FGL HOLDINGS Introduction
This "Management's Discussion and Analysis of Financial Condition and Results of Operations" ofFGL Holdings ("FGL Holdings ," "we," "us," "our" and, collectively with its subsidiaries, the "Company") should be read in conjunction with "Item 6. Selected Financial Data," and our accompanying consolidated financial statements and related notes (the "Consolidated Financial Statements") referred to in "Item 8. Financial Statements and Supplementary Data" of this Annual Report on Form 10-K (the "Form 10-K"). Certain statements we make under this Item 7 constitute "forward-looking statements" under the Private Securities Litigation Reform Act of 1995. See "Forward-Looking Statements" at the beginning of Part I of this Form 10-K. You should consider our forward-looking statements in light of our Consolidated Financial Statements, related notes, and other financial information appearing elsewhere in this Form 10-K and our other filings with theSEC . Basis of Presentation As a result of the completion of the Business Combination onNovember 30, 2017 , our Consolidated Financial Statements included elsewhere in the Annual Report are presented: (i) as ofDecember 31, 2019 and for the year endedDecember 31, 2019 ; (ii) as ofDecember 31, 2018 and the year endedDecember 31, 2018 ; (iii) for the periodDecember 1, 2017 toDecember 31, 2017 ; (iv) for the periodOctober 1, 2017 toNovember 30, 2017 (Predecessor); (v) for the unaudited periodOctober 1, 2016 toDecember 31, 2016 (Predecessor); and (vi) for the year endedSeptember 30, 2017 (Predecessor). In this Management's Discussion and Analysis of Financial Condition and Results of Operations, we present the Predecessor's year endedSeptember 30, 2017 results. We believe this discussion provides helpful information with respect to performance of our business during those respective periods. In Management's Discussion and Analysis of Financial Condition and Results of Operations included within this Form 10-K, we discuss consolidated financial results for the year endedDecember 31, 2019 compared to the year endedDecember 31, 2018 . Discussion for the periodDecember 1, 2017 toDecember 31, 2017 , the periodOctober 1, 2017 toNovember 30, 2017 (Predecessor), the unaudited periodOctober 1, 2016 toDecember 31, 2016 (Predecessor), and the year endedSeptember 30, 2017 (Predecessor) is included within our Annual Report on Form 10-K for the year endedDecember 31, 2018 . Overview See "Item 1. Business" for a detailed discussion ofFGL Holdings company overview, strategy and products, as well as theFebruary 7, 2020 announcement of an agreement to be acquired by Fidelity National Financial, Inc. Trends and Uncertainties The following factors represent some of the key trends and uncertainties that have influenced the development of our business and our historical financial performance and that we believe will continue to influence our business and financial performance in the future. Market Conditions Market volatility has affected and may continue to affect our business and financial performance in varying ways. Volatility can pressure sales and reduce demand as consumers hesitate to make financial decisions. To enhance the attractiveness and profitability of our products and services, we continually monitor the behavior of our customers, as evidenced by annuitization rates and lapse rates, which vary in response to changes in market conditions. Interest Rate Environment Some of our products include guaranteed minimum crediting rates, most notably our fixed rate annuities. As ofDecember 31, 2019 , the Company's reserves, net of reinsurance, and average crediting rate on our fixed rate annuities were$4 billion and 3%, respectively. We are required to pay the guaranteed minimum crediting rates even if earnings on our investment portfolio decline, which would negatively impact earnings. In addition, we expect more policyholders to hold policies with comparatively high guaranteed rates for a longer period in a low interest rate environment. Conversely, a rise in average yield on our investment portfolio would increase earnings if the average interest rate we pay on our products does not rise correspondingly. Similarly, we expect that policyholders would be less likely to hold policies with existing guarantees as interest rates rise and the relative value of other new business offerings are increased, which would negatively impact our earnings and cash flows. 57
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See "Item 7A. Quantitative and Qualitative Disclosures about Market Risk" for a more detailed discussion of interest rate risk. Aging of theU.S. Population We believe that the aging of theU.S. population will increase the demand for our products. As the "baby boomer" generation prepares for retirement, we believe that demand for retirement savings, growth, and income products will grow. The impact of this growth may be offset to some extent by asset outflows as an increasing percentage of the population begins withdrawing assets to convert their savings into income. Industry Factors and Trends Affecting Our Results of Operations Demographics and macroeconomic factors are increasing the demand for our FIA and IUL products. Over 10,000 people will turn 65 each day inthe United States over the next 15 years, and according to theU.S. Census Bureau , the proportion of theU.S. population over the age of 65 is expected to grow from 15% in 2015 to 20% in 2030. We operate in the sector of the insurance industry that focuses on the needs of middle-income Americans. The underserved middle-income market represents a major growth opportunity for the Company. As a tool for addressing the unmet need for retirement planning, we believe that many middle-income Americans have grown to appreciate the "sleep at night protection" that annuities such as our FIA products afford. Accordingly, the FIA market grew from nearly$12 billion of sales in 2002 to$68 billion of sales in 2018. Additionally, this market demand has positively impacted the IUL market as it has expanded from$100 million of annual premiums in 2002 to$2 billion of annual premiums in 2018.
Competition
Please refer to the section titled "Competition" in Item 1. Business for
discussion on our competition.
Annuity and Life Sales
We regularly monitor and report the production volume metric titled "Sales".
Sales are not derived from any specific GAAP income statement accounts or line
items and should not be viewed as a substitute for any financial measure
determined in accordance with GAAP. Annuity and IUL sales are recorded as
deposit liabilities (i.e. contractholder funds) within the Company's
consolidated financial statements in accordance with GAAP. Management believes
that presentation of sales, as measured for management purposes, enhances the
understanding of our business and helps depict longer term trends that may not
be apparent in the results of operations due to the timing of sales and revenue
recognition. Sales of annuities and IULs were as follows:
Annuity Sales IUL Sales
(Dollars in millions) 2019 2018 2017 2019 2018 2017
First Quarter $ 1,053 $ 778 $ 732 $ 8 $ 6 $ 14
Second Quarter 1,122 769 582 10 7 9
Third Quarter 797 842 588 9 7 6
Fourth Quarter 921 957 623 11 8 7
Total $ 3,893 $ 3,346 $ 2,525 $ 38 $ 28 $ 36
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Key Components of Our Historical Results of Operations UnderU.S. GAAP, premium collections for fixed indexed annuities, fixed rate annuities, and immediate annuities without life contingency are reported in the financial statements as deposit liabilities (i.e., contractholder funds) instead of as sales or revenues. Similarly, cash payments to customers are reported as decreases in the liability for contractholder funds and not as expenses. Sources of revenues for products accounted for as deposit liabilities are net investment income; surrender, cost of insurance, and other charges deducted from contractholder funds; and net realized gains (losses) on investments. Components of expenses for products accounted for as deposit liabilities are interest-sensitive and index product benefits (primarily interest credited to account balances or the cost of providing index credits to the policyholder), amortization of deferred acquisition cost ("DAC"), deferred sales inducements ("DSI"), and value of business acquired ("VOBA"), other operating costs and expenses, and income taxes. Through our insurance subsidiaries, we issue a broad portfolio of deferred annuities (fixed indexed and fixed rate annuities) and immediate annuities. A deferred annuity is a type of contract that accumulates value on a tax deferred basis and typically begins making specified periodic or lump sum payments a certain number of years after the contract has been issued. An immediate annuity is a type of contract that begins making specified payments within one annuity period (e.g., one month or one year) and typically makes payments of principal and interest earnings over a period of time. The Company hedges certain portions of its exposure to product related equity market risk by entering into derivative transactions. We purchase derivatives consisting predominantly of call options and, to a lesser degree, futures contracts on the equity indices underlying the applicable policy. These derivatives are used to offset the statutory reserve impact of the index credits due to policyholders under the FIA contracts. The majority of all such call options are one-year options purchased to match the funding requirements underlying the FIA contracts. We attempt to manage the cost of these purchases through the terms of our FIA contracts, which permit us to change caps, spread, or participation rates, subject to certain guaranteed minimums, on each contracts anniversary date. The call options and futures contracts are marked to fair value with the change in fair value included as a component of net investment gains (losses). The change in fair value of the call options and futures contracts includes the gains and losses recognized at the expiration of the instruments' terms or upon early termination and the changes in fair value of open positions. Earnings from products accounted for as deposit liabilities are primarily generated from the excess of net investment income earned over the sum of interest credited to policyholders and the cost of hedging our risk on FIA policies, known as the net investment spread. With respect to FIAs, the cost of hedging our risk includes the expenses incurred to fund the index credits. Proceeds received upon expiration or early termination of call options purchased to fund annual index credits are recorded as part of the change in fair value of derivatives, and are largely offset by an expense for index credits earned on annuity contractholder fund balances. Our profitability depends in large part upon the amount of assets under management ("AUM"), the net investment spreads earned on our AUM, our ability to manage our operating expenses and the costs of acquiring new business (principally commissions to agents and bonuses credited to policyholders). As we grow AUM, earnings generally increase. AUM increases when cash inflows, which include sales, exceed cash outflows. Managing net investment spreads involves the ability to maximize returns on our AUM and minimize risks such as interest rate changes and defaults or impairment of investments. It also includes our ability to manage interest rates credited to policyholders and costs of the options and futures purchased to fund the annual index credits on the FIAs or IULs. We analyze returns on average assets under management ("AAUM") pre- and post-DAC, DSI, and VOBA as well as pre- and post-tax to measure our profitability in terms of growth and improved earnings. Non-GAAP Financial Measures Management believes that certain non-GAAP financial measures may be useful in certain instances to provide additional meaningful comparisons between current results and results in prior operating periods. Our non-GAAP measures may not be comparable to similarly titled measures of other organizations because other organizations may not calculate such non-GAAP measures in the same manner as we do. Reconciliations of such measures to the most comparable GAAP measures are included herein. Adjusted Operating Income ("AOI") is a non-GAAP economic measure we use to evaluate financial performance each period. AOI is calculated by adjusting net income (loss) to eliminate: 59
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(i) the impact of net investment gains/losses, including other than temporary
impairment ("OTTI") losses recognized in operations, but excluding realized
gains and losses on derivatives hedging our indexed annuity policies,
(ii) the impacts related to changes in the fair values of FIA related
derivatives and embedded derivatives, net of hedging cost, and the fair value
accounting impacts of assumed reinsurance by our international subsidiaries,
(iii) the tax effect of affiliated reinsurance embedded derivative,
(iv) the effect of change in fair value of the reinsurance related embedded
derivative,
(v) the effect of integration, merger related & other non-operating items,
(vi) impact of extinguishment of debt, and
(vii) net impact from Tax Cuts and Jobs Act.
Adjustments to AOI are net of the corresponding impact on amortization of
intangibles, as appropriate. The income tax impact related to these adjustments
is measured using an effective tax rate, as appropriate by tax jurisdiction.
While these adjustments are an integral part of the overall performance of the
Company, market conditions and/or the non-operating nature of these items can
overshadow the underlying performance of the core business. Accordingly,
management considers this to be a useful measure internally and to investors and
analysts in analyzing the trends of our operations.
Beginning with the quarter ended March 31, 2018 , the Company updated its AOI
definition to remove the residual impacts of fair value accounting on its FIA
products, including gains and losses on derivatives hedging those policies.
Management believes the revised measure enhances the understanding of the
business post-merger and is more useful and relevant to investors as compared to
the previous definition which eliminated only the effects of changes in the
interest rates used to discount the FIA embedded derivative. Periods shown prior
to March 31, 2018 have not been adjusted to reflect the new definition.
Beginning with the quarter ended December 31, 2018 , the Company updated its AOI
definition to remove the incremental change due to the impact of the fair value
accounting election for international subsidiaries. Management believes this
revision will enhance the understanding of our business as the Company executes
its growth strategy through international third party assumed business and is
more relevant to investors as the impact of fair value accounting election can
create an increase/decrease in the assumed liabilities that does not match the
increase/decrease of the corresponding assets. This change will be applied on a
prospective basis as the Company executes its growth strategy through
international third party assumed reinsurance.
AOI should not be used as a substitute for net income. However, we believe the
adjustments made to net income in order to derive AOI provide an understanding
of our overall results of operations. For example, we could have strong
operating results in a given period, yet report net income that is materially
less, if during such period the fair value of our derivative assets hedging the
FIA index credit obligations decreased due to general equity market conditions
but the embedded derivative liability related to the index credit obligation did
not decrease in the same proportion as the derivative assets because of
non-equity market factors such as interest rate movements. Similarly, we could
also have poor operating results in a given period yet show net income that is
materially greater, if during such period the fair value of the derivative
assets increases but the embedded derivative liability did not increase in the
same proportion as the derivative assets. We hedge our FIA index credits with a
combination of static and dynamic strategies, which can result in earnings
volatility, the effects of which are generally likely to reverse over time. Our
management and board of directors review AOI and net income as part of their
examination of our overall financial results. However, these examples illustrate
the significant impact derivative and embedded derivative movements can have on
our net income. Accordingly, our management and board of directors perform a
review and analysis of these items, as part of their review of our hedging
results each period.
The adjustments to net income are net of intangibles amortization, as
appropriate. Amounts attributable to the fair value accounting for derivatives
hedging the FIA index credits and the related embedded derivative liability
fluctuate from period to period based upon changes in the fair values of call
options purchased to fund the annual index credits for FIAs, changes in the
interest rates used to discount the embedded derivative liability, and the fair
value assumptions reflected in the embedded derivative liability. The accounting
standards for fair value measurement require the discount rates used in the
calculation of the embedded derivative liability to be based on risk-free
interest rates as of the reporting date. The impact of the change in fair values
of FIA related derivatives, embedded derivatives and hedging costs has been
removed from net income in calculating AOI.
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AAUM is a non-GAAP measure we use to assess the rate of return on assets
available for reinvestment. AAUM is calculated as the sum of:
(i) total invested assets at amortized cost, excluding derivatives;
(ii) related party loans and investments;
(iii) accrued investment income;
(iv) funds withheld at fair value;
(v) the net payable/receivable for the purchase/sale of investments, and
(iv) cash and cash equivalents, excluding derivative collateral, at the
beginning of the period and the end of each month in the period, divided by the
total number of months in the period plus one.
Management considers this non-GAAP financial measure to be useful internally and
to investors and analysts when assessing the rate of return on assets available
for reinvestment.
Critical Accounting Policies and Estimates
General
The preparation of financial statements in conformity with GAAP requires
management to make estimates and judgments that affect the reported amounts of
certain assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Critical estimates and
assumptions are evaluated on an ongoing basis based on historical developments,
market conditions, industry trends and other information that is reasonable
under the circumstances. There can be no assurance that actual results will
conform to estimates and assumptions and that reported results of operations
will not be materially affected by the need to make future accounting
adjustments to reflect changes in these estimates and assumptions from time to
time.
We have identified the following accounting policies and estimates as critical
as they involve a higher degree of judgment and are subject to a significant
degree of variability: valuation of available-for sale ("AFS") securities and
derivatives, evaluation of OTTI, amortization of DAC, DSI and VOBA, reserves for
future policy benefits and product guarantees and recognition of deferred income
tax valuation allowances.
In developing these accounting estimates and policies, we make subjective and
complex judgments that are inherently uncertain and subject to material changes
as facts and circumstances develop. Although variability is inherent in these
estimates, we believe the amounts provided are appropriate based upon the facts
available upon preparation of our audited consolidated financial statements. We
continually update and assess the facts and circumstances regarding all of these
critical accounting matters and other significant accounting matters affecting
estimates in our financial statements.
The above critical accounting estimates are also described in "Note 2.
Significant Accounting Policies and Practices" to our audited consolidated
financial statements.
Valuation of AFS Securities , Derivatives and Fund withheld for reinsurance
receivables
Our fixed maturity securities classified as AFS are reported at fair value, with
unrealized gains and losses included within accumulated other comprehensive
income (loss) ("AOCI"), net of associated impact on intangibles adjustments and
deferred income taxes. Our equity securities are reported at fair value, with
unrealized gains and losses included within net income (loss). Unrealized gains
and losses represent the difference between the cost or amortized cost basis and
the fair value of these investments. We measure the fair value of our AFS
securities based on assumptions used by market participants, which may include
inherent risk and restrictions on the sale or use of an asset. The estimate of
fair value is the price that would be received to sell an asset in an orderly
transaction between market participants ("exit price") in the principal market,
or the most advantageous market in the absence of a principal market, for that
asset or liability. We utilize independent pricing services in estimating the
fair values of AFS securities. The independent pricing services incorporate a
variety of observable market data in their valuation techniques, including:
reported trading prices, benchmark yields, broker-dealer quotes, benchmark
securities, bids and offers, credit ratings, relative credit information and
other reference data.
F&G Re and FSRC have elected to apply the fair value option to account for its
funds withheld receivables. F&G Re and FSRC measure fair value of the funds
withheld receivables based on the fair values of the securities in the
underlying funds withheld portfolio held by the cedant. The valuation of AFS
securities by F&G Re and FSRC follows the same process as the Company, as
outlined above.
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We categorize our AFS securities into a three-level 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 (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure fair value fall within different levels of the hierarchy, the category level is based on the lowest priority level input that is significant to the fair value measurement of the instrument. The following table presents the fair value of fixed maturity securities and equity securities by pricing source and hierarchy level as ofDecember 31, 2019 andDecember 31, 2018 . As of December 31, 2019 Quoted Prices in Significant Active Markets for Significant Unobservable (Dollars in millions) Identical Assets Observable Inputs Inputs Total (Level 1) (Level 2) (Level 3) Fixed maturity securities available-for-sale and equity securities: Prices via third party pricing services $ 714 $ 21,250$ 1,043 $ 23,007 Priced via independent broker quotations - - 1,720 1,720 Priced via other methods - - 1 1 Total $ 714 $ 21,250$ 2,764 $ 24,728 Available-for-sale embedded derivative: Priced via other methods - - 21 21 Total $ 714 $ 21,250$ 2,785 $ 24,749 % of Total 3 % 86 % 11 % 100 % As of December 31, 2018 Quoted Prices in Significant Active Markets for Significant Unobservable (Dollars in millions) Identical Assets Observable Inputs Inputs Total (Level 1) (Level 2) (Level 3) Fixed maturity securities available-for-sale and equity securities: Prices via third party pricing services $ 833 $ 19,185 $ 15$ 20,033 Priced via independent broker quotations - - 1,692 1,692 Priced via other methods - - 716 716 Total $ 833 $ 19,185$ 2,423 $ 22,441 Available-for-sale embedded derivative: Priced via other methods - - 14 14 Total $ 833 $ 19,185$ 2,437 $ 22,455 % of Total 4 % 85 % 10 % 99 % Management's assessment of all available data when determining fair value of the AFS securities is necessary to appropriately apply fair value accounting. The independent pricing services also take into account perceived market movements and sector news, as well as a security's terms and conditions, including any features specific to that issue that may influence risk and marketability. 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. We generally obtain one value from our primary external pricing service. In situations where a price is not available from the independent pricing service, we may obtain broker quotes or prices from additional parties recognized to be market participants. We believe the broker quotes are prices at which trades could be executed based on historical trades executed at broker-quoted or slightly higher prices. When quoted prices in active markets are not available, the determination of estimated fair value is based on market standard valuation methodologies, including discounted cash flows, matrix pricing, or other similar techniques. 62
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We validate external valuations at least quarterly through a combination of
procedures that include the evaluation of methodologies used by the pricing
services, comparisons to valuations from other independent pricing services,
analytical reviews and performance analysis of the prices against trends, and
maintenance of a securities watch list. See "Note 4. Investments" and "Note 6.
Fair Value of Financial Instruments" to our audited consolidated financial
statements for a more complete discussion.
The fair value of derivative assets and liabilities is based upon valuation
pricing models and represents what we would expect to receive or pay at the
balance sheet date if we canceled the options, entered into offsetting
positions, or exercised the options. Fair values for these instruments are
determined internally using a conventional model and 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. However, we are largely protected by collateral
arrangements with counterparties when individual counterparty exposures exceed
certain thresholds. The fair value of futures contracts at the balance sheet
date represents the cumulative unsettled variation margin (open trade equity net
of cash settlements). The fair values of the embedded derivatives in our FIA
contracts are derived using market value of options, use of current and budgeted
option cost, swap rates, mortality rates, surrender rates and non-performance
spread and are classified as Level 3. The discount rate used to determine the
fair value of our FIA embedded derivative liabilities includes an adjustment to
reflect the risk that these obligations will not be fulfilled ("non-performance
risk"). For the years ended December 31, 2019 and December 31, 2018 , our
non-performance risk adjustment was based on the expected loss due to default in
debt obligations for similarly rated financial companies. See "Note 5.
Derivative Financial Instruments" and "Note 6. Fair Value of Financial
Instruments" to our audited consolidated financial statements for a more
complete discussion.
As discussed in "Item 1. Business", FGL Insurance entered into a reinsurance
agreement with Kubera effective December 31, 2018 , to cede certain MYGA and
deferred annuity statutory reserve on a coinsurance funds withheld basis, net of
applicable existing reinsurance. This arrangement creates an obligation for FGL
Insurance to pay Kubera at a later date, which results in an embedded
derivative. This embedded derivative is considered a total return swap with
contractual returns that are attributable to the assets and liabilities
associated with this reinsurance arrangement. The fair value of the total return
swap is based on the change in fair value of the underlying assets held in the
funds withheld portfolio. Investment results for the assets that support the
coinsurance with funds withheld reinsurance arrangement, including gains and
losses from sales, were passed directly to the reinsurer pursuant to contractual
terms of the reinsurance arrangement. The reinsurance related embedded
derivative is reported in "Other assets" if in a net gain position, or "Other
liabilities", if in a net loss position, on the Consolidated Balance Sheets and
the related gains or losses are reported in "Net investment gains (losses)" on
the Consolidated Statements of Operations.
Evaluation of OTTI
We have a policy and process in place to evaluate securities and mortgage loans
in our investment portfolio quarterly to assess whether there has been an OTTI.
This evaluation process entails considerable judgment and estimation and
involves monitoring market events and other items that could impact issuers. See
"Note 2. Significant Accounting Policies and Practices" and "Note 4.
Investments" to our audited consolidated financial statements for a more
complete discussion over the Company's OTTI policy.
Intangibles
Acquisition costs that are incremental, direct costs of successful contract
acquisition are capitalized as DAC. DAC consists principally of commissions.
Indirect or unsuccessful acquisition costs, maintenance, product development and
overhead expenses are charged to expense as incurred. DSI consists of contract
enhancements such as premium and interest bonuses credited to policyholder
account balances.
VOBA is an intangible asset that reflects the amount recorded as insurance
contract liabilities less the estimated fair value of in-force contracts in a
life insurance company acquisition. It represents the portion of the purchase
price that is allocated to the value of the rights to receive future cash flows
from the business in force at the acquisition date.
DAC, DSI, and VOBA are subject to loss recognition testing on a quarterly basis
or when an event occurs that may warrant loss recognition.
For annuity products and IUL, DAC, DSI and VOBA are being amortized in
proportion to estimated gross profits from net investment spread margins,
surrender charges and other product fees, policy benefits, maintenance expenses,
mortality net of reinsurance ceded and expense margins, and recognized gains and
losses on investments. Current and future period gross profits for FIA contracts
also include the impact of amounts recorded for the change in fair value of
derivatives and the change in fair value of embedded derivatives. At each
valuation date, the most
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recent quarter's estimated gross profits are updated with actual gross profits and the assumptions underlying future estimated gross profits are evaluated for continued reasonableness. If the update of assumptions causes estimated gross profits to increase, DAC, DSI and VOBA amortization will decrease, resulting in lower amortization expense in the period. The opposite result occurs when the assumption update causes estimated gross profits to decrease. Current period amortization is adjusted retrospectively through an unlocking process when estimates of current or future gross profits (including the impact of recognized investment gains and losses) to be realized from a group of products are revised. Our estimates of future gross profits are based on actuarial assumptions related to the underlying policies' terms, lives of the policies, duration of contract, yield on investments supporting the liabilities, cost to find policy obligations, and level of expenses necessary to maintain the polices over their entire lives. Changes in assumptions can have a significant impact on DAC, DSI and VOBA, amortization rates and results of operations. Assumptions are management's best estimate of future outcomes, and require considerable judgment. We periodically review assumptions against actual experience, and update our assumptions based on historical results and our best estimates of future experience when additional information becomes available. Estimated future gross profits are sensitive to changes in interest rates, which are the most significant component of gross profits. Assumptions related to interest rate spreads and credit losses also impact estimated gross profits for products with credited rates. These assumptions are based on the current investment portfolio yields and credit quality, estimated future crediting rates, capital markets, and estimates of future interest rates and defaults. Significant assumptions also include policyholder behavior assumptions, such as surrender, lapse, and annuitization rates. We use a combination of actual and industry experience when setting and updating our policyholder behavior assumptions. We perform sensitivity analyses to assess the impact that certain assumptions have on DAC, DSI and VOBA. The following table presents the estimated instantaneous net impact to income before income taxes of various assumption changes on our DAC, DSI and VOBA. The effects, increase or (decrease), presented are not representative of the aggregate impacts that could result if a combination of such changes to interest rates and other assumptions occurred. (Dollars in millions) As of
$ (26 ) A change to the long-term interest rate assumption of +50 basis points
21
An assumed 10% increase in surrender rate
(1 )
Assumptions regarding shifts in market factors may be overly simplistic and not
indicative of actual market behavior in stress scenarios.
Lower assumed interest rates or higher assumed annuity surrender rates tend to
decrease the balances of DAC, DSI and VOBA, thus decreasing income before income
taxes. Higher assumed interest rates or lower assumed annuity surrender rates
tend to increase the balances of DAC, DSI and VOBA, thus increasing income
before income taxes.
See "Note 2. Significant Accounting Policies and Practices", "Note 3.
Significant Risks and Uncertainties" and "Note 7. Intangibles" to our audited
consolidated financial statements for a more complete discussion.
Reserves for Future Policy Benefits and Product Guarantees
The determination of future policy benefit reserves is dependent on actuarial
assumptions. The principal assumptions used to establish liabilities for future
policy benefits are based on our experience. These assumptions are established
at issue of the contract and include mortality, morbidity, contract full and
partial surrenders, investment returns, annuitization rates and expenses. The
assumptions used require considerable judgment. We review overall policyholder
experience at least annually and update these assumptions when deemed necessary
based on additional information that becomes available. For traditional life and
immediate annuity products, assumptions used in the reserve calculation can only
be changed if the reserve is deemed to be insufficient. For all other insurance
products, changes in assumptions will be used to calculate reserves. These
changes in assumptions will also incorporate changes in risk free rates and
option market values. Changes in, or deviations from, the assumptions previously
used can significantly affect our reserve levels and related results of
operations.
Mortality is the incidence of death amongst policyholders triggering the payment
of underlying insurance coverage by the insurer. In addition, mortality also
refers to the ceasing of payments on life-contingent annuities due to the death
of the annuitant. We utilize a combination of actual and industry experience
when setting our mortality assumptions.
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A surrender rate is the percentage of account value surrendered by the policyholder. A lapse rate is the percentage of account value canceled by us due to nonpayment of premiums. We make estimates of expected full and partial surrenders of our fixed annuity products. Our surrender rate experience in the years endedDecember 31, 2019 andDecember 31, 2018 on the fixed annuity products averaged 4%, which is within our assumed ranges. Management's best estimate of surrender behavior incorporates actual experience over the entire period, as we believe that, over the duration of the policies, we will experience the full range of policyholder behavior and market conditions. If actual surrender rates are significantly different from those assumed, such differences could have a significant effect on our reserve levels and related results of operations. The assumptions used to establish the liabilities for our product guarantees require considerable judgment and are established as management's best estimate of future outcomes. We periodically review these assumptions and, if necessary, update them based on additional information that becomes available. Changes in or deviations from the assumptions used can significantly affect our reserve levels and related results of operations. At issue, and at each subsequent valuation, we determine the present value of the cost of the GMWB rider benefits in excess of benefits that are funded by the account value. We also calculate the expected value of the future rider charges providing for these benefits. We accumulate a reserve equal to the portion of these fees that would be required to fund the future benefits less benefits paid to date. In making these projections, a number of assumptions are made and we update these assumptions as experience emerges, and determined necessary. We have minimal experience to date on policyholder behavior for our GMWB products which we began issuing in 2008. As a result, future experience could lead to significant changes in our assumptions. If emerging experience deviates from our assumptions on GMWB utilizations, such deviations could have a significant effect on our reserve levels and related results of operations. Our aggregate reserves for contractholder funds, future policy benefits and product guarantees on a direct and net basis as ofDecember 31, 2019 are summarized as follows: (Dollars in millions) Direct Reinsurance Recoverable Net Fixed indexed annuities$ 18,058 $ -$ 18,058 Fixed rate annuities 4,477 (892 ) 3,585 Immediate annuities 3,291 (133 ) 3,158 Universal life 1,633 (1,017 ) 616 Traditional life 2,007 (1,171 ) 836 Offshore reinsurance 1,953 - 1,953 Total$ 31,419 $ (3,213 )$ 28,206 Certain FIA products contain an embedded derivative; a feature that permits the holder to elect an interest rate return or an equity-index linked component, where interest credited to the contract is linked to the performance of various equity indices. The FIA embedded derivative is valued at fair value and included in the liability for contractholder funds in our Consolidated Balance Sheets with changes in fair value included as a component of "Benefits and other changes in policy reserves" in our Consolidated Statements of Operations. See "Note 2. Significant Account Policies and Practices" to our audited consolidated financial statements for a more complete discussion. Deferred Income Tax Valuation Allowance Accounting Standards Codification section 740, Income Taxes (ASC 740), provides that deferred income tax assets are recognized for deductible temporary differences and operating loss and tax credit carry-forwards. A valuation allowance is recorded if, based on available information, it is more likely than not that deferred income tax assets will not be realized. Assessing the need for, and the amount of, a valuation allowance for deferred income tax assets requires significant judgment. Future realization of deferred tax assets ultimately depends on the existence of sufficient taxable income of the appropriate character (i.e., ordinary income or capital gain) in either the carryback or carry-forward period under tax law. The four sources of taxable income that may be considered in determining whether a valuation allowance is required are: • Future reversals of existing taxable temporary differences (i.e., offset of gross deferred tax assets against gross deferred tax liabilities); • Taxable income in prior carryback years, if carryback is permitted under tax law; 65
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• Tax planning strategies; and
• Future taxable income exclusive of reversing temporary differences and
carry-forwards.
At each reporting date, management considers evidence that could impact the
future realization of deferred tax assets. As of December 31, 2019 , management
gathered the following evidence concerning the future realization of deferred
tax assets:
Positive Evidence:
• As of December 31, 2019 , we were in a cumulative income position based
on pre-tax income over the prior 12 quarters;
• We are projecting pre-tax GAAP income from continuing operations or we
have tax planning opportunities in which to affect realization;
• We have a history of utilizing all significant tax attributes before
they expire;
• For U.S. Life Companies, under new tax laws, net operating losses
generated after December 31, 2017 can be carried forwardindefinitely;
and
• We have net unrealized capital gains as of
Negative Evidence:
• §382 limited carry-forwards reduce our ability to utilize tax
attributes in future years; and
• Brief carryback/carry-forward period for capital losses.
Based on management's evaluation of the above positive and negative evidence, management concluded that a valuation allowance continues to be necessary for the deferred tax assets of the non-life insurance companies and FSRC capital deferred tax assets atDecember 31, 2019 . Management also concluded that a valuation allowance is no longer needed for US life insurance companies, as they do not have unrealized deferred tax assets, and for FSRC ordinary deferred tax assets. For the year endedDecember 31, 2019 , the valuation allowance release recorded to the income statement related to the items above was$39 . Recent Accounting Pronouncements Please refer to "Note 2. Significant Accounting Policies and Practices" to our audited consolidated financial statements for disclosure of recent accounting pronouncements. 66
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Results of Operations
(All amounts presented in millions unless otherwise noted)
The following table sets forth the consolidated results of operations for the
periods presented:
Year ended Year ended
Period from
Period from Period from October 1 to
December 1 October 1 to December 31,
December 31, to December November 30, 2016
December 31, 2019 2018 31, 2017 2017 (Unaudited) September 30, 2017
Predecessor Predecessor Predecessor
Revenues:
Premiums $ 40 $ 54 $ 3 $ 7 $ 11 $ 42
Net investment income 1,229 1,107 92 174 240 1,005
Net investment gains (losses) 674 (629 ) 42 146 51 316
Insurance and investment
product fees and other 170 179 28 35 38 167
Total revenues 2,113 711 165 362 340 1,530
Benefits and expenses:
Benefits and other changes in
policy reserves 1,057 423 124 227 20 843
Acquisition and operating
expenses, net of deferrals 330 181 16 51 28 137
Amortization of intangibles 126 49 4 36 123 193
Total benefits and
expenses 1,513 653 144 314 171 1,173
Operating income 600 58 21 48 169 357
Interest expense (32 ) (29 ) (2 ) (4 ) (6 ) (24 )
Income (loss) before income
taxes 568 29 19 44 163 333
Income tax (expense) benefit (61 ) (16 ) (110 ) (16 ) (55 ) (110 )
Net income (loss) $ 507 $ 13 $ (91 ) $ 28 $ 108 $ 223
Less Preferred stock dividend 31 29 2 - - -
Net income (loss) available
to common shareholders $ 476 $ (16 ) $ (93 ) $ 28 $ 108 $ 223
The following table summarizes sales by product type for the periods presented:
Year ended Year ended
Period from
Period from Period from October 1 to
December 1 October 1 to December 31,
December 31, December 31, to December November 30, 2016
2019 2018 31, 2017 2017 (Unaudited) September 30, 2017
Predecessor Predecessor Predecessor
Fixed index annuities ("FIA") $ 2,820 $ 2,283 $ 175 $ 287 $ 551 $ 1,868
Fixed rate annuities ("MYGA") 776 758 47 114 97 546
Institutional spread based 297 305 - - - 136
Total annuity $ 3,893 $ 3,346 $ 222 $ 401 $ 648 $ 2,550
Index universal life ("IUL") $ 38 $ 28 $ 3 $ 4 $ 17 $ 46
Flow reinsurance $ 394 $ 185 $ 8 $ - $ - $ -
• FIA and MYGA sales during the years ended
and capital targets. Increased FIA sales during the year ended
growth strategy.
• Institutional spread based products reflect funding agreements with
fluctuation period to period.
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• The increase in flow reinsurance during the year ended
compared to December 31, 2018 reflect F&G Re's assumed third party flow
reinsurance which includes the on-boarding of F&G Re's new flow
reinsurance partner effective January 1, 2019 .
Revenues
Premiums
Premiums primarily reflect insurance premiums for traditional life insurance
products which are recognized as revenue when due from the policyholder. FGL
Insurance has ceded the majority of its traditional life business to
unaffiliated third party reinsurers. While the base contract has been reinsured,
we continue to retain the return of premium rider. The traditional life
insurance premiums are primarily related to the return of premium riders on
traditional life contracts. The following table summarizes premium revenue for
the periods presented:
Year ended Year ended
Period from
Period from Period from October 1 to
December 1 to October 1 to December 31,
December 31, December 31, December 31, November 30, 2016
2019 2018 2017 2017 (Unaudited) September 30, 2017
Predecessor Predecessor PredecessorTraditional life insurance $ 26 $ 30 $
3 $ 6 $ 10 $ 27
Life-contingent immediate annuity 14 24 - 1 1 15
Premiums $ 40 $ 54 $ 3 $ 7 $ 11 $ 42
• Traditional life insurance premiums for the year ended
reflect a decrease compared to
maturing of the return of premium block of business.
• Immediate annuity premiums for the year ended
decrease compared to
behavior for annuitizations as well as
agreements with
31, 2018 and June 30, 2019 .
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Net investment income
Below is a summary of net investment income ("NII") for the periods presented:
Year ended Year ended
Period from
Period from Period from October 1 to
December 1 to October 1 to December 31,
December 31, November 30, 2016
December 31, 2019 December 31, 2018 2017 2017 (Unaudited) September 30, 2017
Predecessor Predecessor Predecessor
Fixed maturity securities,
available-for-sale $ 1,054 $ 1,009 $ 80 $ 164 $ 228 $ 953
Equity securities 73 73 6 5 10 41
Funds withheld 65 28 2 - - -
Limited partnerships 81 17 1 3 1 5
Mortgage loans, invested cash,
and other investments 72 50 4 6 6 28
Gross investment income 1,345 1,177 93 178 245 1,027
Investment expense (116 ) (70 ) (1 ) (4 ) (5 ) (22 )
Net investment income $ 1,229 $ 1,107 $ 92 $ 174 $ 240 $ 1,005
Our net investment spread and AAUM for the period is summarized as follows
(annualized):
Year ended Year ended
Period from Period from
December 1 to Period from October 1 to
December 31, October 1 to December 31, 2016
December 31, 2019 December 31, 2018 2017 November 30, 2017 (Unaudited) September 30, 2017
Predecessor Predecessor Predecessor
Yield on AAUM (at amortized
cost) 4.49 % 4.32 % 4.48 % 4.93 % 4.85 % 4.95 %
Less: Fixed interest
credited and option cost (2.26 )% (2.37 )% (2.47 )% (2.49 )% (2.56 )% (2.53 )%
Net investment spread 2.23 % 1.95 % 2.01 % 2.44 % 2.29 % 2.42 %
AAUM $ 27,358 $ 25,619 $ 24,722 $ 21,167 $ 19,768 $ 20,324
• The increase in AAUM from
primarily the result of
offshore
partially offset by $0.9 billion reinsurance cession to Kubera.
• NII for the year ended December 31, 2019 compared to December 31, 2018
increased primarily as a result of portfolio reposition uplift andinvested asset growth, as described above, partially offset by higher
planned for asset management fees. The volume increase period over period
resulted in net investment income growth of $75 , with the remaining $47
driven by an increase in rate.
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Net investment gains (losses) Below is a summary of the major components included in net investment gains (losses) for the periods presented:
Year ended Year ended
Period from
Period from Period from October 1 to
December 1 to October 1 to December 31,
December 31, November 30, 2016
December 31, 2019 December 31, 2018 2017 2017 (Unaudited) September 30, 2017
Predecessor Predecessor PredecessorNet realized and unrealized gains (losses) on fixed maturity available-for-sale securities, equity securities and other invested assets $ 176 $ (334 ) $ 5 $ 6 $ - $ (19 ) Net realized and unrealized gains (losses) on certain derivatives instruments 434 (250 ) 37 138 39 348 Change in fair value of funds withheld for reinsurance receivables and reinsurance related embedded derivatives (a) 57 (42 ) - 1 12 (16 ) Change in fair value of other derivatives and embedded derivatives 7 (3 ) - 1 - 3 Net investment gains (losses) $ 674 $ (629 )$ 42 $ 146 $ 51 $ 316 (a) Change in fair value of reinsurance related embedded derivatives startingDecember 1, 2017 and after is due to F&G Re and FSRC unaffiliated third party business under the fair value option election. StartingJanuary 1, 2019 , the balance also includes activity related to theFGL Insurance and Kubera reinsurance treaty. The predecessor periods activity is due to theFGL Insurance and FSRC reinsurance treaty.
• Net investment gains for the year ended
gains on available-for-sale securities of
execution of planned portfolio re-positioning strategies,
and unrealized gains on equity securities, and
• Net investment losses for the year ended
realized losses on available-for-sale securities of
resulting from the execution of planned portfolio re-positioning strategy
following the completion of the merger,
losses on equity securities, and $24 of impairment losses.
• We utilize a combination of static (call options) and dynamic (longfutures contracts) instruments in our hedging strategy. A substantial
portion of the call options and futures contracts are based upon the S&P
500 Index with the remainder based upon other equity, bond and gold market
indices. See the table below for primary drivers of gains (losses) on
certain derivatives.
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The components of the realized and unrealized gains (losses) on certain derivative instruments hedging our indexed annuity and universal life products are as follows for the periods presented:
Year ended Year ended
Period from Period from
December 1 to Period from October October 1 to
December 31, 1 to November 30, December 31, 2016
December 31, 2019 December 31, 2018 2017 2017 (Unaudited) September 30, 2017
Predecessor Predecessor Predecessor
Call Options:
Gains (losses) on option
expiration $ (41 ) $ 3 $ 1 $ 73 $ - $ 212
Change in unrealized gains
(losses) 445 (247 ) 33 56 39 126
Futures contracts:
Gains (losses) on futures
contracts expiration 23 (7 ) 2 7 1 7
Change in unrealized gains
(losses) 4 (1 ) 1 2 (1 ) 3
Foreign currency forward:
Gains (losses) on foreign
currency forward 3 2 - - - -
Total net change in fair value $ 434 $ (250 ) $ 37 $ 138 $ 39 $ 348
Annual Point-to-Point Change in S&P 500 Index during the period 28 % (6 )% 1 % 5 % 3 %
16 %
• Realized gains and losses on certain derivative instruments are directly
correlated to the performance of the indices upon which the call options
and futures contracts are based and the value of the derivatives at the
time of expiration compared to the value at the time of purchase. Gains
(losses) on option expiration reflect the movement during the years ended
December 31, 2019 and 2018 on options settled during the respective
period.
• Additionally, the change in unrealized gains and losses due to fair value
of call options are primarily driven by the underlying performance of the
S&P 500 Index during each respective year relative to the S&P 500 Index on
the policyholder buy dates.
The average index credits to policyholders are as follows for the periods
presented:
Year ended Year ended
Period from
Period from Period from October 1 to
December 1 October 1 to December 31,
to December November 30, 2016
December 31, 2019 December 31, 2018 31, 2017 2017 (Unaudited) September 30, 2017
Predecessor Predecessor PredecessorAverage Crediting Rate 2 % 4 % 6 % 6 % 2 % 4 % S&P 500 Index: Point-to-point strategy 3 % 4 % 4 % 4 % 4 % 4 % Monthly average strategy 2 % 4 % 4 % 4 % 2 % 3 % Monthly point-to-point strategy - % 4 % 10 % 10 % 1 % 4 % 3 year high water mark 18 % 15 % 13 % 16 % 15 % 13 % • Actual amounts credited to contractholder fund balances may differ from
the index appreciation due to contractual features in the FIA contracts
(caps, spreads and participation rates) which allow the Company to manage
the cost of the options purchased to fund the annual index credits. Market
volatility compared to previous years can impact index credits differently
than overall S&P 500 Index appreciation.
• The credits for the periods presented above were based on comparing the
S&P 500 Index on each issue date in these respective periods to the same
issue date in the respective prior year periods. Favorable S&P 500 Indexperformance at different points in these periods caused favorable changes
in crediting rates for the 3 year high water mark strategy in the year
ended December 31, 2019 compared to the year ended December 31, 2018 .Unfavorable S&P 500 Index performance at different points in the periods
presented caused a decline in crediting rates in the point-to-point,
monthly average, and monthly point-to-point
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strategies due to lower equity returns in the year endedDecember 31, 2019 compared toDecember 31, 2018 . Insurance and investment product fees and other Insurance and investment product fees and other consists primarily of the cost of insurance on IUL policies, policy rider fees primarily on FIA policies and surrender charges assessed against policy withdrawals in excess of the policyholder's allowable penalty-free amounts (up to 10% of the prior year's value, subject to certain limitations). Below is a summary of the major components included in Insurance and investment product fees and other for the periods presented: Year ended Year ended Period from Period from Period from October 1 to December 1 to October 1 to December 31, December 31, November 30, 2016 September 30, December 31, 2019 December 31, 2018 2017 2017 (Unaudited) 2017 Predecessor Predecessor Predecessor
Surrender charges $ 30 $ 44 $ 3 $ 10 $ 7 $ 34 Cost of insurance fees and other income 140 135 25 25 31 133 Total insurance and investment product fees and other $ 170 $ 179$ 28 $ 35 $ 38 $ 167
• Surrender charges were higher in the prior year, primarily due to a higher
number of universal life policy surrenders.
• Cost of insurance fees and other income changed year over year primarily
due to the amortization of the deferred reinsurance gain established at
the inception of FGL Insurance's reinsurance agreement with Kubera,
effective December 31, 2018 and amended June 30, 2019 , and the
amortization of unearned revenue liability.
Benefits and expenses
Benefits and other changes in policy reserves
Below is a summary of the major components included in Benefits and other
changes in policy reserves for the periods presented:
Year ended Year ended
Period from
Period from Period from October 1 to
December 1 October 1 to December 31,
to December November 30, 2016 September 30,
December 31, 2019 December 31, 2018 31, 2017 2017 (Unaudited) 2017
Predecessor Predecessor PredecessorFIA embedded derivative impact $ 391 $ (404 )$ 7 $ 39$ (136 ) $ 6 Index credits, interest credited & bonuses 477 688 28 151 112 649 Annuity payments 138 150 13 25 40 152 Other policy benefits and reserve movements 73 (12 ) 71 12 4 36 Change in fair value of reserve liabilities held at fair value (22 ) 1 5 - - - Total benefits and other changes in policy reserves $ 1,057 $ 423$ 124 $ 227$ 20 $ 843
• The FIA embedded derivative impact on reserve changes for the periods
presented above are driven by changes in the equity markets and risk free
rates during the respective periods. The change in risk free rates
increased the FIA embedded derivative reserves by approximately $164 and
reduced the FIA embedded derivative reserves by approximately
years ended
market movements increased reserves by
for the years ended
The change in equity market also impacts the market value of the
derivative assets hedging our FIA policies. See table in the net
investment gains/losses discussion above for summary and discussion of net
unrealized gains (losses) on certain derivative instruments.
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• Annually, the Company reviews assumptions associated with reserves for
policy benefits and product guarantees. The years ended December 31, 2019
and December 31, 2018 included a decrease of $13 and $5 related to the
annual surrender assumption update.
• Index credits, interest credited & bonuses changed during the periods
presented primarily due to changes in the amount of index credits on FIA
policies reflecting the fluctuation in performance of the S&P 500 Index
relative to the S&P 500 Index level on the policyholder buy dates andrelated changes in the options and futures which fund FIA index credits.
Increased index credits, interest credited & bonuses for the years ended
December 31, 2019 andDecember 31, 2018 also reflect increased sales volume for FIA products.
• The change in the fair value of reserve liabilities held at fair value for
the year ended
on F&G Re and FSRC's assumed business.
Acquisition and operating expenses, net of deferrals
Below is a summary of acquisition and operating expenses, net of deferrals for
the periods presented:
Year ended Year ended
Period from
Period from Period from October 1 to
December 1 October 1 to December 31,
to December November 30, 2016
December 31, 2019 December 31, 2018 31, 2017 2017 (Unaudited) September 30, 2017
Predecessor Predecessor Predecessor
General expenses $ 160 $ 150 $ 11 $ 47 $ 25 $ 120
Acquisition expenses 541 348 27 44 92 310
Deferred acquisition costs (371 ) (317 ) (22 ) (40 ) (89 ) (293 )
Total acquisition and
operating expenses, net of
deferrals $ 330 $ 181 $ 16 $ 51 $ 28 $ 137
• The increase in acquisition and operating expenses, net of deferrals,
during the year ended
transaction initial ceding commission (a corresponding offset is
recognized in reserves under the fair value option election), ceding
commissions on flow reinsurance, and project related costs, partially
offset by a decrease in the preferred equity remarketing reimbursement
embedded derivative liability.
Amortization of intangibles Below is a summary of the major components included in amortization of intangibles for the periods presented:
Year ended Year ended
Period from
Period from Period from October 1 to
December 1 to October 1 to December 31,
December 31, November 30, 2016
December 31, 2019 December 31, 2018 2017 2017 (Unaudited) September 30, 2017
Predecessor Predecessor Predecessor
Amortization $ 156 $ 64 $ 8 $ 56 $ 136 $ 280
Interest (35 ) (24 ) (2 ) (10 ) (13 ) (57 )
Unlocking 5 9 - (10 ) - (30 )
Total amortization of intangibles $ 126 $ 49 $ 6 $ 36 $ 123 $ 193
• Amortization of intangibles is based on historical, current and future
expected gross margins (pre-tax operating income before amortization). The
change in amortization year over year is the result of actual gross
profits ("AGPs") in each period on the DAC and VOBA lines of business
("LOBs"). The increase in amortization year over year was driven primarily
by an increase in net investment gains.
• Annually, the Company reviews assumptions associated with the amortization
of intangibles. For the year ended
decrease in future expected margins and an increase of
expense reported as a component of "unlocking". In 2018, this assumption
review process resulted in an increase in future expected margins and a
corresponding decrease of $2 amortization expense.
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Other items affecting net income
Interest expense
The interest expense and amortization of debt issuance costs of the Company's
debt for the periods presented:
Year ended Year ended
Period from Period from Period from
December 1 to October 1 to October 1 to
December 31, November 30, December 31,
December 31, 2019 December 31, 2018 2017 2017 2016 (Unaudited) September 30, 2017
Predecessor Predecessor Predecessor
Debt $ 32 $ 29 $ 2 $ 3 $ 5 $ 19
Revolving credit facility - 2 - 1 1 5
Gain on extinguishment of debt - (2 ) - - - - Total interest expense $ 32 $ 29 $ 2 $ 4 $ 6 $ 24
• On
principal amount of 5.50% senior notes due 2025. The Company used the net
proceeds of the offering (i) to repay
revolving credit facility and related expenses and (ii) to redeem in full
and satisfy and discharge all of the outstanding
amount of FGLH's outstanding 6.375% Senior Notes due 2021.
• The year ended
the
2018. The year ended
the 5.50% senior notes.
Income tax (expense) benefit
Below is a summary of the major components included in Income tax expense for
the periods presented:
Year ended Year ended
Period from
Period from Period from October 1 to
December 1 October 1 to December 31,
to December November 30, 2016
December 31, 2019 December 31, 2018 31, 2017 2017 (Unaudited) September 30, 2017
Predecessor Predecessor Predecessor
Income before taxes $ 568 $ 29 $ 19 $ 44 $ 163 $ 333
Income tax before valuation
allowance and tax law 100 (22 ) (8 ) 14 55 111
impact
Change in tax law impact - - 131 - - -
Change in valuation (39 ) 38 (13 ) 2 - (1 )
allowance
Income tax expense $ 61 $ 16 $ 110 $ 16 $ 55 $ 110
Effective rate 11 % 55 % 579 % 37 % 34 % 33 %
• Income tax expense for the year ended
the impact of the valuation allowance release, the benefit of low taxed
international income in excess of the withholdings taxes, and favorable
permanent adjustments, including low income housing credits and the
dividends received deduction.
• Income tax expense for the year ended
the impact of the valuation allowance expense, partially offset by the
benefit of low taxed international income in excess of the BEAT, and
favorable permanent adjustments, including low income housing credits and
the dividends received deduction.
In assessing the recoverability of our deferred tax assets, we regularly
consider the guidance outlined within Accounting Standards Codification ("ASC")
Topic 740, "Income Taxes". The guidance requires an assessment of both positive
and negative evidence in determining the realizability of deferred tax assets.
See "Note 11. Income Taxes" to our audited consolidated financial statements for
additional information regarding deferred tax assets and our analysis for
recoverability.
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AOI
The table below shows the adjustments made to reconcile net income to AOI and AOI available to common shareholders for the periods presented:
Year ended Year ended
Period from
Period from Period from October 1 to
December 1 October 1 to December 31,
to December November 30, 2016
December 31, 2019 December 31, 2018 31, 2017 2017 (Unaudited) September 30, 2017
Predecessor Predecessor Predecessor
Net income (loss) $ 507 $ 13 $ (91 ) $ 28 $ 108 $ 223
Adjustments to arrive at AOI:
Effect of investment losses
(gains), net of offsets (a) (170 ) 288 - (6 ) (1 ) 13
Impacts related to changes in
the fair values of FIA
related derivatives and
embedded derivatives, net of
hedging cost, and the fair
value accounting impacts of
assumed reinsurance by our
international subsidiaries
(a) (b) (19 ) (25 ) (8 ) (10 ) (92 ) (95 )
Effect of change in fair
value of reinsurance related
embedded derivative, net of
offsets (a) 27 - - (1 ) (10 ) 11
Effects of integration,
merger related & other
non-operating items (1 ) 40 (8 ) 29 - -
Effects of extinguishment of
debt - (2 ) - - - -
Tax effect of affiliated
reinsurance embedded
derivative - - (20 ) - - -
Net impact of Tax Cuts and
Jobs Act (c) - 3 131 - - -
Tax impact of adjusting items 7 (31 ) (1 ) (4 ) 36 25
AOI $ 351 $ 286 $ 3 $ 36 $ 41 $ 177
Less Preferred stock dividend $ 31 $ 29 $ 2 $ - $ - $ -
AOI available to common
shareholders $ 320 $ 257 $ 1 $ 36 $ 41 $ 177
(a) Amounts are net of offsets related to value of business acquired ("VOBA"),
deferred acquisition cost ("DAC"), deferred sale inducement ("DSI"), unearned
revenue ("UREV") and cost of reinsurance amortization, as applicable.
(b) The updated definition of AOI removes the impact of fair value accounting of
FIA products for periods after December 31, 2017 and the fair value accounting
impacts of assumed reinsurance by our international subsidiaries for periods
after September 30, 2018 . Included in the one-month period ended December 31,
2017 is the impact of the immaterial error resulting from the model code error,
net of VOBA amortization.
(c) For the year ended December 31, 2018 , the Company recorded an immaterial out
of period adjustment related to the December 1, 2017 fair value of the deferred
income tax valuation allowance acquired from the Business Combination. See
"Note 2. Significant Accounting Policies and Practices" for additional
information.
• AOI increased for the year ended December 31, 2019 primarily due to
increased investment spread as a result of portfolio repositioning
activity, disciplined crediting rate strategy, and invested asset growth.
Included in these results were
mortality within the single premium immediate annuity ("SPIA") product
line,
held to economically hedge our indexed products, $18 tax benefit due to
the release of the FSRC valuation allowance, and $11 net favorable
adjustments resulting from the annual review of DAC, VOBA, and our
international subsidiaries assumptions, partially offset by
expenses.
• AOI increased for the year ended
an increase in net investment income. Included in these results were
favorable items related to
affiliated reinsurance (pursuant to a tax reform strategy),
favorable actual to expected mortality within the SPIA product line and
other reserve adjustments,
offset by
held to economically hedge our indexed products and
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Investment Portfolio (All dollar amounts presented in millions unless otherwise noted) The types of assets in which we may invest are influenced by various state laws, which prescribe qualified investment assets applicable to insurance companies. Within the parameters of these laws, we invest in assets giving consideration to four primary investment objectives: (i) maintain robust absolute returns; (ii) provide reliable yield and investment income; (iii) preserve capital and (iv) provide liquidity to meet policyholder and other corporate obligations. Our investment portfolio is designed to contribute stable earnings and balance risk across diverse asset classes and is primarily invested in high quality fixed income securities. As ofDecember 31, 2019 andDecember 31, 2018 , the fair value of our investment portfolio was approximately$28 billion and$24 billion , respectively, and was divided among the following asset class and sectors: December 31, 2019 December 31, 2018 Fair Value Percent Fair Value Percent Fixed maturity securities, available for sale: United States Government full faith and credit $ 34 - %$ 119 - % United States Government sponsored entities 134 - % 106 - %United States municipalities, states and territories 1,343 5 % 1,187 5 % Foreign Governments 155 1 % 121 1 % Corporate securities: Finance, insurance and real estate 4,234 15 % 4,113 17 % Manufacturing, construction and mining 771 3 % 574 2 % Utilities, energy and related sectors 2,452 9 % 2,281 10 % Wholesale/retail trade 1,617 6 % 1,376 6 % Services, media and other 2,523 9 % 2,037 9 % Hybrid securities 1,027 4 % 901 4 % Non-agency residential mortgage-backed securities 820 3 % 925 4 % Commercial mortgage-backed securities 2,922 10 % 2,537 10 % Asset-backed securities 5,694 20 % 4,832 20 % Total fixed maturity available for sale securities 23,726 85 % 21,109 88 % Equity securities (a) 1,071 4 % 1,382 6 % Commercial mortgage loans 435 1 % 483 2 % Residential mortgage loans 848 3 % 187 1 % Other (primarily derivatives and limited partnerships) 1,875 7 % 748 3 % Total Investments$ 27,955 100 %$ 23,909 100 % (a) Includes investment grade non-redeemable preferred stocks ($887 and$1,208 , respectively). Insurance statutes regulate the type of investments that our life insurance subsidiaries are permitted to make and limit the amount of funds that may be used for any one type of investment. In light of these statutes and regulations, and our business and investment strategy, we generally seek to invest in (i) corporate securities rated investment grade by established nationally recognized statistical rating organizations (each, an "NRSRO"), (ii)U.S. Government and government-sponsored agency securities, or (iii) securities of comparable investment quality, if not rated. 76
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The following table summarizes the credit quality, byNationally Recognized Statistical Ratings Organization ("NRSRO") rating, of our fixed income portfolio: December 31, 2019 December 31, 2018 Rating Fair Value Percent Fair Value Percent AAA$ 496 2 %$ 627 3 % AA 1,520 6 % 1,415 7 % A 6,601 28 % 5,354 25 % BBB 8,800 37 % 8,328 39 % Not rated (c) 4,304 18 % 3,612 17 % Total investment grade 21,721 91 % 19,336 91 % BB (a) 1,353 6 % 1,307 6 % B and below (b) 519 2 % 351 2 % Not rated (c) 133 1 % 115 1 % Total below investment grade 2,005 9 % 1,773 9 % Total$ 23,726 100 %$ 21,109 100 % (a) Includes$13 and$17 atDecember 31, 2019 andDecember 31, 2018 , respectively, of non-agency residential mortgage-backed securities ("RMBS") that carry aNational Association of Insurance Commissioners ("NAIC") 1 designation. (b) Includes$138 and$175 atDecember 31, 2019 andDecember 31, 2018 , respectively, of non-agency RMBS that carry a NAIC 1 designation. (c) Securities denoted as not-rated by an NRSRO were classified as investment or non-investment grade according to the securities' respective NAIC designation. The NAIC's Securities Valuation Office ("SVO") is responsible for the day-to-day credit quality assessment and valuation of securities owned by state regulated insurance companies. Insurance companies report ownership of securities to the SVO when such securities are eligible for regulatory filings. The SVO conducts credit analysis on these securities for the purpose of assigning an NAIC designation or unit price. Typically, if a security has been rated by an NRSRO, the SVO utilizes that rating and assigns an NAIC designation based upon the following system: NAIC Designation NRSRO Equivalent Rating 1 AAA/AA/A 2 BBB 3 BB 4 B 5 CCC and lower 6 In or near default The NAIC has adopted revised designation methodologies for non-agency RMBS, including RMBS backed by subprime mortgage loans and for commercial mortgage-backed securities ("CMBS"). The NAIC's objective with the revised designation methodologies for these structured securities was to increase accuracy in assessing expected losses and to use the improved assessment to determine a more appropriate capital requirement for such structured securities. The NAIC designations for structured securities, including subprime and Alternative A-paper ("Alt-A") RMBS, are based upon a comparison of the bond's amortized cost to the NAIC's loss expectation for each security. Securities where modeling does not generate an expected loss in all scenarios are given the highest designation of NAIC 1. A number of our RMBS securities carry a NAIC 1 designation while the NRSRO rating indicates below investment grade. The revised methodologies reduce regulatory reliance on rating agencies and allow for greater regulatory input into the assumptions used to estimate expected losses from such structured securities. In the tables below, we present the rating of structured securities based on ratings from the revised NAIC rating methodologies described above (which in some cases do not correspond to rating agency designations). All NAIC designations (e.g., NAIC 1-6) are based on the revised NAIC methodologies. 77
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The tables below present our fixed maturity securities by NAIC designation as of
December 31, 2019
NAIC Designation Amortized Cost Fair Value Percent of Total Fair Value
1 $ 12,326 $ 12,829 54 %
2 9,046 9,350 39 %
3 1,112 1,108 5 %
4 273 280 1 %
5 157 159 1 %
6 - - - %
Total $ 22,914 $ 23,726 100 %
December 31, 2018
NAIC Designation Amortized Cost Fair Value Percent of Total Fair Value
1 $ 11,245 $ 10,928 52 %
2 9,677 9,003 43 %
3 1,064 967 4 %
4 155 139 1 %
5 71 65 - %
6 7 7 - %
Total $ 22,219 $ 21,109 100 %
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Investment Industry Concentration The tables below presents the fair value of the top ten industry categories of our fixed maturity, equity securities, and FHLB common stock, and percent of total fixed maturity, equity securities, and FHLB common stock fair value as ofDecember 31, 2019 andDecember 31, 2018 : December
31, 2019
Percent of Total Fair
Top 10 Industry Concentration Fair Value Value
ABS collateralized loan obligation ("CLO") $ 3,881
10 %
Whole loan collateralized mortgage obligation
("CMO") 2,479 16 %
Banking 2,414 6 %
ABS Other 1,779 5 %
Life insurance 1,610 7 %
Municipal 1,343 10 %
Electric 1,261 5 %
CMBS 887 3 %
Technology 694 3 %
Pipelines 648 4 %
Total $ 16,996 68 %
December 31, 2018
Percent of Total Fair
Top 10 Industry Concentration Fair Value ValueABS collateralized loan obligation ("CLO") $ 3,283
15 %
Banking 2,491 11 %
Whole loan collateralized mortgage obligation
("CMO") 2,234 10 %
ABS Other 1,545 7 %
Life insurance 1,376 6 %
Municipal 1,187 5 %
Electric 939 4 %
CMBS 874 4 %
Pipelines 812 4 %
Property and casualty insurance 542 2 %
Total $ 15,283 68 %
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The amortized cost and fair value of fixed maturity AFS securities by
contractual maturities as of
December 31, 2019 December 31, 2018
Amortized Cost Fair Value Amortized Cost Fair Value
Corporate, Non-structured Hybrids, Municipal
and U.S. Government securities:
Due in one year or less $ 85 $ 85 $ 191 $ 191
Due after one year through five years 888 914 817 794
Due after five years through ten years 2,020 2,082 2,219 2,137
Due after ten years 10,496 11,075 10,443 9,587
Subtotal $ 13,489 $ 14,156 $ 13,670 $ 12,709
Other securities which provide for periodic
payments:
Asset-backed securities $ 5,720 $ 5,694 $ 4,954 $ 4,832
Commercial mortgage-backed securities 2,788 2,922 2,568 2,537
Residential mortgage-backed securities 917 954 1,027 1,031
Subtotal $ 9,425 $ 9,570 $ 8,549 $ 8,400
Total fixed maturity available-for-sale
securities $ 22,914 $ 23,726 $ 22,219 $ 21,109
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Non-Agency RMBS Exposure Our investment in non-agency RMBS securities is predicated on the conservative and adequate cushion between purchase price and NAIC 1 rating, general lack of sensitivity to interest rates, positive convexity to prepayment rates and correlation between the price of the securities and the unfolding recovery of the housing market. The fair value of our investments in subprime and Alt-A RMBS securities was$81 and$130 as ofDecember 31, 2019 , respectively, and$104 and$163 as ofDecember 31, 2018 , respectively. The following tables summarize our exposure to subprime and Alt-A RMBS by credit quality using NAIC designations, NRSRO ratings and vintage year as ofDecember 31, 2019 andDecember 31, 2018 : December 31, 2019 December 31, 2018 NAIC Designation: Fair Value Percent of Total Fair Value Percent of Total 1$ 193 92 %$ 245 92 % 2 6 3 % 18 7 % 3 1 - % - - % 4 11 5 % 4 1 % 5 - - % - - % 6 - - % - - % Total$ 211 100 %$ 267 100 % NRSRO: AAA$ 1 - %$ 1 - % AA 7 3 % 11 4 % A 21 10 % 25 9 % BBB 5 2 % 8 3 % Not rated - Above investment grade (a) 34 16 % 46 17 % BB and below 143 69 % 176 66 % Total$ 211 100 %$ 267 100 % Vintage: 2017$ 13 6 %$ 12 4 % 2016 - - % 15 6 % 2007 44 21 % 51 19 % 2006 55 26 % 63 24 % 2005 and prior 99 47 % 126 47 % Total$ 211 100 %$ 267 100 %
(a) Securities denoted as not-rated by an NRSRO were classified as investment or non-investment grade according to the securities' respective NAIC designation.
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ABS Exposure As ofDecember 31, 2019 andDecember 31, 2018 , our ABS exposure was largely composed of CLOs, which comprised 68% and 68%, respectively, of all ABS holdings. These exposures are generally senior tranches of CLOs which have leveraged loans as their underlying collateral. The remainder of our ABS exposure was largely diversified by underlying collateral and issuer type, including automobile and home equity receivables. As ofDecember 31, 2019 , the non-CLO exposure represents 32% of total ABS assets, or 6% of total invested assets, and the CLO and non-CLO positions were trading at a net unrealized gain (loss) position of$(65) and$38 , respectively. As ofDecember 31, 2018 , the non-CLO exposure represented 32% of total ABS assets, or 6% of total invested assets, and the CLO and non-CLO positions were trading at a net unrealized gain (loss) position of$(128) and$6 , respectively. The following tables summarize our ABS exposure. December 31, 2019 December 31, 2018 Asset Class Fair Value Percent Fair Value Percent ABS CLO$ 3,881 68 %$ 3,283 68 % ABS auto 34 1 % 1 - % ABS credit card - - % 3 - % ABS other 1,779 31 % 1,545 32 % Total ABS$ 5,694 100 %$ 4,832 100 % Mortgage Loans We rate all CMLs to quantify the level of risk. We place those loans with higher risk on a watch list and closely monitor them for collateral deficiency or other credit events that may lead to a potential loss of principal and/or interest. If we determine the value of any CML to be impaired (i.e., when it is probable that we will be unable to collect on amounts due according to the contractual terms of the loan agreement), the carrying value of the CML is reduced to either the present value of expected cash flows from the loan, discounted at the loan's effective interest rate, or fair value of the collateral. For those mortgage loans that are determined to require foreclosure, the carrying value is reduced to the fair value of the underlying collateral, net of estimated costs to obtain and sell at the point of foreclosure. The carrying value of the impaired loans is reduced by establishing a specific write-down recorded in "Net realized capital gains (losses)" in the Consolidated Statements of Operations. Loan-to-value ("LTV") and debt service coverage ("DSC") ratios are utilized as part of the review process described above. As ofDecember 31, 2019 , our mortgage loans on real estate portfolio had a weighted average DSC ratio of 2.21 , and a weighted average LTV ratio of 44%. See "Note 4. Investments" to our audited consolidated financial statements for additional information regarding our LTV and DSC ratios. The Company's residential mortgage loans ("RML") are closed end, amortizing loans and 100% of the properties are located inthe United States . The Company diversifies its RML portfolio by state to reduce concentration risk. Residential mortgage loans have a primary credit quality indicator of either a performing or nonperforming loan. The Company defines non-performing residential mortgage loans as those that are 90 or more days past due and/or in nonaccrual status which is assessed monthly. 82
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Unrealized Losses The amortized cost and fair value of the fixed maturity securities and the equity securities that were in an unrealized loss position as ofDecember 31, 2019 andDecember 31, 2018 , were as follows: December 31, 2019 Number of securities Amortized Cost Unrealized Losses Fair Value Fixed maturity securities, available for sale: United States Government full faith and credit 2 $ 6 $ - $ 6 United States Government sponsored agencies 33 36 - 36United States municipalities, states and territories 23 188 (5 ) 183 Corporate securities: Finance, insurance and real estate 41 413 (14 ) 399 Manufacturing, construction and mining 20 132 (2 ) 130 Utilities, energy and related sectors 54 502 (30 ) 472 Wholesale/retail trade 45 508 (19 ) 489 Services, media and other 39 351 (7 ) 344 Hybrid securities 10 87 (4 ) 83 Non-agency residential mortgage backed securities 62 115 (3 ) 112 Commercial mortgage backed securities 43 254 (6 ) 248 Asset backed securities 364 3,249 (77 ) 3,172 Total fixed maturity available for sale securities 736 5,841 (167 ) 5,674 Equity securities 33 505 (17 ) 488 Total investments 769 $ 6,346 $ (184 )$ 6,162 December 31, 2018 Number of securities Amortized Cost Unrealized Losses Fair Value Fixed maturity securities, available for sale: United States Government full faith and credit 15 $ 120 $ (1 )$ 119 United States Government sponsored agencies 72 88 (2 ) 86United States municipalities, states and territories 103 1,054 (32 ) 1,022 Foreign Governments 16 123 (8 ) 115 Corporate securities: Finance, insurance and real estate 300 3,721 (230 ) 3,491 Manufacturing, construction and mining 86 613 (57 ) 556 Utilities, energy and related sectors 237 2,347 (222 ) 2,125 Wholesale/retail trade 211 1,469 (144 ) 1,325 Services, media and other 266 2,179 (195 ) 1,984 Hybrid securities 67 956 (91 ) 865 Non-agency residential mortgage backed securities 110 249 (6 ) 243 Commercial mortgage backed securities 205 1,768 (40 ) 1,728 Asset backed securities 419 3,704 (137 ) 3,567 Total fixed maturity available for sale securities 2,107 18,391 (1,165 ) 17,226 Equity securities 95 1,523 (145 ) 1,378 Total investments 2,202$ 19,914 $ (1,310 )$ 18,604 The gross unrealized loss position on the available-for-sale fixed maturity security and equity portfolio as ofDecember 31, 2019 andDecember 31, 2018 was$184 and$1,310 , respectively. The gross unrealized loss position decreased$1,126 fromDecember 31, 2018 toDecember 31, 2019 as most components of the portfolio exhibited price appreciation due to interest rates and credit spreads narrowing during the year. Floating rate notes experienced some stress as LIBOR declined through the year in response to interest rate cuts from theUS Federal Reserve Bank , however, some of this was mitigated by tightening spreads. The total book value of all securities in an unrealized loss position was$6,346 and$19,914 as ofDecember 31, 2019 andDecember 31, 2018 , respectively. 83
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The total book value of all securities in an unrealized loss position decreased 68% fromDecember 31, 2018 toDecember 31, 2019 . The average market value/book value of the investment category with the largest unrealized loss position was 98% for asset backed securities and 92% for corporate bonds as ofDecember 31, 2019 andDecember 31, 2018 , respectively. In aggregate, asset backed securities represented 42% and corporate bonds represented 65% of the total unrealized loss position as ofDecember 31, 2019 andDecember 31, 2018 , respectively. Our municipal bond exposure is a combination of general obligation bonds (fair value of$228 and an amortized cost of$215 as ofDecember 31, 2019 ) and special revenue bonds (fair value of$1,115 and amortized cost of$1,069 as ofDecember 31, 2019 ). Across all municipal bonds, the largest issuer represented 9% of the category, less than 1% of the entire portfolio, and is rated NAIC 1. Our focus within municipal bonds is on NAIC 1 rated instruments, and 90% of our municipal bond exposure is rated NAIC 1. The amortized cost and fair value of fixed maturity securities and equity securities (excludingU.S. Government andU.S. Government -sponsored agency securities) in an unrealized loss position greater than 20% and the number of months in an unrealized loss position with fixed maturity investment grade securities (NRSRO rating of BBB/Baa or higher) as ofDecember 31, 2019 andDecember 31, 2018 , were as follows: December 31, 2019 Number of Gross Unrealized securities Amortized Cost Fair Value Losses
Investment grade:
Less than six months - $ - $ - $ -
Six months or more and less than
twelve months - - - -
Twelve months or greater 1 - - -
Total investment grade 1 - - -
Below investment grade:
Less than six months 1 3 2 (1 )
Six months or more and less than
twelve months - - - -
Twelve months or greater 3 42 33 (9 )
Total below investment grade 4 45 35 (10 )
Total 5 $ 45 $ 35 $ (10 )
December 31, 2018
Number of Gross Unrealized
securities Amortized Cost Fair Value LossesInvestment grade:
Less than six months 3 $ 23 $ 18 $ (5 )
Six months or more and less than
twelve months 10 72 55 (17 )
Twelve months or greater 4 25 19 (6 )
Total investment grade 17 120 92 (28 )
Below investment grade:
Less than six months 3 11 9 (2 )
Six months or more and less than
twelve months 9 31 22 (9 )
Twelve months or greater 5 12 9 (3 )
Total below investment grade 17 54 40 (14 )
Total 34 $ 174 $ 132 $ (42 )
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OTTI andWatch List AtDecember 31, 2019 andDecember 31, 2018 , our watch list included 8 and 34 securities, respectively, in an unrealized loss position with an amortized cost of$45 and$174 , unrealized losses of$10 and$42 , and a fair value of$35 and$132 , respectively. As part of the OTTI analysis, we evaluated each of these securities to assess the following: •whether the issuer is currently meeting its financial obligations; •its ability to continue to meet these obligations; •its existing cash available; •its access to additional available capital; •any expense management actions the issuer has taken; and •whether the issuer has the ability and willingness to sell non-core assets to generate liquidity. Based on our analysis, these securities demonstrated that theDecember 31, 2019 andDecember 31, 2018 carrying values were fully recoverable. There were 4 and 4 structured securities with a fair value of$0 and$6 on the watch list to which we had potential credit exposure as ofDecember 31, 2019 andDecember 31, 2018 , respectively. Our analysis of these structured securities, which included cash flow testing results, demonstrated theDecember 31, 2019 andDecember 31, 2018 values were fully recoverable. Exposure to Sovereign Debt Our investment portfolio had no direct exposure to European sovereign debt as ofDecember 31, 2019 andDecember 31, 2018 . As ofDecember 31, 2019 andDecember 31, 2018 , the Company also had no material exposure risk related to financial investments inPuerto Rico . Net Investment Income and Net Investment Gains (Losses) For discussion regarding our net investment income and net investment gains (losses) refer to "Note 4. Investments" to our audited consolidated financial statements.Available-For-Sale Securities For additional information regarding our AFS securities, including the amortized cost, gross unrealized gains (losses), and fair value as well as the amortized cost and fair value of fixed maturity AFS securities by contractual maturities as ofDecember 31, 2019 , refer to "Note 4. Investments" to our audited consolidated financial statements. Concentrations of Financial Instruments For detail regarding our concentration of financial instruments refer to "Note 3. Significant Risks and Uncertainties" to our audited consolidated financial statements. Derivatives We are exposed to credit loss in the event of nonperformance by our counterparties on call options. We attempt to reduce this credit risk by purchasing such options from large, well-established financial institutions. We also hold cash and cash equivalents received from counterparties for call option collateral, as well asU.S. Government securities pledged as call option collateral, if our counterparty's net exposures exceed pre-determined thresholds. The Company is required to pay counterparties the effective federal funds rate each day for cash collateral posted to FGL for daily mark to market margin changes. The Company reduces the negative interest cost associated with cash collateral posted from counterparties under various ISDA agreements by reinvesting derivative cash collateral. This program permits collateral cash received to be invested in short termTreasury securities, bank deposits and commercial paper rated A1/P1 which are included in "Cash and cash equivalents" in the accompanying Consolidated Balance Sheets. See "Note 5. Derivative Financial Instruments" to our audited consolidated financial statements for additional information regarding our derivatives and our exposure to credit loss on call options. 85
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Liquidity and Capital Resources Liquidity and Cash Flow Liquidity refers to the ability of an enterprise to generate adequate amounts of cash from its normal operations to meet cash requirements with a prudent margin of safety. Our principal sources of cash flow from operating activities are insurance premiums, and fees and investment income, however, sources of cash flows from investing activities also result from maturities and sales of invested assets. Our operating activities provided cash of$675 in the year endedDecember 31, 2019 . When considering our liquidity and cash flow, it is important to distinguish between the needs of our insurance subsidiaries and the needs of the holding company,FGL Holdings . As a holding company with no operations of its own,FGL Holdings derives its cash primarily from its insurance subsidiaries andCF Bermuda Holdings Limited ("CF Bermuda"), aBermuda exempted limited liability company and a wholly owned direct subsidiary of the Company, a downstream holding company that provides additional sources of liquidity. Dividends from our insurance subsidiaries flow through CF Bermuda toFGL Holdings . The sources of liquidity of the holding company are principally comprised of dividends from subsidiaries, bank lines of credit (at FGLH level) and the ability to raise long-term public financing under anSEC -filed registration statement or private placement offering. These sources of liquidity and cash flow support the general corporate needs of the holding company, including common stock dividends, interest and debt service, funding acquisitions, and investment in core businesses. Our cash flows associated with collateral received from and posted with counterparties change as the market value of the underlying derivative contract changes. As the value of a derivative asset declines (or increases), the collateral required to be posted by our counterparties would also decline (or increase). Likewise, when the value of a derivative liability declines (or increases), the collateral we are required to post to our counterparties would also decline (or increase). Discussion of Consolidated Cash Flows Presented below is a table that summarizes the cash provided or used in our activities and the amount of the respective increases or decreases in cash provided or used from those activities for the periods presented: (Dollars in millions) Year ended Year ended Period from Period from Period from October 1 to December 1 October 1 to December 31, to
December
December 31, 2019 December 31, 2018 31, 2017 2017 (Unaudited) September 30, 2017
Cash provided by (used
in): Predecessor Predecessor Predecessor
Operating activities $ 675 $ 897 $ 85 $ 79 $ 72 $ 237
Investing activities (1,568 ) (2,280 ) (22 ) (175 ) (594 ) (1,217 )
Financing activities 1,291 739 45 135 290 1,001
Net increase (decrease)
in cash and cash
equivalents $ 398 $ (644 ) $ 108 $ 39 $ (232 ) $ 21
Operating Activities
Cash provided by operating activities for the years ended December 31, 2019 and
December 31, 2018 were principally due to investment income and deferred
acquisition costs. For the year ended December 31, 2019 , net investment income
receipts of $1,280 were partially offset by deferred acquisition costs of $468 .
Investing Activities
Cash used in investing activities for the years ended December 31, 2019 and
December 31, 2018 was principally due to the purchases of fixed maturity
securities and other investments, net of cash proceeds from sales, maturities
and repayments, as a result of the Company's portfolio repositioning.
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Financing Activities Cash provided by financing activities for the years endedDecember 31, 2019 andDecember 31, 2018 was related to the issuance of investment contracts and pending new production, including annuity and universal life insurance contracts, net of redemptions and benefit payments. Sources of Cash Flow Dividends from Insurance Subsidiaries, Statutory Capital and Risk-Based CapitalThe Company's insurance subsidiaries domiciled in theU.S. are restricted by state laws and regulations as to the amount of dividends they may pay to their parent without regulatory approval in any year, the purpose of which is to protect affected insurance policyholders, depositors or investors. Any dividends in excess of limits are deemed "extraordinary" and require regulatory approval. Based on statutory results as ofDecember 31, 2019 , in accordance with applicable dividend restrictions, the Company's subsidiaries may pay "ordinary" dividends to FGLH in 2020 of$175 . However, pursuant to an order issued in connection with the approval of the Merger Agreement by theIowa Commissioner onNovember 28, 2017 ,FGL Insurance shall not pay any dividend or other distribution to shareholders prior toNovember 28, 2021 without the prior approval of theIowa Commissioner. In 2019, upon approval by theIowa Commissioner,FGL Insurance declared and paid extraordinary dividends of$100 to its Parent, FGLH.FGL Insurance andFGL NY Insurance are subject to minimum RBC requirements established by the insurance departments of their applicable state of domicile. The formulas for determining the amount of RBC specify various weighting factors that are applied to financial balances and levels of premium activity based on the perceived degree of risk. Regulatory compliance is determined by a ratio of TAC, as defined by the NAIC, to RBC requirements, as defined by the NAIC.FGL Insurance andFGL NY Insurance exceeded the minimum RBC requirements that would require regulatory or corrective action for all periods presented herein. RBC is an important factor in the determination of the financial strength ratings ofFGL Insurance .FGL Insurance andFGL NY Insurance are required to prepare statutory financial statements in accordance with statutory accounting practices prescribed or permitted by the insurance department of the state of domicile of the respective insurance subsidiary. Statutory accounting practices primarily differ from GAAP by charging policy acquisition costs to expense as incurred, establishing future policy benefit liabilities using different actuarial assumptions as well as valuing investments and certain assets and accounting for deferred taxes on a different basis. Certain assets that are not admitted under statutory accounting principles are charged directly to surplus. For non-U.S. companies, Class C insurers are required to maintain available capital and surplus at a level equal to or in excess of the applicable ECR, which is established by reference to either the applicable BSCR model or an approved internal capital model. Furthermore, to enable the BMA to better assess the quality of the insurer's capital resources, a Class C insurer is required to disclose the makeup of its capital in accordance with its 3-tiered capital system. An insurer may file an application under the Insurance Act to have the aforementioned ECR requirements waived. Statutory capital and surplus ofFGL Insurance and our other insurance subsidiaries is as follows for the periods presented: As of December 31, As of December 31, (Dollars in millions) 2019 2018 SubsidiaryName : F&G Life Re Ltd $ 2 $ 2 FSRC 73 73 F&G Reinsurance Ltd 295 38 Fidelity & Guaranty Life Insurance Company 1,513 1,545 Fidelity & Guaranty Life Insurance Company of New York 95 85 Raven Reinsurance Company 87 94 87
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We monitor the ratio of our insurance subsidiaries' TAC to company action level
risk-based capital ("CAL"). A ratio in excess of either (i) 100% or (ii) 150% if
there is a negative trend, indicates that the insurance subsidiary is not
required to take any corrective actions to increase capital levels at the
direction of the applicable state of domicile.
The ratio of TAC to CAL for FGL Insurance and FGL NY Insurance is set out below
for the periods presented:
As of December 31, 2019 As of December 31, 2018
(Dollars in millions) CAL TAC Ratio CAL TAC Ratio
Fidelity & Guaranty Life Insurance
Company $ 393 $ 1,776 452 % $ 380 $ 1,699 447 %
Fidelity & Guaranty Life Insurance
Company of New York 14 99 709 % 10 88 903 %
Debt
During the year ended December 31, 2018 , FGLH completed a debt offering of $550
aggregate principal amount of 5.50% senior notes due 2025, issued at 99.5% for
proceeds of $547 . The Company also has a credit agreement with certain financial
institutions party thereto, as lenders, and Royal Bank of Canada, as
administrative agent and letter of credit issuer, which provides for a $250
senior unsecured revolving credit facility with a maturity of three years. Refer
to "Note 8. Debt" to our audited consolidated financial statements for further
details regarding the Company's Senior Notes and revolving credit agreement.
The 5.50% Senior Notes were issued pursuant to an indenture, dated as of April
20, 2018 (the "Base Indenture"), among FGLH, the guarantors from time to time
party thereto and Wells Fargo Bank, National Association , as trustee (the
"Trustee"), and a supplemental indenture thereto (the "Supplemental Indenture"
and, together with the Base Indenture, the "Indenture"). FGLH pays interest on
the 5.50% Senior Notes in cash on May 1 and November 1 of each year at a rate of
5.50% per annum. The 5.50% Senior Notes will mature on May 1, 2025 . The 5.50%
Senior Notes are fully and unconditionally guaranteed by FGLH's direct parent,
FGL US Holdings Inc. , a Delaware corporation, FGL's indirect parent, CF Bermuda,
and certain existing and future wholly-owned domestic restricted subsidiaries of
the CF Bermuda, other than its insurance subsidiaries.
The Indenture contains covenants that restrict the CF Bermuda's and its
restricted subsidiaries' ability to, among other things, pay dividends on or
make other distributions in respect of equity interests or make other restricted
payments, make certain investments, incur or guarantee additional indebtedness,
create liens on certain assets to secure debt, sell certain assets, consummate
certain mergers or consolidations or sell all or substantially all assets, or
enter into transactions with affiliates.
Debt Covenants
The Credit Agreement contains a number of covenants that, among other things,
limit or restrict the ability of FGLH, CF Bermuda and their subsidiaries to
incur additional indebtedness, incur or become subject to liens, dispose of
assets, make investments, dividends or distributions or repurchases of certain
equity interests or prepayments of certain indebtedness, enter into certain
transactions with affiliates, undergo fundamental changes, enter into certain
restrictive agreements, and change certain accounting policies or reporting
practices. The Credit Agreement also contains certain affirmative covenants,
including financial and other reporting requirements. In addition, the Credit
Agreement includes the following financial maintenance covenants: (a) minimum
total shareholders' equity of CF Bermuda and its consolidated subsidiaries at
the end of each fiscal quarter of the sum of (i) the greater of (x) 70% of the
total shareholders' equity of CF Bermuda as of the Closing Date and (y) $1.19
billion plus (ii) 50% of the consolidated net income (loss) of CF Bermuda and
its consolidated subsidiaries since the first day of the first fiscal quarter
after November 30, 2017 plus (iii) 50% of all equity issuances of CF Bermuda
after November 30, 2017 ; (b) maximum debt to total capitalization ratio of CF
Bermuda at the end of each fiscal quarter of 0.35 to 1.00 for CF Bermuda and its
consolidated subsidiaries; and (c) a minimum aggregate risk-based capital ratio
of FGL Insurance , at the end of each fiscal quarter, of 300%. As of the date of
this filing, FGLH and CF Bermuda are in compliance with all such covenants.
The Indenture contains a number of covenants that, among other things, limit or
restrict FGLH's ability and the ability of FGLH's restricted subsidiaries to
incur debt, incur liens, make certain asset dispositions or dispositions of
subsidiary stock, enter into transactions with affiliates, enter into mergers,
consolidations or transfers of all or substantially all assets, declare or pay
dividends, redeem stock or prepay certain indebtedness, make investments
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or enter into restrictive agreements. The Indenture also contains certain affirmative covenants, including financial and other reporting requirements. Most of these covenants will cease to apply for so long as the Senior Notes have investment grade ratings from both Moody's and S&P. As of the date of this filing, FGLH is in compliance with all such covenants.
Credit Ratings
The indicative credit ratings published by the primary rating agencies are set forth below. Securities are rated at the time of issuance so actual ratings may differ from the indicative ratings. There may be other rating agencies that also provide credit ratings, which we do not disclose in our reports. Our current financial strength ratings of our principal insurance subsidiaries are described in section titled "Ratings" in Item 1. Business.
The long-term credit rating scales of
Senior Unsecured Notes
Financial Strength Rating Scale Credit Rating Scale
Rating Agency
A.M. Best(1) "A++" to "S" "aaa to rs"
S&P(2) "AAA" to "R" "AAA to D"
Moody's(3) "Aaa" to "C" "Aaa to C"
Fitch(4) "AAA" to "C" "AAA to D"
(1) A.M. Best's financial strength rating is an independent opinion of an
insurer's financial strength and ability to meet its ongoing insurance
policy and contract obligations. It is based on a comprehensive
quantitative and qualitative evaluation of a company's balance sheet
strength, operating performance and business profile. A.M. Best's
long-term credit ratings reflect its assessment of the ability of an
obligor to pay interest and principal in accordance with theterms of
the obligation. Ratings from "aa" to "ccc" may be enhanced with a "+"
(plus) or "-" (minus) to indicate whether credit quality is near the
top or bottom of a category. A.M. Best's short-term creditrating is
an opinion to the ability of the rated entity to meet its senior
financial commitments on obligations maturing in generally less than
one year.
(2) S&P's insurer financial strength rating is a forward-looking opinion
about the financial security characteristics of an insurance
organization with respect to its ability to pay under itsinsurance
policies and contracts in accordance with their terms. A "+" or "-"
indicates relative standing within a category. An S&P credit rating is
an assessment of default risk, but may incorporate an assessment of
relative seniority or ultimate recovery in the event of default.
Short-term issuer credit ratings reflect the obligor's
creditworthiness over a short-term time horizon.
(3) Moody's financial strength ratings are opinions of the ability of
insurance companies to repay punctually senior policyholderclaims and
obligations. Moody's appends numerical modifiers 1, 2, and 3 to each
generic rating classification from Aa through Caa. The modifier 1
indicates that the obligation ranks in the higher end of itsgeneric
rating category; the modifier 2 indicates a mid-range ranking; and the
modifier 3 indicates a ranking in the lower end of that generic rating
category. Moody's long-term credit ratings are opinions of the
relative credit risk of fixed-income obligations with an original
maturity of one year or more. They address the possibility that a
financial obligation will not be honored as promised. Moody's
short-term ratings are opinions of the ability of issuers to honor
short-term financial obligations.
(4) Fitch's financial strength ratings provide an assessment of the
financial strength of an insurance organization. The IFS Rating is
assigned to the insurance company's policyholder obligations,
including assumed reinsurance obligations and contract holder
obligations, such as guaranteed investment contracts. Withinlong-term
and short-term ratings, a "+" or a "-" may be appended to arating to
denote relative position within major rating categories.
A downgrade of our debt ratings could affect our ability to raise additional
debt with terms and conditions similar to our current debt, and accordingly,
likely increase our cost of capital. In addition, a downgrade of these ratings
could make it more difficult to raise capital to refinance any maturing debt
obligations, to support business growth at our insurance subsidiaries and to
maintain or improve the current financial strength ratings of our principal
insurance subsidiaries described in section titled "Ratings" in Item 1.
Business. All of our ratings are subject to
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revision or withdrawal at any time by the rating agencies, and therefore, no assurance can be given that we can maintain these ratings. Each rating should be evaluated independently of any other rating. Preferred Stock Our amended and restated memorandum of association and articles of association provide that we have the authority to issue 100,000,000 preferred shares, including the 275,000 shares of Series A Preferred Shares and the 100,000 Series B Preferred Shares issued onNovember 30, 2017 . Subject to certain consent rights of the holders of the Series A Preferred Shares and the Series B Preferred Shares, we may issue additional series of preferred shares that would rank on parity with the Series A Preferred Shares and the Series B Preferred Shares as to liquidation preference. Under our amended and restated articles of association, our board of directors has the authority, subject to the provisions, if any, in our amended and restated memorandum of association and any rights attached to any existing shares, to issue preferred shares and to fix the preferred, deferred or other rights or restrictions, whether in regard to dividends or other distributions, voting, return of capital or otherwise, including varying such rights at such times and on such other terms as the board of directors thinks proper. The Series A Preferred Shares and the Series B Preferred Shares (together, the "preferred shares") do not have a maturity date and are non-callable for the first five years. The dividend rate of the preferred shares is 7.5% per annum, payable quarterly in cash or additional preferred shares, at the Company's option, subject to increase beginning 10 years after issuance based on the then-current three-month LIBOR rate plus 5.5%. In addition, commencing 10 years after issuance of the preferred shares, and following a failed remarketing event, GSO and FNF will have the right to convert their preferred shares into a number of ordinary shares of the Company as determined by dividing (i) the aggregate par value (including dividends paid in kind and unpaid accrued dividends) of the preferred shares that GSO or FNF, as applicable, wishes to convert by (ii) the higher of (a) a 5% discount to the 30-day volume weighted average of the ordinary shares following the conversion notice, and (b) the then-current Floor Price. The "Floor Price" will be$8.00 per share during the 11th year post-funding,$7.00 per share during the 12th year post-funding, and$6.00 during the 13th year post-funding and thereafter. Because the board of directors has the power to establish the preferences and rights of the shares of preferred shares, it may afford holders of any preferred shares preferences, powers and rights, including voting and dividend rights, senior to the rights of holders of our ordinary stock, which could adversely affect the holders of the ordinary shares and could delay, discourage or prevent a takeover of us even if a change of control of our company would be beneficial to the interests of our shareholders. FHLB We are currently a member of theFederal Home Loan Bank of Atlanta ("FHLB") and are required to maintain a collateral deposit that backs any funding agreements issued. We use these funding agreements as part of a spread enhancement strategy. We have the ability to obtain funding from the FHLB based on a percentage of the value of our assets, subject to the availability of eligible collateral. Collateral is pledged based on the outstanding balances of FHLB funding agreements. The amount of funding varies based on the type, rating and maturity of the collateral posted to the FHLB. Generally,U.S. government agency notes and mortgage-backed securities are pledged to the FHLB as collateral. Market value fluctuations resulting from changes in interest rates, spreads and other risk factors for each type of asset are monitored and additional collateral is either pledged or released as needed. Our borrowing capacity under these credit facilities does not have an expiration date as long as we maintain a satisfactory level of creditworthiness based on the FHLB's credit assessment. As ofDecember 31, 2019 andDecember 31, 2018 , we had$1,096 and$878 in non-putable funding agreements, respectively, included under contract owner account balances on our consolidated balance sheet. As ofDecember 31, 2019 andDecember 31, 2018 , we had assets with a fair value of approximately$1,521 and$1,414 , respectively, which collateralized the FHLB funding agreements. Assets pledged to the FHLB are included in fixed maturities, AFS, on our consolidated balance sheets. Collateral-Derivative Contracts Under the terms of our ISDA agreements, we may receive from, or deliver to, counterparties collateral to assure that all terms of the ISDA agreements will be met with regard to the Credit Support Annex ("CSA"). The terms of the CSA call for us to pay interest on any cash received equal to the federal funds rate. As ofDecember 31, 2019 andDecember 31, 2018 ,$489 and$59 collateral was posted by our counterparties as they did not meet the net exposure thresholds. Collateral requirements are monitored on a daily basis and incorporate changes in market 90
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values of both the derivatives contract as well as the collateral pledged. Market value fluctuations are due to changes in interest rates, spreads and other risk factors.
Uses of Cash Flow Contractual Obligations The following table summarizes, as ofDecember 31, 2019 , our contractual obligations that were fixed and determinable and the payments due under those obligations in the following periods. Payment Due by
Period
Less than 1 More than 5
(Dollars in millions) Total year 1-3 years 3-5 years years
Annuity and universal life
products (a) $ 36,628 $ 2,125 $ 5,540 $ 4,948 $ 24,015
Operating leases 16 2 3 3 8
Debt 550 - - - 550
Interest expense 166 30 60 61 15
Total $ 37,360 $ 2,157 $ 5,603 $ 5,012 $ 24,588 (a) Amounts shown in this table are projected payments through the year 2030
which we are contractually obligated to pay our annuity and IUL
policyholders. The payments are derived from actuarial models which assume a
level interest rate scenario and incorporate assumptions regarding mortality
and persistency, when applicable. These assumptions are based on our
historical experience, but actual amounts will differ.
Return of Capital to Common Stockholders One of the Company's primary goals is to provide a return to our common stockholders through share price accretion, dividends and stock repurchases. In determining dividends, the board of directors takes into consideration items such as current and expected earnings, capital needs, rating agency considerations and requirements for financial flexibility. The amount and timing of share repurchase depends on key capital ratios, rating agency expectations, the generation of free cash flow and an evaluation of the costs and benefits associated with alternative uses of capital. InDecember 2018 , the Company's board of directors authorized a share repurchase program of up to$150 of the Company's outstanding ordinary shares. This program will expire onDecember 15, 2020 , and may be modified at any time. Under the share repurchase program, the Company may repurchase shares from time to time in open market transactions or through privately negotiated transactions in accordance with applicable federal securities laws. Repurchases may also be made pursuant to a trading plan under Rule 10b5-1 of the Exchange Act. The extent to which the Company repurchases its shares, and the timing of such purchases, will depend upon a variety of factors, including market conditions, regulatory requirements and other considerations, as determined by the Company. As ofDecember 31, 2019 , the Company has repurchased 8,652 thousand shares for a total cost of$69 . InDecember 2018 , the Company's board of directors approved the implementation of a quarterly cash dividend of$0.01 per ordinary share, beginning in the first quarter of fiscal year 2019. The dividend equates to$0.04 per share on a full-year basis. Off-Balance Sheet Arrangements Throughout our history, we have entered into indemnifications in the ordinary course of business with our customers, suppliers, service providers, business partners and in certain instances, when we sold businesses. Additionally, we have indemnified our directors and officers who are, or were, serving at our request in such capacities. Although the specific terms or number of such arrangements is not precisely known due to the extensive history of our past operations, costs incurred to settle claims related to these indemnifications have not been material to our financial statements. We have no reason to believe that future costs to settle claims related to our former operations will have a material impact on our financial position, results of operations or cash flows. OnNovember 30, 2017 , FGLH and CF Bermuda, together as borrowers and each as a borrower, entered into the Credit Agreement with certain financial institutions party thereto, as lenders, and Royal Bank of Canada, as administrative agent and letter of credit issuer, which provides for a$250 senior unsecured revolving credit facility with a maturity of three years. The Credit Agreement provides a letter of credit sub-facility in a maximum amount 91
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of$20 . The borrowers are permitted to use the proceeds of the loans under the Credit Agreement for working capital, growth initiatives and general corporate purposes, as well as to pay fees, commissions and expenses incurred in connection with the Credit Agreement and the transactions contemplated thereby. Amounts borrowed under the Credit Agreement may be reborrowed until the maturity date or termination of commitments under the Credit Agreement. The borrowers may increase the maximum amount of availability under the Credit Agreement from time to time by up to an aggregate amount not to exceed$50 , subject to certain conditions, including the consent of the lenders participating in each such increase. As ofDecember 31, 2019 , the Company had not drawn on the revolver. The Company has unfunded investment commitments as ofDecember 31, 2019 based upon the timing of when investments are executed compared to when the actual investments are funded, as some investments require that funding occur over a period of months or years. Please refer to "Note 4. Investments" and "Note 12. Commitments and Contingencies" to our audited consolidated financial statements for additional details on unfunded investment commitments. Item 7A. Quantitative and Qualitative Disclosures about Market Risk Market Risk Factors Market risk is the risk of the loss of fair value resulting from adverse changes in market rates and prices, such as interest rates, foreign currency exchange rates, commodity prices and equity prices. Market risk is directly influenced by the volatility and liquidity in the markets in which the related underlying financial instruments are traded. We have significant holdings in financial instruments and are naturally exposed to a variety of market risks. We are primarily exposed to interest rate risk, credit risk and equity price risk and have some exposure to counterparty risk, which affect the fair value of financial instruments subject to market risk. Enterprise Risk Management We place a high priority to risk management and risk control. As part of our effort to ensure measured risk taking, management has integrated risk management in our daily business activities and strategic planning. We have comprehensive risk management, governance and control procedures in place and have established a dedicated risk management function with responsibility for the formulation of our risk appetite, strategies, policies and limits. The risk management function is also responsible for monitoring our overall market risk exposures and provides review, oversight and support functions on risk-related issues. Our risk appetite is aligned with how our businesses are managed and how we anticipate future regulatory developments. Our risk governance and control systems enable us to identify, control, monitor and aggregate risks and provide assurance that risks are being measured, monitored and reported adequately and effectively in accordance with the following three principles: • Management of the business has primary responsibility for the day-to-day
management of risk.
• The risk management function has the primary responsibility to align risk
taking with strategic planning through risk tolerance and limit setting.
• The internal audit function provides an ongoing independent and objective
assessment of the effectiveness of internal controls, including financial
and operational risk management.
The Chief Risk Officer ("CRO") heads our risk management process and reports
directly to our Chief Executive Officer ("CEO"). Our Enterprise Risk Committee
discusses and approves all risk policies and reviews and approves risks
associated with our activities. This includes volatility (affecting earnings and
value), exposure (required capital and market risk) and insurance risks.
We have implemented several limit structures to manage risk. Examples include,
but are not limited to, the following:
• At-risk limits on sensitivities of regulatory capital to the capital
markets provide the fundamental framework to manage capital markets risks
including the risk of asset / liability mismatch;
• Duration and convexity mismatch limits;
• Credit risk concentration limits; and
• Investment and derivative guidelines.
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We manage our risk appetite based on two key risk metrics: • Regulatory Capital Sensitivities: the potential reduction, under a range
of moderate to extreme capital markets stress scenarios, of the excess of
available statutory capital above the minimum required under the NAIC
regulatory RBC methodology; and
• Earnings Sensitivities: the potential reduction in results of operations
over a 30 year time horizon under the same moderate to extreme capital
markets stress scenario. Maintaining a consistent level of earnings helps
us to finance our operations, support our capital requirements and provide
funds to pay dividends to stockholders.
Our risk metrics cover the most important aspects in terms of performance measures where risk can materialize and are representative of the regulatory constraints to which our business is subject. The sensitivities for earnings and statutory capital are important metrics since they provide insight into the level of risk we take under stress scenarios. They also are the basis for internal risk management. We are also subject to cash flow stress testing pursuant to regulatory requirements. This analysis measures the effect of changes in interest rate assumptions on asset and liability cash flows. The analysis includes the effects of: • The timing and amount of redemptions and prepayments in our asset portfolio; • Our derivative portfolio;
• Death benefits and other claims payable under the terms of our insurance
products;
• Lapses and surrenders in our insurance products;
• Minimum interest guarantees in our insurance products; and
• Book value guarantees in our insurance products.
Interest Rate Risk
Interest rate risk is our primary market risk exposure. We define interest rate
risk as the risk of an economic loss due to adverse changes in interest rates.
This risk arises from our holdings in interest sensitive assets and liabilities,
primarily as a result of investing life insurance premiums and fixed annuity
deposits received in interest-sensitive assets and carrying these funds as
interest-sensitive liabilities. Substantial and sustained increases or decreases
in market interest rates can affect the profitability of the insurance products
and the fair value of our investments, as the majority of our insurance
liabilities are backed by fixed maturity securities.
The profitability of most of our products depends on the spreads between
interest yield on investments and rates credited on insurance liabilities. We
have the ability to adjust the rates credited, primarily caps and credit rates,
on the majority of the annuity liabilities at least annually, subject to minimum
guaranteed values. In addition, the majority of the annuity products have
surrender and withdrawal penalty provisions designed to encourage persistency
and to help ensure targeted spreads are earned. However, competitive factors,
including the impact of the level of surrenders and withdrawals, may limit our
ability to adjust or maintain crediting rates at the levels necessary to avoid a
narrowing of spreads under certain market conditions.
In order to meet our policy and contractual obligations, we must earn a
sufficient return on our invested assets. Significant changes in interest rates
exposes us to the risk of not earning the anticipated spreads between the
interest rate earned on our investments and the credited interest rates paid on
outstanding policies and contracts. Both rising and declining interest rates can
negatively affect interest earnings, spread income and the attractiveness of
certain of our products.
During periods of increasing interest rates, we may offer higher crediting rates
on interest-sensitive products, such as IUL insurance and fixed annuities, and
we may increase crediting rates on in-force products to keep these products
competitive. A rise in interest rates, in the absence of other countervailing
changes, will result in a decline in the market value of our investment
portfolio.
As part of our asset liability management ("ALM") program, we have made a
significant effort to identify the assets appropriate to different product lines
and ensure investing strategies match the profile of these liabilities. Our ALM
strategy is designed to align the expected cash flows from the investment
portfolio with the expected liability cash flows. As such, a major component of
our effort to manage interest rate risk has been to structure the investment
portfolio with cash flow characteristics that are consistent with the cash flow
characteristics of the insurance liabilities. We use actuarial models to
simulate the cash flows expected from the existing business under various
interest rate scenarios. These simulations enable us to measure the potential
gain or loss in the fair value
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of interest rate-sensitive financial instruments, to evaluate the adequacy of expected cash flows from assets to meet the expected cash requirements of the liabilities and to determine if it is necessary to lengthen or shorten the average life and duration of our investment portfolio. Duration measures the price sensitivity of a security to a small change in interest rates. When the durations of assets and liabilities are similar, exposure to interest rate risk is minimized because a change in the value of assets could be expected to be largely offset by a change in the value of liabilities. The duration of the investment portfolio, excluding cash and cash equivalents, derivatives, policy loans, and common stocks as ofDecember 31, 2019 , is summarized as follows: (Dollars in millions) Duration Amortized Cost % of Total 0-4$ 11,195 43 % 5-9 6,406 24 % 10-14 5,854 22 % 15-19 2,959 11 % 20-25 36 - % Total$ 26,450 100 % Credit Risk and Counterparty Risk We are exposed to the risk that a counterparty will default on its contractual obligation resulting in financial loss. The major source of credit risk arises predominantly in our insurance operations' portfolios of debt and similar securities. The fair value of our fixed maturity portfolio totaled$24 billion and$21 billion atDecember 31, 2019 andDecember 31, 2018 , respectively. Our credit risk materializes primarily as impairment losses. We are exposed to occasional cyclical economic downturns, during which impairment losses may be significantly higher than the long-term historical average. This is offset by years where we expect the actual impairment losses to be substantially lower than the long-term average. Credit risk in the portfolio can also materialize as increased capital requirements as assets migrate into lower credit qualities over time. The effect of rating migration on our capital requirements is also dependent on the economic cycle and increased asset impairment levels may go hand in hand with increased asset related capital requirements. We attempt to manage the risk of default and rating migration by applying disciplined credit evaluation and underwriting standards and limiting allocations to lower quality, higher risk investments. In addition, we diversify our exposure by issuer and country, using rating based issuer and country limits. We also set investment constraints that limit our exposure by industry segment. To limit the impact that credit risk can have on earnings and capital adequacy levels, we have portfolio-level credit risk constraints in place. Limit compliance is monitored on a monthly or, in some cases, daily basis. In connection with the use of call options, we are exposed to counterparty credit risk-the risk that a counterparty fails to perform under the terms of the derivative contract. We have adopted a policy of only dealing with credit worthy counterparties and obtaining sufficient collateral where appropriate, as a means of attempting to mitigate the financial loss from defaults. The exposure and credit rating of the counterparties are continuously monitored and the aggregate value of transactions concluded is spread amongst different approved counterparties to limit the concentration in one counterparty. Our policy allows for the purchase of derivative instruments from counterparties and/or clearinghouses that meet the required qualifications under the Iowa Code. The Company reviews the ratings of all the counterparties periodically. Collateral support documents are negotiated to further reduce the exposure when deemed necessary. See "Note 5. Derivative Financial Instruments" to our audited consolidated financial statements for additional information regarding our exposure to credit loss. 94
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We also have credit risk related to the ability of reinsurance counterparties to honor their obligations to pay the contract amounts under various agreements. To minimize the risk of credit loss on such contracts, we diversify our exposures among many reinsurers and limit the amount of exposure to each based on credit rating. We also generally limit our selection of counterparties with which we do new transactions to those with an "A-" credit rating or above and/or that are appropriately collateralized and provide credit for reinsurance. When exceptions are made to that principle, we ensure that we obtain collateral to mitigate our risk of loss. The following table presents our reinsurance recoverable balances and financial strength ratings for our five largest reinsurance recoverable balances as ofDecember 31, 2019 : (Dollars in millions) Financial
Strength Rating
Reinsurance
Parent Company/Principal Reinsurers Recoverable AM Best S&P
Fitch Moody's
Wilton Re 1,496 A+ Not Rated A+ Not Rated
Kubera Insurance (SAC) Ltd 842 Not Rated Not Rated Not Rated Not Rated
Security Life of Denver 156 Not Rated A+ A A3
Hannover Re 131 A+ AA- Not Rated Not Rated
London Life 107 A+ Not Rated Not Rated Not Rated
In the normal course of business, certain reinsurance recoverables are subject
to reviews by the reinsurers. We are not aware of any material disputes arising
from these reviews or other communications with the counterparties as of
December 31, 2019 that would require an allowance for uncollectible amounts.
Through FSRC and F&G Re, the Company is exposed to insurance counterparty risk,
which is the potential for FSRC and F&G Re to incur losses due to a client or
partner becoming distressed or insolvent. This includes run-on-the-bank risk and
collection risk. The run-on-the-bank risk is that a client's in force block
incurs substantial surrenders and/or lapses due to credit impairment, reputation
damage or other market changes affecting the counterparty. Substantially higher
than expected surrenders and/or lapses could result in inadequate in force
business to recover cash paid out for acquisition costs. The collection risk for
clients includes their inability to satisfy a reinsurance agreement because the
right of offset is disallowed by the receivership court; the reinsurance
contract is rejected by the receiver, resulting in a premature termination of
the contract; and/or the security supporting the transaction becomes unavailable
to FSRC and F&G Re.
FSRC and F&G Re are exposed to the risk that a counterparty will default on its
contractual obligation resulting in financial loss. The major source of credit
risk arises predominantly in FSRC and F&G Re's funds withheld receivables
portfolio that consists primarily of debt and equity securities. FSRC and F&G
Re's credit risk materializes primarily as impairment losses. FSRC and F&G Re
are exposed to occasional cyclical economic downturns, during which impairment
losses may be significantly higher than the long-term historical average. This
is offset by years where FSRC and F&G Re expect the actual impairment losses to
be substantially lower than the long-term average. Credit risk in the portfolio
can also materialize as increased capital requirements as assets migrate into
lower credit qualities over time. The effect of rating migration on FSRC and F&G
Re's capital requirements is also dependent on the economic cycle and increased
asset impairment levels may go hand in hand with increased asset related capital
requirements.
FSRC and F&G Re assume reinsurance business from counterparties that seek to
manage the risk of default and rating migration by applying credit evaluation
and underwriting standards and limiting allocations to lower quality, higher
risk investments. In addition, FSRC and F&G Re's reinsurance counterparties
diversify their exposure by issuer and country, using rating based issuer and
country limits and set investment constraints that limit its exposure by
industry segment. To limit the impact that credit risk can have on earnings and
capital adequacy levels, FSRC and F&G Re have portfolio-level credit risk
constraints in place. Limit compliance is monitored on a daily or, in some
cases, monthly basis.
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Equity Price Risk We are primarily exposed to equity price risk through certain insurance products, specifically those products with GMWB. We offer a variety of FIA contracts with crediting strategies linked to the performance of indices such as the S&P 500 Index, Dow Jones Industrials or the NASDAQ 100 Index. The estimated cost of providing GMWB incorporates various assumptions about the overall performance of equity markets over certain time periods. Periods of significant and sustained downturns in equity markets, increased equity volatility or reduced interest rates could result in an increase in the valuation of the future policy benefit or policyholder account balance liabilities associated with such products, resulting in a reduction in our net income (loss). The rate of amortization of intangibles related to FIA products and the cost of providing GMWB could also increase if equity market performance is worse than assumed. To economically hedge the equity returns on these products, we purchase derivatives to hedge the FIA equity exposure. The primary way we hedge FIA equity exposure is to purchase over the counter equity index call options from broker-dealer derivative counterparties approved by the Company. The second way to hedge FIA equity exposure is by purchasing exchange traded equity index futures contracts. Our hedging strategy enables us to reduce our overall hedging costs and achieve a high correlation of returns on the call options purchased relative to the index credits earned by the FIA contractholders. The majority of the call options are one-year options purchased to match the funding requirements underlying the FIA contracts. These hedge programs are limited to the current policy term of the FIA contracts, based on current participation rates. Future returns, which may be reflected in FIA contracts' credited rates beyond the current policy term, are not hedged. We attempt to manage the costs of these purchases through the terms of our FIA contracts, which permit us to change caps or participation rates, subject to certain guaranteed minimums that must be maintained. The derivatives are used to fund the FIA contract index credits and the cost of the call options purchased is treated as a component of spread earnings. While the FIA hedging program does not explicitly hedge GAAP income volatility, the FIA hedging program tends to mitigate a significant portion of the GAAP reserve changes associated with movements in the equity market and risk-free rates. This is due to the fact that a key component in the calculation of GAAP reserves is the market valuation of the current term embedded derivative. Due to the alignment of the embedded derivative reserve component with hedging of this same embedded derivative, there should be a reasonable match between changes in this component of the reserve and changes in the assets backing this component of the reserve. However, there may be an interim mismatch due to the fact that the hedges which are put in place are only intended to cover exposures expected to remain until the end of an indexing term. To the extent index credits earned by the contractholder exceed the proceeds from option expirations and futures income, we incur a raw hedging loss. See "Note 5. Derivative Financial Instruments" to our audited consolidated financial statements for additional details on the derivatives portfolio. Fair value changes associated with these investments are intended to, but do not always, substantially offset the increase or decrease in the amounts added to policyholder account balances for index products. When index credits to policyholders exceed option proceeds received at expiration related to such credits, any shortfall is funded by our net investment spread earnings and futures income. For the years endedDecember 31, 2019 andDecember 31, 2018 , the annual index credits to policyholders on their anniversaries were$196 and$379 , respectively. Proceeds received at expiration on options related to such credits were$214 and$384 , respectively. Other market exposures are hedged periodically depending on market conditions and our risk tolerance. The FIA hedging strategy economically hedges the equity returns and exposes us to the risk that unhedged market exposures result in divergence between changes in the fair value of the liabilities and the hedging assets. We use a variety of techniques including direct estimation of market sensitivities and value-at-risk to monitor this risk daily. We intend to continue to adjust the hedging strategy as market conditions and risk tolerance change. Sensitivity Analysis The analysis below is hypothetical and should not be considered a projection of future risks. Earnings projections are before tax and non-controlling interest. Interest Rate Risk We assess interest rate exposures for financial assets, liabilities and derivatives using hypothetical test scenarios that assume either increasing or decreasing 100 basis point parallel shifts in the yield curve, reflecting changes in either credit spreads or risk-free rates. 96
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If interest rates were to increase 100 basis points from levels atDecember 31, 2019 , the estimated fair value of our fixed maturity securities would decrease by approximately$1,697 . The impact on shareholders' equity of such decrease, net of income taxes (assumes a 21% tax rate) and intangibles adjustments, and the change in reinsurance related derivative would be a decrease of$1,093 in AOCI and in total shareholders' equity. If interest rates were to decrease by 100 basis points from levels atDecember 31, 2019 , the estimated impact on the FIA embedded derivative liability of such a decrease would be an increase of$284 . The actuarial models used to estimate the impact of a one percentage point change in market interest rates incorporate numerous assumptions, require significant estimates and assume an immediate and parallel change in interest rates without any management of the investment portfolio in reaction to such change. Consequently, potential changes in value of financial instruments indicated by these simulations will likely be different from the actual changes experienced under given interest rate scenarios, and the differences may be material. Because we actively manage our investments and liabilities, the net exposure to interest rates can vary over time. However, any such decreases in the fair value of fixed maturity securities, unless related to credit concerns of the issuer requiring recognition of an OTTI, would generally be realized only if we were required to sell such securities at losses prior to their maturity to meet liquidity needs. Our liquidity needs are managed using the surrender and withdrawal provisions of the annuity contracts and through other means. Equity Price Risk Assuming all other factors are constant, we estimate that a decline in equity market prices of 10% would cause the market value of our equity investments to decrease by approximately$107 , our call option investments to decrease by approximately$20 based on equity positions and our FIA embedded derivative liability to decrease by approximately$49 as ofDecember 31, 2019 . Due to the adoption of ASU 2016-01, the 10% decline in market value of our equity securities would affect current earnings. These scenarios consider only the direct effect on fair value of declines in equity market levels and not changes in asset-based fees recognized as revenue, or changes in our estimates of total gross profits used as a basis for amortizing intangibles. Item 8. Financial Statements and Supplementary Data The Reports of the Independent Registered Public Accounting Firm, the Company's consolidated financial statements and notes to the Company's consolidated financial statements appear in a separate section of this Form 10-K (beginning on Page F-2 following Part IV). The index to the Company's consolidated financial statements appears on Page F-1.
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