UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE |
| SECURITIES EXCHANGE ACT OF 1934 |
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| For the Quarterly Period Ended September 30, 2008 |
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| or |
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o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE |
| SECURITIES EXCHANGE ACT OF 1934 |
For the Transition Period from to
Commission file number 333-114888
RIVERSOURCE LIFE INSURANCE COMPANY
(Exact name of registrant as specified in its charter)
Minnesota |
| 41-0823832 |
(State or other jurisdiction of |
| (I.R.S. Employer Identification No.) |
incorporation or organization) |
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1099 Ameriprise Financial Center, Minneapolis, Minnesota |
| 55474 |
(Address of principal executive offices) |
| (Zip Code) |
Registrant’s telephone number, including area code (612) 671-3131
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o | Accelerated filer o | Non-accelerated filer x | Smaller reporting company o |
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| (Do not check if a smaller |
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| reporting company) |
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class |
| Outstanding at November 4, 2008 |
Common Stock (par value $30 per share) |
| 100,000 shares |
THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTIONS H(1) (a) AND (b) OF FORM 10-Q AND IS THEREFORE FILING THIS FORM WITH THE REDUCED DISCLOSURE FORMAT.
RIVERSOURCE LIFE INSURANCE COMPANY
FORM 10-Q
RIVERSOURCE LIFE INSURANCE COMPANY
(in millions, except share amounts)
|
| September 30, |
| December 31, |
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| 2008 |
| 2007 |
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| (unaudited) |
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Assets |
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Investments: |
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Available-for-Sale: |
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Fixed maturities, at fair value (amortized cost: 2008, $19,403; 2007, $21,020) |
| $ | 18,214 |
| $ | 20,792 |
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Common and preferred stocks, at fair value (cost: 2008 and 2007, $30) |
| 23 |
| 29 |
| ||
Commercial mortgage loans, at cost (less allowance for loan losses: 2008 and 2007, $16) |
| 2,762 |
| 2,892 |
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Policy loans |
| 723 |
| 697 |
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Trading securities and other investments |
| 195 |
| 67 |
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Total investments |
| 21,917 |
| 24,477 |
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Cash equivalents |
| 1,148 |
| 973 |
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Reinsurance recoverables |
| 1,551 |
| 1,290 |
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Amounts due from brokers |
| 16 |
| 123 |
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Other accounts receivable |
| 120 |
| 118 |
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Accrued investment income |
| 240 |
| 252 |
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Deferred acquisition costs |
| 4,412 |
| 4,429 |
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Deferred sales inducement costs |
| 523 |
| 511 |
| ||
Deferred income taxes, net |
| 296 |
| — |
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Other assets |
| 487 |
| 491 |
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Separate account assets |
| 49,929 |
| 58,070 |
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Total assets |
| $ | 80,639 |
| $ | 90,734 |
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Liabilities and Shareholder’s Equity |
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Liabilities: |
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Future policy benefits |
| $ | 26,505 |
| $ | 26,977 |
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Policy claims and other policyholders’ funds |
| 102 |
| 91 |
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Amounts due to brokers |
| 182 |
| 361 |
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Deferred income taxes, net |
| — |
| 133 |
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Other liabilities |
| 334 |
| 382 |
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Separate account liabilities |
| 49,929 |
| 58,070 |
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Total liabilities |
| 77,052 |
| 86,014 |
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Shareholder’s equity: |
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Common shares, $30 par value; |
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100,000 shares authorized, issued and outstanding |
| 3 |
| 3 |
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Additional paid-in capital |
| 2,033 |
| 2,031 |
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Retained earnings |
| 2,333 |
| 2,842 |
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Accumulated other comprehensive loss, net of tax |
| (782 | ) | (156 | ) | ||
Total shareholder’s equity |
| 3,587 |
| 4,720 |
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Total liabilities and shareholder’s equity |
| $ | 80,639 |
| $ | 90,734 |
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See Notes to Consolidated Financial Statements.
1
RIVERSOURCE LIFE INSURANCE COMPANY
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(in millions)
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| Three Months Ended |
| Nine Months Ended |
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| 2008 |
| 2007 |
| 2008 |
| 2007 |
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Revenues |
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Premiums |
| $ | 122 |
| $ | 123 |
| $ | 356 |
| $ | 361 |
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Net investment income |
| 306 |
| 352 |
| 962 |
| 1,121 |
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Policy and contract charges |
| 415 |
| 308 |
| 1,054 |
| 893 |
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Other revenue |
| 67 |
| 66 |
| 205 |
| 187 |
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Net realized investment gains (losses) |
| (200 | ) | 35 |
| (229 | ) | 42 |
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Total revenues |
| 710 |
| 884 |
| 2,348 |
| 2,604 |
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Benefits and expenses |
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Benefits, claims, losses and settlement expenses |
| 85 |
| 248 |
| 455 |
| 579 |
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Interest credited to fixed accounts |
| 200 |
| 212 |
| 588 |
| 645 |
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Amortization of deferred acquisition costs |
| 222 |
| 108 |
| 483 |
| 325 |
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Separation costs |
| — |
| 22 |
| — |
| 86 |
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Other insurance and operating expenses |
| 159 |
| 196 |
| 519 |
| 573 |
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Total benefits and expenses |
| 666 |
| 786 |
| 2,045 |
| 2,208 |
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Pretax income |
| 44 |
| 98 |
| 303 |
| 396 |
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Income tax provision (benefit) |
| — |
| (1 | ) | 7 |
| 68 |
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Net income |
| $ | 44 |
| $ | 99 |
| $ | 296 |
| $ | 328 |
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See Notes to Consolidated Financial Statements.
2
RIVERSOURCE LIFE INSURANCE COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in millions)
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| Nine Months Ended |
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| 2008 |
| 2007 |
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Cash Flows from Operating Activities |
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Net income |
| $ | 296 |
| $ | 328 |
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Adjustments to reconcile net income to net cash provided by operating activities: |
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Capitalization of deferred acquisition costs and deferred sales inducement costs |
| (505 | ) | (630 | ) | ||
Amortization of deferred acquisition costs and deferred sales inducement costs |
| 544 |
| 360 |
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Premium and discount amortization on Available-for-Sale |
| 44 |
| 54 |
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Deferred income taxes |
| (77 | ) | 140 |
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Contractholder and policyholder charges, non-cash |
| (183 | ) | (153 | ) | ||
Net realized investment losses (gains) |
| 229 |
| (42 | ) | ||
Net realized gain on trading securities and equity method investments in hedge funds |
| — |
| (1 | ) | ||
Change in operating assets and liabilities: |
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Trading securities and equity method investments in hedge funds, net |
| 1 |
| 125 |
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Future policy benefits for traditional life, disability income and long term care insurance |
| 237 |
| 207 |
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Policy claims and other policyholders’ funds |
| 11 |
| 13 |
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Reinsurance recoverables |
| (261 | ) | (116 | ) | ||
Other accounts receivable |
| (2 | ) | (33 | ) | ||
Accrued investment income |
| 12 |
| 35 |
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Other assets and liabilities, net |
| 1 |
| (85 | ) | ||
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Net cash provided by operating activities |
| 347 |
| 202 |
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Cash Flows from Investing Activities |
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Available-for-Sale securities: |
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Proceeds from sales |
| 189 |
| 2,618 |
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Maturities, sinking fund payments and calls |
| 1,859 |
| 1,380 |
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Purchases |
| (730 | ) | (444 | ) | ||
Other investments, excluding policy loans: |
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Proceeds from sales, maturities, sinking fund payments and calls |
| 231 |
| 401 |
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Purchases |
| (228 | ) | (334 | ) | ||
Change in policy loans, net |
| (26 | ) | (34 | ) | ||
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Net cash provided by investing activities |
| 1,295 |
| 3,587 |
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Cash Flows from Financing Activities |
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Activity related to investment contracts and universal life-type insurance: |
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Considerations received |
| 1,569 |
| 795 |
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Net transfers to separate accounts |
| — |
| 7 |
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Surrenders and other benefits |
| (2,223 | ) | (2,928 | ) | ||
Other |
| (40 | ) | — |
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Tax adjustment of share-based incentive compensation plan |
| 2 |
| — |
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Cash dividends to Ameriprise Financial, Inc. |
| (775 | ) | (800 | ) | ||
Net cash used in financing activities |
| (1,467 | ) | (2,926 | ) | ||
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Net increase in cash equivalents |
| 175 |
| 863 |
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Cash equivalents at beginning of period |
| 973 |
| 160 |
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Cash equivalents at end of period |
| $ | 1,148 |
| $ | 1,023 |
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Supplemental Disclosures: |
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Income taxes paid, net |
| $ | 128 |
| $ | 48 |
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See Notes to Consolidated Financial Statements.
3
RIVERSOURCE LIFE INSURANCE COMPANY
CONSOLIDATED STATEMENTS OF SHAREHOLDER’S EQUITY (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007
(in millions)
|
| Common |
| Additional |
| Retained |
| Accumulated |
| Total |
| |||||
Balances at December 31, 2006 |
| $ | 3 |
| $ | 2,021 |
| $ | 3,455 |
| $ | (209 | ) | $ | 5,270 |
|
Change in accounting principles |
| — |
| — |
| (134 | ) | — |
| (134 | ) | |||||
Other comprehensive income: |
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Net income |
| — |
| — |
| 328 |
| — |
| 328 |
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Change in net unrealized securities losses |
| — |
| — |
| — |
| (24 | ) | (24 | ) | |||||
Total other comprehensive income |
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| 304 |
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Cash dividends to Ameriprise Financial, Inc. |
| — |
| — |
| (800 | ) | — |
| (800 | ) | |||||
Non-cash capital contribution from Ameriprise Financial, Inc. |
| — |
| 10 |
| — |
| — |
| 10 |
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Balances at September 30, 2007 |
| $ | 3 |
| $ | 2,031 |
| $ | 2,849 |
| $ | (233 | ) | $ | 4,650 |
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Balances at December 31, 2007 |
| $ | 3 |
| $ | 2,031 |
| $ | 2,842 |
| $ | (156 | ) | $ | 4,720 |
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Change in accounting principles |
| — |
| — |
| (30 | ) | — |
| (30 | ) | |||||
Other comprehensive income: |
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Net income |
| — |
| — |
| 296 |
| — |
| 296 |
| |||||
Change in net unrealized securities losses |
| — |
| — |
| — |
| (626 | ) | (626 | ) | |||||
Total other comprehensive loss |
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| (330 | ) | |||||
Tax adjustment of share-based incentive compensation plan |
| — |
| 2 |
| — |
| — |
| 2 |
| |||||
Cash dividends to Ameriprise Financial, Inc. |
| — |
| — |
| (775 | ) | — |
| (775 | ) | |||||
Balances at September 30, 2008 |
| $ | 3 |
| $ | 2,033 |
| $ | 2,333 |
| $ | (782 | ) | $ | 3,587 |
|
See Notes to Consolidated Financial Statements.
4
RIVERSOURCE LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. Basis of Presentation
The accompanying Consolidated Financial Statements include the accounts of RiverSource Life Insurance Company and its wholly owned operating subsidiary, RiverSource Life Insurance Co. of New York. RiverSource Life Insurance Company is a wholly owned subsidiary of Ameriprise Financial, Inc. (“Ameriprise Financial”). All significant intercompany accounts and transactions have been eliminated in consolidation. RiverSource Life Insurance Company and its subsidiary are referred to collectively in this Form 10-Q as “RiverSource Life”.
The interim financial information in this report has not been audited. In the opinion of management, all adjustments necessary for a fair presentation of the consolidated financial position and results of operations for the interim periods have been made. All adjustments made were of a normal recurring nature.
Reclassifications
The accompanying Consolidated Financial Statements are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). Certain reclassifications of prior period amounts have been made to conform to the current presentation, including new income statement captions which are described in Note 1 of RiverSource Life’s Annual Report on Form 10-K for the year ended December 31, 2007, filed with the Securities and Exchange Commission (“SEC”) on February 29, 2008 (the “2007 10-K”). In the second quarter of 2008, RiverSource Life reclassified the mark-to-market adjustments on certain derivatives from net investment income to various expense lines where the mark-to-market adjustment on the related embedded derivative resides. The mark-to-market adjustment on derivatives hedging variable annuity living benefits and equity indexed annuities were reclassified to benefits, claims, losses and settlement expenses and interest credited to fixed accounts, respectively. As part of the December 31, 2007 reclassifications, portions of these mark-to-market adjustments were reclassified from other insurance and operating expenses to net investment income.
These reclassifications were made to enhance transparency and to better align the financial statement line captions with the key drivers of the business. The reclassifications did not result in any changes to consolidated net income or shareholder’s equity. Results of operations reported for interim periods are not necessarily indicative of results for the entire year. These Consolidated Financial Statements and Notes should be read in conjunction with the Consolidated Financial Statements and Notes in RiverSource Life’s 2007 10-K.
Income Statement Reclassifications
The following table shows the impact of the new captions and the reclassifications made to RiverSource Life’s previously reported Consolidated Statements of Income.
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| Three Months Ended |
| Nine Months Ended |
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|
| Previously |
| Reclassified |
| Previously |
| Reclassified |
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| (in millions) |
| ||||||||||
Revenues |
|
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Premiums |
| $ | 97 |
| $ | 123 |
| $ | 288 |
| $ | 361 |
|
Net investment income |
| 396 |
| 352 |
| 1,166 |
| 1,121 |
| ||||
Policy and contract charges |
| 173 |
| 308 |
| 505 |
| 893 |
| ||||
Other revenue |
| 213 |
| 66 |
| 606 |
| 187 |
| ||||
Net realized investment gains |
| 35 |
| 35 |
| 42 |
| 42 |
| ||||
|
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|
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Total revenues |
| 914 |
| 884 |
| 2,607 |
| 2,604 |
| ||||
|
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Benefits and expenses |
|
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|
|
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Benefits, claims, losses and settlement expenses |
| 269 |
| 248 |
| 501 |
| 579 |
| ||||
Interest credited to fixed accounts |
| 235 |
| 212 |
| 720 |
| 645 |
| ||||
Amortization of deferred acquisition costs |
| 108 |
| 108 |
| 325 |
| 325 |
| ||||
Separation costs |
| 22 |
| 22 |
| 86 |
| 86 |
| ||||
Other insurance and operating expenses |
| 182 |
| 196 |
| 579 |
| 573 |
| ||||
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Total benefits and expenses |
| 816 |
| 786 |
| 2,211 |
| 2,208 |
| ||||
|
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Pretax income |
| 98 |
| 98 |
| 396 |
| 396 |
| ||||
Income tax provision (benefit) |
| (1 | ) | (1 | ) | 68 |
| 68 |
| ||||
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Net income |
| $ | 99 |
| $ | 99 |
| $ | 328 |
| $ | 328 |
|
5
RIVERSOURCE LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
1. Basis of Presentation (Continued)
Statement of Cash Flows Reclassifications
The effect of reclassifications on prior period net cash flows related to operating, investing and financing activities is summarized below.
|
| Nine Months Ended |
| |
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| (in millions) |
| |
|
|
|
| |
Net cash provided by operating activities, previous presentation |
| $ | 181 |
|
Reclassification for annuity transfers |
| (95 | ) | |
Reclassification for policy loans |
| 2 |
| |
Other reclassifications |
| 114 |
| |
Net cash provided by operating activities, adjusted for these reclassifications |
| $ | 202 |
|
|
|
|
| |
Net cash provided by investing activities, previous presentation |
| $ | 3,733 |
|
Reclassification for policy loans |
| (34 | ) | |
Other reclassifications |
| (112 | ) | |
Net cash provided by investing activities, adjusted for these reclassifications |
| $ | 3,587 |
|
|
|
|
| |
Net cash used in financing activities, previous presentation |
| $ | (3,051 | ) |
Reclassification for annuity transfers |
| 95 |
| |
Reclassification for policy loans |
| 32 |
| |
Other reclassifications |
| (2 | ) | |
Net cash used in financing activities, adjusted for these reclassifications |
| $ | (2,926 | ) |
2. Recent Accounting Pronouncements
In October 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active” (“FSP 157-3”), which was effective upon issuance, including prior periods for which financial statements have not been issued. FSP 157-3 clarifies the application of Statement of Financial Accounting Standards (“SFAS”) No. 157 “Fair Value Measurements” (“SFAS 157”) in a market that is not active and provides an example of key considerations to determine the fair value of financial assets when the market for those assets is not active. The adoption of FSP 157-3 did not have a material effect on RiverSource Life’s consolidated financial condition and results of operations.
In March 2008, the FASB issued SFAS No. 161 “Disclosures about Derivative Instruments and Hedging Activities–an amendment of FASB Statement No. 133” (“SFAS 161”). SFAS 161 intends to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures about their impact on an entity’s financial position, financial performance and cash flows. SFAS 161 requires disclosures regarding the objectives for using derivative instruments, the fair value of derivative instruments and their related gains and losses, and the accounting for derivatives and related hedged items. SFAS 161 is effective for fiscal years and interim periods beginning after November 15, 2008, with early adoption permitted. RiverSource Life is currently evaluating the impact of SFAS 161 on its disclosures. RiverSource Life’s adoption of SFAS 161 will not impact its consolidated financial condition and results of operations.
In December 2007, the FASB issued SFAS No. 141 (revised 2007) “Business Combinations” (“SFAS 141(R)”). SFAS 141(R) establishes principles and requirements for how an acquirer recognizes and measures the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in an acquiree, and goodwill acquired. SFAS 141(R) also requires an acquirer to disclose information about the financial effects of a business combination. SFAS 141(R) is effective prospectively for business combinations with an acquisition date on or after the beginning of the first annual reporting period beginning on or after December 15, 2008, with early adoption prohibited. RiverSource Life will apply the standard to any business combinations within the scope of SFAS 141(R) occurring after December 31, 2008.
In December 2007, the FASB issued SFAS No. 160 “Noncontrolling Interests in Consolidated Financial Statements – an amendment of ARB No. 51” (“SFAS 160”). SFAS 160 establishes the accounting and reporting for ownership interest in subsidiaries not attributable, directly or indirectly, to a parent. SFAS 160 requires that noncontrolling (minority) interests be
6
RIVERSOURCE LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
2. Recent Accounting Pronouncements (Continued)
classified as equity (instead of as a liability) within the Consolidated Balance Sheets, and net income attributable to both the parent and the noncontrolling interest be disclosed on the face of the Consolidated Statements of Income. SFAS 160 is effective for fiscal years beginning after December 15, 2008, and interim periods within those years with early adoption prohibited. The provisions of SFAS 160 are to be applied prospectively, except for the presentation and disclosure requirements which are to be applied retrospectively to all periods presented. RiverSource Life will apply the provisions of SFAS 160 to any noncontrolling interests held after December 31, 2008.
In September 2006, the FASB issued SFAS 157 which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS 157 applies under other accounting pronouncements that require or permit fair value measurements. Accordingly, SFAS 157 does not require any new fair value measurements. The provisions of SFAS 157 are required to be applied prospectively as of the beginning of the fiscal year in which SFAS 157 is initially applied, except for certain financial instruments as defined in SFAS 157 that require retrospective application. Any retrospective application will be recognized as a cumulative effect adjustment to the opening balance of retained earnings for the fiscal year of adoption. RiverSource Life adopted SFAS 157 effective January 1, 2008 and recorded a cumulative effect reduction to the opening balance of retained earnings of $30 million, net of deferred acquisition costs (“DAC”) and deferred sales inducement costs (“DSIC”) amortization and income taxes. This reduction to retained earnings was related to adjusting the fair value of certain derivatives RiverSource Life uses to hedge its exposure to market risk related to certain variable annuity riders. RiverSource Life initially recorded these derivatives in accordance with Emerging Issues Task Force (“EITF”) Issue No. 02-3 “Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities” (“EITF 02-3”). SFAS 157 nullifies the guidance in EITF 02-3 and requires these derivatives to be marked to the price RiverSource Life would receive to sell the derivatives to a market participant (an exit price). The adoption of SFAS 157 also resulted in adjustments to the fair value of RiverSource Life’s embedded derivative liabilities associated with certain variable annuity riders. Since there is no market for these liabilities, RiverSource Life considered the assumptions participants in a hypothetical market would make to determine an exit price. As a result, RiverSource Life adjusted the valuation of these liabilities by updating certain policyholder assumptions, adding explicit margins to provide for profit, risk and expenses and adjusting the rate used to discount expected cash flows to reflect a current market estimate of RiverSource Life’s risk of nonperformance specific to these liabilities. These adjustments resulted in an adoption impact of a $4 million increase in earnings, net of DAC and DSIC amortization and income taxes, at January 1, 2008. The nonperformance risk component of the adjustment is specific to the risk of RiverSource Life not fulfilling these liabilities. As RiverSource Life’s estimate of this credit spread widens or tightens, the liability will decrease or increase.
In accordance with FSP FAS 157-2, “Effective Date of FASB Statement No. 157” (“FSP 157-2”), RiverSource Life will defer the adoption of SFAS 157 until January 1, 2009 for all nonfinancial assets and nonfinancial liabilities, except for those that are recognized or disclosed at fair value in the financial statements on a recurring basis. In January 2008, the FASB published for comment Proposed FSP FAS 157-c “Measuring Liabilities under FASB Statement No. 157” (“FSP 157-c”). FSP 157-c would amend SFAS 157 to clarify the accounting principles on the fair value measurement of liabilities. RiverSource Life is monitoring the impact that this proposed FSP could have on its consolidated financial condition and results of operations. See Note 5 for additional information regarding the fair values of RiverSource Life’s assets and liabilities.
In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in accordance with FASB Statement No. 109, “Accounting for Income Taxes.” FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. RiverSource Life adopted FIN 48 as of January 1, 2007. The effect of adopting FIN 48 on RiverSource Life’s consolidated financial condition and results of operations was not material.
In September 2005, the American Institute of Certified Public Accountants (“AICPA”) issued Statement of Position (“SOP”) 05-1, “Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection With Modifications or Exchanges of Insurance Contracts,” (“SOP 05-1”). SOP 05-1 provides clarifying guidance on accounting for DAC associated with an insurance or annuity contract that is significantly modified or is internally replaced with another contract. Prior to adoption, RiverSource Life accounted for many of these transactions as contract continuations and continued amortizing existing DAC
7
RIVERSOURCE LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
2. Recent Accounting Pronouncements (Continued)
against revenue for the new or modified contract. Effective January 1, 2007, RiverSource Life adopted SOP 05-1 resulting in these transactions being prospectively accounted for as contract terminations. Consistent with this, RiverSource Life now anticipates these transactions in establishing amortization periods and other valuation assumptions. As a result of adopting SOP 05-1, RiverSource Life recorded as a cumulative change in accounting principle $206 million, reducing DAC by $204 million, DSIC by $11 million and liabilities for future policy benefits by $9 million. The after-tax decrease to retained earnings for these changes was $134 million.
3. Separation and Distribution of Ameriprise Financial, Inc. from American Express
Ameriprise Financial was formerly a wholly owned subsidiary of American Express Company (“American Express”). On February 1, 2005, the American Express Board of Directors announced its intention to pursue the disposition of 100% of its shareholdings in Ameriprise Financial (the “Separation”) through a tax-free distribution to American Express shareholders. Effective as of the close of business on September 30, 2005, American Express completed the Separation and the distribution of Ameriprise Financial common shares to American Express shareholders (the “Distribution”). In connection with the Distribution, Ameriprise Financial entered into certain agreements with American Express to effect the Separation and to define the responsibility for obligations arising before and after the date of the Distribution, including, among others, obligations relating to transition services, taxes, and employees. Through 2007, RiverSource Life was allocated certain expenses incurred as a result of Ameriprise Financial becoming an independent company. The separation from American Express was completed in 2007.
4. Investments
The following is a summary of Available-for-Sale securities by type:
September 30, 2008 |
| Amortized |
| Gross |
| Gross |
| Fair |
| ||||
|
| (in millions) |
| ||||||||||
Fixed maturities: |
|
|
|
|
|
|
|
|
| ||||
Corporate debt securities |
| $ | 11,864 |
| $ | 31 |
| $ | (951 | ) | $ | 10,944 |
|
Mortgage and other asset-backed securities |
| 7,077 |
| 31 |
| (310 | ) | 6,798 |
| ||||
U.S. government and agencies obligations |
| 201 |
| 7 |
| (1 | ) | 207 |
| ||||
State and municipal obligations |
| 164 |
| 2 |
| (10 | ) | 156 |
| ||||
Foreign government bonds and obligations |
| 95 |
| 12 |
| — |
| 107 |
| ||||
Structured investments(a) |
| 2 |
| — |
| — |
| 2 |
| ||||
Total fixed maturities |
| 19,403 |
| 83 |
| (1,272 | ) | 18,214 |
| ||||
Common and preferred stocks |
| 30 |
| — |
| (7 | ) | 23 |
| ||||
Total |
| $ | 19,433 |
| $ | 83 |
| $ | (1,279 | ) | $ | 18,237 |
|
(a) Includes unconsolidated collateralized debt obligations.
December 31, 2007 |
| Amortized |
| Gross |
| Gross |
| Fair |
| ||||
|
| (in millions) |
| ||||||||||
Fixed maturities: |
|
|
|
|
|
|
|
|
| ||||
Corporate debt securities |
| $ | 12,870 |
| $ | 112 |
| $ | (307 | ) | $ | 12,675 |
|
Mortgage and other asset-backed securities |
| 7,637 |
| 33 |
| (84 | ) | 7,586 |
| ||||
U.S. government and agencies obligations |
| 249 |
| 7 |
| (1 | ) | 255 |
| ||||
State and municipal obligations |
| 165 |
| 3 |
| (6 | ) | 162 |
| ||||
Foreign government bonds and obligations |
| 97 |
| 15 |
| — |
| 112 |
| ||||
Structured investments(a) |
| 2 |
| — |
| — |
| 2 |
| ||||
Total fixed maturities |
| 21,020 |
| 170 |
| (398 | ) | 20,792 |
| ||||
Common and preferred stocks |
| 30 |
| — |
| (1 | ) | 29 |
| ||||
Total |
| $ | 21,050 |
| $ | 170 |
| $ | (399 | ) | $ | 20,821 |
|
(a) Includes unconsolidated collateralized debt obligations.
8
RIVERSOURCE LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
4. Investments (Continued)
Net realized investment gains and losses on Available-for-Sale securities, determined using the specific identification method, were as follows:
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
|
| 2008 |
| 2007 |
| 2008 |
| 2007 |
| ||||
|
| (in millions) |
| ||||||||||
Gross realized investment gains |
| $ | 3 |
| $ | 14 |
| $ | 13 |
| $ | 42 |
|
Gross realized investment losses |
| (3 | ) | — |
| (5 | ) | (19 | ) | ||||
Other-than-temporary impairments |
| (200 | ) | — |
| (237 | ) | (2 | ) | ||||
RiverSource Life regularly reviews Available-for-Sale securities for impairments in value considered to be other-than-temporary. The cost basis of securities that are determined to be other-than-temporarily impaired is written down to current fair value with a corresponding charge to net income. A write-down for impairment can be recognized for both credit-related events and for changes in fair value due to changes in interest rates. Once a security is written down to fair value through net income, any subsequent recovery in value cannot be recognized in net income until the principal is returned.
Factors RiverSource Life considers in determining whether declines in the fair value of fixed-maturity securities are other-than-temporary include: 1) the extent to which the market value is below amortized cost; 2) RiverSource Life’s ability and intent to hold the investment for a sufficient period of time for it to recover to an amount at least equal to its carrying value; 3) the duration of time in which there has been a significant decline in value; 4) fundamental analysis of the liquidity, business prospects and overall financial condition of the issuer; and 5) market events that could impact credit ratings, economic and business climate, litigation and government actions and similar external business factors. For structured investments (e.g., mortgage-backed securities), RiverSource Life also considers factors such as overall deal structure and its position within the structure, quality of underlying collateral, delinquencies and defaults, loss severities, recoveries, prepayments, cumulative loss projections and discounted cash flows in assessing potential other-than-temporary impairment of these investments. Based upon these factors, securities that have indicators of potential other-than-temporary impairment are subject to detailed review by management. Securities for which declines are considered temporary continue to be carefully monitored by management.
For the three and nine months ended September 30, 2008, other-than-temporary impairments were $200 million and $237 million, respectively, primarily related to credit-related losses in Lehman Brothers securities, Washington Mutual securities and non-agency residential mortgage-backed securities.
The following tables provide information about Available-for-Sale securities with gross unrealized losses and the length of time that individual securities have been in a continuous unrealized loss position:
|
| September 30, 2008 |
| ||||||||||||||||
|
| Less than 12 months |
| 12 months or more |
| Total |
| ||||||||||||
Description of securities: |
| Fair |
| Unrealized |
| Fair |
| Unrealized |
| Fair |
| Unrealized |
| ||||||
|
| (in millions) |
| ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Corporate debt securities |
| $ | 5,818 |
| $ | (354 | ) | $ | 3,417 |
| $ | (597 | ) | $ | 9,235 |
| $ | (951 | ) |
Mortgage and other asset-backed securities |
| 2,543 |
| (101 | ) | 2,273 |
| (209 | ) | 4,816 |
| (310 | ) | ||||||
U.S. government and agencies obligations |
| 49 |
| — |
| 35 |
| (1 | ) | 84 |
| (1 | ) | ||||||
State and municipal obligations |
| 17 |
| — |
| 88 |
| (10 | ) | 105 |
| (10 | ) | ||||||
Foreign government bonds and obligations |
| 14 |
| — |
| — |
| — |
| 14 |
| — |
| ||||||
Common and preferred stocks |
| — |
| — |
| 23 |
| (7 | ) | 23 |
| (7 | ) | ||||||
Total |
| $ | 8,441 |
| $ | (455 | ) | $ | 5,836 |
| $ | (824 | ) | $ | 14,277 |
| $ | (1,279 | ) |
9
RIVERSOURCE LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
4. Investments (Continued)
|
| December 31, 2007 |
| ||||||||||||||||
|
| Less than 12 months |
| 12 months or more |
| Total |
| ||||||||||||
Description of securities: |
| Fair |
| Unrealized |
| Fair |
| Unrealized |
| Fair |
| Unrealized |
| ||||||
|
| (in millions) |
| ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Corporate debt securities |
| $ | 1,477 |
| $ | (45 | ) | $ | 7,083 |
| $ | (262 | ) | $ | 8,560 |
| $ | (307 | ) |
Mortgage and other asset-backed securities |
| 888 |
| (15 | ) | 4,219 |
| (69 | ) | 5,107 |
| (84 | ) | ||||||
U.S. government and agencies obligations |
| — |
| — |
| 154 |
| (1 | ) | 154 |
| (1 | ) | ||||||
State and municipal obligations |
| 47 |
| (4 | ) | 63 |
| (2 | ) | 110 |
| (6 | ) | ||||||
Foreign government bonds and obligations |
| — |
| — |
| 2 |
| — |
| 2 |
| — |
| ||||||
Common and preferred stocks |
| 29 |
| (1 | ) | — |
| — |
| 29 |
| (1 | ) | ||||||
Total |
| $ | 2,441 |
| $ | (65 | ) | $ | 11,521 |
| $ | (334 | ) | $ | 13,962 |
| $ | (399 | ) |
In evaluating potential other-than-temporary impairments, RiverSource Life considers the extent to which amortized cost exceeds fair value and the duration of that difference. A key metric in performing this evaluation is the ratio of fair value to amortized cost. The following tables summarize the unrealized losses by ratio of fair value to amortized cost:
|
| September 30, 2008 |
| ||||||||||||||||||||||
|
| Less than 12 months |
| 12 months or more |
| Total |
| ||||||||||||||||||
Ratio of Fair Value |
| Number |
| Fair |
| Gross |
| Number |
| Fair |
| Gross |
| Number |
| Fair |
| Gross |
| ||||||
|
| (in millions, except number of securities) |
| ||||||||||||||||||||||
95% - 100% |
| 330 |
| $ | 5,995 |
| $ | (119 | ) | 118 |
| $ | 1,987 |
| $ | (55 | ) | 448 |
| $ | 7,982 |
| $ | (174 | ) |
90% - 95% |
| 102 |
| 1,631 |
| (120 | ) | 85 |
| 1,578 |
| (129 | ) | 187 |
| 3,209 |
| (249 | ) | ||||||
80% - 90% |
| 53 |
| 503 |
| (82 | ) | 97 |
| 1,520 |
| (260 | ) | 150 |
| 2,023 |
| (342 | ) | ||||||
Less than 80% |
| 21 |
| 312 |
| (134 | ) | 70 |
| 751 |
| (380 | ) | 91 |
| 1,063 |
| (514 | ) | ||||||
Total |
| 506 |
| $ | 8,441 |
| $ | (455 | ) | 370 |
| $ | 5,836 |
| $ | (824 | ) | 876 |
| $ | 14,277 |
| $ | (1,279 | ) |
|
| December 31, 2007 |
| ||||||||||||||||||||||
|
| Less than 12 months |
| 12 months or more |
| Total |
| ||||||||||||||||||
Ratio of Fair Value |
| Number |
| Fair |
| Gross |
| Number |
| Fair |
| Gross |
| Number |
| Fair |
| Gross |
| ||||||
|
| (in millions, except number of securities) |
| ||||||||||||||||||||||
95% - 100% |
| 164 |
| $ | 2,015 |
| $ | (25 | ) | 486 |
| $ | 10,169 |
| $ | (180 | ) | 650 |
| $ | 12,184 |
| $ | (205 | ) |
90% - 95% |
| 31 |
| 305 |
| (22 | ) | 48 |
| 811 |
| (57 | ) | 79 |
| 1,116 |
| (79 | ) | ||||||
80% - 90% |
| 4 |
| 121 |
| (18 | ) | 32 |
| 461 |
| (66 | ) | 36 |
| 582 |
| (84 | ) | ||||||
Less than 80% |
| 1 |
| — |
| — |
| 10 |
| 80 |
| (31 | ) | 11 |
| 80 |
| (31 | ) | ||||||
Total |
| 200 |
| $ | 2,441 |
| $ | (65 | ) | 576 |
| $ | 11,521 |
| $ | (334 | ) | 776 |
| $ | 13,962 |
| $ | (399 | ) |
10
RIVERSOURCE LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
5. Fair Values of Assets and Liabilities
Effective January 1, 2008, RiverSource Life adopted SFAS 157, which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date; that is, an exit price. The exit price assumes the asset or liability is not exchanged subject to a forced liquidation or distressed sale.
Valuation Hierarchy
Under SFAS 157, RiverSource Life categorizes its fair value measurements according to a three-level hierarchy. The hierarchy prioritizes the inputs used by RiverSource Life’s valuation techniques. A level is assigned to each fair value measurement based on the lowest level input that is significant to the fair value measurement in its entirety. The three levels of the fair value hierarchy are defined as follows:
Level 1 |
| Unadjusted quoted prices for identical assets or liabilities in active markets that are accessible at the measurement date. |
Level 2 |
| Prices or valuations based on observable inputs other than quoted prices in active markets for identical assets and liabilities. |
Level 3 |
| Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable. |
Determination of Fair Value
RiverSource Life uses valuation techniques consistent with the market and income approaches to measure the fair value of its assets and liabilities. RiverSource Life’s market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. RiverSource Life’s income approach uses valuation techniques to convert future projected cash flows to a single discounted present value amount. When applying either approach, RiverSource Life maximizes the use of observable inputs and minimizes the use of unobservable inputs.
The following is a description of the valuation techniques used to measure fair value and the general classification of these instruments pursuant to the fair value hierarchy.
Assets
Cash Equivalents
Cash equivalents include highly liquid investments with original maturities of 90 days or less. Actively traded money market funds are measured at their net asset value (“NAV”) and classified as Level 1. RiverSource Life’s remaining cash equivalents are classified as Level 2 and are measured at amortized cost, which is a reasonable estimate of fair value because of the short time between the purchase of the instrument and its expected realization.
Available-for-Sale Securities
When available, the fair value of securities is based on quoted prices in active markets. If quoted prices are not available, fair values are obtained from nationally-recognized pricing services, broker quotes, or other model-based valuation techniques such as the present value of cash flows. Level 1 securities include U.S. Treasuries. Level 2 securities include agency mortgage-backed securities; and certain non-agency mortgage-backed securities, asset-backed securities, municipal and corporate bonds, and U.S. and foreign government and agency securities. Level 3 securities include certain non-agency mortgage-backed securities, asset-backed securities, and corporate bonds.
Separate Account Assets
The fair value of assets held by separate accounts is determined by the NAV of the funds in which those separate accounts are invested. The NAV represents the exit price for the separate account. These assets are classified as Level 2.
11
RIVERSOURCE LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
5. Fair Values of Assets and Liabilities (Continued)
Derivatives
The fair value of derivatives that are traded in certain over-the-counter markets are generally measured using pricing models with market observable inputs such as interest rates and equity index levels. These measurements are classified as Level 2 within the fair value hierarchy and include interest rate swaps and options. Derivatives that are valued using pricing models that have significant unobservable inputs are classified as Level 3 measurements. Structured derivatives that are used by RiverSource Life to hedge its exposure to market risk related to certain variable annuity riders are classified as Level 3.
Liabilities
Embedded Derivatives
Variable Annuity Riders – Guaranteed Minimum Accumulation Benefit and Guaranteed Minimum Withdrawal Benefit
RiverSource Life values the embedded derivative liability attributable to the provisions of certain variable annuity riders using internal valuation models. These models calculate fair value by discounting expected cash flows from benefits plus margins for profit, risk, and expenses less embedded derivative fees. The projected cash flows used by these models include observable capital market assumptions and incorporate significant unobservable inputs related to policyholder behavior assumptions and margins for risk, profit and expenses that RiverSource Life believes an exit market participant would expect. The fair value of these embedded derivatives also reflects a current estimate of RiverSource Life’s nonperformance risk specific to these liabilities. Given the significant unobservable inputs to this valuation, these measurements are classified as Level 3. The embedded derivative liability attributable to these provisions is recorded in future policy benefits.
Equity Indexed Annuities
RiverSource Life uses various Black-Scholes calculations to determine the fair value of the embedded derivative liability associated with the provisions of its equity indexed annuities. The inputs to these calculations are primarily market observable. As a result, these measurements are classified as Level 2. The embedded derivative liability attributable to the provisions of RiverSource Life’s equity indexed annuities is recorded in future policy benefits.
The following table presents the balances of assets and liabilities measured at fair value on a recurring basis:
|
| September 30, 2008 |
| ||||||||||
|
| Level 1 |
| Level 2 |
| Level 3 |
| Total |
| ||||
|
| (in millions) |
| ||||||||||
|
|
|
|
|
|
|
|
|
| ||||
Assets |
|
|
|
|
|
|
|
|
| ||||
Available-for-Sale: |
|
|
|
|
|
|
|
|
| ||||
Fixed maturities |
| $ | 19 |
| $ | 16,496 |
| $ | 1,699 |
| $ | 18,214 |
|
Common and preferred stocks |
| — |
| 23 |
| — |
| 23 |
| ||||
Cash equivalents |
| 5 |
| 1,143 |
| — |
| 1,148 |
| ||||
Other assets |
| — |
| 223 |
| 95 |
| 318 |
| ||||
Separate account assets |
| — |
| 49,929 |
| — |
| 49,929 |
| ||||
Total assets at fair value |
| $ | 24 |
| $ | 67,814 |
| $ | 1,794 |
| $ | 69,632 |
|
|
|
|
|
|
|
|
|
|
| ||||
Liabilities |
|
|
|
|
|
|
|
|
| ||||
Future policy benefits |
| $ | — |
| $ | 25 |
| $ | 331 |
| $ | 356 |
|
Other liabilities |
| — |
| 11 |
| 5 |
| 16 |
| ||||
Total liabilities at fair value |
| $ | — |
| $ | 36 |
| $ | 336 |
| $ | 372 |
|
12
RIVERSOURCE LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
5. Fair Values of Assets and Liabilities (Continued)
The following tables provide a summary of changes in Level 3 assets and liabilities measured at fair value on a recurring basis:
|
| Three Months Ended September 30, 2008 |
| ||||||||||
|
| Available-for- |
| Other |
| Future Policy |
| Other |
| ||||
|
| (in millions) |
| ||||||||||
Balance, June 30 |
| $ | 1,762 |
| $ | 74 |
| $ | (154 | ) | $ | (4 | ) |
Total gains (losses) included in: |
|
|
|
|
|
|
|
|
| ||||
Net income |
| (2 | )(1) | 21 | (2) | (159 | )(2) | (1 | )(2) | ||||
Other comprehensive loss |
| (48 | ) | — |
| — |
| — |
| ||||
Purchases, sales, issuances and settlements, net |
| (13 | ) | — |
| (18 | ) | — |
| ||||
Balance, September 30 |
| $ | 1,699 |
| $ | 95 |
| $ | (331 | ) | $ | (5 | ) |
|
|
|
|
|
|
|
|
|
| ||||
Change in unrealized gains (losses) included in net income relating to assets and liabilities held at September 30 |
| $ | (2 | )(1) | $ | 21 | (2) | $ | (158 | )(2) | $ | (1 | )(2) |
(1) Represents a $4 million loss included in net realized investment gains (losses) and a $2 million gain included in net investment income in the Consolidated Statements of Income.
(2) Included in benefits, claims, losses and settlement expenses in the Consolidated Statements of Income.
|
| Nine Months Ended September 30, 2008 |
| ||||||||||
|
| Available- |
| Other |
| Future |
| Other |
| ||||
|
| (in millions) |
| ||||||||||
Balance, January 1 |
| $ | 1,810 |
| $ | 280 |
| $ | (158 | ) | $ | — |
|
Total gains (losses) included in: |
|
|
|
|
|
|
|
|
| ||||
Net income |
| (35 | )(1) | 44 | (2) | (125) | (2) | (1 | )(2) | ||||
Other comprehensive loss |
| (169 | ) | — |
| — |
| — |
| ||||
Purchases, sales, issuances and settlements, net |
| 93 |
| (229 | ) | (48 | ) | (4 | ) | ||||
Balance, September 30 |
| $ | 1,699 |
| $ | 95 |
| $ | (331 | ) | $ | (5 | ) |
|
|
|
|
|
|
|
|
|
| ||||
Change in unrealized gains (losses) included in net income relating to assets and liabilities held at September 30 |
| $ | (37 | )(3) | $ | 22 | (2) | $ | (123 | )(2) | $ | (1 | )(2) |
(1) Represents a $41 million loss included in net realized investment gains (losses) and a $6 million gain included in net investment income in the Consolidated Statements of Income.
(2) Included in benefits, claims, losses and settlement expenses in the Consolidated Statements of Income.
(3) Represents a $40 million loss included in net realized investment gains (losses) and a $3 million gain included in net investment income in the Consolidated Statements of Income.
During the reporting period, there were no material assets or liabilities measured at fair value on a non-recurring basis.
13
RIVERSOURCE LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
6. Deferred Acquisition Costs and Deferred Sales Inducement Costs
During the third quarter of 2008, RiverSource Life completed the annual detailed review of valuation assumptions. In addition, during the third quarter of 2008, RiverSource Life converted to a new industry standard valuation system that provides enhanced modeling capabilities.
The total pretax impacts on RiverSource Life’s assets and liabilities attributable to the review of valuation assumptions and the valuation system conversion during the third quarter of 2008 and the review of the valuation assumptions during the third quarter of 2007 were as follows:
Balance Sheet Impact |
| Reinsurance |
| DAC |
| DSIC |
| Other |
| Future |
| Other |
| Total |
| |||||||
|
| (in millions) |
| |||||||||||||||||||
2008 period |
| $ | 92 |
| $ | (82 | ) | $ | (6 | ) | $ | 1 |
| $ | 96 |
| $ | 5 |
| $ | 106 |
|
2007 period |
| (2 | ) | (16 | ) | 3 |
| — |
| (15 | ) | — |
| (30 | ) | |||||||
The total pretax impacts on RiverSource Life’s revenues and expenses attributable to the review of the valuation assumptions and the valuation system conversion for the three months and nine months ended September 30, 2008 and the review of the valuation assumptions for the three months and nine months ended September 30, 2007 were as follows:
Pretax |
| Premiums |
| Policy and |
| Benefits, |
| Amortization |
| Other |
| Total |
| ||||||
|
| (in millions) |
| ||||||||||||||||
2008 period |
| $ | 2 |
| $ | 95 |
| $ | 90 |
| $ | (82 | ) | $ | 1 |
| $ | 106 |
|
2007 period |
| — |
| (2 | ) | (12 | ) | (16 | ) | — |
| (30 | ) | ||||||
The balances of and changes in DAC were as follows:
|
| 2008 |
| 2007 |
| ||
|
| (in millions) |
| ||||
Balance at January 1 |
| $ | 4,429 |
| $ | 4,411 |
|
Cumulative effect of accounting change |
| 36 |
| (204 | ) | ||
Capitalization of acquisition costs |
| 441 |
| 534 |
| ||
Amortization, excluding impacts of valuation assumptions review and valuation system conversion |
| (401 | ) | (309 | ) | ||
Amortization, impact of valuation assumptions review and valuation system conversion |
| (82 | ) | (16 | ) | ||
Impact of change in net unrealized securities gains and losses |
| (11 | ) | 9 |
| ||
Balance at September 30 |
| $ | 4,412 |
| $ | 4,425 |
|
The balances of and changes in DSIC were as follows:
|
| 2008 |
| 2007 |
| ||
|
| (in millions) |
| ||||
Balance at January 1 |
| $ | 511 |
| $ | 452 |
|
Cumulative effect of accounting change |
| 9 |
| (11 | ) | ||
Capitalization of sales inducements |
| 64 |
| 96 |
| ||
Amortization, excluding impacts of valuation assumptions review and valuation system conversion |
| (55 | ) | (38 | ) | ||
Amortization, impact of valuation assumptions review and valuation system conversion |
| (6 | ) | 3 |
| ||
Impact of change in net unrealized securities gains and losses |
| — |
| 1 |
| ||
Balance at September 30 |
| $ | 523 |
| $ | 503 |
|
14
RIVERSOURCE LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
6. Deferred Acquisition Costs and Deferred Sales Inducement Costs (Continued)
Effective January 1, 2008, RiverSource Life adopted SFAS 157 and recorded as a cumulative change in accounting principle a pretax increase of $36 million and $9 million to DAC and DSIC, respectively. See Note 2 and Note 5 for additional information regarding SFAS 157.
Effective January 1, 2007, RiverSource Life adopted SOP 05-1 and recorded as a cumulative change in accounting principle a pretax reduction of $204 million and $11 million to DAC and DSIC, respectively.
7. Lines of Credit
In September 2008, RiverSource Life, as the lender, entered into a revolving credit agreement with Ameriprise Financial as the borrower. This line of credit is not to exceed 3% of RiverSource Life’s statutory admitted assets as of the prior year end. The interest rate for any borrowing is established by reference to LIBOR plus 28 basis points. In the event of default, an additional 1% interest will accrue during such period of default. There were no amounts outstanding on this revolving credit agreement as of September 30, 2008.
RiverSource Life had a collateral loan agreement with Ameriprise Financial aggregating up to $75 million which expired on October 31, 2008.
RiverSource Life has available a committed line of credit with Ameriprise Financial aggregating $200 million. The interest rate for any borrowings is established by reference to LIBOR plus 28 basis points. There were no amounts outstanding on this line of credit at September 30, 2008.
8. Future Policy Benefits, Policy Claims and Other Policyholders’ Funds and Separate Account Liabilities
Future policy benefits and policy claims and other policyholders’ funds consisted of the following:
|
| September 30, |
| December 31, |
| ||
|
| (in millions) |
| ||||
Fixed annuities |
| $ | 13,530 |
| $ | 14,382 |
|
Equity indexed annuities accumulated host values |
| 240 |
| 253 |
| ||
Equity indexed annuities embedded derivatives |
| 25 |
| 53 |
| ||
Variable annuities fixed sub-accounts |
| 5,496 |
| 5,419 |
| ||
Variable annuity guaranteed minimum withdrawal benefits |
| 230 |
| 136 |
| ||
Variable annuity guaranteed minimum accumulation benefits |
| 103 |
| 33 |
| ||
Other variable annuity guarantees |
| 24 |
| 27 |
| ||
Total annuities |
| 19,648 |
| 20,303 |
| ||
Variable universal life (“VUL”)/universal life insurance |
| 2,536 |
| 2,568 |
| ||
Other life, disability income and long term care insurance |
| 4,321 |
| 4,106 |
| ||
Total future policy benefits |
| 26,505 |
| 26,977 |
| ||
Policy claims and other policyholders’ funds |
| 102 |
| 91 |
| ||
Total future policy benefits and policy claims and other policyholders’ funds |
| $ | 26,607 |
| $ | 27,068 |
|
Separate account liabilities consisted of the following:
|
| September 30, |
| December 31, |
| ||
|
| (in millions) |
| ||||
Variable annuity variable sub-accounts |
| $ | 44,805 |
| $ | 51,764 |
|
VUL insurance variable sub-accounts |
| 5,074 |
| 6,244 |
| ||
Other insurance variable sub-accounts |
| 50 |
| 62 |
| ||
Total separate account liabilities |
| $ | 49,929 |
| $ | 58,070 |
|
15
RIVERSOURCE LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
9. Variable Annuity Guarantees
The majority of the variable annuity contracts offered by RiverSource Life contain guaranteed minimum death benefit (“GMDB”) provisions. RiverSource Life also offers variable annuities with death benefit provisions that gross up the amount payable by a certain percentage of contract earnings, which are referred to as gain gross-up (“GGU”) benefits. In addition, RiverSource Life offers contracts with guaranteed minimum withdrawal benefit (“GMWB”) and guaranteed minimum accumulation benefit (“GMAB”) provisions. RiverSource Life previously offered contracts containing guaranteed minimum income benefit (“GMIB”) provisions. RiverSource Life has established additional liabilities for the variable annuity death benefits, GMIB provisions and for life contingent benefits associated with GMWB provisions. GMAB and non-life contingent benefits associated with GMWB provisions are considered embedded derivatives and are recorded at fair value.
The variable annuity contracts with GMWB riders typically have account values that are based on an underlying portfolio of mutual funds, the values of which fluctuate based on equity market performance. At issue, the guaranteed amount is equal to the amount deposited but the guarantee may be increased annually to the account value (a “step-up”) in the case of favorable market performance. The GMWB offered initially guarantees that the client can withdraw 7% per year until the amount withdrawn is equal to the guaranteed amount, regardless of the performance of the underlying funds. In 2007, RiverSource Life added a new GMWB benefit design that is available in a joint version that promises 6% withdrawals while either contractholder remains alive. In addition, once withdrawals begin, the policyholder’s funds are moved to one of the three less aggressive asset allocation models (of the five that are available prior to withdrawal).
Variable annuity contractholders age 79 or younger at contract issue can also obtain a principal-back guarantee by purchasing the optional GMAB rider for an additional charge. The GMAB rider guarantees that, regardless of market performance at the end of the 10-year waiting period, the contract value will be no less than the original investment or 80% of the highest anniversary value, adjusted for withdrawals. If the contract value is less than the guarantee at the end of the 10-year period, a lump sum will be added to the contract value to make the contract value equal to the guarantee value.
The following table provides summary information related to all variable annuity guarantees for which RiverSource Life has established additional liabilities:
Variable Annuity Guarantees by Benefit Type(1) |
| September 30, |
| December 31, |
| ||
|
| (in millions, except age) |
| ||||
Contracts with GMDB providing for return of premium: |
|
|
|
|
| ||
Total contract value |
| $ | 25,077 |
| $ | 25,804 |
|
Contract value in separate accounts |
| $ | 23,016 |
| $ | 23,892 |
|
Net amount at risk(2) |
| $ | 1,715 |
| $ | 26 |
|
Weighted average attained age |
| 61 |
| 60 |
| ||
Contracts with GMDB providing for six-year reset: |
|
|
|
|
| ||
Total contract value |
| $ | 15,477 |
| $ | 20,231 |
|
Contract value in separate accounts |
| $ | 12,896 |
| $ | 17,617 |
|
Net amount at risk(2) |
| $ | 1,195 |
| $ | 167 |
|
Weighted average attained age |
| 61 |
| 60 |
| ||
Contracts with GMDB providing for one-year ratchet: |
|
|
|
|
| ||
Total contract value |
| $ | 6,797 |
| $ | 7,908 |
|
Contract value in separate accounts |
| $ | 6,085 |
| $ | 7,143 |
|
Net amount at risk(2) |
| $ | 1,186 |
| $ | 81 |
|
Weighted average attained age |
| 62 |
| 61 |
| ||
Contracts with GMDB providing for five-year ratchet: |
|
|
|
|
| ||
Total contract value |
| $ | 1,101 |
| $ | 1,211 |
|
Contract value in separate accounts |
| $ | 1,044 |
| $ | 1,163 |
|
Net amount at risk(2) |
| $ | 61 |
| $ | 1 |
|
Weighted average attained age |
| 58 |
| 58 |
| ||
Contracts with other GMDB: |
|
|
|
|
| ||
Total contract value |
| $ | 567 |
| $ | 693 |
|
Contract value in separate accounts |
| $ | 524 |
| $ | 639 |
|
Net amount at risk(2) |
| $ | 106 |
| $ | 12 |
|
Weighted average attained age |
| 66 |
| 65 |
|
16
RIVERSOURCE LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
9. Variable Annuity Guarantees (Continued)
Variable Annuity Guarantees by Benefit Type(1) (Continued) |
| September 30, |
| December 31, |
| ||
|
| (in millions, except age) |
| ||||
Contracts with GGU death benefit: |
|
|
|
|
| ||
Total contract value |
| $ | 832 |
| $ | 950 |
|
Contract value in separate accounts |
| $ | 754 |
| $ | 873 |
|
Net amount at risk(2) |
| $ | 68 |
| $ | 80 |
|
Weighted average attained age |
| 62 |
| 62 |
| ||
Contracts with GMIB: |
|
|
|
|
| ||
Total contract value |
| $ | 706 |
| $ | 927 |
|
Contract value in separate accounts |
| $ | 647 |
| $ | 859 |
|
Net amount at risk(2) |
| $ | 130 |
| $ | 18 |
|
Weighted average attained age |
| 62 |
| 62 |
| ||
Contracts with GMWB: |
|
|
|
|
| ||
Total contract value |
| $ | 4,214 |
| $ | 5,104 |
|
Contract value in separate accounts |
| $ | 4,086 |
| $ | 4,980 |
|
Benefit amount in excess of account value |
| $ | 666 |
| $ | 22 |
|
Weighted average attained age |
| 62 |
| 62 |
| ||
Contracts with GMWB for life: |
|
|
|
|
| ||
Total contract value |
| $ | 9,656 |
| $ | 7,958 |
|
Contract value in separate accounts |
| $ | 9,218 |
| $ | 7,685 |
|
Benefit amount in excess of account value |
| $ | 1,324 |
| $ | 33 |
|
Weighted average attained age |
| 63 |
| 62 |
| ||
Contracts with GMAB: |
|
|
|
|
| ||
Total contract value |
| $ | 2,239 |
| $ | 2,260 |
|
Contract value in separate accounts |
| $ | 2,172 |
| $ | 2,205 |
|
Benefit amount in excess of account value |
| $ | 252 |
| $ | 3 |
|
Weighted average attained age |
| 56 |
| 55 |
|
(1) Individual variable annuity contracts may have more than one guarantee and therefore may be included in more than one benefit type. Variable annuity contracts for which the death benefit always equals account value are not shown in this table.
(2) Represents current death benefit less total contract value for GMDB, amount of gross up for GGU and accumulated guaranteed minimum benefit base less total contract value for GMIB and assumes the actuarially remote scenario that all claims become payable on the same day.
For the nine months ended September 30, 2008, additional liabilities and incurred claims were:
|
| GMDB & |
| GMIB |
| GMWB |
| GMAB |
| ||||
|
| (in millions) |
| ||||||||||
Liability balance at January 1 |
| $ | 24 |
| $ | 3 |
| $ | 136 |
| $ | 33 |
|
Reported claims |
| 7 |
| — |
| — |
| — |
| ||||
Liability balance at September 30 |
| 18 |
| 6 |
| 230 |
| 103 |
| ||||
Incurred claims (sum of reported and change in liability) |
| 1 |
| 3 |
| 94 |
| 70 |
| ||||
10. Income Taxes
RiverSource Life’s effective tax rates were 0% and 2% for the three and nine months ended September 30, 2008, respectively, compared to (1%) and 17% for the three and nine months ended September 30, 2007, respectively. The decrease in the effective tax rates primarily reflects the level of pretax income relative to tax advantaged items, including the dividends received deduction for the three and nine months ended September 30, 2008, as well as a $39 million tax benefit for the nine months ended September 30, 2008 related to changes in the status of current audits.
17
RIVERSOURCE LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
10. Income Taxes (Continued)
RiverSource Life is required to establish a valuation allowance for any portion of the deferred tax assets that management believes will not be realized. Included in RiverSource Life’s deferred tax assets is a significant deferred tax asset relating to capital losses that have been recognized for financial statement purposes but not yet for tax return purposes. Under current U.S. federal income tax law, capital losses generally must be used against capital gain income within five years of the year in which the capital losses are recognized for tax purposes. Based on analysis of RiverSource Life’s tax position, management believes it is more likely than not that the results of future operations and implementation of tax planning strategies will generate sufficient taxable income to enable RiverSource Life to utilize all of its deferred tax assets. Accordingly, no valuation allowance for deferred tax assets has been established as of September 30, 2008 and December 31, 2007.
As of September 30, 2008 and December 31, 2007, RiverSource Life had ($37) million and $97 million, respectively, of gross unrecognized tax benefits. If recognized, approximately $20 million and $49 million of permanent items, net of federal tax benefits as of September 30, 2008 and December 31, 2007, respectively, would affect the effective tax rate.
RiverSource Life recognizes interest and penalties related to unrecognized tax benefits as a component of the income tax provision. RiverSource Life recognized interest of $5 million for the three months ended September 30, 2008 and a net reduction of interest and penalties of $14 million for the nine months ended September 30, 2008. RiverSource Life had a $15 million and a $1 million receivable related to interest and penalties accrued at September 30, 2008 and December 31, 2007, respectively.
It is reasonably possible that the total amounts of unrecognized tax benefits will change in the next 12 months. However, there are a number of open audits and quantification of a range cannot be made at this time.
RiverSource Life or one or more of its subsidiaries files income tax returns in the U.S. federal jurisdiction as well as various state jurisdictions. With few exceptions, RiverSource Life is no longer subject to U.S. federal or state and local income tax examinations by tax authorities for years before 1997. The Internal Revenue Service (“IRS”), as part of the overall examination of the American Express Company consolidated return, commenced an examination of RiverSource Life’s U.S. income tax returns for 1997 through 2002 in the third quarter of 2005. In the first quarter of 2007, the IRS expanded the period of the examination to include 2003 through 2004. RiverSource Life or certain of its subsidiaries’ state income tax returns are currently under examination by various jurisdictions for years ranging from 1998 through 2005.
On September 25, 2007, the IRS issued Revenue Ruling 2007-61 in which it announced that it intends to issue regulations with respect to certain computational aspects of the Dividends Received Deduction (“DRD”) related to separate account assets held in connection with variable contracts of life insurance companies and has added the project to the 2007-2008 Priority Guidance Plan. Revenue Ruling 2007-61 suspended a revenue ruling issued in August 2007 that purported to change accepted industry and IRS interpretations of the statutes governing these computational questions. 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 members of the public 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, but they may result in the elimination of some or all of the separate account DRD tax benefit that RiverSource Life receives. Management believes that it is likely that any such regulations would apply prospectively only.
11. Contingencies
The SEC, the Financial Industry Regulatory Authority, commonly referred to as FINRA, and several state authorities have brought proceedings challenging several mutual fund and variable product financial practices, generally including suitability, late trading, market timing, compensation and disclosure of revenue sharing arrangements. RiverSource Life has received requests for information and has been contacted by regulatory authorities concerning its practices and is cooperating fully with these inquiries.
RiverSource Life is involved in the normal course of business in a number of other legal and arbitration proceedings concerning matters arising in connection with the conduct of its business activities. RiverSource Life believes that it is not a party to, nor are any of its properties the subject of, any pending legal, arbitration or regulatory proceedings that would have a material adverse effect on its consolidated financial condition, results of operations or liquidity. However, it is possible that the outcome of any such proceedings could have a material impact on results of operations in any particular reporting period as the proceedings are resolved.
18
ITEM 2. MANAGEMENT’S NARRATIVE ANALYSIS
The following information should be read in conjunction with RiverSource Life Insurance Company’s Consolidated Financial Statements and Notes presented in Part I, Item 1. RiverSource Life Insurance Company and its subsidiary are referred to collectively in this Form 10-Q as “RiverSource Life”. This narrative analysis may contain forward-looking statements that reflect RiverSource Life’s plans, estimates and beliefs. Actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to these differences include, but are not limited to, those discussed under “Forward-Looking Statements.” RiverSource Life believes it is useful to read this narrative analysis in conjunction with its Annual Report on Form 10-K for the year ended December 31, 2007, filed with the Securities and Exchange Commission (“SEC”) on February 29, 2008 (“2007 10-K”), as well as its current reports on Form 8-K and other publicly available information.
RiverSource Life follows U.S. generally accepted accounting principles (“GAAP”), and the following discussion is presented on a consolidated basis consistent with GAAP. In the second quarter of 2008, RiverSource Life reclassified the mark-to-market adjustments on certain derivatives from net investment income to various expense lines where the mark-to-market adjustment on the related embedded derivative resides. The mark-to-market adjustment on derivatives hedging variable annuity living benefits and equity indexed annuities were reclassified to benefits, claims, losses and settlement expenses and interest credited to fixed accounts, respectively. Prior period amounts were reclassified to conform to the current presentation.
Management’s narrative analysis of the results of operations is presented in lieu of management’s discussion and analysis of financial condition and results of operations, pursuant to General Instructions H(2)(a) of Form 10-Q.
Overview
RiverSource Life Insurance Company is a stock life insurance company with one wholly owned operating subsidiary, RiverSource Life Insurance Co. of New York (“RiverSource Life of NY”). RiverSource Life Insurance Company is a wholly owned subsidiary of Ameriprise Financial, Inc. (“Ameriprise Financial”).
· |
| RiverSource Life Insurance Company is domiciled in Minnesota and holds Certificates of Authority in American Samoa, the District of Columbia and all states except New York. RiverSource Life Insurance Company issues insurance and annuity products. |
|
|
|
· |
| RiverSource Life of NY is a stock life insurance company domiciled in New York, which holds Certificates of Authority in New York, North Dakota and Delaware. RiverSource Life of NY issues insurance and annuity products. |
Ameriprise Financial was formerly a wholly owned subsidiary of American Express Company (“American Express”). On February 1, 2005, the American Express Board of Directors announced its intention to pursue the disposition of 100% of its shareholdings in Ameriprise Financial (the “Separation”) through a tax-free distribution to American Express shareholders. Effective as of the close of business on September 30, 2005, American Express completed the Separation and the distribution of Ameriprise Financial common shares to American Express shareholders (the “Distribution”). In connection with the Distribution, Ameriprise Financial entered into certain agreements with American Express to effect the Separation and to define the responsibility for obligations arising before and after the date of the Distribution, including, among others, obligations relating to transition services, taxes, and employees. Through 2007, RiverSource Life was allocated certain expenses incurred as a result of Ameriprise Financial becoming an independent company. The separation from American Express was completed in 2007.
Recent Accounting Pronouncements
For information regarding recent accounting pronouncements and their expected impact on future consolidated financial condition or results of operations, see Note 2 to the Consolidated Financial Statements.
Results of Operations for the Nine Months Ended September 30, 2008 compared to the Nine Months Ended September 30, 2007
Overview
Consolidated net income was $296 million for the nine months ended September 30, 2008 compared to $328 million for the nine months ended September 30, 2007, a decrease of $32 million. Pretax income decreased $93 million to $303 million for the nine months ended September 30, 2008 from $396 million for the nine months ended September 30, 2007.
Included in the consolidated net income for the nine months ended September 30, 2008 were pretax net realized investment losses of $229 million primarily related to the other-than-temporary impairment of Lehman Brothers securities, Washington Mutual securities, and various other non-agency, residential mortgage-backed securities partially offset by the favorable impact of
19
the annual review of valuation assumptions and conversion to a new industry standard valuation system that provides enhanced modeling capabilities, both of which occurred during the third quarter of 2008.
In the third quarter of 2008, the valuation assumptions review and the valuation system conversion resulted in a net $106 million benefit. The review of the valuation assumptions resulted in a decrease in expenses primarily from updating product mortality and expense assumptions for certain life insurance products and from updating fund mix and policyholder behavior assumptions for variable annuities with guaranteed benefits. The valuation system conversion also resulted in an increase in revenue primarily from improved modeling of the expected value of existing reinsurance agreements and a decrease in expense from modeling annuity amortization periods at the individual policy level. The review of the valuation assumptions in the third quarter of 2007 resulted in a net $30 million increase in expense from updating product persistency assumptions partially offset by decreases in expense from updating other assumptions.
Also included in the results for the nine months ended September 30, 2008 and 2007 is an $83 million expense and a $15 million benefit, respectively, resulting from the impact of markets on deferred acquisition costs (“DAC”) and deferred sales inducement costs (“DSIC”).
The total pretax impacts on RiverSource Life’s assets and liabilities as of September 30, 2008 and 2007 attributable to the annual third quarter review of the valuation assumptions, the valuation system conversion and the impact of markets were as follows:
Balance Sheet Impact |
| Reinsurance |
| DAC |
| DSIC |
| Other |
| Future |
| Other |
| Total |
| |||||||
|
|
|
|
|
| (in millions) |
|
|
|
|
|
|
|
|
| |||||||
2008 period |
| $ | 92 |
| $ | (155 | ) | $ | (16 | ) | $ | 1 |
| $ | 96 |
| $ | 5 |
| $ | 23 |
|
2007 period |
| (2 | ) | (3 | ) | 5 |
| — |
| (15 | ) | — |
| (15 | ) | |||||||
The total pretax impacts on RiverSource Life’s revenues and expenses for the nine months ended September 30, 2008 and 2007 attributable to the annual third quarter review of the valuation assumptions, the valuation system conversion and the impact of markets were as follows:
Pretax |
| Premiums |
| Policy and |
| Benefits, |
| Amortization |
| Other |
| Total |
| ||||||
|
|
|
|
|
| (in millions) |
|
|
|
|
|
|
| ||||||
2008 period |
| $ | 2 |
| $ | 95 |
| $ | 80 |
| $ | (155 | ) | $ | 1 |
| $ | 23 |
|
2007 period |
| — |
| (2 | ) | (10 | ) | (3 | ) | — |
| (15 | ) | ||||||
Revenues
Total revenues decreased $256 million or 9.8% to $2.3 billion for the nine months ended September 30, 2008.
Net investment income decreased $159 million or 14.2% to $962 million for the nine months ended September 30, 2008, primarily due to decreased assets driven by a reduction in fixed annuity balances as well as a decline in yield.
Policy and contract charges increased $161 million or 18.0% to $1.1 billion for the nine months ended September 30, 2008 primarily reflecting a $95 million benefit from updating valuation assumptions and converting to a new valuation system as well as growth in guaranteed benefit rider fees on variable annuities and cost-of-insurance fees for variable universal life/universal life insurance. The impact to policy and contract charges from updating valuation assumptions for the prior year period was immaterial.
Other revenue increased $18 million or 9.6% to $205 million for the nine months ended September 30, 2008 reflecting higher marketing support and administrative fees due to higher average underlying separate account asset values.
Net realized investment losses were $229 million for the nine months ended September 30, 2008 compared to net realized investment gains of $42 million for the nine months ended September 30, 2007. Included in net realized investment losses for the nine months ended September 30, 2008 is $237 million of other-than-temporary impairments primarily related to credit-related losses in Lehman Brothers securities, Washington Mutual securities and non-agency residential mortgage-backed securities. For the nine months ended September 30, 2008, $13 million of gross realized investment gains were offset by $5 million of gross realized losses, classified as Available-for-Sale. Included in net realized investment gains for the nine months ended September
20
30, 2007 was a decrease of $21 million to the allowance for loan losses on commercial mortgage loans. For the nine months ended September 30, 2007, $42 million of gross realized investment gains were partially offset by $19 million of gross realized investment losses as well as $2 million of other-than-temporary impairment losses on investments, classified as Available-for-Sale.
Benefits and Expenses
Total benefits and expenses for the nine months ended September 30, 2008 were $2.0 billion, a decrease of $163 million from the nine months ended September 30, 2007 total of $2.2 billion. Total benefits and expenses reflect the impact of the valuation assumptions review and the valuation system conversion as previously described.
Benefits, claims, losses and settlement expenses decreased $124 million or 21.4% to $455 million for the nine months ended September 30, 2008. This decrease was primarily the result of a $90 million benefit from updating valuation assumptions and converting to a new valuation system, partially offset by an expense of $10 million from the market’s impact on DSIC and by increases in life, long term care and disability income insurance benefits. In the prior year period, updating valuation assumptions resulted in $12 million additional expense and an immaterial market impact on DSIC. The nine months ended September 30, 2007 included $39 million of increased benefit expenses from mark-to-market of variable annuity guaranteed benefit riders compared to a decrease of $31 million in the current nine month period. Expenses in the prior year period also included an unfavorable $12 million adjustment to reserves for disability income insurance claims.
Interest credited to fixed accounts decreased by $57 million or 8.8% to $588 million for the nine months ended September 30, 2008 primarily due to a continued decline in fixed annuity account balances.
The amortization of DAC increased $158 million or 48.6% to $483 million for the nine months ended September 30, 2008, primarily due to an $82 million increase from updating valuation assumptions and converting to a new valuation system, as well as a $73 million increase from the market’s impact on DAC, partially offset by lower fixed annuity volumes. In the prior year period, updating valuation assumptions resulted in $16 million of additional DAC amortization partially offset by a benefit of $13 million from the market’s impact on DAC.
Separation costs incurred in 2007 were primarily associated with separating and reestablishing technology platforms. All separation costs were incurred as of December 31, 2007.
Other insurance and operating expenses decreased $54 million or 9.4% to $519 million for the nine months ended September 30, 2008 primarily due to decreased sales and marketing expenses and lower corporate overhead expenses.
Income Taxes
RiverSource Life’s effective tax rate was 2% for the nine months ended September 30, 2008, compared to 17% for the nine months ended September 30, 2007. The decrease in the effective tax rates primarily reflects a $39 million tax benefit, related to changes in the status of current audits as well as the level of pretax income relative to tax advantaged items, including the dividends received deduction for the nine months ended September 30, 2008.
On September 25, 2007, the Internal Revenue Service (“IRS”) issued Revenue Ruling 2007-61 in which it announced that it intends to issue regulations with respect to certain computational aspects of the Dividends Received Deduction (“DRD”) related to separate account assets held in connection with variable contracts of life insurance companies and has added the project to the 2007-2008 Priority Guidance Plan. Revenue Ruling 2007-61 suspended a revenue ruling issued in August 2007 that purported to change accepted industry and IRS interpretations of the statutes governing these computational questions. 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 members of the public 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, but they may result in the elimination of some or all of the separate account DRD tax benefit that RiverSource Life receives. Management believes that it is likely that any such regulations would apply prospectively only.
Market Risk
Equity market and interest rate fluctuations can have a significant impact on RiverSource Life’s results of operations, primarily due to the “spread” income generated on its annuities and universal life (“UL”) insurance products, the value of DAC and DSIC, assets associated with variable annuity and variable UL products, the values of liabilities for guaranteed benefits associated with RiverSource Life’s variable annuities and the values of derivatives held to hedge these benefits.
21
Changes in both the equity and fixed income markets during the third quarter of 2008 have affected RiverSource Life’s market risk position. These changes resulted in lower asset values against which RiverSource Life takes asset-based fees and expenses as well as increases in stated liabilities for variable annuity guaranteed benefits. The guaranteed benefits associated with RiverSource Life’s variable annuities are guaranteed minimum withdrawal benefit (“GMWB”), guaranteed minimum accumulation benefit (“GMAB”), guaranteed minimum death benefit (“GMDB”) and guaranteed minimum income benefit (“GMIB”) options. Each of the guaranteed benefits mentioned above guarantees payouts to the annuity holder under certain specific conditions regardless of the performance of the underlying investment assets.
To evaluate interest rate and equity price risk, RiverSource Life performs sensitivity testing which measures the impact on pretax income from the sources listed below for a 12 month period following a hypothetical 100 basis point increase in interest rates and a hypothetical 10% decline in equity markets. Due to the market turmoil in the third quarter of 2008, RiverSource Life also performed sensitivity testing assuming a hypothetical 20% decline in equity markets.
The numbers below show RiverSource Life’s estimate of the pretax impact from equity price risk exposures related to asset-based fees and expenses, and variable annuity riders at September 30, 2008.
|
| Equity Price Exposure to Pretax Income |
| |||||||
Equity Price Decline 10% |
| Before |
| Hedge |
| Net Impact |
| |||
|
|
|
| (in millions) |
|
|
| |||
Asset-based fees and expenses, including DAC amortization |
| $ | (98 | ) | $ | N/A |
| $ | (98 | ) |
Variable annuity riders: |
|
|
|
|
|
|
| |||
GMDB and GMIB |
| (51 | ) | N/A |
| (51 | ) | |||
GMWB |
| (82 | ) | 84 |
| 2 |
| |||
GMAB |
| (24 | ) | 28 |
| 4 |
| |||
DAC amortization |
| (3 | ) | N/A |
| (3 | ) | |||
Total variable annuity riders |
| (160 | ) | 112 |
| (48 | ) | |||
Total |
| $ | (258 | ) | $ | 112 |
| $ | (146 | ) |
|
| Equity Price Exposure to Pretax Income |
| |||||||
Equity Price Decline 20% |
| Before |
| Hedge |
| Net Impact |
| |||
|
|
|
| (in millions) |
|
|
| |||
Asset-based fees and expenses, including DAC amortization |
| $ | (159 | ) | $ | N/A |
| $ | (159 | ) |
Variable annuity riders: |
|
|
|
|
|
|
| |||
GMDB and GMIB |
|
| (95 | ) |
| N/A |
|
| (95 | ) |
GMWB |
| (189 | ) | 200 |
| 11 |
| |||
GMAB |
| (54 | ) | 67 |
| 13 |
| |||
DAC amortization |
| (5 | ) | N/A |
| (5 | ) | |||
Total variable annuity riders |
| (343 | ) | 267 |
| (76 | ) | |||
Total |
| $ | (502 | ) | $ | 267 |
| $ | (235 | ) |
The numbers below show RiverSource Life’s estimate of the pretax impact from interest rate risk exposure related to variable annuity riders at September 30, 2008:
|
| Interest Rate Exposure to Pretax Income |
| |||||||
Interest Rate Increase 100 Basis Points |
| Before |
| Hedge |
| Net Impact |
| |||
|
|
|
| (in millions) |
|
|
| |||
Variable annuity riders: |
|
|
|
|
|
|
| |||
GMWB |
| $ | 161 |
| $ | (185 | ) | $ | (24 | ) |
GMAB |
| 37 |
| (25 | ) | 12 |
| |||
DAC amortization |
| 5 |
| N/A |
| 5 |
| |||
Total |
| $ | 203 |
| $ | (210 | ) | $ | (7 | ) |
N/A Not Applicable.
22
The impact of pretax income from interest rate risk exposure related to RiverSource Life’s fixed annuities, fixed portion of variable annuities and fixed insurance products did not materially change from its disclosures in its “Management’s Narrative Analysis - Risk Management” in its 2007 10-K.
Actual results could differ materially from those illustrated above as they are based on a number of estimates and assumptions. These include assuming the composition of invested assets and liabilities does not change in the 12 month period following the hypothetical market decline, that there are no changes in implied market volatility and the increase in interest rates produces a parallel shift in the yield curve. The selection of a 100 basis point interest rate increase and a 10% and 20% equity market decline should not be construed as a prediction of future market events.
Equity Price Risk – Variable Annuity Riders
The variable annuity guaranteed benefits guarantee payouts to the annuity holder under certain specific conditions regardless of the performance of the investment assets. For this reason, when equity markets decline, the returns from the separate account assets coupled with guaranteed benefit fees from annuity holders may not be sufficient to fund expected payouts. In that case, reserves must be increased with a negative impact to earnings. RiverSource Life does not hedge the equity price risk related to GMDB and GMIB. The core derivative instruments with which RiverSource Life hedges the equity price risk of GMWB and GMAB are longer dated put and call options; these core instruments are supplemented with equity futures and total return swaps.
Interest Rate Risk – Variable Annuity Riders
The GMAB and the non-life contingent benefits associated with the GMWB provisions create embedded derivatives which are carried at fair value separately from the underlying host variable annuity contract. Increases in interest rates reduce the fair value of the GMWB and GMAB liabilities. The GMWB and GMAB interest rate exposure is hedged with a portfolio of longer dated put and call options, interest rate swaps and swaptions. During the three months ended September 30, 2008, RiverSource Life continued to adjust the hedge portfolio to reflect the sensitivity of the liabilities.
Credit Risk
RiverSource Life is exposed to credit risk within its investment portfolio, which includes loans, and through derivative and reinsurance counterparties. Credit risk relates to the uncertainty of an obligor’s continued ability to make timely payments in accordance with the contractual terms of the instrument or contract. RiverSource Life’s potential derivative credit exposure to each counterparty is aggregated with all of its other exposures to the counterparty to determine compliance with established credit guidelines at the time it enters into a derivative transaction. RiverSource Life manages credit risk through fundamental credit analysis, issuer and industry concentration guidelines, and diversification requirements. These guidelines and oversight of credit risk are managed through its comprehensive enterprise risk management program that includes members of senior management.
RiverSource Life manages the risk of adverse default experience on these investments by applying disciplined fundamental credit analysis and underwriting standards, prudently limiting exposures to lower-quality, higher-yielding investments, and diversifying exposures by issuer, industry, region and property type. For each counterparty or borrowing entity and its affiliates, RiverSource Life’s exposures from all types of transactions are aggregated and managed in relation to guidelines set by risk tolerance thresholds and external and internal rating quality. RiverSource Life remains exposed to occasional adverse cyclical economic downturns during which default rates may be significantly higher than the long term historical average used in pricing.
Credit exposures on derivative contracts may take into account netting arrangements and collateral arrangements. Before executing a new type of structure of derivative contract, RiverSource Life determines the variability of the contract’s potential market and credit exposures and whether such variability might reasonably be expected to create exposure to a counterparty in excess of established limits.
Additionally, RiverSource Life reinsures a portion of the insurance risks associated with its life, disability income and long term care insurance products through reinsurance agreements with unaffiliated reinsurance companies. Reinsurance is used in order to limit losses, reduce exposure to large risks and provide additional capacity for future growth. To manage exposure to losses from reinsurer insolvencies, the financial condition of reinsurers is evaluated prior to entering into new reinsurance treaties and on a periodic basis during the terms of the treaties. RiverSource Life remains primarily liable as the direct insurer on all risks reinsured.
For additional information regarding our sensitivity to market and credit risk, see “Management’s Narrative Analysis—Risk Management” in RiverSource Life’s 2007 10-K.
Fair Value Measurements
RiverSource Life reports certain assets and liabilities at fair value; specifically, separate account assets, derivatives, embedded derivatives, and most investments and cash equivalents are reported at their fair values. Statement of Financial Accounting Standards No. 157 “Fair Value Measurements” (“SFAS 157”) defines fair value, provides a framework for measuring fair value and expands disclosures about fair value measurements. Fair value assumes the exchange of assets or liabilities occurs in orderly transactions. RiverSource Life includes actual market prices, or observable inputs in its fair value measurements to the extent available. Broker quotes are obtained when quotes from pricing services are not available.
23
RiverSource Life validates prices obtained from third parties through a variety of means such as: price variance analysis, subsequent sales testing, stale price review, price comparison across pricing vendors and due diligence reviews of vendors. SFAS 157 does not require the use of market prices that are the result of a forced liquidation or distressed sale.
Illiquid Markets
Through RiverSource Life’s own experience transacting in the marketplace and through discussions with its pricing vendors, RiverSource Life believes that the market for certain non-agency residential mortgage-backed securities is inactive. Indicators of inactive markets include: pricing services’ reliance on brokers or discounted cash flow analyses to provide prices, an increase in the disparity between prices provided by different pricing services for the same security, unreasonably large bid-offer spreads and a significant decrease in the volume of trades relative to historical levels. This market inactivity has resulted in RiverSource Life applying valuation techniques that rely more on an income approach (discounted cash flows using market rates) than on a market approach (prices from pricing services). RiverSource Life considers market observable yields for other asset classes it considers to be of similar risk which includes nonperformance and liquidity for individual securities to set the discount rate for applying the income approach to certain non-agency residential mortgage-backed securities. The discount rates used for these securities at September 30, 2008 ranged from 11% to 15%.
Residential Mortgage-backed Securities Backed by Subprime or Alt-A Collateral
Sub-prime mortgage lending is the origination of residential mortgage loans to customers with weak credit profiles. Alt-A mortgage lending is the origination of residential mortgage loans to customers who have credit ratings above sub-prime but may not conform to government-sponsored standards. RiverSource Life has exposure to these types of loans only through mortgage-backed and asset-backed securities. The slow down in the U.S. housing market, combined with relaxed underwriting standards by some originators, has recently led to higher delinquency and loss rates for some of these investments. Recent market conditions have increased the likelihood of other-than-temporary impairments for certain non-agency residential mortgage backed securities. As a part of RiverSource Life’s risk management process, an internal rating system is used in conjunction with market data as the basis for analysis to assess the likelihood that RiverSource Life will not receive all contractual principal and interest payments for these investments. For the investments that are more at risk for impairment, RiverSource Life performs its own assessment of projected cash flows incorporating assumptions about default rates, prepayment speeds, loss severity, and geographic concentrations to determine if an other-than-temporary impairment should be recognized. Based on this analysis, other than non-agency mortgage-backed securities that had credit-related impairments recorded in the nine months ended September 30, 2008, all contractual payments are expected to be received.
24
The following table presents, as of September 30, 2008, RiverSource Life’s residential mortgage-backed and asset-backed securities backed by sub-prime and Alt-A mortgage loans by credit rating and vintage year. For presentation in this table, other-than-temporarily impaired securities are shown at their internal rating of BB and below (amounts in millions):
|
| AAA |
| AA |
| A |
| BBB |
| BB & Below |
| Total |
| ||||||||||||||||||||||||
|
| Amortized |
| Fair |
| Amortized Cost |
| Fair |
| Amortized |
| Fair |
| Amortized |
| Fair |
| Amortized |
| Fair |
| Amortized |
| Fair |
| ||||||||||||
Sub-prime |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||
2004 & prior |
| $ | 5 |
| $ | 5 |
| $ | 8 |
| $ | 6 |
| $ | — |
| $ | — |
| $ | — |
| $ | — |
| $ | — |
| $ | — |
| $ | 13 |
| $ | 11 |
|
2005 |
| 77 |
| 69 |
| — |
| — |
| 5 |
| 4 |
| — |
| — |
| — |
| — |
| 82 |
| 73 |
| ||||||||||||
2006 |
| 25 |
| 23 |
| — |
| — |
| — |
| — |
| — |
| — |
| — |
| — |
| 25 |
| 23 |
| ||||||||||||
2007 |
| — |
| — |
| — |
| — |
| — |
| — |
| — |
| — |
| — |
| — |
| — |
| — |
| ||||||||||||
2008 |
| 11 |
| 10 |
| — |
| — |
| — |
| — |
| — |
| — |
| — |
| — |
| 11 |
| 10 |
| ||||||||||||
Total Sub-prime |
| $ | 118 |
| $ | 107 |
| $ | 8 |
| $ | 6 |
| $ | 5 |
| $ | 4 |
| $ | — |
| $ | — |
| $ | — |
| $ | — |
| $ | 131 |
| $ | 117 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||
Alt-A |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||
2004 & prior |
| $ | 46 |
| $ | 41 |
| $ | 15 |
| $ | 10 |
| $ | — |
| $ | — |
| $ | — |
| $ | — |
| $ | — |
| $ | — |
| $ | 61 |
| $ | 51 |
|
2005 |
| 285 |
| 238 |
| 72 |
| 37 |
| 3 |
| 2 |
| — |
| — |
| 20 |
| 20 |
| 380 |
| 297 |
| ||||||||||||
2006 |
| — |
| — |
| — |
| — |
| — |
| — |
| 21 |
| 21 |
| 6 |
| 6 |
| 27 |
| 27 |
| ||||||||||||
2007 |
| 32 |
| 24 |
| — |
| — |
| — |
| — |
| — |
| — |
| — |
| — |
| 32 |
| 24 |
| ||||||||||||
2008 |
| — |
| — |
| — |
| — |
| — |
| — |
| — |
| — |
| — |
| — |
| — |
| — |
| ||||||||||||
Total Alt-A |
| $ | 363 |
| $ | 303 |
| $ | 87 |
| $ | 47 |
| $ | 3 |
| $ | 2 |
| $ | 21 |
| $ | 21 |
| $ | 26 |
| $ | 26 |
| $ | 500 |
| $ | 399 |
|
Grand Total |
| $ | 481 |
| $ | 410 |
| $ | 95 |
| $ | 53 |
| $ | 8 |
| $ | 6 |
| $ | 21 |
| $ | 21 |
| $ | 26 |
| $ | 26 |
| $ | 631 |
| $ | 516 |
|
Fair Value of Liabilities and Nonperformance Risk
SFAS 157 also requires companies to measure the fair value of liabilities at the price that would be received to transfer the liability to a market participant (an exit price). Since there is not a market for RiverSource Life’s obligations of its variable annuity riders, RiverSource Life considered the assumptions participants in a hypothetical market would make to reflect an exit price. As a result, RiverSource Life adjusted the valuation of variable annuity riders by updating certain policyholder assumptions, adding explicit margins to provide for profit, risk and expenses, and adjusting the rates used to discount expected cash flows to reflect a current market estimate of RiverSource Life’s nonperformance risk. The nonperformance risk adjustment is specific to the risk of RiverSource Life not fulfilling these liabilities. This nonperformance risk adjustment is based on broker quotes for credit default-swaps. Consistent with general market conditions, this estimate resulted in a spread over the LIBOR swap curve as of September 30, 2008. As RiverSource Life’s estimate of this spread widens or tightens, the liability will decrease or increase. If this nonperformance credit spread moves to a zero spread over the LIBOR swap curve, the reduction to net income would be approximately $62 million, net of DAC and DSIC amortization and income taxes, based on September 30, 2008 credit spreads.
As outlined in the credit risk section above, nonperformance risk for derivatives is managed and mitigated primarily through the use of master netting arrangements and collateral arrangements. As of September 30, 2008, any deterioration in RiverSource Life’s derivative counterparties’ credit would not materially impact the financial statements.
Liquidity and Capital Resources
Liquidity Strategy
The liquidity requirements of RiverSource Life are generally met by funds provided by investment income, maturities and periodic repayments of investments, deposits, premiums and proceeds from sales of investments as well as capital contributions from Ameriprise Financial. Other liquidity sources RiverSource Life has established are repurchase agreements and an available line of credit with Ameriprise Financial aggregating $200 million. The primary uses of funds are policy benefits, commissions, other product-related acquisition and sales inducement costs, operating expenses, policy loans, dividends to Ameriprise Financial and investment purchases. RiverSource Life routinely reviews its sources and uses of funds in order to meet its ongoing obligations.
On March 26, June 25 and September 25, 2008, RiverSource Life paid cash dividends of $125 million, $275 million and $375 million, respectively, to Ameriprise Financial. On June 25 and September 25, 2008, RiverSource Life of NY paid cash dividends
25
of $27 million and $50 million, respectively, to RiverSource Life Insurance Company. During 2007, RiverSource Life paid cash dividends of $900 million to Ameriprise Financial. Also during 2007, RiverSource Life of NY paid cash dividends of $83 million to RiverSource Life Insurance Company.
RiverSource Life Insurance Company and RiverSource Life of NY are subject to regulatory capital requirements as follows:
|
| Actual Capital as of (a) |
| Regulatory |
| |||||
|
| September 30, |
| December 31, |
| December 31, |
| |||
|
| (in millions) |
| |||||||
RiverSource Life Insurance Company |
| $ | 2,089 |
| $ | 3,017 |
| $ | 442 |
|
RiverSource Life Insurance Co. of New York |
| 157 |
| 288 |
| 34 |
| |||
(a) | Actual capital, as defined by the National Association of Insurance Commissioners for purposes of meeting regulatory capital requirements, includes statutory capital and surplus, plus certain statutory valuation reserves. |
(b) | Regulatory capital requirement is based on the most recent statutory risk-based capital filing. |
In response to a question raised during the Ameriprise Financial third quarter earnings conference call on October 29, 2008, management estimated that the risk based capital (“RBC”) ratio of RiverSource Life was above 450% as of September 30, 2008, without adjusting for capital requirements for year-end C3 Phase II analysis and after year-to-date dividends of $775 million to Ameriprise Financial.
Based upon its preliminary assessment, if equity markets fall 30% during the fourth quarter of 2008, RiverSource Life expects that it will maintain an RBC ratio aligned with its targeted levels for AA ratings, inclusive of C3 Phase II capital requirements. RiverSource Life will finalize the RBC ratio as part of the statutory reporting process in early 2009.
The numerator of RiverSource Life’s estimated RBC ratio was its actual statutory capital as of September 30, 2008, which was impacted by earnings, impairments and variable annuity reserve increases from year-to-date equity market declines of 21% as well as $775 million in dividends paid in 2008 to move excess capital from RiverSource Life to Ameriprise Financial. The denominator was an estimate of RiverSource Life’s company action level risk-based capital based on September 30, 2008 statutory asset and liability balances. Importantly, RiverSource Life had no incremental capital requirement from C3 Phase II at year end 2007, and did not include any such capital requirement in the estimate described above.
For RiverSource Life, the declining equity markets affect statutory capital primarily by increasing required reserves for variable annuities. RiverSource Life’s living benefit hedging program and increases in the value of those hedge instruments help mitigate this impact.
As mentioned above, RiverSource Life had no incremental capital requirement from C3 Phase II as of December 31, 2007. While the significant year-to-date decline in equity levels makes it more likely there will be such a requirement at December 31, 2008, a substantial portion of that requirement will be eliminated due to the diversification benefit of RiverSource Life’s business.
Forward-Looking Statements
This report contains forward-looking statements that reflect RiverSource Life’s plans, estimates and beliefs. RiverSource Life’s actual results could differ materially from those described in these forward-looking statements. The words “believe,” “expect,” “anticipate,” “optimistic,” “intend,” “plan,” “aim,” “will,” “may,” “should,” “could,” “would,” “likely” and similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements. Forward-looking statements are subject to risks and uncertainties which could cause actual results to differ materially from such statements. RiverSource Life cautions the reader that the following list of factors is not exhaustive. There may also be other risks that RiverSource Life is unable to predict at this time that may cause actual results to differ materially from those in forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date on which they are made. RiverSource Life undertakes no obligation to update or revise any forward-looking statements.
26
Factors that could cause actual results to differ materially from these forward-looking statements include, but are not limited to, the following:
· | changes in the valuations, liquidity and volatility in the interest rate, equity market, and foreign exchange environments; |
· | changes in the litigation and regulatory environment, including ongoing legal proceedings and regulatory actions, the frequency and extent of legal claims threatened or initiated by clients, other persons and regulators, and developments in regulation and legislation; |
· | RiverSource Life’s investment management performance and consumer acceptance of RiverSource Life’s products; |
· | effects of competition in the financial services industry and changes in RiverSource Life’s product distribution mix and distribution channels; |
· | RiverSource Life’s capital structure as a subsidiary of Ameriprise Financial, including the ability of its parent to support its financial strength and ratings; |
· | risks of default by issuers or guarantors of investments RiverSource Life owns or by counterparties to hedge derivative, insurance or reinsurance arrangements; |
· | experience deviations from RiverSource Life’s assumptions regarding morbidity, mortality and persistency in certain annuity and insurance products, or from assumptions regarding market volatility underlying RiverSource Life’s hedges on guaranteed benefit annuity riders; |
· | successfully cross-selling insurance and annuity products and services to Ameriprise Financial’s customer base; |
· | RiverSource Life’s ability to effectively hedge risks relating to guaranteed benefit riders and certain other products; |
· | the impact of intercompany allocations to RiverSource Life from Ameriprise Financial and its affiliates; |
· | Ameriprise Financial’s ability to attract, recruit and retain qualified advisors and employees and its ability to distribute RiverSource Life’s products through current and future distribution channels; |
· | the impact of Ameriprise Financial’s efforts to improve distribution economics and of RiverSource Life’s efforts to grow third party distribution and to realize benefits from reengineering and tax planning; |
· | changes in U.S. federal income or estate tax laws potentially making RiverSource Life’s products less attractive to clients; |
· | RiverSource Life’s ability to recover from catastrophes, both natural and man-made; and |
· | general economic and political factors, including consumer confidence in the economy as well as the ability and inclination of consumers generally to invest, the costs of products and services RiverSource Life consumes in the conduct of its business, and applicable legislation and regulation, including tax law, tax treaties, fiscal and central government treasury policy, and regulatory rulings and pronouncements. |
The foregoing list of factors should be read in conjunction with the “Risk Factors” discussion as Part I, Item 1A of RiverSource Life’s 2007 10-K.
ITEM 4T. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
RiverSource Life maintains disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) designed to provide reasonable assurance that the information required to be reported in the Exchange Act filings is recorded, processed, summarized and reported within the time periods specified and pursuant to SEC regulations, including controls and procedures designed to ensure that this information is accumulated and communicated to RiverSource Life’s management, including its principal executive officer and chief financial officer, as appropriate, to allow timely decisions regarding the required disclosure. It should be noted that, because of inherent limitations, RiverSource Life’s disclosure controls and procedures, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the disclosure controls and procedures are met.
RiverSource Life’s management, with the participation of RiverSource Life’s principal executive officer and chief financial officer, evaluated the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report. Based upon that evaluation, RiverSource Life’s principal executive officer and chief financial officer have concluded that RiverSource Life’s disclosure controls and procedures were effective at a reasonable level of assurance as of September 30, 2008.
27
Changes in Internal Control Over Financial Reporting
During the third quarter of 2008, RiverSource Life converted to a new industry standard actuarial valuation system that provides enhanced modeling capabilities. This system strengthens the internal control environment as the valuation is highly automated and manual intervention is significantly reduced. There were no other changes in RiverSource Life’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, RiverSource Life’s internal control over financial reporting.
The information set forth in Note 11 to the Consolidated Financial Statements in Part I, Item 1 is incorporated herein by reference.
The risk factors set forth below update the risk factors section previously disclosed in Item 1A of Part I of RiverSource Life’s Annual Report on Form 10-K for the year ended December 31, 2007 (“2007 Form 10-K”).
Risks Relating to RiverSource Life’s Business
RiverSource Life’s financial condition and results of operations may be adversely affected by interest rate fluctuations and by economic and other factors.
RiverSource Life’s financial condition and results of operations may be materially affected by interest rate fluctuations and economic and other factors. RiverSource Life’s insurance and annuity products are sensitive to interest rate fluctuations, and its future costs associated with such variations may differ from its historical costs. In addition, interest rate fluctuations could result in fluctuations in the valuation of certain minimum guaranteed benefits contained in some of its variable annuity products. Although RiverSource Life typically hedges against such fluctuations, a significant change in interest rates could have a material adverse impact on RiverSource Life’s results of operations.
During periods of increasing market interest rates, RiverSource Life must offer higher crediting rates on interest-sensitive products, such as fixed universal life insurance and fixed annuities, and it must increase crediting rates on insurance and annuity products to keep these products competitive. Because returns on invested assets may not increase as quickly as current interest rates, RiverSource Life may have to accept a lower “spread,” or the difference between the returns it earns on the investments that support its obligations under these products and the amounts that it must pay policyholders and contractholders, and thus lower profitability or face a decline in sales and greater loss of existing contracts and related assets. In addition, increases in market interest rates may cause increased policy surrenders, withdrawals from life insurance policies and annuity contracts and requests for policy loans, as policyholders and contractholders seek to shift assets to products with perceived higher returns. This process may lead to an earlier than expected flow of cash out of the business. Also, increases in market interest rates may result in extension of the maturity of some of RiverSource Life’s investment assets. These earlier outflows and asset maturity extensions may require investment assets to be sold at a time when the prices of those assets are lower because of the increase in market interest rates, which may result in realized investment losses. Increases in crediting rates, as well as surrenders and withdrawals, could have an adverse effect on RiverSource Life’s financial condition and results of operations. An increase in policy surrenders and withdrawals also may require RiverSource Life to accelerate amortization of deferred acquisition costs (“DAC”), which would increase its expenses and reduce its net earnings.
During periods of falling interest rates, RiverSource Life’s “spread” or the difference between the returns it earns on the investments that support its obligations under these products and the amounts that it must pay policyholders and contractholders, may be reduced or could become negative, primarily because some of these products have guaranteed minimum crediting rates. Due to the long term nature of the liabilities associated with RiverSource Life’s fixed annuities and guaranteed benefits on variable annuities, sustained declines in long term interest rates may subject RiverSource Life to reinvestment risks and increased hedging costs.
Interest rate fluctuations also could have an adverse effect on the results of RiverSource Life’s investment portfolio. During periods of declining market interest rates, the interest RiverSource Life receives on variable interest rate investments decreases. In addition, during those periods, RiverSource Life is forced to reinvest the cash it receives as interest or return of principal on its investments in lower–yielding high-grade instruments or in lower–credit instruments to maintain comparable returns. Issuers of fixed income securities also may decide to prepay their obligations in order to borrow at lower market rates, which increases the risk that RiverSource Life may have to invest the cash proceeds of these securities in lower–yielding or lower–credit instruments.
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The guaranteed minimum accumulation benefit (“GMAB”) and the non-life contingent benefits associated with guaranteed minimum withdrawal benefit (“GMWB”) provisions offered with certain RiverSource Life variable annuities create obligations which are carried at fair value separately from the underlying host variable annuity contract. Changes in the fair value of these GMAB and GMWB obligations are recorded through earnings with fair value calculated by estimating the present value of future benefits less applicable fees charged for the rider using actuarial models, which simulate various economic scenarios. Changes in interest rates may impact the fair value of the GMAB and GMWB liabilities. Although RiverSource Life typically hedges against such changes, a significant change in interest rates may result in some net adverse impact to current period financial statements.
For additional information regarding the sensitivity of the fixed income securities in RiverSource Life’s investment portfolio to interest rate fluctuations, see Item 7 of the 2007 Form 10-K – “Management’s Narrative Analysis – Risk Management”.
Many factors of a global or localized nature include: political, economic and market conditions; technological changes and events; inflation; investor sentiment and confidence in the financial markets; terrorism events and armed conflicts; and natural disasters such as weather catastrophes and widespread health emergencies. In addition, during periods of unfavorable market or economic conditions, the level of consumer investing and insuring activity may also decrease, which may negatively impact the results of RiverSource Life’s businesses. Moreover, fluctuations in economic and market activity could impact the way then-existing customers allocate their available resources, which could affect RiverSource Life’s persistency, surrender and product cash value loan experience and could negatively impact its business.
Governmental initiatives intended to address capital market conditions may not be effective and may give rise to additional requirements for RiverSource Life’s business, including new capital requirements or other regulations, that could materially affect its financial condition, results of operations and liquidity in ways that it cannot predict.
Legislation has been passed in an attempt to address the instability in global financial markets. This legislation includes a provision to grant the U.S. Treasury Department the authority to, among other things, purchase up to $700 billion of mortgage-backed and other securities from financial institutions. This legislation or similar proposals, as well as other actions such as monetary or fiscal actions of U.S. government instrumentalities or comparable authorities in other countries, may fail to stabilize the financial markets. This legislation and other proposals or actions may also have other consequences, including material effects on interest rates, which could materially affect RiverSource Life’s investments, results of operations and liquidity in ways that it cannot predict.
In addition, RiverSource Life is subject to extensive laws and regulations that are administered and enforced by a number of different governmental authorities and non-governmental self-regulatory agencies, including state securities and insurance regulators, the Securities and Exchange Commission, the Financial Industry Regulatory Authority, the U.S. Department of Justice and state attorneys general. The current financial crisis has prompted or may prompt some of these authorities to consider additional regulatory requirements intended to prevent future crises or otherwise assure the stability of institutions under their supervision. These authorities may also seek to exercise their authority in new or more expansive ways. All of these possibilities, if they occurred, could affect the way RiverSource Life conducts its business and manages its capital, and may require RiverSource Life to satisfy increased capital requirements, any of which in turn could materially affect its financial condition, results of operations and liquidity.
Poor investment performance in RiverSource Life’s variable products could adversely affect its financial condition and results of operations.
RiverSource Life believes that investment performance is an important factor in the growth of its variable annuity and variable life insurance business. Poor investment performance could impair revenues and earnings, as well as RiverSource Life’s prospects for growth, because:
· RiverSource Life’s ability to attract funds from existing and new clients might diminish; and
· existing clients might withdraw assets from RiverSource Life’s variable products in favor of better performing products of other companies, which would result in lower revenues.
A downgrade or a potential downgrade in RiverSource Life’s financial strength ratings could result in a loss of business and adversely affect its financial condition and results of operations.
Financial strength ratings, which various ratings organizations publish as a measure of an insurance company’s ability to meet contractholder and policyholder obligations, are important to maintaining public confidence in RiverSource Life’s products, the ability to market its products and its competitive position. Any downgrade in RiverSource Life’s financial strength ratings, or the announced potential for a downgrade, could have a significant adverse effect on its financial condition and results of operations in many ways, including:
· reducing new sales of insurance and annuity products;
· adversely affecting RiverSource Life’s relationships with distributors of its products;
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· materially increasing the number or amount of policy surrenders and withdrawals by contractholders and policyholders;
· requiring RiverSource Life to reduce prices for many of its products to remain competitive; and
· adversely affecting RiverSource Life’s ability to obtain reinsurance or obtain reasonable pricing on reinsurance.
In view of the difficulties experienced recently by RiverSource Life’s competitors, RiverSource Life believes it is possible that the ratings organizations will heighten the level of scrutiny that they apply, will increase the frequency and scope of their reviews, will request additional information from the companies that they rate, and may adjust upward the capital and other requirements employed in the ratings organization’s models for maintenance of ratings levels.
RiverSource Life cannot predict what actions rating agencies may take, or what actions RiverSource Life may take in response to the actions of rating agencies, which could adversely affect its business. As with other companies in the insurance industry, RiverSource Life’s ratings could be changed at any time and without any notice by the ratings organizations.
Intense competition and the economics of changes in RiverSource Life’s product revenue mix and distribution channels could negatively affect RiverSource Life’s ability to maintain or increase its market share and profitability.
RiverSource Life operates in an intensely competitive industry. RiverSource Life competes based on a number of factors including name recognition, service, investment performance, product features, price, perceived financial strength, and claims-paying ratings. RiverSource Life’s competitors include insurers and other financial institutions. RiverSource Life may face competitors that have greater market share, offer a broader range of products, have greater financial resources or have higher claims-paying ratings than RiverSource Life does. Some of RiverSource Life’s competitors may possess or acquire intellectual property rights that could provide a competitive advantage to them in certain markets or for certain products, which could make it more difficult for RiverSource Life to introduce new products and services. Some of RiverSource Life’s competitors’ proprietary products or technology could be similar to its own, and this could result in disputes that could impact RiverSource Life’s financial condition or results of operations.
Currently, Ameriprise Financial’s branded advisor network distributes annuity and insurance products issued almost exclusively by RiverSource Life. If Ameriprise Financial’s branded advisor network further opened or expanded its distribution of annuity and insurance products of other companies, RiverSource Life could experience lower sales of its products, higher surrenders or other developments, which could have a material adverse effect on RiverSource Life’s financial condition and results of operations.
Downturns and volatility in equity markets could adversely affect RiverSource Life’s business and profitability.
Significant downturns and volatility in equity markets could have an adverse effect on RiverSource Life’s financial condition and results of operations. Market downturns and volatility may cause potential new purchasers to refrain from purchasing RiverSource Life’s variable annuities and variable universal life insurance products that have returns linked to the performance of the equity markets. Downturns may also cause contractholders in annuity products and policyholders in insurance products to withdraw cash values from those products.
Additionally, downturns in equity markets can have an adverse effect on RiverSource Life’s asset-based revenues because the value of equity-based separate account assets will be reduced.
The GMAB and the non-life contingent benefits associated with GMWB provisions offered with certain RiverSource Life variable annuities create obligations which are carried at fair value separately from the underlying host variable annuity contract. Changes in the fair value of these GMAB and GMWB obligations are recorded through earnings with fair value calculated by estimating the present value of future benefits less applicable fees charged for the rider using actuarial models, which simulate various economic scenarios. Changes in equity prices and/or equity market volatility may impact the fair value of the GMAB and GMWB liabilities. Although RiverSource Life typically hedges against such changes, a significant change in either equity price levels or equity market volatility may result in some net adverse impact to current period financial statements.
A significant market decline in equity price levels could also result in guaranteed minimum benefits under guaranteed minimum death benefits (“GMDB”) and guaranteed minimum income benefit (“GMIB”) provisions being higher than current account values, which could have an adverse effect on RiverSource Life’s financial condition and results of operations. RiverSource Life does not currently hedge or reinsure GMDB or GMIB provisions.
For additional information regarding the sensitivity of RiverSource Life’s business results to equity market fluctuations, see Item 7 of the 2007 Form 10-K – “Management’s Narrative Analysis – Risk Management”.
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Defaults in RiverSource Life’s fixed maturity securities portfolio would adversely affect its earnings.
Issuers of the fixed maturity securities that RiverSource Life owns may default on principal and interest payments. At both December 31, 2007 and 2006, 6% of RiverSource Life’s investment portfolio had ratings below investment-grade. Moreover, economic downturns and corporate malfeasance can increase the number of companies, including those with investment-grade ratings, that default on their debt obligations. Default-related declines in the value of RiverSource Life’s fixed maturity securities portfolio could cause its net earnings to decline and could weaken its capital position.
The determination of the amount of allowances and impairments taken on certain investments is subject to management’s evaluation and judgment and could materially impact RiverSource Life’s financial position or results of operations.
The determination of the amount of allowances and impairments vary by investment type and is based upon RiverSource Life’s periodic evaluation and assessment of inherent and known risks associated with the respective asset class. Such evaluations and assessments are revised as conditions change and new information becomes available. Management updates its evaluations regularly and reflects changes in allowances and impairments in operations as such evaluations are revised. Historical trends may not be indicative of future impairments or allowances.
The assessment of whether impairments have occurred is based on management’s case-by-case evaluation of the underlying reasons for the decline in fair value that considers a wide range of factors about the security issuer and management 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 recovery. Inherent in management’s evaluation of the security are assumptions and estimates about the operations of the issuer and its future earnings potential, which assumptions and estimates are more difficult to make with certainty under current market conditions.
Some of RiverSource Life’s investments are relatively illiquid.
RiverSource Life invests a portion of its general account assets in certain privately placed fixed income securities, mortgage loans, policy loans, and collateralized debt obligations, among others, all of which are relatively illiquid. These asset classes represented 19.0% of the carrying value of RiverSource Life’s investment portfolio as of December 31, 2007. If RiverSource Life requires significant amounts of cash on short notice in excess of its normal cash requirements, it may have difficulty selling these investments in a timely manner, or be forced to sell them for an amount less than it would otherwise have been able to realize, or both. For example, if an unexpected number of contractholders of its annuity products exercise their surrender right and RiverSource Life is unable to access other liquidity sources, it may have to quickly liquidate assets. Any inability to quickly dispose of illiquid investments could have an adverse effect on RiverSource Life’s financial condition and results of operations.
RiverSource Life’s affiliated distributor may be unable to attract and retain financial advisors.
RiverSource Life is dependent on the branded financial advisors of its affiliated broker-dealer selling firm for a significant portion of the sales of its annuity and insurance products. A significant number of its branded financial advisors operate as independent contractors under a franchise agreement with its affiliated selling firm. There can be no assurance that RiverSource Life’s affiliated selling firm will be successful in its efforts to recruit and retain new advisors to its network. If RiverSource Life’s affiliated selling firm is unable to attract and retain quality financial advisors, fewer advisors would be available to sell RiverSource Life’s annuity and insurance products and RiverSource Life’s financial condition and results of operations could be materially adversely affected.
RiverSource Life and its affiliates face intense competition in attracting and retaining key talent.
RiverSource Life’s continued success depends to a substantial degree on its, and its affiliates’, ability to attract and retain qualified personnel to conduct its business. The market for qualified talent is extremely competitive and has grown more so in recent periods due to industry growth. There can be no assurance that RiverSource Life will be successful in its efforts to recruit and retain the required personnel. If RiverSource Life is unable to attract and retain qualified individuals or its recruiting and retention costs increase significantly, its financial condition and results of operations could be materially adversely affected.
If the counterparties to RiverSource Life’s reinsurance arrangements or to the derivative instruments it uses to hedge its business risks default, RiverSource Life may be exposed to risks it had sought to mitigate, which could adversely affect its financial condition and results of operations.
RiverSource Life uses reinsurance to mitigate its risks in various circumstances. See Item 1 of the 2007 Form10-K – “Business – Reinsurance”. Reinsurance does not relieve RiverSource Life of its direct liability to its policyholders, even when the reinsurer is liable to RiverSource Life. Accordingly, RiverSource Life bears credit risk with respect to its reinsurers. RiverSource Life cannot provide assurance that its reinsurers will pay the reinsurance recoverable owed to it now or in the future or that they will pay these recoverables on a timely basis. A reinsurer’s insolvency or its inability or unwillingness to make payments under the terms of its reinsurance agreement could have an adverse effect on RiverSource Life’s financial condition and results of operations that could be material. See Note 2 and Note 13 to the Consolidated Financial Statements in the 2007 Form10-K.
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In addition, RiverSource Life uses derivative instruments to hedge various business risks. The amount and breadth of exposure to derivative counterparties have increased significantly in connection with RiverSource Life’s strategies to hedge guaranteed benefit obligations under its variable annuity products. If RiverSource Life’s counterparties fail to honor in a timely manner their obligations under the derivative instruments, RiverSource Life’s hedges of the related risk will be ineffective. That failure could have a material adverse effect on RiverSource Life’s financial condition and results of operations. This risk of failure of RiverSource Life’s hedge transactions may be increased by capital market volatility, such as the volatility that has been experienced since the second half of 2007.
RiverSource Life’s business is heavily regulated, and changes in regulation may reduce its profitability and limit its growth.
RiverSource Life operates in a highly regulated industry, and is required to obtain and maintain licenses for its business in addition to being subject to regulatory oversight. Financial regulators have significantly increased the level of regulation in recent years and have several outstanding proposals for additional regulation. Significant discussion and activity by regulators concern the sale and suitability of financial products and services to persons planning for retirement, as well as to older investors. In addition, RiverSource Life is subject to heightened requirements and associated costs and risks relating to privacy and the protection of customer data. RiverSource Life’s information systems, moreover, may be subject to increased efforts of “hackers” by reason of the customer data it possesses. These requirements, costs and risks, as well as possible legislative or regulatory changes, may constrain RiverSource Life’s ability to market its products and services to its target demographic and potential customers, and could negatively affect RiverSource Life’s profitability and make it more difficult for RiverSource Life to pursue its growth strategy.
RiverSource Life is subject to state regulation, so must comply with statutory reserve and capital requirements. State regulators are continually reviewing and updating these requirements and other requirements relating to the business operations of insurance companies, including their underwriting and sales practices. Moreover, RiverSource Life is subject to capital requirements for variable annuity contracts with guaranteed death or living benefits. These requirements may have an impact on future statutory reserves and regulatory capital in the event equity market values fall in the future. RiverSource Life is required by state law to be a member of the guaranty fund association in every state where it is licensed to do business. In the event of insolvency of one or more unaffiliated insurance companies, RiverSource Life could be adversely affected by the requirement to pay assessments to the guaranty fund associations. Moreover, there is active discussion at the National Association of Insurance Commissioners (“NAIC”) of moving to a principles-based reserving system. This could change statutory reserve requirements significantly and it is not possible to estimate the impact at this time. Further, RiverSource Life cannot predict the effect that proposed federal legislation, such as the option of federally chartered insurers, may have on RiverSource Life or its competitors.
Compliance with applicable laws and regulations is time consuming and personnel–intensive. Moreover, the evaluation of RiverSource Life’s compliance with these laws and regulations by state insurance regulators, the SEC, and other regulatory organizations is an ongoing feature of RiverSource Life’s business, the outcomes of which may not be foreseeable. Changes in these laws and regulations may materially increase RiverSource Life’s direct and indirect compliance and other expenses of doing business. The costs of the compliance requirements RiverSource Life faces, and the constraints they impose on its operations, could have a material adverse effect on RiverSource Life’s financial condition and results of operations. For a further discussion of the regulatory framework in which RiverSource Life operates, see Item 1 of the 2007 Form10-K – “Business – Regulation”. For more information regarding ongoing investigations, see “Part II – Item 1 – Legal Proceedings.”
Legal and regulatory actions are inherent in RiverSource Life’s business and could result in financial losses or harm its business.
RiverSource Life is, and in the future may be, subject to legal and regulatory actions in the ordinary course of its operations. Substantial legal liability in legal or regulatory actions could have a material financial effect or cause significant reputational harm, which in turn could seriously harm its business prospects.
Competitive and regulatory pressures may require RiverSource Life to reduce the levels of its fees.
RiverSource Life’s profit margins and earnings are dependent in part on its ability to maintain current fee levels for the products and services that it offers. Competition within the financial services industry could lead RiverSource Life to reduce the fees that it charges its clients for products and services. See the risk factor entitled “Intense competition and the economics of changes in RiverSource Life’s product revenue mix and distribution channels could negatively affect RiverSource Life’s ability to maintain or increase its market share and profitability.” In addition, RiverSource Life may be required to reduce its fee levels, or restructure the fees it charges, as a result of regulatory initiatives or proceedings that are either industry-wide or specifically targeted at RiverSource Life. See the risk factor entitled “RiverSource Life’s business is heavily regulated, and changes in regulation may reduce its profitability and limit its growth” and “Part II – Item 1 – Legal Proceedings” for more information regarding this and other regulatory matters. Reductions or other changes in the fees that RiverSource Life charges for its products and services could reduce its revenues and earnings.
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Misconduct by RiverSource Life’s employees and agents and its affiliates’ employees and agents is difficult to detect and deter and could harm RiverSource Life’s business, results of operations or financial condition.
Misconduct by RiverSource Life’s employees and agents and its affiliates’ employees and agents could result in violations of law, regulatory sanctions and/or serious reputational or financial harm. Misconduct can occur in each of RiverSource Life’s businesses and could include:
· attempting to bind RiverSource Life to transactions that exceed authorized limits;
· hiding unauthorized or unsuccessful activities resulting in unknown and unmanaged risks or losses;
· improperly using, disclosing, or otherwise compromising confidential information;
· recommending transactions that are not suitable;
· engaging in fraudulent or otherwise improper activity;
· engaging in unauthorized or excessive trading to the detriment of customers; or
· otherwise not complying with laws or RiverSource Life’s control procedures.
RiverSource Life cannot always deter misconduct by employees and agents and the precautions RiverSource Life takes to prevent and detect this activity may not be effective in all cases. RiverSource Life also cannot provide assurance that misconduct by employees and agents will not lead to a material adverse effect on its business, financial condition or results of operations.
If RiverSource Life’s reserves for future policy benefits and claims are inadequate, it may be required to increase its reserve liabilities, which could adversely affect its financial condition and results of operations.
RiverSource Life establishes reserves as estimates of its liabilities to provide for future obligations under its insurance policies and annuities contracts. Reserves do not represent an exact calculation of liability, but rather are estimates of contract benefits and related expenses RiverSource Life expects to incur over time. The assumptions and estimates RiverSource Life makes in establishing reserves require certain judgments about future experience and, therefore, are inherently uncertain. RiverSource Life cannot determine with precision the actual amounts that it will pay for contract benefits, the timing of payments, or whether the assets supporting its stated reserves will increase to the levels it estimates before payment of benefits or claims. RiverSource Life monitors its reserve levels continually. If RiverSource Life were to conclude that its reserves are insufficient to cover actual or expected contract benefits, it would be required to increase its reserves and incur income statement charges for the period in which it makes the determination, which could adversely affect its financial condition and results of operations. For more information on how RiverSource Life sets its reserves, see Note 2 to the Consolidated Financial Statements in the 2007 Form10-K.
RiverSource Life may face losses if morbidity rates or mortality rates differ significantly from its pricing expectations.
RiverSource Life sets prices for its life, disability income (“DI”) and long term care (“LTC”) insurance and some annuity products based upon expected claim payment patterns, derived from assumptions RiverSource Life makes about the morbidity rates, or likelihood of sickness, and the mortality rates, or likelihood of death, of its policyholders and contractholders. The long-term profitability of these products depends upon how RiverSource Life’s actual experience compares with its pricing assumptions. For example, if morbidity rates are higher, or mortality rates are lower, than its pricing assumptions, RiverSource Life could be required to make greater payments under DI and LTC insurance policies and immediate annuity contracts than it had projected. The same holds true for LTC policies RiverSource Life previously underwrote to the extent of the risks that RiverSource Life has retained. If mortality rates are higher than its pricing assumptions, RiverSource Life could be required to make greater payments under its life insurance policies and annuity contracts with GMDBs than it had projected.
The risk that RiverSource Life’s claims experience may differ significantly from its pricing assumptions is particularly significant for its LTC insurance products, notwithstanding RiverSource Life’s ability to implement future price increases. As with life insurance, LTC insurance policies provide for long-duration coverage and, therefore, its actual claims experience will emerge over many years. However, as a relatively new product in the market, LTC insurance does not have the extensive claims experience history of life insurance, and, as a result, RiverSource Life’s ability to forecast future claim rates for LTC insurance is more limited than for life insurance. RiverSource Life has sought to moderate these uncertainties to some extent by partially reinsuring LTC policies that it had previously underwritten and by limiting its present LTC insurance offerings to policies underwritten fully by an unaffiliated third party, and RiverSource Life has also implemented rate increases on certain inforce policies as described in Item 1 of the 2007 Form10-K – “Business – Insurance: Product Features and Risks – Long Term Care
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Insurance”. There can be no assurance that RiverSource Life will not be required to implement additional rate increases in the future or that RiverSource Life will receive regulatory approval to the full extent and timing of any rate increases that RiverSource Life may seek.
RiverSource Life may face losses if there are significant deviations from its assumptions regarding the future persistency of its insurance policies and annuity contracts.
The prices and expected future profitability of RiverSource Life’s insurance and deferred annuity products are based in part upon expected patterns of premiums, expenses and benefits, using a number of assumptions, including those related to persistency, which is the probability that a policy or contract will remain inforce from one period to the next. The effect of persistency on profitability varies for different products. For most of its life insurance and deferred annuity products, actual persistency that is lower than its persistency assumptions could have an adverse impact on profitability, especially in the early years of a policy or contract, primarily because RiverSource Life would be required to accelerate the amortization of expenses it deferred in connection with the acquisition of the policy or contract.
For RiverSource Life’s LTC insurance, actual persistency that is higher than its persistency assumptions could have a negative impact on profitability. If these policies remain inforce longer than RiverSource Life assumed, then RiverSource Life could be required to make greater benefit payments than it had anticipated when it priced or partially reinsured these products. Some of its LTC insurance policies have experienced higher persistency and poorer loss experience than RiverSource Life had assumed, which led it to increase premium rates on certain of these policies.
Because RiverSource Life’s assumptions regarding persistency experience are inherently uncertain, reserves for future policy benefits and policy claims and other policyholders’ funds may prove to be inadequate if actual persistency experience is different from those assumptions. Although some of its products permit RiverSource Life to increase premiums during the life of the policy or contract, RiverSource Life cannot guarantee that these increases would be sufficient to maintain profitability. Additionally, some of these pricing changes require regulatory approval, which may not be forthcoming. Moreover, many of RiverSource Life’s products do not permit RiverSource Life to increase premiums or limit those increases during the life of the policy or contract while premiums on certain other products (primarily LTC insurance) may not be increased without prior regulatory approval. Significant deviations in experience from pricing expectations regarding persistency could have an adverse effect on the profitability of RiverSource Life’s products.
RiverSource Life may be required to accelerate the amortization of DAC, which would increase its expenses and reduce profitability.
DAC represent the costs of acquiring new business, principally direct sales commissions and other distribution and underwriting costs that have been deferred on the sale of annuity, life, DI and LTC insurance. For annuity and universal life products, DAC are amortized based on projections of estimated gross profits over amortization periods equal to the approximate life of the business. For other insurance products, DAC are generally amortized as a percentage of premiums over amortization periods equal to the premium-paying period.
RiverSource Life’s projections underlying the amortization of DAC require the use of certain assumptions, including interest margins, mortality rates, persistency rates, maintenance expense levels and customer asset value growth rates for variable products. RiverSource Life periodically reviews and, where appropriate, adjusts its assumptions. When RiverSource Life changes its assumptions, it may be required to accelerate the amortization of DAC or to record a charge to increase benefit reserves.
As of both December 31, 2007 and 2006, RiverSource Life had $4.4 billion of DAC, and it amortized $470 million and $356 million of DAC as a current period expense for the years ended December 31, 2007 and 2006, respectively. For more information regarding DAC, see Item 7 of the 2007 Form10-K – “Management’s Narrative Analysis – Critical Accounting Policies – Deferred Acquisition Costs” and “– Recent Accounting Pronouncements”.
Changes in U.S. federal income or estate tax law could make some of RiverSource Life’s products less attractive to clients.
Many of the products RiverSource Life issues or on which its business is based (including both insurance products and non-insurance products) enjoy favorable treatment under current U.S. federal income or estate tax law. Changes in U.S. federal income or estate tax law could make some of its products less attractive to clients.
Breaches of security, or the perception that RiverSource Life’s technology infrastructure is not secure, could harm its business.
RiverSource Life’s business requires the appropriate and secure utilization of consumer and other sensitive information. RiverSource Life’s operations require the secure transmission of confidential information over public networks. Security breaches in connection with the delivery of its products and services, including products and services utilizing the Internet, and the trend toward broad consumer and general public notification of such incidents, could significantly harm RiverSource Life’s
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business, financial condition or results of operations. Even if RiverSource Life successfully protected its technology infrastructure and the confidentiality of sensitive data, RiverSource Life could suffer harm to its business and reputation if attempted security breaches are publicized. RiverSource Life cannot be certain that advances in criminal capabilities, discovery of new vulnerabilities, attempts to exploit vulnerabilities in its systems, data thefts, physical system or network break-ins or inappropriate access, or other developments will not compromise or breach the technology or other security measures protecting the networks used in connection with its products and services.
Protection from system interruptions is important to RiverSource Life’s business. If RiverSource Life experienced a sustained interruption to its telecommunications or data processing systems, it could harm its business.
System or network interruptions could delay and disrupt RiverSource Life’s ability to develop, deliver or maintain its products and services, causing harm to its business and reputation and resulting in loss of customers or revenue. These interruptions can include fires, floods, earthquakes, power losses, equipment failures, failures of internal or vendor software or systems and other events beyond its control.
RiverSource Life’s risk management policies and procedures may not be fully effective in mitigating its risk exposure in all market environments or against all types of risk, including employee and financial advisor misconduct.
RiverSource Life has devoted significant resources toward developing its risk management policies and procedures and will continue to do so in the future. Nonetheless, RiverSource Life’s policies and procedures to identify, monitor and manage risks may not be fully effective in mitigating its risk exposure in all market environments or against all types of risk. Many of its methods of managing risk and exposures are based upon its use of observed historical market behavior or statistics based on historical models. During periods of market volatility or due to unforeseen events, the historically derived correlations upon which these methods are based may not be valid. As a result, these methods may not accurately predict future exposures, which could be significantly greater than what its models indicate. This could cause RiverSource Life to incur investment losses or cause its hedging and other risk management strategies to be ineffective. Other risk management methods depend upon the evaluation of information regarding markets, clients, catastrophe occurrence or other matters that are publicly available or otherwise accessible to RiverSource Life, which may not always be accurate, complete, up-to-date or properly evaluated.
Moreover, RiverSource Life is subject to the risks of errors and misconduct by its employees and affiliated financial advisors – such as fraud, non-compliance with policies, recommending transactions that are not suitable, and improperly using or disclosing confidential information – which are difficult to detect in advance and deter, and could harm its business, financial condition or results of operations. Management of operational, legal and regulatory risks requires, among other things, policies and procedures to record properly and verify a large number of transactions and events, and these policies and procedures may not be fully effective in mitigating RiverSource Life’s risk exposure in all market environments or against all types of risk. Insurance and other traditional risk-shifting tools may be held by or available to RiverSource Life in order to manage certain exposures, but they are subject to terms such as deductibles, coinsurance, limits and policy exclusions, as well as risk of counterparty denial of coverage, default or insolvency.
RiverSource Life is subject to tax contingencies that could adversely affect the provision for income taxes.
RiverSource Life is subject to the income tax laws of the U.S., its states and municipalities and those of the foreign jurisdictions in which it has significant business operations. These tax laws are complex and may be subject to different interpretations. RiverSource Life must make judgments and interpretations about the application of these inherently complex tax laws when determining the provision for income taxes and must also make estimates about when in the future certain items affect taxable income in the various tax jurisdictions. Disputes over interpretations of the tax laws may be settled with the taxing authority upon examination or audit.
In addition, changes to the Internal Revenue Code, administrative rulings or court decisions could increase RiverSource Life’s provision for income taxes. For example, on August 16, 2007, the Internal Revenue Service (“IRS”) issued a revenue ruling which purports, among other things, to modify the calculation of the deduction for dividends received by life insurance companies. Subsequently on September 25, 2007, the IRS issued another revenue ruling that suspended the August 16 ruling and announced a new regulation project on the issue. The income tax benefit of the separate account dividends received deduction for current year dividends was approximately $46 million for the fiscal year ended December 31, 2007.
The list of exhibits required to be filed as exhibits to this report are listed on page E-1 hereof, under “Exhibit Index,” which is incorporated herein by reference.
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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, thereunto duly authorized.
| RIVERSOURCE LIFE INSURANCE COMPANY |
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Date: November 4, 2008 | By | /s/ Timothy V. Bechtold | |
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| Timothy V. Bechtold | |
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| President | |
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| |
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Date: November 4, 2008 | By | /s/ Brian J. McGrane | |
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| Brian J. McGrane | |
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| Executive Vice President and | |
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| Chief Financial Officer | |
36
The following exhibits are filed as part of this Quarterly Report:
Exhibit |
| Description |
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* 31.1 |
| Certification of Timothy V. Bechtold, President, pursuant to Rule 13a-14(a) promulgated under the Securities Exchange Act of 1934, as amended. |
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* 31.2 |
| Certification of Brian J. McGrane, Chief Financial Officer, pursuant to Rule 13a-14(a) promulgated under the Securities Exchange Act of 1934, as amended. |
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* 32.1 |
| Certification of Timothy V. Bechtold, President, and Brian J. McGrane, Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
* Filed electronically herewith.
E-1