UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2005
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OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 333-1173
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GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
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(Exact name of registrant as specified in its charter)
Colorado 84-0467907
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(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification Number)
8515 East Orchard Road, Greenwood Village, CO 80111
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(Address of principal executive offices)
(Zip Code)
(303) 737-3000
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
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Indicate by check mark whether the registrant is an accelerated filer as defined
in Rule 12(b)-2 of the Exchange Act.
Yes No X
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The public may read and copy any of the registrant's reports filed with the SEC
at the SEC's Public Reference Room, 450 Fifth Street NW, Washington DC 20549,
telephone 1-800-SEC-0330 or online at (http://www.sec.gov).
As of November 1, 2005, 7,032,000 shares of the registrant's common stock were
outstanding, all of which were owned by the registrant's parent company.
NOTE: This Form 10-Q is filed by the registrant only as a consequence of
the sale by the registrant of a market value adjusted annuity
product.
TABLE OF CONTENTS
Part I FINANCIAL INFORMATION Page
-----------
Item 1 Financial Statements 3
Consolidated Statements of Income (Unaudited) 3
Consolidated Balance Sheets (Unaudited) 4
Consolidated Statements of Cash Flows (Unaudited) 6
Consolidated Statement of Stockholder's Equity (Unaudited) 8
Notes to Consolidated Financial Statements (Unaudited) 9
Item 2 Management's Discussion and Analysis of Financial Condition and Results
of Operations 15
Item 3 Quantitative and Qualitative Disclosures About Market Risk 25
Item 4 Controls and Procedures 26
Part II OTHER INFORMATION 26
Item 1 Legal Proceedings 26
Item 6 Exhibits 26
Signature 26
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands)
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------------- ---------------------------------
REVENUES: 2005 2004 2005 2004
--------------- --------------- --------------- ---------------
Premium income:
Related party (net of premiums
ceded totaling $1,077, $704
$3,656 and $258,908) $ 40,534 $ 32,294 $ 144,454 $ (86,085)
Other (net of premiums ceded
totaling $65,447, $124,963, 232,339 148,266 678,585 544,452
$200,904 and $307,500)
Fee income 240,411 232,985 715,703 674,164
Net investment income 253,653 277,152 802,757 796,613
Net realized gains on investments 748 14,459 60,570 43,769
--------------- --------------- --------------- ---------------
Total revenue 767,685 705,156 2,402,069 1,972,913
--------------- --------------- --------------- ---------------
BENEFITS AND EXPENSES:
Life and other policy benefits
(net of reinsurance recoveries
totaling $67,959, $99,357,
$194,036 and $292,272) 223,935 174,152 761,715 646,304
Increase (decrease) in reserves:
Related party (93,634) (211,231) (243,116) (427,797)
Other 139,988 224,457 300,276 177,750
Interest paid or credited to
contractholders 116,593 109,423 354,300 364,232
Provision for policyholders' share of
earnings on participating business 909 4,119 2,655 10,670
Dividends to policyholders 23,050 21,938 80,721 79,414
--------------- --------------- --------------- ---------------
Total benefits 410,841 322,858 1,256,551 850,573
Commissions 45,752 46,536 138,495 145,486
Operating expenses 187,352 194,528 559,566 581,330
Premium taxes 5,865 9,654 26,257 24,612
--------------- --------------- --------------- ---------------
Total benefits and expenses 649,810 573,576 1,980,869 1,602,001
--------------- --------------- --------------- ---------------
INCOME BEFORE INCOME TAXES 117,875 131,580 421,200 370,912
PROVISION FOR INCOME TAXES:
Current 50,377 29,085 131,460 121,883
Deferred (13,373) 12,421 (333) (1,361)
--------------- --------------- --------------- ---------------
37,004 41,506 131,127 120,522
--------------- --------------- --------------- ---------------
NET INCOME $ 80,871 $ 90,074 $ 290,073 $ 250,390
=============== =============== =============== ===============
See notes to consolidated financial statements.
GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share Amounts)
(Unaudited)
September 30, December 31,
ASSETS 2005 2004
- ------
-------------------- ---------------------
INVESTMENTS:
Fixed maturities available-for-sale, at fair value
(amortized cost $13,814,538 and $12,909,455) $ 13,919,204 $ 13,215,042
Mortgage loans on real estate (net of allowances
of $18,155 and $30,339) 1,497,237 1,543,507
Equity investments available for sale, at fair value
(cost $581,002 and $557,761) 587,616 637,434
Policy loans 3,654,629 3,548,225
Short-term investments available-for-sale
(cost approximates fair value) 849,470 708,801
-------------------- ---------------------
Total investments 20,508,156 19,653,009
OTHER ASSETS:
Cash 59,940 110,518
Reinsurance receivable:
Related party 525,711 1,072,940
Other 235,231 260,409
Deferred policy acquisition costs 328,021 301,603
Deferred ceding commission 80,954 82,648
Investment income due and accrued 149,421 159,398
Amounts receivable related to uninsured accident
and health plan claims (net of allowances of
$19,752 and $22,938) 151,977 144,312
Premiums in course of collection (net of allowances
of $5,833 and $8,029) 114,844 95,627
Deferred income taxes 196,951 138,845
Collateral for securities lending program 197,759 349,913
Due from GWL&A Financial Inc. 9,452 55,915
Other assets 522,057 485,357
SEPARATE ACCOUNT ASSETS 14,292,436 14,155,397
-------------------- ---------------------
TOTAL ASSETS $ 37,372,910 $ 37,065,891
==================== =====================
See notes to consolidated financial statements. (Continued)
GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share Amounts)
(Unaudited)
September 30, December 31,
LIABILITIES AND STOCKHOLDER'S EQUITY 2005 2004
- ------------------------------------
-------------------- ---------------------
POLICY BENEFIT LIABILITIES:
Policy reserves:
Related party $ 4,927,331 $ 5,170,447
Other 13,217,243 12,771,872
Policy and contract claims 386,260 360,862
Policyholders' funds 319,574 327,409
Provision for policyholders' dividends 117,291 118,096
Undistributed earnings on participating business 187,142 192,878
GENERAL LIABILITIES:
Due to The Great-West Life Assurance Company 36,764 26,659
Due to GWL&A Financial Inc. 199,125 194,164
Repurchase agreements 749,319 563,247
Commercial paper 94,309 95,044
Payable under securities lending agreements 197,759 349,913
Other liabilities 629,515 695,542
SEPARATE ACCOUNT LIABILITIES 14,292,436 14,155,397
-------------------- ---------------------
Total liabilities 35,354,068 35,021,530
-------------------- ---------------------
COMMITMENTS AND CONTINGENCIES - -
STOCKHOLDER'S EQUITY:
Preferred stock, $1 par value, 50,000,000 shares
authorized; 0 shares issued and outstanding - -
Common stock, $1 par value; 50,000,000 shares
authorized; 7,032,000 shares issued and outstanding 7,032 7,032
Additional paid-in capital 727,153 725,935
Accumulated other comprehensive income 23,343 118,795
Retained earnings 1,261,314 1,192,599
-------------------- ---------------------
Total stockholder's equity 2,018,842 2,044,361
-------------------- ---------------------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $ 37,372,910 $ 37,065,891
==================== =====================
See notes to consolidated financial statements. (Concluded)
GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)
Nine Months Ended September 30,
---------------------------------------------
OPERATING ACTIVITIES: 2005 2004
-------------------- ---------------------
Net income $ 290,073 $ 250,390
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Earnings allocated to participating policyholders 2,655 10,670
Amortization of net investment premiums (discounts) (20,944) 32,053
Net realized gains on investments
and write-downs of mortgage loans (60,570) (43,769)
Depreciation and amortization 54,073 54,954
Deferral of acquisition costs (35,768) (38,053)
Deferred income taxes (333) (1,361)
Changes in assets and liabilities:
Policy benefit liabilities 69,609 (265,746)
Reinsurance receivable 104,284 104,853
Accrued interest and other receivables (12,623) 13,598
Other, net (214,885) (100,476)
-------------------- ---------------------
Net cash provided by operating activities 175,571 17,113
-------------------- ---------------------
INVESTING ACTIVITIES:
Proceeds from sales, maturities and redemptions of investments: Fixed
maturities available-for-sale:
Sales 10,518,966 6,334,760
Maturities and redemptions 1,425,046 4,040,872
Mortgage loans on real estate 250,365 271,417
Common stock 170,732 74,265
Purchases of investments:
Fixed maturities available-for-sale (12,394,544) (10,075,221)
Mortgage loans on real estate (67,424) (25,731)
Common stock (113,880) (218,438)
Net change in short-term investments (140,669) (192,280)
Other, net (34,850) (85,320)
-------------------- ---------------------
Net cash (used in) provided by investing activities (386,258) 124,324
-------------------- ---------------------
See notes to consolidated financial statements. (Continued)
GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)
Nine Months Ended September 30,
-------------------- -- ---------------------
FINANCING ACTIVITIES: 2005 2004
-------------------- ---------------------
Net contract deposits (withdrawals) $ 104,954 $ (234,337)
Change in due to The Great-West Life Assurance Company 10,105 (9,249)
Change in due to GWL&A Financial Inc. 51,024 (37,862)
Dividends paid (221,358) (100,072)
Net commercial paper (repayments) borrowings (735) 610
Change in bank overdrafts 30,047 (18,984)
Net repurchase agreement transactions 186,072 181,877
-------------------- ---------------------
Net cash provided by (used in) financing activities 160,109 (218,017)
-------------------- ---------------------
NET DECREASE IN CASH (50,578) (76,580)
CASH, BEGINNING OF PERIOD 110,518 188,329
-------------------- ---------------------
CASH, END OF PERIOD $ 59,940 $ 111,749
==================== =====================
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the periods for:
Income taxes $ 41,879 $ 123,799
Interest 9,381 11,443
See notes to consolidated financial statements. (Concluded)
GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 2005
(In Thousands)
(Unaudited)
Accumulated Other
Comprehensive Income (Loss)
-----------------------------
Unrealized Minimum
Preferred Stock Common Stock Additional Gains Pension
------------------- ------------------ Paid-in (Losses)on Liability Retained
Shares Amount Shares Amount Capital Securities Adjustment Earnings Total
-------- -------- -------- -------- --------- ------------ ----------- ----------- ----------
BALANCE, JANUARY 1, 2005 - $ - 7,032 $ 7,032 $ 725,935 $ 133,546 $ (14,751) $ 1,192,599 $ 2,044,361
Net income 290,073 290,073
Other comprehensive income (95,293) (159) (95,452)
----------
Total comprehensive income 194,621
----------
Dividends (221,358) (221,358)
Income tax benefit on stock
compensation 1,218 1,218
-------- -------- -------- -------- --------- ------------ ----------- ----------- -----------
BALANCE, SEPTEMBER 30, 2005 - $ - 7,032 $ 7,032 $ 727,153 $ 38,253 $ (14,910) $ 1,261,314 $ 2,018,842
======== ======== ======== ======== ========= ============ =========== =========== ==========
See notes to consolidated financial statements.
GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands)
(Unaudited)
1. ORGANIZATION AND BASIS OF PRESENTATION
Great-West Life & Annuity Insurance Company and its subsidiaries
(collectively, the "Company") is a direct wholly-owned subsidiary of
GWL&A Financial Inc. ("GWL&A Financial"), a holding company formed in
1998. GWL&A Financial is an indirect wholly-owned subsidiary of
Great-West Lifeco Inc. ("Lifeco"). The Company offers a wide range of
life insurance, health insurance and retirement and investment products
to individuals, businesses and other private and public organizations
throughout the United States. The Company is an insurance company
domiciled in the State of Colorado and is subject to regulation by the
Colorado Division of Insurance.
The Company's consolidated financial statements and related notes have
been prepared in accordance with accounting principles generally
accepted in the United States of America applicable to interim
financial reporting and do not include all of the information and notes
required for complete financial statements. However, in the opinion of
management, these statements include all normal recurring adjustments
necessary for a fair presentation of the results. These consolidated
financial statements should be read in conjunction with the audited
consolidated financial statements and the accompanying notes included
in the Company's latest annual report on Form 10-K for the year ended
December 31, 2004.
Operating results for the nine-month period ended September 30, 2005
are not necessarily indicative of the results that may be expected for
the full year ending December 31, 2005.
Lifeco maintains the Great-West Lifeco Inc. Stock Option Plan (the
"Plan") that provides for the granting of options on its common shares
to certain of its officers and employees and those of its subsidiaries,
including the Company. The Company accounts for stock options granted
under the plan in accordance with the recognition and measurement
principles of Accounting Principles Board Opinion 25 "Accounting for
Stock Issued to Employees," ("APB No. 25") and related interpretations.
Refer to Note 2 - New Accounting Pronouncements, regarding changes to
the accounting for stock options that the Company will implement on
January 1, 2006. No stock-based employee compensation cost is reflected
in net income in the accompanying consolidated financial statements, as
all options granted under the plan had an exercise price equal to the
market value of the underlying common stock on the date of grant.
The following table illustrates the effect on net income if the Company
had applied the fair value recognition provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS No. 123"), as revised by Statement of Financial
Accounting Standards No. 123R "Share-Based Payment" ("SFAS No. 123R"),
to stock-based employee compensation.
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------------- --------------------------------
2005 2004 2005 2004
---------------- -------------- --------------- -------------
Net income, as reported $ 80,871 $ 90,074 $ 290,073 $ 250,390
Less compensation for the fair
value of stock options, net
of related tax effects 624 934 2,113 2,854
---------------- -------------- --------------- -------------
Proforma net income $ 80,247 $ 89,140 $ 287,960 $ 247,536
================ ============== =============== =============
Certain reclassifications have been made to the 2004 consolidated
financial statements or related notes to conform to the 2005
presentation. These changes in classification had no effect on
previously reported stockholder's equity or net income.
2. NEW ACCOUNTING PRONOUNCEMENTS
In January 2004, Interpretation No. 46, "Consolidation of Variable
Interest Entities" ("FIN 46R") was reissued by the Financial Accounting
Standards Board ("FASB"). FIN 46R addresses consolidation by business
enterprises of variable interest entities ("VIEs"), which have one or
both of the following characteristics: a) insufficient equity
investment at risk, or b) insufficient control by equity investors.
This guidance, as reissued, is effective for VIEs created after January
31, 2003, and for pre-existing VIEs as of March 31, 2004. In
conjunction with the issuance of this guidance, the Company conducted a
review of its involvement with VIEs and concluded that it does not have
any investments or ownership interests in VIEs.
In December 2004, the FASB issued Statement of Financial Accounting
Standards No. 123R "Share-Based Payment" ("SFAS 123R"). SFAS 123R
replaces SFAS 123 and supersedes APB No. 25. SFAS 123R requires a
company to use the fair value method to account for its stock-based
employee compensation and to provide certain other additional
disclosures. Previously, the Company elected to only disclose the
impact of recording the fair value of stock options in the notes to its
consolidated financial statements. The Company will adopt the
provisions of SFAS 123R on January 1, 2006 and does not expect the
adoption of SFAS 123R to have a material effect on its consolidated
financial position or results of operations.
In January 2004, the FASB issued Emerging Issues Task Force Issue No.
03-1, "The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments" ("EITF 03-1"). EITF 03-1 provides
guidance on the disclosure requirements, which were effective as of
December 31, 2003, for other-than-temporary impairments of debt and
marketable equity investments that are accounted for under SFAS No.
115, "Accounting for Certain Investments in Debt and Equity Securities"
("SFAS 115"). EITF 03-1 also included guidance on the measurement and
recognition of other-than-temporary impairments of certain investments,
which was originally going to be effective during the quarter ended
September 30, 2004. However, in response to various concerns raised by
financial statement preparers and others, the measurement and
recognition provisions of EITF 03-1 were delayed. The FASB staff has
announced its intention to issue FASB Staff Position 115-1 ("FSP
115-1"). When issued, FSP 115-1 will replace the guidance set forth in
paragraphs 10-18 of EITF 03-1 with new interpretations of existing
measurement and recognition guidance. FSP 115-1 is expected to be
effective for reporting periods beginning after December 15, 2005. The
Company is evaluating the impact the adoption of FSP 115-1 will have on
its financial position and results of operations.
3. RELATED-PARTY TRANSACTIONS
On August 31, 2003, the Company and The Canada Life Assurance Company
("CLAC"), an affiliate, entered into an Indemnity Reinsurance Agreement
pursuant to which the Company assumed 80% (45% coinsurance and 35%
coinsurance with funds withheld) of certain life, health and annuity
business of CLAC's United States branch.
On February 29, 2004, CLAC recaptured the group life and health
business from the Company associated with the original Indemnity
Reinsurance Agreement dated August 31, 2003. The Company recorded an
income statement impact of $256,318 of negative premium income and
change in reserves associated with these policies. The Company also
recorded, at fair value, the following at February 29, 2004 as a result
of this transaction:
Assets Liabilities and Stockholder's Equity
------ ------------------------------------
Cash $ (126,105) Policy reserves $ (286,149)
Reinsurance receivable (152,077) Policy and contract claims (32,755)
Deferred ceding commission (29,831) Policyholders' funds (3,982)
Premiums in course of collection (14,873)
------------------ ----------------
$ (322,886) $ (322,886)
================== ================
Effective April 1, 2005, the Company and CLAC amended the Indemnity
Reinsurance Agreement to adjust the coinsurance and coinsurance with
funds withheld through the transfer of $468,123 of assets from CLAC to
the Company as follows:
Assets Liabilities and Stockholder's Equity
------ ------------------------------------
Bonds $ 414,623 $ -
Mortgages 49,218
Investment income due and accrued 4,282
Reinsurance receivable (468,123)
------------------ ----------------
$ - $ -
================== ================
As a result of this transaction, the reinsured 80% of the life, health
and annuity business is currently 58% coinsurance and 22% coinsurance
with funds withheld. Under the amended agreement, the remaining funds
withheld assets will be transferred to the Company prior to December
31, 2007.
On November 15, 2004, the Company issued a surplus note to GWL&A
Financial with a face amount of $195,000 and carrying amounts of
$194,172 and $194,164 at September 30, 2005 and December 31, 2004,
respectively. The surplus note bears interest at the rate of 6.675% per
annum, payable in arrears on each May 14 and November 14. The surplus
note matures on November 14, 2034. On December 16, 2004, the Company
used the proceeds from the issuance of the surplus note to redeem its
$175,000 subordinated note payable to GWL&A Financial and for general
corporate purposes.
The Company's separate accounts include mutual funds or other
investment options that, beginning in 2005, purchase guaranteed
interest annuity contracts issued by the Company. During the three and
nine months ended September 30, 2005, these purchases totaled $18,474
and $352,888, respectively. As the general account investment contracts
are also included in the separate account balances in the accompanying
consolidated balance sheets, the Company has reduced the separate
account assets and liabilities by $324,607 at September 30, 2005 to
avoid the overstatement of assets and liabilities in its consolidated
balance sheet at that date.
4. IMPAIRMENT OF FIXED MATURITY AND EQUITY INVESTMENTS
The Company classifies all of its fixed maturity and equity investments
as available-for-sale and marks them to market recording unrealized
gains and losses in the other comprehensive income section of
stockholder's equity. All securities with gross unrealized losses at
the consolidated balance sheet date are subjected to the Company's
process for identifying other-than-temporary impairments.
The Company writes down to fair value securities that it deems to be
other-than-temporarily impaired in the period the securities are deemed
to be so impaired. The Company records writedowns as investment losses
and adjusts the cost basis of the securities accordingly. The Company
does not change the revised cost basis for subsequent recoveries in
value.
The assessment of whether an other-than-temporary impairment has
occurred is based on management's case-by-case evaluation of the
underlying reasons for the decline in fair value. Management considers
a wide range of factors, as described below, about the security issuer
and uses its best judgment in evaluating the cause of the decline in
the estimated fair value of the security and in assessing the prospects
for near-term recovery. Inherent in management's evaluation of the
security are assumptions and estimates about the operations of the
issuer and its future earnings potential.
Considerations used by the Company in the impairment evaluation process
include, but are not limited to, the following:
o The fair value is significantly below cost.
o The decline in fair value is attributable to specific adverse
conditions affecting a particular instrument, its issuer, an
industry or a geographic area.
o The decline in fair value has existed for an extended period of
time.
o A debt security has been downgraded by a rating agency.
o The financial condition of the issuer has deteriorated.
o Dividends have been reduced/eliminated or scheduled interest
payments have not been made.
While all available information is taken into account, it is difficult
to predict the ultimate recoverable amount of a distressed or impaired
security.
The Company's portfolio of fixed maturity investments fluctuates in
value based upon interest rates in financial markets and other economic
factors. These fluctuations, caused by market interest rate changes,
have little bearing on whether or not the investment will be ultimately
recoverable. Therefore, the Company considers these declines in value
to be temporary, even in periods exceeding one year.
During the three months ended September 30, 2005 and 2004, the Company
recorded other-than-temporary impairments in the fair value of its
fixed maturity investments of $3,365 and $8,070, respectively. During
the nine months ended September 30, 2005 and 2004, the Company recorded
other-than-temporary impairments in the fair value of its fixed
maturity investments of $7,797 and $11,232, respectively. No
impairments were recorded on equity securities for any of the three or
nine-month periods ended September 30, 2005 or 2004.
5. REINSURANCE
The Company enters into reinsurance transactions as both a provider and
purchaser of reinsurance. In addition to the Indemnity Reinsurance
Agreement entered into with CLAC (See Note 3 above), the Great-West
Healthcare division of the Company entered into a reinsurance agreement
during 2003 with Allianz Risk Transfer (Bermuda) Limited to cede 40% in
2005 and 75% in 2004 of direct written group health stop-loss and
excess loss activity.
6. COMPONENTS OF NET PERIODIC BENEFIT COST
The components of the cost of employee benefit plans included in
operating expenses during the three and nine-month periods ended
September 30, 2005 and 2004 are as follows:
Three Months Ended Three Months Ended
September 30, September 30,
------------------------------------ -----------------------------------
2005 2004 2005 2004
----------------- --------------- ------------- -----------------
Post-Retirement
Pension Benefits Medical Plan
------------------------------------ -----------------------------------
Service cost $ 2,125 $ 2,144 $ 596 $ 722
Interest cost 3,634 3,329 606 684
Expected return on plan
Assets (3,902) (3,733) - -
Amortization of transition
obligation (379) (379) - -
Amortization of unrecogniz-
ed prior service cost 158 158 (467) (178)
Amortization of gains from
earlier periods 1,009 688 113 166
---------------- --------------- ------------- -----------------
Net periodic benefit cost $ 2,645 $ 2,207 $ 848 $ 1,394
================ =============== ============= =================
Nine Months Ended Nine Months Ended
September 30, September 30,
------------------------------------ -----------------------------------
2005 2004 2005 2004
---------------- ---------------- ------------- ----------------
Post-Retirement
Pension Benefits Medical Plan
------------------------------------ -----------------------------------
Service cost $ 6,399 $ 6,432 $ 2,000 $ 2,166
Interest cost 10,963 9,987 1,953 2,052
Expected return on plan
assets (11,706) (11,199) - -
Amortization of transition
obligation (1,137) (1,137) - -
Amortization of unrecogniz-
ed prior service cost 474 474 (1,112) (534)
Amortization of gains from
earlier periods 3,132 2,064 390 498
--------------- ---------------- ------------- ----------------
Net periodic benefit cost $ 8,125 $ 6,621 $ 3,231 $ 4,182
=============== ================ ============= ================
During the three months ended September 30, 2004, the Company made a
payment in the amount of $3,200 to fund its 2004 pension plan
obligation. This payment completely funded the 2004 obligation. The
Company does not expect to make contributions to its pension plan
during the year ended December 31, 2005.
7. BUSINESS SEGMENT INFORMATION
The Company has two reportable business segments: Great-West Healthcare
and Financial Services. The Great-West Healthcare segment markets group
life and health insurance primarily to small and mid-sized corporate
employers. The Financial Services segment markets and administers
savings products to public and not-for-profit employers, corporations,
and individuals and offers life insurance products to individuals and
businesses. The Company's reportable segments are strategic business
units that offer different products and services. They are managed
separately as each segment has unique distribution channels.
The following table summarizes the financial results of the Company's
Great-West Healthcare segment for the three and nine-month periods
ended September 30, 2005 and 2004:
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------------- ---------------------------------
2005 2004 2005 2004
-------------- ---------------- --------------- -------------
Premium income $ 191,911 $ 131,406 $ 522,457 $ 163,294
Fee income 163,653 165,353 492,534 473,036
Net investment income 17,030 6,571 47,450 32,325
Net realized gains on
investments 1,397 5,382 22,453 11,106
-------------- ---------------- --------------- -------------
Total revenues 373,991 308,712 1,084,894 679,761
Total benefits and expenses 313,979 260,096 887,890 521,025
Income tax expenses 19,950 15,892 64,691 52,541
-------------- ---------------- --------------- -------------
Net income $ 40,062 $ 32,724 $ 132,313 $ 106,195
============== ================ =============== =============
The following table summarizes the financial results of the Company's
Financial Services segment for the three and nine-month periods ended
September 30, 2005 and 2004:
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------------- ---------------------------------
2005 2004 2005 2004
-------------- ---------------- --------------- --------------
Premium income $ 80,962 $ 49,154 $ 300,582 $ 295,073
Fee income 76,758 67,632 223,169 201,128
Net investment income 236,623 270,581 755,307 764,288
Net realized gains (losses)
on investments (649) 9,077 38,117 32,663
-------------- ---------------- --------------- --------------
Total revenues 393,694 396,444 1,317,175 1,293,152
Total benefits and expenses 335,831 313,480 1,092,979 1,080,976
Income tax expenses 17,054 25,614 66,436 67,981
-------------- ---------------- --------------- --------------
Net income $ 40,809 $ 57,350 $ 157,760 $ 144,195
============== ================ =============== ==============
8. COMMITMENTS AND CONTINGENCIES
The Company is involved in various legal proceedings that arise in the
ordinary course of its business. In the opinion of management, after
consultation with counsel, the resolution of these proceedings should
not have a material adverse effect on the Company's consolidated
financial position or results of its operations.
During 2002, the Company entered into a corporate credit facility
agreement in the amount of $50,000 for general corporate purposes. The
agreement was extended by an amended agreement on May 26, 2005. The
credit facility matures on May 26, 2010. Interest accrues at a rate
dependent on various conditions and terms of borrowings. The agreement
requires the Company to maintain a minimum adjusted net worth of
$900,000 plus 50% of its net income, if positive (both compiled by the
unconsolidated statutory accounting basis prescribed by the National
Association of Insurance Commissioners), for each quarter ending after
March 31, 2005. The Company had no borrowings under the credit facility
at either September 30, 2005 or December 31, 2004.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
This Form 10-Q contains forward-looking statements. Forward-looking
statements are statements not based on historical information and that
relate to future operations, strategies, financial results or other
developments. In particular, 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 or projected levels of sales of its
products, investment spreads or yields or the earnings or profitability
of its activities. Forward-looking statements are necessarily based
upon 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, with respect to future business decisions, are subject to
change. These uncertainties and contingencies can affect actual results
and 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 events or developments, some of which may be national in
scope, such as general economic conditions and interest rates, some of
which may be related to the insurance industry generally, such as
pricing competition, regulatory developments and industry
consolidation, and others of which may relate to the Company
specifically, such as credit, volatility and other risks associated
with its investment portfolio and other factors. Readers are also
directed to consider other risks and uncertainties discussed in
documents filed by the Company and certain of its subsidiaries with the
Securities and Exchange Commission.
The following discussion addresses the financial condition of the
Company as of September 30, 2005 compared with December 31, 2004 and
its results of operations for the three and nine-month periods ended
September 30, 2005 compared with the same periods of the preceding
year. The discussion should be read in conjunction with the
Management's Discussion and Analysis of Financial Condition and Results
of Operations section included in the Company's report on Form 10-K for
the year ended December 31, 2004, to which the reader is directed for
additional information.
Three Months Ended Nine Months Ended
Results of Operations September 30, September 30,
----------------------------------- ---------------------------------
(In millions) 2005 2004 2005 2004
------------------------------------ -------------- ----------------- -------------- ---------------
Premium income $ 273 $ 181 $ 823 $ 458
Fee income 240 233 716 674
Net investment income 254 277 803 797
Net realized investment gains 1 14 60 44
-------------- ----------------- -------------- ---------------
Total revenues 768 705 2,402 1,973
Total benefits and expenses 650 573 1,981 1,602
Income tax expenses 37 42 131 121
-------------- ----------------- -------------- ---------------
Net income $ 81 $ 90 $ 290 $ 250
============== ================= ============== ===============
Deposits for investment-
type contracts (1) $ 197 $ 191 $ 988 $ 535
Deposits to separate accounts 534 475 1,616 1,467
Self-funded premium equivalents 1,162 1,194 3,469 3,519
(1) Includes $19 and $0 during the three months ended September 30,
2005 and 2004, respectively, and $353 and $0 during the nine months
ended September 30, 2005 and 2004, respectively, of the Company's
guaranteed interest annuity contracts purchased by affiliated funds or
other separate account investment options as discussed in Note 3 to the
accompanying consolidated financial statements.
Balance Sheet
(In millions) September 30, 2005 December 31, 2004
-------------------------------------------------------- ------------------------ -------------------------
Investment assets $ 20,508 $ 19,653
Separate account assets 14,292 14,155
Total assets 37,373 37,066
Total policy benefit liabilities 19,155 18,942
Due to The Great-West Life Assurance Company 37 27
Due to GWL&A Financial Inc. 199 194
Total stockholder's equity 2,019 2,044
CONSOLIDATED RESULTS
Three months ended September 30, 2005 compared with the three months
ended September 30, 2004
The Company's consolidated net income decreased by $9 million, or 10%,
to $81 million during the three months ended September 30, 2005 when
compared to the same period in 2004. The decrease was due in part to a
$13 million change in the marking to market of the embedded derivative
associated with the CLAC funds withheld reinsurance agreement, net of
policyholder related amounts and deferred taxes.
Total revenues increased by $63 million, or 9%, to $768 million during
the three months ended September 30, 2005 when compared to the same
period in 2004. The increase is largely due to a decrease in the
contractual reinsurance cession percentages, from 75% in 2004 to 40% in
2005, with Allianz Risk Transfer (Bermuda) Limited ("Allianz"). This
ceding percentage decrease caused ceded premiums to decrease by $40
million during 2005 when compared to 2004. Premium revenue was also
favorably impacted by improved renewal pricing in the Great-West
Healthcare segment and by transfers by participants from investment
options for which the Company provides administrative and
record-keeping services to the Company's investment options, which are
offered in connection with its general and separate accounts in the
Financial Services segment. These increases were partially offset by a
$42 million reduction in net investment income resulting from the
marking to market of the embedded derivative on the funds withheld
reinsurance agreement.
Benefits and expenses increased by $77 million, or 13%, to $650 million
during the three months ended September 30, 2005 when compared to the
same period of 2004. Benefits and expenses increased by $54 million in
the Healthcare segment primarily due to a $40 million decrease in
benefits ceded to Allianz during 2005 when compared to 2004 as a result
of the lower contractual cession percentages on the contract. Operating
expenses, including commission expenses and premium taxes, remained
relatively constant during each of the three month periods ended
September 30, 2005 and 2004. Income tax expense decreased by $4 million
principally as a result of lower income during the three months ended
September 30, 2005 when compared to the same period of 2004.
In evaluating its results of operations, the Company also considers net
changes in deposits received for investment-type contracts, deposits to
separate accounts and self-funded premium equivalents. Self-funded
premium equivalents represent paid claims under minimum premium and
administrative services only contracts. These amounts approximate the
additional premiums, which would have been earned under such contracts
if they had been written as traditional indemnity or HMO programs.
Deposits for investment-type contracts remained relatively constant
during each of the three-month periods ended September 30, 2005 and
2004.
Deposits to the separate accounts increased by $59 million, or 12%, to
$534 million during the three month period ended September 30, 2005
when compared to the same period of 2004. The increase reflects higher
transfers by participants in the Financial Services segment from
unaffiliated retail investment options to those options provided by the
Company.
Self-funded premium equivalents decreased by $32 million, or 3%, to
$1,162 million at September 30, 2005 when compared to September 30,
2004.
Nine months ended September 30, 2005 compared with the nine months
ended September 30, 2004
The Company's consolidated net income increased by $40 million, or 16%,
to $290 million during the first nine months of 2005 when compared to
the same period in 2004. The net income increase reflects a $26 million
increase in the Great-West Healthcare segment and a $14 million
increase in the Financial Services segment. The increase was primarily
the result of increased fee income of $42 million and net realized
investment gains of $16 million in both segments.
Total revenues increased by $429 million, or 22%, to $2,402 million
during the first nine months of 2005 when compared to the same period
in 2004. The increase is primarily the result of the February 2004,
CLAC recapture of certain group life and health business from the
Company associated with the original Indemnity Reinsurance Agreement,
as discussed in Note 3 to the accompanying consolidated financial
statements. During the first quarter of 2004, the Company recorded an
income statement impact of $256 million of negative premium income and
change in reserves associated with these recaptured policies. In
addition, premiums ceded to Allianz decreased by $99 million during
2005 when compared to 2004 as a result of the lower contractual cession
percentages on the contract. Fee income increased by $42 million during
the nine-month period ended September 30, 2005. The increase resulted
from approximately equal favorable results from the Great-West
Healthcare segment attributed to increased pharmacy benefits management
contract revenue and from improved renewal pricing and the Financial
Services segment attributed to higher fees for providing administrative
services to institutional clients.
Benefits and expenses increased by $379 million, or 24%, to $1,981
million during the first nine months of 2005 when compared to the first
nine months in 2004. The increase in benefits and expenses is primarily
due to the aforementioned decrease in reinsurance in the amount of $256
million during 2004. In addition, benefits ceded to Allianz decreased
by $99 million during 2005 when compared to 2004 as a result of the
lower contractual cession percentages on the contract. Operating
expenses, including commission expense, premium taxes and other
operating expenses decreased by $27 million, or 4%, to $724 million
during the nine months ended September 30, 2005.
Deposits for investment-type contracts and deposits to the separate
accounts increased by $602 million, or 30%, to $2,604 million during
the nine months ended September 30, 2005 when compared to the same
period in 2004. The increase is due to an increase in transfers by
participants from unaffiliated retail investment options to the
company's investment options for which it provides plan and participant
record keeping services.
Self-funded premium equivalents decreased by $50 million, or 1%, to
$3,469 million during the nine months ended September 30, 2005 when
compared to the same period in 2004.
SEGMENT RESULTS
Great-West Healthcare Segment
The following is a summary of certain financial data of the Great-West
Healthcare segment for the three and nine-month periods ended September
30, 2005 and 2004:
Three Months Ended Nine Months Ended
Operating Summary September 30, September 30,
----------------------------------- ---------------------------------
(In millions) 2005 2004 2005 2004
------------------------------------ -------------- ----------------- -------------- ---------------
Premium income $ 192 $ 132 $ 522 $ 163
Fee income 163 165 493 473
Net investment income 17 7 48 33
Net realized gains on
investments 2 5 22 11
-------------- ----------------- -------------- ---------------
Total revenues 374 309 1,085 680
Total benefits and expenses 314 260 888 521
Income tax expenses 20 16 65 53
-------------- ----------------- -------------- ---------------
Net income $ 40 $ 33 $ 132 $ 106
============== ================= ============== ===============
Self-funded premium
equivalents $ 1,162 $ 1,194 $ 3,469 $ 3,519
The following is a summary of the Great-West Healthcare segment
membership at September 30, 2005 and 2004:
Membership September 30,
-----------------------------------------
(In millions) 2005 2004 Change
------------------------------------------- ------------------- ------------------ ------------------------
Select and Mid Market Groups 1.285 1.349 (4.7%)
National and Specialty Risk Groups .680 .599 13.5%
------------------- ------------------ ------------------------
Total Membership 1.965 1.948 .8%
=================== ================== ========================
Three months ended September 30, 2005 compared with the three months
ended September 30, 2004
Net income for the Great-West Healthcare segment increased by $7
million, or 21%, to $40 million for the three months ended September
30, 2005 when compared to the same period of 2004. This increase is
primarily due to improved net investment income margins and lower
mortgage write-downs partially offset by a slight deterioration in loss
ratios.
Premium revenue increased by $60 million, or 45%, to $192 million
during the three months ended September 30, 2005 when compared to the
same period of 2004. The increase is largely due to a decrease in the
contractual reinsurance cession percentages, from 75% in 2004 to 40% in
2005, with Allianz. This ceding percentage decrease caused ceded
premiums to decrease by $40 million during 2005 when compared to 2004.
Premium revenue was also impacted by improved renewal pricing.
Fee income during the quarter ended September 30, 2005 was relatively
flat when compared to the same period of 2004.
The Great-West Healthcare segment experienced a 4% increase in total
health care membership from 1.892 million members at June 30, 2005, to
1.965 million members at September 30, 2005. The increase in membership
is the result of improved sales during the current quarter, primarily
in the National and Specialty Risk markets, improved in quarter
persistency and the acquisition of a third party administrator in the
Specialty Risk Market during the third quarter of 2005.
Total benefits and expenses increased by $54 million, or 21%, to $314
million during the three months ended September 30, 2005 compared to
the same period of 2004. The increase is primarily due to a $40 million
decrease in benefits ceded to Allianz during 2005 when compared to 2004
as a result of the lower contractual cession percentages on the
contract. The remaining increase is the result of higher health claims
related to specific stop loss coverage.
Self-funded premium equivalents decreased by $32 million, or 3%, to
$1,162 million for the three months ended September 30, 2005 when
compared to the same period of 2004.
Nine months ended September 30, 2005 compared with the nine months
ended September 30, 2004
Net income for the Great-West Healthcare segment increased by $26
million, or 25%, to $132 million for the nine months ended September
30, 2005 when compared to the same period of 2004. This increase is
primarily due to higher realized gains on sales of equity investments
during the period. Earnings were also impacted by an increase in
pharmacy benefits management revenue and lower aggregate loss ratios,
which offset higher specific loss ratios and the impact of lower
membership.
Premium revenue increased by $359 million, or 220%, to $523 million
during the nine months ended September 30, 2005 when compared to the
same period of 2004. The increase is attributable to the inclusion of
negative premium in the amount of $207 million in 2004 as a result of
the February 2004 recapture discussed in Note 3 in the accompanying
consolidated financial statements, comprised of $256 million of
negative premiums offset by $49 million of normal CLAC reinsurance
activity recorded before the recapture. In addition, premiums ceded to
Allianz decreased by $99 million during 2005 when compared to 2004 as a
result of the lower contractual cession percentages on the contract.
The remaining increase is the result of improved renewal pricing.
Fee income during the nine months ended September 30, 2005 increased by
$20 million, or 4%, to $493 million when compared to the same period of
2004. The increase is primarily due to the increased pharmacy benefits
management contract revenue and improved renewal pricing, partially
offset by the impact of lower membership.
The Great-West Healthcare segment experienced a 3% decrease in total
health care membership from 2.021 million members at December 31, 2004,
to 1.965 million members at September 30, 2005. There was a 1% increase
in total health care membership from 1.948 million at September 30,
2004 to 1.965 million at September 30, 2005. This increase is primarily
driven by increased membership in the Specialty Risk market, partially
offset by higher contract terminations and lower sales of new business
in all other markets.
Total benefits and expenses increased by $367 million, or 70%, to $888
million during the nine months ended September 30, 2005 when compared
to the same period of 2004. The increase is primarily due to a
reduction in net Canada Life benefits in the amount of $250 million
associated with the February 2004 reinsurance recapture discussed
above, which was comprised of $256 million of negative change in
reserves offset by $6 million of normal CLAC reinsurance activity
recorded before the recapture. In addition, benefits ceded to Allianz
decreased by $99 million during 2005 when compared to 2004 as a result
of the lower contractual cession percentages on the contract. The
remaining increase is the result of higher health claims related to
specific stop loss coverage.
Self-funded premium equivalents decreased by $50 million, or 1%, to
$3,469 million for the nine month period ended September 30, 2005 when
compared to the same periods of 2004 primarily due to a decline in
membership.
Financial Services Segment
The following is a summary of certain financial data of the Financial
Services segment for the three and nine-month periods ended September
30, 2005 and 2004:
Three Months Ended Nine Months Ended
Operating Summary September 30, September 30,
------------------------------------ ---------------------------------
(In millions) 2005 2004 2005 2004
------------------------------------- --------------- ----------------- -------------- ---------------
Premium income $ 81 $ 49 $ 301 $ 295
Fee income 77 68 223 201
Net investment income 237 270 755 764
Net realized gains (losses)
on investments (1) 9 38 33
--------------- ----------------- -------------- ---------------
Total revenues 394 396 1,317 1,293
Total benefits and expenses 336 313 1,093 1,081
Income tax expenses 17 26 66 68
--------------- ----------------- -------------- ---------------
Net income $ 41 $ 57 $ 158 $ 144
=============== ================= ============== ===============
Deposits for investment
type contracts $ 197 $ 191 $ 988 $ 535
Deposits to separate accounts 534 475 1,616 1,467
Three months ended September 30, 2005 compared with the three months
ended September 30, 2004
Net income for the Financial Services segment decreased by $16 million,
or 28%, to $41 million during the three months ended September 30, 2005
when compared to the same period of 2004. The decrease was due in part
to a $13 million change in the marking to market of the embedded
derivative associated with the CLAC funds withheld reinsurance
agreement, net of policyholder related amounts and deferred taxes.
Total premiums and deposits to investment-type contracts and deposits
to separate accounts increased by $97 million, or 14%, to $812 million
for the three months ended September 30, 2005 when compared to the same
period of 2004 due to an increase in transfers by participants from
unaffiliated retail investment options to the Company's investment
options (general and separate accounts) for which the Company provides
plan and participant record-keeping services.
Fee income increased by $9 million, or 13%, to $77 million during the
three months ended September 30, 2005 when compared to the same period
of 2004. Fee income includes variable asset-based fees for retirement
products and fees earned for providing administrative record keeping
services for institutional accounts. Variable asset-based fees
fluctuate with changes in participant account values. Account values
change due to cash flow and unrealized market gains and losses
associated with fluctuations in equity markets.
Net investment income and net realized gains and losses on the sales of
investments decreased by $43 million, or 15%, to $236 million during
the three months ended September 30, 2005 when compared to the same
period of 2004. The decrease was primarily due to a $42 million change
in the marking to market of the embedded derivative through net
investment income.
Total benefits and expenses increased by $23 million, or 7% to $336
million during the three months ended September 30, 2005 when compared
to the same period of 2004. This is primarily due to an increase in
reserves related to the individual term life insurance business and the
marking to market of the embedded derivative.
Nine months ended September 30, 2005 compared with the nine months
ended September 30, 2004
Net income for the Financial Services segment increased by $14 million,
or 10%, to $158 million during the nine months ended September 30, 2005
when compared to the same period of 2004. The increase in net income
was primarily attributed to higher fee income during 2005 as the result
of new sales in the administrative record keeping area and improved
mortality in the Individual Markets line of business.
Total premiums and deposits to investment-type contracts and deposits
to separate accounts increased by $607 million, or 26%, to $2,904
million during the nine-month period ended September 30, 2005 when
compared to the same period of 2004. The increase is primarily within
the Retirement Services business area. Premium revenue was favorably
impacted by transfers by participants from investment options for which
the Company provides administrative and record-keeping services to the
Company's investment options, which are offered in connection with its
general and separate accounts. The increase is due to an increase in
transfers by participants from unaffiliated retail investment options
to the company's investment options for which it provides plan and
participant record keeping services. As discussed in Note 3 in the
accompanying consolidated financial statements, the Company's separate
accounts offer mutual funds or other investment options that, beginning
in 2005, purchased guaranteed interest annuity contracts issued by the
Company in the amount of $353 million, which is included in deposits
for investment-type contracts.
Fee income has increased by $22 million, or 11%, to $223 million during
the nine months ended September 30, 2005 when compared to the same
period of 2004. The increase during 2005 is primarily associated with
higher fee income from providing administrative services to
institutional clients for the retirement plans they administer.
Retirement participant accounts, including third-party administration
and institutional accounts, increased by 12% during 2005 from 2.412
million at September 30, 2004 to 2.697 million at September 30, 2005.
Net investment income and net realized gains and losses from the sale
of investments remained relatively unchanged during the nine-month
period ended September 30, 2005 compared to the same period of 2004.
Total benefits and expenses increased by $12 million, or 1%, to $1,093
million during the first nine months of 2005 when compared to the same
period of 2004.
GENERAL ACCOUNT INVESTMENTS
The Company's primary investment objective is to acquire assets with
duration and cash flow characteristics reflective of its liabilities,
while meeting industry, size, issuer and geographic diversification
standards. Formal liquidity and credit quality parameters have also
been established.
The Company follows rigorous procedures to control interest rate risk
and observes strict asset and liability matching guidelines. These
guidelines ensure that even under changing market conditions, the
Company's assets will meet the cash flow and income requirements of its
liabilities. Using dynamic modeling to analyze the effects of a range
of possible market changes upon investments and policyholder benefits,
the Company works to ensure that its investment portfolio is
appropriately structured to fulfill financial obligations to its
policyholders.
Fixed Maturities
Fixed maturity investments include public and privately placed
corporate bonds, government bonds, and mortgage-backed and asset-backed
securities. The Company's strategy related to mortgage-backed and
asset-backed securities is to focus on those investments with low
prepayment risk and minimal credit risk. The Company does not invest in
higher-risk collateralized mortgage obligations such as interest-only
and principal-only strips, and currently has no plans to invest in such
securities.
Private placement investments are generally less marketable than
publicly traded assets, yet they typically offer enhanced covenant
protection that allows the Company, if necessary, to take appropriate
action to protect its investment. The Company believes that the cost of
the additional monitoring and analysis required by private placements
is more than offset by their enhanced yield.
During the nine months ended September 30, 2005, net unrealized losses
on fixed maturities included in the other comprehensive section of
stockholder's equity, which is net of policyholder-related amounts and
deferred income taxes, decreased stockholder's equity by $95 million.
One of the Company's primary objectives is to ensure that its fixed
maturity portfolio is maintained at a high average quality so as to
limit credit risk. The following table contains the rating distribution
of the Company's fixed maturity portfolio.
Rating September 30, 2005 December 31, 2004
------ ------------------------- ------------------------
AAA 58.3 % 56.9 %
AA 7.5 % 8.2 %
A 15.2 % 15.6 %
BBB 16.5 % 16.7 %
BB and below (non-investment grade) 2.5 % 2.6 %
------------------------- ------------------------
TOTAL 100.0 % 100.0 %
========================= ========================
Impairment of Securities
The Company classifies all of its fixed maturity and equity investments
as available-for-sale and marks them to market recording unrealized
gains and losses in the other comprehensive income section of
stockholder's equity. All securities with gross unrealized losses at
the consolidated balance sheet date are subjected to the Company's
process for identifying other-than-temporary impairments.
The Company writes down to fair value securities that it deems to be
other-than-temporarily impaired in the period the securities are deemed
to be so impaired. The Company records write-downs as investment losses
and adjusts the cost basis of the securities accordingly. The Company
does not change the revised cost basis for subsequent recoveries in
value.
The assessment of whether an other-than-temporary impairment has
occurred is based on management's case-by-case evaluation of the
underlying reasons for the decline in fair value. Management considers
a wide range of factors, as described below, about the security issuer
and uses its best judgment in evaluating the cause of the decline in
the estimated fair value of the security and in assessing the prospects
for near-term recovery. Inherent in management's evaluation of the
security are assumptions and estimates about the operations of the
issuer and its future earnings potential.
Considerations used by the Company in the impairment evaluation process
include, but are not limited to, the following:
o The fair value is significantly below cost.
o The decline in fair value is attributable to specific adverse
conditions affecting a particular instrument, its issuer, an
industry or a geographic area.
o The decline in fair value has existed for an extended period of
time. o A debt security has been downgraded by a rating agency.
o The financial condition of the issuer has deteriorated.
o Dividends have been reduced/eliminated or scheduled interest
payments have not been made.
While all available information is taken into account, it is difficult
to predict the ultimate recoverable amount of a distressed or impaired
security.
The Company's portfolio of fixed maturities fluctuates in value based
upon interest rates in financial markets and other economic factors.
These fluctuations, caused by market interest rate changes, have little
bearing on whether or not the investment will be ultimately
recoverable. Therefore, the Company considers these declines in value
as temporary, even in periods exceeding one year. At September 30,
2005, the Company's unrealized losses were $148 million compared to $81
million at December 31, 2004. Investments in a loss position for less
than twelve months totaled $100 million at September 30, 2005 which,
was an increase of $67 million over those losses at December 31, 2004.
The increase was generally attributable to the rise in interest rates
during the first nine months of the year. Investments in a loss
position greater than twelve months did not experience a significant
change."
During the three months ended September 30, 2005 and 2004, the Company
recorded other-than-temporary impairments in the fair value of its
fixed maturity investments of $3.4 million and $8.1 million,
respectively. During the nine months ended September 30, 2005 and 2004,
the Company recorded other-than-temporary impairments in the fair value
of its fixed maturity investments of $7.8 million and $11.2 million,
respectively. During the three months ended September 30, 2005, the
other-than-temporary impairments relate primarily to the airline and
automobile industries. At September 30, 2005, the market value of all
fixed maturities in the airline and automobile industries was less than
1.5% of total fixed maturities.
No impairments were recorded on equity securities for any of the three
or nine-month periods ended September 30, 2005 or 2004.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
the Company's management to make a variety of estimates and
assumptions. These estimates and assumptions affect, among other
things, the reported amounts of assets and liabilities, the disclosure
of contingent liabilities and the reported amounts of revenues and
expenses. Actual results can differ from the amounts previously
estimated, which were based on the information available at the time
the estimates were made.
The critical accounting policies, described below, are those that the
Company believes are important to the portrayal of its financial
condition and results, and which require management to make difficult,
subjective and/or complex judgments. Critical accounting policies cover
accounting matters that are inherently uncertain because the future
resolution of such matters is unknown. The Company believes that
critical accounting policies include policy reserves, allowances for
credit losses, deferred policy acquisition costs, and valuation of
privately placed fixed maturities.
Policy Reserves
Life Insurance and Annuity Reserves - Life insurance and annuity policy
reserves with life contingencies are computed on the basis of estimated
mortality, investment yield, withdrawals, future maintenance and
settlement expenses, and retrospective experience rating premium
refunds. Annuity contract reserves without life contingencies are
established at the contractholder's account value.
Reinsurance - Policy reserves ceded to other insurance companies are
carried as a reinsurance receivable on the balance sheet. The cost of
reinsurance related to long-duration contracts is accounted for over
the life of the underlying reinsured policies using assumptions
consistent with those used to account for the underlying policies.
Reinsurance contracts do not relieve the Company from its obligations
to policyholders. Failure of reinsurers to honor their obligations
could result in losses to the Company. The Company evaluates the
financial condition of its reinsurers and monitors concentrations of
credit risk arising from similar geographic regions, activities, or
economic characteristics of the reinsurers to minimize its exposure to
significant losses from reinsurer insolvencies. In the normal course of
business, the Company seeks to limit its exposure to loss on any single
insured and to recover a portion of benefits paid by ceding risks to
other insurance enterprises under excess coverage and co-insurance
contracts. The Company retains a maximum of $3.5 million of coverage
per individual life.
Policy and Contract Claims - Policy and contract claims include
provisions for reported life and health claims in process of
settlement, valued in accordance with the terms of the related policies
and contracts, as well as provisions for claims incurred and unreported
based primarily on prior experience of the Company.
Allowance For Credit Losses
The Company maintains an allowance for credit losses at a level that,
in management's opinion, is sufficient to absorb credit losses on its
amounts receivable related to uninsured accident and health plan claims
paid on behalf of policyholders and premiums in course of collection,
and to absorb credit losses on its impaired loans. Management's
judgment is based on past loss experience and current and projected
economic conditions and extensive situational analysis of each
individual loan. The measurement of impaired loans is based upon the
fair value of the collateral.
Deferred Policy Acquisition Costs
Policy acquisition costs, which primarily consist of sales commissions
and costs associated with the Company's sales representatives related
to the production of new business, have been deferred to the extent
deemed recoverable. These costs are variable in nature and are
dependent upon sales volume. Deferred costs associated with the annuity
products are being amortized over the life of the contracts in
proportion to the emergence of gross profits. Retrospective adjustments
of these amounts are made when the Company revises its estimates of
current or future gross profits. Deferred costs associated with
traditional life insurance are amortized over the premium-paying period
of the related policies in proportion to premium revenues recognized.
Valuation Of Privately Placed Fixed Maturities
A large portion of the Company's invested assets is stated at fair
value in its consolidated balance sheets based on quoted market prices.
However, when such information is not available, fair value is
estimated. The estimated fair values of financial instruments have been
determined using available information and established valuation
methodologies. However, considerable judgment is required to interpret
market data to develop estimates of fair value. Accordingly, the
estimates presented are not necessarily indicative of the amounts the
Company could realize in a current market exchange. The use of
different market assumptions and/or estimation methodologies may have a
material effect on the estimated fair value amounts. The fair value of
approximately 39% of the Company's fixed maturity investments at
September 30, 2005 are valued using these type estimates.
To determine fair value for fixed maturities not actively traded, the
Company utilizes discounted cash flows calculated at current market
rates on investments of similar quality and term.
NEW ACCOUNTING PRONOUNCEMENTS
See Note 2 to the accompanying consolidated financial statements for a
discussion of new accounting pronouncements that the Company has
recently adopted or will be adopting in the future.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity refers to a company's ability to generate sufficient cash
flows to meet the needs of its operations. The Company manages its
operations to ensure stable, reliable and cost-effective sources of
cash flows to meet all of its obligations.
The principal sources of the Company's liquidity are premium and
annuity considerations, investment and fee income and investment
maturities and sales. The principal uses of the Company's liquidity
relate to benefit payments, claim payments, payments to policy and
contract holders in connection with surrenders and withdrawals,
purchase of investments, commissions and general and administrative
expenses.
The Company's operations have liquidity requirements that vary among
its principal product lines. Life insurance and pension plan reserves
are primarily long-term liabilities. Accident and health reserves,
including long-term disability, consist of both short-term and
long-term liabilities. Life insurance and pension plan reserve
requirements are usually stable and predictable, and are supported
primarily by long-term, fixed income investments. Accident and health
claim demands are stable and predictable but generally shorter term,
requiring greater liquidity.
Generally, the Company has met its operating requirements by
maintaining appropriate levels of liquidity in its investment portfolio
and utilizing cash flows from operations. Liquidity for the Company has
remained strong, as evidenced by significant amounts of short-term
investments and cash that totaled $909.4 million and $819.3 million as
of September 30, 2005 and December 31, 2004, respectively. In addition,
as of both September 30, 2005 and December 31, 2004, 97.5% of the
Company's bond portfolio carried an investment grade rating, thereby
providing significant liquidity to its overall investment portfolio.
Funds provided by premiums and fees, investment income and maturities
of investment assets are reasonably predictable and normally exceed
liquidity requirements for payment of claims, benefits and expenses.
However, since the timing of available funds cannot always be matched
precisely to commitments, imbalances may arise when demands for funds
exceed those on hand. Also, a demand for funds may arise as a result of
the Company taking advantage of current investment opportunities. The
sources of the funds that may be required in such situations include
the issuance of commercial paper and equity securities. Management
believes that the liquidity profile of its assets is sufficient to
satisfy the liquidity requirements of reasonably foreseeable scenarios.
The Company's financial strength provides the capacity and flexibility
to enable it to raise funds in the capital markets through the issuance
of commercial paper. The Company continues to be well capitalized, with
sufficient borrowing capacity to meet the anticipated needs of its
business. The Company had $94.3 million and $95.0 million of commercial
paper outstanding at September 30, 2005 and December 31, 2004,
respectively. The commercial paper has been given a rating of A-1+ by
Standard & Poor's Ratings Services and a rating of P-1 by Moody's
Investors Service, each being the highest rating available.
Capital resources provide protection for policyholders and financial
strength to support the underwriting of insurance risks and allow for
continued business growth. The amount of capital resources that may be
needed is determined by the Company's senior management and Board of
Directors, as well as by regulatory requirements. The allocation of
resources to new long-term business commitments is designed to achieve
an attractive return, tempered by considerations of risk and the need
to support the Company's existing business.
OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS
There have been no material changes to the Company's off-balance sheet
arrangements and contractual obligations since the filing of its Annual
Report on Form 10-K for the year ended December 31, 2004.
ITEM 3. QUANTITATIVE AND QUALITIVE DISCLOSURES ABOUT MARKET RISK
The Company's assets are purchased to fund future benefit payments to
its policyholders and contractholders. The primary risk of these assets
is exposure to rising interest rates. The Company's exposure to foreign
currency exchange rate fluctuations is minimal as only nominal foreign
investments are held.
To manage interest rate risk, the Company invests in assets that are
suited to the products that it sells. For products with fixed and
highly predictable benefit payments such as certificate annuities and
payout annuities, the Company invests in fixed income assets with cash
flows that closely match these products' liability cash flows. The
Company is then protected against interest rate changes, as any change
in the fair value of the assets will be offset by a similar change in
the fair value of the liabilities. For products with uncertain timing
of benefit payments such as portfolio annuities and life insurance, the
Company invests in fixed income assets with expected cash flows that
are earlier than the expected timing of the benefit payments.
The Company also manages risk from time to time with interest rate
derivatives such as interest rate caps that would pay it investment
income if interest rates rise above the level specified in the cap.
These derivatives are only used to reduce risk and are not used for
speculative purposes. At September 30, 2005, the Company did not have
any interest rate caps.
To manage foreign currency exchange risk, the Company uses currency
swaps to convert foreign currency back to United States dollars. These
swaps are purchased each time a foreign currency denominated asset is
purchased.
As a result of the coinsurance with funds withheld element of the
Company's reinsurance of business of CLAC's US branch, it has recorded
a derivative financial instrument to account for the different credit
risks and other characteristics of the reinsurance receivable and the
investment assets of CLAC that underlie that receivable. This
derivative is carried at fair value and changes in fair value are
included in net investment income as a non-cash charge or credit.
Therefore, the Company's operating results are exposed to volatility,
reflecting changes in the fair value of the underlying investment
portfolio, which is exposed to interest rate, market and credit risk.
As a result of this derivative, losses in the amounts of $8.5 million
and $7.2 million, net of policyholder related amounts and deferred
taxes, were included in net income for the three and nine-month periods
ended September 30, 2005, respectively.
ITEM 4. CONTROLS AND PROCEDURES
Based on their evaluation as of September 30, 2005, the Chief Executive
Officer and Chief Financial Officer have concluded that the Company's
disclosure controls and procedures are effective at the reasonable
assurance level in ensuring that information relating to the Company
and its subsidiaries which is required to be disclosed in reports filed
under the Securities Exchange Act of 1934 is (i) recorded, processed,
summarized and reported in a timely manner; and is (ii) accumulated and
communicated to the Company's senior management, including the
President and Chief Executive Officer and the Executive Vice President
and Chief Financial Officer, so that timely decisions may be made
regarding disclosure.
The Chief Executive Officer and Chief Financial Officer hereby confirm
that no significant changes in the Company's internal control over
financial reporting occurred during its most recent fiscal quarter that
have materially affected, or are reasonably likely to materially
affect, the registrant's internal control over financial reporting.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the Company or
any of its subsidiaries are a party or of which any of their property
is the subject.
ITEM 6. EXHIBITS
Index to Exhibits
Exhibit Number Title Page
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31.1 Rule 13a-14(a)/15d-14(a) Certification 27
31.2 Rule 13a-14(a)/15d-14(a) Certification 28
32 18 U.S.C. 1350 Certification 29
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY
By: /s/Glen R. Derback Date: November 10, 2005
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Glen R. Derback, Senior Vice President and Controller
(Duly authorized Officer and Chief Accounting Officer)