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SYA > SEC Filings for SYA > Form 10-Q on 7-Nov-2012All Recent SEC Filings

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Quarterly Report

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

This discussion contains forward-looking statements that involve risk and uncertainties. Our actual results may differ materially from those discussed in, or implied by, any of the forward-looking statements as a result of various factors, including but not limited to those listed under "Forward-Looking Statements." You should read the following discussion in conjunction with Item 1
- "Condensed Financial Statements" included in this Form 10-Q, our Annual Report for the year ended December 31, 2011, filed with the SEC on February 29, 2012 ("2011 10-K"), as well as our current reports on Form 8-K and other publicly available information. Our fiscal year ends on December 31 of each calendar year.

Management considers certain non-GAAP financial measures, including adjusted operating income, adjusted operating income per common share, pre-tax adjusted operating income, adjusted book value, adjusted book value, as converted, adjusted book value per common share, adjusted book value per common share, as converted, average adjusted book value, and operating return on average equity (ROAE) to be useful to investors in evaluating our financial performance and condition. These measures have been reconciled to their most comparable GAAP financial measures. For a definition and further discussion of these non-GAAP measures, see Item 7 - "Management's Discussion and Analysis of Financial Condition - Use of non-GAAP Financial Measures" in our 2011 10-K.

Historical financial information has been restated to reflect the retrospective adoption of a new accounting standard for deferred acquisition costs on January 1, 2012. See Note 2 to the accompanying unaudited interim condensed consolidated financial statements for discussion of adoption of new accounting pronouncements.

All dollar and share amounts, except per share data, are in millions unless otherwise stated.


We are a financial services company in the life insurance industry providing employee benefits, annuities and life insurance through a national network of benefits consultants, financial institutions and independent agents and advisers. Our operations date back to 1957 and many of our distribution relationships have been in place for decades.

Our Operations

We manage our business through three divisions composed of four business segments:

Benefits Division

Benefits. We offer medical stop-loss insurance, limited benefit medical plans, group life insurance, accidental death and dismemberment insurance and disability income insurance mainly to employer groups of 50 to 5,000 individuals. In addition to our insurance products, we offer managing general underwriter (MGU) and leave administration services.

Retirement Division

Deferred Annuities. We offer fixed and variable deferred annuities to consumers who want to accumulate tax-deferred assets for retirement.

Income Annuities. We offer single premium income annuities (SPIAs) to customers seeking a reliable source of retirement income or to protect against outliving their assets during retirement, and structured settlement annuities to fund third party personal injury settlements. In addition, we offer funding services options to existing structured settlement clients.

Individual Life Division

Individual Life. We offer an array of insurance products such as term and universal life insurance (UL), including single premium life insurance (SPL), bank-owned life insurance (BOLI) and corporate-owned life insurance (COLI).

In addition, we have our Other segment, which consists primarily of investment income on unallocated surplus, unallocated corporate expenses, interest expense on debt, earnings related to our limited partnership interests, the results of small, non-insurance businesses that are managed outside of our divisions, such as our broker-dealer, and inter-segment elimination entries.

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See Note 11 to the accompanying unaudited interim condensed consolidated financial statements for the financial results of our segments.

Current Outlook

The third quarter of 2012 offered modest U.S. economic growth, despite continued headwinds including European instability and weakness, and U.S. political uncertainty. The political uncertainty in the U.S. is exacerbated by the possibility of a "fiscal cliff" in early 2013, when automatic spending cuts and tax increases are set to take effect unless a deficit reduction plan is implemented. In addition, interest rates continue to be suppressed to historically low levels by the Federal Reserve to support a stronger economic recovery. Recently, in September 2012, the Federal Reserve announced plans to purchase additional agency mortgage-backed securities at a rate of $40 billion per month, which will continue to place downward pressure on interest rates. We expect interest rates to remain low for the next two years, which combined with tighter credit spreads will create continued pressure for our interest-sensitive asset-based businesses, impacting sales of and margins on these products, including fixed annuities, SPIAs, universal life insurance and BOLI.

To mitigate the risk of unfavorable consequences in this environment, such as spread compression on our in-force business, we remain proactive in our investment and product strategies, interest-crediting strategies and overall asset-liability management practices. To manage our asset yield in this environment, we have been and plan to continue increasing our investments in commercial mortgage loans we underwrite. While interest rates on recently written loans have decreased consistent with the overall level of interest rates, they continue to be an attractive investment opportunity. Further, we made additional progress on our investment strategy of selling lower yielding, higher premium agency RMBS where the prepayment characteristics of these securities had deteriorated. During the nine months ended September 30, 2012, we sold $365.3 of these assets. In doing so, we were able to produce realized gains while reducing our future reinvestment risk. We remain proactive in managing our prepayment and reinvestment risk and may seek similar transactions in the fourth quarter of 2012. Looking forward, we continue the pursuit of other investment strategies to help us retain our interest margins in the current low interest rate environment.

To manage our way through this uncertain environment and grow profitably, we will continue to focus on the strategies outlined in Item 1 - "Business - Our Strategies" in the 2011 10-K. Our 2012 focus is to continue executing on our Grow & Diversify initiatives, while at the same time remaining focused on our core businesses and maintaining our financial strength ratings.

We believe we have adequate levels of capital to support our current business and to fund organic and transactional growth. Opportunities for organic growth of our business and for strategic transactions have arisen as major players in the life insurance industry have exited or announced plans to exit the life and annuities marketplace. However, the success of these and other strategies may be affected by the factors discussed in Item 1A - "Risk Factors" and other factors as discussed herein.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with GAAP requires management to adopt accounting policies and make estimates and assumptions that affect amounts reported and disclosed in the unaudited interim condensed consolidated financial statements. The following accounting policies are those we consider to be particularly critical to understanding our condensed financial statements because their application places the most significant demands on our ability to judge the effect of inherently uncertain matters on our financial results:

The evaluation of OTTI of investments;

The valuation of investments at fair value;

The balance, recoverability and amortization of deferred policy acquisition costs and deferred sales inducements; and

The liabilities for future policy benefits and policy and contract claims.

In applying the Company's accounting policies, management makes subjective and complex judgments that frequently require estimates 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 businesses and operations. For all of these policies, we caution that future events rarely develop exactly as forecasted, and our best estimates may require adjustment.

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On January 1, 2012, we retrospectively adopted a new accounting standard related to the deferral of policy acquisition costs. Our new policy regarding deferrable costs, including the impact of retrospective adoption, is described below. This new accounting standard did not impact the accounting for deferred sales inducements.

Other than as described above, there have been no material changes to the critical accounting estimates listed above, which are described in Item 7 - "Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies and Estimates" and Note 2 of the notes to the audited consolidated financial statements included in the 2011 10-K.

Deferred Policy Acquisition Costs (DAC)

Prior to the adoption of new accounting guidance, deferrable acquisition costs were those that varied with and were primarily related to the acquisition of new or renewal business, regardless of whether the efforts were successful or unsuccessful. Under the new standard, we defer only costs that are directly related to the successful acquisition or renewal of insurance contracts, including:

Commissions for successful contract acquisitions;

Premium-based taxes and assessments;

Distribution costs directly related to successful contract acquisition;

Third-party underwriting costs related to contracts that are successfully acquired; and

The portion of the salaries and benefits related to employee time spent on the processing of successfully acquired new and renewal contracts.

All other acquisition-related costs, including costs incurred for soliciting potential customers, managing distribution and underwriting functions, training, administration, unsuccessful acquisition or renewal efforts, market research and product development are not deferrable and are expensed in the period incurred. Additionally, upon adoption, policy acquisition costs in our Benefits segment are no longer being deferred, as the application of the new standard to the short-duration contracts in this segment resulted in an immaterial net impact of deferral of acquisition costs.

While we have restated DAC amortization to reflect the retrospective reduction in costs deferred, our policies and methodology have not changed. For more information on the impact of adoption, see Note 2 to the accompanying unaudited interim condensed consolidated financial statements.

The following table summarizes our DAC asset balances by segment:

                                            As of September 30, 2012            As of December 31, 2011
                                                                                     (As adjusted)
Deferred Annuities                         $                    259.3          $                   265.5
Income Annuities                                                 43.5                               37.9
Individual Life                                                  66.7                               65.0

Total unamortized balance at end of
period                                                          369.5                              368.4
Accumulated effect of net unrealized
gains                                                          (223.4 )                           (182.4 )

Balance at end of period                   $                    146.1          $                   186.0

Amortization of DAC

We amortize DAC over the premium paying period or over the lives of the policies in proportion to the future estimated gross profits (EGPs) of each of these product lines, as follows:

Deferred Annuities. The DAC amortization period is typically 20 years for deferred annuities, although most of the DAC amortization occurs within the first 10 years because the EGPs are highest during such period. It is common for deferred annuity policies to lapse after the surrender charge period expires.

Income Annuities. The DAC amortization period for SPIAs, including structured settlement annuities, is the benefit payment period. The benefit payment periods vary by policy; however, 80% of the benefits will be paid over the next 45 years and nearly all benefits are paid within 80 years of contract issue.

Individual Life. The DAC amortization period related to universal life policies is typically 25 years. DAC amortization related to our term life insurance policies is the premium paying period, which ranges from 10 to 30 years.

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To determine the EGPs, we make assumptions as to lapse and withdrawal rates, expenses, interest margins, mortality experience, long-term equity market returns and investment performance. Estimating future gross profits is a complex process requiring considerable judgment and forecasting of events well into the future.

Changes to assumptions can have a significant impact on DAC amortization. In the event actual experience differs from our assumptions or our future assumptions are revised, we adjust our EGPs, which could result in a significant increase in amortization expense. EGPs are adjusted quarterly to reflect actual experience to date. For example, for our deferred annuity products, if renewal crediting rates are greater or lower than the renewal crediting rates we assumed in our DAC asset amortization models, we would record a change in amortization expense to reflect the change in our EGPs. For future assumptions we complete a study and refine our estimates of future gross profits at least annually during the third quarter. Upon completion of an assumption study, we revise our assumptions to reflect our current best estimate, thereby changing our estimate of projected EGPs used in the DAC asset amortization models. This is often referred to as "unlocking" the DAC asset amortization model. In the quarter ended September 30, 2012, we recorded an unlocking adjustment of $2.6 which increased DAC amortization, primarily in our Individual Life segment. The unlocking was driven by lowering our assumptions for future interest margins, due to expected investment yields in this low interest rate environment. We also revise future assumptions as needed throughout the year if a significant transaction or trend is identified that would warrant a change in those assumptions.

The following would generally cause an increase in DAC amortization expense:

Actual experience differs from our assumptions:

increases to interest margins in the current period from increased yields or decreased crediting rates;

increases to lapse and withdrawal rates in the current period;

decreases to current period expense levels;

significant investment prepayment related income;

increases to equity market returns; and

lower death claims.

Future assumption changes (unlocking):

decreases in expected future interest margins due to increases in expected renewal crediting rates and/or decreases to expected investment yields;

increases to expected future lapse and withdrawal rates;

increases to future expected expense levels;

significant investment prepayment activity, which results in decreased future interest margins;

decreases to expected equity market returns; and

higher expected future death claims.

We regularly conduct DAC recoverability analyses, where we compare the current DAC asset balances with the estimated present value of future profitability of the underlying business. The DAC asset balance is considered recoverable if the present value of future profits is greater than the current DAC asset balance.

In connection with our recoverability analyses, we perform sensitivity analyses on our most significant DAC asset balances, which currently relate to our deferred annuity, universal life, and BOLI products, to capture the effect that certain key assumptions have on DAC asset balances. The sensitivity tests are performed independently, without consideration for any correlation among the key assumptions. The following depicts the sensitivities for our deferred annuity, universal life and BOLI DAC asset balances as of December 31, 2011:

if we increased our future lapse and withdrawal rate assumptions by a factor of 10%, the DAC asset balance would decrease approximately $4.9;

if we increased our future expense assumptions by a factor of 10%, the DAC asset balance would decrease approximately $0.5.

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In addition, depending on the amount and the type of new business written in the future, we may determine that other assumptions may produce significant variations in our financial results.

We adjust the unamortized DAC balance for the accumulated effect of net unrealized gains or losses, which is recorded net of taxes in AOCI. This adjustment reflects the impact on EGPs as if the unrealized investment gains and losses had been realized as of the balance sheet date. Currently, our available-for-sale portfolio is in a net unrealized gain position, primarily due to the low interest rate environment, and the corresponding adjustment decreases our DAC balance and AOCI. In periods of rising interest rates, the fair value of our fixed maturities would generally decrease, and this may result in net unrealized investment losses. In such circumstances, the DAC adjustment would increase our DAC balance and increase AOCI. However, this adjustment is limited to cumulative capitalized acquisition costs plus interest, which would be $200.0, net of taxes of $130.0, in our Deferred Annuities segment, and $11.0, net of taxes of $7.1, in our Individual Life segment as of December 31, 2011.

New Accounting Standards

For a discussion of recently adopted accounting pronouncements, see Note 2 to the accompanying unaudited interim condensed consolidated financial statements.

Sources of Revenues and Expenses

Our primary sources of revenues from our insurance operations are premiums, net investment income and policy fees and contract charges. Our primary sources of expenses from our insurance operations are policyholder benefits and claims, interest credited to policyholder reserves and account balances, and general business and operating expenses, net of DAC. We allocate shared service operating expenses to each segment using multiple factors, including employee headcount, allocated investments, account values and time study results. We also generate net realized investment gains (losses) on sales or impairment of our investments and changes in fair value on our equity trading portfolio.

Each of our four business segments maintains its own portfolio of invested assets, which are managed in accordance with specific guidelines. The net investment income and realized investment gains (losses) are reported in the segment in which they occur. We also allocate surplus net investment income to each segment using a risk-based capital formula. The unallocated portion of net investment income is reported in the Other segment.



Premiums consist primarily of premiums from our medical stop-loss and individual term and whole life insurance products.

Net investment income

Net investment income represents the income earned on our investments, net of investment expenses, including prepayment related income such as bond make-whole payments. Net investment income also includes gains or losses from changes in the fair value of our investments in private equity fund limited partnerships and the amortization of tax credit investments.

Policy fees, contract charges and other

Policy fees, contract charges and other includes cost of insurance (COI) charges on our UL and BOLI policies, mortality expense, surrender and other administrative charges to policyholders, revenues from our non-insurance businesses, and reinsurance allowance fees.

Net realized investment gains (losses)

Net realized investment gains (losses) mainly consists of realized gains (losses) from sales of our investments, realized losses from investment impairments, changes in fair value on our trading portfolio and changes in fair value of our FIA options and related FIA embedded derivative.

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Benefits and Expenses

Policyholder benefits and claims

Policyholder benefits and claims consist of benefits paid and reserve activity on medical stop-loss, individual life and BOLI policies.

Interest credited

Interest credited represents interest credited to policyholder reserves and contract holder general account balances, the impact of mortality and funding services activity within our Income Annuities segment, and the amortization of deferred sales inducement assets.

Other underwriting and operating expenses

Other underwriting and operating expenses represent non-deferrable costs related to the acquisition and ongoing maintenance of insurance and investment contracts, including certain non-deferrable commissions, policy issuance expenses and other business and administrative operating costs.

Interest expense

Interest expense primarily includes interest on corporate debt, the impact of interest rate hedging activities on the debt and amortization of debt issuance costs.

Amortization of deferred policy acquisition costs

We defer as assets certain commissions, distribution costs and other underwriting costs that are directly related to the successful acquisition of new and renewal business. Amortization of previously capitalized DAC is recorded as an expense.

Use of non-GAAP Financial Measures

Certain tables and related disclosures in this report include non-GAAP financial measures. We believe these measures provide useful information to investors in evaluating our financial performance or condition. The non-GAAP financial measures discussed below are not substitutes for their most directly comparable GAAP measures. The adjustments made to derive these non-GAAP measures are important to understanding our overall results of operations and financial position and, if evaluated without proper context, these non-GAAP measures possess material limitations. Therefore, our management and board of directors also separately review the items excluded from or added to the most directly comparable GAAP measures to arrive at these non-GAAP measures. In addition, management and our board of directors also analyze each of the comparable GAAP measures in connection with their review of our results of operations and financial position.

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For a full discussion of each non-GAAP measure, see Item 7 - "Management's Discussion and Analysis of Financial Condition and Results of Operations - Use of non-GAAP Financial Measures" in our 2011 10-K.

                                                                 As of                 As of
                                                             September 30,          December 31,
                                                                 2012                   2011
                                                                                   (As adjusted)
Total stockholders' equity                                  $       3,641.2        $      3,114.9
Less: AOCI                                                          1,404.3               1,027.3

Adjusted book value*                                                2,236.9               2,087.6
Add: Assumed proceeds from exercise of warrants                       218.1                 218.1

Adjusted book value, as converted*                          $       2,455.0        $      2,305.7

Book value per common share(1)                              $         26.37        $        22.64

Adjusted book value per common share(2)*                    $         18.78        $        17.60

Adjusted book value per common share, as converted(3)*      $         17.78        $        16.75

                                                             For the Twelve Months Ended
                                                        September 30,            December 31,
                                                             2012                    2011
                                                                                 (As adjusted)
Return on stockholders' equity, or ROE                              7.6 %                   7.2 %
Net income(4)                                          $          248.1         $         195.8
Average stockholders' equity(5)                                 3,266.3                 2,710.2

Operating return on average equity, or ROAE*                        9.5 %                   9.5 %
Adjusted operating income(6)*                          $          203.5         $         190.2
Average adjusted book value(7)*                                 2,138.1                 2,002.4

* Represents a non-GAAP measure.

(1) Book value per common share is calculated as stockholders' equity divided by outstanding common shares and shares subject to outstanding warrants totaling 138.096 and 137.613 as of September 30, 2012 and December 31, 2011, respectively.

(2) Adjusted book value per common share is calculated as adjusted book value divided by outstanding common shares totaling 119.120 and 118.637 as of September 30, 2012 and December 31, 2011, respectively.

(3) Adjusted book value per common share, as converted is calculated as adjusted book value plus the assumed proceeds from exercise of warrants, divided by outstanding common shares and shares subject to outstanding warrants totaling 138.096 and 137.613 as of September 30, 2012 and December 31, 2011, respectively. The warrants, which will expire in August 2014, have an exercise price of $11.49.

(4) Net income for the most recent twelve months is used in the calculation of ROE. For the twelve months ended September 30, 2012, this consisted of quarterly net income of $55.2, $43.8, $75.4 and $73.7.

(5) Ending stockholder's equity balances for the most recent five quarters are used in the calculation of ROE. As of September 30, 2012, stockholder's equity for the most recent five quarters was $3,641.2, $3,378.4, $3,154.7, $3,114.9 and $3,042.2. As of December 31, 2011, stockholder's equity for the most recent five quarters was $3,114.9, $3,042.2, $2.627.3, $2,410.2 and $2,356.6.

(6) Adjusted operating income for the most recent twelve months is used in the calculation of operating ROAE. For the twelve months ended September 30, 2012, this consisted of quarterly adjusted operating income of $45.9, $47.2, . . .

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