Voya 2014 Annual Report Download - page 224

losses was primarily due to declining interest rates. Gross unrealized losses on fixed maturities, including
securities pledged, increased $843.8 million from $292.7 million to $1,136.5 million for the year ended
December 31, 2013. The increase in gross unrealized losses was primarily due to increasing interest rates.
As of December 31, 2014, we held one fixed maturity with unrealized capital losses in excess of $10.0
million. The unrealized capital losses on this fixed maturity equaled $10.5 million, or 3.2% of the total unrealized
losses. As of December 31, 2013, we held two fixed maturities with unrealized capital losses in excess of $10.0
million. The unrealized capital losses on these fixed maturities equaled $22.0 million, or 1.9% of the total
unrealized losses. See the Investments (excluding Consolidated Investment Entities) Note in our Consolidated
Financial Statements in Part II, Item 8. of this Annual Report on Form 10-K for further information on unrealized
capital losses.
CMO-B Portfolio
As part of our broadly diversified investment portfolio, we have a core holding in a proprietary mortgage
derivatives strategy known as CMO-B, which invests in a variety of CMO securities in combination with interest
rate derivatives in targeting a specific type of exposure to the U.S. residential mortgage market. Because of their
relative complexity and generally small natural buyer base, we believe certain types of CMO securities are
consistently priced below their intrinsic value, thereby providing a source of potential return for investors in this
strategy.
The CMO securities that are part of our CMO-B portfolio are either notional or principal securities, backed
by the interest and principal components, respectively, of mortgages secured by single-family residential real
estate. There are many variations of these two types of securities including interest only and principal only
securities, as well as inverse-floating rate (principal) securities and inverse interest only securities, all of which
are part of our CMO-B portfolio. This strategy has been in place for nearly two decades and thus far has been a
significant source of investment income while exhibiting relatively low volatility and correlation compared to the
other asset types in the investment portfolio, although we cannot predict whether favorable returns will continue
in future periods.
To protect against the potential for credit loss associated with financially troubled borrowers, investments in
our CMO-B portfolio are primarily in CMO securities backed by one of the government sponsored entities: the
Federal National Mortgage Association (“Fannie Mae”), the Federal Home Loan Mortgage Corporation
(“Freddie Mac”) or Government National Mortgage Association (“Ginnie Mae”).
Because the timing of the receipt of the underlying cash flow is highly dependent on the level and direction
of interest rates, our CMO-B portfolio also has exposure to both interest rate and convexity risk. The exposure to
interest rate risk-the potential for changes in value that results from changes in the general level of interest rates-
is managed to a defined target duration using interest rate swaps. The exposure to convexity risk-the potential for
changes in value that result from changes in duration caused by changes in interest rates-is dynamically hedged
using interest rate swaps and at times, interest rate swaptions.
Prepayment risk represents the potential for adverse changes in portfolio value resulting from changes in
residential mortgage prepayment speed (actual and projected), which in turn depends on a number of factors,
including conditions in both credit markets and housing markets. Changes in the prepayment behavior of
homeowners represent both a risk and potential source of return for our CMO-B portfolio. As a result, we seek to
invest in securities that are broadly diversified by collateral type to take advantage of the uncorrelated
prepayment experiences of homeowners with unique characteristics that influence their ability or desire to prepay
their mortgage. We choose collateral types and individual securities based on an in-depth quantitative analysis of
prepayment incentives across available borrower types.
201