Note 11 — Investments
Securities in the following table are included in fixed maturities and equity securities on the Company's Consolidated Balance Sheets. These securities are carried at fair value with changes in fair value reported in other realized investment gains (losses) and interest and dividends reported in net investment income. Hybrid investments include certain preferred stock or debt securities with call or conversion features.
| (In millions) | 2013 | 2012 | |||
| Included in fixed maturities: | |||||
| Trading securities (amortized cost: $1; $1) | $ | 1 | $ | 1 | |
| Hybrid securities (amortized cost: $5; $15) | 5 | 15 | |||
| Total | $ | 6 | $ | 16 | |
| Included in equity securities: | |||||
| Hybrid securities (amortized cost: $68; $84) | $ | 56 | $ | 70 | |
The following information about fixed maturities excludes trading and hybrid securities. The amortized cost and fair value by contractual maturity periods for fixed maturities were as follows at December 31, 2013:
| Amortized | Fair | |||
| (In millions) | Cost | Value | ||
| Due in one year or less | $ | 1,151 | $ | 1,173 |
| Due after one year through five years | 5,283 | 5,656 | ||
| Due after five years through ten years | 5,260 | 5,530 | ||
| Due after ten years | 2,622 | 3,084 | ||
| Mortgage and other asset-backed securities | 951 | 1,037 | ||
| Total | $ | 15,267 | $ | 16,480 |
Actual maturities could differ from contractual maturities because issuers may have the right to call or prepay obligations with or without penalties. In some cases, the Company may also extend maturity dates.
Gross unrealized appreciation (depreciation) on fixed maturities by type of issuer is shown below (excluding trading securities and hybrid securities with a fair value of $6 million at December 31, 2013 and $16 million at December 31, 2012).
| (In millions) | December 31, 2013 | |||||||
| Unrealized | Unrealized | |||||||
| Amortized | Appre- | Depre- | Fair | |||||
| Cost | ciation | ciation | Value | |||||
| Federal government and agency | $ | 640 | $ | 242 | $ | (2) | $ | 880 |
| State and local government | 1,983 | 167 | (6) | 2,144 | ||||
| Foreign government | 1,392 | 64 | (12) | 1,444 | ||||
| Corporate | 10,301 | 749 | (74) | 10,976 | ||||
| Federal agency mortgage-backed | 77 | - | (1) | 76 | ||||
| Other mortgage-backed | 76 | 3 | (2) | 77 | ||||
| Other asset-backed | 798 | 87 | (2) | 883 | ||||
| Total | $ | 15,267 | $ | 1,312 | $ | (99) | $ | 16,480 |
| (In millions) | December 31, 2012 | |||||||
| Federal government and agency | $ | 509 | $ | 393 | $ | - | $ | 902 |
| State and local government | 2,169 | 270 | (2) | 2,437 | ||||
| Foreign government | 1,197 | 126 | (1) | 1,322 | ||||
| Corporate | 10,590 | 1,308 | (17) | 11,881 | ||||
| Federal agency mortgage-backed | 121 | 1 | - | 122 | ||||
| Other mortgage-backed | 82 | 11 | (4) | 89 | ||||
| Other asset-backed | 797 | 145 | (6) | 936 | ||||
| Total | $ | 15,465 | $ | 2,254 | $ | (30) | $ | 17,689 |
The above table includes investments with a fair value of $2.6 billion supporting the Company's run-off settlement annuity business, with gross unrealized appreciation of $478 million and gross unrealized depreciation of $20 million at December 31, 2013. Such unrealized amounts are required to support future policy benefit liabilities of this business and, as such, are not included in accumulated other comprehensive income. At December 31, 2012, investments supporting this business had a fair value of $3.1 billion, gross unrealized appreciation of $883 million and gross unrealized depreciation of $8 million.
As of December 31, 2013, the Company had commitments to purchase $56 million of fixed maturities, all of which bear interest at a fixed market rate.
Review of declines in fair value. Management reviews fixed maturities with a decline in fair value from cost for impairment based on criteria that include:
As of December 31, 2013, fixed maturities (excluding trading and hybrid securities) with a decline in fair value from amortized cost (primarily corporate securities) were by length of time of decline, as follows:
| (Dollars in millions) | December 31, 2013 | ||||||
| Fair | Amortized | Unrealized | Number | ||||
| Value | Cost | Depreciation | of Issues | ||||
| Fixed maturities: | |||||||
| One year or less: | |||||||
| Investment grade | $ | 2,250 | $ | 2,317 | $ | (67) | 599 |
| Below investment grade | $ | 237 | $ | 243 | $ | (6) | 210 |
| More than one year: | |||||||
| Investment grade | $ | 256 | $ | 278 | $ | (22) | 72 |
| Below investment grade | $ | 46 | $ | 50 | $ | (4) | 16 |
As of December 31, 2013, the unrealized depreciation of investment grade fixed maturities is primarily due to increases in market yields since purchase. Excluding trading and hybrid securities, equity securities with a fair value lower than cost were not material at December 31, 2013.
Mortgage loans held by the Company are made exclusively to commercial borrowers and are diversified by property type, location and borrower. Loans are generally issued at a fixed rate of interest and are secured by high quality, primarily completed and substantially leased operating properties.
At December 31, commercial mortgage loans were distributed among the following property types and geographic regions:
| (In millions) | 2013 | 2012 | ||
| Property type | ||||
| Office buildings | $ | 761 | $ | 866 |
| Apartment buildings | 321 | 571 | ||
| Industrial | 450 | 532 | ||
| Hotels | 407 | 463 | ||
| Retail facilities | 285 | 346 | ||
| Other | 28 | 73 | ||
| Total | $ | 2,252 | $ | 2,851 |
| Geographic region | ||||
| Pacific | $ | 805 | $ | 966 |
| South Atlantic | 564 | 730 | ||
| New England | 379 | 387 | ||
| Central | 260 | 352 | ||
| Middle Atlantic | 201 | 300 | ||
| Mountain | 43 | 116 | ||
| Total | $ | 2,252 | $ | 2,851 |
At December 31, 2013, scheduled commercial mortgage loan maturities were as follows (in millions): $177 in 2014, $287 in 2015, $719 in 2016, $252 in 2017 and $817 thereafter. Actual maturities could differ from contractual maturities for several reasons: borrowers may have the right to prepay obligations with or without prepayment penalties; the maturity date may be extended; and loans may be refinanced.
As of December 31, 2013, the Company had commitments to extend credit under commercial mortgage loan agreements of $7 million.
Credit quality. The Company regularly evaluates and monitors credit risk, beginning with the initial underwriting of a mortgage loan and continuing throughout the investment holding period. Mortgage origination professionals employ an internal credit quality rating system designed to evaluate the relative risk of the transaction at each loan's origination that is then updated each year as part of the annual portfolio loan review. The Company evaluates and monitors credit quality on an ongoing basis, classifying each loan as a loan in good standing, potential problem loan or problem loan.
Quality ratings are based on our evaluation of a number of key inputs related to the loan, including real estate market-related factors such as rental rates and vacancies, and property-specific inputs such as growth rate assumptions and lease rollover statistics. However, the two most significant contributors to the credit quality rating are the debt service coverage and loan-to-value ratios. The debt service coverage ratio measures the amount of property cash flow available to meet annual interest and principal payments on debt with a ratio below 1.0 indicating that there is not enough cash flow to cover the required loan payments. The loan-to-value ratio, commonly expressed as a percentage, compares the amount of the loan to the fair value of the underlying property collateralizing the loan.
The following tables summarize the credit risk profile of the Company's commercial mortgage loan portfolio based on loan-to-value and debt service coverage ratios, as of December 31, 2013 and 2012:
| (In millions) | December 31, 2013 | |||||||||||
| Debt Service Coverage Ratio | ||||||||||||
| 1.30x or | 1.20x to | 1.10x to | 1.00x to | Less than | ||||||||
| Loan-to-Value Ratios | Greater | 1.29x | 1.19x | 1.09x | 1.00x | Total | ||||||
| Below 50% | $ | 314 | $ | - | $ | - | $ | 6 | $ | - | $ | 320 |
| 50% to 59% | 581 | 131 | - | 18 | - | 730 | ||||||
| 60% to 69% | 438 | 16 | 29 | - | 24 | 507 | ||||||
| 70% to 79% | 79 | 113 | - | - | - | 192 | ||||||
| 80% to 89% | 65 | 42 | 34 | 28 | 143 | 312 | ||||||
| 90% to 99% | - | - | 58 | 50 | 67 | 175 | ||||||
| 100% or above | - | - | - | - | 16 | 16 | ||||||
| Total | $ | 1,477 | $ | 302 | $ | 121 | $ | 102 | $ | 250 | $ | 2,252 |
| (In millions) | December 31, 2012 | |||||||||||
| Debt Service Coverage Ratio | ||||||||||||
| 1.30x or | 1.20x to | 1.10x to | 1.00x to | Less than | ||||||||
| Loan-to-Value Ratios | Greater | 1.29x | 1.19x | 1.09x | 1.00x | Total | ||||||
| Below 50% | $ | 297 | $ | 8 | $ | - | $ | 50 | $ | - | $ | 355 |
| 50% to 59% | 614 | 104 | 25 | 52 | - | 795 | ||||||
| 60% to 69% | 562 | 75 | - | 66 | - | 703 | ||||||
| 70% to 79% | 194 | 143 | 132 | 4 | 16 | 489 | ||||||
| 80% to 89% | 45 | 42 | 131 | 18 | 58 | 294 | ||||||
| 90% to 99% | 14 | 30 | - | - | 58 | 102 | ||||||
| 100% or above | - | - | 30 | 17 | 66 | 113 | ||||||
| Total | $ | 1,726 | $ | 402 | $ | 318 | $ | 207 | $ | 198 | $ | 2,851 |
The Company's annual in-depth review of its commercial mortgage loan investments is the primary mechanism for identifying emerging risks in the portfolio. The most recent review was completed by the Company's investment professionals in the second quarter of 2013 and included an analysis of each underlying property's most recent annual financial statements, rent rolls, operating plans, budgets, a physical inspection of the property and other pertinent factors. Based on historical results, current leases, lease expirations and rental conditions in each market, the Company estimates the current year and future stabilized property income and fair value, and categorizes the investments as loans in good standing, potential problem loans or problem loans. Based on property valuations and cash flows estimated as part of this review, and considering updates for loans where material changes were subsequently identified, the portfolio's average loan-to-value ratio improved to 64% at December 31, 2013 from 65% at December 31, 2012. The portfolio's average debt service coverage ratio was estimated to be 1.62 at December 31, 2013, a modest improvement from 1.56 at December 31, 2012.
Quality ratings are adjusted between annual reviews if new property information is received or events such as delinquency or a borrower's request for restructure cause management to believe that the Company's estimate of financial performance, fair value or the risk profile of the underlying property has been impacted.
During 2013, the Company restructured its subordinate interest in two cross-collateralized pools of industrial loans totaling $31 million by extending the maturity dates and reducing the interest rates. This modification was considered a troubled debt restructuring and the loans were classified as problem mortgage loans because the borrower was experiencing financial difficulties and an interest rate concession was granted. No valuation reserves were required because the fair values of the underlying properties exceeded the carrying values of the outstanding loans.
During 2012, the Company restructured a $119 million problem mortgage loan, net of a valuation reserve, into two notes carried at $100 million and $19 million. The $100 million note was reclassified to impaired commercial mortgage loans with no valuation reserves and the $19 million note was classified as an other long-term investment. This modification was considered a troubled debt restructuring because the borrower was experiencing financial difficulties and an interest rate concession was granted. No valuation reserve was required because the fair value of the underlying property equaled the carrying value of the outstanding loan. Following the restructuring, the $100 million note was reclassified to good standing based on the results of the 2012 annual loan review and has been subsequently paid in full. In addition, the $19 million note was paid in full in the fourth quarter of 2013.
Certain other loans were modified during 2013 and 2012. However, these were not considered troubled debt restructures and the impact of such modifications was not material to the Company's results of operations, financial condition or liquidity.
Potential problem mortgage loans are considered current (no payment more than 59 days past due), but exhibit certain characteristics that increase the likelihood of future default. The characteristics management considers include, but are not limited to, the deterioration of debt service coverage below 1.0, estimated loan-to-value ratios increasing to 100% or more, downgrade in quality rating and request from the borrower for restructuring. In addition, loans are considered potential problems if principal or interest payments are past due by more than 30 but less than 60 days. Problem mortgage loans are either in default by 60 days or more or have been restructured as to terms, which could include concessions on interest rate, principal payment or maturity date. The Company monitors each problem and potential problem mortgage loan on an ongoing basis, and updates the loan categorization and quality rating when warranted.
Problem and potential problem mortgage loans, net of valuation reserves, totaled $158 million at December 31, 2013 and $215 million at December 31, 2012. At December 31, 2013 and December 31, 2012, mortgage loans located in the South Atlantic region represented the most significant component of problem and potential problem mortgage loans. Loans collateralized by industrial properties represented the most significant concentration by property type at December 31, 2013, with no significant concentration by property type at December 31, 2012.
Impaired commercial mortgage loans. The carrying value of the Company's impaired commercial mortgage loans and related valuation reserves were as follows:
| (In millions) | 2013 | 2012 | |||||||||||
| Gross | Reserves | Net | Gross | Reserves | Net | ||||||||
| Impaired commercial mortgage loans with valuation reserves | $ | 89 | $ | (8) | $ | 81 | $ | 72 | $ | (7) | $ | 65 | |
| Impaired commercial mortgage loans with no valuation reserves | 31 | - | 31 | 60 | - | 60 | |||||||
| Total | $ | 120 | $ | (8) | $ | 112 | $ | 132 | $ | (7) | $ | 125 | |
The average recorded investment in impaired loans was $127 million during 2013 and $167 million during 2012. The Company recognizes interest income on problem mortgage loans only when payment is actually received because of the risk profile of the underlying investment. Interest income that would have been reflected in net income if interest on non-accrual commercial mortgage loans had been received in accordance with the original terms was not significant for 2013 or 2012. Interest income on impaired commercial mortgage loans was not significant for 2013 or 2012. See Note 2 for further information on impaired commercial mortgage loans.
The following table summarizes the changes in valuation reserves for commercial mortgage loans:
| (In millions) | 2013 | 2012 | ||
| Reserve balance, January 1, | $ | 7 | $ | 19 |
| Increase in valuation reserves | 4 | 10 | ||
| Charge-offs upon sales and repayments, net of recoveries | (3) | (3) | ||
| Transfers to other long-term investments | - | (16) | ||
| Transfers to foreclosed real estate | - | (3) | ||
| Reserve balance, December 31, | $ | 8 | $ | 7 |
As of December 31, 2013 and 2012, real estate investments consisted primarily of office and industrial buildings in California. Investments with a carrying value of $63 million as of December 31, 2013 and $49 million as of December 31, 2012 were non-income producing during the preceding twelve months. As of December 31, 2013, the Company had commitments to contribute additional equity of $3 million to real estate investments.
As of December 31, other long-term investments consisted of the following:
| (In millions) | 2013 | 2012 | ||
| Real estate entities | $ | 812 | $ | 823 |
| Securities partnerships | 357 | 343 | ||
| Other | 104 | 89 | ||
| Total | $ | 1,273 | $ | 1,255 |
Investments in real estate entities and securities partnerships with a carrying value of $154 million at December 31, 2013 and $199 million at December 31, 2012 were non-income producing during the preceding twelve months.
As of December 31, 2013, the Company had commitments to contribute:
The Company expects to disburse approximately 63% of the committed amounts in 2014.
E. Short-Term Investments and Cash Equivalents
Short-term investments and cash equivalents included corporate securities of $2.2 billion, federal government securities of $323 million and money market funds of $35 million as of December 31, 2013. The Company's short-term investments and cash equivalents as of December 31, 2012 included corporate securities of $1.1 billion, federal government securities of $167 million and money market funds of $217 million.
F. Concentration of Risk
As of December 31, 2013 and 2012, the Company did not have a concentration of investments in a single issuer or borrower exceeding 10% of shareholders' equity.