UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) [ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number 33-28976 IDS LIFE INSURANCE COMPANY (Exact name of registrant as specified in its charter) MINNESOTA 41-0823832 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) IDS TOWER 10, MINNEAPOLIS, MINNESOTA 55440-0534 (Address of principal executive offices) (Zip Code) (Registrant's telephone number, including area code) (612) 671-3131 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: None 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 Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [Not Applicable] THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTIONS I(1) (a) and (b) OF FORM 10-K AND IS THEREFORE FILING THIS FORM WITH THE PERMITTED ABBREVIATED NARRATIVE DISCLOSURE. PART I ITEM 1. BUSINESS IDS Life Insurance Company (the Company) is a stock life insurance company organized under the laws of the State of Minnesota. The Company is a wholly owned subsidiary of American Express Financial Corporation (AEFC), which is a wholly owned subsidiary of American Express Company. The Company serves residents of all states except New York. The Company is the fourteenth largest life insurance company in the United States, with consolidated assets at December 31, 1999 of $64.4 billion. IDS Life Insurance Company of New York and American Centurion Life Assurance Company are wholly owned subsidiaries of the Company and serve New York State residents. The Company also wholly owns American Enterprise Life Insurance Company, American Partners Life Insurance Company and American Express Corporation. The Company's principal products are deferred annuities and universal life insurance, which are issued primarily to individuals. It offers single premium and flexible premium deferred annuities on both a fixed and variable dollar basis. Immediate annuities are offered as well. The Company's insurance products include universal life (fixed and variable), whole life, single premium life and term products (including waiver of premium and accidental death benefits). The Company also markets disability income and long-term care insurance. The Company's fixed annuity contracts guarantee a minimum interest rate during the accumulation period (the time before annuity payments begin), although the Company has the option of paying a higher rate reflective of current market rates. The Company has also adopted a practice whereby the higher current rate is guaranteed for a specified period. The Company also offers fixed/variable annuity products offering the purchaser a choice among mutual funds with portfolios of equities, bonds, managed assets and/or short-term securities, and the Company's general account, as the underlying investment vehicles. With respect to funds applied to the variable portion of the annuity, the purchaser, rather than the Company, assumes the investment risks and receives the rewards inherent in the ownership of the underlying investments. At December 31, 1999, the Company had $52.4 billion of fixed and variable annuities in force, an increase of 13 percent from the prior year end. The Company's principal insurance product is the flexible-premium, adjustable-benefit universal life insurance policy. In this type of insurance policy, premium payments either accumulate interest in a fixed account or purchase units in one or more variable accounts. The policyholder has access to the cash surrender value in whole or in part after the first year. The size of the cash value of the fund can also be controlled by the policyholder by increasing or decreasing premiums, subject only to maintaining a required minimum to keep the policy in force. Monthly deductions from the cash value of the policy are made for the cost of insurance, expense charges and any policy riders. At December 31, 1999, the Company had $71.4 billion of fixed and variable universal life-type insurance in force, up 11 percent from December 31, 1998. Assets held in separate accounts which fund the variable annuity and variable life insurance products totaled $35.9 billion at December 31, 1999, a 32 percent increase from December 31, 1998. IDS Life Insurance Company, American Enterprise Life Insurance Company and American Partners Life Insurance Company are subject to comprehensive regulation by the Minnesota Department of Commerce (Insurance Division), the Indiana Department of Insurance and the Arizona Department of Insurance, respectively. IDS Life Insurance Company of New York and American Centurion Life Assurance Company are both subject to comprehensive regulation by the New York Department of Insurance. The laws of the other states in which the Company does business regulate such matters as the licensing of sales personnel and, in some cases, the marketing and contents of insurance policies and annuity contracts. The purpose of such regulation and supervision is primarily to protect the interests of policyholders. Recently there has been an increased focus on the variable annuity business by regulators. In the United States, the McCarran-Ferguson Act provides that the primary regulation of the insurance industry is left to the individual states. Typically, states regulate such matters as company licensing, agent licensing, cancellation or nonrenewal of policies, minimum health insurance policy benefits, life insurance cost disclosure, solicitation and replacement practices, unfair trade and claims practices, rates, forms, advertising, investment type and quality, minimum capital and surplus levels and changes in control. Virtually all states mandate participation in insurance guaranty associations, which assess insurance companies in order to fund claims of policyholders of insolvent insurance companies. In addition to state laws, the Company is affected by a variety of federal laws, and there is periodic federal interest in various aspects of the insurance industry including taxation of variable annuities and life insurance policies, solvency and accounting procedures, as well as the treatment of persons differently because of gender, with respect to terms, conditions, rates or benefits of an insurance contract. New federal regulation in any of these areas could potentially have an adverse effect upon the Company. As a distributor of variable contracts, the Company is registered as a broker-dealer and is a member of the National Association of Securities Dealers, Inc. As the investment manager for various investment companies, the Company is registered as an investment advisor under applicable federal requirements. The insurance and annuity business is highly competitive and the Company's competitors consist of both stock and mutual insurance companies and other financial institutions. Competitive factors applicable to the business of the Company include the interest rates credited to its products, the charges deducted from the cash values of such products, the financial strength of the organization and the services provided to policyholders. ITEM 2. PROPERTIES The Company occupies office space in Minneapolis, Minnesota, which is leased by its parent, AEFC. The Company reimburses AEFC for rent based on direct and indirect allocation methods. IDS Life Insurance Company of New York and American Centurion Life Assurance Company rent office space in Albany, New York. Facilities occupied by the Company and its subsidiaries are believed to be adequate for the purposes for which they are used and are well maintained. ITEM 3. LEGAL PROCEEDINGS A number of lawsuits have been filed against life and health insurers in jurisdictions in which the Company and AEFC do business involving insurers' sales practices, alleged agent misconduct, failure to properly supervise agents, and other matters. The Company and AEFC, like other life and health insurers, from time to time are involved in such litigation. On December 13, 1996, an action entitled Lesa Benacquisto and Daniel Benacquisto vs. IDS Life Insurance Company and American Express Financial Corporation was commenced in Minnesota state court. The action is brought by individuals who replaced an existing Company insurance policy with a new Company policy. The plaintiffs purport to represent a class consisting of all persons who replaced existing Company policies with new policies from and after January 1, 1985. The complaint puts at issue various alleged sales practices and misrepresentations, alleged breaches of fiduciary duties and alleged violations of consumer fraud statutes. The Company and AEFC filed an answer to the Complaint on February 18, 1997, denying the allegations. A second action, entitled Arnold Mork, Isabella Mork, Ronald Melchart and Susan Melchart vs. IDS Life Insurance Company and American Express Financial Corporation was commenced in the same court on March 21, 1997. In addition to claims that are included in the Benacquisto lawsuit, the second action includes an allegation of improper replacement of an existing IDS Life annuity contract. A subsequent class action, Richard Thoreson and Elizabeth Thoresen vs. AEFC, American Partners Life Insurance Company, American Enterprise Life Insurance Company, American Centurion Life Assurance Company, IDS Life Insurance Company and IDS Life Insurance Company of New York, was filed in the same court on October 13, 1998 alleging that the sale of annuities in tax-deferred contributory retirement investment plans (e.g. IRA's) was done through deceptive marketing practices, which the Company denies. Plaintiffs in each of the above actions seek damages in an unspecified amount and also seek to establish a claims resolution facility for the determination of individual issues. The Company is included as a party to a preliminary settlement of all three class action lawsuits. The Company believes this approach will put these cases behind it and provide a fair outcome for the Company's clients. The Company's decision to settle does not include any admission of wrongdoing. The settlement costs allocated to the Company are included in the accompanying 1999 statement of income and did not have a material impact on the Company's consolidated financial position or results from operations. Further, the Company does not anticipate that any other lawsuits in which the Company is a defendant will have a material adverse effect on the Company's financial condition. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Not applicable. ITEM 6. SELECTED FINANCIAL DATA Item omitted pursuant to General Instructions I(2) (a) of Form 10-K. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS 1999 Compared to 1998: Consolidated net income increased 18 percent to $636 million in 1999, compared to $540 million in 1998. Earnings growth resulted primarily from increases in management fees and policyholder and contractholder charges. These increases reflect higher average insurance and annuities in force during 1999. Consolidated income before income taxes totaled $904 million in 1999, compared with $776 million in 1998. Total premiums and investment contract deposits received increased to $5.0 billion in 1999, compared with $4.4 billion in 1998. This increase is primarily due to an increase in variable annuity deposits in 1999. Total revenues increased to $3.1 billion in 1999, compared with $3.0 billion in 1998. The increase is primarily due to increased policyholder and contractholder charges and management fees. Net investment income, the largest component of revenues, decreased slightly from the prior year, reflecting decreases in investments owned and investment yields. Policyholder and contractholder charges, which consist primarily of cost of insurance charges on universal life-type policies, increased 7 percent to $412 million in 1999, compared with $384 million in 1998. This increase reflects increased total life insurance in force, which grew 10 percent to $89 billion at December 31, 1999. Net realized gain on investments increased to $27 million in 1999, compared to $7 million in 1998. The increase was primarily due to the sale of available for sale fixed maturity investments at a gain as well as a decrease in the allowance for mortgage loan losses based on management's regular evaluation of allowance adequacy. Management and other fees increased 18 percent to $473 million in 1999, compared with $401 million in 1998. This is primarily due to an increase in separate account assets, which grew 31 percent to $35.9 billion at December 31, 1999, due to market appreciation and sales. The Company provides investment management services for mutual funds used as investment options for variable annuities and variable life insurance. The Company also receives a mortality and expense risk fee from the separate accounts. Total benefits and expenses decreased slightly to $2.2 billion in 1999. The largest component of expenses, interest credited to policyholder accounts for universal life-type insurance and investment contracts, decreased to $1.2 billion, reflecting a decrease in fixed annuities in force. Amortization of deferred policy acquisition costs decreased to $333 million, compared to $383 million in 1998. This decrease was due primarily to the impact of changing prospective separate account investment performance assumptions. Other insurance and operating expenses increased 17 percent to $335 million in 1999, compared to $287 million in 1998. This increase is primarily a result of business growth and technology costs related to growth initiatives. 1998 Compared to 1997: Consolidated net income increased 14 percent to $540 million in 1998, compared to $474 million in 1997. Earnings growth resulted primarily from increases in management fees and policyholder and contractholder charges. These increases reflect higher average insurance and annuities in force during 1998. Consolidated income before income taxes totaled $776 million in 1998, compared with $681 million in 1997. Total premiums and investment contract deposits received decreased to $4.4 billion in 1998, compared with $5.2 billion in 1997. This decrease is primarily due to a decrease in sales of fixed annuities in 1998, reflecting the low interest rate environment. Total revenues increased to $3.0 billion in 1998, compared with $2.9 billion in 1997. The increase is primarily due to increased policyholder and contractholder charges and management fees. Net investment income, the largest component of revenues, decreased slightly from the prior year, reflecting slight decreases in investments owned and investment yields. Policyholder and contractholder charges, which consist primarily of cost of insurance charges on universal life-type policies, increased 12 percent to $384 million in 1998, compared with $342 million in 1997. This increase reflects increased total life insurance in force, which grew 8 percent to $81 billion at December 31, 1998. Management and other fees increased 18 percent to $401 million in 1998, compared with $341 million in 1997. This is primarily due to an increase in separate account assets, which grew 18 percent to $27.3 billion at December 31, 1998, due to market appreciation and sales. The Company provides investment management services for the mutual funds used as investment options for variable annuities and variable life insurance. The Company also receives a mortality and expense risk fee from the separate accounts. Total benefits and expenses increased slightly to $2.2 billion in 1998. The largest component of expenses, interest credited to policyholder accounts for universal life-type insurance and investment contracts, decreased to $1.3 billion, reflecting a decrease in fixed annuities in force and lower interest rates. Amortization of deferred policy acquisition costs increased to $383 million, compared to $323 million in 1997. This increase was due primarily to increased aggregate amounts in force, as well as accelerating amortization to reflect actual lapse experience on certain fixed annuities. Risk Management The sensitivity analysis of two different tests of market risk discussed below estimates the effects of hypothetical sudden and sustained changes in the applicable market conditions on the ensuing year's earnings based on year-end positions. The market changes, assumed to occur as of year-end, are a 100 basis point increase in market interest rates and a 10% decline in equity prices. Computations of the prospective effects of hypothetical interest rate and equity price changes are based on numerous assumptions, including relative levels of market interest rates and equity prices, as well as the levels of assets and liabilities. The hypothetical changes and assumptions will be different from what actually occurs in the future. Furthermore, the computations do not anticipate actions that may be taken by management if the hypothetical market changes actually occurred over time. As a result, actual earnings effects in the future will differ from those quantified below. The Company primarily invests in fixed income securities over a broad range of maturities for the purpose of providing fixed annuity clients with a competitive rate of return on their investments while minimizing risk, and to provide a dependable and targeted spread between the interest rate earned on investments and the interest rate credited to contractholders' accounts. The Company does not invest in securities to generate trading profits. The Company has an investment committee that holds regularly scheduled meetings and, when necessary, special meetings. At these meetings, the committee reviews models projecting different interest rate scenarios and their impact on profitability. The objective of the committee is to structure the investment security portfolio based upon the type and behavior of products in the liability portfolio so as to achieve targeted levels of profitability. Rates credited to contractholders' accounts are generally reset at shorter intervals than the maturity of underlying investments. Therefore, margins may be negatively impacted by increases in the general level of interest rates. Part of the committee's strategy includes the purchase of some types of derivatives, such as interest rate caps, swaps and floors, for hedging purposes. These derivatives protect margins by increasing investment returns if there is a sudden and severe rise in interest rates, thereby mitigating the impact of an increase in rates credited to contractholders' accounts. The negative effect on the Company's pretax earnings of a 100 basis point increase in interest rates, which assumes repricings and customer behavior based on the application of proprietary models to the book of business at December 31, 1999, would be approximately $11 million. On a certain annuity product, the interest is credited to contractholders' accounts based upon the relative change in a major stock market index between the beginning and end of the product's term. As a means of hedging the Company's obligation under the provisions of this product, the committee's strategy is to purchase and write options on the major stock market index. The amount of the fee income the Company receives is based upon the daily market value of the separate account assets. As a result, the Company's fee income would be negatively impacted by a decline in the equity markets. Another part of the committee's strategy is to enter into index option collars (combination of puts and calls) for hedging purposes. These derivatives protect fee income by providing option income when there is a significant decline in the equity markets. The Company finances the cost of this protection through selling a portion of the upside potential from an increasing market through written options. The negative effect on the Company's pretax earnings of the 10% decline in equity prices would be approximately $45 million based on assets under management and the index options as of December 31, 1999. Liquidity and Capital Resources The liquidity requirements of the Company are met by funds provided by premiums, investment income, proceeds from sales of investments as well as maturities and periodic repayments of investment principal. The primary uses of funds are policy benefits, commissions and operating expenses, policy loans, dividends and investment purchases. The Company has available lines of credit with its parent aggregating $200 million ($100 million committed and $100 million uncommitted). The line of credit is used strictly as a short-term source of funds. Borrowings outstanding were $50,000 uncommitted at December 31, 1999. At December 31, 1999, outstanding reverse repurchase agreements totaled $130 million. At December 31, 1999, investments in fixed maturities comprised 81 percent of the Company's total invested assets. Of the fixed maturity portfolio, approximately 31 percent is invested in GNMA, FNMA and FHLMC mortgage-backed securities which are considered AAA/Aaa quality. At December 31, 1999, approximately 14 percent of the Company's investments in fixed maturities were below investment grade bonds. These investments may be subject to a higher degree of risk than the investment grade issues because of the borrower's generally greater sensitivity to adverse economic conditions, such as recession or increasing interest rates, and in certain instances, the lack of an active secondary market. Expected returns on below investment grade bonds reflect consideration of such factors. The Company has identified those fixed maturities for which a decline in fair value is determined to be other than temporary, and has written them down to fair value with a charge to earnings. At December 31, 1999, net unrealized depreciation on fixed maturities held to maturity included $97 million of gross unrealized appreciation and $147 million of gross unrealized depreciation. Net unrealized depreciation on fixed maturities available for sale included $71 million of gross unrealized appreciation and $725 million of gross unrealized depreciation. At December 31, 1999, the Company had an allowance for losses for mortgage loans totaling $28 million and for real estate investments totaling $nil. The economy and other factors have caused a number of insurance companies to go under regulatory supervision. This circumstance has resulted in assessments by state guaranty associations to cover losses to policyholders of insolvent or rehabilitated companies. Some assessments can be partially recovered through a reduction in future premium taxes in certain states. The Company established an asset for guaranty association assessments paid to those states allowing a reduction in future premium taxes over a reasonable period of time. The asset is being amortized as premium taxes are reduced. The Company has also estimated the potential effect of future assessments on the Company's financial position and results of operations and has established a reserve for such potential assessments. The Company has adopted Statement of Position 97-3 providing guidance when an insurer should recognize a liability for guaranty fund assessments. The SOP is effective for fiscal years beginning after December 15, 1998. Adoption did not have a material impact on the Company's results of operations or financial condition. In the first quarter of 2000, the Company paid a $70 million dividend to its parent. In 1999, dividends paid to its parent were $350 million. The National Association of Insurance Commissioners has established risk-based capital standards to determine the capital requirements of a life insurance company based upon the risks inherent in its operations. These standards require the computation of a risk-based capital amount which is then compared to a company's actual total adjusted capital. The computation involves applying factors to various statutory financial data to address four primary risks: asset default, adverse insurance experience, interest rate risk and external events. These standards provide for regulatory attention when the percentage of total adjusted capital to authorized control level risk-based capital is below certain levels. As of December 31, 1999, the Company's total adjusted capital was well in excess of the levels requiring regulatory attention. Year 2000 Issue The Company is a wholly owned subsidiary of American Express Financial Corporation (AEFC), which is a wholly owned subsidiary of American Express Company (American Express). All of the major systems used by the Company are maintained by AEFC and are utilized by multiple subsidiaries and affiliates of AEFC. American Express coordinated the Year 2000 (Y2K) efforts on behalf of all of its businesses and subsidiaries. Representatives of AEFC participated in these efforts. The Company, to date, has not experienced any material systems failures related to the Y2K rollover. American Express' and AEFC's remediation plan for the Y2K issue is discussed in detail in the Company's 1998 10-K report and 1999 10-Q reports. American Express and AEFC will continue their Y2K monitoring and address any issues that may arise from internal systems or those of third parties. American Express' and AEFC's cumulative costs since inception of the Y2K initiative were $505 million and $67.7 million, respectively, through December 31, 1999, and are expected to be approximately $10 million and $0.8 million, respectively, in 2000. The majority of these costs are managed by and included in American Express' Corporate and Other segment, as most remediation efforts are related to systems that are maintained by the American Express Technologies organization. Costs related to Y2K have not had a material adverse effect on the Company's results of operations or financial condition. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Items required under this section are included in the Mangement's Discussion and Analysis of financial condition and results of operations under the section titled risk management. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 1. Financial Statements and Schedules Required under Regulation S-X. Index to financial statements The following consolidated financial statements of IDS Life Insurance Company are included in Item 8: Report of Independent Auditors 18 Consolidated Balance Sheets at December 31, 1999 and 1998 19-20 Consolidated Statements of Income for the years ended December 31, 1999, 1998 and 1997 21 Consolidated Statements of Stockholder's Equity for the years ended December 31, 1999, 1998 and 1997 22-23 Consolidated Statements of Cash Flows for the years ended December 31, 1999, 1998 and 1997 24-25 Notes to Consolidated Financial Statements 26-43 All information on schedules to the consolidated financial statements required by Article 7 of Regulation S-X is included in the consolidated financial statements or is not required. Therefore, all schedules have been omitted. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Item omitted pursuant to General Instructions I(2) (c) of Form 10-K. ITEM 11. EXECUTIVE COMPENSATION Item omitted pursuant to General Instructions I(2) (c) of Form 10-K. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Item omitted pursuant to General Instructions I(2) (c) of Form 10-K. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Item omitted pursuant to General Instructions I(2) (c) of Form 10-K. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) (1) Financial Statements See Index to Financial Statements and Financial Statement Schedules on page 12. (2) Financial Statement Schedules See index to Financial Statements and Financial Statement Schedules. All information on schedules to the consolidated financial statements required by Article 7 of Regulation S-X is included in the consolidated financial statements or is not required. Therefore, all schedules have been omitted. (3) Exhibits 3.1 Copy of Certificate of Incorporation of IDS Life Insurance Company filed electronically as Exhibit 3.1 to Post-Effective Amendment No. 5 to Registration Statement No. 33-28976 is incorporated herein by reference. 3.2 Copy of the Amended By-laws of IDS Life Insurance Company filed electronically as Exhibit 3.2 to Post-Effective Amendment No. 5 to Registration Statement No. 33-28976 is incorporated herein by reference. 3.3 Copy of Resolution of the Board of Directors of IDS Life Insurance Company, dated May 5, 1989, establishing IDS Life Account MGA filed electronically as Exhibit 3.3 to Post-Effective Amendment No. 5 to Registration Statement No. 33-28976 is incorporated herein by reference. 4.1 Copy of Non-tax qualified Group Annuity Contract, Form 30363C, filed electronically as Exhibit 4.1 to Post-Effective Amendment No. 5 to Registration Statement No. 33-28976 is incorporated herein by reference. 4.2 Copy of Non-tax qualified Group Annuity Certificate, Form 30360C, filed electronically as Exhibit 4.2 to Post-Effective Amendment No. 5 to Registration Statement No. 33-28976 is incorporated herein by reference. 4.3 Copy of Endorsement No. 30340C-GP to the Group Annuity Contract filed electronically as Exhibit 4.3 to Post-Effective Amendment No. 5 to Registration Statement No. 33-28976 is incorporated herein by reference. 4.4 Copy of Endorsement No. 30340C to the Group Annuity Certificate filed electronically as Exhibit 4.4 to Post-Effective Amendment No. 5 to Registration Statement No. 33-28976 is incorporated herein by reference. 4.5 Copy of Tax qualified Group Annuity Contract, Form 30369C, filed electronically as Exhibit 4.5 to Post-Effective Amendment No. 10 to Registration Statement No. 33-28976 is incorporated herein by reference. 4.6 Copy of Tax qualified Group Annuity Certificate, Form 30368C, filed electronically as Exhibit 4.6 to Post-Effective Amendment No. 10 to Registration Statement No. 33-28976 is incorporated herein by reference. 4.7 Copy of Group IRA Annuity Contract, Form 30372C, filed electronically as Exhibit 4.7 to Post-Effective Amendment No. 10 to Registration Statement No. 33-28976 is incorporated herein by reference. 4.8 Copy of Group IRA Annuity Certificate, Form 30371C, filed electronically as Exhibit 4.8 to Post-Effective Amendment No. 10 to Registration Statement No. 33-28976 is incorporated herein by reference. 4.9 Copy of Non-tax qualified Individual Annuity Contract, Form 30365D, filed electronically as Exhibit 4.9 to Post-Effective Amendment No. 10 to Registration Statement No. 33-28976 is incorporated herein by reference. 4.10 Copy of Endorsement No. 30379 to the Individual Annuity Contract, filed electronically as Exhibit 4.10 to Post Effective Amendment No. 10 to Registration Statement No. 33-28976 is incorporated herein by reference. 4.11 Copy of Tax qualified Individual Annuity Contract, Form 30370C, filed electronically as Exhibit 4.11 to Post-Effective Amendment No. 10 to Registration Statement No. 33-28976 is incorporated herein by reference. 4.12 Copy of Individual IRA Annuity Contract, Form 30373C, filed electronically as Exhibit 4.12 to Post-Effective Amendment No. 10 to Registration Statement No. 33-28976 is incorporated herein by reference. 4.13 Copy of Endorsement No. 33007 filed electronically as Exhibit 4.13 to Post-Effective Amendment No. 12 to Registration Statement No. 33-28976 is incorporated herein by reference. 4.14 Copy of Group Annuity Contract, Form 30363D, filed electronically as Exhibit 4.1 to Post-Effective Amendment No. 2 to Registration Statement No. 33-50968 is incorporated herein by reference. 4.15 Copy of Group Annuity Certificate, Form 30360D, filed electronically as Exhibit 4.2 to Post-Effective Amendment No. 2 to Registration Statement No. 33-50968 is incorporated herein by reference. 4.16 Form of Deferred Annuity Contract, Form 30365E, filed electronically as Exhibit 4.3 to Post-Effective Amendment No. 2 to Registration Statement No. 33-50968 is incorporated herein by reference. 4.17 Copy of Group Deferred Variable Annuity Contract, Form 34660, filed electronically as Exhibit 4.1 to Post-Effective Amendment No. 2 to Registration Statement No. 33-48701 is incorporated herein by reference. 4.18 Copy of Non-tax qualified Group Annuity Contract, Form 33111, filed electronically as Exhibit 4.1 to Registration Statement No. 333-42793 is incorporated herein by reference. 4.19 Copy of Non-tax qualified Group Annuity Certificate, Form 33114, filed electronically as Exhibit 4.2 to Registration Statement No. 333-42793 is incorporated herein by reference. 4.20 Copy of Tax qualified Group Annuity Contract, Form 33112, filed electronically as Exhibit 4.3 to Registration Statement No. 333-42793 is incorporated herein by reference. 4.21 Copy of Tax qualified Group Annuity Certificate, Form 33115, filed electronically as Exhibit 4.4 to Registration Statement No. 333-42793 is incorporated herein by reference. 4.22 Copy of Group IRA Annuity Contract, Form 33113, filed electronically as Exhibit 4.5 to Registration Statement No. 333-42793 is incorporated herein by reference. 4.23 Copy of Group IRA Annuity Certificate, Form 33116, filed electronically as Exhibit 4.6 to Registration Statement No. 333-42793 is incorporated herein by reference. 4.24 Copy of Non-tax qualified Individual Annuity Contract, Form 30484, filed electronically as Exhibit 4.7 to Post-Effective Amendment No. 1 to Registration Statement No. 333-42793 is incorporated herein by reference. 4.25 Copy of Tax qualified Individual Annuity Contract, Form 30485, filed electronically as Exhibit 4.8 to Post-Effective Amendment No. 1 to Registration Statement No. 333-42793 is incorporated herein by reference. 4.26 Copy of Individual IRA Contract, Form 30486, filed electronically as Exhibit 4.9 to Post-Effective Amendment No. 1 to Registration Statement No. 333-42793 is incorporated herein by reference. 21. Copy of List of Subsidiaries filed electronically as Exhibit 21 to Post-Effective Amendment No. 7 to Registration Statement No. 33-28976 is herein incorporated by reference. 27. Financial data schedule is filed electronically herewith. (b) Reports on Form 8-K filed in the fourth quarter of 1999 No reports on Form 8-K were required to be filed by the Company for the quarter ended December 31, 1999. SIGNATURES 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. IDS LIFE INSURANCE COMPANY Registrant 3/12/2000 By /s/ Richard W. Kling Date Richard W. Kling, President and Chief Executive Officer 3/12/2000 By /s/ Philip C. Wentzel Date Philip C. Wentzel, Vice President and Controller Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been duly signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. 3/12/2000 By /s/ David R. Hubers Date David R. Hubers, Director 3/12/2000 By /s/ Richard W. Kling Date Richard W. Kling, President and Chief Executive Officer 3/12/2000 By /s/ Paul F. Kolkman Date Paul F. Kolkman, Executive Vice President 3/12/2000 By /s/ James A. Mitchell Date James A. Mitchell, Chairman of the Board 3/12/2000 By /s/ Paula R. Meyer Date Paula R. Meyer, Executive Vice President, Assured Assets 3/12/2000 By /s/ Barry J. Murphy Date Barry J. Murphy, Executive Vice President, Client Service Report of Independent Auditors The Board of Directors IDS Life Insurance Company We have audited the accompanying consolidated balance sheets of IDS Life Insurance Company (a wholly-owned subsidiary of American Express Financial Corporation) as of December 31, 1999 and 1998, and the related consolidated statements of income, stockholder's equity and cash flows for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of IDS Life Insurance Company at December 31, 1999 and 1998, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. /s/ KPMG LLP KPMG LLP February 3, 2000 Minneapolis, Minnesota IDS LIFE INSURANCE COMPANY CONSOLIDATED BALANCE SHEETS December 31, ($ thousands) ASSETS 1999 1998 - - Investments: Fixed maturities: Held to maturity, at amortized cost (fair value: 1999, $7,105,743; 1998, $8,420,035) $ 7,156,292 $ 7,964,114 Available for sale, at fair value (amortized cost: 1999, $13,703,137; 1998, $13,344,949) 13,049,549 13,613,139 ------------ ------------ 20,205,841 21,577,253 Mortgage loans on real estate 3,606,377 3,505,458 Policy loans 561,834 525,431 Other investments 506,797 366,604 ------------- ------------ Total investments 24,880,849 25,974,746 Cash and cash equivalents 32,333 22,453 Amounts recoverable from reinsurers 327,168 262,260 Amounts due from brokers 145 327 Other accounts receivable 48,578 47,963 Accrued investment income 343,449 366,574 Deferred policy acquisition costs 2,665,175 2,496,352 Deferred income taxes, net 216,020 -- Other assets 33,089 30,487 Separate account assets 35,894,732 27,349,401 ----------- ------------ Total assets $64,441,538 $56,550,563 =========== =========== IDS LIFE INSURANCE COMPANY CONSOLIDATED BALANCE SHEETS (continued) December 31, ($ thousands, except share amounts) LIABILITIES AND STOCKHOLDER'S EQUITY 1999 1998 -- -- Liabilities: Future policy benefits: Fixed annuities $20,552,159 $21,172,303 Universal life-type insurance 3,391,203 3,343,671 Traditional life insurance 226,842 225,306 Disability income and long-term care insurance 811,941 660,320 Policy claims and other policyholders' funds 24,600 70,309 Deferred income taxes, net -- 16,930 Amounts due to brokers 148,112 195,406 Other liabilities 579,678 410,285 Separate account liabilities 35,894,732 27,349,401 ------------ ------------ Total liabilities 61,629,267 53,443,931 ------------ ------------ Commitments and contingencies Stockholder's equity: Capital stock, $30 par value per share; 100,000 shares authorized, issued and outstanding 3,000 3,000 Additional paid-in capital 288,327 288,327 Accumulated other comprehensive (loss) income, net of tax: Net unrealized securities (losses) gains (411,230) 169,584 Retained earnings 2,932,174 2,645,721 ------------- ------------- Total stockholder's equity 2,812,271 3,106,632 ------------- ------------- Total liabilities and stockholder's equity $64,441,538 $56,550,563 =========== =========== See accompanying notes. IDS LIFE INSURANCE COMPANY CONSOLIDATED STATEMENTS OF INCOME Years ended December 31, ($ thousands) 1999 1998 1997 ----------- ----------- ---------- Revenues: Premiums: Traditional life insurance $ 53,790 $ 53,132 $ 52,473 Disability income and long-term care insurance 201,637 176,298 154,021 ---------- ---------- ---------- Total premiums 255,427 229,430 206,494 Policyholder and contractholder charges 411,994 383,965 341,726 Management and other fees 473,108 401,057 340,892 Net investment income 1,919,573 1,986,485 1,988,389 Net realized gain on investments 26,608 6,902 860 ----------- ------------ ------------ Total revenues 3,086,710 3,007,839 2,878,361 --------- --------- --------- Benefits and expenses: Death and other benefits: Traditional life insurance 29,819 29,835 28,951 Universal life-type insurance and investment contracts 118,561 108,349 92,814 Disability income and long-term care insurance 30,622 27,414 22,333 Increase in liabilities for future policy benefits: Traditional life insurance 7,311 6,052 3,946 Disability income and long-term care insurance 87,620 73,305 63,631 Interest credited on universal life-type insurance and investment contracts 1,240,575 1,317,124 1,386,448 Amortization of deferred policy acquisition costs 332,705 382,642 322,731 Other insurance and operating expenses 335,180 287,326 276,596 ---------- ---------- ---------- Total benefits and expenses 2,182,393 2,232,047 2,197,450 --------- --------- --------- Income before income taxes 904,317 775,792 680,911 Income taxes 267,864 235,681 206,664 ---------- ---------- ---------- Net income $ 636,453 $ 540,111 $ 474,247 ========== ========== ========== See accompanying notes. IDS LIFE INSURANCE COMPANY CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY Three years ended December 31, 1999 ($ thousands) Accumulated Other Total Additional Comprehensive Stockholder's Capital Paid-In (Loss) Income, Retained Equity Stock Capital Net of Tax Earnings Balance, December 31, 1996 $ 2,444,080 $ 3,000 $ 283,615 $ 86,102 $2,071,363 Comprehensive income: Net income 474,247 -- -- -- 474,247 Unrealized holding gains arising during the year, net of deferred policy acquisition costs of ($7,714) and taxes of ($75,215) 139,686 -- -- 139,686 -- Reclassification adjustment for losses included in net income, net of tax of ($308) -- -- 571 571 -- Other comprehensive income 140,257 -- -- 140,257 -- Comprehensive income 614,504 -- -- -- -- Capital contribution from parent 7,232 -- 7,232 -- -- Cash dividends to parent (200,000) -- -- -- (200,000) _____________________________________________________________________________ Balance, December 31, 1997 2,865,816 3,000 290,847 226,359 2,345,610 Comprehensive income: Net income 540,111 -- -- -- 540,111 Unrealized holding losses arising during the year, net of deferred policy acquisition costs of $6,333 and taxes of $32,826 (60,964) -- -- (60,964) -- Reclassification adjustment for losses included in net income, net of tax of ($2,254) 4,189 -- -- 4,189 ------------- -------- Other comprehensive loss (56,775) -- -- (56,775) -- Comprehensive income 483,336 -- -- -- -- Other changes (2,520) -- (2,520) -- -- Cash dividends to parent (240,000) -- -- -- (240,000) ___________ _________ _______ __________ __________ Balance, December 31, 1998 3,106,632 3,000 288,327 169,584 2,645,721 IDS LIFE INSURANCE COMPANY CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY (continued) Three years ended December 31, 1999 ($ thousands) Accumulated Other Total Additional Comprehensive Stockholder's Capital Paid-In (Loss) Income, Retained Equity Stock Capital Net of Tax Earnings Balance, December 31, 1998 $3,106,632 $3,000 $288,327 $169,584 $2,645,721 Comprehensive income: Net income 636,453 -- -- -- 636,453 Unrealized holding losses arising during the year, net of deferred policy acquisition costs of $28,444 and taxes of $304,936 (566,311) -- -- (566,311) -- Reclassification adjustment for gains included in net income, net of tax of $7,810 (14,503) -- -- (14,503) -- ----------------- ---------------- Other comprehensive loss (580,814) -- -- (580,814) -- Comprehensive income 55,639 -- -- -- -- Cash dividends to parent (350,000) -- -- -- (350,000) --------------------------------------------------------------------------- Balance, December 31, 1999 $2,812,271 $3,000 $288,327 $(411,230) $2,932,174 ============================================================================ See accompanying notes. IDS LIFE INSURANCE COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS Years ended December 31, ($ thousands) 1999 1998 1997 ------------ ----------- --------- Cash flows from operating activities: Net income $ 636,453 $ 540,111 $ 474,247 Adjustments to reconcile net income to net cash provided by operating activities: Policy loans, excluding universal life-type insurance: Issuance (56,153) (53,883) (54,665) Repayment 54,105 57,902 46,015 Change in amounts recoverable from reinsurers (64,908) (56,544) (47,994) Change in other accounts receivable (615) (10,068) 6,194 Change in accrued investment income 23,125 (9,184) (14,077) Change in deferred policy acquisition costs, net (140,379) (10,443) (156,486) Change in liabilities for future policy benefits for traditional life, disability income and long-term care insurance 153,157 138,826 112,915 Change in policy claims and other policyholders' funds (45,709) 1,964 (15,289) Deferred income tax provision (benefit) 79,796 (19,122) 19,982 Change in other liabilities 169,395 64,902 13,305 (Accretion of discount), amortization of premium, net (17,907) 9,170 (5,649) Net realized gain on investments (26,608) (6,902) (860) Policyholder and contractholder charges, non-cash (175,059) (172,396) (160,885) Other, net (5,324) 10,786 7,161 ----------- ----------- ----------- Net cash provided by operating activities $ 583,369 $ 485,119 $ 223,914 --------- --------- --------- IDS LIFE INSURANCE COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS (continued) Years ended December 31, ($ thousands) 1999 1998 1997 ------------- ------------- ----------- Cash flows from investing activities: Fixed maturities held to maturity: Purchases $ (3,030) $ (1,020) $ (1,996) Maturities, sinking fund payments and calls 741,949 1,162,731 686,503 Sales 66,547 236,963 236,761 Fixed maturities available for sale: Purchases (3,433,128) (4,100,238) (3,160,133) Maturities, sinking fund payments and calls 1,442,507 2,967,311 1,206,213 Sales 1,691,389 278,955 457,585 Other investments, excluding policy loans: Purchases (657,383) (555,647) (524,521) Sales 406,684 579,038 335,765 Change in amounts due from brokers 182 8,073 2,647 Change in amounts due to brokers (47,294) (186,052) 119,471 ------------- ------------ ----------- Net cash provided by (used in) investing activities 208,423 390,114 (641,705) ----------- ----------- ----------- Cash flows from financing activities: Activity related to universal life-type insurance and investment contracts: Considerations received 2,031,630 1,873,624 2,785,758 Surrenders and other benefits (3,669,759) (3,792,612) (3,736,242) Interest credited to account balances 1,240,575 1,317,124 1,386,448 Universal life-type insurance policy loans: Issuance (102,239) (97,602) (84,835) Repayment 67,881 67,000 54,513 Capital transaction with parent -- -- 7,232 Dividends paid (350,000) (240,000) (200,000) ----------- ----------- ----------- Net cash (used in) provided by financing activities (781,912) (872,466) 212,874 ------------ ------------ ----------- Net increase (decrease) in cash and cash equivalents 9,880 2,767 (204,917) Cash and cash equivalents at beginning of year 22,453 19,686 224,603 ------------ ------------ ------------ Cash and cash equivalents at end of year $ 32,333 $ 22,453 $ 19,686 ============ ============ ============ See accompanying notes IDS LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ($ thousands) 1. Summary of significant accounting policies Nature of business IDS Life Insurance Company (the Company) is a stock life insurance company organized under the laws of the State of Minnesota. The Company is a wholly-owned subsidiary of American Express Financial Corporation (AEFC), which is a wholly owned subsidiary of American Express Company. The Company serves residents of all states except New York. IDS Life Insurance Company of New York is a wholly owned subsidiary of the Company and serves New York State residents. The Company also wholly owns American Enterprise Life Insurance Company, American Centurion Life Assurance Company, American Partners Life Insurance Company and American Express Corporation. The Company's principal products are deferred annuities and universal life insurance, which are issued primarily to individuals. It offers single premium and flexible premium deferred annuities on both a fixed and variable dollar basis. Immediate annuities are offered as well. The Company's insurance products include universal life (fixed and variable), whole life, single premium life and term products (including waiver of premium and accidental death benefits). The Company also markets disability income and long-term care insurance. Basis of presentation The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States which vary in certain respects from reporting practices prescribed or permitted by state insurance regulatory authorities (see Note 4). 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 reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Investments Fixed maturities that the Company has both the positive intent and the ability to hold to maturity are classified as held to maturity and carried at amortized cost. All other fixed maturities and all marketable equity securities are classified as available for sale and carried at fair value. Unrealized gains and losses on securities classified as available for sale are reported as a separate component of accumulated other comprehensive (loss) income, net of the related deferred policy acquisition costs effect and deferred taxes. Realized investment gain or loss is determined on an identified cost basis. Prepayments are anticipated on certain investments in mortgage-backed securities in determining the constant effective yield used to recognize interest income. Prepayment estimates are based on information received from brokers who deal in mortgage-backed securities. 1. Summary of significant accounting policies (continued) Mortgage loans on real estate are carried at amortized cost less reserves for mortgage loan losses. The estimated fair value of the mortgage loans is determined by a discounted cash flow analysis using mortgage interest rates currently offered for mortgages of similar maturities. Impairment of mortgage loans is measured as the excess of a loan's recorded investment over its present value of expected principal and interest payments discounted at the loan's effective interest rate, or the fair value of collateral. The amount of the impairment is recorded in a reserve for mortgage loan losses. The reserve for mortgage loan losses is maintained at a level that management believes is adequate to absorb estimated losses in the portfolio. The level of the reserve account is determined based on several factors, including historical experience, expected future principal and interest payments, estimated collateral values, and current economic and political conditions. Management regularly evaluates the adequacy of the reserve for mortgage loan losses. The Company generally stops accruing interest on mortgage loans for which interest payments are delinquent more than three months. Based on management's judgment as to the ultimate collectibility of principal, interest payments received are either recognized as income or applied to the recorded investment in the loan. The cost of interest rate caps and floors is amortized to investment income over the life of the contracts and payments received as a result of these agreements are recorded as investment income when realized. The amortized cost of interest rate caps and floors is included in other investments. Amounts paid or received under interest rate swap agreements are recognized as an adjustment to investment income. The Company may purchase and write index options to hedge the fee income earned on the management of equity securities in separate accounts and the underlying mutual funds. These index options are carried at market value and are included in other investments or other liabilities, as appropriate. Gains or losses on index options that qualify as hedges are deferred and recognized in management and other fees in the same period as the hedged fee income. The Company also uses index options to manage the risks related to a certain annuity product that pay interest based upon the relative change in a major stock market index between the beginning and end of the product's term. Purchased options used in conjunction with this product are reported in other investments and written options are included in other liabilities. The amortization of the cost of purchased options, the proceeds of written options and the changes in intrinsic value of the contracts are included in net investment income. Policy loans are carried at the aggregate of the unpaid loan balances which do not exceed the cash surrender values of the related policies. When evidence indicates a decline, which is other than temporary, in the underlying value or earning power of individual investments, such investments are written down to the fair value by a charge to income. 1. Summary of significant accounting policies (continued) Statements of cash flows The Company considers investments with a maturity at the date of their acquisition of three months or less to be cash equivalents. These securities are carried principally at amortized cost, which approximates fair value. Supplementary information to the consolidated statements of cash flows for the years ended December 31 is summarized as follows: 1999 1998 1997 --------- ---------- --------- Cash paid during the year for: Income taxes $214,940 $215,003 $174,472 Interest on borrowings 4,521 14,529 8,213 Recognition of profits on annuity contracts and insurance policies Profits on fixed deferred annuities are recognized by the Company over the lives of the contracts, using primarily the interest method. Profits represent the excess of investment income earned from investment of contract considerations over interest credited to contract owners and other expenses. The retrospective deposit method is used in accounting for universal life-type insurance. Under this method, profits are recognized over the lives of the policies in proportion to the estimated gross profits expected to be realized. Premiums on traditional life, disability income and long-term care insurance policies are recognized as revenue when due, and related benefits and expenses are associated with premium revenue in a manner that results in recognition of profits over the lives of the insurance policies. This association is accomplished by means of the provision for future policy benefits and the deferral and subsequent amortization of policy acquisition costs. Policyholder and contractholder charges include the monthly cost of insurance charges, issue and administrative fees and surrender charges. These charges also include the minimum death benefit guarantee fees received from the variable life insurance separate accounts. Management and other fees include investment management fees from underlying proprietary mutual funds and mortality and expense risk fees received from the variable annuity and variable life insurance separate accounts. Deferred policy acquisition costs The costs of acquiring new business, principally sales compensation, policy issue costs, underwriting and certain sales expenses, have been deferred on insurance and annuity contracts. The deferred acquisition costs for most single premium deferred annuities and installment annuities are amortized using primarily the interest method. The costs for universal life-type insurance and certain installment annuities are amortized as a percentage of the estimated gross profits expected to be realized on the policies. For traditional life, disability income and long-term care insurance policies, the costs are amortized over an appropriate period in proportion to premium revenue. 1. Summary of significant accounting policies (continued) Amortization of deferred policy acquisition costs requires the use of assumptions including interest margins, mortality margins, persistency rates, maintenance expense levels and, for variable products, separate account performance. For universal life-type insurance and deferred annuities, actual experience is reflected in the Company's amortization models monthly. As actual experience differs from the current assumptions, management considers the need to change key assumptions underlying the amortization models prospectively. The impact of changing prospective assumptions is reflected in the period that such changes are made and is generally referred to as an unlocking adjustment. During 1999, unlocking adjustments resulted in a net decrease in amortization of $56.8 million. Net unlocking adjustments in 1998 and 1997 were not significant. Liabilities for future policy benefits Liabilities for universal-life type insurance and fixed and variable deferred annuities are accumulation values. Liabilities for equity indexed deferred annuities are determined as the present value of guaranteed benefits and the intrinsic value of index-based benefits. Liabilities for fixed annuities in a benefit status are based on established industry mortality tables and interest rates ranging from 5% to 9.5%, depending on year of issue. Liabilities for future benefits on traditional life insurance are based on the net level premium method, using anticipated mortality, policy persistency and interest earning rates. Anticipated mortality rates are based on established industry mortality tables. Anticipated policy persistency rates vary by policy form, issue age and policy duration with persistency on cash value plans generally anticipated to be better than persistency on term insurance plans. Anticipated interest rates range from 4% to 10%, depending on policy form, issue year and policy duration. Liabilities for future disability income and long-term care policy benefits include both policy reserves and claim reserves. Policy reserves are based on the net level premium method, using anticipated morbidity, mortality, policy persistency and interest earning rates. Anticipated morbidity and mortality rates are based on established industry morbidity and mortality tables. Anticipated policy persistency rates vary by policy form, issue age, policy duration and, for disability income policies, occupation class. Anticipated interest rates for disability income and long-term care policy reserves are 3% to 9.5% at policy issue and grade to ultimate rates of 5% to 7% over 5 to 10 years. Claim reserves are calculated based on claim continuance tables and anticipated interest earnings. Anticipated claim continuance rates are based on established industry tables. Anticipated interest rates for claim reserves for both disability income and long-term care range from 5% to 8%. 1. Summary of significant accounting policies (continued) Reinsurance The maximum amount of life insurance risk retained by the Company is $750 on any policy insuring a single life and $1,500 on any policy insuring a joint-life combination. Beginning in 1999, the Company retains only 20% of the mortality risk on new variable universal life insurance policies. Risk not retained is reinsured with other life insurance companies, primarily on a yearly renewable term basis. Long-term care policies are primarily reinsured on a coinsurance basis. The Company retains all disability income and waiver of premium risk. Beginning in 2000, the Company will retain all accidental death benefit risk. Federal income taxes The Company's taxable income is included in the consolidated federal income tax return of American Express Company. The Company provides for income taxes on a separate return basis, except that, under an agreement between AEFC and American Express Company, tax benefit is recognized for losses to the extent they can be used on the consolidated tax return. It is the policy of AEFC and its subsidiaries that AEFC will reimburse subsidiaries for all tax benefits. Included in other liabilities at December 31, 1999 and 1998 are $852 receivable from and $26,291 payable to, respectively, AEFC for federal income taxes. Separate account business The separate account assets and liabilities represent funds held for the exclusive benefit of the variable annuity and variable life insurance contract owners. The Company receives investment management fees from the proprietary mutual funds used as investment options for variable annuities and variable life insurance. The Company receives mortality and expense risk fees from the separate accounts. The Company makes contractual mortality assurances to the variable annuity contract owners that the net assets of the separate accounts will not be affected by future variations in the actual life expectancy experience of the annuitants and beneficiaries from the mortality assumptions implicit in the annuity contracts. The Company makes periodic fund transfers to, or withdrawals from, the separate account assets for such actuarial adjustments for variable annuities that are in the benefit payment period. The Company also guarantees that the rates at which administrative fees are deducted from contract funds will not exceed contractual maximums. For variable life insurance, the Company guarantees that the rates at which insurance charges and administrative fees are deducted from contract funds will not exceed contractual maximums. The Company also guarantees that the death benefit will continue payable at the initial level regardless of investment performance so long as minimum premium payments are made. 1. Summary of significant accounting policies (continued) Accounting changes American Institute of Certified Public Accountants (AICPA) Statement of Position (SOP) 98-1, "Accounting for Costs of Computer Software Developed or Obtained for Internal Use" became effective January 1, 1999. The SOP requires the capitalization of certain costs incurred after the date of adoption to develop or obtain software for internal use. Software utilized by the Company is owned by AEFC and capitalized by AEFC. As a result, the new rule did not have a material impact on the Company's results of operations or financial condition. Effective January 1, 1999, the Company adopted AICPA SOP 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments," providing guidance for the timing of recognition of liabilities related to guaranty fund assessments. The Company had historically carried a liability for estimated guaranty fund assessment exposure. Adoption of the SOP did not have a material impact on the Company's results of operations or financial condition. In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities," which is effective January 1, 2001. This Statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires the recognition of all derivatives as either assets or liabilities on the balance sheet at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. The ultimate financial effect of adoption of the new rule will depend on the derivatives in place at adoption and cannot be estimated at this time. 2. Investments Fair values of investments in fixed maturities represent quoted market prices and estimated values when quoted prices are not available. Estimated values are determined by established procedures involving, among other things, review of market indices, price levels of current offerings of comparable issues, price estimates and market data from independent brokers and financial files. The amortized cost, gross unrealized gains and losses and fair values of investments in fixed maturities and equity securities at December 31, 1999 are as follows: Gross Gross Amortized Unrealized Unrealized Fair Held to maturity Cost Gains Losses Value _________________ __________ ___________ __________ __________ U.S. Government agency obligations $ 37,613 $ 236 $ 2,158 $ 35,691 State and municipal obligations 9,681 150 -- 9,831 Corporate bonds and obligations 5,713,475 91,571 113,350 5,691,696 Mortgage-backed securities 1,395,523 4,953 31,951 1,368,525 ------------ ---------- ----------- ----------- $ 7,156,292 $ 96,910 $ 147,459 $7,105,743 =========== ======== ========= ========== 2. Investments (continued) Gross Gross Amortized Unrealized Unrealized Fair Available for sale Cost Gains Losses Value __________________ ______________ ____________ ______________ ____________ U.S. Government agency obligations $ 46,325 $ 612 $ 2,231 $ 44,706 State and municipal obligations 13,226 519 191 13,554 Corporate bonds and obligations 7,960,352 60,120 560,450 7,460,022 Mortgage-backed securities 5,683,234 9,692 161,659 5,531,267 ------------- ----------- ---------- ------------- Total fixed maturities 13,703,137 70,943 724,531 13,049,549 Equity securities 16 -- 3,016 ----------- --------- ---------- ------------- 3,000 $13,706,137 $ 70,959 $ 724,531 $13,052,565 =========== ========= ========= =========== The amortized cost, gross unrealized gains and losses and fair values of investments in fixed maturities and equity securities at December 31, 1998 are as follows: Gross Gross Amortized Unrealized Unrealized Fair Held to maturity Cost Gains Losses Value U.S. Government agency obligations $ 39,888 $ 4,460 $ -- $ 44,348 State and municipal obligations 9,683 490 -- 10,173 Corporate bonds and obligations 6,305,476 447,752 27,087 6,726,141 Mortgage-backed securities 1,609,067 30,458 152 1,639,373 ------------ ---------- ---------- ----------- $ 7,964,114 $483,160 $27,239 $8,420,035 =========== ======== ======= ========== Gross Gross Amortized Unrealized Unrealized Fair Available for sale Cost Gains Losses Value U.S. Government agency obligations $ 52,043 $ 3,324 $ -- $ 55,367 State and municipal obligations 11,060 1,231 -- 12,291 Corporate bonds and obligations 7,332,344 271,174 155,181 7,448,337 Mortgage-backed securities 5,949,502 151,511 3,869 6,097,144 ------------ --------- ----------- ------------- Total fixed maturities 13,344,949 427,240 159,050 13,613,139 Equity securities 3,000 158 -- 3,158 ------------- ------------ -------------- ------------ $13,347,949 $427,398 $159,050 13,616,297 =========== ======== ======== =========== 2. Investments (continued) The amortized cost and fair value of investments in fixed maturities at December 31, 1999 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Amortized Fair Held to maturity Cost Value Due in one year or less $ 238,740 $ 239,747 Due from one to five years 2,996,713 3,012,721 Due from five to ten years 1,922,199 1,893,918 Due in more than ten years 603,117 590,832 Mortgage-backed securities 1,395,523 1,368,525 -------------- ------------- $ 7,156,292 $ 7,105,743 ============= ============ Amortized Fair Available for sale Cost Value Due in one year or less $ 271,381 $ 274,415 Due from one to five years 595,747 592,533 Due from five to ten years 4,936,041 4,669,573 Due in more than ten years 2,216,734 1,981,761 Mortgage-backed securities 5,683,234 5,531,267 ------------- ------------- $13,703,137 $13,049,549 During the years ended December 31, 1999, 1998 and 1997, fixed maturities classified as held to maturity were sold with amortized cost of $68,470, $230,036 and $229,848, respectively. Net gains and losses on these sales were not significant. The sale of these fixed maturities was due to significant deterioration in the issuers' credit worthiness. Fixed maturities available for sale were sold during 1999 with proceeds of $1,691,389 and gross realized gains and losses of $36,568 and $14,255, respectively. Fixed maturities available for sale were sold during 1998 with proceeds of $278,955 and gross realized gains and losses of $15,658 and $22,102, respectively. Fixed maturities available for sale were sold during 1997 with proceeds of $457,585 and gross realized gains and losses of $6,639 and $7,518, respectively. At December 31, 1999, bonds carried at $14,559 were on deposit with various states as required by law. 2. Investments (continued) At December 31, 1999, investments in fixed maturities comprised 81 percent of the Company's total invested assets. These securities are rated by Moody's and Standard & Poor's (S&P), except for securities carried at approximately $3.7 billion which are rated by AEFC's internal analysts using criteria similar to Moody's and S&P. A summary of investments in fixed maturities, at amortized cost, by rating on December 31 is as follows: Rating 1999 1998 -------------------- ---------- ------ Aaa/AAA $ 7,144,280 $ 7,629,628 Aaa/AA 1,920 2,277 Aa/AA 301,728 308,053 Aa/A 314,168 301,325 A/A 2,598,300 2,525,283 A/BBB 1,014,566 1,148,736 Baa/BBB 6,319,549 6,237,014 Baa/BB 348,849 492,696 Below investment grade 2,816,069 2,664,051 ------------- ------------- $20,859,429 $21,309,063 At December 31, 1999, 90 percent of the securities rated Aaa/AAA are GNMA, FNMA and FHLMC mortgage-backed securities. No holdings of any other issuer are greater than one percent of the Company's total investments in fixed maturities. At December 31, 1999, approximately 14 percent of the Company's invested assets were mortgage loans on real estate. Summaries of mortgage loans by region of the United States and by type of real estate are as follows: December 31, 1999 December 31, 1998 ------------------------ --------------------- On Balance Commitments On Balance Commitments Region Sheet to Purchase Sheet to Purchase ______________________ _____________ _____________ _____________ _____________ East North Central $ 715,998 $ 10,380 $ 750,705 $ 16,393 West North Central 555,635 42,961 491,006 81,648 South Atlantic 867,838 23,317 839,233 21,020 Middle Atlantic 428,051 1,806 476,448 6,169 New England 259,243 4,415 263,761 2,824 Pacific 238,299 3,466 195,851 16,946 West South Central 144,607 4,516 136,841 1,412 East South Central 43,841 -- 46,029 -- Mountain 381,148 9,380 345,379 8,473 ------------ ----------- ------------ ----------- 3,634,660 100,241 3,545,253 154,885 Less allowance for losses 28,283 -- 39,795 -- ------------- -------------- ------------- ------------- $3,606,377 $100,241 $3,505,458 $154,885 ========== ======== ========== ======== 2. Investments (continued) December 31, 1999 December 31, 1998 --------------------- ----------------------- On Balance Commitments On Balance Commitments Property type Sheet to Purchase Sheet to Purchase _______________ ___________ ____________ _____________ ____________ Department/retail stores $1,158,712 $ 33,829 $1,139,349 $ 59,305 Apartments 887,538 11,343 960,808 9,272 Office buildings 931,234 26,062 783,576 50,450 Industrial buildings 309,845 5,525 298,549 13,263 Hotels/motels 103,625 -- 109,185 14,122 Medical buildings 114,045 -- 124,369 -- Nursing/retirement homes 45,935 -- 46,696 -- Mixed use 66,893 -- 65,151 -- Other 16,833 23,482 17,570 8,473 ------------- ---------- ------------- ----------- 3,634,660 100,241 3,545,253 154,885 Less allowance for losses 28,283 -- 39,795 -- ------------- -------------- ------------- -------------- $3,606,377 $100,241 $3,505,458 $154,885 ========== ======== ========== ======== Mortgage loan fundings are restricted by state insurance regulatory authorities to 80 percent or less of the market value of the real estate at the time of origination of the loan. The Company holds the mortgage document, which gives it the right to take possession of the property if the borrower fails to perform according to the terms of the agreement. Commitments to purchase mortgages are made in the ordinary course of business. The fair value of the mortgage commitments is $nil. At December 31, 1999 and 1998, the Company's recorded investment in impaired loans was $21,375 and $24,941, respectively, with allowances of $5,750 and $6,662, respectively. During 1999 and 1998, the average recorded investment in impaired loans was $23,815 and $37,873, respectively. The Company recognized $1,190, $1,809 and $2,981 of interest income related to impaired loans for the years ended December 31, 1999, 1998 and 1997 respectively. The following table presents changes in the allowance for losses related to all loans: 1999 1998 1997 ---------- ------------ -------- Balance, January 1 $39,795 $38,645 $37,495 Provision (reduction) for investment losses (9,512) 7,582 8,801 Loan payoffs (500) (800) (3,851) Foreclosures and writeoffs (1,500) (5,632) (3,800) -------- -------- --------- Balance, December 31 $28,283 $39,795 $38,645 ======= ======= ======= At December 31, 1999, the Company had no commitments to purchase investments other than mortgage loans. 2. Investments (continued) Net investment income for the years ended December 31 is summarized as follows: 1999 1998 1997 ------------- ------------- --------- Interest on fixed maturities $1,598,059 $1,676,984 $1,692,481 Interest on mortgage loans 285,921 301,253 305,742 Other investment income 70,892 43,518 25,089 Interest on cash equivalents 5,871 5,486 5,914 ----------- ------------- ------------- 1,960,743 2,027,241 2,029,226 Less investment expenses 41,170 40,756 40,837 ----------- ------------- ------------- $1,919,573 $1,986,485 $1,988,389 ========== ========== ========== Net realized gain (loss) on investments for the years ended December 31 is summarized as follows: 1999 1998 1997 --------- ------ -------- Fixed maturities $ 22,387 $ 12,084 $ 16,115 Mortgage loans 10,211 (5,933) (6,424) Other investments (5,990) 751 (8,831) ---------- ------------ ----------- $ 26,608 $ 6,902 $ 860 ========== ========== =========== Changes in net unrealized appreciation (depreciation) of investments for the years ended December 31 are summarized as follows: 1999 1998 1997 ________ _________ _______ Fixed maturities available for sale $(921,778) $(93,474) $223,441 Equity securities (142) (203) 53 3. Income taxes The Company qualifies as a life insurance company for federal income tax purposes. As such, the Company is subject to the Internal Revenue Code provisions applicable to life insurance companies. The income tax expense (benefit) for the years ended December 31 consists of the following: 1999 1998 1997 ---------- ---------- ----------- Federal income taxes: Current $178,444 $244,946 $176,879 Deferred 79,796 (16,602) 19,982 ---------- ---------- --------- 258,240 228,344 196,861 State income taxes-current 9,624 7,337 9,803 ----------- ----------- ---------- Income tax expense $267,864 $235,681 $206,664 ======== ======== ======== 3. Income taxes (continued) Increases (decreases) to the income tax provision applicable to pretax income based on the statutory rate are attributable to: 1999 1998 1997 -------------------------- ------------------------- ------------------------- Provision Rate Provision Rate Provision Rate Federal income taxes based on the statutory rate $316,511 35.0% $271,527 35.0% $238,319 35.0% Tax-excluded interest and dividend income (9,626) (1.1) (12,289) (1.6) (10,294) (1.5) State taxes, net of federal benefit 6,256 0.7 4,769 0.6 6,372 0.9 Affordable housing credits (31,000) (3.4) (19,688) (2.5) (20,705) (3.0) Other, net (14,277) (1.6) (8,638) (1.1) (7,028) (1.0) --------- ---- ---------- ----- ---------- ----- Total income taxes $267,864 29.6% $235,681 30.4% $206,664 30.4% ======== ==== ======== ==== ======== ==== A portion of life insurance company income earned prior to 1984 was not subject to current taxation but was accumulated, for tax purposes, in a policyholders' surplus account. At December 31, 1999, the Company had a policyholders' surplus account balance of $20,114. The policyholders' surplus account is only taxable if dividends to the stockholder exceed the stockholder's surplus account or if the Company is liquidated. Deferred income taxes of $7,040 have not been established because no distributions of such amounts are contemplated. Significant components of the Company's deferred tax assets and liabilities as of December 31 are as follows: 1999 1998 Deferred tax assets: Policy reserves $ 733,647 $756,769 Unrealized loss on available for sale investments 221,431 -- Investments, other 1,873 -- Life insurance guaranty fund assessment reserve 4,789 15,289 Other -- 4,253 ------------- ---------- Total deferred tax assets 961,740 776,311 --------- --------- Deferred tax liabilities: Deferred policy acquisition costs 740,837 698,471 Unrealized gain on available for sale investments -- 91,315 Investments, other -- 3,455 Other 4,883 -- -------------- --------- Total deferred tax liabilities 745,720 793,241 ---------- -------- Net deferred tax assets (liabilities) $ 216,020 $(16,930) ========= ========= 3. Income taxes (continued) The Company is required to establish a valuation allowance for any portion of the deferred tax assets that management believes will not be realized. In the opinion of management, it is more likely than not that the Company will realize the benefit of the deferred tax assets and, therefore, no such valuation allowance has been established. 4. Stockholder's equity Retained earnings available for distribution as dividends to the parent are limited to the Company's surplus as determined in accordance with accounting practices prescribed by state insurance regulatory authorities. Statutory unassigned surplus aggregated $1,693,356 as of December 31, 1999 and $1,598,203 as of December 31, 1998 (see Note 3 with respect to the income tax effect of certain distributions). In addition, any dividend distributions in 2000 in excess of approximately $418,845 would require approval of the Department of Commerce of the State of Minnesota. Statutory net income for the years ended December 31 and capital and surplus as of December 31 are summarized as follows: 1999 1998 1997 ------------ ------------ -------- Statutory net income $ 478,173 $ 429,903 $ 379,615 Statutory capital and surplus 1,978,406 1,883,405 1,765,290 5. Related party transactions The Company loans funds to AEFC under a collateral loan agreement. The balance of the loan was $nil at December 31, 1999 and 1998. This loan can be increased to a maximum of $75,000 and pays interest at a rate equal to the preceding month's effective new money rate for the Company's permanent investments. Interest income on related party loans totaled $nil, $nil and $103 in 1999, 1998 and 1997, respectively. The Company participates in the American Express Company Retirement Plan which covers all permanent employees age 21 and over who have met certain employment requirements. Employer contributions to the plan are based on participants' age, years of service and total compensation for the year. Funding of retirement costs for this plan complies with the applicable minimum funding requirements specified by ERISA. The Company's share of the total net periodic pension cost was $223, $211 and $201 in 1999, 1998 and 1997, respectively. The Company also participates in defined contribution pension plans of American Express Company which cover all employees who have met certain employment requirements. Company contributions to the plans are a percent of either each employee's eligible compensation or basic contributions. Costs of these plans charged to operations in 1999, 1998 and 1997 were $1,906, $1,503 and $1,245, respectively. The Company participates in defined benefit health care plans of AEFC that provide health care and life insurance benefits to retired employees and retired financial advisors. The plans include participant contributions and service related eligibility requirements. Upon retirement, such employees are considered to have been employees of AEFC. AEFC expenses these benefits and allocates the expenses to its subsidiaries. The Company's share of postretirement benefits in 1999, 1998 and 1997 was $1,147, $1,352 and $1,330, respectively. 5. Related party transactions (continued) Charges by AEFC for use of joint facilities, technology support, marketing services and other services aggregated $485,177, $411,337 and $414,155 for 1999, 1998 and 1997, respectively. Certain of these costs are included in deferred policy acquisition costs. 6. Commitments and contingencies At December 31, 1999, 1998 and 1997, traditional life insurance and universal life-type insurance in force aggregated $89,271,957, $81,074,928 and $74,730,720 respectively, of which $8,281,576, $4,912,313 and $4,351,904 were reinsured at the respective year ends. The Company also reinsures a portion of the risks assumed under disability income and long-term care policies. Under all reinsurance agreements, premiums ceded to reinsurers amounted to $76,970, $66,378 and $60,495 and reinsurance recovered from reinsurers amounted to $27,816, $20,982, and $19,042 for the years ended December 31, 1999, 1998 and 1997, respectively. Reinsurance contracts do not relieve the Company from its primary obligation to policyholders. In January 2000, AEFC reached an agreement in principle to settle three class-action lawsuits. The Company had been named as a co-defendant in all three lawsuits. It is expected the settlement will provide $215 million of benefits to more than 2 million class participants. The agreement in principle to settle also provides for release by class members of all insurance and annuity market conduct claims dating back to 1985 and is subject to a number of contingencies including a definitive agreement and court approval. The settlement costs allocated to the Company are included in the accompanying 1999 statement of income and did not have a material impact on the Company's consolidated financial position or results from operations. The Company is named as a defendant in various other lawsuits. The outcome of any litigation cannot be predicted with certainty. In the opinion of management, however, the ultimate resolution of these lawsuits, taken in aggregate should not have a material adverse effect on the Company's consolidated financial position. The IRS routinely examines the Company's federal income tax returns and is currently completing the audit for the 1990 through 1992 tax years. Management does not believe there will be a material adverse effect on the Company's consolidated financial position as a result of this audit. 7. Lines of credit The Company has available lines of credit with its parent aggregating $200,000 ($100,000 committed and $100,000 uncommitted). The interest rate for any borrowings is established by reference to various indices plus 20 to 45 basis points, depending on the term. Borrowings outstanding under this agreement were $50,000 uncommitted at December 31, 1999 and $nil at December 31, 1998. 8. Derivative financial instruments The Company enters into transactions involving derivative financial instruments to manage its exposure to interest rate risk and equity market risk, including hedging specific transactions. The Company does not hold derivative instruments for trading purposes. The Company manages risks associated with these instruments as described below. Market risk is the possibility that the value of the derivative financial instruments will change due to fluctuations in a factor from which the instrument derives its value, primarily an interest rate or equity market index. The Company is not impacted by market risk related to derivatives held for non-trading purposes beyond that inherent in cash market transactions. Derivatives held for purposes other than trading are largely used to manage risk and, therefore, the cash flow and income effects of the derivatives are inverse to the effects of the underlying transactions. Credit risk is the possibility that the counterparty will not fulfill the terms of the contract. The Company monitors credit risk related to derivative financial instruments through established approval procedures, including setting concentration limits by counterparty, and requiring collateral, where appropriate. A vast majority of the Company's counterparties are rated A or better by Moody's and Standard & Poor's. Credit risk related to interest rate caps and floors and index options is measured by the replacement cost of the contracts. The replacement cost represents the fair value of the instruments. The notional or contract amount of a derivative financial instrument is generally used to calculate the cash flows that are received or paid over the life of the agreement. Notional amounts are not recorded on the balance sheet. Notional amounts far exceed the related credit risk. 8. Derivative financial instruments (continued) The Company's holdings of derivative financial instruments are as follows: Notional Carrying Fair Total Credit December 31, 1999 Amount Amount Value Exposure Assets: Interest rate caps $ 2,500,000 $ 9,685 $ 12,773 $ 12,773 Interest rate floors 1,000,000 602 319 319 Options purchased 180,897 49,789 61,745 61,745 Liabilities: Options written 43,262 (1,677) (2,402) -- Off balance sheet: Interest rate swaps 1,267,000 -- (17,582) -- ----------- --------- -------------- $ 58,399 $ 54,853 $ 74,837 ======== ========= ========= Notional Carrying Fair Total Credit December 31, 1998 Amount Amount Value Exposure ----------------- ---------- ------- ------- -------- Assets: Interest rate caps $ 3,400,000 $ 15,985 $ 4,256 $ 4,256 Interest rate floors 1,000,000 1,082 13,971 13,971 Options purchased 110,912 24,094 29,453 29,453 Liabilities: Options purchased/written 265,454 (10,526) (11,062) -- Off balance sheet: Interest rate swaps 1,667,000 -- (73,477) -- ------------- --------- ------------ $ 30,635 $(36,859) $47,680 ======== ======== ======= The fair values of derivative financial instruments are based on market values, dealer quotes or pricing models. The interest rate caps, floors and swaps expire on various dates from 2000 to 2003. The purchased and written options expire on various dates from 2000 to 2006. Interest rate caps, swaps and floors are used principally to manage the Company's interest rate risk. These instruments are used to protect the margin between interest rates earned on investments and the interest rates credited to related annuity contract holders. The Company also uses interest rate swaps to manage interest rate risk related to the level of fee income earned on the management of fixed income securities in separate accounts and the underlying mutual funds. The amount of fee income received is based upon the daily market value of the separate account and mutual fund assets. As a result, changing interest rate conditions could impact the Company's fee income significantly. The Company entered into interest rate swaps to hedge anticipated fee income for 1999 related to separate accounts and mutual funds which invest in fixed income securities. Interest was reported in management and other fees. 8. Derivative financial instruments (continued) The Company offers an annuity product that pays interest based upon the relative change in a major stock market index between the beginning and end of the product's term. As a means of hedging its obligation under the provisions of this product, the Company purchases and writes options on the major stock market index. Indexoptions are used to manage the equity market risk related to the fee income that the Company receives from its separate accounts and the underlying mutual funds. The amount of the fee income received is based upon the daily market value of the separate account and mutual fund assets. As a result, the Company's fee income could be impacted significantly by fluctuations in the equity markets. The Company entered into index option collars (combination of puts and calls) to hedge anticipated fee income for 1999 and 1998 related to separate accounts and mutual funds which invest in equity securities. Testing demonstrated the impact of these instruments on the income statement closely correlates with the amount of fee income the Company realizes. At December 31, 1999 deferred losses on purchased put and written call index options were $nil. At December 31, 1998 deferred losses on purchased put and written call index options were $2,933 and deferred gains on written call index options were $7,435, respectively. 9. Fair values of financial instruments The Company discloses fair value information for most on- and off-balance sheet financial instruments for which it is practicable to estimate that value. Fair values of life insurance obligations and all non-financial instruments, such as deferred acquisition costs are excluded. Off-balance sheet intangible assets, such as the value of the field force, are also excluded. Management believes the value of excluded assets and liabilities is significant. The fair value of the Company, therefore, cannot be estimated by aggregating the amounts presented. 1999 1998 --------------------- -------------------- Carrying Fair Carrying Fair Financial Assets Value Value Value Value Investments: Fixed maturities (Note 2): Held to maturity $ 7,156,292 $ 7,105,743 $ 7,964,114 $ 8,420,035 Available for sale 13,049,549 13,049,549 13,613,139 13,613,139 Mortgage loans on real estate (Note 2) 3,606,377 3,541,958 3,505,458 3,745,617 Other: Equity securities (Note 2) 3,016 3,016 3,158 3,158 Derivative financial Instruments (Note 8) 60,076 74,837 41,161 47,680 Other 2,258 2,258 28,872 28,872 Cash and cash equivalents (Note 1) 32,333 32,333 22,453 22,453 Separate account assets (Note 1) 35,894,732 35,894,732 27,349,401 27,349,401 9. Fair values of financial instruments (continued) 1999 1998 --------------------- -------------------- Carrying Fair Carrying Fair Financial Liabilities Value Value Value Value Future policy benefits for fixed annuities $19,189,170 $18,591,859 $19,855,203 $19,144,838 Derivative financial instruments (Note 8) 1,677 19,984 10,526 84,539 Separate account liabilities 31,869,184 31,016,081 25,005,732 24,179,115 At December 31, 1999 and 1998, the carrying amount and fair value of future policy benefits for fixed annuities exclude life insurance-related contracts carried at $1,270,094 and $1,226,985, respectively, and policy loans of $92,895 and $90,115, respectively. The fair value of these benefits is based on the status of the annuities at December 31, 1999 and 1998. The fair value of deferred annuities is estimated as the carrying amount less any applicable surrender charges and related loans. The fair value for annuities in non-life contingent payout status is estimated as the present value of projected benefit payments at rates appropriate for contracts issued in 1999 and 1998. At December 31, 1999 and 1998, the fair value of liabilities related to separate accounts is estimated as the carrying amount less any applicable surrender charges and less variable insurance contracts carried at $4,025,548 and $2,343,669, respectively. 10. Year 2000 (unaudited) The Year 2000 issue is the result of computer programs having been written using two digits rather than four to define a year. Any programs that have time-sensitive software may recognize a date using "00" as the year 1900 rather than 2000. This could result in the failure of major systems or miscalculations, which could have a material impact on the operations of the Company. All of the major systems used by the Company are maintained by AEFC and are utilized by multiple subsidiaries and affiliates of AEFC. The Company's businesses are heavily dependent upon AEFC's computer systems and have significant interaction with systems of third parties. A comprehensive review of AEFC's computer systems and business processes, including those specific to the Company, was conducted to identify the major systems that could be affected by the Year 2000 issue. Steps were taken to resolve potential problems including modification to existing software and the purchase of new software. As of December 31, 1999, AEFC had completed its program of corrective measures on its internal systems and applications, including Year 2000 compliance testing. As of December 31, 1999, AEFC had also completed an evaluation of the Year 2000 readiness of other third parties whose system failures could have an impact on the Company's operations. AEFC's Year 2000 project also included establishing Year 2000 contingency plans for all key business units. Business continuation plans, which address business continuation in the event of a system disruption, are in place for all key business units. At December 31, 1999, these plans had been amended to include specific Year 2000 considerations. In assessing its Year 2000 initiatives and the results of actual production since January 1, 2000, management believes no material adverse consequences were experienced, and there was no material effect on the Company's business, results of operations, or financial condition as a result of the Year 2000 issue.