| | | | | | | Three Months Ended March 31, |
| | | | | | | 2006 | | | 2005 |
| | | | | | | | | | (Restated) |
| | | | | | | | | | |
Net cash provided by operating activities | $ | 287.5 | | $ | 198.9 |
| | | | | | | | | | |
Cash Flows from Investing Activities: | | | | | |
| Proceeds from the sale, maturity, or redemption of: | | | | | |
| | Fixed maturities, available-for-sale | | 3,704.8 | | | 3,271.1 |
| | Equity securities, available-for-sale | | 0.2 | | | 0.6 |
| | Mortgage loans on real estate | | 147.7 | | | 68.5 |
| Acquisition of: | | | | | |
| | Fixed maturities, available-for-sale | | (4,106.2) | | | (3,765.3) |
| | Equity securities, available-for-sale | | (14.0) | | | - |
| | Mortgage loans on real estate | | (62.3) | | | (111.8) |
| Other investments | | (99.6) | | | 18.3 |
| Short-term investments | | 36.6 | | | 5.9 |
| Other | | | | 2.8 | | | 1.6 |
Net cash used in investing activities | | (390.0) | | | (511.1) |
| | | | | | | | | | |
Cash Flows from Financing Activities: | | | | | |
| Deposits received for investment contracts | | 1,138.2 | | | 975.6 |
| Maturities and withdrawals from investment contracts | | (1,201.2) | | | (1,571.2) |
| Reinsurance recoverable on investment contracts | | 91.3 | | | 517.4 |
| Short-term loan with affiliate | | 32.8 | | | 184.2 |
| Short-term loans | | 24.6 | | | 64.2 |
Net cash provided by financing activities | | 85.7 | | | 170.2 |
Net decrease in cash and cash equivalents | | (16.8) | | | (142.0) |
Cash and cash equivalents, beginning of period | | 215.2 | | | 209.0 |
Cash and cash equivalents, end of period | $ | 198.4 | | $ | 67.0 |
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
(Dollar amounts in millions, unless otherwise stated)
1. | Organization and Significant Accounting Policies |
Basis of Presentation
ING USA Annuity and Life Insurance Company (“ING USA” or the “Company,” as appropriate) is a stock life insurance company domiciled in the State of Iowa and provides financial products and services in the United States. ING USA is authorized to conduct its insurance business in all states, except New York, and the District of Columbia.
ING USA is a direct, wholly-owned subsidiary of Lion Connecticut Holdings Inc. (“Lion” or “Parent”), which is an indirect, wholly-owned subsidiary of ING Groep N.V. (“ING”). ING is a global financial services holding company based in The Netherlands, with American Depository Shares listed on the New York Stock Exchange under the symbol “ING”.
The condensed financial statements and notes as of March 31, 2006, and for the three months ended March 31, 2006 and 2005, have been prepared in accordance with accounting principles generally accepted in the United States and are unaudited.
The condensed financial statements reflect all adjustments (consisting only of normal, recurring accruals) which are, in the opinion of management, necessary for the fair presentation of the financial position, results of operations, and cash flows, for the interim periods. These condensed financial statements and notes should be read in conjunction with the financial statements and related notes as presented in the Company’s 2005 Annual Report on Form 10-K. The results of operations for the interim periods may not be considered indicative of results to be expected for the full year.
Description of Business
The Company offers various insurance products, including immediate and deferred variable and fixed annuities. The Company’s annuity products are distributed by national wirehouses, regional securities firms, independent National Association of Securities Dealers, Inc. firms with licensed registered representatives, banks, life insurance companies with captive agency sales forces, independent insurance agents, independent marketing organizations, and the ING broker-dealer network. The Company’s primary annuity customers are retail consumers.
The Company also offers guaranteed investment contracts and funding agreements (collectively referred to as “GICs”) primarily to institutional investors and corporate benefit plans. These products are marketed by home office personnel or through specialty insurance brokers.
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ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
(Dollar amounts in millions, unless otherwise stated)
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the condensed financial statements and accompanying notes. Actual results could differ from reported results using those estimates.
Reclassifications
Certain reclassifications have been made to prior year financial information to conform to the current year classifications (see Reclassifications and Changes to Prior Year Presentation footnote).
Significant Accounting Policies
For a description of the significant accounting policies, see the Organization and Significant Accounting Policies footnote to the Financial Statements included in the Company’s 2005 Annual Report on Form 10-K.
2. | Recently Adopted Accounting Standards |
The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments
On November 3, 2005, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) Statement of Financial Accounting Standards (“FAS”) No. 115-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“FSP FAS No. 115-1”). FSP FAS No. 115-1 replaces the impairment evaluation guidance of the Emerging Issues Task Force (“EITF”) Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“EITF 03-1”).
FSP FAS No. 115-1 addresses the determination of when an investment is considered impaired, whether that impairment is other-than-temporary, and the measurement of an impairment loss. In addition, it includes considerations for accounting subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporarily impaired. FSP FAS No. 115-1 further clarifies that an impairment loss should be recognized no later than when the impairment is deemed other-than-temporary, even if a decision to sell an impaired security has not been made. FSP FAS No. 115-1 references existing guidance on other-than-temporary impairments.
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ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
(Dollar amounts in millions, unless otherwise stated)
FSP FAS No. 115-1 was effective for reporting periods beginning after December 15, 2005, and was implemented by the Company during the fourth quarter of 2005. The Company recognized impairment losses of $8.3 for the three months ended March 31, 2006, related to investments that the Company does not have the intent to retain for a period of time sufficient to allow for recovery in fair value. The required disclosures are included in the Investments footnote.
Investor’s Accounting for an Investment in a Limited Partnership When the Investor is the Sole General Partner and the Limited Partners Have Certain Rights
In June 2005, the EITF reached a consensus on EITF Issue No. 04-5, “Investor’s Accounting for an Investment in a Limited Partnership When the Investor is the Sole General Partner and the Limited Partners Have Certain Rights” ("EITF 04-5"), which states that the general partner in a limited partnership should presume that it controls and, thus, should consolidate the limited partnership, unless the limited partners have either (a) substantive ability to dissolve the limited partnership or otherwise remove the general partner without cause or (b) substantive participating rights. EITF 04-5 applies to limited partnerships that are not variable interest entities under FASB Interpretation No. 46R: “Consolidation of Variable Interest Entities” ("FIN 46R"). EITF 04-5 was effective immediately for all new limited partnerships formed and for existing limited partnerships for which partnership agreements were modified after June 29, 2005, and was effective for all other limited partnerships at the commencement of the first reporting period beginning after December 15, 2005.
The Company’s limited partnership investment totaling $19.7 in Powers Ferry Properties Ltd Partnership (“PFP”), an affiliate acquired on May 12, 2005, was accounted for using the equity method, as ING USA does not have substantive kick-out or participating rights and, therefore, cannot overcome the presumption of control by the general partner of PFP. The adoption of EITF 04-5 had no additional impact as of March 31, 2006, since the Company’s remaining investments in limited partnerships are generally considered variable interest entities under FIN 46R, and are accounted for using the cost or equity method of accounting since the Company is not the primary beneficiary. Investments in limited partnerships are included in Other investments on the Condensed Balance Sheets.
3. | New Accounting Standards |
Accounting for Servicing of Financial Assets
In March 2006, the FASB issued FAS No. 156, “Accounting for Servicing of Financial Assets – an amendment of FASB Statement No. 140” (“FAS No. 156”). FAS No. 156 requires the separate recognition of servicing assets and servicing liabilities each time an obligation to service a financial asset is undertaken by entering into a servicing contract and permits the fair value measurement of servicing assets and servicing liabilities. In addition, FAS No. 156 does the following:
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ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
(Dollar amounts in millions, unless otherwise stated)
• | Clarifies when a servicer should separately recognize servicing assets and liabilities; |
• | Requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if practicable; |
• | Permits a one-time reclassification of available-for-sale securities to trading securities by entities with recognized servicing rights, provided that the available-for-sale securities are identified in some manner as offsetting the exposure to changes in fair value of servicing assets and servicing liabilities that are subsequently measured at fair value; and |
• | Requires additional disclosures for all separately recognized servicing assets and servicing liabilities. |
FAS No. 156 requirements for recognition and initial measurement of servicing assets and servicing liabilities should be applied prospectively to all transactions entered into after the beginning of the first fiscal year that commences after September 15, 2006. The Company does not expect the impact of adoption of FAS No. 156 to have a material effect on the results of operations or cash flows.
Accounting for Certain Hybrid Financial Instruments
In February 2006, FASB issued FAS No. 155, “Accounting for Certain Hybrid Financial Instruments – an amendment of FASB Statements No. 133 and 140” (“FAS No. 155”), which permits the application of fair value accounting to certain hybrid financial instruments in their entirety if they contain embedded derivatives that would otherwise require bifurcation under FAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“FAS No. 133”). Under this approach, changes in fair value would be recognized currently in earnings. In addition, FAS No. 155 does the following:
• | Clarifies which interest-only strips and principal-only strips are not subject to derivative accounting under FAS No. 133; |
• | Requires that interests in securitized financial assets be analyzed to identify interests that are freestanding derivatives or that are hybrid instruments that contain embedded derivatives requiring bifurcation; |
• | Clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives; and |
• | Allows a qualifying special-purpose entity to hold derivative financial instruments that pertain to beneficial interests, other than another derivative financial instrument. |
11
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
(Dollar amounts in millions, unless otherwise stated)
FAS No. 155 is effective for all instruments acquired, issued, or subject to a remeasurement event, occurring after the beginning of the first fiscal year that commences after September 15, 2006. The Company is in the process of determining the impact of FAS No. 155.
Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection With Modifications or Exchanges of Insurance Contracts
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”), which states that when an internal replacement transaction results in a substantially changed contract, the unamortized deferred acquisition costs, unearned revenue liabilities, and deferred sales inducement assets, related to the replaced contract should not be deferred in connection with the new contract. Contract modifications that meet various conditions defined by SOP 05-1 and result in a new contract that is substantially unchanged from the replaced contract, however, should be accounted for as a continuation of the replaced contract.
SOP 05-1 defines an internal replacement as a modification in product benefits, features, rights, or coverages, that occurs by the exchange of a contract for a new contract, or by amendment, endorsement, or rider, to a contract, or by the election of a feature or coverage within a contract. SOP 05-1 applies to internal replacements made primarily to contracts defined by FAS No. 60, “Accounting and Reporting by Insurance Enterprises” (“FAS No. 60”), as short-duration and long-duration insurance contracts, and by FAS No. 97, “Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments” (“FAS No. 97”), as investment contracts.
SOP 05-1 is effective for internal replacements occurring in fiscal years beginning after December 15, 2006, with earlier adoption encouraged. The Company is in the process of determining the impact of adoption of SOP 05-1.
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ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
(Dollar amounts in millions, unless otherwise stated)
Other-Than-Temporary Impairments
The following table identifies the Company’s other-than-temporary impairments, included in Net realized capital gains (losses), by type for the three months ended March 31, 2006 and 2005.
| | Three Months Ended March 31, |
| | 2006 | | | 2005 |
| | | | No. of | | | | | No. of |
| | Impairment | | Securities | | | Impairment | | Securities |
U.S. Treasury/Agencies | $ | 0.1 | | 1 | | $ | - | | - |
U.S. corporate | | 5.8 | | 12 | | | - | | - |
Foreign(1) | | 1.3 | | 3 | | | - | | - |
Residential mortgage-backed | | 4.9 | | 33 | | | 10.3 | | 67 |
Other asset-backed | | 1.1 | | 2 | | | 0.4 | | 1 |
Limited partnerships | | 0.3 | | 1 | | | - | | - |
Total | $ | 13.5 | | 52 | | $ | 10.7 | | 68 |
| | | | | | | | | |
(1) Primarily U.S. dollar denominated. | | | | | | | | | |
The above schedule for the three months ended March 31, 2006 includes $5.2 in other-than-temporary write-downs related to the analysis of credit risk and the possibility of significant prepayment risk. The remaining $8.3 in write-downs for the three months ended March 31, 2006 relates to investments that the Company does not have the intent to retain for a period of time sufficient to allow for recovery in fair value, based upon the requirements of FSP FAS No. 115-1. The following table summarizes these write-downs by type for the three months ended March 31, 2006.
| | | | 2006 |
| | | | | | | No. of |
| | | | Impairment | | | Securities |
U.S. Treasury/Agencies | | $ | 0.1 | | | 1 |
U.S. corporate | | | 5.8 | | | 12 |
Foreign | | | 1.3 | | | 3 |
Other asset-backed | | | 1.1 | | | 2 |
Total | | $ | 8.3 | | $ | 18 |
The remaining fair value of investments with other-than-temporary impairments at March 31, 2006 and 2005 was $301.0 and $182.7, respectively.
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ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
(Dollar amounts in millions, unless otherwise stated)
The Company may sell securities during the period in which fair value has declined below amortized cost for fixed maturities or cost for equity securities. In certain situations new factors, such as negative developments and subsequent credit deterioration, can subsequently change the Company’s previous intent to continue holding a security.
5. | Deferred Policy Acquisition Costs and Value of Business Acquired |
Activity for the three months ended March 31, 2006 and 2005, within deferred policy acquisition costs (“DAC”), was as follows:
| | | | | | | | | | 2006 | | | 2005 |
Balance at January 1 | $ | 2,255.4 | | $ | 1,704.1 |
| Deferrals of commissions and expenses | | 166.4 | | | 147.6 |
| Amortization: | | | | | | |
| | Amortization | | (75.5) | | | (124.2) |
| | Interest accrued at 5% to 6% | | 30.5 | | | 24.1 |
| Net amortization included in the Condensed | | | | | |
| | Statements of Operations | | (45.0) | | | (100.1) |
| Change in unrealized capital (gains) losses on | | | | | |
| | available-for-sale securities | | 118.0 | | | 140.9 |
Balance at March 31 | $ | 2,494.8 | | $ | 1,892.5 |
Activity for the three months ended March 31, 2006 and 2005, within value of business acquired (“VOBA”), was as follows:
| | | | | | | | | | 2006 | | | 2005 |
Balance at January 1 | $ | 122.1 | | $ | 112.2 |
Amortization: | | | | | | | |
| | Amortization | | (4.7) | | | (6.0) |
| | Interest accrued at 4% to 5% | | 1.4 | | | 1.6 |
| Net amortization included in the Condensed | | | | | |
| | Statements of Operations | | (3.3) | | | (4.4) |
| Change in unrealized capital (gains) losses on | | | | | |
| | available-for-sale securities | | 15.1 | | | 20.3 |
Balance at March 31 | $ | 133.9 | | $ | 128.1 |
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ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
(Dollar amounts in millions, unless otherwise stated)
The Company's effective tax rates for the three months ended March 31, 2006 and 2005, were 25.0% and 31.8%, respectively. The effective rates differ from the expected rate primarily due to the benefit from the dividends received deduction. The decrease in the effective tax rate from March 31, 2005 to March 31, 2006 is primarily due to an increase in the deduction allowed for dividends received relative to the change in Income before income taxes.
An $80.7 valuation allowance was established as of March 31, 2006 related to unrealized capital losses on investments and is included in Accumulated other comprehensive income (loss). The Company had no valuation allowance as of December 31, 2005.
The Company maintains a reciprocal loan agreement with ING America Insurance Holdings, Inc. ("ING AIH"), an affiliate, to facilitate the handling of unanticipated short-term cash requirements that arise in the ordinary course of business. Under this agreement, which became effective in January 2004 and expires on January 14, 2014, either party can borrow from the other up to 3% of the Company's statutory admitted assets as of the preceding December 31. Interest on any ING USA borrowing is charged at the rate of ING AIH’s cost of funds for the interest period, plus 0.15%. Interest on any ING AIH borrowing is charged at a rate based on the prevailing interest rate of U.S. commercial paper available for purchase with a similar duration. Under this agreement, the Company incurred interest expense of $0.7 for the three months ended March 31, 2006 and minimal interest expense for the three months ended March 31, 2005. The Company earned interest income of $0.4 and $1.4 for the three months ended March 31, 2006 and 2005, respectively. At March 31, 2006 and December 31, 2005, the Company had $12.2 and $45.0, respectively, receivable from ING AIH under the reciprocal loan agreement.
8. | Commitments and Contingent Liabilities |
Commitments
Through the normal course of investment operations, the Company commits to either purchase or sell securities, commercial mortgage loans, or money market instruments, at a specified future date and at a specified price or yield. The inability of counterparties to honor these commitments may result in either a higher or lower replacement cost. Also, there is likely to be a change in the value of the securities underlying the commitments. At March 31, 2006, the Company had off-balance sheet commitments to purchase investments equal to their fair value of $440.1, $74.8 of which was with related parties. At December 31, 2005, the Company had off-balance sheet commitments to purchase
15
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
(Dollar amounts in millions, unless otherwise stated)
investments equal to their fair value of $456.1, $77.2 of which was with related parties. During the three months ended March 31, 2006, $18.4 was funded to related parties under these commitments.
Financial Guarantees
In the third quarter of 2005, the Company purchased a 3-year credit-linked note arrangement whereby the Company will reimburse the guaranteed party upon payment default of the referenced obligation. Upon such default, the Company reimburses the guaranteed party for the loss under the reference obligation, and the Company receives that reference obligation in settlement. The Company can then recover any losses under the agreement by sale or collection of the received reference obligation. As of March 31, 2006, the maximum potential future exposure to the Company under the guarantee was $12.0.
Litigation
The Company is involved in threatened or pending lawsuits/arbitrations arising from the normal conduct of business. Due to the climate in insurance and business litigation/arbitrations, suits against the Company sometimes include claims for substantial compensatory, consequential, or punitive damages, and other types of relief. Moreover, certain claims are asserted as class actions, purporting to represent a group of similarly situated individuals. While it is not possible to forecast the outcome of such lawsuits/arbitrations, in light of existing insurance, reinsurance, and established reserves, it is the opinion of management that the disposition of such lawsuits/arbitrations will not have a materially adverse effect on the Company’s operations or financial position.
16
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
(Dollar amounts in millions, unless otherwise stated)
9. | Accumulated Other Comprehensive Income (Loss) |
Shareholder’s equity included the following components of Accumulated other comprehensive income (loss) as of March 31, 2006 and 2005.
| | | | | | | | | | | 2006 | | | 2005 |
Net unrealized capital gains (losses): | | | | | | |
| Fixed maturities, available-for-sale | | $ | (231.5) | | $ | 151.5 |
| Equity securities, available-for-sale | | | 1.5 | | | 0.5 |
| DAC/VOBA adjustment on available-for-sale securities | | | 140.8 | | | (97.3) |
| Sales inducements adjustment on available-for-sale securities | | | 5.2 | | | (0.3) |
| Other investments | | | (0.6) | | | (2.7) |
| Deferred tax asset valuation allowance | | | (80.7) | | | - |
Unrealized capital (losses) gains, before tax | | | (165.3) | | | 51.7 |
Deferred income tax asset (liability) | | | 29.6 | | | (18.0) |
Net unrealized capital (losses) gains | | | (135.7) | | | 33.7 |
Minimum pension liability, net of tax | | | (3.9) | | | (4.9) |
Accumulated other comprehensive (loss) income | | $ | (139.6) | | $ | 28.8 |
Changes in Accumulated other comprehensive income (loss), net of DAC, VOBA, and tax, related to changes in unrealized capital gains (losses) on securities, including securities pledged, were as follows for the three months ended March 31, 2006 and 2005.
| | | | | | | | | | 2006 | | | 2005 |
Net unrealized capital holding losses arising during the period(1) | $ | (63.8) | | $ | (84.5) |
Less: reclassification adjustment for losses and other | | | | | |
| items included in net income(2) | | (9.6) | | | (0.6) |
Net change in unrealized capital losses on securities | $ | (54.2) | | $ | (83.9) |
(1) | Pretax unrealized capital holding losses arising during the period were $(98.1) and $(133.3) for the three months ended March 31, 2006 and 2005, respectively. |
(2) | Pretax reclassification adjustments for losses and other items included in net income were $(14.7) and $(1.0) for the three months ended March 31, 2006 and 2005, respectively. |
17
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
(Dollar amounts in millions, unless otherwise stated)
10. | Reclassifications and Changes to Prior Year Presentation |
During 2006, certain changes were made to the Condensed Statement of Cash Flows for the three months ended March 31, 2005, to reflect the correct balances, primarily related to short-term loan with affiliate and receivables and payables for securities. As a result of these adjustments, the Company has labeled the Condensed Statement of Cash Flows for the three months ended March 31, 2005, as restated. The following summarizes the adjustments:
| | | | | | | | | | Previously | | | | | | |
Three months ended March 31, 2005 | | Reported | | | Adjustment | | | Restated |
| Net cash provided by operating activities | $ | 613.6 | | $ | (414.7) | | $ | 198.9 |
| Net cash used in investing activities | | (738.2) | | | 227.1 | | | (511.1) |
| Net cash (used in) provided by financing activities | | (17.4) | | | 187.6 | | | 170.2 |
18
Item 2. | Management’s Narrative Analysis of the Results of Operations and Financial Condition |
(Dollar amounts in millions, unless otherwise stated)
Overview
The following narrative analysis presents a review of the results of operations of ING USA Annuity and Life Insurance Company (“ING USA” or “the Company,” as appropriate) for the three months ended March 31, 2006 and 2005 and financial condition as of March 31, 2006 and December 31, 2005. This item should be read in its entirety and in conjunction with the condensed financial statements and related notes, which can be found under Part I, Item 1 contained herein, as well as the “Management’s Narrative Analysis of the Results of Operations and Financial Condition” section contained in the Company’s 2005 Annual Report on Form 10-K.
Forward-Looking Information/Risk Factors
In connection with the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, the Company cautions readers regarding certain forward-looking statements contained in this report and in any other statements made by, or on behalf of, the Company, whether or not in future filings with the Securities and Exchange Commission (“SEC”). Forward-looking statements are statements not based on historical information and which relate to future operations, strategies, financial results, or other developments. Statements using verbs such as “expect,” “anticipate,” “believe,” or words of similar import generally involve forward-looking statements. Without limiting the foregoing, forward-looking statements include statements which represent the Company’s beliefs concerning future levels of sales and redemptions of the Company’s products, investment spreads and yields, or the earnings and profitability of the Company’s activities.
Forward-looking statements are necessarily based on estimates and assumptions that are inherently subject to significant business, economic, and competitive uncertainties and contingencies, many of which are beyond the Company’s control and many of which are subject to change. These uncertainties and contingencies could cause actual results to differ materially from those expressed in any forward-looking statements made by, or on behalf of, the Company. Whether or not actual results differ materially from forward-looking statements may depend on numerous foreseeable and unforeseeable developments, including, but not limited to the following:
(1) | equity market volatility could negatively impact profitability and financial condition; |
(2) | efforts to reduce the impact of interest rate changes on profitability and financial condition may not be effective; |
(3) | the Company’s investment portfolio is subject to risks that may reduce the value of invested assets and adversely affect sales, profitability, and investment returns credited to contractowners; |
(4) | the occurrence of natural or man-made disasters may adversely affect the Company’s results of operations and financial condition; |
19
(5) | changes in underwriting and actual experience could materially affect profitability; |
(6) | changes in reserve estimates may reduce profitability; | |
(7) | a downgrade in the Company’s ratings may negatively affect profitability and financial condition; |
(8) | the continued availability of capital may affect the ability to grow; | |
(9) | a loss of key product distribution relationships could materially affect sales; | |
(10) | competition could negatively affect the ability to maintain or increase profitability; |
(11) | changes in federal income tax law could make some products less attractive to contractowners and increase tax costs; |
(12) | litigation may adversely affect profitability and financial condition; | |
(13) | changes in regulation in the United States and recent regulatory investigations may reduce profitability; |
(14) | changes in accounting standards issued by the Financial Accounting Standards Board or other standard-setting bodies may adversely affect profitability and financial condition; |
(15) | reinsurance subjects the Company to the credit risk of reinsurers and may not be adequate to protect against losses arising from ceded reinsurance; and |
(16) | failure of the Company’s operating systems or a compromise of their security could adversely affect the Company’s results of operation and financial condition. |
| | | | | |
Investors are also directed to consider the risks and uncertainties discussed in this Item 2 and in Item 1A of Part II contained herein, as well as in other documents filed by the Company with the SEC. Except as may be required by the federal securities laws, the Company disclaims any obligation to update forward-looking information.
Critical Accounting Policies
There have been no material changes to the Company’s critical accounting policies since the filing of the Company’s 2005 Annual Report on Form 10-K.
Results of Operations
Overview
Products offered by the Company include immediate and deferred variable and fixed annuities, designed to address customer needs for tax-advantaged savings, retirement needs, and wealth-protection concerns, and guaranteed investment contracts and funding agreements (collectively referred to as “GICs”), sold primarily to institutional investors and corporate benefit plans.
20
The Company derives its revenue mainly from (a) fee income generated on variable assets under management (“AUM”), (b) investment income earned on fixed AUM, and (c) certain other management fees. Fee income is primarily generated from separate account assets supporting variable options under variable annuity contract investments, as designated by contractowners. Investment income from fixed AUM is mainly generated from annuity products with fixed investment options. The Company’s expenses primarily consist of (a) interest credited and other benefits to contractowners, (b) amortization of deferred policy acquisition costs (“DAC”) and value of business acquired (“VOBA”), (c) expenses related to the selling and servicing of the various products offered by the Company, and (d) other general business expenses.
Economic Analysis
The current economic environment presents challenges and opportunities for the Company and the insurance industry. The Company’s sales and financial results continue to be affected by economic trends.
On the positive side, the improved equity market performance has presented opportunities for life insurers, as fee revenue from variable annuities has a direct correlation with equity market performance. Also, variable annuity product demand has grown with consumer demand for equity investments.
On the opposite side, the rising interest rates negatively impacted the fair value of the Company's fixed maturity portfolio and resulted in capital losses. In addition, the tightening of the credit spreads in the market made it difficult to find attractive investments to match GIC liabilities. Furthermore, during the first quarter of 2006, the market experienced a flat yield curve, with negligible extra yield on a 10-year bond versus a five-year bond. This flat yield curve hurt the competitiveness of fixed annuities as compared to other short-term instruments.
21
The Company’s results of operations for the three months ended March 31, 2006, and changes therein, were primarily impacted by performance in the separate accounts, changing equity markets, and increased sales of variable annuity products. Each of these items contributed to increase the Company’s average variable AUM. In addition, interest rate movements had an unfavorable impact on the Company’s operations.
| | | | | | | | | | Three Months Ended March 31, | | | $ Increase | | % Increase |
| | | | | | | | | | 2006 | | | 2005 | | | (Decrease) | | (Decrease) |
Revenues: | | | | | | | | | | | | | | |
| Net investment income | $ | 275.8 | | $ | 284.6 | | $ | (8.8) | | (3.1)% |
| Fee income | | | | | 219.0 | | | 168.1 | | | 50.9 | | 30.3% |
| Premiums | | | | | 5.3 | | | 5.5 | | | (0.2) | | (3.6)% |
| Net realized capital (losses) gains | | (75.0) | | | 4.9 | | | (79.9) | | NM |
Total revenue | | | | | 425.1 | | | 463.1 | | | (38.0) | | (8.2)% |
Benefits and expenses: | | | | | | | | | | |
| Interest credited and other | | | | | | | | | | |
| | benefits to contractowners | | 256.6 | | | 264.4 | | | (7.8) | | (3.0)% |
| Operating expenses | | 49.4 | | | 47.3 | | | 2.1 | | 4.4% |
| Amortization of deferred policy | | | | | | | | | | |
| | acquisition costs and value | | | | | | | | | | |
| | of business acquired | | 48.3 | | | 104.5 | | | (56.2) | | (53.8)% |
| Interest expense | | | 7.8 | | | 7.3 | | | 0.5 | | 6.8% |
| Other | | | | | | | 8.9 | | | 1.2 | | | 7.7 | | NM |
Total benefits and expenses | | 371.0 | | | 424.7 | | | (53.7) | | (12.6)% |
Income before income taxes | | 54.1 | | | 38.4 | | | 15.7 | | 40.9% |
Income tax expense | | 13.5 | | | 12.2 | | | 1.3 | | 10.7% |
Net income | | | | | $ | 40.6 | | $ | 26.2 | | $ | 14.4 | | 55.0% |
Effective tax rate | | | 25.0% | | | 31.8% | | | | | |
| | | | | | | | | | | | | | | | | | |
NM - Not meaningful. | | | | | | | | | | |
Revenues
Total revenue decreased mainly due to higher Net realized capital losses and lower Net investment income, partially offset by an increase in Fee income.
The increase in Net realized capital losses reflects higher realized losses on investments in fixed maturities and derivatives used to manage interest rate and equity risks associated with the Company’s annuity products. The losses on fixed maturities were primarily driven by rising interest rates and higher other-than-temporary impairments recognized during the first quarter of 2006. The increase in realized losses on derivatives is primarily driven by the changes in the fair value of Standard & Poor’s (“S&P”) 500 indexed futures (“S&P futures”) and options (“S&P options”) used to hedge risks associated with minimum guarantees on variable annuities and equity indexed annuities, respectively. The S&P futures owned by the Company are in a short position, which resulted in the decrease of value of these
22
securities with the increase of the S&P 500 Index during the first quarter of 2006. These losses were partially offset by gains on S&P options, which are in a long position. The total net losses on both S&P futures and options are largely offset by a related decrease in the amortization of DAC and VOBA and a reduction to the increase in reserves.
In addition, Net investment income decreased due to a decline in the Company’s investment portfolio, which mainly reflects the transfer of $2.5 billion of investments to Security Life of Denver Insurance Company (“Security Life”) during the second quarter of 2005 in conjunction with the coinsurance agreement. In addition, higher expenses on securities lending transactions were incurred during the first quarter of 2006, driven largely by rising short-term interest rates.
The increase in Fee income resulted from an increase in average separate account variable AUM, driven primarily by favorable equity market performance and increased sales of the Company’s variable annuity products during the first quarter of 2006.
Benefits and Expenses
Total benefits and expenses decreased mainly due to lower Amortization of DAC and VOBA. The decrease in the Amortization of DAC and VOBA is primarily due to lower current year gross profits, reflecting total net losses on both S&P futures and options, partially offset by higher fee income, as well as a reduction to the increase in reserves. In addition, the decrease in amortization reflects an increase in estimated future gross profits due to favorable equity market performance.
In addition, Interest credited and other benefits to contractowners decreased, due to (a) the transfer of $2.5 billion in account balances to Security Life in the second quarter of 2005 in conjunction with the coinsurance agreement, (b) a decrease in the cost of guaranteed benefits resulting from the favorable equity market conditions in the first quarter of 2006, and (c) a decrease in amortization of sales inducements. The decreases were partially offset by (a) an increase in interest credited on GICs, due to the growth of this block of business and the rising interest rate environment experienced in 2006, and (b) an increase in the reserves on equity indexed annuities attributable to the equity market growth.
Other benefits and expenses increased over first quarter of 2005 due to $7.2 in amortization of deferred negative ceding commission related to the coinsurance agreement with Security Life.
Income Taxes
The decrease in the effective tax rate is primarily due to an increase in the deduction allowed for dividends received relative to the increase in Income before income taxes.
23
Financial Condition
Investments
Investment Strategy
The Company’s investment strategy focuses on diversification by asset class. The Company seeks to achieve economic diversification while reducing overall credit risk and liquidity risks. In addition, the Company seeks to mitigate the impact of cash flow variability from embedded options within certain investment products, such as prepayment options and interest rate options embedded in collateralized mortgage obligations and call options embedded in corporate bonds. The investment management function is centralized under ING Investment Management LLC, an affiliate of the Company, pursuant to an investment advisory agreement. Separate portfolios are established for groups of products with similar liability characteristics within the Company.
For a discussion of the Company’s use of derivatives, see “Liquidity and Capital Resources – Derivatives.”
Portfolio Composition
The following table presents the investment portfolio at March 31, 2006 and December 31, 2005.
| | | | | | | | | | 2006 | | | 2005 |
| | | | | | | | | | Carrying Value | | % | | | Carrying Value | | % |
Fixed maturities available-for-sale, | | | | | | | | | |
| including securities pledged | $ | 17,263.2 | | 79.8% | | $ | 17,031.3 | | 79.4% |
Equity securities, available-for-sale | | 43.9 | | 0.2% | | | 29.7 | | 0.1% |
Mortgage loans on real estate | | 3,682.3 | | 17.0% | | | 3,766.8 | | 17.6% |
Real estate | | 2.2 | | 0.0% | | | 2.2 | | 0.0% |
Policy loans | | 163.3 | | 0.8% | | | 166.1 | | 0.8% |
Short-term investments | | 19.2 | | 0.1% | | | 55.9 | | 0.2% |
Other investments | | 463.8 | | 2.1% | | | 402.6 | | 1.9% |
Total investments | $ | 21,637.9 | | 100.0% | | $ | 21,454.6 | | 100.0% |
24
Fixed Maturities
Fixed maturities, available-for-sale, were as follows as of March 31, 2006.
| | | | | | | | | | | | | Gross | | | Gross | | | |
| | | | | | | | | | | | | Unrealized | | | Unrealized | | | |
| | | | | | | | | | Amortized | | | Capital | | | Capital | | | Fair |
| | | | | | | | | | Cost | | | Gains | | | Losses | | | Value |
Fixed maturities: | | | | | | | | | | | | | |
| U.S. government and government | | | | | | | | | | | |
| | agencies and authorities | $ | 504.2 | | $ | 0.2 | | $ | 8.4 | | $ | 496.0 |
| State, municipalities, and political | | | | | | | | | | | |
| | subdivisions | | | | 10.4 | | | - | | | 0.6 | | | 9.8 |
| | | | | | | | | | | | | | | | | | | |
| U.S. corporate securities: | | | | | | | | | | | |
| | Public utilities | | | 1,583.5 | | | 26.3 | | | 35.6 | | | 1,574.2 |
| | Other corporate securities | | 5,188.3 | | | 43.5 | | | 110.8 | | | 5,121.0 |
| Total U.S. corporate securities | | 6,771.8 | | | 69.8 | | | 146.4 | | | 6,695.2 |
| | | | | | | | | | | | | | | | | | | |
| Foreign securities(1): | | | | | | | | | | | |
| | Government | | | 451.6 | | | 13.2 | | | 8.5 | | | 456.3 |
| | Other | | | | | | 2,658.6 | | | 22.7 | | | 68.8 | | | 2,612.5 |
| Total foreign securities | | 3,110.2 | | | 35.9 | | | 77.3 | | | 3,068.8 |
| | | | | | | | | | | | | | | | | | | |
| Residential mortgage-backed securities | | 3,883.7 | | | 32.5 | | | 102.2 | | | 3,814.0 |
| Commercial mortgaged-backed securities | | 1,547.7 | | | 11.1 | | | 34.5 | | | 1,524.3 |
| Other asset-backed securities | | 1,666.7 | | | 4.7 | | | 16.3 | | | 1,655.1 |
| | | | | | | | | | | | | | | | | | | |
| Total fixed maturities, including fixed | | | | | | | | | | | |
| | maturities pledged | | 17,494.7 | | | 154.2 | | | 385.7 | | | 17,263.2 |
| Less: fixed maturities pledged | | 1,247.1 | | | 0.9 | | | 36.0 | | | 1,212.0 |
| | | | | | | | | | | | | | | | | | | |
Total fixed maturities | $ | 16,247.6 | | $ | 153.3 | | $ | 349.7 | | $ | 16,051.2 |
| | | | | | | | | | | | | | | | | | | |
(1) Primarily U.S. dollar denominated. | | | | | | | | | | | |
25
Fixed maturities, available-for-sale, were as follows as of December 31, 2005.
| | | | | | | | | | | | | Gross | | | Gross | | | |
| | | | | | | | | | | | | Unrealized | | | Unrealized | | | |
| | | | | | | | | | Amortized | | | Capital | | | Capital | | | Fair |
| | | | | | | | | | Cost | | | Gains | | | Losses | | | Value |
Fixed maturities: | | | | | | | | | | | | | |
| U.S. government and government | | | | | | | | | | | |
| | agencies and authorities | $ | 476.5 | | $ | 1.1 | | $ | 4.2 | | $ | 473.4 |
| State, municipalities, and political | | | | | | | | | | | |
| | subdivisions | | | | 20.1 | | | - | | | 0.7 | | | 19.4 |
| | | | | | | | | | | | | | | | | | | |
| U.S. corporate securities: | | | | | | | | | | | |
| | Public utilities | | | 1,579.2 | | | 39.7 | | | 19.4 | | | 1,599.5 |
| | Other corporate securities | | 5,077.9 | | | 86.4 | | | 63.5 | | | 5,100.8 |
| Total U.S. corporate securities | | 6,657.1 | | | 126.1 | | | 82.9 | | | 6,700.3 |
| | | | | | | | | | | | | | | | | | | |
| Foreign securities(1): | | | | | | | | | | | |
| | Government | | | 464.7 | | | 13.8 | | | 4.1 | | | 474.4 |
| | Other | | | | | | 2,447.6 | | | 33.3 | | | 38.5 | | | 2,442.4 |
| Total foreign securities | | 2,912.3 | | | 47.1 | | | 42.6 | | | 2,916.8 |
| | | | | | | | | | | | | | | | | | | |
| Residential mortgage-backed securities | | 3,938.1 | | | 35.6 | | | 70.7 | | | 3,903.0 |
| Commercial mortgaged-backed securities | | 1,309.8 | | | 17.0 | | | 19.5 | | | 1,307.3 |
| Other asset-backed securities | | 1,723.8 | | | 6.8 | | | 19.5 | | | 1,711.1 |
| | | | | | | | | | | | | | | | | | | |
| Total fixed maturities, including fixed | | | | | | | | | | | |
| | maturities pledged | | 17,037.7 | | | 233.7 | | | 240.1 | | | 17,031.3 |
| Less: fixed maturities pledged | | 952.1 | | | 1.0 | | | 14.2 | | | 938.9 |
| | | | | | | | | | | | | | | | | | | |
Total fixed maturities | $ | 16,085.6 | | $ | 232.7 | | $ | 225.9 | | $ | 16,092.4 |
| | | | | | | | | | | | | | | | | | | |
(1) Primarily U.S. dollar denominated. | | | | | | | | | | | |
It is management’s objective that the portfolio of fixed maturities be of high quality and be well diversified by market sector. The fixed maturities in the Company’s portfolio are generally rated by external rating agencies and, if not externally rated, are rated by the Company on a basis believed to be similar to that used by the rating agencies. The average quality rating of the Company's fixed maturities portfolio was A+ at March 31, 2006 and December 31, 2005. Ratings are calculated using a rating hierarchy that considers S&P, Moody’s Investor’s Service, Inc., and internal ratings.
26
Total fixed maturities by quality rating category, including fixed maturities pledged to creditors, were as follows at March 31, 2006 and December 31, 2005.
| | | | | | | | | | 2006 | | | 2005 |
| | | | | | | | | | Fair | | % of | | | Fair | | % of |
| | | | | | | | | | Value | | Total | | | Value | | Total |
AAA | $ | 6,585.7 | | 38.2% | | $ | 6,556.9 | | 38.5% |
AA | | 1,146.7 | | 6.6% | | | 1,117.2 | | 6.6% |
A | | 3,630.5 | | 21.0% | | | 3,470.5 | | 20.4% |
BBB | | 5,322.2 | | 30.8% | | | 5,351.0 | | 31.4% |
BB | | 495.2 | | 2.9% | | | 459.6 | | 2.7% |
B and below | | 82.9 | | 0.5% | | | 76.1 | | 0.4% |
Total | | | | | | | $ | 17,263.2 | | 100.0% | | $ | 17,031.3 | | 100.0% |
96.6% and 96.9% of fixed maturities were invested in securities rated BBB and above (Investment Grade) at March 31, 2006 and December 31, 2005, respectively.
Fixed maturities rated BB and below (Below Investment Grade) may have speculative characteristics, and changes in economic conditions or other circumstances are more likely to lead to a weakened capacity of the issuer to make principal and interest payments than is the case with higher rated fixed maturities.
Total fixed maturities by market sector, including fixed maturities pledged to creditors, were as follows at March 31, 2006 and December 31, 2005.
| | | | | | | | | | 2006 | | | 2005 |
| | | | | | | | | | Fair | | % of | | | Fair | | % of |
| | | | | | | | | | Value | | Total | | | Value | | Total |
U.S. corporate, states, and municipalities | $ | 6,705.0 | | 38.8% | | $ | 6,719.7 | | 39.5% |
Residential mortgage-backed | | 3,814.0 | | 22.1% | | | 3,903.0 | | 22.9% |
Foreign | | 3,068.8 | | 17.8% | | | 2,916.8 | | 17.1% |
Other asset-backed | | 1,655.1 | | 9.6% | | | 1,711.1 | | 10.0% |
Commercial mortgage-backed | | 1,524.3 | | 8.8% | | | 1,307.3 | | 7.7% |
U.S. Treasuries/Agencies | | 496.0 | | 2.9% | | | 473.4 | | 2.8% |
Total | | | | | | | $ | 17,263.2 | | 100.0% | | $ | 17,031.3 | | 100.0% |
The Company did not have any investments in a single issuer, other than obligations of the U.S. government, with a carrying value in excess of 10% of the Company’s shareholder’s equity at March 31, 2006 and December 31, 2005.
27
Mortgage Loans
Mortgage loans, primarily commercial mortgage loans, totaled $3,682.3 and $3,766.8 at March 31, 2006 and December 31, 2005, respectively. These loans are reported at amortized cost, less impairment write-downs. If the value of any mortgage loan is determined to be impaired (i.e., when it is probable that the Company will be unable to collect on all amounts due according to the contractual terms of the loan agreement), the carrying value of the mortgage loan is reduced to either the present value of expected cash flows from the loan, discounted at the loan’s effective interest rate, or fair value of the collateral. If the loan is in foreclosure, the carrying value is reduced to the fair value of the underlying collateral, net of estimated costs to obtain and sell. The carrying value of the impaired loans is reduced by establishing a permanent write-down charged to realized loss. At March 31, 2006 and December 31, 2005, the Company had no allowance for mortgage loan credit losses. The properties collateralizing mortgage loans are geographically dispersed throughout the United States, with the largest concentration of 20.2% and 19.5% of properties in California at March 31, 2006 and December 31, 2005, respectively.
Unrealized Capital Losses
Fixed maturities, including securities pledged to creditors, comprise 79.8% and 79.4% of the Company’s total investment portfolio at March 31, 2006 and December 31, 2005, respectively. Unrealized capital losses related to fixed maturities are analyzed in detail in the following tables.
Unrealized capital losses in fixed maturities, including securities pledged to creditors, for Investment Grade (“IG”) and Below Investment Grade (“BIG”) securities by duration were as follows at March 31, 2006 and December 31, 2005.
| | | | | | | | | 2006 | | | 2005 |
| | | | | | | | | | | % of IG | | | | | % of IG | | | | | % of IG | | | | | % of IG |
| | | | | | | | | IG | | and BIG | | | BIG | | and BIG | | | IG | | and BIG | | BIG | | and BIG |
Less than six months | | | | | | | | | | | | | | | | | | | |
| below amortized cost | $ | 91.7 | | 23.9% | | | 1.5 | | 0.4% | | $ | 95.0 | | 39.6% | | $ | 1.8 | | 0.7% |
More than six months | | | | | | | | | | | | | | | | | | | |
| and less than twelve | | | | | | | | | | | | | | | | | | | |
| months below | | | | | | | | | | | | | | | | | | | | |
| amortized cost | | 192.6 | | 49.9% | | | 2.5 | | 0.6% | | | 59.6 | | 24.8% | | | 2.7 | | 1.1% |
More than twelve months | | | | | | | | | | | | | | | | | | | |
| below amortized cost | | 95.0 | | 24.6% | | | 2.4 | | 0.6% | | | 80.1 | | 33.4% | | | 0.9 | | 0.4% |
Total unrealized capital loss | $ | 379.3 | | 98.4% | | $ | 6.4 | | 1.6% | | $ | 234.7 | | 97.8% | | $ | 5.4 | | 2.2% |
28
Unrealized capital losses in fixed maturities at March 31, 2006 and December 31, 2005, were primarily related to interest rate movement or spread widening and to mortgage and other asset-backed securities. Mortgage and other asset-backed securities include U.S. government backed securities, principal protected securities, and structured securities, which did not have an adverse change in cash flows. The following table summarizes the unrealized capital losses by duration and reason, along with the fair value of fixed maturities, including securities pledged to creditors, in unrealized loss positions at March 31, 2006 and December 31, 2005.
| | | | | | | | | | | | More than | | | | | | |
| | | | | | | | | Less than | | | Six Months | | | More than | | | |
| | | | | | | | | Six Months | | | and less than | | | Twelve Months | | | |
| | | | | | | | | Below | | | Twelve Months | | | Below | | | |
| | | | | | | | | Amortized | | | Below | | | Amortized | | | |
2006 | | | | | | | Cost | | | Amortized Cost | | | Cost | | | Total |
Interest rate or spread widening | $ | 56.3 | | $ | 109.8 | | $ | 66.6 | | $ | 232.7 |
Mortgage and other asset-backed | | | | | | | | | | | |
| securities | | | | | 36.9 | | | 85.3 | | | 30.8 | | | 153.0 |
Total unrealized capital loss | $ | 93.2 | | $ | 195.1 | | $ | 97.4 | | $ | 385.7 |
Fair value | | | | $ | 5,215.2 | | $ | 5,085.5 | | $ | 2,092.8 | | $ | 12,393.5 |
| | | | | | | | | | | | | | | | | | |
2005 | | | | | | | | | | | | | | | | |
Interest rate or spread widening | $ | 49.1 | | $ | 32.6 | | $ | 48.7 | | $ | 130.4 |
Mortgage and other asset-backed | | | | | | | | | | | |
| securities | | | | | 47.7 | | | 29.7 | | | 32.3 | | | 109.7 |
Total unrealized capital loss | $ | 96.8 | | $ | 62.3 | | $ | 81.0 | | $ | 240.1 |
Fair value | | | | $ | 5,757.0 | | $ | 2,266.6 | | $ | 2,243.0 | | $ | 10,266.6 |
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Unrealized capital losses in fixed maturities, including securities pledged to creditors, by market sector and duration were as follows at March 31, 2006 and December 31, 2005.
| | | | | | | | | | | | More than | | | | | | |
| | | | | | | | | Less than | | | Six Months | | | More than | | | |
| | | | | | | | | Six Months | | | and less than | | | Twelve Months | | | Total |
| | | | | | | | | Below | | | Twelve Months | | | Below | | | Unrealized |
| | | | | | | | | Amortized | | | Below | | | Amortized | | | Capital |
2006 | | | | | | | Cost | | | Amortized Cost | | | Cost | | | Loss |
U.S. Treasuries/Agencies | $ | 3.9 | | $ | 3.1 | | $ | 1.4 | | $ | 8.4 |
U.S. corporate, state, and | | | | | | | | | | | |
| municipalities | | | 36.1 | | | 71.4 | | | 39.5 | | | 147.0 |
Foreign | | | | | | 16.3 | | | 35.3 | | | 25.7 | | | 77.3 |
Residential mortgage-backed | | 25.8 | | | 56.3 | | | 20.1 | | | 102.2 |
Commercial mortgage-backed | | 6.6 | | | 20.7 | | | 7.2 | | | 34.5 |
Other asset-backed | | 4.5 | | | 8.3 | | | 3.5 | | | 16.3 |
Total | | | | | | $ | 93.2 | | $ | 195.1 | | $ | 97.4 | | $ | 385.7 |
| | | | | | | | | | | | | | | | | | |
2005 | | | | | | | | | | | | | | | | |
U.S. Treasuries/Agencies | $ | 2.6 | | $ | 0.3 | | $ | 1.3 | | $ | 4.2 |
U.S. corporate, state, and | | | | | | | | | | | |
| municipalities | | | 30.6 | | | 22.4 | | | 30.6 | | | 83.6 |
Foreign | | | | | | 15.9 | | | 9.9 | | | 16.8 | | | 42.6 |
Residential mortgage-backed | | 32.0 | | | 23.8 | | | 14.9 | | | 70.7 |
Commercial mortgage-backed | | 10.0 | | | 3.4 | | | 6.1 | | | 19.5 |
Other asset-backed | | 5.7 | | | 2.5 | | | 11.3 | | | 19.5 |
Total | | | | | | $ | 96.8 | | $ | 62.3 | | $ | 81.0 | | $ | 240.1 |
Of the unrealized capital losses aged more than twelve months, the average market value of the related fixed maturities is 95.6% of the average book value as of March 31, 2006. In addition, this category includes 440 securities, which have an average quality rating of A+. No other-than-temporary impairment loss was considered necessary for these fixed maturities as of March 31, 2006.
Overall, there has been an increase in unrealized capital losses from December 31, 2005 to March 31, 2006. This increase is largely caused by an increase in prevailing market interest rates, which tends to have a negative market value impact on fixed maturities.
Other-Than-Temporary Impairments
The Company analyzes the general account investments to determine whether there has been an other-than-temporary decline in fair value below the amortized cost basis. Management considers the length of time and the extent to which the fair value has been less than amortized cost, the issuer’s financial condition and near-term prospects, future economic conditions and market forecasts, interest rate changes, and the Company’s intent to retain the investment for a period of time sufficient to allow for recovery in fair value. If it is probable that all amounts due
30
according to the contractual terms of an investment will not be collected, an other-than-temporary impairment is considered to have occurred.
In addition, the Company invests in asset-backed securities. Determination of the required impairment is based on the analysis discussed in the preceding paragraph, as well as credit risk and the possibility of significant prepayment risk that restricts the Company’s ability to recover the investment. An impairment is recognized if the fair value of the security is less than book value and there has been an adverse change in cash flow since the last remeasurement date.
When a decline in fair value is determined to be other-than-temporary, the individual security is written down to fair value, and the loss is recorded in Net realized capital gains (losses).
The following table identifies the Company’s other-than-temporary impairments by type for the three months ended March 31, 2006 and 2005.
| | Three Months Ended March 31, |
| | 2006 | | | 2005 |
| | | | No. of | | | | | No. of |
| | Impairment | | Securities | | | Impairment | | Securities |
U.S. Treasury/Agencies | $ | 0.1 | | 1 | | $ | - | | - |
U.S. corporate | | 5.8 | | 12 | | | - | | - |
Foreign | | 1.3 | | 3 | | | - | | - |
Residential mortgage-backed | | 4.9 | | 33 | | | 10.3 | | 67 |
Other asset-backed | | 1.1 | | 2 | | | 0.4 | | 1 |
Limited partnerships | | 0.3 | | 1 | | | - | | - |
Total | $ | 13.5 | | 52 | | $ | 10.7 | | 68 |
The above schedule for the three months ended March 31, 2006 includes $5.2 in other-than-temporary write-downs related to the analysis of credit risk and the possibility of significant prepayment risk. The remaining $8.3 in write-downs for the three months ended March 31, 2006 relates to investments that the Company does not have the intent to retain for a period of time sufficient to allow for recovery in fair value, based upon the requirements of Financial Accounting Standards Board (“FASB”) Staff Position (“FSP”) Statement of Financial Accounting Standards (“FAS”) No. 115-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” The following table summarizes these write-downs by type for the three months ended March 31, 2006.
| | | | 2006 |
| | | | | | | No. of |
| | | | Impairment | | | Securities |
U.S. Treasury/Agencies | | $ | 0.1 | | | 1 |
U.S. corporate | | | 5.8 | | | 12 |
Foreign | | | 1.3 | | | 3 |
Other asset-backed | | | 1.1 | | | 2 |
Total | | $ | 8.3 | | $ | 18 |
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The Company may sell securities during the period in which fair value has declined below amortized cost for fixed maturities or cost for equity securities. In certain situations new factors, such as negative developments and subsequent credit deterioration, can subsequently change the Company’s previous intent to continue holding a security.
Net Realized Capital Gains (Losses)
Net realized capital gains (losses) are comprised of the difference between the carrying value of investments and proceeds from sale, maturity, and redemption, as well as losses incurred due to the other-than-temporary impairment of investments and changes in fair value of derivatives. Net realized capital gains (losses) on investments were as follows for the three months ended March 31, 2006 and 2005.
| | | | | | | | | | 2006 | | | 2005 |
Fixed maturities, available-for-sale | $ | (26.4) | | $ | (4.9) |
Equity securities, available-for-sale | | - | | | 0.1 |
Derivatives | | | | | (49.5) | | | 9.3 |
Other | | | | | | | | 0.9 | | | 0.4 |
Net realized capital (losses) gains | $ | (75.0) | | $ | 4.9 |
After-tax net realized capital (losses) gains | $ | (48.8) | | $ | 3.2 |
The increase in realized losses on derivatives is primarily driven by the changes in the fair value of S&P 500 indexed futures (“S&P futures”) and options (“S&P options”) used to hedge risks associated with minimum guarantees on variable annuities and equity indexed annuities, respectively. The S&P futures owned by the Company are in a short position, which resulted in the decrease of value of these securities with the increase of the S&P 500 Index during the first quarter of 2006. These losses were partially offset by gains on the S&P options, which are in a long position.
Income Taxes
An $80.7 valuation allowance was established as of March 31, 2006 related to unrealized capital losses on investments and is included in Accumulated other comprehensive income (loss). The Company had no valuation allowance as of December 31, 2005.
Liquidity and Capital Resources
Liquidity is the ability of the Company to generate sufficient cash flows to meet the cash requirements of operating, investing, and financing activities.
Sources and Uses of Liquidity
The Company’s principal sources of liquidity are annuity product charges, GIC deposits, investment income, proceeds from the maturity and sale of investments, proceeds from debt issuance, and capital contributions. Primary uses of these funds are payments of commissions and operating expenses, interest and premium credits,
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payments under guaranteed death and living benefits, investment purchases, repayment of debt, and contract maturities, withdrawals, and surrenders.
The Company’s liquidity position is managed by maintaining adequate levels of liquid assets, such as cash, cash equivalents, and short-term investments. Asset/liability management is integrated into many aspects of the Company’s operations, including investment decisions, product development, and determination of crediting rates. As part of the risk management process, different economic scenarios are modeled, including cash flow testing required for insurance regulatory purposes, to determine that existing assets are adequate to meet projected liability cash flows. Key variables in the modeling process include interest rates, anticipated contractowner behavior, and variable separate account performance. Contractowners bear the investment risk related to variable annuity products, subject to certain minimum guaranteed death and living benefits included in these contracts.
The fixed account liabilities are supported by a general account portfolio, principally composed of fixed rate investments with matching duration characteristics that can generate predictable, steady rates of return. The portfolio management strategy for the fixed account considers the assets available-for-sale. This strategy enables the Company to respond to changes in market interest rates, prepayment risk, relative values of asset sectors and individual securities and loans, credit quality outlook, and other relevant factors. The objective of portfolio management is to maximize returns, taking into account interest rate and credit risk, as well as other risks. The Company’s asset/liability management discipline includes strategies to minimize exposure to loss as interest rates and economic and market conditions change.
Liquidity and Capital Resources
Additional sources of liquidity include borrowing facilities to meet short-term cash requirements that arise in the ordinary course of business. The Company maintains the following agreements:
• | A reciprocal loan agreement with ING America Insurance Holdings, Inc. (“ING AIH”), an affiliate, whereby either party can borrow from the other up to 3% of the Company’s statutory admitted assets as of the prior December 31. The Company had $12.2 and $45.0 receivable from ING AIH under the reciprocal loan agreement as of March 31, 2006 and December 31, 2005, respectively. |
• | A $100.0 uncommitted, perpetual revolving note facility with the Bank of New York. At March 31, 2006 and December 31, 2005, the Company had no amounts outstanding under the revolving note facility. |
• | A $75.0 uncommitted line-of-credit agreement with PNC Bank, effective December 19, 2005. Borrowings are guaranteed by ING AIH, with maximum aggregate borrowings outstanding at anytime to ING AIH and its affiliates of $75.0. As of March 31, 2006 and December 31, 2005, the Company had no amounts outstanding under the line-of-credit agreement. |
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Management believes that these sources of liquidity are adequate to meet the Company’s short-term cash obligations.
The Company is a member of the Federal Home Loan Bank of Des Moines (“FHLB”) and is required to maintain a collateral deposit that backs funding agreements issued to the FHLB. At March 31, 2006 and December 31, 2005, the Company had $276.3 and $126.1, respectively, in non-putable funding agreements, including accrued interest, issued to FHLB. At March 31, 2006 and December 31, 2005, assets with a carrying value of approximately $437.7 and $159.4, respectively, collateralized the funding agreements issued to the FHLB. Assets pledged to the FHLB are included in Fixed maturities, available-for-sale, in the Condensed Balance Sheets.
Capital Contributions and Dividends
During the three months ended March 31, 2006 and 2005, the Company did not receive any capital contributions from its parent.
During the three months ended March 31, 2006 and 2005, the Company did not pay any dividends on its common stock to its parent.
Minimum Guarantees
Variable annuity contracts containing guaranteed death and living benefits expose the Company to equity risk. An increase in the value of the equity markets may increase account values for these contracts, thereby decreasing the Company’s risk associated with guaranteed death and living benefits. A decrease in the equity markets may cause a decrease in the account values, thereby increasing the possibility that the Company may be required to pay amounts to customers due to guaranteed and living benefits.
The Company sells variable annuity contracts that offer one or more of the following guaranteed death benefits and living benefits:
Guaranteed Minimum Death Benefits: The Company has offered the following guaranteed death benefits:
• | Standard – Guarantees that, upon the death of the annuitant, the death benefit will be no less than the premiums paid by the contractowner, net of any contract withdrawals. |
• | Ratchet – Guarantees that, upon the death of the annuitant, the death benefit will be no less than the greater of (1) Standard or (2) the maximum contract anniversary (or quarterly) value of the variable annuity adjusted for contract withdrawals. |
• | Rollup (7% or 5.5% Solution) – Guarantees that, upon the death of the annuitant, the death benefit will be no less than the aggregate premiums paid by the contractowner accruing interest at 7% or 5.5% per annum adjusted for contract withdrawals, subject to a maximum cap on the rolled up amount. (The Company has discontinued this option for new sales.) |
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• | Combo (Max 7) – Guarantees that, upon the death of the annuitant, the death benefit will be no less than the greater of (1) Ratchet or (2) Rollup. |
At March 31, 2006, the guaranteed value of these death benefits in excess of account values was estimated to be $2.4 billion before reinsurance, which was a $133.4 decrease from the estimated $2.5 billion at December 31, 2005. The decrease is attributable to the favorable equity market returns. For contracts issued prior to January 1, 2000, most contracts with enhanced death benefit guarantees were reinsured to third party reinsurers to mitigate the risk produced by such guaranteed death benefits. For contracts issued after December 31, 1999, the Company has instituted an equity hedging program in lieu of reinsurance. The equity hedging program is based on the Company entering into derivative positions to offset exposures to guaranteed minimum death benefits due to adverse changes in the equity markets. At March 31, 2006, the guaranteed value of minimum guaranteed death benefits in excess of account values, net of reinsurance, was estimated to be $1.4 billion, of which $488.6 is projected to be covered by the Company’s equity hedging program. At December 31, 2005, the guaranteed value of minimum guaranteed death benefits in excess of account value, net of reinsurance was estimated to be $1.4 billion, of which $591.6 was projected to be covered by the Company’s equity hedging program. As of March 31, 2006, the Company recorded a liability of $115.4, net of reinsurance, representing the estimated net present value of the Company’s future obligation for guaranteed minimum death benefits in excess of account values. The liability increased $2.6 from $112.8 at December 31, 2005, mainly due to higher fees used to fund the reserve during 2006. The increase in liability was partially offset by the decrease of the present value of the Company's future obligations resulting from the favorable equity market returns.
Guaranteed Living Benefits: The Company offers the following guaranteed living benefits:
• | Guaranteed Minimum Income Benefit - Guarantees a minimum income payout, exercisable each contract anniversary on or after the 10th rider anniversary. This type of living benefit is the predominant selection in the Company’s sales of variable annuities. |
• | Guaranteed Minimum Withdrawal Benefit - Guarantees that annual withdrawals of up to 7% of eligible premiums may be made until eligible premiums previously paid by the contractowner are returned, regardless of account value performance. The benefit has some reset and step-up features that may increase the guaranteed withdrawal amount in certain conditions. In addition, in 2005 the Company introduced a life-time withdrawal benefit option. |
• | Guaranteed Minimum Accumulation Benefit - Guarantees that the account value will be at least 100% of the premiums paid by the contractowner after 10 years (GMAB10). An alternative design guarantees that the account value will be at least 200% of premiums paid by contractowners after 20 years (GMAB 20). |
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At March 31, 2006, the guaranteed value of these living benefits in excess of account values was estimated to be $240.1, which is a decrease of $48.3 from an estimated $288.4 at December 31, 2005. The decrease was primarily driven by the favorable equity market returns and partially offset by the increase in liability due to higher in force contracts. All living benefits are covered by the Company’s equity hedging program. The Company does not seek hedge accounting treatment. As of March 31, 2006, the Company recorded a liability of $71.2 representing the estimated net present value of its future obligation for living benefits in excess of account values. The liability increased $0.9 from $70.3 at December 31, 2005, mainly due to the increase in fees used to fund the reserve during 2006. The increase in liability was partially offset by the decrease of present value of the Company's future obligations resulting from the favorable equity market returns.
Off-Balance Sheet Arrangements
In the third quarter of 2005, the Company purchased a 3-year credit-linked note arrangement, whereby the Company agreed to reimburse the guaranteed party upon payment default of the referenced obligation. Upon such default, the Company reimburses the guaranteed party for the loss under the reference obligation, and the Company receives that reference obligation in settlement. The Company can then recover any losses under the agreement by sale or collection of the received reference obligation. As of March 31, 2006, the maximum potential future exposure to the Company under the guarantee was $12.0.
Recently Adopted Accounting Standards
(See the Recently Adopted and New Accounting Standards footnotes to the condensed financial statements.)
Legislative Initiatives
Legislative proposals which have been or are being considered by Congress include repealing the estate tax, reducing the taxation on annuity benefits, expanding private pension plan incentives, changing the tax treatment of insurance products relative to other financial products, and changing life insurance company taxation. Some of these proposals, if enacted, could have a material adverse effect on life insurance, annuity, and other retirement savings product sales, while others could have a material beneficial effect. Certain recommendations made in late 2005 by the President’s Tax Advisory Panel on Federal Tax Reform could adversely affect the market for some life insurance and annuity products if enacted by Congress. However, there are no indications at the present time that Congress will enact fundamental tax reforms in 2006, or that it has a favorable view of the Tax Panel’s recommendations regarding tax preferred savings.
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Item 4. | Controls and Procedures |
a) | The Company carried out an evaluation, under the supervision and with the participation of its management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that the Company’s current disclosure controls and procedures are effective in ensuring that material information relating to the Company required to be disclosed in the Company’s periodic SEC filings is made known to them in a timely manner. |
b) | There has not been any change in the internal controls over financial reporting of the Company that occurred during the period covered by this report that has materially affected or is reasonably likely to materially affect these internal controls. |
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PART II. | OTHER INFORMATION |
The Company is involved in threatened or pending lawsuits/arbitrations arising from the normal conduct of business. Due to the climate in insurance and business litigation/arbitrations, suits against the Company sometimes include claims for substantial compensatory, consequential, or punitive damages, and other types of relief. Moreover, certain claims are asserted as class actions, purporting to represent a group of similarly situated individuals. While it is not possible to forecast the outcome of such lawsuits/arbitrations, in light of existing insurance, reinsurance, and established reserves, it is the opinion of management that the disposition of such lawsuits/arbitrations will not have a materially adverse effect on the Company’s operations or financial position.
As with many financial services companies, the Company and its affiliates have received informal and formal requests for information from various state and federal governmental agencies and self-regulatory organizations in connection with inquiries and investigations of the products and practices of the financial services industry. In each case, the Company and its affiliates have been and are providing full cooperation. Reference is made to the “Other Regulatory Matters” section of “Management’s Narrative Analysis of the Results of Operations and Financial Condition” included in the Company’s 2005 Annual Report on Form 10-K, filed March 30, 2006 (SEC File No. 333-123457).
In addition to the normal risks of business, the Company is subject to significant risks and uncertainties, including those which are described below.
Equity market volatility could negatively impact profitability and financial condition
The decline of the equity markets over an extended period of time may reduce the profitability and negatively affect the financial condition of the Company due to the following:
• | Sales of new contracts and profitability of in force annuity products that provide returns based on equities or equity indices may decrease, which results in a decrease in fees and profits earned on the accounts. The amount of fees the Company earns on variable annuity products is based on such account values. |
• | The Company’s exposure under certain guarantees related to the equity markets may increase due to equity markets decline. As a result, the Company may need to increase reserves through a charge to earnings while at the same time receiving lower fees from such products. |
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• | The Company tries to minimize its exposure to these guarantees by using reinsurance and other risk management strategies, including a hedging program. If the Company is not successful in minimizing these risks, the Company’s future profitability may be negatively impacted. |
• | If the Company’s expectations of future performance and profits decrease, it may be required to accelerate the amortization of deferred policy acquisition costs, decreasing profits. |
Efforts to reduce the impact of interest rate changes on profitability and financial condition may not be effective
Changes in interest rates may negatively affect the Company’s attempts to maintain profitable spreads between the amounts earned on its general account investments and the amounts paid under its annuity and insurance contracts.
As interest rates rise, fixed annuity contract surrenders and withdrawals may increase as contractowners seek higher returns. To raise the cash necessary to fund such surrenders and withdrawals, the Company may need to sell assets at capital losses. An increase in contract surrenders and withdrawals may also require the Company to accelerate amortization of deferred policy acquisition costs relating to such contracts, further reducing profits.
As interest rates decline, borrowers may prepay or redeem mortgages and bonds with embedded call options that are owned as investments by the Company. This may force the Company to reinvest the proceeds at lower interest rates. In addition, many of the Company’s annuity products contain minimum interest rate guarantees that limit the Company’s ability to lower interest rates credited to contractowners in response to lower investment returns. A decrease in the difference between earned investment income and the interest credited to contractowners further reduces profits. This decrease in profits may also require the Company to accelerate amortization of deferred policy acquisition costs.
The Company’s investment portfolio is subject to risks that may reduce the value of invested assets and adversely affect sales, profitability, and investment returns credited to contractowners
The Company’s investment portfolio is subject to several risks, including the following:
• | An increase in defaults or delinquency in investment portfolios, including derivative contracts; |
• | Greater difficulty selling privately placed and certain asset-backed fixed maturity securities and commercial mortgage loans at attractive prices and in a timely manner, as both are less liquid than publicly traded fixed maturity securities; |
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• | Borrower prepayment or redemption, prior to maturity, of mortgages that back mortgage-backed securities and bonds with embedded call options could force the Company to reinvest proceeds at lower interest rates; |
• | An increase in environmental liability exposure from the Company’s commercial mortgage loan portfolio; and |
• | Losses in the commercial mortgage loan portfolio as a result of economic downturns or natural disasters. |
The occurrence of natural or man-made disasters may adversely affect the Company’s results of operations and financial condition
The Company is exposed to various risks arising from natural disasters, including hurricanes, floods, earthquakes, tornadoes, and pandemic disease, caused by a virus such as H5N1 (the “Avian flu” virus), as well as man-made disasters, including acts of terrorism and military actions, which may adversely affect results of operations and financial condition, as follows:
• | Losses in the Company’s investment portfolio due to significant volatility in global financial markets or the failure of counterparties to perform. |
• | Changes in the rate of lapses and surrenders of existing policies/contracts, as well as sales of new policies/contracts. |
• | Reduced collectibility of reinsurance. | |
• | Disruption of the Company’s normal business operations due to catastrophic property damage, loss of life, or disruption of public and private infrastructure, including communications and financial services. |
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While the Company has a business continuation and crisis management plan, there can be no assurance that the Company’s plan and insurance coverages would be effective in mitigating any negative effects on operations or profitability in the event of a disaster.
Changes in underwriting and actual experience could materially affect profitability
The Company prices its products based on long-term assumptions regarding investment returns, mortality, morbidity, persistency, and operating costs. Management establishes target returns for each product based upon these factors and the average amount of regulatory and rating agency capital that the Company must hold to support in-force contracts. The Company monitors and manages pricing and sales mix to achieve target returns. Profitability from a new business emerges over a period of years, depending on the nature and life of the product, and is subject to variability, either positive or negative, as actual results may differ from pricing assumptions.
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The Company’s profitability depends on the following:
• | Adequacy of investment margins; | |
• | Management of market and credit risks associated with investments; | |
• | Ability to maintain premiums and contract charges at a level adequate to cover mortality and morbidity benefits and contract administration expenses; |
• | Adequacy of contract charges on variable contracts to cover the cost of product features; |
• | Persistency of policies to ensure recovery of acquisition expenses; and | |
• | Management of operating costs and expenses within anticipated pricing allowances. |
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Changes in reserve estimates may reduce profitability
The Company establishes reserves based upon estimates of how much the Company will pay for future benefits and claims. The Company calculates reserve based on many assumptions and estimates including future investment yields, mortality, morbidity, policy terminations, and expenses. The assumptions and estimates used in connection with the reserve estimation process are inherently uncertain. The Company periodically reviews the adequacy of reserves. However, the Company cannot determine with precision the amounts that the Company will pay for, or the timing of payment of, actual benefits and claims or whether the assets supporting the policy liabilities will grow to the level assumed prior to payment of benefits or claims. If actual experience differs significantly from assumptions or estimates, reserves may not be adequate. As a result, the Company would incur a charge to earnings in the quarter in which the reserves are increased.
A downgrade in the Company’s ratings may negatively affect profitability and financial condition
Ratings are an important factor in establishing the competitive position of insurance companies. A downgrade, or the potential for a downgrade, of any of the Company’s ratings may lead to lower fee income as follows:
• | Increase in contract surrenders and withdrawals; | |
• | Termination of relationships with broker-dealers, banks, agents, wholesalers, and other distributors of products and services; and |
• | Reduction of new annuity contract and guaranteed investment contract and funding agreement sales. |
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The Company cannot predict what actions rating organizations may take, or what actions it may be required to take in response to the actions of rating organizations, which could adversely affect the Company. Rating organizations assign ratings based upon several factors, including the following:
• | Statutory capital; | |
• | Risk of investment portfolio; | |
• | Economic trends affecting the financial services industry; | |
• | Changes in models and formulas used by rating organizations to assess the financial strength of a rated company; |
• | Enterprise risk management; and | |
• | Other circumstances outside the rated company’s control. | |
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The continued availability of capital may affect the ability to grow
The Company has, from time to time, required capital to increase its reserves associated with growth from product sales. Although the Company believes it has sufficient capital to fund its immediate growth and capital needs, the amount of capital required and available can vary due to a variety of circumstances that may not be predictable, foreseeable, or within its control. A lack of sufficient capital could hinder the Company’s ability to grow.
A loss of key product distribution relationships could materially affect sales
The Company distributes certain products under agreements with other members of the financial services industry that are not affiliated with the Company. Termination of one or more of these agreements due to, for example, a change in control of one of the distributors, could reduce sales.
Competition could negatively affect the ability to maintain or increase profitability
The insurance industry is intensely competitive. The Company competes based on factors including the following:
• | Name recognition and reputation; | |
• | Service; | |
• | Investment performance; | |
• | Product features; |
• | Price; | |
• | Perceived financial strength; and | |
• | Claims paying and credit ratings | |
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The Company’s competitors include insurers, broker-dealers, financial advisors, asset managers, and other financial institutions, which may, for example, have greater market share, offer a broader range of products, or have higher claims-paying or credit ratings than the Company.
In recent years, there has been substantial consolidation among companies in the financial services industry resulting in increased competition from large, well-capitalized financial services firms. Many of these firms also have been able to increase their distribution systems through mergers or contractual arrangements. Furthermore, larger competitors may lower operating costs and have an ability to absorb greater risk, while maintaining financial strength ratings, allowing them to price products more competitively. The Company expects consolidation to continue and perhaps accelerate in the future, increasing competitive pressure.
Changes in federal income tax law could make some products less attractive to contractowners and increase tax costs
The Economic Growth and Tax Relief Reconciliation Act of 2001 and the Jobs and Growth Tax Relief Reconciliation Act of 2003 contain provisions that will, over time, significantly lower individual tax rates. This decrease will reduce the benefits of deferral on the build-up of value of annuities. Many of these provisions expire in 2008 and 2010. The Bush Administration, however, has proposed that many of the rate reductions and tax-favored savings initiatives be made permanent. Although the Company cannot predict the overall effect on product sales, some of these tax law changes could hinder sales and result in the increased surrender of annuity contracts.
Litigation may adversely affect profitability and financial condition
The Company is, and may be in the future, subject to legal actions in the ordinary course of insurance, investment management and other business operations. These legal actions may include proceedings relating to aspects of businesses and operations that are specific to the Company, and proceedings that are typical of the businesses in which the Company operates. Some of these proceedings may be brought on behalf of a class. Plaintiffs may seek large or indeterminate amounts of damage, including compensatory, liquidated, treble and/or punitive damages. Given the large or indeterminate amounts sometimes sought, and the inherent unpredictability of litigation, it is possible that an adverse outcome could, from time to time, have an adverse effect on the Company’s results of operation or cash flows in particular quarterly or annual periods.
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Changes in regulation in the United States and recent regulatory investigations may reduce profitability
The Company’s insurance and securities business is subject to comprehensive state and federal regulation and supervision throughout the United States. The primary purpose of state regulation is to protect contractowners, and not necessarily to protect creditors and investors. State insurance regulators, state attorneys general, the National Association of Insurance Commissioners, the Securities and Exchange Commission, and the National Association of Securities Dealers, Inc. continually reexamine existing laws and regulations and may impose changes in the future. Changes in legislation and administrative policies in areas such as employee benefit plan regulation, financial services regulation, and federal taxation, could lessen the competitive advantages of certain of the Company’s products, result in the surrender of existing contracts and policies, increase costs, or reduce new product sales, thus reducing the Company’s profitability.
Since 2002, the insurance industry has become the focus of increased regulatory scrutiny as various state and federal governmental agencies and self-regulatory organizations conduct inquiries and investigations into the products and practices of the financial services industries. These initiatives currently focus on areas such as, inappropriate trading of fund shares; revenue sharing and directed brokerage; sales and marketing practices; suitability; arrangements with service providers; pricing; compensation and sales incentives; potential conflicts of interest; potential anti-competitive activity; reinsurance; specific product types (including group annuities and indexed annuities); and adequacy of disclosure. It is likely that the scope of these industry investigations will become broader before they conclude.
In some cases, this regulatory scrutiny has led to new proposed legislation and regulation that could significantly affect the financial services industry, including businesses in which the Company is engaged, or has resulted in regulatory penalties, and litigation. At this time, the Company does not believe that any of this regulatory scrutiny will have a material adverse affect on it. However, the Company cannot guarantee that new laws, regulations and other regulatory action aimed at the business practices under scrutiny would not adversely affect its business. The adoption of new laws and regulations, enforcement action, or litigation, whether or not involving the Company, could influence the manner in which the Company distributes its products and adversely impact profitability.
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Changes in accounting standards issued by the Financial Accounting Standards Board or other standard-setting bodies may adversely affect profitability and financial condition
The Company’s financial statements are subject to the application of generally accepted accounting principles, or GAAP, which is periodically revised and/or expanded. Accordingly, the Company is required to adopt new or revised accounting standards issued by recognized authoritative bodies, including the Financial Accounting Standards Board. The adoption of new or revised accounting standards could change the Company’s current accounting treatment and have a material adverse effect on the timing and/or amount of its reported profitability and financial condition.
Reinsurance subjects the Company to the credit risk of reinsurers and may not be adequate to protect against losses arising from ceded reinsurance
The collectibility of reinsurance recoverables is subject to uncertainty arising from a number of factors, including whether the insured losses meet the qualifying conditions of the reinsurance contract and whether reinsurers, or their affiliates, have the financial capacity and willingness to make payments under the terms of the reinsurance treaty or contract. The Company’s inability to collect a material recovery from a reinsurer could have a material adverse effect on profitability and financial condition.
A failure of the Company’s operating systems or a compromise of their security could adversely affect the Company’s results of operation and financial condition
The Company is highly dependent on automated systems to record and process Company and customer transactions. The Company may experience a failure of its operating systems or a compromise of their security due to technical system flaws, clerical or record-keeping errors, or tampering or manipulation of those systems by employees or unauthorized third parties. The Company may also be subject to disruptions of its operating systems arising from events that are wholly or partially beyond its control (for example, natural disasters, acts of terrorism, epidemics, computer viruses and electrical/telecommunications outages). All of these risks are also applicable where the Company relies on outside vendors to provide services to it and its customers. Operating system failures or disruptions or the compromise of their security could subject the Company to regulatory sanctions, or other claims, harm the Company’s reputation, interrupt the Company’s operations and adversely affect the Company’s business, results of operation or financial condition.
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2. | Agreement and Plan of Merger dated June 25, 2003, by and between USG Annuity & Life Company, United Life & Annuity Insurance Company, Equitable Life Insurance Company of Iowa and Golden American, incorporated by reference in Exhibit 99-8 in the Company’s Form 8K filed with the SEC on January 2, 2004 (File No. 333-87270). |
3.(i) | Restated Articles of Incorporation Providing for the Redomestication of Golden American Life Insurance Company dated July 2 and 3, 2003, effective January 1, 2004, incorporated by reference to Company’s 10-K, as filed with the SEC on March 29, 2004 (File No. 033-87270). |
Amendment to Articles of Incorporation Providing for the Name Change of Golden American Life Insurance Company dated November 20, 2003, effective January 1, 2004, incorporated by reference to the Company’s 10-K, as filed with the SEC on March 29, 2004 (File No. 033-87270).
Amendment to Articles of Incorporation Providing for the Change in Purpose and Powers of ING USA Annuity and Life Insurance Company dated March 3 and 4, 2004, effective March 11, 2004, incorporated by reference to the Company’s 10-Q, as filed with the SEC on May 17, 2004 (File No. 033-87270).
(ii) | Amended and Restated By-Laws of ING USA Annuity and Life Insurance Company effective January 1, 2005, incorporated by reference to the Company’s Form 10-Q, as filed with the SEC on May 13, 2005 (File No. 033-87270). |
4. | Instruments Defining the Rights of Security Holders, including Indentures (Annuity Contracts). |
(a) | Single Premium Deferred Modified Guaranteed Annuity Contract, Single Premium Deferred modified Guaranteed Annuity Master Contract, and Single Premium Deferred Modified Guaranteed Annuity Certificate - Incorporated herein by reference to Pre-Effective Amendment No. 1 to Registration Statement on Form S-1 for Golden American Life Insurance Company as filed with the SEC on February 8, 2002 (File No. 333-67660). |
(b) | Single Premium Deferred Modified Guaranteed Annuity Master Contract and Single Premium Deferred Modified guaranteed Annuity Certificate – Incorporated by reference to Post-Effective Amendment No. 1 to Registration Statement on Form S-1 for Golden American Life Insurance Company, as filed with the SEC on September 13, 2000 (File No. 333-40596). |
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(c) | Individual Retirement Annuity Rider; Roth Individual Retirement Annuity Rider; Simple Retirement Account Rider; and 403(b) Rider - Incorporated herein by reference to Post-Effective Amendment No. 34 to Registration Statement on Form N-4 for Golden American Life Insurance Company Separate Account B, as filed with the SEC on April 15, 2003 (File No. 033-23351). |
(c.1) | 403(b) Rider - Incorporated herein by reference to Initial Registration Statement on Form S-2 for Golden American Life Insurance Company, as filed with the SEC on April 15, 2003 (File No. 333-104547). |
(d) | Single Premium Deferred Equity Indexed Modified Guaranteed Annuity Contract; Single Premium Deferred Modified Guaranteed Annuity Group Master Contract; and Single Premium Deferred Equity Indexed Modified Guaranteed Annuity Certificate, - Incorporated herein by reference to Pre-Effective Amendment No. 1 to Registration Statement on Form S-2, as filed with the SEC on August 13, 2004 (File No. 333-116137). |
(e) | Interest in Fixed Account I under Variable Annuity Contracts - Incorporated herein by reference to: Post-Effective Amendment No. 12 to Registration Statement on Form N-4 for Golden American Life Insurance Company Separate Account B, as filed with the Securities and Exchange Commission on April 23, 1999 (File Nos. 033-59261, 811-5626); Incorporated by reference to Post-Effective Amendment No. 3 to Registration Statement on Form N-4 for Golden American life Insurance Company, as filed with the SEC on April 23, 1999 (File Nos. 333-28769, 811-5626); and Incorporated by reference to Pre-Effective Amendment No. 1 to Registration statement on Form N-4 for Golden American Life Insurance Company Separate Account B, as filed with the SEC on June 24, 2000 (File Nos. 333-33914, 811-5626). |
(f) | Interests in Fixed Account II under Variable Annuity Contracts - Incorporated herein by reference to Post-Effective Amendment No. 7 to Registration Statement on Form N-4 for Separate Account B of Golden American Life Insurance Company as filed with the SEC on October 2, 2000 (File No. 333-28679, 811-5626), Incorporated herein by reference to Post-Effective Amendment No. 2 to Registration Statement on Form N-4 for Separate Account B of Golden American Life Insurance Company as filed with the SEC on October 2, 2000 (File No. 333-30180, 811-5626), Incorporated herein by reference to Post-Effective Amendment No. 5 to Registration Statement on Form N-4 for Separate Account B of Golden American Life Insurance Company as filed with the SEC on April 23, 1999 (File No. 333-28755, 811-5626), Incorporated herein by reference to Post-Effective |
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Amendment No. 1 to Registration Statement on Form N-4 for Separate Account B of Golden American Life Insurance Company as filed with the SEC on April 23, 1999 (File No. 333-66757, 811-5626), Incorporated herein by reference to Pre-Effective Amendment No. 1 to Registration Statement on Form N-4 for Separate Account B of Golden American Life Insurance Company as filed with the SEC on October 26, 2001 (File No. 333-63692, 811-5626), Incorporated herein by reference to Pre-Effective Amendment No. 1 to Registration Statement on Form N-4 for Separate Account B of Golden American Life Insurance Company as filed with the SEC on December 11, 2001 (File No.333-70600, 811-5626), Incorporated by reference to Post-Effective Amendment No. 1 to Registration Statement on Form N-4 for Golden American Life Insurance Company Separate Account B, as filed with the SEC on April 16, 2003 (File No. 333-90516, 811-5626) and Incorporated by reference to Pre-Effective Amendment No. 1 to Registration Statement on Form N-4 for Golden American Life Insurance Company Separate Account B, as filed with the SEC on July 3, 2003 (File No. 333-101487, 811-5626).
(g) | Interest in the Guaranteed Account under Variable Annuity Contracts - Incorporated herein by reference to Pre-Effective Amendment No. 1 to Registration Statement on Form S-2 for Golden American Life Insurance Company, as filed with the SEC on June 29, 2001 (File No. 333-57212). |
Joinder Number 2005-1 to Tax Sharing Agreement, dated January 20, 2006, between ING USA Annuity and Life Insurance Company and ING America Insurance Holdings, Inc.
12. | Computation of Ratio of Earnings to Fixed Charges, filed herewith. |
31.1 | Certificate of David A. Wheat pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
31.2 | Certificate of Harry N. Stout pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
32.1 | Certificate of David A. Wheat pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
32.2 | Certificate of Harry N. Stout pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) 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.
May 11, 2006 (Date) | ING USA Annuity and Life Insurance Company (Registrant) |
| By: | /s/ David A. Wheat | |
| | David A. Wheat Director, Executive Vice President, and Chief Financial Officer (Duly Authorized Officer and Principal Financial Officer) | |
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