UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
For the quarterly period ended June 30, 2014
OR
For the transition period from to
Assurant, Inc.
(Exact name of registrant as specified in its charter)
(State or other jurisdiction
of incorporation)
(Commission
File Number)
(I.R.S. Employer
Identification No.)
One Chase Manhattan Plaza, 41st Floor
New York, New York 10005
(212) 859-7000
(Address, including zip code, and telephone number, including area code, of Registrant’s Principal Executive Offices)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, 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 smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES ¨ NO x
The number of shares of the registrant’s Common Stock outstanding at July 24, 2014 was 71,379,490.
ASSURANT, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2014
TABLE OF CONTENTS
Item
Number
PART I
FINANCIAL INFORMATION
1.
Financial Statements of Assurant, Inc.:
Consolidated Balance Sheets (unaudited) at June 30, 2014 and December 31, 2013
Consolidated Statements of Operations (unaudited) for the three and six months ended June 30, 2014 and 2013
Consolidated Statements of Comprehensive Income (unaudited) for the three and six months ended June 30, 2014 and 2013
Consolidated Statement of Changes in Stockholders’ Equity (unaudited) from December 31, 2013 through June 30, 2014
Consolidated Statements of Cash Flows (unaudited) for the six months ended June 30, 2014 and 2013
Notes to Consolidated Financial Statements (unaudited) for the three and six months ended June 30, 2014 and 2013
2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
3.
Quantitative and Qualitative Disclosures About Market Risk
4.
1A.
6.
Amounts are presented in United States of America (“U.S.”) dollars and all amounts are in thousands, except number of shares and per share amounts.
1
Consolidated Balance Sheets (unaudited)
At June 30, 2014 and December 31, 2013
Assets
Investments:
Fixed maturity securities available for sale, at fair value (amortized cost - $10,601,787 in 2014 and $10,520,310 in 2013)
Equity securities available for sale, at fair value (cost - $422,221 in 2014 and $417,535 in 2013)
Commercial mortgage loans on real estate, at amortized cost
Policy loans
Short-term investments
Collateral held/pledged under securities agreements
Other investments
Total investments
Cash and cash equivalents
Premiums and accounts receivable, net
Reinsurance recoverables
Accrued investment income
Deferred acquisition costs
Property and equipment, at cost less accumulated depreciation
Tax receivable
Goodwill
Value of business acquired
Other intangible assets, net
Other assets
Assets held in separate accounts
Total assets
See the accompanying notes to the consolidated financial statements
2
Liabilities
Future policy benefits and expenses
Unearned premiums
Claims and benefits payable
Commissions payable
Reinsurance balances payable
Funds held under reinsurance
Deferred gain on disposal of businesses
Obligation under securities agreements
Accounts payable and other liabilities
Deferred income taxes, net
Tax payable
Debt
Liabilities related to separate accounts
Total liabilities
Commitments and contingencies (Note 14)
Stockholders’ equity
Common stock, par value $0.01 per share, 800,000,000 shares authorized, 71,300,394 and 71,828,208 shares outstanding at June 30, 2014 and December 31, 2013, respectively
Additional paid-in capital
Retained earnings
Accumulated other comprehensive income
Treasury stock, at cost; 77,231,252 and 76,039,652 shares at June 30, 2014 and December 31, 2013, respectively
Total stockholders’ equity
Total liabilities and stockholders’ equity
3
Consolidated Statements of Operations (unaudited)
Three and Six Months Ended June 30, 2014 and 2013
(in thousands except number of shares and
per share amounts)
Revenues
Net earned premiums
Net investment income
Net realized gains on investments, excluding other-than-temporary impairment losses
Total other-than-temporary impairment losses
Portion of net loss recognized in other comprehensive income, before taxes
Net other-than-temporary impairment losses recognized in earnings
Amortization of deferred gain on disposal of businesses
Fees and other income
Total revenues
Benefits, losses and expenses
Policyholder benefits
Amortization of deferred acquisition costs and value of business acquired
Underwriting, general and administrative expenses
Interest expense
Total benefits, losses and expenses
Income before provision for income taxes
Provision for income taxes
Net income
Earnings Per Share
Basic
Diluted
Dividends per share
Share Data
Weighted average shares outstanding used in basic per share calculations
Plus: Dilutive securities
Weighted average shares used in diluted per share calculations
4
Consolidated Statements of Comprehensive Income (unaudited)
Other comprehensive income (loss):
Change in unrealized gains on securities, net of taxes of $(69,980), $172,721, $(156,856) and $199,026, respectively
Change in other-than-temporary impairment gains, net of taxes of $(400), $488, $(1,284) and $(914), respectively
Change in foreign currency translation, net of taxes of $9,012, $3,240, $12,354 and $5,804, respectively
Amortization of pension and postretirement unrecognized net periodic benefit cost, net of taxes of $(1,094), $(2,929), $(2,188) and $(5,863), respectively
Total other comprehensive income (loss)
Total comprehensive income (loss)
5
Consolidated Statement of Stockholders’ Equity (unaudited)
From December 31, 2013 through June 30, 2014
Balance, December 31, 2013
Stock plan exercises
Stock plan compensation expense
Change in tax benefit from share-based payment arrangements
Dividends
Acquisition of common stock
Other comprehensive income
Balance, June 30, 2014
6
Consolidated Statements of Cash Flows (unaudited)
Six Months Ended June 30, 2014 and 2013
Net cash provided by operating activities
Investing activities
Sales of:
Fixed maturity securities available for sale
Equity securities available for sale
Other invested assets
Property and equipment and other
Maturities, calls, prepayments, and scheduled redemption of:
Commercial mortgage loans on real estate
Purchases of:
Subsidiary, net of cash transferred (1)
Equity interest (2)
Change in short-term investments
Change in policy loans
Change in collateral held/pledged under securities agreements
Net cash provided by (used in) investing activities
Financing activities
Issuance of debt
Repayment of debt
Dividends paid
Payment of contingent obligations (3)
Change in obligation under securities agreements
Net cash (used in) provided by financing activities
Effect of exchange rate changes on cash and cash equivalents
Change in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
7
Notes to Consolidated Financial Statements (unaudited)
(In thousands, except number of shares and per share amounts)
1. Nature of Operations
Assurant, Inc. (the “Company”) is a holding company whose subsidiaries provide specialized insurance products and related services in North America, Latin America, Europe and other select worldwide markets.
The Company is traded on the New York Stock Exchange under the symbol AIZ.
Through its operating subsidiaries, the Company provides mobile device protection, debt protection administration, credit-related insurance, warranties and service contracts, pre-funded funeral insurance, lender-placed homeowners insurance, renters insurance and related products, manufactured housing homeowners insurance, individual health and small employer group health insurance, group dental insurance, group disability insurance, and group life insurance.
2. Basis of Presentation
The accompanying unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information. Accordingly, these statements do not include all of the information and footnotes required by GAAP for complete financial statements.
The interim financial data as of June 30, 2014 and December 31, 2013 and for the three and six months ended June 30, 2014 and 2013 is unaudited; in the opinion of management, the interim data includes all adjustments, consisting only of normal recurring adjustments, necessary to a fair statement of the results for the interim periods. The unaudited interim consolidated financial statements include the accounts of the Company and all of its wholly owned subsidiaries. All inter-company transactions and balances are eliminated in consolidation.
The Affordable Care Act introduced new and significant premium stabilization programs beginning in 2014. These programs required the Company to record amounts to our consolidated financial statements based on assumptions and estimates which could materially change as experience develops.
Operating results for the three and six months ended June 30, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014. The accompanying unaudited interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.
3. Recent Accounting Pronouncements
Adopted
On January 1, 2014, the Company adopted the new guidance on presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. The amendments in this guidance state that an unrecognized tax benefit, or a portion thereof, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. An exception to this guidance would be where a net operating loss carryforward or similar tax loss or credit carryforward would not be available under the tax law to settle any additional income taxes that would result from the disallowance of a tax position, or the tax law does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose. In such a case, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The adoption of this new presentation guidance did not impact the Company’s financial position or results of operations.
On January 1, 2014, the Company adopted the other expenses guidance that addresses how health insurers should recognize and classify in their statements of operations fees mandated by the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010, and the rules and regulations thereunder (together, the “Affordable Care Act”). The Affordable Care Act imposes an annual fee on health insurers for each calendar year beginning on or after January 1, 2014. The amendments
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specify that the liability for the fee should be estimated and recorded in full once the entity provides qualifying health insurance in the applicable calendar year in which the fee is payable with a corresponding deferred cost that is amortized to expense ratably over the calendar year during which it is payable. The Company’s adoption of this guidance impacts the results of our Assurant Health and Assurant Employee Benefits segments. The estimated liability for the mandated fees and the corresponding deferred cost asset for calendar year 2014 is $25,600 and was recorded in accounts payable and other liabilities and in other assets, respectively, on the consolidated balance sheets. For the six months ended June 30, 2014, the Company recorded $12,800 of amortization expense related to these deferred costs in underwriting, general and administrative expenses in the consolidated statements of operations. These are estimated amounts and may be adjusted once the final assessment is received from the federal government.
Not Yet Adopted
In May 2014, the Financial Accounting Standards Board (“FASB”) issued amended guidance on revenue recognition. The amended guidance affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards. Insurance contracts are within the scope of other standards and therefore are specifically excluded from the scope of the amended revenue recognition guidance. The core principle of the amended guidance is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve the core principle, the entity applies a five step process outlined in the amended guidance. The amended guidance also includes a cohesive set of disclosure requirements. The amended guidance is effective for interim and annual periods beginning after December 15, 2016 and early adoption is not permitted. Therefore, the Company is required to adopt the guidance on January 1, 2017. An entity can chose to apply the amended guidance using either the full retrospective approach or a modified retrospective approach. The Company is currently evaluating the requirements of the revenue recognition guidance as it relates to its non-insurance contract revenue and the potential impact on the Company’s financial position and results of operations.
4. Acquisitions
As previously disclosed, on December 30, 2013, the Company paid Mex$1,191,499 (U.S.D. $91,420) for a 40% investment in the Mexican operations of Iké Asistencia (“Iké”), an assistance services business with operations in Mexico and other countries in Latin America. In addition, on February 10, 2014, the Company made a previously disclosed payment of Mex$272,541 (U.S.D. $20,950) for 40% of Iké’s Latin American operations. Following the February 10, 2014 payment, the Company owns 40% of the equity interests and outstanding shares of Iké and, under the terms of the agreements, will also have options to acquire the remaining interest in Iké over time.
On March 24, 2014, the Company made the required delayed payment of £3,000 ($4,951) and contingent payment of £16,313 ($26,920) to complete the previously disclosed October 25, 2013 acquisition of the Lifestyle Services Group. The contingent payment was made given the stipulated contractual renewal of a key client.
On April 16, 2014, the Company acquired StreetLinks, LLC, a leading independent appraisal management company, from Novation Companies, Inc. The acquisition-date fair value of the consideration transferred totaled $65,905, which consists of an initial cash payment of $60,905 and a contingent payment of $5,000. The contingent consideration arrangement is based on future expected revenue. In connection with the acquisition, the Company recorded $47,970 of customer and technology based intangible assets, all of which are amortizable over a 2 to 12 year period, and $14,738 of goodwill, none of which is tax-deductible. The primary factor contributing to the recognition of goodwill is the future expected growth of this business within Assurant Specialty Property.
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5. Investments
The following tables show the cost or amortized cost, gross unrealized gains and losses, fair value and other-than-temporary impairment (“OTTI”) of our fixed maturity and equity securities as of the dates indicated:
Fixed maturity securities:
United States Government and government agencies and authorities
States, municipalities and political subdivisions
Foreign governments
Asset-backed
Commercial mortgage-backed
Residential mortgage-backed
Corporate
Total fixed maturity securities
Equity securities:
Common stocks
Non-redeemable preferred stocks
Total equity securities
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Our states, municipalities and political subdivisions holdings are highly diversified across the U.S. and Puerto Rico, with no individual state’s exposure (including both general obligation and revenue securities) exceeding 0.6% and 0.5% of the overall investment portfolio as of June 30, 2014 and December 31, 2013, respectively. At June 30, 2014 and December 31, 2013, the securities include general obligation and revenue bonds issued by states, cities, counties, school districts and similar issuers, including $265,874 and $234,640, respectively, of advance refunded or escrowed-to-maturity bonds (collectively referred to as “pre-refunded bonds”), which are bonds for which an irrevocable trust has been established to fund the remaining payments of principal and interest. As of June 30, 2014 and December 31, 2013, revenue bonds account for 53% of the holdings. Excluding pre-refunded revenue bonds, the activities supporting the income streams of the Company’s revenue bonds are across a broad range of sectors, primarily highway, water, airport and marina, higher education, specifically pledged tax revenues, and other miscellaneous sources such as bond banks, finance authorities and appropriations.
The Company’s investments in foreign government fixed maturity securities are held mainly in countries and currencies where the Company has policyholder liabilities, which allow the assets and liabilities to be more appropriately matched. At June 30, 2014, approximately 72%, 15% and 5% of the foreign government securities were held in the Canadian government/provincials and the governments of Brazil and Germany, respectively. At December 31, 2013, approximately 70%, 15% and 6% of the foreign government securities were held in the Canadian government/provincials and the governments of Brazil and Germany, respectively. No other country represented more than 3% of our foreign government securities as of June 30, 2014 and December 31, 2013.
The Company has European investment exposure in its corporate fixed maturity and equity securities of $1,128,779 with an unrealized gain of $118,437 at June 30, 2014 and $1,082,129 with an unrealized gain of $78,126 at December 31, 2013. Approximately 22% and 25% of the corporate European exposure is held in the financial industry at June 30, 2014 and December 31, 2013, respectively. Our largest European country exposure represented approximately 5% and 6% of the fair value of our corporate securities as of June 30, 2014 and December 31, 2013, respectively. Approximately 5% of the fair value of the corporate European securities are pound and euro-denominated and are not hedged to U.S. dollars, but held to support those foreign-denominated liabilities. Our international investments are managed as part of our overall portfolio with the same approach to risk management and focus on diversification.
The cost or amortized cost and fair value of fixed maturity securities at June 30, 2014 by contractual maturity are shown below. Expected maturities may differ from contractual maturities because issuers of the securities may have the right to call or prepay obligations with or without call or prepayment penalties.
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years
Total
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The following table summarizes the proceeds from sales of available-for-sale securities and the gross realized gains and gross realized losses that have been included in earnings as a result of those sales.
Proceeds from sales
Gross realized gains
Gross realized losses
The following table sets forth the net realized gains (losses), including OTTI, recognized in the statement of operations as follows:
Net realized gains (losses) related to sales and other:
Fixed maturity securities
Equity securities
Total net realized gains related to sales and other
Net realized losses related to other-than-temporary impairments:
Total net realized losses related to other-than-temporary impairments
Total net realized gains
Other-Than-Temporary Impairments
The Company follows the OTTI guidance which requires entities to separate an OTTI of a debt security into two components when there are credit related losses associated with the impaired debt security for which the Company asserts that it does not have the intent to sell, and it is more likely than not that it will not be required to sell before recovery of its cost basis. Under the OTTI guidance, the amount of the OTTI related to a credit loss is recognized in earnings, and the amount of the OTTI related to other, non-credit factors (e.g., interest rates, market conditions, etc.) is recorded as a component of other comprehensive income. In instances where no credit loss exists but the Company intends to sell the security or it is more likely than not that the Company will have to sell the debt security prior to the anticipated recovery, the decline in market value below amortized cost is recognized as an OTTI in earnings. In periods after the recognition of an OTTI on debt securities, the Company accounts for such securities as if they had been purchased on the measurement date of the OTTI at an amortized cost basis equal to the previous amortized cost basis less the OTTI recognized in earnings. For debt securities for which OTTI was recognized in earnings, the difference between the new amortized cost basis and the cash flows expected to be collected will be accreted or amortized into net investment income.
For the three and six months ended June 30, 2014, the Company recorded $40 and $69, respectively, of OTTI, of which $30 and $30, respectively, was related to credit losses and recorded as net OTTI losses recognized in earnings, with the remaining $10 and $39, respectively, related to all other factors and recorded as an unrealized loss component of AOCI. For the three and six months
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ended June 30, 2013, the Company recorded $179 of OTTI, of which $107 was related to credit losses and recorded as net OTTI losses recognized in earnings, with the remaining $72 related to all other factors and recorded as an unrealized loss component of AOCI.
The following tables set forth the amount of credit loss impairments recognized within the results of operations on fixed maturity securities held by the Company as of the dates indicated, for which a portion of the OTTI loss was recognized in AOCI, and the corresponding changes in such amounts.
Balance, March 31,
Additions for credit loss impairments recognized in the current period on securities previously impaired
Reductions for increases in cash flows expected to be collected that are recognized over the remaining life of the security
Reductions for credit loss impairments previously recognized on securities which matured, paid down, prepaid or were sold during the period
Balance, June 30,
Balance, January 1,
We regularly monitor our investment portfolio to ensure investments that may be other-than-temporarily impaired are identified in a timely fashion, properly valued, and charged against earnings in the proper period. The determination that a security has incurred an other-than-temporary decline in value requires the judgment of management. Assessment factors include, but are not limited to, the length of time and the extent to which the market value has been less than cost, the financial condition and rating of the issuer, whether any collateral is held, the intent and ability of the Company to retain the investment for a period of time sufficient to allow for recovery for equity securities and the intent to sell or whether it is more likely than not that the Company will be required to sell for fixed maturity securities. Inherently, there are risks and uncertainties involved in making these judgments. Changes in circumstances and critical assumptions such as a continued weak economy, a more pronounced economic downturn or unforeseen events which affect one or more companies, industry sectors, or countries could result in additional impairments in future periods for other-than-temporary declines in value. Any equity security whose price decline is deemed other-than-temporary is written down to its then current market value with the amount of the impairment reported as a realized loss in that period. The impairment of a fixed maturity security that the Company has the intent to sell or that it is more likely than not that the Company will be required to sell is deemed other-than-temporary and is written down to its market value at the balance sheet date with the amount of the impairment reported as a realized loss in that period. For all other-than-temporarily impaired fixed maturity securities that do not meet either of these two criteria, the Company is required to analyze its ability to recover the amortized cost of the security by calculating the net present value of projected future cash flows. For these other-than-temporarily impaired fixed maturity securities, the net amount recognized in earnings is equal to the difference between the amortized cost of the fixed maturity security and its net present value.
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The Company considers different factors to determine the amount of projected future cash flows and discounting methods for corporate debt and residential and commercial mortgage-backed or asset-backed securities. For corporate debt securities, the split between the credit and non-credit losses is driven principally by assumptions regarding the amount and timing of projected future cash flows. The net present value is calculated by discounting the Company’s best estimate of projected future cash flows at the effective interest rate implicit in the security at the date of acquisition. For residential and commercial mortgage-backed and asset-backed securities, cash flow estimates, including prepayment assumptions, are based on data from widely accepted third-party data sources or internal estimates. In addition to prepayment assumptions, cash flow estimates vary based on assumptions regarding the underlying collateral including default rates, recoveries and changes in value. The net present value is calculated by discounting the Company’s best estimate of projected future cash flows at the effective interest rate implicit in the fixed maturity security prior to impairment at the balance sheet date. The discounted cash flows become the new amortized cost basis of the fixed maturity security.
In periods subsequent to the recognition of an OTTI, the Company generally accretes the discount (or amortizes the reduced premium) into net investment income, up to the non-discounted amount of projected future cash flows, resulting from the reduction in cost basis, based upon the amount and timing of the expected future cash flows over the estimated period of cash flows.
The investment category and duration of the Company’s gross unrealized losses on fixed maturity securities and equity securities at June 30, 2014 and December 31, 2013 were as follows:
Common stock
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Total gross unrealized losses represent approximately 2% and 3% of the aggregate fair value of the related securities at June 30, 2014 and December 31, 2013, respectively. Approximately 15% and 94% of these gross unrealized losses have been in a continuous loss position for less than twelve months at June 30, 2014 and December 31, 2013, respectively. The total gross unrealized losses are comprised of 296 and 667 individual securities at June 30, 2014 and December 31, 2013, respectively. In accordance with its policy described above, the Company concluded that for these securities an adjustment to its results of operations for other-than-temporary impairments of the gross unrealized losses was not warranted at June 30, 2014 and December 31, 2013. These conclusions were based on a detailed analysis of the underlying credit and expected cash flows of each security. As of June 30, 2014, the gross unrealized losses that have been in a continuous loss position for twelve months or more were concentrated in the Company’s foreign governments, residential mortgage-backed, and corporate fixed maturity securities, and in non-redeemable preferred stocks. Within the Company’s corporate fixed maturity securities, the majority of the loss position relates to securities in the utilities sector. The utilities sector’s gross unrealized losses of twelve months or more were $1,219, or 28%, of the corporate fixed maturity securities total. The non-redeemable preferred stocks are perpetual preferred securities that have characteristics of both debt and equity securities. To evaluate these securities, we apply an impairment model similar to that used for our fixed maturity securities. As of June 30, 2014, the Company did not intend to sell these securities and it was not more likely than not that the Company would be required to sell them and no underlying cash flow issues were noted. Therefore, the Company did not recognize an OTTI on those perpetual preferred securities that had been in a continuous unrealized loss position for twelve months or more. As of June 30, 2014, the Company did not intend to sell the fixed maturity securities and it was not more likely than not that the Company would be required to sell the securities before the anticipated recovery of their amortized cost basis. The gross unrealized losses are primarily attributable to widening credit spreads associated with an underlying shift in overall credit risk premium.
The Company has entered into commercial mortgage loans, collateralized by the underlying real estate, on properties located throughout the U.S. and Canada. At June 30, 2014, approximately 39% of the outstanding principal balance of commercial mortgage loans was concentrated in the states of California, New York, and Utah. Although the Company has a diversified loan portfolio, an economic downturn could have an adverse impact on the ability of its debtors to repay their loans. The outstanding balance of commercial mortgage loans ranges in size from $23 to $15,385 at June 30, 2014 and from $9 to $15,574 at December 31, 2013.
Credit quality indicators for commercial mortgage loans are loan-to-value and debt-service coverage ratios. Loan-to-value and debt-service coverage ratios are measures commonly used to assess the credit quality of commercial mortgage loans. The loan-to-value ratio compares the principal amount of the loan to the fair value of the underlying property collateralizing the loan, and is commonly expressed as a percentage. The debt-service coverage ratio compares a property’s net operating income to its debt-service payments and is commonly expressed as a ratio. The loan-to-value and debt-service coverage ratios are generally updated annually in the third quarter.
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The following summarizes our loan-to-value and average debt-service coverage ratios as of the dates indicated:
Loan-to-Value
70% and less
71 – 80%
81 – 95%
Greater than 95%
Gross commercial mortgage loans
Less valuation allowance
Net commercial mortgage loans
All commercial mortgage loans that are individually impaired have an established mortgage loan valuation allowance for losses. Changing economic conditions affect our valuation of commercial mortgage loans. Changing vacancies and rents are incorporated into the discounted cash flow analysis that we perform for monitored loans and may contribute to the establishment of (or an increase or decrease in) a commercial mortgage loan valuation allowance for losses. In addition, we continue to monitor the entire commercial mortgage loan portfolio to identify risk. Areas of emphasis are properties that have exposure to specific geographic events, have deteriorating credits or have experienced a reduction in debt-service coverage ratio. Where warranted, we have established or increased a valuation allowance based upon this analysis.
Collateralized Transactions
The Company engages in transactions in which fixed maturity securities, primarily bonds issued by the U.S. government and government agencies and authorities, and U.S. corporations, are loaned to selected broker/dealers. Collateral, greater than or equal to 102% of the fair value of the securities lent, plus accrued interest, is received in the form of cash and cash equivalents held by a custodian bank for the benefit of the Company. The use of cash collateral received is unrestricted. The Company reinvests the cash collateral received, generally in investments of high credit quality that are designated as available-for-sale. The Company monitors the fair value of securities loaned and the collateral received, with additional collateral obtained, as necessary. The Company is subject to the risk of loss to the extent there is a loss on the re-investment of cash collateral.
As of June 30, 2014 and December 31, 2013, our collateral held under securities lending agreements, of which its use is unrestricted, was $95,222 and $95,215, respectively, and is included in the consolidated balance sheets under the collateral held/pledged under securities agreements. Our liability to the borrower for collateral received was $95,217 and $95,206, respectively, and is included in the consolidated balance sheets under obligation under securities agreements. The difference between the collateral held and obligations under securities lending is recorded as an unrealized gain (loss) and is included as part of AOCI. There was one security in an unrealized loss position as of June 30, 2014 and it has been in an unrealized loss position for less than 12 months. All securities were in an unrealized gain position as of December 31, 2013. The Company includes the available-for-sale investments purchased with the cash collateral in its evaluation of other-than-temporary impairments.
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Cash proceeds that the Company receives as collateral for the securities it lends and subsequent repayment of the cash are regarded by the Company as cash flows from financing activities, since the cash received is considered a borrowing. Since the Company reinvests the cash collateral generally in investments that are designated as available-for-sale, the reinvestment is presented as cash flows from investing activities.
6. Fair Value Disclosures
Fair Values, Inputs and Valuation Techniques for Financial Assets and Liabilities Disclosures
The fair value measurements and disclosures guidance defines fair value and establishes a framework for measuring fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In accordance with this guidance, the Company has categorized its recurring basis financial assets and liabilities into a three-level fair value hierarchy based on the priority of the inputs to the valuation technique.
The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.
The levels of the fair value hierarchy are described below:
Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company can access.
Level 2 inputs utilize other than quoted prices included in Level 1 that are observable for the asset, either directly or indirectly, for substantially the full term of the asset. Level 2 inputs include quoted prices for similar assets in active markets, quoted prices for identical or similar assets in markets that are not active and inputs other than quoted prices that are observable in the marketplace for the asset. The observable inputs are used in valuation models to calculate the fair value for the asset.
Level 3 inputs are unobservable but are significant to the fair value measurement for the asset, and include situations where there is little, if any, market activity for the asset. These inputs reflect management’s own assumptions about the assumptions a market participant would use in pricing the asset.
A review of fair value hierarchy classifications is conducted on a quarterly basis. Changes in the observability of valuation inputs may result in a reclassification of levels for certain securities within the fair value hierarchy.
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The following tables present the Company’s fair value hierarchy for assets and liabilities measured at fair value on a recurring basis as of June 30, 2014 and December 31, 2013. The amounts presented below for Collateral held/pledged under securities agreements, Other investments, Cash equivalents, Other assets, Assets and Liabilities held in separate accounts and Other liabilities differ from the amounts presented in the consolidated balance sheets because only certain investments or certain assets and liabilities within these line items are measured at estimated fair value. Other investments are comprised of investments in the Assurant Investment Plan, American Security Insurance Company Investment Plan, Assurant Deferred Compensation Plan, a modified coinsurance arrangement and other derivatives. Other liabilities are comprised of investments in the Assurant Investment Plan, contingent consideration related to a business combination and other derivatives. The fair value amount and the majority of the associated levels presented for Other investments and Assets and Liabilities held in separate accounts are received directly from third parties.
Financial Assets
State, municipalities and political subdivisions
Cash equivalents
Total financial assets
Financial Liabilities
Other liabilities
Total financial liabilities
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There were no transfers between Level 1 and Level 2 financial assets during either period. However, there were transfers between Level 2 and Level 3 financial assets during the periods, which are reflected in the “Transfers in” and “Transfers out” columns below. Transfers between Level 2 and Level 3 most commonly occur from changes in the availability of observable market information and re-evaluation of the observability of pricing inputs. Any remaining unpriced securities are submitted to independent brokers who provide non-binding broker quotes or are priced by other qualified sources.
The following tables summarize the change in balance sheet carrying value associated with Level 3 financial assets and liabilities carried at fair value during the three months ended June 30, 2014 and 2013:
Fixed Maturity Securities
Equity Securities
Total level 3 assets and liabilities
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21
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Three different valuation techniques can be used in determining fair value for financial assets and liabilities: the market, income or cost approaches. The three valuation techniques described in the fair value measurements and disclosures guidance are consistent with generally accepted valuation methodologies. The market approach valuation techniques use prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. When possible, quoted prices (unadjusted) in active markets are used as of the period-end date (such as for mutual funds and money market funds). Otherwise, valuation techniques consistent with the market approach including matrix pricing and comparables are used. Matrix pricing is a mathematical technique employed principally to value debt securities without relying exclusively on quoted prices for those securities but rather by relying on the securities’ relationship to other benchmark quoted securities. Market approach valuation techniques often use market multiples derived from a set of comparables. Multiples might lie in ranges with a different multiple for each comparable. The selection of where within the range the appropriate multiple falls requires judgment, considering both qualitative and quantitative factors specific to the measurement.
Income approach valuation techniques convert future amounts, such as cash flows or earnings, to a single present amount, or a discounted amount. These techniques rely on current market expectations of future amounts as of the period-end date. Examples of income approach valuation techniques include present value techniques, option-pricing models, binomial or lattice models that incorporate present value techniques and the multi-period excess earnings method.
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Cost approach valuation techniques are based upon the amount that would be required to replace the service capacity of an asset at the period-end date, or the current replacement cost. That is, from the perspective of a market participant (seller), the price that would be received for the asset is determined based on the cost to a market participant (buyer) to acquire or construct a substitute asset of comparable utility, adjusted for obsolescence.
While not all three approaches are applicable to all financial assets or liabilities, where appropriate, one or more valuation techniques may be used. For all the classes of financial assets and liabilities included in the above hierarchy, excluding the CPI Caps and certain privately placed corporate bonds, the market valuation technique is generally used. For certain privately placed corporate bonds, the CPI Caps, and certain derivatives, the income valuation technique is generally used. For the periods ended June 30, 2014 and December 31, 2013, the application of the valuation technique applied to the Company’s classes of financial assets and liabilities has been consistent.
Level 1 Securities
The Company’s investments and liabilities classified as Level 1 as of June 30, 2014 and December 31, 2013, consisted of mutual funds and money market funds, foreign government fixed maturities and common stocks that are publicly listed and/or actively traded in an established market.
Level 2 Securities
The Company’s Level 2 securities are valued using various observable market inputs obtained from a pricing service. The pricing service prepares estimates of fair value measurements for our Level 2 securities using proprietary valuation models based on techniques such as matrix pricing which include observable market inputs. The fair value measurements and disclosures guidance defines observable market inputs as the assumptions market participants would use in pricing the asset or liability developed on market data obtained from sources independent of the Company. The extent of the use of each observable market input for a security depends on the type of security and the market conditions at the balance sheet date. Depending on the security, the priority of the use of observable market inputs may change as some observable market inputs may not be relevant or additional inputs may be necessary. The following observable market inputs (“standard inputs”), listed in the approximate order of priority, are utilized in the pricing evaluation of Level 2 securities: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data including market research data. Further details for Level 2 investment types follow:
United States Government and government agencies and authorities: U.S. government and government agencies and authorities securities are priced by our pricing service utilizing standard inputs. Included in this category are U.S. Treasury securities which are priced using vendor trading platform data in addition to the standard inputs.
State, municipalities and political subdivisions: State, municipalities and political subdivisions securities are priced by our pricing service utilizing material event notices and new issue data inputs in addition to the standard inputs.
Foreign governments: Foreign government securities are primarily fixed maturity securities denominated in Canadian dollars which are priced by our pricing service utilizing standard inputs. The pricing service also evaluates each security based on relevant market information including relevant credit information, perceived market movements and sector news.
Commercial mortgage-backed, residential mortgage-backed and asset-backed: Commercial mortgage-backed, residential mortgage-backed and asset-backed securities are priced by our pricing service utilizing monthly payment information and collateral performance information in addition to the standard inputs. Additionally, commercial mortgage-backed securities and asset-backed securities utilize new issue data while residential mortgage-backed securities utilize vendor trading platform data.
Corporate: Corporate securities are priced by our pricing service utilizing standard inputs. Non-investment grade securities within this category are priced by our pricing service utilizing observations of equity and credit default swap curves related to the issuer in addition to the standard inputs. Certain privately placed corporate bonds are priced by a non-pricing service source using a model with observable inputs including, but not limited to, the credit rating, credit spreads, sector add-ons, and issuer specific add-ons.
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Non-redeemable preferred stocks: Non-redeemable preferred stocks are priced by our pricing service utilizing observations of equity and credit default swap curves related to the issuer in addition to the standard inputs.
Short-term investments, collateral held/pledged under securities agreements, other investments, cash equivalents, and assets/liabilities held in separate accounts: To price the fixed maturity securities in these categories, the pricing service utilizes the standard inputs.
Other liabilities: The contingent consideration liability related to a business combination is valued at the contractual amount stated in the purchase agreement plus accrued interest. The contractual amount plus interest represents the fair value and is a market observable input due to the fact the amount is specifically stated in the agreement and there is a short time frame (less than three months) for determining whether the payment will be made or not.
Valuation models used by the pricing service can change period to period, depending on the appropriate observable inputs that are available at the balance sheet date to price a security. When market observable inputs are unavailable to the pricing service, the remaining unpriced securities are submitted to independent brokers who provide non-binding broker quotes or are priced by other qualified sources. If the Company cannot corroborate the non-binding broker quotes with Level 2 inputs, these securities are categorized as Level 3 securities.
Level 3 Securities
The Company’s investments classified as Level 3 as of June 30, 2014 and December 31, 2013 consisted of fixed maturity and equity securities and derivatives. All of the Level 3 fixed maturity and equity securities are priced using non-binding broker quotes which cannot be corroborated with Level 2 inputs. Of our total Level 3 fixed maturity and equity securities, $63,286 and $70,244 were priced by a pricing service using single broker quotes due to insufficient information to provide an evaluated price as of June 30, 2014 and December 31, 2013, respectively. The single broker quotes are provided by market makers or broker-dealers who are recognized as market participants in the markets in which they are providing the quotes. The remaining $58,432 and $97,219 were priced internally using independent and non-binding broker quotes as of June 30, 2014 and December 31, 2013, respectively. The inputs factoring into the broker quotes include trades in the actual bond being priced, trades of comparable bonds, quality of the issuer, optionality, structure and liquidity. Significant changes in interest rates, issuer credit, liquidity, and overall market conditions would result in a significantly lower or higher broker quote. The prices received from both the pricing service and internally are reviewed for reasonableness by management and if necessary, management works with the pricing service or broker to further understand how they developed their price. Further details on Level 3 derivative investment types follow:
Other investments and other liabilities: Swaptions are priced using a Black-Scholes pricing model incorporating third-party market data, including swap volatility data. Credit default swaps are priced using non-binding quotes provided by market makers or broker-dealers who are recognized as market participants. Inputs factored into the non-binding quotes include trades in the actual credit default swap which is being priced, trades in comparable credit default swaps, quality of the issuer, structure and liquidity. The net option related to the investment in Iké is valued using an income approach; specifically, a Monte Carlo simulation option pricing model. The inputs to the model include, but are not limited to, the projected normalized earnings before interest, tax, depreciation, and amortization (EBITDA) and free cash flow for the underlying asset, the discount rate, and the volatility of and the correlation between the normalized EBITDA and the value of the underlying asset. Significant increases (decreases) in the projected normalized EBITDA relative to the value of the underlying asset in isolation would result in a significantly higher (lower) fair value.
Other assets: A non-pricing service source prices the CPI Cap derivatives using a model with inputs including, but not limited to, the time to expiration, the notional amount, the strike price, the forward rate, implied volatility and the discount rate.
Management evaluates the following factors in order to determine whether the market for a financial asset is inactive. The factors include, but are not limited to:
There are few recent transactions,
Little information is released publicly,
The available prices vary significantly over time or among market participants,
The prices are stale (i.e., not current), and
The magnitude of the bid-ask spread.
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Illiquidity did not have a material impact in the fair value determination of the Company’s financial assets.
The Company generally obtains one price for each financial asset. The Company performs a monthly analysis to assess if the evaluated prices represent a reasonable estimate of their fair value. This process involves quantitative and qualitative analysis and is overseen by investment and accounting professionals. Examples of procedures performed include, but are not limited to, initial and on-going review of pricing service methodologies, review of the prices received from the pricing service, review of pricing statistics and trends, and comparison of prices for certain securities with two different appropriate price sources for reasonableness. Following this analysis, the Company generally uses the best estimate of fair value based upon all available inputs. On infrequent occasions, a non-pricing service source may be more familiar with the market activity for a particular security than the pricing service. In these cases the price used is taken from the non-pricing service source. The pricing service provides information to indicate which securities were priced using market observable inputs so that the Company can properly categorize our financial assets in the fair value hierarchy.
For the net option, the Company will perform a periodic analysis to assess if the evaluated price represents a reasonable estimate of the fair value for the financial liability. This process will involve quantitative and qualitative analysis overseen by finance and accounting professionals. Examples of procedures to be performed include, but are not limited to, initial and on-going review of the pricing methodology and review of the projection for the underlying asset including the probability distribution of possible scenarios.
Disclosures for Non-Financial Assets Measured at Fair Value on a Non-Recurring Basis
The Company also measures the fair value of certain assets on a non-recurring basis, generally on an annual basis, or when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. These assets include commercial mortgage loans, goodwill and finite-lived intangible assets.
The Company utilizes both the income and market valuation approaches to measure the fair value of its reporting units when required. Under the income approach, the Company determined the fair value of the reporting units considering distributable earnings, which were estimated from operating plans. The resulting cash flows were then discounted using a market participant weighted average cost of capital estimated for the reporting units. After discounting the future discrete earnings to their present value, the Company estimated the terminal value attributable to the years beyond the discrete operating plan period. The discounted terminal value was then added to the aggregate discounted distributable earnings from the discrete operating plan period to estimate the fair value of the reporting units. Under the market approach, the Company derived the fair value of the reporting units based on various financial multiples, including but not limited to: price to tangible book value of equity, price to estimated 2014 earnings and price to estimated 2014 earnings, which were estimated based on publicly available data related to comparable guideline companies. In addition, financial multiples were also estimated from publicly available purchase price data for acquisitions of companies operating in the insurance industry. The estimated fair value of the reporting units was more heavily weighted towards the income approach because in the current economic environment the earnings capacity of a business is generally considered the most important factor in the valuation of a business enterprise. This fair value determination was categorized as Level 3 (unobservable) in the fair value hierarchy.
Fair Value of Financial Instruments Disclosures
The financial instruments guidance requires disclosure of fair value information about financial instruments, as defined therein, for which it is practicable to estimate such fair value. Therefore, it requires fair value disclosure for financial instruments that are not recognized or are not carried at fair value in the consolidated balance sheets. However, this guidance excludes certain financial instruments, including those related to insurance contracts and those accounted for under the equity method and joint ventures guidance (such as real estate joint ventures).
For the financial instruments included within the following financial assets and financial liabilities, the carrying value in the consolidated balance sheets equals or approximates fair value. Please refer to the Fair Value Inputs and Valuation Techniques for Financial Assets and Liabilities Disclosures section above for more information on the financial instruments included within the following financial assets and financial liabilities and the methods and assumptions used to estimate fair value:
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In estimating the fair value of the financial instruments that are not recognized or are not carried at fair value in the consolidated balance sheets, the Company used the following methods and assumptions:
Commercial mortgage loans: the fair values of mortgage loans are estimated using discounted cash flow models. The model inputs include mortgage amortization schedules and loan provisions, an internally developed credit spread based on the credit risk associated with the borrower and the U.S. Treasury spot curve. Mortgage loans with similar characteristics are aggregated for purposes of the calculations.
Policy loans: the carrying value of policy loans reported in the consolidated balance sheets approximates fair value.
Policy reserves under investment products: the fair values for the Company’s policy reserves under investment products are determined using discounted cash flow analysis. Key inputs to the valuation include projections of policy cash flows, reserve run-off, market yields and risk margins.
Funds held under reinsurance: the carrying value reported approximates fair value due to the short maturity of the instruments.
Debt: the fair value of debt is based upon matrix pricing performed by the pricing service utilizing the standard inputs.
Obligation under securities agreements: obligation under securities agreements is reported at the amount of cash received from the selected broker/dealers.
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The following table discloses the carrying value, fair value amount and hierarchy level of the financial instruments that are not recognized or are not carried at fair value in the consolidated balance sheets:
Policy reserves under investment products (Individual and group annuities, subject to discretionary withdrawal) (1)
Funds withheld under reinsurance
Obligations under securities agreements
Reinsurance Recoverables Credit Disclosures
A key credit quality indicator for reinsurance is the A.M. Best financial strength ratings of the reinsurer. The A.M. Best ratings are an independent opinion of a reinsurer’s ability to meet ongoing obligations to policyholders. The A.M. Best ratings for new reinsurance agreements where there is material credit exposure are reviewed at the time of execution. The A.M. Best ratings for existing reinsurance agreements are reviewed on a periodic basis, at least annually. The A.M. Best ratings have not changed significantly since December 31, 2013.
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An allowance for doubtful accounts for reinsurance recoverables is recorded on the basis of periodic evaluations of balances due from reinsurers (net of collateral), reinsurer solvency, management’s experience and current economic conditions. Information about the allowance for doubtful accounts for reinsurance recoverable as of June 30, 2014 is as follows:
Balance as of beginning-of-year
Provision
Other additions
Direct write-downs charged against the allowance
Balance as of the end-of-period
7. Debt
On March 28, 2013, the Company issued two series of senior notes with an aggregate principal amount of $700,000 (the “2013 Senior Notes”). The Company received net proceeds of $698,093 from this transaction, which represents the principal amount less the discount before offering expenses. The discount of $1,907 is being amortized over the life of the 2013 Senior Notes and is included as part of interest expense on the consolidated statements of operations. The first series is $350,000 in principal amount, bears interest at 2.50% per year and is payable in a single installment due March 15, 2018 and was issued at a 0.18% discount. The second series is $350,000 in principal amount, bears interest at 4.00% per year and is payable in a single installment due March 15, 2023 and was issued at a 0.37% discount. Interest on the 2013 Senior Notes is payable semi-annually on March 15 and September 15 of each year. The 2013 Senior Notes are unsecured obligations and rank equally with all of the Company’s other senior unsecured indebtedness. The Company may redeem each series of the 2013 Senior Notes in whole or in part at any time and from time to time before their maturity at the redemption price set forth in the Indenture. The 2013 Senior Notes are registered under the Securities Act of 1933, as amended.
The interest expense incurred related to the 2013 Senior Notes was $5,745 and $5,743 for the three months ended June 30, 2014 and 2013, respectively, and $11,489 and $5,743 for the six months ended June 30, 2014 and 2013, respectively. There was $6,635 and $5,688 of accrued interest at June 30, 2014 and 2013, respectively. The Company made an interest payment on the 2013 Senior Notes of $11,375 on March 15, 2014.
In February 2004, the Company issued two series of senior notes with an aggregate principal amount of $975,000 (the “2004 Senior Notes”). The Company received proceeds of $971,537 from this transaction, which represents the principal amount less the discount before offering expenses. The discount of $3,463 is being amortized over the life of the 2004 Senior Notes and is included as part of interest expense on the statements of operations. The first series was $500,000 in principal amount, issued at a 0.11% discount, bore interest at 5.63% per year and was repaid on February 18, 2014. The second series is $475,000 in principal amount, bears interest at 6.75% per year and is payable in a single installment due February 15, 2034 and was issued at a 0.61% discount. Interest on the 2004 Senior Notes is payable semi-annually on February 15 and August 15 of each year. The 2004 Senior Notes are unsecured obligations and rank equally with all of the Company’s other senior unsecured indebtedness. The 2004 Senior Notes are not redeemable prior to maturity. All of the holders of the 2004 Senior Notes exchanged their notes in May 2004 for new notes registered under the Securities Act of 1933, as amended.
The interest expense incurred related to the 2004 Senior Notes was $8,031 and $15,003 for the three months ended June 30, 2014 and 2013, respectively, and $19,352 and $30,081 for the six months ended June 30, 2014 and 2013, respectively. There was $12,023 and $22,070 of accrued interest at June 30, 2014 and 2013, respectively. The Company made interest payments of $30,094 on February 15, 2014 and 2013.
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Credit Facility
The Company’s commercial paper program requires the Company to maintain liquidity facilities either in an available amount equal to any outstanding notes from the commercial paper program or in an amount sufficient to maintain the ratings assigned to the notes issued from the commercial paper program. The Company’s subsidiaries do not maintain commercial paper or other borrowing facilities at their level. This program is currently backed up by a $350,000 senior revolving credit facility, of which $345,740 was available at June 30, 2014, due to $4,260 of outstanding letters of credit related to this program.
On September 21, 2011, the Company entered into a four-year unsecured $350,000 revolving credit agreement (“2011 Credit Facility”) with a syndicate of banks arranged by JP Morgan Chase Bank, N.A. and Bank of America, N.A. The 2011 Credit Facility provides for revolving loans and the issuance of multi-bank, syndicated letters of credit and/or letters of credit from a sole issuing bank in an aggregate amount of $350,000 and is available until September 2015, provided the Company is in compliance with all covenants. The 2011 Credit Facility has a sublimit for letters of credit issued thereunder of $50,000. The proceeds of these loans may be used for the Company’s commercial paper program or for general corporate purposes. The Company may increase the total amount available under the 2011 Credit Facility to $525,000 subject to certain conditions. No bank is obligated to provide commitments above their share of the $350,000 facility.
The Company did not use the commercial paper program during the six months ended June 30, 2014 and 2013 and there were no amounts outstanding relating to the commercial paper program at June 30, 2014 and December 31, 2013. The Company made no borrowings using the 2011 Credit Facility and no loans are outstanding at June 30, 2014.
The 2011 Credit Facility contains restrictive covenants and requires that the Company maintain certain specified minimum ratios and thresholds. Among others, these covenants include maintaining a maximum debt to capitalization ratio and a minimum consolidated adjusted net worth. At June 30, 2014, the Company was in compliance with all covenants, minimum ratios and thresholds.
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8. Accumulated Other Comprehensive Income
Certain amounts included in the consolidated statements of comprehensive income are net of reclassification adjustments. The following tables summarize those reclassification adjustments (net of taxes):
Balance at March 31, 2014
Other comprehensive income before reclassifications
Amounts reclassified from accumulated other comprehensive income
Net current-period other comprehensive income
Balance at June 30, 2014
Balance at March 31, 2013
Other comprehensive loss before reclassifications
Net current-period other comprehensive (loss) income
Balance at June 30, 2013
Balance at December 31, 2013
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Balance at December 31, 2012
Other comprehensive (loss) income before reclassifications
The following tables summarize the reclassifications out of accumulated other comprehensive income for the three and six months ended June 30, 2014 and 2013:
Details about accumulated other comprehensiveincome components
Affected line item in the
statement where net
income is presented
Unrealized gains on securities
Net of tax
OTTI
Portion of net loss (gain) recognized in other comprehensive income, before taxes
Amortization of pension and postretirement unrecognized net periodic benefit cost:
Amortization of prior service cost
(1)
Amortization of net loss
Total before tax
Total reclassifications for the period
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Details about accumulated other comprehensive incomecomponents
9. Stock Based Compensation
Long-Term Equity Incentive Plan
In May 2008, the Company’s shareholders approved the Assurant, Inc. Long-Term Equity Incentive Plan (“ALTEIP”), which authorized the granting of up to 3,400,000 new shares of the Company’s common stock to employees, officers and non-employee directors. In May 2010, the Company’s shareholders approved an amended and restated ALTEIP, increasing the number of shares of the Company’s common stock authorized for issuance to 5,300,000 new shares. Under the ALTEIP, the Company may grant awards based on shares of its common stock, including stock options, stock appreciation rights (“SARs”), restricted stock (including performance shares), unrestricted stock, restricted stock units (“RSUs”), performance share units (“PSUs”) and dividend equivalents. All share-based grants are awarded under the ALTEIP.
The Compensation Committee of the Board of Directors (the “Compensation Committee”) awards PSUs and RSUs annually. RSUs and PSUs are promises to issue actual shares of common stock at the end of a vesting period or performance period. The RSUs granted to employees under the ALTEIP were based on salary grade and performance and vest one-third each year over a three-year period. RSUs granted to non-employee directors also vest one-third each year over a three-year period, however, issuance of vested shares is deferred until separation from Board service. RSUs receive dividend equivalents in cash during the restricted period and do not have voting rights during the restricted period. PSUs accrue dividend equivalents during the performance period based on a target payout, and will be paid in cash at the end of the performance period based on the actual number of shares issued. The fair value of RSUs is estimated using the fair market value of a share of the Company’s common stock at the date of grant. The fair value of PSUs is estimated using the Monte Carlo simulation model and is described in further detail below.
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For the PSU portion of an award, the number of shares a participant will receive upon vesting is contingent upon the Company’s performance with respect to selected metrics, identified below, compared against a broad index of insurance companies and assigned a percentile ranking. These rankings are then averaged to determine the composite percentile ranking for the performance period. The payout levels can vary between 0% and 150% (maximum) of the target (100%) ALTEIP award amount based on the Company’s level of performance against the selected metrics.
PSU Performance Goals. The Compensation Committee established book value per share (“BVPS”) growth excluding AOCI, revenue growth and total stockholder return as the three performance measures for PSU awards. BVPS growth is defined as the year-over-year growth of the Company’s stockholders’ equity excluding AOCI divided by the number of fully diluted total shares outstanding at the end of the period. Revenue growth is defined as the year-over-year change in total revenues as disclosed in the Company’s annual statement of operations. Total stockholder return is defined as appreciation in Company stock plus dividend yield to stockholders. Payouts will be determined by measuring performance against the average performance of companies included in an insurance industry market index.
Since 2009, the Company has used the A.M. Best U.S. Insurance Index to measure its relative performance ranking. In 2014, A.M. Best stopped publishing this index. As of January 1, 2014, the Company is using the S&P Total Market Index to measure the Company’s performance for all new and outstanding PSU awards. Consistent with adjustments made to the A.M. Best U.S. Insurance Index, adjustments will be made to the S&P Total Market Index to exclude companies with revenues of less than $1,000,000 or that are not in the insurance or managed healthcare Global Industry Classification Standard codes. In addition, companies within the Company’s compensation peer group, but not otherwise in the S&P Total Market Index, will be included. The adjusted S&P Total Market Index is substantially similar in composition to the previous A.M. Best U.S. Insurance Index.
Under the ALTEIP, the Company’s Chief Executive Officer (“CEO”) is authorized by the Board of Directors to grant common stock, restricted stock and RSUs to employees other than the executive officers of the Company (as defined in Section 16 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)). The Board of Directors reviews and ratifies these grants quarterly. Restricted stock and RSUs granted under this program may have different vesting periods.
Restricted Stock Units
RSUs granted to employees and to non-employee directors were 42,470 and 34,310 for the three months ended June 30, 2014 and 2013, respectively, and 329,339 and 466,218 for the six months ended June 30, 2014 and 2013, respectively. The compensation expense recorded related to RSUs was $6,148 and $6,720 for the three months ended June 30, 2014 and 2013, respectively, and $10,977 and $12,271 for the six months ended June 30, 2014 and 2013, respectively. The related total income tax benefit was $2,149 and $2,357 for the three months ended June 30, 2014 and 2013, respectively, and $3,834 and $4,289 for the six months ended June 30, 2014 and 2013, respectively. The weighted average grant date fair value for RSUs granted during the six months ended June 30, 2014 and 2013 was $65.26 and $43.94, respectively.
As of June 30, 2014, there was $24,437 of unrecognized compensation cost related to outstanding RSUs. That cost is expected to be recognized over a weighted-average period of 1.34 years. The total fair value of RSUs vested during the three months ended June 30, 2014 and 2013 was $2,616 and $2,170, respectively, and $30,824 and $19,842 for the six months ended June 30, 2014 and 2013, respectively.
Performance Share Units
No PSUs were granted to employees during the three months ended June 30, 2014 and 2013. PSUs granted to employees were 379,174 and 408,808 for the six months ended June 30, 2014 and 2013, respectively. The compensation expense recorded related to PSUs was $10,109 and $6,907 for the three months ended June 30, 2014 and 2013, respectively, and $13,562 and $8,850 for the six months ended June 30, 2014 and 2013, respectively. The related total income tax benefit was $3,534 and $2,425 for the three months ended June 30, 2014 and 2013, respectively, and $4,736 and $3,093 for the six months ended June 30, 2014 and 2013, respectively. The weighted average grant date fair value for PSUs granted during the six months ended June 30, 2014 and 2013 was $64.93 and $44.22, respectively.
As of June 30, 2014, there was $32,935 of unrecognized compensation cost related to outstanding PSUs. That cost is expected to be recognized over a weighted-average period of 1.05 years.
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The fair value of PSUs with market conditions was estimated on the date of grant using a Monte Carlo simulation model, which utilizes multiple variables that determine the probability of satisfying the market condition stipulated in the award. Expected volatilities for awards issued during the six months ended June 30, 2014 and 2013 were based on the historical stock prices of the Company’s stock and peer insurance group. The expected term for grants issued during the six months ended June 30, 2014 and 2013 was assumed to equal the average of the vesting period of the PSUs. The risk-free rate was based on the U.S. Treasury yield curve in effect at the time of grant.
Employee Stock Purchase Plan
Under the Employee Stock Purchase Plan (“ESPP”), the Company is authorized to issue up to 5,000,000 new shares to employees who are participants in the ESPP. Eligible employees can purchase shares at a 10% discount applied to the lower of the closing price of the common stock on the first or last day of the offering period.
In January 2014, the Company issued 75,709 shares at a discounted price of $46.36 for the offering period of July 1, 2013 through December 31, 2013. In January 2013, the Company issued 107,535 shares at a discounted price of $31.23 for the offering period of July 1, 2012 through December 31, 2012.
In July 2014, the Company issued 65,867 shares at a discounted price of $58.79 for the offering period of January 1, 2014 through June 30, 2014. In July 2013, the Company issued 110,038 shares at a discounted price of $31.93 for the offering period of January 1, 2013 through June 30, 2013.
The compensation expense recorded related to the ESPP was $292 and $249 for the three months ended June 30, 2014 and 2013, respectively, and $585 and $499 for the six months ended 2014 and 2013, respectively.
The fair value of each award under the ESPP was estimated at the beginning of each offering period using the Black-Scholes option-pricing model. Expected volatilities are based on implied volatilities from traded options on the Company’s stock and the historical volatility of the Company’s stock. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. The dividend yield is based on the current annualized dividend and share price as of the grant date.
10. Stock Repurchase
The following table shows the shares repurchased during the periods indicated:
Period in 2014
January
February
March
April
May
June
On November 18, 2013, the Company’s Board of Directors authorized the Company to repurchase up to an additional $600,000 of its outstanding common stock, making the total remaining under the total repurchase authorization $752,436 as of that date.
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As of December 31, 2013, there was $704,874 remaining under the total repurchase authorization. During the six months ended June 30, 2014, the Company repurchased 1,191,600 shares of the Company’s outstanding common stock at a cost of $79,490, exclusive of commissions, leaving $625,384 remaining under the total repurchase authorization at June 30, 2014.
11. Earnings Per Common Share
The following table presents net income, the weighted average common shares used in calculating basic earnings per common share (“EPS”) and those used in calculating diluted EPS for each period presented below.
Numerator
Deduct dividends paid
Undistributed earnings
Denominator
Weighted average shares outstanding used in basic earnings per share
Incremental common shares from:
SARs
PSUs
ESPPs
Weighted average shares used in diluted earnings per share calculations
Earnings per common share - Basic
Distributed earnings
Earnings per common share - Diluted
There were no anti-dilutive SARs or PSUs outstanding that were not included in the computation of diluted EPS under the treasury stock method during the three and six months ended June 30, 2014 and 2013.
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12. Retirement and Other Employee Benefits
The components of net periodic benefit cost for the Company’s qualified pension benefits plan, nonqualified pension benefits plan and retirement health benefits plan for the three and six months ended June 30, 2014 and 2013 were as follows:
Service cost
Interest cost
Expected return on plan assets
Amortization of net loss (gain)
Net periodic benefit cost
Our qualified pension benefits plan (the “Plan”) was under-funded by $6,429 and over-funded by $18,078 (based on the fair value of Plan assets compared to the projected benefit obligation) at June 30, 2014 and December 31, 2013, respectively. This equates to a 99% and 102% funded status at June 30, 2014 and December 31, 2013, respectively. The change in funded status is mainly due to a decrease in the discount rate used to determine the projected benefit obligation. During the first six months of 2014, $15,000 in cash was contributed to the Plan. Additional cash, up to $15,000, is expected to be contributed to the Plan over the remainder of 2014.
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13. Segment Information
The Company has five reportable segments, which are defined based on the nature of the products and services offered: Assurant Solutions, Assurant Specialty Property, Assurant Health, Assurant Employee Benefits, and Corporate & Other. Assurant Solutions provides mobile device protection, debt protection administration, credit-related insurance, warranties and service contracts and pre-funded funeral insurance. Assurant Specialty Property provides lender-placed homeowners insurance, renters insurance and related products and manufactured housing homeowners insurance. Assurant Health provides individual health and small employer group health insurance. Assurant Employee Benefits primarily provides group dental insurance, group disability insurance and group life insurance. Corporate & Other includes activities of the holding company, financing and interest expenses, net realized gains (losses) on investments and interest income earned from short-term investments held. Corporate & Other also includes the amortization of deferred gains associated with the sales of Fortis Financial Group and Long-Term Care through reinsurance agreements.
The Company evaluates performance of the operating segments based on segment income (loss) after-tax excluding realized gains (losses) on investments. The Company determines reportable segments in a manner consistent with the way the Chief Operating Decision Maker makes operating decisions and assesses performance.
The following tables summarize selected financial information by segment:
Net realized gains on investments
Segment income (loss) before provision (benefit) for income tax
Provision (benefit) for income taxes
Segment income (loss) after tax
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Segment Assets:
Segment assets, excluding goodwill
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14. Commitments and Contingencies
In the normal course of business, letters of credit are issued primarily to support reinsurance arrangements in which the Company is the reinsurer. These letters of credit are supported by commitments under which the Company is required to indemnify the financial institution issuing the letter of credit if the letter of credit is drawn. The Company had $18,364 and $17,343 of letters of credit outstanding as of June 30, 2014 and December 31, 2013, respectively.
As previously disclosed, during the first quarter of 2013, the Company and two of its wholly owned subsidiaries in the Assurant Specialty Property segment, American Security Insurance Company (“ASIC”) and American Bankers Insurance Company of Florida (“ABIC”), reached an agreement with the New York Department of Financial Services (the “NYDFS”) regarding the Company’s lender-placed insurance business in the State of New York. Under the terms of the agreement, and without admitting or denying any wrongdoing, ASIC made a $14,000 settlement payment to the NYDFS. In addition, among other things, ASIC and ABIC agreed to modify certain business practices in accordance with requirements that apply to all New York-licensed lender-placed insurers of properties in the state, and filed our new lender-placed program and new rates in New York. The Company also continues to respond to and cooperate with other regulators regarding its lender-placed insurance business.
In addition, as previously disclosed, the Company is involved in a variety of litigation relating to its current and past business operations and may from time to time become involved in other such actions. In particular, the Company is a defendant in class actions in a number of jurisdictions regarding its lender-placed insurance programs. These cases allege a variety of claims under a number of legal theories. The plaintiffs seek premium refunds and other relief. The Company continues to defend itself vigorously in these class actions. The Company has accrued an estimated loss for this litigation.
We have participated and may participate in settlements on terms that we consider reasonable given the strength of our defenses. However, the possible loss or range of loss resulting from such litigation and regulatory proceedings, if any, in excess of the amounts accrued is inherently unpredictable and involves significant uncertainty. Consequently, no estimate can be made of any possible loss or range of loss in excess of the above-mentioned accrual.
In July 2007 an Assurant subsidiary acquired Swansure Group, a privately held U.K. company, which owned D&D Homecare Limited (“D&D”). D&D was a packager of mortgages and certain insurance products, including Payment Protection Insurance (“PPI”) policies that, for a period of time, were underwritten by an Assurant subsidiary and sold by an alleged agent called Carrington Carr Home Finance Limited (“CCHFL”), which is now in administration. In early 2014, as a result of consumer complaints alleging that CCHFL missold certain D&D-packaged PPI policies between August 8, 2003 and November 1, 2004, the U.K. Financial Ombudsman Service (“FOS”) requested that an Assurant subsidiary, Assurant Intermediary Limited (“AIL”), review complaints relating to CCHFL’s sale of such PPI policies. AIL is cooperating with the FOS. Although management has determined that a loss from this matter is reasonably possible, we cannot make any estimate of possible loss or range of possible loss because our investigation is at an early stage.
Although the Company cannot predict the outcome of any action, it is possible that such outcome could have a material adverse effect on the Company’s consolidated results of operations or cash flows for an individual reporting period. However, based on currently available information, management does not believe that the pending matters are likely to have a material adverse effect, individually or in the aggregate, on the Company’s financial condition.
15. Income Taxes
During the three months ended June 30, 2014, the Company converted the Canadian branch operations of certain U.S. companies to foreign corporate entities. This conversion is an election for U.S. tax classification purposes only and requires the Company to record deferred taxes at local tax rates. As a result of this conversion, the Company recorded a one-time benefit of $20,753, which is reflected in the provision for income taxes line item in the consolidated statements of operations.
During the six months ended June 30, 2014, the Company increased its estimated amount of compensation expenses that are non-tax deductible under the Affordable Care Act. Due to this change in estimate, the Company recorded $5,749 of income tax expense in the Assurant Health segment, which increased the consolidated effective tax rate by 134 basis points.
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16. Catastrophe Bond Program
On January 30, 2012, certain of the Companies’ subsidiaries (“the Subsidiaries”) entered into two reinsurance agreements with Ibis Re II Ltd. (“Ibis Re II”). Ibis Re II is an independent special purpose reinsurance company domiciled in the Cayman Islands. The Ibis Re II agreements provide up to $130,000 of reinsurance coverage for protection against losses over a three-year period from individual hurricane events in Hawaii, Puerto Rico, and along the Gulf and Eastern Coasts of the United States. The agreements expire in February 2015. Ibis Re II financed the property catastrophe reinsurance coverage by issuing $130,000 in catastrophe bonds to unrelated investors (the “Series 2012-1 Notes”).
On June 26, 2013, the Subsidiaries entered into three additional reinsurance agreements with Ibis Re II providing up to $185,000 of reinsurance coverage for protection against losses over a three-year period from individual hurricane events in Hawaii, Puerto Rico, and along the Gulf and Eastern Coasts of the United States. The agreements expire in June 2016. Ibis Re II financed the property catastrophe reinsurance coverage by issuing $185,000 in catastrophe bonds to unrelated investors (the “Series 2013-1 Notes”).
The $315,000 of coverage represents approximately 18% of the expected first event coverage (net of reimbursements of the Florida Hurricane Catastrophe Fund) purchased by the Company in excess of the Company’s anticipated retention.
Under the terms of these reinsurance agreements, the Subsidiaries are obligated to pay annual reinsurance premiums to Ibis Re II for the reinsurance coverage. The reinsurance agreements with Ibis Re II utilize a dual trigger that is based upon an index that is created by applying predetermined percentages to insured industry losses in each state in the covered area as reported by an independent party and the Subsidiaries’ covered losses incurred. Reinsurance contracts that have a separate, pre-identified variable (e.g., a loss-based index) are accounted for as reinsurance if certain conditions are met. In the case of the reinsurance agreements with Ibis Re II, these conditions were met, thus the Company accounted for them as reinsurance in accordance with the guidance for reinsurance contracts.
Amounts payable to the Subsidiaries under the reinsurance agreements will be determined by the index-based losses, which are designed to approximate the Subsidiaries’ actual losses from any covered event. The amount of actual losses and index losses from any covered event may differ. For each covered event, Ibis Re II pays the Subsidiaries the lesser of the covered index-based losses or the Subsidiaries’ actual losses. The principal amount of the catastrophe bonds will be reduced by any amounts paid to the Subsidiaries under the reinsurance agreements. The Subsidiaries have not incurred any losses subject to the reinsurance agreements since their inception.
As of June 30, 2014 and 2013, the Company had not ceded any losses to Ibis Re II.
As with any reinsurance agreement, there is credit risk associated with collecting amounts due from reinsurers. With regard to the Series 2012-1 Notes and Series 2013-1 Notes, the credit risk is mitigated by reinsurance trust accounts for each tranche within each Series. The reinsurance trust accounts have been funded by Ibis Re II with money market funds that invest solely in direct government obligations backed by the U.S. government with maturities of no more than 13 months. The money market funds must have a principal stability rating of at least AAA by Standard & Poor’s.
As a result of an evaluation of the reinsurance agreements with Ibis Re II, the Company concluded that Ibis Re II is a variable interest entity (“VIE”). However, while Ibis Re II is a VIE, the Company concluded that it does not have a significant variable interest in Ibis Re II as the variability in results, caused by the reinsurance agreements, is expected to be absorbed entirely by the bondholders and the Company is not entitled to any residual amounts. Accordingly, the Company is not the primary beneficiary of Ibis Re II and does not consolidate the entities in the Company’s financial statements.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Dollar amounts in thousands, except number of shares and per-share amounts)
This Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) addresses the financial condition of Assurant, Inc. and its subsidiaries (which we refer to collectively as “Assurant” or “the Company”) as of June 30, 2014, compared with December 31, 2013, and our results of operations for the three and six months ended June 30, 2014 and 2013. This discussion should be read in conjunction with our MD&A and annual audited consolidated financial statements as of December 31, 2013 included in our Annual Report on Form 10-K for the year ended December 31, 2013 filed with the U.S. Securities and Exchange Commission (the “SEC”) and the June 30, 2014 unaudited consolidated financial statements and related notes included elsewhere in this Form 10-Q. The 2013 Annual Report on Form 10-K, Second Quarter 2014 Form 10-Q, and other documents related to the Company are available free of charge through the SEC website at www.sec.gov and through our website at www.assurant.com.
Some of the statements in this MD&A and elsewhere in this report, particularly those anticipating future financial performance, business prospects, growth and operating strategies and similar matters, are forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. You can identify these statements by the fact that they may use words such as “will,” “may,” “anticipates,” “expects,” “estimates,” “projects,” “intends,” “plans,” “believes,” “targets,” “forecasts,” “potential,” “approximately,” or the negative version of those words and other words and terms with a similar meaning. Any forward-looking statements contained in this report are based upon our historical performance and on current plans, estimates and expectations. The inclusion of this forward-looking information should not be regarded as a representation by us or any other person that the future plans, estimates or expectations contemplated by us will be achieved. Our actual results might differ materially from those projected in the forward-looking statements. The Company undertakes no obligation to update or review any forward-looking statement, whether as a result of new information, future events or other developments.
In addition to the factors described under “Critical Factors Affecting Results,” the following risk factors could cause our actual results to differ materially from those currently estimated by management:
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For a more detailed discussion of the risk factors that could affect our actual results, please refer to “Item 1A—Risk Factors” and “Item 7—MD&A Critical Factors Affecting Results” in our 2013 Annual Report on Form 10-K.
General
We report our results through five segments: Assurant Solutions, Assurant Specialty Property, Assurant Health, Assurant Employee Benefits, and Corporate and Other. The Corporate and Other segment includes activities of the holding company, financing and interest expenses, net realized gains (losses) on investments and investment income earned from short-term investments held. The Corporate and Other segment also includes the amortization of deferred gains associated with the sales of FFG and LTC, through reinsurance agreements as described below.
The following discussion relates to the three and six months ended June 30, 2014 (“Second Quarter 2014” and “Six Months 2014”) and the three and six months ended June 30, 2013 (“Second Quarter 2013” and “Six Months 2013”).
Executive Summary
Consolidated net income increased $10,087, or 8%, to $143,610 in Second Quarter 2014, compared with $133,523 of net income for Second Quarter 2013. For Six Months 2014, net income increased $29,552 or 12%, to $280,855, compared with $251,303 of net income for Six Months 2013.
Assurant Solutions net income increased $28,142, or 90%, to $59,533 for Second Quarter 2014 from $31,391 for Second Quarter 2013. The increase was primarily driven by improved results in our mobile business, reflecting contributions from ongoing client marketing programs and continued favorable loss experience.
Second Quarter 2014 net earned premiums increased 13% and fees and other income increased 76% compared with Second Quarter 2013, primarily due to the global market success of our mobile protection programs, despite foreign exchange volatility.
During Second Quarter 2014, we extended our exclusive distribution partnership with Service Corporation International (“SCI”), the largest funeral provider in North America, an additional 10 years, through September 29, 2024.
Overall, we expect Assurant Solutions net earned premiums and fees to increase compared to 2013, primarily driven by growth in mobile. The timing of new mobile device introductions, client marketing programs and seasonal trends in mobile will cause quarterly results to vary.
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Assurant Specialty Property net income decreased $38,210, or 36%, to $68,310 for Second Quarter 2014 from $106,520 for Second Quarter 2013, primarily due to a significant increase in non-catastrophe losses in our lender-placed insurance business. This increase was mainly attributable to severe weather, including approximately $14,625 (after-tax) of adverse reserve development from the first quarter of 2014, and high severity fire claims.
The Second Quarter 2014 expense ratio increased 600 basis points compared with the Second Quarter 2013. The increase was primarily due to growth in fee-based businesses, which have higher expense ratios, and additional costs to support our lender-placed insurance business. The increase in fee-based business expense was offset by additional revenue.
Net earned premiums and fees in this segment increased in Second Quarter 2014 compared with Second Quarter 2013, mainly attributable to continued growth in our lender-placed insurance and multi-family housing businesses. Lender-placed insurance premiums benefited primarily from the previously disclosed discontinuation of a client quota share reinsurance agreement and loan portfolio additions in 2013.
In addition, our placement rate on lender-placed insurance in Second Quarter 2014 declined to 2.68% compared with 2.81% in Second Quarter 2013.
Overall, we expect Assurant Specialty Property’s net earned premiums and fees to increase slightly from 2013 driven by growth in targeted areas, including contributions from the Field Asset Services and StreetLinks, LLC acquisitions. We expect revenues in our lender-placed insurance business to approximate 2013 levels. In addition, we expect our expense ratio to increase, primarily reflecting a higher mix of fee income business and additional costs to support lender-placed insurance business. We also expect our non-catastrophe loss ratio to remain elevated due to higher claims frequency and lower premium rates.
Overall, we expect results in our lender-placed insurance business to continue to be affected by catastrophe losses and lower placement and premium rates. In addition, as previously disclosed, we are currently in discussions with a client regarding a possible loss of business to another carrier. This loss could materially affect results at this segment.
Assurant Health Second Quarter 2014 results decreased $6,585, or 161%, to a net loss of $2,502 compared with Second Quarter 2013 net income of $4,083. The decrease was primarily attributable to less favorable loss experience from new Affordable Care Act qualified policies, reflecting the current guaranteed issue requirements and the health profiles of many first-time buyers, as well as a higher effective tax rate related to the Affordable Care Act.
The Second Quarter 2014 loss ratio was 78.1%, an increase of 290 basis points from Second Quarter 2013. This increase reflects early claim submissions on policies sold during the open enrollment period, partially offset by estimated recoveries from the Affordable Care Act risk-mitigation programs that went into effect on January 1, 2014. Please refer to Assurant Health’s results of operations section further below in this Item 2 for details on these risk-mitigation programs.
We expect Assurant Health’s full year 2014 net earned premiums and fees to increase compared to 2013, reflecting sales of new individual major medical policies under the Affordable Care Act. Based on our current assumptions, we expect our share of recoveries from risk-mitigation programs to increase during the year, but our estimates may change materially as experience develops. We expect overall results to vary based on emerging claims experience under the Affordable Care Act and related risk-mitigation programs. We also anticipate our effective tax rate to remain very high due to non-deductible compensation expenses.
At Assurant Employee Benefits, net income increased $2,958, or 26%, to $14,432 for Second Quarter 2014 from $11,474 for Second Quarter 2013. This increase was primarily attributable to improved disability results, reflecting lower claim incidence and the previously disclosed increase in the reserve discount rate for new long-term disability claims. In addition, results also benefitted from favorable life insurance mortality rates.
Second Quarter 2014 voluntary sales and net earned premiums increased 33% and 13%, respectively, compared to Second Quarter 2013, reflecting our strategic focus on this market. In addition, we are preparing to participate on several private exchanges related to the Affordable Care Act. While we do not expect these exchanges to be a material source of near-term sales, they will further expand our distribution.
We expect Assurant Employee Benefits’ full year 2014 net earned premiums and fees to increase compared to 2013 due to growth in voluntary products. We also expect continued expense reduction actions will offset higher expenditures to support growth in our voluntary business. Results will continue to be impacted by employment trends and capital market conditions.
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Critical Factors Affecting Results and Liquidity
Our results depend on the appropriateness of our product pricing, underwriting and the accuracy of our methodology for the establishment of reserves for future policyholder benefits and claims, returns on and values of invested assets and our ability to manage our expenses. Factors affecting these items, including unemployment, difficult conditions in financial markets and the global economy, may have a material adverse effect on our results of operations or financial condition. For more information on these factors, see “Item 1A—Risk Factors” and “Item 7—MD&A Critical Factors Affecting Results” in our 2013 Annual Report on Form 10-K.
Management believes the Company will have sufficient liquidity to satisfy its needs over the next twelve months including the ability to pay interest on our debt and dividends on our common stock.
For the six months ended June 30, 2014, net cash provided by operating activities, including the effect of exchange rate changes on cash and cash equivalents, totaled $252,890; net cash provided by investing activities totaled $34,595 and net cash used in financing activities totaled $605,799. We had $1,398,870 in cash and cash equivalents as of June 30, 2014. Please see “—Liquidity and Capital Resources,” below for further details.
Critical Accounting Policies and Estimates
Our 2013 Annual Report on Form 10-K describes the accounting policies and estimates that are critical to the understanding of our results of operations, financial condition and liquidity. The accounting policies and estimation process described in the 2013 Annual Report on Form 10-K were consistently applied to the unaudited interim consolidated financial statements for Second Quarter 2014.
The Affordable Care Act introduced new and significant premium stabilization programs beginning in 2014. These programs required the Company to record amounts to our consolidated financial statements based on assumptions and estimates which could materially change as experience develops. Please refer to Assurant Health’s results of operations section further below in this Item 2 for details on these programs and the estimates recorded.
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Assurant Consolidated
Overview
The table below presents information regarding our consolidated results of operations:
Revenues:
Benefits, losses and expenses:
Selling, underwriting and general expenses (1)
The following discussion provides a general overall analysis of how the consolidated results were affected by our four operating segments and our Corporate and Other segment for Second Quarter 2014 and Six Months 2014 and Second Quarter 2013 and Six Months 2013. Please see the discussion that follows, for each of these segments, for a more detailed analysis of the fluctuations.
For the Three Months Ended June 30, 2014 Compared to the Three Months Ended June 30, 2013
Net Income
Net income increased $10,087 or 8%, to $143,610 in Second Quarter 2014, compared with $133,523 of net income for Second Quarter 2013. The increase was mainly due to improved results in our Assurant Solutions segment and a $20,753 one-time tax benefit related to the conversion of the Canadian branch operations of certain U.S. companies to foreign corporate entities. These items were partially offset by lower net income in our Assurant Specialty Property segment primarily due to increased non-catastrophe losses caused by severe weather, including adverse reserve development from the first quarter of 2014, and high severity fire claims. Please see Note 15 to the Consolidated Financial Statements for further information about the entity conversion described above.
For the Six Months Ended June 30, 2014 Compared to the Six Months Ended June 30, 2013
Net income increased $29,552 or 12%, to $280,855 for Six Months 2014, compared with $251,303 of net income for Six Months 2013. The improvement was primarily due to the items noted above.
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Assurant Solutions
The table below presents information regarding Assurant Solutions’ segment results of operations:
Selling, underwriting and general expenses
Segment income before provision for income taxes
Segment net income
Net earned premiums:
Domestic:
Credit
Service contracts
Other (1)
Total Domestic
International:
Total International
Preneed
Fees and other income:
Debt protection
International
Gross written premiums (2):
Preneed (face sales)
Combined ratios (3):
Domestic
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Segment net income increased $28,142, or 90%, to $59,533 for Second Quarter 2014 from $31,391 for Second Quarter 2013. The increase was primarily driven by improved results in our mobile business, reflecting contributions from ongoing client marketing programs and continued favorable loss experience.
Total Revenues
Total revenues increased $161,996, or 19%, to $1,030,989 for Second Quarter 2014 from $868,993 for Second Quarter 2013. The increase was driven primarily by higher net earned premiums in our domestic and international service contract businesses, reflecting continued growth in the number of covered mobile devices globally. Fees and other income increased $70,369 primarily driven by ongoing mobile client marketing programs and from the Lifestyle Services Group (“LSG”) acquisition during the fourth quarter of 2013.
Gross written premiums increased $215,758, or 20%, to $1,299,371 for Second Quarter 2014 from $1,083,613 for Second Quarter 2013. Gross written premiums from our domestic service contract business increased $243,455 driven by growth in the number of covered mobile devices. Gross written premiums from our international service contract business increased $14,019 due to growth in the number of covered mobile devices, the LSG acquisition and new and existing clients in Latin America. This increase was partially offset by the unfavorable impact of changes in foreign exchange rates, primarily in Latin America.
Preneed face sales increased $3,281, or 1%, to $260,194 for Second Quarter 2014 from $256,913 for Second Quarter 2013. This increase was mostly attributable to growth from our exclusive distribution partnership with SCI, the largest funeral provider in North America. On June 25, 2014, we extended this exclusive distribution partnership for an additional 10 years, through September 29, 2024.
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Total Benefits, Losses and Expenses
Total benefits, losses and expenses increased $125,644, or 15%, to $944,305 for Second Quarter 2014 from $818,661 for Second Quarter 2013. Policyholder benefits increased $59,229 primarily related to the LSG acquisition, partially offset by favorable loss experience in our mobile business. Selling, underwriting and general expenses increased $66,412, mostly related to growth in our domestic mobile business and the LSG acquisition.
Segment net income increased $42,704, or 64%, to $109,002 for Six Months 2014 from $66,298 for Six Months 2013. The increase was primarily driven by improved results in our domestic mobile business, reflecting contributions from ongoing client marketing programs and continued favorable loss experience.
Total revenues increased $286,861, or 17%, to $2,019,695 for Six Months 2014 from $1,732,834 for Six Months 2013. The increase was driven by higher net earned premiums in our domestic and international service contract businesses, reflecting continued growth in the number of covered mobile devices globally. Fees and other income increased $132,611 primarily driven by ongoing mobile client marketing programs and the LSG acquisition.
Gross written premiums increased $444,305, or 21%, to $2,516,575 for Six Months 2014 from $2,072,270 for Six Months 2013. Gross written premiums from our domestic service contract business increased $447,212 driven by growth in the number of covered mobile devices. Gross written premiums from our international service contract business increased $58,805 due to growth in the number of covered mobile devices, the LSG acquisition and new and existing clients in Latin America. This increase was partially offset by the unfavorable impact of changes in foreign exchange rates, primarily in Latin America.
Preneed face sales increased $15,507, or 3%, to $501,898 for Six Months 2014 from $486,391 for Six Months 2013. This increase was mostly attributable to growth from our exclusive distribution partnership with SCI.
Total benefits, losses and expenses increased $228,556, or 14%, to $1,858,564 for Six Months 2014 from $1,630,008 for Six Months 2013. Policyholder benefits increased $103,458 primarily related to the LSG acquisition, partially offset by favorable loss experience in our mobile business. Selling, underwriting and general expenses increased $125,098, mostly related to growth in our domestic mobile business and the LSG acquisition.
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Assurant Specialty Property
The table below presents information regarding Assurant Specialty Property’s segment results of operations:
Homeowners (lender-placed and voluntary)
Manufactured housing (lender-placed and voluntary)
Ratios:
Loss ratio (2)
Expense ratio (3)
Combined ratio (4)
Regulatory Matters
As previously disclosed, on March 21, 2013, the Company and two of its wholly owned subsidiaries, ASIC and ABIC, reached an agreement with the New York Department of Financial Services (the “NYDFS”) regarding the Company’s lender-placed insurance business in the State of New York. Under the terms of the agreement, and without admitting or denying any wrongdoing, ASIC made a $14,000 (non tax-deductible) settlement payment to the NYDFS. In addition, among other things, ASIC and ABIC agreed to modify certain business practices in accordance with requirements that apply to all New York-licensed lender-placed insurers of properties in the state, and filed their new lender-placed program and new rates in New York. Proposed changes to the program would affect annual lender-placed hazard and real estate owned policies issued in the State of New York, which accounted for approximately $59,000 and $101,000 of Assurant Specialty Property’s net earned premiums for Six Months 2014 and full year 2013, respectively.
On October 7, 2013, the Company reached an agreement with the Florida Office of Insurance Regulation to file for a 10% reduction in lender-placed hazard insurance rates in Florida. The rates have been filed and approved, and were effective for new and renewing policies starting in the first quarter of 2014. As part of the agreement, ASIC will eliminate commissions and client quota-share
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reinsurance arrangements to meet new requirements of lender-placed insurance providers in Florida. These new lender-placed practices will take effect one year following the agreement. ASIC recorded approximately $236,000 and $547,000 of direct earned premiums in Florida for Six Months 2014 and full year 2013, respectively, for the type of policies that are subject to the rate reduction.
At the federal level, in early 2013, the Consumer Financial Protection Bureau published mortgage servicing guidelines that incorporate certain requirements mandated by the Dodd-Frank Act. In addition, the Federal Housing Finance Agency (“FHFA”) issued new mortgage servicer guidelines, which became effective in June 2014, that eliminate lender-placed insurance-related commissions and client quota share arrangements on properties securing government-sponsored entity loans. At the directive of the FHFA, Federal National Mortgage Association and Federal Home Loan Mortgage Corporation each issued bulletins in December 2013 implementing these mortgage servicer guidelines.
Lender-placed insurance products accounted for 73% of net earned premiums for both Six Months 2014 and full year 2013. The approximate corresponding contributions to the segment net income in these periods were 73% and 87%, respectively. The portion of total segment net income attributable to lender-placed products may vary substantially over time depending on the frequency, severity and location of catastrophic losses, the cost of catastrophe reinsurance and reinstatement coverage, the variability of claim processing costs and client acquisition costs, and other factors. In addition, we expect placement rates for these products to decline.
Segment net income decreased $38,210, or 36%, to $68,310 for Second Quarter 2014 from $106,520 for Second Quarter 2013 primarily due to higher non-catastrophe losses in our lender-placed insurance business. These losses were driven by severe weather, including approximately $14,625 (after-tax) of adverse reserve development from the first quarter of 2014. High severity fire claims also contributed to the decline. Second Quarter 2014 results include $13,373 (after-tax) of reportable catastrophe losses, compared with $9,163 (after-tax) in Second Quarter 2013. Reportable catastrophe losses include only individual catastrophic events that generated losses to the Company in excess of $5,000, pre-tax and net of reinsurance.
Total revenues increased $102,503, or 16%, to $739,634 for Second Quarter 2014 from $637,131 for Second Quarter 2013. The increase was primarily due to growth in lender-placed homeowners insurance and multifamily housing net earned premiums as well as fee income from the recent acquisitions of Field Asset Services and StreetLinks. Growth in lender-placed homeowners insurance was primarily due to the previously disclosed discontinuation of a client quota share reinsurance agreement and loan portfolios added in 2013.
Total benefits, losses and expenses increased $157,718, or 33%, to $636,222 for Second Quarter 2014 from $478,504 for Second Quarter 2013. The loss ratio increased to 48.7% from 40.0% primarily due to higher non-catastrophe losses from severe weather, including approximately $22,500 of adverse reserve development from the first quarter of 2014, high severity fire claims and lower premium rates from the new lender-placed homeowners insurance product. Reportable catastrophe losses were $20,574 for Second Quarter 2014 compared to $14,097 for Second Quarter 2013. The expense ratio increased to 45.9% in Second Quarter 2014 from 39.9% in Second Quarter 2013 mainly due to growth in fee based businesses and additional costs to support our lender-placed insurance business.
Segment net income decreased $34,713, or 17%, to $166,051 for Six Months 2014 from $200,764 for Six Months 2013 primarily due to the items noted above. Six Months 2014 results include $18,467 (after-tax) of reportable catastrophe losses, compared with $19,177 (after-tax) in Six Months 2013. In addition, Six Months 2013 includes a $14,000 (non-tax deductible) regulatory settlement with the NYDFS.
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Total revenues increased $212,761, or 17%, to $1,431,640 for Six Months 2014 from $1,218,879 for Six Months 2013. Growth in lender-placed homeowners and multifamily housing net earned premiums and fee income related to Field Asset Services and StreetLinks were the main drivers of the increase. Growth in lender-placed homeowners insurance was primarily due to the previously disclosed discontinuation of a client quota share reinsurance agreement and loan portfolios added in 2013.
Total benefits, losses and expenses increased $270,304, or 30%, to $1,180,810 for Six Months 2014 from $910,506 for Six Months 2013. The loss ratio increased to 45.5% for Six Months 2014 from 37.7% for Six Months 2013 due to higher non-catastrophe losses from severe weather, high severity fire claims and lower premium rates from the new lender-placed homeowners insurance product. Reportable catastrophes losses for Six Months 2014 were $28,411 compared to reportable catastrophe losses for Six Months 2013 of $29,503. The expense ratio increased to 44.2% for Six Months 2014 from 41.9% for Six Months 2013 primarily due to growth in fee based businesses and additional costs to support our lender-placed insurance business. Six Months 2013 included a $14,000 (non-tax deductible) regulatory settlement with the NYDFS.
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Assurant Health
The table below presents information regarding Assurant Health’s segment results of operations:
Segment net (loss) income
Individual
Small employer group
Insured lives by product line:
Loss ratio (1)
Expense ratio (2)
Combined ratio (3)
The Affordable Care Act
Most provisions of the Affordable Care Act have now taken effect. The Affordable Care Act caused sweeping changes to the individual health insurance market. The full extent of the impact of those changes on our operation will not be known for some time. For more information, see Item 1A, “Risk Factors - Risk related to our industry - Reform of the health insurance industry could materially reduce the profitability of certain of our businesses or render them unprofitable” in our 2013 Annual Report on Form 10-K.
Because all individuals now have a guaranteed right to purchase health insurance policies, the Affordable Care Act introduced new and significant premium stabilization programs beginning in 2014: reinsurance, risk adjustment, and risk corridor (together, the “3 Rs”). These programs, discussed in further detail below, are meant to mitigate the potential adverse impact to individual health insurers as a result of Affordable Care Act provisions that became effective January 1, 2014.
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Reinsurance
This is a transitional program for 2014-2016, with decreasing impact over the three years. All commercial individual and group medical health plans are required to contribute to the funding of the program. Only individual health plans that are compliant with the essential health benefits of the Affordable Care Act are eligible to receive benefits from the program.
We are required to make contributions, which are recorded quarterly, based on both our Affordable Care Act and non-Affordable Care Act business. Contributions based on our non-Affordable Care Act business are included in selling, underwriting and general expenses and contributions based on our Affordable Care Act business are included as ceded premiums. Recoveries are recorded quarterly as ceded policyholder benefits and reflect the anticipated experience of our Affordable Care Act plans based on our analysis of current and historical claim data.
For the Second Quarter 2014 and Six Months 2014, we recorded reinsurance contributions of $4,497 and $8,440 and reinsurance recoveries of $63,996 and $80,012, respectively, in our consolidated statements of operations. As of June 30, 2014, we recorded reinsurance contributions payable of $10,127 and reinsurance recoverables of $80,012 on our consolidated balance sheets. Both contributions and recoveries for the 2014 program are scheduled to be settled in 2015.
Risk adjustment
This is a permanent program to transfer funds between health insurers based on the average health risk scores of their Affordable Care Act insured populations. Insurers with below-average risk scores will contribute into the pool. Insurers with above-average risk scores will receive payments out of the pool.
Risk scores are evaluated at the state, market, and legal entity level for Affordable Care Act-compliant policies. Risk adjustment amounts payable and receivable are reflected as adjustments to net earned premiums, and are recorded quarterly based on our current estimated loss experience of our Affordable Care Act business.
Based on the demographics of our Affordable Care Act population, extensive analytical evaluations, current and historical claim data as well as other internal and external data sources, external market studies and other published data, we believe that our average risk scores will be significantly higher than the industry averages.
For Second Quarter 2014 and Six Months 2014, we recorded net risk adjustment premiums of $55,317 and $61,538, respectively, in our consolidated statements of operations. As of June 30, 2014, we carried net risk adjustment receivables of $61,538 on our consolidated balance sheets. Risk transfer payments and receipts for the 2014 program are scheduled to be settled in 2015.
Risk corridor
This is a temporary risk-sharing program for 2014-2016. Based on ratios of allowable costs to target costs as defined by the Affordable Care Act, health insurers will make payments to the Department of Health and Human Services (“HHS”) or receive funds from HHS. Because Assurant Health is not participating in any insurance marketplaces for 2014, risk corridors have no impact on our 2014 operations. Because the reinsurance and risk-adjustment programs are brand new and historical results are not available, estimates of amounts receivable from them are subject to considerable uncertainty. Actual amounts received may vary substantially from our estimates.
Net (Loss) Income
Segment results decreased $6,585, or 161%, to a net loss of $2,502 for Second Quarter 2014 from net income of $4,083 for Second Quarter 2013. The decrease was primarily attributable to less favorable loss experience from new Affordable Care Act qualified policies, reflecting the guaranteed issue requirements and the health profiles of many first-time buyers, as well as a higher effective tax rate related to the Affordable Care Act.
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Total revenues increased $112,338, or 27%, to $524,605 for Second Quarter 2014 from $412,267 for Second Quarter 2013. Net earned premiums from our individual medical business increased $110,067, or 38%, due to growth in individual major medical product sales, including estimated recoveries from the Affordable Care Act’s risk adjustment program.
Total benefits, losses and expenses increased $117,220, or 29%, to $517,094 for Second Quarter 2014 from $399,874 for Second Quarter 2013. Policyholder benefits increased $97,563, or 33%, while the loss ratio increased to 78.1% from 75.2%. The increases in policyholder benefits and the loss ratio were primarily attributable to higher volumes of business and higher loss experience on individual major medical policies. Selling, underwriting and general expenses increased $19,657, or 19%, primarily due to higher commissions on new sales and $5,279 related to the annual fee on health insurers mandated by the Affordable Care Act effective January 1, 2014.
Net Loss
Segment net loss increased $8,311, or 660%, to a net loss of $9,571 for Six Months 2014 from a net loss of $1,260 for Six Months 2013. The increased net loss was primarily attributable to less favorable loss experience from new Affordable Care Act qualified policies, reflecting the guaranteed issue requirements and the health profiles of many first-time buyers, as well as a higher effective tax rate related to the Affordable Care Act.
Total revenues increased $157,542, or 20%, to $964,441 for Six Months 2014 from $806,899 for Six Months 2013. Net earned premiums from our individual medical business increased $149,653, or 26%, due to growth in individual major medical product sales, including estimated recoveries from the Affordable Care Act’s risk adjustment program.
Total benefits, losses and expenses increased $169,233, or 22%, to $949,271 for Six Months 2014 from $780,038 for Six Months 2013. Policyholder benefits increased $132,841, or 23%, while the loss ratio increased to 76.0% from 73.9%. The increases in policyholder benefits and the loss ratio were primarily attributable to higher volumes of and higher loss experience on individual major medical policies. Selling, underwriting and general expenses increased $36,392, or 18%, primarily due to higher commissions on new sales and $9,933 related to the annual fee on health insurers mandated by the Affordable Care Act effective January 1, 2014.
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Assurant Employee Benefits
The table below presents information regarding Assurant Employee Benefits’ segment results of operations:
Group dental
Group disability
Group life
Group supplemental and vision products
Voluntary
Employer-paid and other
Segment net income increased $2,958, or 26%, to $14,432 for Second Quarter 2014 from $11,474 for Second Quarter 2013. This increase was primarily attributable to improved disability results, reflecting lower claim incidence and the previously disclosed increase in the reserve discount rate for new long-term disability claims. In addition, results also benefitted from favorable life insurance mortality rates.
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Total revenues increased $9,076, or 3%, to $298,483 for Second Quarter 2014 from $289,407 for Second Quarter 2013. Net earned premium growth was driven by voluntary products which increased $12,827, or 13%, partially offset by declines in employer paid products.
Total benefits, losses and expenses increased $3,574, or 1% to $275,609 for Second Quarter 2014 from $272,035 for Second Quarter 2013. The loss ratio decreased to 67.4% from 68.8% primarily driven by favorable disability and life insurance loss experience. Disability results include the effect of a previously disclosed increase in the reserve discount rate for new long-term disability claims. The expense ratio decreased to 36.6% in Second Quarter 2014 compared to 37.8% in Second Quarter 2013 due to ongoing expense saving initiatives.
Segment net income increased $10,790, or 61%, to $28,347 for Six Months 2014 from $17,557 for Six Months 2013. Results for Six Months 2014 were driven by favorable loss experience in all major product lines. Six Months 2014 results include the effect of a previously disclosed increase in the reserve discount rate primarily for new long-term disability claims.
Total revenues increased $20,457, or 4%, to $597,571 for Six Months 2014 from $577,114 for Six Months 2013. Net earned premiums growth was driven by voluntary products which increased $23,599, or 12%, partially offset by declines in employer paid products.
Total benefits, losses and expenses increased $2,166, or less than 1%, to $552,719 for Six Months 2014 from $550,553 for Six Months 2013. The loss ratio decreased to 67.8% from 70.8% primarily driven by favorable experience in all major product lines. The expense ratio decreased to 36.8% for Six Months 2014 from 37.3% for Six Months 2013 due to ongoing expenses saving initiatives.
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Assurant Corporate & Other
The table below presents information regarding the Corporate & Other segment’s results of operations:
Segment loss before benefit for income taxes
Benefit for income taxes
Segment net income (loss)
Net Income (Loss)
Segment results increased $23,782, or 119%, to net income of $3,837 for Second Quarter 2014 compared with a net loss of $19,945 for Second Quarter 2013. The increase was primarily due to a $20,753 one-time tax benefit related to the conversion of the Canadian branch operations of certain U.S. companies to foreign corporate entities.
Total revenues decreased $15,578, or 52%, to $14,390 for Second Quarter 2014 compared with $29,968 for Second Quarter 2013. The decrease is primarily related to a $14,770 decrease in net realized gains on investments.
Total benefits, losses and expenses decreased $16,841, or 29%, to $41,084 for Second Quarter 2014 compared with $57,925 for Second Quarter 2013. Interest expense declined $7,744 primarily due to repayment of the 2004 Senior Notes with an aggregate principal amount of $500,000 on February 18, 2014. In addition, Second Quarter 2014 had lower selling, underwriting and general expenses compared with Second Quarter 2013 primarily due to lower employee-related benefit costs and expense reduction initiatives.
Segment net loss decreased $19,082, or 60%, to $12,974 for Six Months 2014 compared with $32,056 for Six Months 2013. The decrease is primarily due to the $20,753 one-time tax benefit related to a change in tax entity classification discussed above.
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Total revenues decreased $9,537, or 18%, to $43,126 for Six Months 2014 compared with $52,663 for Six Months 2013. The decrease is primarily related to an $8,057 decrease in net realized gains on investments.
Total expenses decreased $14,024, or 14%, to $86,069 for Six Months 2014 compared with $100,093 for Six Months 2013. Interest expense declined $5,757 primarily due to repayment of the 2004 Senior Notes with an aggregate principal amount of $500,000 on February 18, 2014. In addition, Six Months 2014 had lower selling, underwriting and general expenses compared with Six Months 2013 primarily due to lower employee-related benefit costs and expenses reduction initiatives.
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Investments
The Company had total investments of $14,661,819 and $14,244,015 as of June 30, 2014 and December 31, 2013, respectively. For more information on our investments see Note 5 to the Notes to Consolidated Financial Statements included elsewhere in this report.
The following table shows the credit quality of our fixed maturity securities portfolio as of the dates indicated:
Fixed Maturity Securities by Credit Quality (Fair Value)
Aaa / Aa / A
Baa
Ba
B and lower
Major categories of net investment income were as follows:
Total investment income
Investment expenses
Net investment income increased $3,584, or 2.2%, to $167,508 for Second Quarter 2014 compared with $163,924 for Second Quarter 2013. The increase for the period was primarily related to $2,859 in additional investment income from real estate joint venture partnerships and $1,760 in additional investment income related to the loss recovery on certain mortgage-backed securities as a result of a trust settlement agreement. Excluding the investment income from the real estate joint venture partnerships and the trust settlement agreement, net investment income decreased $1,035, primarily reflecting lower investment yields. Net investment income increased $5,657, or 1.7%, to $335,566 for Six Months 2014 compared with $329,909 for Six Months 2013. The increase for the period was primarily related to $9,812 in additional investment income from real estate joint venture partnerships and $1,760 in additional investment income related to the loss recovery on certain mortgage-backed securities as a result of a trust settlement agreement. Excluding the investment income from the real estate joint venture partnerships and the trust settlement agreement, net investment income decreased $5,915, primarily reflecting lower investment yields.
As of June 30, 2014, the Company owned $205,780 of securities guaranteed by financial guarantee insurance companies. Included in this amount was $194,813 of municipal securities, whose credit rating was A+ with the guarantee, but would have had a rating of A without the guarantee.
The Company has exposure to sub-prime and related mortgages within our fixed maturity securities portfolio. At June 30, 2014, approximately 3.0% of our residential mortgage-backed holdings had exposure to sub-prime mortgage collateral. This represented
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approximately 0.2% of the total fixed income portfolio and 1.5% of the total unrealized gain position. Of the securities with sub-prime exposure, approximately 11.9% are rated as investment grade. All residential mortgage-backed securities, including those with sub-prime exposure, are reviewed as part of the ongoing other-than-temporary impairment monitoring process.
As of June 30, 2014 and December 31, 2013, our collateral held under securities lending agreements, the use of which is unrestricted, was $95,222 and $95,215, respectively, and is included in the consolidated balance sheets under the collateral held/pledged under securities agreements. Our liability to the borrower for collateral received was $95,217 and $95,206, respectively, and is included in the consolidated balance sheets under the obligation under securities agreements. The difference between the collateral held and obligations under securities lending agreements is recorded as an unrealized gain (loss) and is included as part of AOCI. There was one security in an unrealized loss position as of June 30, 2014 and it has been in an unrealized loss position for less than 12 months. All securities were in an unrealized gain position as of December 31, 2013. The Company includes the available-for-sale investments purchased with the cash collateral in its evaluation of other-than-temporary impairments.
Liquidity and Capital Resources
Regulatory Requirements
Assurant, Inc. is a holding company and, as such, has limited direct operations of its own. Our holding company’s assets consist primarily of the capital stock of our subsidiaries. Accordingly, our holding company’s future cash flows depend upon the availability of dividends and other statutorily permissible payments from our subsidiaries, such as payments under our tax allocation agreement and under management agreements with our subsidiaries. The ability to pay such dividends and to make such other payments will be limited by applicable laws and regulations of the states in which our subsidiaries are domiciled, which subject our subsidiaries to significant regulatory restrictions. The dividend requirements and regulations vary from state to state and by type of insurance provided by the applicable subsidiary. These laws and regulations require, among other things, our insurance subsidiaries to maintain minimum solvency requirements and limit the amount of dividends these subsidiaries can pay to the holding company. For further information on pending amendments to state insurance holding company laws, including the NAIC’s “Solvency Modernization Initiative,” see “Item 1A—Risk Factors—Risks Related to Our Industry—Changes in regulation may reduce our profitability and limit our growth” in our 2013 Annual Report on Form 10-K. Along with solvency regulations, the primary driver in determining the amount of capital used for dividends is the level of capital needed to maintain desired financial strength ratings from A.M. Best.
It is possible that regulators or rating agencies could become more conservative in their methodology and criteria, including increasing capital requirements for our insurance subsidiaries which, in turn, could negatively affect our capital resources. On November 18, 2013, A.M. Best affirmed the financial strength ratings of Assurant’s businesses with a stable outlook. At that time, A.M. Best also affirmed Assurant’s debt rating of bbb and revised the outlook from stable to positive. On March 12, 2013, Moody’s Investor Services (“Moody’s”) downgraded the insurance financial strength ratings of two of Assurant’s rated life and health subsidiaries from A3 to Baa1 due to pressures on earnings and concerns about the impact of the Affordable Care Act. Moody’s outlook on these two subsidiaries remains negative. On July 1, 2014, Standard and Poor’s (“S&P”) affirmed the financial strength ratings of Assurant’s businesses with a stable outlook. At that time, S&P also affirmed Assurant’s debt rating of BBB+ and stable outlook. For further information on our ratings and the risks of ratings downgrades, see “Item 1—Business” and “Item 1A—Risk Factors—Risks Related to Our Company—A.M. Best, Moody’s and S&P rate the financial strength of our insurance company subsidiaries, and a decline in these ratings could affect our standing in the insurance industry and cause our sales and earnings to decrease” in our 2013 Annual Report on Form 10-K. For 2014, the maximum amount of dividends our U.S. domiciled insurance subsidiaries could pay, under applicable laws and regulations without prior regulatory approval, is approximately $484,000.
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Liquidity
As of June 30, 2014, we had $559,124 in holding company capital. We use the term “holding company capital” to represent the portion of cash and other liquid marketable securities held at Assurant, Inc., out of a total of $762,657, that we are not otherwise holding for a specific purpose as of the balance sheet date, but can be used for stock repurchases, stockholder dividends, acquisitions, and other corporate purposes. $250,000 of the $559,124 of holding company capital is intended to serve as a buffer against remote risks (such as large-scale hurricanes). Dividends or returns of capital, net of infusions, made to the holding company from its operating companies were $122,440 for Six Months 2014. In 2013, dividends, net of infusions, made to the holding company from its operating companies were $607,295. We use these cash inflows primarily to pay expenses, to make interest payments on indebtedness, to make dividend payments to our stockholders, to make subsidiary capital contributions, to fund acquisitions and to repurchase our outstanding shares.
In addition to paying expenses and making interest payments on indebtedness, our capital management strategy provides for several uses for the cash generated by our subsidiaries, including without limitation, returning capital to shareholders through share repurchases and dividends, investing in our businesses to support growth in targeted areas, and making prudent and opportunistic acquisitions. We made share repurchases and paid dividends to our stockholders of $118,447 and $472,308 during Six Months 2014 and the year ended December 31, 2013, respectively. We expect 2014 net dividends from the operating segments to approximate their earnings subject to the growth of the businesses, rating agency and regulatory capital requirements and investment performance.
The primary sources of funds for our subsidiaries consist of premiums and fees collected, proceeds from the sales and maturity of investments and net investment income. Cash is primarily used to pay insurance claims, agent commissions, operating expenses and taxes. We generally invest our subsidiaries’ excess funds in order to generate investment income.
We conduct periodic asset liability studies to measure the duration of our insurance liabilities, to develop optimal asset portfolio maturity structures for our significant lines of business and ultimately to assess that cash flows are sufficient to meet the timing of cash needs. These studies are conducted in accordance with formal company-wide Asset Liability Management (“ALM”) guidelines.
To complete a study for a particular line of business, models are developed to project asset and liability cash flows and balance sheet items under a large, varied set of plausible economic scenarios. These models consider many factors including the current investment portfolio, the required capital for the related assets and liabilities, our tax position and projected cash flows from both existing and projected new business.
Alternative asset portfolio structures are analyzed for significant lines of business. An investment portfolio maturity structure is then selected from these profiles given our return hurdle and risk preference. Sensitivity testing of significant liability assumptions and new business projections is also performed.
Our liabilities generally have limited policyholder optionality, which means that the timing of payments is relatively insensitive to the interest rate environment. In addition, our investment portfolio is largely comprised of highly liquid fixed maturity securities with a sufficient component of such securities invested that are near maturity which may be sold with minimal risk of loss to meet cash needs. Therefore, we believe we have limited exposure to disintermediation risk.
Generally, our subsidiaries’ premiums, fees and investment income, along with planned asset sales and maturities, provide sufficient cash to pay claims and expenses. However, there may be instances when unexpected cash needs arise in excess of that available from usual operating sources. In such instances, we have several options to raise needed funds, including selling assets from the subsidiaries’ investment portfolios, using holding company cash (if available), issuing commercial paper, or drawing funds from our revolving credit facility. In addition, we have filed an automatically effective shelf registration statement on Form S-3 with the SEC. This registration statement allows us to issue equity, debt or other types of securities through one or more methods of distribution. The terms of any offering would be established at the time of the offering, subject to market conditions. If we decide to make an offering of securities, we will consider the nature of the cash requirement as well as the cost of capital in determining what type of securities we may offer.
We paid dividends of $0.27 per common share on June 10, 2014 to stockholders of record as of May 27, 2014. This represents an 8% increase above the quarter dividend of $0.25 per common share paid on March 10, 2014 to stockholders of record as of February 24, 2014. Any determination to pay future dividends will be at the discretion of our Board of Directors and will be dependent upon: our subsidiaries’ payment of dividends and/or other statutorily permissible payments to us; our results of operations and cash flows; our financial position and capital requirements; general business conditions; legal, tax, regulatory and contractual restrictions on the payment of dividends; and other factors our Board of Directors deems relevant.
On November 18, 2013, our Board of Directors authorized the Company to repurchase up to an additional $600,000 of its outstanding common stock. As of December 31, 2013, there was $704,874 remaining under the total repurchase authorization. During the six months ended June 30, 2014, we repurchased 1,191,600 shares of our outstanding common stock at a cost of $79,490, exclusive of commissions. As of June 30, 2014, $625,384 remained under the total repurchase authorization. The timing and the amount of future repurchases will depend on market conditions and other factors.
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Management believes the Company will have sufficient liquidity to satisfy its needs over the next twelve months, including the ability to pay interest on our Senior Notes and dividends on our common shares.
Retirement and Other Employee Benefits
Our qualified pension benefits plan (the “Plan”) was under-funded by $6,429 and over-funded by $18,078 (based on the fair value of Plan assets compared to the projected benefit obligation) at June 30, 2014 and December 31, 2013, respectively. This equates to a 99% and 102% funded status at June 30, 2014 and December 31, 2013, respectively. The change in funded status is mainly due to a decrease in the discount rate used to determine the projected benefit obligation.
In prior years we established a funding policy in which service cost plus 15% of qualified plan deficit will be contributed annually. During Six Months 2014, we contributed $15,000 in cash to the Plan. Additional cash, up to $15,000, is expected to be contributed to the Plan over the remainder of 2014.
As of January 1, 2014, the Assurant Pension and Executive Pension Plans are no longer offered to new hires. Current employees will not be affected and will continue to accrue benefits under the Assurant Pension and Executive Pension Plans. Employees who are currently eligible but not yet participating will remain eligible to participate in the future once they meet the Assurant Pension and Executive Pension Plan requirements.
Commercial Paper Program
Our commercial paper program requires us to maintain liquidity facilities either in an available amount equal to any outstanding notes from the program or in an amount sufficient to maintain the ratings assigned to the notes issued from the program. Our commercial paper is rated AMB-2 by A.M. Best, P-2 by Moody’s and A-2 by S&P. Our subsidiaries do not maintain commercial paper or other borrowing facilities. This program is currently backed up by a $350,000 senior revolving credit facility, of which $345,740 was available at June 30, 2014, due to $4,260 of outstanding letters of credit related to this program.
On September 21, 2011, we entered into a four-year unsecured $350,000 revolving credit agreement (“2011 Credit Facility”) with a syndicate of banks arranged by JP Morgan Chase Bank, N.A. and Bank of America, N.A. The 2011 Credit Facility provides for revolving loans and the issuance of multi-bank, syndicated letters of credit and/or letters of credit from a sole issuing bank in an aggregate amount of $350,000 and is available until September 2015, provided we are in compliance with all covenants. The 2011 Credit Facility has a sublimit for letters of credit issued thereunder of $50,000. The proceeds of these loans may be used for our commercial paper program or for general corporate purposes. The Company may increase the total amount available under the 2011 Credit Facility to $525,000 subject to certain conditions. No bank is obligated to provide commitments above their current share of the $350,000 facility.
We did not use the commercial paper program during the three months ended June 30, 2014 or 2013, and there were no amounts outstanding relating to the commercial paper program at June 30, 2014 and December 31, 2013. The Company made no borrowings using the 2011 Credit Facility and no loans are outstanding at June 30, 2014.
The 2011 Credit Facility contains restrictive covenants and requires that the Company maintain certain specified minimum ratios and thresholds. Among others, these covenants include maintaining a maximum debt to capitalization ratio and a minimum consolidated adjusted net worth. At June 30, 2014, we were in compliance with all covenants, minimum ratios, and thresholds.
Senior Notes
On March 28, 2013, we issued two series of senior notes with an aggregate principal amount of $700,000 (the “2013 Senior Notes”). The first series is $350,000 in principal amount, bears interest at 2.50% per year and is payable in a single installment due March 15, 2018. The second series is $350,000 in principal amount, bears interest at 4.00% per year and is payable in a single installment due March 15, 2023.
The net proceeds from the sale of the 2013 Senior Notes was $698,093, which represents the principal amount less the discount before offering expenses. The Company used the net proceeds of the 2013 Senior Notes for general corporate purposes, including to repay $500,000 of debt that matured in February 2014.
Interest on our 2013 Senior Notes is payable semi-annually on March 15 and September 15 of each year. Interest expense incurred related to the 2013 Senior Notes was $5,745 and $5,743 for the three months ended June 30, 2014 and 2013, respectively, and $11,489 and $5,743 for the six months ended June 30, 2014 and 2013, respectively. There was $6,635 and $5,688 of accrued interest at June 30, 2014 and 2013, respectively. The 2013 Senior Notes are unsecured obligations and rank equally with all of the Company’s other senior unsecured indebtedness. The Company may redeem each series of the 2013 Senior Notes in whole or in part at any time and from time to time before their maturity at the redemption price set forth in the Indenture.
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In addition, as of December 31, 2013, we had two series of senior notes outstanding in an aggregate principal amount of $975,000 (the “2004 Senior Notes”). The first series was $500,000 in principal amount, bore interest at 5.63% per year and was repaid on February 18, 2014. The second series is $475,000 in principal amount, bears interest at 6.75% per year and is due February 15, 2034.
Interest on our 2004 Senior Notes is payable semi-annually on February 15 and August 15 of each year. The interest expense incurred related to the 2004 Senior Notes was $19,352 and $30,081 for the six months ended June 30, 2014 and 2013, respectively. There was $12,023 and $22,070 of accrued interest at June 30, 2014 and 2013, respectively. The 2004 Senior Notes are unsecured obligations and rank equally with all of our other senior unsecured indebtedness. The 2004 Senior Notes are not redeemable prior to maturity.
Cash Flows
We monitor cash flows at the consolidated, holding company and subsidiary levels. Cash flow forecasts at the consolidated and subsidiary levels are provided on a monthly basis, and we use trend and variance analyses to project future cash needs, making adjustments to the forecasts when needed.
The table below shows our recent net cash flows:
Net cash provided by (used in):
Operating activities (1)
Net change in cash
We typically generate operating cash inflows from premiums collected from our insurance products and income received from our investments while outflows consist of policy acquisition costs, benefits paid, and operating expenses. These net cash flows are then invested to support the obligations of our insurance products and required capital supporting these products. Our cash flows from operating activities are affected by the timing of premiums, fees, and investment income received and expenses paid.
Net cash provided by operating activities was $252,890 and $261,096 for Six Months 2014 and Six Months 2013, respectively. The decrease in cash provided by operating activities was primarily due to changes in the timing of payments and by amounts yet to be recovered under the 3 R’s program, partially offset by increased net written premiums across all segments. For more information on the 3 R’s, please refer to Assurant Health’s Results of Operations section in this Item 2.
Net cash provided by (used in) investing activities was $34,595 and $(343,602) for Six Months 2014 and Six Months 2013, respectively. The increase in cash used in investing activities was primarily due to the change in short-term investments and fewer purchases of fixed maturity securities. These increases are partially offset by lower sales of fixed maturity securities, the acquisition of StreetLinks LLC and the purchase of an equity interest in Iké Asistencia.
Net cash (used in) provided by financing activities was $(605,799) and $443,497 for Six Months 2014 and Six Months 2013, respectively. The cash used in financing activities during Six Months 2014 was primarily due to the repayment of $467,330 of senior debt, which represents $500,000 in principal less amounts repurchased in 2013, and the payment of a contingent liability related to the acquisition of LSG. The cash provided by financing activities during Six Months 2013 was primarily due to the issuance of two series of senior notes. The Company received proceeds of $698,093 from this transaction, which represents the principal amount less the discount before offering expenses.
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The table below shows our cash outflows for interest and dividends for the periods indicated:
Interest paid on debt
Common stock dividends
Letters of Credit
In the normal course of business, we issue letters of credit primarily to support reinsurance arrangements. These letters of credit are supported by commitments with financial institutions. We had $18,364 and $17,343 of letters of credit outstanding as of June 30, 2014 and December 31, 2013.
Recent Accounting Pronouncements
For a discussion of recent accounting pronouncements, see Note 3 to the Consolidated Financial Statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Our 2013 Annual Report on Form 10-K described our Quantitative and Qualitative Disclosures About Market Risk. There were no material changes to the assumptions or risks during Second Quarter 2014.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
The Company’s Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the Company’s disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as of June 30, 2014. They have concluded that the Company’s disclosure controls and procedures are effective, and provide reasonable assurance that information the Company is required to disclose in its reports under the Exchange Act is recorded, processed, summarized and reported accurately. They also have concluded that information that the Company is required to disclose is accumulated and communicated to the Company’s management as appropriate to allow timely decisions regarding required disclosure.
Internal Control over Financial Reporting
During the quarter ended June 30, 2014, we made no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II
OTHER INFORMATION
Item 1. Legal Proceedings.
The Company is involved in litigation in the ordinary course of business, both as a defendant and as a plaintiff and may from time to time be subject to a variety of legal and regulatory actions relating to our current and past business operations. See Note 14 to the Notes to Consolidated Financial Statements for a description of certain matters, which description is incorporated herein by reference. Although the Company cannot predict the outcome of any pending or future litigation, examination or investigation, it is possible that the outcome of such matters could have a material adverse effect on the Company’s consolidated results of operations or cash flows for an individual reporting period. However, based on currently available information, management does not believe that any pending matter is likely to have a material adverse effect, individually or in the aggregate, on the Company’s financial condition.
Item 1A. Risk Factors.
Certain factors may have a material adverse effect on our business, financial condition and results of operations and you should carefully consider them. It is not possible to predict or identify all such factors. For discussion of our potential risks or uncertainties, please refer to “Item 1A—Risk Factors” included in our 2013 Annual Report on Form 10-K. There have been no material changes during Second Quarter 2014.
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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Repurchase of Equity Securities:
January 1-31
February 1-28
March 1-31
April 1-30
May 1-31
June 1-30
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Item 6. Exhibits.
Pursuant to the rules and regulations of the SEC, the Company has filed or incorporated by reference certain agreements as exhibits to this quarterly report on Form 10-Q. These agreements may contain representations and warranties by the parties. These representations and warranties have been made solely for the benefit of the other party or parties to such agreements and (i) may have been qualified by disclosures made to such other party or parties, (ii) were made only as of the date of such agreements or such other date(s) as may be specified in such agreements and are subject to more recent developments, which may not be fully reflected in the Company’s public disclosure, (iii) may reflect the allocation of risk among the parties to such agreements and (iv) may apply materiality standards different from what may be viewed as material to investors. Accordingly, these representations and warranties may not describe the Company’s actual state of affairs at the date hereof and should not be relied upon.
The following exhibits either (a) are filed with this report or (b) have previously been filed with the SEC and are incorporated herein by reference to those prior filings. Exhibits are available upon request at the investor relations section of our website at www.assurant.com. Our website is not a part of this report and is not incorporated by reference in this report.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
/s/ ROBERT B. POLLOCK
/s/ MICHAEL J. PENINGER
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