminate the registration of 2007 Junior Debentures and the 2020 Senior Notes and its reporting obligations with respect to the 2007 Junior Debentures and the 2020 Senior Notes under the Securities Exchange Act of 1934, as amended. If the closing of the merger with Tokio Marine does not occur, the Company does not expect to proceed with such delisting and deregistration.

In December 2010, theThe Company entered into a Credit Agreement with Bank of America, N.A. as administrative agent and a group of banking institutions (the “Credit Agreement”) providing for a revolving loan facility of $175$205.0 million which matures on December 22, 2013 and a term loan facility of $125$125.0 million which matures on December 22, 2015. Concurrently with the consummation of the Credit Agreement, the Company terminated the Prior Credit Agreement, which was scheduled to expire in October 2011. On June 7, 2011, a new lender was added to the revolving loan facility and its amount was increased to $205 million. Interest on borrowings under the Credit Agreement is payable, at the Company’s election, either at a floating rate based on LIBOR plus a specified margin which varies based upon the specified ratings of the Company’s senior unsecured debt, as in effect from time to time, or a base rate equal to the highest of Bank of America’s prime rate, LIBOR plus a specified margin or the federal funds rate plus a specified margin. The Credit Agreement contains various financial and other affirmative and negative covenants, along with various representations and warranties. The covenants include, among others, a maximum Company consolidated debt to capital ratio, a minimum Company consolidated net worth, minimum statutory risk-based capital requirements for RSLIC and SNCC, and

-27-


certain limitations on subsidiary indebtedness. As of September 30, 2011,March 31, 2012, the Company was in compliance in all material respects with the financial and various other affirmative and negative covenants in the Credit Agreement. At September 30, 2011,March 31, 2012, the Company had $125$125.0 million of outstanding borrowings and $205$205.0 million of borrowings remaining available under the Credit Agreement.

As a holding company that does not conduct business operations in its own right, substantially all of the assets of the Company are comprised of its ownership interests in its insurance subsidiaries. In addition, the Company had approximately $135.0$169.8 million of financial resources available at the holding company level at September 30, 2011,March 31, 2012, primarily comprised of short-term investments, equity securities and investments in investment subsidiaries whose assets are primarily invested in investment funds organized as limited partnerships and limited liability companies. Other sources of liquidity at the holding company level include dividends paid from subsidiaries, primarily generated from operating cash flows and investments, and borrowings under the Credit Agreement. During 2011,2012, the Company’s insurance subsidiaries will be permitted, without prior regulatory approval, to make dividend payments totaling $99.8$91.1 million, in addition to the dividend payments of $52.0$58.0 million made during the first ninethree months of 2011.2012. However, the level of dividends that could be paid consistent with maintaining the insurance subsidiaries’ RBC and other measures of capital adequacy at levels consistent with its current claims-paying and financial strength ratings from rating agencies is likely to be substantially lower than such amount. In general, dividends from the Company’s non-insurance subsidiaries are not subject to regulatory or other restrictions. In addition, the Company is presently categorized as a well knownwell-known seasoned issuer under Rule 405 of the Securities Act. As such, the Company has the ability to file automatically effective shelf registration statements for unspecified amounts of different securities, allowing for immediate, on-demand offerings.

During the first quarter of 2006, the Company issued $100.0 million in aggregate principal amount of fixed and floating rate funding agreements which had maturities of three to five years in connection with the issuance by an unconsolidated special purpose vehicle of funding agreement-backed notes in a corresponding principal amount. During the first quarter of 2011, the Company repaid the remaining $65.0 million in aggregate principal amount of fixed rate funding agreements at their maturity.

On November 3, 2011, the Company’s Board of Directors declared a cash dividend of $0.12 per share, which will be paid on the Company’s Class A Common Stock and Class B Common Stock on December 1, 2011.

The Company and its subsidiaries expect available sources of liquidity to exceed their current and long-term cash requirements.

Share Repurchase Authorization. On August 3, 2011, the Company’s Board of Directors authorized repurchases of the Company’s outstanding Class A Common Stock in a total amount of up to $50 million. Such repurchases may be effected in the open market or in privately negotiated transactions in compliance with applicable laws, rules and regulations, including Rule 10b-18 under the Securities Exchange Act of 1934. Repurchases pursuant to this authorization will depend upon management’s assessment of market and business conditions, the Company’s stock price, alternative uses of capital and other factors. The authorization replaces an existing share repurchase authorization which had 1.0 million shares remaining. During the third quarter of 2011, the Company repurchased 421,500 shares at a total cost of $9.7 million.

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Investments. The Company’s overall investment strategy emphasizes safety and liquidity, while seeking the best available return, by focusing on, among other things, managing the Company’s interest-sensitive assets and liabilities and seeking to minimize the Company’s exposure to fluctuations in interest rates. The Company’s investment portfolio, which totaled $7,336.2$7,919.7 million at September 30, 2011,March 31, 2012, consists primarily of investments in fixed maturity securities available for sale, short-term investments, mortgage loans and equity securities. The Company’s investment portfolio also includes investments in investment funds organized as limited partnerships and limited liability companies and trading account securities which collectively totaled $305.0$321.9 million at September 30, 2011.March 31, 2012.

During the first ninethree months of 2011,2012, the marketfair value of the Company’s available for sale fixed maturity investment portfolio, in relation to its amortized cost, increased by $107.6$150.6 million from year-end 2010,2011, before the related decrease in the cost of business acquired of $9.5$15.6 million and an increasea decrease in the federal income tax provision of $34.3$47.3 million. At September 30, 2011,March 31, 2012, gross unrealized appreciation and gross unrealized depreciation, before the related income tax expense or benefit and the related adjustment to cost of business acquired, with respect to the available for sale fixed maturity securities in the Company’s portfolio totaled $334.2$438.1 million (of which $292.0$367.6 million was attributable to investment grade securities) and $155.5$79.0 million (of which $69.4$27.6 million was attributable to investment grade securities), respectively. During the first ninethree months of 2011,2012, the Company recognized pre-tax net investment lossesgains of $5.9$1.0 million. The weighted average credit rating of the securities in the Company’s fixed maturity portfolio having ratings by nationally recognized statistical rating organizations, based upon the highest of the ratings assigned to the respective securities, was “A” at September 30, 2011.March 31, 2012. While ratings of this type are intended to address credit risk, they do not address other risks, such as prepayment and extension risks.

See “Forward-Looking Statements and Cautionary Statements Regarding Certain Factors That May Affect Future Results,” and Part I, Item 1A of the 2010 Form 10-K, “Risk Factors”, for a discussion of various risks relating to the Company’s investment portfolio.

Cash Flows. Operating activities increased cash by $323.7$94.0 million and $253.0$117.4 million in the first ninethree months of 20112012 and 2010,2011, respectively. Net investing activities used $545.4$179.1 million and $425.1$95.7 million of cash during the first ninethree months of 20112012 and 2010,2011, respectively, primarily for the purchase of securities. Financing activities provided $239.9$100.3 million of cash during the first ninethree months of 2011,2012, principally from deposits to policyholder accounts, partially offset byaccounts. During the first three months of 2011, financing activities used $1.5 million of cash, reflecting, among other things, the repayment of $65.0 million in aggregate principal amount of fixed rate funding agreements at their maturity. During the first nine months of 2010, financing activities provided $183.9 million of cash, principally from the issuance of the 2020 Senior Notes, partially offset by the full repayment of the then outstanding borrowings under the Prior Credit Agreement.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes in the Company’s exposure to market risk or its management of such risk since December 31, 2010.2011.

Item 4. Controls and Procedures

As of the end of the period covered by this report, an evaluation was performed under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in the rules and regulations of the Securities and Exchange Commission). Based on that evaluation, the Company’s management, including the CEO and CFO, concluded that the Company’s disclosure controls and procedures were effective. There were no changes in the Company’s internal control over financial reporting during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Forward-Looking Statements And Cautionary Statements Regarding Certain Factors That May Affect Future Results

In connection with, and because it desires to take advantage of, the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, the Company cautions readers regarding certain forward-looking statements in the above “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this Form 10-Q and in any other statement made by, or on behalf of, the Company, whether in future filings with the Securities and Exchange Commission or otherwise. Forward-looking statements are statements not based on historical information and which relate to future operations, strategies, financial results, prospects, outlooks or other developments. Some forward-looking statements may be identified by the use of terms such as “expects,” “believes,” “anticipates,” “intends,” “judgment,” “outlook,” “effort,” “attempt,” “achieve,” “project” or other similar expressions. Forward-looking statements are necessarily based upon estimates and assumptions that are inherently subject to significant business, economic, competitive and other uncertainties and contingencies, many of which

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are beyond the Company’s control and many of which, with respect to future business decisions, are subject to change. Examples of such uncertainties and contingencies include, among other important factors, those affecting the insurance industry generally, such as the economic and interest rate environment, federal and state legislative and regulatory developments, including but not limited to changes in financial services, employee benefit and tax laws and regulations, changes in accounting rules and interpretations thereof, market pricing and competitive trends relating to insurance products and services, acts of terrorism or war, and the availability and cost of reinsurance, and those relating specifically to the Company’s business, such as the level of its insurance premiums and fee income, the claims experience, persistency and other factors affecting the profitability of its insurance products, the performance of its investment portfolio and changes in the Company’s investment strategy, acquisitions of companies or blocks of business, and ratings by major rating organizations of the Company and its insurance subsidiaries. These uncertainties and contingencies can affect actual results and could cause actual results to differ materially from those expressed in any forward-looking statements made by, or on behalf of, the Company. Certain of these uncertainties and contingencies are described in more detail in Part I, Item 1A of the 20102011 Form 10-K, “Risk Factors”. The Company disclaims any obligation to update forward-looking information.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

The Company, Mr. Rosenkranz, certain other members of the Company’s management, members of the Company’s board of directors, Tokio Marine and TM Sub have been named as defendants in four lawsuits brought by and on behalf of the Company’s stockholders in the Court of Chancery of the State of Delaware (the “Court”) challenging certain aspects of the merger. These lawsuits have been consolidated by the Court into a single action known asIn re Delphi Financial Group Shareholder Litigation, Consolidated C.A. No. 7144-VCG. On February 16, 2012, plaintiffs filed a second amended complaint in the consolidated action, which alleges, among other things, that Mr. Rosenkranz has breached his fiduciary duties by (1) engaging in improper related-party transactions and using the Company’s resources to run a competing business, and (2) appropriating for himself a disproportionate amount of the merger consideration through (a) an incremental premium being paid to Class B stockholders and (b) an alleged agreement with Tokio Marine to compensate Mr. Rosenkranz in connection with the related-party transactions referred to above. The second amended complaint further alleges that the Company’s directors have breached their fiduciary duties by (1) approving the merger agreement, which the plaintiffs allege to be unfair to the Company’s public stockholders, (2) approving the payment of additional consideration to the Class B stockholders, and (3) structuring the vote on a proposed amendment to the Company’s certificate of incorporation in an improperly coercive manner. In addition, the complaint alleges that members of the Company’s management breached their fiduciary duties to the Company’s public stockholders by aiding Mr. Rosenkranz in seeking additional merger consideration. The complaint alleges that Mr. Rosenkranz and the Company breached the implied covenant of good faith allegedly inherent in the Company’s certificate of incorporation. The second amended complaint also alleges that Tokio Marine and TM Sub aided and abetted these alleged breaches. Finally, the second amended complaint alleges that the preliminary proxy statement omitted material information and provided materially misleading information. Based on these allegations, the second amended complaint in the consolidated action seeks, among other relief, certain injunctive relief, including enjoining the merger, and damages. It also purports to seek recovery of the costs of the actions, including attorneys’ fees.

In a memorandum opinion, issued March 6, 2012, the Court denied plaintiffs’ motion for a preliminary injunction in the consolidated action.

On April 9, 2012, the Company announced that a settlement in principle had been reached, contingent on, among other things, definitive documentation and Court approval. If the settlement is finalized and approved, Delphi’s Class A putative classstockholders and certain option holders as of the effective time of the merger, other than the defendants to the consolidated action Moore v. Reliance Standard Life Insuranceand their affiliates, will receive a payment equal to $49 million less plaintiffs’ counsel fees and expenses, which have not yet been determined, and less other administrative expenses such as the costs of providing notice to stockholders and option holders. The payment will be made after and subject to approval of the settlement by the Court. A hearing to consider the settlement is expected to occur subsequent to the closing of the merger. The amount of plaintiffs’ counsel fees and expenses will be determined at or after the time the Court decides whether to approve the settlement agreement.

The settlement is contingent upon, among other things, completion of the merger and approval by the Court. In the event the court does not approve the settlement or the other conditions are not satisfied, the Delphi defendants will continue to vigorously defend all claims. The payment described above is separate and distinct from the merger consideration payable to Delphi’s Class A stockholders.

On April 24, 2012, pursuant to a stipulation among the parties to the action, Harold F. Ilg, a former director of the Company, was filed in the United States District Court for the Northern District of Mississippi in July 2008 against the Company’s subsidiary, RSLIC. The action challenges RSLIC’s ability to pay certain insurance policy benefits through a mechanism commonly known in the insurance industrydismissed as a retained asset account and contains related claims of breach of fiduciary duty and prohibited transactions underdefendant from the federal Employee Retirement Income Security Act of 1974. The parties have entered into an agreement to settle this litigation, and the settlement has been preliminarily approved by the court. It is not anticipated that this settlement will have a material adverse effect on the Company’s results of operations, liquidity or financial condition.action with prejudice.

In addition, the Company is a party to various other litigation and proceedings in the ordinary course of its business, primarily involving its subsidiaries’ insurance operations. In some cases, these proceedings entail claims against the Company for punitive damages and similar types of relief. The ultimate disposition of such litigation and proceedings is not expected to have a material adverse effect on the Company’s results of operations, liquidity or financial condition.

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Item 1A. Risk Factors

The following discussion, which supplements the significant factors that may affect our business and operations described in Part I, Item 1A of the 2010 2011.

Form 10-K, “Risk Factors”, updates and supercedessupersedes the discussion contained therein relating to thesethis risk factors.factor.

Certain risks and uncertainties are associated with the pending merger with Tokio Marine.

On December 21, 2011, the Company entered into a merger agreement with Tokio Marine and TM Sub pursuant to which all of the Company’s outstanding shares will be acquired by Tokio Marine. While the Company expects that the merger with Tokio Marine will close on or about May 15, 2012, certain risks and uncertainties remain associated with the merger. For example, the merger may not be consummated in the time frame or manner currently anticipated or at all, as a result of several factors, including, among other things, the failure of one or more of the merger agreement’s closing conditions to be satisfied. There can be no assurance that the closing conditions will be satisfied or, to the extent permitted, waived or that other events will not intervene to delay or result in the termination of the merger. If the merger is not completed, the price of the Company’s Class A Common Stock may decrease to the extent that the current market price of such stock reflects an assumption that the merger will be consummated. Pending the closing of the merger, the merger agreement also restricts the Company from engaging in certain actions without Tokio Marine’s consent, which could prevent the Company from pursuing opportunities that may arise prior to the closing of the merger. Any delay in closing or a failure to close could have a negative impact on the Company’s business and the Company’s stock price as well as the relationships of the Company’s subsidiaries with customers or employees, as well as a negative impact on the Company’s ability to pursue alternative strategic transactions and/or the Company’s ability to implement alternative business plans. In addition, if the merger agreement is terminated under certain circumstances, the Company would be required to pay a termination fee of $82 million to Tokio Marine.

The Company’s financial position andbusiness could be adversely impacted as a result of uncertainty related to the pending merger.

The pending merger with Tokio Marine could cause disruptions to the Company’s business or business relationships, which could have an adverse impact on the Company’s results of operations, liquidity and financial condition. For example, the attention of the Company’s management may be adversely impacted by changes in accounting rules and indirected to merger-related considerations; the interpretations of such rules.

The Company’s financial position and results of operations are reported in accordanceemployees may experience uncertainty about their future roles with GAAP, in the case of the Company, and in accordance with statutory accounting principles, in the case of the statutory financial statements of its insurance subsidiaries. Changes in the applicable GAAP or statutory accounting rules, or in the interpretations of such rules,which may adversely affect the Company’s ability to hire and such subsidiaries’ reported financial positionsretain key personnel; and results of operations.

On January 1, 2011,parties with which the Company adopted, on a retrospective basis, guidance issued by the Financial Accounting Standards Board limiting the extent to which an insurerhas business relationships may capitalize costs incurred in the acquisition of an insurance contract. The guidance provides that, in order to be capitalized, such costs must be incremental and directly relatedexperience uncertainty as to the acquisitionfuture of a newsuch relationships and seek alternative relationships with third parties or renewal insurance contract. Insurers may only capitalize costs relatedseek to successful efforts in attaining a contract and advertising costs may only be capitalized if certain direct response advertising criteria are met. As a result of its adoption,alter their present business relationships with the Company. In addition, the Company made an after-tax reductionhas incurred, and will continue to its retained earnings at January 1, 2010incur, significant costs, expenses and fees for professional services and other transaction costs in connection with the amountmerger, and many of $60.0 million, netthese fees and costs are payable regardless of an income tax benefit of $32.3 million, which representswhether or not the net reduction in deferred policy acquisition cost included in cost of business acquired on the consolidated balance sheet, net income attributable to shareholders was reduced by $0.03 per diluted share and $0.09 per diluted share for the three and nine months ended September 30, 2010, respectively. This adoption also resulted in the restatement of certain other financial information for 2010.

merger is consummated.

 

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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

There were no unregistered sales of equity securities during the period covered by this report.

Issuer Purchases of Registered Equity Securities.

The following table shows the purchases of registered equity securities under the Company’s existing repurchase authorization during the three months ended September 30, 2011:

   Number
of Shares
Purchased
   Total
Average
Price
Paid per
Share
   Total
Number of
Shares
Purchased
as Part of
Publicly
Announced
Plans or
Programs (1)
   Maximum
Dollar Value of
Shares that May
Yet Be
Purchased Under
the Plans or
Programs (2)
 

July 1 – 31, 2011

   —      $—       —       —    

August 1 – 31, 2011

   421,500    $22.96     421,500    $40,314,199  

September 1 – 30, 2011

   —      $—       —       —    
  

 

 

     

 

 

   

Total

   421,500    $22.96     421,500     —    
  

 

 

     

 

 

   

(1)

The Company had previously purchased 7,741,452 shares of its Class A Common Stock, at a total cost of $187.8 million, in the open market under previous share repurchase authorizations and had received 19,764 shares of the Company’s Class A Common Stock with an aggregate value of $0.3 million in liquidation of a partnership interest, resulting in a total number of shares of treasury stock outstanding on December 31, 2010 of 7,761,216.

(2)

On August 3, 2011, the Board authorized the repurchase of an aggregate value of $50.0 million of the Company’s Class A Common Stock, which replaced an existing share repurchase authorization having 1.0 million shares remaining. During the third quarter of 2011, the Company repurchased 421,500 shares of its Class A Common Stock at a total cost of $9.7 million in the open market, resulting in a total number of shares of treasury stock outstanding on September 30, 2011 of 8,182,716. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources” in Part I, Item 2 of this Quarterly Report.

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Item 6.Exhibits

 

  3.1Amendment to Amended and Restated By-laws of Delphi Financial Group, Inc.
11.1  Computation of Results per Share of Common Stock (incorporated by reference to Note GF to the Consolidated Financial Statements included elsewhere herein)
31.1  Certification by the Chairman of the Board and Chief Executive Officer of Periodic Report Pursuant to Rule 13a-14(a) or 15d-14(a)
31.2  Certification by the Executive Vice President and Chief Financial Officer of Periodic Report Pursuant to Rule 13a-14(a) or 15d-14(a)
32.1  Certification of Periodic Report Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.  The following financial information from the Company’s Quarterly Report on Form 10-Q for the ninethree months ended September 30, 2011,March 31, 2012, formatted in XBRL: (i) Consolidated Statements of Income for the three and nine months ended September 30,March 31, 2012 and 2011; (ii) Consolidated Statements of Other Comprehensive Income for the three months ended March 31, 2012 and 2011 and 2010; (ii)(iii) Consolidated Balance Sheets at September 30, 2011March 31, 2012 and December 31, 2010; (iii)2011; (iv) Consolidated Statement of Equity for the ninethree months ended September 30, 2011March 31, 2012 and 2010; (iv)2011; (v) Consolidated Statements of Cash Flows for the ninethree months ended September 30, 2011March 31, 2012 and 2010;2011; and (v)(vi) Notes to Consolidated Financial Statements.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

DELPHI FINANCIAL GROUP, INC.

/s/ ROBERT ROSENKRANZ

Robert Rosenkranz

Chairman of the Board and Chief Executive Officer

(Principal Executive Officer)

/s/ STEPHAN KIRATSOUS

Stephan Kiratsous

Executive Vice President and Chief Financial Officer

Date: November 8, 2011May 09, 2012

 

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