UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2004
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: 333-57212, 333-104539, 333-104546,
333-104547, 333-104548
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ING USA Annuity and Life Insurance Company
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(Exact name of registrant as specified in its charter)
Iowa 41-0991508
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(State or other jurisdiction of (IRS employer identification no.)
incorporation or organization)
1475 Dunwoody Drive, West Chester, Pennsylvania 19380-1478
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(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code (610) 425-3400
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Former name, former address and formal fiscal year, if changed since last report
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [ X ] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: As of August 12, 2004, 250,000
shares of Common Stock, $10 Par Value, are authorized, issued, and outstanding,
all of which were directly owned by Lion Connecticut Holdings Inc.
NOTE: WHEREAS ING USA ANNUITY AND LIFE INSURANCE COMPANY MEETS THE CONDITIONS
SET FORTH IN GENERAL INSTRUCTION H(1)(a) AND (b) OF FORM 10Q, THIS FORM IS BEING
FILED WITH THE REDUCED DISCLOSURE FORMAT PURSUANT TO GENERAL INSTRUCTION H(2).
ING USA ANNUITY AND LIFE INSURANCE COMPANY
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Form 10Q for the period ended June 30, 2004
INDEX
Page
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PART I. FINANCIAL INFORMATION (Unaudited)
Item 1. Financial Statements:
Condensed Statements of Income 3
Condensed Balance Sheets 4
Condensed Statements of Changes in
Shareholder's Equity 6
Condensed Statements of Cash Flows 7
Notes to Condensed Financial Statements 8
Item 2. Management's Narrative Analysis of the Results of
Operations and Financial Condition 46
Item 4. Controls and Procedures 59
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 60
Item 6. Exhibits and Reports on Form 8-K 60
Signatures 61
2
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
PART I. FINANCIAL INFORMATION (UNAUDITED)
Item 1. Financial Statements
Condensed Statements of Income
(Unaudited)
(Millions)
Three months ended June 30, Six months ended June 30,
2004 2003 2004 2003
------------------------------- -------------------------------
Revenue:
Premiums $ 6.8 $ 7.4 $ 12.4 $ 14.8
Fee income 140.2 96.5 269.1 177.1
Net investment income 293.6 281.7 563.9 566.0
Net realized capital (losses) gains (9.7) 6.1 19.0 (5.0)
Other (expense) income (0.7) 0.3 1.5 4.1
------------------------------- -------------------------------
Total revenue 430.2 392.0 865.9 757.0
------------------------------- -------------------------------
Benefits, losses and expenses:
Benefits:
Interest credited and other benefits to policyholders 285.2 236.7 576.2 537.5
Underwriting, acquisition, and insurance expenses:
General expenses 58.1 53.8 109.9 106.1
Commissions 130.6 91.7 242.9 145.1
Policy acquisition costs deferred (152.3) (128.5) (274.9) (212.5)
Amortization of deferred policy acquisition costs
and value of business acquired 35.1 87.6 101.4 147.6
Other:
Expense and charges reimbursed under modified
coinsurance agreements 0.1 - 0.7 0.2
Interest expense 3.6 4.2 7.3 7.5
------------------------------- -------------------------------
Total benefits, losses and expenses 360.4 345.5 763.5 731.5
------------------------------- -------------------------------
Income before income taxes and cumulative
effect of change in accounting principle 69.8 46.5 102.4 25.5
Income tax expense 23.2 14.4 33.2 6.9
------------------------------- -------------------------------
Net income before cumulative effect of change
in accounting principle 46.6 32.1 69.2 18.6
Cumulative effect of change in accounting principle - - (2.3) -
------------------------------- -------------------------------
Net income $ 46.6 $ 32.1 $ 66.9 $ 18.6
=============================== ===============================
The accompanying notes are an integral part of these financial statements.
3
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Condensed Balance Sheets
(Unaudited)
(Millions, except share data)
June 30, December 31,
2004 2003
------------------ ------------------
Assets
Investments:
Fixed maturities, available for sale, at fair value (amortized cost of
$16,453.4 at 2004 and $15,558.3 at 2003) $ 16,563.2 $ 16,075.5
Equity securities, at fair value:
Common stock (cost of $13.5 at 2004 and 2003) 13.8 13.7
Preferred stock (cost of $6.4 at 2004 and $1.5 at 2003) 6.6 1.7
Investment in mutual funds (cost of $2.3 at 2004 and $100.5 at 2003) 2.4 104.8
Mortgage loans on real estate 3,553.2 3,388.7
Real estate 1.8 4.5
Policy loans 170.9 177.1
Short-term investments 22.1 0.3
Other investments 169.8 56.0
Securities pledged under securities lending agreement (amortized
cost of $391.7 at 2004 and $22.2 at 2003) 387.6 22.3
------------------ ------------------
Total investments 20,891.4 19,844.6
Cash and cash equivalents 98.3 65.1
Short-term investments under securities loan agreement 398.5 22.9
Accrued investment income 200.3 185.7
Reinsurance recoverable 629.4 634.8
Receivable for securities sold 49.4 11.7
Deferred policy acquisition costs 1,635.1 1,826.7
Value of business acquired 135.7 111.5
Sales inducements to Contractholders 496.1 -
Due from affiliates 174.9 117.7
Deferred income tax asset 99.8 28.6
Other assets 24.9 20.1
Assets held in separate accounts 20,821.7 18,220.1
------------------ ------------------
Total assets $ 45,655.5 $ 41,089.5
================== ==================
The accompanying notes are an integral part of these financial statements.
4
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Condensed Balance Sheets
(Unaudited)
(Millions, except share data)
June 30, December 31,
2004 2003
------------------ ------------------
Liabilities and Shareholder's Equity
Policy liabilities and accruals:
Future policy benefits and claims reserves $ 20,823.6 $ 19,400.5
Notes to affiliates 35.0 35.0
Due to affiliates 46.2 60.7
Payables for securities purchased 77.8 -
Payables under securities loan agreement 398.5 22.9
Borrowed money 669.9 584.2
Current income taxes 12.2 19.4
Other liabilities 291.7 209.5
Liabilities related to separate accounts 20,821.7 18,220.1
----------------- -----------------
Total liabilities 43,176.6 38,552.3
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Shareholder's equity
Common stock (250,000 shares authorized, issued and outstanding;
$10.00 per share value) 2.5 2.5
Additional paid-in capital 3,852.7 3,812.7
Accumulated other comprehensive income 24.8 190.0
Retained deficit (1,401.1) (1,468.0)
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Total shareholder's equity 2,478.9 2,537.2
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Total liabilities and shareholder's equity $ 45,655.5 $ 41,089.5
================= =================
The accompanying notes are an integral part of these financial statements.
5
ING USA Annuity and Life Insurance Company,
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Condensed Statements of Changes in Shareholder's Equity
(Unaudited)
(Millions)
Accumulated
Additional Other Total
Common Paid-In Comprehensive Retained Shareholder's
Stock Capital Income Deficit Equity
-------------- --------------- ---------------- --------------- ----------------
Balance at December 31, 2002 $ 2.5 $ 3,724.0 $ 135.1 $ (1,512.9) $ 2,348.7
Dividends paid - - - (12.4) (12.4)
Contribution of capital - 88.7 - - 88.7
Comprehensive income:
Net income - - - 18.6 18.6
Other comprehensive income
net of tax:
Unrealized gain on securities
($97.4 pretax) - - 63.3 - 63.3
----------------
Comprehensive income 81.9
-------------- --------------- ---------------- --------------- ----------------
Balance at June 30, 2003 $ 2.5 $ 3,812.7 $ 198.4 $ (1,506.7) $ 2,506.9
============== =============== ================ =============== ================
Balance at December 31, 2003 $ 2.5 $ 3,812.7 $ 190.0 $ (1,468.0) $ 2,537.2
Contribution of capital - 40.0 - - 40.0
Comprehensive loss:
Net income - - - 66.9 66.9
Other comprehensive loss net of tax:
Unrealized loss on securities
(($254.2) pretax) - - (165.2) - (165.2)
----------------
Comprehensive loss (98.3)
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Balance at June 30, 2004 $ 2.5 $ 3,852.7 $ 24.8 $ (1,401.1) $ 2,478.9
============== =============== ================ =============== ================
The accompanying notes are an integral part of these financial statements.
6
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Condensed Statements of Cash Flows
(Unaudited)
(Millions)
Six months ended June 30,
2004 2003
------------------ ------------------
Net cash provided by operating activities $ 648.1 $ 509.2
Cash Flows from Investing Activities:
Proceeds from the sale, maturity, or redemption of:
Fixed maturities, available for sale 9,907.8 10,921.9
Equity securities 103.2 3.6
Mortgage loans on real estate originated 182.9 285.8
Short-term investments 2,569.2 3,587.8
Acquisition of investments:
Fixed maturities, available for sale (11,211.7) (12,124.4)
Equity securities (5.0) (12.2)
Mortgage loans on real estate (350.3) (253.8)
Short-term investments (2,591.0) (3,689.6)
Policy loans 6.2 2.5
Proceeds from sale of real estate 2.7 1.4
Other investments (111.1) (33.9)
Other - (0.5)
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Net cash used in investing activities (1,497.1) (1,311.4)
------------------ ------------------
Cash Flows from Financing Activities:
Deposits and interest credited for investment contracts 1,959.9 1,817.3
Maturities and withdrawals from insurance and investment contracts (980.9) (851.3)
Reinsurance recapture - 134.5
Transfers to separate accounts (222.5) (512.8)
Short-term loans 85.7 130.0
Intercompany dividends - (12.4)
Intercompany loans - 59.1
Contribution of capital from Parent 40.0 88.7
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Net cash provided by financing activities 882.2 853.1
------------------ ------------------
Net increase in cash and cash equivalents 33.2 50.9
Cash and cash equivalents, beginning of period 65.1 199.1
------------------ ------------------
Cash and cash equivalents, end of period $ 98.3 $ 250.0
================== ==================
Supplemental cash flow information:
Income taxes paid (received), net $ 7.2 $ (2.2)
================== ==================
Interest paid $ 0.1 $ 5.2
================== ==================
The accompanying notes are an integral part of these financial statements.
7
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
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1. Significant Accounting Policies
Basis of Presentation
ING USA Annuity and Life Insurance Company ("ING USA" or the "Company"), a
wholly-owned subsidiary of Lion Connecticut Holdings Inc. ("Lion" or
"Parent"), is a stock life insurance company organized under the laws of
the State of Iowa. ING USA was originally incorporated under the laws of
the State of Minnesota on January 2, 1973, in the name of St. Paul Life
Insurance Company. On December 21, 1993, the Company redomesticated from
Minnesota to Delaware.
On January 1, 2004, the Company redomesticated from Delaware to Iowa. In
addition, on January 1, 2004 (the "merger date"), Equitable Life Insurance
Company of Iowa ("Equitable Life"), USG Annuity & Life Company ("USG") and
United Life & Annuity Insurance Company ("ULA") (the "Merger Companies"),
merged with and into Golden American Life Insurance Company ("Golden
American"). Immediately after the merger, Golden American changed its name
to ING USA Annuity and Life Insurance Company. As of the merger date, the
Merger Companies ceased to exist and were merged into ING USA. Lion is an
indirect, wholly-owned subsidiary of ING Groep N.V. ("ING"), a global
financial services holding company based in The Netherlands. ING USA is
authorized to do business in the District of Columbia and all states except
New York. ING USA is licensed as a life insurance company under the laws of
the State of Delaware until December 31, 2003 and Iowa since January 1,
2004.
Prior to the merger date, ING USA was a wholly-owned subsidiary of
Equitable Life from December 30, 2001 through December 31, 2003. Formerly,
from October 24, 1997, until December 30, 2001, Equitable of Iowa
Companies, Inc. ("EIC" or "Former Holding Company") directly owned 100% of
Golden American's stock.
Statement of Financial Accounting Standards No. 141, "Business
Combinations" ("FAS 141"), excludes transfers of net assets or exchanges of
shares between entities under common control, and notes that certain
provisions under Accounting Principles Board Opinion No. 16, "Business
Combinations" ("APB 16"), provide a source of guidance for such
transactions. In accordance with APB 16, financial information of the
combined entity is presented as if the entities had been combined for the
full year, and all comparative financial statements are restated and
presented as if the entities had previously been combined, in a manner
similar to a pooling-of-interests.
The unaudited condensed financial statements have been prepared in a manner
similar to a pooling-of-interests, in accordance with the provisions of APB
16 in order to present the condensed financial position and results of
operations of the Company and the Merger Companies, as if the entities had
previously been combined. The unaudited condensed balance sheets and
statements of income give effect to the consolidation transaction as if it
had occurred on December 31, 2003 and January 1, 2003, respectively.
8
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
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The financial statements and notes as of June 30, 2004 and December 31,
2003 and for the three and six-month periods ended June 30, 2004 and 2003
("interim periods"), have been prepared in accordance with U.S. generally
accepted accounting principles and are unaudited. The condensed financial
statements reflect all normal recurring adjustments, which are, in the
opinion of management, necessary for the fair presentation of the financial
position, results of operations and cash flows for the interim periods.
Description of Business
The Company offers various insurance products including deferred and
immediate annuities, variable annuities, interest sensitive and traditional
life insurance, and health insurance. All health insurance is ceded to
other insurers. The Company's products are marketed by broker/dealers,
financial institutions, insurance agents, and a career agency force. The
Company's primary customers are consumers and corporations.
Recently Adopted Accounting Standards
Accounting and Reporting by Insurance Enterprises for Certain
Nontraditional Long-Duration Contracts and for Separate Accounts
The Company adopted Statement of Position ("SOP") 03-1, "Accounting and
Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration
Contracts and for Separate Accounts," on January 1, 2004. SOP 03-1
establishes several new accounting and disclosure requirements for certain
nontraditional long-duration contracts and for separate accounts including,
among other things, a requirement that assets and liabilities of separate
account arrangements that do not meet certain criteria be accounted for as
general account assets and liabilities, and that the revenue and expenses
related to such arrangements be consolidated within the respective line
items in the Condensed Statements of Income. In addition, the SOP requires
additional liabilities be established for certain guaranteed death and
other benefits and for products with certain patterns of cost of insurance
charges, and that sales inducements provided to contractholders be
recognized on the balance sheet separately from deferred acquisition costs
and amortized as a component of benefits expense using methodology and
assumptions consistent with those used for amortization of deferred policy
acquisition costs.
The Company evaluated all requirements of SOP 03-1 and determined that it
is affected by the SOP's requirements to establish additional liabilities
for certain guaranteed benefits and products with patterns of cost
insurance charges resulting in losses in later policy durations from the
insurance benefit function and to defer, amortize, and recognize
separately, sales inducements to contractholders. Requirements for certain
separate account arrangements that do not meet the established criteria for
separate asset and liability recognition are applicable to the Company,
however, the Company's policies on separate account assets and liabilities
have historically been, and continue to be, in conformity with the
requirements newly established. Upon adoption of the SOP, the Company
9
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
recognized a cumulative effect of a change in accounting principle of
$(3.6) million, before tax or $(2.3) million, net of $1.3 million of income
taxes, as of January 1, 2004.
The Meaning of Other-Than-Temporary Impairment and its Application to
Certain Investments
In March 2004, the Emerging Issues Task Force ("EITF") reached a final
consensus on EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary
Impairment and its Application to Certain Investments," adopting a
three-step impairment model for securities within its scope. The three-step
model is to be applied on a security-by-security basis as follows:
Step 1: Determine whether an investment is impaired. An investment is
impaired if its fair value of the investment is less than its cost
basis.
Step 2: Evaluate whether an impairment is other-than-temporary.
Step 3: If the impairment is other-than-temporary, recognize an impairment
loss equal to the difference between the investment's cost and
its fair value.
The Company included this three-step model in the impairment evaluation for
the quarter ended June 30, 2004. This guidance resulted in no additional
impairments for the Company.
Earlier consensus reached by the EITF on this issue required that certain
quantitative and qualitative disclosures be made for unrealized losses on
debt and equity securities that have not been recognized as
other-than-temporary impairments. These disclosures were adopted by the
Company, effective December 31, 2003, and included in the Investments
footnote of the Notes to Condensed Financial Statements included in the
Company's December 31, 2003 Form 10-K. In addition to the disclosure
requirements adopted by the Company effective December 31, 2003, the final
consensus of EITF 03-01 reached in March 2004 included additional
disclosure requirements that are effective for fiscal years ending after
June 15, 2004.
Accounting for Derivative Instruments and Hedging Activities
In June 1998, the FASB issued FAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," as amended and interpreted by FAS No.
137, "Accounting for Derivative Instruments and Hedging Activities -
Deferral of the Effective Date of FASB Statement 133," and FAS No. 138,
"Accounting for Certain Derivative Instruments and Certain Hedging
Activities - an Amendment of FASB 133, and certain FAS 133 implementation
issues." This standard, as amended, requires companies to record all
derivatives on the balance sheet as either assets or liabilities and
measure those instruments at fair value. The manner in which companies are
to record gains or losses resulting from changes in the fair values of
those derivatives depends on the use of the derivative and whether it
qualifies for hedge accounting. FAS No. 133 was effective for the Company's
financial statements beginning January 1, 2001.
10
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
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The Company occasionally purchases a financial instrument that contains a
derivative that is "embedded" in the instrument. In addition, the Company's
insurance products are reviewed to determine whether they contain an
embedded derivative. The Company assesses whether the economic
characteristics of the embedded derivative are clearly and closely related
to the economic characteristics of the remaining component of the financial
instrument or insurance product (i.e., the host contract) and whether a
separate instrument with the same terms as the embedded instrument would
meet the definition of a derivative instrument. When it is determined that
the embedded derivative possesses economic characteristics that are not
clearly and closely related to the economic characteristics of the host
contract and that a separate instrument with the same terms would qualify
as a derivative instrument, the embedded derivative is separated from the
host contract and carried at fair value. However, in cases where the host
contract is measured at fair value, with changes in fair value reported in
current period earnings or the Company is unable to reliably identify and
measure the embedded derivative for separation from its host contracts, the
entire contract is carried on the balance sheet at fair value and is not
designated as a hedging instrument.
In 2003, the Derivative Implementation Group ("DIG") responsible for
issuing guidance on behalf of the FASB for implementation of FAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities" issued
Statement Implementation Issue No. B36, "Embedded Derivatives: Modified
Coinsurance Arrangements and Debt Instruments That Incorporate Credit Risk
Exposures That Are Unrelated or Only Partially Related to the Credit
Worthiness of the Obligor under Those Instruments" ("DIG B36"). Under this
interpretation, modified coinsurance and coinsurance with funds withheld
reinsurance agreements as well as other types of receivables and payables
where interest is determined by reference to a pool of fixed maturity
assets or total return debt index may be determined to contain embedded
derivatives that are required to be bifurcated. The Company adopted DIG B36
on October 1, 2003 and has modified coinsurance treaties that are
applicable to the guidance. The applicable contracts, however, were
determined to generate embedded derivatives with a fair value of zero.
Therefore, the guidance, while implemented, does not impact the Company's
financial position, results of operations, or cash flows.
Variable Interest Entities
In January 2003, the Financial Accounting Standards Board (FASB) issued
FASB Interpretation 46, "Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51" (FIN 46). In December 2003, the FASB modified
FIN 46 to make certain technical corrections and address certain
implementation issues that had arisen. FIN 46 provides a new framework for
identifying variable interest entities (VIEs) and determining when a
company should include the assets, liabilities, noncontrolling interests
and results of activities of a VIE in its consolidated financial
statements.
In general, a VIE is a corporation, partnership, limited-liability
corporation, trust, or any other legal structure used to conduct activities
11
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
or hold assets that either (1) has an insufficient amount of equity to
carry out its principal activities without additional subordinated
financial support, (2) has a group of equity owners that are unable to make
significant decisions about its activities, or (3) has a group of equity
owners that do not have the obligation to absorb losses or the right to
receive returns generated by its operations.
FIN 46 requires a VIE to be consolidated if a party with an ownership,
contractual or other financial interest in the VIE (a variable interest
holder) is obligated to absorb a majority of the risk of loss from the
VIE's activities, is entitled to receive a majority of the VIE's residual
returns (if no party absorbs a majority of the VIE's losses), or both. A
variable interest holder that consolidates the VIE is called the primary
beneficiary. Upon consolidation, the primary beneficiary generally must
initially record all of the VIE's assets, liabilities and noncontrolling
interests at fair value and subsequently account for the VIE as if it were
consolidated based on majority voting interest. FIN 46 also requires
disclosures about VIEs that the variable interest holder is not required to
consolidate but in which it has a significant variable interest.
At June 30, 2004, the Company held the following investments that, for
purposes of FIN 46, were evaluated and determined that the investments do
not require consolidation in the Company's financial statements:
(Millions)
Asset Type Purpose Book Value (1) Market Value
--------------------------------------------- -------------------------- ---------------- ----------------
Private Corporate Securities - synthetic
leases; project financings; credit tenant leases Investment Holdings $ 2,962.6 $ 3,036.8
Foreign Securities - US VIE subsidiaries of
foreign companies Investment Holdings 538.4 551.1
Commercial Mortgage Obligations (CMO) Investment Holdings 3,465.9 3,461.1
Collateralized Debt Obligations (CDO) Investment Holdings
and/or
Collateral Manager 61.3 55.9
Asset-Backed Securities (ABS) Investment Holdings 1,488.5 1,482.0
Commercial Mortgage Backed Securities (CMBS) Investment Holdings 1,048.4 1,058.2
(1) Represents maximum exposure to loss except for those structures for which the Company also receives asset management fees.
New Accounting Pronouncements
FSP FAS 97-1
The implementation of the American Institute of Certified Public
Accountants ("AICPA") SOP 03-01, "Accounting and Reporting by Insurance
Enterprises for certain Nontraditional Long-Duration Contracts and for
Separate Accounts," has raised questions regarding the interpretation of
the requirements of SFAS No. 97, concerning when it is appropriate to
record an unearned revenue liability related to the insurance benefit
function. To clarify its position, in June of 2004 the Financial Accounting
Standards Board ("FASB") issued FSP FAS 97-1, "Situations in which
paragraphs 17(b) and 20 of FASB Statement No. 97, Accounting and Reporting
12
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
by Insurance Enterprises for certain Long-Duration Contracts and for
Realized Gains and Losses from the Sale of Investments, Permit or Require
Accrual of an Unearned Revenue Liability." FSP FAS 97-1 outlines that SFAS
No. 97 is clear in its intent and language, and requires the recognition of
an unearned revenue liability for amounts that have been assessed to
compensate insurers for services provided over future periods. The
requirement of SOP 03-01 is not intended to amend or limit the requirement
of SFAS No. 97 to recognize a liability for unearned revenue only to those
situations where profits are expect to be followed by a loss. The guidance
contained in FSP FAS 97-1 is effective for financial statements with fiscal
periods beginning subsequent to July 18, 2004. The Company is currently
evaluating the impact of FSP FAS 97-1 and related accounting guidance and
anticipates a potential increase in the (net) liability established under
SOP 03-01 in future accounting periods.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. Actual results
could differ from reported results using those estimates.
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand, money market instruments
and other debt issues with a maturity of 90 days or less when purchased.
Investments
All of the Company's fixed maturity and equity securities are currently
designated as available-for-sale. Available-for-sale securities are
reported at fair value and unrealized gains and losses on these securities
are included directly in shareholder's equity, after adjustment for related
charges in deferred policy acquisition costs, value of business acquired,
and deferred 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 in accordance with FAS No. 115, "Accounting for
Certain Investments in Debt and Equity Securities." 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.
13
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
In addition, the Company invests in structured securities that meet the
criteria of Emerging Issues Task Force ("EITF") Issue No. 99-20,
"Recognition of Interest Income and Impairment on Purchased and Retained
Beneficial Interests in Securitized Financial Assets." Under Issue No. EITF
99-20, a determination of the required impairment is based on credit risk
and the possibility of significant prepayment risk that restricts the
Company's ability to recover the investment. An impairment is recognized if
the fair value of the security is less than amortized cost and there has
been an adverse change in cash flow since the remeasurement date.
When a decline in fair value is determined to be other than temporary, the
individual security is written down to fair value and the loss is accounted
for as a realized loss.
Realized capital gains and losses on all other investments are included in
the Condensed Statements of Income. Unrealized capital gains and losses on
all other investments are reflected in shareholder's equity, net of related
income taxes.
Purchases and sales of fixed maturities and equity securities (excluding
private placements) are recorded on the trade date. Purchases and sales of
private placements and mortgage loans are recorded on the closing date.
Fair values for fixed maturities are obtained from independent pricing
services or broker/dealer quotations. Fair values for privately placed
bonds are determined using a matrix-based model. The matrix-based model
considers the level of risk-free interest rates, current corporate spreads,
the credit quality of the issuer and cash flow characteristics of the
security. The fair values for equity securities are based on quoted market
prices. For equity securities not actively traded, estimated fair values
are based upon values of issues of comparable yield and quality or
conversion value where applicable.
The Company engages in securities lending whereby certain securities from
its portfolio are loaned to other institutions for short periods of time.
Initial collateral, primarily cash, is required at a rate of 102% of the
market value of the loaned domestic securities. The collateral is deposited
by the borrower with a lending agent, and retained and invested by the
lending agent according to the Company's guidelines to generate additional
income. The market value of the loaned securities is monitored on a daily
basis with additional collateral obtained or refunded as the market value
of the loaned securities fluctuates.
The Company engages in dollar repurchase agreements ("dollar rolls") and
repurchase agreements. These transactions involve a sale of securities and
an agreement to repurchase substantially the same securities as those sold.
Company policies require a minimum of 95% of the fair value of securities
pledged under dollar rolls and repurchase agreement transactions to be
maintained as collateral. Cash collateral received is invested in
short-term investments and the offsetting collateral liability is included
in borrowed money on the Condensed Balance Sheets.
14
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
The Company enters into reverse repurchase agreements. These transactions
involve a purchase of securities and an agreement to sell substantially the
same securities as those purchased. Company policies require a minimum of
102% of the fair value of securities pledged under reverse repurchase
agreements to be pledged as collateral. The market value of the pledged
securities is monitored on a daily basis with additional collateral
obtained or refunded as the market value fluctuates.
The investment in mutual funds represents an investment in mutual funds
managed by the Company, and is carried at fair value.
Mortgage loans on real estate are reported at amortized cost less
impairment writedowns. If the value of any mortgage loan is determined to
be impaired (i.e., when it is probable that the Company will be unable to
collect all amounts due according to the contractual terms of the loan
agreement), the carrying value of the mortgage loan is reduced to the
present value of expected cash flows from the loan, discounted at the
loan's effective interest rate, or to the loan's observable market price,
or the fair value of the underlying collateral. The carrying value of the
impaired loans is reduced by establishing a permanent writedown charged to
realized loss.
Investments in real estate are reported at historical cost, less
accumulated depreciation and impairment writedowns, with the exception of
land, which is not depreciated. If the value of any real estate is
determined to be impaired (i.e., when it is probable that the Company will
be unable to recover the carrying value of the real estate), the carrying
value of the real estate is reduced to the current fair value. The carrying
value of the impaired real estate is reduced by establishing a permanent
writedown charged to realized loss.
Policy loans are carried at unpaid principal balances, net of impairment
reserves.
Short-term investments, consisting primarily of money market instruments
and other fixed maturity issues purchased with an original maturity of 91
days to one year, are considered available for sale and are carried at fair
value, which approximates amortized cost.
The Company's use of derivatives is limited to hedging purposes. The
Company enters into interest rate and currency contracts, including swaps,
caps, floors, options, futures, and embedded derivatives, to reduce and
manage risks associated with changes in value, yield, price, cash flow or
exchange rates of assets or liabilities held or intended to be held.
Changes in the fair value of open derivative contracts are recorded in net
realized capital gains and losses.
On occasion, the Company sells call options written on underlying
securities that are carried at fair value. Changes in fair value of these
options are recorded in net realized capital gains or losses.
15
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Deferred Policy Acquisition Costs and Value of Business Acquired
Deferred Policy Acquisition Costs ("DAC") is an asset, which represents
certain costs of acquiring certain insurance business, which are deferred
and amortized. These costs, all of which vary with and are primarily
related to the production of new and renewal business, consist principally
of commissions, certain underwriting and contract issuance expenses, and
certain agency expenses. Value of Business Acquired ("VOBA") is an asset,
which represents the present value of estimated net cash flows embedded in
the Company's contracts, which existed at the time the Company was acquired
by ING. DAC and VOBA are evaluated for recoverability at each balance sheet
date and these assets would be reduced to the extent that gross profits are
inadequate to recover the asset.
The amortization methodology varies by product type based upon two
accounting standards: FAS No. 60, "Accounting and Reporting by Insurance
Enterprises" ("FAS No. 60") and FAS No. 97, "Accounting and Reporting by
Insurance Enterprises for Certain Long-Duration Contracts and Realized
Gains and Losses from the Sale of Investments" ("FAS No. 97").
Under FAS No. 60, acquisition costs for traditional life insurance
products, which primarily include whole life and term life insurance
contracts, are amortized over the premium payment period in proportion to
the premium revenue recognition.
Under FAS No. 97, acquisition costs for universal life and investment-type
products, which include universal life policies and fixed and variable
deferred annuities, are amortized over the life of the blocks of policies
(usually 25 years) in relation to the emergence of estimated gross profits
from surrender charges, investment margins, mortality and expense margins,
asset-based fee income, and actual realized gains (losses) on investments.
Amortization is adjusted retrospectively when estimates of current or
future gross profits to be realized from a group of products are revised.
DAC and VOBA are written off to the extent that it is determined that
future policy premiums and investment income or gross profits are not
adequate to cover related expenses.
16
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Activity for the periods ended June 30, 2004 and 2003 within VOBA was as
follows:
(Millions)
Balance at December 31, 2002 $ 134.5
Adjustment for FAS No. 115 (18.5)
Interest accrued at 5% - 7% 3.5
Amortization (8.3)
------------------
Balance at June 30, 2003 $ 111.2
==================
Balance at December 31, 2003 $ 111.5
Adjustment for FAS No. 115 21.5
Interest accrued at 4% - 6% 3.4
Amortization (0.7)
------------------
Balance at June 30, 2004 $ 135.7
==================
The estimated amount of VOBA to be amortized, net of interest, over the
next five years is $3.3 million, $14.7 million, $14.0 million, $9.6 million
and $9.6 million for the years 2004, 2005, 2006, 2007 and 2008,
respectively. Actual amortization incurred during these years may vary as
assumptions are modified to incorporate actual results.
Separate Accounts
Separate Account assets and liabilities generally represent funds
maintained to meet specific investment objectives of contractholders who
bear the investment risk, subject, in limited cases, to certain minimum
guarantees. Investment income and investment gains and losses generally
accrue directly to such contractholders. The assets of each account are
legally segregated and are not subject to claims that arise out of any
other business of the Company.
Separate Account assets supporting variable options under universal life
and annuity contracts are invested, as designated by the policyholder or
participant (who bears the investment risk subject, in limited cases, to
minimum guaranteed rates) under a contract in shares of mutual funds which
are managed by the Company, or in other selected mutual funds not managed
by the Company.
Separate Account assets are carried at fair value. At June 30, 2004 and
2003, unrealized gains of $35.3 million and $216.3 million, respectively,
after taxes, on assets supporting a guaranteed interest option are
reflected in shareholder's equity.
Separate Account assets and liabilities are carried at fair value and shown
as separate captions in the Consolidated Balance Sheets. Deposits,
investment income and net realized and unrealized capital gains and losses
of the Separate Accounts are not reflected in the Consolidated Financial
Statements. The Consolidated Statements of Cash Flows do not reflect
investment activity of the Separate Accounts.
17
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Assets and liabilities of separate account arrangements that do not meet
the criteria in SOP 03-1 for presentation in the separate caption in the
Condensed Balance Sheets, and revenue and expenses related to such
arrangements, are consolidated in the financial statements with the general
account.
Policy Liabilities and Accruals
Future policy benefits include reserves for universal life, immediate
annuities with life contingent payouts and traditional life insurance
contracts. Reserves for universal life products are equal to cumulative
deposits less withdrawals and charges plus credited interest thereon.
Reserves for traditional life insurance contracts represent the present
value of future benefits to be paid to or on behalf of policyholders and
related expenses less the present value of future net premiums.
Reserves for immediate annuities with life contingent payout contracts are
computed on the basis of assumed investment yield, mortality, and expenses,
including a margin for adverse deviations. Such assumptions generally vary
by plan, year of issue and policy duration. Reserve interest rates ranged
from 3.0% to 7.95% for all periods presented. Investment yield is based on
the Company's experience.
Mortality and withdrawal rate assumptions are based on relevant Company
experience and are periodically reviewed against both industry standards
and experience.
Other policyholders' fund include reserves for deferred annuity investment
contracts and immediate annuity without life contingent payouts. Reserves
on such contracts are equal to cumulative deposits less charges and
withdrawals plus credited interest thereon (rates range from 2.4% to 8.0%
for all periods presented) net of adjustments for investment experience
that the Company is entitled to reflect in future credited interest.
Sales Inducements
Sales inducements represent benefits paid to contractholders that are
incremental to the amounts the Company credits on similar contracts and are
higher than the contract's expected ongoing crediting rates for periods
after the inducement. As of January 1, 2004, such amounts are reported
separately on the balance sheet in accordance with SOP 03-1. Prior to 2004,
sales inducements were recorded as a component of DAC on the Condensed
Balance Sheet. Sales inducements are amortized as a component of benefit
expense using methodology and assumptions consistent with those used for
amortization of DAC.
Revenue Recognition
For universal life and certain annuity contracts, charges assessed against
policyholders' funds for the cost of insurance, surrender, expenses, and
other fees are recorded as revenue as charges are assessed against
policyholders. Other amounts received for these contracts are reflected as
deposits and are not recorded as revenue. Related policy benefits are
18
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
recorded in relation to the associated premiums or gross profit so that
profits are recognized over the expected lives of the contracts. When
annuity payments with life contingencies begin under contracts that were
initially investment contracts, the accumulated balance in the account is
treated as a single premium for the purchase of an annuity and reflected as
an offsetting amount in both premiums and current and future benefits in
the Condensed Statement of Income.
Reinsurance
The Company utilizes indemnity reinsurance agreements to reduce its
exposure to large losses in all aspects of its insurance business. Such
reinsurance permits recovery of a portion of losses from reinsurers,
although it does not discharge the primary liability of the Company as
direct insurer of the risks reinsured. The Company evaluates the financial
strength of potential reinsurers and continually monitors the financial
condition of reinsurers. Only those reinsurance recoverable balances deemed
probable of recovery are reflected as assets on the Company's Condensed
Balance Sheets.
Participating Insurance
Participating business approximates 10% of the Company's ordinary life
insurance in force and 25% of premium income. The amount of dividends to be
paid is determined annually by the Board of Directors. Amounts allocable to
participating policyholders are based on published dividend projections or
expected dividend scales. Dividends of $8.1 million and $8.6 million were
incurred during the six months ended June 30, 2004 and 2003, respectively.
Income Taxes
The Company is taxed at regular corporate rates after adjusting income
reported for financial statement purposes for certain items. Deferred
income tax expenses/benefits result from changes during the year in
cumulative temporary differences between the tax basis and book basis of
assets and liabilities.
19
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
2. Investments
Fixed maturities available for sale as of June 30, 2004 were as follows:
Gross Gross
Amortized Unrealized Unrealized Fair
(Millions) Cost Gains Losses Value
--------------- --------------- --------------- ---------------
U.S. government and government
agencies and authorities $ 388.5 $ 1.7 $ 0.4 $ 389.8
State, municipalities and political subdivisions 20.7 - 2.3 18.4
U.S. corporate securities:
Public utilities 1,714.9 54.4 25.4 1,743.9
Other corporate securities 7,247.9 197.8 113.8 7,331.9
--------------- --------------- --------------- ---------------
Total U.S. corporate securities 8,962.8 252.2 139.2 9,075.8
--------------- --------------- --------------- ---------------
Foreign securities:
Government 445.0 8.2 10.9 442.3
Other 2,092.5 64.8 43.4 2,113.9
--------------- --------------- --------------- ---------------
Total foreign securities 2,537.5 73.0 54.3 2,556.2
--------------- --------------- --------------- ---------------
Mortgage-backed securities 3,258.7 49.9 62.5 3,246.1
Other asset-backed securities 1,676.9 13.2 25.6 1,664.5
Total fixed maturities, including fixed
maturities pledged to creditors 16,845.1 390.0 284.3 16,950.8
Less: fixed maturities pledged to
creditors 391.7 3.6 7.7 387.6
--------------- --------------- --------------- ---------------
Fixed maturities $ 16,453.4 $ 386.4 $ 276.6 $ 16,563.2
=============== =============== =============== ===============
20
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Fixed maturities available for sale as of December 31, 2003 were as
follows:
Gross Gross
Amortized Unrealized Unrealized Fair
(Millions) Cost Gains Losses Value
--------------- --------------- --------------- ---------------
U.S. government and government
agencies and authorities $ 195.5 $ 2.0 $ 0.1 $ 197.4
State, municipalities and political subdivisions 31.7 - 2.5 29.2
U.S. corporate securities:
Public utilities 1,341.2 84.3 8.0 1,417.5
Other corporate securities 7,020.6 346.7 35.8 7,331.5
--------------- --------------- --------------- ---------------
Total U.S. corporate securities 8,361.8 431.0 43.8 8,749.0
--------------- --------------- --------------- ---------------
Foreign securities:
Government 487.1 21.7 3.9 504.9
Other 1,984.4 96.0 24.1 2,056.3
--------------- --------------- --------------- ---------------
Total foreign securities 2,471.5 117.7 28.0 2,561.2
--------------- --------------- --------------- ---------------
Mortgage-backed securities 3,247.0 66.7 21.8 3,291.9
Other asset-backed securities 1,273.0 17.2 21.1 1,269.1
Total fixed maturities, including fixed
maturities pledged to creditors 15,580.5 634.6 117.3 16,097.8
Less: fixed maturities pledged to
creditors 22.2 0.1 - 22.3
--------------- --------------- --------------- ---------------
Fixed maturities $ 15,558.3 $ 634.5 $ 117.3 $ 16,075.5
=============== =============== =============== ===============
At June 30, 2004 and December 31, 2003, net unrealized appreciation is
$105.7 million and $517.3 million, respectively, on available-for-sale
fixed maturities, including fixed maturities pledged to creditors.
The aggregate unrealized losses and related fair values of investments with
unrealized losses as of June 30, 2004, are shown below by duration:
Unrealized Fair
Loss Value
------------------ ------------------
(Millions)
Duration category:
Less than six months below cost $ 208.6 $ 7,280.3
More than six months and less than twelve months below cost 32.1 499.2
More than twelve months below cost 43.6 428.8
------------------ ------------------
Fixed maturities $ 284.3 $ 8,208.3
================== ==================
21
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Of the losses less than 6 months in duration of $208.6 million, there were
$146.7 million in unrealized losses that are primarily related to interest
rate movement or spread widening for other than credit-related reasons.
Business and operating fundamentals are performing as expected. The
remaining losses of $61.9 million as of June 30, 2004 included the
following significant items:
|X| $59.2 million of unrealized losses related to securities reviewed for
impairment under the guidance prescribed by EITF 99-20. This category
includes U.S. government-backed securities, principal protected
securities and structured securities, which did not have an adverse
change in cash flows for which the carrying amount was $2,589.1
million.
|X| $2.7 million of unrealized losses related to the airlines industry,
for which the carrying amount was $78.3 million.
Of the losses more than 6 months and less than 12 months in duration of
$32.1 million, there were $24.3 million in unrealized losses that are
primarily related to interest rate movement or spread widening for other
than credit-related reasons. Business and operating fundamentals are
performing as expected. The remaining losses of $7.8 million as of June 30,
2004 included the following significant items:
|X| $6.8 million of unrealized losses related to securities reviewed for
impairment under the guidance prescribed by EITF 99-20. This category
includes U.S. government-backed securities, principal protected
securities and structured securities, which did not have an adverse
change in cash flows for which the carrying amount was $162.9 million.
|X| $1.0 million of unrealized losses related to a foreign security, the
issuer of which is in the Dominican Republic, for which the carrying
amount was $3.1 million.
Of the losses more than 12 months in duration of $43.6 million, there were
$23.1 million, in unrealized losses that are primarily related to interest
rate movement or spread widening for other than credit-related reasons.
Business and operating fundamentals are performing as expected. The
remaining losses of $20.5 million as of June 30, 2004 included the
following significant items:
|X| $17.2 million of unrealized losses related to securities reviewed for
impairment under the guidance prescribed by EITF 99-20. This category
includes U.S. government-backed securities, principal protected
securities and structured securities, which did not have an adverse
change in cash flows for which the carrying amount was $142.4 million.
22
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
|X| $1.8 million of unrealized losses relating to the airlines industry,
for which the carrying amount was $22.1 million.
|X| $1.5 million of unrealized losses related to a foreign security, the
issuer of which is in the Dominican Republic, for which the carrying
amount was $4.0.
The amortized cost and fair value of total fixed maturities as of June 30,
2004 are shown below by contractual maturity. Actual maturities may differ
from contractual maturities because securities may be restructured, called,
or prepaid.
Amortized Fair
Cost Value
------------------ ------------------
(Millions)
Due to mature:
One year or less $ 206.4 $ 211.1
After one year through five years 3,625.8 3,707.6
After five years through ten years 3,954.1 4,037.2
After ten years 3,026.2 2,977.1
Mortgage-backed securities 4,355.7 4,353.3
Other asset-backed securities 1,676.9 1,664.5
Less: fixed maturities pledged to creditors 391.7 387.6
------------------ ------------------
Fixed maturities $ 16,453.4 $ 16,563.2
================== ==================
At June 30, 2004 and December 31, 2003, fixed maturities with fair values
of $14.1 million and $20.1 million, respectively, were on deposit as
required by regulatory authorities.
The Company did not have any investments in a single issuer, other than
obligations of the U.S. government, with a carrying value in excess of 10%
of the Company's shareholder's equity at June 30, 2004.
The Company enters into dollar repurchase agreement and repurchase
agreement transactions to increase its return on investments and improve
liquidity. These transactions involve a sale of securities and an agreement
to repurchase substantially the same securities as those sold. The dollar
rolls and repurchase agreements are accounted for as short-term
collateralized financing and the repurchase obligation is reported on the
Condensed Balance Sheets in borrowed money. At June 30, 2004 and December
31, 2003, the carrying value of the securities pledged in dollar rolls and
repurchase agreement transactions was $676.3 million and $536.8 million,
respectively. The carrying value of the securities pledged in dollar rolls
and repurchase agreement transactions is included in fixed maturities on
the Condensed Balance Sheets. The repurchase obligation totaled $670.0
million and $534.2 million at June 30, 2004 and December 31, 2003,
respectively.
23
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
The primary risk associated with short-term collateralized borrowings is
that the counterparty will 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, an amount that was not material at June 30, 2004. The Company
believes the counterparties to the dollar roll and reverse repurchase
agreements are financially responsible and that the counterparty risk is
immaterial.
During the three months ended June 30, 2004, the Company determined that 15
fixed maturities had an other than temporary impairment. As a result, for
the three months ended June 30, 2004, the Company recognized a pre-tax loss
of $7.0 million to reduce the carrying value of the fixed maturities to
their fair value of $15.9 million. During the three months ended June 30,
2003, the Company determined that 130 fixed maturities had other than
temporary impairments. As a result, for the three months ended June 30,
2003, the Company recognized a pre-tax loss of $30.5 million to reduce the
carrying value of the fixed maturities to their combined fair value of
$141.9 million.
During the six months ended June 30, 2004, the Company determined that 70
fixed maturities had an other than temporary impairment. As a result, for
the six months ended June 30, 2004, the Company recognized a pre-tax loss
of $13.1 million to reduce the carrying value of the fixed maturities to
their fair value of $69.2 million. During the six months ended June 30,
2003, the Company determined that 170 fixed maturities had other than
temporary impairments. As a result, for the six months ended June 30, 2003,
the Company recognized a pre-tax loss of $87.0 million to reduce the
carrying value of the fixed maturities to their combined fair value of
$351.2 million.
3. Financial Instruments
Estimated Fair Value
The following disclosures are made in accordance with the requirements of
FAS No. 107, "Disclosures about Fair Value of Financial Instruments." FAS
No. 107 requires disclosure of fair value information about financial
instruments, whether or not recognized in the balance sheet, for which it
is practicable to estimate that value. In cases where quoted market prices
are not available, fair values are based on estimates using present value
or other valuation techniques.
Those techniques are significantly affected by the assumptions used,
including the discount rate and estimates of future cash flows. In that
regard, the derived fair value estimates, in many cases, could not be
realized in immediate settlement of the instrument. FAS No. 107 excludes
certain financial instruments and all nonfinancial instruments from its
disclosure requirements. Accordingly, the aggregate fair value amounts
presented do not represent the underlying value of the Company.
24
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
The following valuation methods and assumptions were used by the Company in
estimating the fair value of the above financial instruments:
Fixed maturities securities: The fair values for the actively traded
marketable bonds are determined based upon the quoted market prices. The
fair values for marketable bonds without an active market are obtained
through several commercial pricing services which provide the estimated
fair values. Fair values of privately placed bonds are determined using a
matrix-based pricing model. The model considers the current level of
risk-free interest rates, current corporate spreads, the credit quality of
the issuer and cash flow characteristics of the security. Using this data,
the model generates estimated market values which the Company considers
reflective of the fair value of each privately placed bond. Fair values for
privately placed bonds are determined through consideration of factors such
as the net worth of the borrower, the value of collateral, the capital
structure of the borrower, the presence of guarantees and the Company's
evaluation of the borrower's ability to compete in their relevant market.
Equity securities: Fair values of these securities are based upon quoted
market value.
Mortgage loans on real estate: The fair values for mortgage loans on real
estate are estimated using discounted cash flow analyses and rates
currently being offered in the marketplace for similar loans to borrowers
with similar credit ratings. Loans with similar characteristics are
aggregated for purposes of the calculations.
Real estate: The fair values for real estate are estimated using three
methods of review: a discounted cash flow analyses utilizing rates
currently being offered in the marketplace, market value/sales comparisons
of similar products in the subject property market, and cost to reproduce
the asset. These reviews are done periodically; however, a major event,
such as signing/loss of a tenant, physical change to the property, or local
governmental zoning or regulation changes, will trigger an immediate
valuation review.
Cash, short-term investments and policy loans: The carrying amounts for
these assets approximate the assets' fair values.
Assets held in separate accounts: Assets held in separate accounts are
reported at the quoted fair values of the individual securities in the
separate accounts.
Notes to affiliates: Estimated fair value of the Company's notes to
affiliates are based upon discounted future cash flows using a discount
rate approximating the current market value.
25
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Investment contract liabilities (included in future policy benefits and
claims' reserves):
With a fixed maturity: Fair value is estimated by discounting cash flows at
interest rates currently being offered by, or available to, the Company for
similar contracts.
Without a fixed maturity: Fair value is estimated as the amount payable to
the policyholder upon demand. However, the Company has the right under such
contracts to delay payment of withdrawals which may ultimately result in
paying an amount different than that determined to be payable on demand.
Liabilities related to separate accounts: Liabilities related to separate
accounts are reported at full account value in the Company's historical
balance sheet. Estimated fair values of separate account liabilities are
equal to their carrying amount.
The carrying values and estimated fair values of certain of the Company's
financial instruments at June 30, 2004 and December 31, 2003 were as
follows:
2004 2003
------------------------------ ------------------------------
Carrying Fair Carrying Fair
Value Value Value Value
------------------------------ ------------------------------
(Millions)
Assets:
Fixed maturity, including securities
pledged to creditors $ 16,950.8 $ 16,950.8 $ 16,097.8 $ 16,097.8
Equity securities 22.8 22.8 120.2 120.2
Mortgage loans on real estate 3,553.2 3,649.2 3,388.7 3,581.4
Real estate 1.8 2.0 4.5 4.8
Policy loans 170.9 170.9 177.1 177.1
Cash and short-term investments 518.9 518.9 88.3 88.3
Other investments 169.8 169.8 56.0 56.0
Assets held in separate accounts 20,821.7 20,821.7 18,220.1 18,220.1
Liabilities:
Notes to affiliates 35.0 54.0 35.0 57.3
Investment contract liabilities:
Deferred annuities 16,833.6 15,757.2 16,072.4 15,069.0
Supplementary contracts and
immediate annuities 840.1 840.1 840.1 840.1
Liabilities related to separate accounts 20,821.7 20,821.7 18,220.1 18,220.1
Fair value estimates are made at a specific point in time, based on
available market information and judgments about various financial
instruments, such as estimates of timing and amounts of future cash flows.
Such estimates do not reflect any premium or discount that could result
from offering for sale at one time the Company's entire holdings of a
particular financial instrument, nor do they consider the tax impact of the
realization of unrealized gains or losses. In many cases, the fair value
estimates cannot be substantiated by comparison to independent markets, nor
can the disclosed value be realized in immediate settlement of the
instruments. In evaluating the Company's management of interest rate, price
26
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
and liquidity risks, the fair values of all assets and liabilities should
be taken into consideration, not only those presented above.
Derivative Financial Instruments
Interest Rate Caps
Interest rate caps are used to manage the interest rate risk in the
Company's bond portfolio. Interest rate caps are purchased contracts that
provide the Company with an annuity in an increasing interest rate
environment. The notional amount, carrying value and estimated fair value
of the Company's open interest rate caps as of June 30, 2004 were $736.2
million, $4.0 thousand and $4.0 thousand, respectively. The notional
amount, carrying value and estimated fair value (liabilities are denoted
with parentheses) of the Company's open interest rate caps as of December
31, 2003 were $1,036.2 million, $20.0 thousand and $20.0 thousand,
respectively.
Interest Rate Swaps
Interest rate swaps are used to manage the interest rate risk in the
Company's bond portfolio as well as the Company's liabilities. Interest
rate swaps represent contracts that require the exchange of cash flows at
regular interim periods, typically monthly or quarterly. The notional
amount, carrying value and estimated fair value of the Company's open
interest rate swaps as of June 30, 2004 were $1,573.4 million, $20.4
million and $20.4 million, respectively. The notional amount, carrying
value and estimated fair value of the Company's open interest rate swaps as
of December 31, 2003 were $1,266.5 million, $(91.2) million and $(91.2)
million, respectively.
Futures
Futures contracts are used to hedge against a decrease in certain indexes.
Such decrease results in increased reserve liabilities, and the futures
offset this increased expense. The underlying reserve liabilities are
carried at market value with the change in value running through the
statement of income, which is offset by the daily cash movement of the
futures. The notional amount, carrying value and estimated fair value of
the Company's open interest rate swaps as of June 30, 2004, were $(922.7)
million, $(4.5) million and $(4.5) million, respectively. The notional
amount, carrying value and estimated fair value of the Company's open
interest rate swaps as of December 31, 2003, were $491.3 million, $0.8
million and $0.8 million, respectively.
Foreign Exchange Swaps
Foreign exchange swaps are used to reduce the risk of a change in the
value, yield or cash flow with respect to invested assets. Foreign exchange
swaps represent contracts that require the exchange of foreign currency
cash flows for US dollar cash flows at regular interim periods, typically
quarterly or semi-annually. The notional amount, carrying value and
estimated fair value of the Company's open foreign exchange rate swaps as
27
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
of June 30, 2004 were $18.5 million, $(19.9) million and $(19.9) million,
respectively. The notional amount, carrying value and estimated fair value
of the Company's open foreign exchange rate swaps as of December 31, 2003
were $128.2 million, $(19.4) million and $(19.4) million, respectively.
Options
S&P Options are used to hedge against an increase in the S&P Index. Such
increase results in increased reserve liabilities, and the options offset
this increased expense. The options are accounted for in a consistent
manner with the underlying reserve liabilities, both of which are carried
at fair value with the change in value running through the statement of
income. If the options mature in the money, the amount received is recorded
in income to offset the increased expense for the reserve liabilities. The
notional amount, carrying value and estimated fair value of the Company's
open options as of June 30, 2004 were $1,762.1 million, $118.8 million, and
$118.8 million, respectively. The notional amount, carrying value and
estimated fair value of the Company's open options as of December 31, 2003
were $1,287.8 million, $100.9 million, and $100.9 million, respectively.
Embedded Derivatives
The Company also had investments in certain fixed maturity instruments and
retail annuity products that contain embedded derivatives, including those
whose market value is at least partially determined by, among other things,
levels of or changes in domestic and/or foreign interest rates (short- or
long-term), exchange rates, prepayment rates, equity markets or credit
ratings/spreads. The estimated fair value of the embedded derivatives
within securities as of June 30, 2004 and December 31, 2003 was $0 million
and $(1.1) million, respectively. The estimated fair value of the embedded
derivatives within retail annuity products as of June 30, 2004 and December
31, 2003, was $314.0 million and $238.9 million, respectively.
28
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
4. Net Investment Income
Sources of net investment income were as follows:
Three months Three months
ended ended
June 30, June 30,
(Millions) 2004 2003
------------------ -------------------
Fixed maturities $ 241.4 $ 246.9
Equity securities 0.1 2.6
Mortgage loans 57.0 51.6
Real estate 0.1 -
Policy loans 2.0 1.4
Short-term investments and cash equivalents 0.3 0.7
Other 9.8 (5.5)
------------------ -------------------
Gross investment income 310.7 297.7
Less: investment expenses 17.1 16.0
------------------ -------------------
Net investment income $ 293.6 $ 281.7
================== ===================
Six months Six months
ended ended
June 30, June 30,
(Millions) 2004 2003
------------------ -------------------
Fixed maturities $ 472.7 $ 484.9
Equity securities 0.1 2.6
Mortgage loans 110.3 102.2
Real estate 0.2 0.5
Policy loans 4.9 3.8
Short-term investments and cash equivalents 0.6 1.3
Other 9.4 0.5
------------------ -------------------
Gross investment income 598.2 595.8
Less: investment expenses 34.3 29.8
------------------ -------------------
Net investment income $ 563.9 $ 566.0
================== ===================
5. Dividend Restrictions and Shareholder's Equity
The Company's ability to pay dividends to its Parent is subject to the
prior approval of insurance regulatory authorities for payment of
dividends, which exceed an annual limit. The Company did not pay common
stock dividends during the period ended June 30, 2004 or the year ended
December 31, 2003.
The Insurance Department of the State of Iowa (the "Department"), effective
January 1, 2004, recognizes as net income and capital and surplus those
amounts determined in conformity with statutory accounting practices
prescribed or permitted by the Department, which differ in certain respects
from accounting principles generally accepted in the United States.
Statutory net income (loss) was $(10.7) million and $8.5 million, for the
29
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
three months ended June 30, 2004 and 2003, respectively. Statutory net loss
was $12.6 million and $60.4 million, for the six months ended June 30, 2004
and 2003, respectively. Statutory capital and surplus was $1,154.8 million
and $1,020.1 million as of June 30, 2004 and 2003, respectively.
As of June 30, 2004, the Company does not utilize any statutory accounting
practices, which are not prescribed by state regulatory authorities that,
individually or in the aggregate, materially affect statutory capital and
surplus.
6. Capital Gains and Losses
Realized capital gains and losses are comprised of the difference between
the carrying value of investments and proceeds from sale, maturity, and
redemption, as well as losses incurred due to the impairment of
investments. Net realized capital gains (losses) on investments were as
follows:
Six months Six months
ended ended
June 30, June 30,
(Millions) 2004 2003
------------------ -------------------
Fixed maturities $ 28.6 $ 75.7
Equity securities 5.3 (0.3)
Derivatives (14.9) (77.9)
Real Estate - (2.3)
Other - (0.2)
------------------ -------------------
Pretax realized capital gains (losses) 19.0 (5.0)
================== ===================
After-tax realized capital gains (losses) $ 12.4 $ (3.3)
================== ===================
Proceeds from the sale of total fixed maturities and the related gross
gains and losses were as follows:
Six months Six months
ended ended
June 30, June 30,
(Millions) 2004 2003
------------------ -------------------
Proceeds on sales $ 9,291.4 $ 8,032.9
Gross gains 86.1 188.5
Gross losses 38.3 26.1
30
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Changes in shareholder's equity related to changes in accumulated other
comprehensive income were as follows:
Six months Six months
ended ended
June 30, June 30,
(Millions) 2004 2003
------------------ -------------------
Fixed maturities $ (411.7) $ 378.3
Equity securities (4.5) 5.6
DAC/VOBA 145.6 (96.7)
Derivatives 2.7 (26.8)
Sales inducements (0.4) -
Other - 0.9
------------------ -------------------
Subtotal (268.3) 261.3
Decrease (increase) in deferred income taxes 103.1 (198.0)
------------------ -------------------
Net changes in accumulated other
comprehensive income $ (165.2) $ 63.3
================== ===================
Shareholder's equity included the following accumulated other comprehensive
income:
June 30, June 30,
(Millions) 2004 2003
------------------ -------------------
Net unrealized capital gains (losses):
Fixed maturities $ 105.6 $ 986.1
Equity securities 0.7 2.1
DAC/VOBA (64.9) (486.2)
Derivatives (11.3) (26.8)
Sales inducements (0.5) -
Other - 1.2
------------------ -------------------
Subtotal 29.6 476.4
Less: deferred income taxes 4.8 278.0
------------------ -------------------
Net accumulated other comprehensive income $ 24.8 $ 198.4
================== ===================
Changes in accumulated other comprehensive income related to changes in
unrealized gains (losses) on securities, were as follows:
Six months Six months
ended ended
June 30, June 30,
(Millions) 2004 2003
------------------ -------------------
Unrealized holding gains (losses) arising
during the year (1) $ (111.8) $ 113.7
Less: reclassification adjustment for gains
(losses) and other items included in
net income (2) 53.4 50.4
------------------ -------------------
Net unrealized gains (losses) on securities $ (165.2) $ 63.3
================== ===================
(1) Pretax unrealized holding gains (losses) arising during the period
were $(172.0) million and $174.9 million for the six months ended June
30, 2004 and 2003, respectively.
(2) Pretax reclassification adjustments for gains (losses) and other items
included in net income were $82.2 million and $77.5 million for the
six months ended June 30, 2004 and 2003, respectively.
31
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
7. Additional Insurance Benefits and Minimum Guarantees
Under SOP 03-1, the Company calculates additional liabilities ("SOP
reserves") for certain guaranteed benefits and for Universal Life products
with certain patterns of cost of insurance charges. The SOP reserve
recognized for such products is in addition to the liability previously
held (the Account Value) and is to recognize the portion of contract
assessments received in early years used to compensate the insurer for
services provided in later years.
ING USA calculates a benefit ratio for each block of business subject to
the SOP, and calculates an SOP reserve by accumulating amounts equal to the
benefit ratio multiplied by the assessments for each period, reduced by
excess death benefits during the period. The SOP reserve is accumulated at
interest using the contract-credited rate for the period. The calculated
reserve includes a provision for Universal Life contracts with patterns of
Cost of Insurance Charges that produce expected gains from the insurance
benefit function followed by losses from that function in later years.
The SOP reserve for annuities with minimum guaranteed death benefits
("MGDB") is determined each period by estimating the expected value of
death benefits in excess of the projected account balance and recognizing
the excess ratably over the accumulation period based on total expected
assessments. The Company regularly evaluates estimates used to adjust the
additional liability balance, with a related charge or credit to benefit
expense, if actual experience or other evidence suggests that earlier
assumptions should be revised. The following assumptions and methodology
were used to determine the MGDB SOP reserve at June 30, 2004:
Area Assumptions/Basis for Assumptions
---------------------------------- -------------------------------------
Data used Based on 101 investment performance
scenarios stratified based on
10,000 random generated scenarios
Mean investment performance 8.5%
Volatility 18.0%
Mortality 60.0%, 60.0%, 75.0%, 75.0% of the
90-95 ultimate mortality table for
standard, rachet, rollup and
combination rollup and rachet,
respectively
Lapse rates Vary by contract type and duration;
range between 1.0% and 40.0%
Discount rates 6.5%, based on the portfolio earned
rate of the general account
The SOP reserve for annuities with guaranteed minimum accumulation benefits
("GMAB") and guaranteed minimum withdrawal benefits ("GMWB") are considered
to be derivatives under Financial Accounting Standards Board Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities," and are recognized at fair value
through earnings.
32
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
The SOP reserve for the guaranteed minimum income benefits ("GMIB") is
determined each period by estimating the expected value of the annutization
benefits in excess of the projected account balance at the date of
annuitization and recognizing the excess ratably over the accumulation
period based on total expected assessments. The Company regularly evaluates
estimates used and adjusts the additional liability balance, with a related
charge or credit to benefit expense, if the actual experience or other
evidence suggests that earlier assumptions should be revised. The
assumptions used for calculating the additional GMIB liability at June 30,
2004, are consistent with those used for the calculating the additional
MGDB liability. In addition, the calculation of the GMIB liability assumes
dynamic surrenders and dynamic annuitization reflecting the extent to which
the benefit, at the time of payment, has a positive value.
The separate account liabilities subject to SOP 03-1 for minimum guaranteed
benefits, and the additional liabilities recognized related to minimum
guarantees, by type, as of June 30, 2004, and the paid and incurred amounts
by type for the six months ended June 30, 2004 are as follows:
Minimum Guaranteed Guaranteed
Guaranteed Minimum Minimum
Death Accumulation/ Income
Benefit Withdrawal Benefit Benefit
(MGDB) (GMAB/GMWB) (GMIB)
--------------- ----------------------- ---------------
Separate account liability
balance $ 20,821.7 $ 1,418.6 $ 6,463.8
Additional liability balance:
Balance at January 1, 2004 $ 56.5 $ 14.5 $ 13.6
Incurred guaranteed benefits 22.4 (1.8) 10.3
Paid guaranteed benefits (16.1) - -
--------------- ----------------------- ---------------
Balance at June 30, 2004 $ 62.8 $ 12.7 $ 23.9
=============== ======================= ===============
The net amount at risk (net of reinsurance) and the weighted average
attained age of contractholders by type of minimum guaranteed benefit, are
as follows as of June 30, 2004:
Minimum Guaranteed Guaranteed
Guaranteed Minimum Minimum
Death Accumulation/ Income
Benefit Withdrawal Benefit Benefit
(MGDB) (GMAB/GMWB) (GMIB)
--------------- ----------------------- ---------------
Net Amount at Risk (net of reinsurance) $ 1,565.0 $ 88.5 $ 263.0
Weighted Average Attained Age 64 59 59
The aggregate fair value of equity securities (including mutual funds),
supporting separate accounts with additional insurance benefits and minimum
investment return guarantees as of June 30, 2004 is $20,821.7 million.
33
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
8. Sales Inducements
Sales inducements represent benefits paid to contractholders that are
incremental to the amounts the Company credits on similar contracts and are
higher than the contract's expected ongoing crediting rates for periods
after the inducement. Such amounts are reported separately on the balance
sheet as of January 1, 2004. Prior to 2004, these amounts were included in
DAC. Sales inducements are amortized as a component of benefit expense
using methodology and assumptions consistent with those used for
amortization of DAC. During the three months ended June 30, 2004, the
Company capitalized and amortized $25.9 million and $15.0 million,
respectively, of sales inducements. During the six months ended June 30,
2004, the Company capitalized and amortized $50.8 million and $40.2
million, respectively, of sales inducements. The unamortized balance of
capitalized sales inducements, net of unrealized gains and losses, is
$496.1 million as of June 30, 2004.
9. Income Taxes
Effective January 1, 2004, the Company files a stand-alone federal income
tax return. Prior to that date, the Company and each of the Merger
Companies, filed federal income tax returns with their respective filing
groups.
At June 30, 2004, the Company has net operating loss carryforwards of
approximately $510.7 million for federal income tax purposes, which are
available to offset future taxable income. If not used, these carryforwards
will expire between 2015 and 2019.
At June 30, 2004, the Company has capital loss carryforwards of
approximately $75.5 million for federal income tax purposes, which are
available to offset future capital gains. If not used, these carryforwards
will expire in 2009.
Income tax expense (benefit) from continuing operations included in the
condensed financial statements are as follows:
Three months Three months
ended ended
June 30, June 30,
(Millions) 2004 2003
------------------ -------------------
Current tax (benefit):
Federal $ - $ (42.4)
------------------- ------------------
Total current tax (benefit) - (42.4)
------------------- ------------------
Deferred tax (benefit):
Operations and capital loss carryforwards (42.8) -
Other federal deferred tax 66.0 56.8
------------------- ------------------
Total deferred tax (benefit) 23.2 56.8
------------------- ------------------
Total income tax expense (benefit) $ 23.2 $ 14.4
=================== ==================
34
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Six months Six months
ended ended
June 30, June 30,
(Millions) 2004 2003
------------------- -------------------
Current tax (benefit):
Federal $ - $ (44.5)
------------------- -------------------
Total current tax (benefit) - (44.5)
------------------- -------------------
Deferred tax (benefit):
Operations and capital loss carryforwards (36.6) -
Other federal deferred tax 69.8 51.4
------------------- -------------------
Total deferred tax (benefit) 33.2 51.4
------------------- -------------------
Total income tax expense (benefit) $ 33.2 $ 6.9
=================== ===================
Income taxes were different from the amount computed by applying the
federal income tax rate to income from continuing operations before income
taxes for the following reasons:
Three months Three months
ended ended
June 30, June 30,
(Millions) 2004 2003
------------------ -------------------
Income before income taxes $ 69.8 $ 46.5
Tax rate 35% 35%
------------------ -------------------
Income tax at federal statutory rate 24.4 16.3
Tax effect of:
Meals and entertainment 0.2 0.1
Dividend received deduction (1.4) (2.0)
------------------ -------------------
Income taxes $ 23.2 $ 14.4
================== ===================
Six months Six months
ended ended
June 30, June 30,
(Millions) 2004 2003
------------------ --------------------
Income before income taxes $ 102.4 $ 25.5
Tax rate 35% 35%
------------------ --------------------
Income tax at federal statutory rate 35.8 8.9
Tax effect of:
Meals and entertainment 0.3 0.2
Dividend received deduction (2.9) (2.2)
------------------ --------------------
Income taxes $ 33.2 $ 6.9
================== ====================
35
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
The tax effects of temporary differences that give rise to deferred tax
assets and deferred tax liabilities at June 30, 2004 and December 31, 2003
are presented below:
(Millions) 2004 2003
------------------- ------------------
Deferred tax assets:
Operations and capital loss carryforwards $ 205.2 $ 168.5
Future policy benefits 415.9 470.7
Goodwill 9.1 9.8
Investments 13.4 20.5
Employee compensation and benefits 19.3 16.8
Other 33.9 33.4
------------------- ------------------
Total gross assets 696.8 719.7
------------------- ------------------
Deferred tax liabilities:
Unrealized gains on investments (67.0) (123.4)
Deferred policy acquisition cost (486.4) (529.1)
Value of purchased insurance in force (43.2) (38.3)
Other (0.4) (0.3)
------------------- ------------------
Total gross liabilities (597.0) (691.1)
------------------- ------------------
Net deferred income tax asset (liability) $ 99.8 $ 28.6
=================== ==================
The Internal Revenue Service has commenced examinations for the years 2000
and 2001. Management does not believe adverse consequences will result from
those examinations.
10. Benefit Plans
Defined Benefit Plan
ING North America Insurance Corporation ("ING North America") sponsors the
ING Americas Retirement Plan (the "Retirement Plan"), effective as of
December 31, 2001. Substantially all employees of ING North America and its
subsidiaries and affiliates (excluding certain employees) are eligible to
participate, including the Company's employees other than Company agents.
The Retirement Plan is a tax-qualified defined benefit plan, the benefits
of which are guaranteed (within certain specified legal limits) by the
Pension Benefit Guaranty Corporation ("PBGC"). As of January 1, 2002, each
participant in the Retirement Plan (except for certain specified employees)
earns a benefit under a final average compensation formula. Subsequent to
December 31, 2001, ING North America is responsible for all Retirement Plan
liabilities. The costs allocated to the Company for its employees'
participation in the Retirement Plan were $2.7 million and $(0.3) million
for the three-month periods ended June 30, 2004 and 2003, respectively and
$5.5 million and $4.3 million for the six-month periods ended June 30, 2004
and 2003, respectively.
36
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Non-Qualified Retirement Plans
Through December 31, 2001, the Company, in conjunction with ING, offered
certain eligible employees a Supplemental Executive Retirement Plan and an
Excess Plan (collectively, the "SERPs"). The SERPs are non-qualified
defined benefit pension plans, which means all benefits are payable from
the general assets of the Company. SERP benefits are not guaranteed by the
PBGC. Benefit accruals under the SERPs ceased effective as of December 31,
2001. Benefits under the SERPs are determined based on an eligible
employees years of service and such employee's average annual compensation
for the highest five years during the last ten years of employment. Pre-tax
charges of operations of the Company for the SERPs were $0.1 million and
$0.8 million for the three-month periods ended June 30, 2004 and 2003,
respectively and $0.2 million and $0.1 million for the six-month periods
ended June 30, 2004 and 2003, respectively.
The following tables summarize the benefit obligations and the funded
status for the SERP and the Excess Plan for the year ended December 31,
2003:
(Millions)
Change in Benefit Obligation:
Defined Benefit Obligation, January 1 $ 8.8
Interest cost 0.6
Benefits paid (0.4)
Actuarial (gain) loss on obligation 2.0
------------------
Defined Benefit Obligation, December 31 $ 11.0
==================
Funded status:
Funded status at December 31 $ (11.0)
Unrecognized past service cost (0.1)
Unrecognized net loss (1.8)
------------------
Net amount recognized $ (12.9)
==================
At December 31, 2003, the accumulated benefit obligation was $9.3 million.
The weighted-average assumptions used in the measurement of the benefit
obligation for the Retirement Plan were as follows:
2004 2003
-------------- --------------
Discount rate at beginning of period 6.25% 6.75%
Rate of compensation increase 3.75 3.75
37
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Net periodic benefit costs for the periods ended June 30, 2004 and 2003
were as follows:
Three months Three months
ended ended
June 30, June 30,
(Millions) 2004 2003
------------------ -------------------
Interest cost $ 0.1 $ 0.2
Unrecognized past service cost recognized in period - (0.1)
------------------ -------------------
Net periodic benefit cost $ 0.1 $ 0.1
================== ===================
Six months Six months
ended ended
June 30, June 30,
(Millions) 2004 2003
------------------ --------------------
Interest cost $ 0.3 $ 0.3
Unrecognized past service cost recognized in period (0.1) (0.2)
------------------ --------------------
Net periodic benefit cost $ 0.2 $ 0.1
================== ====================
Contributions for the SERPs are expected to be $0.4 million during 2004.
Defined Contribution Plans
ING North America sponsors the ING Savings Plan and ESOP (the "Savings
Plan"). Substantially all employees of ING North America and its
subsidiaries and affiliates (excluding certain employees, including but not
limited to Career Agents are eligible to participate, including the
Company's employees other than Company agents. The Savings Plan is a
tax-qualified profit sharing and stock bonus plan, which includes an
employee stock ownership plan ("ESOP") component. Savings Plan benefits are
not guaranteed by the PBGC. The Savings Plan allows eligible participants
to defer into the Savings Plan a specified percentage of eligible
compensation on a pre-tax basis. ING North America matches such pre-tax
contributions, up to a maximum of 6% of eligible compensation. All matching
contributions are subject to a 4-year graded vesting schedule (although
certain specified participants are subject to a 5-year graded vesting
schedule). All contributions made to the Savings Plan are subject to
certain limits imposed by applicable law. Pre-tax charges to operations of
the Company for the Savings Plan were $1.0 million and $0.7 million for the
three-month periods ended June 30, 2004 and 2003, respectively and $1.9
million and $1.5 million for the six-month periods ended June 30, 2004 and
2003, respectively.
Post-Retirement Benefits
In addition to providing pension benefits, the Company, in conjunction with
ING, provides certain health care and life insurance benefits for retired
employees and certain agents. Generally, retired employees and eligible
agents pay a portion of the cost of these post-retirement benefits, usually
38
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
based on their years of service with the Company. The amount a retiree or
eligible agent pays for such coverage is subject to change in the future.
The following tables summarize the benefit obligations and the funded
status for retired employees' and retired agents' post-retirement health
care benefits for the year ended December 31, 2003:
(Millions)
Change in Benefit Obligation:
Defined Benefit Obligation, January 1 $ 8.8
Service cost 0.5
Interest cost 0.6
Benefits paid (0.6)
Actuarial loss on obligation (0.7)
------------------
Defined Benefit Obligation, December 31 8.6
Funded status:
Funded status at December 31 (8.6)
Unrecognized losses (0.6)
Unrecognized past service cost 0.4
------------------
Net amount recognized $ (8.8)
==================
The medical health care trend rate was 10% for 2004, gradually decreasing
to 5.0% by 2009. Increasing the health care trend by 1% would increase the
benefit obligation by $0.5 million as of December 31, 2003. Decreasing the
health care trend rate by 1% would decrease the benefit obligation by $0.5
million as of December 31, 2003.
Net periodic benefit costs for the periods ended June 30, 2004 and 2003
were as follows:
Three months Three months
ended ended
June 30, June 30,
(Millions) 2004 2003
----------------- -------------------
Service cost $ 0.1 $ 0.2
Interest cost 0.2 0.1
----------------- -------------------
Net periodic benefit cost $ 0.3 $ 0.3
================= ===================
Six months Six months
ended ended
June 30, June 30,
(Millions) 2004 2003
------------------ -------------------
Service cost $ 0.3 $ 0.3
Interest cost 0.3 0.3
------------------ -------------------
Net periodic benefit cost $ 0.6 $ 0.6
================== ===================
Contributions for retired employees' and retired agents' post-retirement
health care benefits are expected to be $0.5 million during 2004.
39
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Effect of Recently Enacted Legislation
On December 8, 2003, the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 ("the Act") was enacted. The Act introduced both
a Medicare prescription drug benefit and a federal subsidy to sponsors of
retiree healthcare plans. In January 2004, the FASB issued FASB Staff
Position No. 106-1 ("FSP 106-1"), "Accounting and Disclosure Requirements
Related to the Medicare Prescription Drug, Improvement and Modernization
Act of 2003." This statement permitted a sponsor of a postretirement
benefit plan that provides a prescription drug benefit to make a one-time
election to defer recognizing the effects of the Act until authoritative
guidance on accounting for the federal subsidy was issued or until certain
other events occurred. In May 2004, the FASB issued FASB Staff Position No.
106-2 ("FSP 106-2"), "Accounting and Disclosure Requirements Related to the
Medicare Prescription Drug, Improvement and Modernization Act of 2003,"
which superseded FSP 106-1. FSP 106-2 provides guidance on the accounting
for the effects of the Act and requires certain disclosures regarding the
effect of the federal subsidy provided by the Act. FSP 106-2 will become
effective for the Company in the third quarter of 2004. The Company
maintains a postretirement benefit plan that provides a prescription drug
benefit. The Company expects that application of this guidance will not
have a material impact on the Company's condensed financial statements.
11. Related Party Transactions
Operating Agreements
The Company has certain agreements whereby it generates revenues and incurs
expenses with affiliated entities. The agreements are as follows:
|X| Underwriting and distribution agreement with Directed Services, Inc.
("DSI"), for the variable insurance products issued by the Company.
DSI is authorized to enter into agreements with broker/dealers to
distribute the Company's variable products and appoint representatives
of the broker/dealers as agents. For the three months ended June 30,
2004 and 2003, commission expenses were incurred in the amounts of
$128.1 million and $90.3 million, respectively. For the six months
ended June 30, 2004 and 2003, commission expenses were incurred in the
amounts of $237.2 million and $160.3 million, respectively.
|X| Asset management agreement with ING Investment Management LLC ("IIM"),
in which IIM provides asset management and accounting services. The
Company records a fee, which is paid quarterly, based on the value of
the assets under management. For the three months ended June 30, 2004
and 2003, expenses were incurred in the amounts of $16.7 million and
$15.6 million, respectively. For the six months ended June 30, 2004
and 2003, expenses were incurred in the amounts of $33.4 million and
$29.1 million, respectively.
40
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
|X| Expense sharing agreements with ING AIH for administrative,
management, financial, and information technology services, which were
approved in 2001. For the three months ended June 30, 2004 and 2003,
ING USA incurred expenses of $16.1 million and $17.3 million,
respectively. For the six months ended June 30, 2004 and 2003, ING USA
incurred expenses of $30.4 million and $32.4 million, respectively.
|X| Services agreement with ING Financial Advisors, LLC ("ING FA") to
provide certain administrative, management, professional advisory,
consulting and other services to the Company for the benefit of its
customers. Charges for these services are to be determined in
accordance with fair and reasonable standards with neither party
realizing a profit nor incurring a loss as a result of the services
provided to the Company. The Company will reimburse ING FA for direct
and indirect costs incurred on behalf of the Company.
Reinsurance Agreements
ING USA entered into a reinsurance agreement with Security Life of Denver
International, Ltd. ("SLDI"), an affiliate, covering variable annuity
minimum guaranteed death benefits and minimum guaranteed living benefits of
variable annuities issued after January 1, 2000. In March 2003, the Company
amended its reinsurance agreement with SLDI. Under this amendment, the
Company terminated the reinsurance agreement for all inforce and new
business and recaptured all inforce business reinsured under the
reinsurance agreement between the Company and SLDI retroactive to January
1, 2003 and the Company reduced its reinsurance recoverable related to
these liabilities by $150.1 million. On March 28, 2003, SLDI transferred
assets to the Company in the amount of $185.6 million. The difference in
amounts transferred on March 28, 2003 and the reduction of the reinsurance
recoverables as of January 1, 2003, reflects adjustments on the investment
of the reinsurance recoverable as of January 1, 2003. It also reflects
adjustments on the investment income on the assets and letter of credit
costs between January 1, 2003 and the date of the asset transfer. It also
encompasses the net effect of a recapture fee paid in the amount of $5.0
million offset by the receipt of a $24.1 million negative ceding
commission. The net impact of which was deferred in policy acquisition
costs and is being amortized over the period of estimated future profits.
Reciprocal Loan Agreement
On January 1, 2004, the Company entered into a new reciprocal loan
agreement with ING AIH, a Delaware corporation and affiliate, to facilitate
the handling of unusual and/or unanticipated short-term cash requirements.
In accordance with this agreement, the maximum outstanding amount to be
borrowed or lent shall not exceed 3% of ING USA's total admitted assets.
This agreement supercedes the previous reciprocal loan agreement with ING
AIH, by which the Company and ING AIH could borrow up to $499 million from
one another.
Under the previous reciprocal loan agreement, interest on any ING USA
borrowings was charged at the rate of ING AIH's cost of funds for the
41
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
interest period plus 0.15%. Interest on any ING AIH borrowings was charged
at a rate based on the prevailing interest rate of U.S. commercial paper
available for purchase with a similar duration. Under this agreement, ING
USA incurred interest expense of $0.1 million for the six months ended June
30, 2004 and 2003, respectively. ING USA incurred minimal interest expense
for the three months ended June 30, 2004 and 2003. ING USA earned interest
of $0.4 million and $20.0 thousand for the three months ended June 30, 2004
and 2003, respectively, and $1.1 million and $0.3 million for the six
months ended June 30, 2004 and 2003, respectively. At June 30, 2004 and
December 31, 2003, ING USA had $174.5 million and $120.4 million receivable
from ING AIH under this agreement included in due from affiliates.
Notes to Affiliates
The Company's promissory note in the amount of $50 million payable to Lion
Connecticut Holdings, Inc. was repaid on May 17, 2004. The note was issued
on April 15, 1997. Interest was charged at an annual rate of 8.75% and the
face amount was due on demand. The Company incurred interest expense of
$0.6 million and $1.1 million for the three months ended June 30, 2004 and
2003, respectively, and $1.7 million and $2.2 million for the six months
ended June 30, 2004 and 2003, respectively.
ING USA issued a 30-year surplus note for $35 million with its affiliate,
Security Life of Denver, which matures on December 7, 2029. Interest is
charged at an annual rate of 7.98%. Payment of the notes and related
accrued interest is subordinate to payments due to policyholders and
claimant and beneficiary claims, as well as debts owed to all other classes
of debtors, other than surplus note holders, of ING USA. Any payment of
principal and/or interest made is subject to the prior approval of the Iowa
Insurance Commissioner. Interest expense was $0.7 million for the three
months ended June 30, 2004 and 2003, respectively. Interest expense was
$1.4 million for the six months ended June 30, 2004 and 2003, respectively.
Tax Sharing Agreements
The Company has 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.
Capital Transactions
During the six months ended June 30, 2004, ING USA received capital
contributions of $40.0 million. During the six months ended June 30, 2003,
ING USA received capital contributions of $88.7 million.
42
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
12. Financing Agreements
The Company maintains a revolving loan agreement with SunTrust Bank,
Atlanta (the "Bank"). Under this agreement, which is due on demand, the
Company can borrow up to $125 million from the Bank. Interest on any
borrowing accrues at an annual rate equal to a rate quoted by the Bank to
the Company for the borrowing. Under the agreement, the Company incurred
minimal interest expense for the three and six months ended June 30, 2004
and 2003. At June 30, 2004 and December 31, 2003, the Company did not have
any balances payable to the Bank.
The Company also maintains a revolving loan agreement with Bank of New
York, New York (the "BONY"). Under this agreement, the Company can borrow
up to $100 million from BONY. Interest on any of the Company borrowing
accrues at an annual rate equal to a rate quoted by BONY to the Company for
the borrowing. Under this agreement, the Company incurred no interest
expense for the three and six months ended June 30, 2004 and 2003. At June
30, 2004 and December 31, 2003, the Company did not have any balances
payable to BONY.
13. Reinsurance
At June 30, 2004, ING USA had reinsurance treaties with 2 unaffiliated
reinsurers and 19 affiliated reinsurers covering a significant portion of
the mortality risks and guaranteed death and living benefits under its
variable contracts. ING USA remains liable to the extent its reinsurers do
not meet their obligations under the reinsurance agreements.
Reinsurance ceded in force for life mortality risks were $957.9 million and
$1,209.4 million at June 30, 2004 and December 31, 2003, respectively. At
June 30, 2004 and December 31, 2003, the Company had net receivables of
$629.4 million and $634.8 million, respectively for reinsurance claims,
reserve credits, or other receivables from these reinsurers. At June 30,
2004 and December 31, 2003, respectively, these net receivables were
comprised of the following: $8.0 million and $17.1 million for claims
recoverable from reinsurers; $2.8 million and $6.6 million payable for
reinsurance premiums; $10.5 million and $20.2 million for reserve credits;
and $19.4 million and $21.1 million for reinsured surrenders and allowances
due from an unaffiliated reinsurer; and $613.1 million and $619.4 million
for reinsurance ceded. Included in the accompanying condensed financial
statements, are net policy benefits recoveries of $8.5 million and $9.7
million for the three months ended June 30, 2004 and 2003, respectively and
$21.4 million and $22.4 million for the six months ended June 30, 2004 and
2003, respectively.
Premiums ceded under reinsurance were $3.7 million and $4.7 million for the
three months ended June 30, 2004 and 2003, respectively. Premiums ceded
under reinsurance were $7.0 million and $7.8 million for the six months
ended June 30, 2004 and 2003, respectively. Reinsurance recoveries were
$2.4 million and $0.3 million for the three months ended June 30, 2004 and
43
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
2003, respectively. Reinsurance recoveries were $3.1 million and $(0.1)
million for the six months ended June 30, 2004 and 2003, respectively.
Premiums ceded and reinsurance recoveries are included in interest credited
and other benefits to policyholders.
ING USA participates in a modified coinsurance agreement with an
unaffiliated reinsurer. The accompanying condensed financial statements are
presented net of the effects of the treaty which decreased income by $0.7
million and $0.8 million for the three months ended June 30, 2004 and 2003,
respectively and $1.0 million and $0.9 million for the six months ended
June 30, 2004 and 2003, respectively.
14. Commitments and Contingent Liabilities
Leases
The Company leases its home office space and certain other equipment under
operation leases that expire through 2017.
For the three months ended June 30, 2004 and 2003, rent expense for leases
was $1.9 million and $1.8 million, respectively. For the six months ended
June 30, 2004 and 2003, rent expense for leases was $3.8 million and $3.6
million, respectively. The future net minimum payments under noncancelable
leases for the years ended December 31, 2004 through 2008 are estimated to
be $7.6 million, $7.7 million, $7.7 million, $7.5 million and $7.4 million,
respectively, and $42.9 million, thereafter. The Company pays substantially
all expenses associated with its leased and subleased office properties.
Expenses not paid directly by the Company are paid for by an affiliate and
allocated back to the Company.
Commitments
Through the normal course of investment operations, the Company commits to
either purchase or sell securities, commercial mortgage loans or money
market instruments at a specified future date and at a specified price or
yield. The inability of counterparties to honor these commitments may
result in either higher or lower replacement cost. Also, there is likely to
be a change in the value of the securities underlying the commitments. At
June 30, 2004 and December 31, 2003, the Company had off-balance sheet
commitments to purchase investments equal to their fair value of $450.3
million and $154.0 million, respectively.
44
ING USA Annuity and Life Insurance Company
(A wholly-owned subsidiary of Lion Connecticut Holdings Inc.)
Notes to Condensed Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Litigation
The Company is a party to threatened or pending lawsuits/arbitrations
arising from the normal conduct of business. Due to the climate in
insurance and business litigation/arbitrations, suits against the Company
sometimes include claims for substantial compensatory, consequential or
punitive damages and other types of relief. Moreover, certain claims are
asserted as class actions, purporting to represent a group of similarly
situated individuals. While it is not possible to forecast the outcome of
such lawsuits/arbitrations, in light of existing insurance, reinsurance and
established reserves, it is the opinion of management that the disposition
of such lawsuits/arbitrations will not have a materially adverse effect on
the Company's operations or financial position.
45
Item 2. Management's Narrative Analysis of the Results of Operations
and Financial Condition
Overview
The following narrative analysis of the results of operations and
financial condition presents a review of the Company as of June 30,
2004 and December 31, 2003 and for the three and six-month periods
ended June 30, 2004 and 2003. This review should be read in
conjunction with the condensed financial statements and other data
presented herein.
Basis of Presentation
On January 1, 2004, the Company redomesticated from Delaware to Iowa.
In addition, on January 1, 2004 (the "merger date"), Equitable Life
Insurance Company of Iowa ("Equitable Life"), USG Annuity & Life
Company ("USG") and United Life & Annuity Insurance Company ("ULA")
(the "Merger Companies"), merged with and into Golden American Life
Insurance Company ("Golden American"). Immediately after the merger,
Golden American changed its name to ING USA Annuity and Life Insurance
Company. As of the merger date, the Merger Companies ceased to exist
and were merged into ING USA. Lion is an indirect, wholly-owned
subsidiary of ING Groep N.V. ("ING"), a global financial services
holding company based in The Netherlands. ING USA is authorized to do
business in the District of Columbia and all states except New York.
ING USA is licensed as a life insurance company under the laws of the
State of Delaware until December 31, 2003 and Iowa since January 1,
2004.
Prior to the merger date, ING USA was a wholly-owned subsidiary of
Equitable Life from December 30, 2001 through December 31, 2003.
Formerly, from October 24, 1997, until December 30, 2001, Equitable of
Iowa Companies, Inc. ("EIC" or "Former Holding Company") directly
owned 100% of Golden American's stock.
Statement of Financial Accounting Standards No. 141, "Business
Combinations" ("FAS 141"), excludes transfers of net assets or
exchanges of shares between entities under common control, and notes
that certain provisions under Accounting Principles Board Opinion No.
16, "Business Combinations" ("APB 16"), provide a source of guidance
for such transactions. In accordance with APB 16, financial
information of the combined entity is presented as if the entities had
been combined for the full year, and all comparative financial
statements are restated and presented as if the entities had
previously been combined, in a manner similar to a
pooling-of-interests.
The unaudited condensed financial statements have been prepared in a
manner similar to a pooling-of-interests, in accordance with the
provisions of APB 16 in order to present the condensed financial
position and results of operations of the Company and the Merger
Companies, as if the entities had previously been combined. The
unaudited condensed balance sheets and statements of income give
46
effect to the consolidation transaction as if it had occurred on
December 31, 2003 and January 1, 2003, respectively.
Results of Operations
Premiums decreased by $0.6 million and $2.4 million for the three and
six months ended June 30, 2004, respectively, compared to the same
periods in 2003. This decrease in premium is related to the closed
block of participating life business.
Fee income and other income increased by $42.7 million and $89.4
million for the three and six months ended June 30, 2004,
respectively, compared to the same periods in 2003. The increase is
primarily due to an increase in the average variable assets under
management by the Company. The increase in average variable assets
under administration reflects continued business growth in the
Company's variable annuity product lines.
Net investment income for the three months ended June 30, 2004
increased by $11.9 million compared to the same period in 2003. This
increase in net investment income is consistent with the increase in
net invested assets. Net investment income for the six months ended
June 30, 2004 is comparable to that for the same period in 2003.
Net realized capital gains (losses) for the three months ended June
30, 2004 decreased by $15.8 million compared to the same period in
2003. The decrease is primarily due to the interest rate environment.
Rising interest rates during second quarter 2004 has resulted in lower
net gains (losses). Net realized capital gains (losses) for the six
months ended June 30, 2004 increased by $24.0 million compared to the
same period in 2003. The increase is primarily due to the increase in
the value of the derivatives portfolio due to rising interest rates.
Interest credited and other benefits to the policyholders for the
three and six months ended June 30, 2004 increased by $48.5 million
and $38.7 million, respectively, compared to the same periods in 2003.
The increase is primarily due to the inclusion of deferred sales
inducement amortization of $25.1 million and $40.1 million,
respectively, as a component of benefit expense in 2004, as required
with the adoption of SOP 03-1. In addition, lower separate account
benefit guarantees were recognized during the three months ended June
30, 2003 as a result of improved separate account market performance.
General expenses for the three and six months ended June 30, 2004 are
comparable to that for the same periods in 2003.
Commissions increased $38.9 million and $97.8 million for the three
and six months ended June 30, 2004, respectively, compared to the same
periods in 2003. This increase is primarily due to additional
commissions on higher new sales of variable and fixed annuity
products. Also contributing to the six months ended increase was a
$24.1 million ceded commission adjustment in the first quarter of 2003
related to the recapture of an affiliate reinsurance agreement.
47
Policy acquisition costs deferred for the three and six months ended
June 30, 2004 increased by $23.8 million and $62.4 million,
respectively, compared to the same periods in 2003. This increase was
primarily due to the deferral of increased commissions and selling
expense on higher annuity product sales.
Amortization of deferred policy acquisition costs and value of
business acquired decreased $52.5 million and $46.2 million for the
three and six months ended June 30, 2004, respectively, compared to
the same periods in 2003. Amortization of long-duration products is
reflected in proportion to actual and estimated future gross profits.
Estimated future gross profits are computed based on underlying
assumptions related to the underlying contracts, including but not
limited to interest margins, surrenders, withdrawals, expenses, and
asset growth. The decrease in the amortization of deferred policy
acquisition costs and value of insurance acquired reflects the impact
of these variables on the overall book of business.
Expense and charges reimbursed under modified coinsurance ("MODCO")
agreements for the three and six months ended June 30, 2004, increased
by $0.1 million and $0.5 million, respectively, compared to the same
periods in 2003. This balance represents the net cash flows from the
Paine Webber MODCO agreements. As this MODCO agreement does not cover
new business, the run-off of the reserve credit and the product charge
reimbursement to Paine Webber exceed the commission and expense
allowances that accrue to the Company.
Interest expense for the three and six months ended June 30, 2004 is
comparable to that for the same periods in 2003.
The cumulative effect of the change in accounting principle for the
six months ended June 30, 2004, was a loss of $2.3 million, net of
tax, due to the implementation of SOP 03-1. The change in accounting
principle was taken during the first quarter of 2004.
Net income, excluding change in accounting principle, increased by
$14.5 million and $50.6 million for the three and six months ended
June 30, 2004, respectively, as compared to the three and six months
ended June 30, 2003. The increase in net earnings is primarily the
result of increased fee income and decreased amortization of deferred
policy acquisition costs and value of new business acquired, partially
offset by higher interest credited and other guarantee benefits
related to expenses. Also contributing were higher net realized gains
for the six month period, while lower realized gains were recognized
for the three months ended June 30 as interest rates increased during
this period in 2004.
48
Financial Condition
Investments
Fixed Maturities
Total fixed maturities reflected net unrealized capital gains of
$105.7 million and $517.3 million at June 30, 2004 and December 31,
2003, respectively.
It is management's objective that the portfolio of fixed maturities be
of high quality and be well diversified by market sector. The fixed
maturities in the Company's portfolio are generally rated by external
rating agencies and, if not externally rated, are rated by the Company
on a basis believed to be similar to that used by the rating agencies.
The average quality rating of the Company's fixed maturities portfolio
was A+ at June 30, 2004 and December 31, 2003.
Fixed maturities rated BBB and below may have speculative
characteristics, and changes in economic conditions or other
circumstances are more likely to lead to a weakened capacity of the
issuer to make principal and interest payments than is the case with
higher rated fixed maturities.
The percentage of total fixed maturities by quality rating category is
as follows:
June 30, December 31,
2004 2003
-------------- -------------
AAA 35.1% 35.3%
AA 4.6 4.7
A 20.5 21.3
BBB 35.7 33.4
BB 3.3 4.0
B and below 0.8 1.3
-------------- -------------
Total 100.0% 100.0%
============== =============
The percentage of total fixed maturities by market sector is as
follows:
June 30, December 31,
2004 2003
-------------- -------------
U.S. Corporate 47.1% 48.9%
Residential Mortgaged-backed 19.2 20.8
Commercial/Multifamily Mortgage-backed 6.5 5.0
Foreign (1) 15.1 15.9
U.S. Treasuries/Agencies 2.3 1.3
Asset-backed 9.8 8.1
-------------- -------------
Total 100.0% 100.0%
============== =============
(1) Primarily U.S. dollar denominated
49
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 in accordance with FAS No. 115,
"Accounting for Certain Investments in Debt and Equity Securities."
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 that meet
the criteria of Emerging Issues Task Force ("EITF") Issue No. 99-20,
"Recognition of Interest Income and Impairment on Purchased and
Retained Beneficial Interests in Securitized Financial Assets." Under
EITF Issue No. 99-20, a determination of the required impairment is
based on credit risk and the possibility of significant prepayment
risk that restricts the Company's ability to recover the investment.
An impairment is recognized if the fair value of the security is less
than book value and there has been an adverse change in cash flow
since the last remeasurement date.
When a decline in fair value is determined to be other than temporary,
the individual security is written down to fair value and the loss is
accounted for as a realized loss.
Liquidity and Capital Resources
Liquidity is the ability of the Company to generate sufficient cash
flows to meet the cash requirements of operating, investing, and
financing activities. The Company's principal sources of liquidity are
annuity premiums and product charges, investment income, maturing
investments, proceeds from debt issuance, and capital contributions.
Primary uses of these funds are payments of commissions and operating
expenses, interest and premium credits, investment purchases,
repayment of debt, as well as withdrawals and surrenders.
The Company's liquidity position is managed by maintaining adequate
levels of liquid assets, such as cash or cash equivalents and
short-term investments. Additional sources of liquidity include
borrowing facilities to meet short-term cash requirements. The Company
maintains a $499 million revolving note facility with ING America
Insurance Holdings, Inc. ("ING AIH"), a perpetual $100 million
revolving note facility with Bank of New York and a $125 million
revolving note facility with SunTrust Bank which expires on July 30,
2004. Management believes that these sources of liquidity are adequate
to meet the Company's short-term cash obligations.
The National Association of Insurance Commissioners ("NAIC")
risk-based capital requirements require insurance companies to
calculate and report information under a risk-based capital formula.
These requirements are intended to allow insurance regulators to
monitor the capitalization of insurance companies based upon the type
50
and mixture of risks inherent in a Company's operations. The formula
includes components for asset risk, liability risk, interest rate
exposure, and other factors. The Company has complied with the NAIC's
risk-based capital reporting requirements. Amounts reported indicate
that the Company has total adjusted capital above all required capital
levels.
During the six months ended June 30, 2004, ING USA received capital
contributions of $40.0 million. During the six months ended June 30,
2003, ING USA received capital contributions of $88.7 million.
Recently Adopted Accounting Standards
Accounting and Reporting by Insurance Enterprises for Certain
Nontraditional Long-Duration Contracts and for Separate Accounts
The Company adopted Statement of Position ("SOP") 03-1, "Accounting
and Reporting by Insurance Enterprises for Certain Nontraditional
Long-Duration Contracts and for Separate Accounts," on January 1,
2004. SOP 03-1 establishes several new accounting and disclosure
requirements for certain nontraditional long-duration contracts and
for separate accounts including, among other things, a requirement
that assets and liabilities of separate account arrangements that do
not meet certain criteria be accounted for as general account assets
and liabilities, and that the revenue and expenses related to such
arrangements be consolidated with the respective line items in the
Condensed Statements of Income. In addition, the SOP requires
additional liabilities be established for certain guaranteed death
benefits and for products with certain patterns of cost of insurance
charges, and that sales inducements provided to contractholders be
recognized on the balance sheet separately from deferred acquisition
costs and amortized as a component of benefits expense using
methodology and assumptions consistent with those used for
amortization of deferred policy acquisition costs.
The Company evaluated all requirements of SOP 03-1 and determined that
it is affected by the SOP's requirements to establish additional
liabilities for certain guaranteed benefits and products with patterns
of cost insurance charges resulting in losses in later policy
durations from the insurance benefit function and to defer, amortize,
and recognize separately, sales inducements to contractholders.
Requirements for certain separate account arrangements that do not
meet the established criteria for separate asset and liability
recognition are applicable to the Company, however, the Company's
policies on separate account assets and liabilities have historically
been, and continue to be, in conformity with the requirements newly
established. Upon adoption of the SOP, the Company recognized a
cumulative effect of a change in accounting principle of $(3.6)
million, before tax or $(2.3) million, net of $1.3 million of income
taxes as of January 1, 2004.
51
The Meaning of Other-Than-Temporary Impairment and its Application to
Certain Investments
In March 2004, the Emerging Issues Task Force ("EITF") reached a final
consensus on EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary
Impairment and its Application to Certain Investments," adopting a
three-step impairment model for securities within its scope. The
three-step model is to be applied on a security-by-security basis as
follows:
Step 1: Determine whether an investment is impaired. An
investment is impaired if its fair value of the investment is
less than its cost basis.
Step 2: Evaluate whether an impairment is other-than-temporary.
Step 3: If the impairment is other-than-temporary, recognize an
impairment loss equal to the difference between the
investment's cost and its fair value.
The Company included this three-step model in the impairment
evaluation for the quarter ended June 30, 2004. This guidance resulted
in no additional impairments for the Company.
Earlier consensus reached by the EITF on this issue required that
certain quantitative and qualitative disclosures be made for
unrealized losses on debt and equity securities that have not been
recognized as other-than-temporary impairments. These disclosures were
adopted by the Company, effective December 31, 2003, and included in
the Investments footnote of the Notes to Condensed Financial
Statements included in the Company's December 31, 2003 Form 10-K. In
addition to the disclosure requirements adopted by the Company
effective December 31, 2003, the final consensus of EITF 03-01 reached
in March 2004 included additional disclosure requirements that are
effective for fiscal years ending after June 15, 2004.
Accounting for Derivative Instruments and Hedging Activities
In June 1998, the FASB issued FAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," as amended and interpreted by FAS
No. 137, "Accounting for Derivative Instruments and Hedging Activities
- Deferral of the Effective Date of FASB Statement 133," and FAS No.
138, "Accounting for Certain Derivative Instruments and Certain
Hedging Activities - an Amendment of FASB 133, and certain FAS 133
implementation issues." This standard, as amended, requires companies
to record all derivatives on the balance sheet as either assets or
liabilities and measure those instruments at fair value. The manner in
which companies are to record gains or losses resulting from changes
in the fair values of those derivatives depends on the use of the
derivative and whether it qualifies for hedge accounting. FAS No. 133
was effective for the Company's financial statements beginning January
1, 2001.
The Company occasionally purchases a financial instrument that
contains a derivative that is "embedded" in the instrument. In
addition, the Company's insurance products are reviewed to determine
whether they contain an embedded derivative. The Company assesses
52
whether the economic characteristics of the embedded derivative are
clearly and closely related to the economic characteristics of the
remaining component of the financial instrument or insurance product
(i.e., the host contract) and whether a separate instrument with the
same terms as the embedded instrument would meet the definition of a
derivative instrument. When it is determined that the embedded
derivative possesses economic characteristics that are not clearly and
closely related to the economic characteristics of the host contract
and that a separate instrument with the same terms would qualify as a
derivative instrument, the embedded derivative is separated from the
host contract and carried at fair value. However, in cases where the
host contract is measured at fair value, with changes in fair value
reported in current period earnings or the Company is unable to
reliably identify and measure the embedded derivative for separation
from its host contracts, the entire contract is carried on the balance
sheet at fair value and is not designated as a hedging instrument.
In 2003, the Derivative Implementation Group ("DIG") responsible for
issuing guidance on behalf of the FASB for implementation of FAS No.
133, "Accounting for Derivative Instruments and Hedging Activities"
issued Statement Implementation Issue No. B36, "Embedded Derivatives:
Modified Coinsurance Arrangements and Debt Instruments That
Incorporate Credit Risk Exposures That Are Unrelated or Only Partially
Related to the Credit Worthiness of the Obligor under Those
Instruments" ("DIG B36"). Under this interpretation, modified
coinsurance and coinsurance with funds withheld reinsurance agreements
as well as other types of receivables and payables where interest is
determined by reference to a pool of fixed maturity assets or total
return debt index may be determined to contain embedded derivatives
that are required to be bifurcated. The Company adopted DIG B36 on
October 1, 2003 and has modified coinsurance treaties that are
applicable to the guidance. The applicable contracts, however, were
determined to generate embedded derivatives with a fair value of zero.
Therefore, the guidance, while implemented, does not impact the
Company's financial position, results of operations, or cash flows.
Off-Balance Sheet Arrangements
In January 2003, the Financial Accounting Standards Board (FASB)
issued FASB Interpretation 46, "Consolidation of Variable Interest
Entities, an Interpretation of ARB No.51" (FIN 46). In December 2003,
the FASB modified FIN 46 to make certain technical corrections and
address certain implementation issues that had arisen. FIN 46 provides
a new framework for identifying variable interest entities (VIEs) and
determining when a company should include the assets, liabilities,
noncontrolling interests and results of activities of a VIE in its
consolidated financial statements.
In general, a VIE is a corporation, partnership, limited-liability
corporation, trust, or any other legal structure used to conduct
activities or hold assets that either (1) has an insufficient amount
of equity to carry out its principal activities without additional
subordinated financial support, (2) has a group of equity owners that
are unable to make significant decisions about its activities, or (3)
53
has a group of equity owners that do not have the obligation to absorb
losses or the right to receive returns generated by its operations.
FIN 46 requires a VIE to be consolidated if a party with an ownership,
contractual or other financial interest in the VIE (a variable
interest holder) is obligated to absorb a majority of the risk of loss
from the VIE's activities, is entitled to receive a majority of the
VIE's residual returns (if no party absorbs a majority of the VIE's
losses), or both. A variable interest holder that consolidates the VIE
is called the primary beneficiary. Upon consolidation, the primary
beneficiary generally must initially record all of the VIE's assets,
liabilities and noncontrolling interests at fair value and
subsequently account for the VIE as if it were consolidated based on
majority voting interest. FIN 46 also requires disclosures about VIEs
that the variable interest holder is not required to consolidate but
in which it has a significant variable interest.
At June 30, 2004, the Company held the following investments that, for
purposes of FIN 46, were evaluated and determined that the investments
do not require consolidation in the Company's financial statements:
(Millions)
Asset Type Purpose Book Value (1) Market Value
--------------------------------------------- -------------------------- ---------------- ----------------
Private Corporate Securities - synthetic
leases; project financings; credit tenant leases Investment Holdings $ 2,962.6 $ 3,036.8
Foreign Securities - US VIE subsidiaries of
foreign companies Investment Holdings 538.4 551.1
Commercial Mortgage Obligations (CMO) Investment Holdings 3,465.9 3,461.1
Collateralized Debt Obligations (CDO) Investment Holdings
and/or
Collateral Manager 61.3 55.9
Asset-Backed Securities (ABS) Investment Holdings 1,488.5 1,482.0
Commercial Mortgage Backed Securities (CMBS) Investment Holdings 1,048.4 1,058.2
(1) Represents maximum exposure to loss except for those structures for which the Company also receives asset
management fees.
New Accounting Pronouncements
FSP FAS 97-1
The implementation of the American Institute of Certified Public
Accountants ("AICPA") SOP 03-01, "Accounting and Reporting by
Insurance Enterprises for certain Nontraditional Long-Duration
Contracts and for Separate Accounts," has raised questions regarding
the interpretation of the requirements of SFAS No. 97, concerning when
it is appropriate to record an unearned revenue liability related to
the insurance benefit function. To clarify its position, in June of
2004 the Financial Accounting Standards Board ("FASB") issued FSP FAS
97-1, "Situations in which paragraphs 17(b) and 20 of FASB Statement
No. 97, Accounting and Reporting by Insurance Enterprises for certain
Long-Duration Contracts and for Realized Gains and Losses from the
Sale of Investments, Permit or Require Accrual of an Unearned Revenue
Liability." FSP FAS 97-1 outlines that SFAS No. 97 is clear in its
intent and language, and requires the recognition of an unearned
revenue liability for amounts that have been assessed to compensate
insurers for services provided over future periods. The requirement of
54
SOP 03-01 is not intended to amend or limit the requirement of SFAS
No. 97 to recognize a liability for unearned revenue only to those
situations where profits are expect to be followed by a loss. The
guidance contained in FSP FAS 97-1 is effective for financial
statements with fiscal periods beginning subsequent to July 18, 2004.
The Company is currently evaluating the impact of FSP FAS 97-1 and
related accounting guidance and anticipates a potential increase in
the (net) liability established under SOP 03-01 in future accounting
periods.
Critical Accounting Policies
General
The preparation of financial statements in conformity with U.S.
generally accepted accounting principles requires the use of estimates
and assumptions in certain circumstances that affect amounts reported
in the accompanying condensed financial statements and related
footnotes. These estimates and assumptions are evaluated on an
on-going basis based on historical developments, market conditions,
industry trends and other information that is reasonable under the
circumstances. There can be no assurance that actual results will
conform to estimates and assumptions, and that reported results of
operations will not be affected in a materially adverse manner by the
need to make future accounting adjustments to reflect changes in these
estimates and assumptions from time to time.
The Company has identified the following estimates as critical in that
they involve a higher degree of judgment and are subject to a
significant degree of variability: investment impairment testing,
amortization of deferred acquisition costs and value of business
acquired and goodwill impairment testing. In developing these
estimates, management makes subjective and complex judgments that are
inherently uncertain and subject to material changes as facts and
circumstances develop. Although variability is inherent in these
estimates, management believes the amounts provided are appropriate
based upon the facts available upon compilation of the condensed
financial statements.
Investment Impairment Testing
The Company reviews the general account investments for impairments by
analyzing the amount and length of time amortized cost has exceeded
fair value, and by making certain estimates and assumptions regarding
the issuing companies' business prospects, future economic conditions
and market forecasts. Based on the facts and circumstances of each
case, management uses judgment in deciding whether any calculated
impairments are temporary or other than temporary. For those
impairments judged to be other than temporary, the Company reduces the
carrying value of those investments to the current fair value and
records impairment losses for the difference.
55
Amortization of Deferred Acquisition Costs and Value of Business
Acquired
Deferred policy acquisition costs ("DAC") and value of business
acquired ("VOBA") are amortized with interest over the life of the
contracts (usually 25 years) in relation to the present value of
estimated gross profits from projected interest and mortality margins,
asset-based fees, policy administration and surrender charges less
policy maintenance fees and non-capitalized commissions.
Changes in assumptions can have a significant impact on the
calculation of DAC/VOBA and its related amortization patterns. Due to
the relative size of DAC/VOBA balance and the sensitivity of the
calculation to minor changes in the underlying assumptions and the
related volatility that could result in the reported DAC/VOBA balance,
the Company performs a quarterly analysis of DAC/VOBA for the annuity
business (annually for the life business).
At each balance sheet date, actual historical gross profits are
reflected and expected future gross profits and related assumptions
are evaluated for continued reasonableness. Any adjustment in
estimated profit requires that the amortization rate be revised
retroactively to the date of policy or contract issuance
("unlocking"), which could be significant. The cumulative difference
related to prior periods is recognized as a component of current
period's amortization, along with amortization associated with the
actual gross profits of the period. In general, increases in estimated
returns result in increased expected future profitability and may
lower the rate of amortization, while increases in lapse/surrender and
mortality assumptions or decreases in returns reduce the expected
future profitability of the underlying business and may increase the
rate of amortization.
One of the most significant assumptions involved in the estimation of
future gross profits for variable universal life and variable deferred
annuity products is the assumed return associated with future variable
account performance. To reflect the near-term and long-term volatility
in the equity markets, this assumption involves a combination of
near-term expectations and a long-term assumption about market
performance. The overall return generated by the variable account is
dependent on several factors, including the relative mix of the
underlying sub-accounts among bond funds and equity funds as well as
equity sector weightings.
Sales Inducements
Sales inducements represent benefits paid to contractholders that are
incremental to the amounts the Company credits on similar contracts
and are higher than the contract's expected ongoing crediting rates
for periods after the inducement. Such amounts are reported separately
on the balance sheet and are amortized as a component of benefit
56
Contractual Obligations
As of June 30, 2004, the Company had certain contractual obligations
due over a period of time as summarized in the following table:
Payments due by Period (in millions)
-------------------------------------------------------------------
Less than More than
Contractual Obligations Total 1 Year 1-3 Years 3-5 Years 5 Years
----------------------------------- -------------------------------------------------------------------
Long-Term Debt $ 106.1 $ 2.8 $ 5.6 $ 5.6 $ 92.1
Operating Lease Obligations 80.8 7.6 15.4 14.9 42.9
Purchase Obligations 450.3 450.3 - - -
-------------------------------------------------------------------
Total $ 637.2 $ 460.7 $ 21.0 $ 20.5 $ 135.0
===================================================================
The Company's long-term debt consists of a surplus note and the
related interest payable, with Security Life of Denver Insurance
Company. As of June 30, 2004, the outstanding principal, interest
rate, and maturity date of the surplus note are $35 million, 7.98%,
and December 7, 2029, respectively.
Operating lease obligations relate to the rental of office space under
various non-cancelable operating lease agreements that expire through
May 2010.
Purchase obligations consist primarily of commitments to fund
additional limited partnerships and joint ventures and commitments to
enter into mortgage loan and private placement arrangements during
2004.
Legislative Initiatives
The Jobs and Growth Tax Relief Reconciliation Act of 2003, which was
enacted in the second quarter, may impact the Company. The Act's
provisions, which reduce the tax rates on long-term capital gains and
corporate dividends, impact the relative competitiveness of the
Company's products especially variable annuities.
Other legislative proposals under consideration include repealing the
estate tax, changing the taxation of products, changing life insurance
company taxation and making changes to nonqualified deferred
compensation arrangements. Some of these proposals, if enacted, could
have a material effect on life insurance, annuity and other retirement
savings product sales.
The impact on the tax position of the Company's products cannot be
predicted.
Forward-Looking Information/Risk Factors
In connection with the "safe harbor" provisions of the Private
Securities Litigation Reform Act of 1995, the Company cautions readers
regarding certain forward-looking statements contained in this report
and in any other statements made by, or on behalf of, the Company,
whether or not in future filings with the SEC. Forward-looking
statements are statements not based on historical information and
which relate to future operations, strategies, financial results, or
57
other developments. Statements using verbs such as "expect,"
"anticipate," "believe" or words of similar import generally involve
forward-looking statements. Without limiting the foregoing,
forward-looking statements include statements which represent the
Company's beliefs concerning future levels of sales and redemptions of
the Company's products, investment spreads and yields, or the earnings
and profitability of the Company's activities.
Forward-looking statements are necessarily based on estimates and
assumptions that are inherently subject to significant business,
economic and competitive uncertainties and contingencies, many of
which are beyond the Company's control and many of which are subject
to change. These uncertainties and contingencies could cause actual
results to differ materially from those expressed in any
forward-looking statements made by, or on behalf of, the Company.
Whether or not actual results differ materially from forward-looking
statements may depend on numerous foreseeable and unforeseeable
developments. Some may be national in scope, such as general economic
conditions, changes in tax law and changes in interest rates. Some may
be related to the insurance industry generally, such as pricing
competition, regulatory developments and industry consolidation.
Others may relate to the Company specifically, such as credit,
volatility and other risks associated with the Company's investment
portfolio. Investors are also directed to consider other risks and
uncertainties discussed in documents filed by the Company with the
SEC. The Company disclaims any obligation to update forward-looking
information.
58
Item 4. Controls and Procedures
a) The Company carried out an evaluation, under the supervision and
with the participation of its management, including its Chief
Executive Officer and Chief Financial Officer, of the
effectiveness of the Company's disclosure controls and procedures
(as defined in Rule 13a-15(e) and 15d-15(e) of the Securities
Exchange Act of 1934) as of the end of the period covered by this
report. Based on that evaluation, the Chief Executive Officer and
the Chief Financial Officer have concluded that the Company's
current disclosure controls and procedures are effective in
ensuring that material information relating to the Company
required to be disclosed in the Company's periodic SEC filings is
made known to them in a timely manner.
b) There has not been any change in the internal controls over
financial reporting of the Company that occurred during the
period covered by this report that has materially affected or is
reasonably likely to materially affect these internal controls.
59
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company is a party to threatened or pending lawsuits/arbitrations
arising from the normal conduct of business. Due to the climate in
insurance and business litigation/arbitrations, suits against the
Company sometimes include claims for substantial compensatory,
consequential or punitive damages and other types of relief. Moreover,
certain claims are asserted as class actions, purporting to represent
a group of similarly situated individuals. While it is not possible to
forecast the outcome of such lawsuits/arbitrations, in light of
existing insurance, reinsurance and established reserves, it is the
opinion of management that the disposition of such
lawsuits/arbitrations will not have a materially adverse effect on the
Company's operations or financial position.
As with many financial services companies, the Company and its
affiliates have received requests for information from various
governmental and self-regulatory agencies in connection with
investigations related to trading in investment company shares. In
each case, full cooperation and responses have been and are being
provided. The Company is also reviewing its policies and procedures in
this area.
Item 6. Exhibits and reports on Form 8-K
(a) Exhibits
31.1 Certificate of David A. Wheat pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certificate of Keith Gubbay pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certificate of David A. Wheat pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certificate of Keith Gubbay pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
None.
60
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ING USA ANNUITY AND LIFE INSURANCE COMPANY
(Registrant)
August 12, 2004 By:/s/ David A. Wheat
- --------------- ---------------------------------------
(Date) David A. Wheat
Director, Senior Vice President and
Chief Financial Officer
(Duly Authorized Officer and Principal
Financial Officer)
61
Exhibit 31.1
CERTIFICATION
I, David A. Wheat, certify that:
1. I have reviewed this quarterly report on Form 10-Q of ING USA Annuity and
Life Insurance Company;
2. Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
c) disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of the registrant's board
of directors (or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: August 12, 2004
---------------
By
/s/ David A. Wheat
----------------------------------
David A. Wheat
Director, Senior Vice President and Chief Financial Officer
(Duly Authorized Officer and Principal Financial Officer)
Exhibit 31.2
CERTIFICATION
I, Keith Gubbay, certify that:
1. I have reviewed this quarterly report on Form 10-Q of ING USA Annuity and
Life Insurance Company;
2. Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
c) disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of the registrant's board
of directors (or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date August 12, 2004
---------------
By
/s/ Keith Gubbay
----------------------------------
Keith Gubbay
Director and President
(Duly Authorized Officer and Principal Executive Officer)