UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2005 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Transition Period from ________ to ________ Commission file number 33-28976 IDS LIFE INSURANCE COMPANY -------------------------- (Exact name of registrant as specified in its charter) MINNESOTA 41-0823832 - ------------------------------------------------- ------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 829 AXP FINANCIAL CENTER, MINNEAPOLIS, MINNESOTA 55474 - ------------------------------------------------- ------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (612) 671-3131 ----------------------------- None - ------------------------------------------------------------------------------- Former name, former address and former 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 ----- ----- Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes No X ----- ----- THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTIONS H(1) (a) AND (b) OF FORM 10-Q AND IS THEREFORE FILING THIS FORM WITH THE REDUCED DISCLOSURE FORMAT. IDS LIFE INSURANCE COMPANY FORM 10-Q INDEX Page No. -------- PART I. Financial Information: Item 1. Financial Statements Consolidated Balance Sheets - March 31, 2005 and December 31, 2004 1 Consolidated Statements of Income - Three Months Ended March 31, 2005 and 2004 2 Consolidated Statements of Cash Flows - Three Months Ended March 31, 2005 and 2004 3 Consolidated Statements of Stockholder's Equity - Three Months Ended March 31, 2005 and 2004 4 Notes to Consolidated Financial Statements 5-7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 8-13 Item 4. Controls and Procedures 14-15 PART II. Other Information Item 1. Legal Proceedings 16 Item 6. Exhibits and Reports on Form 8-K 16 Signatures 17 Exhibit Index E-1 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS IDS LIFE INSURANCE COMPANY CONSOLIDATED BALANCE SHEETS (thousands, except share data) March 31, December 31, 2005 2004 ------------------- --------------------- Assets (Unaudited) - ------ Investments: Available-for-Sale: Fixed maturities, at fair value (amortized cost: 2005, $27,268,249; 2004, $27,400,640) $ 27,436,247 $ 28,131,195 Preferred and common stocks, at fair value (cost: 2005 and 2004, $30,019) 30,054 31,256 Mortgage loans on real estate, at cost (less reserves: 2005 and 2004, $45,347) 2,929,845 2,923,542 Policy loans 590,830 588,574 Trading and other investments 694,190 753,298 ------------------- --------------------- Total investments 31,681,166 32,427,865 Cash and cash equivalents 196,981 131,427 Restricted cash 576,085 535,821 Reinsurance recoverables 910,299 876,408 Amounts due from brokers 103,784 7,109 Other accounts receivable 57,317 52,527 Accrued investment income 358,552 351,522 Deferred policy acquisition costs 3,740,171 3,637,956 Deferred sales inducement costs 323,620 302,997 Other assets 185,651 308,398 Separate account assets 32,491,964 32,454,032 ------------------- --------------------- Total assets $ 70,625,590 $ 71,086,062 =================== ===================== Liabilities and Stockholder's Equity - ------------------------------------ Liabilities: Future policy benefits: Fixed annuities $ 26,823,122 $ 26,978,596 Variable annuity guarantees 24,820 32,955 Universal life insurance 3,701,328 3,689,639 Traditional life insurance 277,463 271,516 Disability income and long-term care insurance 1,996,046 1,942,656 Policy claims and other policyholders' funds 77,746 69,884 Amounts due to brokers 137,509 162,609 Deferred income taxes, net 14,057 141,202 Other liabilities 367,156 437,418 Separate account liabilities 32,491,964 32,454,032 ------------------- --------------------- Total liabilities 65,911,211 66,180,507 ------------------- --------------------- Stockholder's equity: Capital stock, $30 par value; 100,000 shares authorized, issued and outstanding 3,000 3,000 Additional paid-in capital 1,370,388 1,370,388 Retained earnings 3,316,015 3,190,474 Accumulated other comprehensive income, net of tax: Net unrealized securities gains 60,582 370,615 Net unrealized derivative losses (35,606) (28,922) ------------------- --------------------- Total accumulated other comprehensive income 24,976 341,693 ------------------- --------------------- Total stockholder's equity 4,714,379 4,905,555 ------------------- --------------------- Total liabilities and stockholder's equity $ 70,625,590 $ 71,086,062 =================== ===================== See Notes to Consolidated Financial Statements 1 IDS LIFE INSURANCE COMPANY CONSOLIDATED STATEMENTS OF INCOME (thousands) (Unaudited) Three Months Ended March 31, ----------------------------------------- 2005 2004 ------------------ ------------------ Revenues: Premiums: Traditional life insurance $ 17,490 $ 17,051 Disability income and long-term care insurance 71,343 68,098 ------------------ ------------------ Total premiums 88,833 85,149 Net investment income 458,788 415,173 Contractholder and policyholder charges 143,057 136,203 Mortality and expense risk and other fees 114,778 107,242 Net realized gain on investments 194 8,646 ------------------ ------------------ Total 805,650 752,413 ------------------ ------------------ Benefits and Expenses: Death and other benefits: Traditional life insurance 12,069 10,562 Investment contracts and universal life-type insurance 52,287 58,233 Disability income and long-term care insurance 17,177 15,358 Increase (decrease) in liabilities for future policy benefits: Traditional life insurance 938 (1,265) Disability income and long-term care insurance 29,597 20,120 Interest credited to account values 273,262 283,071 Amortization of deferred policy acquisition costs 99,082 23,578 Other insurance and operating expenses 137,524 125,588 ------------------ ------------------ Total 621,936 535,245 ------------------ ------------------ Income before income tax provision and accounting change 183,714 217,168 Income tax provision 58,173 70,371 ------------------ ------------------ Income before accounting change 125,541 146,797 Cumulative effect of accounting change, net of tax (Note 1) - (70,568) ------------------ ------------------- Net income $ 125,541 $ 76,229 ================== ================== See Notes to Consolidated Financial Statements 2 IDS LIFE INSURANCE COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS (thousands) (Unaudited) Three Months Ended March 31, ---------------------------------------- 2005 2004 ------------------ ------------------ CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 125,541 $ 76,229 Adjustments to reconcile net income to net cash provided by operating activities: Policy loans, excluding universal life-type insurance Repayment 8,799 9,761 Issuance (8,856) (8,475) Change in reinsurance recoverables (33,891) (18,730) Change in other accounts receivable (4,790) (6,398) Change in accrued investment income (7,030) 4,281 Change in deferred policy acquisition costs, net (42,456) (102,534) Change in liabilities for future policy benefits for traditional life, disability income and long-term care insurance 59,337 37,066 Change in policy claims and other policyholders' funds 7,862 11,578 Deferred income taxes 43,394 24,282 Change in other assets and liabilities, net 29,505 47,396 Amortization of premium, net 22,719 25,364 Net realized gain on investments (194) (8,646) Trading securities, net 63,236 (20,937) Net realized gain on trading securities (8,971) (21,056) Contractholder and policyholder charges, non-cash (57,584) (57,277) Cumulative effect of accounting change, net of tax (Note 1) - 70,568 ------------------ ------------------ NET CASH PROVIDED BY OPERATING ACTIVITIES 196,621 62,472 ------------------ ------------------ CASH FLOWS FROM INVESTING ACTIVITIES Available-for-Sale securities: Sales 547,237 263,213 Maturities, sinking fund payments and calls 428,245 479,186 Purchases (864,336) (1,121,743) Other investments, excluding policy loans: Sales, maturities, sinking fund payments and calls 98,233 167,346 Purchases (99,298) (59,634) Change in amounts due to and from brokers, net (121,775) 72,529 Change in restricted cash (40,264) 9,247 ------------------ ------------------ NET CASH USED IN INVESTING ACTIVITIES (51,958) (189,856) ------------------ ------------------ CASH FLOWS FROM FINANCING ACTIVITIES Activity related to investment contracts and universal life-type insurance: Considerations received 443,345 565,352 Interest credited to account values 273,262 283,071 Surrenders and other benefits (793,517) (757,542) Universal life-type insurance policy loans: Repayment 21,991 24,438 Issuance (24,190) (23,421) ------------------ ------------------ NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES (79,109) 91,898 ------------------ ------------------ NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 65,554 (35,486) Cash and cash equivalents at beginning of period 131,427 400,294 ------------------ ------------------ CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 196,981 $ 364,808 ================== ================== SUPPLEMENTAL DISCLOSURES: Income taxes paid $ 31,651 $ 11,836 Interest paid on borrowings $ 53 $ 258 See Notes to Consolidated Financial Statements 3 IDS LIFE INSURANCE COMPANY CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY (thousands) (Unaudited) Accumulated Additional Other Capital Paid-In Comprehensive Retained Total Stock Capital Income/(Loss) Earnings - --------------------------------------------------------------------------------------------------------------------------- Balances at December 31, 2003 $ 5,397,836 $ 3,000 $ 1,370,388 $ 399,611 $ 3,624,837 - --------------------------------------------------------------------------------------------------------------------------- Comprehensive income: Net income 76,229 76,229 Change in net unrealized holding gains on Available-for-Sale securities, net of reclassification adjustments and other adjustments to deferred policy acquisition costs, deferred sales inducement costs and fixed annuity liabilities, net of related deferred income taxes 278,772 278,772 Reclassification adjustment for gains on derivatives included in net income, net of related deferred income taxes (7,582) (7,582) ---------------- Total comprehensive income 347,419 - --------------------------------------------------------------------------------------------------------------------------- Balances at March 31, 2004 $ 5,745,255 $ 3,000 $ 1,370,388 $ 670,801 $ 3,701,066 =========================================================================================================================== Balances at December 31, 2004 $ 4,905,555 $ 3,000 $ 1,370,388 $ 341,693 $ 3,190,474 Comprehensive loss: Net income 125,541 125,541 Change in net unrealized holding gains on Available-for-Sale securities, net of reclassification adjustments and other adjustments to deferred policy acquisition costs, deferred sales inducement costs and fixed annuity liabilities, net of related deferred income taxes (310,033) (310,033) Reclassification adjustment for gains on derivatives included in net income, net of related deferred income taxes (6,684) (6,684) ---------------- Total comprehensive loss (191,176) - --------------------------------------------------------------------------------------------------------------------------- Balances at March 31, 2005 $ 4,714,379 $ 3,000 $ 1,370,388 $ 24,976 $ 3,316,015 =========================================================================================================================== See Notes to Consolidated Financial Statements 4 IDS LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. BASIS OF PRESENTATION The accompanying Consolidated Financial Statements should be read in conjunction with the financial statements in the Annual Report on Form 10-K of IDS Life Insurance Company (IDS Life) for the year ended December 31, 2004. Certain reclassifications of prior period amounts have been made to conform to the current presentation. The interim financial information in this report has not been audited. In the opinion of management, all adjustments necessary for a fair presentation of the consolidated financial position and the consolidated results of operations for the interim periods have been made. All adjustments made were of a normal, recurring nature. Results of operations reported for interim periods are not necessarily indicative of results for the entire year. Application of Recently Issued Accounting Standards --------------------------------------------------- In July 2003, the American Institute of Certified Public Accountants issued SOP 03-1 effective for fiscal years beginning after December 15, 2003. SOP 03-1 provides guidance on separate account presentation and accounting for interests in separate accounts. Additionally, SOP 03-1 provides clarifying guidance as to the recognition of bonus interest and other sales inducement benefits and the presentation of any deferred amounts in the financial statements. Lastly, SOP 03-1 requires insurance enterprises to establish additional liabilities for benefits that may become payable under variable annuity death benefit guarantees or other insurance or annuity contract provisions. Where an additional liability is established, the recognition of this liability will then be considered in amortizing deferred policy acquisition costs (DAC) and any deferred sales inducement costs associated with those insurance or annuity contracts. The adoption of SOP 03-1 as of January 1, 2004, resulted in a cumulative effect of accounting change that reduced the first quarter 2004 results by $70.6 million ($108.6 million pretax). The cumulative effect of accounting change consisted of: (i) $42.9 million pretax from establishing additional liabilities for certain variable annuity guaranteed benefits ($32.8 million) and from considering these liabilities in valuing DAC and deferred sales inducement costs associated with those contracts ($10.1 million) and (ii) $65.7 million pretax from establishing additional liabilities for certain variable universal life and single pay universal life insurance contracts under which contractual cost of insurance charges are expected to be less than future death benefits ($92 million) and from considering these liabilities in valuing DAC associated with those contracts ($26.3 million offset). Prior to the adoption of SOP 03-1, amounts paid in excess of contract value were expensed when payable. IDS Life's accounting for separate accounts was already consistent with the provisions of SOP 03-1 and, therefore, there was no impact related to this requirement. In November 2003, the Financial Accounting Standards Board (FASB) ratified a consensus on the disclosure provisions of Emerging Issues Task Force (EITF) Issue 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments" (EITF 03-1). IDS Life complied with the disclosure provisions of this rule in Note 2 to the Consolidated Financial Statements included in its Annual Report on Form 10-K for the years ended December 31, 2004 and 2003. In March 2004, the FASB reached a consensus regarding the application of a three-step impairment model to determine whether investments accounted for in accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities" (SFAS No. 115), and other cost method investments are other-than-temporarily impaired. However, with the issuance of FASB Staff Position (FSP) No. EITF 03-1-1, "Effective Date of Paragraphs 10-20 of EITF 03-1," on September 30, 2004, the provisions of the consensus relating to the measurement 5 IDS LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) and recognition of other-than-temporary impairments will be deferred pending further clarification from the FASB. The remaining provisions of this rule, which primarily relate to disclosure requirements, are required to be applied prospectively to all current and future investments accounted for in accordance with SFAS No. 115 and other cost method investments. IDS Life will evaluate the potential impact of EITF 03-1 after the FASB completes its reassessment. 2. INVESTMENT SECURITIES Gross realized gains and losses on sales and losses recognized for other-than-temporary impairments of securities classified as Available-for-Sale, using the specific identification method, were as follows for the three months ended March 31: ------------------------------- 2005 2004 -------------- ------------- (Thousands) Gross realized gains on sales $ 8,834 $ 13,226 Gross realized (losses) on sales $ (8,094) $ (3,726) Realized (losses) recognized for other-than-temporary impairments $ (636) $ (130) 3. COMMITMENTS AND CONTINGENCIES At March 31, 2005 and December 31, 2004, IDS Life had commitments to fund mortgage loans on real estate of $96.1 million and $92.5 million, respectively. The Securities and Exchange Commission (SEC), the National Association of Securities Dealers (NASD) and several state attorneys general have brought proceedings challenging several mutual fund and variable account financial practices, including suitability generally, late trading, market timing, disclosure of revenue sharing arrangements and inappropriate sales of B shares. IDS Life and its subsidiaries have received requests for information and have been contacted by regulatory authorities concerning its practices and is cooperating fully with these inquiries. IDS Life and its subsidiaries are involved in a number of other legal and arbitration proceedings concerning matters arising in connection with the conduct of their respective business activities. IDS Life believes it has meritorious defenses to each of these actions and intends to defend them 6 IDS LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) vigorously. IDS Life believes that it is not a party to, nor are any of its properties the subject of, any pending legal or arbitration proceedings that would have a material adverse effect on IDS Life's consolidated financial condition, results of operations or liquidity. However, it is possible that the outcome of any such proceedings could have a material impact on results of operations in any particular reporting period as the proceedings are resolved. The IRS routinely examines IDS Life's federal income tax returns and is currently conducting an audit for the 1993 through 1996 tax years and in February 2005 began the examination of the 1997 through 2002 tax years. Management does not believe there will be a material adverse effect on IDS Life's consolidated financial position as a result of these audits. 7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS IDS Life Insurance Company is a stock life insurance company organized under the laws of the State of Minnesota. IDS Life Insurance Company is a wholly owned subsidiary of American Express Financial Corporation (AEFC), which is a wholly owned subsidiary of American Express Company. IDS Life Insurance Company serves residents of the District of Columbia and all states except New York. IDS Life Insurance Company distributes its fixed and variable insurance and annuity products almost exclusively through the American Express Financial Advisors Inc. (AEFAI) retail sales force. IDS Life Insurance Company has four wholly owned life insurance company subsidiaries: IDS Life Insurance Company of New York, a New York stock life insurance company (IDS Life of New York); American Partners Life Insurance Company, an Arizona stock life insurance company (American Partners Life); American Enterprise Life Insurance Company, an Indiana stock life insurance company (American Enterprise Life); and American Centurion Life Assurance Company, a New York stock life insurance company (American Centurion Life). IDS Life of New York serves New York State residents and distributes its fixed and variable insurance and annuity products exclusively through AEFAI's retail sales force. American Enterprise Life provides clients of financial institutions and regional and/or independent broker-dealers with American Express branded financial products and wholesaling services to support its retail insurance and annuity operations. American Enterprise Life underwrites fixed and variable annuity contracts primarily through regional and national financial institutions and regional and/or independent broker-dealers, in all states except New York. Effective in December 2004, American Enterprise Life received a Certificate of Authority to transact business in the State of New Hampshire. American Centurion Life offers fixed and variable annuity contracts directly to American Express(R) Cardmembers and others in New York, as well as fixed and variable annuity contracts for sale through non-affiliated representatives and agents of third party distributors, in New York. American Partners Life offers fixed and variable annuity contracts directly to American Express(R) Cardmembers and others who reside in states other than New York. IDS Life Insurance Company also owns IDS REO 1, LLC and IDS REO 2, LLC which hold real estate investments. IDS Life Insurance Company and its six subsidiaries are referred to collectively as "IDS Life" in this Form 10-Q. On February 1, 2005, American Express Company announced plans to pursue a tax-free spin-off of the common stock of AEFC through a special dividend to American Express common shareholders. The final transaction, which is subject to certain conditions including receipt of a favorable tax ruling and approval by American Express Company's Board of Directors, is expected to close in the third quarter of 2005. In connection with the spin-off, American Express Company intends to provide additional capital to IDS Life to confirm its current financial strength ratings. IDS Life follows United States generally accepted accounting principles (GAAP), and the following discussion is presented on a consolidated basis consistent with GAAP. Certain of the statements below are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. See the Forward-Looking Statements section below. Management's narrative analysis of the results of operations is presented in lieu of management's discussion and analysis of financial condition and results of operations, pursuant to General Instructions H(1)(a) of Form 10-Q. 8 RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2005 AND 2004 Net income for the three months ended March 31, 2005 was $125.5 million compared to $76.2 million for the three months ended March 31, 2004. Net income for the three months ended March 31, 2004 reflects the $70.6 million ($108.6 million pretax) impact of IDS Life's January 1, 2004 adoption of the American Institute of Certified Public Accountants Statement of Position 03-1, "Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration contracts and for Separate Accounts" (SOP 03-1). SOP 03-1 requires insurance enterprises to establish liabilities for benefits that may become payable under variable annuity death benefit guarantees or other insurance or annuity contract provisions. See "Application of Recently Issued Accounting Standards" section in Note 1 to the Consolidated Financial Statements regarding the impact of adoption of SOP 03-1. REVENUES Net investment income increased $43.6 million or 11 percent. Net investment income for the three months ended March 31, 2005 includes a $7.8 million benefit from lower than expected losses resulting from management's fourth quarter 2004 decision to liquidate the remaining two structured investments. Net investment income for the three months ended March 31, 2004 includes management's first quarter 2004 decision to further improve IDS Life's portfolio risk profile by liquidating a structured investment before maturity resulting in a $49 million pretax charge. Offsetting the impacts related to the structured securities, the mark-to-market impact of trading securities was $17 million lower during the current quarter compared to the same period a year ago, as well as the effect of depreciation during the current quarter versus appreciation in the same period a year ago in the S&P 500 on the value of options hedging equity indexed annuities. Contractholder and policyholder charges increased $6.9 million or 5 percent reflecting increased cost of insurance charges on variable universal life products, as well as a slight increase in the amount of surrender charges on variable annuity products. Mortality and expense risk and other fees increased $7.5 million or 7 percent reflecting higher average market values of separate account assets. Net realized gain on investments was $0.2 million for the three months ended March 31, 2005 compared to $8.6 million for the three months ended March 31, 2004. For the three months ended March 31, 2005, $8.8 million of gross realized gains were partially offset by $8.1 million of gross realized losses from sales of securities, as well as $0.6 million of other-than-temporary impairment losses on investments, classified as Available-for-Sale. For the three months ended March 31, 2004, $15 million of investment gains were partially offset by $6.4 million of losses and impairments. Included in these total investment gains and losses are $13.2 million of gross realized gains and $3.7 million of gross realized losses from sales of securities, as well as $0.1 million of other-than-temporary impairment losses on investments, classified as Available-for-Sale. BENEFITS AND EXPENSES Interest credited to account values decreased $9.8 million or 3 percent, reflecting lower interest crediting rates on annuity products and the effect of depreciation during the current quarter versus appreciation in the same period a year ago in the S&P 500 on equity index annuities, partially offset by higher life insurance inforce levels and average annuity accumulation values. Amortization of deferred policy acquisition costs (DAC) increased to $99.1 million for the three months ended March 31, 2005 from $23.6 million for the three months ended March 31, 2004 9 reflecting the first quarter 2004 $65.7 million pretax DAC valuation benefit reflecting an adjustment associated with the lengthening of amortization periods for certain insurance and annuity products in conjunction with the adoption of SOP 03-1. These increases were partially offset by changes made to the benefit ratios which are used to estimate the cost of certain variable annuity guarantee features. Other insurance and operating expenses increased $11.9 million or 10 percent reflecting increases in certain non-deferrable product distribution costs. DEFERRED POLICY ACQUISITION COSTS DAC represent the costs of acquiring new business, principally direct sales commissions and other distribution and underwriting costs that have been deferred on the sale of annuity and life and health insurance products. These costs are deferred to the extent they are recoverable from future profits. For annuity and insurance products, DAC are amortized over periods approximating the lives of the business, generally as a percentage of premiums or estimated gross profits or as a portion of product interest margins depending on the product's characteristics. For IDS Life's annuity and insurance products, the projections underlying the amortization of DAC require the use of certain assumptions, including interest margins, mortality rates, persistency rates, maintenance expense levels and customer asset value growth rates for variable products. Management routinely monitors a wide variety of trends in the business, including comparisons of actual and assumed experience. The customer asset value growth rate is the rate at which contract values are assumed to appreciate in the future. The rate is net of asset fees and anticipates a blend of equity and fixed income investments. Management reviews and, where appropriate, adjusts its assumptions with respect to customer asset value growth rates on a quarterly basis. Management monitors other principal DAC assumptions, such as persistency, mortality rates, interest margin and maintenance expense level assumptions, each quarter. Unless management identifies a material deviation over the course of the quarterly monitoring, management reviews and updates these DAC assumptions annually in the third quarter of each year. When assumptions are changed, the percentage of estimated gross profits or portion of interest margins used to amortize DAC might also change. A change in the required amortization percentage is applied retrospectively; an increase in amortization percentage will result in an increase in DAC amortization expense while a decrease in amortization percentage will result in a decrease in DAC amortization expense. The impact on results of operations of changing assumptions with respect to the amortization of DAC can be either positive or negative in any particular period and is reflected in the period in which such changes are made. During the first quarter of 2004 and in conjunction with the adoption of SOP 03-1, IDS Life (1) established additional liabilities for insurance benefits that may become payable under variable annuity death benefit guarantees or on single pay universal life contracts, which prior to January 1, 2004, were expensed when payable; and (2) extended the time periods over which DAC associated with certain insurance and annuity products are amortized to coincide with the liability funding periods in order to establish the proper relationships between these liabilities and DAC associated with the same contracts. As a result, IDS Life recognized a $108.6 million pretax charge due to accounting change on establishing the future liability under death benefit guarantees and recognized a $65.7 million pretax reduction in DAC amortization expense to reflect the lengthening of the amortization periods for certain products impacted by SOP 03-1. 10 DAC balances for various insurance and annuity products sold by IDS Life are set forth below: (Millions) March 31, 2005 December 31, 2004 ----------------------- ---------------------- (Unaudited) Life and health insurance $ 1,792 $ 1,766 Annuities 1,948 1,872 ----------------------- ---------------------- Total $ 3,740 $ 3,638 ======================= ====================== LIQUIDITY AND CAPITAL RESOURCES Risk Management IDS Life and its subsidiaries through their respective Board of Directors' investment committees or staff functions, review models projecting different interest rate scenarios, risk/return measures, and their effect on profitability. They also review the distribution of assets in the portfolio by type and credit risk sector. The objective is to structure the investment security portfolios based upon the type and behavior of the liabilities underlying the products, portfolios to achieve targeted levels of profitability within defined risk parameters and to meet contractual obligations. IDS Life has developed an asset/liability management approach with separate investment objectives to support specific product liabilities, such as insurance and annuity. As part of this approach, IDS Life develops specific investment guidelines outlining the minimum required investment return and liquidity requirements to support future benefit payments under its insurance and annuity obligations. These same objectives must be consistent with management's overall investment objectives for the general account investment portfolio. IDS Life's owned investment securities are primarily invested in long-term and intermediate-term fixed maturity securities to provide clients with a competitive rate of return on their investments while controlling risk. Investment in fixed maturity securities is designed to provide IDS Life with a targeted margin between the yield earned on investments and the interest rate credited to clients' accounts. IDS Life does not trade in securities to generate short-term profits for its own account. As part of IDS Life's investment process, management, with the assistance of its investment advisors, conducts a quarterly review of investment performance. The review process conducted by IDS Life's Investment Committee involves the review of certain invested assets which the committee evaluates to determine whether or not any investments are other than temporarily impaired and/or which specific interest earning investments should be put on an interest non-accrual basis. Capital Strategy The liquidity requirements of IDS Life are generally met by funds provided by deposits, premiums, investment income, proceeds from sales of investments as well as maturities and periodic repayments of investments and capital contributions from AEFC. The primary uses of funds are policy benefits, commissions, other product-related acquisition and sales inducement costs, operating expenses, policy loans, dividends to AEFC and investment purchases. IDS Life routinely reviews its sources and uses of funds in order to meet its ongoing obligations. Funding Strategy IDS Life, on a consolidated basis, has available lines of credit with AEFC aggregating $295 million ($195 million committed and $100 million uncommitted). At March 31, 2005, there were no line of credit borrowings outstanding with AEFC and no outstanding reverse repurchase 11 agreements. Both the line of credit and the reverse repurchase agreements are used strictly as short-term sources of funds. Investment securities include $2.2 billion, $2.3 billion and $2.5 billion of below investment grade securities (excluding net unrealized appreciation and depreciation) at March 31, 2005, December 31, 2004 and March 31, 2004, respectively. These investments represent 7 percent, 7 percent and 8 percent of IDS Life's investment portfolio at March 31, 2005, December 31, 2004 and March 31, 2004, respectively. Separate account assets represent funds held for the exclusive benefit of variable annuity contractholders and variable life insurance policyholders. These assets are generally carried at market value, and separate account liabilities are equal to separate account assets. IDS Life earns fees from the related accounts. As of March 31, 2005, IDS Life continued to hold investments in collateralized debt obligations (CDOs), some of which are also managed by an affiliate, and were not consolidated pursuant to the adoption of FIN 46 as IDS Life was not considered the primary beneficiary. IDS Life invested in CDOs as part of its investment strategy in order to offer a competitive rate to contractholders' accounts. IDS Life's exposure as an investor is limited solely to its aggregate investment in the CDOs, and it has no obligations or commitments, contingent or otherwise, that could require any further funding of such investments. As of March 31, 2005, the carrying values of the CDO residual tranches, managed by an affiliate, were $4.1 million. IDS Life also has an interest in a CDO securitization with a carrying value of $487.5 million of which $351.2 million is considered investment grade. CDOs are illiquid investments. As an investor in the residual tranche of CDOs, IDS Life's return correlates to the performance of portfolios of high-yield bonds and/or bank loans comprising the CDOs. The carrying value of the CDOs, as well as derivatives recorded on the balance sheet as a result of consolidating the two secured loan trusts (SLTs), which are in the process of being liquidated, and IDS Life's projected return are based on discounted cash flow projections that require a significant degree of management judgment as to assumptions primarily related to default and recovery rates of the high-yield bonds and/or bank loans either held directly by the CDOs or in the reference portfolio of the SLTs and, as such, are subject to change. Although the exposure associated with IDS Life's investment in CDOs is limited to the carrying value of such investments, the CDOs have significant volatility associated with them because the amount of the initial value of the loans and/or other debt obligations in the related portfolios is significantly greater than IDS Life's exposure. In the event of significant deterioration of a portfolio, the relevant CDO may be subject to early liquidation, which could result in further deterioration of the investment return or, in severe cases, loss of the CDO carrying amount. The derivatives recorded as a result of consolidating and now liquidating certain SLTs under FIN 46 are primarily valued based on the expected gains and losses from liquidating a reference portfolio of high-yield loans. The overall exposure to loss related to these derivatives is represented by the pretax net assets of the SLTs, which is $465 million at March 31, 2005. However, because the portfolio has been substantially liquidated, a significant portion of the net assets within the structure is cash and cash equivalents and, as a result, the overall market exposure has been reduced to approximately $20 million. IMPACT OF MARKET VOLATILITY ON RESULTS OF OPERATIONS As discussed above, various aspects of IDS Life's business are impacted by equity market levels and other market-based events. Several areas in particular involve DAC and deferred sales inducements, recognition of guaranteed minimum death benefits (GMDB) and certain other variable annuity benefits, asset management fees and structured investments. The direction and 12 magnitude of the changes in equity markets can increase or decrease amortization of DAC and deferred sales inducement benefits, incurred amounts under GMDB and other variable annuity benefit provisions and asset management fees and correspondingly affect results of operations in any particular period. Similarly, the value of IDS Life's structured investment portfolios are impacted by various market factors. Persistency of, or increases in, bond and loan default rates, among other factors, could result in negative adjustments to the market values of these investments in the future, which would adversely impact results of operations. OTHER REPORTING MATTERS Accounting Developments See "Application of Recently Issued Accounting Standards" section of Note 1 to the Consolidated Financial Statements. 13 ITEM 4. CONTROLS AND PROCEDURES IDS Life's management, with the participation of IDS Life's Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of IDS Life's disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the end of the period covered by this report. Based on such evaluation, IDS Life's Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, IDS Life's disclosure controls and procedures are effective. There have not been any changes in IDS Life's internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, IDS Life's internal control over financial reporting. FORWARD-LOOKING STATEMENTS This report includes forward-looking statements, which are subject to risks and uncertainties. The words "believe," "expect," "anticipate," "optimistic," "intend," "plan," "aim," "will," "may," "should," "could," "would," "likely," and similar expressions are intended to identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date on which they are made. IDS Life undertakes no obligation to update or revise any forward-looking statements. Factors that could cause actual results to differ materially from these forward-looking statements include, but are not limited to: fluctuation in the equity and fixed income markets, which can affect the amount and types of investment products sold by IDS Life, and other fees received based on the value of those assets; IDS Life's ability to recover Deferred Policy Acquisition Costs (DAC), as well as the timing of such DAC amortization, in connection with the sale of annuity and insurance products; changes in assumptions relating to DAC, which could impact the amount of DAC amortization; the ability to improve investment performance in IDS Life's businesses, including attracting and retaining high-quality personnel; the success, timeliness and financial impact, including costs, cost savings and other benefits including increased revenues, of reengineering initiatives being implemented or considered by IDS Life, including cost management, structural and strategic measures such as vendor, process, facilities and operations consolidation, outsourcing (including, among others, technologies operations), relocating certain functions to lower-cost overseas locations, moving internal and external functions to the Internet to save costs, and planned staff reductions relating to certain of such reengineering actions; the ability to control and manage operating, infrastructure, advertising and promotion and other expenses as business expands or changes, including balancing the need for longer-term investment spending; the potential negative effect on IDS Life's businesses and infrastructure, including information technology, of terrorist attacks, disasters or other catastrophic events in the future; IDS Life's ability to develop and roll out new and attractive products to clients in a timely manner; successfully cross-selling insurance and annuity products and services to AEFC's customer base; fluctuations in interest rates, which impacts IDS Life's spreads in the insurance and annuity businesses; credit trends and the rate of bankruptcies which can affect returns on IDS Life's investment portfolios; lower than anticipated spreads in the insurance and annuity business; the types and the value of certain death benefit features on variable annuity contracts; the affect of assessments and other surcharges for guaranty funds; the response of reinsurance companies under reinsurance contracts; the impact of reinsurance rates and the availability and adequacy of reinsurance to protect IDS Life against losses; negative changes in IDS Life Insurance Company's and its four life insurance company subsidiaries' credit ratings; increasing competition in all of IDS Life's insurance and annuity business; the adoption of recently issued rules related to the consolidation of variable interest entities, including those involving SLTs that IDS Life invests in which could affect both IDS Life's financial condition and results of operations; changes in laws or government regulations; outcomes associated with litigation and compliance and regulatory matters. A further description of these and other risks and 14 uncertainties can be found in IDS Life's Annual Report on Form 10-K for the year ended December 31, 2004, and its other reports filed with the Securities and Exchange Commission (SEC). 15 PART II - OTHER INFORMATION IDS LIFE INSURANCE COMPANY Item 1. Legal Proceedings The Securities and Exchange Commission (SEC), the National Association of Securities Dealers (NASD) and several state attorneys general have brought proceedings challenging several mutual fund and variable account financial practices, including suitability generally, late trading, market timing, disclosure of revenue sharing arrangements and inappropriate sales of B shares. IDS Life and its subsidiaries have received requests for information and have been contacted by regulatory authorities concerning its practices and is cooperating fully with these inquiries. IDS Life and its subsidiaries are involved in a number of other legal and arbitration proceedings concerning matters arising in connection with the conduct of their respective business activities. IDS Life believes it has meritorious defenses to each of these actions and intends to defend them vigorously. IDS Life believes that it is not a party to, nor are any of its properties the subject of, any pending legal or arbitration proceedings that would have a material adverse effect on IDS Life's consolidated financial condition, results of operations or liquidity. However, it is possible that the outcome of any such proceedings could have a material impact on results of operations in any particular reporting period as the proceedings are resolved. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits See Exhibit Index on page E-1 hereof. (b) Reports on Form 8-K. Reports on Form 8-K filed by IDS Life during the quarterly period ended March 31, 2005 were previously disclosed on Form 10-K. There were no additional reports on Form 8-K filed by IDS Life during the quarterly period ended March 31, 2005. 16 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. IDS LIFE INSURANCE COMPANY -------------------------- (Registrant) Date: May 5, 2005 By /s/ Mark E. Schwarzmann --------------------------------------- Mark E. Schwarzmann Director, Chairman of the Board and Chief Executive Officer Date: May 5, 2005 By /s/ Arthur H. Berman --------------------------------------- Arthur H. Berman Director and Executive Vice President - Finance and Chief Financial Officer 17 EXHIBIT INDEX The following exhibits are filed as part of this Quarterly Report: Exhibit Description - ------- ----------- 31.1 Certification of Mark E. Schwarzmann pursuant to Rule 13a-14(a) promulgated under the Securities Exchange Act of 1934, as amended. 31.2 Certification of Arthur H. Berman pursuant to Rule 13a-14(a) promulgated under the Securities Exchange Act of 1934, as amended. 32.1 Certification of Mark E. Schwarzmann and Arthur H. Berman pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. E-1