UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

 

FORM 8-K

 

 

CURRENT REPORT

PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

Date of report (Date of earliest event reported): November 14, 2014 

 

 

MetLife Insurance Company USA

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

Delaware		33-03094		06-0566090
(State of Incorporation or Other Jurisdiction)		(Commission File Number)		(IRS Employer Identification No.)

 

11225 North Community House Road Charlotte, North Carolina		28277
(Address of Principal Executive Offices)		(Zip Code)

(980) 949-3626

(Registrant’s Telephone Number, Including Area Code)

MetLife Insurance Company of Connecticut

(Former Name or Former Address, if Changed Since Last Report)

 

 

Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions:

 

¨

Written communications pursuant to Rule 425 under the Securities Act (17 CFR 230.425)

 

¨

Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR 240.14a-12)

 

¨

Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b))

 

¨

Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c))

 

 

 

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Item 1.01

Entry into a Material Definitive Agreement.

The disclosure in Item 2.01 is incorporated by reference herein.

 

Item 2.01

Completion of Acquisition or Disposition of Assets.

On November 14, 2014, as part of MetLife, Inc.’s plan to create one larger U.S.-based and U.S.-regulated life insurance company (the “Mergers”), MetLife Insurance Company of Connecticut (“MICC”), a wholly owned subsidiary of MetLife, Inc.:

 

(i)

redomesticated from the State of Connecticut to the State of Delaware;

 

(ii)

changed its name to MetLife Insurance Company USA (“MetLife USA” or the “Company”); and

 

(iii)

completed its mergers with three other of MetLife, Inc.’s wholly owned subsidiaries (collectively, the “Merger Subsidiaries”):

 

a.

MetLife Investors USA Insurance Company (“MLI-USA”), pursuant to the Agreement and Plan of Merger dated November 14, 2014, between MLI-USA and the Company;

 

b.

MetLife Investors Insurance Company (“MLIIC”), pursuant to the Agreement and Plan of Merger dated November 14, 2014, between MLIIC and the Company; and

 

c.

Exeter Reassurance Company, Ltd. (“Exeter”), pursuant to the Agreement and Plan of Merger dated November 14, 2014, between Exeter and the Company.

Under the Agreements and Plans of Merger, each Merger Subsidiary agreed to merge with and into the Company, subject to certain closing conditions, including the receipt of required regulatory approvals, all of which have been received. Upon the effective time of the Mergers all of the outstanding equity securities of each of the Merger Subsidiaries were cancelled, with no consideration being issued in respect thereof, and the Company, as the surviving corporation, is now successor to all of the rights and assets and all of the liabilities and obligations of the Merger Subsidiaries. The Agreements and Plans of Merger each contain customary representations and warranties as well as covenants by each of the parties.

 

Item 8.01

Other Events.

 

In connection with the completion of the Mergers, the following financial statements and pro forma financial statements are being filed and incorporated herein by reference:

 

(i)

balance sheets of MLIIC as of September 30, 2014 and December 31, 2013, and the related statements of operations and comprehensive income (loss), stockholder’s equity and cash flows for the nine months ended September 30, 2014 and September 30, 2013, together with the notes related thereto;

 

(ii)

balance sheets of MLIIC as of December 31, 2013 and 2012, and the related statements of operations, comprehensive income (loss), stockholder’s equity and cash flows for each of the three years in the period ended December 31, 2013, together with the notes related thereto;

 

(iii)

balance sheets of Exeter as of September 30, 2014 and December 31, 2013, and the related statements of operations and comprehensive income (loss), stockholder’s equity and cash flows for the nine months ended September 30, 2014 and September 30, 2013, together with the notes related thereto;

 

(iv)

balance sheets of Exeter as of December 31, 2013 and 2012, and the related statements of operations, comprehensive income (loss), stockholder’s equity and cash flows for each of the three years in the period ended December 31, 2013, together with the notes related thereto (as restated); and

 

(v)

the following unaudited pro forma condensed combined financial statements of MetLife USA, giving effect to the Mergers:

 

a.

unaudited pro forma condensed combined balance sheet of MetLife USA as of September 30, 2014;

 

b.

unaudited pro forma condensed combined statements of operations of MetLife USA for the nine months ended September 30, 2014 and for each of the years ended December 31, 2013, 2012 and 2011; and

 

c.

notes to unaudited pro forma condensed combined financial statements of MetLife USA.

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Item 9.01

Financial Statements and Exhibits.

 

(d)

Exhibits

 

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.

 

Date: November 20, 2014

 

- 4 -

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EXHIBIT INDEX

 

EXHIBIT NUMBER		EXHIBIT
23.1		Consent of Deloitte & Touche LLP
99.1		Balance sheets of MLIIC as of September 30, 2014 and December 31, 2013, and the related statements of operations and comprehensive income (loss), stockholder’s equity and cash flows for the nine months ended September 30, 2014 and September 30, 2013, together with the notes related thereto.
99.2		Balance sheets of MLIIC as of December 31, 2013 and 2012, and the related statements of operations, comprehensive income (loss), stockholder’s equity and cash flows for each of the three years in the period ended December 31, 2013, together with the notes related thereto.
99.3		Balance sheets of Exeter as of September 30, 2014 and December 31, 2013, and the related statements of operations and comprehensive income (loss), stockholder’s equity and cash flows for the nine months ended September 30, 2014 and September 30, 2013, together with the notes related thereto.
99.4		Balance sheets of Exeter as of December 31, 2013 and 2012, and the related statements of operations, comprehensive income (loss), stockholder’s equity and cash flows for each of the three years in the period ended December 31, 2013, together with the notes related thereto (as restated).
99.5		Unaudited pro forma condensed combined balance sheet of MetLife USA as of September 30, 2014 and unaudited pro forma condensed combined statements of operations of MetLife USA for the nine months ended September 30, 2014 and for each of the three years ended December 31, 2013, together with notes to unaudited pro forma condensed combined financial statements of MetLife USA.

 

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Exhibit 23.1

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We consent to the incorporation by reference in Registration Statement Nos. 333-178884, 333-178885, 333-178886, 333-178888, 333-178889, and 333-185333 on Form S-3 of our report dated March 31, 2014, relating to the financial statements of MetLife Investors Insurance Company (“MLI”) (which report expresses an unmodified opinion and includes an other matter paragraph related to MLI being a member of a controlled group), and our report dated April 2, 2014 (October 27, 2014 as to Note 1 related to the restatements and November 7, 2014 as to Note 14), relating to the financial statements of Exeter Reassurance Company, Ltd. (“Exeter”) (which report expresses an unmodified opinion and includes an emphasis of matter paragraph related to restatements of the statements of cash flows, and an other matters paragraph related to a change in Exeter’s presentation of insurance liabilities and to Exeter being a member of a controlled group), both appearing in the Current Report on Form 8-K of MetLife Insurance Company USA.

/s/ DELOITTE & TOUCHE LLP

Tampa, Florida

November 20, 2014

Exhibit 99.1

MetLife Investors Insurance Company

Financial Statements

As of September 30, 2014 and December 31, 2013 and for the Nine Months Ended September 30, 2014 and 2013

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Interim Condensed Balance Sheets

September 30, 2014 (Unaudited) and December 31, 2013

(In millions, except share and per share data)

 

		September 30, 2014				December 31, 2013
Assets
Investments:
Fixed maturity securities available-for-sale, at estimated fair value (amortized cost: $2,459 and $2,200, respectively)		$	2,542			$	2,250
Equity securities available-for-sale, at estimated fair value (cost: $46 and $46, respectively)			45				45
Mortgage loans (net of valuation allowances of $1 and $1, respectively)			260				286
Policy loans			27				27
Other limited partnership interests			38				32
Short-term investments, at estimated fair value			70				75
Other invested assets			4				68
Total investments			2,986				2,783
Cash and cash equivalents			28				24
Accrued investment income			21				26
Premiums, reinsurance and other receivables			1,983				1,829
Deferred policy acquisition costs and value of business acquired			190				291
Current income tax recoverable			—				9
Other assets			101				110
Separate account assets			11,435				12,033
Total assets		$	16,744			$	17,105
Liabilities and Stockholder’s Equity
Liabilities
Future policy benefits		$	546			$	501
Policyholder account balances			2,696				2,748
Other policy-related balances			96				102
Payables for collateral under securities loaned and other transactions			299				266
Current income tax payable			1				—
Deferred income tax liability			234				192
Other liabilities			85				94
Separate account liabilities			11,435				12,033
Total liabilities			15,392				15,936
Contingencies, Commitments and Guarantees (Note 8)
Stockholder’s Equity
Common stock, par value $2 per share; 5,000,000 shares authorized; 2,899,446 shares issued and outstanding			6				6
Additional paid-in capital			637				636
Retained earnings			666				504
Accumulated other comprehensive income (loss)			43				23
Total stockholder’s equity			1,352				1,169
Total liabilities and stockholder’s equity		$	16,744			$	17,105

See accompanying notes to the interim condensed financial statements.

 

1

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Interim Condensed Statements of Operations and Comprehensive Income (Loss)

For the Nine Months Ended September 30, 2014 and 2013 (Unaudited)

(In millions)

 

		Nine Months Ended September 30,
		2014				2013
Revenues
Premiums		$	15			$	23
Universal life and investment-type product policy fees			157				155
Net investment income			81				84
Fees on ceded reinsurance and other			58				67
Net investment gains (losses)			4				1
Net derivative gains (losses)			175				(325	)
Total revenues			490				5
Expenses
Policyholder benefits and claims			55				36
Interest credited to policyholder account balances			78				86
Other expenses			128				(4	)
Total expenses			261				118
Income (loss) before provision for income tax			229				(113	)
Provision for income tax expense (benefit)			67				(47	)
Net income (loss)		$	162			$	(66	)
Comprehensive income (loss)		$	182			$	(113	)

See accompanying notes to the interim condensed financial statements.

 

2

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Interim Condensed Statements of Stockholder’s Equity

For the Nine Months Ended September 30, 2014 and 2013 (Unaudited)

(In millions)

 

														Accumulated Other Comprehensive Income (Loss)
		Common Stock				Additional Paid-in Capital				Retained Earnings				Net Unrealized Investment Gains (Losses)				Other-Than- Temporary Impairments				Total Stockholder’s Equity
Balance at December 31, 2013		$	6			$	636			$	504			$	25			$	(2	)		$	1,169
Capital contribution							1																1
Net income (loss)											162												162
Other comprehensive income (loss), net of income tax															20				—				20
Balance at September 30, 2014		$	6			$	637			$	666			$	45			$	(2	)		$	1,352

 

														Accumulated Other Comprehensive Income (Loss)
		Common Stock				Additional Paid-in Capital				Retained Earnings				Net Unrealized Investment Gains (Losses)				Other-Than- Temporary Impairments				Total Stockholder’s Equity
Balance at December 31, 2012		$	6			$	636			$	722			$	79			$	(3	)		$	1,440
Net income (loss)											(66	)											(66	)
Other comprehensive income (loss), net of income tax															(47	)			—				(47	)
Balance at September 30, 2013		$	6			$	636			$	656			$	32			$	(3	)		$	1,327

See accompanying notes to the interim condensed financial statements.

 

3

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Interim Condensed Statements of Cash Flows

For the Nine Months Ended September 30, 2014 and 2013 (Unaudited)

(In millions)

 

		Nine Months Ended September 30,
		2014				2013
Net cash provided by (used in) operating activities		$	320			$	211
Cash flows from investing activities
Sales, maturities and repayments of:
Fixed maturity securities			420				625
Equity securities			—				2
Mortgage loans			37				27
Purchases of:
Fixed maturity securities			(677	)			(736	)
Mortgage loans			(9	)			(31	)
Other limited partnership interests			(4	)			(4	)
Cash received in connection with freestanding derivatives			—				1
Cash paid in connection with freestanding derivatives			—				(10	)
Sales of loans to affiliates			49				—
Net change in short-term investments			5				(5	)
Net cash provided by (used in) investing activities			(179	)			(131	)
Cash flows from financing activities
Policyholder account balances:
Deposits			923				582
Withdrawals			(1,089	)			(734	)
Net change in payables for collateral under securities loaned and other transactions			33				79
Other, net			(4	)			(2	)
Net cash provided by (used in) financing activities			(137	)			(75	)
Change in cash and cash equivalents			4				5
Cash and cash equivalents, beginning of period			24				27
Cash and cash equivalents, end of period		$	28			$	32
Supplemental disclosures of cash flow information
Net cash paid (received) for:
Income tax		$	26			$	27
Non-cash transations:
Capital contributions from MetLife, Inc.		$	1			$	—

See accompanying notes to the interim condensed financial statements.

 

4

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited)

1. Business, Basis of Presentation and Summary of Significant Accounting Policies

Business

MetLife Investors Insurance Company (“MLIIC”), a Missouri domiciled life insurance company (the “Company”) is a wholly-owned subsidiary of MetLife, Inc. (“MetLife”).

The Company markets, administers and insures a broad range of term life, universal life and variable and fixed annuity products to individuals. The Company is licensed to conduct business in 49 states and the District of Columbia. Most of the policies issued present no significant mortality or longevity risk to the Company, but rather represent investment deposits by the policyholders.

On November 14, 2014, MetLife, Inc. completed the mergers of three wholly-owned U.S.-based life insurance companies and a wholly-owned, former offshore, reinsurance subsidiary to create one larger U.S.-based and U.S.-regulated life insurance company (the “Mergers”). The companies that merged were MetLife Insurance Company of Connecticut, MetLife Investors USA Insurance Company and MLIIC, each a U.S. insurance company that issued variable annuity products in addition to other products, and Exeter Reassurance Company, Ltd., a reinsurance company that mainly reinsured guarantees associated with variable annuity products. As of the date of the Mergers, MetLife Insurance Company of Connecticut, a directly owned subsidiary of MetLife, was renamed to MetLife Insurance Company USA and re-domiciled to Delaware.

In anticipation of the Mergers, in July 2014, MetLife Investors Insurance Company transferred to certain affiliates $45 million in affiliated loans, which are included in other invested assets. See Note 3.

Basis of Presentation

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to adopt accounting policies and make estimates and assumptions that affect amounts reported in the interim condensed financial statements. In applying these policies and estimates, management makes subjective and complex judgments that frequently require assumptions about matters that are inherently uncertain. Many of these policies, estimates and related judgments are common in the insurance and financial services industries; others are specific to the Company’s business and operations. Actual results could differ from estimates.

The Company uses the equity method of accounting for investments in equity securities when it has significant influence or at least 20% interest and for investments in other limited partnership interests (“investees”) when it has more than a minor ownership interest or more than a minor influence over the investee’s operations, but does not have a controlling financial interest. The Company generally recognizes its share of the investee’s earnings on a three-month lag in instances where the investee’s financial information is not sufficiently timely or when the investee’s reporting period differs from the Company’s reporting period. The Company uses the cost method of accounting for investments in which it has virtually no influence over the investee’s operations.

Certain amounts in the prior year period’s interim condensed financial statements and related footnotes thereto have been reclassified to conform with the 2014 presentation as discussed throughout the Notes to the Interim Condensed Financial Statements.

Since the Company is a member of a controlled group of affiliated companies, its results may not be indicative of those of a stand-alone entity.

The accompanying interim condensed financial statements are unaudited and reflect all adjustments (including normal recurring adjustments) necessary to present fairly the financial position, results of operations and cash flows for the interim period presented in conformity with GAAP. Interim results are not necessarily indicative of full year performance. The December 31, 2013 balance sheet data was derived from audited financial statements which include all disclosures required by GAAP. Therefore, these interim condensed financial statements should be read in conjunction with the financial statements of the Company for the year ended December 31, 2013.

 

5

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited) — (Continued)

 

2. Insurance

Guarantees

As discussed in Notes 1 and 2 of the Notes to the Financial Statements for the year ended December 31, 2013, the Company issues variable annuity products with guaranteed minimum benefits. The non-life contingent portion of guaranteed minimum withdrawal benefits (“GMWBs”) and the portion of certain guaranteed minimum income benefits (“GMIBs”) that does not require annuitization are accounted for as embedded derivatives in policyholder account balances (“PAB”) and are further discussed in Note 4.

Variable Annuity Guarantees

In the Event of Death

Defined as the death benefit less the total contract account value, as of the balance sheet date. It represents the amount of the claim that the Company would incur if death claims were filed on all contracts on the balance sheet date and includes any additional contractual claims associated with riders purchased to assist with covering income taxes payable upon death.

At Annuitization

Defined as the amount (if any) that would be required to be added to the total contract account value to purchase a lifetime income stream, based on current annuity rates, equal to the minimum amount provided under the guaranteed benefit. This amount represents the Company’s potential economic exposure to such guarantees in the event all contractholders were to annuitize on the balance sheet date, even though the contracts contain terms that allow annuitization of the guaranteed amount only after the 10th anniversary of the contract, which not all contractholders have achieved.

Information regarding the types of guarantees relating to annuity contracts was as follows at:

 

		September 30, 2014								December 31, 2013
		In the Event of Death				At Annuitization				In the Event of Death				At Annuitization
		(In millions)
Annuity Contracts (1)
Variable Annuity Guarantees
Total contract account value		$	12,702			$	8,333			$	13,348			$	8,712
Separate account value		$	12,210			$	8,100			$	12,841			$	8,470
Net amount at risk		$	371			$	189			$	327			$	116
Average attained age of contractholders			67 years				67 years				67 years				66 years

 

(1)	The Company’s annuity contracts with guarantees may offer more than one type of guarantee in each contract. Therefore, the amounts listed above may not be mutually exclusive.

 

6

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited) — (Continued)

 

3. Investments

Fixed Maturity and Equity Securities Available-for-Sale

Fixed Maturity and Equity Securities Available-for-Sale by Sector

The following table presents the fixed maturity and equity securities available-for-sale (“AFS”) by sector. Redeemable preferred stock is reported within U.S. corporate fixed maturity securities and non-redeemable preferred stock is reported within equity securities. Included within fixed maturity securities are structured securities including residential mortgage-backed securities (“RMBS”), commercial mortgage-backed securities (“CMBS”) and asset-backed securities (“ABS”).

 

		September 30, 2014																				December 31, 2013
		Cost or				Gross Unrealized												Estimated				Cost or				Gross Unrealized												Estimated
		Amortized Cost				Gains				Temporary Losses				OTTI Losses				Fair Value				Amortized Cost				Gains				Temporary Losses				OTTI Losses				Fair Value
																		(In millions)
Fixed maturity securities
U.S. corporate		$	827			$	60			$	4			$	—			$	883			$	825			$	55			$	8			$	—			$	872
U.S Treasury and agency			762				6				6				—				762				469				2				14				—				457
RMBS			301				15				2				5				309				312				12				7				5				312
CMBS			259				6				1				—				264				293				8				4				—				297
Foreign corporate			229				10				3				—				236				223				9				3				—				229
ABS			53				2				—				—				55				51				2				—				—				53
State and political subdivision			17				3				—				—				20				17				2				—				—				19
Foreign government			11				2				—				—				13				10				1				—				—				11
Total fixed maturity securities		$	2,459			$	104			$	16			$	5			$	2,542			$	2,200			$	91			$	36			$	5			$	2,250
Equity securities
Common stock		$	26			$	—			$	—			$	—			$	26			$	26			$	—			$	—			$	—			$	26
Non-redeemable preferred stock			20				—				1				—				19				20				—				1				—				19
Total equity securities		$	46			$	—			$	1			$	—			$	45			$	46			$	—			$	1			$	—			$	45

The Company held non-income producing fixed maturity securities with an estimated fair value of less than $1 million with unrealized gains (losses) of less than $1 million at both September 30, 2014 and December 31, 2013.

Maturities of Fixed Maturity Securities

The amortized cost and estimated fair value of fixed maturity securities, by contractual maturity date, were as follows at:

 

		September 30, 2014								December 31, 2013
		Amortized Cost				Estimated Fair Value				Amortized Cost				Estimated Fair Value
		(In millions)
Due in one year or less		$	372			$	374			$	240			$	242
Due after one year through five years			549				572				487				512
Due after five years through ten years			645				683				566				595
Due after ten years			280				285				251				239
Subtotal			1,846				1,914				1,544				1,588
Structured securities (RMBS, CMBS and ABS)			613				628				656				662
Total fixed maturity securities		$	2,459			$	2,542			$	2,200			$	2,250

Actual maturities may differ from contractual maturities due to the exercise of call or prepayment options. Fixed maturity securities not due at a single maturity date have been presented in the year of final contractual maturity. RMBS, CMBS and ABS are shown separately, as they are not due at a single maturity.

 

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited) — (Continued)

 

3. Investments (continued)

Continuous Gross Unrealized Losses for Fixed Maturity and Equity Securities AFS by Sector

The following table presents the estimated fair value and gross unrealized losses of fixed maturity and equity securities AFS in an unrealized loss position, aggregated by sector and by length of time that the securities have been in a continuous unrealized loss position.

 

		September 30, 2014																December 31, 2013
		Less than 12 Months								Equal to or Greater than 12 Months								Less than 12 Months								Equal to or Greater than 12 Months
		Estimated Fair Value				Gross Unrealized Losses				Estimated Fair Value				Gross Unrealized Losses				Estimated Fair Value				Gross Unrealized Losses				Estimated Fair Value				Gross Unrealized Losses
		(In millions, except number of securities)
Fixed maturity securities
U.S. corporate		$	57			$	2			$	40			$	2			$	84			$	7			$	13			$	1
U.S. Treasury and agency			113				1				108				5				169				14				—				—
RMBS			26				—				92				7				84				4				34				8
CMBS			5				—				30				1				73				4				—				—
Foreign corporate			39				2				8				1				27				2				7				1
ABS			15				—				5				—				7				—				5				—
Foreign government			2				—				1				—				1				—				1				—
Total fixed maturity securities		$	257			$	5			$	284			$	16			$	445			$	31			$	60			$	10
Equity securities
Non-redeemable preferred stock		$	—			$	—			$	19			$	1			$	—			$	—			$	18			$	1
Total equity securities		$	—			$	—			$	19			$	1			$	—			$	—			$	18			$	1
Total number of securities in an unrealized loss position			60								33								87								18

Evaluation of AFS Securities for OTTI and Evaluating Temporarily Impaired AFS Securities

As described more fully in Notes 1 and 5 of the Notes to the Financial Statements for the year ended December 31, 2013, the Company performs a regular evaluation of all investment classes for impairment, including fixed maturity securities, equity securities and perpetual hybrid securities, in accordance with its impairment policy, in order to evaluate whether such investments are other-than-temporarily impaired.

Current Period Evaluation

Based on the Company’s current evaluation of its AFS securities in an unrealized loss position in accordance with its impairment policy, and the Company’s current intentions and assessments (as applicable to the type of security) about holding, selling and any requirements to sell these securities, the Company has concluded that these securities are not other-than-temporarily impaired at September 30, 2014. Future other-than-temporary impairment (“OTTI”) will depend primarily on economic fundamentals, issuer performance (including changes in the present value of future cash flows expected to be collected), and changes in credit ratings, collateral valuation, interest rates and credit spreads. If economic fundamentals deteriorate or if there are adverse changes in the above factors, OTTI may be incurred in upcoming periods.

Gross unrealized losses on fixed maturity securities decreased $20 million during the nine months ended September 30, 2014 from $41 million to $21 million. The decrease in gross unrealized losses for the nine months ended September 30, 2014, was primarily attributable to a decrease in interest rates, and to a lesser extent narrowing credit spreads.

At September 30, 2014, $5 million of the total $21 million of gross unrealized losses were from one below investment grade fixed maturity security with an unrealized loss position of 20% or more of amortized cost for six months or greater. Unrealized losses on the below investment grade fixed maturity security are related to non-agency RMBS (alternative residential mortgage loan) and are the result of significantly wider credit spreads resulting from higher risk premiums since purchase, largely due to economic and market uncertainties including concerns over valuations of residential real estate supporting non-agency RMBS. Management evaluates non-agency RMBS based on actual and projected cash flows after considering the quality of underlying collateral, expected prepayment speeds, current and forecasted loss severity, consideration of the payment terms of the underlying assets backing a particular security, and the payment priority within the tranche structure of the security.

 

8

---

MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited) — (Continued)

 

3. Investments (continued)

Equity Securities

Gross unrealized losses on equity securities were $1 million at both September 30, 2014 and December 31, 2013. None of the $1 million of gross unrealized losses were from equity securities with gross unrealized losses of 20% or more of cost for 12 months or greater.

Mortgage Loans

Mortgage Loans by Portfolio Segment

Mortgage loans are summarized as follows at:

 

		September 30, 2014								December 31, 2013
		Carrying Value				% of Total				Carrying Value				% of Total
		(In millions)								(In millions)
Mortgage loans:
Commercial		$	222				85.4	%		$	246				86.0	%
Agricultural			39				15.0				41				14.3
Subtotal			261				100.4				287				100.3
Valuation allowances			(1	)			(0.4	)			(1	)			(0.3	)
Total mortgage loans, net		$	260				100.0	%		$	286				100.0	%

Mortgage Loans and Valuation Allowance by Portfolio Segment

All commercial and agricultural mortgage loans held at both September 30, 2014 and December 31, 2013 were evaluated collectively for credit losses. The valuation allowances maintained at both September 30, 2014 and December 31, 2013 were primarily for the commercial mortgage loan portfolio segment and were for non-specifically identified credit losses. The valuation allowance for agricultural mortgage loans was less than $1 million at both September 30, 2014 and December 31, 2013.

Valuation Allowance Rollforward by Portfolio Segment

The changes in the valuation allowance, by portfolio segment, were as follows:

 

		Nine Months Ended September 30,
		2014												2013
		Commercial				Agricultural				Total				Commercial				Agricultural				Total
		(In millions)
Balance, beginning of period		$	1			$	—			$	1			$	2			$	—			$	2
Provision (release)			—				—				—				(1	)			—				(1	)
Balance, end of period		$	1			$	—			$	1			$	1			$	—			$	1

 

9

---

MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited) — (Continued)

 

3. Investments (continued)

Credit Quality of Commercial Mortgage Loans

The credit quality of commercial mortgage loans, were as follows at:

 

		Recorded Investment
		Debt Service Coverage Ratios																% of Total								% of Total
		> 1.20x				1.00x -1.20x				< 1.00x				Total								Estimated Fair Value
						(In millions)																(In millions)
September 30, 2014
Loan-to-value ratios:
Less than 65%		$	189			$	7			$	16			$	212				95.5	%		$	228				95.8	%
65% to 75%			—				10				—				10				4.5				10				4.2
Total		$	189			$	17			$	16			$	222				100.0	%		$	238				100.0	%
December 31, 2013
Loan-to-value ratios:
Less than 65%		$	193			$	9			$	15			$	217				88.2	%		$	228				88.4	%
65% to 75%			19				—				10				29				11.8				30				11.6
Total		$	212			$	9			$	25			$	246				100.0	%		$	258				100.0	%

Credit Quality of Agricultural Mortgage Loans

All of the agricultural mortgage loans held at both September 30, 2014 and December 31, 2013 had loan-to-value ratios of less than 65%.

Past Due and Interest Accrual Status of Mortgage Loans

The Company has a high quality, well performing mortgage loan portfolio, with 99% of all mortgage loans classified as performing at both September 30, 2014 and December 31, 2013. The Company defines delinquency consistent with industry practice, when mortgage loans are past due as follows: commercial mortgage loans — 60 days and agricultural mortgage loans — 90 days. The Company had no impaired mortgage loans, no mortgage loans past due and no mortgage loans in non-accrual status at both September 30, 2014 and December 31, 2013. The Company did not recognize interest income on impaired mortgage loans during the nine months ended September 30, 2014 and 2013.

Mortgage Loans Modified in a Troubled Debt Restructuring

There were no mortgage loans modified in a troubled debt restructuring during the nine months ended September 30, 2014 and 2013.

During the nine months ended September 30, 2014 and 2013, the Company held no mortgage loans that were modified in a troubled debt restructuring during the 12 months before September 30, 2014 and 2013, and became subject to a payment default after the restructuring. Payment default is determined in the same manner as delinquency status as described above.

Cash Equivalents

The carrying value of cash equivalents, which includes securities and other investments with an original or remaining maturity of three months or less at the time of purchase, was $5 million and $17 million at September 30, 2014 and December 31, 2013, respectively.

 

10

---

MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited) — (Continued)

 

3. Investments (continued)

Net Unrealized Investment Gains (Losses)

The components of net unrealized investment gains (losses), included in accumulated other comprehensive income (loss) (“AOCI”), were as follows:

 

The changes in fixed maturity securities with noncredit OTTI losses included in AOCI were as follows:

 

The changes in net unrealized investment gains (losses) were as follows:

 

 

 

11

---

MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited) — (Continued)

 

3. Investments (continued)

Concentrations of Credit Risk

There were no investments in any counterparty that were greater than 10% of the Company’s stockholder’s equity, other than the U.S. government and its agencies, at both September 30, 2014 and December 31, 2013.

Securities Lending

Elements of the securities lending program are presented below at:

 

		September 30, 2014				December 31, 2013
		(In millions)
Securities on loan: (1)
Amortized cost		$	289			$	249
Estimated fair value		$	292			$	241
Cash collateral on deposit from counterparties (2)		$	299			$	249
Reinvestment portfolio — estimated fair value		$	298			$	247

 

(1)	Included within fixed maturity securities and short-term investments.

(2)	Included within payables for collateral under securities loaned and other transactions.

Invested Assets on Deposit and Pledged as Collateral

Invested assets on deposit and pledged as collateral are presented below at estimated fair value for fixed maturity securities at:

 

		September 30, 2014				December 31, 2013
		(In millions)
Invested assets on deposit (regulatory deposits)		$	7			$	7
Invested assets pledged as collateral (1)			473				505
Total invested assets on deposit and pledged as collateral		$	480			$	512

 

(1)	The Company has pledged invested assets in connection with various agreements and transactions, including funding agreements (see Note 2 of the Notes to the Financial Statements included in the 2013 Financial Statements) and derivative transactions (see Note 4).

See “— Securities Lending” for securities on loan.

 

12

---

MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited) — (Continued)

 

3. Investments (continued)

Variable Interest Entities

The Company has invested in certain structured transactions that are variable interest entities (“VIEs”). In certain instances, the Company may hold both the power to direct the most significant activities of the entity, as well as an economic interest in the entity and, as such, it would be deemed to be the primary beneficiary or consolidator of the entity.

The determination of the VIE’s primary beneficiary requires an evaluation of the contractual and implied rights and obligations associated with each party’s relationship with or involvement in the entity, an estimate of the entity’s expected losses and expected residual returns and the allocation of such estimates to each party involved in the entity. The Company generally uses a qualitative approach to determine whether it is the primary beneficiary. However, for VIEs that are investment companies or apply measurement principles consistent with those utilized by investment companies, the primary beneficiary is based on a risks and rewards model and is defined as the entity that will absorb a majority of a VIE’s expected losses, receive a majority of a VIE’s expected residual returns if no single entity absorbs a majority of expected losses, or both. The Company reassesses its involvement with VIEs on a quarterly basis. The use of different methodologies, assumptions and inputs in the determination of the primary beneficiary could have a material effect on the amounts presented within the financial statements.

Consolidated VIEs

There were no VIEs for which the Company has concluded that it is the primary beneficiary and which are consolidated at September 30, 2014 and December 31, 2013.

Unconsolidated VIEs

The carrying amount and maximum exposure to loss relating to VIEs in which the Company holds a significant variable interest but is not the primary beneficiary and which have not been consolidated were as follows at:

 

		September 30, 2014								December 31, 2013
		Carrying Amount				Maximum Exposure to Loss (1)				Carrying Amount				Maximum Exposure to Loss (1)
		(In millions)
Fixed maturity securities AFS:
Structured securities (RMBS, CMBS and ABS) (2)		$	628			$	628			$	662			$	662
U.S and foreign corporate			22				22				21				21
Other limited partnership interests			22				22				19				20
Equity securities AFS:
Non-redeemable preferred stock			19				19				18				18
Total		$	691			$	691			$	720			$	721

 

(1)

The maximum exposure to loss relating to fixed maturity and equity securities AFS is equal to their carrying amounts or the carrying amounts of retained interests. The maximum exposure to loss relating to other limited partnership interests is equal to the carrying amounts plus any unfunded commitments of the Company. Such a maximum loss would be expected to occur only upon bankruptcy of the issuer or investee.

(2)	For these variable interests, the Company’s involvement is limited to that of a passive investor.

As described in Note 8, the Company makes commitments to fund partnership investments in the normal course of business. Excluding these commitments, the Company did not provide financial or other support to investees designated as VIEs during the nine months ended September 30, 2014 and during the year ended December 31, 2013.

 

13

---

MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited) — (Continued)

 

3. Investments (continued)

Net Investment Income

The components of net investment income were as follows:

 

See “— Related Party Investment Transactions” for discussion of affiliated net investment income and investment expenses.

Net Investment Gains (Losses)

Components of Net Investment Gains (Losses)

The components of net investment gains (losses) were as follows:

 

See “— Related Party Investment Transactions” for discussion of affiliated net investment gains.

Sales or Disposals and Impairments of Fixed Maturity and Equity Securities

Proceeds from sales or disposals of fixed maturity and equity securities and the components of fixed maturity and equity securities net investment gains (losses) are as shown in the table below. Investment gains and losses on sales of securities are determined on a specific identification basis.

 

		Nine Months Ended September 30,
		2014				2013				2014				2013				2014				2013
		Fixed Maturity Securities								Equity Securities								Total
										(In millions)
Proceeds		$	154			$	315			$	—			$	—			$	154			$	315
Gross investment gains		$	2			$	1			$	—			$	—			$	2			$	1
Gross investment losses			(2	)			(1	)			—				—				(2	)			(1	)
Net investment gains (losses)		$	—			$	—			$	—			$	—			$	—			$	—

There were no OTTI losses on fixed maturity securities or equity securities during the nine months ended September 30, 2014 and 2013.

 

14

---

MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited) — (Continued)

 

3. Investments (continued)

Credit Loss Rollforward

The table below presents a rollforward of the cumulative credit loss component of OTTI loss recognized in earnings on fixed maturity securities still held for which a portion of the OTTI loss was recognized in other comprehensive income (loss) (“OCI”):

 

		Nine Months Ended September 30,
		2014				2013
		(In millions)
Balance, beginning of period		$	2			$	2
Reductions:
Sales (maturities, pay downs or prepayments) during the period of securities previously impaired as credit loss OTTI			(1	)			—
Balance, end of period		$	1			$	2

Related Party Investment Transactions

The Company has an affiliated loan outstanding to MetLife, Inc., which are included in other invested assets, totaling $45 million at December 31, 2013. In anticipation of the Mergers, in July 2014 MetLife Investors Insurance Company sold these affiliated loans to certain affiliates at estimated fair value of $49 million and recognized a gain of $4 million which is included in net investment gains (losses). Net investment income from this loan was $1 million and $2 million for the nine months ended September 30, 2014 and 2013, respectively. See Note 1.

The Company receives investment administrative services from an affiliate. The related investment administrative service charges were $2 million and $3 million for the nine months ended September 30, 2014 and 2013, respectively.

4. Derivatives

Accounting for Derivatives

Freestanding Derivatives

Freestanding derivatives are carried on the Company’s balance sheet either as assets within other invested assets or as liabilities within other liabilities at estimated fair value. The Company does not offset the fair value amounts recognized for derivatives executed with the same counterparty under the same master netting agreement. See “Credit Risk on Freestanding Derivatives”.

Accruals on derivatives are generally recorded in accrued investment income or within other liabilities. However, accruals that are not scheduled to settle within one year are included with the derivatives carrying value in other invested assets or other liabilities.

If a derivative is not designated as an accounting hedge or its use in managing risk does not qualify for hedge accounting, changes in the estimated fair value of the derivative are reported in net derivative gains (losses).

Hedge Accounting

To qualify for hedge accounting, at the inception of the hedging relationship, the Company formally documents its risk management objective and strategy for undertaking the hedging transaction, as well as its designation of the hedge. Hedge designation and financial statement presentation of changes in estimated fair value of the hedging derivatives are as follows:

 

•

Fair value hedge (a hedge of the estimated fair value of a recognized asset or liability) - in net derivative gains (losses), consistent with the change in fair value of the hedged item attributable to the designated risk being hedged.

 

•

Cash flow hedge (a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability) - effectiveness in OCI (deferred gains or losses on the derivative are reclassified into the statement of operations when the Company’s earnings are affected by the variability in cash flows of the hedged item); ineffectiveness in net derivative gains (losses).

 

15

---

MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited) — (Continued)

 

4. Derivatives (continued)

The changes in estimated fair values of the hedging derivatives are exclusive of any accruals that are separately reported on the statement of operations within interest income or interest expense to match the location of the hedged item.

In its hedge documentation, the Company sets forth how the hedging instrument is expected to hedge the designated risks related to the hedged item and sets forth the method that will be used to retrospectively and prospectively assess the hedging instrument’s effectiveness and the method that will be used to measure ineffectiveness. A derivative designated as a hedging instrument must be assessed as being highly effective in offsetting the designated risk of the hedged item. Hedge effectiveness is formally assessed at inception and at least quarterly throughout the life of the designated hedging relationship. Assessments of hedge effectiveness and measurements of ineffectiveness are also subject to interpretation and estimation and different interpretations or estimates may have a material effect on the amount reported in net income.

The Company discontinues hedge accounting prospectively when: (i) it is determined that the derivative is no longer highly effective in offsetting changes in the estimated fair value or cash flows of a hedged item; (ii) the derivative expires, is sold, terminated, or exercised; (iii) it is no longer probable that the hedged forecasted transaction will occur; or (iv) the derivative is de-designated as a hedging instrument.

When hedge accounting is discontinued because it is determined that the derivative is not highly effective in offsetting changes in the estimated fair value or cash flows of a hedged item, the derivative continues to be carried on the balance sheet at its estimated fair value, with changes in estimated fair value recognized in net derivative gains (losses). The carrying value of the hedged recognized asset or liability under a fair value hedge is no longer adjusted for changes in its estimated fair value due to the hedged risk, and the cumulative adjustment to its carrying value is amortized into income over the remaining life of the hedged item. Provided the hedged forecasted transaction is still probable of occurrence, the changes in estimated fair value of derivatives recorded in OCI related to discontinued cash flow hedges are released into the statement of operations when the Company’s earnings are affected by the variability in cash flows of the hedged item.

When hedge accounting is discontinued because it is no longer probable that the forecasted transactions will occur on the anticipated date or within two months of that date, the derivative continues to be carried on the balance sheet at its estimated fair value, with changes in estimated fair value recognized currently in net derivative gains (losses). Deferred gains and losses of a derivative recorded in OCI pursuant to the discontinued cash flow hedge of a forecasted transaction that is no longer probable are recognized immediately in net derivative gains (losses).

In all other situations in which hedge accounting is discontinued, the derivative is carried at its estimated fair value on the balance sheet, with changes in its estimated fair value recognized in the current period as net derivative gains (losses).

Embedded Derivatives

The Company sells variable annuities and issues certain insurance products and investment contracts and is a party to certain reinsurance agreements that have embedded derivatives. The Company assesses each identified embedded derivative to determine whether it is required to be bifurcated. The embedded derivative is bifurcated from the host contract and accounted for as a freestanding derivative if:

 

•

the combined instrument is not accounted for in its entirety at fair value with changes in fair value recorded in earnings;

 

•

the terms of the embedded derivative are not clearly and closely related to the economic characteristics of the host contract; and

 

•

a separate instrument with the same terms as the embedded derivative would qualify as a derivative instrument.

Such embedded derivatives are carried on the balance sheet at estimated fair value with the host contract and changes in their estimated fair value are generally reported in net derivative gains (losses). If the Company is unable to properly identify and measure an embedded derivative for separation from its host contract, the entire contract is carried on the balance sheet at estimated fair value, with changes in estimated fair value recognized in the current period in net investment gains (losses) or net investment income. Additionally, the Company may elect to carry an entire contract on the balance sheet at estimated fair value, with changes in estimated fair value recognized in the current period in net investment gains (losses) or net investment income if that contract contains an embedded derivative that requires bifurcation. At inception, the Company attributes to the embedded derivative a portion of the projected future guarantee fees to be collected from the policyholder equal to the present value of projected future guaranteed benefits. Any additional fees represent “excess” fees and are reported in universal life and investment-type product policy fees.

 

16

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited) — (Continued)

 

4. Derivatives (continued)

See Note 5 for information about the fair value hierarchy for derivatives.

Derivative Strategies

The Company is exposed to various risks relating to its ongoing business operations, including interest rate, foreign currency exchange rate and credit. The Company uses a variety of strategies to manage these risks, including the use of derivatives.

Derivatives are financial instruments whose values are derived from interest rates, foreign currency exchange rates, credit spreads and/or other financial indices. Derivatives may be exchange-traded or contracted in the over-the-counter (“OTC”) market. Certain of the Company’s OTC derivatives are cleared and settled through central clearing counterparties (“OTC-cleared”), while others are bilateral contracts between two counterparties (“OTC-bilateral”). The types of derivatives the Company uses include swaps, and option contracts. To a lesser extent, the Company uses credit default swaps to synthetically replicate investment risks and returns which are not readily available in the cash market.

Interest Rate Derivatives

The Company uses a variety of interest rate derivatives to reduce its exposure to changes in interest rates, including interest rate swaps and floors.

Interest rate swaps are used by the Company primarily to reduce market risks from changes in interest rates and to alter interest rate exposure arising from mismatches between assets and liabilities (duration mismatches). In an interest rate swap, the Company agrees with another party to exchange, at specified intervals, the difference between fixed rate and floating rate interest amounts as calculated by reference to an agreed notional amount. The Company utilizes interest rate swaps in fair value and non-qualifying hedging relationships.

The Company purchases interest rate floors primarily to protect its minimum rate guarantee liabilities against declines in interest rates below a specified level. In certain instances, the Company locks in the economic impact of existing purchased floors by entering into offsetting written floors. The Company utilizes interest rate floors in non-qualifying hedging relationships.

Foreign Currency Exchange Rate Derivatives

The Company uses foreign currency swaps to reduce the risk from fluctuations in foreign currency exchange rates associated with its assets denominated in foreign currencies. In a foreign currency swap transaction, the Company agrees with another party to exchange, at specified intervals, the difference between one currency and another at a fixed exchange rate, generally set at inception, calculated by reference to an agreed upon notional amount. The notional amount of each currency is exchanged at the inception and termination of the currency swap by each party. The Company utilizes foreign currency swaps in cash flow and non-qualifying hedging relationships.

Credit Derivatives

The Company enters into purchased credit default swaps to hedge against credit-related changes in the value of its investments. In a credit default swap transaction, the Company agrees with another party to pay, at specified intervals, a premium to hedge credit risk. If a credit event occurs, as defined by the contract, the contract may be cash settled or it may be settled gross by the delivery of par quantities of the referenced investment equal to the specified swap notional in exchange for the payment of cash amounts by the counterparty equal to the par value of the investment surrendered. Credit events vary by type of issuer but typically include bankruptcy, failure to pay debt obligations, repudiation, moratorium, or involuntary restructuring. In each case, payout on a credit default swap is triggered only after the Credit Derivatives Determinations Committee of the International Swaps and Derivatives Association, Inc. (“ISDA”) deems that a credit event has occurred. The Company utilizes credit default swaps in non-qualifying hedging relationships.

The Company enters into written credit default swaps to synthetically create credit investments that are either more expensive to acquire or otherwise unavailable in the cash markets. These transactions are a combination of a derivative and one or more cash instruments, such as U.S. Treasury securities, agency securities or other fixed maturity securities. These credit default swaps are not designated as hedging instruments.

 

17

---

MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited) — (Continued)

 

4. Derivatives (continued)

Primary Risks Managed by Derivatives

The following table presents the gross notional amount, estimated fair value and primary underlying risk exposure of the Company’s derivatives, excluding embedded derivatives, held at:

 

				September 30, 2014												December 31, 2013
								Estimated Fair Value												Estimated Fair Value
		Primary Underlying Risk Exposure		Notional Amount				Assets				Liabilities				Notional Amount				Assets				Liabilities
				(In millions)
Derivatives Designated as Hedging Instruments
Fair value hedges:
Interest rate swaps		Interest rate		$	10			$	—			$	—			$	10			$	—			$	—
Cash flow hedges:
Foreign currency swaps		Foreign currency exchange rate			41				3				1				30				2				3
Total qualifying hedges					51				3				1				40				2				3
Derivatives Not Designated or Not Qualifying as Hedging Instruments
Interest rate swaps		Interest rate			741				—				13				741				12				22
Interest rate floors		Interest rate			900				1				1				2,040				9				4
Foreign currency swaps		Foreign currency exchange rate			37				—				2				37				—				5
Credit default swaps — purchased		Credit			3				—				—				8				—				—
Credit default swaps — written		Credit			20				—				—				20				—				—
Total non-designated or non-qualifying derivatives					1,701				1				16				2,846				21				31
Total				$	1,752			$	4			$	17			$	2,886			$	23			$	34

Based on notional amounts, a substantial portion of the Company’s derivatives was not designated or did not qualify as part of a hedging relationship at both September 30, 2014 and December 31, 2013. The Company’s use of derivatives includes (i) derivatives that serve as macro hedges of the Company’s exposure to various risks and that generally do not qualify for hedge accounting due to the criteria required under the portfolio hedging rules; (ii) derivatives that economically hedge insurance liabilities that contain mortality or morbidity risk and that generally do not qualify for hedge accounting because the lack of these risks in the derivatives cannot support an expectation of a highly effective hedging relationship; and (iii) written credit default swaps that are used to synthetically create credit investments and that do not qualify for hedge accounting because they do not involve a hedging relationship. For these non-qualified derivatives, changes in market factors can lead to the recognition of fair value changes on the statement of operations without an offsetting gain or loss recognized in earnings for the item being hedged.

Net Derivative Gains (Losses)

The components of net derivative gains (losses) were as follows:

 

		Nine Months Ended September 30,
		2014				2013
		(In millions)
Derivatives and hedging gains (losses)		$	5			$	(24	)
Embedded derivatives			170				(301	)
Total net derivative gains (losses)		$	175			$	(325	)

The amount the Company recognized in net investment income from earned income related to qualifying hedges for both the nine months ended September 30, 2014 and 2013 was not significant.

The Company recognized $16 million and $20 million of net derivative gains (losses) from earned income related to non-qualifying hedges for the nine months ended September 30, 2014 and 2013, respectively.

 

18

---

MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited) — (Continued)

 

4. Derivatives (continued)

Non-Qualifying Derivatives and Derivatives for Purposes Other Than Hedging

The following table presents the amount and location of gains (losses) recognized in income for derivatives that were not designated or qualifying as hedging instruments:

 

		Net Derivative Gains (Losses)
		(In millions)
Nine Months Ended September 30, 2014
Interest rate derivatives		$	(13	)
Foreign currency exchange rate derivatives			3
Total		$	(10	)
Nine Months Ended September 30, 2013
Interest rate derivatives		$	(43	)
Foreign currency exchange rate derivatives			(2	)
Total		$	(45	)

Fair Value Hedges

The Company designates and accounts for interest rate swaps to convert fixed rate assets to floating rate assets as fair value hedges when they have met the requirements of fair value hedging.

The amounts recognized in net derivative gains (losses) representing the ineffective portion of all fair value hedges were not significant for both the nine months ended September 30, 2014 and 2013. Changes in the fair value of the derivatives and the hedged items recognized in net derivative gains (losses) were not significant for both the nine months ended September 30, 2014 and 2013.

All components of each derivative’s gain or loss were included in the assessment of hedge effectiveness.

 

19

---

MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited) — (Continued)

 

4. Derivatives (continued)

Cash Flow Hedges

The Company designates and accounts for foreign currency swaps to hedge the foreign currency cash flow exposure of foreign currency denominated assets as cash flow hedges when they have met the requirements of cash flow hedging.

In certain instances, the Company discontinued cash flow hedge accounting because the forecasted transactions were no longer probable of occurring. When such forecasted transactions are not probable of occurring within two months of the anticipated date, the Company reclassifies certain amounts from AOCI into net derivative gains (losses). For both the nine months ended September 30, 2014 and 2013, there were no amounts reclassified into net derivative gains (losses) related to such discontinued cash flow hedges.

At both September 30, 2014 and December 31, 2013, there were no hedged forecasted transactions, other than the receipt or payment of variable interest payments.

At September 30, 2014 and December 31, 2013, the balance in AOCI associated with foreign currency swaps designated and qualifying as cash flow hedges was $1 million and ($1) million, respectively.

For the nine months ended September 30, 2014 and 2013, there was $2 million and ($1) million of gains (losses) deferred in AOCI related to foreign currency swaps, respectively. For the nine months ended September 30, 2014, the amounts reclassified to net derivative gains (losses) related to foreign currency swaps were not significant. For the nine months ended September 30, 2013, there were no amounts reclassified to net derivative gains (losses) related to foreign currency swaps. For the nine months ended September 30, 2014 and 2013, there were no amounts reclassified into net investment income related to foreign currency swaps.

For both the nine months ended September 30, 2014 and 2013, the amounts recognized in net derivative gains (losses) which represented the ineffective portion of all cash flow hedges were not significant.

At September 30, 2014, the amounts of deferred net gains (losses) on derivatives in AOCI that was expected to be reclassified to earnings within the next 12 months was not significant.

All components of each derivative’s gain or loss were included in the assessment of hedge effectiveness.

 

20

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited) — (Continued)

 

4. Derivatives (continued)

Credit Derivatives

In connection with synthetically created credit investment transactions, the Company writes credit default swaps for which it receives a premium to insure credit risk. Such credit derivatives are included within the non-qualifying derivatives and derivatives for purposes other than hedging table. If a credit event occurs, as defined by the contract, the contract may be cash settled or it may be settled gross by the Company paying the counterparty the specified swap notional amount in exchange for the delivery of par quantities of the referenced credit obligation. The Company’s maximum amount at risk, assuming the value of all referenced credit obligations is zero, was $20 million at both September 30, 2014 and December 31, 2013. The Company can terminate these contracts at any time through cash settlement with the counterparty at an amount equal to the then current fair value of the credit default swaps. At both September 30, 2014 and December 31, 2013, the amount the Company would have received to terminate all of these contracts was not significant.

The following table presents the estimated fair value, maximum amount of future payments and weighted average years to maturity of written credit default swaps at:

 

September 30, 2014

December 31, 2013

Estimated Fair Value of Credit Default Swaps

Maximum Amount of Future Payments under Credit Default Swaps (2)

Weighted Average Years to Maturity (3)

Estimated Fair Value of Credit Default Swaps

Maximum Amount of Future Payments under Credit Default Swaps (2)

Weighted Average Years to Maturity (3)

Rating Agency Designation of Referenced Credit Obligations (1)

(In millions)

(In millions)

Baa

Credit default swaps referencing indices

—

20

4.3

—

20

5.0

 

(1)	The rating agency designations are based on availability and the midpoint of the applicable ratings among Moody’s Investors Service (“Moody’s”), Standard & Poor’s Ratings Services (“S&P”) and Fitch Ratings. If no rating is available from a rating agency, then an internally developed rating is used.

(2)	Assumes the value of the referenced credit obligations is zero.

(3)	The weighted average years to maturity of the credit default swaps is calculated based on weighted average notional amounts.

 

21

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited) — (Continued)

 

4. Derivatives (continued)

Credit Risk on Freestanding Derivatives

The Company may be exposed to credit-related losses in the event of nonperformance by counterparties to derivatives. Generally, the current credit exposure of the Company’s derivatives is limited to the net positive estimated fair value of derivatives at the reporting date after taking into consideration the existence of master netting or similar agreements and any collateral received pursuant to such agreements.

The Company manages its credit risk related to derivatives by entering into transactions with creditworthy counterparties and establishing and monitoring exposure limits. The Company’s OTC-bilateral derivative transactions are generally governed by ISDA Master Agreements which provide for legally enforceable set-off and close-out netting of exposures to specific counterparties in the event of early termination of a transaction, which includes, but is not limited to, events of default and bankruptcy. In the event of an early termination, the Company is permitted to set off receivables from the counterparty against payables to the same counterparty arising out of all included transactions. Substantially all of the Company’s ISDA Master Agreements also include Credit Support Annex provisions which require both the pledging and accepting of collateral in connection with its OTC-bilateral derivatives.

The Company’s OTC-cleared derivatives are effected through central clearing counterparties and its exchange-traded derivatives are effected through regulated exchanges. Such positions are marked to market and margined on a daily basis (both initial margin and variation margin), and the Company has minimal exposure to credit-related losses in the event of nonperformance by counterparties to such derivatives.

See Note 5 for a description of the impact of credit risk on the valuation of derivatives.

 

22

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited) — (Continued)

 

4. Derivatives (continued)

The estimated fair values of the Company’s net derivative assets and net derivative liabilities after the application of master netting agreements and collateral were as follows at:

 

		September 30, 2014								December 31, 2013
Derivatives Subject to a Master Netting Arrangement or a Similar Arrangement		Assets				Liabilities				Assets				Liabilities
		(In millions)
Gross estimated fair value of derivatives:
OTC-bilateral (1)		$	4			$	15			$	25			$	32
OTC-cleared (1)			—				1				—				—
Exchange-traded			—				—				—				—
Total gross estimated fair value of derivatives (1)			4				16				25				32
Amounts offset on the balance sheets			—				—				—				—
Estimated fair value of derivatives presented on the balance sheets (1)			4				16				25				32
Gross amounts not offset on the balance sheets:
Gross estimated fair value of derivatives: (2)
OTC-bilateral			(3	)			(3	)			(5	)			(5	)
OTC-cleared			—				—				—				—
Exchange-traded			—				—				—				—
Cash collateral: (3)
OTC-bilateral			—				—				(17	)			—
OTC-cleared			—				(1	)			—				—
Exchange-traded			—				—				—				—
Securities collateral: (4)
OTC-bilateral			—				(10	)			(2	)			(26	)
OTC-cleared			—				—				—				—
Exchange-traded			—				—				—				—
Net amount after application of master netting agreements and collateral		$	1			$	2			$	1			$	1

 

(1)

At September 30, 2014 and December 31, 2013, derivative assets include income or expense accruals reported in accrued investment income or in other liabilities of less than $1 million and $2 million, respectively, and derivative liabilities include income or expense accruals reported in accrued investment income or in other liabilities of ($1) million and ($2) million, respectively.

(2)	Estimated fair value of derivatives is limited to the amount that is subject to set-off and includes income or expense accruals.

(3)

Cash collateral received is included in cash and cash equivalents, short-term investments or in fixed maturity securities, and the obligation to return it is included in payables for collateral under securities loaned and other transactions on the balance sheet. The receivable for the return of cash collateral provided by the Company is inclusive of initial margin on exchange traded and OTC-cleared derivatives and is included in premiums, reinsurance and other receivables on the balance sheet. The amount of cash collateral offset in the table above is limited to the net estimated fair value of derivatives after application of netting agreements. At both September 30, 2014 and December 31, 2013 the Company had not received or paid any excess cash collateral.

(4)

Securities collateral received by the Company is held in separate custodial accounts and is not recorded on the balance sheet. Subject to certain constraints, the Company is permitted by contract to sell or repledge this collateral, but at September 30, 2014 none of the collateral had been sold or repledged. Securities collateral pledged by the Company is reported in fixed maturity securities on the balance sheet. Subject to certain constraints, the counterparties are permitted by contract to sell or repledge this collateral. The amount of securities collateral offset in the table above is limited to the net estimated fair value of derivatives after application of netting agreements and cash collateral. At September 30, 2014 and December 31, 2013, the Company received excess securities collateral with an estimated fair value of $0 and $1 million, respectively, for its OTC-bilateral derivatives, which are not included in the table above due to the foregoing limitation. At September 30, 2014 and December 31, 2013, the Company provided excess securities collateral with an estimated fair value of $2 million and $0, respectively, for its OTC-bilateral derivatives, and had provided $1 million and $1 million, respectively, for its OTC-cleared derivatives, which are not included in the table above due to the foregoing limitation.

 

23

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited) — (Continued)

 

4. Derivatives (continued)

The Company’s collateral arrangements for its OTC-bilateral derivatives generally require the counterparty in a net liability position, after considering the effect of netting agreements, to pledge collateral when the fair value of that counterparty’s derivatives reaches a pre-determined threshold. Certain of these arrangements also include financial strength-contingent provisions that provide for a reduction of these thresholds (on a sliding scale that converges toward zero) in the event of downgrades in the financial strength ratings of the Company and/or the credit ratings of the counterparty. In addition, certain of the Company’s netting agreements for derivatives contain provisions that require both the Company and the counterparty to maintain a specific investment grade financial strength or credit rating from each of Moody’s and S&P. If a party’s financial strength or credit ratings were to fall below that specific investment grade financial strength or credit rating, that party would be in violation of these provisions, and the other party to the derivatives could terminate the transactions and demand immediate settlement and payment based on such party’s reasonable valuation of the derivatives.

The following table presents the estimated fair value of the Company’s OTC-bilateral derivatives that are in a net liability position after considering the effect of netting agreements, together with the estimated fair value and balance sheet location of the collateral pledged. The table also presents the incremental collateral that the Company would be required to provide if there was a one notch downgrade in the Company’s financial strength rating at the reporting date or if the Company’s financial strength rating sustained a downgrade to a level that triggered full overnight collateralization or termination of the derivative position at the reporting date. OTC-bilateral derivatives that are not subject to collateral agreements are excluded from this table.

 

						Estimated Fair Value of Collateral Provided:				Fair Value of Incremental Collateral Provided Upon:
		Estimated Fair Value of Derivatives in Net Liability Position (1)				Fixed Maturity Securities				One Notch Downgrade in the Company’s Financial Strength Rating				Downgrade in the Company’s Financial Strength Rating to a Level that Triggers Full Overnight Collateralization or Termination of the Derivative Position
						(In millions)
September 30, 2014		$	12			$	12			$	—			$	1
December 31, 2013		$	27			$	26			$	—			$	1

 

(1)	After taking into consideration the existence of netting agreements.

 

24

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited) — (Continued)

 

4. Derivatives (continued)

Embedded Derivatives

The Company issues certain products or purchases certain investments that contain embedded derivatives that are required to be separated from their host contracts and accounted for as freestanding derivatives. These host contracts principally include: variable annuities with guaranteed minimum benefits, including GMWBs, guaranteed minimum accumulation benefits (“GMABs”) and certain GMIBs; and affiliated ceded reinsurance of guaranteed minimum benefits related to GMWBs, GMABs and certain GMIBs.

The following table presents the estimated fair value and balance sheet location of the Company’s embedded derivatives that have been separated from their host contracts at:

 

		Balance Sheet Location		September 30, 2014				December 31, 2013
				(In millions)
Net embedded derivatives within asset host contracts:
Ceded guaranteed minimum benefits		Premiums, reinsurance and other receivables		$	599			$	376
Net embedded derivatives within liability host contracts:
Direct guaranteed minimum benefits		PABs		$	(94	)		$	(131	)

The following table presents changes in estimated fair value related to embedded derivatives:

 

		Nine Months Ended September 30,
		2014				2013
		(In millions)
Net derivative gains (losses) (1), (2)		$	170			$	(301	)

 

(1)

The valuation of direct guaranteed minimum benefits includes a nonperformance risk adjustment. The amounts included in net derivative gains (losses), in connection with this adjustment, was not significant and ($4) million for the nine months ended September 30, 2014 and 2013, respectively. In addition, the valuation of ceded guaranteed minimum benefits includes a nonperformance risk adjustment. The amounts included in net derivative gains (losses), in connection with this adjustment, were ($11) million and $30 million for the nine months ended September 30, 2014 and 2013, respectively.

(2)	See Note 9 for discussion of affiliated net derivative gains (losses) included in the table above.

 

25

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited) — (Continued)

 

5. Fair Value

Considerable judgment is often required in interpreting market data to develop estimates of fair value, and the use of different assumptions or valuation methodologies may have a material effect on the estimated fair value amounts.

Recurring Fair Value Measurements

The assets and liabilities measured at estimated fair value on a recurring basis and their corresponding placement in the fair value hierarchy are presented below.

 

		September 30, 2014
		Fair Value Hierarchy
		Level 1				Level 2				Level 3				Total Estimated Fair Value
		(In millions)
Assets
Fixed maturity securities:
U.S. corporate		$	—			$	873			$	10			$	883
U.S. Treasury and agency			727				35				—				762
RMBS			—				280				29				309
CMBS			—				264				—				264
Foreign corporate			—				194				42				236
ABS			—				48				7				55
State and political subdivision			—				20				—				20
Foreign government			—				13				—				13
Total fixed maturity securities			727				1,727				88				2,542
Equity securities:
Common stock			—				26				—				26
Non-redeemable preferred stock			—				—				19				19
Total equity securities			—				26				19				45
Short-term investments			25				45				—				70
Derivative assets: (1)
Interest rate			—				1				—				1
Foreign currency exchange rate			—				3				—				3
Total derivative assets			—				4				—				4
Net embedded derivatives within asset host contracts (2)			—				—				599				599
Separate account assets (3)			—				11,435				—				11,435
Total assets		$	752			$	13,237			$	706			$	14,695
Liabilities
Derivative liabilities: (1)
Interest rate		$	—			$	14			$	—			$	14
Foreign currency exchange rate			—				3				—				3
Total derivative liabilities			—				17				—				17
Net embedded derivatives within liability host contracts (2)			—				—				(94	)			(94	)
Total liabilities		$	—			$	17			$	(94	)		$	(77	)

 

26

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited) — (Continued)

 

5. Fair Value (continued)

 

		December 31, 2013
		Fair Value Hierarchy
		Level 1				Level 2				Level 3				Total Estimated Fair Value
		(In millions)
Assets
Fixed maturity securities:
U.S. corporate		$	—			$	859			$	13			$	872
U.S. Treasury and agency			408				49				—				457
RMBS			—				285				27				312
CMBS			—				297				—				297
Foreign corporate			—				185				44				229
ABS			—				46				7				53
State and political subdivision			—				19				—				19
Foreign government			—				11				—				11
Total fixed maturity securities			408				1,751				91				2,250
Equity securities:
Common stock			—				26				—				26
Non-redeemable preferred stock			—				—				19				19
Total equity securities			—				26				19				45
Short-term investments			14				61				—				75
Derivative assets: (1)
Interest rate			—				21				—				21
Foreign currency exchange rate			—				2				—				2
Total derivative assets			—				23				—				23
Net embedded derivatives within asset host contracts (2)			—				—				376				376
Separate account assets (3)			—				12,033				—				12,033
Total assets		$	422			$	13,894			$	486			$	14,802
Liabilities
Derivative liabilities: (1)
Interest rate		$	—			$	26			$	—			$	26
Foreign currency exchange rate			—				8				—				8
Total derivative liabilities			—				34				—				34
Net embedded derivatives within liability host contracts (2)			—				—				(131	)			(131	)
Total liabilities		$	—			$	34			$	(131	)		$	(97	)

 

(1)

Derivative assets are presented within other invested assets on the balance sheets and derivative liabilities are presented within other liabilities on the balance sheets. The amounts are presented gross in the tables above to reflect the presentation on the balance sheets, but are presented net for purposes of the rollforward in the Fair Value Measurements Using Significant Unobservable Inputs (Level 3) tables.

(2)	Net embedded derivatives within asset host contracts are presented within premiums, reinsurance and other receivables on the balance sheets. Net embedded derivatives within liability host contracts are presented within PABs on the balance sheets.

(3)	Investment performance related to separate account assets is fully offset by corresponding amounts credited to contractholders whose liability is reflected within separate account liabilities. Separate account liabilities are set equal to the estimated fair value of separate account assets.

 

27

---

MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited) — (Continued)

 

5. Fair Value (continued)

The following describes the valuation methodologies used to measure assets and liabilities at fair value. The description includes the valuation techniques and key inputs for each category of assets or liabilities that are classified within Level 2 and Level 3 of the fair value hierarchy.

Investments

Valuation Controls and Procedures

On behalf of the Company and MetLife, Inc.’s Chief Investment Officer and Chief Financial Officer, a pricing and valuation committee that is independent of the trading and investing functions and comprised of senior management, provides oversight of control systems and valuation policies for securities, mortgage loans and derivatives. On a quarterly basis, this committee reviews and approves new transaction types and markets, ensures that observable market prices and market-based parameters are used for valuation, wherever possible, and determines that judgmental valuation adjustments, when applied, are based upon established policies and are applied consistently over time. This committee also provides oversight of the selection of independent third party pricing providers and the controls and procedures to evaluate third party pricing. Periodically, the Chief Accounting Officer reports to the Audit Committee of MetLife, Inc.’s Board of Directors regarding compliance with fair value accounting standards.

The Company reviews its valuation methodologies on an ongoing basis and revises those methodologies when necessary based on changing market conditions. Assurance is gained on the overall reasonableness and consistent application of input assumptions, valuation methodologies and compliance with fair value accounting standards through controls designed to ensure valuations represent an exit price. Several controls are utilized, including certain monthly controls, which include, but are not limited to, analysis of portfolio returns to corresponding benchmark returns, comparing a sample of executed prices of securities sold to the fair value estimates, comparing fair value estimates to management’s knowledge of the current market, reviewing the bid/ask spreads to assess activity, comparing prices from multiple independent pricing services and ongoing due diligence to confirm that independent pricing services use market-based parameters. The process includes a determination of the observability of inputs used in estimated fair values received from independent pricing services or brokers by assessing whether these inputs can be corroborated by observable market data. The Company ensures that prices received from independent brokers, also referred to herein as “consensus pricing,” represent a reasonable estimate of fair value by considering such pricing relative to the Company’s knowledge of the current market dynamics and current pricing for similar financial instruments. While independent non-binding broker quotations are utilized, they are not used for a significant portion of the portfolio. For example, fixed maturity securities priced using independent non-binding broker quotations represent less than 1% of the total estimated fair value of fixed maturity securities and 5% of the total estimated fair value of Level 3 fixed maturity securities.

The Company also applies a formal process to challenge any prices received from independent pricing services that are not considered representative of estimated fair value. If prices received from independent pricing services are not considered reflective of market activity or representative of estimated fair value, independent non-binding broker quotations are obtained, or an internally developed valuation is prepared. Internally developed valuations of current estimated fair value, which reflect internal estimates of liquidity and nonperformance risks, compared with pricing received from the independent pricing services, did not produce material differences in the estimated fair values for the majority of the portfolio; accordingly, overrides were not material. This is, in part, because internal estimates of liquidity and nonperformance risks are generally based on available market evidence and estimates used by other market participants. In the absence of such market-based evidence, management’s best estimate is used.

Securities and Short-term Investments

When available, the estimated fair value of these financial instruments is based on quoted prices in active markets that are readily and regularly obtainable. Generally, these are the most liquid of the Company’s securities holdings and valuation of these securities does not involve management’s judgment.

 

28

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited) — (Continued)

 

5. Fair Value (continued)

When quoted prices in active markets are not available, the determination of estimated fair value is based on market standard valuation methodologies, giving priority to observable inputs. The significant inputs to the market standard valuation methodologies for certain types of securities with reasonable levels of price transparency are inputs that are observable in the market or can be derived principally from, or corroborated by, observable market data. When observable inputs are not available, the market standard valuation methodologies rely on inputs that are significant to the estimated fair value that are not observable in the market or cannot be derived principally from, or corroborated by, observable market data. These unobservable inputs can be based in large part on management’s judgment or estimation and cannot be supported by reference to market activity. Even though these inputs are unobservable, management believes they are consistent with what other market participants would use when pricing such securities and are considered appropriate given the circumstances.

Level 2 Valuation Techniques and Key Inputs:

This level includes securities priced principally by independent pricing services using observable inputs. Short-term investments within this level are of a similar nature and class to the Level 2 fixed maturity securities and equity securities.

U.S. corporate and foreign corporate securities

These securities are principally valued using the market and income approaches. Valuations are based primarily on quoted prices in markets that are not active, or using matrix pricing or other similar techniques that use standard market observable inputs such as benchmark yields, spreads off benchmark yields, new issuances, issuer rating, duration, and trades of identical or comparable securities. Privately-placed securities are valued using matrix pricing methodologies using standard market observable inputs, and inputs derived from, or corroborated by, market observable data including market yield curve, duration, call provisions, observable prices and spreads for similar publicly traded or privately traded issues that incorporate the credit quality and industry sector of the issuer, and in certain cases, delta spread adjustments to reflect specific credit-related issues.

U.S. Treasury and agency securities

These securities are principally valued using the market approach. Valuations are based primarily on quoted prices in markets that are not active, or using matrix pricing or other similar techniques using standard market observable inputs such as a benchmark U.S. Treasury yield curve, the spread off the U.S. Treasury yield curve for the identical security and comparable securities that are actively traded.

Structured securities comprised of RMBS, CMBS and ABS

These securities are principally valued using the market and income approaches. Valuations are based primarily on matrix pricing, discounted cash flow methodologies or other similar techniques using standard market inputs, including spreads for actively traded securities, spreads off benchmark yields, expected prepayment speeds and volumes, current and forecasted loss severity, rating, weighted average coupon, weighted average maturity, average delinquency rates, geographic region, debt-service coverage ratios and issuance-specific information, including, but not limited to: collateral type, payment terms of the underlying assets, payment priority within the tranche, structure of the security, deal performance and vintage of loans.

State and political subdivision and foreign government securities

These securities are principally valued using the market approach. Valuations are based primarily on matrix pricing or other similar techniques using standard market observable inputs, including a benchmark U.S. Treasury yield or other yields, issuer ratings, broker-dealer quotes, issuer spreads and reported trades of similar securities, including those within the same sub-sector or with a similar maturity or credit rating.

Common stock

These securities are principally valued using the market approach. Valuations are based principally on observable inputs, including quoted prices in markets that are not considered active.

 

29

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited) — (Continued)

 

5. Fair Value (continued)

Level 3 Valuation Techniques and Key Inputs:

In general, securities classified within Level 3 use many of the same valuation techniques and inputs as described previously for Level 2. However, if key inputs are unobservable, or if the investments are less liquid and there is very limited trading activity, the investments are generally classified as Level 3. The use of independent non-binding broker quotations to value investments generally indicates there is a lack of liquidity or a lack of transparency in the process to develop the valuation estimates, generally causing these investments to be classified in Level 3.

U.S. corporate and foreign corporate securities

These securities, including financial services industry hybrid securities classified within fixed maturity securities, are principally valued using the market approach. Valuations are based primarily on matrix pricing or other similar techniques that utilize unobservable inputs or inputs that cannot be derived principally from, or corroborated by, observable market data, including illiquidity premium, delta spread adjustments to reflect specific credit-related issues, credit spreads; and inputs including quoted prices for identical or similar securities that are less liquid and based on lower levels of trading activity than securities classified in Level 2. Certain valuations are based on independent non-binding broker quotations.

Structured securities comprised of RMBS and ABS

These securities are principally valued using the market and income approaches. Valuations are based primarily on matrix pricing, discounted cash flow methodologies or other similar techniques that utilize inputs that are unobservable or cannot be derived principally from, or corroborated by, observable market data, including credit spreads. Below investment grade securities and sub-prime RMBS included in this level are valued based on inputs including quoted prices for identical or similar securities that are less liquid and based on lower levels of trading activity than securities classified in Level 2. Certain of these valuations are based on independent non-binding broker quotations.

Non-redeemable preferred stock

These securities, including financial services industry hybrid securities classified within equity securities, are principally valued using the market and income approaches. Valuations are based primarily on matrix pricing, discounted cash flow methodologies or other similar techniques using inputs such as comparable credit ratings and issuance structures. Certain of these securities are valued based on inputs including quoted prices for identical or similar securities that are less liquid and based on lower levels of trading activity than securities classified in Level 2 and independent non-binding broker quotations.

Separate Account Assets

Separate account assets are carried at estimated fair value and reported as a summarized total on the balance sheets. The estimated fair value of separate account assets is based on the estimated fair value of the underlying assets. Separate account assets within the Company’s separate accounts consist of mutual funds.

Level 2 Valuation Techniques and Key Inputs:

These assets are comprised of certain mutual funds without readily determinable fair values, as prices are not published publicly. Valuation of the mutual funds is based upon quoted prices or reported net asset value (“NAV”) provided by the fund managers.

Derivatives

The estimated fair value of derivatives is determined through the use of quoted market prices for exchange-traded derivatives, or through the use of pricing models for OTC-bilateral and OTC-cleared derivatives. The determination of estimated fair value, when quoted market values are not available, is based on market standard valuation methodologies and inputs that management believes are consistent with what other market participants would use when pricing such instruments. Derivative valuations can be affected by changes in interest rates, foreign currency exchange rates, financial indices, credit spreads, default risk, nonperformance risk, volatility, liquidity and changes in estimates and assumptions used in the pricing models. The valuation controls and procedures for derivatives are described in “— Investments”.

 

30

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited) — (Continued)

 

5. Fair Value (continued)

The significant inputs to the pricing models for most OTC-bilateral and OTC-cleared derivatives are inputs that are observable in the market or can be derived principally from, or corroborated by, observable market data. Significant inputs that are observable generally include: interest rates, foreign currency exchange rates, interest rate curves, credit curves and volatility. However, certain OTC-bilateral and OTC-cleared derivatives may rely on inputs that are significant to the estimated fair value that are not observable in the market or cannot be derived principally from, or corroborated by, observable market data. Significant inputs that are unobservable generally include references to emerging market currencies and inputs that are outside the observable portion of the interest rate curve, credit curve, volatility or other relevant market measure. These unobservable inputs may involve significant management judgment or estimation. Even though unobservable, these inputs are based on assumptions deemed appropriate given the circumstances and management believes they are consistent with what other market participants would use when pricing such instruments.

Most inputs for OTC-bilateral and OTC-cleared derivatives are mid-market inputs but, in certain cases, liquidity adjustments are made when they are deemed more representative of exit value. Market liquidity, as well as the use of different methodologies, assumptions and inputs, may have a material effect on the estimated fair values of the Company’s derivatives and could materially affect net income.

The credit risk of both the counterparty and the Company are considered in determining the estimated fair value for all OTC-bilateral and OTC-cleared derivatives, and any potential credit adjustment is based on the net exposure by counterparty after taking into account the effects of netting agreements and collateral arrangements. The Company values its OTC-bilateral and OTC-cleared derivatives using standard swap curves which may include a spread to the risk-free rate, depending upon specific collateral arrangements. This credit spread is appropriate for those parties that execute trades at pricing levels consistent with similar collateral arrangements. As the Company and its significant derivative counterparties generally execute trades at such pricing levels and hold sufficient collateral, additional credit risk adjustments are not currently required in the valuation process. The Company’s ability to consistently execute at such pricing levels is in part due to the netting agreements and collateral arrangements that are in place with all of its significant derivative counterparties. An evaluation of the requirement to make additional credit risk adjustments is performed by the Company each reporting period.

Freestanding Derivatives

Level 2 Valuation Techniques and Key Inputs:

This level includes all types of derivatives utilized by the Company with the exception of exchange-traded derivatives included within Level 1 and those derivatives with unobservable inputs as described in Level 3. These derivatives are principally valued using the income approach.

Interest rate

Non-option-based. Valuations are based on present value techniques, which utilize significant inputs that may include the swap yield curve and basis curves.

Option-based. Valuations are based on option pricing models, which utilize significant inputs that may include the swap yield curve, basis curves and interest rate volatility.

Foreign currency exchange rate

Non-option-based. Valuations are based on present value techniques, which utilize significant inputs that may include the swap yield curve, basis curves, currency spot rates and cross currency basis curves.

Embedded Derivatives

Embedded derivatives principally include certain direct variable annuity guarantees and certain affiliated ceded reinsurance agreements related to such variable annuity guarantees. Embedded derivatives are recorded at estimated fair value with changes in estimated fair value reported in net income.

The Company issues certain variable annuity products with guaranteed minimum benefits. GMWBs, GMABs and certain GMIBs contain embedded derivatives, which are measured at estimated fair value separately from the host variable annuity contract, with changes in estimated fair value reported in net derivative gains (losses). These embedded derivatives are classified within PABs on the balance sheets.

 

31

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited) — (Continued)

 

5. Fair Value (continued)

The fair value of these embedded derivatives, estimated as the present value of projected future benefits minus the present value of projected future fees using actuarial and capital market assumptions including expectations concerning policyholder behavior, is calculated by the Company’s actuarial department. The calculation is based on in-force business, and is performed using standard actuarial valuation software which projects future cash flows from the embedded derivative over multiple risk neutral stochastic scenarios using observable risk-free rates.

Capital market assumptions, such as risk-free rates and implied volatilities, are based on market prices for publicly traded instruments to the extent that prices for such instruments are observable. Implied volatilities beyond the observable period are extrapolated based on observable implied volatilities and historical volatilities. Actuarial assumptions, including mortality, lapse, withdrawal and utilization, are unobservable and are reviewed at least annually based on actuarial studies of historical experience.

The valuation of these guarantee liabilities includes nonperformance risk adjustments and adjustments for a risk margin related to non-capital market inputs. The nonperformance adjustment is determined by taking into consideration publicly available information relating to spreads in the secondary market for MetLife, Inc.’s debt, including related credit default swaps. These observable spreads are then adjusted, as necessary, to reflect the priority of these liabilities and the claims paying ability of the issuing insurance subsidiaries compared to MetLife, Inc.

Risk margins are established to capture the non-capital market risks of the instrument which represent the additional compensation a market participant would require to assume the risks related to the uncertainties of such actuarial assumptions as annuitization, premium persistency, partial withdrawal and surrenders. The establishment of risk margins requires the use of significant management judgment, including assumptions of the amount and cost of capital needed to cover the guarantees. These guarantees may be more costly than expected in volatile or declining equity markets. Market conditions including, but not limited to, changes in interest rates, equity indices, market volatility and foreign currency exchange rates; changes in nonperformance risk; and variations in actuarial assumptions regarding policyholder behavior, mortality and risk margins related to non-capital market inputs, may result in significant fluctuations in the estimated fair value of the guarantees that could materially affect net income.

The Company ceded, to an affiliated reinsurance company, the risk associated with certain of the GMIBs, GMABs and GMWBs described above that are also accounted for as embedded derivatives. In addition to ceding risks associated with guarantees that are accounted for as embedded derivatives, the Company also cedes, to the same affiliated reinsurance company, certain directly written GMIBs that are accounted for as insurance (i.e., not as embedded derivatives), but where the reinsurance agreement contains an embedded derivative. These embedded derivatives are included within premiums, reinsurance and other receivables on the balance sheets with changes in estimated fair value reported in net derivative gains (losses). The value of the embedded derivatives on the ceded risk is determined using a methodology consistent with that described previously for the guarantees directly written by the Company with the exception of the input for nonperformance risk that reflects the credit of the reinsurer.

Embedded Derivatives Within Asset and Liability Host Contracts

Level 3 Valuation Techniques and Key Inputs:

Direct guaranteed minimum benefits

These embedded derivatives are principally valued using the income approach. Valuations are based on option pricing techniques, which utilize significant inputs that may include swap yield curve, currency exchange rates and implied volatilities. These embedded derivatives result in Level 3 classification because one or more of the significant inputs are not observable in the market or cannot be derived principally from, or corroborated by, observable market data. Significant unobservable inputs generally include: the extrapolation beyond observable limits of the swap yield curve and implied volatilities, actuarial assumptions for policyholder behavior and mortality and the potential variability in policyholder behavior and mortality, nonperformance risk and cost of capital for purposes of calculating the risk margin.

Reinsurance ceded on certain guaranteed minimum benefits

These embedded derivatives are principally valued using the income approach. The valuation techniques and significant market standard unobservable inputs used in their valuation are similar to those described above in “— Direct guaranteed minimum benefits” and also include counterparty credit spreads.

 

32

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited) — (Continued)

 

5. Fair Value (continued)

Transfers between Levels

Overall, transfers between levels occur when there are changes in the observability of inputs and market activity. Transfers into or out of any level are assumed to occur at the beginning of the period.

Transfers between Levels 1 and 2:

There were no transfers between Levels 1 and 2 for assets and liabilities measured at estimated fair value and still held at both September 30, 2014 and December 31, 2013.

Transfers into or out of Level 3:

Assets and liabilities are transferred into Level 3 when a significant input cannot be corroborated with market observable data. This occurs when market activity decreases significantly and underlying inputs cannot be observed, current prices are not available, and/or when there are significant variances in quoted prices, thereby affecting transparency. Assets and liabilities are transferred out of Level 3 when circumstances change such that a significant input can be corroborated with market observable data. This may be due to a significant increase in market activity, a specific event, or one or more significant input(s) becoming observable.

Transfers into Level 3 for fixed maturity securities were due primarily to a lack of trading activity, decreased liquidity and credit ratings downgrades (e.g., from investment grade to below investment grade) which have resulted in decreased transparency of valuations and an increased use of independent non-binding broker quotations and unobservable inputs, such as illiquidity premiums, delta spread adjustments, or credit spreads.

Transfers out of Level 3 for fixed maturity securities resulted primarily from increased transparency of both new issuances that, subsequent to issuance and establishment of trading activity, became priced by independent pricing services and existing issuances that, over time, the Company was able to obtain pricing from, or corroborate pricing received from, independent pricing services with observable inputs (such as observable spreads used in pricing securities) or increases in market activity and upgraded credit ratings.

 

33

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited) — (Continued)

 

5. Fair Value (continued)

Assets and Liabilities Measured at Fair Value Using Significant Unobservable Inputs (Level 3)

The following table presents certain quantitative information about the significant unobservable inputs used in the fair value measurement, and the sensitivity of the estimated fair value to changes in those inputs, for the more significant asset and liability classes measured at fair value on a recurring basis using significant unobservable inputs (Level 3) at:

 

						September 30, 2014				December 31, 2013				Impact of Increase in Input on Estimated Fair Value (2)
		Valuation Techniques		Significant Unobservable Inputs		Range		Weighted Average (1)		Range		Weighted Average (1)
Fixed maturity securities (3)
U.S. corporate and foreign corporate		• Matrix pricing		• Delta spread   adjustments (4)		(5) - 190		35		(10) - 30		6		Decrease
				• Illiquidity   premium (4)		30 - 30		30		30 - 30		30		Decrease
				• Credit spreads (4)		28 - 28		28						Decrease
		• Market pricing		• Quoted prices (5)		20 - 110		106						Increase
RMBS		•Matrix pricing and discounted cash flow		• Credit spreads (4)						97 - 574		411		Decrease (6)
		• Market pricing		• Quoted prices (5)		98 - 98		98		100 - 100		100		Increase (6)
		• Consensus pricing		• Offered quotes (5)		60 - 103		90						Increase (6)
ABS		• Market pricing		• Quoted prices (5)		100 - 100		100		99 - 99		99		Increase (6)
		• Consensus pricing		• Offered quotes (5)						99 - 99		99		Increase (6)
Embedded derivatives
Direct and ceded guaranteed minimum benefits		• Option pricing techniques		• Mortality rates:
				Ages 0 - 40		0% - 0.10%				0% - 0.10%				Decrease (7)
				Ages 41 - 60		0.04% - 0.65%				0.04% - 0.65%				Decrease (7)
				Ages 61 - 115		0.26% - 100%				0.26% - 100%				Decrease (7)
				• Lapse rates:
				Durations 1 - 10		0.50% - 100%				0.50% - 100%				Decrease (8)
				Durations 11 - 20		3% - 100%				3% - 100%				Decrease (8)
				Durations 21 - 116		3% - 100%				3% - 100%				Decrease (8)
				• Utilization rates		20% - 50%				20% - 50%				Increase (9)
				• Withdrawal rates		0.07% - 10%				0.07% - 10%				(10)
				• Long-term equity volatilities		17.40% - 25%				17.40% - 25%				Increase (11)
				• Nonperformance risk spread		0.03% - 0.45%				0.03% - 0.44%				Decrease (12)

 

(1)	The weighted average for fixed maturity securities is determined based on the estimated fair value of the securities.

(2)	The impact of a decrease in input would have the opposite impact on the estimated fair value. For embedded derivatives, changes to direct guaranteed minimum benefits are based on liability positions and changes to ceded guaranteed minimum benefits are based on asset positions.

(3)	Significant increases (decreases) in expected default rates in isolation would result in substantially lower (higher) valuations.

(4)	Range and weighted average are presented in basis points.

(5)	Range and weighted average are presented in accordance with the market convention for fixed maturity securities of dollars per hundred dollars of par.

 

34

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited) — (Continued)

 

5. Fair Value (continued)

 

(6)	Changes in the assumptions used for the probability of default is accompanied by a directionally similar change in the assumption used for the loss severity and a directionally opposite change in the assumptions used for prepayment rates.

(7)

Mortality rates vary by age and by demographic characteristics such as gender. Mortality rate assumptions are based on company experience. A mortality improvement assumption is also applied. For any given contract, mortality rates vary throughout the period over which cash flows are projected for purposes of valuing the embedded derivative.

(8)

Base lapse rates are adjusted at the contract level based on a comparison of the actuarially calculated guaranteed values and the current policyholder account value, as well as other factors, such as the applicability of any surrender charges. A dynamic lapse function reduces the base lapse rate when the guaranteed amount is greater than the account value as in the money contracts are less likely to lapse. Lapse rates are also generally assumed to be lower in periods when a surrender charge applies. For any given contract, lapse rates vary throughout the period over which cash flows are projected for purposes of valuing the embedded derivative.

(9)

The utilization rate assumption estimates the percentage of contract holders with a GMIB or lifetime withdrawal benefit who will elect to utilize the benefit upon becoming eligible. The rates may vary by the type of guarantee, the amount by which the guaranteed amount is greater than the account value, the contract’s withdrawal history and by the age of the policyholder. For any given contract, utilization rates vary throughout the period over which cash flows are projected for purposes of valuing the embedded derivative.

(10)

The withdrawal rate represents the percentage of account balance that any given policyholder will elect to withdraw from the contract each year. The withdrawal rate assumption varies by age and duration of the contract, and also by other factors such as benefit type. For any given contract, withdrawal rates vary throughout the period over which cash flows are projected for purposes of valuing the embedded derivative. For GMWBs, any increase (decrease) in withdrawal rates results in an increase (decrease) in the estimated fair value of the guarantees. For GMABs and GMIBs, any increase (decrease) in withdrawal rates results in a decrease (increase) in the estimated fair value.

(11)

Long-term equity volatilities represent equity volatility beyond the period for which observable equity volatilities are available. For any given contract, long-term equity volatility rates vary throughout the period over which cash flows are projected for purposes of valuing the embedded derivative.

(12)	Nonperformance risk spread varies by duration and by currency. For any given contract, multiple nonperformance risk spreads will apply, depending on the duration of the cash flow being discounted for purposes of valuing the embedded derivative.

The following is a summary of the valuation techniques and significant unobservable inputs used in the fair value measurement of assets and liabilities classified within Level 3 that are not included in the preceding table. Generally, all other classes of securities classified within Level 3 use the same valuation techniques and significant unobservable inputs as previously described for Level 3 securities. This includes matrix pricing and discounted cash flow methodologies, inputs such as quoted prices for identical or similar securities that are less liquid and based on lower levels of trading activity than securities classified in Level 2, as well as independent non-binding broker quotations. The sensitivity of the estimated fair value to changes in the significant unobservable inputs for these other assets and liabilities is similar in nature to that described in the preceding table.

 

35

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited) — (Continued)

 

5. Fair Value (continued)

The following tables summarize the change of all assets and (liabilities) measured at estimated fair value on a recurring basis using significant unobservable inputs (Level 3):

 

		Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
		Fixed Maturity Securities																				Equity Securities				Net Embedded Derivatives (6)
		U.S. Corporate				RMBS				CMBS				Foreign Corporate				ABS				Non-redeemable Preferred Stock
		(In millions)
Nine Months Ended September 30, 2014
Balance, beginning of period		$	13			$	27			$	—			$	44			$	7			$	19			$	507
Total realized/unrealized gains (losses) included in:
Net income (loss): (1), (2)
Net investment income			—				—				—				—				—				—				—
Net investment gains (losses)			—				—				—				—				—				—				—
Net derivative gains (losses)			—				—				—				—				—				—				170
OCI			—				3				—				(1	)			—				—				—
Purchases (3)			2				—				—				9				7				—				—
Sales (3)			(8	)			(1	)			—				—				—				—				—
Issuances (3)			—				—				—				—				—				—				—
Settlements (3)			—				—				—				—				—				—				16
Transfers into Level 3 (4)			3				—				—				—				—				—				—
Transfers out of Level 3 (4)			—				—				—				(10	)			(7	)			—				—
Balance, end of period		$	10			$	29			$	—			$	42			$	7			$	19			$	693
Changes in unrealized gains (losses) included in net income (loss): (5)
Net investment income		$	—			$	—			$	—			$	—			$	—			$	—			$	—
Net investment gains (losses)		$	—			$	—			$	—			$	—			$	—			$	—			$	—
Net derivative gains (losses)		$	—			$	—			$	—			$	—			$	—			$	—			$	177

 

36

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited) — (Continued)

 

5. Fair Value (continued)

 

		Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
		Fixed Maturity Securities																				Equity Securities
		U.S. Corporate				RMBS				CMBS				Foreign Corporate				ABS				Non-redeemable Preferred Stock				Net Embedded Derivatives (6)
		(In millions)
Nine Months Ended September 30, 2013
Balance, beginning of period		$	55			$	14			$	14			$	42			$	—			$	17			$	903
Total realized/unrealized gains (losses) included in:
Net income (loss): (1), (2)
Net investment income			—				—				—				—				—				—				—
Net investment gains (losses)			—				—				—				—				—				—				—
Net derivative gains (losses)			—				—				—				—				—				—				(301	)
OCI			—				—				—				—				—				—				—
Purchases (3)			4				17				—				15				2				—				—
Sales (3)			(10	)			—				—				(8	)			—				—				—
Issuances (3)			—				—				—				—				—				—				—
Settlements (3)			—				—				—				—				—				—				13
Transfers into Level 3 (4)			—				—				—				—				—				—				—
Transfers out of Level 3 (4)			(36	)			—				(14	)			(1	)			—				—				—
Balance, end of period		$	13			$	31			$	—			$	48			$	2			$	17			$	615
Changes in unrealized gains (losses) included in net income (loss): (5)
Net investment income		$	—			$	—			$	—			$	—			$	—			$	—			$	—
Net investment gains (losses)		$	—			$	—			$	—			$	—			$	—			$	—			$	—
Net derivative gains (losses)		$	—			$	—			$	—			$	—			$	—			$	—			$	(293	)

 

(1)	Amortization of premium/accretion of discount is included within net investment income. Impairments charged to net income (loss) on securities are included in net investment gains (losses). Lapses associated with net embedded derivatives are included in net derivative gains (losses).

(2)	Interest and dividend accruals, as well as cash interest coupons and dividends received, are excluded from the rollforward.

(3)	Items purchased/issued and then sold/settled in the same period are excluded from the rollforward. Fees attributed to embedded derivatives are included in settlements.

(4)	Gains and losses, in net income (loss) and OCI, are calculated assuming transfers into and/or out of Level 3 occurred at the beginning of the period. Items transferred into and then out of Level 3 in the same period are excluded from the rollforward.

(5)	Changes in unrealized gains (losses) included in net income (loss) relate to assets and liabilities still held at the end of the respective periods.

(6)	Embedded derivative assets and liabilities are presented net for purposes of the rollforward.

Fair Value of Financial Instruments Carried at Other Than Fair Value

The following tables provide fair value information for financial instruments that are carried on the balance sheet at amounts other than fair value. These tables exclude the following financial instruments: cash and cash equivalents, accrued investment income and payables for collateral under securities loaned and other transactions. The estimated fair value of the excluded financial instruments, which are primarily classified in Level 2 and, to a lesser extent, in Level 1, approximates carrying value as they are short-term in nature such that the Company believes there is minimal risk of material changes in interest rates or credit quality. All remaining balance sheet amounts excluded from the table below are not considered financial instruments subject to this disclosure.

 

37

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited) — (Continued)

 

5. Fair Value (continued)

The carrying values and estimated fair values for such financial instruments, and their corresponding placement in the fair value hierarchy, are summarized as follows at:

 

		September 30, 2014
						Fair Value Hierarchy
		Carrying Value				Level 1				Level 2				Level 3				Total Estimated Fair Value
		(In millions)
Assets
Mortgage loans		$	260			$	—			$	—			$	279			$	279
Policy loans		$	27			$	—			$	3			$	40			$	43
Other limited partnership interests		$	1			$	—			$	—			$	1			$	1
Other invested assets		$	—			$	—			$	—			$	—			$	—
Premiums, reinsurance and other receivables		$	1,214			$	—			$	1			$	1,310			$	1,311
Other assets		$	5			$	—			$	5			$	—			$	5
Liabilities
PABs		$	2,221			$	—			$	—			$	2,432			$	2,432
Other liabilities		$	3			$	—			$	3			$	—			$	3

 

		December 31, 2013
						Fair Value Hierarchy
		Carrying Value				Level 1				Level 2				Level 3				Total Estimated Fair Value
		(In millions)
Assets
Mortgage loans		$	286			$	—			$	—			$	303			$	303
Policy loans		$	27			$	—			$	3			$	39			$	42
Other limited partnership interests		$	1			$	—			$	—			$	1			$	1
Other invested assets		$	45			$	—			$	50			$	—			$	50
Premiums, reinsurance and other receivables		$	1,258			$	—			$	—			$	1,359			$	1,359
Other assets		$	5			$	—			$	5			$	—			$	5
Liabilities
PABs		$	2,293			$	—			$	—			$	2,501			$	2,501
Other liabilities		$	1			$	—			$	1			$	—			$	1

The methods, assumptions and significant valuation techniques and inputs used to estimate the fair value of financial instruments are summarized as follows:

Mortgage Loans

The estimated fair value of mortgage loans is primarily determined by estimating expected future cash flows and discounting them using current interest rates for similar mortgage loans with similar credit risk, or is determined from pricing for similar loans.

Policy Loans

Policy loans with fixed interest rates are classified within Level 3. The estimated fair values for these loans are determined using a discounted cash flow model applied to groups of similar policy loans determined by the nature of the underlying insurance liabilities. Cash flow estimates are developed by applying a weighted-average interest rate to the outstanding principal balance of the respective group of policy loans and an estimated average maturity determined through experience studies of the past performance of policyholder repayment behavior for similar loans. These cash flows are discounted using current risk-free interest rates with no adjustment for borrower credit risk as these loans are fully collateralized by the cash surrender value of the underlying insurance policy. Policy loans with variable interest rates are classified within Level 2 and the estimated fair value approximates carrying value due to the absence of borrower credit risk and the short time period between interest rate resets, which presents minimal risk of a material change in estimated fair value due to changes in market interest rates.

 

38

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited) — (Continued)

 

5. Fair Value (continued)

Other Limited Partnership Interests

The estimated fair values of these cost method investments are generally based on the Company’s share of the NAV as provided in the financial statements of the investees. In certain circumstances, management may adjust the NAV by a premium or discount when it has sufficient evidence to support applying such adjustments.

Other Invested Assets

These other invested assets are principally comprised of loans to affiliates. The estimated fair value of loans to affiliates is determined by discounting the expected future cash flows using market interest rates currently available for instruments with similar terms and remaining maturities.

Premiums, Reinsurance and Other Receivables

Premiums, reinsurance and other receivables are principally comprised of certain amounts recoverable under reinsurance agreements.

Amounts recoverable under ceded reinsurance agreements, which the Company has determined do not transfer significant risk such that they are accounted for using the deposit method of accounting, have been classified as Level 3. The valuation is based on discounted cash flow methodologies using significant unobservable inputs. The estimated fair value is determined using interest rates determined to reflect the appropriate credit standing of the assuming counterparty.

Other Assets

Other assets are comprised of a receivable for the reimbursable portion of the estimated future guaranty liability that pertains to pre-acquisition business. With the exception of the receivable, other assets are not considered financial instruments subject to disclosure. Accordingly, the amount represents the receivable from an unaffiliated institution for which the estimated fair value was determined by discounting the expected future cash flows using a discount rate that reflects the credit standing of the unaffiliated institution.

PABs

These PABs include investment contracts. Embedded derivatives on investment contracts and certain variable annuity guarantees accounted for as embedded derivatives are excluded from this caption in the preceding tables as they are separately presented in “— Recurring Fair Value Measurements.”

The investment contracts primarily include fixed deferred annuities and fixed term payout annuities. The valuation of these investment contracts is based on discounted cash flow methodologies using significant unobservable inputs. The estimated fair value is determined using current market risk-free interest rates adding a spread to reflect the nonperformance risk in the liability.

Other Liabilities

Other liabilities consist of derivative payables and amounts due for securities purchased but not yet settled. The Company evaluates the specific terms, facts and circumstances of each instrument to determine the appropriate estimated fair values, which are not materially different from the carrying values.

 

39

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited) — (Continued)

 

6. Equity

Accumulated Other Comprehensive Income (Loss)

Information regarding changes in the balances of each component of AOCI, net of income tax, was as follows:

 

		Nine Months Ended September 30, 2014
		Unrealized Investment Gains (Losses), Net of Related Offsets (1)				Unrealized Gains (Losses) on Derivatives				Total
		(In millions)
Balance, beginning of period		$	24			$	(1	)		$	23
OCI before reclassifications			28				2				30
Deferred income tax benefit (expense)			(10	)			—				(10	)
OCI before reclassifications, net of income tax			42				1				43
Amounts reclassified from AOCI			—				—				—
Deferred income tax benefit (expense)			—				—				—
Amounts reclassified from AOCI, net of income tax			—				—				—
Balance, end of period		$	42			$	1			$	43

 

		Nine Months Ended September 30, 2013
		Unrealized Investment Gains (Losses), Net of Related Offsets (1)				Unrealized Gains (Losses) on Derivatives				Total
		(In millions)
Balance, beginning of period		$	76			$	—			$	76
OCI before reclassifications			(69	)			(1	)			(70	)
Deferred income tax benefit (expense)			24				—				24
OCI before reclassifications, net of income tax			31				(1	)			30
Amounts reclassified from AOCI			(1	)			—				(1	)
Deferred income tax benefit (expense)			—				—				—
Amounts reclassified from AOCI, net of income tax			(1	)			—				(1	)
Balance, end of period		$	30			$	(1	)		$	29

 

(1)	See Note 3 for information on offsets to investments related to insurance liabilities and DAC and VOBA.

Information regarding amounts reclassified out of each component of AOCI was as follows:

 

AOCI Components		Amounts Reclassified              from AOCI								Statement of Operations and Comprehensive Income (Loss) Location
		Nine Months Ended September 30,
		2014				2013
		(In millions)
Net unrealized investment gains (losses):
Net unrealized investment gains (losses)		$	(1	)		$	—			Net investment gains (losses)
Net unrealized investment gains (losses)			1				1			Net investment income
Net unrealized investment gains (losses), before income tax			—				1
Income tax (expense) benefit			—				—
Net unrealized investment gains (losses), net of income tax		$	—			$	1

 

40

---

MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited) — (Continued)

 

7. Other Expenses

Information on other expenses was as follows:

 

		Nine Months Ended September 30,
		2014				2013
		(In millions)
Compensation		$	(14	)		$	4
Commissions			44				37
Volume-related costs			(12	)			—
Capitalization of DAC			(4	)			(5	)
Amortization of DAC and VOBA			100				(63	)
Premium taxes, licenses and fees			2				3
Other			12				20
Total other expenses		$	128			$	(4	)

Affiliated Expenses

Commissions, capitalization of DAC and amortization of DAC and VOBA include the impact of affiliated reinsurance transactions. See Note 9 for discussion of affiliated expenses included in the table above.

8. Contingencies, Commitments and Guarantees

Contingencies

Litigation

Unclaimed Property Inquiries

In April 2012, MetLife, for itself and on behalf of entities including the Company, reached agreements with representatives of the U.S. jurisdictions that were conducting audits of MetLife and certain of its affiliates for compliance with unclaimed property laws, and with state insurance regulators directly involved in a multistate targeted market conduct examination relating to claim-payment practices and compliance with unclaimed property laws.

Sales Practices Claims

Over the past several years, the Company has faced claims and regulatory inquiries and investigations, alleging improper marketing or sales of individual life insurance policies, annuities, mutual funds or other products. The Company continues to vigorously defend against the claims in these matters. The Company believes adequate provision has been made in its financial statements for all probable and reasonably estimable losses for sales practices matters.

Summary

Various litigation, claims and assessments against the Company, in addition to those discussed previously and those otherwise provided for in the Company’s financial statements, have arisen in the course of the Company’s business, including, but not limited to, in connection with its activities as an insurer, employer, investor, investment advisor and taxpayer. Further, state insurance regulatory authorities and other federal and state authorities regularly make inquiries and conduct investigations concerning the Company’s compliance with applicable insurance and other laws and regulations.

It is not possible to predict the ultimate outcome of all pending investigations and legal proceedings. In some of the matters referred to previously, large and/or indeterminate amounts, including punitive and treble damages, are sought. Although, in light of these considerations it is possible that an adverse outcome in certain cases could have a material effect upon the Company’s financial position, based on information currently known by the Company’s management, in its opinion, the outcomes of such pending investigations and legal proceedings are not likely to have such an effect. However, given the large and/or indeterminate amounts sought in certain of these matters and the inherent unpredictability of litigation, it is possible that an adverse outcome in certain matters could, from time to time, have a material effect on the Company’s net income or cash flows in particular quarterly or annual periods.

 

41

---

MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Consolidated Financial Statements (Unaudited) — (Continued)

 

8. Contingencies, Commitments and Guarantees (continued)

Commitments

Mortgage Loan Commitments

The Company commits to lend funds under mortgage loan commitments. The amounts of these mortgage loan commitments were $3 million and $6 million at September 30, 2014 and December 31, 2013, respectively.

Commitments to Fund Partnerships Investments and Private Corporate Bond Investments

The Company commits to fund partnership investments and to lend funds under private corporate bond investments. The amounts of these unfunded commitments were $5 million and $21 million at September 30, 2014 and December 31, 2013, respectively.

9. Related Party Transactions

Service Agreements

The Company has entered into various agreements with affiliates for services necessary to conduct its activities. Typical services provided under these agreements include management, policy administrative functions, personnel, investment advice and distribution services. For certain agreements, charges are based on various performance measures or activity-based costing. The bases for such charges are modified and adjusted by management when necessary or appropriate to reflect fairly and equitably the actual incidence of cost incurred by the Company and/or affiliate. Expenses incurred with affiliates related to these agreements, recorded in other expenses, were $25 million and $58 million for the nine months ended September 30, 2014 and 2013, respectively. Revenues received from affiliates related to these agreements, recorded in universal life and investment-type product policy fees, were $29 million and $28 million for the nine months ended September 30, 2014 and 2013, respectively. Revenues received from affiliates related to these agreements, recorded in fees on ceded reinsurance and other, were $17 million and $18 million for the nine months ended September 30, 2014 and 2013, respectively.

The Company had net receivables (payables) to affiliates, related to the items discussed above, of ($15) million and $4 million at September 30, 2014 and December 31, 2013, respectively.

See Note 3 for additional information on related party transactions.

Related Party Reinsurance Transactions

The Company has reinsurance agreements with certain MetLife subsidiaries, including Metropolitan Life Insurance Company, General American Life Insurance Company, Exeter, and MetLife Insurance Company of Connecticut, all of which are related parties.

Information regarding the significant effects of affiliated reinsurance included on the interim condensed statements of operations and comprehensive income (loss) was as follows:

 

		Nine Months Ended September 30,
		2014				2013
		(In millions)
Premiums
Reinsurance ceded		$	—			$	—
Universal life and investment-type product policy fees
Reinsurance ceded		$	(32	)		$	(30	)
Fees on ceded reinsurance and other
Reinsurance ceded		$	41			$	49
Policyholder benefits and claims
Reinsurance ceded		$	(30	)		$	(10	)

 

42

---

MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Interim Condensed Financial Statements (Unaudited) — (Continued)

 

9. Related Party Transactions (continued)

Information regarding the significant effects of ceded affiliated reinsurance included on the interim condensed balance sheets was as follows at:

 

		September 30, 2014				December 31, 2013
		(In millions)
Assets
Premiums, reinsurance and other receivables		$	1,969			$	1,798
Deferred policy acquisition costs and value of business acquired			(20	)			(20	)
Total assets		$	1,949			$	1,778

The Company ceded risks to affiliates related to guaranteed minimum benefit guarantees written directly by the Company. These ceded reinsurance agreements contain embedded derivatives and changes in their fair value are included within net derivative gains (losses). The embedded derivatives associated with the cessions are included within premiums, reinsurance and other receivables and were assets of $599 million and $376 million at September 30, 2014 and December 31, 2013, respectively. Net derivative gains (losses) associated with the embedded derivatives were $178 million and ($468) million for the nine months ended September 30, 2014 and 2013, respectively.

10. Subsequent Events

The Company has evaluated events subsequent to September 30, 2014, through November 18, 2014, which is the date these financial statements were available to be issued, and has determined there are no material subsequent events requiring adjustment to or disclosure in the financial statements.

 

43

Exhibit 99.2

MetLife Investors Insurance Company

Financial Statements

As of December 31, 2013 and 2012 and for the Years Ended December 31, 2013, 2012 and 2011 and Independent Auditors’ Report

---

INDEPENDENT AUDITORS’ REPORT

To the Board of Directors and Stockholder of

MetLife Investors Insurance Company:

We have audited the accompanying financial statements of MetLife Investors Insurance Company (a wholly-owned subsidiary of MetLife, Inc.) (the “Company”), which comprise the balance sheets as of December 31, 2013 and 2012, and the related statements of operations, comprehensive income (loss), stockholder’s equity, and cash flows for each of the three years in the period ended December 31, 2013, and the related notes to the financial statements.

Management’s Responsibility for the Financial Statements

Management is responsible for the preparation and fair presentation of these financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error.

Auditors’ Responsibility

Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the Company’s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.

Opinion

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of MetLife Investors Insurance Company as of December 31, 2013 and 2012, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2013 in accordance with accounting principles generally accepted in the United States of America.

Other Matter

Results of the Company may not be indicative of those of a stand-alone entity, as the Company is a member of a controlled group of affiliated companies.

/s/ DELOITTE & TOUCHE LLP

Certified Public Accountants

Tampa, Florida

March 31, 2014

 

1

---

MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Balance Sheets

December 31, 2013 and 2012

(In millions, except share and per share data)

 

		2013				2012
Assets
Investments:
Fixed maturity securities available-for-sale, at estimated fair value (amortized cost: $2,200 and $2,178, respectively)		$	2,250			$	2,320
Equity securities available-for-sale, at estimated fair value (cost: $46 and $48, respectively)			45				45
Mortgage loans (net of valuation allowances of $1 and $2, respectively)			286				284
Policy loans			27				27
Other limited partnership interests			32				23
Short-term investments, at estimated fair value			75				139
Other invested assets			68				93
Total investments			2,783				2,931
Cash and cash equivalents			24				27
Accrued investment income			26				28
Premiums, reinsurance and other receivables			1,829				2,485
Deferred policy acquisition costs and value of business acquired			291				148
Current income tax recoverable			9				9
Other assets			110				115
Separate account assets			12,033				11,072
Total assets		$	17,105			$	16,815
Liabilities and Stockholder’s Equity
Liabilities
Future policy benefits		$	501			$	482
Policyholder account balances			2,748				3,077
Other policy-related balances			102				102
Payables for collateral under securities loaned and other transactions			266				238
Deferred income tax liability			192				326
Other liabilities			94				78
Separate account liabilities			12,033				11,072
Total liabilities			15,936				15,375
Contingencies, Commitments and Guarantees (Note 11)
Stockholder’s Equity
Common stock, par value $2 per share; 5,000,000 shares authorized; 2,899,446 shares issued and outstanding			6				6
Additional paid-in capital			636				636
Retained earnings			504				722
Accumulated other comprehensive income (loss)			23				76
Total stockholder’s equity			1,169				1,440
Total liabilities and stockholder’s equity		$	17,105			$	16,815

See accompanying notes to the financial statements.

 

2

---

MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Statements of Operations

For the Years Ended December 31, 2013, 2012 and 2011

(In millions)

 

		2013				2012				2011
Revenues
Premiums		$	29			$	11			$	7
Universal life and investment-type product policy fees			202				198				204
Net investment income			114				113				114
Fees on ceded reinsurance and other			90				93				104
Net investment gains (losses):
Other-than-temporary impairments on fixed maturity securities			—				(2)				—
Other net investment gains (losses)			1				(2)				(5)
Total net investment gains (losses)			1				(4)				(5)
Net derivative gains (losses)			(442)				329				326
Total revenues			(6)				740				750
Expenses
Policyholder benefits and claims			48				100				59
Interest credited to policyholder account balances			113				118				127
Other expenses			(11)				229				259
Total expenses			150				447				445
Income (loss) before provision for income tax			(156)				293				305
Provision for income tax expense (benefit)			(67)				94				90
Net income (loss)		$	(89)			$	199			$	215

 

See accompanying notes to the financial statements.

 

3

---

MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Statements of Comprehensive Income (Loss)

For the Years Ended December 31, 2013, 2012 and 2011

(In millions)

 

		2013				2012				2011
Net income (loss)		$	(89)			$	199			$	215
Other comprehensive income (loss):
Unrealized investment gains (losses), net of related offsets			(80)				64				23
Unrealized gains (losses) on derivatives			(2)				(1)				—
Other comprehensive income (loss), before income tax			(82)				63				23
Income tax (expense) benefit related to items of other comprehensive income (loss)			29				(22)				(8)
Other comprehensive income (loss), net of income tax			(53)				41				15
Comprehensive income (loss)		$	(142)			$	240			$	230

 

 

See accompanying notes to the financial statements.

 

4

---

MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Statements of Stockholder’s Equity

For the Years Ended December 31, 2013, 2012 and 2011

(In millions)

 

														Accumulated Other Comprehensive Income (Loss)
		Common Stock				Additional Paid-in Capital				Retained Earnings				Net Unrealized Investment Gains (Losses)				Other-Than- Temporary Impairments				Total Stockholder’s Equity
Balance at December 31, 2010		$	6			$	636			$	326			$	24			$	(4)			$	988
Net income (loss)											215												215
Other comprehensive income (loss), net of income tax															16				(1)				15
Balance at December 31, 2011			6				636				541				40				(5)				1,218
Dividend on common stock											(18)												(18)
Net income (loss)											199												199
Other comprehensive income (loss), net of income tax															39				2				41
Balance at December 31, 2012			6				636				722				79				(3)				1,440
Dividend on common stock											(129)												(129)
Net income (loss)											(89)												(89)
Other comprehensive income (loss), net of income tax															(54)				1				(53)
Balance at December 31, 2013		$	6			$	636			$	504			$	25			$	(2)			$	1,169

See accompanying notes to the financial statements.

 

5

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Statements of Cash Flows

For the Years Ended December 31, 2013, 2012 and 2011

(In millions)

 

		2013				2012				2011
Cash flows from operating activities
Net income (loss)		$	(89)			$	199			$	215
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization expenses			2				2				2
Amortization of premiums and accretion of discounts associated with investments, net			3				(3)				(5)
(Gains) losses on investments and derivatives, net			437				(321)				(329)
(Income) loss from equity method investments, net of dividends or distributions			(4)				(1)				—
Interest credited to policyholder account balances			113				118				127
Universal life and investment-type product policy fees			(202)				(198)				(204)
Change in accrued investment income			2				1				(4)
Change in premiums, reinsurance and other receivables			71				74				(6)
Change in deferred policy acquisition costs and value of business acquired, net			(135)				130				139
Change in income tax			(105)				68				91
Change in other assets			194				193				200
Change in insurance-related liabilities and policy-related balances			19				94				34
Change in other liabilities			10				(12)				14
Net cash provided by operating activities			316				344				274
Cash flows from investing activities
Sales, maturities and repayments of:
Fixed maturity securities			794				909				696
Equity securities			2				6				5
Mortgage loans			47				13				3
Other limited partnership interests			1				1				4
Purchases of:
Fixed maturity securities			(808)				(958)				(840)
Equity securities			—				(13)				(13)
Mortgage loans			(49)				(72)				(98)
Other limited partnership interests			(5)				(15)				(2)
Cash received in connection with freestanding derivatives			1				5				1
Cash paid in connection with freestanding derivatives			(12)				(1)				—
Issuances of loans to affiliates			—				—				(45)
Net change in policy loans			(1)				(1)				1
Net change in short-term investments			64				(70)				(12)
Net cash provided by (used in) investing activities			34				(196)				(300)
Cash flows from financing activities
Policyholder account balances:
Deposits			632				1,077				725
Withdrawals			(882)				(1,155)				(732)
Net change in payables for collateral under securities loaned and other transactions			28				(87)				46
Dividend on common stock			(129)				(18)				—
Other, net			(2)				18				—
Net cash provided by (used in) financing activities			(353)				(165)				39
Change in cash and cash equivalents			(3)				(17)				13
Cash and cash equivalents, beginning of year			27				44				31
Cash and cash equivalents, end of year		$	24			$	27			$	44
Supplemental disclosures of cash flow information:
Net cash paid (received) for:
Income tax		$	34			$	27			$	(1)

See accompanying notes to the financial statements.

 

6

---

MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements

1.  Business, Basis of Presentation and Summary of Significant Accounting Policies

Business

MetLife Investors Insurance Company (“MLIIC”), a Missouri domiciled life insurance company (the “Company”) is a wholly-owned subsidiary of MetLife, Inc. (“MetLife”).

The Company markets, administers and insures a broad range of term life, universal life and variable and fixed annuity products to individuals. The Company is licensed to conduct business in 49 states and the District of Columbia. Most of the policies issued present no significant mortality or longevity risk to the Company, but rather represent investment deposits by the policyholders.

In the second quarter of 2013, MetLife, Inc. announced its plans to merge three U.S.-based life insurance companies and an offshore reinsurance subsidiary to create one larger U.S.-based and U.S.-regulated life insurance company (the “Mergers”). The companies to be merged consist of MetLife Insurance Company of Connecticut (“MICC”), MetLife Investors USA Insurance Company (“MLI-USA”) and MLIIC, each a U.S. insurance company that issues variable annuity products in addition to other products, and Exeter Reassurance Company, Ltd. (“Exeter”), a reinsurance company that mainly reinsures guarantees associated with variable annuity products. MICC, which is expected to be renamed and domiciled in Delaware, will be the surviving entity. Exeter, formerly a Cayman Islands company, was re-domesticated to Delaware in October 2013. The Mergers are expected to occur in the fourth quarter of 2014, subject to regulatory approvals.

Basis of Presentation

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to adopt accounting policies and make estimates and assumptions that affect amounts reported in the financial statements. In applying these policies and estimates, management makes subjective and complex judgments that frequently require assumptions about matters that are inherently uncertain. Many of these policies, estimates and related judgments are common in the insurance and financial services industries; others are specific to the Company’s business and operations. Actual results could differ from estimates.

Since the Company is a member of a controlled group of affiliated companies, its results may not be indicative of those of a stand-alone entity.

Separate Accounts

Separate accounts are established in conformity with insurance laws and are generally not chargeable with liabilities that arise from any other business of the Company. Separate account assets are subject to general account claims only to the extent the value of such assets exceeds the separate account liabilities. The Company reports separately, as assets and liabilities, investments held in separate accounts and liabilities of the separate accounts if:

 

•

such separate accounts are legally recognized;

•

assets supporting the contract liabilities are legally insulated from the Company’s general account liabilities;

•

investments are directed by the contractholder; and

 

7

---

MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

1.  Business, Basis of Presentation and Summary of Significant Accounting Policies (continued)

 

•

all investment performance, net of contract fees and assessments, is passed through to the contractholder.

The Company reports separate account assets at their fair value, which is based on the estimated fair values of the underlying assets comprising the individual separate account portfolios. Investment performance (including investment income, net investment gains (losses) and changes in unrealized gains (losses)) and the corresponding amounts credited to contractholders of such separate accounts are offset within the same line in the statements of operations.

The Company’s revenues reflect fees charged to the separate accounts, including mortality charges, risk charges, policy administration fees, investment management fees and surrender charges. Such fees are included in universal life and investment-type product policy fees in the statements of operations.

Reclassifications

Certain amounts in the prior years’ financial statements and related footnotes thereto have been reclassified to conform with the current year presentation as discussed throughout the Notes to the Financial Statements.

Summary of Significant Accounting Policies

The following are the Company’s significant accounting policies with references to notes providing additional information on such policies and critical accounting estimates relating to such policies.

 

Accounting Policy			Note
Insurance			2
Deferred Policy Acquisition Costs, Value of Business Acquired and Other Policy-Related Intangibles			3
Reinsurance			4
Investments			5
Derivatives			6
Fair Value			7
Income Tax			10
Litigation Contingencies			11

Insurance

Future Policy Benefit Liabilities and Policyholder Account Balances

The Company establishes liabilities for amounts payable under insurance policies. Generally, amounts are payable over an extended period of time and related liabilities are calculated as the present value of future expected benefits to be paid reduced by the present value of future expected premiums. Such liabilities are established based on methods and underlying assumptions in accordance with GAAP and applicable actuarial

 

8

---

MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

1.  Business, Basis of Presentation and Summary of Significant Accounting Policies (continued)

 

standards. Principal assumptions used in the establishment of liabilities for future policy benefits are mortality, policy lapse, renewal, investment returns, inflation, expenses and other contingent events as appropriate to the respective product type. These assumptions are established at the time the policy is issued and are intended to estimate the experience for the period the policy benefits are payable. Utilizing these assumptions, liabilities are established on a block of business basis. For long duration insurance contracts, assumptions such as mortality and interest rates are “locked in” upon the issuance of new business. However, significant adverse changes in experience on such contracts may require the establishment of premium deficiency reserves. Such reserves are determined based on the then current assumptions and do not include a provision for adverse deviation.

The Company regularly reviews its estimates of liabilities for future policy benefits and compares them with its actual experience. Differences result in changes to the liability balances with related charges or credits to benefit expenses in the period in which the changes occur.

Policyholder account balances (“PABs”) relate to contract or contract features where the Company has no significant insurance risk.

The Company issues certain variable annuity products with guaranteed minimum benefits that provide the policyholder a minimum return based on their initial deposit (i.e., the benefit base) less withdrawals. These guarantees are accounted for as insurance liabilities or as embedded derivatives depending on how and when the benefit is paid. Specifically, a guarantee is accounted for as an embedded derivative if a guarantee is paid without requiring (i) the occurrence of specific insurable event, or (ii) the policyholder to annuitize. Alternatively, a guarantee is accounted for as an insurance liability if the guarantee is paid only upon either (i) the occurrence of a specific insurable event, or (ii) annuitization. In certain cases, a guarantee may have elements of both an insurance liability and an embedded derivative and in such cases the guarantee is split and accounted for under both models.

Guarantees accounted for as insurance liabilities in future policy benefits include guaranteed minimum death benefits (“GMDBs”), the portion of guaranteed minimum income benefits (“GMIBs”) that require annuitization, and the life-contingent portion of guaranteed minimum withdrawal benefits (“GMWBs”).

Guarantees accounted for as embedded derivatives in PABs include the non life-contingent portion of GMWBs, guaranteed minimum accumulation benefits (“GMABs”) and the portion of GMIBs that do not require annuitization. At inception, the Company attributes to the embedded derivative a portion of the projected future guarantee fees to be collected from the policyholder equal to the present value of projected future guaranteed benefits. Any additional fees represent “excess” fees and are reported in universal life and investment-type product policy fees.

Other Policy-Related Balances

Other policy-related balances include policy and contract claims and unearned revenue liabilities.

The liability for policy and contract claims generally relates to incurred but not reported death claims, as well as claims which have been reported but not yet settled. The liability for these claims is based on the Company’s estimated ultimate cost of settling all claims. The Company derives estimates for the development

 

9

---

MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

1.  Business, Basis of Presentation and Summary of Significant Accounting Policies (continued)

 

of incurred but not reported claims principally from analyses of historical patterns of claims by business line. The methods used to determine these estimates are continually reviewed. Adjustments resulting from this continuous review process and differences between estimates and payments for claims are recognized in policyholder benefits and claims expense in the period in which the estimates are changed or payments are made.

The unearned revenue liability relates to universal life-type and investment-type products and represents policy charges for services to be provided in future periods. The charges are deferred as unearned revenue and amortized using the product’s estimated gross profits, similar to deferred policy acquisition costs (“DAC”) as discussed further herein. Such amortization is recorded in universal life and investment-type product policy fees.

Recognition of Insurance Revenues and Deposits

Premiums related to traditional life and annuity policies with life contingencies are recognized as revenues when due from policyholders. Policyholder benefits and expenses are provided to recognize profits over the estimated lives of the insurance policies. When premiums are due over a significantly shorter period than the period over which benefits are provided, any excess profit is deferred and recognized into earnings in a constant relationship to insurance in-force or, for annuities, the amount of expected future policy benefit payments.

Deposits related to universal life-type and investment-type products are credited to PABs. Revenues from such contracts consist of fees for mortality, policy administration and surrender charges and are recorded in universal life and investment-type product policy fees in the period in which services are provided. Amounts that are charged to earnings include interest credited and benefit claims incurred in excess of related PABs.

Premiums, policy fees, policyholder benefits and expenses are presented net of reinsurance.

Deferred Policy Acquisition Costs, Value of Business Acquired and Other Policy-Related Intangibles

The Company incurs significant costs in connection with acquiring new and renewal insurance business. Costs that are related directly to the successful acquisition or renewal of insurance contracts are capitalized as DAC. Such costs include:

 

•

incremental direct costs of contract acquisition, such as commissions;

•

the portion of an employee’s total compensation and benefits related to time spent selling, underwriting or processing the issuance of new and renewal insurance business only with respect to actual policies acquired or renewed; and

•

other essential direct costs that would not have been incurred had a policy not been acquired or renewed.

All other acquisition-related costs, including those related to general advertising and solicitation, market research, agent training, product development, unsuccessful sales and underwriting efforts, as well as all indirect costs, are expensed as incurred.

 

10

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

1.  Business, Basis of Presentation and Summary of Significant Accounting Policies (continued)

 

Value of business acquired (“VOBA”) is an intangible asset resulting from a business combination that represents the excess of book value over the estimated fair value of acquired insurance, annuity, and investment-type contracts in-force at the acquisition date. The estimated fair value of the acquired liabilities is based on projections, by each block of business, of future policy and contract charges, premiums, mortality, separate account performance, surrenders, operating expenses, investment returns, nonperformance risk adjustment and other factors. Actual experience on the purchased business may vary from these projections.

DAC and VOBA are amortized as follows:

 

Products:		In proportion to the following over estimated lives of the contracts:
•  Fixed and variable universal life contracts		Actual and expected future gross profits.
•  Fixed and variable deferred annuity contracts

See Note 3 for additional information on DAC and VOBA amortization.

The recovery of DAC and VOBA is dependent upon the future profitability of the related business. DAC and VOBA are aggregated in the financial statements for reporting purposes.

The Company generally has two different types of sales inducements which are included in other assets: (i) the policyholder receives a bonus whereby the policyholder’s initial account balance is increased by an amount equal to a specified percentage of the customer’s deposit; and (ii) the policyholder receives a higher interest rate using a dollar cost averaging method than would have been received based on the normal general account interest rate credited. The Company defers sales inducements and amortizes them over the life of the policy using the same methodology and assumptions used to amortize DAC. The amortization of sales inducements is included in policyholder benefits and claims. Each year, or more frequently if circumstances indicate a potential recoverability issue exists, the Company reviews deferred sales inducements to determine the recoverability of the asset.

Reinsurance

For each of its reinsurance agreements, the Company determines whether the agreement provides indemnification against loss or liability relating to insurance risk in accordance with applicable accounting standards. Cessions under reinsurance agreements do not discharge the Company’s obligations as the primary insurer. The Company reviews all contractual features, including those that may limit the amount of insurance risk to which the reinsurer is subject or features that delay the timely reimbursement of claims.

For reinsurance of existing in-force blocks of long-duration contracts that transfer significant insurance risk, the difference, if any, between the amounts paid, and the liabilities ceded related to the underlying contracts is considered the net cost of reinsurance at the inception of the reinsurance agreement. The net cost of reinsurance is recorded as an adjustment to DAC when there is a gain at inception on the ceding entity and to other liabilities when there is a loss at inception. The net cost of reinsurance is recognized as a component of other expenses when there is a gain at inception and as policyholder benefits and claims when there is a loss and is subsequently amortized on a basis consistent with the methodology used for amortizing the DAC related to the

 

11

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

1.  Business, Basis of Presentation and Summary of Significant Accounting Policies (continued)

 

underlying reinsured contracts. Subsequent amounts paid on the reinsurance of in-force blocks, as well as amounts paid related to new business, are recorded as ceded premiums and ceded premiums, reinsurance and other receivables are established.

Amounts currently recoverable under reinsurance agreements are included in premiums, reinsurance and other receivables and amounts currently payable are included in other liabilities. Assets and liabilities relating to reinsurance agreements with the same reinsurer may be recorded net on the balance sheet, if a right of offset exists within the reinsurance agreement. In the event that reinsurers do not meet their obligations to the Company under the terms of the reinsurance agreements, reinsurance recoverable balances could become uncollectible. In such instances, reinsurance recoverable balances are stated net of allowances for uncollectible reinsurance.

Premiums, fees and policyholder benefits and claims are net of reinsurance ceded. Amounts received from reinsurers for policy administration are reported in fees on ceded reinsurance and other. With respect to GMIBs, a portion of the directly written GMIBs are accounted for as insurance liabilities, but the associated reinsurance agreements contain embedded derivatives. These embedded derivatives are included in premiums, reinsurance and other receivables with changes in estimated fair value reported in net derivative gains (losses).

If the Company determines that a reinsurance agreement does not expose the reinsurer to a reasonable possibility of a significant loss from insurance risk, the Company records the agreement using the deposit method of accounting. Deposits received are included in other liabilities and deposits made are included within premiums, reinsurance and other receivables. As amounts are paid or received, consistent with the underlying contracts, the deposit assets or liabilities are adjusted. Interest on such deposits is recorded as fees on ceded reinsurance and other or other expenses, as appropriate. Periodically, the Company evaluates the adequacy of the expected payments or recoveries and adjusts the deposit asset or liability through fees on ceded reinsurance and other or other expenses, as appropriate.

Investments

Net Investment Income and Net Investment Gains (Losses)

Income on investments is reported within net investment income, unless otherwise stated herein. Gains and losses on sales of investments, impairment losses and changes in valuation allowances are reported within net investment gains (losses).

Fixed Maturity and Equity Securities

The Company’s fixed maturity and equity securities are classified as available-for-sale (“AFS”) and are reported at their estimated fair value. Unrealized investment gains and losses on these securities are recorded as a separate component of other comprehensive income (loss) (“OCI”), net of policyholder-related amounts and deferred income taxes. All security transactions are recorded on a trade date basis. Investment gains and losses on sales are determined on a specific identification basis.

Interest income on fixed maturity securities is recognized when earned using an effective yield method giving effect to amortization of premiums and accretion of discounts. Prepayment fees are recognized when earned. Dividends on equity securities are recognized when declared.

 

12

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

1.  Business, Basis of Presentation and Summary of Significant Accounting Policies (continued)

 

The Company periodically evaluates fixed maturity and equity securities for impairment. The assessment of whether impairments have occurred is based on management’s case-by-case evaluation of the underlying reasons for the decline in estimated fair value, as well as an analysis of the gross unrealized losses by severity and/or age as described in Note 5 “— Evaluation of AFS Securities for OTTI and Evaluating Temporarily Impaired AFS Securities.”

For fixed maturity securities in an unrealized loss position, an other-than-temporary impairment (“OTTI”) is recognized in earnings when it is anticipated that the amortized cost will not be recovered. When either: (i) the Company has the intent to sell the security; or (ii) it is more likely than not that the Company will be required to sell the security before recovery, the OTTI recognized in earnings is the entire difference between the security’s amortized cost and estimated fair value. If neither of these conditions exist, the difference between the amortized cost of the security and the present value of projected future cash flows expected to be collected is recognized as an OTTI in earnings (“credit loss”). If the estimated fair value is less than the present value of projected future cash flows expected to be collected, this portion of OTTI related to other-than-credit factors is recorded in OCI.

With respect to equity securities, the Company considers in its OTTI analysis its intent and ability to hold a particular equity security for a period of time sufficient to allow for the recovery of its estimated fair value to an amount equal to or greater than cost. If a sale decision is made for an equity security and recovery to an amount at least equal to cost prior to the sale is not expected, the security will be deemed to be other-than-temporarily impaired in the period that the sale decision was made and an OTTI loss will be recorded in earnings. The OTTI loss recognized is the entire difference between the security’s cost and its estimated fair value.

Mortgage Loans

The Company disaggregates its mortgage loan investments into two portfolio segments: commercial and agricultural. The accounting policies that are applicable to all portfolio segments are presented below and the accounting policies related to each of the portfolio segments are included in Note 5.

Mortgage loans are stated at unpaid principal balance, adjusted for any unamortized premium or discount, deferred fees or expenses, and are net of valuation allowances. Interest income and prepayment fees are recognized when earned. Interest income is recognized using an effective yield method giving effect to amortization of premiums and accretion of discounts.

Policy Loans

Policy loans are stated at unpaid principal balances. Interest income on such loans is recorded as earned using the contractual interest rate. Generally, accrued interest is capitalized on the policy’s anniversary date. Valuation allowances are not established for policy loans, as they are fully collateralized by the cash surrender value of the underlying insurance policies. Any unpaid principal or interest on the loan is deducted from the cash surrender value or the death benefit prior to settlement of the insurance policy.

Other Limited Partnership Interests

The Company uses the equity method of accounting for investments in equity securities when it has significant influence or at least 20% interest and other limited partnership interests (“investees”) when it has

 

13

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

1.  Business, Basis of Presentation and Summary of Significant Accounting Policies (continued)

 

more than a minor ownership interest or more than a minor influence over the investee’s operations, but does not have a controlling financial interest. The Company generally recognizes its share of the investee’s earnings on a three-month lag in instances where the investee’s financial information is not sufficiently timely or when the investee’s reporting period differs from the Company’s reporting period.

The Company uses the cost method of accounting for investments in which it has virtually no influence over the investee’s operations. The Company recognizes distributions on cost method investments as earned or received. Because of the nature and structure of these cost method investments, they do not meet the characteristics of an equity security in accordance with applicable accounting standards.

The Company routinely evaluates its equity method and cost method investments for impairment. For equity method investees, the Company considers financial and other information provided by the investee, other known information and inherent risks in the underlying investments, as well as future capital commitments, in determining whether an impairment has occurred. The Company considers its cost method investments for impairment when the carrying value of such investments exceeds the net asset value (“NAV”). The Company takes into consideration the severity and duration of this excess when determining whether the cost method investment is impaired.

Short-term Investments

Short-term investments include securities and other investments with remaining maturities of one year or less, but greater than three months, at the time of purchase and are stated at estimated fair value or amortized cost, which approximates estimated fair value.

Other Invested Assets

Other invested assets consist principally of the following:

 

•

Loans to affiliates are stated at unpaid principal balance, adjusted for any unamortized premium or discount.

•

Freestanding derivatives with positive estimated fair values are described in “—Derivatives” below.

Securities Lending Program

Securities lending transactions, whereby blocks of securities are loaned to third parties, primarily brokerage firms and commercial banks, are treated as financing arrangements and the associated liability is recorded at the amount of cash received. The Company obtains collateral at the inception of the loan, usually cash, in an amount generally equal to 102% of the estimated fair value of the securities loaned, and maintains it at a level greater than or equal to 100% for the duration of the loan. The Company is liable to return to the counterparties the cash collateral received. Security collateral on deposit from counterparties in connection with the securities lending transactions may not be sold or repledged, unless the counterparty is in default, and is not reflected in the financial statements. The Company monitors the estimated fair value of the securities loaned on a daily basis and additional collateral is obtained as necessary. Income and expenses associated with securities lending transactions are reported as investment income and investment expense, respectively, within net investment income.

 

14

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

1.  Business, Basis of Presentation and Summary of Significant Accounting Policies (continued)

 

Derivatives

Freestanding Derivatives

Freestanding derivatives are carried in the Company’s balance sheets either as assets within other invested assets or as liabilities within other liabilities at estimated fair value. The Company does not offset the fair value amounts recognized for derivatives executed with the same counterparty under the same master netting agreement.

Accruals on derivatives are generally recorded in accrued investment income or within other liabilities. However, accruals that are not scheduled to settle within one year are included with the derivatives carrying value in other invested assets or other liabilities.

If a derivative is not designated as an accounting hedge or its use in managing risk does not qualify for hedge accounting, changes in the estimated fair value of the derivative are reported in net derivative gains (losses).

Hedge Accounting

To qualify for hedge accounting, at the inception of the hedging relationship, the Company formally documents its risk management objective and strategy for undertaking the hedging transaction, as well as its designation of the hedge. Hedge designation and financial statement presentation of changes in estimated fair value of the hedging derivatives are as follows:

 

•

Fair value hedge (a hedge of the estimated fair value of a recognized asset or liability)—in net derivative gains (losses), consistent with the change in fair value of the hedged item attributable to the designated risk being hedged.

 

•

Cash flow hedge (a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability)—effectiveness in OCI (deferred gains or losses on the derivative are reclassified into the statement of operations when the Company’s earnings are affected by the variability in cash flows of the hedged item); ineffectiveness in net derivative gains (losses).

The changes in estimated fair values of the hedging derivatives are exclusive of any accruals that are separately reported in the statement of operations within interest income or interest expense to match the location of the hedged item.

In its hedge documentation, the Company sets forth how the hedging instrument is expected to hedge the designated risks related to the hedged item and sets forth the method that will be used to retrospectively and prospectively assess the hedging instrument’s effectiveness and the method that will be used to measure ineffectiveness. A derivative designated as a hedging instrument must be assessed as being highly effective in offsetting the designated risk of the hedged item. Hedge effectiveness is formally assessed at inception and at least quarterly throughout the life of the designated hedging relationship. Assessments of hedge effectiveness and measurements of ineffectiveness are also subject to interpretation and estimation and different interpretations or estimates may have a material effect on the amount reported in net income.

 

15

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

1.  Business, Basis of Presentation and Summary of Significant Accounting Policies (continued)

 

The Company discontinues hedge accounting prospectively when: (i) it is determined that the derivative is no longer highly effective in offsetting changes in the estimated fair value or cash flows of a hedged item; (ii) the derivative expires, is sold, terminated, or exercised; (iii) it is no longer probable that the hedged forecasted transaction will occur; or (iv) the derivative is de-designated as a hedging instrument.

When hedge accounting is discontinued because it is determined that the derivative is not highly effective in offsetting changes in the estimated fair value or cash flows of a hedged item, the derivative continues to be carried in the balance sheets at its estimated fair value, with changes in estimated fair value recognized in net derivative gains (losses). The carrying value of the hedged recognized asset or liability under a fair value hedge is no longer adjusted for changes in its estimated fair value due to the hedged risk, and the cumulative adjustment to its carrying value is amortized into income over the remaining life of the hedged item. Provided the hedged forecasted transaction is still probable of occurrence, the changes in estimated fair value of derivatives recorded in OCI related to discontinued cash flow hedges are released into the statements of operations when the Company’s earnings are affected by the variability in cash flows of the hedged item.

When hedge accounting is discontinued because it is no longer probable that the forecasted transactions will occur on the anticipated date or within two months of that date, the derivative continues to be carried in the balance sheets at its estimated fair value, with changes in estimated fair value recognized currently in net derivative gains (losses). Deferred gains and losses of a derivative recorded in OCI pursuant to the discontinued cash flow hedge of a forecasted transaction that is no longer probable are recognized immediately in net derivative gains (losses).

In all other situations in which hedge accounting is discontinued, the derivative is carried at its estimated fair value in the balance sheets, with changes in its estimated fair value recognized in the current period as net derivative gains (losses).

Embedded Derivatives

The Company sells variable annuities and issues certain insurance products and investment contracts and is a party to certain reinsurance agreements that have embedded derivatives. The Company assesses each identified embedded derivative to determine whether it is required to be bifurcated. The embedded derivative is bifurcated from the host contract and accounted for as a freestanding derivative if:

 

•

the combined instrument is not accounted for in its entirety at fair value with changes in fair value recorded in earnings;

•

the terms of the embedded derivative are not clearly and closely related to the economic characteristics of the host contract; and

•

a separate instrument with the same terms as the embedded derivative would qualify as a derivative instrument.

Such embedded derivatives are carried in the balance sheets at estimated fair value with the host contract and changes in their estimated fair value are generally reported in net derivative gains (losses). If the Company is unable to properly identify and measure an embedded derivative for separation from its host contract, the entire contract is carried on the balance sheet at estimated fair value, with changes in estimated fair value recognized in the current period in net investment gains (losses) or net investment income. Additionally, the

 

16

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

1.  Business, Basis of Presentation and Summary of Significant Accounting Policies (continued)

 

Company may elect to carry an entire contract on the balance sheet at estimated fair value, with changes in estimated fair value recognized in the current period in net investment gains (losses) or net investment income if that contract contains an embedded derivative that requires bifurcation. At inception, the Company attributes to the embedded derivative a portion of the projected future guarantee fees to be collected from the policyholder equal to the present value of projected future guaranteed benefits. Any additional fees represent “excess” fees and are reported in universal life and investment-type product policy fees.

Fair Value

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. In most cases, the exit price and the transaction (or entry) price will be the same at initial recognition.

Subsequent to initial recognition, fair values are based on unadjusted quoted prices for identical assets or liabilities in active markets that are readily and regularly obtainable. When such quoted prices are not available, fair values are based on quoted prices in markets that are not active, quoted prices for similar but not identical assets or liabilities, or other observable inputs. If these inputs are not available, or observable inputs are not determinable, unobservable inputs and/or adjustments to observable inputs requiring management judgment are used to determine the estimated fair value of assets and liabilities.

Goodwill

Goodwill, which is included in other assets, is the excess of cost over the estimated fair value of net assets acquired which represents the future economic benefits arising from such net assets acquired that could not be individually identified. Goodwill is not amortized but is tested for impairment at least annually or more frequently if events or circumstances, such as adverse changes in the business climate, indicate that there may be justification for conducting an interim test. The Company performs its annual goodwill impairment testing during the third quarter of each year based upon data as of the close of the second quarter. Goodwill associated with a business acquisition is not tested for impairment during the year the business is acquired unless there is a significant identified impairment event.

Impairment testing is performed using the fair value approach, which requires the use of estimates and judgment, at the “reporting unit” level. A reporting unit is the operating segment or a business one level below the operating segment, if discrete financial information is prepared and regularly reviewed by management at that level. Management has concluded that the Company has one reporting unit.

For purposes of goodwill impairment testing, if the carrying value of a reporting unit exceeds its estimated fair value, there may be an indication of impairment. In such instances, the implied fair value of the goodwill is determined in the same manner as the amount of goodwill that would be determined in a business combination. The excess of the carrying value of goodwill over the implied fair value of goodwill would be recognized as an impairment and recorded as a charge against net income.

In performing the Company’s goodwill impairment test, the estimated fair value of the reporting unit is determined using a market multiple approach. When further corroboration is required, the Company uses a discounted cash flow approach. The Company may use additional valuation methodologies when appropriate.

 

17

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

1.  Business, Basis of Presentation and Summary of Significant Accounting Policies (continued)

 

The key inputs, judgments and assumptions necessary in determining estimated fair value of the reporting unit include projected operating earnings, current book value, the level of economic capital required to support the mix of business, long-term growth rates, comparative market multiples, the account value of in-force business, projections of new and renewal business, as well as margins on such business, the level of interest rates, credit spreads, equity market levels, and the discount rate that the Company believes is appropriate for the reporting unit.

The Company applies significant judgment when determining the estimated fair value of its reporting unit. The valuation methodologies utilized are subject to key judgments and assumptions that are sensitive to change. Estimates of fair value are inherently uncertain and represent only management’s reasonable expectation regarding future developments. These estimates and the judgments and assumptions upon which the estimates are based will, in all likelihood, differ in some respects from actual future results. Declines in the estimated fair value of the Company’s reporting unit could result in goodwill impairments in future periods which could adversely affect the Company’s results of operations or financial position.

In 2013, the Company performed its annual goodwill impairment test using the market multiple valuation approach. The analysis results indicated that the fair value of the reporting unit was in excess of its carrying value and, therefore, goodwill was not impaired. On an ongoing basis, the Company evaluates potential triggering events that may affect the estimated fair value of the Company’s reporting unit to assess whether any goodwill impairment exists. Deteriorating or adverse market conditions may have an impact on the estimated fair value and could result in future impairments of goodwill. The Company has no accumulated goodwill impairment as of December 31, 2013. Goodwill was $33 million at both December 31, 2013 and 2012.

Income Tax

The Company joined with MetLife and its includable subsidiaries in filing a consolidated U.S. life and non-life federal income tax return in accordance with the provisions of the Internal Revenue Code of 1986, as amended. Current taxes (and the benefits of tax attributes such as losses) are allocated to the Company under the consolidated tax return regulations and a tax sharing agreement. Under the consolidated tax return regulations, MetLife has elected the “percentage method” (and 100 percent under such method) of reimbursing companies for tax attributes such as losses. As a result, 100 percent of tax attributes such as losses are reimbursed by MetLife to the extent that consolidated federal income tax of the consolidated federal tax return group is reduced in a year by tax attributes such as losses. Profitable subsidiaries pay to MetLife each year the federal income tax which such profitable subsidiary would have paid that year based upon that year’s taxable income. If the Company has current or prior deductions and credits (including but not limited to losses) which reduce the consolidated tax liability of the consolidated federal tax return group, the deductions and credits are characterized as realized (or realizable) by the Company when those tax attributes are realized (or realizable) by the consolidated federal tax return group, even if the Company would not have realized the attributes on a stand-alone basis under a “wait and see” method.

The Company’s accounting for income taxes represents management’s best estimate of various events and transactions.

 

18

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

1.  Business, Basis of Presentation and Summary of Significant Accounting Policies (continued)

 

Deferred tax assets and liabilities resulting from temporary differences between the financial reporting and tax bases of assets and liabilities are measured at the balance sheet date using enacted tax rates expected to apply to taxable income in the years the temporary differences are expected to reverse.

The realization of deferred tax assets depends upon the existence of sufficient taxable income within the carryback or carryforward periods under the tax law in the applicable tax jurisdiction. Valuation allowances are established when management determines, based on available information, that it is more likely than not that deferred income tax assets will not be realized. Factors in management’s determination include the performance of the business and its ability to generate capital gains. Significant judgment is required in determining whether valuation allowances should be established, as well as the amount of such allowances. When making such determination, consideration is given to, among other things, the following:

 

•

future taxable income exclusive of reversing temporary differences and carryforwards;

•

future reversals of existing taxable temporary differences;

•

taxable income in prior carryback years; and

•

tax planning strategies.

The Company may be required to change its provision for income taxes in certain circumstances. Examples of such circumstances include when estimates used in determining valuation allowances on deferred tax assets significantly change or when receipt of new information indicates the need for adjustment in valuation allowances. Additionally, future events, such as changes in tax laws, tax regulations, or interpretations of such laws or regulations, could have an impact on the provision for income tax and the effective tax rate. Any such changes could significantly affect the amounts reported in the financial statements in the year these changes occur.

The Company determines whether it is more likely than not that a tax position will be sustained upon examination by the appropriate taxing authorities before any part of the benefit can be recorded in the financial statements. A tax position is measured at the largest amount of benefit that is greater than 50% likely of being realized upon settlement. Unrecognized tax benefits due to tax uncertainties that do not meet the threshold are included within other liabilities and are charged to earnings in the period that such determination is made.

The Company classifies interest recognized as interest expense and penalties recognized as a component of income tax.

Litigation Contingencies

The Company is a party to a number of legal actions and is involved in a number of regulatory investigations. Given the inherent unpredictability of these matters, it is difficult to estimate the impact on the Company’s financial position. Liabilities are established when it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. Legal costs are recognized as incurred. On an annual basis, the Company reviews relevant information with respect to liabilities for litigation, regulatory investigations and litigation-related contingencies to be reflected in the Company’s financial statements.

 

19

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

1.  Business, Basis of Presentation and Summary of Significant Accounting Policies (continued)

 

Other Accounting Policies

Cash and Cash Equivalents

The Company considers all highly liquid securities and other investments purchased with an original or remaining maturity of three months or less at the date of purchase to be cash equivalents. Cash equivalents are stated at amortized cost, which approximates estimated fair value.

Computer Software

Computer software, which is included in other assets, is stated at cost, less accumulated amortization. Purchased software costs, as well as certain internal and external costs incurred to develop internal-use computer software during the application development stage, are capitalized. Such costs are amortized generally over a four-year period using the straight-line method. The cost basis of computer software was $15 million and $14 million at December 31, 2013 and 2012, respectively. Accumulated amortization of capitalized software was $8 million and $6 million at December 31, 2013 and 2012, respectively. Related amortization expense was $2 million for each of the years ended December 31, 2013, 2012 and 2011.

Fees on Ceded Reinsurance and Other

Fees on ceded reinsurance and other primarily include, in addition to items described elsewhere herein, fee income on financial reinsurance agreements. Such fees are recognized in the period in which services are performed.

Adoption of New Accounting Pronouncements

Effective July 17, 2013, the Company adopted new guidance regarding derivatives that permits the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) to be used as a U.S. benchmark interest rate for hedge accounting purposes, in addition to the United States Treasury and London Interbank Offered Rate. Also, this new guidance removes the restriction on using different benchmark rates for similar hedges. The new guidance did not have a material impact on the financial statements upon adoption, but may impact the selection of benchmark interest rates for hedging relationships in the future.

Effective January 1, 2013, the Company adopted new guidance regarding comprehensive income that requires an entity to provide information about the amounts reclassified out of accumulated OCI (“AOCI”) by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of AOCI by the respective line items of net income but only if the amount reclassified is required under GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under GAAP that provide additional detail about those amounts. The adoption was prospectively applied and resulted in additional disclosures in Note 8.

Effective January 1, 2013, the Company adopted new guidance regarding balance sheet offsetting disclosures which requires an entity to disclose information about offsetting and related arrangements for derivatives, including bifurcated embedded derivatives, repurchase and reverse repurchase agreements, and securities

 

20

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

1.  Business, Basis of Presentation and Summary of Significant Accounting Policies (continued)

 

borrowing and lending transactions, to enable users of its financial statements to understand the effects of those arrangements on its financial position. Entities are required to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement. The adoption was retrospectively applied and resulted in additional disclosures related to derivatives in Note 6.

On January 1, 2012, the Company adopted new guidance regarding accounting for DAC, which was retrospectively applied. The guidance specifies that only costs related directly to successful acquisition of new or renewal contracts can be capitalized as DAC; all other acquisition-related costs must be expensed as incurred. As a result, certain sales manager compensation and administrative costs previously capitalized by the Company will no longer be deferred.

On January 1, 2012, the Company adopted new guidance regarding comprehensive income, which was retrospectively applied, that provides companies with the option to present the total of comprehensive income, components of net income, and the components of OCI either in a single continuous statement of comprehensive income or in two separate but consecutive statements in annual financial statements. The standard eliminates the option to present components of OCI as part of the statement of changes in stockholder’s equity. The Company adopted the two-statement approach for annual financial statements.

Effective January 1, 2012, the Company adopted new guidance regarding fair value measurements that establishes common requirements for measuring fair value and for disclosing information about fair value measurements in accordance with GAAP and International Financial Reporting Standards. Some of the amendments clarify the Financial Accounting Standards Board’s (“FASB”) intent on the application of existing fair value measurement requirements. Other amendments change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements. The adoption did not have a material impact on the Company’s financial statements other than the expanded disclosures in Note 7.

Future Adoption of New Accounting Pronouncements

In February 2013, the FASB issued new guidance regarding liabilities (Accounting Standards Update 2013-04, Liabilities (Topic 405): Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation Is Fixed at the Reporting Date), effective retrospectively for fiscal years beginning after December 15, 2013 and interim periods within those years. The amendments require an entity to measure obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of the guidance is fixed at the reporting date, as the sum of the amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors and any additional amount the reporting entity expects to pay on behalf of its co-obligors. In addition, the amendments require an entity to disclose the nature and amount of the obligation, as well as other information about the obligation. The Company does not expect the adoption of this new guidance to have a material impact on its financial statements.

 

21

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

2.  Insurance

 

Insurance Liabilities

Future policy benefits are measured as follows:

 

Product Type:		Measurement Assumptions:
Nonparticipating life		Aggregate of the present value of expected future benefit payments and related expenses less the present value of expected future net premiums. Assumptions as to mortality and persistency are based upon the Company’s experience when the basis of the liability is established. Interest rate assumptions for the aggregate future policy benefit liabilities are 5%.
Traditional fixed annuities after annuitization		Present value of expected future payments. Interest rate assumptions used in establishing such liabilities range from 3% to 8%.

PABs are equal to: (i) policy account values, which consist of an accumulation of gross premium payments; and (ii) credited interest, ranging from 1% to 8%, less expenses, mortality charges and withdrawals.

 

22

---

MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

2.  Insurance (continued)

 

Guarantees

The Company issues variable annuity products with guaranteed minimum benefits. The non-life contingent portion of GMWBs and the portion of certain GMIBs that does not require annuitization are accounted for as embedded derivatives in PABs and are further discussed in Note 6. Guarantees accounted for as insurance liabilities include:

 

Guarantee:						Measurement Assumptions:
GMDBs		•  A return of purchase payment upon death even if the account value is reduced to zero.				•  Present value of expected death benefits in excess of the projected account balance recognizing the excess ratably over the accumulation period based on the present value of total expected assessments.
		•  An enhanced death benefit may be available for an additional fee.				•  Assumptions are consistent with those used for amortizing DAC, and are thus subject to the same variability and risk.
						•  Investment performance and volatility assumptions are consistent with the historical experience of the appropriate underlying equity index, such as the Standard & Poor’s Ratings Services (“S&P”) 500 Index.
						•  Benefit assumptions are based on the average benefits payable over a range of scenarios.
GMIBs		•  After a specified period of time determined at the time of issuance of the variable annuity contract, a minimum accumulation of purchase payments, even if the account value is reduced to zero, that can be annuitized to receive a monthly income stream that is not less than a specified amount.				•  Present value of expected income benefits in excess of the projected account balance at any future date of annuitization and recognizing the excess ratably over the accumulation period based on present value of total expected assessments.
		•  Certain contracts also provide for a guaranteed lump sum return of purchase premium in lieu of the annuitization benefit.				•  Assumptions are consistent with those used for estimating GMDB liabilities.
						•  Calculation incorporates an assumption for the percentage of the potential annuitizations that may be elected by the contractholder.
GMWBs		•  A return of purchase payment via partial withdrawals, even if the account value is reduced to zero, provided that cumulative withdrawals in a contract year do not exceed a certain limit.				•  Expected value of the life contingent payments and expected assessments using assumptions consistent with those used for estimating the GMDB liabilities.
		•  Certain contracts include guaranteed withdrawals that are life contingent.

 

23

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

2.  Insurance (continued)

 

Information regarding the liabilities for guarantees (excluding base policy liabilities and embedded derivatives) relating to annuity contracts was as follows:

 

		Annuity Contracts								Total
		GMDBs				GMIBs
		(In millions)
Direct
Balance at January 1, 2011		$	32			$	88			$	120
Incurred guaranteed benefits			17				31				48
Paid guaranteed benefits			(7)				—				(7)
Balance at December 31, 2011			42				119				161
Incurred guaranteed benefits			10				98				108
Paid guaranteed benefits			(9)				—				(9)
Balance at December 31, 2012			43				217				260
Incurred guaranteed benefits			11				1				12
Paid guaranteed benefits			(5)				—				(5)
Balance at December 31, 2013		$	49			$	218			$	267
Ceded
Balance at January 1, 2011		$	32			$	30			$	62
Incurred guaranteed benefits			17				11				28
Paid guaranteed benefits			(7)				—				(7)
Balance at December 31, 2011			42				41				83
Incurred guaranteed benefits			10				34				44
Paid guaranteed benefits			(9)				—				(9)
Balance at December 31, 2012			43				75				118
Incurred guaranteed benefits			11				1				12
Paid guaranteed benefits			(5)				—				(5)
Balance at December 31, 2013		$	49			$	76			$	125
Net
Balance at January 1, 2011		$	—			$	58			$	58
Incurred guaranteed benefits			—				20				20
Paid guaranteed benefits			—				—				—
Balance at December 31, 2011			—				78				78
Incurred guaranteed benefits			—				64				64
Paid guaranteed benefits			—				—				—
Balance at December 31, 2012			—				142				142
Incurred guaranteed benefits			—				—				—
Paid guaranteed benefits			—				—				—
Balance at December 31, 2013		$	—			$	142			$	142

 

24

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

2.  Insurance (continued)

 

Account balances of contracts with insurance guarantees were invested in separate account asset classes as follows at:

 

		December 31,
		2013				2012
		(In millions)
Fund Groupings:
Balanced		$	7,255			$	6,507
Equity			4,086				3,816
Bond			551				588
Money Market			98				118
Total		$	11,990			$	11,029

Based on the type of guarantee, the Company defines net amount at risk as listed below. These amounts include direct business, but exclude offsets from hedging or reinsurance, if any.

Variable Annuity Guarantees

In the Event of Death

Defined as the death benefit less the total contract account value, as of the balance sheet date. It represents the amount of the claim that the Company would incur if death claims were filed on all contracts on the balance sheet date and includes any additional contractual claims associated with riders purchased to assist with covering income taxes payable upon death.

At Annuitization

Defined as the amount (if any) that would be required to be added to the total contract account value to purchase a lifetime income stream, based on current annuity rates, equal to the minimum amount provided under the guaranteed benefit. This amount represents the Company’s potential economic exposure to such guarantees in the event all contractholders were to annuitize on the balance sheet date, even though the contracts contain terms that allow annuitization of the guaranteed amount only after the 10th anniversary of the contract, which not all contractholders have achieved.

Information regarding the types of guarantees relating to annuity contracts was as follows at:

 

		December 31,
		2013								2012
		In the Event of Death				At Annuitization				In the Event of Death				At Annuitization
		(In millions)
Annuity Contracts (1)
Variable Annuity Guarantees
Total contract account value		$	13,348			$	8,712			$	12,309			$	7,963
Separate account value		$	12,841			$	8,470			$	11,797			$	7,715
Net amount at risk		$	327			$	116			$	594			$	554
Average attained age of contractholders			67 years				66 years				66 years				65 years

 

 

 

(1)	The Company’s annuity contracts with guarantees may offer more than one type of guarantee in each contract. Therefore, the amounts listed above may not be mutually exclusive.

 

25

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

2.  Insurance (continued)

 

Obligations Under Funding Agreements

MLIIC is a member of the Federal Home Loan Bank (“FHLB”) of Des Moines. Holdings of the FHLB of Des Moines common stock, included in equity securities, were as follows at:

 

		December 31,
		2013				2012
		(In millions)
FHLB of Des Moines		$	26			$	28

The Company has also entered into funding agreements with the FHLB of Des Moines. The liability for such funding agreements is included in PABs. Information related to such funding agreements was as follows at:

 

		Liability								Collateral
		December 31,
		2013				2012				2013				2012
		(In millions)
FHLB of Des Moines (1)		$	405			$	405			$	477 (2)			$	604 (2)

 

 

 

(1)

Represents funding agreements issued to the FHLB of Des Moines in exchange for cash and for which the FHLB of Des Moines has been granted a lien on certain assets, some of which are in the custody of the FHLB of Des Moines, including residential mortgage-backed securities (“RMBS”), to collateralize obligations under advances evidenced by funding agreements. The Company is permitted to withdraw any portion of the collateral in the custody of the FHLB of Des Moines as long as there is no event of default and the remaining qualified collateral is sufficient to satisfy the collateral maintenance level. Upon any event of default by the Company, the FHLB of Des Moines’ recovery on the collateral is limited to the amount of the Company’s liability to the FHLB of Des Moines.

 

(2)	Advances are collateralized by mortgage-backed securities. The amount of collateral presented is at estimated fair value.

Separate Accounts

Separate account assets and liabilities consist of pass-through separate accounts totaling $12.0 billion and $11.1 billion at December 31, 2013 and 2012, respectively, for which the policyholder assumes all investment risk.

For the years ended December 31, 2013, 2012 and 2011, there were no investment gains (losses) on transfers of assets from the general account to the separate accounts.

3.  Deferred Policy Acquisition Costs, Value of Business Acquired and Other Policy-Related Intangibles

See Note 1 for a description of capitalized acquisition costs.

 

26

---

MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

3.  Deferred Policy Acquisition Costs, Value of Business Acquired and Other Policy-Related Intangibles (continued)

 

Fixed and Variable Universal Life Contracts and Fixed and Variable Deferred Annuity Contracts

The Company amortizes DAC and VOBA related to these contracts over the estimated lives of the contracts in proportion to actual and expected future gross profits. The amortization includes interest based on rates in effect at inception or acquisition of the contracts. The amount of future gross profits is dependent principally upon returns in excess of the amounts credited to policyholders, mortality, persistency, interest crediting rates, expenses to administer the business, creditworthiness of reinsurance counterparties, the effect of any hedges used and certain economic variables, such as inflation. Of these factors, the Company anticipates that investment returns, expenses and persistency are reasonably likely to impact significantly the rate of DAC and VOBA amortization. Each reporting period, the Company updates the estimated gross profits with the actual gross profits for that period. When the actual gross profits change from previously estimated gross profits, the cumulative DAC and VOBA amortization is re-estimated and adjusted by a cumulative charge or credit to current operations. When actual gross profits exceed those previously estimated, the DAC and VOBA amortization will increase, resulting in a current period charge to earnings. The opposite result occurs when the actual gross profits are below the previously estimated gross profits. Each reporting period, the Company also updates the actual amount of business remaining in-force, which impacts expected future gross profits. When expected future gross profits are below those previously estimated, the DAC and VOBA amortization will increase, resulting in a current period charge to earnings. The opposite result occurs when the expected future gross profits are above the previously estimated expected future gross profits. Each period, the Company also reviews the estimated gross profits for each block of business to determine the recoverability of DAC and VOBA balances.

Factors Impacting Amortization

Separate account rates of return on variable universal life contracts and variable deferred annuity contracts affect in-force account balances on such contracts each reporting period, which can result in significant fluctuations in amortization of DAC and VOBA. Returns that are higher than the Company’s long-term expectation produce higher account balances, which increases the Company’s future fee expectations and decreases future benefit payment expectations on minimum death and living benefit guarantees, resulting in higher expected future gross profits. The opposite result occurs when returns are lower than the Company’s long-term expectation. The Company’s practice to determine the impact of gross profits resulting from returns on separate accounts assumes that long-term appreciation in equity markets is not changed by short-term market fluctuations, but is only changed when sustained interim deviations are expected. The Company monitors these events and only changes the assumption when its long-term expectation changes.

The Company also periodically reviews other long-term assumptions underlying the projections of estimated gross profits. These assumptions primarily relate to investment returns, interest crediting rates, mortality, persistency and expenses to administer business. Management annually updates assumptions used in the calculation of estimated gross profits which may have significantly changed. If the update of assumptions causes expected future gross profits to increase, DAC and VOBA amortization will decrease, resulting in a current period increase to earnings. The opposite result occurs when the assumption update causes expected future gross profits to decrease.

Periodically, the Company modifies product benefits, features, rights or coverages that occur by the exchange of a contract for a new contract, or by amendment, endorsement, or rider to a contract, or by election or coverage

 

27

---

MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

3.  Deferred Policy Acquisition Costs, Value of Business Acquired and Other Policy-Related Intangibles (continued)

 

within a contract. If such modification, referred to as an internal replacement, substantially changes the contract, the associated DAC or VOBA is written off immediately through income and any new deferrable costs associated with the replacement contract are deferred. If the modification does not substantially change the contract, the DAC or VOBA amortization on the original contract will continue and any acquisition costs associated with the related modification are expensed.

Amortization of DAC and VOBA is attributed to net investment gains (losses) and net derivative gains (losses), and to other expenses for the amount of gross profits originating from transactions other than investment gains and losses. Unrealized investment gains and losses represent the amount of DAC and VOBA that would have been amortized if such gains and losses had been recognized.

Information regarding DAC and VOBA was as follows:

 

		Years Ended December 31,
		2013				2012				2011
		(In millions)
DAC
Balance at January 1,		$	97			$	220			$	352
Capitalizations			6				19				34
Amortization related to:
Net investment gains (losses) and net derivative gains (losses)			122				(96)				(84)
Other expenses			(27)				(38)				(76)
Total amortization			95				(134)				(160)
Unrealized investment gains (losses)			8				(8)				(6)
Other (1)			38				—				—
Balance at December 31,			244				97				220
VOBA
Balance at January 1,			51				66				79
Total amortization related to other expenses			(6)				(14)				(12)
Unrealized investment gains (losses)			2				(1)				(1)
Balance at December 31,			47				51				66
Total DAC and VOBA
Balance at December 31,		$	291			$	148			$	286

 

 

 

(1)

The year ended December 31, 2013 includes $38 million that was reclassified to DAC from premiums, reinsurance and other receivables. The amounts reclassified relate to an affiliated reinsurance agreement accounted for using the deposit method of accounting and represent the DAC amortization on the expense allowances ceded on the agreement from inception. These amounts were previously included in the calculated value of the deposit receivable on this agreement and recorded within premiums, reinsurance and other receivables.

 

28

---

MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

3.  Deferred Policy Acquisition Costs, Value of Business Acquired and Other Policy-Related Intangibles (continued)

 

Information regarding other policy-related intangibles was as follows:

 

		Years Ended December 31,
		2013				2012				2011
		(In millions)
Deferred Sales Inducements
Balance at January 1,		$	65			$	71			$	84
Capitalization			—				1				3
Amortization			(2)				(7)				(16)
Balance at December 31,		$	63			$	65			$	71

The estimated future amortization expense to be reported in other expenses for the next five years is as follows:

 

		VOBA
		(In millions)
2014		$	12
2015		$	10
2016		$	9
2017		$	6
2018		$	6

4.  Reinsurance

The Company enters into reinsurance agreements primarily as a purchaser of reinsurance for its various insurance products. The Company participates in reinsurance activities in order to limit losses and minimize exposure to significant risks.

Accounting for reinsurance requires extensive use of assumptions and estimates, particularly related to the future performance of the underlying business and the potential impact of counterparty credit risks. The Company periodically reviews actual and anticipated experience compared to the aforementioned assumptions used to establish assets and liabilities relating to ceded reinsurance and evaluates the financial strength of counterparties to its reinsurance agreements using criteria similar to that evaluated in the security impairment process discussed in Note 5.

For its individual life insurance products, the Company has historically reinsured the mortality risk primarily on an excess of retention basis or on a quota share basis. In addition to reinsuring mortality risk as described above, the Company reinsures other risks, as well as specific coverages. Placement of reinsurance is done primarily on an automatic basis and also on a facultative basis for risks with specified characteristics.

The Company currently reinsures 100% of the living and death benefit guarantees issued in connection with its variable annuities to affiliated reinsurers. Under these reinsurance agreements, the Company pays a reinsurance premium generally based on fees associated with the guarantees collected from policyholders, and receives reimbursement for benefits paid or accrued in excess of account values, subject to certain limitations. The Company also reinsures 90% of its fixed annuities to an affiliated reinsurer. The value of the embedded

 

29

---

MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

4.  Reinsurance (continued)

 

derivatives on the ceded risk is determined using a methodology consistent with the guarantees directly written by the Company with the exception of the input for nonperformance risk that reflects the credit of the reinsurer.

The Company has exposure to catastrophes which could contribute to significant fluctuations in the Company’s results of operations. The Company uses excess of retention and quota share reinsurance agreements to provide greater diversification of risk and minimize exposure to larger risks.

The Company reinsures its remaining business through a diversified group of well-capitalized reinsurers. The Company analyzes recent trends in arbitration and litigation outcomes in disputes, if any, with its reinsurers. The Company monitors ratings and evaluates the financial strength of its reinsurers by analyzing their financial statements. In addition, the reinsurance recoverable balance due from each reinsurer is evaluated as part of the overall monitoring process. Recoverability of reinsurance recoverable balances is evaluated based on these analyses. These reinsurance recoverable balances are stated net of allowances for uncollectible reinsurance, which at December 31, 2013 and 2012, were not significant.

The Company had $6 million and $8 million of unsecured unaffiliated ceded reinsurance recoverable balances at December 31, 2013 and 2012, respectively. Of these totals, 100% were with the Company’s five largest unaffiliated ceded reinsurers at both December 31, 2013 and 2012.

The amounts in the statements of operations include the impact of reinsurance. Information regarding the significant effects of reinsurance was as follows:

 

		Years Ended December 31,
		2013				2012				2011
		(In millions)
Premiums
Direct premiums		$	30			$	12			$	8
Reinsurance ceded			(1)				(1)				(1)
Net premiums		$	29			$	11			$	7
Universal life and investment-type product policy fees
Direct universal life and investment-type product policy fees		$	244			$	237			$	240
Reinsurance ceded			(42)				(39)				(36)
Net universal life and investment-type product policy fees		$	202			$	198			$	204
Fees on ceded reinsurance and other
Direct fees on ceded reinsurance and other		$	25			$	25			$	26
Reinsurance ceded			65				68				78
Net fees on ceded reinsurance and other		$	90			$	93			$	104
Policyholder benefits and claims
Direct policyholder benefits and claims		$	61			$	144			$	92
Reinsurance ceded			(13)				(44)				(33)
Net policyholder benefits and claims		$	48			$	100			$	59

 

30

---

MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

4.  Reinsurance (continued)

 

The amounts in the balance sheets include the impact of reinsurance. Information regarding the significant effects of reinsurance was as follows at:

 

		December 31,
		2013												2012
		Direct				Ceded				Total Balance Sheet				Direct				Ceded				Total Balance Sheet
		(In millions)
Assets
Premiums, reinsurance and other receivables		$	26			$	1,803			$	1,829			$	26			$	2,459			$	2,485
Deferred policy acquisition costs and value of business acquired			311				(20)				291				207				(59)				148
Total assets		$	337			$	1,783			$	2,120			$	233			$	2,400			$	2,633

Reinsurance agreements that do not expose the Company to a reasonable possibility of a significant loss from insurance risk are recorded using the deposit method of accounting. Deposit assets and deposit liabilities, if any, are the result of affiliated reinsurance transactions. See “ Related Party Reinsurance Transactions.”

Related Party Reinsurance Transactions

The Company has reinsurance agreements with certain MetLife subsidiaries, including Metropolitan Life Insurance Company, General American Life Insurance Company, Exeter and MICC, all of which are related parties.

Information regarding the significant effects of affiliated reinsurance included in the statements of operations was as follows:

 

		Years Ended December 31,
		2013				2012				2011
		(In millions)
Premiums
Reinsurance ceded		$	—			$	(1)			$	—
Universal life and investment-type product policy fees
Reinsurance ceded		$	(41)			$	(39)			$	(35)
Fees on ceded reinsurance and other
Reinsurance ceded		$	65			$	68			$	78
Policyholder benefits and claims
Reinsurance ceded		$	(13)			$	(44)			$	(31)

 

31

---

MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

4.  Reinsurance (continued)

 

Information regarding the significant effects of ceded affiliated reinsurance included in the balance sheets was as follows at:

 

		December 31,
		2013				2012
		(In millions)
Assets
Premiums, reinsurance and other receivables		$	1,798			$	2,451
Deferred policy acquisition costs and value of business acquired			(20)				(59)
Total assets		$	1,778			$	2,392

The Company ceded risks to affiliates related to guaranteed minimum benefit guarantees written directly by the Company. These ceded reinsurance agreements contain embedded derivatives and changes in their fair value are included within net derivative gains (losses). The embedded derivatives associated with the cessions are included within premiums, reinsurance and other receivables and were assets of $376 million and $959 million at December 31, 2013 and 2012, respectively. Net derivative gains (losses) associated with the embedded derivatives were ($639) million, $190 million and $380 million for the years ended December 31, 2013, 2012 and 2011, respectively.

The Company has secured certain reinsurance recoverable balances with various forms of collateral, including secured trusts and irrevocable letters of credit. The Company had $1.3 billion and $1.4 billion of unsecured affiliated reinsurance recoverable balances at December 31, 2013 and 2012, respectively.

Affiliated reinsurance agreements that do not expose the Company to a reasonable possibility of a significant loss from insurance risk are recorded using the deposit method of accounting. The deposit assets on affiliated reinsurance were $1.3 billion and $1.4 billion at December 31, 2013 and 2012, respectively. There were no deposit liabilities on affiliated reinsurance at both December 31, 2013 and 2012.

5.  Investments

See Note 7 for information about the fair value hierarchy for investments and the related valuation methodologies.

Investment Risks and Uncertainties

Investments are exposed to the following primary sources of risk: credit, interest rate, liquidity, market valuation, currency and real estate risk. The financial statement risks, stemming from such investment risks, are those associated with the determination of estimated fair values, the diminished ability to sell certain investments in times of strained market conditions, the recognition of impairments, the recognition of income on certain investments and the potential consolidation of variable interest entities (“VIEs”). The use of different methodologies, assumptions and inputs relating to these financial statement risks may have a material effect on the amounts presented within the financial statements.

The determination of valuation allowances and impairments is highly subjective and is based upon periodic evaluations and assessments of known and inherent risks associated with the respective asset class. Such evaluations and assessments are revised as conditions change and new information becomes available.

 

32

---

MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

5.  Investments (continued)

 

The recognition of income on certain investments (e.g. structured securities, including mortgage-backed securities, asset-backed securities (“ABS”) and certain structured investment transactions) is dependent upon certain factors such as prepayments and defaults, and changes in such factors could result in changes in amounts to be earned.

Fixed Maturity and Equity Securities AFS

Fixed Maturity and Equity Securities AFS by Sector

The following table presents the fixed maturity and equity securities AFS by sector. Redeemable preferred stock is reported within U.S. corporate fixed maturity securities and non-redeemable preferred stock is reported within equity securities. Included within fixed maturity securities are structured securities including RMBS, commercial mortgage-backed securities (“CMBS”) and ABS.

 

		December 31, 2013																				December 31, 2012
		Cost or Amortized Cost				Gross Unrealized												Estimated Fair Value				Cost or Amortized Cost				Gross Unrealized												Estimated Fair Value
						Gains				Temporary Losses				OTTI Losses												Gains				Temporary Losses				OTTI Losses
		(In millions)
Fixed maturity securities
U.S. corporate		$	825			$	55			$	8			$	—			$	872			$	913			$	87			$	1			$	—			$	999
U.S. Treasury and agency			469				2				14				—				457				391				6				—				—				397
RMBS			312				12				7				5				312				286				21				4				6				297
CMBS			293				8				4				—				297				302				17				—				—				319
Foreign corporate			223				9				3				—				229				209				14				1				—				222
ABS			51				2				—				—				53				51				4				1				—				54
State and political subdivision			17				2				—				—				19				17				3				—				—				20
Foreign government			10				1				—				—				11				9				3				—				—				12
Total fixed maturity securities		$	2,200			$	91			$	36			$	5			$	2,250			$	2,178			$	155			$	7			$	6			$	2,320
Equity securities
Common stock		$	26			$	—			$	—			$	—			$	26			$	28			$	—			$	—			$	—			$	28
Non-redeemable preferred stock			20				—				1				—				19				20				—				3				—				17
Total equity securities		$	46			$	—			$	1			$	—			$	45			$	48			$	—			$	3			$	—			$	45

The Company held non-income producing fixed maturity securities with an estimated fair value of less than $1 million with unrealized gains (losses) of less than $1 million at both December 31, 2013 and 2012.

Methodology for Amortization of Premium and Accretion of Discount on Structured Securities

Amortization of premium and accretion of discount on structured securities considers the estimated timing and amount of prepayments of the underlying loans. Actual prepayment experience is periodically reviewed and effective yields are recalculated when differences arise between the originally anticipated and the actual prepayments received and currently anticipated. Prepayment assumptions for single class and multi-class mortgage-backed and ABS are estimated using inputs obtained from third-party specialists and based on management’s knowledge of the current market. For credit-sensitive mortgage-backed and ABS and certain prepayment-sensitive securities, the effective yield is recalculated on a prospective basis. For all other mortgage-backed and ABS, the effective yield is recalculated on a retrospective basis.

 

33

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

5.  Investments (continued)

 

Maturities of Fixed Maturity Securities

The amortized cost and estimated fair value of fixed maturity securities, by contractual maturity date, were as follows at:

 

		December 31,
		2013								2012
		Amortized Cost				Estimated Fair Value				Amortized Cost				Estimated Fair Value
		(In millions)
Due in one year or less		$	240			$	242			$	306			$	308
Due after one year through five years			487				512				446				476
Due after five years through ten years			566				595				588				657
Due after ten years			251				239				199				209
Subtotal			1,544				1,588				1,539				1,650
Structured securities (RMBS, CMBS and ABS)			656				662				639				670
Total fixed maturity securities		$	2,200			$	2,250			$	2,178			$	2,320

Actual maturities may differ from contractual maturities due to the exercise of call or prepayment options. Fixed maturity securities not due at a single maturity date have been presented in the year of final contractual maturity. RMBS, CMBS and ABS are shown separately, as they are not due at a single maturity.

 

34

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

5.  Investments (continued)

 

Continuous Gross Unrealized Losses for Fixed Maturity and Equity Securities AFS by Sector

The following table presents the estimated fair value and gross unrealized losses of fixed maturity and equity securities AFS in an unrealized loss position, aggregated by sector and by length of time that the securities have been in a continuous unrealized loss position.

 

		December 31, 2013																December 31, 2012
		Less than 12 Months								Equal to or Greater than 12 Months								Less than 12 Months								Equal to or Greater than 12 Months
		Estimated Fair Value				Gross Unrealized Losses				Estimated Fair Value				Gross Unrealized Losses				Estimated Fair Value				Gross Unrealized Losses				Estimated Fair Value				Gross Unrealized Losses
		(In millions, except number of securities)
Fixed maturity securities
U.S. corporate		$	84			$	7			$	13			$	1			$	20			$	1			$	9			$	—
U.S. Treasury and agency			169				14				—				—				60				—				—				—
RMBS			84				4				34				8				—				—				49				10
CMBS			73				4				—				—				4				—				15				—
Foreign corporate			27				2				7				1				2				—				7				1
ABS			7				—				5				—				—				—				5				1
Foreign government			1				—				1				—				1				—				—				—
Total fixed maturity securities		$	445			$	31			$	60			$	10			$	87			$	1			$	85			$	12
Equity securities
Non-redeemable preferred stock		$	—			$	—			$	18			$	1			$	—			$	—			$	17			$	3
Total number of securities in an unrealized loss position			87								18								18								22

Evaluation of AFS Securities for OTTI and Evaluating Temporarily Impaired AFS Securities

Evaluation and Measurement Methodologies

Management considers a wide range of factors about the security issuer and uses its best judgment in evaluating the cause of the decline in the estimated fair value of the security and in assessing the prospects for near-term recovery. Inherent in management’s evaluation of the security are assumptions and estimates about the operations of the issuer and its future earnings potential. Considerations used in the impairment evaluation process include, but are not limited to: (i) the length of time and the extent to which the estimated fair value has been below cost or amortized cost; (ii) the potential for impairments when the issuer is experiencing significant financial difficulties; (iii) the potential for impairments in an entire industry sector or sub-sector; (iv) the potential for impairments in certain economically depressed geographic locations; (v) the potential for impairments where the issuer, series of issuers or industry has suffered a catastrophic loss or has exhausted natural resources; (vi) with respect to fixed maturity securities, whether the Company has the intent to sell or will more likely than not be required to sell a particular security before the decline in estimated fair value below amortized cost recovers; (vii) with respect to structured securities, changes in forecasted cash flows after considering the quality of underlying collateral, expected prepayment speeds, current and forecasted loss severity, consideration of the payment terms of the underlying assets backing a particular security, and the payment priority within the tranche structure of the security; and (viii) other subjective factors, including concentrations and information obtained from regulators and rating agencies.

 

35

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

5.  Investments (continued)

 

The methodology and significant inputs used to determine the amount of credit loss on fixed maturity securities are as follows:

 

•

The Company calculates the recovery value by performing a discounted cash flow analysis based on the present value of future cash flows. The discount rate is generally the effective interest rate of the security prior to impairment.

 

•

When determining collectability and the period over which value is expected to recover, the Company applies considerations utilized in its overall impairment evaluation process which incorporates information regarding the specific security, fundamentals of the industry and geographic area in which the security issuer operates, and overall macroeconomic conditions. Projected future cash flows are estimated using assumptions derived from management’s best estimates of likely scenario-based outcomes after giving consideration to a variety of variables that include, but are not limited to: payment terms of the security; the likelihood that the issuer can service the interest and principal payments; the quality and amount of any credit enhancements; the security’s position within the capital structure of the issuer; possible corporate restructurings or asset sales by the issuer; and changes to the rating of the security or the issuer by rating agencies.

 

•

Additional considerations are made when assessing the unique features that apply to certain structured securities including, but not limited to: the quality of underlying collateral, expected prepayment speeds, current and forecasted loss severity, consideration of the payment terms of the underlying loans or assets backing a particular security, and the payment priority within the tranche structure of the security.

 

•

When determining the amount of the credit loss for U.S. and foreign corporate securities, state and political subdivision securities and foreign government securities, the estimated fair value is considered the recovery value when available information does not indicate that another value is more appropriate. When information is identified that indicates a recovery value other than estimated fair value, management considers in the determination of recovery value the same considerations utilized in its overall impairment evaluation process as described above, as well as any private and public sector programs to restructure such securities.

With respect to securities that have attributes of debt and equity (perpetual hybrid securities), consideration is given in the OTTI analysis as to whether there has been any deterioration in the credit of the issuer and the likelihood of recovery in value of the securities that are in a severe and extended unrealized loss position. Consideration is also given as to whether any perpetual hybrid securities, with an unrealized loss, regardless of credit rating, have deferred any dividend payments. When an OTTI loss has occurred, the OTTI loss is the entire difference between the perpetual hybrid security’s cost and its estimated fair value with a corresponding charge to earnings.

The cost or amortized cost of fixed maturity and equity securities is adjusted for OTTI in the period in which the determination is made. The Company does not change the revised cost basis for subsequent recoveries in value.

 

36

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

5.  Investments (continued)

 

In periods subsequent to the recognition of OTTI on a fixed maturity security, the Company accounts for the impaired security as if it had been purchased on the measurement date of the impairment. Accordingly, the discount (or reduced premium) based on the new cost basis is accreted over the remaining term of the fixed maturity security in a prospective manner based on the amount and timing of estimated future cash flows.

Current Period Evaluation

Based on the Company’s current evaluation of its AFS securities in an unrealized loss position in accordance with its impairment policy, and the Company’s current intentions and assessments (as applicable to the type of security) about holding, selling and any requirements to sell these securities, the Company has concluded that these securities are not other-than-temporarily impaired at December 31, 2013. Future OTTI will depend primarily on economic fundamentals, issuer performance (including changes in the present value of future cash flows expected to be collected), and changes in credit ratings, collateral valuation, interest rates and credit spreads. If economic fundamentals deteriorate or if there are adverse changes in the above factors, OTTI may be incurred in upcoming periods.

Gross unrealized losses on fixed maturity securities increased $28 million during the year ended December 31, 2013 from $13 million to $41 million. The increase in gross unrealized losses for the year ended December 31, 2013, was primarily attributable to an increase in interest rates, partially offset by narrowing credit spreads.

At December 31, 2013, $5 million of the total $41 million of gross unrealized losses were from one below investment grade fixed maturity security with an unrealized loss position of 20% or more of amortized cost for six months or greater. Unrealized losses on the below investment grade fixed maturity security are related to non-agency RMBS (alternative residential mortgage loans) and are the result of significantly wider credit spreads resulting from higher risk premiums since purchase, largely due to economic and market uncertainties including concerns over unemployment levels and valuations of residential real estate supporting non-agency RMBS. Management evaluates non-agency RMBS based on actual and projected cash flows after considering the quality of underlying collateral, expected prepayment speeds, current and forecasted loss severity, consideration of the payment terms of the underlying assets backing a particular security, and the payment priority within the tranche structure of the security.

Equity Securities

Gross unrealized losses on equity securities decreased $2 million during the year ended December 31, 2013 from $3 million to $1 million. None of the $1 million of gross unrealized losses were from equity securities with gross unrealized losses of 20% or more of cost for 12 months or greater.

 

37

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

5.  Investments (continued)

 

Mortgage Loans

Mortgage Loans by Portfolio Segment

Mortgage loans are summarized as follows at:

 

		December 31,
		2013								2012
		Carrying Value				% of Total				Carrying Value				% of Total
		(In millions)								(In millions)
Mortgage loans:
Commercial		$	246				86.0	%		$	238				83.8	%
Agricultural			41				14.3				48				16.9
Subtotal (1)			287				100.3				286				100.7
Valuation allowances			(1)				(0.3)				(2)				(0.7)
Total mortgage loans, net		$	286				100.0	%		$	284				100.0	%

 

 

(1)	The Company did not purchase any mortgage loans during the year ended December 31, 2013. In 2012, the Company purchased $ 48 million of mortgage loans, of which $38 million were purchased at estimated fair value from an affiliate, MetLife Bank, National Association.

Mortgage Loans and Valuation Allowance by Portfolio Segment

All commercial and agricultural mortgage loans held at both December 31, 2013 and 2012 were evaluated collectively for credit losses. The valuation allowances maintained at both December 31, 2013 and 2012 were primarily for the commercial mortgage loan portfolio segment and were for non-specifically identified credit losses. The valuation allowance for agricultural mortgage loans was less than $1 million at both December 31, 2013 and 2012.

Valuation Allowance Rollforward by Portfolio Segment

The changes in the valuation allowance, by portfolio segment, were as follows:

 

		Commercial				Agricultural				Total
		(In millions)
Balance at January 1, 2011		$	1			$	—			$	1
Provision (release)			1				—				1
Balance at December 31, 2011			2				—				2
Provision (release)			—				—				—
Balance at December 31, 2012			2				—				2
Provision (release)			(1)				—				(1)
Balance at December 31, 2013		$	1			$	—			$	1

 

38

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

5.  Investments (continued)

 

Valuation Allowance Methodology

Mortgage loans are considered to be impaired when it is probable that, based upon current information and events, the Company will be unable to collect all amounts due under the loan agreement. Specific valuation allowances are established using the same methodology for both portfolio segments as the excess carrying value of a loan over either (i) the present value of expected future cash flows discounted at the loan’s original effective interest rate, (ii) the estimated fair value of the loan’s underlying collateral if the loan is in the process of foreclosure or otherwise collateral dependent, or (iii) the loan’s observable market price. A common evaluation framework is used for establishing non-specific valuation allowances for both loan portfolio segments; however, a separate non-specific valuation allowance is calculated and maintained for each loan portfolio segment that is based on inputs unique to each loan portfolio segment. Non-specific valuation allowances are established for pools of loans with similar risk characteristics where a property-specific or market-specific risk has not been identified, but for which the Company expects to incur a credit loss. These evaluations are based upon several loan portfolio segment-specific factors, including the Company’s experience for loan losses, defaults and loss severity, and loss expectations for loans with similar risk characteristics. These evaluations are revised as conditions change and new information becomes available.

Commercial and Agricultural Mortgage Loan Portfolio Segments

The Company typically uses several years of historical experience in establishing non-specific valuation allowances which captures multiple economic cycles. For evaluations of commercial mortgage loans, in addition to historical experience, management considers factors that include the impact of a rapid change to the economy, which may not be reflected in the loan portfolio, and recent loss and recovery trend experience as compared to historical loss and recovery experience. For evaluations of agricultural mortgage loans, in addition to historical experience, management considers factors that include increased stress in certain sectors, which may be evidenced by higher delinquency rates, or a change in the number of higher risk loans. On a quarterly basis, management incorporates the impact of these current market events and conditions on historical experience in determining the non-specific valuation allowance established for commercial and agricultural mortgage loans.

All commercial mortgage loans are reviewed on an ongoing basis which may include an analysis of the property financial statements and rent roll, lease rollover analysis, property inspections, market analysis, estimated valuations of the underlying collateral, loan-to-value ratios, debt service coverage ratios, and tenant creditworthiness. All agricultural mortgage loans are monitored on an ongoing basis. The monitoring process focuses on higher risk loans, which include those that are classified as restructured, delinquent or in foreclosure, as well as loans with higher loan-to-value ratios and lower debt service coverage ratios. The monitoring process for agricultural mortgage loans is generally similar to the commercial mortgage loan monitoring process, with a focus on higher risk loans, including reviews on a geographic and property-type basis. Higher risk loans are reviewed individually on an ongoing basis for potential credit loss and specific valuation allowances are established using the methodology described above. Quarterly, the remaining loans are reviewed on a pool basis by aggregating groups of loans that have similar risk characteristics for potential credit loss, and non-specific valuation allowances are established as described above using inputs that are unique to each segment of the loan portfolio.

 

39

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

5.  Investments (continued)

 

For commercial mortgage loans, the primary credit quality indicator is the debt service coverage ratio, which compares a property’s net operating income to amounts needed to service the principal and interest due under the loan. Generally, the lower the debt service coverage ratio, the higher the risk of experiencing a credit loss. The Company also reviews the loan-to-value ratio of its commercial mortgage loan portfolio. Loan-to-value ratios compare the unpaid principal balance of the loan to the estimated fair value of the underlying collateral. Generally, the higher the loan-to-value ratio, the higher the risk of experiencing a credit loss. The debt service coverage ratio and loan-to-value ratio, as well as the values utilized in calculating these ratios, are updated annually, on a rolling basis, with a portion of the loan portfolio updated each quarter.

For agricultural mortgage loans, the Company’s primary credit quality indicator is the loan-to-value ratio. The values utilized in calculating this ratio are developed in connection with the ongoing review of the agricultural mortgage loan portfolio and are routinely updated.

Credit Quality of Commercial Mortgage Loans

The credit quality of commercial mortgage loans, were as follows:

 

		Recorded Investment
		Debt Service Coverage Ratios												Total				% of Total				Estimated Fair Value				% of Total
		> 1.20x				1.00x - 1.20x				< 1.00x
		(In millions)																				(In millions)
December 31, 2013:
Loan-to-value ratios:
Less than 65%		$	193			$	9			$	15			$	217				88.2	%		$	228				88.4	%
65% to 75%			19				—				10				29				11.8				30				11.6
Total		$	212			$	9			$	25			$	246				100.0	%		$	258				100.0	%
December 31, 2012:
Loan-to-value ratios:
Less than 65%		$	194			$	10			$	9			$	213				89.5	%		$	231				90.2	%
65% to 75%			15				—				10				25				10.5				25				9.8
Total		$	209			$	10			$	19			$	238				100.0	%		$	256				100.0	%

Credit Quality of Agricultural Mortgage Loans

All of the agricultural mortgage loans held at both December 31, 2013 and 2012 had loan-to-value ratios of less than 65%.

Past Due, Interest Accrual Status and Impaired Mortgage Loans

The Company has a high quality, well performing, mortgage loan portfolio, with all mortgage loans classified as performing at both December 31, 2013 and 2012. The Company defines delinquency consistent with industry practice, when mortgage loans are past due as follows: commercial mortgage loans — 60 days and agricultural mortgage loans — 90 days. The Company had no impaired mortgage loans, no mortgage loans past due and no mortgage loans in non-accrual status at both December 31, 2013 and 2012. The Company did not recognize interest income on impaired mortgage loans during the years ended December 31, 2013, 2012 and 2011.

 

40

---

MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

5.  Investments (continued)

 

Mortgage Loans Modified in a Troubled Debt Restructuring

The Company may grant concessions related to borrowers experiencing financial difficulties which are classified as troubled debt restructurings. Generally, the types of concessions include: reduction of the contractual interest rate, extension of the maturity date at an interest rate lower than current market interest rates, and/or a reduction of accrued interest. The amount, timing and extent of the concession granted is considered in determining any impairment or changes in the specific valuation allowance recorded with the restructuring. Through the continuous monitoring process, a specific valuation allowance may have been recorded prior to the quarter when the mortgage loan is modified in a troubled debt restructuring. Accordingly, the carrying value (after specific valuation allowance) before and after modification through a troubled debt restructuring may not change significantly, or may increase if the expected recovery is higher than the pre-modification recovery assessment.

There were no mortgage loans modified in a troubled debt restructuring during the years ended December 31, 2013 and 2012.

Other Invested Assets

Other invested assets is comprised of loans to affiliates (see “ — Related Party Investment Transactions”) and freestanding derivatives with positive estimated fair values (see Note 6).

Cash Equivalents

The carrying value of cash equivalents, which includes securities and other investments with an original or remaining maturity of three months or less at the time of purchase, was $17 million and $23 million at December 31, 2013 and 2012, respectively.

 

41

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

5.  Investments (continued)

 

Net Unrealized Investment Gains (Losses)

The components of net unrealized investment gains (losses), included in AOCI, were as follows:

 

		Years Ended December 31,
		2013				2012				2011
		(In millions)
Fixed maturity securities		$	55			$	148			$	88
Fixed maturity securities with noncredit OTTI losses in AOCI			(5)				(6)				(10)
Total fixed maturity securities			50				142				78
Equity securities			(1)				(3)				(5)
Derivatives			(1)				1				2
Short-term investments			(1)				(1)				(1)
Subtotal			47				139				74
Amounts allocated from:
Insurance liability loss recognition			—				—				(7)
DAC and VOBA related to noncredit OTTI losses recognized in AOCI			1				1				1
DAC and VOBA			(14)				(24)				(15)
Subtotal			(13)				(23)				(21)
Deferred income tax benefit (expense) related to noncredit OTTI losses recognized in AOCI			2				2				4
Deferred income tax benefit (expense)			(13)				(42)				(22)
Net unrealized investment gains (losses)		$	23			$	76			$	35

The changes in fixed maturity securities with noncredit OTTI losses included in AOCI were as follows:

 

		Years Ended December 31,
		2013				2012
		(In millions)
Balance at January 1,		$	(6)			$	(10)
Securities sold with previous noncredit OTTI loss			1				3
Subsequent changes in estimated fair value			—				1
Balance at December 31,		$	(5)			$	(6)

 

42

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

5.  Investments (continued)

 

The changes in net unrealized investment gains (losses) were as follows:

 

		Years Ended December 31,
		2013				2012				2011
		(In millions)
Balance at January 1,		$	76			$	35			$	20
Fixed maturity securities on which noncredit OTTI losses have been recognized			1				4				(2)
Unrealized investment gains (losses) during the year			(93)				61				39
Unrealized investment gains (losses) relating to:
Insurance liability gain (loss) recognition			—				7				(7)
DAC and VOBA			10				(9)				(7)
Deferred income tax benefit (expense) related to noncredit OTTI losses recognized in AOCI			—				(2)				1
Deferred income tax benefit (expense)			29				(20)				(9)
Balance at December 31,		$	23			$	76			$	35
Change in net unrealized investment gains (losses)		$	(53)			$	41			$	15

Concentrations of Credit Risk

There were no investments in any counterparty that were greater than 10% of the Company’s stockholder’s equity, other than the U.S. government and its agencies, at both December 31, 2013 and 2012.

Securities Lending

Elements of the securities lending program are presented below at:

 

		December 31,
		2013				2012
		(In millions)
Securities on loan: (1)
Amortized cost		$	249			$	185
Estimated fair value		$	241			$	191
Cash collateral on deposit from counterparties (2)		$	249			$	196
Reinvestment portfolio — estimated fair value		$	247			$	196

 

 

 

(1)	Included within fixed maturity securities and short-term investments.

 

(2)	Included within payables for collateral under securities loaned and other transactions.

 

43

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

5.  Investments (continued)

 

Invested Assets on Deposit and Pledged as Collateral

Invested assets on deposit and pledged as collateral are presented below at estimated fair value for fixed maturity securities at:

 

		December 31,
		2013				2012
		(In millions)
Invested assets on deposit (regulatory deposits)		$	7			$	4
Invested assets pledged as collateral (1)			505				620
Total invested assets on deposit and pledged as collateral		$	512			$	624

 

 

(1)	The Company has pledged invested assets in connection with various agreements and transactions, including funding agreements (see Note 2) and derivative transactions (see Note 6).

See “— Securities Lending” for securities on loan.

Variable Interest Entities

The Company has invested in certain structured transactions that are VIEs. In certain instances, the Company may hold both the power to direct the most significant activities of the entity, as well as an economic interest in the entity and, as such, it would be deemed the primary beneficiary or consolidator of the entity.

The determination of the VIE’s primary beneficiary requires an evaluation of the contractual and implied rights and obligations associated with each party’s relationship with or involvement in the entity, an estimate of the entity’s expected losses and expected residual returns and the allocation of such estimates to each party involved in the entity. The Company generally uses a qualitative approach to determine whether it is the primary beneficiary. However, for VIEs that are investment companies or apply measurement principles consistent with those utilized by investment companies, the primary beneficiary is based on a risks and rewards model and is defined as the entity that will absorb a majority of a VIE’s expected losses, receive a majority of a VIE’s expected residual returns if no single entity absorbs a majority of expected losses, or both. The Company reassesses its involvement with VIEs on a quarterly basis. The use of different methodologies, assumptions and inputs in the determination of the primary beneficiary could have a material effect on the amounts presented within the financial statements.

Consolidated VIEs

There were no VIEs for which the Company has concluded that it is the primary beneficiary and which are consolidated at December 31, 2013 and 2012.

 

44

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

5.  Investments (continued)

 

Unconsolidated VIEs

The carrying amount and maximum exposure to loss relating to VIEs in which the Company holds a significant variable interest but is not the primary beneficiary and which have not been consolidated were as follows at:

 

		December 31,
		2013								2012
		Carrying Amount				Maximum Exposure to Loss (1)				Carrying Amount				Maximum Exposure to Loss (1)
		(In millions)
Fixed maturity securities AFS:
Structured securities (RMBS, CMBS, and ABS) (2)		$	662			$	662			$	670			$	670
U.S. and foreign corporate			21				21				23				23
Other limited partnership interests			19				20				14				15
Equity securities AFS:
Non-redeemable preferred stock			18				18				17				17
Total		$	720			$	721			$	724			$	725

 

 

 

(1)

The maximum exposure to loss relating to fixed maturity and equity securities AFS is equal to their carrying amounts or the carrying amounts of retained interests. The maximum exposure to loss relating to other limited partnership interests is equal to the carrying amounts plus any unfunded commitments of the Company. Such a maximum loss would be expected to occur only upon bankruptcy of the issuer or investee.

 

(2)	For these variable interests, the Company’s involvement is limited to that of a passive investor.

As described in Note 11, the Company makes commitments to fund partnership investments in the normal course of business. Excluding these commitments, the Company did not provide financial or other support to investees designated as VIEs during the years ended December 31, 2013, 2012 and 2011.

 

45

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

5.  Investments (continued)

 

Net Investment Income

The components of net investment income were as follows:

 

		Years Ended December 31,
		2013				2012				2011
		(In millions)
Investment income:
Fixed maturity securities		$	94			$	98			$	104
Equity securities			1				1				2
Mortgage loans			16				15				10
Policy loans			2				2				2
Other limited partnership interests			4				1				—
Cash, cash equivalents and short-term investments			1				—				—
Subtotal			118				117				118
Less: Investment expenses			4				4				4
Net investment income		$	114			$	113			$	114

See “— Related Party Investment Transactions” for discussion of affiliated net investment income and investment expenses.

Net Investment Gains (Losses)

Components of Net Investment Gains (Losses)

The components of net investment gains (losses) were as follows:

 

		Years Ended December 31,
		2013				2012				2011
		(In millions)
Total gains (losses) on fixed maturity securities:
Total OTTI losses recognized — by industry:
U.S. and foreign corporate securities — by industry:
Finance		$	—			$	(1)			$	—
Utility			—				(1)				—
Total U.S. and foreign corporate securities			—				(2)				—
OTTI losses on fixed maturity securities recognized in earnings			—				(2)				—
Fixed maturity securities — net gains (losses) on sales and disposals			1				(2)				(5)
Total gains (losses) on fixed maturity securities			1				(4)				(5)
Total net investment gains (losses)		$	1			$	(4)			$	(5)

 

46

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

5.  Investments (continued)

 

Sales or Disposals and Impairments of Fixed Maturity and Equity Securities

Proceeds from sales or disposals of fixed maturity and equity securities and the components of fixed maturity and equity securities net investment gains (losses) are as shown in the table below. Investment gains and losses on sales of securities are determined on a specific identification basis.

 

		Years Ended December 31,
		2013				2012				2011				2013				2012				2011				2013				2012				2011
		Fixed Maturity Securities												Equity Securities												Total
		(In millions)
Proceeds		$	417			$	576			$	318			$	—			$	1			$	5			$	417			$	577			$	323
Gross investment gains		$	3			$	2			$	3			$	—			$	—			$	—			$	3			$	2			$	3
Gross investment losses			(2)				(4)				(8)				—				—				—				(2)				(4)				(8)
Total OTTI losses:
Credit-related			—				(1)				—				—				—				—				—				(1)				—
Other (1)			—				(1)				—				—				—				—				—				(1)				—
Total OTTI losses			—				(2)				—				—				—				—				—				(2)				—
Net investment gains (losses)		$	1			$	(4)			$	(5)			$	—			$	—			$	—			$	1			$	(4)			$	(5)

 

 

(1)	Other OTTI losses recognized in earnings include impairments on fixed maturity securities where there is an intent to sell or it is more likely than not that the Company will be required to sell the security before recovery of the decline in estimated fair value.

Credit Loss Rollforward

The table below presents a rollforward of the cumulative credit loss component of OTTI loss recognized in earnings on fixed maturity securities still held for which a portion of the OTTI loss was recognized in OCI:

 

		Years Ended December 31,
		2013				2012
		(In millions)
Balance at January 1,		$	2			$	3
Reductions:
Sales (maturities, pay downs or prepayments) during the period of securities previously impaired as credit loss OTTI			—				(1)
Balance at December 31,		$	2			$	2

Related Party Investment Transactions

The Company has an affiliated loan outstanding, which is included in other invested assets, totaling $45 million at both years ended December 31, 2013 and 2012. At December 31, 2011, the loan was outstanding with Exeter, an affiliate. During 2012, MetLife assumed this affiliated debt from Exeter. The loan is due on July 15, 2021, and bears interest, payable semi-annually, at 5.64%. Net investment income from this loan was $3 million, $3 million and $1 million for the years ended December 31, 2013, 2012 and 2011, respectively.

 

47

---

MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

5.  Investments (continued)

 

The Company receives investment administrative services from an affiliate. The related investment administrative service charges were $3 million for each of the years ended December 31, 2013, 2012 and 2011.

6.  Derivatives

Accounting for Derivatives

See Note 1 for a description of the Company’s accounting policies for derivatives and Note 7 for information about the fair value hierarchy for derivatives.

Derivative Strategies

The Company is exposed to various risks relating to its ongoing business operations, including interest rate, foreign currency exchange rate, credit and equity. The Company uses a variety of strategies to manage these risks, including the use of derivatives.

Derivatives are financial instruments whose values are derived from interest rates, foreign currency exchange rates, credit spreads and/or other financial indices. Derivatives may be exchange-traded or contracted in the over-the-counter (“OTC”) market. Certain of the Company’s OTC derivatives are cleared and settled through central clearing counterparties (“OTC-cleared”), while others are bilateral contracts between two counterparties (“OTC-bilateral”). The types of derivatives the Company uses include swaps, futures and option contracts. To a lesser extent, the Company uses credit default swaps to synthetically replicate investment risks and returns which are not readily available in the cash market.

Interest Rate Derivatives

The Company uses a variety of interest rate derivatives to reduce its exposure to changes in interest rates, including interest rate swaps and floors.

Interest rate swaps are used by the Company primarily to reduce market risks from changes in interest rates and to alter interest rate exposure arising from mismatches between assets and liabilities (duration mismatches). In an interest rate swap, the Company agrees with another party to exchange, at specified intervals, the difference between fixed rate and floating rate interest amounts as calculated by reference to an agreed notional amount. The Company utilizes interest rate swaps in fair value and non-qualifying hedging relationships.

The Company purchases interest rate floors primarily to protect its minimum rate guarantee liabilities against declines in interest rates below a specified level. In certain instances, the Company locks in the economic impact of existing purchased floors by entering into offsetting written floors. The Company utilizes interest rate floors in non-qualifying hedging relationships.

To a lesser extent, the Company uses interest rate futures in non-qualifying hedging relationships.

Foreign Currency Exchange Rate Derivatives

The Company uses foreign currency swaps to reduce the risk from fluctuations in foreign currency exchange rates associated with its assets denominated in foreign currencies. In a foreign currency swap transaction, the Company agrees with another party to exchange, at specified intervals, the difference between one currency and

 

48

---

MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

6.  Derivatives (continued)

 

another at a fixed exchange rate, generally set at inception, calculated by reference to an agreed upon notional amount. The notional amount of each currency is exchanged at the inception and termination of the currency swap by each party. The Company utilizes foreign currency swaps in cash flow and non-qualifying hedging relationships.

Credit Derivatives

The Company enters into purchased credit default swaps to hedge against credit-related changes in the value of its investments. In a credit default swap transaction, the Company agrees with another party to pay, at specified intervals, a premium to hedge credit risk. If a credit event occurs, as defined by the contract, the contract may be cash settled or it may be settled gross by the delivery of par quantities of the referenced investment equal to the specified swap notional in exchange for the payment of cash amounts by the counterparty equal to the par value of the investment surrendered. Credit events vary by type of issuer but typically include bankruptcy, failure to pay debt obligations, repudiation, moratorium, or involuntary restructuring. In each case, payout on a credit default swap is triggered only after the Credit Derivatives Determinations Committee of the International Swaps and Derivatives Association, Inc. (“ISDA”) deems that a credit event has occurred. The Company utilizes credit default swaps in non-qualifying hedging relationships.

The Company enters into written credit default swaps to synthetically create credit investments that are either more expensive to acquire or otherwise unavailable in the cash markets. These transactions are a combination of a derivative and one or more cash instruments, such as U.S. Treasury securities, agency securities or other fixed maturity securities. These credit default swaps are not designated as hedging instruments.

Primary Risks Managed by Derivatives

The following table presents the gross notional amount, estimated fair value and primary underlying risk exposure of the Company’s derivatives, excluding embedded derivatives, held at:

 

				December 31,
				2013												2012
								Estimated Fair Value												Estimated Fair Value
		Primary Underlying Risk Exposure		Notional Amount				Assets				Liabilities				Notional Amount				Assets				Liabilities
				(In millions)
Derivatives Designated as Hedging Instruments
Fair value hedges:
Interest rate swaps		Interest rate		$	10			$	—			$	—			$	12			$	—			$	—
Cash flow hedges:
Foreign currency swaps		Foreign currency exchange rate			30				2				3				27				2				1
Total qualifying hedges					40				2				3				39				2				1
Derivatives Not Designated or Not Qualifying as Hedging Instruments
Interest rate swaps		Interest rate			741				12				22				741				9				6
Interest rate floors		Interest rate			2,040				9				4				2,040				36				17
Foreign currency swaps		Foreign currency exchange rate			37				—				5				23				—				1
Credit default swaps—purchased		Credit			8				—				—				9				—				—
Credit default swaps—written		Credit			20				—				—				22				—				—
Total non-designated or non-qualifying derivatives					2,846				21				31				2,835				45				24
Total				$	2,886			$	23			$	34			$	2,874			$	47			$	25

 

49

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

6.  Derivatives (continued)

 

Based on notional amounts, a substantial portion of the Company’s derivatives was not designated or did not qualify as part of a hedging relationship at both December 31, 2013 and 2012. The Company’s use of derivatives includes (i) derivatives that serve as macro hedges of the Company’s exposure to various risks and that generally do not qualify for hedge accounting due to the criteria required under the portfolio hedging rules; (ii) derivatives that economically hedge insurance liabilities that contain mortality or morbidity risk and that generally do not qualify for hedge accounting because the lack of these risks in the derivatives cannot support an expectation of a highly effective hedging relationship; and (iii) written credit default swaps that are used to synthetically create credit investments and that do not qualify for hedge accounting because they do not involve a hedging relationship. For these non-qualified derivatives, changes in market factors can lead to the recognition of fair value changes in the statement of operations without an offsetting gain or loss recognized in earnings for the item being hedged.

Net Derivative Gains (Losses)

The components of net derivative gains (losses) were as follows:

 

		Years Ended December 31,
		2013				2012				2011
		(In millions)
Derivatives and hedging gains (losses)		$	(27)			$	26			$	36
Embedded derivatives			(415)				303				290
Total net derivative gains (losses)		$	(442)			$	329			$	326

The amount the Company recognized in net investment income from settlement payments related to qualifying hedges for the years ended December 31, 2013, 2012 and 2011, was not significant.

The Company recognized $26 million, $25 million and $14 million of net derivative gains (losses) from settlement payments related to non-qualifying hedges for the years ended December 31, 2013, 2012 and 2011, respectively.

 

50

---

MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

6.  Derivatives (continued)

 

Non-Qualifying Derivatives and Derivatives for Purposes Other Than Hedging

The following table presents the amount and location of gains (losses) recognized in income for derivatives that were not designated or qualifying as hedging instruments:

 

		Net Derivative Gains (Losses)
		(In millions)
Year Ended December 31, 2013:
Interest rate derivatives		$	(50)
Foreign currency exchange rate derivatives			(4)
Credit derivatives — purchased			—
Credit derivatives — written			—
Total		$	(54)
Year Ended December 31, 2012:
Interest rate derivatives		$	2
Foreign currency exchange rate derivatives			(1)
Credit derivatives — purchased			—
Credit derivatives — written			—
Total		$	1
Year Ended December 31, 2011:
Interest rate derivatives		$	22
Foreign currency exchange rate derivatives			—
Credit derivatives — purchased			—
Credit derivatives — written			1
Total		$	23

Fair Value Hedges

The Company designates and accounts for interest rate swaps to convert fixed rate assets to floating rate assets as fair value hedges when they have met the requirements of fair value hedging.

The amounts recognized in net derivative gains (losses) representing the ineffective portion of all fair value hedges for each of the years ended December 31, 2013, 2012 and 2011 were not significant. Changes in the fair value of the derivatives and the hedged items recognized in net derivative gains (losses) were not significant for each of the years ended December 31, 2013, 2012 and 2011.

All components of each derivative’s gain or loss were included in the assessment of hedge effectiveness.

Cash Flow Hedges

The Company designates and accounts for foreign currency swaps to hedge the foreign currency cash flow exposure of foreign currency denominated assets as cash flow hedges when they have met the requirements of cash flow hedging.

 

51

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

6.  Derivatives (continued)

 

In certain instances, the Company discontinued cash flow hedge accounting because the forecasted transactions were no longer probable of occurring. When such forecasted transactions are not probable of occurring within two months of the anticipated date, the Company reclassifies certain amounts from AOCI into net derivative gains (losses). For the year ended December 31, 2013 the amounts reclassified into net derivative gains (losses) related to such discontinued cash flow hedges were not significant. For both the years ended 2012 and 2011, there were no amounts reclassified into net derivative gains (losses) related to such discontinued cash flow hedges.

There were no hedged forecasted transactions, other than the receipt or payment of variable interest payments, for the years ended December 31, 2013, 2012 and 2011.

At December 31, 2013 and 2012, the balance in AOCI associated with foreign currency swaps designated and qualifying as cash flow hedges was ($1) million and $1 million, respectively.

For the years ended December 31, 2013, 2012 and 2011, there was ($2) million, ($1) million and $1 million of gains (losses) deferred in AOCI related to foreign currency swaps, respectively. For both the years ended December 31, 2013 and 2012, the amounts reclassified to net derivative gains (losses) related to foreign currency swaps were not significant. For the year ended December 31, 2011, there were no amounts reclassified to net derivative gains (losses) related to foreign currency swaps. For the years ended December 31, 2013, 2012 and 2011, there were no amounts reclassified to net investment income related to foreign currency swaps.

For both the years ended December 31, 2013 and 2012, the amounts recognized in net derivative gains (losses) which represented the ineffective portion of all cash flow hedges were not significant. For the year ended December 31, 2011, the Company did not recognize any net derivative gains (losses) which represented the ineffective portion of all cash flow hedges.

At December 31, 2013, ($1) million of deferred net gains (losses) on derivatives in AOCI was expected to be reclassified to earnings within the next 12 months.

All components of each derivative’s gain or loss were included in the assessment of hedge effectiveness.

Credit Derivatives

In connection with synthetically created credit investment transactions, the Company writes credit default swaps for which it receives a premium to insure credit risk. Such credit derivatives are included within the non-qualifying derivatives and derivatives for purposes other than hedging table. If a credit event occurs, as defined by the contract, the contract may be cash settled or it may be settled gross by the Company paying the counterparty the specified swap notional amount in exchange for the delivery of par quantities of the referenced credit obligation. The Company’s maximum amount at risk, assuming the value of all referenced credit obligations is zero, was $20 million and $22 million at December 31, 2013 and 2012, respectively. The Company can terminate these contracts at any time through cash settlement with the counterparty at an amount equal to the then current fair value of the credit default swaps. At both December 31, 2013 and 2012, the amounts the Company would have received to terminate all of these contracts was not significant.

 

52

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

6.  Derivatives (continued)

 

The following table presents the estimated fair value, maximum amount of future payments and weighted average years to maturity of written credit default swaps at:

 

		December 31,
		2013												2012
Rating Agency Designation of Referenced Credit Obligations (1)		Estimated Fair Value of Credit Default Swaps				Maximum Amount of Future Payments under Credit Default Swaps (2)				Weighted Average Years to Maturity (3)				Estimated Fair Value of Credit Default Swaps				Maximum Amount of Future Payments under Credit Default Swaps (2)				Weighted Average Years to Maturity (3)
		(In millions)												(In millions)
Aaa/Aa/A
Single name credit default swaps (corporate)		$	—			$	—				—			$	—			$	2				1.0
Baa
Credit default swaps referencing indices			—				20				5.0				—				20				4.5
Total		$	—			$	20				5.0			$	—			$	22				4.2

 

 

 

(1)	The rating agency designations are based on availability and the midpoint of the applicable ratings among Moody’s Investors Service (“Moody’s”), S&P and Fitch Ratings. If no rating is available from a rating agency, then an internally developed rating is used.

 

(2)	Assumes the value of the referenced credit obligations is zero.

 

(3)	The weighted average years to maturity of the credit default swaps is calculated based on weighted average notional amounts.

Credit Risk on Freestanding Derivatives

The Company may be exposed to credit-related losses in the event of nonperformance by counterparties to derivatives. Generally, the current credit exposure of the Company’s derivatives is limited to the net positive estimated fair value of derivatives at the reporting date after taking into consideration the existence of master netting or similar agreements and any collateral received pursuant to such agreements.

The Company manages its credit risk related to derivatives by entering into transactions with creditworthy counterparties and establishing and monitoring exposure limits. The Company’s OTC-bilateral derivative transactions are generally governed by ISDA Master Agreements which provide for legally enforceable set-off and close-out netting of exposures to specific counterparties in the event of early termination of a transaction, which includes, but is not limited to, events of default and bankruptcy. In the event of an early termination, the Company is permitted to set off receivables from the counterparty against payables to the same counterparty arising out of all included transactions. Substantially all of the Company’s ISDA Master Agreements also include Credit Support Annex provisions which require both the pledging and accepting of collateral in connection with its OTC-bilateral derivatives.

 

53

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

6.  Derivatives (continued)

 

The Company’s OTC-cleared derivatives are effected through central clearing counterparties and its exchange-traded derivatives are effected through regulated exchanges. Such positions are marked to market and margined on a daily basis, and the Company has minimal exposure to credit-related losses in the event of nonperformance by counterparties to such derivatives.

See Note 7 for a description of the impact of credit risk on the valuation of derivatives.

The estimated fair value of the Company’s net derivative assets and net derivative liabilities after the application of master netting agreements and collateral was as follows at:

 

Derivatives Subject to a Master Netting Arrangement or a Similar Arrangement		December 31, 2013								December 31, 2012
		Assets				Liabilities				Assets				Liabilities
		(In millions)
Gross estimated fair value of derivatives:
OTC-bilateral (1)		$	25			$	32			$	53			$	27
OTC-cleared (1)			—				—				—				—
Exchange-traded			—				—				—				—
Total gross estimated fair value of derivatives (1)			25				32				53				27
Amounts offset in the balance sheets			—				—				—				—
Estimated fair value of derivatives presented in the balance sheets (1)			25				32				53				27
Gross amounts not offset in the balance sheets:
Gross estimated fair value of derivatives: (2)
OTC-bilateral			(5)				(5)				(10)				(10)
OTC-cleared			—				—				—				—
Exchange-traded			—				—				—				—
Cash collateral: (3)
OTC-bilateral			(17)				—				(42)				—
OTC-cleared			—				—				—				—
Exchange-traded			—				—				—				—
Securities collateral: (4)
OTC-bilateral			(2)				(26)				(1)				(16)
OTC-cleared			—				—				—				—
Exchange-traded			—				—				—				—
Net amount after application of master netting agreements and collateral		$	1			$	1			$	—			$	1

 

 

 

(1)

At December 31, 2013 and 2012, derivative assets include income or expense accruals reported in accrued investment income or in other liabilities of $2 million and $6 million, respectively, and derivative liabilities include income or expense accruals reported in accrued investment income or in other liabilities of ($2) million and $2 million, respectively.

 

(2)	Estimated fair value of derivatives is limited to the amount that is subject to set-off and includes income or expense accruals.

 

54

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

6.  Derivatives (continued)

 

(3)

Cash collateral received is included in cash and cash equivalents, short-term investments, or in fixed maturity securities, and the obligation to return it is included in payables for collateral under securities loaned and other transactions in the balance sheets. The receivable for the return of cash collateral provided by the Company is inclusive of initial margin on exchange traded and OTC-cleared derivatives and is included in premiums, reinsurance and other receivables in the balance sheets. The amount of cash collateral offset in the table above is limited to the net estimated fair value of derivatives after application of netting agreements. At both December 31, 2013 and 2012, the Company had not received or paid any excess cash collateral.

 

(4)

Securities collateral received by the Company is held in separate custodial accounts and is not recorded on the balance sheets. Subject to certain constraints, the Company is permitted by contract to sell or repledge this collateral, but at December 31, 2013 none of the collateral had been sold or repledged. Securities collateral pledged by the Company is reported in fixed maturity securities in the balance sheets. Subject to certain constraints, the counterparties are permitted by contract to sell or repledge this collateral. The amount of securities collateral offset in the table above is limited to the net estimated fair value of derivatives after application of netting agreements and cash collateral. At both December 31, 2013 and 2012, the Company received excess securities collateral with an estimated fair value of $1 million for its OTC-bilateral derivatives, which are not included in the table above due to the foregoing limitation. At both December 31, 2013 and 2012, the Company had provided no excess securities collateral for its OTC-bilateral derivatives, and had provided $1 million and $0, respectively, for its OTC- cleared derivatives, which are not included in the table above due to the foregoing limitation. At both December 31, 2013 and 2012, the Company did not pledge any securities collateral for its exchange-traded derivatives.

The Company’s collateral arrangements for its OTC-bilateral derivatives generally require the counterparty in a net liability position, after considering the effect of netting agreements, to pledge collateral when the fair value of that counterparty’s derivatives reaches a pre-determined threshold. Certain of these arrangements also include financial strength-contingent provisions that provide for a reduction of these thresholds (on a sliding scale that converges toward zero) in the event of downgrades in the financial strength ratings of the Company and/or the credit ratings of the counterparty. In addition, certain of the Company’s netting agreements for derivatives contain provisions that require both the Company and the counterparty to maintain a specific investment grade financial strength or credit rating from each of Moody’s and S&P. If a party’s financial strength or credit ratings were to fall below that specific investment grade financial strength or credit rating, that party would be in violation of these provisions, and the other party to the derivatives could terminate the transactions and demand immediate settlement and payment based on such party’s reasonable valuation of the derivatives.

The following table presents the estimated fair value of the Company’s OTC-bilateral derivatives that are in a net liability position after considering the effect of netting agreements, together with the estimated fair value and balance sheet location of the collateral pledged. The table also presents the incremental collateral that the Company would be required to provide if there was a one notch downgrade in the Company’s financial strength rating at the reporting date or if the Company’s financial strength rating sustained a downgrade to a level that

 

55

---

MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

6.  Derivatives (continued)

 

triggered full overnight collateralization or termination of the derivative position at the reporting date. OTC-bilateral derivatives that are not subject to collateral agreements are excluded from this table.

 

						Estimated Fair Value of Collateral Provided:				Fair Value of Incremental Collateral Provided Upon:
		Estimated Fair Value of Derivatives in Net Liability Position (1)				Fixed Maturity Securities				One Notch Downgrade in the Company’s Financial Strength Rating				Downgrade in the Company’s Financial Strength Rating to a Level that Triggers Full Overnight Collateralization or Termination of the Derivative Position
		(In millions)
December 31, 2013		$	27			$	26			$	—			$	1
December 31, 2012		$	17			$	16			$	—			$	2

 

 

(1)	After taking into consideration the existence of netting agreements.

Embedded Derivatives

The Company issues certain products or purchases certain investments that contain embedded derivatives that are required to be separated from their host contracts and accounted for as freestanding derivatives. These host contracts principally include: variable annuities with guaranteed minimum benefits, including GMWBs, GMABs and certain GMIBs; and affiliated ceded reinsurance of guaranteed minimum benefits related to GMWBs, GMABs and certain GMIBs.

The following table presents the estimated fair value and balance sheet location of the Company’s embedded derivatives that have been separated from their host contracts at:

 

				December 31,
		Balance Sheet Location		2013				2012
				(In millions)
Net embedded derivatives within asset host contracts:
Ceded guaranteed minimum benefits		Premiums, reinsurance and other receivables		$	376			$	959
Net embedded derivatives within liability host contracts:
Direct guaranteed minimum benefits		PABs		$	(131)			$	56

The following table presents changes in estimated fair value related to embedded derivatives:

 

		Years Ended December 31,
		2013				2012				2011
		(In millions)
Net derivative gains (losses) (1), (2)		$	(415)			$	303			$	290

 

 

 

(1)

The valuation of direct guaranteed minimum benefits includes a nonperformance risk adjustment. The amounts included in net derivative gains (losses) in connection with this adjustment were ($6) million, ($26) million and $29 million for the years ended December 31, 2013, 2012 and 2011, respectively. In addition,

 

56

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

6.  Derivatives (continued)

 

the valuation of ceded guaranteed minimum benefits includes a nonperformance risk adjustment. The amounts included in net derivative gains (losses) in connection with this adjustment were $42 million, $28 million and ($62) million for the years ended December 31, 2013, 2012 and 2011, respectively.

 

(2)	See Note 4 for discussion of affiliated net derivative gains (losses) included in the table above.

7.  Fair Value

When developing estimated fair values, the Company considers three broad valuation techniques: (i) the market approach, (ii) the income approach, and (iii) the cost approach. The Company determines the most appropriate valuation technique to use, given what is being measured and the availability of sufficient inputs, giving priority to observable inputs. The Company categorizes its assets and liabilities measured at estimated fair value into a three-level hierarchy, based on the significant input with the lowest level in its valuation. The input levels are as follows:

 

Level 1		Unadjusted quoted prices in active markets for identical assets or liabilities. The Company defines active markets based on average trading volume for equity securities. The size of the bid/ask spread is used as an indicator of market activity for fixed maturity securities.
Level 2		Quoted prices in markets that are not active or inputs that are observable either directly or indirectly. These inputs can include quoted prices for similar assets or liabilities other than quoted prices in Level 1, quoted prices in markets that are not active, or other significant inputs that are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3		Unobservable inputs that are supported by little or no market activity and are significant to the determination of estimated fair value of the assets or liabilities. Unobservable inputs reflect the reporting entity’s own assumptions about the assumptions that market participants would use in pricing the asset or liability.

Financial markets are susceptible to severe events evidenced by rapid depreciation in asset values accompanied by a reduction in asset liquidity. The Company’s ability to sell securities, or the price ultimately realized for these securities, depends upon the demand and liquidity in the market and increases the use of judgment in determining the estimated fair value of certain securities.

Considerable judgment is often required in interpreting market data to develop estimates of fair value, and the use of different assumptions or valuation methodologies may have a material effect on the estimated fair value amounts.

 

57

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

7.  Fair Value (continued)

 

Recurring Fair Value Measurements

The assets and liabilities measured at estimated fair value on a recurring basis and their corresponding placement in the fair value hierarchy are presented below.

 

		December 31, 2013
		Fair Value Hierarchy
														Total Estimated Fair Value
		Level 1				Level 2				Level 3
		(In millions)
Assets
Fixed maturity securities:
U.S. corporate		$	—			$	859			$	13			$	872
U.S. Treasury and agency			408				49				—				457
RMBS			—				285				27				312
CMBS			—				297				—				297
Foreign corporate			—				185				44				229
ABS			—				46				7				53
State and political subdivision			—				19				—				19
Foreign government			—				11				—				11
Total fixed maturity securities			408				1,751				91				2,250
Equity securities:
Common stock			—				26				—				26
Non-redeemable preferred stock			—				—				19				19
Total equity securities			—				26				19				45
Short-term investments			14				61				—				75
Derivative assets: (1)
Interest rate			—				21				—				21
Foreign currency exchange rate			—				2				—				2
Total derivative assets			—				23				—				23
Net embedded derivatives within asset host contracts (2)			—				—				376				376
Separate account assets (3)			—				12,033				—				12,033
Total assets		$	422			$	13,894			$	486			$	14,802
Liabilities
Derivative liabilities: (1)
Interest rate		$	—			$	26			$	—			$	26
Foreign currency exchange rate			—				8				—				8
Total derivative liabilities			—				34				—				34
Net embedded derivatives within liability host contracts (2)			—				—				(131)				(131)
Total liabilities		$	—			$	34			$	(131)			$	(97)

 

58

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

7.  Fair Value (continued)

 

		December 31, 2012
		Fair Value Hierarchy
		Level 1				Level 2				Level 3				Total Estimated Fair Value
		(In millions)
Assets
Fixed maturity securities:
U.S. corporate		$	—			$	944			$	55			$	999
U.S. Treasury and agency			382				15				—				397
RMBS			—				283				14				297
CMBS			—				305				14				319
Foreign corporate			—				180				42				222
ABS			—				54				—				54
State and political subdivision			—				20				—				20
Foreign government			—				12				—				12
Total fixed maturity securities			382				1,813				125				2,320
Equity securities:
Common stock			—				28				—				28
Non-redeemable preferred stock			—				—				17				17
Total equity securities			—				28				17				45
Short-term investments			116				23				—				139
Derivative assets: (1)
Interest rate			—				45				—				45
Foreign currency exchange rate			—				2				—				2
Total derivative assets			—				47				—				47
Net embedded derivatives within asset host contracts (2)			—				—				959				959
Separate account assets (3)			—				11,072				—				11,072
Total assets		$	498			$	12,983			$	1,101			$	14,582
Liabilities
Derivative liabilities: (1)
Interest rate		$	—			$	23			$	—			$	23
Foreign currency exchange rate			—				2				—				2
Total derivative liabilities			—				25				—				25
Net embedded derivatives within liability host contracts (2)			—				—				56				56
Total liabilities		$	—			$	25			$	56			$	81

 

 

(1)

Derivative assets are presented within other invested assets in the balance sheets and derivative liabilities are presented within other liabilities in the balance sheets. The amounts are presented gross in the tables above to reflect the presentation in the balance sheets, but are presented net for purposes of the rollforward in the Fair Value Measurements Using Significant Unobservable Inputs (Level 3) tables.

 

(2)	Net embedded derivatives within asset host contracts are presented within premiums, reinsurance and other receivables in the balance sheets. Net embedded derivatives within liability host contracts are presented within PABs in the balance sheets.

 

(3)	Investment performance related to separate account assets is fully offset by corresponding amounts credited to contractholders whose liability is reflected within separate account liabilities. Separate account liabilities are set equal to the estimated fair value of separate account assets.

 

59

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

7.  Fair Value (continued)

 

The following describes the valuation methodologies used to measure assets and liabilities at fair value. The description includes the valuation techniques and key inputs for each category of assets or liabilities that are classified within Level 2 and Level 3 of the fair value hierarchy.

Investments

Valuation Controls and Procedures

On behalf of the Company and MetLife, Inc.’s Chief Investment Officer and Chief Financial Officer, a pricing and valuation committee that is independent of the trading and investing functions and comprised of senior management, provides oversight of control systems and valuation policies for securities, mortgage loans and derivatives. On a quarterly basis, this committee reviews and approves new transaction types and markets, ensures that observable market prices and market-based parameters are used for valuation, wherever possible, and determines that judgmental valuation adjustments, when applied, are based upon established policies and are applied consistently over time. This committee also provides oversight of the selection of independent third party pricing providers and the controls and procedures to evaluate third party pricing. Periodically, the Chief Accounting Officer reports to the Audit Committee of MetLife, Inc.’s Board of Directors regarding compliance with fair value accounting standards.

The Company reviews its valuation methodologies on an ongoing basis and revises those methodologies when necessary based on changing market conditions. Assurance is gained on the overall reasonableness and consistent application of input assumptions, valuation methodologies and compliance with fair value accounting standards through controls designed to ensure valuations represent an exit price. Several controls are utilized, including certain monthly controls, which include, but are not limited to, analysis of portfolio returns to corresponding benchmark returns, comparing a sample of executed prices of securities sold to the fair value estimates, comparing fair value estimates to management’s knowledge of the current market, reviewing the bid/ask spreads to assess activity, comparing prices from multiple independent pricing services and ongoing due diligence to confirm that independent pricing services use market-based parameters. The process includes a determination of the observability of inputs used in estimated fair values received from independent pricing services or brokers by assessing whether these inputs can be corroborated by observable market data. The Company ensures that prices received from independent brokers, also referred to herein as “consensus pricing,” represent a reasonable estimate of fair value by considering such pricing relative to the Company’s knowledge of the current market dynamics and current pricing for similar financial instruments. While independent non-binding broker quotations are utilized, they are not used for a significant portion of the portfolio. For example, fixed maturity securities priced using independent non-binding broker quotations represent less than 1% of the total estimated fair value of fixed maturity securities and 2% of the total estimated fair value of Level 3 fixed maturity securities.

The Company also applies a formal process to challenge any prices received from independent pricing services that are not considered representative of estimated fair value. If prices received from independent pricing services are not considered reflective of market activity or representative of estimated fair value, independent non-binding broker quotations are obtained, or an internally developed valuation is prepared. Internally developed valuations of current estimated fair value, which reflect internal estimates of liquidity and nonperformance risks, compared with pricing received from the independent pricing services, did not produce material differences in the estimated fair values for the majority of the portfolio; accordingly, overrides were

 

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

7.  Fair Value (continued)

 

not material. This is, in part, because internal estimates of liquidity and nonperformance risks are generally based on available market evidence and estimates used by other market participants. In the absence of such market-based evidence, management’s best estimate is used.

Securities and Short-term Investments

When available, the estimated fair value of these financial instruments is based on quoted prices in active markets that are readily and regularly obtainable. Generally, these are the most liquid of the Company’s securities holdings and valuation of these securities does not involve management’s judgment.

When quoted prices in active markets are not available, the determination of estimated fair value is based on market standard valuation methodologies, giving priority to observable inputs. The significant inputs to the market standard valuation methodologies for certain types of securities with reasonable levels of price transparency are inputs that are observable in the market or can be derived principally from, or corroborated by, observable market data. When observable inputs are not available, the market standard valuation methodologies rely on inputs that are significant to the estimated fair value that are not observable in the market or cannot be derived principally from, or corroborated by, observable market data. These unobservable inputs can be based in large part on management’s judgment or estimation and cannot be supported by reference to market activity. Even though these inputs are unobservable, management believes they are consistent with what other market participants would use when pricing such securities and are considered appropriate given the circumstances.

Level 2 Valuation Techniques and Key Inputs:

This level includes securities priced principally by independent pricing services using observable inputs. Short-term investments within this level are of a similar nature and class to the Level 2 fixed maturity securities and equity securities.

U.S. corporate and foreign corporate securities

These securities are principally valued using the market and income approaches. Valuations are based primarily on quoted prices in markets that are not active, or using matrix pricing or other similar techniques that use standard market observable inputs such as benchmark yields, spreads off benchmark yields, new issuances, issuer rating, duration, and trades of identical or comparable securities. Privately-placed securities are valued using matrix pricing methodologies using standard market observable inputs, and inputs derived from, or corroborated by, market observable data including market yield curve, duration, call provisions, observable prices and spreads for similar publicly traded or privately traded issues that incorporate the credit quality and industry sector of the issuer, and in certain cases, delta spread adjustments to reflect specific credit-related issues.

U.S. Treasury and agency securities

These securities are principally valued using the market approach. Valuations are based primarily on quoted prices in markets that are not active, or using matrix pricing or other similar techniques using standard market observable inputs such as a benchmark U.S. Treasury yield curve, the spread off the U.S. Treasury yield curve for the identical security and comparable securities that are actively traded.

 

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

7.  Fair Value (continued)

 

Structured securities comprised of RMBS, CMBS and ABS

These securities are principally valued using the market and income approaches. Valuations are based primarily on matrix pricing, discounted cash flow methodologies or other similar techniques using standard market inputs, including spreads for actively traded securities, spreads off benchmark yields, expected prepayment speeds and volumes, current and forecasted loss severity, rating, weighted average coupon, weighted average maturity, average delinquency rates, geographic region, debt-service coverage ratios and issuance-specific information, including, but not limited to: collateral type, payment terms of the underlying assets, payment priority within the tranche, structure of the security, deal performance and vintage of loans.

State and political subdivision and foreign government securities

These securities are principally valued using the market approach. Valuations are based primarily on matrix pricing or other similar techniques using standard market observable inputs, including a benchmark U.S. Treasury yield or other yields, issuer ratings, broker-dealer quotes, issuer spreads and reported trades of similar securities, including those within the same sub-sector or with a similar maturity or credit rating.

Common stock

These securities are principally valued using the market approach. Valuations are based principally on observable inputs, including quoted prices in markets that are not considered active.

Level 3 Valuation Techniques and Key Inputs:

In general, securities classified within Level 3 use many of the same valuation techniques and inputs as described previously for Level 2. However, if key inputs are unobservable, or if the investments are less liquid and there is very limited trading activity, the investments are generally classified as Level 3. The use of independent non-binding broker quotations to value investments generally indicates there is a lack of liquidity or a lack of transparency in the process to develop the valuation estimates, generally causing these investments to be classified in Level 3.

U.S. corporate and foreign corporate securities

These securities, including financial services industry hybrid securities classified within fixed maturity securities, are principally valued using the market approach. Valuations are based primarily on matrix pricing or other similar techniques that utilize unobservable inputs or inputs that cannot be derived principally from, or corroborated by, observable market data, including illiquidity premium, delta spread adjustments to reflect specific credit-related issues, credit spreads; and inputs including quoted prices for identical or similar securities that are less liquid and based on lower levels of trading activity than securities classified in Level 2. Certain valuations are based on independent non-binding broker quotations.

Structured securities comprised of RMBS, CMBS and ABS

These securities are principally valued using the market and income approaches. Valuations are based primarily on matrix pricing, discounted cash flow methodologies or other similar techniques that utilize

 

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

7.  Fair Value (continued)

 

inputs that are unobservable or cannot be derived principally from, or corroborated by, observable market data, including credit spreads. Below investment grade securities and sub-prime RMBS included in this level are valued based on inputs including quoted prices for identical or similar securities that are less liquid and based on lower levels of trading activity than securities classified in Level 2. Certain of these valuations are based on independent non-binding broker quotations.

Non-redeemable preferred stock

These securities, including financial services industry hybrid securities classified within equity securities, are principally valued using the market and income approaches. Valuations are based primarily on matrix pricing, discounted cash flow methodologies or other similar techniques using inputs such as comparable credit rating and issuance structure. Certain of these securities are valued based on inputs including quoted prices for identical or similar securities that are less liquid and based on lower levels of trading activity than securities classified in Level 2 and independent non-binding broker quotations.

Separate Account Assets

Separate account assets are carried at estimated fair value and reported as a summarized total on the balance sheets. The estimated fair value of separate account assets is based on the estimated fair value of the underlying assets. Separate account assets within the Company’s separate accounts consist of mutual funds.

Level 2 Valuation Techniques and Key Inputs:

These assets are comprised of certain mutual funds without readily determinable fair values, as prices are not published publicly. Valuation of the mutual funds is based upon quoted prices or reported NAV provided by the fund managers.

Derivatives

The estimated fair value of derivatives is determined through the use of quoted market prices for exchange-traded derivatives or through the use of pricing models for OTC-bilateral and OTC-cleared derivatives. The determination of estimated fair value, when quoted market values are not available, is based on market standard valuation methodologies and inputs that management believes are consistent with what other market participants would use when pricing such instruments. Derivative valuations can be affected by changes in interest rates, foreign currency exchange rates, financial indices, credit spreads, default risk, nonperformance risk, volatility, liquidity and changes in estimates and assumptions used in the pricing models. The valuation controls and procedures for derivatives are described in “— Investments.”

The significant inputs to the pricing models for most OTC-bilateral and OTC-cleared derivatives are inputs that are observable in the market or can be derived principally from, or corroborated by, observable market data. Significant inputs that are observable generally include: interest rates, foreign currency exchange rates, interest rate curves, credit curves and volatility. However, certain OTC-bilateral and OTC-cleared derivatives may rely on inputs that are significant to the estimated fair value that are not observable in the market or cannot be derived principally from, or corroborated by, observable market data. Significant inputs that are unobservable generally include references to emerging market currencies and inputs that are outside the observable portion of

 

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

7.  Fair Value (continued)

 

the interest rate curve, credit curve, volatility or other relevant market measure. These unobservable inputs may involve significant management judgment or estimation. Even though unobservable, these inputs are based on assumptions deemed appropriate given the circumstances and management believes they are consistent with what other market participants would use when pricing such instruments.

Most inputs for OTC-bilateral and OTC-cleared derivatives are mid-market inputs but, in certain cases, liquidity adjustments are made when they are deemed more representative of exit value. Market liquidity, as well as the use of different methodologies, assumptions and inputs, may have a material effect on the estimated fair values of the Company’s derivatives and could materially affect net income.

The credit risk of both the counterparty and the Company are considered in determining the estimated fair value for all OTC-bilateral and OTC-cleared derivatives, and any potential credit adjustment is based on the net exposure by counterparty after taking into account the effects of netting agreements and collateral arrangements. The Company values its OTC-bilateral and OTC-cleared derivatives using standard swap curves which may include a spread to the risk free rate, depending upon specific collateral arrangements. This credit spread is appropriate for those parties that execute trades at pricing levels consistent with similar collateral arrangements. As the Company and its significant derivative counterparties generally execute trades at such pricing levels and hold sufficient collateral, additional credit risk adjustments are not currently required in the valuation process. The Company’s ability to consistently execute at such pricing levels is in part due to the netting agreements and collateral arrangements that are in place with all of its significant derivative counterparties. An evaluation of the requirement to make additional credit risk adjustments is performed by the Company each reporting period.

Freestanding Derivatives

Level 2 Valuation Techniques and Key Inputs:

This level includes all types of derivatives utilized by the Company with the exception of exchange traded derivatives included within Level 1 and those derivatives with unobservable inputs as described in Level 3. These derivatives are principally valued using the income approach.

Interest rate

Non-option-based. Valuations are based on present value techniques, which utilize significant inputs that may include the swap yield curve and basis curves.

Option-based. Valuations are based on option pricing models, which utilize significant inputs that may include the swap yield curve, basis curves and interest rate volatility.

Foreign currency exchange rate

Non-option-based. Valuations are based on present value techniques, which utilize significant inputs that may include the swap yield curve, basis curves, currency spot rates and cross currency basis curves.

Embedded Derivatives

Embedded derivatives principally include certain direct variable annuity guarantees and certain affiliated ceded reinsurance agreements related to such variable annuity guarantees. Embedded derivatives are recorded at estimated fair value with changes in estimated fair value reported in net income.

 

64

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

7.  Fair Value (continued)

 

The Company issues certain variable annuity products with guaranteed minimum benefits. GMWBs, GMABs and certain GMIBs contain embedded derivatives, which are measured at estimated fair value separately from the host variable annuity contract, with changes in estimated fair value reported in net derivative gains (losses). These embedded derivatives are classified within PABs in the balance sheets.

The fair value of these embedded derivatives, estimated as the present value of projected future benefits minus the present value of projected future fees using actuarial and capital market assumptions including expectations concerning policyholder behavior, is calculated by the Company’s actuarial department. The calculation is based on in-force business, and is performed using standard actuarial valuation software which projects future cash flows from the embedded derivative over multiple risk neutral stochastic scenarios using observable risk free rates.

Capital market assumptions, such as risk free rates and implied volatilities, are based on market prices for publicly traded instruments to the extent that prices for such instruments are observable. Implied volatilities beyond the observable period are extrapolated based on observable implied volatilities and historical volatilities. Actuarial assumptions, including mortality, lapse, withdrawal and utilization, are unobservable and are reviewed at least annually based on actuarial studies of historical experience.

The valuation of these guarantee liabilities includes nonperformance risk adjustments and adjustments for a risk margin related to non-capital market inputs. The nonperformance adjustment is determined by taking into consideration publicly available information relating to spreads in the secondary market for MetLife’s debt, including related credit default swaps. These observable spreads are then adjusted, as necessary, to reflect the priority of these liabilities and the claims paying ability of the issuing insurance subsidiaries compared to MetLife.

Risk margins are established to capture the non-capital market risks of the instrument which represent the additional compensation a market participant would require to assume the risks related to the uncertainties of such actuarial assumptions as annuitization, premium persistency, partial withdrawal and surrenders. The establishment of risk margins requires the use of significant management judgment, including assumptions of the amount and cost of capital needed to cover the guarantees. These guarantees may be more costly than expected in volatile or declining equity markets. Market conditions including, but not limited to, changes in interest rates, equity indices, market volatility and foreign currency exchange rates; changes in nonperformance risk; and variations in actuarial assumptions regarding policyholder behavior, mortality and risk margins related to non-capital market inputs, may result in significant fluctuations in the estimated fair value of the guarantees that could materially affect net income.

The Company ceded, to an affiliated reinsurance company, the risk associated with certain of the GMIBs, GMABs and GMWBs described above that are also accounted for as embedded derivatives. In addition to ceding risks associated with guarantees that are accounted for as embedded derivatives, the Company also cedes, to the same affiliated reinsurance company, certain directly written GMIBs that are accounted for as insurance (i.e., not as embedded derivatives), but where the reinsurance agreement contains an embedded derivative. These embedded derivatives are included within premiums, reinsurance and other receivables in the balance sheets with changes in estimated fair value reported in net derivative gains (losses). The value of the embedded derivatives on the ceded risk is determined using a methodology consistent with that described previously for the guarantees directly written by the Company with the exception of the input for nonperformance risk that reflects the credit of the reinsurer.

 

65

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

7.  Fair Value (continued)

 

Embedded Derivatives Within Asset and Liability Host Contracts

Level 3 Valuation Techniques and Key Inputs:

Direct guaranteed minimum benefits

These embedded derivatives are principally valued using the income approach. Valuations are based on option pricing techniques, which utilize significant inputs that may include swap yield curve, currency exchange rates and implied volatilities. These embedded derivatives result in Level 3 classification because one or more of the significant inputs are not observable in the market or cannot be derived principally from, or corroborated by, observable market data. Significant unobservable inputs generally include: the extrapolation beyond observable limits of the swap yield curve and implied volatilities, actuarial assumptions for policyholder behavior and mortality and the potential variability in policyholder behavior and mortality, nonperformance risk and cost of capital for purposes of calculating the risk margin.

Reinsurance ceded on certain guaranteed minimum benefits

These embedded derivatives are principally valued using the income approach. The valuation techniques and significant market standard unobservable inputs used in their valuation are similar to those described above in “— Direct Guaranteed Minimum Benefits” and also include counterparty credit spreads.

Transfers between Levels

Overall, transfers between levels occur when there are changes in the observability of inputs and market activity. Transfers into or out of any level are assumed to occur at the beginning of the period.

Transfers between Levels 1 and 2:

There were no transfers between Levels 1 and 2 for assets and liabilities measured at estimated fair value and still held at December 31, 2013 and 2012.

Transfers into or out of Level 3:

Assets and liabilities are transferred into Level 3 when a significant input cannot be corroborated with market observable data. This occurs when market activity decreases significantly and underlying inputs cannot be observed, current prices are not available, and/or when there are significant variances in quoted prices, thereby affecting transparency. Assets and liabilities are transferred out of Level 3 when circumstances change such that a significant input can be corroborated with market observable data. This may be due to a significant increase in market activity, a specific event, or one or more significant input(s) becoming observable.

Transfers into Level 3 for fixed maturity securities were due primarily to a lack of trading activity, decreased liquidity and credit ratings downgrades (e.g., from investment grade to below investment grade) which have resulted in decreased transparency of valuations and an increased use of independent non-binding broker quotations and unobservable inputs, such as illiquidity premiums, delta spread adjustments, or credit spreads.

 

66

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

7.  Fair Value (continued)

 

Transfers out of Level 3 for fixed maturity securities resulted primarily from increased transparency of both new issuances that, subsequent to issuance and establishment of trading activity, became priced by independent pricing services and existing issuances that, over time, the Company was able to obtain pricing from, or corroborate pricing received from, independent pricing services with observable inputs (such as observable spreads used in pricing securities) or increases in market activity and upgraded credit ratings.

Assets and Liabilities Measured at Fair Value Using Significant Unobservable Inputs (Level 3)

The following table presents certain quantitative information about the significant unobservable inputs used in the fair value measurement, and the sensitivity of the estimated fair value to changes in those inputs, for the more significant asset and liability classes measured at fair value on a recurring basis using significant unobservable inputs (Level 3) at:

 

						December 31, 2013																December 31, 2012																Impact of Increase in Input on Estimated Fair Value (2)
		Valuation Techniques		Significant Unobservable Inputs		Range												Weighted Average (1)				Range												Weighted Average (1)
Fixed maturity securities: (3)
U.S. corporate and foreign corporate		•    Matrix pricing		•    Delta spread adjustments (4)			(10)				–				30				6				50				–				100				57			Decrease
				•    Illiquidity premium (4)			30				–				30				30				30				–				30				30			Decrease
				•    Credit spreads (4)																			23				–				421				129			Decrease
		•    Consensus pricing		•    Offered quotes (5)																			100				–				102				101			Increase
RMBS		•    Matrix pricing and discounted cash flow		•    Credit spreads (4)			97				–				574				411				161				–				657				541			Decrease (6)
		•    Market pricing		•    Quoted prices (5)			100				–				100				100																			Increase (6)
CMBS		•    Market pricing		•    Quoted prices (5)																			100				–				100				100			Increase (6)
ABS		•    Market pricing		•    Quoted prices (5)			99				–				99				99																			Increase (6)
		•    Consensus pricing		•    Offered quotes (5)			99				–				99				99																			Increase (6)
Embedded derivatives:
Direct and ceded guaranteed minimum benefits		•    Option pricing techniques		•    Mortality rates:
				Ages 0 - 40			0	%			–				0.10	%							0	%			–				0.10	%						Decrease (7)
				Ages 41 - 60			0.04	%			–				0.65	%							0.05	%			–				0.64	%						Decrease (7)
				Ages 61 - 115			0.26	%			–				100	%							0.32	%			–				100	%						Decrease (7)
				•    Lapse rates:
				Durations 1 - 10			0.50	%			–				100	%							0.50	%			–				100	%						Decrease (8)
				Durations 11 -20			3	%			–				100	%							3	%			–				100	%						Decrease (8)
				Durations 21 -116			3	%			–				100	%							3	%			–				100	%						Decrease (8)
				•    Utilization rates			20	%			–				50	%							20	%			–				50	%						Increase (9)
				•    Withdrawal rates			0.07	%			–				10	%							0.07	%			–				10	%						(10)
				•    Long-term equity volatilities			17.40	%			–				25	%							17.40	%			–				25	%						Increase (11)
				•    Nonperformance risk spread			0.03	%			–				0.44	%							0.10	%			–				0.67	%						Decrease (12)

 

 

 

(1)	The weighted average for fixed maturity securities is determined based on the estimated fair value of the securities.

 

(2)	The impact of a decrease in input would have the opposite impact on the estimated fair value. For embedded derivatives, changes to direct guaranteed minimum benefits are based on liability positions and changes to ceded guaranteed minimum benefits are based on asset positions.

 

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

7.  Fair Value (continued)

 

(3)	Significant increases (decreases) in expected default rates in isolation would result in substantially lower (higher) valuations.

 

(4)	Range and weighted average are presented in basis points.

 

(5)	Range and weighted average are presented in accordance with the market convention for fixed maturity securities of dollars per hundred dollars of par.

 

(6)	Changes in the assumptions used for the probability of default is accompanied by a directionally similar change in the assumption used for the loss severity and a directionally opposite change in the assumptions used for prepayment rates.

 

(7)

Mortality rates vary by age and by demographic characteristics such as gender. Mortality rate assumptions are based on company experience. A mortality improvement assumption is also applied. For any given contract, mortality rates vary throughout the period over which cash flows are projected for purposes of valuing the embedded derivative.

 

(8)

Base lapse rates are adjusted at the contract level based on a comparison of the actuarially calculated guaranteed values and the current policyholder account value, as well as other factors, such as the applicability of any surrender charges. A dynamic lapse function reduces the base lapse rate when the guaranteed amount is greater than the account value as in the money contracts are less likely to lapse. Lapse rates are also generally assumed to be lower in periods when a surrender charge applies. For any given contract, lapse rates vary throughout the period over which cash flows are projected for purposes of valuing the embedded derivative.

 

(9)

The utilization rate assumption estimates the percentage of contract holders with a GMIB or lifetime withdrawal benefit who will elect to utilize the benefit upon becoming eligible. The rates may vary by the type of guarantee, the amount by which the guaranteed amount is greater than the account value, the contract’s withdrawal history and by the age of the policyholder. For any given contract, utilization rates vary throughout the period over which cash flows are projected for purposes of valuing the embedded derivative.

 

(10)

The withdrawal rate represents the percentage of account balance that any given policyholder will elect to withdraw from the contract each year. The withdrawal rate assumption varies by age and duration of the contract, and also by other factors such as benefit type. For any given contract, withdrawal rates vary throughout the period over which cash flows are projected for purposes of valuing the embedded derivative. For GMWBs, any increase (decrease) in withdrawal rates results in an increase (decrease) in the estimated fair value of the guarantees. For GMABs and GMIBs, any increase (decrease) in withdrawal rates results in a decrease (increase) in the estimated fair value.

 

(11)

Long-term equity volatilities represent equity volatility beyond the period for which observable equity volatilities are available. For any given contract, long-term equity volatility rates vary throughout the period over which cash flows are projected for purposes of valuing the embedded derivative.

 

(12)	Nonperformance risk spread varies by duration and by currency. For any given contract, multiple nonperformance risk spreads will apply, depending on the duration of the cash flow being discounted for purposes of valuing the embedded derivative.

 

68

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

7.  Fair Value (continued)

 

The following is a summary of the valuation techniques and significant unobservable inputs used in the fair value measurement of assets and liabilities classified within Level 3 that are not included in the preceding table. Generally, all other classes of securities classified within Level 3 use the same valuation techniques and significant unobservable inputs as previously described for Level 3 securities. This includes matrix pricing and discounted cash flow methodologies, inputs such as quoted prices for identical or similar securities that are less liquid and based on lower levels of trading activity than securities classified in Level 2, as well as independent non-binding broker quotations. The sensitivity of the estimated fair value to changes in the significant unobservable inputs for these other assets and liabilities is similar in nature to that described in the preceding table.

The following tables summarize the change of all assets and (liabilities) measured at estimated fair value on a recurring basis using significant unobservable inputs (Level 3):

 

		Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
		Fixed Maturity Securities:																				Equity Securities:								Short-term Investments				Net Embedded Derivatives (6)
		U.S. Corporate				RMBS				CMBS				Foreign Corporate				ABS				Common Stock				Non- redeemable Preferred Stock
		(In millions)
Year Ended December 31, 2013:
Balance at January 1,		$	55			$	14			$	14			$	42			$	—			$	—			$	17			$	—			$	903
Total realized/unrealized gains (losses) included in:
Net income (loss): (1), (2)
Net investment income			—				—				—				—				—				—				—				—				—
Net investment gains (losses)			—				—				—				—				—				—				—				—				—
Net derivative gains (losses)			—				—				—				—				—				—				—				—				(415)
OCI			—				—				—				2				—				—				2				—				—
Purchases (3)			4				13				—				10				7				—				—				—				—
Sales (3)			(10)				—				—				(9)				—				—				—				—				—
Issuances (3)			—				—				—				—				—				—				—				—				—
Settlements (3)			—				—				—				—				—				—				—				—				19
Transfers into Level 3 (4)			—				—				—				—				—				—				—				—				—
Transfers out of Level 3 (4)			(36)				—				(14)				(1)				—				—				—				—				—
Balance at December 31,		$	13			$	27			$	—			$	44			$	7			$	—			$	19			$	—			$	507
Changes in unrealized gains (losses) included in net income (loss): (5)
Net investment income		$	—			$	—			$	—			$	—			$	—			$	—			$	—			$	—			$	—
Net investment gains (losses)		$	—			$	—			$	—			$	—			$	—			$	—			$	—			$	—			$	—
Net derivative gains (losses)		$	—			$	—			$	—			$	—			$	—			$	—			$	—			$	—			$	(402)

 

69

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

7.  Fair Value (continued)

 

		Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
		Fixed Maturity Securities:																				Equity Securities:								Short-term Investments				Net Embedded Derivatives (6)
		U.S. Corporate				RMBS				CMBS				Foreign Corporate				ABS				Common Stock				Non- redeemable Preferred Stock
		(In millions)
Year Ended December 31, 2012:
Balance at January 1,		$	16			$	11			$	—			$	6			$	6			$	19			$	15			$	—			$	580
Total realized/unrealized gains (losses) included in:
Net income (loss): (1), (2)
Net investment income			—				—				—				—				—				—				—				—				—
Net investment gains (losses)			—				—				—				—				—				—				—				—				—
Net derivative gains (losses)			—				—				—				—				—				—				—				—				303
OCI			2				3				—				—				—				—				2				—				—
Purchases (3)			31				—				14				36				—				—				—				—				—
Sales (3)			(2)				—				—				—				(6)				—				—				—				—
Issuances (3)			—				—				—				—				—				—				—				—				—
Settlements (3)			—				—				—				—				—				—				—				—				20
Transfers into Level 3 (4)			11				—				—				—				—				—				—				—				—
Transfers out of Level 3 (4)			(3)				—				—				—				—				(19)				—				—				—
Balance at December 31,		$	55			$	14			$	14			$	42			$	—			$	—			$	17			$	—			$	903
Changes in unrealized gains (losses) included in net income (loss): (5)
Net investment income		$	—			$	—			$	—			$	—			$	—			$	—			$	—			$	—			$	—
Net investment gains (losses)		$	—			$	—			$	—			$	—			$	—			$	—			$	—			$	—			$	—
Net derivative gains (losses)		$	—			$	—			$	—			$	—			$	—			$	—			$	—			$	—			$	309

 

		Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
		Fixed Maturity Securities:																				Equity Securities:								Short-term Investments				Net Embedded Derivatives (6)
		U.S. Corporate				RMBS				CMBS				Foreign Corporate				ABS				Common Stock				Non- redeemable Preferred Stock
		(In millions)
Year Ended December 31, 2011:
Balance at January 1,		$	22			$	11			$	—			$	25			$	19			$	10			$	15			$	9			$	269
Total realized/unrealized gains (losses) included in:
Net income (loss): (1), (2)
Net investment income			—				—				—				—				—				—				—				—				—
Net investment gains (losses)			—				—				—				(3)				—				—				—				—				—
Net derivative gains (losses)			—				—				—				—				—				—				—				—				290
OCI			1				—				—				2				1				—				—				—				—
Purchases (3)			2				—				—				6				5				9				—				—				—
Sales (3)			(2)				—				—				(17)				(9)				—				—				(9)				—
Issuances (3)			—				—				—				—				—				—				—				—				—
Settlements (3)			—				—				—				—				—				—				—				—				21
Transfers into Level 3 (4)			—				—				—				—				—				—				—				—				—
Transfers out of Level 3 (4)			(7)				—				—				(7)				(10)				—				—				—				—
Balance at December 31,		$	16			$	11			$	—			$	6			$	6			$	19			$	15			$	—			$	580
Changes in unrealized gains (losses) included in net income (loss): (5)
Net investment income		$	—			$	—			$	—			$	—			$	—			$	—			$	—			$	—			$	—
Net investment gains (losses)		$	—			$	—			$	—			$	—			$	—			$	—			$	—			$	—			$	—
Net derivative gains (losses)		$	—			$	—			$	—			$	—			$	—			$	—			$	—			$	—			$	293

 

 

(1)	Amortization of premium/discount is included within net investment income. Impairments charged to net income (loss) on securities are included in net investment gains (losses). Lapses associated with net embedded derivatives are included in net derivative gains (losses).

 

70

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

7.  Fair Value (continued)

 

(2)	Interest and dividend accruals, as well as cash interest coupons and dividends received, are excluded from the rollforward.

 

(3)	Items purchased/issued and then sold/settled in the same period are excluded from the rollforward. Fees attributed to embedded derivatives are included in settlements.

 

(4)	Gains and losses, in net income (loss) and OCI, are calculated assuming transfers into and/or out of Level 3 occurred at the beginning of the period. Items transferred into and then out of Level 3 in the same period are excluded from the rollforward.

 

(5)	Changes in unrealized gains (losses) included in net income (loss) relate to assets and liabilities still held at the end of the respective periods.

 

(6)	Embedded derivative assets and liabilities are presented net for purposes of the rollforward.

Fair Value of Financial Instruments Carried at Other Than Fair Value

The following tables provide fair value information for financial instruments that are carried on the balance sheet at amounts other than fair value. These tables exclude the following financial instruments: cash and cash equivalents, accrued investment income and payables for collateral under securities loaned and other transactions. The estimated fair value of the excluded financial instruments, which are primarily classified in Level 2 and, to a lesser extent, in Level 1, approximates carrying value as they are short-term in nature such that the Company believes there is minimal risk of material changes in interest rates or credit quality. All remaining balance sheet amounts excluded from the table below are not considered financial instruments subject to this disclosure.

The carrying values and estimated fair values for such financial instruments, and their corresponding placement in the fair value hierarchy, are summarized as follows at:

 

		December 31, 2013
						Fair Value Hierarchy
		Carrying Value				Level 1				Level 2				Level 3				Total Estimated Fair Value
		(In millions)
Assets
Mortgage loans		$	286			$	—			$	—			$	303			$	303
Policy loans		$	27			$	—			$	3			$	39			$	42
Other limited partnership interests		$	1			$	—			$	—			$	1			$	1
Other invested assets		$	45			$	—			$	50			$	—			$	50
Premiums, reinsurance and other receivables		$	1,258			$	—			$	—			$	1,359			$	1,359
Other assets		$	5			$	—			$	5			$	—			$	5
Liabilities
PABs		$	2,293			$	—			$	—			$	2,501			$	2,501
Other liabilities		$	1			$	—			$	1			$	—			$	1

 

71

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

7.  Fair Value (continued)

 

		December 31, 2012
						Fair Value Hierarchy
		Carrying Value				Level 1				Level 2				Level 3				Total Estimated Fair Value
		(In millions)
Assets
Mortgage loans		$	284			$	—			$	—			$	307			$	307
Policy loans		$	27			$	—			$	2			$	46			$	48
Other limited partnership interests		$	1			$	—			$	—			$	2			$	2
Other invested assets		$	45			$	—			$	57			$	—			$	57
Premiums, reinsurance and other receivables		$	1,364			$	—			$	—			$	1,527			$	1,527
Other assets		$	6			$	—			$	6			$	—			$	6
Liabilities
PABs		$	2,431			$	—			$	—			$	2,788			$	2,788
Other liabilities		$	3			$	—			$	3			$	—			$	3

The methods, assumptions and significant valuation techniques and inputs used to estimate the fair value of financial instruments are summarized as follows:

Mortgage Loans

For mortgage loans, estimated fair value is primarily determined by estimating expected future cash flows and discounting them using current interest rates for similar mortgage loans with similar credit risk, or is determined from pricing for similar loans.

Policy Loans

Policy loans with fixed interest rates are classified within Level 3. The estimated fair values for these loans are determined using a discounted cash flow model applied to groups of similar policy loans determined by the nature of the underlying insurance liabilities. Cash flow estimates are developed by applying a weighted-average interest rate to the outstanding principal balance of the respective group of policy loans and an estimated average maturity determined through experience studies of the past performance of policyholder repayment behavior for similar loans. These cash flows are discounted using current risk-free interest rates with no adjustment for borrower credit risk as these loans are fully collateralized by the cash surrender value of the underlying insurance policy. Policy loans with variable interest rates are classified within Level 2 and the estimated fair value approximates carrying value due to the absence of borrower credit risk and the short time period between interest rate resets, which presents minimal risk of a material change in estimated fair value due to changes in market interest rates.

Other Limited Partnership Interests

The estimated fair values of these cost method investments are generally based on the Company’s share of the NAV as provided in the financial statements of the investees. In certain circumstances, management may adjust the NAV by a premium or discount when it has sufficient evidence to support applying such adjustments.

 

72

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

7.  Fair Value (continued)

 

Other Invested Assets

These other invested assets are principally comprised of loans to affiliates. The estimated fair value of loans to affiliates is determined by discounting the expected future cash flows using market interest rates currently available for instruments with similar terms and remaining maturities.

Premiums, Reinsurance and Other Receivables

Premiums, reinsurance and other receivables are principally comprised of certain amounts recoverable under reinsurance agreements.

Amounts recoverable under ceded reinsurance agreements, which the Company has determined do not transfer significant risk such that they are accounted for using the deposit method of accounting, have been classified as Level 3. The valuation is based on discounted cash flow methodologies using significant unobservable inputs. The estimated fair value is determined using interest rates determined to reflect the appropriate credit standing of the assuming counterparty.

Other Assets

Other assets are comprised of a receivable for the reimbursable portion of the estimated future guaranty liability that pertains to pre-acquisition business. With the exception of the receivable, other assets are not considered financial instruments subject to disclosure. Accordingly, the amount represents the receivable from an unaffiliated institution for which the estimated fair value was determined by discounting the expected future cash flows using a discount rate that reflects the credit standing of the unaffiliated institution.

PABs

These PABs include investment contracts. Embedded derivatives on investment contracts and certain variable annuity guarantees accounted for as embedded derivatives are excluded from this caption in the preceding tables as they are separately presented in “— Recurring Fair Value Measurements.”

The investment contracts primarily include fixed deferred annuities and fixed term payout annuities. The valuation of these investment contracts is based on discounted cash flow methodologies using significant unobservable inputs. The estimated fair value is determined using current market risk-free interest rates adding a spread to reflect the nonperformance risk in the liability.

Other Liabilities

Other liabilities consist of derivative payables and amounts due for securities purchased but not yet settled. The Company evaluates the specific terms, facts and circumstances of each instrument to determine the appropriate estimated fair values, which are not materially different from the carrying values.

 

73

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

8.  Equity

 

Statutory Equity and Income

Each U.S. insurance company’s state of domicile imposes risk-based capital (“RBC”) requirements that were developed by the National Association of Insurance Commissioners (“NAIC”). Regulatory compliance is determined by a ratio of a company’s total adjusted capital, calculated in the manner prescribed by the NAIC (“TAC”) to its authorized control level RBC, calculated in the manner prescribed by the NAIC (“ACL RBC”). Companies below specific trigger points or ratios are classified within certain levels, each of which requires specified corrective action. The minimum level of TAC before corrective action commences is twice ACL RBC (“Company Action RBC”). The RBC ratio for the Company was in excess of 1,400% for all periods presented.

The Company prepares statutory-basis financial statements in accordance with statutory accounting practices prescribed or permitted by the insurance department of its state of domicile. The NAIC has adopted the Codification of Statutory Accounting Principles (“Statutory Codification”). Statutory Codification is intended to standardize regulatory accounting and reporting to state insurance departments. However, statutory accounting principles continue to be established by individual state laws and permitted practices. Modifications by state insurance departments may impact the effect of Statutory Codification on the statutory capital and surplus of the Company.

Statutory accounting principles differ from GAAP primarily by charging policy acquisition costs to expense as incurred, establishing future policy benefit liabilities using different actuarial assumptions, reporting of reinsurance agreements and valuing securities on a different basis.

In addition, certain assets are not admitted under statutory accounting principles and are charged directly to surplus. The most significant assets not admitted by the Company are net deferred income tax assets resulting from temporary differences between statutory accounting principles basis and tax basis not expected to reverse and become recoverable within three years.

Statutory net income (loss) of the Company, a Missouri domiciled insurer, was $111 million, $132 million and $94 million for the years ended December 31, 2013, 2012 and 2011, respectively. Statutory capital and surplus was $666 million and $704 million at December 31, 2013 and 2012, respectively. All such amounts are derived from the statutory-basis financial statements as filed with the Missouri State Department of Insurance.

Dividend Restrictions

Under Missouri State Insurance Law, MLIIC is permitted, without prior insurance regulatory clearance, to pay a stockholder dividend to MetLife as long as the amount of the dividend when aggregated with all other dividends in the preceding 12 months does not exceed the greater of: (i) 10% of its surplus to policyholders as of the end of the immediately preceding calendar year; or (ii) its statutory net gain from operations for the immediately preceding calendar year (excluding net realized capital gains). MLIIC will be permitted to pay a dividend to MetLife in excess of the greater of such two amounts only if it files notice of the declaration of such a dividend and the amount thereof with the Missouri Director of Insurance (the “Missouri Director”) and the Missouri Director either approves the distribution of the dividend or does not disapprove the distribution within 30 days of its filing. In addition, any dividend that exceeds earned surplus (defined by the Company as “unassigned funds (surplus)”) as of the last filed annual statutory statement requires insurance regulatory approval. Under Missouri State Insurance Law, the Missouri Director has broad discretion in determining

 

74

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

8.  Equity (continued)

 

whether the financial condition of a stock life insurance company would support the payment of such dividends to its stockholders. During the years ended December 31, 2013 and 2012, MLIIC paid a dividend to MetLife of $129 million and $18 million, respectively. During the year ended December 31, 2011, MLIIC did not pay a dividend to MetLife. Based on amounts at December 31, 2013, MLIIC could pay a stockholder dividend in 2014 of $99 million without prior regulatory approval of the Missouri Director.

Accumulated Other Comprehensive Income (Loss)

Information regarding changes in the balances of each component of AOCI, net of income tax, was as follows:

 

		Unrealized Investment Gains (Losses), Net of Related Offsets (1)				Unrealized Gains (Losses) on Derivatives				Total
		(In millions)
Balance at December 31, 2010		$	19			$	1			$	20
OCI before reclassifications			19				—				19
Income tax expense (benefit)			(7)				—				(7)
OCI before reclassifications, net of income tax			31				1				32
Amounts reclassified from AOCI			4				—				4
Income tax expense (benefit)			(1)				—				(1)
Amounts reclassified from AOCI, net of income tax			3				—				3
Balance at December 31, 2011			34				1				35
OCI before reclassifications			61				(1)				60
Income tax expense (benefit)			(21)				—				(21)
OCI before reclassifications, net of income tax			74				—				74
Amounts reclassified from AOCI			3				—				3
Income tax expense (benefit)			(1)				—				(1)
Amounts reclassified from AOCI, net of income tax			2				—				2
Balance at December 31, 2012			76				—				76
OCI before reclassifications			(78)				(2)				(80)
Income tax expense (benefit)			27				1				28
OCI before reclassifications, net of income tax			25				(1)				24
Amounts reclassified from AOCI			(2)				—				(2)
Income tax expense (benefit)			1				—				1
Amounts reclassified from AOCI, net of income tax			(1)				—				(1)
Balance at December 31, 2013		$	24			$	(1)			$	23

 

 

(1)	See Note 5 for information on offsets to investments related to insurance liabilities and DAC and VOBA.

 

75

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

8.  Equity (continued)

 

Information regarding amounts reclassified out of each component of AOCI, was as follows:

 

AOCI Components		Amounts Reclassified from AOCI												Statement of Operations and Comprehensive Income (Loss) Location
		Years Ended December 31,
		2013				2012				2011
		(In millions)
Net unrealized investment gains (losses):
Net unrealized investment gains (losses)		$	1			$	(5)			$	(5)			Other net investment gains (losses)
Net unrealized investment gains (losses)			1				2				1			Net investment income
Net unrealized investment gains (losses), before income tax			2				(3)				(4)
Income tax (expense) benefit			(1)				1				1
Net unrealized investment gains (losses), net of income tax		$	1			$	(2)			$	(3)
Total reclassifications, net of income tax		$	1			$	(2)			$	(3)

9.  Other Expenses

Information on other expenses was as follows:

 

		Years Ended December 31,
		2013				2012				2011
		(In millions)
Compensation		$	5			$	9			$	10
Commissions			50				57				68
Volume-related costs			—				3				7
Capitalization of DAC			(6)				(19)				(34)
Amortization of DAC and VOBA			(89)				148				172
Premium taxes, licenses and fees			3				1				6
Other			26				30				30
Total other expenses		$	(11)			$	229			$	259

Capitalization and Amortization of DAC and VOBA

See Note 3 for additional information on DAC and VOBA including impacts of capitalization and amortization.

Affiliated Expenses

See Note 12 for discussion of affiliated expenses included in the table above.

 

76

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

10.  Income Tax

 

The provision for income tax was as follows:

 

		Years Ended December 31,
		2013				2012				2011
		(In millions)
Current:
Federal		$	38			$	8			$	24
Deferred:
Federal			(105)				86				66
Provision for income tax expense (benefit)		$	(67)			$	94			$	90

The reconciliation of the income tax provision at the U.S. statutory rate to the provision for income tax as reported was as follows:

 

		Years Ended December 31,
		2013				2012				2011
		(In millions)
Tax provision at U.S. statutory rate		$	(55)			$	103			$	107
Tax effect of:
Dividend received deduction			(12)				(11)				(13)
Prior year tax			(2)				3				(2)
Tax credits			(1)				(1)				(2)
Other, net			3				—				—
Provision for income tax expense (benefit)		$	(67)			$	94			$	90

Deferred income tax represents the tax effect of the differences between the book and tax basis of assets and liabilities. Net deferred income tax assets and liabilities consisted of the following at:

 

		December 31,
		2013				2012
		(In millions)
Deferred income tax assets:
Investments, including derivatives		$	9			$	—
Tax credit carryforwards			5				—
Other, net			2
Total deferred income tax assets			16				—
Deferred income tax liabilities:
Policyholder liabilities and receivables			110				234
DAC and VOBA			86				33
Net unrealized investment gains			11				40
Investments, including derivatives			—				18
Other			1				1
Total deferred income tax liabilities			208				326
Net deferred income tax asset (liability)		$	(192)			$	(326)

 

77

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

10.  Income Tax (continued)

 

Tax credit carryforwards of $5 million at December 31, 2013 will expire beginning in 2021.

The Company participates in a tax sharing agreement with MetLife, as described in Note 1. Pursuant to this tax sharing agreement, the amounts due from affiliates include $18 million and $8 million at December 31, 2013 and 2012, respectively. The amounts due to affiliates include $8 million at December 31, 2011.

The Company files income tax returns with the U.S. federal government and various state and local jurisdictions. The Company is under continuous examination by the Internal Revenue Service (“IRS”) and other tax authorities in jurisdictions in which the Company has significant business operations. The income tax years under examination vary by jurisdiction. The Company is no longer subject to U.S. federal, state or local income tax examinations in major taxing jurisdictions for years prior to 2006. The IRS audit cycle for the year 2006, which began in April 2010, is expected to conclude in 2014.

It is not expected that there will be a material change in the Company’s liability for unrecognized tax benefits in the next 12 months.

A reconciliation of the beginning and ending amount of unrecognized tax benefits was as follows:

 

		Year Ended December 31, 2013
		(In millions)
Balance at January 1,		$	—
Additions for tax positions of prior years			3
Balance at December 31,		$	3
Unrecognized tax benefits that, if recognized would impact the effective rate		$	3

There were no unrecognized tax benefits at December 31, 2012 and 2011.

The Company classifies interest accrued related to unrecognized tax benefits in interest expense, included within other expenses, while penalties are included in income tax expense.

Interest was as follows:

 

		Year Ended December 31, 2013
		(In millions)
Interest recognized in the statements of operations		$	1
		December 31, 2013
		(In millions)
Interest included in other liabilities in the balance sheets		$	1

 

78

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

10.  Income Tax (continued)

 

There was no interest recognized in the statements of operations for the years ended December 31, 2012 and 2011. There was no interest included in other liabilities in the balance sheets at December 31, 2012.

The Company had no penalties for the years ended December 31, 2013, 2012 and 2011.

The U.S. Treasury Department and the IRS have indicated that they intend to address through regulations the methodology to be followed in determining the dividends received deduction (“DRD”), related to variable life insurance and annuity contracts. The DRD reduces the amount of dividend income subject to tax and is a significant component of the difference between the actual tax expense and expected amount determined using the federal statutory tax rate of 35%. Any regulations that the IRS ultimately proposes for issuance in this area will be subject to public notice and comment, at which time insurance companies and other interested parties will have the opportunity to raise legal and practical questions about the content, scope and application of such regulations. As a result, the ultimate timing and substance of any such regulations are unknown at this time. For the years ended December 31, 2013 and 2012, the Company recognized an income tax benefit of $14 million and $8 million, respectively, related to the separate account DRD. The 2013 benefit included a benefit of $2 million related to a true-up of the 2012 tax return. The 2012 benefit included an expense of $3 million related to a true-up of the 2011 tax return.

11.  Contingencies, Commitments and Guarantees

Contingencies

Litigation

Unclaimed Property Inquiries

In April 2012, MetLife, for itself and on behalf of entities including the Company, reached agreements with representatives of the U.S. jurisdictions that were conducting audits of MetLife and certain of its affiliates for compliance with unclaimed property laws, and with state insurance regulators directly involved in a multistate targeted market conduct examination relating to claim-payment practices and compliance with unclaimed property laws. At least one other jurisdiction is pursuing a market conduct examination. It is possible that other jurisdictions may pursue similar examinations or audits and that such actions may result in additional payments to beneficiaries, additional escheatment of funds deemed abandoned under state laws, administrative penalties, interest, and/or further changes to the Company’s procedures. The Company is not currently able to estimate these additional possible costs.

Sales Practices Claims

Over the past several years, the Company has faced claims and regulatory inquiries and investigations, alleging improper marketing or sales of individual life insurance policies, annuities, mutual funds or other products. The Company continues to vigorously defend against the claims in these matters. The Company believes adequate provision has been made in its financial statements for all probable and reasonably estimable losses for sales practices matters.

 

79

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

11.  Contingencies, Commitments and Guarantees (continued)

 

Summary

Various litigation, claims and assessments against the Company, have arisen in the course of the Company’s business, including, but not limited to, in connection with its activities as an insurer, employer, investor, investment advisor, and taxpayer. Further, state insurance regulatory authorities and other federal and state authorities regularly make inquiries and conduct investigations concerning the Company’s compliance with applicable insurance and other laws and regulations.

It is not possible to predict the ultimate outcome of all pending investigations and legal proceedings. In some of the matters, very large and/or indeterminate amounts, including punitive and treble damages, are sought. Although in light of these considerations it is possible that an adverse outcome in certain cases could have a material effect upon the Company’s financial position, based on information currently known by the Company’s management, in its opinion, the outcomes of such pending investigations and legal proceedings are not likely to have such an effect. However, given the large and/or indeterminate amounts sought in certain of these matters and the inherent unpredictability of litigation, it is possible that an adverse outcome in certain matters could, from time to time, have a material effect on the Company’s net income or cash flows in particular annual periods.

Insolvency Assessments

Most of the jurisdictions in which the Company is admitted to transact business require insurers doing business within the jurisdiction to participate in guaranty associations, which are organized to pay contractual benefits owed pursuant to insurance policies issued by impaired, insolvent or failed insurers. These associations levy assessments, up to prescribed limits, on all member insurers in a particular state on the basis of the proportionate share of the premiums written by member insurers in the lines of business in which the impaired, insolvent or failed insurer engaged. Some states permit member insurers to recover assessments paid through full or partial premium tax offsets. Assets and liabilities held for insolvency assessments were as follows:

 

		December 31,
		2013				2012
		(In millions)
Other Assets:
Premium tax offset for future undiscounted assessments		$	1			$	1
Receivable for reimbursement of paid assessments (1)			5				6
		$	6			$	7
Other Liabilities:
Insolvency assessments		$	6			$	8

 

 

 

(1)	The Company holds a receivable from the seller of a prior acquisition in accordance with the purchase agreement.

 

80

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

11.  Contingencies, Commitments and Guarantees (continued)

 

Commitments

Commitments to Fund Partnership Investments

The Company makes commitments to fund partnership investments in the normal course of business. The amounts of these unfunded commitments were $7 million and $9 million at December 31, 2013 and 2012, respectively. The Company anticipates that these amounts will be invested in partnerships over the next five years.

Mortgage Loan Commitments

The Company commits to lend funds under mortgage loan commitments. The amounts of these mortgage loan commitments were $6 million and $1 million at December 31, 2013 and 2012, respectively.

Commitments to Fund Private Corporate Bond Investments

The Company commits to lend funds under private corporate bond investments. The amounts of these unfunded commitments were $14 million and $13 million at December 31, 2013 and 2012, respectively.

Guarantees

In the normal course of its business, the Company has provided certain indemnities, guarantees and commitments to third parties such that it may be required to make payments now or in the future. In the context of acquisition, disposition, investment and other transactions, the Company has provided indemnities and guarantees, including those related to tax, environmental and other specific liabilities, and other indemnities and guarantees that are triggered by, among other things, breaches of representations, warranties or covenants provided by the Company. In addition, in the normal course of business, the Company provides indemnifications to counterparties in contracts with triggers similar to the foregoing, as well as for certain other liabilities, such as third-party lawsuits. These obligations are often subject to time limitations that vary in duration, including contractual limitations and those that arise by operation of law, such as applicable statutes of limitation. In some cases, the maximum potential obligation under the indemnities and guarantees is subject to a contractual limitation, while in other cases such limitations are not specified or applicable. Since certain of these obligations are not subject to limitations, the Company does not believe that it is possible to determine the maximum potential amount that could become due under these guarantees in the future. Management believes that it is unlikely the Company will have to make any material payments under these indemnities, guarantees, or commitments.

In addition, the Company indemnifies its directors and officers as provided in its charters and by-laws. Also, the Company indemnifies its agents for liabilities incurred as a result of their representation of the Company’s interests. Since these indemnities are generally not subject to limitation with respect to duration or amount, the Company does not believe that it is possible to determine the maximum potential amount that could become due under these indemnities in the future.

The Company had no liability for indemnities, guarantees and commitments at both December 31, 2013 and 2012.

 

81

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MetLife Investors Insurance Company

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Notes to the Financial Statements — (Continued)

 

12.  Related Party Transactions

 

Service Agreements

The Company has entered into various agreements with affiliates for services necessary to conduct its activities. Typical services provided under these agreements include management, policy administrative functions, personnel, investment advice and distribution services. For certain agreements, charges are based on various performance measures or activity-based costing. The bases for such charges are modified and adjusted by management when necessary or appropriate to reflect fairly and equitably the actual incidence of cost incurred by the Company and/or affiliate. Expenses incurred with affiliates related to these agreements, recorded in other expenses, were $78 million, $53 million and $76 million for the years ended December 31, 2013, 2012 and 2011, respectively. Revenues received from affiliates related to these agreements, recorded in universal life and investment-type product policy fees, were $38 million, $34 million and $32 million for the years ended December 31, 2013, 2012 and 2011, respectively. Revenues received from affiliates related to these agreements, recorded in fees on ceded reinsurance and other, were $25 million, $24 million and $26 million for the years ended December 31, 2013, 2012 and 2011, respectively.

The Company had net receivables from affiliates, related to the items discussed above, of $4 million and $2 million at December 31, 2013 and 2012, respectively.

See Notes 4 and 5 for additional information on related party transactions.

13.  Subsequent Event

The Company has evaluated events subsequent to December 31, 2013, through March 31, 2014, which is the date these financial statements were available to be issued, and has determined there are no material subsequent events requiring adjustment to or disclosure in the financial statements.

 

82

Exhibit 99.3

EXETER REASSURANCE COMPANY, LTD.

Financial Statements

As of September 30, 2014 and December 31, 2013 and

for the Nine Months Ended September 30, 2014 and 2013

---

Exeter Reassurance Company, Ltd.

Interim Condensed Balance Sheets

September 30, 2014 (Unaudited) and December 31, 2013

(In thousands, except share and per share data)

 

		2014				2013
Assets
Investments:
Fixed maturity securities available-for-sale, at estimated fair value (amortized cost: $1,261,872 and $1,311,922, respectively)		$	1,303,531			$	1,321,081
Short-term investments, at estimated fair value			3,008,544				2,781,282
Derivative assets			3,208,279				2,375,499
Funds withheld at interest			2,820,782				2,694,267
Total investments			10,341,136				9,172,129
Cash and cash equivalents			570,242				629,616
Accrued investment income			83,906				94,238
Premiums, reinsurance and other receivables			480,303				645,814
Deferred policy acquisition costs			148,231				159,820
Current income tax recoverable			300,929				196,592
Deferred income tax recoverable			1,710,897				1,529,464
Total assets		$	13,635,644			$	12,427,673
Liabilities and Stockholder’s Equity
Liabilities
Future policy benefits			2,842,887				2,747,421
Policyholder account balances			4,263,280				2,488,945
Other policy-related balances			2,188,676				2,170,145
Policyholder dividends payable			15,996				16,256
Debt - affiliated			575,118				575,118
Derivative liabilities			2,364,192				2,648,454
Other liabilities			855,204				551,170
Total liabilities			13,105,353				11,197,509
Contingencies and Commitments (Note 8)
Stockholder’s Equity
Preferred stock, par value $.01 per share; 250,000 shares authorized, 200,000 issued and outstanding; $2,000,000 aggregate liquidation preference			2				2
Common stock, par value $.01 per share; 13,875,000 shares authorized; 13,466,000 shares issued and outstanding			135				135
Additional paid-in capital			4,135,159				4,125,653
Retained earnings (accumulated deficit)			(3,696,165	)			(2,964,638	)
Accumulated other comprehensive income (loss)			91,160				69,012
Total stockholder’s equity			530,291				1,230,164
Total liabilities and stockholder’s equity		$	13,635,644			$	12,427,673

See accompanying notes to the interim condensed financial statements.

 

2

---

Exeter Reassurance Company, Ltd.

Interim Condensed Statements of Operations and Comprehensive Income (Loss)

For the Nine Months Ended September 30, 2014 and 2013 (Unaudited)

(In thousands)

 

		Nine Months Ended September 30,
		2014				2013
Revenues
Premiums		$	36,127			$	40,436
Universal life and investment-type product policy fees			488,790				430,720
Net investment income			25,365				26,346
Net investment gains (losses)			(40,853	)			(12,697	)
Net derivative gains (losses)			(914,104	)			1,146,285
Other revenues			14,892				(3,808	)
Total revenues			(389,783	)			1,627,282
Expenses
Policyholder benefits and claims			413,580				1,001,147
Interest credited to policyholder account balances			13,574				12,905
Policyholder dividends			17,952				19,718
Other expenses			53,229				74,792
Total expenses			498,335				1,108,562
Income (loss) before provision for income tax			(888,118	)			518,720
Provision for income tax expense (benefit)			(311,141	)			183,276
Net income (loss)		$	(576,977	)		$	335,444
Comprehensive income (loss)		$	(554,829	)		$	276,877

See accompanying notes to the interim condensed financial statements.

 

3

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Exeter Reassurance Company, Ltd.

Interim Condensed Statements of Stockholder’s Equity

For the Nine Months Ended September 30, 2014 and 2013 (Unaudited)

(In thousands)

 

																		Accumulated Other Comprehensive Income (Loss)
		Preferred Stock				Common Stock				Additional Paid-in Capital				Retained Earnings				Net Unrealized Investment Gains (Losses)				Foreign Currency Translation Adjustments				Total Stockholders’ Equity
Balance at December 31, 2013		$	2			$	135			$	4,125,653			$	(2,964,638	)		$	5,896			$	63,116			$	1,230,164
Capital contribution from MetLife, Inc.											9,506																9,506
Non-cumulative perpetual preferred stock dividend															(154,550	)											(154,550	)
Comprehensive income (loss):
Net income (loss)															(576,977	)											(576,977	)
Other comprehensive income (loss), net of income tax																			21,182				966				22,148
Balance at September 30, 2014		$	2			$	135			$	4,135,159			$	(3,696,165	)		$	27,078			$	64,082			$	530,291

 

																		Accumulated Other Comprehensive Income (Loss)
		Preferred Stock				Common Stock				Additional Paid-in Capital				Retained Earnings				Net Unrealized Investment Gains (Losses)				Foreign Currency Translation Adjustments				Total Stockholders’ Equity
Balance at December 31, 2012			200				13,466				4,085,299				(3,504,200	)			42,709				36,568				674,042
Capital contribution from MetLife, Inc.											22,961																22,961
Non-cumulative perpetual preferred stock dividend															(132,484	)											(132,484	)
Comprehensive income (loss):
Net income (loss)															335,444												335,444
Other comprehensive income (loss), net of income tax																			(28,489	)			(30,078	)			(58,567	)
Balance at September 30, 2013		$	200			$	13,466			$	4,108,260			$	(3,301,240	)		$	14,220			$	6,490			$	841,396

See accompanying notes to the interim condensed financial statements.

 

4

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Exeter Reassurance Company, Ltd.

Interim Condensed Statements of Cash Flows

For the Nine Months Ended September 30, 2014 and 2013 (Unaudited)

(In thousands)

 

		Nine Months Ended September 30,
		2014				2013
Net cash provided by (used in) operating activities		$	965,234			$	1,028,110
Cash flows from investing activities
Sales, maturities and repayments of:
Fixed maturity securities			383,530				713,537
Purchases of fixed maturity securities			(280,970	)			(372,538	)
Cash received in connection with freestanding derivatives			41,447				149,252
Cash paid in connection with freestanding derivatives			(1,050,776	)			(2,383,569	)
Net change in short-term investments			(225,959	)			2,318,060
Net change in funds withheld at interest			(72,438	)			(223,285	)
Other, net			190,187				184,306
Net cash provided by (used in) investing activities			(1,014,979	)			385,763
Cash flows from financing activities
Change in payables for derivative collateral			356,840				(1,166,600	)
Dividends on preferred stock			(154,550	)			(132,484	)
Financing element on certain derivative instruments			(201,376	)			(99,496	)
Net cash provided by (used in) financing activities			914				(1,398,580	)
Effect of change in foreign currency exchange rates on cash and cash equivalents balances			(10,543	)			(34,935	)
Change in cash and cash equivalents			(59,374	)			(19,642	)
Cash and cash equivalents, beginning of period			629,616				905,519
Cash and cash equivalents, end of period		$	570,242			$	885,877
Supplemental disclosures of cash flow information
Net cash paid for:
Interest		$	8,728			$	2,553
Income tax		$	61,750			$	750
Non-cash transactions:
Capital contributions from MetLife, Inc.		$	9,506			$	22,961

See accompanying notes to the interim condensed financial statements.

 

5

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Exeter Reassurance Company, Ltd.

Notes to the Interim Condensed Financial Statements (Unaudited)

1. Business, Basis of Presentation and Summary of Significant Accounting Policies

Business

Exeter Reassurance Company, Ltd. (the “Company” or “Exeter”) is a wholly-owned stock life insurance subsidiary of MetLife, Inc. (the “Holding Company”).

Effective October 1, 2013, the Company redomesticated to the state of Delaware (“Delaware”). The Company is licensed as a Delaware pure captive insurance company under the Delaware Captive Insurance Law (“Delaware Law”). The Company engages in traditional and financial reinsurance of life insurance and annuity policies, primarily with affiliates.

On November 14, 2014, MetLife, Inc. completed the mergers of three wholly-owned U.S.-based life insurance companies and a wholly-owned, former offshore, reinsurance subsidiary to create one larger U.S.-based and U.S.-regulated life insurance company (the “Mergers”). The companies that merged were MetLife Insurance Company of Connecticut (“MICC”), MetLife Investors USA Insurance Company (“MLI-USA”) and MetLife Investors Insurance Company (“MLIIC”), each a U.S. insurance company that issues variable annuity products in addition to other products, and Exeter. As of the date of the Mergers, MICC, a directly owned subsidiary of MetLife, Inc., was renamed to MetLife Insurance Company USA (“MetLife USA”) and redomiciled to Delaware. See Note 10.

Basis of Presentation

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to adopt accounting policies and make estimates and assumptions that affect amounts reported in the financial statements. In applying these policies and estimates, management makes subjective and complex judgments that frequently require assumptions about matters that are inherently uncertain. Many of these policies, estimates and related judgments are common in the insurance and financial services industries; others are specific to the Company’s business and operations. Actual results could differ from estimates.

Since the Company is a member of a controlled group of affiliated companies, its results may not be indicative of those of a stand-alone entity.

The accompanying interim condensed financial statements are unaudited and reflect all adjustments (including normal recurring adjustments) necessary to present fairly the financial position, results of operations and cash flows for the interim periods presented in conformity with GAAP. Interim results are not necessarily indicative of full year performance. The December 31, 2013 balance sheet data was derived from audited financial statements which include all disclosures required by GAAP. Therefore, these interim condensed financial statements should be read in conjunction with the financial statements of the Company for the year ended December 31, 2013 as restated.

Adoption of New Accounting Pronouncements

Effective January 1, 2014, the Company adopted new guidance regarding the presentation of an unrecognized tax benefit. The new guidance requires that an unrecognized tax benefit, or a portion of an unrecognized tax benefit, be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. However, when the carryforwards are not available at the reporting date to settle any additional income taxes that would result from the disallowance of a tax position or the applicable tax law does not require, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit will be presented in the financial statements as a liability and will not be combined with the related deferred tax asset. The adoption was prospectively applied and did not have an impact on the Company’s financial statements.

Effective January 1, 2014, the Company adopted new guidance regarding foreign currency that requires an entity that ceases to have a controlling financial interest in a subsidiary or group of assets within a foreign entity to release any related cumulative translation adjustment into net income. Accordingly, the cumulative translation adjustment should be released into net income only if the sale or transfer results in the complete or substantially complete liquidation of the foreign entity in which the subsidiary or group of assets had resided. For an equity method investment that is a foreign entity, a pro rata portion of the cumulative translation adjustment should be released into net income upon a partial sale of such an equity method investment. The new guidance did not have an impact on the Company’s financial statements upon adoption.

 

6

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Exeter Reassurance Company, Ltd.

Notes to the Interim Condensed Financial Statements (Unaudited) – (Continued)

 

Effective January 1, 2014, the Company adopted new guidance regarding liabilities that requires an entity to measure obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of the guidance is fixed at the reporting date, as the sum of the amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors and any additional amount the reporting entity expects to pay on behalf of its co-obligors. In addition, the amendments require an entity to disclose the nature and amount of the obligation, as well as other information about the obligation. The new guidance did not have an impact on the Company’s financial statements upon adoption.

2. Reserves

As discussed in Notes 1 and 3 of the Notes to the Consolidated Financial Statements for the year ended December 31, 2013, the Company reinsures variable annuity products with guaranteed minimum benefits. The non-life contingent portion of guaranteed minimum withdrawal benefits (“GMWB”), guaranteed minimum accumulation benefits (“GMAB”) and the portion of certain guaranteed minimum income benefits (“GMIB”) that does not require annuitization are accounted for as embedded derivatives in policyholder account balances (“PAB”) and other policy-related balances which are further discussed in Note 4.

3. Investments

Fixed Maturity Securities Available-for-Sale

Fixed Maturity Securities Available-for-Sale by Sector

The following table presents the fixed maturity securities available-for-sale (“AFS”) by sector. Included within fixed maturity securities are structured securities including commercial mortgage-backed securities (“CMBS”), asset-backed securities (“ABS”) and residential mortgage-backed securities (“RMBS”).

 

		September 30, 2014																				December 31, 2013
		Cost or				Gross Unrealized												Estimated				Cost or				Gross Unrealized												Estimated
		Amortized Cost				Gains				Temporary Losses				OTTI Losses				Fair Value				Amortized Cost				Gains				Temporary Losses				OTTI Losses				Fair Value
		(In thousands)																				(In thousands)
Fixed Maturity Securities:
Foreign corporate		$	410,638			$	7,401			$	2,606			$	—			$	415,433			$	535,332			$	5,294			$	7,203			$	—			$	533,423
U.S. corporate			240,175				15,785				338				—				255,622				255,510				10,478				2,366				—				263,622
CMBS			169,450				3,018				1,763				—				170,705				135,781				1,724				4,941				—				132,564
State and political subdivision			108,297				14,478				172				—				122,603				114,310				6,862				916				—				120,256
U.S. Treasury and agency			108,519				1,111				26				—				109,604				101,947				1,225				3,924				—				99,248
ABS			143,829				1,405				66				—				145,168				79,461				1,323				264				—				80,520
RMBS			62,432				3,104				33				—				65,503				61,322				2,261				794				—				62,789
Foreign government			18,532				361				—				—				18,893				28,259				400				—				—				28,659
Total fixed maturity securities		$	1,261,872			$	46,663			$	5,004			$	—			$	1,303,531			$	1,311,922			$	29,567			$	20,408			$	—			$	1,321,081

The Company held no non-income producing fixed maturity securities at both September 30, 2014 and December 31, 2013.

 

7

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Exeter Reassurance Company, Ltd.

Notes to the Interim Condensed Financial Statements (Unaudited) – (Continued)

 

Maturities of Fixed Maturity Securities

The amortized cost and estimated fair value of fixed maturity securities, by contractual maturity date, were as follows at:

 

		September 30, 2014								December 31, 2013
		Amortized Cost				Estimated Fair Value				Amortized Cost				Estimated Fair Value
		(In thousands)
Due in one year or less		$	142,210			$	142,628			$	246,228			$	246,780
Due after one year through five years			288,120				291,071				280,090				283,376
Due after five years through ten years			305,523				317,951				308,324				311,927
Due after ten years			150,308				170,505				200,716				203,125
Subtotal			886,161				922,155				1,035,358				1,045,208
Structured securities (CMBS, ABS and RMBS)			375,711				381,376				276,564				275,873
Total fixed maturity securities		$	1,261,872			$	1,303,531			$	1,311,922			$	1,321,081

Actual maturities may differ from contractual maturities due to the exercise of call or prepayment options. Fixed maturity securities not due at a single maturity date have been presented in the year of final contractual maturity. CMBS, ABS and RMBS are shown separately, as they are not due at a single maturity.

Continuous Gross Unrealized Losses for Fixed Maturity Securities AFS by Sector

The following table presents the estimated fair value and gross unrealized losses of fixed maturity securities AFS in an unrealized loss position, aggregated by sector and by length of time that the securities have been in a continuous unrealized loss position.

 

		September 30, 2014																December 31, 2013
		Less than 12 Months								Equal to or Greater than 12 Months								Less than 12 Months								Equal to or Greater than 12 Months
		Estimated Fair Value				Gross Unrealized Losses				Estimated Fair Value				Gross Unrealized Losses				Estimated Fair Value				Gross Unrealized Losses				Estimated Fair Value				Gross Unrealized Losses
		(In thousands, except number of securities)
Fixed Maturity Securities:
Foreign corporate		$	129,661			$	2,606			$	—			$	—			$	214,876			$	7,203			$	—			$	—
U.S. corporate			25,182				281				1,980				57				50,458				1,771				4,378				595
CMBS			28,654				913				27,053				850				62,872				4,941				—				—
State and political subdivision			—				—				6,068				172				14,936				916				—				—
U.S. Treasury and agency			80,977				26				—				—				28,434				3,924				—				—
ABS			32,671				66				—				—				18,907				264				—				—
RMBS			—				—				4,333				33				17,541				794				—				—
Total fixed maturity securities		$	297,145			$	3,892			$	39,434			$	1,112			$	408,024			$	19,813			$	4,378			$	595
Total number of securities in an unrealized loss position			49								12								79								2

Evaluation of AFS Securities for OTTI and Evaluating Temporarily Impaired AFS Securities

As described more fully in Notes 1 and 5 of the Notes to the Financial Statements for the year ended December 31, 2013, the Company performs a regular evaluation of all investment classes for impairment, including fixed maturity securities, in accordance with its impairment policy, in order to evaluate whether such investments are other-than-temporarily impaired.

 

8

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Exeter Reassurance Company, Ltd.

Notes to the Interim Condensed Financial Statements (Unaudited) – (Continued)

 

Current Period Evaluation

Based on the Company’s current evaluation of its AFS securities in an unrealized loss position in accordance with its impairment policy, and the Company’s current intentions and assessments (as applicable to the type of security) about holding, selling and any requirements to sell these securities, the Company has concluded that these securities are not other-than-temporarily impaired at September 30, 2014. Future other-than-temporary impairment (“OTTI”) will depend primarily on economic fundamentals, issuer performance (including changes in the present value of future cash flows expected to be collected) and changes in credit ratings, collateral valuation, interest rates and credit spreads. If economic fundamentals deteriorate or if there are adverse changes in the above factors, OTTI may be incurred in upcoming periods.

Gross unrealized losses on fixed maturity securities decreased $15.4 million during the nine months ended September 30, 2014 from $20.4 million to $5.0 million. The decrease in gross unrealized losses for the nine months ended September 30, 2014, was primarily attributable to a decrease in interest rates, and to a lesser extent narrowing credit spreads.

At September 30, 2014, there were no fixed maturity securities with an unrealized loss position of 20% or more of amortized cost for six months or greater.

Funds Withheld at Interest

Funds withheld at interest represents amounts contractually withheld by ceding companies in accordance with reinsurance agreements. At September 30, 2014 and December 31, 2013, such amounts consisted of balances withheld in connection with reinsurance agreements with affiliates of the Holding Company, as presented in Note 9, and an unaffiliated company.

Cash Equivalents

The carrying value of cash equivalents, which includes securities and other investments with an original or remaining maturity of three months or less at the time of purchase, was $22.8 million and $40.8 million at September 30, 2014 and December 31, 2013, respectively.

Net Unrealized Investment Gains (Losses)

The components of net unrealized investment gains (losses), included in accumulated other comprehensive income (loss) (“AOCI”), were as follows:

 

		September 30, 2014				December 31, 2013
		(In thousands)
Fixed maturity securities		$	41,659			$	9,072
Deferred income tax benefit (expense)			(14,581	)			(3,176	)
Net unrealized investment gains (losses)		$	27,078			$	5,896

The changes in net unrealized investment gains (losses) were as follows:

 

		Nine Months Ended September 30, 2014
		(In thousands)
Balance, January 1		$	5,896
Unrealized investment gains (losses) during the period			32,587
Deferred income tax benefit (expense)			(11,405	)
Balance, September 30		$	27,078
Change in net unrealized investment gains (losses)		$	21,182

 

9

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Exeter Reassurance Company, Ltd.

Notes to the Interim Condensed Financial Statements (Unaudited) – (Continued)

 

Concentrations of Credit Risk

There were no investments in any counterparty that were greater than 10% of the Company’s stockholder’s equity, other than the U.S. government and its agencies, at both September 30, 2014 and December 31, 2013.

Invested Assets Held in Trust and Pledged as Collateral

Invested assets held in trust and pledged as collateral are presented below at estimated fair value for cash and cash equivalents, short-term investments, and fixed maturity securities at:

 

		September 30, 2014				December 31, 2013
		(In thousands)
Invested assets held in trust (1)		$	2,410,237			$	2,754,170
Invested assets pledged as collateral (2)			652,319				1,024,682
Total invested assets held in trust and pledged as collateral		$	3,062,556			$	3,778,852

 

(1)	The Company has held in trust certain investments, primarily fixed maturity securities and short-term investments, in connection with certain reinsurance transactions.

(2)	Certain of the Company’s invested assets are pledged as collateral for various derivative transactions as described in Note 4.

Variable Interest Entities

The Company has invested in certain structured transactions that are variable interest entities (“VIEs”). In certain instances, the Company may hold both the power to direct the most significant activities of the entity, as well as an economic interest in the entity and, as such, it would be deemed to be the primary beneficiary or consolidator of the entity.

The determination of the VIE’s primary beneficiary requires an evaluation of the contractual and implied rights and obligations associated with each party’s relationship with or involvement in the entity, an estimate of the entity’s expected losses and expected residual returns and the allocation of such estimates to each party involved in the entity. The Company generally uses a qualitative approach to determine whether it is the primary beneficiary. However, for VIEs that are investment companies or apply measurement principles consistent with those utilized by investment companies, the primary beneficiary is based on a risks and rewards model and is defined as the entity that will absorb a majority of a VIE’s expected losses, receive a majority of a VIE’s expected residual returns if no single entity absorbs a majority of expected losses, or both. The Company reassesses its involvement with VIEs on a quarterly basis. The use of different methodologies, assumptions and inputs in the determination of the primary beneficiary could have a material effect on the amounts presented within the financial statements.

Consolidated VIEs

There were no VIEs for which the Company has concluded that it is the primary beneficiary and which are consolidated at September 30, 2014 and December 31, 2013.

 

10

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Exeter Reassurance Company, Ltd.

Notes to the Interim Condensed Financial Statements (Unaudited) – (Continued)

 

Unconsolidated VIEs

The carrying amount and maximum exposure to loss relating to VIEs in which the Company holds a significant variable interest but is not the primary beneficiary and which have not been consolidated were as follows at:

 

		September 30, 2014								December 31, 2013
		Carrying Amount				Maximum Exposure to Loss (1)				Carrying Amount				Maximum Exposure to Loss (1)
		(In thousands)
Fixed maturity securities AFS:
Structured securities (CMBS, ABS and RMBS) (2)		$	381,376			$	381,376			$	275,873			$	275,873
Foreign corporate			43,895				43,895				5,186				5,186
Total		$	425,271			$	425,271			$	281,059			$	281,059

 

(1)	The maximum exposure to loss relating to fixed maturity securities AFS is equal to their carrying amounts or the carrying amounts of retained interests.

(2)	For these variable interests, the Company’s involvement is limited to that of a passive investor.

Net Investment Income

The components of net investment income were as follows:

 

		Nine Months Ended September 30,
		2014				2013
		(In thousands)
Investment income:
Fixed maturity securities		$	29,448			$	30,936
Cash, cash equivalents and short-term investments			1,424				2,696
Other			(1,909	)			(2,520	)
Subtotal			28,963				31,112
Less: Investment expenses			3,598				4,766
Net investment income		$	25,365			$	26,346

See “— Related Party Investment Transactions” for discussion of affiliated net investment income and expenses included in the table above.

 

11

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Exeter Reassurance Company, Ltd.

Notes to the Interim Condensed Financial Statements (Unaudited) – (Continued)

 

Net Investment Gains (Losses)

Components of Net Investment Gains (Losses)

The components of net investment gains (losses) were as follows:

 

		Nine Months Ended September 30,
		2014				2013
		(In thousands)
Fixed maturity securities		$	(1,846	)		$	1,701
Other investment portfolio gains (losses)			(39,007	)			(14,398	)
Total net investment gains (losses)		$	(40,853	)		$	(12,697	)

Gains (losses) from foreign currency transactions included within net investment gains (losses) were ($39.1) million and ($14.8) million for the nine months ended September 30, 2014 and 2013, respectively.

Sales or Disposals of Fixed Maturity and Equity Securities

Proceeds from sales or disposals of fixed maturity securities and the components of fixed maturity securities net investment gains (losses) are as shown in the table below. Investment gains and losses on sales of securities are determined on a specific identification basis.

 

		Nine Months Ended September 30,
		2014				2013
		(In thousands)
Proceeds		$	104,143			$	240,042
Gross investment gains		$	542			$	2,288
Gross investment losses			(2,388	)			(587	)
Net investment gains (losses)		$	(1,846	)		$	1,701

There were no OTTI losses on fixed maturity securities during the nine months ended September 30, 2014 and 2013, respectively.

Related Party Investment Transactions

The Company receives investment administrative services from an affiliate. The related investment administrative service charges were $3.2 million and $3.6 million for the nine months ended September 30, 2014 and 2013, respectively.

4. Derivatives

Accounting for Derivatives

See Note 1 of the Notes to the Financial Statements for the year ended December 31, 2013, for a description of the Company’s accounting policies for derivatives. See Note 5 for information about the fair value hierarchy for derivatives.

 

12

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Exeter Reassurance Company, Ltd.

Notes to the Interim Condensed Financial Statements (Unaudited) – (Continued)

 

Derivative Strategies

The Company is exposed to various risks relating to its ongoing business operations, including interest rate, foreign currency exchange rate and equity market. The Company uses a variety of strategies to manage these risks, including the use of derivatives.

Derivatives are financial instruments whose values are derived from interest rates, foreign currency exchange rates, credit spreads and/or other financial indices. Derivatives may be exchange-traded or contracted in the over-the-counter (“OTC”) market. Certain of the Company’s OTC derivatives may be cleared and settled through central clearing counterparties (“OTC-cleared”), while others are bilateral contracts between two counterparties (“OTC-bilateral”). The types of derivatives the Company uses include swaps, forwards, futures and option contracts. The Company also purchases certain securities and engages in certain reinsurance agreements that have embedded derivatives.

The Company utilizes all derivatives in non-qualifying hedging relationships.

Interest Rate Derivatives

The Company uses a variety of interest rate derivatives to reduce its exposure to changes in interest rates, including interest rate swaps, futures and options.

Interest rate swaps are used by the Company primarily to reduce market risks from changes in interest rates and to alter interest rate exposure arising from mismatches between assets and liabilities (duration mismatches). In an interest rate swap, the Company agrees with another party to exchange, at specified intervals, the difference between fixed rate and floating rate interest amounts as calculated by reference to an agreed notional amount.

In exchange-traded interest rate Treasury futures transactions, the Company agrees to purchase or sell a specified number of contracts, the value of which is determined by the different classes of interest rate securities, and to post variation margin on a daily basis in an amount equal to the difference in the daily market values of those contracts. The Company enters into exchange-traded futures with regulated futures commission merchants that are members of the exchange. Exchange-traded interest rate Treasury futures are used primarily to hedge mismatches between the duration of assets in a portfolio and the duration of liabilities supported by those assets, to hedge against changes in value of securities the Company owns or anticipates acquiring and to hedge against changes in interest rates on anticipated liability issuances by replicating Treasury or swap curve performance.

Swaptions are used by the Company to hedge interest rate risk associated with the Company’s long-term liabilities and invested assets. A swaption is an option to enter into a swap with a forward starting effective date. In certain instances, the Company locks in the economic impact of existing purchased swaptions by entering into offsetting written swaptions. The Company pays a premium for purchased swaptions and receives a premium for written swaptions. Swaptions are included in interest rate options.

Foreign Currency Exchange Rate Derivatives

The Company uses foreign currency forwards to reduce the risk from fluctuations in foreign currency exchange rates associated with its assets and liabilities denominated in foreign currencies. In a foreign currency forward transaction, the Company agrees with another party to deliver a specified amount of an identified currency at a specified future date. The price is agreed upon at the time of the contract and payment for such a contract is made at the specified future date.

To a lesser extent, the Company uses exchange-traded currency futures to hedge currency mismatches between assets and liabilities.

Equity Derivatives

The Company uses a variety of equity derivatives to reduce its exposure to equity market risk, including equity index options, variance swaps, exchange-traded equity futures and total rate of return swaps (“TRRs”).

 

13

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Exeter Reassurance Company, Ltd.

Notes to the Interim Condensed Financial Statements (Unaudited) – (Continued)

 

Equity index options are used by the Company primarily to hedge minimum guarantees embedded in certain variable annuity products assumed by the Company. To hedge against adverse changes in equity indices, the Company enters into contracts to sell the equity index within a limited time at a contracted price. The contracts will be net settled in cash based on differentials in the indices at the time of exercise and the strike price. Certain of these contracts may also contain settlement provisions linked to interest rates. In certain instances, the Company may enter into a combination of transactions to hedge adverse changes in equity indices within a pre-determined range through the purchase and sale of options.

Equity variance swaps are used by the Company primarily to hedge minimum guarantees embedded in certain variable annuity products reinsured by the Company. In an equity variance swap, the Company agrees with another party to exchange amounts in the future, based on changes in equity volatility over a defined period.

In exchange-traded equity futures transactions, the Company agrees to purchase or sell a specified number of contracts, the value of which is determined by the different classes of equity securities, and to post variation margin on a daily basis in an amount equal to the difference in the daily market values of those contracts. The Company enters into exchange-traded futures with regulated futures commission merchants that are members of the exchange. Exchange-traded equity futures are used primarily to hedge liabilities embedded in certain variable annuity products reinsured by the Company.

TRRs are swaps whereby the Company agrees with another party to exchange, at specified intervals, the difference between the economic risk and reward of an asset or a market index and the London Inter-Bank Offered Rate (“LIBOR”), calculated by reference to an agreed notional amount. No cash is exchanged at the outset of the contract. Cash is paid and received over the life of the contract based on the terms of the swap. The Company uses TRRs to hedge its equity market guarantees in certain of its reinsured products. TRRs can be used as hedges or to synthetically create investments.

Primary Risks Managed by Derivatives

The following table presents the gross notional amount, estimated fair value and primary underlying risk exposure of the Company’s derivatives, excluding embedded derivatives, held at:

 

				September 30, 2014												December 31, 2013
		Primary Underlying		Notional				Estimated Fair Value								Notional				Estimated Fair Value
		Risk Exposure		Amount				Assets				Liabilities				Amount				Assets				Liabilities
				(In thousands)
Derivatives Not Designated or Not Qualifying as Hedging
Interest rate swaps		Interest rate		$	23,221,522			$	1,442,421			$	678,178			$	23,221,522			$	1,040,377			$	562,851
Interest rate futures		Interest rate			3,411,416				3,942				2,390				4,462,013				9,047				6,547
Interest rate options		Interest rate			32,260,095				450,644				94,606				17,690,095				131,341				235,516
Foreign currency forwards		Foreign currency exchange rate			2,293,347				4,868				56,050				2,324,152				728				171,078
Currency futures		Foreign currency exchange rate			455,277				282				2,275				364,550				1,169				1,022
Equity futures		Equity market			4,729,754				19,984				4,680				4,327,600				1,284				39,600
Equity options		Equity market			32,231,519				1,031,530				996,209				31,414,484				1,024,034				1,005,551
Variance swaps		Equity market			19,030,136				186,904				517,382				18,917,116				167,519				469,330
Total rate of return swaps		Equity market			3,083,928				67,704				12,422				3,339,982				—				156,959
Total non-designated or non-qualifying derivatives				$	120,716,994			$	3,208,279			$	2,364,192			$	106,061,514			$	2,375,499			$	2,648,454

Net Derivative Gains (Losses)

The components of net derivative gains (losses) were as follows:

 

		Nine Months Ended September 30,
		2014				2013
		(In thousands)
Derivatives and hedging gains (losses)		$	253,765			$	(3,590,020	)
Embedded derivatives			(1,167,869	)			4,736,305
Total net derivatives gains (losses)		$	(914,104	)		$	1,146,285

 

14

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Exeter Reassurance Company, Ltd.

Notes to the Interim Condensed Financial Statements (Unaudited) – (Continued)

 

The following table presents earned income on derivatives for the:

 

		Nine Months Ended September 30,
		2014				2013
		(In thousands)
Net derivative gains (losses)		$	115,914			$	(163,655	)
Policyholder benefits and claims			5,572				(190,196	)
Total		$	121,486			$	(353,851	)

Non-Qualifying Derivatives

The following table presents the amount and location of gains (losses) recognized in income for derivatives that were not designated or qualifying as hedging instruments:

 

		Net Derivative Gains (Losses)				Policyholder Benefits and Claims (1)
		(In thousands)
For the Nine Months Ended September 30, 2014:
Interest rate contracts		$	498,453			$	—
Foreign currency contracts			(1,648	)			—
Equity contracts			(358,954	)			(123,264	)
Total		$	137,851			$	(123,264	)
For the Nine Months Ended September 30, 2013:
Interest rate contracts		$	(710,605	)		$	(1,363	)
Foreign currency contracts			(329,027	)			—
Equity contracts			(2,370,112	)			(455,413	)
Total		$	(3,409,744	)		$	(456,776	)

 

(1)	Changes in estimated fair value related to economic hedges of reinsured variable annuity guarantees reported in future policy benefits.

Credit Risk on Freestanding Derivatives

The Company may be exposed to credit-related losses in the event of nonperformance by counterparties to derivatives. Generally, the current credit exposure of the Company’s derivatives is limited to the net positive estimated fair value of derivatives at the reporting date after taking into consideration the existence of master netting or similar agreements and any collateral received pursuant to such agreements.

The Company manages its credit risk related to derivatives by entering into transactions with creditworthy counterparties and establishing and monitoring exposure limits. The Company’s OTC-bilateral derivative transactions are generally governed by International Swaps and Derivatives Association (“ISDA”) Master Agreements which provide for legally enforceable set-off and close-out netting of exposures to specific counterparties in the event of early termination of a transaction, which includes, but is not limited to, events of default and bankruptcy. In the event of an early termination, the Company is permitted to set-off receivables from the counterparty against payables to the same counterparty arising out of all included transactions. Substantially all of the Company’s ISDA Master Agreements also include Credit Support Annex provisions which require both the pledging and accepting of collateral in connection with its OTC-bilateral derivatives. See Note 5 for a description of the impact of credit risk on the valuation of derivatives.

 

15

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Exeter Reassurance Company, Ltd.

Notes to the Interim Condensed Financial Statements (Unaudited) – (Continued)

 

The estimated fair value of the Company’s net derivative assets and net derivative liabilities after the application of master netting agreements and collateral was as follows at:

 

		September 30, 2014								December 31, 2013
		(In thousands)
Derivatives Subject to a Master Netting Arrangement or a Similar Arrangement		Assets				Liabilities				Assets				Liabilities
Gross estimated fair value of derivatives:
OTC-bilateral		$	3,238,589			$	2,358,111			$	2,430,173			$	2,593,152
Exchange-traded			24,208				9,345				11,500				47,169
Total gross estimated fair value of derivatives (1)			3,262,797				2,367,456				2,441,673				2,640,321
Amounts offset in the balance sheets			—				—				—				—
Estimated fair value of derivatives presented in the balance sheets (1)			3,262,797				2,367,456				2,441,673				2,640,321
Gross amounts not offset in the balance sheets:
Gross estimated fair value of derivatives: (2)
OTC-bilateral			(2,057,209	)			(2,057,209	)			(1,869,869	)			(1,869,869	)
Exchange-traded			(3,862	)			(3,862	)			(5,368	)			(5,368	)
Cash collateral (3), (4)
OTC-bilateral			(553,214	)			—				(163,210	)			—
Exchange-traded			—				(2,896	)			—				(39,008	)
Securities collateral (5)
OTC-bilateral			(549,832	)			(299,543	)			(377,561	)			(646,079	)
Exchange-traded			—				(2,588	)			—				(2,793	)
Net amount after application of master netting agreements and collateral		$	98,680			$	1,358			$	25,665			$	77,204

 

(1)

At September 30, 2014 and December 31, 2013, derivative assets include income or expense accruals reported in accrued investment income or in other liabilities of $54,518 thousand and $66,175 thousand, respectively, and derivative liabilities include income or expense accruals reported in accrued investment income or in other liabilities of $3,264 thousand and $8,133 thousand, respectively.

(2)	Estimated fair value of derivatives is limited to the amount that is subject to set-off and includes income or expense accruals.

(3)

Cash collateral received by the Company for OTC-bilateral derivatives is included in cash and cash equivalents and the obligation to return it is included in other liabilities in the balance sheet. In certain instances, cash collateral pledged to the Company as initial margin for OTC-bilateral derivatives is held in separate custodial accounts and is not recorded on the Company’s balance sheet because the account title is in the name of the counterparty (but ring fenced for the benefit of the company). The amount of this off-balance sheet collateral was $84,809 thousand and $0, at September 30, 2014 and December 31, 2013, respectively.

(4)

The receivable for the return of cash collateral provided by the Company is inclusive of initial margin on exchange-traded derivatives and is included in premiums, reinsurance and other receivables in the balance sheet. The amount of cash collateral offset in the table above is limited to the net estimated fair value of derivatives after application of netting agreements. At September 30, 2014 and December 31, 2013, the Company received excess cash collateral of $84,965 thousand (including $84,232 thousand off-balance sheet cash collateral held in separate custodial accounts) and $33,319 thousand, respectively, and provided excess cash collateral of $106,883 thousand and $185,299 thousand, respectively, which is not included in the table above due to the foregoing limitation.

 

16

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Exeter Reassurance Company, Ltd.

Notes to the Interim Condensed Financial Statements (Unaudited) – (Continued)

 

(5)

Securities collateral received by the Company is held in separate custodial accounts and is not recorded on the balance sheet. Subject to certain constraints, the Company is permitted by contract to sell or repledge this collateral, but at September 30, 2014 none of the collateral had been sold or repledged. Securities collateral pledged by the Company is reported in fixed maturity securities in the balance sheet. Subject to certain constraints, the counterparties are permitted by contract to sell or repledge this collateral. The amount of securities collateral offset in the table above is limited to the net estimated fair value of derivatives after application of netting agreements and cash collateral. At September 30, 2014 and December 31, 2013, the Company received excess securities collateral of $6,771 thousand and $96,746 thousand, respectively, for its OTC-bilateral derivatives which are not included in the table above due to the foregoing limitation. At September 30, 2014 and December 31, 2013, the Company provided excess securities collateral of $16,274 and $0, respectively, for its OTC-bilateral derivatives and $145,901 thousand and $36,182 thousand, respectively, for its exchange-traded derivatives, which are not included in the table above due to the foregoing limitation.

The following table presents the estimated fair value of the Company’s OTC-bilateral derivatives that are in a net liability position after considering the effect of netting agreements, together with the estimated fair value and balance sheet location of the collateral pledged. The table also presents the incremental collateral that the Company would be required to provide if there was a one notch downgrade in the Company’s credit rating at the reporting date or if the Company’s credit rating sustained a downgrade to a level that triggered full overnight collateralization or termination of the derivative position at the reporting date. OTC-bilateral derivatives that are not subject to collateral agreements are excluded from this table.

 

						Estimated Fair Value of Collateral Provided:				Fair Value of Incremental Collateral Provided Upon:
		Estimated Fair Value of Derivatives in Net Liability Position (1)				Fixed Maturity Securities				One Notch Downgrade in the Holding Company’s Credit Rating				Downgrade in the Holding Company’s Credit Rating to a Level that Triggers Full Overnight Collateralization or Termination of the Derivative Position
		(In thousands)
September 30, 2014		$	300,902			$	315,817			$	7,427			$	7,427
December 31, 2013		$	723,283			$	646,079			$	20,912			$	21,353

 

(1)	After taking into consideration the existence of netting agreements.

 

17

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Exeter Reassurance Company, Ltd.

Notes to the Interim Condensed Financial Statements (Unaudited) – (Continued)

 

Embedded Derivatives

The Company assumes variable annuities, modified coinsurance contracts, equity indexed deferred annuities and purchases certain investments that contain embedded derivatives that are required to be separated from their host contracts and accounted for as freestanding derivatives. These host contracts principally include: assumed variable annuities with guaranteed minimum benefits, including GMWBs, GMABs and certain GMIBs; ceded reinsurance agreements of guaranteed minimum benefits related to GMABs and certain GMIBs; assumed modified coinsurance contracts; assumed reinsurance on equity indexed deferred annuities; and options embedded in debt and equity securities.

The following table presents the estimated fair value and balance sheet location of the Company’s embedded derivatives that have been separated from their host contracts at:

 

		Balance Sheet Location		September 30, 2014				December 31, 2013
				(In thousands)
Net embedded derivatives within asset host contracts:
Ceded guaranteed minimum benefits		Premiums, reinsurance and other receivables		$	180,065			$	122,515
Assumed modified coinsurance contracts		Funds withheld at interest			78,484				24,035
Net embedded derivatives within asset host contracts				$	258,549			$	146,550
Net embedded derivatives within liability host contracts:
Assumed guaranteed minimum benefits		PABs		$	4,263,280			$	2,488,944
Net embedded derivatives within liability host contracts				$	4,263,280			$	2,488,944

The following table presents changes in estimated fair value related to embedded derivatives:

 

		Nine Months Ended September 30,
		2014				2013
		(In thousands)
Net derivative gains (losses) (1)		$	(1,167,869	)		$	4,736,305
Policyholder benefits and claims		$	54,687			$	(109,550	)

 

(1)

The valuation of reinsured guaranteed minimum benefits includes a nonperformance risk adjustment. The amounts included in net derivative gains (losses), in connection with this adjustment, were $124.8 million and ($955.8) million, for the years ended September 30, 2014 and 2013, respectively. In addition, the valuation of ceded guaranteed minimum benefits includes a nonperformance risk adjustment. The amounts included in net derivative gains (losses), in connection with this adjustment were ($4.3) million and $11.1 million for the nine months ended September 30, 2014, and 2013, respectively.

 

18

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Exeter Reassurance Company, Ltd.

Notes to the Interim Condensed Financial Statements (Unaudited) – (Continued)

 

5.	Fair Value

Considerable judgment is often required in interpreting market data to develop estimates of fair value, and the use of different assumptions or valuation methodologies may have a material effect on the estimated fair value amounts.

Recurring Fair Value Measurements

The assets and liabilities measured at estimated fair value on a recurring basis and their corresponding placement in the fair value hierarchy are presented below.

 

		September 30, 2014
		Fair Value Hierarchy
		Level 1				Level 2				Level 3				Total Estimated Fair Value
		(In thousands)
Assets:
Fixed maturity securities:
Foreign corporate		$	—			$	415,433			$	—			$	415,433
U.S. corporate			—				255,622				—				255,622
CMBS			—				128,982				41,723				170,705
State and political subdivision			—				122,603				—				122,603
U.S. Treasury and agency			109,604				—				—				109,604
ABS			—				118,924				26,244				145,168
RMBS			—				65,503				—				65,503
Foreign government			—				18,893				—				18,893
Total fixed maturity securities			109,604				1,125,960				67,967				1,303,531
Short-term investments (1)			2,528,422				432,872				—				2,961,294
Derivative assets: (2)
Interest rate			3,942				1,893,065				—				1,897,007
Foreign currency exchange rate			282				4,868				—				5,150
Equity market			19,984				975,720				310,418				1,306,122
Total derivative assets			24,208				2,873,653				310,418				3,208,279
Net embedded derivatives within asset host contracts (3)			—				—				258,549				258,549
Total assets		$	2,662,234			$	4,432,485			$	636,934			$	7,731,653
Liabilities:
Derivative liabilities: (2)
Interest rate		$	2,390			$	772,784			$	—			$	775,174
Foreign currency exchange rate			2,275				56,050				—				58,325
Equity market			4,680				982,082				543,931				1,530,693
Total derivative liabilities			9,345				1,810,916				543,931				2,364,192
Net embedded derivatives within liability host contracts (3)			—				—				4,263,280				4,263,280
Total liabilities		$	9,345			$	1,810,916			$	4,807,211			$	6,627,472

 

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		December 31, 2013
		Fair Value Hierarchy
		Level 1				Level 2				Level 3				Total Estimated Fair Value
		(In thousands)
Assets:
Fixed maturity securities:
Foreign corporate		$	—			$	533,423			$	—			$	533,423
U.S. corporate			—				253,705				9,917				263,622
CMBS			—				75,017				57,547				132,564
State and political subdivision			—				120,256				—				120,256
U.S. Treasury and agency			99,248				—				—				99,248
ABS			—				80,520				—				80,520
RMBS			—				62,789				—				62,789
Foreign government			—				28,659				—				28,659
Total fixed maturity securities			99,248				1,154,369				67,464				1,321,081
Short-term investments (1)			2,630,762				101,270				—				2,732,032
Derivative assets: (2)
Interest rate contracts			9,046				1,171,719				—				1,180,765
Foreign currency contracts			1,169				728				—				1,897
Equity market contracts			1,284				917,797				273,756				1,192,837
Total derivative assets			11,499				2,090,244				273,756				2,375,499
Net embedded derivatives within asset host contracts (3)			—				—				146,550				146,550
Total assets		$	2,741,509			$	3,345,883			$	487,770			$	6,575,162
Liabilities:
Derivative liabilities: (2)
Interest rate contracts		$	6,547			$	798,367			$	—			$	804,914
Foreign currency contracts			1,022				171,078				—				172,100
Equity market contracts			39,601				1,136,875				494,964				1,671,440
Total derivative liabilities			47,170				2,106,320				494,964				2,648,454
Net embedded derivatives within liability host contracts (3)			—				—				2,488,944				2,488,944
Total liabilities		$	47,170			$	2,106,320			$	2,983,908			$	5,137,398

 

(1)	Short-term investments as presented in the tables above differ from the amounts presented on the balance sheets because certain short-term investments are not measured at estimated fair value on a recurring basis.

(2)	Derivative amounts are presented gross in the tables above to reflect the presentation on the balance sheets, but are presented net for purposes of the rollforward in the Fair Value Measurements Using Significant Unobservable Inputs (Level 3) tables.

(3)	Net embedded derivatives within asset host contracts are presented within premiums, reinsurance and other receivables and funds withheld at interest on the balance sheets. Net embedded derivatives within liability host contracts are presented within other PABs on the balance sheets.

The following describes the valuation methodologies used to measure assets and liabilities at fair value. The description includes the valuation techniques and key inputs for each category of assets or liabilities that are classified within Level 2 and Level 3 of the fair value hierarchy.

Investments

Valuation Controls and Procedures

On behalf of the Company and MetLife Inc.’s, Chief Investment Officer and Chief Financial Officer, a pricing and valuation committee that is independent of the trading and investing functions and comprised of senior management, provides oversight of control systems and valuation policies for securities and derivatives. On a quarterly basis, this committee reviews

 

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and approves new transaction types and markets, ensures that observable market prices and market-based parameters are used for valuation, wherever possible, and determines that judgmental valuation adjustments, when applied, are based upon established policies and are applied consistently over time. This committee also provides oversight of the selection of independent third party pricing providers and the controls and procedures to evaluate third party pricing. Periodically, the Chief Accounting Officer reports to the Audit Committee of the MetLife, Inc.’s Board of Directors regarding compliance with fair value accounting standards.

The Company reviews its valuation methodologies on an ongoing basis and revises those methodologies when necessary based on changing market conditions. Assurance is gained on the overall reasonableness and consistent application of input assumptions, valuation methodologies and compliance with fair value accounting standards through controls designed to ensure valuations represent an exit price. Several controls are utilized, including certain monthly controls, which include, but are not limited to, analysis of portfolio returns to corresponding benchmark returns, comparing a sample of executed prices of securities sold to the fair value estimates, comparing fair value estimates to management’s knowledge of the current market, reviewing the bid/ask spreads to assess activity, comparing prices from multiple independent pricing services and ongoing due diligence to confirm that independent pricing services use market-based parameters. The process includes a determination of the observability of inputs used in estimated fair values received from independent pricing services or brokers by assessing whether these inputs can be corroborated by observable market data. The Company ensures that prices received from independent brokers, also referred to herein as “consensus pricing,” represent a reasonable estimate of fair value by considering such pricing relative to the Company’s knowledge of the current market dynamics and current pricing for similar financial instruments.

The Company also applies a formal process to challenge any prices received from independent pricing services that are not considered representative of estimated fair value. If prices received from independent pricing services are not considered reflective of market activity or representative of estimated fair value, independent non-binding broker quotations are obtained, or an internally developed valuation is prepared. Internally developed valuations of current estimated fair value, which reflect internal estimates of liquidity and nonperformance risks, compared with pricing received from the independent pricing services, did not produce material differences in the estimated fair values for the majority of the portfolio; accordingly, overrides were not material. This is, in part, because internal estimates of liquidity and nonperformance risks are generally based on available market evidence and estimates used by other market participants. In the absence of such market-based evidence, management’s best estimate is used.

Securities and Short-term Investments

When available, the estimated fair value of these financial instruments is based on quoted prices in active markets that are readily and regularly obtainable. Generally, these are the most liquid of the Company’s securities holdings and valuation of these securities does not involve management’s judgment.

When quoted prices in active markets are not available, the determination of estimated fair value is based on market standard valuation methodologies, giving priority to observable inputs. The significant inputs to the market standard valuation methodologies for certain types of securities with reasonable levels of price transparency are inputs that are observable in the market or can be derived principally from, or corroborated by, observable market data. When observable inputs are not available, the market standard valuation methodologies rely on inputs that are significant to the estimated fair value that are not observable in the market or cannot be derived principally from, or corroborated by, observable market data. These unobservable inputs can be based in large part on management’s judgment or estimation and cannot be supported by reference to market activity. Even though these inputs are unobservable, management believes they are consistent with what other market participants would use when pricing such securities and are considered appropriate given the circumstances.

Level 2 Valuation Techniques and Key Inputs:

This level includes fixed maturity securities priced principally by independent pricing services using observable inputs. Short-term investments within this level are of a similar nature and class to the Level 2 fixed maturity securities.

 

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Foreign Corporate and U.S. corporate securities

These securities are principally valued using the market and income approaches. Valuations are based primarily on quoted prices in markets that are not active, or using matrix pricing or other similar techniques that use standard market observable inputs such as benchmark yields, spreads off benchmark yields, new issuances, issuer rating, duration, and trades of identical or comparable securities. Privately-placed securities are valued using matrix pricing methodologies using standard market observable inputs, and inputs derived from, or corroborated by, market observable data including market yield curve, duration, call provisions, observable prices and spreads for similar publicly traded or privately traded issues that incorporate the credit quality and industry sector of the issuer and, in certain cases, delta spread adjustments to reflect specific credit-related issues.

Structured securities comprised of CMBS, ABS and RMBS

These securities are principally valued using the market and income approaches. Valuations are based primarily on matrix pricing, discounted cash flow methodologies or other similar techniques using standard market inputs, including spreads for actively traded securities, spreads off benchmark yields, expected prepayment speeds and volumes, current and forecasted loss severity, rating, weighted average coupon, weighted average maturity, average delinquency rates, geographic region, debt-service coverage ratios and issuance-specific information, including, but not limited to: collateral type, payment terms of the underlying assets, payment priority within the tranche, structure of the security, deal performance and vintage of loans.

State and political subdivision and foreign government securities

These securities are principally valued using the market approach. Valuations are based primarily on matrix pricing or other similar techniques using standard market observable inputs including a benchmark U.S. Treasury yield or other yields, issuer ratings, broker-dealer quotes, issuer spreads and reported trades of similar securities, including those within the same sub-sector or with a similar maturity or credit rating.

Level 3 Valuation Techniques and Key Inputs:

In general, securities classified within Level 3 use many of the same valuation techniques and inputs as described previously for Level 2. However, if key inputs are unobservable, or if the investments are less liquid and there is very limited trading activity, the investments are generally classified as Level 3. The use of independent non-binding broker quotations to value investments generally indicates there is a lack of liquidity or a lack of transparency in the process to develop the valuation estimates, generally causing these investments to be classified in Level 3.

Short-term investments within this level are of a similar nature and class to the Level 3 securities described below; accordingly, the valuation techniques and significant market standard observable inputs used in their valuation are also similar to those described below.

U.S. corporate and foreign corporate securities

These securities are principally valued using the market approach. Valuations are based primarily on matrix pricing or other similar techniques that utilize unobservable inputs or inputs that cannot be derived principally from, or corroborated by, observable market data, including illiquidity premium, delta spread adjustments to reflect specific credit-related issues, credit spreads; and inputs including quoted prices for identical or similar securities that are less liquid and based on lower levels of trading activity than securities classified in Level 2. Certain valuations are based on independent non-binding broker quotations.

Structured securities comprised of CMBS and ABS

These securities are principally valued using the market and income approaches. Valuations are based primarily on matrix pricing, discounted cash flow methodologies or other similar techniques that utilize inputs that are unobservable or cannot be derived principally from, or corroborated by, observable market data, including credit spreads. Below

 

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investment grade securities included in this level are valued based on inputs including quoted prices for identical or similar securities that are less liquid and based on lower levels of trading activity than securities classified in Level 2. Certain of these valuations are based on independent non-binding broker quotations.

Derivatives

The estimated fair value of derivatives is determined through the use of quoted market prices for exchange-traded derivatives, or through the use of pricing models for OTC-bilateral and OTC-cleared derivatives. The determination of estimated fair value, when quoted market values are not available, is based on market standard valuation methodologies and inputs that management believes are consistent with what other market participants would use when pricing such instruments. Derivative valuations can be affected by changes in interest rates, foreign currency exchange rates, financial indices, credit spreads, default risk, nonperformance risk, volatility, liquidity and changes in estimates and assumptions used in the pricing models. The valuation controls and procedures for derivatives are described in “— Investments.”

The significant inputs to the pricing models for most OTC-bilateral and OTC-cleared derivatives are inputs that are observable in the market or can be derived principally from, or corroborated by, observable market data. Significant inputs that are observable generally include: interest rates, foreign currency exchange rates, interest rate curves, credit curves and volatility. However, certain OTC-bilateral and OTC-cleared derivatives may rely on inputs that are significant to the estimated fair value that are not observable in the market or cannot be derived principally from, or corroborated by, observable market data. Significant inputs that are unobservable generally include references to emerging market currencies and inputs that are outside the observable portion of the interest rate curve, credit curve, volatility or other relevant market measure. These unobservable inputs may involve significant management judgment or estimation. Even though unobservable, these inputs are based on assumptions deemed appropriate given the circumstances and management believes they are consistent with what other market participants would use when pricing such instruments.

Most inputs for OTC-bilateral and OTC-cleared derivatives are mid-market inputs but, in certain cases, liquidity adjustments are made when they are deemed more representative of exit value. Market liquidity, as well as the use of different methodologies, assumptions and inputs, may have a material effect on the estimated fair values of the Company’s derivatives and could materially affect net income.

The credit risk of both the counterparty and the Company are considered in determining the estimated fair value for all OTC-bilateral and OTC-cleared derivatives, and any potential credit adjustment is based on the net exposure by counterparty after taking into account the effects of netting agreements and collateral arrangements. The Company values its OTC-bilateral and OTC-cleared derivatives using standard swap curves which may include a spread to the risk-free rate, depending upon specific collateral arrangements. This credit spread is appropriate for those parties that execute trades at pricing levels consistent with similar collateral arrangements. As the Company and its significant derivative counterparties generally execute trades at such pricing levels and hold sufficient collateral, additional credit risk adjustments are not currently required in the valuation process. The Company’s ability to consistently execute at such pricing levels is in part due to the netting agreements and collateral arrangements that are in place with all of its significant derivative counterparties. An evaluation of the requirement to make additional credit risk adjustments is performed by the Company each reporting period.

Freestanding Derivatives

Level 2 Valuation Techniques and Key Inputs:

This level includes all types of derivatives utilized by the Company with the exception of exchange-traded derivatives included within Level 1 and those derivatives with unobservable inputs as described in Level 3. These derivatives are principally valued using the income approach.

Interest rate

Non-option-based. Valuations are based on present value techniques, which utilize significant inputs that may include the swap yield curve and basis curves.

 

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Option-based. Valuations are based on option pricing models, which utilize significant inputs that may include the swap yield curve, basis curves and interest rate volatility.

Foreign currency exchange rate

Non-option-based. Valuations are based on present value techniques, which utilize significant inputs that may include the swap yield curve, basis curves, currency spot rates and cross currency basis curves.

Equity market

Non-option-based. Valuations are based on present value techniques, which utilize significant inputs that may include the swap yield curve, spot equity index levels and dividend yield curves.

Option-based. Valuations are based on option pricing models, which utilize significant inputs that may include the swap yield curve, spot equity index levels, dividend yield curves and equity volatility.

Level 3 Valuation Techniques and Key Inputs:

These derivatives are principally valued using the income approach. Valuations of non-option-based derivatives utilize present value techniques, whereas valuations of option-based derivatives utilize option pricing models. These valuation methodologies generally use the same inputs as described in the corresponding sections above for Level 2 measurements of derivatives. However, these derivatives result in Level 3 classification because one or more of the significant inputs are not observable in the market or cannot be derived principally from, or corroborated by, observable market data.

Equity market

Non-option-based. Significant unobservable inputs may include the extrapolation beyond observable limits of dividend yield curves and equity volatility.

Option-based. Significant unobservable inputs may include the extrapolation beyond observable limits of dividend yield curves, equity volatility and unobservable correlation between model inputs.

Embedded Derivatives

Embedded derivatives principally include certain assumed and ceded variable annuity guarantees and equity indexed crediting rates within certain funding agreements. Embedded derivatives are recorded at estimated fair value with changes in estimated fair value reported in net income.

The fair value of these embedded derivatives, estimated as the present value of projected future benefits minus the present value of projected future fees using actuarial and capital market assumptions including expectations concerning policyholder behavior, is calculated by the Company’s actuarial department. The calculation is based on in-force business, and is performed using standard actuarial valuation software which projects future cash flows from the embedded derivative over multiple risk neutral stochastic scenarios using observable risk-free rates.

Capital market assumptions, such as risk-free rates and implied volatilities, are based on market prices for publicly traded instruments to the extent that prices for such instruments are observable. Implied volatilities beyond the observable period are extrapolated based on observable implied volatilities and historical volatilities. Actuarial assumptions, including mortality, lapse, withdrawal and utilization, are unobservable and are reviewed at least annually based on actuarial studies of historical experience.

The valuation of these guarantee liabilities includes nonperformance risk adjustments and adjustments for a risk margin related to non-capital market inputs. The nonperformance adjustment is determined by taking into consideration publicly available information relating to spreads in the secondary market for the Holding Company’s debt, including related credit default swaps.

 

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Risk margins are established to capture the non-capital market risks of the instrument which represent the additional compensation a market participant would require to assume the risks related to the uncertainties of such actuarial assumptions as annuitization, premium persistency, partial withdrawal and surrenders. The establishment of risk margins requires the use of significant management judgment, including assumptions of the amount and cost of capital needed to cover the guarantees. These guarantees may be more costly than expected in volatile or declining equity markets. Market conditions including, but not limited to, changes in interest rates, equity indices, market volatility and foreign currency exchange rates; changes in nonperformance risk; and variations in actuarial assumptions regarding policyholder behavior, mortality and risk margins related to non-capital market inputs, may result in significant fluctuations in the estimated fair value of the guarantees that could materially affect net income.

The Company ceded the risk associated with certain of the GMIBs previously described. These reinsurance agreements contain embedded derivatives which are included within premiums, reinsurance and other receivables on the balance sheets with changes in estimated fair value reported in net derivative gains (losses) or policyholder benefits and claims depending on the statement of operations classification of the direct risk. The value of the embedded derivatives on the ceded risk is determined using a methodology consistent with that described previously with the exception of the input for nonperformance risk that reflects the credit of the reinsurer.

The estimated fair value of the embedded derivatives within funds withheld related to certain assumed reinsurance is determined based on the change in estimated fair value of the underlying assets held by the Company in a reference portfolio backing the funds withheld liability. The estimated fair value of the underlying assets is determined as previously described in “— Investments —Securities and Short-term Investments.” The estimated fair value of these embedded derivatives is included, along with their funds withheld hosts, in derivative liabilities and funds withheld at interest on the balance sheets with changes in estimated fair value recorded in net derivative gains (losses). Changes in the credit spreads on the underlying assets, interest rates and market volatility may result in significant fluctuations in the estimated fair value of these embedded derivatives that could materially affect net income.

Embedded Derivatives Within Asset and Liability Host Contracts

Level 3 Valuation Techniques and Key Inputs:

Assumed guaranteed minimum benefits

These embedded derivatives are principally valued using the income approach. Valuations are based on option pricing techniques, which utilize significant inputs that may include swap yield curve, currency exchange rates and implied volatilities. These embedded derivatives result in Level 3 classification because one or more of the significant inputs are not observable in the market or cannot be derived principally from, or corroborated by, observable market data. Significant unobservable inputs generally include: the extrapolation beyond observable limits of the swap yield curve and implied volatilities, actuarial assumptions for policyholder behavior and mortality and the potential variability in policyholder behavior and mortality, nonperformance risk and cost of capital for purposes of calculating the risk margin.

Reinsurance ceded on certain guaranteed minimum benefits

These embedded derivatives are principally valued using the income approach. The valuation techniques and significant market standard unobservable inputs used in their valuation are similar to those described above in “— Assumed guaranteed minimum benefits” and also include counterparty credit spreads.

Embedded derivatives within funds withheld related to certain assumed reinsurance

These embedded derivatives are principally valued using an income approach. Valuations are based on present value techniques, which utilize significant inputs that may include the swap yield curve and the fair value of assets within the reference portfolio. These embedded derivatives result in Level 3 classification because one or more of the significant inputs are not observable in the market or cannot be derived principally from, or corroborated by, observable market

 

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data. Significant unobservable inputs generally include: the fair value of certain assets within the reference portfolio which are not observable in the market and cannot be derived principally from, or corroborated by, observable market data.

Transfers between Levels

Overall, transfers between levels occur when there are changes in the observability of inputs and market activity. Transfers into or out of any level are assumed to occur at the beginning of the period.

Transfers between Levels 1 and 2:

There were no transfers between Levels 1 and 2 for assets and liabilities measured at estimated fair value and still held at both September 30, 2014 and December 31, 2013.

Transfers into or out of Level 3:

Assets and liabilities are transferred into Level 3 when a significant input cannot be corroborated with market observable data. This occurs when market activity decreases significantly and underlying inputs cannot be observed, current prices are not available, and/or when there are significant variances in quoted prices, thereby affecting transparency. Assets and liabilities are transferred out of Level 3 when circumstances change such that a significant input can be corroborated with market observable data. This may be due to a significant increase in market activity, a specific event, or one or more significant input(s) becoming observable.

Transfers into Level 3 for fixed maturity securities were due primarily to a lack of trading activity, decreased liquidity and credit ratings downgrades (e.g., from investment grade to below investment grade) which have resulted in decreased transparency of valuations and an increased use of independent non-binding broker quotations and unobservable inputs, such as illiquidity premiums, delta spread adjustments, or credit spreads.

Transfers out of Level 3 for fixed maturity securities resulted primarily from increased transparency of both new issuances that, subsequent to issuance and establishment of trading activity, became priced by independent pricing services and existing issuances that, over time, the Company was able to obtain pricing from, or corroborate pricing received from, independent pricing services with observable inputs (such as observable spreads used in pricing securities) or increases in market activity and upgraded credit ratings.

 

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Assets and Liabilities Measured at Fair Value Using Significant Unobservable Inputs (Level 3)

The following table presents certain quantitative information about the significant unobservable inputs used in the fair value measurement, and the sensitivity of the estimated fair value to changes in those inputs, for the more significant asset and liability classes measured at fair value on a recurring basis using significant unobservable inputs (Level 3) at:

 

						September 30, 2014				December 31, 2013				Impact of Increase in Input on Estimated Fair Value (2)
		Valuation Techniques		Significant Unobservable Inputs		Range		Weighted Average (1)		Range		Weighted Average (1)
Fixed maturity securities: (3)
U.S. corporate and foreign corporate		• Matrix pricing		• Credit spreads (4)		— - —		—		95 - 95		95		Decrease
				•  Illiquidity premium (4)		— - —		—		30 - 30		30		Decrease
CMBS		•  Matrix pricing and discounted cash flow		• Credit spreads (4)		— - —		—		215 - 215		215		Decrease (6)
		•  Market pricing		• Quoted prices (5)		104 - 104		104		104 - 104		104		Increase (6)
		•  Consensus pricing		• Offered quotes (5)		— - —		—		90 - 92		91		Increase (6)
ABS		•  Matrix pricing and discounted cash flow		• Credit spreads (4)		126 - 180		157						Decrease (6)
		•  Market pricing		• Quoted prices (5)		100 - 100		100						Increase (6)
Derivatives:
Equity market		•  Present value techniques or option pricing models		• Volatility (7)		14% - 28%				13% - 28%				Increase (8)
				• Correlation (9)		65% - 65%				60% - 60%
Embedded derivatives:
Assumed and ceded guaranteed minimum benefits		•  Option pricing techniques		• Mortality rates:
				Ages 0 - 40		0% - 10%				0% - 0.10%				Decrease (10)
				Ages 41 - 60		0.04% - 0.65%				0.04% - 0.65%				Decrease (10)
				Ages 61 - 115		0.26% - 100%				0.26% - 100%				Decrease (10)
				• Lapse rates:
				Durations 1 - 10		0.50% - 100%				0.50% - 100%				Decrease (11)
				Durations 11 - 20		3% - 100%				3% - 100%				Decrease (11)
				Durations 21 - 116		3% - 100%				3% - 100%				Decrease (11)
				• Utilization rates		20% - 50%				20% - 50%				Increase (12)
				• Withdrawal rates		0.07% - 10%				0.07% - 10%				(13)
				• Long-term equity   volatilities		17.40% - 25%				17.40% - 25%				Increase (14)
				• Nonperformance   risk spread		0.03% - 0.45%				0.03% - 0.44%				Decrease (15)

 

(1)	The weighted average for fixed maturity securities is determined based on the estimated fair value of the securities.

(2)	The impact of a decrease in input would have the opposite impact on the estimated fair value. For embedded derivatives, changes to assumed guaranteed minimum benefits are based on liability positions and changes to ceded guaranteed minimum benefits are based on asset positions.

(3)	Significant increases (decreases) in expected default rates in isolation would result in substantially lower (higher) valuations.

(4)	Range and weighted average are presented in basis points.

(5)	Range and weighted average are presented in accordance with the market convention for fixed maturity securities of dollars per hundred dollars of par.

(6)	Changes in the assumptions used for the probability of default is accompanied by a directionally similar change in the assumption used for the loss severity and a directionally opposite change in the assumptions used for prepayment rates.

(7)	Ranges represent the underlying equity volatility quoted in percentage points. Since this valuation methodology uses a range of inputs across multiple volatility surfaces to value the derivative, presenting a range is more representative of the unobservable input used in the valuation.

 

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(8)	Changes are based on long U.S. dollar net asset positions and will be inversely impacted for short U.S. dollar net asset positions.

(9)

Ranges represent the different correlation factors utilized as components within the valuation methodology. Presenting a range of correlation factors is more representative of the unobservable input used in the valuation. Increases (decreases) in correlation in isolation will increase (decrease) the significance of the change in valuations.

(10)

Mortality rates vary by age and by demographic characteristics such as gender. Mortality rate assumptions are based on company experience. A mortality improvement assumption is also applied. For any given contract, mortality rates vary throughout the period over which cash flows are projected for purposes of valuing the embedded derivative.

(11)

Base lapse rates are adjusted at the contract level based on a comparison of the actuarially calculated guaranteed values and the current policyholder account value, as well as other factors, such as the applicability of any surrender charges. A dynamic lapse function reduces the base lapse rate when the guaranteed amount is greater than the account value as in the money contracts are less likely to lapse. Lapse rates are also generally assumed to be lower in periods when a surrender charge applies. For any given contract, lapse rates vary throughout the period over which cash flows are projected for purposes of valuing the embedded derivative.

(12)

The utilization rate assumption estimates the percentage of contract holders with a GMIB or lifetime withdrawal benefit who will elect to utilize the benefit upon becoming eligible. The rates may vary by the type of guarantee, the amount by which the guaranteed amount is greater than the account value, the contract’s withdrawal history and by the age of the policyholder. For any given contract, utilization rates vary throughout the period over which cash flows are projected for purposes of valuing the embedded derivative.

(13)

The withdrawal rate represents the percentage of account balance that any given policyholder will elect to withdraw from the contract each year. The withdrawal rate assumption varies by age and duration of the contract, and also by other factors such as benefit type. For any given contract, withdrawal rates vary throughout the period over which cash flows are projected for purposes of valuing the embedded derivative. For GMWBs, any increase (decrease) in withdrawal rates results in an increase (decrease) in the estimated fair value of the guarantees. For GMABs and GMIBs, any increase (decrease) in withdrawal rates results in a decrease (increase) in the estimated fair value.

(14)

Long-term equity volatilities represent equity volatility beyond the period for which observable equity volatilities are available. For any given contract, long-term equity volatility rates vary throughout the period over which cash flows are projected for purposes of valuing the embedded derivative.

(15)	Nonperformance risk spread varies by duration and by currency. For any given contract, multiple nonperformance risk spreads will apply, depending on the duration of the cash flow being discounted for purposes of valuing the embedded derivative.

The following is a summary of the valuation techniques and significant unobservable inputs used in the fair value measurement of assets and liabilities classified within Level 3 that are not included in the preceding table. Generally, all other classes of securities classified within Level 3, including those within embedded derivatives within funds withheld related to certain assumed reinsurance, use the same valuation techniques and significant unobservable inputs as previously described for Level 3 securities. This includes matrix pricing and discounted cash flow methodologies, inputs such as quoted prices for identical or similar securities that are less liquid and based on lower levels of trading activity than securities classified in Level 2, as well as independent non-binding broker quotations. The sensitivity of the estimated fair value to changes in the significant unobservable inputs for these other assets and liabilities is similar in nature to that described in the preceding table.

 

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The following tables summarize the change of all assets and (liabilities) measured at estimated fair value on a recurring basis using significant unobservable inputs (Level 3):

 

		Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
		Fixed Maturity Securities																				Net Derivatives (6)
		Foreign Corporate				U.S. Corporate				CMBS				ABS				Short-term Investments				Equity Market				Net Embedded Derivatives (7)
		(In thousands)
Nine Months Ended September 30, 2014:
Balance, beginning of period		$	—			$	9,917			$	57,547			$	—			$	—			$	(221,208	)		$	(2,342,394	)
Total realized/unrealized gains (losses) included in:
Net income (loss): (1), (2)
Net investment income			—				—				(132	)			—				—				—				—
Net investment gains (losses)			—				—				—				—				—				—				—
Net derivative gains (losses)			—				—				—				—				—				(21,600	)			(1,167,869	)
Policyholder benefits and claims			—				—				—				—				—				3,661				54,687
OCI			—				—				132				257				—				1,515				80,621
Purchases (3)			—				—				—				25,987				—				4,119				—
Sales (3)			—				—				—				—				—				—				—
Settlements (3)			—				—				—				—				—				—				(629,776	)
Transfers into Level 3 (4)			—				—				—				—				—				—				—
Transfers out of Level 3 (4)			—				(9,917	)			(15,824	)			—				—				—				—
Balance, end of period		$	—			$	—			$	41,723			$	26,244			$	—			$	(233,513	)		$	(4,004,731	)
Changes in unrealized gains (losses) included in net income (loss): (5)
Net investment income		$	—			$	—			$	(132	)		$	—			$	—			$	—			$	—
Net investment gains (losses)		$	—			$	—			$	—			$	—			$	—			$	—			$	—
Net derivative gains (losses)		$	—			$	—			$	—			$	—			$	—			$	(21,601	)		$	(1,061,387	)
Policyholder benefits and claims		$	—			$	—			$	—			$	—			$	—			$	3,661			$	56,722

 

		Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
		Fixed Maturity Securities																				Net Derivatives (6)
		Foreign Corporate				U.S. Corporate				CMBS				ABS				Short-term Investments				Equity Market				Net Embedded Derivatives (7)
		(In thousands)
Nine Months Ended September 30, 2013:
Balance, beginning of period		$	2,714			$	15,465			$	41,723			$	4,000			$	4,996			$	185,601			$	(8,501,238	)
Total realized/unrealized gains (losses) included in:
Net income (loss): (1), (2)
Net investment income			9				(54	)			(191	)			—				8				—				—
Net investment gains (losses)			—				—				—				—				—				—				—
Net derivative gains (losses)			—				—				—				—				—				(346,338	)			4,739,671
Policyholder benefits and claims			—				—				—				—				—				15,167				(109,550	)
OCI			(9	)			(507	)			40				—				—				(531	)			186,520
Purchases (3)			—				—				17,894				—				4,996				4,119				—
Sales (3)			—				(2,243	)			—				—				(5,000	)			—				—
Settlements (3)			—				—				—				—				—				—				(605,531	)
Transfers into Level 3 (4)			—				3,847				—				—				—				—				—
Transfers out of Level 3 (4)			—				—				—				(4,000	)			—				—				—
Balance, end of period		$	2,714			$	16,508			$	59,466			$	—			$	5,000			$	(141,982	)		$	(4,290,128	)
Changes in unrealized gains (losses) included in net income (loss): (5)
Net investment income		$	9			$	5			$	(191	)		$	—			$	4			$	—			$	—
Net investment gains (losses)		$	—			$	—			$	—			$	—			$	—			$	—			$	—
Net derivative gains (losses)		$	—			$	—			$	—			$	—			$	—			$	(346,338	)		$	4,763,773
Policyholder benefits and claims		$	—			$	—			$	—			$	—			$	—			$	15,167			$	(134,839	)

 

(1)	Amortization of premium/accretion of discount is included within net investment income. Impairments charged to net income (loss) on securities are included in net investment gains (losses). Lapses associated with net embedded derivatives are included in net derivative gains (losses).

(2)	Interest and dividend accruals, as well as cash interest coupons and dividends received, are excluded from the rollforward.

 

29

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Exeter Reassurance Company, Ltd.

Notes to the Interim Condensed Financial Statements (Unaudited) – (Continued)

 

(3)

The amount reported within purchases, sales and settlements is the purchase price and the sales or settlement proceeds based upon the actual date purchased and sold or settled, respectively. Items purchased and sold/settled in the same period are excluded from the rollforward. Fees attributed to embedded derivatives are included in settlements.

(4)	Gains and losses, in net income (loss) and other comprehensive income (loss), are calculated assuming transfers into and/or out of Level 3 occurred at the beginning of the period. Items transferred into and then out of Level 3 in the same period are excluded from the rollforward.

(5)	Changes in unrealized gains (losses) included in net income (loss) relate to assets and liabilities still held at the end of the respective periods.

(6)	Freestanding derivative assets and liabilities are presented net for purposes of the rollforward.

(7)	Embedded derivative assets and liabilities are presented net for purposes of the rollforward.

Fair Value of Financial Instruments Carried at Other Than Fair Value

The following tables provide fair value information for financial instruments that are carried on the balance sheet at amounts other than fair value. These tables exclude the following financial instruments: cash and cash equivalents, accrued investment income, the obligation to return cash collateral received (included in other liabilities on the balance sheets) and short-term investments that are not securities, such as time deposits, and therefore are not included in the three level hierarchy table disclosed in the “— Recurring Fair Value Measurements” section. The estimated fair value of the excluded financial instruments, which are primarily classified in Level 2 and, to a lesser extent, in Level 1, approximates carrying value as they are short-term in nature such that the Company believes there is minimal risk of material changes in interest rates or credit quality. All remaining balance sheet amounts excluded from the table below are not considered financial instruments subject to this disclosure.

The carrying values and estimated fair values for such financial instruments, and their corresponding placement in the fair value hierarchy, are summarized as follows at:

 

		September 30, 2014
						Fair Value Hierarchy
		Carrying Value				Level 1				Level 2				Level 3				Total Estimated Fair Value
		(In thousands)
Assets:
Premiums, reinsurance and other receivables		$	118,155			$	—			$	110,093			$	(134,906	)		$	(24,813	)
Liabilities:
Debt - affiliated		$	575,118			$	—			$	584,367			$	—			$	584,367
Other liabilities		$	96,728			$	—			$	95,985			$	743			$	96,728

 

		December 31, 2013
						Fair Value Hierarchy
		Carrying Value				Level 1				Level 2				Level 3				Total Estimated Fair Value
		(In thousands)
Assets
Premiums, reinsurance and other receivables		$	228,140			$	—			$	224,672			$	(161,249	)		$	63,423
Liabilities
Debt - affiliated		$	575,118			$	—			$	592,278			$	—			$	592,278
Other liabilities		$	3,836			$	—			$	3,836			$	—			$	3,836

 

30

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Exeter Reassurance Company, Ltd.

Notes to the Interim Condensed Financial Statements (Unaudited) – (Continued)

 

The methods, assumptions and significant valuation techniques and inputs used to estimate the fair value of financial instruments are summarized as follows:

Premiums, Reinsurance and Other Receivables

Premiums, reinsurance and other receivables are principally comprised of certain amounts recoverable under reinsurance agreements and amounts on deposit with financial institutions to facilitate daily settlements related to certain derivatives.

Premiums receivable and those amounts recoverable under reinsurance agreements determined to transfer significant risk are not financial instruments subject to disclosure and thus have been excluded from the amounts presented. Amounts recoverable under ceded reinsurance agreements, which the Company has determined do not transfer significant risk such that they are accounted for using the deposit method of accounting, have been classified as Level 3. The valuation is based on discounted cash flow methodologies using significant unobservable inputs. The estimated fair value is determined using interest rates determined to reflect the appropriate credit standing of the assuming counterparty.

The amounts on deposit for derivative settlements, classified within Level 2, essentially represent the equivalent of demand deposit balances and amounts due for securities sold are generally received over short periods such that the estimated fair value approximates carrying value.

Debt - Affiliated

The estimated fair value of debt is principally determined using market standard valuation methodologies. Valuations of instruments classified as Level 2 are based primarily on quoted prices in markets that are not active or using matrix pricing that use standard market observable inputs such as quoted prices in markets that are not active and observable yields and spreads in the market. Instruments valued using discounted cash flow methodologies use standard market observable inputs including market yield curve, duration, observable prices and spreads for similar publicly traded or privately traded issues.

Other Liabilities

Other liabilities consist of interest payable, amounts due for securities purchased but not yet settled, and amounts payable under certain assumed reinsurance agreements, which are recorded using the deposit method of accounting. The Company evaluates the specific terms, facts and circumstances of each instrument to determine the appropriate estimated fair values, which are not materially different from the carrying values.

 

31

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Exeter Reassurance Company, Ltd.

Notes to the Interim Condensed Financial Statements (Unaudited) – (Continued)

 

6.	Stockholder’s Equity

Accumulated Other Comprehensive Income (Loss)

Information regarding changes in the balances of each component of AOCI, net of income tax, was as follows:

 

		Nine Months Ended September 30, 2014
		Unrealized Investment Gains (Losses), Net of Related Offsets				Foreign Currency Translation Adjustment				Total
		(In thousands)
Balance, beginning of period		$	5,896			$	63,116			$	69,012
OCI before reclassifications			30,852				35,468				66,320
Deferred income tax benefit (expense)			(10,798	)			(34,502	)			(45,300	)
OCI before reclassifications, net of income tax			25,950				64,082				90,032
Amounts reclassified from AOCI			1,735				—				1,735
Deferred income tax benefit (expense)			(607	)			—				(607	)
Amounts reclassified from AOCI, net of income tax			1,128				—				1,128
Balance, end of period		$	27,078			$	64,082			$	91,160

 

		Nine Months Ended September 30, 2013
		Unrealized Investment Gains (Losses), Net of Related Offsets				Foreign Currency Translation Adjustment				Total
		(In thousands)
Balance, beginning of period		$	42,709			$	36,568			$	79,277
OCI before reclassifications			(42,117	)			(30,078	)			(72,195	)
Deferred income tax benefit (expense)			14,741				—				14,741
OCI before reclassifications, net of income tax			15,333				6,490				21,823
Amounts reclassified from AOCI			(1,712	)			—				(1,712	)
Deferred income tax benefit (expense)			599				—				599
Amounts reclassified from AOCI, net of income tax			(1,113	)			—				(1,113	)
Balance, end of period		$	14,220			$	6,490			$	20,710

 

32

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Exeter Reassurance Company, Ltd.

Notes to the Interim Condensed Financial Statements (Unaudited) – (Continued)

 

Information regarding amounts reclassified out of each component of AOCI was as follows:

 

AOCI Components		Amounts Reclassified from AOCI								Statement of Operations and Comprehensive Income (Loss) Location
		Nine Months Ended September 30,
		2014				2013
		(In thousands)
Net unrealized investment gains (losses):
Net unrealized investment gains (losses)		$	(1,846	)		$	1,701			Net investment gains (losses)
Net unrealized investment gains (losses)			111				11			Net investment income
Net unrealized investment gains (losses), before income tax			(1,735	)			1,712
Income tax (expense) benefit			607				(599	)
Net unrealized investment gains (losses), net income tax			(1,128	)			1,113
Total reclassifications, net of income tax		$	(1,128	)		$	1,113

 

7.	Other Expenses

Information on other expenses was as follows:

 

		Nine Months Ended September 30,
		2014				2013
		(In thousands)
Commissions		$	5,084			$	8,610
Volume-related costs			9,505				22,952
Affiliated costs of reinsurance			9,542				52,758
Capitalization of deferred policy acquisition costs (“DAC”)			(1,922	)			(1,543	)
Amortization of DAC			13,511				(15,703	)
Interest expense on debt			13,092				3,830
Premium taxes, licenses and fees			2				21
Professional services			230				335
Other			4,185				3,532
Total other expenses		$	53,229			$	74,792

Affiliated Expenses

Commissions, volume-related costs and capitalization and amortization of DAC include the impact of affiliated reinsurance transactions.

See Note 9 for a discussion of affiliated expenses included in the table above.

 

8.	Contingencies and Commitments

There is no pending or threatened litigation, claim or assessment against the Company that would constitute a material loss contingency.

Various litigation, claims or assessments against the Company may arise in the ordinary course of the Company’s business. Liabilities for litigations, claims or assessments are established when it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. The Company regularly reviews relevant information with respect to liabilities for litigation, regulatory investigations and litigation-related contingencies to be reflected in the Company’s financial statements. Based on information currently known by the Company’s management, in its opinion, there are no current legal proceedings, likely to have such an effect. However, it is possible that an adverse outcome in a litigation matter, should such a litigation matter arise in the future, could have a material effect on the Company’s net income or cash flows.

 

33

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Exeter Reassurance Company, Ltd.

Notes to the Interim Condensed Financial Statements (Unaudited) – (Continued)

 

9.	Related Party Transactions

Service Agreements

The Company had net payables to affiliates of $548 thousand and $593 thousand at September 30, 2014 and December 31, 2013, respectively.

See Note 3 for additional related party transactions.

Related Party Reinsurance Transactions

The Company has reinsurance agreements with certain affiliates, including Metropolitan Life Insurance Company, First MetLife Investors Insurance Company, MICC, MLI-USA, MLIIC, MetLife Europe Limited (“MEL”), New England Life Insurance Company and Alico Life International Limited, all of which are related parties.

Information regarding the significant effects of affiliated reinsurance included in the statements of operations was as follows:

 

		Nine Months Ended September 30,
		2014				2013
		(In thousands)
Revenues:
Premiums		$	15,259			$	17,625
Universal life and investment-type product policy fees			394,102				328,185
Net derivative gain (loss)			(1,190,345	)			3,995,687
Other revenues			14,892				(3,808	)
Total revenues		$	(766,092	)		$	4,337,689
Expenses:
Policyholder benefits and claims		$	300,075			$	195,205
Interest credited to policyholder account balances			13,574				12,905
Policyholder dividends			9,537				9,298
Other expenses			23,157				58,939
Total expenses		$	346,343			$	276,347

Information regarding the significant effects of affiliated reinsurance included in the balance sheets was as follows at:

 

34

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Exeter Reassurance Company, Ltd.

Notes to the Interim Condensed Financial Statements (Unaudited) – (Continued)

 

		September 30, 2014				December 31, 2013
		(In thousands)
Assets:
Funds withheld at interest		$	2,146,385			$	2,045,389
Premiums, reinsurance and other receivables			132,642				243,080
Deferred policy acquisition costs			71,449				80,831
Total assets		$	2,350,476			$	2,369,300
Liabilities:
Future policy benefits		$	2,132,914			$	2,062,320
Other policy-related balances			5,212,755				3,561,663
Policyholder dividends payable			15,996				16,256
Other liabilities			123,860				250,807
Total liabilities		$	7,485,525			$	5,891,046

In September 2012, the Company entered into a reinsurance agreement to assume 100% quota share of certain blocks of indemnity reinsurance from MEL. This agreement covers a portion of liabilities under defined portfolios of living time annuities contracts issued on or after the effective date. This agreement transfers risk to the Company, and therefore, is accounted for as reinsurance. As a result of the agreement, the Company recorded future policy benefits, presented within future policy benefits, of $475.6 million and $649.3 million, other reinsurance liabilities of $2.6 million and $16.9 million, and other reinsurance payables, included in other liabilities, were $30.7 million and $43.7 million at September 30, 2014 and December 31, 2013, respectively. The Company’s statement of operations reflects a loss for this agreement of $3.1 million and $7.0 million, which includes premiums of $21 thousand and $1 thousand and policyholder benefits of $3.2 million and $7.0 million for the nine months ended September 31, 2014 and 2013, respectively.

The Company assumes risks from affiliates related to guaranteed minimum benefit guarantees written directly by the affiliates. These assumed reinsurance agreements contain embedded derivatives and changes in their fair value are also included within net derivative gains (losses). The embedded derivatives associated with the cessions are included within policyholder account balances and were liabilities of $3,029.5 million and $1,226.6 million at September 30, 2014 and December 31, 2013, respectively. For the nine months ended September 30, 2014 and 2013, net derivative gains (losses) included ($1,235.1) million and $4,020.9 million, respectively, in changes in fair value of such embedded derivatives.

 

10.	Subsequent Events

In anticipation of the Mergers, certain risks formerly reinsured by Exeter were re-directed to affiliates through various forms of transactions. For certain risks that were re-directed in October 2014 and November 2014, the agreement terms included that the initial settlement amounts were to be based upon the reinsurance balances at September 30, 2014. The estimated impacts of these transactions to Exeter were a decrease in cash and invested assets of $2.6 billion, a decrease in future policy benefits of $500 million, a decrease in policyholder account balances of $1.2 billion and a decrease in other policy-related balances of $800 million. Also as a result of these transactions, Exeter recorded an estimated net loss of $100 million during the fourth quarter of 2014. These estimated amounts will be adjusted to actual settlement amounts by January 2015, in accordance with the applicable reinsurance recapture agreements’ terms. The Company entered into another affiliated reinsurance transaction on November 10, 2014. The estimated impacts, based upon the account balances at September 30, 2014, are a decrease in cash and invested assets of $400 million, as decrease in future policy benefits of $500 million, offset by an increase in other policy-related balances of $100 million. It is likely that the final settlement amounts of these reinsurance transactions, that will consider additional available information, will differ from the estimated amounts and it is possible the differences may be material. Other than the above transactions, there are no additional transactions that have occurred subsequent to September 30, 2014, but prior to November 18, 2014, the date these financial statements were available to be issued.

 

35

Exhibit 99.4

 

EXETER REASSURANCE COMPANY, LTD.

Financial Statements

As of December 31, 2013 and 2012 and for the years ended

December 31, 2013, 2012 and 2011 (As restated)

and Independent Auditors’ Report

---

INDEPENDENT AUDITORS’ REPORT

To the Board of Directors and Stockholder of

Exeter Reassurance Company, Ltd.:

We have audited the accompanying financial statements of Exeter Reassurance Company, Ltd. (a wholly-owned subsidiary of MetLife, Inc.) (the “Company”), which comprise the balance sheets as of December 31, 2013 and 2012, and the related statements of operations, comprehensive income (loss), stockholder’s equity, and cash flows for each of the three years in the period ended December 31, 2013, and the related notes to the financial statements.

Management’s Responsibility for the Financial Statements

Management is responsible for the preparation and fair presentation of these financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error.

Auditors’ Responsibility

Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the Company’s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.

Opinion

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Exeter Reassurance Company, Ltd. as of December 31, 2013 and 2012, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2013, in accordance with accounting principles generally accepted in the United States of America.

Emphasis of Matter

As discussed in Note 1 to the financial statements, the accompanying financial statements have been restated to correct misstatements on the 2013, 2012 and 2011 statements of cash flows. Our opinion is not modified with respect to this matter.

Other Matters

In our report dated April 2, 2014 on the previously issued 2012 financial statements filed with the Cayman Islands Monetary Authority (“CIMA”), we expressed an opinion that the Company’s 2012 balance sheet did not fairly present insurance liabilities and, accordingly, did not conform to the presentation required under accounting principles generally accepted in the United States of America. That presentation was based on practices prescribed or permitted by CIMA. As noted in Note 1, in these general purpose financial statements, the Company has changed its presentation of insurance liabilities to conform to accounting principles generally accepted in the United States of America. Accordingly, our present opinion on the 2012 financial statements, as presented herein, is different from that expressed in our previous report.

In addition, results of the Company may not be indicative of those of a stand-alone entity, as the Company is a member of a controlled group of affiliated companies.

/s/ DELOITTE & TOUCHE LLP

Certified Public Accountants

Princeton, New Jersey

April 2, 2014

(October 27, 2014 as to Note 1 related to the restatements and November 7, 2014 as to Note 14)

 

1

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Exeter Reassurance Company, Ltd.

Balance Sheets

December 31, 2013 and 2012

(In thousands, except share and per share data)

 

		2013				2012
Assets
Investments:
Fixed maturity securities available-for-sale, at estimated fair value (amortized cost: $1,311,922 and $1,719,913, respectively)		$	1,321,081			$	1,785,619
Short-term investments, at estimated fair value			2,781,282				4,307,652
Derivative assets			2,375,499				4,652,428
Funds withheld at interest			2,694,267				2,436,815
Total investments			9,172,129				13,182,514
Cash and cash equivalents			629,616				905,519
Accrued investment income			94,238				93,501
Premiums, reinsurance and other receivables			645,814				775,433
Deferred policy acquisition costs			159,820				136,661
Current income tax recoverable			196,592				261,720
Deferred income tax recoverable			1,529,464				2,267,071
Total assets		$	12,427,673			$	17,622,419
Liabilities and Stockholder’s Equity
Liabilities
Future policy benefits		$	2,747,421			$	2,735,580
Policyholder account balances			2,488,945				8,831,285
Other policy-related balances			2,170,145				1,896,818
Policyholder dividends payable			16,256				17,438
Debt — affiliated			575,118				75,118
Derivative liabilities			2,648,454				1,665,997
Other liabilities			551,170				1,726,141
Total liabilities			11,197,509				16,948,377
Contingencies and Commitments (Note 12)
Stockholder’s Equity
Preferred stock, par value $.01 per share; 250,000 shares authorized, 200,000 issued and outstanding at December 31, 2013; par value $1.00 per share; 200,000 shares authorized, issued and outstanding at December 31, 2012; $2,000,000 aggregate liquidation preference at December 31, 2013 and 2012			2				200
Common stock, par value $.01 per share; 13,875,000 shares authorized, 13,466,000 issued and outstanding at December 31, 2013; par value $1.00 per share; 14,125,000 shares authorized, 13,466,000 shares issued and outstanding at December 31, 2012			135				13,466
Additional paid-in capital			4,125,653				4,085,299
Retained earnings (accumulated deficit)			(2,964,638)				(3,504,200)
Accumulated other comprehensive income (loss)			69,012				79,277
Total stockholder’s equity			1,230,164				674,042
Total liabilities and stockholder’s equity		$	12,427,673			$	17,622,419

See accompanying notes to the financial statements.

 

2

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Exeter Reassurance Company, Ltd.

Statements of Operations

For the Years Ended December 31, 2013, 2012 and 2011

(In thousands)

 

		2013				2012				2011
Revenues
Premiums		$	59,372			$	949,827			$	71,518
Universal life and investment-type product policy fees			586,571				548,425				432,722
Net investment income			35,423				20,695				17,238
Net investment gains (losses)			(56,581)				41,793				(1,086)
Net derivative gains (losses)			1,935,248				(3,676,589)				230,434
Other revenues			1,395				22,916				43,740
Total revenues			2,561,428				(2,092,933)				794,566
Expenses
Policyholder benefits and claims			1,379,886				1,811,746				309,339
Interest credited to policyholder account balances			17,399				16,598				15,831
Policyholder dividends			26,675				30,279				30,722
Other expenses			101,207				206,841				169,883
Total expenses			1,525,167				2,065,464				525,775
Income (loss) before provision for income tax			1,036,261				(4,158,397)				268,791
Provision for income tax expense (benefit)			364,215				(1,455,499)				94,077
Net income (loss)		$	672,046			$	(2,702,898)			$	174,714

 

 

See accompanying notes to the financial statements.

 

3

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Exeter Reassurance Company, Ltd.

Statements of Comprehensive Income (Loss)

For the Years Ended December 31, 2013, 2012 and 2011

(In thousands)

 

		2013				2012				2011
Net income (loss)		$	672,046			$	(2,702,898)			$	174,714
Other comprehensive income (loss):
Unrealized investment gains (losses), net of related offsets			(56,634)				25,017				35,549
Foreign currency translation adjustments			26,548				13,028				(15,751)
Other comprehensive income (loss), before income tax			(30,086)				38,045				19,798
Income tax (expense) benefit related to items of other comprehensive income (loss)			19,821				(8,756)				(12,442)
Other comprehensive income (loss), net of income tax			(10,265)				29,289				7,356
Comprehensive income (loss)		$	661,781			$	(2,673,609)			$	182,070

 

 

 

See accompanying notes to the financial statements.

 

4

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Exeter Reassurance Company, Ltd.

Statements of Stockholder’s Equity

For the Years Ended December 31, 2013, 2012 and 2011

(In thousands)

 

																		Accumulated Other Comprehensive Income (Loss)
		Preferred   Stock				Common   Stock				Additional   Paid-in Capital				Retained   Earnings (Accumulated Deficit)				Net Unrealized Investment   Gains (Losses)				Foreign Currency Translation   Adjustments				Total   Stockholder’s Equity
Balance at December 31, 2010		$	—			$	13,466			$	548,218			$	(976,016)			$	3,341			$	39,291			$	(371,700)
Capital contribution from MetLife, Inc. (Note 9)											703,860																703,860
Comprehensive income (loss):
Net income (loss)															174,714												174,714
Other comprehensive income (loss), net of income tax																			23,107				(15,751)				7,356
Balance at December 31, 2011			—				13,466				1,252,078				(801,302)				26,448				23,540				514,230
Capital contribution from MetLife, Inc. (Note 9)											833,421																833,421
Non-cumulative perpetual preferred stock issuance — newly issued shares (Note 9)			200								1,999,800																2,000,000
Comprehensive income (loss):
Net income (loss)															(2,702,898)												(2,702,898)
Other comprehensive income (loss), net of income tax																			16,261				13,028				29,289
Balance at December 31, 2012			200				13,466				4,085,299				(3,504,200)				42,709				36,568				674,042
Capital contribution from MetLife, Inc. (Note 9)											26,825																26,825
Change in preferred and common stock par value (Note 9)			(198)				(13,331)				13,529																—
Dividends on perpetual preferred stock															(132,484)												(132,484)
Comprehensive income (loss):
Net income (loss)															672,046												672,046
Other comprehensive income (loss), net of income tax																			(36,813)				26,548				(10,265)
Balance at December 31, 2013		$	2			$	135			$	4,125,653			$	(2,964,638)			$	5,896			$	63,116			$	1,230,164

 

See accompanying notes to the financial statements.

 

5

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Exeter Reassurance Company, Ltd.

Statements of Cash Flows

For the Years Ended December 31, 2013, 2012 and 2011

(In thousands)

 

		2013				2012				2011
		As Restated See Note 1				As Restated See Note 1				As Restated See Note 1
Cash flows from operating activities
Net income (loss)		$	672,046			$	(2,702,898)			$	174,714
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Amortization of premiums and accretion of discounts associated with investments, net			20,823				5,956				(62)
(Gains) losses on investments, net			56,581				(41,793)				1,086
(Gains) losses on derivatives, net			(204,378)				4,802,934				469,752
Universal life and investment-type product policy fees			11,088				(556)				(3,781)
Change in accrued investment income			28				(77,901)				(6,706)
Change in premiums, reinsurance and other receivables			112,292				155,762				358,863
Change in deferred policy acquisition costs, net			(23,159)				41,444				28,571
Change in income tax recoverable (payable)			670,461				(1,675,874)				(19,555)
Change in insurance-related liabilities and policy-related balances			272,897				530,400				256,552
Change in other liabilities			101,876				(96,015)				(355,242)
Other, net			31,681				24,977				29,195
Net cash provided by (used in) operating activities			1,722,236				966,436				933,387
Cash flows from investing activities
Sales, maturities and repayments of:
Fixed maturity securities			813,413				1,310,619				604,979
Equity securities			128				7,212				2,880
Purchases of fixed maturity securities			(415,825)				(1,486,466)				(754,191)
Cash received in connection with freestanding derivatives			146,845				415,944				876,691
Cash paid in connection with freestanding derivatives			(2,882,508)				(1,790,917)				(2,032,925)
Net change in short-term investments			1,525,163				1,497,830				(4,538,307)
Net change in funds withheld at interest			(336,545)				(146,444)				(98,811)
Other, net			272,335				24,279				158,928
Net cash provided by (used in) investing activities			(876,994)				(167,943)				(5,780,756)
Cash flows from financing activities
Policyholder account balances:
Deposits			—				212				416
Withdrawals			—				(10,330)				(2,644)
Change in payables for derivative collateral			(1,276,847)				(1,627,743)				2,563,812
Long-term debt issuances — affiliated			500,000				—				1,000,000
Capital contribution from MetLife, Inc.			—				800,000				673,000
Dividend on preferred stock			(132,484)				—				—
Other, net			(166,050)				(122,628)				80,761
Net cash provided by (used in) financing activities			(1,075,381)				(960,489)				4,315,345
Effect of change in foreign currency exchange rates on cash and cash equivalents balances			(45,764)				(23,555)				7,065
Change in cash and cash equivalents			(275,903)				(185,551)				(524,959)
Cash and cash equivalents, beginning of year			905,519				1,091,070				1,616,029
Cash and cash equivalents, end of year		$	629,616			$	905,519			$	1,091,070
Supplemental disclosures of cash flow information:
Net cash paid for:
Interest		$	5,107			$	134,691			$	69,232
Income tax		$	304,518			$	222,025			$	115,497
Non-cash transactions:
Purchase of fixed maturity securities associated with business transfer		$	—			$	760,628			$	—
Purchase of short-term investments associated with business transfer		$	—			$	72,453			$	—
Capital contribution from MetLife, Inc.		$	26,825			$	33,421			$	30,860
Issuance of non-cumulative perpetual preferred shares		$	—			$	2,000,000			$	—
Assignment of senior notes to MetLife, Inc.		$	—			$	(2,000,000)			$	—

See accompanying notes to the financial statements.

 

6

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements

 

1.  Business, Basis of Presentation and Summary of Significant Accounting Policies

Business

Exeter Reassurance Company, Ltd. (the “Company” or “Exeter”) is a wholly-owned stock life insurance subsidiary of MetLife, Inc. (the “Holding Company”).

In 2011, the Company was redomesticated to the Cayman Islands. The Company was licensed as an Unrestricted Class B Insurer under the Insurance Law of the Cayman Islands (the “Law”).

Effective October 1, 2013, the Company redomesticated to the state of Delaware (“Delaware”). The Company is licensed as a Delaware pure captive insurance company under the Delaware Captive Insurance Law (“Delaware Law”). The Company engages in traditional and financial reinsurance of life insurance and annuity policies, primarily with affiliates.

In the second quarter of 2013, the Holding Company announced its plans to merge three U.S.-based life insurance companies and an offshore reinsurance subsidiary to create one larger U.S.-based and U.S.-regulated life insurance company (the “Mergers”). The companies to be merged consist of MetLife Insurance Company of Connecticut (“MICC”), MetLife Investors USA Insurance Company (“MLI-USA”) and MetLife Investors Insurance Company (“MLIIC”), each a U.S. insurance company that issues variable annuity products in addition to other products, and Exeter. MICC, which is expected to be renamed and domiciled in Delaware, will be the surviving entity. The Mergers are expected to occur in the fourth quarter of 2014, subject to regulatory approvals.

Basis of Presentation

The Company has previously prepared, and filed, financial statements that comply with the filing requirements of the Cayman Islands Monetary Authority (“CIMA”). The financial statements as of and for the year ended December 31, 2012 presented insurance liabilities in the balance sheet in accordance with practices prescribed or permitted by CIMA, which presentation differs from the presentation requirements under generally accepted accounting principles. The presentation of insurance liabilities in these financial statements has been revised to present such amounts in accordance with accounting principles generally accepted in the United States.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to adopt accounting policies and make estimates and assumptions that affect amounts reported in the financial statements. In applying these policies and estimates, management makes subjective and complex judgments that frequently require assumptions about matters that are inherently uncertain. Many of these policies, estimates and related judgments are common in the insurance and financial services industries; others are specific to the Company’s business and operations. Actual results could differ from estimates.

Since the Company is a member of a controlled group of affiliated companies, its results may not be indicative of those of a stand-alone entity.

 

7

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

1.  Business, Basis of Presentation and Summary of Significant Accounting Policies (continued)

 

Restatements

The Company identified the following errors relating to the 2013, 2012 and 2011 statements of cash flows:

 

•

Net cash provided by operating activities was overstated and net cash used in investing activities was understated in 2012, as a result of errors relating to the non-cash component of the consideration received for the transfer of business to the Company from an affiliate.

 

•

The effects of changes in foreign currency exchange rates on cash and cash equivalents were incorrectly reported in 2013, 2012 and 2011, resulting in offsetting impacts on net cash provided by operating activities and net cash used in investing activities.

 

•

Certain transactions relating to fees on embedded derivatives were incorrectly reported in the cash flow statement in 2013, 2012 and 2011 including: (a) cash transactions incorrectly reported in (gains) losses on derivatives, net, resulting in impacts to both net cash provided by operating activities and net cash used in investing activities: and (b) non-cash transactions incorrectly reported in cash flows from investing activities in other, net, resulting in impacts to net cash used in investing activities.

 

•

Non-cash transactions relating to funds withheld at interest were incorrectly reported in net cash used in investing activities in 2013, 2012 and 2011.

The combined errors resulted in an overstatement/(understatement) of (i) net cash provided by operating activities of $93,333 thousand, $991,168 thousand and ($76,861) thousand in 2013, 2012 and 2011, respectively; (ii) net cash used in investing activities of ($139,097) thousand, ($1,014,723) thousand and $83,926 thousand in 2013, 2012 and 2011, respectively; and (iii) the effect of change in foreign currency exchange rates on cash and cash equivalents of $45,764 thousand, $23,555 thousand and ($7,065) thousand in 2013, 2012 and 2011, respectively.

The impact of the 2013, 2012 and 2011 restatements is shown in the tables below:

 

		For the Year Ended December 31, 2013
		As Previously Reported				Correction of Errors				As Adjusted
		(In thousands)
Cash flows from operating activities
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
(Gains) losses on derivatives, net		$	(1,095,691)			$	891,313			$	(204,378)
Change in accrued investment income		$	(737)			$	765			$	28
Change in premiums, reinsurance and other receivables		$	130,149			$	(17,857)			$	112,292
Change in income tax recoverable (payable)		$	822,557			$	(152,096)			$	670,461
Change in other assets		$	26,549			$	(26,549)			$	—
Change in insurance-related liabilities and policy-related balances		$	979,232			$	(706,335)			$	272,897
Change in other liabilities		$	101,875			$	1			$	101,876
Other, net		$	114,256			$	(82,575)			$	31,681
Net cash provided by (used in) operating activities		$	1,815,569			$	(93,333)			$	1,722,236
Cash flows from investing activities
Sales, maturities and repayments of:
Fixed maturity securities		$	803,256			$	10,157			$	813,413
Net change in short-term investments		$	1,528,444			$	(3,281)			$	1,525,163
Net change in funds withheld at interest		$	(257,452)			$	(79,093)			$	(336,545)
Other, net		$	61,021			$	211,314			$	272,335
Net cash provided by (used in) investing activities		$	(1,016,091)			$	139,097			$	(876,994)
Effect of change in foreign currency exchange rates on cash and cash equivalents balances		$	—			$	(45,764)			$	(45,764)

 

8

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

1.  Business, Basis of Presentation and Summary of Significant Accounting Policies (continued)

 

		For the Year Ended December 31, 2012
		As Previously Reported				Correction of Errors				As Adjusted
		(In thousands)
Cash flows from operating activities
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
(Gains) losses on derivatives, net		$	4,156,565			$	646,369			$	4,802,934
Change in premiums, reinsurance and other receivables		$	149,271			$	6,491			$	155,762
Change in income tax recoverable (payable)		$	(1,617,392)			$	(58,482)			$	(1,675,874)
Change in other assets		$	13,027			$	(13,027)			$	—
Change in insurance-related liabilities and policy-related balances		$	1,932,786			$	(1,402,386)			$	530,400
Change in other liabilities		$	(31,859)			$	(64,156)			$	(96,015)
Other, net		$	130,954			$	(105,977)			$	24,977
Net cash provided by (used in) operating activities		$	1,957,604			$	(991,168)			$	966,436
Cash flows from investing activities
Purchases of fixed maturity securities		$	(2,264,346)			$	777,880			$	(1,486,466)
Net change in short-term investments		$	1,423,762			$	74,068			$	1,497,830
Net change in funds withheld at interest		$	(218,801)			$	72,357			$	(146,444)
Other, net		$	(66,139)			$	90,418			$	24,279
Net cash provided by (used in) investing activities		$	(1,182,666)			$	1,014,723			$	(167,943)
Effect of change in foreign currency exchange rates on cash and cash equivalents balances		$	—			$	(23,555)			$	(23,555)

 

		For the Year Ended December 31, 2011
		As Previously Reported				Correction of Errors				As Adjusted
		(In thousands)
Cash flows from operating activities
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
(Gains) losses on derivatives, net		$	(153,956)			$	623,708			$	469,752
Change in accrued investment income		$	(8,031)			$	1,325			$	(6,706)
Change in premiums, reinsurance and other receivables		$	349,645			$	9,218			$	358,863
Change in income tax recoverable (payable)		$	(50,030)			$	30,475			$	(19,555)
Change in other assets		$	(15,750)			$	15,750			$	—
Change in insurance-related liabilities and policy-related balances		$	757,824			$	(501,272)			$	256,552
Change in other liabilities		$	(354,977)			$	(265)			$	(355,242)
Other, net		$	131,273			$	(102,078)			$	29,195
Net cash provided by (used in) operating activities		$	856,526			$	76,861			$	933,387
Cash flows from investing activities
Net change in funds withheld at interest		$	(91,382)			$	(7,429)			$	(98,811)
Other, net		$	235,425			$	(76,497)				158,928
Net cash provided by (used in) investing activities		$	(5,696,830)			$	(83,926)				(5,780,756)
Effect of change in foreign currency exchange rates on cash and cash equivalents balances		$	—			$	7,065			$	7,065

 

9

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

1.  Business, Basis of Presentation and Summary of Significant Accounting Policies (continued)

 

Summary of Significant Accounting Policies

The following are the Company’s significant accounting policies with references to notes providing additional information on such policies and critical accounting estimates relating to such policies.

 

Accounting Policy			Note
Deferred Policy Acquisition Costs			2
Reserves			3
Reinsurance			4
Investments			5
Derivatives			6
Fair Value			7
Income Tax			11
Litigation Contingencies			12

Future Policyholder Benefits, Policyholder Account Balances and Other Policy-Related Balances

The Company establishes liabilities for insurance policies assumed by the Company. Generally, amounts are payable over an extended period of time and related liabilities are calculated as the present value of future expected benefits to be paid reduced by the present value of future expected premiums. Such liabilities are established based on methods and underlying assumptions in accordance with GAAP and applicable actuarial standards. Principal assumptions used in the establishment of liabilities for future policy benefits are mortality, morbidity, policy lapse, renewal, retirement, investment returns, inflation, expenses and other contingent events as appropriate to the respective product type. For long duration insurance contracts, assumptions such as mortality and interest rates are “locked in” upon the issuance of new business. However, significant adverse changes in experience on such contracts may require the establishment of premium deficiency reserves. Such reserves are determined based on the then current assumptions and do not include a provision for adverse deviation.

Liabilities for assumed universal secondary guarantees are determined by estimating the expected value of death benefits payable when the account balance is projected to be zero and recognizing those benefits ratably over the accumulation period based on total expected assessments. The assumptions used in estimating the secondary liabilities are consistent with those used for amortizing deferred policy acquisition costs (“DAC”), and are thus subject to the same variability and risk as further discussed herein. The assumptions of investment performance and volatility for variable products are consistent with historical experience of appropriate underlying equity indices, such as the Standard & Poor’s Ratings Services (“S&P”) 500 Index. The benefits used in calculating the liabilities assumed are based on the average benefits payable over a range of scenarios.

The assumed unearned revenue liability included in other policy-related balances relates to universal life-type products and represents policy charges for services to be provided in future periods. The charges are deferred as unearned revenue and amortized using the product’s estimated gross profits, similar to DAC as discussed further herein. Such amortization is recorded in universal life and investment-type product policy fees.

 

10

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

1.  Business, Basis of Presentation and Summary of Significant Accounting Policies (continued)

 

The Company regularly reviews its estimates of liabilities for future policy benefits and compares them with its actual experience. Differences result in changes to the liability balances with related charges or credits to benefit expenses in the period in which the changes occur.

The Company assumed and ceded guaranteed minimum benefits associated with certain variable annuity product risks that provide the policyholder a minimum return based on their initial deposit (i.e., the benefit base) less withdrawals. These guarantees are accounted for as insurance liabilities or as embedded derivatives depending on how and when the benefit is paid. Specifically, a guarantee is accounted for as an embedded derivative if a guarantee is paid without requiring (i) the occurrence of specific insurable event, or (ii) the policyholder to annuitize. Alternatively, a guarantee is accounted for as an insurance liability if the guarantee is paid only upon either (i) the occurrence of a specific insurable event, or (ii) annuitization. In certain cases, a guarantee may have elements of both an insurance liability and an embedded derivative and in such cases the guarantee is split and accounted for under both models.

Guarantees assumed are accounted for as insurance liabilities in future policy benefits include guaranteed minimum death benefits (“GMDB”), the portion of guaranteed minimum income benefits (“GMIB”) that require annuitization, and the life-contingent portion of guaranteed minimum withdrawal benefits (“GMWB”).

Guarantees assumed are accounted for as embedded derivatives in policyholder account balances include the non life-contingent portion of GMWB, guaranteed minimum accumulation benefits (“GMAB”) and the portion of GMIB that do not require annuitization. At inception, the Company attributes to the embedded derivative a portion of the projected future guarantee fees to be collected from the policyholder equal to the present value of projected future guaranteed benefits. Any additional fees represent “excess” fees and are reported in universal life and investment-type product policy fees.

Other policy-related balances include policy and contract claims and policyholder dividends due and unpaid.

The liability for policy and contract claims generally relates to incurred but not reported death claims, as well as claims which have been reported but not yet settled.

Dividend Liability

The terminal dividend liability for assumed participating traditional life insurance policies is equal to the liability for dividends paid to policyholders upon termination and after satisfying minimum period in-force requirements.

Recognition of Insurance Revenue and Related Benefits

Premiums related to assumed traditional life and variable annuity business are recognized as revenues when due. Policyholder benefits and expenses are provided against such revenues to recognize profits over the estimated lives of the policies. When premiums are due over a significantly shorter period than the period over which benefits are provided, any excess profit is deferred and recognized into operations in a constant relationship to the business assumed.

 

11

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

1.  Business, Basis of Presentation and Summary of Significant Accounting Policies (continued)

 

Deferred Policy Acquisition Costs

The Company reimburses the direct writer of the reinsured agreements for significant costs in connection with acquiring new and renewal reinsurance business. Costs that are related directly to the successful acquisition or renewal of reinsurance agreements are capitalized as DAC. Such costs primarily include:

 

•

incremental direct costs of contract acquisition, such as commissions;

•

other essential direct costs that would not have been incurred had a policy not been acquired or renewed.

All other acquisition-related costs, as well as all indirect costs, are expensed as incurred.

DAC is amortized as follows:

 

Products reinsured:		In proportion to the following over estimated lives of the reinsurance agreements:
•  Participating, dividend-paying traditional contracts		Actual and expected future gross margins.
•  Variable universal life contracts •  Variable deferred annuity contracts		Actual and expected future gross profits.

See Note 2 for additional information on DAC amortization.

The recovery of DAC is dependent upon the future profitability of the related business.

Reinsurance Agreements

For each of its reinsurance agreements, the Company determines whether the agreement provides indemnification against loss or liability relating to insurance risk in accordance with applicable accounting standards. Cessions under reinsurance agreements do not discharge the Company’s obligations as a reinsurer. The Company reviews all contractual features, particularly those that may limit the amount of insurance risk to which the Company is subject or features that delay the timely reimbursement of claims.

For reinsurance of existing in-force blocks of long-duration contracts that transfer significant insurance risk, the difference, if any, between the amounts paid (received), and the liabilities ceded (assumed) related to the underlying contracts is considered the net cost of reinsurance at the inception of the reinsurance agreement. The net cost of reinsurance is recorded as an adjustment to DAC when there is a gain at inception on the ceding entity and to other liabilities when there is a loss at inception. The net cost of reinsurance is recognized as a component of other expenses when there is a gain at inception and as policyholder benefits and claims when there is a loss and is subsequently amortized on a basis consistent with the methodology used for amortizing DAC related to the underlying reinsured contracts. Subsequent amounts paid (received) on the reinsurance of in-force blocks, as well as amounts paid (received) related to new business, are recorded as ceded (assumed) premiums and ceded (assumed) future policy benefit liabilities are established.

Amounts currently recoverable under reinsurance agreements are included in premiums, reinsurance and other receivables and amounts currently payable are included in other liabilities and other policy-related balances.

 

12

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

1.  Business, Basis of Presentation and Summary of Significant Accounting Policies (continued)

 

Assets and liabilities relating to reinsurance agreements with the same reinsurer may be recorded net on the balance sheet, if a right of offset exists within the reinsurance agreement. In the event that reinsurers do not meet their obligations to the Company under the terms of the reinsurance agreements, reinsurance recoverable balances could become uncollectible. In such instances, reinsurance recoverable balances are stated net of allowances for uncollectible reinsurance.

Premiums, fees and policyholder benefits and claims include amounts assumed under reinsurance agreements and are net of reinsurance ceded. Amounts received from reinsurers for policy administration are reported in other revenues. Certain assumed GMWB, GMAB and GMIB are accounted for as embedded derivatives with changes in estimated fair value reported in net derivative gains (losses).

If the Company determines that a reinsurance agreement does not expose the reinsurer to a reasonable possibility of a significant loss from insurance risk, the Company records the agreement using the deposit method of accounting. Deposits received are included in other liabilities and deposits made are included within premiums, reinsurance and other receivables. As amounts are paid or received, consistent with the underlying contracts, the deposit assets or liabilities are adjusted. Interest on such deposits is recorded as other revenues or other expenses, as appropriate. Periodically, the Company evaluates the adequacy of the expected payments or recoveries and adjusts the deposit asset or liability through other revenues or other expenses, as appropriate.

Investments

Net Investment Income

Income on investments is reported within net investment income, unless otherwise stated herein.

Fixed Maturity Securities

The Company’s fixed maturity securities are classified as available-for-sale (“AFS”) and are reported at their estimated fair value. Unrealized investment gains and losses on these securities are recorded as a separate component of other comprehensive income (loss) (“OCI”), net of policyholder-related amounts and deferred income taxes. All security transactions are recorded on a trade date basis. Investment gains and losses on sales are determined on a specific identification basis.

Interest income on fixed maturity securities is recognized when earned using an effective yield method giving effect to amortization of premiums and accretion of discounts. Prepayment fees are recognized when earned.

The Company periodically evaluates fixed maturity securities for impairment. The assessment of whether impairments have occurred is based on management’s case-by-case evaluation of the underlying reasons for the decline in estimated fair value and an analysis of the gross unrealized losses by severity and/or age. The analysis of gross unrealized losses is described further in Note 5 “—Evaluation of AFS Securities for OTTI and Evaluating Temporarily Impaired AFS Securities.”

For fixed maturity securities in an unrealized loss position, an other-than-temporary impairment (“OTTI”) is recognized in earnings when it is anticipated that the amortized cost will not be recovered. When either: (i) the Company has the intent to sell the security; or (ii) it is more likely than not that the Company will be required

 

13

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

1.  Business, Basis of Presentation and Summary of Significant Accounting Policies (continued)

 

to sell the security before recovery, the OTTI recognized in earnings is the entire difference between the security’s amortized cost and estimated fair value. If neither of these conditions exist, the difference between the amortized cost of the security and the present value of projected future cash flows expected to be collected is recognized as an OTTI in earnings (“credit loss”). If the estimated fair value is less than the present value of projected future cash flows expected to be collected, this portion of OTTI related to other-than-credit factors (“noncredit loss”) is recorded in OCI. Adjustments are not made for subsequent recoveries in value.

Short-term Investments

Short-term investments include securities and other investments with remaining maturities of one year or less, but greater than three months, at the time of purchase and are stated at the estimated fair value or amortized cost, which approximates estimated fair value.

Derivative Assets

Derivative assets consist principally of freestanding derivatives with positive estimated fair values and are described in “ — Derivatives” below.

Funds Withheld at Interest

Funds withheld at interest represent amounts contractually withheld by ceding companies in accordance with reinsurance agreements. The Company records a funds withheld asset rather than the underlying investments. The Company recognizes interest on funds withheld at rates defined by the terms of the agreement which may be contractually specified or directly related to the underlying investments.

Derivatives

Freestanding Derivatives

Freestanding derivatives are carried in the Company’s balance sheets either as assets within derivative assets or as liabilities within derivative liabilities at estimated fair value. The Company does not offset the fair value amounts recognized for derivatives executed with the same counterparty absent a master netting agreement.

Accruals on derivatives are generally recorded in accrued investment income or within derivative liabilities. However, accruals that are not scheduled to settle within one year are included with the derivatives carrying value in derivative assets or derivative liabilities.

The Company’s derivatives are not designated as qualifying for hedge accounting. Changes in the estimated fair value of derivatives are generally reported in net derivative gains (losses) except for those in policyholder benefits and claims for economic hedges of variable annuity guarantees included in future policy benefits in the balance sheets. The fluctuations in estimated fair value of derivatives can result in significant volatility in net income.

Embedded Derivatives

The Company assumes variable annuity guarantees, modified coinsurance contracts and equity indexed deferred annuities that contain embedded derivatives. Additionally, the Company has retroceded certain of

 

14

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

1.  Business, Basis of Presentation and Summary of Significant Accounting Policies (continued)

 

these variable annuity guarantees to unaffiliated reinsurance counterparties that also contain embedded derivatives. The Company assesses each identified embedded derivative to determine whether it is required to be bifurcated. The embedded derivative is bifurcated from the host contract and accounted for as a freestanding derivative if:

 

•

the combined instrument is not accounted for in its entirety at fair value with changes in fair value recorded in earnings;

•

the terms of the embedded derivative are not clearly and closely related to the economic characteristics of the host contract; and

•

a separate instrument with the same terms as the embedded derivative would qualify as a derivative instrument.

Such embedded derivatives are carried in the balance sheets at estimated fair value with the host contract and changes in their estimated fair value are generally reported in net derivative gains (losses) for assumed reinsurance or in policyholder benefits and claims for ceded reinsurance. At inception, the Company attributes to the embedded derivative a portion of the projected future guarantee fees to be collected from the policyholder equal to the present value of projected future guaranteed benefits. Any additional fees represent “excess” fees and are reported in universal life and investment-type product policy fees.

Fair Value

Certain assets and liabilities are measured at estimated fair value in the Company’s balance sheets. In addition, the notes to these financial statements include further disclosures of estimated fair values. The Company defines fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. In most cases, the exit price and the transaction (or entry) price will be the same at initial recognition.

Subsequent to initial recognition, fair values are based on unadjusted quoted prices for identical assets or liabilities in active markets that are readily and regularly obtainable. When such quoted prices are not available, fair values are based on quoted prices in markets that are not active, quoted prices for similar but not identical assets or liabilities, or other observable inputs. If these inputs are not available, or observable inputs are not determinative, unobservable inputs and/or adjustments to observable inputs requiring management judgment are used to determine the fair value of assets and liabilities.

Income Tax

The Company joins with the Holding Company and its includable life insurance and non-life insurance subsidiaries in filing a consolidated U.S. federal income tax return in accordance with the provision of the Internal Revenue Code of 1986 as amended (the “Code”). Current taxes (and the benefits of tax attributes such as losses) are allocated to the Holding Company under the consolidated tax return regulations and a tax sharing agreement. Under the consolidated tax return regulations, the Holding Company has elected the “percentage method’ (and 100 percent under such method) of reimbursing companies for tax attributes such as losses. As a result, one hundred percent of tax attributes such as losses are reimbursed by the Holding Company to the extent that consolidated federal income tax of the consolidated federal tax return group is reduced in a year by tax attributes such as losses. Profitable subsidiaries pay to the Holding company each year the federal income tax

 

15

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

1.  Business, Basis of Presentation and Summary of Significant Accounting Policies (continued)

 

which such profitable subsidiary would have paid that year based upon that year’s taxable income. The Holding Company has current or prior deductions and credits (including by not limited to losses) which reduce the consolidated tax liability of the consolidated federal tax return group, the deductions and credits are characterized as realized (or realizable) by the Holding Company when those tax attributes are realized (or realizable) by the consolidated federal tax return group, even if the Holding Company would not have realized the attributes on a stand-alone basis under a “wait and see” method.

Deferred income tax assets and liabilities resulting from temporary differences between the financial reporting and tax basis of assets and liabilities are measured at the balance sheet date using enacted tax rates expected to apply to taxable income in the years the temporary differences are expected to reverse.

The realization of deferred income tax assets depends upon the existence of sufficient taxable income within the carryback or carryforward periods under the tax law in the applicable tax jurisdiction. Valuation allowances are established when management determines, based on available information, that it is more likely than not that deferred income tax assets will not be realized. Factors in management’s determination include the performance of the business and its ability to generate capital gains. Significant judgment is required in determining whether valuation allowances should be established, as well as the amount of such allowances. When making such determination, consideration is given to, among other things, the following:

 

•

future taxable income exclusive of reversing temporary differences and carryforwards;

•

future reversals of existing taxable temporary differences;

•

taxable income in prior carryback years; and

•

tax planning strategies.

The Company may be required to change its provision for income taxes in certain circumstances. Examples of such circumstances include when estimates used in determining valuation allowances on deferred tax assets significantly change or when receipt of new information indicates the need for adjustment in valuation allowances. Additionally, future events, such as changes in tax laws, tax regulations, or interpretations of such laws or regulations, could have an impact on the provision for income tax and the effective tax rate. Any such changes could significantly affect the amounts reported in the financial statements in the year these changes occur.

The Company determines whether it is more likely than not that a tax position will be sustained upon examination by the appropriate taxing authorities before any part of the benefit can be recorded in the financial statements. A tax position is measured at the largest amount of benefit that is greater than 50% likely of being realized upon settlement. Unrecognized tax benefits due to tax uncertainties that do not meet the threshold are included in other liabilities and are charged to earnings in the period that such determination is made.

The Company classifies interest recognized as other expense and penalties recognized as a component of income tax expense.

Other Accounting Policies

Cash and Cash Equivalents

The Company considers all highly liquid securities and other investments purchased with an original or remaining maturity of three months or less at the date of purchase to be cash equivalents. Cash equivalents are stated at amortized cost, which approximates estimated fair value.

 

16

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

1.  Business, Basis of Presentation and Summary of Significant Accounting Policies (continued)

 

Other Revenues

Other revenues consist of funds withheld investment credit fees associated with financial reinsurance.

Policyholder Dividends

Pursuant to the terms of certain reinsurance agreements, the Company participates in the policyholder dividend scale of the ceding company. Policyholder dividends are approved annually by the ceding company’s board of directors. The aggregate amount of policyholder dividends is related to actual interest, mortality, morbidity and expense experience for the year, as well as the judgment of the ceding company’s management as to the appropriate level of statutory surplus to be retained by the ceding company.

Foreign Currency

Balance sheet accounts for reinsurance agreements that are settled in foreign currencies are translated at the exchange rate in effect at each year end and income and expense accounts are translated at the average exchange rates during the year. Translation adjustments are charged or credited directly to foreign currency translation adjustments, included in accumulated other comprehensive income or loss, net of applicable taxes. Intercompany receivables (payables) that are held in foreign currencies are translated at the exchange rate in effect at each year end and translation adjustments are charged directly to net investment gains (losses) in the period in which they occur.

Adoption of New Accounting Pronouncements

Effective January 1, 2013, the Company adopted new guidance regarding comprehensive income that requires an entity to provide information about the amounts reclassified out of Accumulated Other Comprehensive Income (“AOCI”) by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of AOCI by the respective line items of net income but only if the amount reclassified is required under GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under GAAP that provide additional detail about those amounts. The adoption was prospectively applied and resulted in additional disclosures in Note 9.

Effective January 1, 2013, the Company adopted new guidance regarding balance sheet offsetting disclosures which requires an entity to disclose information about offsetting and related arrangements for derivatives, including bifurcated embedded derivatives, repurchase and reverse repurchase agreements, and securities borrowing and lending transactions, to enable users of its financial statements to understand the effects of those arrangements on its financial position. Entities are required to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement. The adoption was retrospectively applied and resulted in additional disclosures related to derivatives in Note 6.

On January 1, 2012, the Company adopted new guidance regarding accounting for DAC, which was retrospectively applied. The guidance specifies that only costs related directly to successful acquisition of new or renewal contracts can be capitalized as DAC; all other acquisition-related costs must be expensed as incurred.

 

17

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

1.  Business, Basis of Presentation and Summary of Significant Accounting Policies (continued)

 

Under the new guidance, advertising costs may only be included in DAC if the capitalization criteria in the direct-response advertising guidance in Subtopic 340-20, Other Assets and Deferred Costs—Capitalized Advertising Costs, are met. As a result, certain direct marketing, sales manager compensation and administrative costs previously capitalized by the Company will no longer be deferred.

On January 1, 2012, the Company adopted new guidance regarding comprehensive income, which was retrospectively applied, that provides companies with the option to present the total of comprehensive income, components of net income, and the components of OCI either in a single continuous statement of comprehensive income or in two separate but consecutive statements in annual financial statements. The standard eliminates the option to present components of OCI as part of the statement of changes in stockholders’ equity. The Company adopted the two-statement approach for annual financial statements.

Effective January 1, 2012, the Company adopted new guidance regarding fair value measurements that establishes common requirements for measuring fair value and for disclosing information about fair value measurements in accordance with GAAP and International Financial Reporting Standards. Some of the amendments clarify the Financial Accounting Standards Board’s (“FASB”) intent on the application of existing fair value measurement requirements. Other amendments change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements. The adoption did not have a material impact on the Company’s financial statements other than the expanded disclosures in Note 7.

Future Adoption of New Accounting Pronouncements

In March 2013, the FASB issued new guidance regarding foreign currency (Accounting Standards Update (“ASU”) 2013-05, Foreign Currency Matters (Topic 830): Parent’s Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity), effective prospectively for fiscal years and interim reporting periods within those years beginning after December 15, 2013. The amendments require an entity that ceases to have a controlling financial interest in a subsidiary or group of assets within a foreign entity to apply the guidance in Subtopic 830-30, Foreign Currency Matters — Translation of Financial Statements, to release any related cumulative translation adjustment into net income. Accordingly, the cumulative translation adjustment should be released into net income only if the sale or transfer results in the complete or substantially complete liquidation of the foreign entity in which the subsidiary or group of assets had resided. For an equity method investment that is a foreign entity, the partial sale guidance in section 830-30-40, Derecognition, still applies. As such, a pro rata portion of the cumulative translation adjustment should be released into net income upon a partial sale of such an equity method investment. The Company does not expect the adoption of this new guidance to have a material impact on its financial statements.

In February 2013, the FASB issued new guidance regarding liabilities (ASU 2013-04, Liabilities (Topic 405): Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation Is Fixed at the Reporting Date), effective retrospectively for fiscal years beginning after December 15, 2013 and interim periods within those years. The amendments require an entity to measure obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of the guidance is fixed at the reporting date, as the sum of the amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors and any additional amount the reporting entity expects to pay on behalf of its co-obligors. In addition, the amendments require an entity to disclose the nature and amount of the obligation, as well as other information about the obligation. The Company does not expect the adoption of this new guidance to have a material impact on its financial statements.

 

18

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

2.  Deferred Policy Acquisition Costs

See Note 1 for a description of capitalized acquisition costs.

Participating and Dividend-Paying Traditional Contracts

The Company amortizes DAC related to these contracts over the estimated lives of the contracts in proportion to actual and expected future gross margins. The amortization includes interest based on rates in effect at inception or acquisition of the contracts. The future gross margins are dependent principally on investment returns, policyholder dividend scales, mortality, persistency, expenses to administer the business, creditworthiness of reinsurance counterparties, and certain economic variables, such as inflation. Of these factors, the Company anticipates that investment returns, expenses, persistency, and other factor changes and policyholder dividend scales are reasonably likely to significantly impact the rate of DAC amortization. On a quarterly basis, the Company updates the estimated gross margins with the actual gross margins for that period. When the actual gross margins change from previously estimated gross margins, the cumulative DAC amortization is re-estimated and adjusted by a cumulative charge or credit to earnings. When actual gross margins exceed those previously estimated, the DAC amortization will increase, resulting in a charge to earnings. The opposite result occurs when the actual gross margins are below the previously estimated gross margins. On a quarterly basis, the Company also updates the actual amount of business in-force, which impacts expected future gross margins. When expected future gross margins are below those previously estimated, the DAC amortization will increase, resulting in a charge to earnings. The opposite result occurs when the expected future gross margins are above the previously estimated expected future gross margins. Total DAC amortization during a particular period may increase or decrease depending upon the relative size of the amortization change resulting from the adjustment to DAC for the update of actual gross margins and the re-estimation of expected future gross margins. On a quarterly basis, the Company also reviews the estimated gross margins for each block of business to determine the recoverability of DAC balances.

Variable Universal Life Contracts, Variable Deferred Annuity Contracts and Equity Indexed Deferred Annuity Contracts

The Company amortizes DAC related to these contracts over the estimated lives of the contracts in proportion to actual and expected future gross profits. The amortization includes interest based on rates in effect at inception of the contracts. The amount of expected future gross profits is dependent principally upon investment returns in excess of the amounts credited to policyholders, mortality, persistency, interest crediting rates, expenses to administer the business, creditworthiness of reinsurance counterparties, and certain economic variables, such as inflation. Of these factors, the Company anticipates that investment returns, expenses, and persistency are reasonably likely to impact significantly the rate of DAC amortization. On a quarterly basis, the Company updates the estimated gross profits with the actual gross profits for that period. When the actual gross profits change from previously estimated gross profits, the cumulative DAC amortization is re-estimated and adjusted by the cumulated charge or credit to current operations. When actual gross profits exceed those previously estimated, the DAC amortization will increase, resulting in a current period charge to earnings. The opposite result occurs when the actual gross profits are below the previously estimated gross profits. On a quarterly basis, the Company also updates the actual amount of business remaining in-force, which impact expected future gross profits. When expected future gross profits are below those previously estimated, the DAC amortization will increase, resulting in a current period charge to earnings. The opposite result occurs when the expected future gross profits are above the previously estimated expected future gross profits. Each period, the Company also reviews the estimated gross profits for each block of business to determine the recoverability of DAC balances.

 

19

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

2.  Deferred Policy Acquisition Costs (continued)

 

Factors Impacting Amortization

The Company also periodically reviews other long-term assumptions underlying the projections of estimated gross margins and profits. These include investment returns, policyholder dividend scales, interest crediting rates, mortality, persistency and expenses to administer business. Management annually updates assumptions used in the calculation of estimated gross margins and profits which may have significantly changed. If the update of assumptions causes expected future gross margins and profits to increase, DAC amortization will decrease, resulting in a current period increase to earnings. The opposite result occurs when the assumption update causes expected future gross margins and profits to decrease.

Amortization of DAC is attributed to net investment gains (losses) and net derivative gains (losses), and to other expenses for the amount of gross margins or profits originating from transactions other than investment gains and losses. Unrealized investment gains and losses represent the amount of DAC that would have been amortized if such gains and losses had been recognized.

Information regarding DAC was as follows:

 

		Years Ended December 31,
		2013				2012				2011
		(In thousands)
Balance at January 1,		$	136,661			$	178,105			$	206,677
Capitalizations			2,013				1,760				2,955
Amortization related to:
Net investment gains (losses) and net derivative gains (losses)			23,559				(28,204)				(21,453)
Other expenses			(2,413)				(15,000)				(10,074)
Total amortization			21,146				(43,204)				(31,527)
Balance at December 31,		$	159,820			$	136,661			$	178,105

3.  Reserves

Reinsurance Liabilities

Future policy benefits are measured as follows:

 

Product Type		Measurement Assumptions:
Assumed Participating Life		Aggregate of (i) net level premium reserves for death and endowment policy benefits (calculated based upon the non-forfeiture interest rate ranging from 4% to 6% and mortality rates guaranteed in calculating the cash surrender values described in such contracts); and (ii) the liability for terminal dividends.
Assumed traditional fixed annuities after annuitization		Present value of expected future payments. Interest rate assumptions used in establishing such liabilities range from 1% to 7% for domestic business and 2% to 5% for international business.

 

20

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

3.  Reserves (continued)

 

Guarantees

The Company reinsures variable annuity products with guaranteed minimum benefits. The non-life contingent portion of GMWB, GMAB and the portion of certain GMIB that does not require annuitization are accounted for as embedded derivatives in policyholder account balances and other policy-related balances which are further discussed in Note 6. Guarantees accounted for as reinsurance liabilities include:

 

Guarantee:						Measurement Assumptions:
GMDBs		•   A return of purchase payment upon death even if the account value is reduced to zero.				•   Present value of expected death benefits in excess of the projected account balance recognizing the excess ratably over the accumulation period based on the present value of total expected assessments.
		•   An enhanced death benefit may be available for an additional fee.				•   Assumptions are consistent with those used for amortizing DAC, and are thus subject to the same variability and risk.
						•   Investment performance and volatility assumptions are consistent with the historical experience of the appropriate underlying equity index, such as the S&P 500 Index.
						•   Benefit assumptions are based on the average benefits payable over a range of scenarios.
GMIBs		•   After a specified period of time determined at the time of issuance of the variable annuity contract, a minimum accumulation of purchase payments, even if the account value is reduced to zero, that can be annuitized to receive a monthly income stream that is not less than a specified amount.   •   Certain contracts also provide for a guaranteed lump sum return of purchase premium in lieu of the annuitization benefit.				•   Present value of expected income benefits in excess of the projected account balance at any future date of annuitization and recognizing the excess ratably over the accumulation period based on the present value of total expected assessments.   •   Assumptions are consistent with those used for estimating GMDBs liabilities.   •   Calculation incorporates an assumption for the percentage of the potential annuitizations that may be elected by the contractholder.
GMWBs		•   A return of purchase payment via partial withdrawals, even if the account value is reduced to zero, provided that cumulative withdrawals in a contract year do not exceed a certain limit.				•   Expected value of the life contingent payments and expected assessments using assumptions consistent with those used for estimating the GMDBs liabilities.
		•   Certain contracts include guaranteed withdrawals that are life contingent.

 

21

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

3.  Reserves (continued)

 

Information regarding the liabilities for guarantees (excluding embedded derivatives) relating to annuity and universal and variable life contracts was as follows:

 

		Annuity Contracts								Universal and Variable Life Contracts
		GMDBs				GMIBs				Secondary Guarantees				Total
Assumed
Balance at January 1, 2011		$	204,783			$	172,260			$	41,159			$	418,202
Incurred guaranteed benefits			197,432				72,496				(1,514	)			268,414
Paid guaranteed benefits			(74,439	)			—				—				(74,439	)
Balance at December 31, 2011			327,776				244,756				39,645				612,177
Incurred guaranteed benefits			169,545				230,988				10,288				410,821
Paid guaranteed benefits			(79,815	)			—				—				(79,815	)
Balance at December 31, 2012			417,506				475,744				49,933				943,183
Incurred guaranteed benefits			125,884				52,561				7,018				185,463
Paid guaranteed benefits			(59,132	)			—				—				(59,132	)
Balance at December 31, 2013		$	484,258			$	528,305			$	56,951			$	1,069,514
Ceded
Balance at January 1, 2011		$	8,210			$	—			$	—			$	8,210
Incurred guaranteed benefits			(32	)			—				—				(32	)
Paid guaranteed benefits			—				—				—				—
Balance at December 31, 2011			8,178				—				—				8,178
Incurred guaranteed benefits			2,920				—				—				2,920
Paid guaranteed benefits			—				—				—				—
Balance at December 31, 2012			11,098				—				—				11,098
Incurred guaranteed benefits			3,704				—				—				3,704
Paid guaranteed benefits			—				—				—				—
Balance at December 31, 2013		$	14,802			$	—			$	—			$	14,802
Net
Balance at January 1, 2011		$	196,573			$	172,260			$	41,159			$	409,992
Incurred guaranteed benefits			197,464				72,496				(1,514	)			268,446
Paid guaranteed benefits			(74,439	)			—				—				(74,439	)
Balance at December 31, 2011			319,598				244,756				39,645				603,999
Incurred guaranteed benefits			166,625				230,988				10,288				407,901
Paid guaranteed benefits			(79,815	)			—				—				(79,815	)
Balance at December 31, 2012			406,408				475,744				49,933				932,085
Incurred guaranteed benefits			122,180				52,561				7,018				181,759
Paid guaranteed benefits			(59,132	)			—				—				(59,132	)
Balance at December 31, 2013		$	469,456			$	528,305			$	56,951			$	1,054,712

 

22

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

4.  Reinsurance

The Company assumes insurance risk from affiliated and unaffiliated insurance companies. The Company also cedes certain assumed insurance risks to unaffiliated reinsurers.

Accounting for reinsurance requires extensive use of assumptions and estimates, particularly related to the future performance of the underlying business and the potential impact of counterparty credit risks. The Company periodically reviews actual and anticipated experience compared to the aforementioned assumptions used to establish assets and liabilities relating to ceded and assumed reinsurance and evaluates the financial strength of counterparties to its reinsurance agreements using criteria similar to that evaluated in the security impairment process discussed previously.

Premiums and policyholder benefits and claims in the statements of operations consist of amounts assumed, partially offset by amounts ceded under reinsurance agreements.

The Company assumes risks from an unaffiliated company related to guaranteed minimum benefit guarantees written directly by the unaffiliated company. These assumed reinsurance agreements contain embedded derivatives and changes in their fair value are also included within net derivative gains (losses). The embedded derivatives associated with the cessions are included within policyholder’s account balance and were liabilities of $1,262.3 million and $2,581.9 million at December 31, 2013 and 2012, respectively. For the years ended December 31, 2013, 2012 and 2011, net derivative gains (losses) included $1,126.5 million, ($394.9) million and $80.6 million, respectively, in changes in fair value of such embedded derivatives.

At December 31, 2013 and 2012, the Company had $99.2 million and $287.2 million, respectively, of unsecured unaffiliated ceded reinsurance recoverable balances.

Certain unaffiliated reinsurance agreements that do not expose the Company to a reasonable possibility of a significant loss from insurance risk are recorded using the deposit method of accounting. The deposit assets on ceded unaffiliated reinsurance were $3.5 million and $28.9 million, at December 31, 2013 and 2012, respectively.

The deposit liabilities on assumed unaffiliated reinsurance were $545 thousand and $335 thousand at December 31, 2013 and 2012, respectively.

Related Party Reinsurance Transactions

The Company has reinsurance agreements with certain of the Holding Company’s subsidiaries, including Metropolitan Life Insurance Company, First MetLife Investors Insurance Company, MetLife Insurance Company of Connecticut, MetLife Investors USA Insurance Company, MetLife Investors Insurance Company, MetLife Europe Limited (“MEL”), New England Life Insurance Company and Alico Life International Limited, all of which are related parties.

 

23

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

4.  Reinsurance (continued)

 

Information regarding the significant effects of affiliated reinsurance included in the statements of operations was as follows:

 

		Years Ended December 31,
		2013				2012				2011
		(In thousands)
Revenues
Premiums		$	23,922			$	909,170			$	29,894
Universal life and investment-type product policy fees			450,583				398,509				283,097
Net derivative gain (loss)			5,678,708				(723,305)				(2,818,107)
Other revenues			1,396				22,917				43,740
Total revenues		$	6,154,609			$	607,291			$	(2,461,376)
Expenses
Policyholder benefits and claims		$	255,205			$	1,273,113			$	234,143
Interest credited to policyholder account balances			17,399				16,598				15,831
Policyholder dividends			12,295				14,256				14,013
Other expenses			82,569				16,845				26,466
Total expenses		$	367,468			$	1,320,812			$	290,453

Information regarding the significant effects of affiliated reinsurance included in the balance sheets was as follows at:

 

		December 31,
		2013				2012
		(In thousands)
Assets
Funds withheld at interest		$	2,045,389			$	1,796,083
Premiums, reinsurance and other receivables			243,080				160,658
Deferred policy acquisition costs			80,831				76,892
Total assets		$	2,369,300			$	2,033,633
Liabilities
Future policy benefits		$	2,062,320			$	2,043,905
Other policy-related balances			3,561,663				8,130,768
Policyholder dividends payable			16,256				17,438
Other liabilities			250,807				161,603
Total liabilities		$	5,891,046			$	10,353,714

In September 2012, the Company entered into a reinsurance agreement to assume 100% quota share of certain blocks of indemnity reinsurance from MEL. This agreement covers a portion of liabilities under defined portfolios of living time annuities contracts issued on or after the effective date. This agreement transfers risk to the Company, and therefore, is accounted for as reinsurance. As a result of the agreement, the Company recorded future policy benefits, presented within future policy benefits, of $649.3 million and $792.3 million, other reinsurance liabilities of $16.9 million and $10.7 million, and other reinsurance payables, included in other

 

24

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

4.  Reinsurance (continued)

 

liabilities, were $43.7 million and $61.1 million at December 31, 2013 and 2012, respectively. The Company’s statement of operations reflects a loss for this agreement of $8.6 million and $3.5 million, which includes premiums of $1 thousand and $881.2 million and policyholder benefits of $8.6 million and $884.7 million for the years ended December 31, 2013 and 2012, respectively.

The Company assumes risks from affiliates related to guaranteed minimum benefit guarantees written directly by the affiliates. These assumed reinsurance agreements contain embedded derivatives and changes in their fair value are also included within net derivative gains (losses). The embedded derivatives associated with the cessions are included within policyholder account balances and were liabilities of $1,226.6 million and $6,249.3 million at December 31, 2013 and 2012, respectively. For the years ended December 31, 2013, 2012 and 2011, net derivative gains (losses) included $5,729.1 million, ($729.3) million and ($2,818.1) million, respectively, in changes in fair value of such embedded derivatives.

The Company had no ceded affiliated reinsurance recoverable balances at December 31, 2013 and 2012.

5.  Investments

See Note 7 for information about the fair value hierarchy for investments and the related valuation methodologies.

Investment Risks and Uncertainties

Investments are exposed to the following primary sources of risk: credit, interest rate, liquidity, market valuation and currency. The financial statement risks, stemming from such investment risks, are those associated with the determination of estimated fair values, the diminished ability to sell certain investments in times of strained market conditions, the recognition of impairments, the recognition of income on certain investments and the potential consolidation of variable interest entities (“VIEs”). The use of different methodologies, assumptions and inputs relating to these financial statement risks may have a material effect on the amounts presented within the financial statements.

The determination of valuation allowances and impairments is highly subjective and is based upon periodic evaluations and assessments of known and inherent risks associated with the respective asset class. Such evaluations and assessments are revised as conditions change and new information becomes available.

The recognition of income on certain investments (e.g., structured securities, including mortgage-backed securities, asset-backed securities (“ABS”) and certain structured investment transactions) is dependent upon certain factors such as prepayments and defaults, and changes in such factors could result in changes in amounts to be earned.

 

25

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

5.  Investments (continued)

 

Fixed Maturity Securities AFS

Fixed Maturity Securities AFS by Sector

The following table presents the fixed maturity securities AFS by sector. Included within fixed maturity securities are structured securities including commercial mortgage-backed securities (“CMBS”), ABS and residential mortgage-backed securities (“RMBS”).

 

		December 31, 2013																				December 31, 2012
		Cost or Amortized Cost				Gross Unrealized												Estimated Fair Value				Cost or Amortized Cost				Gross Unrealized												Estimated Fair Value
						Gains				Temporary Losses				OTTI Losses												Gains				Temporary Losses				OTTI Losses
		(In thousands)																				(In thousands)
Fixed Maturity Securities:
Foreign corporate		$	535,332			$	5,294			$	7,203			$	—			$	533,423			$	621,950			$	11,286			$	1,814			$	—			$	631,422
U.S. corporate			255,510				10,478				2,366				—				263,622				302,993				19,714				241				—				322,466
CMBS			135,781				1,724				4,941				—				132,564				82,307				4,019				—				—				86,326
State and political subdivision			114,310				6,862				916				—				120,256				115,352				20,220				5				—				135,567
U.S. Treasury and agency			101,947				1,225				3,924				—				99,248				290,766				2,765				2				—				293,529
ABS			79,461				1,323				264				—				80,520				195,178				2,707				9				—				197,876
RMBS			61,322				2,261				794				—				62,789				76,727				5,179				—				—				81,906
Foreign government			28,259				400				—				—				28,659				34,640				1,887				—				—				36,527
Total fixed maturity securities		$	1,311,922			$	29,567			$	20,408			$	—			$	1,321,081			$	1,719,913			$	67,777			$	2,071			$	—			$	1,785,619

The Company held no non-income producing fixed maturity securities at December 31, 2013 and 2012.

Methodology for Amortization of Premium and Accretion of Discount on Structured Securities

Amortization of premium or accretion of discount on structured securities considers the estimated timing and amount of prepayments of the underlying loans. Actual prepayment experience is periodically reviewed and effective yields are recalculated when differences arise between the originally anticipated and the actual prepayments received and currently anticipated. Prepayment assumptions for single class and multi-class mortgage-backed and ABS are estimated using inputs obtained from third-party specialists and based on management’s knowledge of the current market. For credit-sensitive mortgage-backed and ABS and certain prepayment-sensitive securities, the effective yield is recalculated on a prospective basis. For all other mortgage-backed and ABS, the effective yield is recalculated on a retrospective basis.

 

26

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

5.  Investments (continued)

 

Maturities of Fixed Maturity Securities

The amortized cost and estimated fair value of fixed maturity securities, by contractual maturity date, were as follows at:

 

		December 31,
		2013								2012
		Amortized Cost				Estimated Fair Value				Amortized Cost				Estimated Fair Value
		(In thousands)
Due in one year or less		$	246,228			$	246,780			$	273,190			$	273,472
Due after one year through five years			280,090				283,376				520,894				524,882
Due after five years through ten years			308,324				311,927				364,081				386,994
Due after ten years			200,716				203,125				207,536				234,163
Subtotal			1,035,358				1,045,208				1,365,701				1,419,511
Structured securities (CMBS, ABS and RMBS)			276,564				275,873				354,212				366,108
Total fixed maturity securities		$	1,311,922			$	1,321,081			$	1,719,913			$	1,785,619

Actual maturities may differ from contractual maturities due to the exercise of call or prepayment options. Fixed maturity securities not due at a single maturity date have been presented in the year of final contractual maturity. CMBS, ABS and RMBS are shown separately, as they are not due at a single maturity.

Continuous Gross Unrealized Losses for Fixed Maturity Securities AFS by Sector

The following table presents the estimated fair value and gross unrealized losses of fixed maturity securities AFS in an unrealized loss position, aggregated by sector and by length of time that the securities have been in a continuous unrealized loss position. The unrealized loss amounts include the noncredit component of OTTI loss.

 

		December 31, 2013																December 31, 2012
		Less than 12 Months								Equal to or Greater than 12 Months								Less than 12 Months								Equal to or Greater than 12 Months
		Estimated Fair Value				Gross Unrealized Losses				Estimated Fair Value				Gross Unrealized Losses				Estimated Fair Value				Gross Unrealized Losses				Estimated Fair Value				Gross Unrealized Losses
		(In thousands, except number of securities)
Fixed Maturity Securities:
Foreign corporate		$	214,876			$	7,203			$	—			$	—			$	288,797			$	1,814			$	—			$	—
U.S. corporate			50,458				1,771				4,378				595				54,064				241				—				—
CMBS			62,872				4,941				—				—				—				—				—				—
State and political subdivision			14,936				916				—				—				775				5				—				—
U.S. Treasury and agency			28,434				3,924				—				—				2,522				2				—				—
ABS			18,907				264				—				—				72,441				9				—				—
RMBS			17,541				794				—				—				—				—				—				—
Total fixed maturity securities		$	408,024			$	19,813			$	4,378			$	595			$	418,599			$	2,071			$	—			$	—
Total number of securities in an unrealized loss position			79								2								67								—

 

27

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

5.  Investments (continued)

 

Evaluation of AFS Securities for OTTI and Evaluating Temporarily Impaired AFS Securities

Evaluation and Measurement Methodologies

Management considers a wide range of factors about the security issuer and uses its best judgment in evaluating the cause of the decline in the estimated fair value of the security and in assessing the prospects for near-term recovery. Inherent in management’s evaluation of the security are assumptions and estimates about the operations of the issuer and its future earnings potential. Considerations used in the impairment evaluation process include, but are not limited to: (i) the length of time and the extent to which the estimated fair value has been below amortized cost; (ii) the potential for impairments when the issuer is experiencing significant financial difficulties; (iii) the potential for impairments in an entire industry sector or sub-sector; (iv) the potential for impairments in certain economically depressed geographic locations; (v) the potential for impairments of securities where the issuer, series of issuers or industry has suffered a catastrophic loss or has exhausted natural resources; (vi) whether the Company has the intent to sell or will more likely than not be required to sell a particular security before the decline in estimated fair value below amortized cost recovers; (vii) with respect to structured securities, changes in forecasted cash flows after considering the quality of underlying collateral, expected prepayment speeds, current and forecasted loss severity, consideration of the payment terms of the underlying assets backing a particular security, and the payment priority within the tranche structure of the security; and (viii) other subjective factors, including concentrations and information obtained from regulators and rating agencies.

The methodology and significant inputs used to determine the amount of credit loss on fixed maturity securities are as follows:

 

•

The Company calculates the recovery value by performing a discounted cash flow analysis based on the present value of future cash flows. The discount rate is generally the effective interest rate of the security prior to impairment.

 

•

When determining collectability and the period over which value is expected to recover, the Company applies considerations utilized in its overall impairment evaluation process which incorporates information regarding the specific security, fundamentals of the industry and geographic area in which the security issuer operates, and overall macroeconomic conditions. Projected future cash flows are estimated using assumptions derived from management’s best estimates of likely scenario-based outcomes after giving consideration to a variety of variables that include, but are not limited to: payment terms of the security; the likelihood that the issuer can service the interest and principal payments; the quality and amount of any credit enhancements; the security’s position within the capital structure of the issuer; possible corporate restructurings or asset sales by the issuer; and changes to the rating of the security or the issuer by rating agencies.

 

•

Additional considerations are made when assessing the unique features that apply to certain structured securities including, but not limited to: the quality of underlying collateral, expected prepayment speeds; current and forecasted loss severity, consideration of the payment terms of the underlying loans or assets backing a particular security, and the payment priority within the tranche structure of the security.

 

28

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

5.  Investments (continued)

 

•

When determining the amount of the credit loss for U.S. and foreign corporate securities and state and political subdivision securities, the estimated fair value is considered the recovery value when available information does not indicate that another value is more appropriate. When information is identified that indicates a recovery value other than estimated fair value, management considers in the determination of recovery value the same considerations utilized in its overall impairment evaluation process as described above, as well as private and public sector programs to restructure such securities.

With respect to securities that have attributes of debt and equity (perpetual hybrid securities), consideration is given in the OTTI analysis as to whether there has been any deterioration in the credit of the issuer and the likelihood of recovery in value of the securities that are in a severe and extended unrealized loss position. Consideration is also given as to whether any perpetual hybrid securities, with an unrealized loss, regardless of credit rating, have deferred any dividend payments. When an OTTI loss has occurred, the OTTI loss is the entire difference between the perpetual hybrid security’s cost and its estimated fair value with a corresponding charge to earnings.

The amortized cost of fixed maturity securities is adjusted for OTTI in the period in which the determination is made. The Company does not change the revised cost basis for subsequent recoveries in value.

In periods subsequent to the recognition of OTTI on a fixed maturity security, the Company accounts for the impaired security as if it had been purchased on the measurement date of the impairment. Accordingly, the discount (or reduced premium) based on the new cost basis is accreted over the remaining term of the fixed maturity security in a prospective manner based on the amount and timing of estimated future cash flows.

Current Period Evaluation

Based on the Company’s current evaluation of its AFS securities in an unrealized loss position in accordance with its impairment policy, and the Company’s current intentions and assessments (as applicable to the type of security) about holding, selling and any requirements to sell these securities, the Company has concluded that these securities are not other-than-temporarily impaired at December 31, 2013. Future OTTI will depend primarily on economic fundamentals, issuer performance (including changes in the present value of future cash flows expected to be collected) and changes in credit ratings, collateral valuation, interest rates and credit spreads. If economic fundamentals deteriorate or if there are adverse changes in the above factors, OTTI may be incurred in upcoming periods.

Gross unrealized losses on fixed maturity securities increased $18.3 million during the year ended December 31, 2013 from $2.1 million to $20.4 million. The increase in gross unrealized losses for the year ended December 31, 2013, was primarily attributable to an increase in interest rates, partially offset by narrowing credit spreads.

At December 31, 2013, there were no fixed maturity securities with an unrealized loss position of 20% or more of amortized cost for six months or greater.

Funds Withheld at Interest

Funds withheld at interest represent amounts contractually withheld by ceding companies in accordance with reinsurance agreements. At December 31, 2013 and 2012, such amounts consisted of balances withheld in connection with reinsurance agreements with affiliates of the Holding Company, as presented in Note 4, and an unaffiliated company.

 

29

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

5.  Investments (continued)

 

Cash Equivalents

The carrying value of cash equivalents, which includes securities and other investments with an original or remaining maturity of three months or less at the time of purchase, was $40.8 million and $410.6 million at December 31, 2013 and 2012, respectively.

Net Unrealized Investment Gains (Losses)

The components of net unrealized investment gains (losses), included in AOCI, were as follows:

 

		Years Ended December 31,
		2013				2012				2011
		(In thousands)
Fixed maturity securities		$	9,072			$	65,706			$	41,752
Equity securities			—				—				(1,063)
Deferred income tax benefit (expense)			(3,176)				(22,997)				(14,241)
Net unrealized investment gains (losses)		$	5,896			$	42,709			$	26,448

The changes in net unrealized investment gains (losses) were as follows:

 

		Years Ended December 31,
		2013				2012				2011
		(In thousands)
Balance, January 1,		$	42,709			$	26,448			$	3,341
Unrealized investment gains (losses) during the year			(56,634)				25,017				35,549
Deferred income tax benefit (expense)			19,821				(8,756)				(12,442)
Balance, December 31,		$	5,896			$	42,709			$	26,448
Change in net unrealized investment gains (losses)		$	(36,813)			$	16,261			$	23,107

Concentrations of Credit Risk

There were no investments in any counterparty that were greater than 10% of the Company’s stockholder’s equity, other than the U.S. government and its agencies, at both December 31, 2013 and 2012.

Invested Assets Held in Trust and Pledged as Collateral

Invested assets held in trust and pledged as collateral are presented below at estimated fair value for cash and cash equivalents, short-term investments, and fixed maturity securities at:

 

		December 31,
		2013				2012
		(In thousands)
Invested assets held in trust (1)		$	2,754,170			$	4,697,418
Invested assets pledged as collateral (2)			1,024,682				289,145
Total invested assets held in trust and pledged as collateral		$	3,778,852			$	4,986,563

 

 

(1)	The Company has held in trust certain investments, primarily fixed maturity securities, in connection with certain reinsurance transactions.

 

30

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

5.  Investments (continued)

 

(2)	Certain of the Company’s invested assets are pledged as collateral for various derivative transactions as described in Note 6.

Variable Interest Entities

The Company has invested in certain structured transactions that are VIEs. In certain instances, the Company may hold both the power to direct the most significant activities of the entity, as well as an economic interest in the entity and, as such, it would be deemed to be the primary beneficiary or consolidator of the entity.

The determination of the VIE’s primary beneficiary requires an evaluation of the contractual and implied rights and obligations associated with each party’s relationship with or involvement in the entity, an estimate of the entity’s expected losses and expected residual returns and the allocation of such estimates to each party involved in the entity. The Company generally uses a qualitative approach to determine whether it is the primary beneficiary. However, for VIEs that are investment companies or apply measurement principles consistent with those utilized by investment companies, the primary beneficiary is based on a risks and rewards model and is defined as the entity that will absorb a majority of a VIE’s expected losses, receive a majority of a VIE’s expected residual returns if no single entity absorbs a majority of expected losses, or both. The Company reassesses its involvement with VIEs on a quarterly basis. The use of different methodologies, assumptions and inputs in the determination of the primary beneficiary could have a material effect on the amounts presented within the financial statements.

Consolidated VIEs

There were no VIEs for which the Company has concluded that it is the primary beneficiary and which are consolidated at December 31, 2013 and 2012.

Unconsolidated VIEs

The carrying amount and maximum exposure to loss relating to VIEs in which the Company holds a significant variable interest but is not the primary beneficiary and which have not been consolidated were as follows at:

 

		December 31,
		2013								2012
		Carrying Value				Maximum Exposure to Loss (1)				Carrying Value				Maximum Exposure to Loss (1)
		(In thousands)
Fixed maturity securities AFS:
Structured securities (ABS, CMBS and RMBS) (2)		$	275,873			$	275,873			$	366,108			$	366,108
Foreign corporate			5,186				5,186				5,525				5,525
Total		$	281,059			$	281,059			$	371,633			$	371,633

 

(1)	The maximum exposure to loss relating to fixed maturity securities is equal to their carrying amounts or the carrying amounts of retained interests.

 

(2)	For these variable interests, the Company’s involvement is limited to that of a passive investor.

 

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

5.  Investments (continued)

 

Net Investment Income

The components of net investment income were as follows:

 

		Years Ended December 31,
		2013				2012				2011
		(In thousands)
Investment Income:
Fixed maturity securities		$	41,202			$	29,831			$	23,825
Equity securities			—				94				619
Cash, cash equivalents and short-term investments			3,247				6,415				3,314
Other			(3,155)				(4,792)				(4,622)
Subtotal			41,294				31,548				23,136
Less: Investment expenses			5,871				10,853				5,898
Net investment income		$	35,423			$	20,695			$	17,238

See “— Related Party Investment Transactions” for discussion of affiliated net investment income and expenses included in the table above.

Net Investment Gains (Losses)

Components of Net Investment Gains (Losses)

The components of net investment gains (losses) were as follows:

 

		Years Ended December 31,
		2013				2012				2011
		(In thousands)
Fixed maturity securities		$	2,066			$	711			$	4,717
Equity securities			—				3,675				(292)
Other investment portfolio gains (losses)			(58,647)				37,407				(5,511)
Total net investment gains (losses)		$	(56,581)			$	41,793			$	(1,086)

Gains (losses) from foreign currency transactions included within net investment gains (losses) were ($59.2) million, $37.3 million and ($5.9) million for the years ended December 31, 2013, 2012 and 2011, respectively.

 

32

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

5.  Investments (continued)

 

Sales or Disposals of Fixed Maturity and Equity Securities

Proceeds from sales or disposals of fixed maturity and equity securities and the components of fixed maturity and equity securities net investment gains (losses) are as shown in the table below. Investment gains and losses on sales of securities are determined on a specific identification basis.

 

		Years Ended December 31,												Years Ended December 31,												Years Ended December 31,
		2013				2012				2011				2013				2012				2011				2013				2012				2011
		Fixed Maturity Securities												Equity Securities												Total
		(In thousands)
Proceeds		$	251,239			$	34,432			$	421,298			$	—			$	7,212			$	2,880			$	251,239			$	41,644			$	424,178
Gross investment gains		$	2,721			$	755			$	5,178			$	—			$	3,675			$	—			$	2,721			$	4,430			$	5,178
Gross investment losses			(655)				(44)				(461)				—				—				(292)				(655)				(44)				(753)
Net investment gains (losses)		$	2,066			$	711			$	4,717			$	—			$	3,675			$	(292)			$	2,066			$	4,386			$	4,425

There were no OTTI losses on fixed maturity securities or equity securities during the years ended December 31, 2013, 2012 and 2011.

Related Party Investment Transactions

In the normal course of business, the Company transfers invested assets, primarily consisting of fixed maturity securities, to and from affiliates. There were no invested assets transferred to affiliates for the years ended December 31, 2013 and 2012. There were no invested assets transferred from affiliates for the year ended December 31, 2013. The estimated fair value of invested assets transferred from affiliates for the year ended December 31, 2012 was $857.4 million. There were no invested assets transferred from affiliates for the year ended December 31, 2011.

The Company receives investment administrative services from an affiliate. The related investment administrative service charges were $4.6 million, $7.2 million and $4.5 million for the years ended December 31, 2013, 2012 and 2011, respectively.

6.  Derivatives

Accounting for Derivatives

See Note 1 for a description of the Company’s accounting policies for derivatives and Note 7 for information about the fair value hierarchy for derivatives.

Derivative Strategies

The Company is exposed to various risks relating to its ongoing business operations, including interest rate, foreign currency exchange rate and equity market. The Company uses a variety of strategies to manage these risks, including the use of derivatives.

 

33

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

6.  Derivatives (continued)

 

Derivatives are financial instruments whose values are derived from interest rates, foreign currency exchange rates, credit spreads and/or other financial indices. Derivatives may be exchange-traded or contracted in the over-the-counter (“OTC”) market. Certain of the Company’s OTC derivatives may be cleared and settled through central clearing counterparties (“OTC-cleared”), while others are bilateral contracts between two counterparties (“OTC-bilateral”). The types of derivatives the Company uses include swaps, forwards, futures and option contracts. The Company also purchases certain securities and engages in certain reinsurance agreements that have embedded derivatives.

The Company utilizes all derivatives in non-qualifying hedging relationships.

Interest Rate Derivatives

The Company uses a variety of interest rate derivatives to reduce its exposure to changes in interest rates, including interest rate swaps, futures and options.

Interest rate swaps are used by the Company primarily to reduce market risks from changes in interest rates and to alter interest rate exposure arising from mismatches between assets and liabilities (duration mismatches). In an interest rate swap, the Company agrees with another party to exchange, at specified intervals, the difference between fixed rate and floating rate interest amounts as calculated by reference to an agreed notional amount.

In exchange-traded interest rate Treasury futures transactions, the Company agrees to purchase or sell a specified number of contracts, the value of which is determined by the different classes of interest rate securities, and to post variation margin on a daily basis in an amount equal to the difference in the daily market values of those contracts. The Company enters into exchange-traded futures with regulated futures commission merchants that are members of the exchange. Exchange-traded interest rate Treasury futures are used primarily to hedge mismatches between the duration of assets in a portfolio and the duration of liabilities supported by those assets, to hedge against changes in value of securities the Company owns or anticipates acquiring and to hedge against changes in interest rates on anticipated liability issuances by replicating Treasury or swap curve performance.

Swaptions are used by the Company to hedge interest rate risk associated with the Company’s long-term liabilities and invested assets. A swaption is an option to enter into a swap with a forward starting effective date. In certain instances, the Company locks in the economic impact of existing purchased swaptions by entering into offsetting written swaptions. The Company pays a premium for purchased swaptions and receives a premium for written swaptions. Swaptions are included in interest rate options.

Foreign Currency Exchange Rate Derivatives

The Company uses foreign currency forwards to reduce the risk from fluctuations in foreign currency exchange rates associated with its assets and liabilities denominated in foreign currencies. In a foreign currency forward transaction, the Company agrees with another party to deliver a specified amount of an identified currency at a specified future date. The price is agreed upon at the time of the contract and payment for such a contract is made at the specified future date.

To a lesser extent, the Company uses exchange-traded currency futures to hedge currency mismatches between assets and liabilities.

 

34

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

6.  Derivatives (continued)

 

Equity Derivatives

The Company uses a variety of equity derivatives to reduce its exposure to equity market risk, including equity index options, variance swaps, exchange-traded equity futures and total rate of return swaps (“TRRs”).

Equity index options are used by the Company primarily to hedge minimum guarantees embedded in certain variable annuity products assumed by the Company. To hedge against adverse changes in equity indices, the Company enters into contracts to sell the equity index within a limited time at a contracted price. The contracts will be net settled in cash based on differentials in the indices at the time of exercise and the strike price. Certain of these contracts may also contain settlement provisions linked to interest rates. In certain instances, the Company may enter into a combination of transactions to hedge adverse changes in equity indices within a pre-determined range through the purchase and sale of options.

Equity variance swaps are used by the Company primarily to hedge minimum guarantees embedded in certain variable annuity products reinsured by the Company. In an equity variance swap, the Company agrees with another party to exchange amounts in the future, based on changes in equity volatility over a defined period.

In exchange-traded equity futures transactions, the Company agrees to purchase or sell a specified number of contracts, the value of which is determined by the different classes of equity securities, and to post variation margin on a daily basis in an amount equal to the difference in the daily market values of those contracts. The Company enters into exchange-traded futures with regulated futures commission merchants that are members of the exchange. Exchange-traded equity futures are used primarily to hedge liabilities embedded in certain variable annuity products reinsured by the Company.

TRRs are swaps whereby the Company agrees with another party to exchange, at specified intervals, the difference between the economic risk and reward of an asset or a market index and the London Inter-Bank Offered Rate (“LIBOR”), calculated by reference to an agreed notional amount. No cash is exchanged at the outset of the contract. Cash is paid and received over the life of the contract based on the terms of the swap. The Company uses TRRs to hedge its equity market guarantees in certain of its reinsured products. TRRs can be used as hedges or to synthetically create investments.

 

35

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

6.  Derivatives (continued)

 

Primary Risks Managed by Derivatives

The following table presents the gross notional amount, estimated fair value and primary underlying risk exposure of the Company’s derivatives, excluding embedded derivatives, held at:

 

				December 31, 2013												December 31, 2012
Derivatives Not Designated or Not Qualifying as Hedging Instruments		Primary Underlying Risk Exposure		Notional Amount				Estimated Fair Value								Notional Amount				Estimated Fair Value
								Assets				Liabilities								Assets				Liabilities
				(In thousands)
Interest rate swaps		Interest rate		$	23,221,522			$	1,040,377			$	562,851			$	22,298,852			$	1,867,230			$	611,572
Interest rate futures		Interest rate			4,462,013				9,047				6,547				6,437,033				598				20,980
Interest rate options		Interest rate			17,690,095				131,341				235,516				11,440,095				302,989				58,486
Foreign currency forwards		Foreign currency exchange rate			2,324,152				728				171,078				2,281,296				1,051				177,496
Currency futures		Foreign currency exchange rate			364,550				1,169				1,022				518,160				3,864				—
Equity futures		Equity market			4,327,600				1,284				39,600				5,898,717				14,146				105,452
Equity options		Equity market			31,414,484				1,024,034				1,005,551				18,897,916				2,346,326				355,433
Variance swaps		Equity market			18,917,116				167,519				469,330				17,177,849				111,788				241,073
Total rate of return swaps		Equity market			3,339,982				—				156,959				2,791,568				4,436				95,505
Total non-designated or non-qualifying derivatives				$	106,061,514			$	2,375,499			$	2,648,454			$	87,741,486			$	4,652,428			$	1,665,997

Net Derivative Gains (Losses)

The components of net derivative gains (losses) were as follows:

 

		Years Ended December 31,
		2013				2012				2011
		(In thousands)
Derivatives and hedging gains (losses)		$	(4,841,296)			$	(2,586,885)			$	2,941,895
Embedded derivatives			6,776,544				(1,089,704)				(2,711,461)
Total net derivatives gains (losses)		$	1,935,248			$	(3,676,589)			$	230,434

The following table presents earned income on derivatives for the:

 

		Years Ended December 31,
		2013				2012				2011
		(In thousands)
Net derivative gains (losses)		$	(262,379)			$	20,202			$	141,929
Policyholder benefits and claims			(274,848)				(113,899)				16,833
Total		$	(537,227)			$	(93,697)			$	158,762

 

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

6.  Derivatives (continued)

 

Non-Qualifying Derivatives

The following table presents the amount and location of gains (losses) recognized in income for derivatives that were not designated or qualifying as hedging instruments:

 

		Net Derivative Gains (Losses)				Policyholder Benefits and Claims (1)
		(In thousands)
For the Year Ended December 31, 2013:
Interest rate derivatives		$	(925,139)			$	(1,364)
Foreign currency exchange rate derivatives			(514,563)				—
Equity derivatives			(3,139,215)				(635,931)
Total		$	(4,578,917)			$	(637,295)
For the Year Ended December 31, 2012:
Interest rate derivatives		$	(204,299)			$	—
Foreign currency exchange rate derivatives			(284,745)				—
Equity derivatives			(2,118,043)				(367,490)
Total		$	(2,607,087)			$	(367,490)
For the Year Ended December 31, 2011:
Interest rate derivatives		$	1,527,402			$	—
Foreign currency exchange rate derivatives			143,177				—
Equity derivatives			1,129,387				(82,696)
Total		$	2,799,966			$	(82,696)

 

 

(1)	Changes in estimated fair value related to economic hedges of reinsured variable annuity guarantees.

Credit Risk on Freestanding Derivatives

The Company may be exposed to credit-related losses in the event of nonperformance by counterparties to derivatives. Generally, the current credit exposure of the Company’s derivatives is limited to the net positive estimated fair value of derivatives at the reporting date after taking into consideration the existence of master netting or similar agreements and any collateral received pursuant to such agreements.

The Company manages its credit risk related to derivatives by entering into transactions with creditworthy counterparties and establishing and monitoring exposure limits. The Company’s OTC-bilateral derivative transactions are generally governed by International Swaps and Derivatives Association (“ISDA”) Master Agreements which provide for legally enforceable set-off and close-out netting of exposures to specific counterparties in the event of early termination of a transaction, which includes, but is not limited to, events of default and bankruptcy. In the event of an early termination, the Company is permitted to set-off receivables from the counterparty against payables to the same counterparty arising out of all included transactions. Substantially all of the Company’s ISDA Master Agreements also include Credit Support Annex provisions which require both the pledging and accepting of collateral in connection with its OTC-bilateral derivatives. See Note 7 for a description of the impact of credit risk on the valuation of derivatives.

 

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

6.  Derivatives (continued)

 

The estimated fair value of the Company’s net derivative assets and net derivative liabilities after the application of master netting agreements and collateral was as follows at:

 

		December 31, 2013								December 31, 2012
Derivatives Subject to a Master Netting Arrangement or a Similar Arrangement		Assets				Liabilities				Assets				Liabilities
		(In thousands)
Gross estimated fair value of derivatives:
OTC-bilateral		$	2,430,173			$	2,593,152			$	4,708,762			$	1,534,233
Exchange-traded			11,500				47,169				18,608				126,432
Total gross estimated fair value of derivatives (1)			2,441,673				2,640,321				4,727,370				1,660,665
Amounts offset in the balance sheets			—				—				—				—
Estimated fair value of derivatives presented in the balance sheets (1)			2,441,673				2,640,321				4,727,370				1,660,665
Gross amounts not offset in the balance sheets:
Gross estimated fair value of derivatives: (2)
OTC-bilateral			(1,869,869)				(1,869,869)				(1,518,669)				(1,518,669)
Exchange-traded			(5,368)				(5,368)				(18,608)				(18,608)
Cash collateral (3)
OTC-bilateral			(163,210)				—				(1,473,376)				—
Exchange-traded			—				(39,008)				—				(107,824)
Securities collateral (4)
OTC-bilateral			(377,561)				(646,079)				(1,716,717)				(13,667)
Exchange-traded			—				(2,793)				—				—
Net amount after application of master netting agreements and collateral		$	25,665			$	77,204			$	—			$	1,897

 

 

 

(1)

At December 31, 2013 and 2012, derivative assets include income or expense accruals reported in accrued investment income or in other liabilities of $66,175 thousand and $74,942 thousand, respectively, and derivative liabilities include income or expense accruals reported in accrued investment income or in other liabilities of $8,133 thousand and $5,332 thousand, respectively.

 

(2)	Estimated fair value of derivatives is limited to the amount that is subject to set-off and includes income or expense accruals.

 

(3)

Cash collateral received is included in cash and cash equivalents and the obligation to return it is included in other liabilities in the balance sheet. The receivable for the return of cash collateral provided by the Company is inclusive of initial margin on exchange-traded derivatives and is included in premiums, reinsurance and other receivables in the balance sheet. The amount of cash collateral offset in the table above is limited to the net estimated fair value of derivatives after application of netting agreements. At December 31, 2013 and 2012, the Company received excess cash collateral of $33,319 thousand and $0, respectively, and provided excess cash collateral of $185,299 thousand and $167,655 thousand, respectively, which is not included in the table above due to the foregoing limitation.

 

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

6.  Derivatives (continued)

 

(4)

Securities collateral received by the Company is held in separate custodial accounts and is not recorded on the balance sheet. Subject to certain constraints, the Company is permitted by contract to sell or repledge this collateral, but at December 31, 2013 none of the collateral had been sold or repledged. Securities collateral pledged by the Company is reported in fixed maturity securities in the balance sheet. Subject to certain constraints, the counterparties are permitted by contract to sell or repledge this collateral. The amount of securities collateral offset in the table above is limited to the net estimated fair value of derivatives after application of netting agreements and cash collateral. At December 31, 2013 and 2012, the Company received excess securities collateral of $96,746 thousand and $59,320 thousand, respectively, for its OTC-bilateral derivatives which are not included in the table above due to the foregoing limitation. At December 31, 2013 and 2012, the Company provided excess securities collateral of $0 and $0, respectively, for its OTC-bilateral derivatives and $36,182 thousand and $39,989 thousand, respectively, for its exchange-traded derivatives, which are not included in the table above due to the foregoing limitation.

The following table presents the estimated fair value of the Company’s OTC-bilateral derivatives that are in a net liability position after considering the effect of netting agreements, together with the estimated fair value and balance sheet location of the collateral pledged. The table also presents the incremental collateral that the Company would be required to provide if there was a one notch downgrade in the Company’s credit rating at the reporting date or if the Company’s credit rating sustained a downgrade to a level that triggered full overnight collateralization or termination of the derivative position at the reporting date. OTC-bilateral derivatives that are not subject to collateral agreements are excluded from this table.

 

						Estimated Fair Value of Collateral Provided:				Fair Value of Incremental Collateral Provided Upon:
		Estimated Fair Value of Derivatives in Net Liability Position (1)				Fixed Maturity Securities				One Notch Downgrade in the Holding Company’s Credit Rating				Downgrade in the Holding Company’s Credit Rating to a Level that Triggers Full Overnight Collateralization or Termination of the Derivative Position
		(In thousands)
December 31, 2013		$	723,283			$	646,079			$	20,912			$	21,353
December 31, 2012		$	15,564			$	13,667			$	—			$	—

 

 

(1)	After taking into consideration the existence of netting agreements.

Embedded Derivatives

The Company assumes variable annuities, modified coinsurance contracts, equity indexed deferred annuities and purchases certain investments that contain embedded derivatives that are required to be separated from their host contracts and accounted for as freestanding derivatives. These host contracts principally include: assumed variable annuities with guaranteed minimum benefits, including GMWBs, GMABs and certain GMIBs; ceded reinsurance agreements of guaranteed minimum benefits related to GMABs and certain GMIBs; assumed modified coinsurance contracts; assumed reinsurance on equity indexed deferred annuities; and options embedded in debt and equity securities.

 

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

6.  Derivatives (continued)

 

The following table presents the estimated fair value and balance sheet location of the Company’s embedded derivatives that have been separated from their host contracts at:

 

				December 31,
		Balance Sheet Location		2013				2012
				(In thousands)
Net embedded derivatives within asset host contracts:
Ceded guaranteed minimum benefits		Premiums, reinsurance and other receivables		$	122,515			$	257,690
Assumed modified coinsurance contracts		Funds withheld at interest			24,035				72,357
Net embedded derivatives within asset host contracts				$	146,550			$	330,047
Net embedded derivatives within liability host contracts:
Assumed guaranteed minimum benefits		Other policy-related balances		$	2,488,944			$	8,831,285
Net embedded derivatives within liability host contracts				$	2,488,944			$	8,831,285

The following table presents changes in estimated fair value related to embedded derivatives:

 

		Years Ended December 31,
		2013				2012				2011
		(In thousands)
Net derivative gains (losses) (1)		$	6,776,544			$	(1,089,704)			$	(2,711,461)
Policyholder benefits and claims		$	(139,134)			$	72,507			$	70,390

 

 

 

(1)

The valuation of reinsured guaranteed minimum benefits includes a nonperformance risk adjustment. The amounts included in net derivative gains (losses), in connection with this adjustment, were ($996.3) million, ($1,603.0) million and $1,956.9 million, for the years ended December 31, 2013, 2012 and 2011, respectively. In addition, the valuation of ceded guaranteed minimum benefits includes a nonperformance risk adjustment. The amounts included in net derivative gains (losses), in connection with this adjustment, were $19.4 million, $2.9 million and ($23.1) million, for the years ended December 31, 2013, 2012 and 2011, respectively.

 

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

7.  Fair Value

When developing estimated fair values, the Company considers three broad valuation techniques: (i) the market approach, (ii) the income approach, and (iii) the cost approach. The Company determines the most appropriate valuation technique to use, given what is being measured and the availability of sufficient inputs, giving priority to observable inputs. The Company categorizes its assets and liabilities measured at estimated fair value into a three-level hierarchy, based on the significant input with the lowest level in its valuation. The input levels are as follows:

 

		Level 1		Unadjusted quoted prices in active markets for identical assets or liabilities. The size of the bid/ask spread is used as an indicator of market activity for fixed maturity securities.
		Level 2		Quoted prices in markets that are not active or inputs that are observable either directly or indirectly. These inputs can include quoted prices for similar assets or liabilities other than quoted prices in Level 1, quoted prices in markets that are not active, or other significant inputs that are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities.
		Level 3		Unobservable inputs that are supported by little or no market activity and are significant to the determination of estimated fair value of the assets or liabilities. Unobservable inputs reflect the reporting entity’s own assumptions about the assumptions that market participants would use in pricing the asset or liability.

Financial markets are susceptible to severe events evidenced by rapid depreciation in asset values accompanied by a reduction in asset liquidity. The Company’s ability to sell securities, or the price ultimately realized for these securities, depends upon the demand and liquidity in the market and increases the use of judgment in determining the estimated fair value of certain securities.

Considerable judgment is often required in interpreting market data to develop estimates of fair value, and the use of different assumptions or valuation methodologies may have a material effect on the estimated fair value amounts.

 

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

7.  Fair Value (continued)

 

Recurring Fair Value Measurements

The assets and liabilities measured at estimated fair value on a recurring basis and their corresponding placement in the fair value hierarchy are presented below.

 

		December 31, 2013
		Fair Value Hierarchy
		Level 1				Level 2				Level 3				Total Estimated Fair Value
		(In thousands)
Assets:
Fixed maturity securities:
Foreign corporate		$	—			$	533,423			$	—			$	533,423
U.S. corporate			—				253,705				9,917				263,622
CMBS			—				75,017				57,547				132,564
State and political subdivision			—				120,256				—				120,256
U.S. Treasury and agency			99,248				—				—				99,248
ABS			—				80,520				—				80,520
RMBS			—				62,789				—				62,789
Foreign government			—				28,659				—				28,659
Total fixed maturity securities			99,248				1,154,369				67,464				1,321,081
Short-term investments (1)			2,630,762				101,270				—				2,732,032
Derivative assets: (2)
Interest rate contracts			9,046				1,171,719				—				1,180,765
Foreign currency contracts			1,169				728				—				1,897
Equity market contracts			1,284				917,797				273,756				1,192,837
Total derivative assets			11,499				2,090,244				273,756				2,375,499
Net embedded derivatives within asset host contracts (3)			—				—				146,550				146,550
Total assets		$	2,741,509			$	3,345,883			$	487,770			$	6,575,162
Liabilities:
Derivative liabilities: (2)
Interest rate contracts		$	6,547			$	798,367			$	—			$	804,914
Foreign currency contracts			1,022				171,078				—				172,100
Equity market contracts			39,601				1,136,875				494,964				1,671,440
Total derivative liabilities			47,170				2,106,320				494,964				2,648,454
Net embedded derivatives within liability host contracts (3)			—				—				2,488,944				2,488,944
Total liabilities		$	47,170			$	2,106,320			$	2,983,908			$	5,137,398

 

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

7.  Fair Value (continued)

 

		December 31, 2012
		Fair Value Hierarchy												Total Estimated Fair Value
		Level 1				Level 2				Level 3
		(In thousands)
Assets:
Fixed maturity securities:
Foreign corporate		$	—			$	628,708			$	2,714			$	631,422
U.S. corporate			—				307,001				15,465				322,466
CMBS			—				44,603				41,723				86,326
State and political subdivision			—				135,567				—				135,567
U.S. Treasury and agency			285,259				8,270				—				293,529
ABS			—				193,876				4,000				197,876
RMBS			—				81,906				—				81,906
Foreign government			—				36,527				—				36,527
Total fixed maturity securities			285,259				1,436,458				63,902				1,785,619
Short-term investments (1)			3,824,840				425,354				4,996				4,255,190
Derivative assets: (2)
Interest rate contracts			598				2,170,219				—				2,170,817
Foreign currency contracts			3,864				1,051				—				4,915
Equity market contracts			14,146				2,000,970				461,580				2,476,696
Total derivative assets			18,608				4,172,240				461,580				4,652,428
Net embedded derivatives within asset host contracts (3)			—				—				330,047				330,047
Total assets		$	4,128,707			$	6,034,052			$	860,525			$	11,023,284
Liabilities:
Derivative liabilities: (2)
Interest rate contracts		$	20,980			$	670,059			$	—			$	691,039
Foreign currency contracts			—				177,496				—				177,496
Equity market contracts			105,452				416,032				275,979				797,463
Total derivative liabilities			126,432				1,263,587				275,979				1,665,998
Net embedded derivatives within liability host contracts (3)			—				—				8,831,285				8,831,285
Total liabilities		$	126,432			$	1,263,587			$	9,107,264			$	10,497,283

 

 

(1)	Short-term investments as presented in the tables above differ from the amounts presented in the balance sheets because certain short-term investments are not measured at estimated fair value on a recurring basis.

 

(2)	Derivative amounts are presented gross in the tables above to reflect the presentation in the balance sheets, but are presented net for purposes of the rollforward in the Fair Value Measurements Using Significant Unobservable Inputs (Level 3) tables.

 

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

7.  Fair Value (continued)

 

(3)

Net embedded derivatives within asset host contracts are presented within funds withheld at interest and premiums, reinsurance and other receivables in the balance sheets. Net embedded derivatives within liability host contracts are presented within other policy-related balances in the balance sheets.

The following describes the valuation methodologies used to measure assets and liabilities at fair value. The description includes the valuation techniques and key inputs for each category of assets or liabilities that are classified within Level 2 and Level 3 of the fair value hierarchy.

Investments

Valuation Controls and Procedures

On behalf of the Company and the Holding Company’s Chief Investment Officer and Chief Financial Officer, a pricing and valuation committee that is independent of the trading and investing functions and comprised of senior management provides oversight of control systems and valuation policies for securities and derivatives. On a quarterly basis, this committee reviews and approves new transaction types and markets, ensures that observable market prices and market-based parameters are used for valuation, wherever possible, and determines that judgmental valuation adjustments, when applied, are based upon established policies and are applied consistently over time. This committee also provides oversight of the selection of independent third party pricing providers and the controls and procedures to evaluate third party pricing. Periodically, the Chief Accounting Officer reports to the Audit Committee of the Holding Company’s Board of Directors regarding compliance with fair value accounting standards.

The Company reviews its valuation methodologies on an ongoing basis and revises those methodologies when necessary based on changing market conditions. Assurance is gained on the overall reasonableness and consistent application of input assumptions, valuation methodologies and compliance with fair value accounting standards through controls designed to ensure valuations represent an exit price. Several controls are utilized, including certain monthly controls, which include, but are not limited to, analysis of portfolio returns to corresponding benchmark returns, comparing a sample of executed prices of securities sold to the fair value estimates, comparing fair value estimates to management’s knowledge of the current market, reviewing the bid/ask spreads to assess activity, comparing prices from multiple independent pricing services and ongoing due diligence to confirm that independent pricing services use market-based parameters. The process includes a determination of the observability of inputs used in estimated fair values received from independent pricing services or brokers by assessing whether these inputs can be corroborated by observable market data. The Company ensures that prices received from independent brokers, also referred to herein as “consensus pricing,” represent a reasonable estimate of fair value by considering such pricing relative to the Company’s knowledge of the current market dynamics and current pricing for similar financial instruments.

The Company also applies a formal process to challenge any prices received from independent pricing services that are not considered representative of estimated fair value. If prices received from independent pricing services are not considered reflective of market activity or representative of estimated fair value, independent non-binding broker quotations are obtained, or an internally developed valuation is prepared. Internally developed valuations of current estimated fair value, which reflect internal estimates of liquidity and nonperformance risks, compared with pricing received from the independent pricing services, did not produce material differences in the estimated fair values for the majority of the portfolio; accordingly, overrides were not material. This is, in part, because internal estimates of liquidity and nonperformance risks are generally

 

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

7.  Fair Value (continued)

 

based on available market evidence and estimates used by other market participants. In the absence of such market-based evidence, management’s best estimate is used.

Securities and Short-term Investments

When available, the estimated fair value of these investments is based on quoted prices in active markets that are readily and regularly obtainable. Generally, these are the most liquid of the Company’s securities holdings and valuation of these securities does not involve management’s judgment.

When quoted prices in active markets are not available, the determination of estimated fair value is based on market standard valuation methodologies, giving priority to observable inputs. The significant inputs to the market standard valuation methodologies for certain types of securities with reasonable levels of price transparency are inputs that are observable in the market or can be derived principally from, or corroborated by, observable market data. When observable inputs are not available, the market standard valuation methodologies rely on inputs that are significant to the estimated fair value that are not observable in the market or cannot be derived principally from, or corroborated by, observable market data. These unobservable inputs can be based in large part on management’s judgment or estimation and cannot be supported by reference to market activity. Even though these inputs are unobservable, management believes they are consistent with what other market participants would use when pricing such securities and are considered appropriate given the circumstances.

Level 2 Valuation Techniques and Key Inputs:

This level includes fixed maturity securities priced principally by independent pricing services using observable inputs. Short-term investments within this level are of a similar nature and class to the Level 2 fixed maturity securities.

U.S. corporate and foreign corporate securities

These securities are principally valued using the market and income approaches. Valuations are based primarily on quoted prices in markets that are not active, or using matrix pricing or other similar techniques that use standard market observable inputs such as benchmark yields, spreads off benchmark yields, new issuances, issuer rating, duration, and trades of identical or comparable securities. Privately placed securities are valued using matrix pricing methodologies using standard market observable inputs, and inputs derived from, or corroborated by, market observable data including market yield curve, duration, call provisions, observable prices and spreads for similar publicly traded or privately traded issues that incorporate the credit quality and industry sector of the issuer and in certain cases, delta spread adjustments to reflect specific credit related issues.

Structured securities comprised of ABS, CMBS and RMBS

These securities are principally valued using the market and income approaches. Valuations are based primarily on matrix pricing, discounted cash flow methodologies or other similar techniques using standard market inputs including spreads for actively traded securities, spreads off benchmark yields, expected prepayment speeds and volumes, current and forecasted loss severity, rating, weighted average coupon,

 

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

7.  Fair Value (continued)

 

weighted average maturity, average delinquency rates, geographic region, debt-service coverage ratios and issuance-specific information including, but not limited to: collateral type, payment terms of the underlying assets, payment priority within the tranche, structure of the security, deal performance and vintage of loans.

State and political subdivision and foreign government securities

These securities are principally valued using the market approach. Valuations are based primarily on matrix pricing or other similar techniques using standard market observable inputs including a benchmark U.S. Treasury yield or other yields, issuer ratings, broker-dealer quotes, issuer spreads and reported trades of similar securities, including those within the same sub-sector or with a similar maturity or credit rating.

U.S. Treasury and agency securities

These securities are principally valued using the market approach. Valuations are based primarily on quoted prices in markets that are not active or using matrix pricing or other similar techniques using standard market observable inputs such as a benchmark U.S. Treasury yield curve, the spread off the U.S. Treasury yield curve for the identical security and comparable securities that are actively traded.

Level 3 Valuation Techniques and Key Inputs:

In general, securities classified within Level 3 use many of the same valuation techniques and inputs as described previously for in the Level 2. However, if key inputs are unobservable, or if the investments are less liquid and there is very limited trading activity, the investments are generally classified as Level 3. The use of independent non-binding broker quotations to value investments generally indicates there is a lack of liquidity or a lack of transparency in the process to develop the valuation estimates, generally causing these investments to be classified in Level 3.

Short-term investments within this level are of a similar nature and class to the Level 3 securities described below; accordingly, the valuation techniques and significant market standard observable inputs used in their valuation are also similar to those described below.

U.S. corporate and foreign corporate securities

These securities are principally valued using the market approach. Valuations are based primarily on matrix pricing or other similar techniques that utilize unobservable inputs or inputs that cannot be derived principally from, or corroborated by, observable market data, including illiquidity premium, delta spread adjustments to reflect specific credit-related issues, credit spreads and inputs including quoted prices for identical or similar securities that are less liquid and based on lower levels of trading activity than securities classified in Level 2. Certain valuations are based on independent non-binding broker quotations.

Structured securities comprised of ABS and CMBS

These securities are principally valued using the market and income approaches. Valuations are based primarily on matrix pricing, discounted cash flow methodologies or other similar techniques that utilize inputs that are unobservable or cannot be derived principally from, or corroborated by, observable market data including credit spreads. Below investment grade securities and sub-prime RMBS included in this level

 

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

7.  Fair Value (continued)

 

are valued based on inputs including quoted prices for identical or similar securities that are less liquid and based on lower levels of trading activity than securities classified in Level 2. Certain of these valuations are based on independent non-binding broker quotations.

Derivatives

The estimated fair value of derivatives is determined through the use of quoted market prices for exchange-traded derivatives, or through the use of pricing models for OTC-bilateral and OTC-cleared derivatives. The determination of estimated fair value, when quoted market values are not available, is based on market standard valuation methodologies and inputs that management believes are consistent with what other market participants would use when pricing such instruments. Derivative valuations can be affected by changes in interest rates, foreign currency exchange rates, financial indices, credit spreads, default risk, nonperformance risk, volatility, liquidity and changes in estimates and assumptions used in the pricing models. The valuation controls and procedures for derivatives are described in “— Investments.”

The significant inputs to the pricing models for most OTC-bilateral and OTC-cleared derivatives are inputs that are observable in the market or can be derived principally from, or corroborated by, observable market data. Significant inputs that are observable generally include: interest rates, foreign currency exchange rates, interest rate curves, credit curves and volatility. However, certain OTC-bilateral and OTC-cleared derivatives may rely on inputs that are significant to the estimated fair value that are not observable in the market or cannot be derived principally from, or corroborated by, observable market data. Significant inputs that are unobservable generally include references to emerging market currencies and inputs that are outside the observable portion of the interest rate curve, credit curve, volatility or other relevant market measure. These unobservable inputs may involve significant management judgment or estimation. Even though unobservable, these inputs are based on assumptions deemed appropriate given the circumstances and management believes they are consistent with what other market participants would use when pricing such instruments.

Most inputs for OTC-bilateral and OTC-cleared derivatives are mid-market inputs but, in certain cases, liquidity adjustments are made when they are deemed more representative of exit value. Market liquidity, as well as the use of different methodologies, assumptions and inputs, may have a material effect on the estimated fair values of the Company’s derivatives and could materially affect net income.

The credit risk of both the counterparty and the Company are considered in determining the estimated fair value for all OTC-bilateral and OTC-cleared derivatives, and any potential credit adjustment is based on the net exposure by counterparty after taking into account the effects of netting agreements and collateral arrangements. The Company values its OTC-bilateral and OTC-cleared derivatives using standard swap curves which may include a spread to the risk free rate, depending upon specific collateral arrangements. This credit spread is appropriate for those parties that execute trades at pricing levels consistent with similar collateral arrangements. As the Company and its significant derivative counterparties generally execute trades at such pricing levels and hold sufficient collateral, additional credit risk adjustments are not currently required in the valuation process. The Company’s ability to consistently execute at such pricing levels is in part due to the netting agreements and collateral arrangements that are in place with all of its significant derivative counterparties. An evaluation of the requirement to make additional credit risk adjustments is performed by the Company each reporting period.

 

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

7.  Fair Value (continued)

 

Freestanding Derivatives

Level 2 Valuation Techniques and Key Inputs:

This level includes all types of derivatives utilized by the Company with the exception of exchange-traded derivatives included within Level 1 and those derivatives with unobservable inputs as described in Level 3. These derivatives are principally valued using the income approach.

Interest rate

Non-option-based. — Valuations are based on present value techniques, which utilize significant inputs that may include the swap yield curve and basis curves.

Option-based. — Valuations are based on option pricing models, which utilize significant inputs that may include the swap yield curve, basis curves and interest rate volatility.

Foreign currency exchange rate

Non-option-based. — Valuations are based on present value techniques, which utilize significant inputs that may include the swap yield curve, basis curves, currency spot rates and cross currency basis curves.

Equity market

Non-option-based. — Valuations are based on present value techniques, which utilize significant inputs that may include the swap yield curve, spot equity index levels and dividend yield curves.

Option-based. — Valuations are based on option pricing models, which utilize significant inputs that may include the swap yield curve, spot equity index levels, dividend yield curves and equity volatility.

Level 3 Valuation Techniques and Key Inputs:

These derivatives are principally valued using the income approach. Valuations of non-option-based derivatives utilize present value techniques, whereas valuations of option-based derivatives utilize option pricing models. These valuation methodologies generally use the same inputs as described in the corresponding sections above for Level 2 measurements of derivatives. However, these derivatives result in Level 3 classification because one or more of the significant inputs are not observable in the market or cannot be derived principally from, or corroborated by, observable market data.

Equity market

Non-option-based. — Significant unobservable inputs may include the extrapolation beyond observable limits of dividend yield curves and equity volatility.

Option-based. — Significant unobservable inputs may include the extrapolation beyond observable limits of dividend yield curves, equity volatility and unobservable correlation between model inputs.

 

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

7.  Fair Value (continued)

 

Embedded Derivatives

Embedded derivatives principally include certain assumed and ceded variable annuity guarantees and equity indexed crediting rates within certain funding agreements. Embedded derivatives are recorded at estimated fair value with changes in estimated fair value reported in net income.

The fair value of these embedded derivatives, estimated as the present value of projected future benefits minus the present value of projected future fees using actuarial and capital market assumptions including expectations concerning policyholder behavior, is calculated by the Company’s actuarial department. The calculation is based on in-force business, and is performed using standard actuarial valuation software which projects future cash flows from the embedded derivative over multiple risk neutral stochastic scenarios using observable risk free rates.

Capital market assumptions, such as risk free rates and implied volatilities, are based on market prices for publicly traded instruments to the extent that prices for such instruments are observable. Implied volatilities beyond the observable period are extrapolated based on observable implied volatilities and historical volatilities. Actuarial assumptions, including mortality, lapse, withdrawal and utilization, are unobservable and are reviewed at least annually based on actuarial studies of historical experience.

The valuation of these guarantee liabilities includes nonperformance risk adjustments and adjustments for a risk margin related to non-capital market inputs. The nonperformance adjustment is determined by taking into consideration publicly available information relating to spreads in the secondary market for the Holding Company’s debt, including related credit default swaps.

Risk margins are established to capture the non-capital market risks of the instrument which represent the additional compensation a market participant would require to assume the risks related to the uncertainties of such actuarial assumptions as annuitization, premium persistency, partial withdrawal and surrenders. The establishment of risk margins requires the use of significant management judgment, including assumptions of the amount and cost of capital needed to cover the guarantees. These guarantees may be more costly than expected in volatile or declining equity markets. Market conditions including, but not limited to, changes in interest rates, equity indices, market volatility and foreign currency exchange rates; changes in nonperformance risk; and variations in actuarial assumptions regarding policyholder behavior, mortality and risk margins related to non-capital market inputs, may result in significant fluctuations in the estimated fair value of the guarantees that could materially affect net income.

The Company ceded the risk associated with certain of the GMIBs previously described. These reinsurance agreements contain embedded derivatives which are included within premiums, reinsurance and other receivables in the balance sheets with changes in estimated fair value reported in net derivative gains (losses) or policyholder benefits and claims depending on the statement of operations classification of the direct risk. The value of the embedded derivatives on the ceded risk is determined using a methodology consistent with that described previously with the exception of the input for nonperformance risk that reflects the credit of the reinsurer.

 

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

7.  Fair Value (continued)

 

The estimated fair value of the embedded derivatives within funds withheld related to certain assumed reinsurance is determined based on the change in estimated fair value of the underlying assets held by the Company in a reference portfolio backing the funds withheld liability. The estimated fair value of the underlying assets is determined as previously described in “— Investments — Securities and Short-term Investments.” The estimated fair value of these embedded derivatives is included, along with their funds withheld hosts, in derivative liabilities and funds withheld at interest in the balance sheets with changes in estimated fair value recorded in net derivative gains (losses). Changes in the credit spreads on the underlying assets, interest rates and market volatility may result in significant fluctuations in the estimated fair value of these embedded derivatives that could materially affect net income.

Embedded Derivatives Within Asset and Liability Host Contracts

Level 3 Valuation Techniques and Key Inputs:

Assumed Guaranteed Minimum Benefits

These embedded derivatives are principally valued using the income approach. Valuations are based on option pricing techniques, which utilize significant inputs that may include swap yield curve, currency exchange rates and implied volatilities. These embedded derivatives result in Level 3 classification because one or more of the significant inputs are not observable in the market or cannot be derived principally from, or corroborated by, observable market data. Significant unobservable inputs generally include: the extrapolation beyond observable limits of the swap yield curve and implied volatilities, actuarial assumptions for policyholder behavior and mortality and the potential variability in policyholder behavior and mortality, nonperformance risk and cost of capital for purposes of calculating the risk margin.

Reinsurance Ceded on Certain Guaranteed Minimum Benefits

These embedded derivatives are principally valued using the income approach. The valuation techniques and significant market standard unobservable inputs used in their valuation are similar to those described above in “ — Assumed Guaranteed Minimum Benefits” and also include counterparty credit spreads.

Embedded Derivatives within Funds Withheld Related to Certain Assumed Reinsurance

These embedded derivatives are principally valued using an income approach. Valuations are based on present value techniques, which utilize significant inputs that may include the swap yield curve and the fair value of assets within the reference portfolio. These embedded derivatives result in Level 3 classification because one or more of the significant inputs are not observable in the market or cannot be derived principally from, or corroborated by, observable market data. Significant unobservable inputs generally include: the fair value of certain assets within the reference portfolio which are not observable in the market and cannot be derived principally from, or corroborated by, observable market data.

Transfers between Levels

Overall, transfers between levels occur when there are changes in the observability of inputs and market activity. Transfers into or out of any level are assumed to occur at the beginning of the period.

 

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

7.  Fair Value (continued)

 

Transfers between Levels 1 and 2:

There were no transfers between Levels 1 and 2 for assets and liabilities measured at estimated fair value and still held at December 31, 2013 and 2012.

Transfers into or out of Level 3:

Assets and liabilities are transferred into Level 3 when a significant input cannot be corroborated with market observable data. This occurs when market activity decreases significantly and underlying inputs cannot be observed, current prices are not available, and/or when there are significant variances in quoted prices, thereby affecting transparency. Assets and liabilities are transferred out of Level 3 when circumstances change such that a significant input can be corroborated with market observable data. This may be due to a significant increase in market activity, a specific event, or one or more significant input(s) becoming observable.

Transfers into Level 3 for fixed maturity securities were due primarily to a lack of trading activity, decreased liquidity and credit ratings downgrades (e.g., from investment grade to below investment grade) which have resulted in decreased transparency of valuations and an increased use of independent non-binding broker quotations and unobservable inputs, such as illiquidity premiums, delta spread adjustments, or credit spreads.

Transfers out of Level 3 for fixed maturity securities resulted primarily from increased transparency of both new issuances that, subsequent to issuance and establishment of trading activity, became priced by independent pricing services and existing issuances that, over time, the Company was able to obtain pricing from, or corroborate pricing received from, independent pricing services with observable inputs (such as observable spreads used in pricing securities) or increases in market activity and upgraded credit ratings.

 

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

7.  Fair Value (continued)

 

Assets and Liabilities Measured at Fair Value Using Significant Unobservable Inputs (Level 3)

The following table presents certain quantitative information about the significant unobservable inputs used in the fair value measurement, and the sensitivity of the estimated fair value to changes in those inputs, for the more significant asset and liability classes measured at fair value on a recurring basis using significant unobservable inputs (Level 3) at:

 

						December 31, 2013																December 31, 2012																Impact of Increase in Input on Estimated Fair Value (2)
		Valuation Techniques		Significant Unobservable Inputs		Range												Weighted Average (1)				Range												Weighted Average (1)
Fixed maturity securities: (3)
U.S. corporate and foreign corporate		•   Matrix pricing		•   Credit spreads (4)			95				–				95				95				103				–				499				168			Decrease
				•   Illiquidity premium (4)			30				–				30				30				30				–				30				30			Decrease
CMBS		•   Matrix pricing and discounted cash flow		•   Credit spreads (4)			215				–				215				215																			Decrease (6)
		•   Market pricing		•   Quoted prices (5)			104				–				104				104				104				–				104				104			Increase (6)
		•   Consensus pricing		•   Offered quotes (5)			90				–				92				91																			Increase (6)
Derivatives:
Equity market		•   Present value techniques		•   Volatility (7)			13	%			–				28	%							13	%			–				32	%						Increase (8)
		or option pricing models		•   Correlation (9)			60	%			–				60	%							65	%			–				65	%
Embedded derivatives:
Assumed and ceded guaranteed minimum benefits		•   Option pricing techniques		•   Mortality rates:     Ages 0 - 40			0	%			–				0.10	%							0	%			–				0.14	%						Decrease (10)
				Ages 41 - 60			0.04	%			–				0.65	%							0.05	%			–				0.75	%						Decrease (10)
				Ages 61 - 115			0.26	%			–				100	%							0.26	%			–				100	%						Decrease (10)
				•   Lapse rates:
				Durations 1 - 10			0.50	%			–				100	%							0.50	%			–				100	%						Decrease (11)
				Durations 11 - 20			3	%			–				100	%							3	%			–				100	%						Decrease (11)
				Durations 21 - 116			3	%			–				100	%							2.5	%			–				100	%						Decrease (11)
				•   Utilization rates			20	%			–				50	%							20	%			–				50	%						Increase (12)
				•   Withdrawal rates			0.07	%			–				10	%							0.07	%			–				20	%						(13)
				•   Long-term equity volatilities			17.40	%			–				25	%							15.18	%			–				40	%						Increase (14)
				•   Nonperformance risk spread			0.03	%			–				0.44	%							0.10	%			–				1.72	%						Decrease (15)

 

 

(1)	The weighted average for fixed maturity securities is determined based on the estimated fair value of the securities.

 

(2)	The impact of a decrease in input would have the opposite impact on the estimated fair value. For embedded derivatives, changes to assumed guaranteed minimum benefits are based on liability positions and changes to ceded guaranteed minimum benefits are based on asset positions.

 

(3)	Significant increases (decreases) in expected default rates in isolation would result in substantially lower (higher) valuations.

 

(4)	Range and weighted average are presented in basis points.

 

(5)	Range and weighted average are presented in accordance with the market convention for fixed maturity securities of dollars per hundred dollars of par.

 

(6)	Changes in the assumptions used for the probability of default is accompanied by a directionally similar change in the assumption used for the loss severity and a directionally opposite change in the assumptions used for prepayment rates.

 

(7)	Ranges represent the underlying equity volatility quoted in percentage points. Since this valuation methodology uses a range of inputs across multiple volatility surfaces to value the derivative, presenting a range is more representative of the unobservable input used in the valuation.

 

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

7.  Fair Value (continued)

 

(8)	Changes are based on long U.S. dollar net asset positions and will be inversely impacted for short U.S. dollar net asset positions.

 

(9)

Ranges represent the different correlation factors utilized as components within the valuation methodology. Presenting a range of correlation factors is more representative of the unobservable input used in the valuation. Increases (decreases) in correlation in isolation will increase (decrease) the significance of the change in valuations.

 

(10)

Mortality rates vary by age and by demographic characteristics such as gender. Mortality rate assumptions are based on company experience. A mortality improvement assumption is also applied. For any given contract, mortality rates vary throughout the period over which cash flows are projected for purposes of valuing the embedded derivative.

 

(11)

Base lapse rates are adjusted at the contract level based on a comparison of the actuarially calculated guaranteed values and the current policyholder account value, as well as other factors, such as the applicability of any surrender charges. A dynamic lapse function reduces the base lapse rate when the guaranteed amount is greater than the account value as in the money contracts are less likely to lapse. Lapse rates are also generally assumed to be lower in periods when a surrender charge applies. For any given contract, lapse rates vary throughout the period over which cash flows are projected for purposes of valuing the embedded derivative.

 

(12)

The utilization rate assumption estimates the percentage of contract holders with a GMIB or lifetime withdrawal benefit who will elect to utilize the benefit upon becoming eligible. The rates may vary by the type of guarantee, the amount by which the guaranteed amount is greater than the account value, the contract’s withdrawal history and by the age of the policyholder. For any given contract, utilization rates vary throughout the period over which cash flows are projected for purposes of valuing the embedded derivative.

 

(13)

The withdrawal rate represents the percentage of account balance that any given policyholder will elect to withdraw from the contract each year. The withdrawal rate assumption varies by age and duration of the contract, and also by other factors such as benefit type. For any given contract, withdrawal rates vary throughout the period over which cash flows are projected for purposes of valuing the embedded derivative. For GMWBs, any increase (decrease) in withdrawal rates results in an increase (decrease) in the estimated fair value of the guarantees. For GMABs and GMIBs, any increase (decrease) in withdrawal rates results in a decrease (increase) in the estimated fair value.

 

(14)

Long-term equity volatilities represent equity volatility beyond the period for which observable equity volatilities are available. For any given contract, long-term equity volatility rates vary throughout the period over which cash flows are projected for purposes of valuing the embedded derivative.

 

(15)	Nonperformance risk spread varies by duration and by currency. For any given contract, multiple nonperformance risk spreads will apply, depending on the duration of the cash flow being discounted for purposes of valuing the embedded derivative.

The following is a summary of the valuation techniques and significant unobservable inputs used in the fair value measurement of assets and liabilities classified within Level 3 that are not included in the preceding table. Generally, all other classes of securities classified within Level 3, including those within embedded derivatives within funds withheld related to certain assumed reinsurance, use the same valuation techniques and significant unobservable inputs as previously described for Level 3 fixed maturity securities. This includes matrix pricing and discounted cash flow methodologies, inputs such as quoted prices for identical or similar securities that are less liquid and based on lower levels of trading activity than securities classified in Level 2, as well as independent non-binding broker quotations. The sensitivity of the estimated fair value to changes in the significant unobservable inputs for these other assets and liabilities is similar in nature to that described in the preceding table.

 

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

7.  Fair Value (continued)

 

The following tables summarize the change of all assets and (liabilities) measured at estimated fair value on a recurring basis using significant unobservable inputs (Level 3):

 

		Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
		Fixed Maturity Securities:
		Foreign Corporate				U.S. Corporate				CMBS				ABS				Short-term Investments				Equity Market				Net Embedded Derivatives (6)
		(In thousands)
Year Ended December 31, 2013:
Balance, January 1,		$	2,714			$	15,465			$	41,723			$	4,000			$	4,996			$	185,601			$	(8,501,238)
Total realized/unrealized gains (losses) included in:
Net income (loss): (1), (2)
Net investment income			11				(63)				(242)				—				4				—				—
Net investment gains (losses)			—				—				—				—				—				—				—
Net derivative gains (losses)			—				—				—				—				—				(425,674)				6,789,870
Policyholder benefits and claims			—				—				—				—				—				18,720				(139,134)
OCI			(25)				(652)				(1,828)				—				—				252				291,536
Purchases (3)			—				—				17,894				—				—				7,149				—
Sales (3)			(2,700)				(8,680)				—				—				(5,000)				—				—
Settlements (3)			—				—				—				—				—				(7,256)				(783,428)
Transfers into Level 3 (4)			—				3,847				—				—				—				—				—
Transfers out of Level 3 (4)			—				—				—				(4,000)				—				—				—
Balance, December 31,		$	—			$	9,917			$	57,547			$	—			$	—			$	(221,208)			$	(2,342,394)
Changes in unrealized gains (losses) included in net income (loss): (5)
Net investment income		$	—			$	4			$	(242)			$	—			$	—			$	—			$	—
Net investment gains (losses)		$	—			$	—			$	—			$	—			$	—			$	—			$	—
Net derivative gains (losses)		$	—			$	—			$	—			$	—			$	—			$	(414,667)			$	6,743,952
Policyholder benefits and claims		$	—			$	—			$	—			$	—			$	—			$	18,720			$	(134,839)

 

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

7.  Fair Value (continued)

 

		Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
		Fixed Maturity Securities:																Equity Securities:
		Foreign Corporate				U.S. Corporate				CMBS				ABS				Non-redeemable Preferred Stock				Short-term Investments				Equity Market				Net Embedded Derivatives (6)
		(In thousands)
Year Ended December 31, 2012:
Balance, January 1,		$	2,533			$	15,114			$	41,724			$	—			$	—			$	39,967			$	844,062			$	(7,033,096)
Total realized/unrealized gains (losses) included in:
Net income (loss): (1), (2)
Net investment income			12				(16)				(164)				—				—				35				—				—
Net investment gains (losses)			—				—				—				—				—				—				—				—
Net derivative gains (losses)			—				—				—				—				—				—				(507,571)				(1,085,812)
Policyholder benefits and claims			—				—				—				—				—				—				28,895				72,507
OCI			169				(4)				163				—				—				—				(2,565)				259,765
Purchases (3)			—				6,501				—				4,000				—				4,994				19,056				—
Sales (3)			—				(701)				—				—				—				(40,000)				(43,500)				—
Settlements (3)			—				—				—				—				—				—				(152,776)				(714,602)
Transfers into Level 3 (4)			—				—				—				—				—				—				—				—
Transfers out of Level 3 (4)			—				(5,429)				—				—				—				—				—				—
Balance, December 31,		$	2,714			$	15,465			$	41,723			$	4,000			$	—			$	4,996			$	185,601			$	(8,501,238)
Changes in unrealized gains (losses) included in net income (loss): (5)
Net investment income		$	11			$	9			$	(163)			$	—			$	—			$	2			$	—			$	—
Net investment gains (losses)		$	—			$	—			$	—			$	—			$	—			$	—			$	—			$	—
Net derivative gains (losses)		$	—			$	—			$	—			$	—			$	—			$	—			$	(498,377)			$	(1,139,890)
Policyholder benefits and claims		$	—			$	—			$	—			$	—			$	—			$	—			$	28,895			$	75,146

 

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

7.  Fair Value (continued)

 

		Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
		Fixed Maturity Securities:																Equity Securities:
		Foreign Corporate				U.S. Corporate				CMBS				ABS				Non-redeemable Preferred Stock				Short-term Investments				Equity Market				Net Embedded Derivatives (6)
		(In thousands)
Year Ended December 31, 2011:
Balance, January 1,		$	2,673			$	10,430			$	—			$	—			$	2,835			$	49,980			$	124,720			$	(3,660,494	)
Total realized/unrealized gains (losses) included in:
Net income (loss): (1), (2)
Net investment income			10				4				(104	)			—				—				19				—				—
Net investment gains (losses)			—				1				—				—				(292	)			—				—				—
Net derivative gains (losses)			—				—				—				—				—				—				563,864				(2,710,927	)
Policyholder benefits and claims			—				—				—				—				—				—				7,131				70,390
OCI			(150	)			(511	)			104				—				337				—				409				(120,058	)
Purchases (3)			—				—				41,724				—				—				39,951				225,211				—
Sales (3)			—				(1,974	)			—				—				(2,880	)			(49,983)				—				—
Settlements (3)			—				—				—				—				—				—				(2,563)				(612,007	)
Transfers into Level 3 (4)			—				7,164				—				—				—				—				—				—
Transfers out of Level 3 (4)			—				—				—				—				—				—				(74,710)				—
Balance, December 31,		$	2,533			$	15,114			$	41,724			$	—			$	—			$	39,967			$	844,062			$	(7,033,096	)
Changes in unrealized gains (losses) included in net income (loss): (5)
Net investment income		$	10			$	4			$	(104	)		$	—			$	—			$	15			$	—			$	—
Net investment gains (losses)		$	—			$	1			$	—			$	—			$	(292	)		$	—			$	—			$	—
Net derivative gains (losses)		$	—			$	—			$	—			$	—			$	—			$	—			$	566,325			$	2,735,936
Policyholder benefits and claims		$	—			$	—			$	—			$	—			$	—			$	—			$	7,131			$	108,678

 

 

(1)	Amortization of premium/accretion of discount is included within net investment income. Impairments charged to net income (loss) on securities are included in net investment gains (losses). Lapses associated with net embedded derivatives are included in net derivative gains (losses).

 

(2)	Interest and dividend accruals, as well as cash interest coupons and dividends received, are excluded from the rollforward.

 

(3)

The amount reported within purchases, sales, issuances and settlements is the purchase or issuance price and the sales or settlement proceeds based upon the actual date purchased or issued and sold or settled, respectively. Items purchased/issued and sold/settled in the same period are excluded from the rollforward. Fees attributed to embedded derivatives are included in settlements.

 

(4)	Gains and losses, in net income (loss) and other comprehensive income (loss), are calculated assuming transfers into and/or out of Level 3 occurred at the beginning of the period. Items transferred into and then out of Level 3 in the same period are excluded from the rollforward.

 

(5)	Changes in unrealized gains (losses) included in net income (loss) relate to assets and liabilities still held at the end of the respective periods.

 

(6)	Embedded derivative assets and liabilities are presented net for purposes of the rollforward.

 

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

7.  Fair Value (continued)

 

Fair Value of Financial Instruments Carried at Other Than Fair Value

The following tables provide fair value information for financial instruments that are carried on the balance sheet at amounts other than fair value. These tables exclude the following financial instruments: cash and cash equivalents, accrued investment income, the obligation to return cash collateral received (included in other liabilities on the balance sheets) and short-term investments that are not securities, such as time deposits, and therefore are not included in the three level hierarchy table disclosed in the “— Recurring Fair Value Measurements” section. The estimated fair value of the excluded financial instruments, which are primarily classified in Level 2 and, to a lesser extent, in Level 1, approximates carrying value as they are short-term in nature such that the Company believes there is minimal risk of material changes in interest rates or credit quality. All remaining balance sheet amounts excluded from the table below are not considered financial instruments subject to this disclosure.

The carrying values and estimated fair values for such financial instruments, and their corresponding placement in the fair value hierarchy, are summarized as follows at:

 

		December 31, 2013
		Carrying Value				Fair Value Hierarchy												Total Estimated Fair Value
						Level 1				Level 2				Level 3
		(In thousands)
Assets
Premiums, reinsurance and other receivables		$	228,140			$	—			$	224,672			$	(161,249	)		$	63,423
Liabilities
Debt — affiliated		$	575,118			$	—			$	592,278			$	—			$	592,278
Other liabilities		$	3,836			$	—			$	3,836			$	—			$	3,836
		December 31, 2012
		Carrying Value				Fair Value Hierarchy												Total Estimated Fair Value
						Level 1				Level 2				Level 3
		(In thousands)
Assets
Premiums, reinsurance and other receivables		$	304,411			$	—			$	275,479			$	174,126			$	449,605
Liabilities
Debt — affiliated		$	75,118			$	—			$	82,174			$	—			$	82,174
Other liabilities		$	72			$	—			$	72			$	—			$	72

The methods, assumptions and significant valuation techniques and inputs used to estimate the fair value of financial instruments are summarized as follows:

Premiums, Reinsurance and Other Receivables

Premiums, reinsurance and other receivables are principally comprised of certain amounts recoverable under reinsurance agreements and amounts on deposit with financial institutions to facilitate daily settlements related to certain derivatives.

 

57

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

7.  Fair Value (continued)

 

Premiums receivable and those amounts recoverable under reinsurance agreements determined to transfer significant risk are not financial instruments subject to disclosure and thus have been excluded from the amounts presented. Amounts recoverable under ceded reinsurance agreements, which the Company has determined do not transfer significant risk such that they are accounted for using the deposit method of accounting, have been classified as Level 3. The valuation is based on discounted cash flow methodologies using significant unobservable inputs. The estimated fair value is determined using interest rates determined to reflect the appropriate credit standing of the assuming counterparty.

The amounts on deposit for derivative settlements, classified within Level 2, essentially represent the equivalent of demand deposit balances and amounts due for securities sold are generally received over short periods such that the estimated fair value approximates carrying value.

Debt — Affiliated

The estimated fair value of debt is principally determined using market standard valuation methodologies. Valuations are based primarily on quoted prices in markets that are not active or using matrix pricing that use standard market observable inputs such as quoted prices in markets that are not active and observable yields and spreads in the market. Instruments valued using discounted cash flow methodologies use standard market observable inputs including market yield curve, duration, observable prices and spreads for similar publicly traded or privately traded issues.

Other Liabilities

Other liabilities consist primarily of interest payable. The Company evaluates the specific terms, facts and circumstances of each instrument to determine the appropriate estimated fair values, which are not materially different from the carrying values.

8. Debt — Affiliated

The table below presents information for the Company’s long-term and short-term debt-affiliated outstanding at:

 

										December 31,
		Interest Rate				Maturity				2013				2012
										(in thousands)
Short-term and Long-term debt
Surplus note			6.798	%			2014			$	75,118			$	75,118
Senior notes			2.470	%			2015				500,000				—
Total debt-affiliated										$	575,118			$	75,118

On October 15, 2013, the Company issued $500.0 million of guaranteed senior notes, Series A, to various affiliates, maturing in 2015 with an interest rate of 2.47%.

On September 27, 2012, the Holding Company assumed $750.0 million of the Company’s senior notes with interest rates of 6.440% and 5.330%, payable to an affiliate. In exchange for the assumption of senior notes, the

 

58

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

8. Debt — Affiliated (continued)

 

Company issued to the Holding Company 75,000 shares of Series A 7.69% non-cumulative perpetual preferred shares with a par value of $1 per share and a liquidity preference of $10,000 per share. The dividend is payable semi-annually. (See Note 9 for additional information on preferred stock).

On December 19, 2012, the Holding Company assumed $1,250.0 million of the Company’s senior notes with interest rates of 7.440%, 5.640% and 5.860%, payable to various affiliates. In exchange for the assumption of senior notes, the Company issued to the Holding Company 125,000 shares of Series A 7.75% non-cumulative perpetual preferred shares with a par value of $1 per share and a liquidity preference of $10,000 per share. The dividend is payable semi-annually. (See Note 9 for additional information on preferred stock).

On July 15, 2011, the Company issued a $500.0 million guaranteed senior note, Series A, to various affiliates, maturing in 2021 with an interest rate of 5.64%.

On December 16, 2011, the Company issued a $500.0 million guaranteed senior note, Series B, to various affiliates, maturing in 2021 with an interest rate of 5.86%.

Interest expense related to the Company’s indebtedness, included in other expenses, was $7.7 million, $112.6 million and $83.3 million for the years ended December 31, 2013, 2012 and 2011, respectively.

Letters of Credit

The Company had access to certain letter of credit agreements totaling $5,450.0 million in letter of credit capacity from various banks, either directly with the bank or indirectly through letters of credit available to the Holding Company for the benefit of the Company and certain other affiliates of the Holding Company. At December 31, 2013, the Company had $802.0 million in outstanding letters of credit. The letters of credit were used to collateralize assumed liabilities.

Letters of credit outstanding as of December 31, 2013 were as follows:

 

Borrower(s)		Expiration				Capacity				Used by the Company				Used by Affiliates				Remaining Unused
		(In thousands)
Exeter			December 2027 (1)			$	650,000			$	600,000			$	—			$	50,000
Holding Company and MetLife Funding, Inc.			September 2017 (1)				1,000,000				—				59,000				941,000
Holding Company and MetLife Funding, Inc.			August 2016				3,000,000				2,000				130,789				2,867,211
Exeter, Holding Company & Missouri Reinsurance, Inc.			June 2016				500,000				—				490,000				10,000
Holding Company			August 2014				300,000				200,000				100,000				—
Total						$	5,450,000			$	802,000			$	779,789			$	3,868,211

 

 

(1)	The Holding Company is a guarantor under this agreement.

9.  Stockholder’s Equity

Effective October 1, 2013 in conjunction with the Company’s redomestication to Delaware the stockholder’s equity was restructured.

 

 

59

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

9.  Stockholder’s Equity (continued)

 

Information regarding the restructure was as follows at:

 

		December 31,
		2013				2012
Common stock
Shares authorized			13,875,000				14,125,000
Shares issued			13,466,000				13,466,000
Shares outstanding			13,466,000				13,466,000
Par value per share			$0.01				$1.00
		December 31,
		2013				2012
Preferred stock
Shares authorized			250,000				200,000
Shares issued			200,000				200,000
Shares outstanding			200,000				200,000
Par value per share			$0.01				$1.00
Liquidation preference per share			$10,000				$10,000

Preferred Stock

On September 27, 2012, the Company issued to the Holding Company 75,000 shares of 7.69% Series A non-cumulative perpetual preferred stock in exchange for the assumption of $750.0 million of the Company’s senior notes. See Note 8.

On December 19, 2012, the Company issued to the Holding Company 125,000 shares of 7.75% Series A non-cumulative perpetual preferred stock in exchange for the assumption of $1,250.0 million of the Company’s senior notes. See Note 8.

Equity

Under Delaware Law, the Company is required to maintain minimum capital of $250 thousand. The Company was in compliance with this requirement at December 31, 2013.

Under the Law, the Company was required to maintain net worth of $240 thousand. The Company was in compliance with this requirement at September 30, 2013 (prior to redomestication to Delaware) and December 31, 2012.

During the year ended December 31, 2013, the Company received no capital contributions from the Holding Company. The Company received capital contributions of $800.0 million and $673.0 million in cash from the Holding Company during the years ended December 31, 2012 and 2011.

During the years ended December 31, 2013, 2012 and 2011, the Holding Company paid and contributed, on the Company’s behalf, $26.8 million, $33.4 million and $30.9 million, respectively, in the form of letter of credit fees.

 

60

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

9.  Stockholder’s Equity (continued)

 

Dividend Restrictions

Under the strategic business plan of the company approved by the Delaware Insurance commissioner (the “Commissioner”), the company may not declare or pay dividend in any form to its parent without the approval of the Commissioner and in no event shall the Commissioner grant such approval if the dividend would result in the insolvency or impairment of the Company.

The company paid non-cumulative perpetual preferred stock dividend to the Holding company of $132.5 million during the year ended December 31, 2013. The Company did not pay a dividend to the Holding Company during the years ended December 31, 2012 and 2011.

Accumulated Other Comprehensive Income (Loss)

Information regarding changes in the balances of each component of AOCI, net of income tax, was as follows:

 

		Unrealized Investment Gains (Losses), Net of Related Offsets				Foreign Currency Translation Adjustment				Total
		(In thousands)
Balance at December 31, 2010		$	3,341			$	39,291			$	42,632
OCI before reclassifications			39,974				(15,751)				24,223
Income tax expense (benefit)			(13,991)				—				(13,991)
OCI before reclassifications, net of income tax			29,324				23,540				52,864
Amounts reclassified from AOCI			(4,425)				—				(4,425)
Income tax expense (benefit)			1,549				—				1,549
Amounts reclassified from AOCI, net of income tax			(2,876)				—				(2,876)
Balance at December 31, 2011			26,448				23,540				49,988
OCI before reclassifications			29,412				13,028				42,440
Income tax expense (benefit)			(10,294)				—				(10,294)
OCI before reclassifications, net of income tax			45,566				36,568				82,134
Amounts reclassified from AOCI			(4,395)				—				(4,395)
Income tax expense (benefit)			1,538				—				1,538
Amounts reclassified from AOCI, net of income tax			(2,857)				—				(2,857)
Balance at December 31, 2012			42,709				36,568				79,277
OCI before reclassifications			(54,557)				26,548				(28,009)
Income tax expense (benefit)			19,094				—				19,094
OCI before reclassifications, net of income tax			7,246				63,116				70,362
Amounts reclassified from AOCI			(2,077)				—				(2,077)
Income tax expense (benefit)			727				—				727
Amounts reclassified from AOCI, net of income tax			(1,350)				—				(1,350)
Balance at December 31, 2013		$	5,896			$	63,116			$	69,012

 

61

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

9.  Stockholder’s Equity (continued)

 

Information regarding amounts reclassified out of each component of AOCI, was as follows:

 

AOCI Components		Amounts Reclassified from AOCI												Statement of Operations and Comprehensive Income (Loss) Location
		Years Ended December 31,
		2013				2012				2011
		(In thousands)
Net unrealized investment gains (losses):
Net unrealized investment gains (losses)		$	2,066			$	4,387			$	4,426			Other net investment gains (losses)
Net unrealized investment gains (losses)			11				8				(1)			Net investment income
Net unrealized investment gains (losses), before income tax			2,077				4,395				4,425
Income tax (expense) benefit			(727)				(1,538)				(1,549)
Net unrealized investment gains (losses), net income tax		$	1,350			$	2,857			$	2,876
Total reclassification, net of income tax		$	1,350			$	2,857			$	2,876

10.  Other Expenses

Information on other expenses was as follows:

 

		Years Ended December 31,
		2013				2012				2011
		(In thousands)
Commissions		$	11,775			$	11,116			$	9,155
Volume-related costs			26,816				33,524				30,929
Affiliated costs of reinsurance			72,517				297				12,073
Capitalization of DAC			(2,013)				(1,760)				(2,955)
Amortization of DAC			(21,146)				43,204				31,527
Interest expense on debt and debt issuance costs			7,714				112,646				83,296
Premium taxes, licenses & fees			25				9				34
Professional services			468				858				84
Other			5,051				6,947				5,740
Total other expenses		$	101,207			$	206,841			$	169,883

Capitalization and Amortization of DAC

See Note 2 for additional information on DAC including impacts of capitalization and amortization.

Affiliated Expenses

Commissions, volume-related costs and capitalization and amortization of DAC include the impact of affiliated reinsurance transactions.

See Notes 4 and 8 for a discussion of affiliated expenses included in the table above.

Interest Expense on Debt

See Note 8 for attribution of interest expense by debt issuance.

 

62

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

11.  Income Tax

The provision for income tax was as follows:

 

		Years Ended December 31,
		2013				2012				2011
		(In thousands)
Current:
Federal		$	(267,685)			$	(363,174)			$	273,521
Foreign			50				50				—
			(267,635)				(363,124)				273,521
Deferred:
Federal			631,850				(1,092,375)				(179,444)
Provision for income tax expense (benefit)		$	364,215			$	(1,455,499)			$	94,077

The reconciliation of the income tax provision at the U.S. statutory rate to the provision for income tax as reported was follows:

 

		Years Ended December 31,
		2013				2012				2011
		(In thousands)
Tax provision at U.S. statutory rate		$	362,691			$	(1,455,439)			$	94,077
Tax effect of:
Other			1,464				—				—
Tax exempt investment income			—				(60)				—
Prior year tax			60				—				—
Provision for income tax expense (benefit)		$	364,215			$	(1,455,499)			$	94,077

Deferred income tax represents the tax effect of the differences between the book and tax basis of assets and liabilities. Net deferred income tax assets and liabilities consisted of the following at:

 

		December 31,
		2013				2012
		(In thousands)
Deferred income tax assets:
Benefit, reinsurance and other reserves		$	726,167			$	2,752,083
Investments, including derivatives			821,544				—
Net operating loss			67,235				—
Tax credits			113				—
Other			—				753
			1,615,059				2,752,836
Deferred income tax liabilities:
Net unrealized investment gains			3,176				22,997
DAC			35,280				33,288
Investments, including derivatives			—				429,480
Other			47,139				—
			85,595				485,765
Net deferred income tax asset (liability)		$	1,529,464			$	2,267,071

 

63

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

11.  Income Tax (continued)

 

Domestic net operating carryforwards of $192,099 thousand at December 31, 2013 will expire beginning in 2028. Tax credit carryforwards of $113 thousand at December 31, 2013 will expire beginning in 2022.

The lack of a valuation allowance reflects management’s assessment, based on available information, that it is more likely than not that the deferred income tax asset will be realizable. In 2013, management believes that it is more likely than not that the results of future operations will generate sufficient taxable income to realize gross deferred tax assets. Accordingly, the Company has not recorded a valuation allowance against its gross deferred tax assets. The Company has determined that a valuation allowance against its deferred tax assets is not appropriate as of the year ended December 31, 2012.

Prior to October 1, 2013, the Company was registered as an exempted company pursuant to the Companies Law of the Cayman Islands. No local income, profits or capital gains taxes are levied in the Cayman Islands at the current time. As a result, no provision for such taxes is recorded by the Company.

Prior to the re-domestication, the Company made an election to be treated as an U.S. Domestic entity under Internal Revenue Code Section (“Sec.”) 953(d). The election under Sec. 953(d) is valid through December 31, 2013. The Company joins with the Holding Company and its includable life insurance and non-life insurance subsidiaries in filing a consolidated U.S. federal income tax return in accordance with the provision of the Code. Pursuant to this tax sharing agreement, the amount due from the Holding Company was $196.6 million and $261.7 million at December 31, 2013 and 2012, respectively.

The Company files income tax returns with the U.S. federal government and is under continuous examination by the Internal Revenue Service. The Company is no longer subject to U.S. federal income tax examinations for years prior to 2003, with the exception of the period October 31, 2000 through December 31, 2000. The IRS audit cycle for the years 2003 through 2006, which began in April 2010, is expected to conclude in 2014. It is not expected to have a material impact on the financial statements. As of December 31, 2013, the Company had no liability for unrecognized tax benefits.

12.  Contingencies and Commitments

There is no pending or threatened litigation, claim or assessment against the Company that would constitute a material loss contingency.

Various litigation, claims or assessments against the Company may arise in the ordinary course of the Company’s business. Liabilities for litigations, claims or assessments are established when it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. The Company regularly reviews relevant information with respect to liabilities for litigation, regulatory investigations and litigation-related contingencies to be reflected in the Company’s financial statements. Based on information currently known by the Company’s management, in its opinion, there are no current legal proceedings, likely to have such an effect. However, it is possible that an adverse outcome in a litigation matter, should such a litigation matter arise in the future, could have a material effect on the Company’s net income or cash flows.

 

64

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Exeter Reassurance Company, Ltd.

Notes to the Financial Statements — (Continued)

 

13.  Other Related Party Transactions

The Company had net payables to affiliates of $593 thousand and $877 thousand at December 31, 2013 and 2012, respectively. These payables exclude affiliated reinsurance balances discussed in Note 4 and affiliated debt balances discussed in Note 8.

See Note 5 for additional related party transactions.

14.  Subsequent Events

In anticipation of the Mergers, certain risks formerly reinsured by Exeter were re-directed to affiliates through various forms of transactions. For certain risks that were re-directed in October 2014 and November 2014, the agreement terms included that the initial settlement amounts were to be based upon the reinsurance balances at September 30, 2014. The estimated impacts of these transactions to Exeter were a decrease in cash and invested assets of $2.6 billion, a decrease in future policy benefits of $500 million, a decrease in policyholder account balances of $1.2 billion and a decrease in other policy-related balances of $800 million. Also as a result of these transactions, Exeter recorded an estimated net loss of $100 million during the fourth quarter of 2014. These estimated amounts will be adjusted to actual settlement amounts by January 2015, in accordance with the applicable reinsurance recapture agreements’ terms. The Company expects to enter into another affiliated reinsurance transaction on or around November 10, 2014. The estimated impacts, based upon the account balances at September 30, 2014, are a decrease in cash and invested assets of $400 million, a decrease in future policy benefits of $500 million, offset by an increase in other policy-related balances of $100 million. It is likely that the final settlement amounts of these reinsurance transactions, that will consider additional available information, will differ from the estimated amounts and it is possible the differences may be material.

 

65

Exhibit 99.5

MetLife Insurance Company USA

Unaudited Pro Forma Interim Condensed Combined Financial Statements

On November 14, 2014, MetLife, Inc. completed the mergers of three wholly-owned U.S.-based life insurance companies and a wholly-owned, former offshore, reinsurance subsidiary to create one larger U.S.-based and U.S.-regulated life insurance company (the “Mergers”). The companies that merged were MetLife Insurance Company of Connecticut, MetLife Investors USA Insurance Company (“MLI-USA”), a wholly-owned subsidiary of MetLife Insurance Company of Connecticut, and MetLife Investors Insurance Company (“MLIIC”), each a U.S. insurance company that issued variable annuity products in addition to other products, and Exeter Reassurance Company, Ltd. (“Exeter”), a reinsurance company that mainly reinsured guarantees associated with variable annuity products. As of the date of the Mergers, MetLife Insurance Company of Connecticut, a directly owned subsidiary of MetLife, Inc., was renamed MetLife Insurance Company USA (“MetLife USA”) and re-domiciled to Delaware.

In connection with the Mergers, Exeter, formerly a Cayman Islands company, was re-domesticated to Delaware in October 2013. Effective January 1, 2014, following receipt of New York State Department of Financial Services approval, MetLife Insurance Company of Connecticut withdrew its license to issue insurance policies and annuity contracts in New York. Also, effective January 1, 2014, MetLife Insurance Company of Connecticut reinsured with an affiliate all existing New York insurance policies and annuity contracts that include a separate account feature. In July 2014, MetLife Insurance Company of Connecticut and MLI-USA sold to certain affiliates $430 million in affiliated loans, which are included in other invested assets. In August 2014, MetLife Insurance Company of Connecticut redeemed and retired 4,595,317 shares of MetLife Insurance Company of Connecticut’s common stock owned by MetLife Investors Group, LLC (“MLIG”) for $1.4 billion. As a result, all of the outstanding shares of common stock of MetLife Insurance Company of Connecticut were directly held by MetLife, Inc. Following the redemption, in August 2014, MLIG paid a dividend of $1.4 billion to MetLife, Inc., and MetLife Insurance Company of Connecticut received a capital contribution from MetLife, Inc. of $231 million. MetLife USA does not expect to pay any dividends to MetLife, Inc. in 2014. In October and November 2014, certain risks formerly reinsured by Exeter were re-directed to affiliates through various forms of transactions.

The unaudited pro forma condensed combined financial statements and accompanying notes present the impact of the Mergers as a transaction among entities under common control which is more fully described in the notes to the unaudited pro forma condensed combined financial statements. Transactions among entities under common control are prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”).

The unaudited pro forma condensed combined financial statements include historical unaudited amounts as of September 30, 2014 and for the nine months ended September 30, 2014 and audited amounts for the years ended December 31, 2013, 2012 and 2011, for MetLife Insurance Company of Connecticut and its subsidiaries, including MLI-USA (collectively “MICC”), MLIIC and Exeter. The unaudited pro forma condensed combined financial statements give effect to the Mergers as if they had occurred (i) on September 30, 2014 for purposes of the unaudited pro forma condensed combined balance sheet and (ii) on January 1, 2011 for purposes of the unaudited pro forma condensed combined statements of operations for the nine months ended September 30, 2014 and for the years ended December 31, 2013, 2012 and 2011. The historical financial information has been adjusted in the unaudited pro forma condensed combined financial statements to give effect to pro forma events that are directly attributable to the Mergers, factually supportable, and are expected to have a continuing impact on the combined results. It is likely that the actual adjustments reflected in the final accounting, that will consider additional available information, will differ from the pro forma adjustments and it is possible the differences may be material.

The unaudited pro forma condensed combined financial statements, filed as Exhibit 99.5 to the Current Report on Form 8-K, should be read in conjunction with the accompanying notes. In addition, the unaudited proforma condensed combined financial statements were derived from and should be read in conjunction with:

 

•

The unaudited interim condensed consolidated financial statements of MICC included in MetLife Insurance Company of Connecticut’s quarterly report on Form 10-Q for the nine months ended September 30, 2014;

 

•

The audited historical consolidated financial statements of MICC included in MetLife Insurance Company of Connecticut’s Annual Report on Form 10-K for the year ended December 31, 2013, as revised by MetLife Insurance Company of Connecticut’s Current Report on Form 8-K filed on October 28, 2014;

 

•

The unaudited interim condensed balance sheet of MLIIC as of September 30, 2014, the audited historical balance sheet as of December 31, 2013 and the related interim condensed consolidated statements of operations and comprehensive income (loss), stockholder’s equity and cash flows for the nine months ended September 30, 2014 together with the notes thereto, as included as Exhibit 99.1 to the Current Report on Form 8-K;

 

•

The audited historical balance sheets of MLIIC as of December 31, 2013 and 2012, and the related statements of operations, comprehensive income (loss), stockholder’s equity and cash flows for each of the three years in the period ended December 31, 2013 together with the notes thereto, as included as Exhibit 99.2 to the Current Report on Form 8-K;

 

•

The unaudited interim condensed balance sheet of Exeter as of September 30, 2014, the audited historical balance sheet as of December 31, 2013 and the related interim condensed statements of operations and comprehensive income (loss), stockholder’s equity and cash flows for the nine months ended September 30, 2014, together with the notes thereto, as included as Exhibit 99.3 to the Current Report on Form 8-K; and

 

1

---

•

The audited historical balance sheets of Exeter as of December 31, 2013 and 2012, and the related statements of operations, comprehensive income (loss), stockholder’s equity and cash flows for each of the three years in the period ended December 31, 2013 together with the notes thereto, as restated on October 27, 2014 and as revised on November 7, 2014, as included as Exhibit 99.4 to the Current Report on Form 8-K.

The unaudited pro forma condensed combined financial statements are presented for informational purposes only and are not intended to reflect the results of operations or the financial position of the combined company that would have resulted had the Mergers been effective as of and during the periods presented or the results that may be obtained by the combined company in the future. The unaudited pro forma condensed combined financial statements as of and for the periods presented do not reflect future events that are not directly attributable to the Mergers and that may occur after the Mergers, including, but not limited to, expense efficiencies or revenue enhancements arising from the Mergers or management actions. Future results may vary significantly from the results reflected in the unaudited pro forma condensed combined financial statements.

 

2

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MetLife Insurance Company USA

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Unaudited Pro Forma Interim Condensed Combined Balance Sheet

September 30, 2014

(In millions, except per share data)

 

		Historical
		MICC				MetLife Investors Insurance Company				Exeter Reassurance Company Ltd.				Reinsurance Adjustments				Other Adjustments				Notes		Pro Forma Combined
Assets
Investments:
Fixed maturity securities available-for-sale, at estimated fair value		$	43,890			$	2,542			$	1,304			$	(481	)		$	—			3(b)		$	47,255
Equity securities available-for-sale, at estimated fair value			416				45				—				—				—						461
Mortgage loans, net; at estimated fair value			5,778				260				—				—				—						6,038
Policy loans			1,178				27				—				—				—						1,205
Real estate and real estate joint ventures			838				—				—				—				—						838
Other limited partnership interests			2,220				38				—				—				—						2,258
Short-term investments, principally at estimated fair value			1,508				70				3,009				—				—						4,587
Derivative assets			—				—				3,208				—				(3,208	)		4(a)			—
Funds withheld at interest			—				—				2,821				—				(2,821	)		4(a)			—
Other invested assets, principally at estimated fair value			1,926				4				—				(2,834	)			5,529			3(a),(b),4(a),5(a)			4,625
Total investments			57,754				2,986				10,342				(3,315	)			(500	)					67,267
Cash and cash equivalents, principally at estimated fair value			608				28				570				(966	)			—			3(b)			240
Accrued investment income			441				21				84				—				(6	)		5(a)			540
Premiums, reinsurance and other receivables			23,196				1,983				480				(4,688	)			—			3(a),(b)			20,971
Deferred policy acquisition costs and value of business acquired			4,034				190				148				667				—			3(a),(b)			5,039
Current income tax recoverable			416				—				301				—				(1	)		4(b)			716
Deferred income tax recoverable			—				—				1,711				—				(1,711	)		4(b)			—
Goodwill			381				—				—				—				33			4(c)			414
Other assets			740				101				—				75				(33	)		3(a),4(c)			883
Separate account assets			97,239				11,435				—				—				—						108,674
Total assets		$	184,809			$	16,744			$	13,636			$	(8,227	)		$	(2,218	)				$	204,744
Liabilities and Stockholders’ Equity
Liabilities
Future policy benefits		$	25,806			$	546			$	2,843			$	(1,757	)		$	12			3(a),(b),4(d)		$	27,450
Policyholder account balances			31,745				2,696				4,263				(3,715	)			—			3(a),(b)			34,989
Other policy-related balances			3,184				96				2,189				(2,030	)			4			3(a),(b),4(d)			3,443
Policyholder dividends payable			—				—				16				—				(16	)		4(d)			—
Payables for collateral under securities loaned and other transactions			7,169				299				—				—				553			4(e)			8,021
Long-term debt			961				—				575				—				(500	)		5(a)			1,036
Current income tax payable			—				1				—				—				(1	)		4(b)			—
Deferred income tax liability			2,068				234				—				273				(1,711	)		3(a),4(b)			864
Derivative liabilities			—				—				2,364				—				(2,364	)		4(f)			—
Other liabilities			7,353				85				856				(1,504	)			1,805			3(a),(b),4(e), (f),5(a)			8,595
Separate account liabilities			97,239				11,435				—				—				—						108,674
Total liabilities			175,525				15,392				13,106				(8,733	)			(2,218	)					193,072
Stockholders’ Equity
Preferred stock			—				—				—				—				—						—
Common stock, par value $2.50 per share			75				6				—				—				(6	)		5(d)			75
Additional paid-in capital			6,073				637				4,135				—				6			5(d)			10,851
Retained earnings (accumulated deficit)			1,143				666				(3,696	)			506				—			3(a)			(1,381	)
Accumulated other comprehensive income (loss)			1,993				43				91				—				—						2,127
Total stockholders’ equity			9,284				1,352				530				506				—						11,672
Total liabilities and stockholders’ equity		$	184,809			$	16,744			$	13,636			$	(8,227	)		$	(2,218	)				$	204,744

See accompanying notes to unaudited pro forma condensed combined financial statements.

 

3

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MetLife Insurance Company USA

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Unaudited Pro Forma Interim Condensed Combined Statement of Operations

For the Nine Months Ended September 30, 2014

(In millions)

 

		Historical
		MICC				MetLife Investors Insurance Company				Exeter Reassurance Company Ltd.				Reinsurance Adjustments				Other Adjustments				Notes		Pro Forma Combined
Revenues
Premiums		$	828			$	15			$	36			$	(3	)		$	—			3(a)		$	876
Universal life and investment-type product policy fees			1,827				157				489				(253	)			—			3(a),(b)			2,220
Net investment income			1,932				81				25				(10	)			(9	)		3(b),5(a)			2,019
Fees on ceded reinsurance and other			—				58				—				—				(58	)		4(g)			—
Other revenues			323				—				15				(25	)			58			3(a),(b),4(g)			371
Net investment gains (losses):
Other-than-temporary impairments on fixed maturity securities			(5	)			—				—				—				—						(5	)
Other-than-temporary impairments on fixed maturity securities transferred to other comprehensive income (loss)			(6	)			—				—				—				—						(6	)
Other net investment gains (losses)			(508	)			4				(41	)			39				—			3(b)			(506	)
Total net investment gains (losses)			(519	)			4				(41	)			39				—						(517	)
Net derivative gains (losses)			725				175				(914	)			118				—			3(b)			104
Total revenues			5,116				490				(390	)			(134	)			(9	)					5,073
Expenses
Policyholder benefits and claims			1,631				55				414				(97	)			18			3(a),(b),4(h)			2,021
Interest credited to policyholder account balances			716				78				14				(14	)			—			3(b)			794
Policyholder dividends			—				—				18				—				(18	)		4(h)			—
Other expenses			2,035				128				52				(225	)			(34	)		3(a),(b),5(a),(c)			1,956
Total expenses			4,382				261				498				(336	)			(34	)					4,771
Income (loss) from continuing operations before provision for income tax			734				229				(888	)			202				25						302
Provision for income tax expense (benefit)			183				67				(311	)			71				9			3(d),5(e)			19
Income from continuing operations, net of income tax		$	551			$	162			$	(577	)		$	131			$	16					$	283

See accompanying notes to unaudited pro forma condensed combined financial statements.

 

4

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MetLife Insurance Company USA

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Unaudited Pro Forma Condensed Combined Statement of Operations

For the Year End December 31, 2013

(In millions)

 

		Historical
		MICC				MetLife Investors Insurance Company				Exeter Reassurance Company Ltd.				Reinsurance Adjustments				Other Adjustments				Notes		Pro Forma Combined
Revenues
Premiums		$	606			$	29			$	59			$	(5	)		$	—			3(a)		$	689
Universal life and investment-type product policy fees			2,336				202				587				(177	)			—			3(a),(b)			2,948
Net investment income			2,852				114				35				(16	)			(2	)		3(b),5(a)			2,983
Fees on ceded reinsurance and other			—				90				—				—				(90	)		4(g)			—
Other revenues			592				—				2				(74	)			90			3(a),(b),4(g)			610
Net investment gains (losses):
Other-than-temporary impairments on fixed maturity securities			(9	)			—				—				—				—						(9	)
Other-than-temporary impairments on fixed maturity securities transferred to other comprehensive income (loss)			(11	)			—				—				—				—						(11	)
Other net investment gains (losses)			102				1				(57	)			59				(45	)		3(b),5(b)			60
Total net investment gains (losses)			82				1				(57	)			59				(45	)					40
Net derivative gains (losses)			(1,052	)			(442	)			1,935				375				—			3(b)			816
Total revenues			5,416				(6	)			2,561				162				(47	)					8,086
Expenses
Policyholder benefits and claims			1,707				48				1,380				(44	)			27			3(a),(b),4(h)			3,118
Interest credited to policyholder account balances			1,037				113				17				(17	)			—			3(b)			1,150
Policyholder dividends			—				—				27				—				(27	)		4(h)			—
Goodwill impairment			66				—				—				—				—						66
Other expenses			1,659				(11	)			101				215				(2	)		3(a)-(c),5(a)			1,962
Total expenses			4,469				150				1,525				154				(2	)					6,296
Income (loss) from continuing operations before provision for income tax			947				(156	)			1,036				8				(45	)					1,790
Provision for income tax expense (benefit)			227				(67	)			364				3				(16	)		3(d),5(e)			511
Income from continuing operations, net of income tax		$	720			$	(89	)		$	672			$	5			$	(29	)				$	1,279

See accompanying notes to unaudited pro forma condensed combined financial statements.

 

5

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MetLife Insurance Company USA

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Unaudited Pro Forma Condensed Combined Statement of Operations

For the Year End December 31, 2012

(In millions)

 

		Historical
		MICC				MetLife Investors Insurance Company				Exeter Reassurance Company Ltd.				Reinsurance Adjustments				Other Adjustments				Notes		Pro Forma Combined
Revenues
Premiums		$	1,261			$	11			$	950			$	(888	)		$	—			3(a),(b)		$	1,334
Universal life and investment-type product policy fees			2,261				198				548				(183	)			—			3(a),(b)			2,824
Net investment income			2,952				113				21				(2	)			(26	)		3(b),5(a)			3,058
Fees on ceded reinsurance and other			—				93				—				—				(93	)		4(g)			—
Other revenues			511				—				23				(24	)			93			3(b),4(g)			603
Net investment gains (losses):
Other-than-temporary impairments on fixed maturity securities			(52	)			(2	)			—				—				—						(54	)
Other-than-temporary impairments on fixed maturity securities transferred to other comprehensive income (loss)			3				—				—				—				—						3
Other net investment gains (losses)			201				(2	)			42				(37	)			—			3(b)			204
Total net investment gains (losses)			152				(4	)			42				(37	)			—						153
Net derivative gains (losses)			1,003				329				(3,677	)			1,432				—			3(b)			(913	)
Total revenues			8,140				740				(2,093	)			298				(26	)					7,059
Expenses
Policyholder benefits and claims			2,389				100				1,812				(1,001	)			30			3(a),(b),4(h)			3,330
Interest credited to policyholder account balances			1,147				118				17				(17	)			—			3(b)			1,265
Policyholder dividends			—				—				30				—				(30	)		4(h)			—
Goodwill impairment			394				—				—				—				—						394
Other expenses			2,720				229				206				(709	)			(26	)		3(a)-(c),5(a)			2,420
Total expenses			6,650				447				2,065				(1,727	)			(26	)					7,409
Income (loss) from continuing operations before provision for income tax			1,490				293				(4,158	)			2,025				—						(350	)
Provision for income tax expense (benefit)			372				94				(1,455	)			709				—			3(d),5(e)			(280	)
Income (loss) from continuing operations, net of income tax		$	1,118			$	199			$	(2,703	)		$	1,316			$	—					$	(70	)

See accompanying notes to unaudited pro forma condensed combined financial statements.

 

6

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MetLife Insurance Company USA

(A Wholly-Owned Subsidiary of MetLife, Inc.)

Unaudited Pro Forma Condensed Combined Statement of Operations

For the Year End December 31, 2011

(In millions)

 

		Historical
		MICC				MetLife Investors Insurance Company				Exeter Reassurance Company Ltd.				Reinsurance Adjustments				Other Adjustments				Notes		Pro Forma Combined
Revenues
Premiums		$	1,828			$	7			$	72			$	(9	)		$	—			3(a)		$	1,898
Universal life and investment-type product policy fees			1,956				204				433				(136	)			—			3(a),(b)			2,457
Net investment income			3,074				114				17				3				(9	)		3(b),5(a)			3,199
Fees on ceded reinsurance and other			—				104				—				—				(104	)		4(g)			—
Other revenues			508				—				44				(55	)			104			3(a),(b),4(g)			601
Net investment gains (losses):
Other-than-temporary impairments on fixed maturity securities			(42	)			—				—				—				—						(42	)
Other-than-temporary impairments on fixed maturity securities transferred to other comprehensive income (loss)			(5	)			—				—				—				—						(5	)
Other net investment gains (losses)			82				(5	)			(1	)			—				—						76
Total net investment gains (losses)			35				(5	)			(1	)			—				—						29
Net derivative gains (losses)			1,096				326				230				(787	)			—			3(b)			865
Total revenues			8,497				750				795				(984	)			(9	)					9,049
Expenses
Policyholder benefits and claims			2,660				59				309				(88	)			31			3(a),(b),4(h)			2,971
Interest credited to policyholder account balances			1,189				127				16				(16	)			—			3(b)			1,316
Policyholder dividends			—				—				31				—				(31	)		4(h)			—
Other expenses			2,981				259				170				(101	)			(9	)		3(a)-(c),5(a)			3,300
Total expenses			6,830				445				526				(205	)			(9	)					7,587
Income (loss) from continuing operations before provision for income tax			1,667				305				269				(779	)			—						1,462
Provision for income tax expense (benefit)			493				90				94				(272	)			—			3(d),5(e)			405
Income (loss) from continuing operations, net of income tax		$	1,174			$	215			$	175			$	(507	)		$	—					$	1,057

See accompanying notes to unaudited pro forma condensed combined financial statements.

 

7

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MetLife Insurance Company USA

(A Wholly-Owned Subsidiary of MetLife, Inc.)

NOTES TO THE UNAUDITED PRO FORMA

INTERIM CONDENSED COMBINED FINANCIAL STATEMENTS

 

1. Description of Transaction

On November 14, 2014, MetLife, Inc. completed the mergers of three wholly-owned U.S.-based life insurance companies and a wholly-owned, former offshore, reinsurance subsidiary to create one larger U.S.-based and U.S.-regulated life insurance company (the “Mergers”). The companies that merged were MetLife Insurance Company of Connecticut, MetLife Investors USA Insurance Company (“MLI-USA”), a wholly-owned subsidiary of MetLife Insurance Company of Connecticut, and MetLife Investors Insurance Company (“MLIIC”), each a U.S. insurance company that issued variable annuity products in addition to other products, and Exeter Reassurance Company, Ltd. (“Exeter”), a reinsurance company that mainly reinsured guarantees associated with variable annuity products. As of the date of the Mergers, MetLife Insurance Company of Connecticut, a directly owned subsidiary of MetLife, Inc., was renamed MetLife Insurance Company USA (“MetLife USA”) and re-domiciled to Delaware.

In connection with the Mergers, Exeter, formerly a Cayman Islands company, was re-domesticated to Delaware in October 2013. Effective January 1, 2014, following receipt of New York State Department of Financial Services approval, MetLife Insurance Company of Connecticut withdrew its license to issue insurance policies and annuity contracts in New York. Also, effective January 1, 2014, MetLife Insurance Company of Connecticut reinsured with an affiliate all existing New York insurance policies and annuity contracts that include a separate account feature. In July 2014, MetLife Insurance Company of Connecticut and MLI-USA sold to certain affiliates $430 million in affiliated loans, which are included in other invested assets. In August 2014, MetLife Insurance Company of Connecticut redeemed and retired 4,595,317 shares of MetLife Insurance Company of Connecticut’s common stock owned by MetLife Investors Group, LLC (“MLIG”) for $1.4 billion. As a result, all of the outstanding shares of common stock of MetLife Insurance Company of Connecticut were directly held by MetLife, Inc. Following the redemption, in August 2014, MLIG paid a dividend of $1.4 billion to MetLife, Inc., and MetLife Insurance Company of Connecticut received a capital contribution from MetLife, Inc. of $231 million. MetLife USA does not expect to pay any dividends to MetLife, Inc. in 2014. In October and November 2014, certain risks formerly reinsured by Exeter were re-directed to affiliates through various forms of transactions.

2. Basis of Presentation

The Mergers represent a transaction among entities under common control. Transactions among entities under common control are accounted for as if the transaction occurred at the beginning of the earliest date presented and prior years are retrospectively adjusted to furnish comparative information similar to the pooling method. The unaudited pro forma condensed combined financial statements include historical amounts derived from the unaudited amounts as of September 30, 2014 and for the nine months ended September 30, 2014 and the audited financial statements for the years ended December 31, 2013, 2012 and 2011, for MetLife Insurance Company of Connecticut and its subsidiaries, including MLI-USA (collectively “MICC”), MLIIC and Exeter. The unaudited pro forma condensed combined financial statements give effect to the Mergers as if they had occurred (i) on September 30, 2014 for purposes of the unaudited pro forma condensed combined balance sheet and (ii) on January 1, 2011 for purposes of the unaudited pro forma condensed combined statements of operations for the nine months ended September 30, 2014 and for the years ended December 31, 2013, 2012 and 2011.

The unaudited pro forma condensed combined financial statements were prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) and presented in accordance with the requirements of Article 11 of Regulation S-X published by the U.S. Securities and Exchange Commission. In accordance with Article 11 of Regulation S-X, discontinued operations have been excluded from the presentation of the unaudited pro forma condensed combined statements of operations.

The historical financial information has been adjusted in the unaudited pro forma condensed combined financial statements to give effect to pro forma events that are directly attributable to the Mergers, factually supportable, and are expected to have a continuing impact on the combined results. The unaudited pro forma condensed combined financial statements exclude the effects of adjustments that rely on highly judgmental estimates including how historical management practices and operating decisions may or may not have changed as a result of the Mergers.

The unaudited pro forma condensed combined financial statements are presented for informational purposes only and are not intended to reflect the results of operations or the financial position of the combined company that would have resulted had the Mergers been effective during the periods presented or the results that may be obtained by the combined company in the future.

 

8

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MetLife Insurance Company USA

(A Wholly-Owned Subsidiary of MetLife, Inc.)

NOTES TO THE UNAUDITED PRO FORMA

CONDENSED COMBINED FINANCIAL STATEMENTS— (CONTINUED)

 

These unaudited pro forma condensed combined financial statements should be read in conjunction with:

 

•

The unaudited interim condensed consolidated financial statements of MICC included in MetLife Insurance Company of Connecticut’s quarterly report on Form 10-Q for the nine months ended September 30, 2014;

 

•

The audited historical consolidated financial statements of MICC included in MetLife Insurance Company of Connecticut’s Annual Report on Form 10-K for the year ended December 31, 2013, as revised by MetLife Insurance Company of Connecticut’s Current Report on Form 8-K filed on October 28, 2014;

 

•

The unaudited interim condensed balance sheet of MLIIC as of September 30, 2014, the audited historical balance sheet as of December 31, 2013 and the related interim condensed consolidated statements of operations and comprehensive income (loss), stockholder’s equity and cash flows for the nine months ended September 30, 2014 together with the notes thereto, as included as Exhibit 99.1 to the Current Report on Form 8-K;

 

•

The audited historical balance sheets of MLIIC as of December 31, 2013 and 2012, and the related statements of operations, comprehensive income (loss), stockholder’s equity and cash flows for each of the three years in the period ended December 31, 2013 together with the notes thereto, as included as Exhibit 99.2 to the Current Report on Form 8-K;

 

•

The unaudited interim condensed balance sheet of Exeter as of September 30, 2014, the audited historical balance sheet as of December 31, 2013 and the related interim condensed statements of operations and comprehensive income (loss), stockholder’s equity and cash flows for the nine months ended September 30, 2014, together with the notes thereto, as included as Exhibit 99.3 to the Current Report on Form 8-K; and

 

•

The audited historical balance sheets of Exeter as of December 31, 2013 and 2012, and the related statements of operations, comprehensive income (loss), stockholder’s equity and cash flows for each of the three years in the period ended December 31, 2013 together with the notes thereto, as restated on October 27, 2014 and as revised on November 7, 2014, as included as Exhibit 99.4 to the Current Report on Form 8-K.

3. Reinsurance Adjustments

In connection with the Mergers, adjustments have been included for new reinsurance agreements, for the recapture of certain reinsurance agreements and to eliminate non-recurring bank fees. The total of the reinsurance adjustments at September 30, 2014 resulted in changes to total assets of ($8,227) million, total liabilities of ($8,733) million, and total stockholders’ equity of $506 million and for the nine months ended September 30, 2014 and for the years ended December 31, 2013, 2012 and 2011 resulted in changes to total revenues of ($134) million, $162 million, $298 million and ($984) million, respectively, and to total expenses of ($336) million, $154 million, ($1,727) million, and ($205) million, respectively.

 

(a)

Adjustment to eliminate reinsurance transactions among the merging companies. The adjustments at September 30, 2014 include: changes of ($5,158) million to total assets, ($5,664) million to total liabilities and $506 million to retained earnings. The adjustments for the nine months ended September 30, 2014 and for the years ended December 31, 2013, 2012 and 2011 include: reductions to total revenue of $10 million, $73 million, $0 and $12 million, respectively, and changes to total expenses of ($206) million, $208 million, ($690) million and ($61) million, respectively.

 

(b)

Adjustment to reflect reinsurance transactions to re-direct to one or more affiliates certain risks that were reinsured by Exeter. The adjustments at September 30, 2014 include: reductions of $3,069 million to total assets and $3,069 million to total liabilities. The adjustments for the nine months ended September 30, 2014 and for the years ended December 31, 2013, 2012 and 2011 include: changes to total revenue of ($124) million, $235 million, $298 million and ($972) million, respectively, and reductions to total expenses of $130 million, $37 million, $1,018 million and $119 million, respectively.

 

(c)

Adjustment to eliminate from other expenses non-recurring credit facility usage fees for letters of credit, which were held to collateralize assumed liabilities and which were canceled when Exeter re-domesticated to Delaware of $17 million, $19 million and $25 million, for the years ended December 31, 2013, 2012 and 2011, respectively.

 

(d)

Adjustment for the income tax impact for all reinsurance adjustments at the federal statutory tax rate of 35%.

4. Reclassification Adjustments

Reclassification adjustments, included in other adjustments, are reflected herein to conform the presentation of Exeter’s and MLIIC’s financial statements to the presentation of MICC’s financial statements.

 

(a)

Adjustment to reclassify derivative assets of $3,208 million and funds withheld at interest of $2,821 million to other invested assets.

 

9

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MetLife Insurance Company USA

(A Wholly-Owned Subsidiary of MetLife, Inc.)

NOTES TO THE UNAUDITED PRO FORMA

CONDENSED COMBINED FINANCIAL STATEMENTS— (CONTINUED)

 

(b)

Adjustment to net deferred income tax recoverable of $1,711 million with deferred income tax liability and net current income tax payable of $1 million with current income tax recoverable.

 

(c)

Adjustment to reclassify goodwill of $33 million from other assets to goodwill.

 

(d)

Adjustment to reclassify policyholder dividends payable of $12 million and $4 million to future policy benefits and other policy-related balances, respectively.

 

(e)

Adjustment to reclassify cash collateral on deposit of $553 million from other liabilities to payables for collateral under securities loaned and other transactions

 

(f)

Adjustment to reclassify derivative liabilities of $2,364 million to other liabilities.

 

(g)

Adjustment to reclassify fees on ceded reinsurance and other of $58 million, $90 million, $93 million and $104 million to other revenues for the nine months ended September 30, 2014 and for the years ended December 31, 2013, 2012 and 2011, respectively.

 

(h)

Adjustment to reclassify policyholder dividends of $18 million, $27 million, $30 million and $31 million to policyholder benefits and claims for the nine months ended September 30, 2014 and for the years ended December 31, 2013, 2012 and 2011, respectively.

5. Other Adjustments

The following other pro forma adjustments have been recorded in the unaudited pro forma condensed combined financial statements.

 

(a)

Adjustments to eliminate related party debt transactions among the merging entities. The adjustments at September 30, 2014 include: reductions of $6 million to accrued investment income and other liabilities and reductions of $500 million to other invested assets and long-term debt. The adjustments for the nine months ended September 30, 2014 and for the years ended December 31, 2013, 2012 and 2011 include: reductions of $9 million, $2 million, $26 million and $9 million, respectively, to net investment income and other expenses.

 

(b)

Adjustment to eliminate related party investment gains of $45 million for the year ended December 31, 2013. The non-recurring gains were recorded in connection with establishing a custodial account when MetLife Insurance Company of Connecticut withdrew its license to issue insurance policies and annuity contracts in New York.

 

(c)

Adjustment to eliminate non-recurring expenses recorded in connection with completing the Mergers of $25 million for the nine months ended September 30, 2014.

 

(d)

Adjustment to reclassify common stock of $6 million at September 30, 2014 to additional paid in capital for a pooling accounting adjustment.

(e)

Adjustment for the income tax impact for all other adjustments at the federal statutory tax rate of 35%.

6. Forward Looking Statements

These unaudited pro forma condensed combined financial statements may be deemed to be forward looking statements within the meaning of the safe harbor provisions of the United States Private Securities Litigation Reform Act of 1995. Forward looking statements are identified by words such as “anticipate,” “estimate,” “expect,” “project,” “intend,” “plan,” “believe” and other words and terms of similar meaning, or are tied to future periods, in connection with a discussion of future operating or financial performance. Such statements may include, but are not limited to statements about the benefits of the Mergers, including future financial and operating results, the combined company’s plans, objectives, expectations and intentions and other statements that are not historical facts. These forward looking statements are based largely on management’s expectations and are subject to a number of risks and uncertainties. Actual results could differ materially from these forward looking statements.

7. Disposition

In May 2014, a subsidiary of MetLife Insurance Company of Connecticut completed the sale of its wholly-owned subsidiary, MetLife Assurance Limited (“MAL”). These unaudited pro forma condensed combined statements of operations for the years ended December 31, 2013, 2012 and 2011 have not been adjusted for the impact of the MAL disposition as the transaction does not meet the significant subsidiary conditions of Article 11 of Regulation S-X and is not directly attributable to the Mergers.

 

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