EXHIBIT 99.4
Report of Independent Auditors
Board of Directors and Stockholder
USG Annuity & Life Company
We have audited the accompanying statutory basis balance sheets of USG Annuity &
Life Company ("the Company" and a wholly owned subsidiary of ING America
Insurance Holdings, Inc.) as of December 31, 2002 and 2001, and the related
statutory basis statements of operations, changes in capital and surplus, and
cash flows for the years then ended. 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.
As described in Note 1 to the financial statements, the Company presents its
financial statements in conformity with accounting practices prescribed or
permitted by the Commissioner of Insurance of the State of Oklahoma (Oklahoma
Insurance Department), which practices differ from accounting principles
generally accepted in the United States. The variances between such practices
and accounting principles generally accepted in the United States are described
in Note 1. The effects on the financial statements of these variances are not
reasonably determinable but are presumed to be material.
In our opinion, because of the effects of the matter described in the preceding
paragraph, the financial statements referred to above do not present fairly, in
conformity with accounting principles generally accepted in the United States,
the financial position of USG Annuity & Life Company at December 31, 2002 and
2001 or the results of its operations or its cash flows for the years then
ended.
1
However, in our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of USG Annuity & Life
Company at December 31, 2002 and 2001, and the results of its operations and its
cash flows for the years then ended, in conformity with accounting practices
prescribed or permitted by the Oklahoma Insurance Department.
As discussed in Note 3 to the financial statements, in 2001 the Company changed
various accounting policies to be in accordance with the revised NAIC Accounting
Practices and Procedures Manual, as adopted by the Oklahoma Insurance
Department.
/s/ Ernst & Young LLP
April 25, 2003
2
USG Annuity & Life Company
Balance Sheets - Statutory Basis
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December 31
2002 2001
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(In Thousands)
Admitted assets
Cash and invested assets:
Bonds $ 6,116,495 $ 5,285,956
Preferred stocks 1,088 134
Common stocks - 22
Mortgage loans 1,483,855 1,659,518
Real estate, less accumulated depreciation (2002- $304,
2001-$242) 1,477 2,964
Policy loans 32,454 32,732
Other invested assets 47,704 40,847
Cash and short-term investments 9,116 102,848
-------------- --------------
Total cash and invested assets 7,692,189 7,125,021
Deferred and uncollected premiums, less loading (2002- ($58),
2001- $49) 386 1,304
Accrued investment income 77,674 72,706
Reinsurance balances recoverable 335 90
Indebtedness from related parties 25 3,945
Federal income tax recoverable, including a deferred
tax asset (2002 - $15,601, 2001 - $6,976) 22,163 6,976
Other assets 2,451 5,484
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Total admitted assets $ 7,795,223 $ 7,215,526
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3
USG Annuity & Life Company
Balance Sheets - Statutory Basis (continued)
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December 31
2002 2001
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(In Thousands)
except share amounts)
Liabilities and capital and surplus
Liabilities:
Policy and contract liabilities:
Life and annuity reserves $ 6,859,914 $ 6,211,216
Deposit type contracts 246,501 232,745
Policyholders' funds 53 33
Unpaid claims 3,622 3,930
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Total policy and contract liabilities 7,110,090 6,447,924
Interest maintenance reserve 11,799 4,992
Accounts payable and accrued expenses 27,197 69,739
Indebtedness to related parties 22,147 6,548
Contingency reserve 876 1,907
Asset valuation reserve 50,634 71,621
Borrowed money 184,450 183,094
Other liabilities 1,844 120,244
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Total liabilities 7,409,037 6,906,069
Capital and surplus:
Common stock: authorized - 1,000 shares of $3,000 par value;
833 issued and outstanding 2,500 2,500
Additional paid-in capital 316,963 286,963
Unassigned surplus 66,723 19,994
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Total capital and surplus 386,186 309,457
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Total liabilities and capital and surplus $ 7,795,223 $ 7,215,526
============== ==============
See accompanying notes - statutory basis.
4
USG Annuity & Life Company
Statements of Operations - Statutory Basis
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2002 2001
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(In Thousands)
Premiums and other revenues:
Life, annuity, and accident and health premiums $ 1,285,640 $ 833,347
Policy proceeds and dividends left on deposit 9,267 11,396
Net investment income 536,206 520,614
Amortization of interest maintenance reserve (7,446) 2,383
Commissions, expense allowances and reserve adjustments
on reinsurance ceded 14,159 23,933
Other income 1,619 17,445
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Total premiums and other revenues 1,839,445 1,409,118
Benefits paid or provided:
Death benefits 112,299 141,633
Annuity benefits 250,411 274,447
Surrender benefits 582,708 739,979
Interest on policy or contract funds 8,033 11,409
Other benefits:
Life contract withdrawals 8,968 6,081
Increase in life, annuity, and accident and
health reserves 648,698 25,124
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Total benefits paid or provided 1,611,117 1,198,673
Insurance expenses:
Commissions 86,074 59,252
General expenses 33,272 22,962
Insurance taxes, licenses and fees, excluding
federal income taxes (231) (1,827)
Other 856 (291)
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Total insurance expenses 119,971 80,096
5
USG Annuity & Life Company
Statements of Operations - Statutory Basis (continued)
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2002 2001
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(In Thousands)
Gain from operations before federal income taxes and
net realized capital losses 108,357 130,349
Federal income taxes 41,015 49,747
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Gain from operations before net realized capital losses 67,342 80,602
Net realized capital losses net of income taxes 2002 - $6,049;
2001 - $ (7,981) and excluding net transfers to the interest
maintenance reserve 2002- $638; 2001- $(13,377) (41,467) (51,090)
-------------- --------------
Net income $ 25,875 $ 29,512
============== ==============
See accompanying notes - statutory basis.
6
USG Annuity & Life Company
Statements of Changes in Capital and Surplus--Statutory Basis
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2002 2001
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(In Thousands)
Common stock:
Balance at beginning and end of year $ 2,500 $ 2,500
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Paid-in and contributed surplus:
Balance at beginning and end of year 286,963 286,963
Capital contributions 30,000 -
-------------- --------------
Balance at end of year 316,963 286,963
Unassigned surplus (deficit):
Balance at beginning of year 19,994 (16,701)
Net income 25,875 29,512
Change in net unrealized capital losses (7,240) (1,001)
Change in non-admitted assets 3,284 (15,515)
Change in asset valuation reserve 20,987 18,143
Change in net deferred income tax 3,480 26,376
Change in accounting principle, net of tax - 5,180
Dividends to stockholder - (26,000)
Other 343 -
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Balance at end of year 66,723 19,994
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Total capital and surplus $ 386,186 $ 309,457
============== ==============
See accompanying notes - statutory basis.
7
USG Annuity & Life Company
Statements of Cash Flows--Statutory Basis
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2002 2001
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(In Thousands)
Operations
Premiums, policy proceeds, and other considerations received,
net of reinsurance paid $ 1,295,738 $ 844,992
Net investment income received 647,957 565,770
Commission and expense allowances received on reinsurance ceded 14,159 23,933
Benefits paid (998,100) (1,195,459)
Insurance expenses paid (122,791) (70,176)
Federal income taxes paid (58,643) (41,271)
Net other revenue 89 10,907
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Net cash provided by operations 778,409 138,696
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Investments
Proceeds from sales, maturities, or repayments of investments:
Bonds 8,709,883 5,845,574
Preferred stocks 133 961
Common stocks 224 46,233
Mortgage loans 275,949 170,155
Other invested assets 6,856 7,254
Net loss on cash and short term investment - (75)
Net tax on capital gains 4,947 3,874
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Net proceeds from sales, maturities, or repayments of investments 8,997,992 6,073,976
Cost of investments acquired:
Bonds 9,713,052 6,229,459
Preferred stocks 17,047 2,085
Common stocks (15,817) (2,085)
Mortgage loans 100,251 93,125
Other invested assets 14,594 19,254
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Total cost of investments acquired 9,829,127 6,341,838
Net decrease (increase) in policy loans 279 (938)
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Net cash used in investment activities (830,856) (268,800)
8
USG Annuity & Life Company
Statements of Cash Flows--Statutory Basis (continued)
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2002 2001
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(In Thousands)
Financing and miscellaneous activities
Cash provided:
Capital and surplus paid-in 30,000 -
Borrowed money 1,356 135,270
Net deposits on deposit-type contract funds (8) (38,422)
Interest paid on indebtedness (254) -
Other (uses) sources (72,379) 124,461
Dividends to stockholder - (26,000)
-------------- --------------
Net cash (used in) provided by financing and miscellaneous
activities (41,285) 195,309
Net (decrease) increase in cash and short-term investments (93,732) 65,205
Cash and short-term investments:
Beginning of year 102,848 37,643
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End of year $ 9,116 $ 102,848
============== ===============
See accompanying notes - statutory basis.
9
USG Annuity & Life Company
Notes to Financial Statements - Statutory Basis
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1. Nature of Operations and Significant Accounting Policies
USG Annuity & Life Company (the "Company") is domiciled in Oklahoma and is
a wholly owned subsidiary of Equitable Life Insurance Company of Iowa
("Equitable"), an Iowa domiciled insurance company. Equitable, in turn, is
a wholly owned subsidiary of ING America Insurance Holdings, Inc. ("ING
AIH").
The Company offers various insurance products including deferred fixed
annuities, immediate annuities, and interest-sensitive life insurance.
These products are primarily marketed to individuals by independent
insurance broker/dealers, financial institutions, and the career agency
force. The Company is licensed in 48 states and the District of Columbia.
The preparation of financial statements of insurance companies requires
management to make estimates and assumptions that affect amounts reported
in the financial statements and accompanying notes. Such estimates and
assumptions could change in the future as more information becomes known,
which could impact the amounts reported and disclosed herein.
Basis of Presentation
The accompanying financial statements of the Company have been prepared in
conformity with accounting practices prescribed or permitted by the
Commissioner of Insurance of the State of Oklahoma (Oklahoma Insurance
Department), which practices differ from accounting principles generally
accepted in the United States ("GAAP"). The most significant variances from
GAAP are as follows:
Investments: Investments in bonds and mandatorily redeemable preferred
stocks are reported at amortized cost or market value based on the National
Association of Insurance Commissioners ("NAIC") rating; for GAAP, such
fixed maturity investments are designated at purchase as held-to-maturity,
trading or available-for-sale. Held-to-maturity investments are reported at
amortized cost, and the remaining fixed maturity investments are reported
at fair value with unrealized capital gains and losses reported in
operations for those designated as trading and as a component of other
comprehensive income in stockholder's equity for those designated as
available-for-sale.
10
USG Annuity & Life Company
Notes to Financial Statements - Statutory Basis
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1. Nature of Operations and Significant Accounting Policies (continued)
Basis of Presentation (continued)
Investments in real estate are reported net of related obligations rather
than on a gross basis. Real estate owned and occupied by the Company is
included in investments rather than reported as an operating asset as under
GAAP, and investment income and operating expenses include rent for the
Company's occupancy of those properties. Changes between depreciated cost
and admitted asset investment amounts are credited or charged directly to
unassigned surplus rather than income as would be required under GAAP.
Derivative instruments that meet the criteria of an effective hedge are
valued and reported in a manner that is consistent with the hedged asset or
liability. Embedded derivatives are not accounted for separately from the
host contract. Under GAAP, the effective and ineffective portions of a
single hedge are accounted for separately, an embedded derivative within a
contract that is not clearly and closely related to the economic
characteristics and risk of the host contract is accounted for separately
from the host contract and valued and reported at fair value, and the
change in fair value for cash flow hedges is credited or charged directly
to a separate component of shareholders' equity rather than to income as
required for fair value hedges.
The Company invests in structured securities including mortgage-backed
securities/collateralized mortgage obligations, asset-backed securities,
collateralized debt obligations, and commercial mortgage-backed securities.
For these structured securities, management compares the undiscounted cash
flows to the carrying value. An other than temporary impairment is
considered to have occurred when the undiscounted cash flows are less than
the carrying value. For structured securities, when a negative yield
results from a revaluation based on new prepayment assumptions (i.e.,
undiscounted cash flows are less than current book value), an other than
temporary impairment is considered to have occurred and the asset is
written down to the value of the undiscounted cash flows. For GAAP, assets
are re-evaluated based on the discounted cash flows using a current market
rate. Impairments are recognized when there has been an adverse change in
cash flows and the fair value is less than book. The asset is then written
down to fair value.
When a decline in fair value is determined to be other than temporary, the
individual security is written down to fair value and the loss accounted
for as a realized loss.
Valuation Reserves: The asset valuation reserve ("AVR") is determined by an
NAIC-prescribed formula and is reported as a liability rather than as a
valuation allowance or an appropriation of surplus. The change in AVR is
reported directly to unassigned surplus.
11
USG Annuity & Life Company
Notes to Financial Statements - Statutory Basis
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1. Nature of Operations and Significant Accounting Policies (continued)
Basis of Presentation (continued)
Under a formula prescribed by the NAIC, the Company defers the portion of
realized gains and losses on sales of fixed-income investments, principally
bonds and mortgage loans, attributable to changes in the general level of
interest rates and amortizes those deferrals over the remaining period to
maturity based on groupings of individual securities sold in five-year
bands. The net deferral is reported as the interest maintenance reserve
(IMR) in the accompanying balance sheets.
Realized gains and losses on investments are reported in operations net of
federal income tax and transfers to the IMR. Under GAAP, realized capital
gains and losses are reported in the statements of operations on a pretax
basis in the period that the asset giving rise to the gain or loss is sold
and valuation allowances are provided when there has been a decline in
value deemed other than temporary, in which case the provision for such
declines is charged to income.
Valuation allowances, if necessary, are established for mortgage loans
based on the difference between the net value of the collateral, determined
as the fair value of the collateral less estimated costs to obtain and
sell, and the recorded investment in the mortgage loan. Under GAAP, such
allowances are based on the present value of expected future cash flows
discounted at the loan's effective interest rate or, if foreclosure is
probable, on the estimated fair value of the collateral.
The initial valuation allowance and subsequent changes in the allowance for
mortgage loans as a result of a temporary impairment are charged or
credited directly to unassigned surplus, rather than being included as a
component of earnings as would be required under GAAP.
Policy Acquisition Costs: The costs of acquiring and renewing business are
expensed when incurred. Under GAAP, acquisition costs related to
traditional life insurance, to the extent recoverable from future policy
revenues, are deferred and amortized over the premium-paying period of the
related policies using assumptions consistent with those used in computing
policy benefit reserves. For universal life insurance and investment
products, to the extent recoverable from future gross profits, acquisition
costs are amortized generally in proportion to the present value of
expected gross margins from surrender charges and investment, mortality,
and expense margins.
Premiums: Life premiums are recognized as revenue when due. Premiums for
annuity policies with mortality and morbidity risk, except for guaranteed
interest and group annuity contracts, are also recognized as revenue when
due. Premiums received for annuity policies without mortality or morbidity
risk and for guaranteed interest and group annuity contracts are recorded
using deposit accounting.
12
USG Annuity & Life Company
Notes to Financial Statements - Statutory Basis
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1. Nature of Operations and Significant Accounting Policies (continued)
Basis of Presentation (continued)
Under GAAP, premiums for traditional life insurance products, which include
those products with fixed and guaranteed premiums and benefits and consist
primarily of whole life insurance policies, are recognized as revenue when
due. Group insurance premiums are recognized as premium revenue over the
time period to which the premiums relate. Revenues for universal life,
annuities and guaranteed interest contracts consist of policy charges for
the cost of insurance, policy administration charges, amortization of
policy initiation fees and surrender charges assessed during the period.
Benefit and Contract Reserves: Life policy and contract reserves under
statutory accounting practices are calculated based upon both the net level
premium and Commissioners' Reserve Valuation methods using statutory rates
for mortality and interest. GAAP requires that policy reserves for
traditional products be based upon the net level premium method utilizing
reasonably conservative estimates of mortality, interest, and withdrawals
prevailing when the policies were sold. For interest-sensitive products,
the GAAP policy reserve is equal to the policy fund balance plus an
unearned revenue reserve which reflects the unamortized balance of early
year policy loads over renewal year policy loads.
Reinsurance: For business ceded to unauthorized reinsurers, statutory
accounting practices require that reinsurance credits permitted by the
treaty be recorded as an offsetting liability and charged against
unassigned surplus. Under GAAP, an allowance for amounts deemed
uncollectible would be established through a charge to earnings. Statutory
income recognized on certain reinsurance treaties representing financing
arrangements is not recognized on a GAAP basis.
Policy and contract liabilities ceded to reinsurers have been reported as
reductions of the related reserves rather than as assets as required under
GAAP.
Commissions allowed by reinsurers on business ceded are reported as income
when received rather than being deferred and amortized with deferred policy
acquisition costs as required under GAAP.
Nonadmitted Assets: Certain assets designated as "nonadmitted," principally
deferred federal income tax assets, disallowed interest maintenance
reserves, non-operating software, past-due agents' balances, furniture and
equipment, intangible assets, and other assets not specifically identified
as an admitted asset within the NAIC Accounting Practices and Procedures
Manual are excluded from the accompanying balance sheets and are charged
directly to unassigned surplus. Under GAAP, such assets are included in the
balance sheet.
13
USG Annuity & Life Company
Notes to Financial Statements - Statutory Basis
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1. Nature of Operations and Significant Accounting Policies (continued)
Basis of Presentation (continued)
Universal Life and Annuity Policies: Revenues for universal life and
annuity policies consist of the entire premium received and benefits
incurred represent the total of death benefits paid and the change in
policy reserves. Under GAAP, premiums received in excess of policy charges
would not be recognized as premium revenue and benefits would represent the
excess of benefits paid over the policy account value and interest credited
to the account values.
Deferred Income Taxes: Deferred tax assets are provided for and admitted to
an amount determined under a standard formula. This formula considers the
amount of differences that will reverse in the subsequent year, taxes paid
in prior years that could be recovered through carrybacks, surplus limits
and the amount of deferred tax liabilities available for offset. Any
deferred tax assets not covered under the formula are non-admitted.
Deferred taxes do not include any amounts for state taxes. Under GAAP, a
deferred tax asset is recorded for the amount of gross deferred tax assets
that are expected to be realized in future years and a valuation allowance
is established for the portion that is not realizable.
Statements of Cash Flows: Cash and short-term investments in the statements
of cash flows represent cash balances and investments with initial
maturities of one year or less. Under GAAP, the corresponding caption of
cash and cash equivalents include cash balances and investments with
initial maturities of three months or less.
Reconciliation to GAAP
The effects of the preceding variances from GAAP on the accompanying
statutory basis financial statements have not been determined, but are
presumed to be material.
Other significant accounting practices are as follows:
Investments
Bonds, preferred stocks, common stocks, short-term investments and
derivative instruments are stated at values prescribed by the NAIC, as
follows:
Bonds not backed by other loans are principally stated at amortized cost
using the interest method.
14
USG Annuity & Life Company
Notes to Financial Statements - Statutory Basis
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1. Nature of Operations and Significant Accounting Policies (continued)
Investments (continued)
Single class and multi-class mortgage-backed/asset-backed securities are
valued at amortized cost using the interest method including anticipated
prepayments. Prepayment assumptions are obtained from dealer surveys or
internal estimates and are based on the current interest rate and economic
environment. The retrospective adjustment method is used to value all such
securities except for higher-risk asset backed securities, which are valued
using the prospective method.
Redeemable preferred stocks rated as high quality or better are reported at
cost or amortized cost. All other redeemable preferred stocks are reported
at the lower of cost, amortized cost, or market value and nonredeemable
preferred stocks are reported at market value or the lower of cost or
market value as determined by the Securities Valuation Office of the NAIC
("SVO").
Common stocks are reported at market value as determined by the SVO and the
related unrealized capital gains/(losses) are reported in unassigned
surplus along with adjustment for federal income taxes.
The Company analyzes the general account investments to determine whether
there has been an other than temporary decline in fair value below the
amortized cost basis. Management considers the length of the time and the
extent to which the market value has been less than cost; the financial
condition and near-term prospects of the issuer; future economic conditions
and market forecasts; and the Company's intent and ability to retain the
investment in the issuer for a period of time sufficient to allow for
recovery in market value. If it is probable that all amounts due according
to the contractual terms of a debt security will not be collected, an other
than temporary impairment is considered to have occurred.
In addition, the Company invests in structured securities including
mortgage-backed securities/collateralized mortgage obligations,
asset-backed securities, collateralized debt obligations, and commercial
mortgage-backed securities. For these structured securities, management
compares the undiscounted cash flows to the carrying value. An other than
temporary impairment is considered to have occurred when the undiscounted
cash flows are less than the carrying value.
When a decline in fair value is determined to be other than temporary, the
individual security is written down to fair value and the loss accounted
for as a realized loss.
15
USG Annuity & Life Company
Notes to Financial Statements - Statutory Basis
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1. Nature of Operations and Significant Accounting Policies (continued)
Investments (continued)
The Company uses interest rate swaps, caps and floors, options and certain
other derivatives as part of its overall interest rate risk management
strategy for certain life insurance and annuity products. As the Company
only uses derivatives for hedging purposes, the Company values all
derivative instruments on a consistent basis with the hedged item. Upon
termination, gains and losses on those instruments are included in the
carrying values of the underlying hedged items and are amortized over the
remaining lives of the hedged items as adjustments to investment income or
benefits from the hedged items. Any unamortized gains or losses are
recognized when the underlying hedged items are sold.
Interest rate swap contracts are used to convert the interest rate
characteristics (fixed or variable) of certain investments to match those
of the related insurance liabilities that the investments are supporting.
The net interest effect of such swap transactions is reported as an
adjustment of interest income from the hedged items as incurred.
Interest rate caps and floors are used to limit the effects of changing
interest rates on yields of variable rate or short-term assets or
liabilities. The initial cost of any such agreement is amortized to net
investment income over the life of the agreement. Periodic payments that
are receivable as a result of the agreements are accrued as an adjustment
of interest income or benefits from the hedged items.
Mortgage loans are reported at amortized cost, less allowance for
impairments.
Policy loans are reported at unpaid principal balances.
Land is reported at cost. Real estate occupied by the company is reported
at depreciated cost; other real estate is reported at the lower of
depreciated cost or fair value. Depreciation is calculated on a
straight-line basis over the estimated useful lives of the properties.
For reverse repurchase agreements, Company policies require a minimum of
102% of the fair value of securities purchased under reverse repurchase
agreements to be maintained as collateral. Cash collateral received is
invested in short-term investments and the offsetting collateral liability
is included in miscellaneous liabilities.
Reverse dollar repurchase agreements are accounted for as collateral
borrowings, where the amount borrowed is equal to the sales price of the
underlying securities.
16
USG Annuity & Life Company
Notes to Financial Statements - Statutory Basis
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1. Nature of Operations and Significant Accounting Policies (continued)
Investments (continued)
The Company engages in securities lending whereby certain domestic bonds
from its portfolio are loaned to other institutions for short periods of
time. Collateral, primarily cash, which is in excess of the market value of
the loaned securities, is deposited by the borrower with a lending agent,
and retained and invested by the lending agent to generate additional
income for the Company. The Company does not have access to the collateral.
The Company's policy requires a minimum of 102% of the fair value of
securities loaned to be maintained as collateral. The market value of the
loaned securities is monitored on a daily basis with additional collateral
obtained or refunded as the market value fluctuates.
At December 31, 2002 and 2001, the Company had loaned securities (which are
reflected as invested assets on the Balance Sheets) with a market value of
approximately $32,662,000 and $62,905,000, respectively.
Short-term investments are reported at amortized cost. Short-term
investments include investments with maturities of less than one year at
the date of acquisition.
Other invested assets are reported at amortized cost using the effective
interest method. Other invested assets primarily consist of residual
collateralized mortgage obligations and partnership interests.
Realized capital gains and losses are determined using the specific
identification basis.
Aggregate Reserve for Life Policies and Contracts
Life, annuity, and accident and health reserves are developed by actuarial
methods and are determined based on published tables using statutorily
specified interest rates and valuation methods that will provide, in the
aggregate, reserves that are greater than or equal to the minimum or
guaranteed policy cash value or the amounts required by law. Interest rates
range from 4.00% to 8.75%.
The Company waives the deduction of deferred fractional premiums upon the
death of the insured. It is the Company's practice to return a pro rata
portion of any premium paid beyond the policy month of death, although it
is not contractually required to do so for certain issues.
17
USG Annuity & Life Company
Notes to Financial Statements - Statutory Basis
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1. Nature of Operations and Significant Accounting Policies (continued)
Aggregate Reserve for Life Policies and Contracts (continued)
The methods used in valuation of substandard policies are as follows:
For life, endowment and term policies issued substandard, the standard
reserve during the premium-paying period is increased by 50% of the
gross annual extra premium. Standard reserves are held on Paid-Up
Limited Pay contracts.
For reinsurance accepted with table rating, the reserve established is
a multiple of the standard reserve corresponding to the table rating.
For reinsurance with flat extra premiums, the standard reserve is increased
by 50% of the flat extra.
The tabular interest has been determined from the basic data for the
calculation of policy reserves for all direct ordinary life insurance and
for the portion of group life insurance classified as group Section 79. The
tabular interest of funds not involving life contingencies is calculated as
the current year reserves, plus payments, less prior year reserves, less
funds added.
Reinsurance
Reinsurance premiums, commissions, expense reimbursements, and reserves
related to reinsured business are accounted for on bases consistent with
those used in accounting for the original policies issued and the terms of
the reinsurance contracts. Reserves are based on the terms of the
reinsurance contract and are consistent with the risks assumed. Premiums
and benefits ceded to other companies have been reported as a reduction of
premium revenue and benefits expense. Amounts applicable to reinsurance
ceded for reserves and unpaid claim liabilities have been reported as
reductions of these items, and expense allowances received in connection
with reinsurance ceded have been reflected in operations.
18
USG Annuity & Life Company
Notes to Financial Statements - Statutory Basis
- --------------------------------------------------------------------------------
1. Nature of Operations and Significant Accounting Policies (continued)
Nonadmitted Assets
Nonadmitted assets are summarized as follows:
December 31
2002 2001
-------------- --------------
(In Thousands)
Deferred federal income taxes $ 54,496 $ 55,833
Agents' debit balances 519 255
Deferred and uncollected premium 119 120
Other 885 3,095
-------------- --------------
Total nonadmitted assets $ 56,019 $ 59,303
============== ==============
Changes in nonadmitted assets are generally reported directly in surplus as
an increase or decrease in nonadmitted assets. Certain changes are reported
directly in surplus as a change in unrealized capital gains or losses.
Claims and Claims Adjustment Expenses
Claims expenses represent the estimated ultimate net cost of all reported
and unreported claims incurred through December 31, 2002. The Company does
not discount claims and claims adjustment expense reserves. Such estimates
are based on actuarial projections applied to historical claims payment
data. Such liabilities are considered to be reasonable and adequate to
discharge the Company's obligations for claims incurred but unpaid as of
December 31, 2002.
Cash Flow Information
Cash and short-term investments include cash on hand, demand deposits and
short-term fixed maturity instruments (with a maturity of less than one
year at date of acquisition).
The Company borrowed $1,021,035,000 and repaid $1,021,035,000 in 2002 and
borrowed $880,600,000 and repaid $928,400,000 during 2001. These borrowings
were on a short-term basis, at an interest rate that approximated current
money market rates and exclude borrowings from reverse dollar repurchase
transactions. Interest paid on borrowed money was $109,000 and $645,000
during 2002 and 2001, respectively.
Reclassifications
Certain prior year amounts in the Company's statutory basis financial
statements have been reclassified to conform to the 2002 financial
statement presentation.
19
USG Annuity & Life Company
Notes to Financial Statements - Statutory Basis
- --------------------------------------------------------------------------------
2. Permitted Statutory Basis Accounting Practices
The financial statements of the Company are presented on the basis of
accounting practices prescribed or permitted by the Oklahoma Insurance
Department. The Oklahoma Insurance Department recognizes only statutory
accounting practices prescribed or permitted by the State of Oklahoma for
determining and reporting the financial condition and results of operations
of an insurance company, for determining its solvency under the Oklahoma
Insurance Laws. NAIC Accounting Practices and Procedures Manual has been
adopted as a component of prescribed or permitted practices by the state of
Oklahoma. The Commissioner of Insurance has the right to permit other
specific practices that deviate from prescribed practices.
The Company is required to identify those significant accounting practices
that are permitted, and obtain written approval of the practices from the
Oklahoma Insurance Department. As of December 31, 2002 and 2001, the
Company had no such permitted accounting practices.
3. Accounting Changes
The Company prepares its statutory financial statements in conformity with
accounting practices prescribed or permitted by the State of Oklahoma.
Effective January 1, 2001, the State of Oklahoma required that insurance
companies domiciled in the State of Oklahoma prepare their statutory basis
financial statements in accordance with the NAIC Accounting Practices and
Procedures Manual subject to any deviations prescribed or permitted by the
State of Oklahoma insurance commissioner.
Accounting changes adopted to conform to the provisions of the NAIC
Accounting Practices and Procedures Manual are reported as changes in
accounting principles. The cumulative effect of changes in accounting
principles is reported as an adjustment to unassigned surplus in the period
of the change in accounting principle. The cumulative effect is the
difference between the amount of capital and surplus at the beginning of
the year and the amount of capital and surplus that would have been
reported at that date if the new accounting principles had been applied
retroactively for all prior periods.
As a result of these changes, the Company reported a change of accounting
principle, as an adjustment that increased unassigned surplus, by
$5,180,000 as of January 1, 2001. These changes are primarily attributed to
an increase in unassigned surplus of approximately $5,911,000 related to
deferred tax assets, $15,384,000 related to prepayment penalties on bonds
and mortgage loans released from the IMR liability. Offsetting this
increase is a reduction of approximately $15,988,000 to guaranty fund
assessment and $127,000 to cost of collection of premiums.
20
USG Annuity & Life Company
Notes to Financial Statements - Statutory Basis
- --------------------------------------------------------------------------------
4. Investments
The amortized cost and fair value of bonds and equity securities are as
follows:
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ----------- ----------- -----------
(In Thousands)
At December 31, 2002:
U.S. Treasury securities and obligations of
U.S. government corporations and agencies $ 285,347 $ 4,998 $ 36 $ 290,309
States, municipalities, and political subdivisions - - - -
Foreign government 120,649 4,200 2,385 122,464
Public utilities securities 270,390 14,526 4,008 280,908
Corporate securities 3,244,826 182,420 34,973 3,392,273
Mortgage-backed securities 1,668,901 90,300 46,006 1,713,195
Other structured securities 320,274 9,786 28,080 301,980
Commercial mortgage-backed securities 217,028 18,254 76 235,206
----------- ----------- ----------- -----------
Total fixed maturities 6,127,415 324,484 115,564 6,336,335
Preferred stocks 1,088 - - 1,088
----------- ----------- ----------- -----------
Total equity securities 1,088 - - 1,088
----------- ----------- ----------- -----------
Total $6,128,503 $ 324,484 $ 115,564 $6,337,423
=========== =========== =========== ===========
At December 31, 2001:
U.S. Treasury securities and obligations of
U.S. government corporations and agencies $ 38,620 $ 244 $ 82 $ 38,782
Public utilities securities 136,285 3,665 4,478 135,472
Corporate securities 2,785,911 97,406 68,734 2,814,583
Mortgage-backed securities 1,700,989 163,964 118,566 1,746,387
Other structured securities 463,485 12,125 27,898 447,712
Commercial mortgage-backed securities 161,939 6,507 1,499 166,947
----------- ----------- ----------- -----------
Total fixed maturities 5,287,229 283,911 221,257 5,349,883
Preferred stocks 134 - - 134
Common stocks 22 - - 22
----------- ----------- ----------- -----------
Total equity securities 156 - - 156
----------- ----------- ----------- -----------
Total $5,287,385 $ 283,911 $ 221,257 $5,350,039
=========== =========== =========== ===========
21
USG Annuity & Life Company
Notes to Financial Statements - Statutory Basis
- --------------------------------------------------------------------------------
4. Investments (continued)
The amortized cost and fair value of investments in bonds at December 31,
2002, by contractual maturity, are shown below. Expected maturities may
differ from contractual maturities because borrowers may have the right to
call or prepay obligations with or without call or prepayment penalties.
Amortized Fair
Cost Value
-------------- --------------
December 31, 2002 (In Thousands)
Maturity:
Due in 1 year or less $ 44,173 $ 45,096
Due after 1 year through 5 years 1,118,169 1,177,925
Due after 5 years through 10 years 1,886,593 1,962,788
Due after 10 years 872,277 900,145
-------------- --------------
Total Maturity 3,921,212 4,085,954
Mortgage-backed securities 1,668,901 1,713,195
Other structured securities 320,274 301,980
Commercial mortgage-backed securities 217,028 235,206
-------------- --------------
Total $ 6,127,415 $ 6,336,335
============== ==============
At December 31, 2002, investments in certificates of deposit and bonds,
with an admitted asset value of $3,285,000, were on deposit with state
insurance departments to satisfy regulatory requirements.
Reconciliation of bonds from amortized cost to carrying value as of
December 31, 2002 and 2001 is as follows:
December 31
2002 2001
-------------- --------------
(In Thousands)
Amortized cost $ 6,127,415 $ 5,287,229
Less nonadmitted bonds 10,920 1,273
-------------- --------------
Carrying value $ 6,116,495 $ 5,285,956
============== ==============
Proceeds from the sales of investments in bonds and other fixed maturity
interest securities were $4,334,623,000 and $1,852,588,000 in 2002 and
2001, respectively. Gross gains of $109,772,000 and $49,178,000 and gross
losses of $97,962,000 and $34,222,000 during 2002 and 2001, respectively,
were realized on those sales. A portion of the gains realized in 2002 and
2001 has been deferred to future periods in the interest maintenance
reserve.
22
USG Annuity & Life Company
Notes to Financial Statements - Statutory Basis
- --------------------------------------------------------------------------------
4. Investments (continued)
Major categories of net investment income are summarized as follows:
December 31
2002 2001
-------------- --------------
(In Thousands)
Income:
Bonds $ 459,813 $ 415,872
Mortgage loans 128,230 137,032
Policy loans 1,091 1,199
Company-occupied property 376 204
Other (26,548) (4,625)
-------------- --------------
Total investment income 562,962 549,682
Investment expenses 26,756 29,068
-------------- --------------
Net investment income $ 536,206 $ 520,614
============== ==============
As part of its overall investment strategy, the Company has entered into
agreements to purchase securities as follows:
December 31
2002 2001
-------------- --------------
(In Thousands)
Investment purchase commitments $ 87,963 $ 55,776
============== ==============
The Company entered into reverse dollar repurchase transactions to increase
its return on investments and improve liquidity. Reverse dollar repurchases
involve a sale of securities and an agreement to repurchase substantially
the same securities as those sold. The reverse dollar repurchases are
accounted for as short term collateralized financing and the repurchase
obligation is reported in borrowed money. The repurchase obligation totaled
$173,189,000 and $177,558,000 at December 31, 2002 and 2001, respectively.
The securities underlying these agreements are mortgage-backed securities
with a book value and fair value of $173,245,000 at December 31, 2002. The
securities have a weighted average coupon of 5.99% and have maturities
ranging from December 2017 through December 2032. The primary risk
associated with short-term collateralized borrowings is that the
counterparty may be unable to perform under the terms of the contract. The
Company's exposure is limited to the excess of the net replacement cost of
the securities over the value of the short-term investments, which was not
material at December 31, 2002. The Company believes the counterparties to
the reverse dollar repurchase agreements are financially responsible and
that the counterparty risk is minimal.
23
USG Annuity & Life Company
Notes to Financial Statements - Statutory Basis
- --------------------------------------------------------------------------------
4. Investments (continued)
The Company participates in reverse repurchase transactions. Such
transactions include the sale of corporate securities to a major securities
dealer and a simultaneous agreement to repurchase the same security in the
near term. The proceeds are invested in new securities of intermediate
durations. The terms of the reverse repurchase agreements call for payment
of interest at a rate of 1.4%. The agreements mature prior to the end of
January 2003. The amount due on these agreements included in borrowed money
is $11,000,000. The securities underlying these agreements are
mortgage-backed securities with a book value and fair value of $12,687,000.
The securities have a weighted average coupon of 6.5% and have a maturity
of August 2032.
The maximum and minimum lending rates for long-term mortgage loans during
2002 were 7.66% and 2.99%. Fire insurance is required on all properties
covered by mortgage loans and must at least equal the excess of the loan
over the maximum loan which would be permitted by law on the land without
the buildings.
The maximum percentage of any loan to the value of collateral at the time
of the loan, exclusive of insured or guaranteed or purchase money
mortgages, was 66.7% on commercial properties. As of December 31, 2002, the
Company held no mortgages with interest more than 180 days overdue. Total
interest due, as of December 31, 2002 is $0.
5. Derivative Financial Instruments Held for Purposes Other than Trading
The Company enters into interest rate and currency contracts, including
swaps, caps, floors, and options, to reduce and manage risks, which include
the risk of a change in the value, yield, price, cash flows, exchange rates
or quantity of, or a degree of exposure with respect to, assets,
liabilities, or future cash flows, which the Company has acquired or
incurred. Hedge accounting practices are supported by cash flow matching,
scenario testing and duration matching.
The Company uses interest rate swaps to reduce market risks from changes in
interest rates and to alter interest rate exposure arising from mismatches
between assets and liabilities. Interest rate swap agreements generally
involve the exchange of fixed and floating interest payments over the life
of the agreement without an exchange of the underlying principal amount.
Currency swap agreements generally involve the exchange of local and
foreign currency payments over the life of the agreements without an
exchange of the underlying principal amount. Interest rate cap and interest
rate floor agreements owned entitle the Company to receive payments to the
extent reference interest rates exceed or fall below strike levels in the
contracts based on the notional amounts.
24
USG Annuity & Life Company
Notes to Financial Statements - Statutory Basis
- --------------------------------------------------------------------------------
5. Derivative Financial Instruments Held for Purposes Other than Trading
(continued)
Premiums paid for the purchase of interest rate contracts are included in
other invested assets and are being amortized to interest expense over the
remaining terms of the contracts or in a manner consistent with the
financial instruments being hedged.
Amounts paid or received, if any, from such contracts are included in
interest expense or income. Accrued amounts payable to or receivable from
counterparties are included in other liabilities or other invested assets.
Gains or losses realized as a result of early terminations of interest rate
contracts are amortized to investment income over the remaining term of the
items being hedged to the extent the hedge is considered to be effective;
otherwise, they are recognized upon termination.
Interest rate contracts that are matched or otherwise designated to be
associated with other financial instruments are recorded at fair value if
the related financial instruments mature, are sold, or are otherwise
terminated or if the interest rate contracts cease to be effective hedges.
Changes in the fair value of derivatives are recorded as investment income.
The Company manages the potential credit exposure from interest rate
contracts through careful evaluation of the counterparties' credit
standing, collateral agreements, and master netting agreements.
The Company is exposed to credit loss in the event of nonperformance by
counterparties on interest rate contracts; however, the Company does not
anticipate nonperformance by any of these counterparties. The amount of
such exposure is generally the unrealized gains in such contracts.
25
USG Annuity & Life Company
Notes to Financial Statements - Statutory Basis
- --------------------------------------------------------------------------------
5. Derivative Financial Instruments Held for Purposes Other than Trading
(continued)
The table below summarizes the Company's interest rate contracts included
in other invested assets at December 31, 2002 and 2001:
Notional Amount Carrying Value Fair Value
--------------- --------------- ---------------
(In Thousands)
December 31, 2002
Interest rate contracts
Swaps $ 1,146,498 $ - $ (138,473)
Caps and floors 548,465 3,393 1,296
--------------- --------------- ---------------
Total derivatives $ 1,694,963 $ 3,393 $ (137,177)
=============== =============== ===============
Notional Amount Carrying Value Fair Value
--------------- --------------- ---------------
(In Thousands)
December 31, 2001
Interest rate contracts:
Swaps $ 921,000 $ 936 $ (56,090)
Caps and floors 298,465 547 2,302
--------------- --------------- ---------------
Total derivatives $ 1,219,465 $ 1,483 $ (53,788)
=============== =============== ===============
6. Concentrations of Credit Risk
The Company held less-than-investment-grade bonds with an aggregate book
value of $435,061,000 and $520,834,000 and with an aggregate market value
of $413,437,000 and $477,494,000 at December 31, 2002 and 2001,
respectively. Those holdings amounted to 7.1% of the Company's investments
in bonds and 5.6% of total admitted assets at December 31, 2002. The
holdings of less-than-investment-grade bonds are widely diversified and of
satisfactory quality based on the Company's investment policies and credit
standards.
The Company held unrated bonds of $204,268,000 and $357,815,000 with an
aggregate NAIC market value of $208,297,000 and $356,506,000 at December
31, 2002 and 2001, respectively. The carrying value of these holdings
amounted to 3.3% of the Company's investment in bonds and 2.6% of the
Company's total admitted assets at December 31, 2002.
At December 31, 2002, the Company's commercial mortgages involved a
concentration of properties located in California (11.6%) and Pennsylvania
(9.9%). The remaining commercial mortgages relate to properties located in
37 other states. The portfolio is well diversified; covering many different
types of income-producing properties on which the Company has first
mortgage liens. The maximum mortgage outstanding on any individual property
is $23,935,000.
26
USG Annuity & Life Company
Notes to Financial Statements - Statutory Basis
- --------------------------------------------------------------------------------
7. Annuity Reserves
At December 31, 2002 and 2001, the Company's annuity reserves, including
those held in separate accounts and deposit fund liabilities that are
subject to discretionary withdrawal with adjustment, subject to
discretionary withdrawal without adjustment, and not subject to
discretionary withdrawal provisions are summarized as follows:
December 31, 2002
Amount Percent
-------------- --------------
(In Thousands)
Subject to discretionary withdrawal (with adjustment):
With market value adjustment $ 4,447,295 56%
At book value less surrender charge 1,635,038 21
-------------- --------------
Subtotal 6,082,333 77
Subject to discretionary withdrawal (without adjustment) at book
value with minimal or no charge or adjustment 1,194,281 15
Not subject to discretionary withdrawal 641,496 8
-------------- --------------
Total annuity reserves and deposit fund liabilities before reinsurance 7,918,110 100%
==============
Less reinsurance ceded 895,734
--------------
Net annuity reserves and deposit fund liabilities $ 7,022,376
==============
December 31, 2001
Amount Percent
-------------- --------------
(In Thousands)
Subject to discretionary withdrawal (with adjustment):
With market value adjustment $ 3,927,063 55%
At book value less surrender charge 1,568,029 22
-------------- --------------
Subtotal 5,495,092 77
Subject to discretionary withdrawal (without adjustment) at book
value with minimal or no charge or adjustment 1,030,501 15
Not subject to discretionary withdrawal 588,714 8
-------------- --------------
Total annuity reserves and deposit fund liabilities before reinsurance 7,114,307 100%
==============
Less reinsurance ceded 744,333
--------------
Net annuity reserves and deposit fund liabilities $ 6,369,974
==============
27
USG Annuity & Life Company
Notes to Financial Statements - Statutory Basis
- --------------------------------------------------------------------------------
8. Reinsurance
The Company is involved in both ceded and assumed reinsurance with other
companies for the purpose of diversifying risk and limiting exposure on
larger risks. As of December 31, 2002, the Company's retention limit for
acceptance of risk on life insurance policies had been set at various
levels up to $500,000.
To the extent that the assuming companies become unable to meet their
obligations under these treaties, the Company remains contingently liable
to its policyholders for the portion reinsured. To minimize its exposure to
significant losses from retrocessionaire insolvencies, the Company
evaluates the financial condition of the retrocessionaire and monitors
concentrations of credit risk.
Assumed premiums amounted to $136,400,000 and $147,163,000 for the years
ended December 31, 2002 and 2001, respectively.
The Company's ceded reinsurance arrangements reduced certain items in the
accompanying financial statements by the following amounts:
December 31
2002 2001
-------------- --------------
(In Thousands)
Premiums $ 260,544 $ 234,110
Benefits paid or provided 9,447 6,950
Policy and contract liabilities at year end $ 896,762 $ 775,452
9. Federal Income Taxes
The Company joins in filing a consolidated federal income tax return with
its parent, Equitable, and other affiliates. The method of tax allocation
is governed by a written tax sharing agreement. The tax sharing agreement
provides that each member of the consolidated return shall reimburse
Equitable for its respective share of the consolidated federal income tax
liability and shall receive a benefit for its losses at the statutory rate.
Significant components of income taxes incurred as of December 31 are:
December 31
2002 2001
-------------- --------------
(In Thousands)
Current income taxes incurred consist of the following major components:
Federal taxes on operations $ 41,015 $ 49,747
Federal taxes on capital gains (6,049) 7,981
-------------- --------------
Total current taxes incurred $ 34,966 $ 57,728
============== ==============
28
USG Annuity & Life Company
Notes to Financial Statements - Statutory Basis
- --------------------------------------------------------------------------------
9. Federal Income Taxes (continued)
The components of the net deferred tax asset/(liability) at December 31 are
as follows:
December 31
2002 2001
-------------- --------------
(In Thousands)
Total gross deferred tax assets $ 70,328 $ 63,290
Total deferred tax liabilities (231) (481)
-------------- --------------
Net deferred tax asset 70,097 62,809
Deferred tax asset non-admitted (54,496) (55,833)
-------------- --------------
Net admitted deferred tax asset 15,601 6,976
============== ==============
Decrease (increase) in non-admitted asset $ 1,337 $ (25,312)
============== ==============
The main components of deferred tax assets and deferred tax liabilities are
as follows:
December 31
2002 2001
-------------- --------------
(In Thousands)
Deferred tax assets resulting from book/tax differences in:
Investments $ 32,290 $ 17,875
Deferred acquisition costs 23,431 26,735
Guaranty assessments 4,339 5,596
Insurance reserves 8,423 8,957
Unrealized loss on investments 499 3,309
Other 1,346 818
-------------- --------------
Total deferred tax assets 70,328 63,290
Deferred tax assets non-admitted (54,496) (55,833)
-------------- --------------
Admitted deferred tax assets 15,832 7,457
Deferred tax liabilities resulting from book/tax differences in:
Due and deferred premiums 231 481
-------------- --------------
Total deferred tax liabilities 231 481
-------------- --------------
Net admitted deferred tax asset $ 15,601 $ 6,976
============== ==============
29
USG Annuity & Life Company
Notes to Financial Statements - Statutory Basis
- --------------------------------------------------------------------------------
9. Federal Income Taxes (continued)
The change in net deferred income taxes in comprised of the following:
December 31
2002 2001 Change
-------------- -------------- --------------
(In Thousands)
Total deferred tax assets $ 70,328 $ 63,290 $ 7,038
Total deferred tax liabilities 231 481 (250)
-------------- -------------- --------------
Net deferred tax asset $ 70,097 $ 62,809 7,288
============== ==============
Tax effect of items in surplus:
Unrealized gains (losses) 2,278
--------------
Change in net deferred income tax $ 9,566
==============
The provision for federal income taxes expense and change in deferred taxes
differs from the amount obtained applying the statutory federal income tax
rate to income (including capital losses) before income taxes for the
following reasons:
Year ended
December 31,
2002
--------------
(In Thousands)
Ordinary income $ 108,357
Capital losses (48,154)
--------------
Total pre-tax book income $ 60,203
==============
Provision computed at statutory rate $ 21,071
Audit settlement not provided for 5,185
Interest maintenance reserve 2,606
Nondeductible general expenses 22
Refinement of deferred tax balances (3,488)
Other 4
---------------
Total $ 25,400
===============
Federal income taxes incurred $ 34,966
Change in net deferred income taxes (9,566)
---------------
Total statutory income taxes $ 25,400
===============
The amount of federal income taxes incurred that will be available for
recoupment in the event of future net losses is $0 and $6,791,473 from 2002
and 2001, respectively.
The Company has a recoverable of $6,561,673 at December 31, 2002 and had a
payable of $17,114,498 at December 31, 2001 for federal income taxes under
the intercompany tax sharing agreement.
30
USG Annuity & Life Company
Notes to Financial Statements - Statutory Basis
- --------------------------------------------------------------------------------
10. Capital and Surplus
Under Oklahoma insurance regulations, the Company is required to maintain a
minimum total capital and surplus of $750,000. Additionally, the amount of
dividends which can be paid by the Company to its stockholder without prior
approval of the Oklahoma Insurance Department is limited to the greater of
10% of statutory surplus or the statutory net gain from operations.
11. Fair Values of Financial Instruments
Life insurance liabilities that contain mortality risk and all nonfinancial
instruments have been excluded from the disclosure requirements. However,
the fair values of liabilities under all insurance contracts are taken into
consideration in the Company's overall management of interest rate risk,
such that the Company's exposure to changing interest rates is minimized
through the matching of investment maturities with amounts due under
insurance contracts. The carrying amounts and fair values of the Company's
financial instruments are summarized as follows:
December 31, 2002 December 31, 2001
--------------------------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
----------- ----------- ----------- -----------
(In Thousands)
Assets:
Bonds $6,116,495 $6,336,335 $5,285,956 $5,349,883
Preferred stocks 1,088 1,088 134 134
Unaffiliated common stocks - - 22 22
Mortgage loans 1,483,855 1,632,720 1,659,518 1,738,458
Policy loans 32,454 32,454 32,732 32,732
Derivative securities 3,393 (137,177) 1,483 (53,788)
Short-term investments 5,650 5,650 84,678 84,678
Cash 3,466 3,466 18,170 18,170
Indebtedness from related parties 25 25 3,945 3,945
Receivable for securities 2,873 2,873 4,268 4,268
Liabilities:
Individual and group annuities 6,775,875 6,621,753 6,339,976 6,218,709
Deposit type contract 246,501 258,945 232,745 247,377
Indebtedness to related parties 22,147 22,147 6,548 6,548
Payable for securities - - 101,206 101,206
The following methods and assumptions were used by the Company in
estimating the fair value disclosures for financial instruments in the
accompanying financial statements and notes thereto:
31
USG Annuity & Life Company
Notes to Financial Statements - Statutory Basis
- --------------------------------------------------------------------------------
11. Fair Values of Financial Instruments (continued)
Cash and short-term investments: The carrying amounts reported in the
accompanying balance sheets for these financial instruments
approximate their fair values.
Fixed maturities and equity securities: The fair values for bonds,
preferred stocks and common stocks, reported herein, are based on
quoted market prices, where available. For securities not actively
traded, fair values are estimated using values obtained from
independent pricing services or, in the case of private placements,
collateralized mortgage obligations and other mortgage derivative
investments, are estimated by discounting the expected future cash
flows. The discount rates used vary as a function of factors such as
yield, credit quality, and maturity, which fall within a range between
0% and 15% over the total portfolio. Fair values determined on this
basis can differ from values published by the NAIC Securities
Valuation Office. Market value as determined by the NAIC as of
December 31, 2002 and 2001 is $6,154,770,000 and $5,317,444,000,
respectively.
Mortgage loans: Estimated market values for commercial real estate
loans were generated using a discounted cash flow approach. Loans in
good standing are discounted using interest rates determined by U.S.
Treasury yields on December 31 and spreads applied on new loans with
similar characteristics. The amortizing features of all loans are
incorporated in the valuation. Where data on option features is
available, option values are determined using a binomial valuation
method, and are incorporated into the mortgage valuation. Restructured
loans are valued in the same manner; however, these loans were
discounted at a greater spread to reflect increased risk. All
residential loans are valued at their outstanding principal balances,
which approximate their fair values.
Derivative financial instruments: Fair values for on-balance-sheet
derivative financial instruments (caps, options and floors) and
off-balance-sheet derivative financial instruments (swaps) are based
on broker/dealer valuations or on internal discounted cash flow
pricing models taking into account current cash flow assumptions and
the counterparties' credit standing.
Other investment-type insurance contracts: The fair values of the
Company's deferred annuity contracts are estimated based on the cash
surrender values. The carrying values of other policyholder
liabilities, including immediate annuities, dividend accumulations,
supplementary contracts without life contingencies, and premium
deposits, approximate their fair values.
The carrying value of all other financial instruments approximates
their fair value.
32
USG Annuity & Life Company
Notes to Financial Statements - Statutory Basis
- --------------------------------------------------------------------------------
12. Commitments and Contingencies
The Company is a party to threatened or pending lawsuits arising from the
normal conduct of business. Due to the climate in insurance and business
litigation, suits against the Company sometimes include claims for
substantial compensatory, consequential or punitive damages and other types
of relief. Moreover, certain claims are asserted as class actions,
purporting to represent a group of similarly situated individuals. While it
is not possible to forecast the outcome of pending lawsuits, in light of
existing insurance, reinsurance and established reserves, it is the opinion
of management that the disposition of such lawsuits will not have a
materially adverse effect on the Company's operations or financial
position.
The Company has committed to provide additional capital contributions of
$42,012,000 in partnership investments at December 31, 2002.
13. Financing Agreements
The Company maintains a revolving loan agreement with SunTrust Bank,
Atlanta (the "Bank"). Under this agreement, which expires July 31, 2003,
the Company can borrow up to $75,000,000 from the Bank. Interest on any
borrowing accrues at an annual rate equal to: the cost of funds for the
Bank for the period applicable for the advance plus 0.225% or a rate quoted
by the Bank to the Company for the borrowing. Under this agreement, the
Company incurred interest expense of $20,000 for the year ended December
31, 2002. At December 31, 2002, the Company had $0 payable to the Bank.
The Company also maintains a revolving loan agreement with Bank of New
York, New York (the "Bank"). Under this agreement, the Company can borrow
up to $100,000,000 from the Bank. Interest on any of the Company borrowing
accrues at an annual rate equal to: the cost of funds for the Bank for the
period applicable for the advance plus 0.225% or a rate quoted by the Bank
to the Company for the borrowing. Under this agreement, the Company
incurred interest expense of $31,000 for the year ended December 31, 2002.
At December 31, 2002, the Company had $0 payable to the Bank.
33
USG Annuity & Life Company
Notes to Financial Statements - Statutory Basis
- --------------------------------------------------------------------------------
14. Related Party Transactions
Affiliates
Management and service contracts and all cost sharing arrangements with
other affiliated ING US life insurance companies are allocated among
companies in accordance with normal, generally accepted expense and cost
allocation methods.
Investment Management: The Company has entered into an investment advisory
agreement and an administrative services agreement with ING Investment
Management, LLC ("IIM") under which IIM provides the Company with
investment management and asset liability management services. Total fees
under the agreement were approximately $19,698,000 and $17,852,000 for the
year ended December 31, 2002 and 2001, respectively.
Inter-insurer Services Agreement: The Company has entered into a services
agreement with certain of its affiliated insurance companies in the United
States ("affiliated insurers") whereby the affiliated insurers provide
certain administrative, management, professional, advisory, consulting and
other services to each other. Net amounts received under these agreements
were $31,437,000 and $19,154,000 for the year ended December 31, 2002 and
2001, respectively.
Tax Sharing Agreements: The Company has entered into federal tax sharing
agreements with members of an affiliated group as defined in Section 1504
of the Internal Revenue Code of 1986, as amended. The agreement provides
for the manner of calculation and the amounts/timing of the payments
between the parties as well as other related matters in connection with the
filing of consolidated federal income tax returns. The Company has also
entered into a state tax sharing agreement with ING AIH and each of the
specific subsidiaries that are parties to the agreement. The state tax
agreement applies to situations in which ING AIH and all or some of the
subsidiaries join in the filing of a state or local franchise, income tax
or other tax return on a consolidated, combined or unitary basis.
34
USG Annuity & Life Company
Notes to Financial Statements - Statutory Basis
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15. Guaranty Fund Assessments
Insurance companies are assessed the costs of funding the insolvencies of
other insurance companies by the various state guaranty associations,
generally based on the amount of premiums companies collect in that state.
The Company accrues the cost of future guaranty fund assessments based on
estimates of insurance company insolvencies provided by the National
Organization of Life and Health Insurance Guaranty Associations (NOLHGA)
and the amount of premiums written in each state. The Company reduces the
accrual by credits allowed in some states to reduce future premium taxes by
a portion of assessments in that state. The Company has estimated this
liability to be $12,397,000 and 15,988,000 as of December 31, 2002 and
2001, respectively and has recorded a reserve. The Company has also
recorded an asset of $2,451,000 and $5,447,000 as of December 31, 2002 and
2001, respectively, for future credits to premium taxes for assessments
already paid.
16. Regulatory Risk-Based Capital
Life and health insurance companies are subject to certain Risk-Based
Capital ("RBC") requirements as specified by the NAIC. Under those
requirements, the amount of capital and surplus maintained by a life and
health insurance company is to be determined based on the various risk
factors related to it. At December 31, 2002, USG Annuity & Life Company
meets the RBC requirements.
35