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Fair Value of Financial Instruments
 6 Months Ended
Apr. 01, 2012
Fair Value of Financial Instruments [Abstract]  
Fair Value of Financial Instruments

(5) 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, are summarized according to the hierarchy previously described as follows:

 

                                         
    April 1, 2012  
    Level 1     Level 2     Level 3     Fair Value     Carrying
Amount		  

Assets

                                        

Consumer Products and Other

                                        

Cash and cash equivalents

   $ 303,438     $ —       $ —       $ 303,438     $ 303,438  

Contingent purchase price reduction receivable

     —         —         41,000       41,000       41,000  

Short-term investments (including related interest receivable of $6)

                                        

Equity securities — trading

     177,113       —         —         177,113       177,113  

Fixed maturity securities —held-to-maturity

     —         34,993       —         34,993       35,002  

Fixed maturity securities — trading

     —         6,625       —         6,625       6,625  

Derivatives:

                                        

Foreign exchange forward agreements

     —         2,508       —         2,508       2,508  

Commodity swap and option agreements

     —         408       —         408       408  
           

Insurance and Financial Services

                                        

Cash and cash equivalents

     1,973,399       42,831       —         2,016,230       2,016,230  

Fixed maturity securities, available-for-sale:

                                        

Asset-backed securities

     —         84,821       502,938       587,759       587,759  

Commercial mortgage-backed securities

     —         539,221       —         539,221       539,221  

Corporates

     —         10,883,932       120,180       11,004,112       11,004,112  

Hybrids

     —         667,303       5,100       672,403       672,403  

Municipals

     —         951,573       10,308       961,881       961,881  

Agency residential mortgage-backed securities

     —         179,476       3,330       182,806       182,806  

Non-agency residential mortgage-backed securities

     —         462,200       1,217       463,417       463,417  

U.S. Government

     94,941       —         —         94,941       94,941  

Equity securities — available-for-sale

     —         236,391       —         236,391       236,391  

Derivative financial instruments

     —         186,547       —         186,547       186,547  

Asset-backed loans and other invested assets

     —         —         55,569       55,569       55,569  
   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

  

Total financial assets

   $ 2,548,891     $ 14,278,829     $ 739,642     $ 17,567,362     $ 17,567,371  
   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

  
           

Liabilities

                                        

Consumer Products and Other

                                        

Total debt

   $ 510,000     $ 2,006,738     $ —       $ 2,516,738     $ 2,379,516  

Derivatives:

                                        

Foreign exchange forward agreements

     —         16,890       —         16,890       16,890  

Commodity swap and option agreements

     —         420       —         420       420  

Equity conversion feature of preferred stock

     —         —         73,820       73,820       73,820  

Redeemable preferred stock, excluding equity conversion feature

     —         —         375,480       375,480       307,733  
           

Insurance and Financial Services

                                        

Derivatives:

                                        

FIA embedded derivatives, included in contractholder funds

     —         —         1,496,803       1,496,803       1,496,803  

Available-for-sale embedded derivatives

     —         —         376       376       376  

Investment contracts, included in contractholder funds

     —         —         12,266,715       12,266,715       13,675,365  
   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

  

Total financial liabilities

   $ 510,000     $ 2,024,048     $ 14,213,194     $ 16,747,242     $ 17,950,923  
   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

  

 

                                         
    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  

Future contracts

     —         3,828       —         3,828       3,828  

Available-for-sale embedded derivatives

     —         —         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. Investment contracts include deferred annuities, FIAs, universal life insurance (“UL”) and immediate annuities. The fair values of deferred annuity, FIAs, and UL 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 April 1, 2012 and September 30, 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 or retired at such carrying value in October 2011.

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

FGL measures the fair value of its securities based on assumptions used by market participants in pricing the security. The 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, 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.

FGL did not adjust prices received from third parties as of April 1, 2012 and September 30, 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 represent 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.

 

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

 

                     
    Fair Value
at April 1,
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%

1 year

0.74%

11.7%

Asset-backed securities

     502,938     Broker-quoted   Offered quotes   82.23% - 101.4% (93.4%)

Corporates

     120,180     Broker-quoted   Offered quotes   0% - 137.48% (77.8%)

Hybrids

     5,100     Broker-quoted   Offered quotes   0% - 102% (17%)

Municipals

     10,308     Broker-quoted   Offered quotes   98.59% - 122.56% (100.86%)

Agency residential-mortgage-backed securities

     3,330     Broker-quoted   Offered quotes   0% - 101.48% (34.21%)

Non-agency residential-mortgage-backed securities

     1,217     Broker-quoted   Offered quotes   34.03% - 68.21% (44.87%)
   

 

 

              

Total

   $ 684,073              
   

 

 

              

Liabilities

                    

FIA embedded derivatives, included in contractholder funds

   $ 1,496,803     Discounted cash flow   Market value of option   0% - 27.99% (3.12%)
                SWAP rates

Mortality multiplier

Surrender rates

  

1.27% - 2.29% (1.78%)

70% - 70% (70%)

2% - 50% (7%)
                Non-performance spread   0.25% - 0.25% (0.25%)
         

Equity conversion feature of preferred stock

     73,820     Monte Carlo simulation
/ Option model		   Annualized volatility of equity
Discount yield

Non-cash accretion rate

Calibration factor

  

37% (37%)

12.5% - 12.7% (12.6%)

0% - 4%

25%

Available-for-sale embedded derivatives

     376     Broker-quoted   Offered quote  

$31.79
   

 

 

              

Total

   $ 1,570,999              
   

 

 

              

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 and 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 assumptions 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 a 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 three and six month periods ended April 1, 2012. 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.

 

                                                 
    Three Month Period Ended April 1, 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		  
      Included in
Earnings		     Included
in AOCI		        

Assets

                                                

Contingent purchase price reduction receivable

   $ —       $ 41,000     $ —       $ —       $ —       $ 41,000  

Fixed maturity securities, available-for-sale:

                                                

Asset-backed securities

     400,703       —         10,641       80,771       10,823       502,938  

Corporates

     138,553       89       (1,409 )      (17,106 )      53       120,180  

Hybrids

     5,138       —         (38 )      —         —         5,100  

Municipals

     50       (1 )      72       10,187       —         10,308  

Agency residential mortgage-backed securities

     3,312       —         18       —         —         3,330  

Non-agency residential mortgage-backed securities

     3,637       —         (58 )      (117 )      (2,245 )      1,217  
   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

  

Total assets at Level 3 fair value

   $ 551,393     $ 41,088     $ 9,226     $ 73,735     $ 8,631     $ 684,073  
   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

  

Liabilities

                                                

FIA embedded derivatives, included in contractholder funds

   $ (1,455,073 )    $ (41,730 )    $ —       $ —       $ —       $ (1,496,803 ) 

Available-for-sale embedded derivatives

     (388 )      12       —         —         —         (376 ) 

Equity conversion feature of preferred stock

     (47,430 )      (26,390 )      —         —         —         (73,820 ) 
   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

  

Total liabilities at Level 3 fair value

   $ (1,502,891 )    $ (68,108 )    $ —       $ —       $ —       $ (1,570,999 ) 
   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

  

 

                                                 
    Six Month Period Ended April 1, 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		  
      Included in
Earnings		     Included
in AOCI		        

Assets

                                                

Contingent purchase price reduction receivable

   $ —       $ 41,000     $ —       $ —       $ —       $ 41,000  

Fixed maturity securities available-for-sale:

                                                

Asset-backed securities

     374,518       —         6,066       111,531       10,823       502,938  

Corporates

     159,684       23       (2,265 )      (26,917 )      (10,345 )      120,180  

Hybrids

     5,205       —         (105 )      —         —         5,100  

Municipals

     —         (2 )      72       10,177       61       10,308  

Agency residential mortgage-backed securities

     3,312       —         18       —         —         3,330  

Non-agency residential mortgage-backed securities

     3,759       —         (83 )      (214 )      (2,245 )      1,217  
   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

  

Total assets at Level 3 fair value

   $ 546,478     $ 41,021     $ 3,703     $ 94,577     $ (1,706 )    $ 684,073  
   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

  

Liabilities

                                                

FIA embedded derivatives, included in contractholder funds

   $ (1,396,340 )    $ (100,463 )    $ —       $ —       $ —       $ (1,496,803 ) 

Available-for-sale embedded derivatives

     (400 )      24       —         —         —         (376 ) 

Equity conversion feature of preferred stock

     (75,350 )      1,530       —         —         —         (73,820 ) 
   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

  

Total liabilities at Level 3 fair value

   $ (1,472,090 )    $ (98,909 )    $ —       $ —       $ —       $ (1,570,999 ) 
   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

  

 

(a)

The net transfers in and out of Level 3 during the three and six month periods ended April 1, 2012 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 three and six month periods ended April 1, 2012.

During the three and six month periods ended April 1, 2012, primary market issuance and secondary market activity for certain non-agency residential mortgage-backed securities and corporate securities 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 April 1, 2012. Accordingly, FGL’s assessment resulted in a net transfer out of Level 3 of $2,245 and $12,590 related to non-agency residential mortgage-backed securities and corporate securities and a net transfer in to Level 3 of $10,876 and $10,884 related to asset-backed securities, corporates and municipal securities during the three and six months ended April 1, 2012, respectively.

 

The following table presents the gross components of purchases, sales, and settlements, net, of Level 3 financial instruments for the three and six month periods ended April 1, 2012. There were no issuances during this period.

 

                                 
    Three Month Period Ended April 1, 2012  
    Purchases     Sales     Settlements     Net Purchases, Sales
& Settlements		  

Assets

                                

Fixed maturity, securities available-for-sale:

                                

Asset-backed securities

   $ 93,522     $ —       $ (12,751 )    $ 80,771  

Corporates

     1,326       (9,674 )      (8,758 )      (17,106 ) 

Municipal

     10,197       —         (10 )      10,187  

Non-agency residential mortgage-backed securities

     —         —         (117 )      (117 ) 
   

 

 

    

 

 

    

 

 

    

 

 

  

Total assets at Level 3 fair value

   $ 105,045     $ (9,674 )    $ (21,636 )    $ 73,735  
   

 

 

    

 

 

    

 

 

    

 

 

  

 

                                 
    Six Month Period Ended April 1, 2012  
    Purchases     Sales     Settlements     Net Purchases, Sales
& Settlements		  

Assets

                                

Fixed maturity, securities available-for-sale:

                                

Asset-backed securities

   $ 132,351     $ —       $ (20,820 )    $ 111,531  

Corporates

     1,326       (16,685 )      (11,558 )      (26,917 ) 

Municipal

     10,197       —         (20 )      10,177  

Non-agency residential mortgage-backed securities

     —         —         (214 )      (214 ) 
   

 

 

    

 

 

    

 

 

    

 

 

  

Total assets at Level 3 fair value

   $ 143,874     $ (16,685 )    $ (32,612 )    $ 94,577