(7) Fair Value of Financial Instruments

The Company’s measurement of fair value is based on assumptions used by market participants in pricing the asset or liability, which may include inherent risk, restrictions on the sale or use of an asset or non-performance risk, which may include the Company’s own credit risk. The Company’s estimate of an exchange price is the price in an orderly transaction between market participants to sell the asset or transfer the liability (“exit price”) in the principal market, or the most advantageous market in the absence of a principal market, for that asset or liability, as opposed to the price that would be paid to acquire the asset or receive a liability (“entry price”). The Company categorizes financial instruments carried at fair value into a three-level fair value hierarchy, based on the priority of inputs to the respective valuation technique. The three-level hierarchy for fair value measurement is defined as follows:


Level 1 —		Values are unadjusted quoted prices for identical assets and liabilities in active markets accessible at the measurement date.

Level 2 —		Inputs include quoted prices for similar assets or liabilities in active markets, quoted prices from those willing to trade in markets that are not active, or other inputs that are observable or can be corroborated by market data for the term of the instrument. Such inputs include market interest rates and volatilities, spreads and yield curves.

Level 3 —		Certain inputs are unobservable (supported by little or no market activity) and significant to the fair value measurement. Unobservable inputs reflect the Company’s best estimate of what hypothetical market participants would use to determine a transaction price for the asset or liability at the reporting date based on the best information available in the circumstances.

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an investment’s level within the fair value hierarchy is based on the lower level of input that is significant to the fair value measurement. 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 investment.

When a determination is made to classify an asset or liability within Level 3 of the fair value hierarchy, the determination is based upon the significance of the unobservable inputs to the overall fair value measurement. Because certain securities trade in less liquid or illiquid markets with limited or no pricing information, the determination of fair value for these securities is inherently more difficult. However, Level 3 fair value investments may include, in addition to the unobservable or Level 3 inputs, observable components, which are components that are actively quoted or can be validated to market-based sources.

The carrying amounts and estimated fair values of the Company’s consolidated financial instruments for which the disclosure of fair values is required, including financial assets and liabilities measured and carried at fair value on a recurring basis, with the exception of investment contracts, are summarized according to the hierarchy previously described as follows:


	September 30, 2012
	Level 1		Level 2		Level 3		Fair Value		Carrying Amount
Assets
Consumer Products and Other
Cash and cash equivalents	$	408,889	$	—	$	—	$	408,889	$	408,889
Contingent purchase price reduction receivable		—		—		41,000		41,000		41,000
Short-term investments (including related interest receivable of $5)
Equity securities — trading		146,842		—		—		146,842		146,842
Fixed maturity securities — held-to-maturity		—		35,000		—		35,000		34,991
Derivatives:
Foreign exchange forward agreements		—		1,235		—		1,235		1,235
Commodity swap and option agreements		—		2,002		—		2,002		2,002

Insurance and Financial Services
Cash and cash equivalents		1,059,572		2,250		—		1,061,822		1,061,822
Fixed maturity securities, available-for-sale:
Asset-backed securities		—		1,012,027		15,855		1,027,882		1,027,882
Commercial mortgage-backed securities		—		548,791		5,023		553,814		553,814
Corporates		—		10,873,715		135,296		11,009,011		11,009,011
Hybrids		—		519,422		8,873		528,295		528,295
Municipals		—		1,223,995		—		1,223,995		1,223,995
Agency residential mortgage-backed securities		—		154,890		—		154,890		154,890
Non-agency residential mortgage-backed securities		—		660,659		—		660,659		660,659
U.S. Government		930,367		—		—		930,367		930,367
Equity securities — available-for-sale		—		248,087		—		248,087		248,087
Derivative financial instruments		—		200,667		—		200,667		200,667
Asset-backed loans and other invested assets		—		—		198,868		198,868		198,868

Total financial assets	$	2,545,670	$	15,482,740	$	404,915	$	18,433,325	$	18,433,316

Liabilities
Consumer Products and Other
Total debt	$	524,000	$	1,804,831	$	—	$	2,328,831	$	2,167,039
Derivatives:
Foreign exchange forward agreements		—		9,956		—		9,956		9,956
Commodity swap and option agreements		—		9		—		9		9
Equity conversion feature of preferred stock		—		—		231,950		231,950		231,950
Redeemable preferred stock, excluding equity conversion feature		—		—		368,880		368,880		319,225

Insurance and Financial Services
Derivatives:
FIA embedded derivatives, included in contractholder funds		—		—		1,550,805		1,550,805		1,550,805
Futures contracts		—		928		—		928		928
Investment contracts, included in contractholder funds		—		—		12,271,882		12,271,882		13,739,670

Total financial liabilities	$	524,000	$	1,815,724	$	14,423,517	$	16,763,241	$	18,019,582


	September 30, 2011
	Level 1		Level 2		Level 3		Fair Value		Carrying Amount
Assets
Consumer Products and Other
Cash and cash equivalents	$	321,352	$	—	$	—	$	321,352	$	321,352
Short-term investments (including related interest receivable of $9)
Equity securities — trading		238,062		24,023		—		262,085		262,085
Fixed maturity securities — held to maturity		—		75,899		—		75,899		75,897
Fixed maturity securities — trading		—		12,665		—		12,665		12,665
Derivatives:
Foreign exchange forward agreements		—		3,189		—		3,189		3,189
Commodity swap and option agreements		—		274		—		274		274

Insurance and Financial Services
Cash and cash equivalents		813,239		2,768		—		816,007		816,007
Fixed maturity securities, available-for-sale:
Asset-backed securities		—		125,966		374,518		500,484		500,484
Commercial mortgage-backed securities		—		565,577		—		565,577		565,577
Corporates		—		11,696,090		159,684		11,855,774		11,855,774
Hybrids		—		654,084		5,205		659,289		659,289
Municipals		—		936,484		—		936,484		936,484
Agency residential mortgage-backed securities		—		218,713		3,312		222,025		222,025
Non-agency residential mortgage-backed securities		—		440,758		3,759		444,517		444,517
U.S. Government		183,324		—		—		183,324		183,324
Equity securities — available-for-sale		—		287,043		—		287,043		287,043
Derivative financial instruments		—		52,335		—		52,335		52,335
Other invested assets		—		—		44,279		44,279		44,279

Total financial assets	$	1,555,977	$	15,095,868	$	590,757	$	17,242,602	$	17,242,600

Liabilities
Consumer Products and Other
Total debt	$	500,000	$	1,635,528	$	—	$	2,135,528	$	2,048,780
Derivatives:
Foreign exchange forward agreements		—		25,679		—		25,679		25,679
Interest rate swap agreements		—		1,954		—		1,954		1,954
Commodity swap and option agreements		—		1,232		—		1,232		1,232
Equity conversion feature of preferred stock		—		—		75,350		75,350		75,350
Redeemable preferred stock, excluding equity conversion feature		—		—		337,060		337,060		292,437

Insurance and Financial Services
Derivatives:
FIA embedded derivatives, included in contractholder funds		—		—		1,396,340		1,396,340		1,396,340
Futures contracts		—		3,828		—		3,828		3,828
Available-for-sale embedded derivative		—		—		400		400		400
Investment contracts, included in contractholder funds		—		—		11,992,013		11,992,013		13,153,630
Note payable		—		95,000		—		95,000		95,000

Total financial liabilities	$	500,000	$	1,763,221	$	13,801,163	$	16,064,384	$	17,094,630

The carrying amounts of trade receivables, accounts payable, accrued investment income and portions of other insurance liabilities approximate fair value due to their short duration and, accordingly, they are not presented in the tables above.

The fair values of cash equivalents, short-term investments and debt set forth above are generally based on quoted or observed market prices.

FGL measures the fair value of its securities based on assumptions used by market participants in pricing the security. The most appropriate valuation methodology is selected based on the specific characteristics of the fixed maturity or equity security, and FGL will then consistently apply the valuation methodology to measure the security’s fair value. FGL’s fair value measurement is based on a market approach, which utilizes prices and other relevant information generated by market transactions involving identical or comparable securities. Sources of inputs to the market approach include a third-party pricing service, independent broker quotations or pricing matrices. FGL uses observable and unobservable inputs in its valuation methodologies. Observable inputs include benchmark yields, reported trades, broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data. In addition, market indicators and industry and economic events are monitored and further market data will be acquired when certain thresholds are met. For certain security types, additional inputs may be used, or some of the inputs described above may not be applicable. For broker-quoted only securities, quotes from market makers or broker-dealers are obtained from sources recognized to be market participants. Management believes the broker quotes are prices at which trades could be executed based on historical trades executed at broker-quoted or slightly higher prices. The fair value of the asset-backed loans originated by Salus approximate their carrying value, as those loans carry a variable rate, are revolving in nature, and can be settled at the demand of either party.

FGL did not adjust prices received from third parties as of September 30, 2012 and 2011. However, FGL does analyze the third party valuation methodologies and its related inputs to perform assessments to determine the appropriate level within the fair value hierarchy.

The fair value of derivative assets and liabilities is based upon valuation pricing models, which represents what FGL would expect to receive or pay at the balance sheet date if it cancelled the options, entered into offsetting positions, or exercised the options. The fair value of futures contracts represents the cumulative unsettled variation margin (open trade equity net of cash settlements). Fair values for these instruments are determined externally by an independent actuarial firm using market observable inputs, including interest rates, yield curve volatilities, and other factors. Credit risk related to the counterparty is considered when estimating the fair values of these derivatives. The fair values of the embedded derivatives in FGL’s FIA products are derived using market indices, pricing assumptions and historical data.

Investment contracts include deferred annuities, FIAs, IUL and immediate annuities. The fair values of deferred annuity, FIAs, and IUL contracts are based on their cash surrender value (i.e. the cost FGL would incur to extinguish the liability) as these contracts are generally issued without an annuitization date. The fair value of immediate annuities contracts is derived by calculating a new fair value interest rate using the updated yield curve and treasury spreads as of the respective reporting date. At September 30, 2012 and 2011, this resulted in lower fair value reserves relative to the carrying value. FGL is not required to and has not estimated the fair value of the liabilities under contracts that involve significant mortality or morbidity risks, as these liabilities fall within the definition of insurance contracts that are exceptions from financial instruments that require disclosure of fair value. The fair value of FGL’s note payable at September 30, 2011 approximated its carrying value as it was settled at such carrying value in October 2011.

Goodwill, intangible assets and other long-lived assets are also tested annually or if an event occurs that indicates an impairment loss may have been incurred (see Note 10) using fair value measurements with unobservable inputs (Level 3).

See Note 15 with respect to fair value measurements of the Company’s pension plan assets.

Quantitative information regarding significant unobservable inputs used for recurring Level 3 fair value measurements of financial instruments carried at fair value as of September 30, 2012 is as follows:


	Fair Value at September 30, 2012		Valuation technique	Unobservable input(s)	Range (Weighted average)
Assets
Contingent purchase price reduction receivable	$	41,000	Discounted cash flow	Probability of collection Expected term Discount rate Credit insurance risk premium	88% - 96% (92%) 9 months 0.72% 11.7%
Asset-backed securities		15,855	Broker-quoted	Offered quotes	100% - 109.73% (103.09%)
Corporates		103,319	Broker-quoted	Offered quotes	0% - 140.61% (68.47%)
Corporates		31,977	Market pricing	Quoted prices	87.50% - 158.11% (97.89%)
Hybrids		8,873	Broker-quoted	Offered quotes	0% - 103% (25.35%)
Commercial mortgage-backed securities		5,023	Broker-quoted	Offered quotes	100.69%

Total	$	206,047

Liabilities
FIA embedded derivatives, included in contractholder funds	$	1,550,805	Discounted cash flow	Market value of option SWAP rates Mortality multiplier Surrender rates Non-performance spread	0% - 31.05% (3.55%) 0.76% - 1.7% (1.22%) 70% - 70% (70%) 2% - 50% (7%) 0.25% - 0.25% (0.25%)

Equity conversion feature of preferred stock		231,950	Monte Carlo simulation / Option model	Annualized volatility of equity Discount yield Non-cash accretion rate Calibration adjustment	41% 11.5% - 12.7% (11.9%) 0% 10% - 13% (10.9%)

Total	$	1,782,755

The significant unobservable inputs used in the fair value measurement of the contingent purchase price reduction receivable are the probability of collection depending on the outcomes of litigation and regulatory action, the expected term until payment, discount rate and the credit insurance risk premium. Generally, an increase in the assumptions for the expected term, discount rate or credit insurance risk premium would decrease the fair value of the contingent purchase price receivable. An increase in the probability of collection would increase the fair value of the contingent purchase price reduction receivable.

The significant unobservable inputs used in the fair value measurement of FIA embedded derivatives included in contractholder funds are market value of option, interest swap rates, mortality multiplier, surrender rates, and non-performance spread. The mortality multiplier is based on the 1983 annuity table and assumes the contractholder population is 50% female and 50% male. Significant increases (decreases) in the market value of option in isolation would result in a higher (lower) fair value measurement. Significant increases (decreases) in interest swap rates, mortality multiplier, surrender rates, or non-performance spread in isolation would result in a lower (higher) fair value measurement. Generally, a change in any one unobservable input would not result in a change in any other unobservable input.

The significant unobservable inputs used in the fair value measurement of the equity conversion feature of the Company’s Preferred Stock are annualized volatility of the market value of the Company’s listed shares of common stock, the discount yield as of the valuation date, a calibration factor to the issued date fair value of the Preferred Stock and the forecasted non-cash accretion rate. Significant increases (decreases) in any of the inputs in isolation would result in a significantly higher (lower) fair value measurement. Generally, an increase in the assumptions used for the volatility and discount yield would increase the fair value of the equity conversion feature of Preferred Stock, and maintaining a higher forecasted non-cash accretion rate, would also increase the fair value of the equity conversion feature of Preferred Stock. A decrease in the calibration factor would result in an increase in the fair value of the equity conversion feature of Preferred Stock.

The following tables summarize changes to the Company’s financial instruments carried at fair value and classified within Level 3 of the fair value hierarchy for the years ended September 30, 2012 and 2011 (none in Fiscal 2010). This summary excludes any impact of amortization of VOBA and DAC. The gains and losses below may include changes in fair value due in part to observable inputs that are a component of the valuation methodology.


	Year Ended September 30, 2012
	Balance at Beginning of Period			Total Gains (Losses)						Net Purchases, Sales & Settlements			Net Transfer In (Out) of Level 3 ^(a)			Balance at End of Period
	Balance at Beginning of Period			Included in Earnings			Included in AOCI			Net Purchases, Sales & Settlements			Net Transfer In (Out) of Level 3 ^(a)			Balance at End of Period
Assets
Contingent purchase price reduction receivable	$	—		$	41,000		$	—		$	—		$	—		$	41,000
Fixed maturity securities, available-for-sale:
Asset-backed securities		374,518			—			7,355			371,896			(737,914	)		15,855
Commercial mortgage-backed securities		—			—			24			4,999			—			5,023
Corporates		159,684			28			(3,662	)		(39,686	)		18,932			135,296
Hybrids		5,205			—			(44	)		—			3,712			8,873
Municipals		—			(2	)		72			10,177			(10,247	)		—
Agency residential mortgage-backed securities		3,312			—			18			—			(3,330	)		—
Non-agency residential mortgage-backed securities		3,759			(126	)		4			(777	)		(2,860	)		—

Total assets at Level 3 fair value	$	546,478		$	40,900		$	3,767		$	346,609		$	(731,707	)	$	206,047

Liabilities
FIA embedded derivatives, included in contractholder funds	$	(1,396,340	)	$	(154,465	)	$	—		$	—		$	—		$	(1,550,805	)
Available-for-sale embedded derivatives		(400	)		400			—			—			—			—
Equity conversion feature of preferred stock		(75,350	)		(156,600	)		—			—			—			(231,950	)

Total liabilities at Level 3 fair value	$	(1,472,090	)	$	(310,665	)	$	—		$	—		$	—		$	(1,782,755	)

(a)	The net transfers in and out of Level 3 during the year ended September 30, 2012 were exclusively to or from Level 2.


	Year Ended to September 30, 2011
	Balance at FGL Acquisition Date			Total Gains (Losses)					Net Purchases, Sales & Settlements			Net Transfer In (Out) of Level 3 ^(a)			Balance at End of Period
	Balance at FGL Acquisition Date			Included in Earnings		Included in AOCI			Net Purchases, Sales & Settlements			Net Transfer In (Out) of Level 3 ^(a)			Balance at End of Period
Assets
Fixed maturity securities, available-for-sale:
Asset-backed securities	$	399,967		$	—	$	863		$	(11,709	)	$	(14,603	)	$	374,518
Corporates		197,573			1,993		5,408			(45,229	)		(61	)		159,684
Hybrids		8,305			—		(61	)		—			(3,039	)		5,205
Agency residential mortgage-backed securities		3,271			—		41			—			—			3,312
Non-agency residential mortgage-backed securities		18,519			2,364		379			(17,503	)		—			3,759

Total assets at Level 3 fair value	$	627,635		$	4,357	$	6,630		$	(74,441	)	$	(17,703	)	$	546,478

Liabilities
FIA embedded derivatives, included in contractholder funds	$	(1,466,308	)	$	69,968	$	—		$	—		$	—		$	(1,396,340	)
Available-for-sale embedded derivatives		(419	)		19		—			—			—			(400	)
Equity conversion feature of preferred stock		—			27,910		—			(103,260	)		—			(75,350	)

Total liabilities at Level 3 fair value	$	(1,466,727	)	$	97,897	$	—		$	(103,260	)	$	—		$	(1,472,090	)

(a)	The net transfers in and out of Level 3 during the year ended September 30, 2011 were exclusively to or from Level 2.

FGL reviews the fair value hierarchy classifications each reporting period. Changes in the observability of the valuation attributes may result in a reclassification of certain financial assets or liabilities. Such reclassifications are reported as transfers in and out of Level 3, or between other levels, at the beginning fair value for the reporting period in which the changes occur. There were no transfers between Level 1 and Level 2 for the years ended September 30, 2012 and 2011.

Primary market issuance and secondary market activity for certain asset-backed securities, corporates, municipals and residential mortgage-backed securities during Fiscal 2012, as well as asset-backed securities, corporates and hybrid securities during Fiscal 2011 increased the market observable inputs used to establish fair values for similar securities. These factors, along with more consistent pricing from third-party sources, resulted in FGL concluding that there is sufficient trading activity in similar instruments to support classifying these securities as Level 2 as of September 30, 2012 and 2011, respectively. Additionally, during the year a new third party began pricing FGL’s collateral loan obligations (“CLOs”) holdings included in asset-backed securities. This new pricing vendor uses market observable inputs such as actual trade prices, yields, and other market assumptions as well as observable deal, tranche and collateral information in the pricing of CLOs and therefore supported a level 2 classification of these securities as of September 30, 2012. Accordingly, FGL’s assessment resulted in a net transfer out of Level 3 of $794,012 related to asset-backed securities, corporates, hybrids, municipals, and residential mortgage-backed securities during the year ended September 30, 2012 and $17,703 related to asset-backed securities, corporates and hybrids during the year ended September 30, 2011. There were also net transfers in to Level 3 of $3,712 related to hybrid securities during the year ended September 30, 2012.

The following tables present the gross components of purchases, sales, and settlements, net, of Level 3 financial instruments for the years ended September 30, 2012 and 2011. There were no issuances during these periods.


	Year Ended September 30, 2012
	Purchases		Sales			Settlements			Net Purchases, Sales & Settlements
Assets
Fixed maturity, securities available-for-sale:
Asset-backed securities	$	410,707	$	—		$	(38,811	)	$	371,896
Commercial mortgage-backed securities		4,999		—			—			4,999
Corporates		1,326		(26,788	)		(14,224	)		(39,686	)
Municipals		10,197		—			(20	)		10,177
Non-agency residential mortgage-backed securities		—		(475	)		(302	)		(777	)

Total assets at Level 3 fair value	$	427,229	$	(27,263	)	$	(53,357	)	$	346,609


	Year Ended September 30, 2011
	Purchases		Sales			Settlements			Net Purchases, Sales & Settlements
Assets
Fixed maturity, securities available-for-sale:
Asset-backed securities	$	2,007	$	—		$	(13,716	)	$	(11,709	)
Corporates		10,365		(48,898	)		(6,696	)		(45,229	)
Non-agency residential mortgage-backed securities		—		(15,729	)		(1,774	)		(17,503	)

Total assets at Level 3 fair value	$	12,372	$	(64,627	)	$	(22,186	)	$	(74,441	)

Liabilities
Equity conversion option of preferred stock	$	—	$	(103,260	)	$	—		$	(103,260	)