Fair Value of Financial Instruments | Note 9 – Fair Value of Financial Instruments The carrying amount and fair value of financial instruments are shown below (in thousands): June 30, 2015 December 31, 2014 Carrying Fair Value Carrying Fair Value Financial assets Fixed maturity securities, bonds held-to-maturity $ 7,834,732 $ 8,184,118 $ 8,225,050 $ 8,652,913 Fixed maturity securities, bonds available-for-sale 5,131,957 5,131,957 4,921,807 4,921,807 Equity securities 1,516,244 1,516,244 1,516,978 1,516,978 Equity-indexed options 183,963 183,963 189,449 189,449 Mortgage loans on real estate, net of allowance 3,311,017 3,524,217 3,359,586 3,618,944 Policy loans 405,400 405,400 405,979 405,979 Short-term investments 430,242 430,242 431,000 431,000 Separate account assets 974,233 974,233 1,001,515 1,001,515 Total financial assets $ 19,787,788 $ 20,350,374 $ 20,051,364 $ 20,738,585 Financial liabilities Investment contracts $ 8,557,961 $ 8,557,961 $ 8,894,747 $ 8,894,747 Embedded derivative liability for equity-indexed contracts 208,827 208,827 208,187 208,187 Notes payable 122,464 122,464 108,177 108,177 Separate account liabilities 974,233 974,233 1,001,515 1,001,515 Total financial liabilities $ 9,863,485 $ 9,863,485 $ 10,212,626 $ 10,212,626 Summary Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability. A fair value hierarchy is used to determine fair value based on a hypothetical transaction at the measurement date from the perspective of a market participant. American National has evaluated the types of securities in its investment portfolio to determine an appropriate hierarchy level based upon trading activity and the observability of market inputs. The classification of assets or liabilities within the fair value hierarchy is based on the lowest level of significant input to its valuation. The input levels are defined as follows: Level 1 Unadjusted quoted prices in active markets for identical assets or liabilities. Level 2 Quoted prices in markets that are not active or inputs that are observable directly or indirectly. Level 2 inputs include quoted prices for similar assets or liabilities other than quoted prices in Level 1; quoted prices in markets that are not active; or other inputs that are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 Unobservable inputs that are supported by little or no market activity and are significant to the fair value of the assets or liabilities. Unobservable inputs reflect American National’s own assumptions about the assumptions that market participants would use in pricing the asset or liability. Level 3 assets and liabilities include financial instruments whose values are determined using pricing models and third-party evaluation, as well as instruments for which the determination of fair value requires significant management judgment or estimation. Fixed Maturity Securities and Equity Options The pricing service utilizes market quotations for fixed maturity securities that have quoted prices in active markets. Since fixed maturity securities generally do not trade on a daily basis, the pricing service prepares estimates of fair value measurements for these securities using its proprietary pricing applications, which include available relevant market information, benchmark curves, benchmarking of like securities, sector groupings and matrix pricing. Additionally, an option adjusted spread model is used to develop prepayment and interest rate scenarios. The pricing service evaluates each asset class based on relevant market information, credit information, perceived market movements and sector news. The market inputs utilized in the pricing evaluation, listed in the approximate order of priority, include: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, and economic events. The extent of the use of each market input depends on the asset class and the market conditions. Depending on the security, the priority of the use of inputs may change or some market inputs may not be relevant. For some securities, additional inputs may be necessary. American National has reviewed the inputs and methodology used and the techniques applied by the pricing service to produce quotes that represent the fair value of a specific security. The review confirms that the pricing service is utilizing information from observable transactions or a technique that represents a market participant’s assumptions. American National does not adjust quotes received from the pricing service. The pricing service utilized by American National has indicated that they will only produce an estimate of fair value if there is objectively verifiable information available. American National holds a small amount of private placement debt and fixed maturity securities that have characteristics that make them unsuitable for matrix pricing. For these securities, a quote from an independent broker (typically a market maker) is obtained. Due to the disclaimers on the quotes that indicate that the price is indicative only, American National includes these fair value estimates in Level 3. For securities priced using a quote from an independent broker, such as the equity options and certain fixed maturity securities, American National uses a market-based fair value analysis to validate the reasonableness of prices received from an independent broker. Price variances above a certain threshold are analyzed further to determine if any pricing issue exists. This analysis is performed quarterly. Equity Securities Mortgage Loans Embedded Derivative The significant unobservable input used to calculate the fair value of the embedded derivatives is equity option implied volatility. An increase in implied volatility will result in an increase in the value of the equity-indexed embedded derivatives, all other things being equal. At June 30, 2015 and December 31, 2014, the one year implied volatility used to estimate embedded derivative value was 16.5% and 17.3%, respectively. Other Financial Instruments Policy loans—The carrying value of policy loans is the outstanding balance plus any accrued interest. Due to the collateralized nature of policy loans such that they cannot be separated from the policy contracts and the unpredictable timing of repayments and the fact that settlement is at outstanding value, American National believes the carrying value of policy loans approximates fair value. Investment contracts —The carrying value of investment contracts is equivalent to the accrued account balance. The accrued account balance consists of deposits, net of withdrawals, plus or minus interest credited, fees and charges assessed and other adjustments. American National believes that the carrying value of investment contracts approximates fair value because the majority of these contracts’ interest rates reset to current rates offered at anniversary. Notes payable—Notes payable are carried at outstanding principal balance. The carrying value of the notes payable approximates fair value because the underlying interest rates approximate market rates at the balance sheet date. Quantitative Disclosures The fair value hierarchy measurements of the financial instruments are shown below (in thousands): Fair Value Measurement as of June 30, 2015 Total Level 1 Level 2 Level 3 Financial assets Fixed maturity securities, bonds held-to-maturity U.S. states and political subdivisions $ 330,272 $ — $ 330,272 $ — Foreign governments 5,038 — 5,038 — Corporate debt securities 7,508,577 — 7,453,341 55,236 Residential mortgage-backed securities 321,161 — 320,215 946 Collateralized debt securities 2,082 — — 2,082 Other debt securities 16,988 — 12,682 4,306 Total bonds held-to-maturity 8,184,118 — 8,121,548 62,570 Fixed maturity securities, bonds available-for-sale U.S. treasury and government 24,808 — 24,808 — U.S. states and political subdivisions 898,664 — 896,164 2,500 Foreign governments 6,827 — 6,827 — Corporate debt securities 4,158,502 — 4,097,421 61,081 Residential mortgage-backed securities 33,525 — 31,719 1,806 Collateralized debt securities 9,631 — 7,818 1,813 Total bonds available-for-sale 5,131,957 — 5,064,757 67,200 Equity securities Common stock 1,490,774 1,490,774 — — Preferred stock 25,470 25,470 — — Total equity securities 1,516,244 1,516,244 — — Options 183,963 — — 183,963 Mortgage loans on real estate 3,524,217 — 3,524,217 — Policy loans 405,400 — — 405,400 Short-term investments 430,242 — 430,242 — Separate account assets 974,233 — 974,233 — Total financial assets $ 20,350,374 $ 1,516,244 $ 18,114,997 $ 719,133 Financial liabilities Investment contracts $ 8,557,961 $ — $ — $ 8,557,961 Embedded derivative liability for equity-indexed contracts 208,827 — — 208,827 Notes payable 122,464 — — 122,464 Separate account liabilities 974,233 — 974,233 — Total financial liabilities $ 9,863,485 $ — $ 974,233 $ 8,889,252 Fair Value Measurement as of December 31, 2014 Total Level 1 Level 2 Level 3 Financial assets Fixed maturity securities, bonds held-to-maturity U.S. states and political subdivisions $ 349,760 $ — $ 349,760 $ — Foreign governments 30,423 — 30,423 — Corporate debt securities 7,894,725 — 7,833,564 61,161 Residential mortgage-backed securities 357,635 — 356,670 965 Collateralized debt securities 2,470 — — 2,470 Other debt securities 17,900 — 12,975 4,925 Total bonds held-to-maturity 8,652,913 — 8,583,392 69,521 Fixed maturity securities, bonds available-for-sale U.S. treasury and government 23,233 — 23,233 — U.S. states and political subdivisions 837,616 — 835,106 2,510 Foreign governments 7,021 — 7,021 — Corporate debt securities 4,000,049 — 3,941,925 58,124 Residential mortgage-backed securities 42,399 — 40,473 1,926 Collateralized debt securities 11,489 — 9,616 1,873 Total bonds available-for-sale 4,921,807 — 4,857,374 64,433 Equity securities Common stock 1,487,125 1,487,125 — — Preferred stock 29,853 29,853 — — Total equity securities 1,516,978 1,516,978 — — Options 189,449 — — 189,449 Mortgage loans on real estate 3,618,944 — 3,618,944 — Policy loans 405,979 — — 405,979 Short-term investments 431,000 — 431,000 — Separate account assets 1,001,515 — 1,001,515 — Total financial assets $ 20,738,585 $ 1,516,978 $ 18,492,225 $ 729,382 Financial liabilities Investment contracts $ 8,894,747 $ — $ — $ 8,894,747 Embedded derivative liability for equity-indexed contracts 208,187 — — 208,187 Notes payable 108,177 — — 108,177 Separate account liabilities 1,001,515 — 1,001,515 — Total financial liabilities $ 10,212,626 $ — $ 1,001,515 $ 9,211,111 For financial instruments measured at fair value on a recurring basis using Level 3 inputs during the period, a reconciliation of the beginning and ending balances is shown below (in thousands): Level 3 Three months ended June 30, Six months ended June 30, Assets Liability Assets Liability Investment Equity- Embedded Investment Equity- Embedded Beginning balance, 2015 $ 65,299 $ 188,006 $ 208,412 $ 64,433 $ 189,449 $ 208,187 Total realized and unrealized investment gains (losses) included in other comprehensive income (1,105 ) — — (168 ) — — Net fair value change included in realized gains (losses) — — — — — — Net gain (loss) for derivatives included in net investment income — (3,880 ) — — (4,623 ) — Net change included in interest credited — — (4,413 ) — — (3,217 ) Purchases, sales and settlements or maturities Purchases — 5,825 — — 9,588 — Sales (60 ) — — (121 ) — — Settlements or maturities (332 ) (5,988 ) — (342 ) (10,451 ) — Premiums less benefits — — 4,828 — — 3,857 Gross transfers into Level 3 3,398 — — 3,398 — — Gross transfers out of Level 3 — — — — — — Ending balance June 30, 2015 $ 67,200 $ 183,963 $ 208,827 $ 67,200 $ 183,963 $ 208,827 Beginning balance, 2014 $ 11,973 $ 146,147 $ 155,191 $ 48,304 $ 164,753 $ 148,435 Total realized and unrealized investment gains (losses) included in other comprehensive income 321 — — (11,873 ) — — Net fair value change included in realized gains (losses) — — — 13,056 — — Net gain (loss) for derivatives included in net investment income — 16,678 — — 18,790 — Net change included in interest credited — — 11,826 — — 14,722 Purchases, sales and settlements or maturities Purchases — 4,017 — — 8,690 — Sales (362 ) — — (37,550 ) — — Settlements or maturities — (2,981 ) — (5 ) (28,372 ) — Premiums less benefits — — 19,244 — — 23,104 Gross transfers into Level 3 — — — — — — Gross transfers out of Level 3 — — — — — — Ending balance June 30, 2014 $ 11,932 $ 163,861 $ 186,261 $ 11,932 $ 163,861 $ 186,261 Within the net gain (loss) for derivatives included in net investment income were unrealized gains (losses) of $(10,602,000) and $3,641,000 relating to assets still held at June 30, 2015 and 2014, respectively. The transfers during the three and six months ended June 30, 2015 into Level 3 were the result of existing securities no longer being priced by the third-party pricing service at the end of the period. American National’s valuation of these securities involves judgment regarding assumptions market participants would use including quotes from independent brokers. There were no transfers between fair value hierarchies during the three or six months ended June 30, 2014. |